Rent Seeking

Rent Seeking Meaning

What exactly is the meaning of rent-seeking, and how does it occur? The world we live in is pervaded by competition. Billions of humans are trying to find a place where they can make a living and provide for themselves. Sometimes the niches in which people find a way to make a living don't create value. Being paid for something without actually adding value to it is known as rent-seeking. Consider the example below for clarification.

Fig. 1 - Tresco Gardens £10 entrance fee by Phillip Williams Source: Wikimedia Commons¹

The image above shows a public park charging an entrance fee similar to the river example. The key difference is that funds generated by the park are reinvested in the park to improve the consumer experience, so it is not rent-seeking.

Rent-seeking is a concept that has existed in the world for all of human existence. Think back to protection rackets, where merchants were shaken down for "protection". Even though the protection was to stop the racketeers from beating you up.

Rent-seeking in a broader understanding applies to all actions which give monopoly power. The more monopoly power a firm has, the less price and value need to be aligned. Companies are considered to be rent-seeking when they lobby political forces to apply tariffs to foreign competitors.

Rent Seeking Behavior

There are many different forms in which rent-seeking behavior can manifest. Additionally, the spectrum of what is considered rent-seeking is wide and debated fiercely.

The key to what determines instances of rent-seeking is what economists call utility. Utility is a catch-all term for the value, benefit, experience, and effectiveness of good at doing what we want it to.

The understanding of utility is important to recognize what is rent-seeking, and what isn't. Rent-seeking provides no utility or a disproportionately low utility for the price.

Rent-seeking despite being morally bad is very economically smart for the individual. It's natural economic thinking to get paid that absolute most, for as little as possible. Competition is what interrupts most rent-seeking efforts, as price competition reduces the profit margins to zero. This tells us that rent-seeking requires some sort of monopoly to function.

Rent Seeking Economics

Rent-seeking occurs across various sectors of the economy, from small-scale to massive international trade balances. One key location rent-seeking occurs is around government regulations and controls such as protectionist policies.

Quotas are a protectionist policy that governments implement to control imports. They do this to protect domestic industry. A quota is some form of maximum that can be traded internationally. Where this leads to rent-seeking is the unintentional competitive game created by the quota. If a quota sets the maximum of goods a country can buy, then there is a race for suppliers to get their goods in before the quota is met.

So suppliers are racing against each other to fill the quota before the others do. What will they do to win? They might store mass amounts of goods in warehouses, standing by for the yearly quota reset. Consider, what benefit does that provide consumers? It doesn't increase the quality of the good, nor add utility to it. While suppliers race each other to meet the quota, they incur costs such as storage, and other inefficiencies created, all, in turn, raising prices for the consumer. The rent-seeking beneficiary in this case is the storage warehouses.

Rent-seeking efforts can also pervade numerous government functions such as tariffs, regulations, and subsidies. Competing international industries can lobby their domestic governments to impose tariffs to obtain greater market control. Economically, businesses would not support a regulation that hurts their own production. If regulation hurts their competition then they have the incentive to invest in supporting it.

• Remember the key in all of these isn't that rent-seeking is a bad investment for the company. The problem is that it provides an effective return on investments, however, they don't improve market efficiency or create value, only profit. Therefore it is an overall loss to the economy.

A concept that plays a role in rent-seeking behavior is what is known as public choice theory. Public choice theory is the practice of using economic tools to address inherent problems of political science. The economic dilemma with public choice is that benefits tend to be selective, while costs are socialized. This creates the opening for rent-seeking behavior because for an individual receiving benefits it doesn't require the full cost paid. This creates a structure of 'why would I pay for it myself when I can reap the benefits and have the government spread the cost out.' This doesn't imply that all government expenditures are immoral rent-seeking efforts. The key is that the opportunity for rent-seeking will lead individuals to invest resources into non-productive efforts, that could be used in the private market to generate value.

Effects of Rent Seeking

So now we know the various shapes and forms that rent-seeking can occur as, but what effect does it have on the economy? Let's establish the initial level of the problem, rent-seeking collects money without providing value. Meaning that whoever is giving the money, willingly or otherwise is at a complete loss. The costs can be broken down into three general categories, direct, opportunity, and social costs.

The direct costs of rent-seeking occur when rent-seekers successfully get what they want. This can vary in many forms, whether it's securing a subsidy, in which the taxpayers are covering the cost. If the rent-seeker lobbies for tariffs on imported goods, then consumers will suffer higher prices in the market and weakened competitive checks and balances. There are many more scenarios, but interesting that both of those cause consumers who are also taxpayers to suffer the cost.

Opportunity costs are the price of choosing one option over another, this will become very clear with an example.

In the example above we see that part of the cost created by rent-seeking is the investments made to do so. These are not put toward productive efforts that make the economy better as a whole. If the company didn't choose rent-seeking, then their money would be invested in a way that reduces costs for consumers.

Fig. 1 - Stylish dog wearing monocle Source: Wikimedia commons²

The final cost of rent-seeking is the social cost, which can be hard to measure and source back to rent-seeking. Rent-seeking and its behaviors erode confidence in the free market, creating doubts that it is an equal playing field. This then incentivizes others to rent-seek in retaliation, or from a general lack of opportunity.

Rent Seeking Examples

Rent-seeking occurs in multitudes of ways and while it's easy to find elements of rent-seeking in many examples, there is no definitive classification or measurement system. Consider this example below:

While reading this explanation on rent-seeking you may have wondered whether renting property, for example, housing constitutes as rent-seeking. While it's easy to consider that this is the case, after all, they are seeking rent payments from their tenants. The purchasing of housing to then sell temporary rental arrangements is not rent-seeking. When houses are built and placed on the market, they are typically not available to rent from the holding company. Landlords provide housing in a less capital-intensive structure than the market otherwise would. Additionally, effective landlords will manage various elements of the property, such as structural repairs and maintenance. Consider reading the deep dive below on Adam Smith for an interesting historical reference.

Rent-seeking in all forms should be minimized, as it distorts the market and creates negative outcomes across the economy. However, rent-seeking behaviors are very much legal and their efforts are largely successful. To adequately address rent-seeking it must we must recognize areas where incentives are likely to lead to such behavior. The difficulty with controlling rent-seeking is that it self-reinforces, rent-seekers already bought the political power.