The Locke Luminary Vol. I, No. 2 (Winter 1998) Part 2
Edited by Amanda J. Owens, Director of Legal Studies, and Dr. Charles K. Rowley, General Director
The Fundamentals of Rent-Seeking
by Gordon Tullock, Professor of Economics, University of Arizona
Prior to 1967, twentieth century neoclassical economists (myself included) taught students that the social cost of monopoly and special privilege was the deadweight loss triangle which shows the loss of consumers' surplus to those excluded from the market by the rise in price above the competitive level. According to this argument the profit gained by the monopolist did not constitute a loss of welfare but rather was a transfer of welfare from consumers to producers.
Echoing back to the late nineteenth century, when monopolies and trusts were much feared and despised in the United States, my students always objected to my minimalist criticism of monopoly. They became especially incredulous when they discovered that, according to Arnold Harberger (1954), the social cost of monopoly as measured by the welfare triangle was less than one tenth of one per cent of gross national product for the United States during the 1920's. Nevertheless, this was the received wisdom within a profession that assumed that monopoly or special privilege could be obtained without any cost at all. I feel embarrassed even now that I taught such specious nonsense for so long. In any event, this conflict between my instinct and my observation eventually triggered my 1967 paper (Tullock 1967) which is the genesis of the rent-seeking literature.
The point of departure for my 1967 paper was the conventional welfare loss to monopoly associated with tariffs, monopoly and theft. In this short essay, I shall focus almost entirely on the monopoly example. Original contributions very often occur when a scholar looks at a well-established theory with his eyes open, and not closed as so many of us do for so much of our existence. Such was the nature of my 1967 insight. I simply shifted attention from the welfare triangle to the profit rectangle and asked what self-seeking entrepreneurs would do to access such a profit rectangle from the zero profit environment of a competitive market.
If the profit rectangle is the income transfer that a successful monopolist can extort from his customers, surely we should expect potential monopolists, with so large a prize dangling before them, to invest large resources in the activity of monopolizing. Indeed, the capital value of the monopoly transfer, properly discounted, is much greater than the profit rectangle suggests, since the latter represents only a single period transfer.
Rational entrepreneurs should be willing to invest resources in attempts to form a monopoly until the marginal cost equals the properly discounted marginal return. Under certain assumptions (see Posner 1975) the competitive outlays to establish a monopoly will exactly equal the present value of the profit rectangle. The winning firm of course will secure an above-normal return on its investment, exactly offset by the losses of those who fail to secure the monopoly. >From this perspective, the Tullock rectangle may have to be added to the Harberger triangle when calculating the potential loss of welfare associated with monopoly. I use the word may advisedly since the discussion so far in this essay does not establish that rent-seeking for monopoly necessarily dissipates the transfer.
To understand my caution on this point, suppose that the purveyor of the monopoly is a very powerful king, secure in his power because his subjects believe that he is imbued with a Divine Right to the throne. Such a powerful king sells the monopoly privilege in a manner designed to avoid competitive waste and takes the rent-seeking outlay as a personal transfer. There is no waste in such a transaction.
Compare this situation with that of a weak democratic government, incapable of imposing its will on the bidding process for the monopoly that it is purveying, and vulnerable to competitive bidding for the rent-creating mechanism from other would-be governments. Surely, in this situation, the monopoly profits will be dissipated to a much greater degree than would occur under the powerful monarch. The discerning student will recognize that the United States government resembles much more closely the model of wealth dissipation than that of wealth transference, as above outlined.
In any event, my 1967 paper was not received well by an economics profession that largely perceived government to be an omniscient and impartial enforcer of the public good. It was rejected both by The American Economic Review and by The Southern Economic Journal ostensibly on the ground that it made no contribution to knowledge. Eventually I had it published in a relatively obscure, new journal, The Western Economic Journal, where it remained largely unread for the better part of a decade. This self-same paper is now one of the most widely cited papers in economics - an ultimate triumph of science over ideology.
In 1971, I returned to the theme of my 1967 paper, which as yet had made little headway in mainstream economics. Drawing on my discussion of theft, rather than of tariffs and monopoly, I directed attention to the cost of transfers. Economists motivated by notions of utility-enhancing income transfers at that time still assumed that such transfers could be effected at low cost from rich to poor individuals by benevolent and impartial governments. The transfer process was viewed as being Pareto-preferred since rich individuals were deemed to gain utility from income transfers to the poor. Such arguments seemed to me to bear little relationship to the realities of the political process. My paper was designed to add a dash of reality to Fantasy Island.
Even if the rich were disposed to have the government take their wealth and redistribute it to the poor, it seemed clear to me that such a process would be vulnerable to moral hazard. Potential recipients would be well-advised to become suitable objects for charity. When stationed in China with the US Department of State, I would see many beggars who had deliberately and horribly disfigured themselves in order to beg successfully. Even though I often felt disposed to supply the charity that they sought, I did so at a considerable negative utility to myself.
The problem worsens sharply once government replaces private individuals in the charitable process. There is no obvious reason why governments driven by a vote motive should stop at the point where the utility of the rich is maximized. Much more likely is the outcome where the median voters coercively transfer, at no cost to themselves, a large part of the wealth of the rich to the poor, or where special interest groups access the political process to transfer the wealth of consumers to their own members.
Much more clearly than in 1967, my 1971 paper focused on the resource cost of competitive lobbying of politicians and bureaucrats, both by those who seek to extract government transfers and by those who seek to prevent such transfers. Irrrespective of which party wins the struggle, the resources invested in the struggle are wasted and society as a whole is worse off.
In 1975, I extended my analysis of transfers to demonstrate that wasteful competition over transfers was not restricted to individuals, but also occurred among the various levels of government. In 'Competing for Aid' (Tullock 1975), I discussed a situation, common in the United States, in which a higher level of government provided public road rebuilding programs to lower level governments in accordance with 'need'. I showed how lower level governments would respond to such a set of incentives by deliberately neglecting road repairs on order to qualify for assistance. Such governments had become the self-mutilated beggars of China, figures of pity and disgust.
Until 1974, the term 'rent seeking' did not exist. This term was invented in 1974 by Anne Kreuger in an excellent paper published in the American Economic Review. At that time Kreuger was unaware of my contributions. The fact that her paper was published in a major journal, together with the catchy nature of the term 'rent seeking' undoubtedly speeded up the process of dissemination of the basic idea within the economics profession.
Kreuger's paper focused attention on third world mixed economies in which government intervention was extensive. She provided quantitative estimates of the social losses imposed upon the economies of India and Turkey by rent-seeking for import licences. According to her estimates, such losses amounted in 1964 to 7.3 per cent of the national income of India and to a staggering 15 per cent of the national income of Turkey. Numbers of this magnitude were sufficient to turn the heads of even the most left-leaning of the world's development economists.
It is perhaps worthy of note that the three early contributors to the rent seeking literature - myself, Anne Kreuger and Jagdish Bhagwati (1984) - had all spent a good deal of time in the Far East. This is a region where there co-exists a number of immensely successful cultures capable of generating high quality art, and literature. Yet many of these civilizations are economically backward, despite the fact that their emigres perform extremely well in foreign environments. The rent seeking concept provides an explanation for this curiosum.
It used to be the custom in the lumbering industry to fell trees and to roll them into a stream and float them down to the mill. Such trees often would get caught in gigantic jams that dammed up the waters of the stream. The breaking of these log-jams involved a process of locating the key logs. When such logs were removed the log-jam was broken and the downstream movement of the logs recommenced.
It would appear that the concept of rent seeking was a key log in certain areas of economic research. In these areas, progress was retarded by the existence of a log-jam. Once the concept of rent seeking was discovered - and defined as the outlay of resources by individuals and organizations in the pursuit of rents created by government - there followed a flourishing of research as relevant ideas began to disseminate throughout economics. It is now rare to find an issue of an economics journal that does not refer at least implicitly to the concept of rent seeking. All this came from an ill-received article that dared to suggest that the social cost of monopoly was as high as first year undergraduates believed it to be despite exhortations to the contrary by almost all mainstream professional economists.
Dr. Gordon Tullock is the Karl Eller Professor of Economics and Political Science at the University of Arizona, United States © The Locke Institute 1998.
Bhagwati, J.N., Brecher, R.A. and Srinivasa, T.N. (1984). 'DUP Activities and Economic Theory' in D.C. Colander (ed.) Neoclassical Political Economy. Cambridge: Ballinger, pp. 17-32.
Kreuger, A.O. (1974) 'The Political Economy of the Rent-Seeking Society' American Economic Review, 64, pp. 291-303.
Tullock, G. (1967). 'The Welfare Costs of Tariffs, Monopolies and Theft' Western Economic Journal, 5, pp. 224-232.
Tullock, G. (1971). 'The Cost of Transfers' Kyklos, 24, pp. 629-643.
Tullock, G. (1975) 'Competing for Aid' Public Choice, 21, pp. 41-52.
Tullock, G. (1993) Rent Seeking. The Shaftesbury Papers, 2. Aldershot, England and Brookfield, USA: Edward Elgar Publishing