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Where are the rent seekers?

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Abstract

In a remarkably simple and yet one of the most original and insightful observations of 20th century economics, Gordon Tullock pointed out that there are efficiency losses when public policies and political behavior create contestable rents. Tullock also observed that social losses from contesting rents appeared smaller than might be expected, so raising the question ‘where are the rent seekers?’ Tullock proposed that political accountability and ‘free-riding’ incentives in interest groups limit social losses from rent seeking. We affirm Tullock’s explanations, which apply differently under different political institutions. We compare Tullock with Gary Becker, who focused on deadweight losses from redistribution and concluded, in contrast to Tullock, that political redistribution is efficient. The comparison with Becker highlights the significance of the recognition of Tullock’s concept of rent seeking. By excluding rent-seeking losses from the social costs of redistribution, Becker could arrive at a conclusion more favorable than Tullock to an ideology that sees merit in extensive redistribution. Tullock’s model, although more encompassing of actual social costs of redistribution, would have been less welcome in the social democratic welfare state.

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Notes

  1. A political-economy perspective on public policy includes ‘rent creation’ and ‘rent seeking’ as part of the political principal-agent problem (Hillman 2009, chapter 2; 2015). For an overview of the concept of ‘rent seeking’, see Hillman (2013). Long (2013 [2015]) sets out the basic rent-seeking model and adds extensions. On contest theory, which encompasses ‘rent seeking’, see Konrad (2009). Papers from the extensive theoretical and applied literature on ‘rent seeking’ are reprinted in Congleton et al. (2008a, b). For surveys of aspects of ‘rent seeking’ and country case studies, see Congleton and Hillman (2015).

  2. Social costs of rent seeking and deadweight losses are often simultaneously present: the interdependence between the two sources of social loss is described by Kahana and Klunover (2014). Mainstream normative theory recognized deadweight losses from redistribution (although the deadweight losses were often assumed away by proposing ‘lump-sum’ taxes and subsidies). An ideal world was described in which income redistribution was the outcome of social insurance implemented by a social-welfare-maximizing government (Bergson 1938; Samuelson 1947). Social insurance and the social welfare function can be described as chosen behind a veil of ignorance. Tullock (1981) raised the interesting question whether the people envisaged as behind the veil of ignorance include populations everywhere, or only, for example, U.S. citizens. He deduced that the intention was not to include people in other countries.

  3. Cowling and Mueller (1978) obtained high estimates of the social costs of rent seeking for the United States and the United Kingdom by defining advertising expenditures in the private sector as rent seeking. The high estimates proposed by Cowling and Mueller could be regarded as undermining faith in a market economy because of the large rent seeking losses attributed to firms’ market activities. Littlechild (1981) provided the defense of markets.

  4. Using a general contest-success function, Hillman and Katz (1984) showed that compete rent dissipation occurs in the limit as the number of risk-neutral rent seekers increases without bound and rent dissipation is quite high when rent seekers are risk averse with constant relative risk aversion. When the scale parameter of the Tullock contest-success function exceeds all bounds, the contest becomes an ‘all-pay’ auction (the contender making the highest outlay wins and all unsuccessful ‘bids’ are also paid). Rent dissipation is then, on average, complete for any number of contenders in contests for an equally-valued rent (Hillman and Samet 1987). A justification is thereby provided for the complete-dissipation assumption. Systematic over-dissipation of rents cannot take place in models with rational expected-utility maximizing Nash behavior. Other ‘behavioral’ assumptions are, however, consistent with over-dissipation and over-dissipation occurs in experiments (Shermeta 2015). Rent dissipation in the basic model in which rents are private benefits is reduced by entry costs into contests (Hillman and Samet 1987) and asymmetric valuations of contested rents (Hillman and Riley 1989).

  5. Political competition in ‘weak’ democracies is for display. In ‘weak’ democracies, incumbents can have the same regime security as is provided by autocracy, with elections taking place but incumbent rulers assured of retaining office. Persistence in office can be due to permanent majorities based on group identity (tribal loyalty or religious affiliation). Because of permanent majorities and minorities, weak democracy often does not persist and is replaced by autocracy. For an uncommon case of sustained democracy with group identity, see Hillman et al. (2015).

  6. Becker received the Nobel Prize in economics in 1991. His principal contribution was to expand the domain of economics into topics previously studied by sociologists.

  7. See Downs (1957). Ursprung (1991) provides elaborations.

  8. ‘Ego-rents’ appear to have been first noted by Downs (1957), who observed that politicians were motivated by ‘prestige and power from being in office, in addition to the income they receive’ (p. 28). Brennan and Buchanan (1980) ask whether the ‘power to tax’ should be constrained, which would then also, besides constraining Leviathan government, constrain ego rents.

  9. Aidt and Dutta (2008) have shown that there can be social benefits from high ego rents. With retrospective voting, high ego rents are socially beneficial by reducing policy-created rents of incumbents in political office. In contests in which candidates place different values on achieving political office, contenders with high ego rents are predicted to deter others with low ego rents from competing, leaving the contest to be between candidates with high-ego-rent valuations of political success. Hillman and Riley (1989) showed that, in an all-pay auction with asymmetric valuations of the ‘prize’, only the two highest valuation contenders compete and that the value of resources used in the contest does not exceed the valuation of the low-valuation contender.

  10. For a case study of regime use of violence, see Fielding (2015).

  11. Taxpayers finance (R+C). With full information, a mutually beneficial Pareto improvement would give bus drivers rents of more than R and reduce by a greater amount the additional costs C imposed on taxpayers (and also reduce deadweight losses). Again, however, the creation of the rents would be politically unattractive if the rents were visibly provided.

  12. The literature on the political economy of protection has described inefficient rent creation through protectionist policies, beginning with Hillman (1982), Cassing and Hillman (1986), Hillman and Ursprung (1988), and Grossman and Helpman (1994). On inefficient rent creation through regulation of industry, see Peltzman (1976). Shughart and Thomas (2015) provide an overview of regulation of industry and rents. McKenzie (2015) describes rents created through environmental policy. For a general exposition of contests contrived for political benefit, see Epstein and Nitzan (2015).

  13. For another view that proposes efficiency in political distribution, see Donald Wittman, ‘Why democracies produce efficient results’ (1989) and ‘the myth of democratic failure: why political institutions are efficient’ (1995). In Wittman’s view, voters are informed and spending by interest groups does not distract the informed voters from choosing efficient policies (Wittman 2009). Wittman does not regard voters as subject to ‘rational ignorance’ or economic illiteracy. ‘Rational ignorance’ assumes a rational choice to be uninformed by people who could be informed if they so wished. Economic illiteracy allows for people having no awareness of what they do not know. In an empirical study, Tullio Jappelli (2010) found that human capital increases, and living in a welfare state reduces, economic literacy. People who have invested in knowledge therefore are also more knowledgeable about economics. In the welfare state, where people who live off government income transfers, people are less knowledgeable.

  14. Becker did not cite Tullock (neither in the 1983 nor in his 1985 paper), but, in the latter paper, he wrote (p. 335): “Aggregate efficiency should be defined not only net of dead weight costs and benefits of taxes and subsidies, but also net of expenditures on the production of political pressure (m s +m t ) since these expenditures are only ‘rent-seeking’ inputs into the determination of policies”.

  15. “Therefore, efficiency would be raised if all groups could agree to reduce their expenditures on political influence. Restrictions on campaign contributions, registration of and monitoring of lobbying organizations, limitations on total taxes and public expenditures, and other laws may be evidence of cooperative efforts to reduce ‘wasteful’ expenditures on cross-hauling and political pressure. Unfortunately, little is known about the success of different kinds of political systems in reducing the waste from competition among pressure groups” (Becker, ibid).

  16. Toke Aidt (2003) introduced rent seeking into Becker’s model. Aidt showed that Becker’s logic is only internally consistent if it is assumed that all groups are organized and active. Taxpayer groups have an incentive to stay passive and this incentive is maximal if the redistribution policy being contested is associated with high (marginal) deadweight cost, which implies that inefficient policies can win the day—the opposite of Becker’s claim.

  17. Additional deadweight losses incurred in hiding rents from taxpayers might decrease the value of rents, hence further explaining why rents are smaller than might be expected. If deadweight losses affect rents, someone has to care about the deadweight losses. A relation between deadweight losses and the magnitude of the rent requires the government or the transfer-receiving group to care about inefficiency through taxpayer deadweight losses when the income transfer and the associated deadweight losses of taxation are hidden from taxpayers.

  18. The inefficiency derives from individuals not internalizing the benefit to other group members from their contributions to group rent seeking. Mutual internalization would result in efficient individual contributions (see for example Hillman 2009, chapter 3).

  19. The proof is in “Appendix 2”.

  20. When two groups have a common source of benefit, the lower-valuation group does not contribute if, in the Nash equilibrium, the latter group has zero marginal benefit, given the equilibrium contribution of the high-valuation group. The result that only the members of the group with the highest valuation are politically active is robust with respect to the specification of the contest success function but is an artefact of assuming linear cost. Convex cost functions are compatible with interior solutions in which all group members contribute. Moreover, given convex costs, total rent-seeking outlays can vary positively with group size, indicating that the Olson presumption does not immediately follow from the fundamentals of contest theory (see Konrad 2009, Sect. 5.5) and needs to be grounded on empirical evidence.

  21. Issues of internal group organization are often assumed away in theoretical models. For example, in ‘Protection for sale’, Grossman and Helpman (1994) assume that industries benefiting from protection have overcome all internal free-rider problems, whereas consumers who oppose protection are unorganized. In the political-competition model of Hillman and Ursprung (1988), groups are ‘unorganized’ in the sense that individual firms in different industries make independent Nash contributions to political candidates who favor the policies sought by the group’s members.

  22. See also Holcombe (2015), who considers ‘rent seeking’ in a context of constitutionally determined rules.

  23. In autocracies, repression (or the threat thereof) can deter objection by the population to privileged rents for insiders. Still, autocratic governments can confront the discomfort of popular opposition. Falkinger (1999) proposed a model of authoritarian government in which discontent with income distribution can affect ‘social stability’ and disrupt productive activity.

  24. Kauder and Potrafke (2015, 2016) have studied rent creation in Germany by politicians through nepotism. On British parliamentarians creating rents for themselves, see Graffin et al. (2013). We refer here to political scandals that have no social virtue. Holler and Wickström (1999) studied socially beneficial scandals that change conventions.

  25. On rent seeking through the government budget, see Katz and Rosenberg (1989) and Park et al. (2005).

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Acknowledgments

This paper is a development of a presentation at the Gordon Tullock Memorial Conference, George Mason University, Arlington (October 2–3, 2015). We thank for helpful comments participants in the Tullock Memorial Conference, participants in the Australasian Public Choice Society Conference at Queensland University of Technology (December 3–4, 2015), and seminar participants at the University of Pittsburgh (October 7, 2015), Monash University (November 11, 2015), and the University of New England (November 18, 2015). We have also benefited from observations by Toke Aidt, Geoffrey Brennan, Roger Congleton, David Laidler, Niklas Potrafke, Donald Wittman, William Shughart II, and an anonymous reviewer.

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Appendices

Appendix 1: The presumption of high rent dissipation with individuals as rent seekers and private benefits

In the standard model of a rent-seeking contest with origins in Tullock (1980), individuals compete for a rent that is a private good. With r indicating returns to scale from rent-seeking effort or expenditures, with n contenders, and with a contender i outlaying x i , the contest-success function gives the probability p i of contender i winning the rent as

$$p_{i} (x_{1} , \ldots ,x_{n} ) = \frac{{x_{i}^{r} }}{{\sum\nolimits_{j = 1}^{n} {x_{i}^{r} } }} .$$
(1)

With V denoting the common valuation of the prize (the rent) in the contest, the expected utility of individual i who participates in rent seeking is

$$EU_{i} = \frac{{x_{i}^{r} }}{{\sum\nolimits_{j = 1}^{n} {x_{i}^{r} } }}V - x_{i} .$$
(2)

From (2), we establish that, in a symmetric Nash equilibrium, all contest participants choose the rent-seeking outlay.

$$x = \left( {\frac{n - 1}{{n^{2} }}} \right)rV.$$
(3)

Expected utility in (2) is strictly positive if

$$r < \left( {\frac{n}{n - 1}} \right) .$$
(4)

From (3), the total value of resources used in the contest is

$$nx = \left( {\frac{n - 1}{n}} \right)rV.$$
(5)

When r = 1, the contest-success function is like a lottery and rent dissipation is

$$D \equiv \frac{nx}{V} = \left( {\frac{n - 1}{n}} \right).$$
(6)

When n = 2, rent dissipation (the value of resources used in rent seeking relative to the value of the rent) in the Nash equilibrium is 50 %. As n increases, rent dissipation increases. For example, with n=10, 90 % of the rent is dissipated. When in (1) r → , the contest is an all-pay auction (an auction in which bidders lose their bid whether successful or not) with the individual who makes the highest outlay or bid securing the rent. As shown in Hillman and Samet (1987), rent dissipation is then complete on average for any number of individuals, with the expected value of total outlays in the contest equal to the value of the rent.

Appendix 2: Groups and public-good benefits

When we apply the standard Tullock contest success function with two competing groups having respectively n and m identical members, and with p 1 denoting the first group’s probability of winning, and x i and y j denoting the individual contributions of members of groups 1 and 2, we have:

$$p_{1} = \frac{{\sum\nolimits_{i = 1}^{n} {x_{i} } }}{{\sum\nolimits_{i = 1}^{n} {x_{i} } + \sum\nolimits_{j = 1}^{m} {y_{j} } }} .$$
(7)

It is straightforward (see Ursprung 1990) to show that, in the simplest case of two competing groups and with linear cost functions, in the Nash equilibrium total resources used in rent seeking and thereby determining rent dissipation is

$$Z = \sum {x_{i} } + \sum {y_{j} } = \frac{{v_{1} v_{2} }}{{v_{1} + v_{2} }} ,$$
(8)

which is bounded upwards by the average individual contestant’s valuation

$$\frac{{nv_{1} + mv_{2} }}{m + n},$$
(9)

where v 1 (v 2 ) denotes the common value of the contested group-specific public good to an individual member of group 1 (2).

When the basic contest model is amended to describe rent seekers as members of interest groups, rent dissipation is therefore much more limited than predicted in models in which individuals compete for a private rent. Moreover, with p 2 the probability of success of group 2, total rent-seeking outlays, and also the groups’ respective probabilities of success, as given in

$$p_{1} = 1 - p_{2} = \frac{{v_{1} }}{{v_{1} + v_{2} }} ,$$
(10)

are independent of the number of members of the two groups.

Appendix 3: Incentives to contribute within groups

With distribution of a private-benefit rent feasible, the proceeds \(\pi_{i}\) of individual i from a share of a successfully contested rent R can be conditioned on the individual rent-seeking contributions \(x_{i}\) of the n group members according to the sharing rule proposed by Nitzan (1991) and re-formulated by Davis and Reilly (1999):

$$\pi_{i} = \left( {a\frac{1}{n} + \left( {1 - a} \right)\frac{{x_{i} }}{{\sum x_{j} }}} \right)R .$$
(11)

This rule specifies a convex combination of uniform and contribution-contingent distribution \(\left( {0 < a \le 1} \right)\). Fundamental contest mechanisms suggest that appropriately incentivizing group members by this sharing rule will crowd out cooperation in formal group organization regimes (Ursprung 2012). Assuming that the design (as indicated by the parameter a) of the rent-distribution scheme needs to be discovered in an evolutionary trial-and-error process, the crowding-out of cooperation is likely to take a long time.

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Hillman, A.L., Ursprung, H.W. Where are the rent seekers?. Const Polit Econ 27, 124–141 (2016). https://doi.org/10.1007/s10602-016-9211-0

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