Rent-seeking is a behavior that describes the tendency of people to seek profits without doing any real work. This reduces economic efficiency through the misallocation of resources. Rent-seeking also hinders the creation of wealth, reduces government revenue, increases income inequality, and potentially leads to national decline.
“…Thank you for teaching me what the concept was called!”
– Pichu Elric
the full story
In economics and public choice theory, rent-seeking is a behavior that is aimed to increase one’s existing wealth without creating new wealth for others. In other words, it describes the tendency of some people to seek profits without doing any real work.
The Classic example
A classic example of rent-seeking is the story of a lord. The lord inherited a lot of land and wealth and never worked a day in his life. However, as the lord knows of another man who has even more than him, being wealthy isn’t enough. He needs more and he has an idea.
The lord sets up a chain across the river that flows through his land and hires a collector to charge fishermen a fee if they want to pass through. There is nothing productive about the chain.
The lord has made no improvements to the river and is not adding value to society in any way, directly or indirectly, except for himself. All he is doing is finding a way to make money from something that used to be free.
To society there are three costs to this
Direct costs
First, the direct costs. The fisherman, who now has to pay a fee, needs to sell the fish at a higher price to make a living. On the market fish become more expensive for everybody.
Opportunity costs
Then the opportunity costs. The lord invests his money and resources into equipment that adds no value to society, instead of investing into something meaningful, such as fixing up the broken school building.
Moral costs
Lastly, the moral costs. The fisherman feels that paying for something that used to be free is unfair and, following the lord’s example, is more likely to engage in rent-seeking himself. What if he were to eliminate all his competitors and then increase prices?
The fisherman turns to his friend — a smooth talker who cares for the environment — to help him convince the lord of an idea: If a fence were to be running down the banks, it would protect the river from overfishing because access would be limited.
When rent-seekers and moral advocates lobby in teams, economists speak of bootleggers and baptists. The lord agrees and soon after the river is being protected.
Once the fence is built, only a few fishermen are able to access the river. That means our fisherman not only has more fish than ever before, but he can also keep selling them at very high prices.
To keep it that way, the fisherman and his lobbyist soon form the fishery department under the royal patronage of the lord. From this day on, only those who pay a license fee are allowed to fish in the river. The lord gets a nice cut for his growing empire.
On the market the fish has become so expensive that the commoners begin to complain. Unfortunately there is little they can do.
Without ever taking notable risks the landlord, the lobbyists, and the fisherman get richer every day. Or as economists would say, without having skin in the game, they create a lot of wealth for themselves but no wealth for society.
Rent-seeking reduces economic efficiency
In theory, rent-seeking behavior reduces economic efficiency through the misallocation of resources. It also hinders the creation of wealth, reduces government revenue, increases income inequality, and potentially leads to national decline.
The term itself was coined by the British economist David Ricardo, who had built his ideas on the thoughts of the Scottish economist Adam Smith. The original meaning of “rent” does not refer specifically to payment on a lease, but to gaining control of land or other natural resources.
adam smith’s definition
In 1776 Adam Smith wrote: “As soon as the land of any country has all become private property, the landlords reap where they never sowed, and demand a rent. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when the land was incommon, cost the laborer only the trouble of gathering them, come to have an additional price fixed upon them.
He must then pay for a license and must give up to the landlord a portion of what his labor either collects or produces. This portion constitutes the rent of land.”
share your thought
How about you, where do you see rent-seekers? Are they in your government and in the corporations? Or do you see them in the streets in the form of gangsters or corrupt police?Maybe you even have your own personal story where you seek to profit without adding any value?
Sources
- https://en.wikipedia.org/wiki/Rent-seeking
- https://www.econlib.org/library/Enc/RentSeeking.html
- https://www.investopedia.com/terms/r/rentseeking.asp
Dig deeper!
- Private and Public Rent-Seeking (and Chilean Buses), listen to Russ Roberts and his guest Mikel Munger discuss rent seeking on econtalk
- What is Rent Seeking – what Forbes Magazine explains it
- Evonomics 101 — How we can prevent rent seeking
- Another way of preventing rent-seeking and corruption – real life example
Classroom exercise
Role play with your students: If available, find a real life example of a company exhibiting rent-seeking behavior that was brought to the public eye and resolved recently. Split your class into company representatives, company employees and government officials or other key players in the case. Act out the case of how the officials are accusing the company of rent seeking behavior. But how should the company react? How does this affect the employees? What would your students do differently as compared to how the case was resolved in real life?
