Dinging the rent-seekers

Posted on August 16, 2016 in Policy Context

NationalPost.com – Full Comment
August 15, 2016. Stephen Gordon

“Rent” is one of those words that mean different things to economists and non-economists. For non-economists, “rent” usually refers to the price one pays for the temporary use of an asset, such as land, an apartment, or a moving van. “Economic rent” is something else.

If markets are functioning properly, then wages will be set at the level necessary to make sure that the right people are working at the right jobs, and profit rates will be whatever is required to attract the appropriate capital investment. Payments beyond the levels required to attract and retain labour and capital are “economic rents,” and are generally interpreted as an inefficient allocation of productive resources: that extra money could and should be put to better use.

It is perhaps here that the distinction between training in economics and training in business is sharpest. Among economists, rents and rent-seeking are things to be discouraged as much as possible. But for a firm, more profits are always good news, and there is no such thing as a profit rate that is “too high.” Business leaders try to maximize economic rents; economists try to keep them as close to zero as possible.

It’s sometimes a tricky balance. The economic rationale for protecting intellectual property is to let creators of new ideas recoup their costs. Patents and copyrights create monopolies and monopoly rents, and these rents are the return on the costs of research and development. But it can go too far: the retroactive extension of Disney’s copyright on Mickey Mouse was granted long after the death of Walt Disney. As the economist Alex Tabarrok remarked, this can hardly be justified in terms of providing incentives for innovation: “Dead people tend not to be very creative.”

Rents aren’t only associated with profits, of course. The surge in compensation paid for high earners is a potential policy concern because it’s not clear to what extent these higher salaries can be justified as being necessary to retain talent, or if high earners are using their positions to extract higher rents simply because they can.

Further down the income distribution, a traditional strategy of labour unions has been to try to extract “quasi-rents.” For many firms, especially in such capital-intensive sectors as motor vehicle production, investment is not completely reversible: there are significant sunk costs that cannot be recovered if a plant shuts down. These fixed investments can be used as bargaining power by workers to extract modest rents. If a union can present employers with the choice of accepting the costs of higher wages, or accepting the even higher costs of closing the plant, firms will likely prefer low profits over a deadweight loss. Of course, this strategy is hard to sustain over the long term, which is why they’re called quasi-rents. At some point, firms will just stop making new investments and go elsewhere. Of course, governments cannot do the same, which is at least a partial explanation for why the public sector now accounts for well more than half of the unionized workforce.

Rents are an area where politics usually matters more than economics. It’s all very well for economists to point out the potential for increasing the size of the economic pie, but that doesn’t seem to be a winning strategy. Rent-seeking may be a negative-sum game, but its winners aren’t much interested in abandoning their privileged status in order to increase total incomes. And since rent-seekers are invariably well-connected in political circles — there’s no such thing as a marginalized recipient of rents — they’re usually pretty good at defending their positions.

We’re going to have to start thinking more about rents over the next few years as they become more prevalent. As the Queen’s University tax expert Robin Boadway put it in a recent study, Canada is developing a “rent-rich economy.”

Moreover, the usual policy remedies for dealing with rent seeking are losing political support. A traditional approach for reducing the power of rent-seekers is to introduce more competition into domestic markets. And this usually is done by opening them up to foreign competition.

(Here I once again have to make the point that is almost never made in public discussions about trade liberalization. The benefits of opening up our markets take the form of the efficiency gains produced from increased foreign competition. Not increased exports.)

Many commentators are interpreting the Brexit vote in the U.K. — and the common Clinton-Trump anti-trade front in the U.S. presidential campaign — as evidence that the trend towards deeper integration of global markets may have stopped, and may even be reversing. If so, then rent-seeking looks to become even more attractive.

The economics of rent-rich economies are non-standard, especially when it comes to taxes. In principle, as Boadway notes, governments can tax economic rents without worrying about the “deadweight losses” associated with other forms of taxation. In practice, of course, it’s not immediately obvious how to identify which income is “excessive,” and which is not. But as we move into a world where the importance of markets decreases and rents make up a larger share of income, figuring out the technicalities of taxing economic rents is going to move higher up on the policy agenda.

National Post

Stephen Gordon is a professor of economics at Université Laval.

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