Rent-Seeking Behavior: The Lobbying Return on Investment

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Rent-Seeking-Behavior-The-Lobbying-Return-on-Investment

Rent-Seeking Definition

A term used in both public-choice theory and economics, rent-seeking refers to when an individual, company, or other entity looks to increase one’s share of existing wealth/benefits without producing additional wealth/benefits. While British economist David Ricardo coined the term in the early 19th century, it did not become widely known until the latter half of the 20th century. Gordon Tullock and Anner Krueger each published seminal studies into rent-seeking, popularizing the concept and sparking interest. Rent-seeking, when successful, harms economic efficiency as resources get misallocated or poorly distributed. In essence, it can result in people or companies getting more than their ‘fair share’—at least, in terms of how much wealth or benefits they are producing for society. But if a company or individual has a bigger share of the same amount of wealth/benefits, others must lose out. Something has to give, right?

Did you know AIG played a major role in the 2008 financial crisis? 

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Who are Rent-Seekers? Parsing Out a Much-Confused Term

In the 18th century, Scottish economist Adam Smith, often referred to as the ‘father of economics,’ established the three sources of revenue and exchangeable value: profit, wages, and rent.

Out of the three revenue sources, rent is the easiest to obtain and can require little risk.

When Smith first conceived of the idea, rent was deeply tied to agriculture. Landowners could rent out parts of their property for a price, take a cut of the sales, etc. As societies industrialized and developed, the definitional scope of economic rent has broadened.

Generally, rent refers to when an entity receives a surplus from their resources.

But if you think about it, most behavior that technically falls under ‘rent-seeking’ isn’t necessarily bad or unethical. For example, let’s say someone receives an annual salary of $100,000, but they would have happily taken the job for $85,000. They aren’t offering or producing anything more for the extra income. So in this case, they are making $15,000 in rent.

While it’s not the most economically efficient agreement for the employer, most would likely say receiving that extra $15,000 is not only ethical, but good. Even if they requested a raise for the same work (given they are industrious), the perception would be the same. Furthermore, it’s up to the employer to decide whether the employee’s work is worth the extra cost.

Is this individual and the many of us who have looked for a raise rent seekers? Are landlords rent seekers?

Well, no. Economists would not classify those cases as rent-seeking. So what exactly is it?

‘Privilege-seeking’

Rent-seeking is primarily used to refer to when corporations try to gain special privileges from the government in the form of tax breaks, grants, legislation that stifles rather than promotes industry competition. lobby governments to give them special privileges.

In other words, rather than producing more or better quality products for consumers, some corporations attempt to take more without adding any extra value to society. Typically, they achieve this by hiring lobbyists who attempt to influence legislators and regulators.

Professor David Henderson proposed a much better term for this behavior: “privilege seeking.”

Lobbying itself isn’t so much the issue; it’s actually a right protected under the First Amendment. The problem is that corporations have a certain persuasive tool most individuals do not have: money.

A political campaign takes a great deal of money to run. The amount spent on the 2020 presidential election came out to be $10.8 billion. Advertisements, rallies, travel expenses, you can see how the costs can quickly rack up. This is to say, the U.S. government can often devolve into a Pay-to-Play system. 

Politicians actively rent-seek to fund their next election campaign, and corporations happily oblige to secure their interests. That means, corporations rather than the public can take precedence. This is called ‘regulatory capture,’ where authorities view themselves as ‘allies’ to the industry rather than as regulators.

The Cost of Rent-Seeking Behavior

In 2019, the total lobbying spend was $3.47 billion. According to Forbes, the top ten companies out of the Fortune 100 that received the best returns on lobbying spent $325 million and received a return of $338 billion in federal contracts and grants. That’s a bit over a 1000% return on investment.

Of course, those figures apply to the megacorporations that managed to get the best returns. This doesn’t suggest most or even many rent-seeking efforts end up succeeding.

Karam Kang, an economics professor at Carnegie Mellon University, examined how lobbying affects the policy and private returns in the energy sector. Kang writes, “…although the effect of lobbying expenditures on the policy enactment probability is very small…the average returns to lobbying expenditures are estimated to be 137–152%. Because the average value of a policy to a particular group is estimated to be over $500 million, even a small change in its enactment probability can lead to large private returns.”

Even though the effects of lobbying on policy enactment probability proves miniscule, that little uptick in one’s chances generates, on average, a 130+% ROI. The money spent on rent-seeking appears to pay back multiple times over.

The Tullock Paradox

But for such great returns, you would expect the lobbying spend to be much higher. This oddity was famously framed in the form of the following question: “Why is there so little money in politics?” Hoping to make sense of such a massive cost-benefit discrepancy, now known as the ‘Tullock Paradox,’ economists have come up with a handful of possible explanations:

  • In a democracy, citizens have the ability to ‘punish’ rent-seeking politicians by voting for other candidates in future elections. This prevents politicians from demanding and/or accepting egregious amounts of rent. 
  • Competition for campaign funding can drive down prices for political favors
  • The questionable nature of the deal, as well as the absence of both legal recourse and reputational incentives to enforce compliance, drives down prices
  • Rent-seekers can promise a cut of the benefits if participating politicians manage to get the enabling legislation passed

The Negative Effects of Rent-Seeking

Throughout the article, we covered some of the negative effects caused by successful rent-seeking behavior, but we’ll summarize the key points here.

  • Rent-seeking can harm economic growth because it can shift businesses’ focus from productivity to marketing/lobbying. Rent-seeking, when prevalent enough, will hurt innovation and, as a result, economic growth.
  • It can limit competition and establish high barriers to entry so existing market players can continue to corner the market—for example, taxi licensing in New York. Consumers might have to pay exorbitant fees for life-saving products because of a lack of competition and/or proper price regulation
  • Those who successfully rent-seek can gain undue advantages over competitors in the form of tax breaks, subsidies, contracts, etc.
  • Some government officials, rather than promoting and protecting the interests of the public, operated based on what will bring them the most benefit

Joseph Stiglitz, a Nobel Prize-winning economist, penned the New York Times bestseller The Price of Inequality: How Today’s Divided Society Endangers Our Future. In the book, Stiglitiz argues that rent-seeking has significantly contributed to the income inequality we face in the United States today. Thus, while the size of the ‘pie’ (GDP) has steadily increased, most people’s portions (wages) have not. The corrupt among the wealthy have just continued to increase their own share, according to Stiglitz.

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Beyond Rent-Seeking…

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