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Corruption, Rent Seeking and Multiple Equilibria - YouTube
Channel: Marginal Revolution University
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Welcome, everyone! Alex Tabarrok here.
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Today, we're going to be looking
at rent-seeking
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and why it's so bad for the economy.
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Just a note on terminology:
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rent-seeking, like corruption,
is a nonproductive activity
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which takes from
the productive side of the economy.
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Rent-seeking doesn't have
to be illegal, however.
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We can think about creating
a cartel, or a monopoly,
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or a tariff or a tax.
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These could all be types of rent-seeking
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which take from
the productive side of the economy
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and are themselves, unproductive.
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Rent-seeking would also include theft
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and other corrupt activities,
but is not necessarily itself corrupt.
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Okay, let's take a look at a model.
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So our model is based on one created by
Kevin Murphy, Andrei Shleifer,
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and Robert Vishny;
three famous economists;
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in a paper called,
"Why is Rent-Seeking So Costly to Growth?"
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And the very basic idea is going to be
that rent-seeking can drive out
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productive activities
in a way that is self-fulfilling.
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It will be a kind of snowball effect.
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So there will be a good equilibrium
which is stable,
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but if you hit a tipping point,
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we're going to show that
you can be driven way down here
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to the bad equilibrium.
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And the bad equilibrium is very bad,
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and once you're down here,
it's hard to climb your way back out.
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It's gonna be hard
to climb your way back out.
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That's going to be
the basic idea of the model.
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Let's take a closer look.
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So we're going to have a model
of a developing economy in which
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there are three activities,
things you can do.
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First, you can produce a cash crop,
that is, produce a crop for market sale.
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This is where you're going
to get money for your crop.
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We might think, for example,
about producing coffee.
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This is a productive thing to do,
you're going to make lots of money,
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you're going to be given cash,
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you're not going to consume
the coffee yourself,
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perhaps just even for export.
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The second thing you can do
is to go into subsistence production.
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You can produce for your own family
or produce a crop that will feed you
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but has negligible market value.
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So you can produce potatoes, for example.
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There's no real market for the potatoes.
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You're just going to consume them yourself,
it's enough to keep you going,
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keep you in subsistence,
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but you're not going to sell
these potatoes on the market,
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you're not going to get cash for them.
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The third thing you can do
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is you can go to the capital
and you can rent-seek.
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You can tax, you can steal,
you can create cartels, and so forth,
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which enable you to take
from the producers of the cash crop.
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Notice you can take cash --
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but you cannot rent-seek
from the subsistence farmers, --
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and this is because
it's easier to steal the cash
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than it is to steal the potatoes.
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The rent-seekers,
they don't even want the potatoes,
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you know, they want cash, they want money.
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You can't really take very much
from these subsistence farmers,
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but you can take from the people
producing the coffee, the cash crop.
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You can take their money,
it's much easier.
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So it's much easier to rent-seek
from the cash crop.
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The key idea is going to be
the rent-seeking pushes the returns
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to the cash crop down, --
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and in particular, --
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the more people who enter
the rent-seeking sector,
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the lower the returns
to producing the cash crop.
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Okay, let be N the number of rent-seekers
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and then let's take a look at
what can happen in this model.
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So our first case is going to be
the simplest case:
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"the property rights
are well-protected" case.
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This will help us to understand
the basic mechanics of the model.
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Notice on the horizontal axis down here,
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we have the number of rent-seekers.
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On the vertical axis, we have
the returns or the rewards --
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to the different types of activities
to being a producer,
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to going into subsistence farming,
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or to being a rent-seeker, here in red.
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Now, notice that
if there are zero rent-seekers,
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then the return to production
is very high, up here.
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Forget that it says "Good Equilibrium"
for the moment,
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just notice that with zero rent-seekers
the return to production is very high,
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and, because property rights
are well protected,
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the return to rent-seeking is low.
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So it costs a lot, in this case,
to steal money
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from the productive sector of the economy.
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Now imagine that the number
of rent-seekers increases.
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So as the number of
rent-seekers increases,
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the returns to the productive side
of the economy fall.
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And they continue to fall until
they are equal to the subsistence return.
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At this stage, people say,
"Okay, I'm gonna leave the cash-crop.
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So much is being stolen from me,
it's just not worth it anymore.
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I'm going to go into producing
potatoes instead, subsistence farming."
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For the rent-seekers, --
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their returns stay constant
as the number of rent-seekers increase --
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until you hit the subsistence farming.
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This is because, as you get
more rent-seekers, they can continue --
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to take from the cash-crop side
of the economy,
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each one of them gets a chunk of
that cash-crop side of the economy.
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But once you have people
entering subsistence farming,
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the return to rent-seekers falls.
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Okay.
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Now the equilibrium
in this model is pretty simple,
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because the returns to being a producer,
the rewards to being a producer,
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exceed the rewards to rent-seeking.
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There is no reason to be a rent-seeker,
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so everybody ends up being a producer,
and you end up here,
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in the good equilibrium.
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This is the good case, the great case.
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Everyone is working in
the most productive sector of the economy,
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the cash-crop sector.
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We don't have any rent-seekers
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because it pays more to be a coffee-grower
than it does to be a coffee-stealer.
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Okay, what else can happen?
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Case two, in a way,
is the diametrically opposite case.
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This is the case where property rights
are very weakly protected.
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So in this case,
it's so easy to be a rent-seeker
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that the returns to rent-seeking exceed
the returns to being a producer.
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As a result, the number of rent-seekers
increases and continues increasing --
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until we reach the bad equilibrium.
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So what happens here is
you get more and more rent-seekers, --
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the returns to the productive side
of the economy fall
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until you reach the subsistence return.
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Then, you still get more and more people
entering the subsistence economy
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until the returns to rent-seeking
equal the returns to subsistence,
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which equal the returns
in the cash sector of the economy.
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So here we may have
all three sectors operating.
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The rent-seekers are taking
from the cash sector of the economy
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leaving the people in the cash sector
with just the subsistence return.
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There's no incentive for people
in the cash sector any longer
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to switch to subsistence farming.
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because subsistence farming
is paying the same return.
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Also, there's no incentive
to go from potatoes to coffee
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because, again, you get the same return.
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There's also no more incentive
to enter the rent-seeking sector
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because they have driven
the economy to such a low level
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that everyone is making the bad return.
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Nobody, whether they're
in the cash crop sector of the economy,
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the rent-seeking sector,
or the subsistence sector,
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nobody is making a good return,
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everyone is making the potato return,
the subsistence return.
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This is the bad equilibrium.
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And here we have the third case,
which is perhaps the most interesting.
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In this case, if you don't have
very many rent-seekers
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then everything is okay because --
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the returns to being a producer exceed
the returns to being a rent-seeker
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and you end up in the good equilibrium.
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However, suppose that for random reasons,
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perhaps there's a war,
perhaps there's some kind of shock,
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we get an increase in rent-seeking.
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If we get an increase
in rent-seeking enough
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which pushes us over this tipping point,
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then, all hell breaks loose.
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Because, if we push
over the tipping point,
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the returns to rent-seeking will
exceed the returns to being a producer,
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and very quickly we're gonna be
driven down here to the bad equilibrium.
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Also, notice that if you get
into the bad equilibrium,
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it can be really hard
to get back out again.
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You've really got to reduce
rent-seeking a lot,
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get rid of a lot of rent-seekers,
transfer all of these rent-seekers --
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back into the productive side
of the economy.
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That's gonna be difficult,
it may require --
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very strict changes in the laws,
very tough changes in the laws --
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because if you make just small changes,
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okay, you reduce ease of being
a rent-seeker just a little bit.
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Well, then, the rent-seeking returns
are going to be bigger
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than the returns in
the productive sector of the economy
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and you're gonna be driven
back to this bad equilibrium.
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We've got so many people
in that sector of the economy,
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it's hard to get them all out,
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to switch them in a big push
to get you back into the good equilibrium.
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I also think about this part of the model
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as being a little bit like
the Atlas Shrugged model.
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So in Ayn Rand's novel,
"Atlas Shrugged", --
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the rent-seekers are getting
more powerful over time,
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"the looters and the moochers,"
as Ayn Rand would have put it,
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are getting more powerful.
You're getting all these laws
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so that kind of this curve
is shifting up like this --
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putting you closer and closer
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to the tipping point,
getting that tipping point
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closer and closer
until finally you tip over
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and you end up in the bad equilibrium,
where all the good guys now,
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all the entrepreneurs, the people who
were creating all of the wealth,
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they end up going to Galt's gulch.
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They end up leaving the economy.
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So you can also think about
the subsistence return
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as not being the potato sector,
but you could think about
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the productive sector being
the innovative sector,
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the high-tech, innovative
and advanced sector,
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the new sector, new-ideas sector,
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and the subsistence return
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as being the less entrepreneurial,
the non-entrepreneurial sector.
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And, as the rent-seeking goes up,
as you get more and more rent-seeking,
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you may hit that tipping point
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and then people leave,
the entrepreneurial sector;
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they leave entrepreneurship,
they go to Galt's Gulch
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or they become ordinary workers,
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and you get into the bad equilibrium.
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This model has another --
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interesting aspect.
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Suppose that, the returns
to being a producer go up.
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So perhaps, coffee prices go up,
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or perhaps there's
a greater technological change,
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there's more innovation,
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and that increases the returns
in the productive sector of the economy.
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Well, notice that that pushes
the tipping point way far to the right,
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it pushes you beyond, perhaps, where
you're going to get for random reasons.
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So this says that --
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an increase in economic growth
or an increase
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in the productivity of your export sector,
your coffee sector, your cash sector,
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this actually has two good things to it.
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First of all,
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just because it means
higher returns that's better,
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but also, --
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good times means it's easier
to keep the rent-seekers at bay.
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Simply by raising the return
in the productive side of the economy,
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you reduce the return
from being a rent-seeker.
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So it's kind of a double benefit.
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There's a political benefit
as well as an economic benefit.
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This is why you typically notice that
when things are good, they're very good.
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So when the economy is booming,
you often have good politics.
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On the other hand,
when the economy falters,
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when the returns
to being a producer fall; --
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so we have a situation more like this,
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those returns to being a producer fall; --
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then you even get the worst of all.
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The economy falls at the same time
you get more people into rent-seeking.
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So the bad times are really bad,
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the good times, however, are really good.
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Another way of putting that is
you want to make sure
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that your rent-seeking returns
are always low,
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because you don't want
to fall into that tipping point,
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because it will be
really hard to get back,
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and if the good times get
a little bit worse, do get worse,
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for some random reason,
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you want to make sure
you don't fall over that tipping point.
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So you've got to keep
those rent-seeking returns --
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low at all times.
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Okay, let's sum up.
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So here are three cases:
the strong-property-rights case,
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the weak-property-rights case,
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and, really, the one which we're in,
the multiple-equilibria case.
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And, as we saw,
there's lots of good lessons here
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about staying in that good equilibrium,
keeping those rent-seeking returns low,
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how good times reinforce good politics,
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how bad times reinforce bad politics,
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and the importance of keeping out
of that bad equilibrium.
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Thanks.
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