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Definition of Rents
A person gets a rent if he or she earns an income higher than the minimum that person would have accepted, the minimum being usually defined as the income in his or her next-best opportunity.
A typical textbook definition of a rent is “the portion of earnings in excess of the minimum amount needed to attract a worker to accept a particular job or a firm to enter a particular industry” (Milgrom and Roberts 1992: 269).
The “minimum amount needed to attract” suppliers of inputs (such as workers and capitalists) to particular industries should not be confused with the payments which may actually be necessary to induce them to produce the good or service.
If the payment is necessary, the rent may be efficient.
Why are rents interesting?
Stiglitz and others have shown that many rents are essential for the normal operation of a market economy: the competitive market model is not only wrong but actually very misleading: many types of surpluses can be necessary and growth-enhancing
Stiglitz focuses on rents that are necessary for overcoming information asymmetries and achieving second-best efficient outcomes: these rents are important but they are a very narrow range of necessary rents
At the same time many rents are damaging and are very similar to the unproductive surpluses that Marx was writing about
We will see that rents are closely related to rights, that is to the enforcement of rules by institutions: rents are therefore a lens through which to examine the role of institutions in economic development
Monopoly Rents 1: The Competitive Market Equilibrium
Price
Quantity
Demand Price
Marginal Cost / Supply Price
Q1
P1
ConsumerSurplus
ProducerSurplus
A
E
F
O
The existence of the producer surplus is not in itself a problem. Its existence, like that of any other rent, would only be a problem if it signalled a lower net social benefit.
Monopoly Rents 2: The Monopoly Outcome
Price
Quantity
Demand
Marginal Cost/Supply
Q2
P1
P2
Monopoly
Rent
Q1
A
E
F
BC
D
O
The social cost of the monopoly is not the rent BCDP2 (which is only a transfer within society), the social cost is the deadweight loss DCE.
Rent, Consumer Surplus, Producer Surplus under a Monopoly Price
Quantity
Demand Price
Marginal Cost / Supply Price
Q2 Q1
P2
ProducerSurplus
ConsumerSurplus
Rent DeadweightWelfare Loss
B
A
C
D
E
F
O
BCDP2 remains part of the net social benefit, but is differently distributed, but CDE is lost completely.
What the neoclassical analysis of monopoly rents ignores
The static neoclassical analysis described so far misses out a number of other potential costs and benefits of monopolies
i) Monopolies may have higher costs due to X-Inefficiency. Low incentives to lower costs.
However, even a small group of companies can engage in vigorous competition which lowers costs: we do not need perfect competition.
ii) Monopolies may have lower incentives for dynamic cost reductions, namely through technical progress.
However, they may also have higher incentives for technical progress if the monopoly allows them to retain the benefits of technological innovations for longer. This is the Schumpeterian argument.
Natural Resource Rents
Marginal Cost
Average Cost
Demand
RentDissipation
when OutputIncreases
Q1 Q2
A
B
C
D
E
F
Output (Fish)O
NaturalResourceRent
Prices
With free access, the rent is ABC-CDE. With private or collective property rights, ABC (which is like a producer surplus) is the rent which is collected by the new owners, by virtue of their ownership of the asset.
What the neoclassical analysis of natural resource rents ignores
The creation of property rights need not enhance net social benefit if alternative opportunities for employment for excluded users of resources do not exist. There is no point in saving the commons at the cost of starving people to death
What is true of natural resources is true of all property rights in a capitalist economy. The owners of all property rights earn a surplus simply by virtue of ownership and control (but through different mechanisms): this is what Marx described as the capitalist surplus
The period of transition to a property right system is therefore likely to be a period of intense contestation and conflict where property right stability is not likely to dominate
Transfer Rents 1
Tax Raised (andTransferred as Rent toOther Sectors) Transferred to
Other Sectors
Q1Q2 Output of Taxed Sector
DeadweightLoss
MarginalCost
MarginalCost plusTax
Prices in TaxedSector
O
What the mainstream analysis of Transfer Rents ignores
The focus on transfers in mainstream theory is largely on the incentive effects of the transfer for other sectors that have to pay for it.
The conclusion is that transfers have a social cost measured by a deadweight loss just like any other rent.
This analysis ignores the critical role of transfers in capitalist societies for maintaining political stability (even ignoring any welfare gains as a result of transferring from the rich to the poor)
Many economically necessary rents are also often created through transfers (for instance taxes or subsidies to deal with environmental externalities)
The net social benefit change associated with a transfer can therefore be very negative with the deadweight loss outweighed by much larger benefits
Schumpeterian Rents
S ch um peterianR ent
Marginal Cost
Demand
Quantity
Price
ConsumerSurplus
P1
P2
Q2 Q3
NotionalDeadweightWelfare Loss
Q1
A B
C
D
O
Giving the innovator a rent of P1ADP2 involves a notional loss for the consumer of ABCD in the short run. The policy question is “does the long-run spur to innovation justify this short-run sacrifice?”
Policy Question about the Period of Protection
Sum of Net Social Costs overtime due to the persistence of
Notional Welfare Losses
Sum of Net Social Benefits overtime due to Faster Innovations
Period of Rent Protection
Net Social Cost/Benefitover Time
P*
The shape of the benefits curve is a matter of judgement: it depends on i) the riskiness of technologies and ii) the “animal spirits” of investors.
Learning Rents in Developing Countries
Marginal Cost withForeign Technology
DomesticMarginal Cost
Rent for Learning /
Conditional Subsidy
O Q1 Q2
P
A
B
C
D
P'Q
Price
Quantity
Learning Effect
E
F
The short-run social cost in this case is PFCD + the deadweight loss as other sectors are taxed. The long-run social benefit is the possibility of technology progress and the capture of APQ.
Policy Question about the Period of Protection
Sum of Net Social Costs overtime due to the persistence of
Notional Welfare Losses
Sum of Net Social Benefits overtime due to Faster Innovations
Period of Rent Protection
Net Social Cost/Benefitover Time
P*
The shape of the benefits curve is a matter of judgement: it depends on i) the degree of backwardness of the catching up country and ii) the existing capacities of entrepreneurs and workers to learn rapidly
The Maintenance of Rents Involves the State in Maintaining or Changing Property Rights
TYPE OF RENT OR SURPLUS STRUCTURE OF RIGHTS SUSTAINING IT
Classical Economic SurplusProperty Rights of Capitalists over CapitalEquipment and of Landlords over Land
Monopoly Rent Indivisible Rights over Lumpy Assets orLegal Right to be Sole Supplier in Market
Natural Resource Rent Exclusive Rights over Natural Resource
Rents Based on TransfersTransfers of Rights through the PoliticalMechanism
Schumpeterian Rents Rights over Intellectual Property
Rents for Learning Transfers conditional on learning
Rents for Monitoring Rights over Residual Earnings
Efficiency and Growth Characteristics of Rents
EFFICIENCYIMPLICATIONS
(Static NSB)
TYPE OFRENT
GROWTHIMPLICATIONS(NSB Over Time)
OBSERVATIONS
Monopoly Rent
Natural Resource Rent
Inefficient
Efficient
Likely to BeGrowth-Reducing
Sometimes Difficult to Distinguish fromSchumpeterian or Learning Rents
Likely to BeGrowth-Enhancing
Rent-LikeTransfers
Neutral withPossible Incentive
Inefficiencies
Indeterminate:May Be Growth-
Enhancing
May Be Essential for PrimitiveAccumulation and to Maintain Political
Stability but may also becomeInefficient very rapidly
SchumpeterianRent
May Be Efficient Likely to Be Growth-Enhancing
May Become Monopoly Rent if itpersists for too long
Rents forLearning Inefficient May Be
Growth-EnhancingEfficiency May Depend on Monitoringand Enforcement Ability of the State
Rents forMonitoring May Be Efficient May Be
Growth-EnhancingEfficiency May Depend on Monitoringand Enforcement Ability of Monitors
Rent-seeking and Conventional Production Compared
Conventional Production Process
Net Value Added = Gross Value of Final Output
Rent-Seeking Process
Net Effect = Net Social Benefit Associated withthe Rent-Outcome
Cost of Inputs Used in Rent-Seeking(the Rent Seeking Cost)
Inputs used up in Rent-Seeking (The Rent-Seeking Cost:
Inputs used up in Lobbying,Political Activity, Bribing andother Influencing Activities)
Rent-Outcomes: EconomicRights are created, maintained,
destroyed or transferred tocreate specific Rents (for
instance, Licenses areallocated, Monopolies and
Subsidies granted, PropertyRights created)
Inputs used up in Production(Labour, Capital, Land)
Final Outputs(Goods and Services)
Cost of Inputs Used Up
How Much will Rent-seekers Invest in Rent-seeking?
The answer depends on the assumption we make about how rent-seeking expenditures change the probability of winning the rent:
Suppose we assume that the probability of winning depends on the proportion of total expenditure spent by that person:
πi = Ei / (ΣEi)
Then each person will spend till ΣE = R (the total rent available)
The Rent-Seeking Expenditure: Additional Variables
i) Institutional Rules: Can a dictator ration rents such that the total rent-seeking expenditure is lower?
In principle the answer is yes, but only if the distribution of social power prevents secondary rent-seeking that seeks to contest such allocations.
ii) Insider advantages: If insiders have large sunk costs, outsiders might find their threat to fight credible and stay out.
However, once again the distribution of power plays a key role, insiders are frequently challenged when outsiders are powerful and can take on the insiders.
iii) The Distribution of Power: An equal contest may lead to prolonged contestation and large rent-seeking costs.
The Power-Based Rent-seeking game
A
Engage inRent-Seeking
AvoidRent-Seeking
Engage inRent-Seeking
AvoidRent-Seeking
B
0,0
1,1
10,5
5,10
The Rent Outcome of Rent-Seeking typically has both gainers and losers
Creation or Transfer ofParticular Rights Results in
The Effect of the New Rights on Net Social Benefits = x - y
Net Gains for Gainers = x Net Losses for Losers = y
A Framework Analysing Different Scenarios of Rent-seeking
A: Rent-Seeking throughprivate negotiation with norole for the state
A-i) Gainers always compensate losers
B: Rent-Seeking byattempting to influence thestate
C: Rent-seeking led by thestate
C-i) State officials are value maximizerswho learn rapidly from their mistakesC-ii) The costs of collecting bribes andtaxes do not differ across groupsC-iii)The state’s institutional structureallows all costs and benefits to beinternalizedC-iv) Losers do not have the power topolitically resist the state
Conditions Conducive for the Creationof Socially Valuable Rents
Different Rent-SeekingScenarios
B-i) The spending power of rent-seekers isproportional to their gain or lossB-ii) The political power of rent-seekers isproportional to their gain or loss- if this does not hold, we require at least-B-iii) Political demands for transfers canbe met with a stable set of redistributions
Rent-Seeking Structures and Rents in Four Asian Countries 1960-90SOUTH KOREA
RENT-OUTCOMES Value-Enhancing Rents for
Learning sustained by EffectivePerformance Monitoring
RENT-SEEKING INPUTS Substantial Centralized Bribes
Lobbying Limited Expenditures by
Political Factions
INDIAN SUBCONTINENT
RENT-SEEKING INPUTS Moderate but Dispersed Bribes
Lobbying, Substantial Expenditures by
Political Factions
RENT-OUTCOMES Learning Rents which becameValue-Reducing Monopoly Rents Value-Reducing Redistributive
Rents to Political Factions
MALAYSIA
RENT-OUTCOMES Redistributive Rents with some
Value-Reducing Effects Rents for Learning in Public Sector
but with weak Monitoring Secure Rents for Multinationals
RENT-SEEKING INPUTS Moderate Centralized Bribes
Lobbying Moderate Expenditures by
Political Factions
THAILAND
RENT-OUTCOMES Redistributive Rents for Factions
controlled by Capitalists Competitive Destruction of
Monopoly Rents by New Entrants
RENT-SEEKING INPUTS Substantial Dispersed Bribes
Lobbying Substantial Expenditures by
Political Factions
South Korea 1960s: ‘Patrimonial’ Patron-client networks
BureaucracyPoliticians
Capitalist
BBB
B B BC
PPP
P P P
PB
South Asia: Fragmented Clientelism
Bureaucracy Politicians
Capitalists Non-CapitalistClients
B
BB
B
B B BC C N N
P
PPP
PPP
Malaysia 1980s: Centralized Clientelism
Bureaucracy Politicians
Capitalists
Non-CapitalistClients
B
B
B B
BB BC C
P
PPP
PP
P
N N
Capitalism from Below: Thailand 1980s
Bureaucracy Politicians
Capitalists
B
BBB
B B BC C
P
P
P PP P P P
C C
N N N N
Non-Capitalists
Conditions Explaining Difference in Rent-Outcomes
Country/Region
Scenario(s) appropriate for modellingdominant rent-seeking processes
Conditions explainingdifferences in rent-outcomes
IndianSubcontinent
B and C(B-i)-(B-iii) did not hold(C-i)-(C-iii) partially held(C-iv) did not hold
South Korea Primarily C (C-i)-(C-iii) partially held(C-iv) held
Malaysia B and C(B-i)-(B-ii) did not hold(B-iii) held(C-i)-(C-iv) partially held
Thailand Primarily B
(B-i)-(B-ii) held(B-iii) did not hold(C-i)-(C-iii) partially held(C-iv) did not hold
Classifying State Failure and Success
Costs of Intervention
Low Rent-Seeking Costs, Low Corruption, Few Mistakes
High Rent-Seeking Costs, High Corruption,Many Mistakes Types of Intervention Growth-Enhancing RentsGrowth-Reducing Rents and Extractions
Range of Most Historical Observations High-Growth StatesFailing StatesFailed StatesUtopian Developmental StateUtopian Neo-Liberal State (Highest Growth Quadrant)
(Intermediate Growth Quadrant)(Lowest Growth Quadrant)
(Low Growth Quadrant)
C o s ts o f In te r v e n t io n
L o w R e n t-S e e k in g
C o s ts , L o w C o rru p tio n ,
F e w M is ta k e s
H ig h R e n t-S e e k in g
C o s ts , H ig h C o r ru p tio n ,
M a n y M is ta k e s
Ty p e s o f In te r v e n t io n
G ro w th -E n h a n c in g R e n tsG ro w th -R e d u c in g R e n ts
a n d E x tra c tio n s
R a n g e o f M o st H is to r ic a l O b se rv a tio n s
H ig h -G ro w th S ta te s
F a il in g S ta te sF a ile d S ta te s
T h e o re tic a l D e v e lo p m e n ta l S ta teT h e o re tic a l N e o -L ib e ra l S ta te
(H ig h e s t G ro w th Q u a d ra n t)
( In te rm e d ia te G ro w th Q u a d ra n t)(L o w e s t G ro w th Q u a d ra n t)
(L o w G ro w th Q u a d ra n t)