Tag Archives: rent seeking

Adam Smith opposes “shock therapy” for developing and transitioning economies

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Michael Giberson

“Get the prices right!” was the rallying cry of some economists in the aftermath of the break up of the Soviet Union. Don’t plan the transition, stop planning and let markets sort it out. Similar advice goes out to developing economies around the world. Don’t ease your way to liberalization, throw open the gates!

In a paper just published in The European Journal of the History of Economic Thought, Maria Pia Paganelli considers what advice Adam Smith might offer: “Economies in Transition and in Development: a Possible Warning from Adam Smith.” (Alternate link). Here is a hint, Smith wouldn’t focus on “getting the prices right.”

Paganelli writes (and I’m skipping a lot of good stuff to get directly to the Smithian advice, so do read the whole thing):

Smith offers one explicit policy prescription: avoid rent-seeking, if you can.

The legislature, were it possible that its deliberations could be always directed, not by the clamourous importunity of partial interests, but by an extensive view of the general good, ought upon this very account, perhaps, to be particularly careful neither to establish any new monopolies of this kind, nor to extend further those which are already established. Every such regulation introduces some degree of real disorder into the constitution of the state, which it will be difficult afterwards to cure without occasioning another disorder. (WN IV.ii.44: 471–2)

Smith’s advice sounds like some contemporary advice. Acemoglu (2008) claims, in fact, that:

Every policy intervention creates winners and losers. The winners not only gain economically, but also become politically powerful. These politically powerful groups can then become a barrier against further progress. This is well illustrated by the experience of import substitution, which supported nascent industrial groups in many developing economies. In most cases, the subsidized conglomerates were highly inefficient and became a formidable obstacle to further reform.

His advice: ‘Refrain from policies that will create new and potentially dangerous political constituencies’ (p. 5).

But how can it be possible to refrain? How can it be possible for the legislature to not be directed by ‘the clamourous importunity of partial interests’? Smith appeals to the legislator, claiming that he should not fall for the flattery of the self-interested merchants but should preserve the natural system of liberty out of reverence toward its beauty. But our civic spirit is generally weak (TMS IV.1.11). So how can it be strengthened? Additionally, if a ‘regular administration of justice’ is needed for commerce to flourish, how do we get this ‘justice of government’, which is so deeply missing in most transitioning and developing countries?

One can infer at least two suggestions from Smith’s work. One is to avoid situations that may generate rent-seeking opportunities, as we just saw. The other is to develop a strong sense of moral respect for rules, for institutions and for the public good. Both of these prescriptions collapse into only one: the gradual introduction of commerce. A gradual opening of the large wealth offered by international trade restrains rent-seeking opportunities and is likely to develop sound institutions and a strong moral sense that leads to respect for them. Smith indeed tells us that a just set of institutions and a public spirit do not come from any human wisdom, plan or design. They are not something that can be imposed from above or from the outside. They are something that comes, gradually, with commerce. Only commerce, when very gradually introduced, can ignite what no army or wisdom is able to start (WN III.iv.10: 418, WN V.i.g. 24–25: 803).

Smith claims indeed that it is from the gradual introduction of commerce that we generate both a strong set of institutions and the conditions that develop a strong moral sense, which would be fertile ground for prosperity.

Why did water utilities in the U.S. become mostly publicly owned?

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Michael Giberson

Among U.S. water utilities, some are publicly owned and some are privately owned. Same thing for gas utilities and electric utilities. But unlike in the gas and electric power industries, the water business has become predominantly organized by publicly-owned utilities. Scott Masten explores why it was that public utility ownership became dominant among water utilities in an article, “Public Utility Ownership in 19th-Century America: The ‘Aberrant’ Case of Water,”  appearing in the October 2011 issue of the Journal of Law, Economics, and Organization.

I would have guessed that the large up-front costs with low salvage value (termed “relationship-specific assets”) created a large potential for post-investment opportunism (i.e., like the “competition over infra-marginal rents” story that John Neufeld says help explain the rise of state electric power regulation). After all, seems like there are few better examples of sunk costs than the networks of underground pipes that make up a municipal water supply system.

Masten discusses the idea that relationship-specific asset related problems favored municipalization, but finds no evidence in his data to suggest that water utilities will larger investments were more likely to be publicly owned. And yet his favored explanation is related: he finds strong support for the idea that frictions between city governments and private water utilities was a key contributor to municipalization. Friction was often over city-demanded expansions that were resisted by private water utilities, mostly because contracts negotiated between cities and private utilities didn’t provide efficient incentives for expansions and occasionally cities reneged on promised subsidy arrangements to induce expansion. This is, as Masten explains at pp. 621-625, is a fight over infra-marginal rents, so I’m not sure why Masten favors a “relational friction” story over a “relationship-specific assets” story. In any case public ownership, by integrating city and water utility, eliminates the costly conflict that would otherwise undermine the efficiency of private operations.

While his data and analysis mostly revolve around the late 19th century, he notes the issue is of more than historical interest. From the conclusion (notes omitted):

The World Bank has recently been actively studying privatization of waterworks as a way of addressing severe water problems in developing countries.The dominance of public ownership of water and sanitation services in the United States should, at a minimum, give policymakers pause: If, despite an institutional environment conducive to private ownership, American water and sanitation systems are overwhelmingly publicly owned and operated, is it reasonable to expect privatization to yield long-term gains in developing countries where the environment for private enterprise may be much less hospitable? Understanding the determinants of variations in waterworks ownership both over time and between communities may help inform whether privatization of water systems in developing countries makes sense .

Public ownership does eliminate costly fighting between city and private utility over infra-marginal rents, but it doesn’t eliminate the rents and so likely won’t eliminate the competition to capture them. Masten’s suggestion for further research are useful, but also needed are complementary studies of the efficiency of publicly owned water utilities in countries “where the environment for private enterprise may be much less hospitable.” The question in terms of generalized economic growth seems to be under which system are more of the rents yielded to consumers.

Masten’s abstract:

Unlike other public utilities, most water in the United States is supplied by publicly owned and operated waterworks. The predominance of the public sector in the supply of water was not always the case, however; private firms dominated US water supply throughout most of the 19th century. This article analyzes the puzzle of why water and sanitation systems were the only major utilities to become predominantly public by, first, reexamining historical accounts of the problems of contracting for water services in light of modern theories of economic organization and, then, evaluating hypotheses derived from those accounts using data on 373 waterworks serving US municipalities with populations over 10,000 in 1890. Among other results, municipal ownership is found to be related to the distribution of population and commerce within a city in ways that suggest that frictions between cities and private companies over system extensions and improvements played a significant role in the shift to municipal ownership.

Bootleggers and Baptists alert: RIAA and radio broadcasters

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Lynne Kiesling

Bruce Yandle, call your office — it’s another bootleggers and Baptists alert! This time it’s RIAA and radio broadcasters, who usually are at loggerheads over things like song royalties but have found common cause and joined forces to lobby the FCC to mandate that all mobile devices have an FM receiver implanted in them.

Bootleggers and Baptists is one of the most robust political economy models of rent seeking around, and it’s a topic of perpetual interest here at KP. RIAA and radio doing joint lobbying to impose a technology mandate on everyone is a classic example; what would be a seemingly small cost per device could generate a lot of profit for them … concentrated benefits and diffuse costs, IF we actually listen to the radio and radio can sell advertising and pay royalties to RIAA artists. In my experience, that’s an increasingly big IF.

But, as the Wired post indicates, perhaps we have bilateral monopoly in federal regulatory rent-seeking, because the CEA is committed to fighting technology mandates for consumer devices.

When there’s bilateral monopoly in rent-seeking, only the politicians win.

Lobbying pays — is anyone surprised?

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Lynne Kiesling

Perhaps the only thing surprising about the research described in this Washington Post article is how demonstrable and quantifiable the effects are:

In a remarkable illustration of the power of lobbying in Washington, a study released last week found that a single tax break in 2004 earned companies $220 for every dollar they spent on the issue — a 22,000 percent rate of return on their investment.

The study by researchers at the University of Kansas underscores the central reason that lobbying has become a $3 billion-a-year industry in Washington: It pays.

I like the way Mr. Coyote put it:

We have a sense that there is more corruption than ever in politics, but I think its demonstrably true that people and politicians are not any more or less evil than they were 100 years ago.  The only difference is that the sums in play from political influence are so much larger.  Its a concept I try to explain to people all the time.  The way to fix corruption in politics is not through campaign finance reform, it is through reducing the size of government.  Because no matter what restrictions one puts in place, if we set up a system where it pays to invest in politicians, then people will find a way to do so.

Yes. This statement is a variation on my oft-made claim that the way to reduce corruption, lobbying, wasteful rent-seeking, and the inefficiency and distortion that political processes induce is to remove as many important decision from the political process as possible.

The Blagojevich saga: the psychology of power, and rent-seeking

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Lynne Kiesling

Two items have kept my attention over the holidays with respect to the Blagojevich fiasco. First, back when the story first broke, our local NPR station interviewed my colleague Adam Galinsky on the psychology of power. Adam’s research is fascinating, and in this interview he communicates very effectively how positions of power affect individual incentives and decision-making: “putting people into positions of power basically alters their psychological processes.” People in power start to feel more invulnerable and focus on their rewards and ignore potential pitfalls; this change leads them to make more risky decisions. I heartily encourage you to listen to this interview; it’s superb.

And it ties in to the second item, which relates to the endemic corrupting incentives that arise from political power. Don Boudreaux’s Christian Science Monitor column last week does a really good job of turning the whole Blagojevich fiasco into a “teachable moment” on rent seeking, as Josh Wright calls it.

Tullock’s insight is that the very ability of government to create lucrative special privileges diverts resources from socially productive pursuits into wasteful ones.

Knowing that government is willing and able to impose tariffs that will protect them from foreign competition – and knowing that such protection will raise their incomes – sugar farmers understandably spend some of their resources farming government rather than farming their land. …

… And the larger the potential gain from being granted such a privilege – that is, the larger the rents – the more intense will be rent-seekers’ incentives to chase after them. That puts tremendous pressure on – and gives tremendous leverage to – politicians.

It’s easy to look at the Blagojevich case and see a failure of personal ethics. It is about character. But it’s also about how government itself creates the very conditions for corruption. Think of all the special privileges governors can bestow: subsidies for stadiums, public-works contracts, special taxes and fees, not to mention myriad regulations with myriad loopholes. Chief executives – mayors, governors, and presidents – are supposed to be the chief enforcers of the law. Today, though, they are also chief bestowers of privileges. As such, the trading of favors is intense, leaving little bandwidth for actual public service. Society loses.

See also Brian Doherty’s comments at Reason Hit & Run. These commentaries are all consistent with my observations when this first broke: lobbying/rent seeking and political corruption are different in degree, but not in kind.