Rent-seeking - Development of Theory

Development of Theory

The phenomenon of rent-seeking in connection with monopolies was first formally identified in 1967 by Gordon Tullock. The expression rent-seeking was coined in 1974 by Anne Krueger. The word "rent" does not refer here to payment on a lease but stems instead from Adam Smith's division of incomes into profit, wage, and rent. Rent-seeking behavior is distinguished in theory from profit-seeking behavior, in which entities seek to extract value by engaging in mutually beneficial transactions.

Critics of the concept point out that in practice, there may be difficulties distinguishing between beneficial profit-seeking and detrimental rent-seeking. Often a further distinction is drawn between rents obtained legally through political power and the proceeds of private common-law crimes such as fraud, embezzlement and theft. This viewpoint sees "profit" as obtained consensually, through a mutually agreeable transaction between two entities (buyer and seller), and the proceeds of common-law crime non-consensually, by force or fraud inflicted on one party by another.

Rent, by contrast with these two, is obtained when a third party deprives one party of access to otherwise accessible transaction opportunities, making nominally "consensual" transactions a rent-collection opportunity for the third party.

The high profits of the illegal drug trade are considered rents by this definition, as they are neither legal profits nor the proceeds of common-law crimes. Taxi medallions are another commonly referenced example of rent-seeking. To the extent that the issuing of medallions constrains overall supply of taxi services (rather than ensuring competence or quality), forbidding competition by non-medallion taxis makes the otherwise consensual transaction of taxi service a forced transfer of wealth from the passenger to the medallion holder.

Rent-seeking often occurs as lobbying for economic regulations such as tariffs. Regulatory capture is a related concept which refers to collusion between firms and the government agencies assigned to regulate them, which is seen as enabling extensive rent-seeking behavior, especially when the government agency must rely on the firms for knowledge about the market.

The concept of rent-seeking would also apply to corruption of bureaucrats who solicit and extract ‘bribe’ or ‘rent’ for applying their legal but discretionary authority for awarding legitimate or illegitimate benefits to clients. For example, tax officials may take bribes for lessening the tax burden of the tax payers.

In many market-driven economies, much of the competition for rents is legal, regardless of purported harm it may do to an economy. However, some rent-seeking competition is illegal – such as bribery, corruption, smuggling, and even black market deals. Anne Krueger concludes that, “empirical evidence suggests that the value of rents associated with import licenses can be relatively large, and it has been shown that the welfare cost of quantitative restrictions equals that of their tariff equivalents plus the value of the rents”