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

B C

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 RentsMarginal Cost

Average Cost

Demand

RentDissipation

when OutputIncreases

Q1 Q2

A

BC

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

CD

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 Surplus Property 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 Transfers Transfers 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 OF

RENT

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-EnhancingMay Become Monopoly Rent if it

persists 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

Bureaucracy Politicians

Capitalist

BBB

B B B C

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

PPP

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 NNon-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

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 r ru 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 s t 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 t ic a l D e v e lo p m e n ta l S ta teT h e o re t ic 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 st 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)