Rent-seeking Torun Dewan EC260, July...
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Lobbying and Interest Groups Rent-seeking Torun Dewan EC260, July 2007
Transcript of Rent-seeking Torun Dewan EC260, July...
Lobbying and Interest GroupsRent-seeking
Torun Dewan
EC260, July 2007
Introduction
• Interest groups or associations are central to the political process
“A landed interest, a manufacturing interest,a mercantile interest, amoneyed interest, with many lesser interests, grow up of necessity incivilized nations, and divide them into different classes, accentuated bydifferent sentiments and views. The regulation of these various andinterfering interests form the principal task of modern legislation” (Publius,Federalist Papers No 10).
• Yet standard Economic models assume benevolent policy maker who maximisessocial welfare - no role for organised interests
• Pluralist Political Science- benevolent view of interests
From Virginia to Chicago
Modern Political Economy looks at the policy making process in terms of thestrategic interaction between political decision-makers, voters and interests
• Within PE two schools of thought
– Virginia Political Economy or Public Choice : Focus on role of IG’s in rentcreation and competition for rents
– The Chicago School focus on role of IG’s on political and legal mechanismssuch as regulation
Introduction to Rent-seeking
• A rent is payment made for use of asset which does not transfer ownership.
• Monopoly Rent:
– Profits over and above that received in a competitive market
• Rent-seeking:
– Socially costly activity aimed at securing monopoly profit“The existence of opportunity to obtain monopoly profits attractsresources into efforts to obtain rents” Posner (1975)
– Any activity aimed at redistribution which takes up resources
Creating Rents
• In the Public Choice view rents are created as part of the political process.Examples include
– Property right over production of a public good.– Protection for discriminating monopolist– Natural Monopoly– Regulation of Professions– Imposition of trade restrictions
• Remember, it is not the rent per se, but how they are created which causesconcern.
The Social Costs of Rent-Seeking
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Types of rent-seeking behaviour
• Competition between firms for rent: Lobbying, Wining and Dining etc...
• Competition between government officials to secure access to bribes
– In this argument the bribe itself is not inefficient– Bribes may even increase the quality of politicians– Competition for access to bribes is costly to society due to opportunity cost
• Spillover effect
– If rent is lucrative attracts productive resources from other markets– Similarly, politicians lobby to enter departments, committees where rent-
seeking occurs
Nothing Going On Except the Rent
Consider Tullock’s “Taxi Driver” example
• Drivers of taxis earn competitive market price
– Drivers set up interest group to lobby City Hall for a taxi license.– License restricts access to the market– Lower supply means drivers can secure rents– Anticipation of rents under the license scheme leads to rent-seeking
• Rent-seeking incentive for Politicians
– City Hall sets up committee to oversee license distribution.– Drivers lobby committee members for licences and bribes may be made– Opportunity Cost: Politicians are less productive– Spillover Effect: Legislators lobby to be put on committee.
Summary
The rent-seeking literature provides us with a framework to evaluate the effect ofinterest group activity
• What are the costs to society?
• How are the effects of rent-seeking enhanced or mitigated by politicalinstitutions?
Estimating the Costs
• Krueger (1974) identifies a number of rent-seeking measures wrt importlicensing in India.
– Where licenses awarded according to plant capacity construction of excesscapacity
– Hiring unproductive help from families /friends for lobbying purposes– Wasteful competition between government agencies to secure access to bribes
• Calculates loss due to rent-seeking for import licences the Indian economy as7.3 percent of national income
• Equivalent loss due to rent-seeking in import licenses in Turkey at 15 percentGDP
The Tullock Paradox
“The problem which immediately concerns me is that the resources we candetect seem to be too small for their apparent value” (Tullock)
• In the 99th congress 56 members of the House Ways and Means and SenateFinance Committees raised 26.5 million USD from interest groups
– The Tax Reform bill alone involved billions of dollars.
• Of course we need to focus on outlays
– Hazlett and Michael: In FCC cellular telephone bandwidth lotteries 38percent of rents dissipated in expenses associated with applications.
The Tullock Paradox
• Two lobbies A and B invest xA and xB to secure a prize of unit value.
• Probability either wins the rent is proportional to investment
– probability A secures rent is xαA
xαA+xα
B(where α is the rate of return on the
investment).
• We seek Nash equilibrium investments so that xA and xB are best responses toeach other
• Formally uA(x∗A(xB)) ≥ uA(xA(xB)) and uB(x∗B(xA)) ≥ uB(xB(xA))
The Tullock Paradox
• Suppose that α = 1 so that
u(xA) =xA
xA + xB− xA and u(xB) =
xB
xB + xA− xB
• First order conditions satisfy
xB
(xA + xB)2− 1 = 0 and
xA
(xA + xB)2− 1 = 0
• Solution yields symmetrical bids xA = xB = 14 and thus dissipation of half the
rent
The Tullock Paradox
• The problem has general solution solution xA = xB = α4 .
– For α = 0 no rent dissipation occurs.– If α = 2 then each invests 1
2 and rents are dissipated.
• For α > 2 expected utility is negative.
– When this is so there is no pure strategy equilibrium.– A mixed strategy equilibrium exists in which rents are fully dissipated.
Understanding the Paradox
Consider the following scenario (Dal Bo, AJPS 2007)):
You are one of three neighbours who own a piece of green land. Jointly you form acommittee and decisions concerning the sale or management are made by majorityrule. A real estate developer wishes to purchase the land for a small sum and buildhouses. You and your neighbours realise that selling at the low price is bad andyields a cost equal to θ > 0 to each of you. The developer makes you the followingoffer: he will reimburse you with θ + ε in the case where your vote determines thesale of the land in his favor, otherwise you get nothing. What should you do?
Bribing Voters
Dal Bo extends this example to a game with a single principle and an N membercommittee. He finds
• Principal will induce the committee to vote yes at no cost
• Coalition of ‘yes’ voters may consist of a simple majority + 1, a qualifiedmajority, or all voters.
– Result breaks down however if the committee adopts unanimity
• Outcomes need not be efficient.
State Capture
The previous example raises the possibility that the political process can becaptured by interest groups despite (because of) democratic procedures. The’Chicago School’ analyses the extent to which the state can be ‘captured’ by interestgroups
• Focus on interaction between political, economic and legal process throughregulation,
• Politicians supply regulation but face counter-veiling pressures from producersand consumers acting as voters
State Capture
“Regulation is not about the public interest at all, but is a process, by whichinterest groups seek to promote their private interest ... Over time, regulatoryagencies come to be dominated by the industries regulated.”(Posner)
“As a rule, regulation is acquired by the industry and is designed andoperated primarily for its benefit” (Stigler)
Peltzman Regulatory Model (Mueller pp 344)
• Consider a politician who can regulate the price of an industry. Her utility isrepresented by
V (UP , UC)
– V is number of votes, UP is the utility of producers and UC that of consumers– V is increasing in both of its arguments
• Now consider the effect of the price on UP and UC. Producers benefit from anincrease in p since rents are higher
– UP = R(p) where R captures the positive effect of p
• Consumers face a utility loss from higher rents
– UC = K −R(p)− L(p) where L is the deadweight loss.
Peltzman
• Higher p may yield higher campaign contributions from producers and highervotes, but may cost votes from consumers
• The politician chooses p which solves
dV
dp=
∂V
∂UP
dR
dp︸ ︷︷ ︸state capture
− ∂V
∂UC
dR
dp− ∂V
∂UC
dL
dp︸ ︷︷ ︸counter-veiling effect
= 0
– First term, positive marginal effect of p on V through UP
– Second term negative marginal effect of p on V through UC
– p also has an effect on L
– Intermediate price represents where an oligopolist would price– Supply of regulation/de-regulation is higher in monopoly/perfect competition
State Capture Graphic
qc
pr = MaxV
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Implications
• State Capture may be complete or incomplete
• Opportunities for rent-seeking are greater where relationship between moneyand votes are stronger
Legislation for Sale
In the economic theory of the legislative process, legislation has a value and hencecan be bought and sold like any other valuable commodity
“In the economists version of the interest group theory of government,legislation is supplied to groups or coalitions that outbid rival seekers offavourable legislation. The price that the winning winning group bids isdetermined by both the value of legislative protection to the group’s membersand the group’s ability to overcome the free-rider problems that plaguecoalitions. Payments take the form of campaign contributions , votes, implicitpromises of future favours and sometimes outright bribes. In short legislationis “sold” by the legislature and bought by the beneficiaries of legislation”Landes and Posner (1975)
Legislation for Sale
• Problem due to dynamic nature of politics
– Deals struck today may be overturned tomorrow; thus uncertainty over thefuture drives down price of legislation
– Institutional mechanisms such as committee systems with seniority increasepolicy ‘durability’
• Problem due to legal impediments to the enforcement of deals
– A judiciary subservient to a current legislature can nullify legislation enactedin a previous session of legislature by refusing to enforce it
– According to Landes and Posner (1975) an independent judiciary increasespolicy durability (hence price).
Judicial Independence: Landes and Posner
Legislation
Price
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