The Trouble With “Rent Seeking”

In Equal Is Unfair, Yaron Brook and I argue that one of the problems with the concept of “economic inequality” is that it lumps together two fundamentally different things: inequality that reflects differences in productive achievement and inequality that reflects some people’s ability to gain unearned wealth. Package-deals like this lay the groundwork for injustice.

For example, you’ll often hear critics of economic inequality point to instances of cronyism — people getting rich through government privileges like subsidies — in order to justify “fighting inequality.” But then they propose solutions that would penalize every successful person, including the Jeff Bezoses of the world who get rich by creating enormous amounts of value.

There’s a fundamental moral distinction between voluntary trade and physical force, and so if you are using a concept that treats those as the same, there’s something wrong with your concept.

Another concept that comes up again and again in the inequality debate, and which also commits this error, is “rent seeking.”

Most free-market-leaning thinkers treat rent seeking as synonymous with cronyism. Here, for example, is how economist David Henderson describes it:

People are said to seek rents when they try to obtain benefits for themselves through the political arena. They typically do so by getting a subsidy for a good they produce or for being in a particular class of people, by getting a tariff on a good they produce, or by getting a special regulation that hampers their competitors. Elderly people, for example, often seek higher Social Security payments; steel producers often seek restrictions on imports of steel; and licensed electricians and doctors often lobby to keep regulations in place that restrict competition from unlicensed electricians or doctors.

But why do economists use the term “rent”? Unfortunately, there is no good reason. David Ricardo introduced the term “rent” in economics. It means the payment to a factor of production in excess of what is required to keep that factor in its present use. So, for example, if I am paid $150,000 in my current job but I would stay in that job for any salary over $130,000, I am making $20,000 in rent. What is wrong with rent seeking? Absolutely nothing. I would be rent seeking if I asked for a raise. My employer would then be free to decide if my services are worth it. Even though I am seeking rents by asking for a raise, this is not what economists mean by “rent seeking.” They use the term to describe people’s lobbying of government to give them special privileges. A much better term is “privilege seeking.”

In Henderson’s description, rent seeking can consist of gaining money through voluntary exchange and making money through government coercion. True, Henderson says that economists “use the term to describe people’s lobbying of government to give them special privileges.” But that unfortunately is not always the case.

Here’s a recent example from columnist Megan McArdle, who argues that finance and academia are benefiting from rent seeking.

The next question is, “How are these guys managing to capture so much rent?” The classic answer is “barriers to entry,” which means pretty much what it sounds like: aspiring entrepreneurs might like to compete with your products, but there’s some reason it’s hard for them to do so.

It’s hard to start a new college or a new investment bank. There are regulatory barriers, but there are also market factors. In both cases, customers are often paying for the reputation of an institution. Reputations are hard to amass, and that protects banks and colleges from competition. Thus shielded from new entrants, bankers can collect multi-million dollar fees and colleges robust tuitions to fund a bloated and top-heavy institutional form that has, if anything, seen falling productivity while the rest of the world races ahead.

Get that? On the one hand, financiers can capture rents when the government uses its coercive power to restrict freedom of competition in finance. On the other hand, financiers can capture rents by earning a good reputation that makes it more difficult for newcomers to successfully compete.

The lesson that most people draw from this sort of view is that sometimes we’ll have to fight rent seeking by reducing government intervention — but other times we’ll have to fight it by increasing government intervention in the name of “promoting competition.” (See Ayn Rand on why using coercion to “promote competition” is a contradiction in terms.)

I don’t mean to pick on Megan. Hers is really the standard view. Joseph Stiglitz, a Nobel Prize-winning economist and one of the leading critics of economic inequality, rests his case for fighting inequality on the claim that rent seeking is responsible for much of the high incomes we observe among “the 1 percent.”

Is that because they’re all running to Washington and asking for special privileges? Nope. According to Stiglitz, “Not all rent seeking uses government to extract money from ordinary citizens.” The “private sector can excel on its own,” e.g., by creating “entry barriers. . . . such as maintaining excess capacity, so that an entrant knows that, should he enter, the incumbent firm can increase production, lowering prices to the point that entry would be impossible.” (The Price of Inequality, 50, 54)

The lesson here is that to speak of “rent seeking” (or “barriers to entry” or “economic inequality”) is to blur the distinction between voluntary trade and physical force. But if we are trying to create a moral, just system, then no distinction can be more important.