Why is Rent-Seeking So Costly to Growth?

Why is Rent-Seeking So Costly to Growth?
By Kevin M. Murphy, Andrei Shleifer and Robert W. Vishny They use the term to describe people’s lobbying of government to give them special privileges. A much better term is “privilege seeking.”

Outline Introduction Theoretical framework
1. Increasing returns in rent-seeking activities 2. Public rent-seeking hurts innovative activities Case study on Ghana Case study on Romania Conclusion

Introduction What is Rent-Seeking Definition of economic growth:
Public Private Definition of economic growth: “The increasing capacity of the economy to satisfy the wants of goods and services of the members of society”.  Increase of GDP Why rent-seeking is so costly to growth? Exhibits very natural increasing returns Public rent-seeking hurts innovative activities

Causes of Rent-seeking
The criterion of survival rather than that of maximization is encountered at all levels, including politics. The dominant strategy they use is a simple trade: Material advancement in exchange for political loyalty and support. Reform in developing countries comes as a result of political survival rather than social welfare maximization. Political leaders and their appointed and dependent bureaucrats have to focus consistently on their political survival and ensure adequate political support from social groups. The fact that countries further east are more prone to rent seeking is not due simply to the geographical position, but because these countries are poor and lack a post cold war democracy and competitive market economy.

Consequences of Rent-Seeking
Rent seeking raises transaction costs and uncertainty in transition countries. It leads to inefficient economic outcomes, impeding long-term foreign and domestic investment and misallocating talent to unproductive activities. It creates a vicious circle of increasing corruption and underground economic activity. It undermines the state's legitimacy.

I. Increasing returns in rent-seeking activities
Three relevant mechanisms Fixed cost to setting up a rent-seeking system Rent-seeking may be self-generating Rent-seekers have a “strength in numbers” All these mechanisms, which rely on an increasing returfns to the aggregate rent-seeking technology, can generate equilibria

I. Increasing returns in rent-seeking activities: example
Farm economy where one can ingage in one of three activities: Produce a cash crop for the market Produce a subsistence crop which is not subject to rent-seeking Rent-seeking (theft, piracy, litigation etc.)

Case 1: Rent-seeking < Subsistence crop

Case 2: Rent-seeking > Cash crop

Case 3: Subsistence crop < Rent-seeking < Cash crop

I. Increasing returns in rent-seeking activities
Essential point of this model is that the bad equilibrium exists and is characterized by extremely low living standards. If the economy starts out in that equilibrium, it needs to be jump started out of it. Q1: How to “Jump start” an economy out of it?

2. Public rent-seeking hurts innovative activities
Redistribution from the private sector to the state, such as taxation, or interference of government bureaucrats that affect the fortunes of the private sector  Lobbying, corruption Public rent-seeking attacks innovation, since innovators need government supplied goods such as permits, licences, import quotas and so on.

New producers are more vulnerable to public rent-seeking for the following reasons: Innovators have no established lobbies and are not part of the government “elite”. Innovators are often credit-constrained Innovative projects are typically long-term and involve slow accumulation of capital Innovative projects are typically risky, which makes them particularly vulnerable to rent-seeking This puts a severe tax on innovative activities and thereby move resources into established production or the public rent-seeking sector. The result being a sharp reduction in economic growth. Q2: How to solve the problem of public rent-seeking?

The problems can be mitigated if the rulers or the bureaucrats can take an equity stake in innovative activities Establish a system of checks and balances, which is difficult to implement as the ruling class does not wish to change the status-quo

The Nature, Significance, and Cost of Rent Seeking in Ghana
GHANA CASE The Nature, Significance, and Cost of Rent Seeking in Ghana By Emmanuel Ampofo-Tuffuor, Charles D. Delorme Jr. And David R. Kamerschen

Presentation Outline Introduction
Concept and History of Rent Seeking Costs Political and Economic Background of Ghana Sources of Rent Seeking Cost of Rent Seeking in Ghana Conclusion Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

I. Introduction Evaluation of the nature, significance and cost of rent seeking in Ghana. Measurement for the cost of rent seeking: Import licences Premia on goods, wages etc. Estimation of rent seeking costs in Ghana for the years 1981 and 1984. Methods used like for India by Mohammad Whalley 1984 1981 marks the end of the last elected civilian administration in Ghana 1984 represents an era of military rule No consideration of the years after 1984 because the military administration made it difficult to obtain Figures and Data for some sectors or they were just simply omitted. Where Data is unavailable the authors use a very conservative estimate of the data using the same assumptions like for India Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

II. Concept and History Concept:
Rent seeking is the spending of resources to establish, acquire or maintain a government-granted monopoly or monopoly power. Social Problems: Loss of consumer and producer surplus arises from monopolization. All spent resources result in a loss to society because they result in no additional social product. Rent-avoidance expenditures In this paper the concept of rent seeking differs from the main iterature. When analyzing a partial equilibrium several social problems arise from rent seeking or unproductive rent seeking activities. Rent-avoidance expenditures decrease the possible rents and hence discourage rent seeking activities. For example Micrsosoft. US spends money to avoid monopoly of Microsoft. The expenditures represent a social waste of resources and may constitute a large portion of the total cost of rent seeking Mishan (1981) estimates the losses from “non productive astivities” from seeking special favors or priveleges in society at 50% of GNP. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

II. Concept and History History:
Tullock [1967] pointed out the underestimation of the welfare costs from tariffs, theft and the activities of monopolies. Anne Krüger [1974] estimated the welfare costs of qunatitiative restrictions on imports for India and Turkey. Tullock [1967] sees the cost of rent seeking as a metaphysical problem involving a confusing concept. History of the rent seeking costs important for this paper which are highlighted in the paper. In Western economies where intensive lobbying can influence regulation and rent-granting legislation, The cost of rent seeking can indeed be metaphysical. In developing economies with dictatorial or military regimes lobbying takes the form of political outcry because small groups and individuals seeking priveleges can be crushed. (Meaning that they are trying to say what they need hence there is a lack of welfare thus social costs) Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

II. Concept and History e.g. Anne Krüger [1974]
Cost of rent seeking in India 7% of GNP in 1964 and in Turkey 15% of GNP in 1968. Rent seeking activities took the form of bribery, corruption, smuggling and black markets. Calculation of the rent seeking costs by estimating the premia on commidities sold on the black market and of premia on import licences. Conclusion: Social costs from tariffs are undoubtedly less than the cost from quantitive restricitions Assumptions on the calculations: Perfect competition Development of the model around import regimes with quantitative restrictions Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

III. Political and Economic Background
Postidependence period marked by political instability and economic decay. Foreign debt $3.23 billion as in 1989 Main exports: Cocoa, gold, diamonds, timber, bauxite and manganese Anbnormal current account surpluses Fixed exchange rate regime of the Ghanian currency Cedi. Excessive governamental control and intervention Price setting, quantity and qualitiy controls, and policy intervention Independence from Great Britain in 1957 Main creditor the IMF for 14 million thats a lot of debt. Imports: Petroleum, machinery, spare parts, raw materials and food. Given the high demand of imports and the falling prices of their exports (cocoa) huge ca surpluses Trade imbalances with their main trading partners Great Britain, Germany, Japan, USA and France. Fixed regime due to the severe shortage of foreign exchange and the illegal currency black markets Even with civilian administrations high governamental presence and disregard of previous government’s Policies. Fun fact: “Every adminşstration in power is assumed to have the economic prosperityof the nation as its highest priority. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

III. Political and Economic Background
Radical economic policy changes in the 2nd half of the 1980’s. Structural Adjustment Program (SAP) in 1983 with the help of the IMF, World Bank and bileteral support. Establishment of a foreign exchange auction system by the Provisional National Defence Council. Gradual reduction and monitoring of corruption and theft in the civil service. Reduction of the size of civil service Elimination of “ghost workers” at the Ghana Cocoa Marketing Board Devaluation of the currency cedi close to the free market rate and ultimate establishment of the foreign exchange auction program. The system sold the convertible currencies to the highest bidders (usually importers) which induced a huge devaluation and flotation of the cedi to major currencies. This devaluation of the Cedi restricted the level of imports and helped to adjust the current account deficits of Ghana and finally encouraging the exports of e.g. Cocoa and eventually a raise in prices of Ghanian products. Reduction at a rate of workers per year. Payroll fraud of an estimated ghost workers. Ghost workers created by payrolls officials. Despite the promising outlook and the first signs of improvement Ghanaians still have to fight the present poverty, low income and high costs of living. The paper examines the two periods of Ghana. An era of high government controls and two years of SAP. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

IV. Sources of Rent Seeking
Rent seeking in Ghana is primiraly a result of governmental control presumably for the sake of Ghana’s prosperity. The governmental control resulted in the shifting of resources to compete to the excess profits of some sectors. The governmental control on economic activity can be divided by sectors: foreign exchange, capital, goods and labor market Government did this by setting prices of import goods to local goods, regulation of external trade, subsidation of local industries, foreign exhange fixtures and priority treatment of some local sectors. Given the length of the paper we are only going to emphasize on the goods and labor market. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Controls in the goods market: The annual budget in Ghana contains not only the means of revenue and expenditure for a fiscal year but also a list of prices of almost all commodities sold in the economy. Prices set by the Ministry of Finance and Economic Planning recommended by the Prices and Income Board The National Procurement Agency allocates the commodities at the controlled prices Excess demand and supply shortages result in higher prices at black markets Premia on most goods are usually 100% Fun fact: “controlled price” is the most common phrase in the Ghanaian vocabulary. As expected prices are below the free market prices. “Kalabule” = clever bully guy who sells at higher prices than the buying prices. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Traders and retailers expend resources in the form of bribes to get goverment allocations. Pay off price enforcement agents to avoid prosecution. Use resources to establish contacts with government employees in “sensitive” places. Government employees require premia on goods they allocate Problems: spent resources on this activities are difficult to measure but undoubtedly substantial. Control of agricultural produce: domestic products are controlled along with other domestic manufactured goods by the government. The result is food shortages (given the low prices) and agrevated By the restriction on imports. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Controls of the labor market: 65% work in the agricultural sector 35% work in the private or public sector The government is the largest employer and setter of the minimum wage for the private and public sector. Clear bias between the private and public wage. Incentives include bribes, free or subsidized housing, goods at controlled prices Civil servants work on avg. only 30 hours of a 40 hours work week. The private wage is higher than the public but when including the monetary and non-monetary elements the reverse is true. Government jobs in the middle to upper level are very popular. Labor supply of government jobs exceed clearly the demand. The youth of Ghana spends a remarkable amount of time and education on the of getting a job in the civil service. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

V. Cost of Rent Seeking in Ghana
Rents are evaluated as a percentage of the Gross Domestic Product (GDP). Current values are used because real values yield the same percentages. Annual rent is calculated as the annual rent seeking costs from controls. Rent seeking costs from controls are computed by sectors of the economy (goods,labor, capital and foreign exchange) If we use the real GDP and the real values of rents we will get the same percentage values as if we use the current values (nominal values). We will look into the goods and labor sectors due to the extent of the paper. The overall rent seeking costs of the other sectors will anyhow be displayed to give you an idea of the costdimensions of each sector. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Rent seeking costs in the Goods Market: Controlled pricing below market prices resold at higher prices in black markets. Assumption: price premia 100% on non agricultural products like cement, petroleum products, iron goods, canned food, detergents, basic commodities etc. Output of non agricultural products: 1981 C billion 1984 C billion Long queues to be able to buy products at the controlled price. Even retailers hoard goods as an anticipation of higher prices. 100% premia seems like a conservative guess given the decay of the economy and the high inflation at that time. Guessestimate enforced by the fact that the controls are similar to the Indian controls and thus the use of the Mohammed and Whaley (1984) method seems reasonable. If we assume a 100% premia the rent seeking costs equal the gross output. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Agricultural products like rice, maize, palm nuts, sorghum, yams etc. are bought by The Ghana Food Distribution Corporation. Products are sold to the public and civil servants below the market price. Assumption: Price premia 50% and only 20% is tightly controlled by the government. Output of agricultural products: 1981 C billion 1984 C billion Given that the case is similar to India’s case we again use the assumptions of Mohammed and Whaley (1984). Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Rent seekink costs in the Labor Market: Vigorous competition for governement jobs which require high qualifications and pay high full wages. Rent seekins costs equal the difference between full wages of government jobs and private jobs. Assumptions: 50% premia of the government wage bill. Government’s wage and salary bill: 1981 C2.274 billion 1984 C 6.84 billion -> of 1985’s bill Full wages include monetary and non monetary aspects. Given the similar colonial background of India and Ghana (UK) hence same method than Mohammed and Whaley (1984). The premia is assumed to equal the difference of the wages in the differrent sectors. Given this similarities of Ghana with India and the high benefits of government jobs a 50% wage premia seems reasonable for the rent seeking costs. In the military administration government wages and salaries were unknown so a conservative guessestimate of the 1985’s wage and salary bill was made. The 1985’s figure is presumed to be actually lower than the 1984 figure. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Upper and lower bound explanation of the capital goods. Lower bound is just the rent seeking costs of non angricultural products Upper bound is the joint rent seeking costs of non and agricultural products. The table shows the overall rent seeking cost in 1981 and 1984 in the Ghanaian economy. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

Rent seeking costs were 3% lower in 1981 than ın 1984. Clear hint that costs are likely higher in military regimes even if controls are fewer (SAP). Despite unnormal fewer controls in the military regime in 1984 rent seeking costs are higher than in the civilian administration in 1981. Although underground activities are not factored the rent seeking costs are unquestionably higher. 1984 was the second year of the SAP that devaluated the currency and eased controls. Underground activities are for instance smuggling cocoa, diamonds or gold. These activities Weren’t factored even though they are rampant, visible and on-going. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

VI. Conclusion The paper uses the best feasible method to calculate and compare the rent seeking costs between two types of administrations. Despite the SAP and the fewer controls the military regime had higher costs. The percentage of rent seekings costs on the GDP inherently shows that rent seeking activities have an adverse effect on growth. The results indicate that policy intervention and unbridled controls of price and business activity may be detrimental to economic activity. The military and civilian administration. A possible explanation for this is that military coup may have had rent seeking motives. Since a lot of resources are beeing spent on rent seeking activities. The latter 1980’s has been marked by an era of fewer controls and greater economic prudence since any other military government since independence but still managed to have greater rent seeking costs. Prof. Sumru Altug, Econ by Antoine Petit, Christian Hugo Bärtges and Yuri van Loon

ROMANIA CASE Rent seeking behavior in transition countries: the case of Romania by Ileana Tache, Dorin Lixandroiu

Introduction Country is free since 1989 ex-member of the USSR
Rent seeking expanded during the transition period, because of : Weak financial discipline Privatization was slow Corruption was unpunished Environment was not good for business Key measures in the area of liberalization and enterprise reform only coming after 1997.

Clientelism Heritage of communism : an established set of privileges continue to seem normal to a great number of people. This created an environment permissive to corruption, a tolerance of rent seeking behavior, constituting an informal institution that is not amenable to deliberate short run change.

Judicial System Recent official surveys [Institute of Criminology, 2003] found that a majority of judges had come under political pressure while exercising their duties.

Privatization Process
The transition from a collective property to a private one implies the inevitable process of sharing out the national wealth. Amount of sell was not revealed by state (non transparency) The selection decision could be easily manipulated, creating the appearance of corruption.

The Problem of Arrears Larger number of companies choose to maximize profits and optimize their behavior by not paying taxes and energy bills on time. They fall largely into two categories: 1) Big public firms were protected by authorities because of fear that bankruptcy accompanied by massive lay-offs would lead to social problems. 2) Private companies with strong political connections, able to extract preferential treatment from their state-owned energy suppliers.

The Banking System Most of the them were public
Some banks were drawn into questionable business by financing very risky projects, Ex : Bancorex (2nd largest bank), which after exhausting its own capital, accumulated very high debts and eventually became bankrupt. Results was a banking crisis and a huge inflation (154,9% in 1997) Now all banks are almost private

State Assistance There existed a lot of attempts to obtain privileges through pressures on administration The lack of competition culture has permitted all the governments after 1989 to offer assistance, to cancel debts, to favor different economic sectors, without taking into consideration the market signals. During 14 years, about 16 billion € was given by the state Only in 2004, the amount of state aids authorized by the Competition Council was $1.8 billion.

Conclusion Reducing rent seeking in Romania means the improvement of the reforms climate, privatization of state enterprises, transparency and accountability in political life, a sound business environment, and openness in society. 1997 1998 1999 2000 2001 2002 2003 2004 Growth rate -6.1 -4.8 -1.2 2.1 5.7 5 4.9 8 Inflation rate--annual 154.9 59.1 45.8 45.7 34.5 22.5 15.3 11,9 Unemployment rate 5.3 5.4 6.2 6.8 6.6 7.5

Conclusion Also transition countries need FDI, but foreign investors value stability, predictability, and honesty in government. Evidence is emerging [Kaminski and Ng, 2004] that rent seeking activities impose a significant 'tax' on FDI.

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