Posts Tagged ‘rent-seeking’

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Economic inequality is arguably the crucial issue facing contemporary capitalism—especially in the United States but also across the entire world economy.

Over the course of the last four decades, income inequality has soared in the United States, as the share of pre-tax national income captured by the top 1 percent (the red line in the chart above) has risen from 10.4 percent in 1976 to 20.2 percent in 2014. For the world economy as a whole, the top 1-percent share (the green line), which was already 15.6 percent in 1982, has continued to rise, reaching 20.4 percent in 2016. Even in countries with less inequality—such as France, Germany, China, and the United Kingdom—the top 1-percent share has been rising in recent decades.

Clearly, many people are worried about the obscene levels of inequality in the world today.

In a famous study, which I wrote about back in 2010, Dan Ariely and Michael I. Norton showed that Americans both underestimate the current level of inequality in the United States and prefer a much more equal distribution than currently exists.*

In other words, the amount of inequality favored by Americans—their ideal or utopian horizon—hovers somewhere between the level of inequality that obtains in modern-day Sweden and perfect equality.

What about contemporary economists? What is their utopian horizon when it comes to the distribution of income?

Not surprisingly, economists are fundamentally divided. They hold radically different views about the distribution of income, which both inform and informed by their different utopian visions.

For example, neoclassical economists, the predominant group in U.S. colleges and universities, analyze the distribution of income in terms of marginal productivity theory. Within their framework of analysis, each factor of production (labor, capital, and land) receives a portion of total output in the form of income (wages, profits, or rent) within perfectly competitive markets according to its marginal contributions to production. In this sense, neoclassical economics represents a confirmation and celebration of capitalism’s “just deserts,” that is, everyone gets what they deserve.

From the perspective of neoclassical economics, inequality is simply not a problem, as long as each factor is rewarded according to its productivity. Since in the real world they see few if any exceptions to perfectly competitive markets, their view is that the distribution of income within contemporary capitalism corresponds to—or at least comes close to matching—their utopian horizon.

Other mainstream economists, especially those on the more liberal wing (such as Paul Krugman, Joseph Stiglitz, and Thomas Piketty), hold the exact same utopian horizon—of just deserts based on marginal productivity theory. However, in their view, the real world falls short, generating a distribution of income in recent years that is more unequal, and therefore less fair, than is predicted within neoclassical theory. So, bothered by the obscene levels of contemporary inequality, they look for exceptions to perfectly competitive markets.

Thus, for example, Stiglitz has focused on what he calls rent-seeking behavior—and therefore on the ways economic agents (such as those in the financial sector or CEOs) often rely on forms of power (political and/or economic) to secure more than their “just deserts.” Thus, for Stiglitz and others, the distribution of income is more unequal than it would be under perfect markets because some agents are able to capture rents that exceed their marginal contributions to production.** If such rents were eliminated—for example, by regulating markets—the distribution of income would match the utopian horizon of neoclassical economics.***

What about Marxian theory? It’s quite a bit different, in the sense that it relies on the assumptions similar to those of neoclassical theory while arriving at conclusions that are diametrically opposed. The implication is that, even if and when markets are perfect (in the way neoclassical economists assume and work to achieve), the capitalist distribution of income violates the idea of “just deserts.” That’s because Marxian economics is informed by a radically different utopian horizon.

Let me explain. Marx started with the presumption that all markets operate much in the way the classical political economists then (and neoclassical economists today) presume. He then showed that even when all commodities exchange at their values and workers receive the value of their labor power (that is, no cheating), capitalists are able to appropriate a surplus-value (that is, there is exploitation). No special modifications of the presumption of perfect markets need to be made. As long as capitalists are able, after the exchange of money for the commodity labor power has taken place, to extract labor from labor power during the course of commodity production, there will be an extra value, a surplus-value, that capitalists are able to appropriate for doing nothing.

The point is, the Marxian theory of the distribution of income identifies an unequal distribution of income that is endemic to capitalism—and thus a fundamental violation of the idea of “just deserts”—even if all markets operate according to the unrealistic assumptions of mainstream economists. And that intrinsically unequal distribution of income within capitalism becomes even more unequal once we consider all the ways the mainstream assumptions about markets are violated on a daily basis within the kinds of capitalism we witness today.

That’s because the Marxian critique of political economy is informed by a radically different utopian horizon: the elimination of exploitation. Marxian economists don’t presume that, under capitalism, the distribution of income will be equal. Nor do they promise that the kinds of noncapitalist economic and social institutions they seek to create will deliver a perfectly equal distribution of income. However, in focusing on class exploitation, they both show how the unequal distribution of income in the world today is affected by and in turn affects the appropriation and distribution of surplus-value and argue that the distribution of income would likely change—in the direction of greater equality—if the conditions of existence of exploitation were dismantled.

In my view, lurking behind the scenes of the contemporary debate over economic inequality is a raging battle between radically different utopian visions of the distribution of income.

 

*The Ariely and Norton research focused on wealth, not income, inequality. I suspect much the same would hold true if Americans were asked about their views concerning the actual and desired degree of inequality in the distribution of income.

**It is important to note that, according to mainstream economics, any economic agent can engage in rent-seeking behavior. In come cases it may be labor, in other cases capital or even land.

***More recently, some mainstream economists (such as Piketty) have started to look outside the economy, at the political sphere. They’ve long held the view that, within a democracy, if voters are dissatisfied with the distribution of income, they will support political candidates and parties that enact a redistribution of income. But that hasn’t been the case in recent decades—not in the United States, the United Kingdom, or France—and the question is why. Here, the utopian horizon concerning the economy is the neoclassical one, or marginal productivity theory, but they imagine a separate democratic politics is able to correct any imbalances generated by the economy. As I see it, this is consistent with the neoclassical tradition, in that neoclassical economists have long taken the distribution of factor endowments as a given, exogenous to the economy and therefore subject to political decisions.

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As James Surowiecki explains in his review of Joseph Stiglitz’s most recent books, “the fundamental truth about American economic growth today is that while the work is done by many, the real rewards largely go to the few.”

Economic inequality is clearly back on the agenda in the United States, in political discourse as well as in the discipline of economics.

Historically, inequality was not something that academic economists, at least in the dominant neoclassical tradition, worried much about. Economics was about production and allocation, and the efficient use of scarce resources. It was about increasing the size of the pie, not figuring out how it should be divided. Indeed, for many economists, discussions of equity were seen as perilous, because there was assumed to be a necessary “tradeoff” between efficiency and equity: tinkering with the way the market divided the pie would end up making the pie smaller. As the University of Chicago economist Robert Lucas put it, in an oft-cited quote: “Of the tendencies that are harmful to sound economics, the most seductive, and…the most poisonous, is to focus on questions of distribution.”

Today, the landscape of economic debate has changed. Inequality was at the heart of the most popular economics book in recent memory, the economist Thomas Piketty’s Capital. The work of Piketty and his colleague Emmanuel Saez has been instrumental in documenting the rise of income inequality, not just in the US but around the world. Major economic institutions, like the IMF and the OECD, have published studies arguing that inequality, far from enhancing economic growth, actually damages it. And it’s now easy to find discussions of the subject in academic journals.

First, after decades of simply ignoring the problem, mainstream economists tried to make sense of growing inequality in terms of “earnings inequality,” that is payments to different amounts of human capital (measured, for example, in terms of years of education). But that couldn’t account for huge differences within the top 10 percent, most of whom have college degrees. A second, more recent attempt has focused on the “rent-seeking” behavior of individuals (like CEOs) and sectors (such as pharmaceuticals and finance). The idea is that a small group of individuals and industries at the top are able to capture excess payments—”rents”—because they’re able to keep competitive forces from driving returns down. From Stiglitz’s perspective, the issue is

the economy suffers when “more efforts go into ‘rent seeking’—getting a larger slice of the country’s economic pie—than into enlarging the size of the pie.”

As I’ve explained before, the idea of rent-seeking behavior puts the final nail in the coffin of neoclassical marginal productivity theory, that is, the idea that “everybody gets what they deserve, according to their marginal contributions to production.”

But rent-seeking theory fails to account for where the extra value that takes the form of rents comes from, that is, it doesn’t offer an explanation of how a surplus is created, which can then be captured—in competitive situations (so-called normal profits) as well as in noncompetitive situations (which give rise to rents).

The fact is those at the top, in the immediate postwar period (when income inequality was much less than it is today), were left with both the incentive and the means to remake the circumstances to capture the surplus that was being created. And, of course, they eventually did so, beginning in the 1970s—allowing them both to make sure more surplus was pumped out of the workers (by paying wages that remained stagnant) and to capture more of that surplus (by funneling it into areas like finance and pharmaceuticals and by paying CEOs higher and higher salaries).

That, in my view, is the “fundamental truth about American economic growth.”

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Harvard economics professor Sendhil Mullainathan is worried that too many of his students are taking jobs in finance. He should be worried for other reasons, too.

Mullainathan’s concern stems from the idea that much of the activity in the financial sector involves “rent-seeking”:

Instead of creating wealth, rent seekers simply transfer it — from others to themselves. . .

The economists Eric Budish at the Booth School of Business and Peter Cramton at the University of Maryland, and John J. Shim, a Ph.D. candidate at Booth, have shown in a study how extreme this financial gold rush has become in at least one corner of the financial world. From 2005 to 2011, they found that the duration of arbitrage opportunities in the Chicago Mercantile Exchange and the New York Stock Exchange declined from a median of 97 milliseconds to seven milliseconds. No doubt that’s an achievement, but correcting mispricing at this speed is unlikely to have any real social benefit: What serious investment is being guided by prices at the millisecond level? Short-term arbitrage, while lucrative, seems to be mainly rent-seeking.

This kind of rent-seeking behavior is widespread in other parts of finance. Banks sometimes make money by using hidden fees rather than adding true value. Debt collection agencies may use unscrupulous practices. Lenders to poor people buying used cars can make profits with business models that encourage high rates of default — making money by taking advantage of people’s overconfidence about what cars they can afford and by repossessing vehicles. These kinds of practices may be both lucrative — and socially pernicious.

Mullainathan makes clear that that kind of rent-seeking behavior is ubiquitous in the world of finance. But, it seems to me, he has an even bigger problem: it’s not clear there’s an area in finance that doesn’t involve some kind of rent-seeking (or, as I prefer, surplus-seeking) behavior. The best Mullainathan can come up with is a general summary of the effects of the division of labor in Adam Smith and a movie, It’s a Wonderful Life.

Mainstream economists and Wall Street bankers have tried mightily to come up with concepts and measures of how the financial sector creates value and thus has an economic or social benefit. But, in the end (to judge by Mullainathan’s column), they’ve failed.

Finance may be very lucrative, for banking institutions and Harvard students alike, but all it does is capture some of the value created elsewhere in the economy. And in an attempt to capture more and more of that value, by taking advantage of arbitrage opportunities and developing new financial instruments, it created the worst crisis since the first Great Depression.

Not even George Bailey would have been able to prevent that from happening.

 

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I have to spend the rest of the day preparing Upton Sinclair’s The Jungle for class tomorrow (for the labor section of my course on Commodities: The Making of Market Society). But before I get to that. . .

The campaign against college players forming unions, as exemplified by Patrick T. Harker in his column today, continues to repeat the false impression that what the “student-athlete-employees” are demanding is to be paid for their efforts. (Even Joe Nocera, who has been very good on exposing the NCAA’s mistreatment of college athletes, makes the mistake.) No, what these employees are asking for is a voice in setting and enforcing the rules that govern their employment in NCAA-supervised athletic competitions—nontrivial things like how much time they are forced to spend in preparing for their sports, what majors and courses they can take, whether or not athletes who are injured will be given adequate medical care, and so on. No one—except the cavalcade of critics—is talking about making the athletes paid employees.

Sure, as Mark Thoma explains, rent-seeking behavior can explain at least some of the rise in inequality we’ve seen in recent decades. But why go through such tortured explanations, which require one or another deviation from perfect competition, when we can explain inequality in a much simpler manner, even when there’s perfect competition: surplus-seeking behavior. Because that’s what we need to focus on: the ability of a tiny minority in today’s economy to capture and keep the surplus being produced by the majority of workers. And how do they manage to get that surplus? Through high corporate profits that flow into CEO salaries, the growth of the financial sector, and capital gains, which in turn are taxed at low rates. And then, on top of those “normal” flows of surplus, we can consider various forms of market power that culminate in economic rents, which make the already-unequal distribution of income based on flows of the surplus even more unequal.

Speaking of inequality, how is it possible to write a paper on “Consumption Contagion: Does the Consumption of the Rich Drive the Consumption of the Less Rich?” in which Marianne Bertrand and Adair Morse [pdf] describe yet another departure from the Permanent Income Hypothesis, and never mention Thorstein Veblen and his Theory of the Leisure Class?

And, finally, under the heading of “let them eat flip-flops and cheap lingerie from Macy’s,” Thomas Edsall does a nice job summarizing the literature that explains why American workers might be wary about the claims that everyone gains from free trade and how the arguments of free-trade zealots like Jagdish Bhagwati ring so hollow these days.

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I’m intrigued by the increasing references to rent-seeking as a way of making sense of the grotesquely unequal distribution of income in the United States. What explains this trend?

We now have Joseph Stiglitz, Josh Bivens and Lawrence Mishel, and Paul Krugman all referring to rents or rent-seeking in order to analyze how the 1 percent has managed to capture a larger and larger share of the income generated within the U.S. economy. It seems that, within “polite company” (or at least what passes for polite company within mainstream economics), it’s now permissible to invoke and describe the rent-seeking behavior of the economic elite (in a manner analogous to the way rent was originally used, to describe what landlords received for the use of their land, as the return obtained by virtue of ownership, not because of anything they actually did or produced).

Here’s my sense: the obscene amounts of income going into the pockets of the top 1 percent and the fact that much of that income is associated with what are increasingly seen as economically useless activities (such as returns to stock ownership, serving as Chief Executive Officers of large corporations, and the financial sector) have put the final nail in the coffin of neoclassical marginal productivity theory. It’s simply become increasingly difficult to square the concentration of income among those at the very top (and the stagnation of incomes for pretty much everyone else) with the idea that everybody gets what they deserve, according to their marginal contributions to production.

So, what’s the alternative? Well, clearly the idea of surplus extraction and distribution is one way of making sense of the problem. But such a theory of income distribution brings with it notions of class and exploitation—and, of course, a critique of capitalism. The idea of rent-seeking is thus a way out. It represents a critique of the marginal-productivity theory of distribution but it refuses the idea that the incomes of the those at the top can be explained by their capturing a larger and larger share of the surplus produced by those who labor at the bottom.

As for me, I’m curious to see in which directions this debate will go in the coming months and years, as the top 1 percent continue to grab the money and run.