Rent-seeking is the activity of generating and allocating transfers between economic actors. It results in waste and inequality. The rise of rent-seeking, with its epicentre in the accountancy, legal and banking professions, has been seriously damaging.
In the OECD the damage is most evident in the USA, where rent-seeking has faced fewer policy impediments than in Europe. There, astoundingly, median living standards have been stagnant for three decades despite the growth of per capita GDP. Two factors account for it: the expansion of activities which are counted in GDP but do not contribute to real income, and rising inequality in the distribution of real income. Modern rent-seeking generates both of them.
The loss to real income has been the standard insight of the rent-seeking literature. Resources that would otherwise be productive are diverted into generating transfers. The distributional consequences of rent-seeking are less explored but may be even more damaging. In the OECD most rent-seeking requires complexity: fancy accounting, fancy resort to law, or fancy use of information. It is therefore intensive in highly skilled labour. The expansion of the sector reallocates the highly intelligent from the other skill-intensive parts of the economy. This has three unfortunate effects besides the direct waste of tying thousands of people up in socially useless activity.
Rent-Seeking And Elite Professions
First, the extra demand for the highly intelligent raises their wages relative to those of other people and so constitutes a regressive redistribution of income. Second, the sectors from which the highly intelligent are drawn are disproportionately knowledge-generating. Since knowledge is intrinsically a public good, innovators face limitations on their ability to appropriate the returns on their work. As a consequence, while working in knowledge-generating activities, the social product of the highly intelligent is greater than their private returns so that others benefit. The reallocation of intelligence from productive activities to rent-seeking thus not only shifts it to where it is socially unproductive, but withdraws it from sectors where it is socially valuable.
Finally, many of the intelligent people working in the rent-seeking sector recognize it for what it is. As a result they feel bad about themselves. As with other morally distinctive activities, these psychic costs are reflected in earnings: prostitutes earn more than vicars. Rent-seeking activities therefore have to pay a premium to compensate for the morally suspect nature of the work, and this further widens inequality.
The upshot of rent-seeking is thus lower real income and rising inequality. It therefore needs to be curbed. The only way of doing so is through smart regulation, but this in turn generates incentives to develop ingenious avoidance. Two factors have enabled rent-seeking to race ahead of regulation: globalization and technological complexity.
While business has globalized, regulation has remained predominantly national, increasing the scope for regulatory arbitrage: hence the rise of rent-seeking by means of corporate tax avoidance. The problem has become sufficiently pronounced that the OECD has established a major initiative on ‘base erosion and profit shifting’. This year’s examples of base erosion include the largest corporate bond ever issued – $90bn, by Apple – to be used solely for the repurchase of equity. Since debt service is tax deductible whereas dividends are not, this will significantly reduce the base on which the company must pay taxes.
Rent-Seeking And Profit Shifting
A recent attempt at profit-shifting was the bid by Pfizer for AstraZeneca, the rationale for which was that Pfizer would thereby shift its tax domicile, though not real activity, from the USA to the UK and so reduce its tax rate from 35 percent to 21 percent. Such reductions in taxation are instances of a rent transfer from governments to corporations. However, in order to achieve this transfer, the corporate sector has to employ a growing army of highly sophisticated legal expertise, sometimes accounting for a quarter of corporate profits.
The increase in technological complexity has created new opportunities for rent-seeking. Complex innovations require complex patents and this has opened up scope for patent-hunting. Law firms buy up patents and sue corporations for their infringement. This has proved so costly to American corporations that Congress has recently legislated to curtail it.
Similarly, the increased sophistication of information technology has enabled the emergence of high-frequency trading in the financial sector. Investments in algorithms and technology provide some traders with a momentary informational advantage over others. While this can be highly profitable it has no material benefit for resource allocation: indeed, by reducing the confidence of disadvantaged actors in financial markets, it is liable to reduce market efficiency.
The elite professions smugly parade their high incomes as evidence of productivity while denouncing regulatory impediments. In public relations, nothing succeeds like the big lie.
Sir Paul Collier is Professor of Economics and Public Policy at the Blavatnik School of Government, Oxford University. His latest book is 'Exodus: Immigration and Multiculturalism in the 21st Century' published by Penguin and Oxford University Press.