Rent Extraction and Rent Creation in the Economic Theory of Regulation

  • Fred S. McChesney
Chapter
Part of the Topics in Regulatory Economics and Policy book series (TREP, volume 1)

Abstract

The economic theory of regulation has advanced considerably since Stigler’s seminal piece explained government’s ability to create rents by cartelizing private producers.1 Because political action can redistribute wealth generally, it is now seen that private interest groups other than producers also have an incentive to organize, both to obtain the gains and to avoid the losses from a whole menu of government enactments.2 The configuration of winners and losers depends on many factors, and it changes as the underlying demands for and costs of regulation shift. New technology, for example, may render existing government regulations undesirable to their prior beneficiaries or make current regulations useful to groups previously not benefited. Finally, “government” itself has come to be treated, not as a unit, but as a complicated network of individuals, each with an incentive to maximize his own interest.

Keywords

Supra Note Federal Trade Commission Private Capital Private Party Capital Owner 
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Notes

  1. 1.
    George J. Stigler, “The Theory of Economic Regulation,” 2 Bell J. Econ. 3 (1971).Google Scholar
  2. 2.
    Sam Peltzman, “Toward a More General Theory of Regulation,” 19 J. Law & Econ. 211 (1976);Google Scholar
  3. Gary S. Becker, “A Theory of Competition among Pressure Groups for Political Influence,” 98 Q.J. Econ. 371 (1983).Google Scholar
  4. 3.
    Robert D. Tollison, “Rent-Seeking: A Survey,” 35 Kyklos 575, 592 (1982).Google Scholar
  5. 4.
    For example, Robert E. McCormick & Robert D. Tollison, Politicians, Legislation, and the Economy (1981).Google Scholar
  6. 5.
    The ‘consumerist’ measures of the last few years… are not an obvious product of interest group pressures, and the proponents of the economic theory of regulation have thus far largely ignored such measures.” Richard A. Posner. “Theories of Economic Regulation.” 5 Bell J. Econ. 335 (1974).Google Scholar
  7. Migué also discusses regulations that are “difficult to reconcile with the economic theory of regulation.” Jean-Luc Migué. Controls versus Subsidies in the “Economic Theory of Regulation.” 20 J. Law & Econ. 213, 214 (1977).Google Scholar
  8. 6.
    Technically, some of the returns to private individuals are true economic rents (for example, the returns to entrepreneurial capacity), while others are more properly termed “quasi rents” (the returns to any fixed-cost investment). See Milton Friedman. Price Theory: A Provisional Text 115–18 (1962). Often, however, the differences are of little operational significance. See, for example, Donald N. McCloskey, The Applied Theory of Price 294 (1985) (“Producers’ Surplus Is Economic Rent Is Quasi-Rent Is Supernormal Profit”). It is not the type of rent but its source that is of interest in this article. For expositional clarity, therefore, all profits created politically are described here as “political rents,” while the returns to private capital are referred to as “private rents.” Also, the term “capital” is used here to refer to both human (including entrepreneurial) and other types of capital.Google Scholar
  9. 7.
    Gordon Tullock, “The Welfare Costs of Tariffs, Monopolies, and Theft.” 5 W. Econ. J. 224 (1967);Google Scholar
  10. Richard A. Posner, “The Social Costs of Monopoly and Regulation.” 83 J. Pol. Econ. 807 (1975).Google Scholar
  11. 8.
    For a diagrammatic presentation of the theory, see Fred S. McChesney, “Commercial Speech in the Professions: The Supreme Court’s Unanswered Questions and Questionable Answers,” 134 U. Pa. L. Rev. 45, 74–100 (1985).Google Scholar
  12. 9.
    For example, Howard P. Marvel, “Factory Regulation: A Reinterpretation of Early English Experience.” 20 J. Law & Econ. 379 (1977);Google Scholar
  13. R. H. Coase, “Payola in Radio and Television Broadcasting.” 22 J. Law & Econ. 269 (1979);Google Scholar
  14. Michael T. Maloney & Robert E. McCormick. “A Positive Theory of Environmental Quality Regulation.” 25 J. Law & Econ. 99 (1982);Google Scholar
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  17. 10.
    Regulation is… an instrument of wealth transfer—the extent of which is determined in a political market—where interest groups demand regulation and politician-regulators supply it.” Migué, supra note 5, at 214.Google Scholar
  18. 11.
    For one of the few models based on political demands being made of private individuals, see William P. Welch, “The Economics of Campaign Funds.” 17 Pub. Choice 83, 84 (1974) (“[tjhe politician demands funds in exchange for political influence”).Google Scholar
  19. 12.
    Robert E. McCormick. The Strategic Use of Regulation: A Review of the Literature, in The Political Economy of Regulation: Private Interests in the Regulatory Process 14 ( Robert A. Rogowsky & Bruce Yandle eds. 1984 ).Google Scholar
  20. 13.
    Dairy interests pay handsomely for the continuation of congressional milk-price supports. Larry J. Sabato, PAC Power: Inside the World of Political Action Committees 133, 137 (1984). Physician and dentist “political action committees” (PACs) contribute large sums for continuation of self-regulation. Id. at 134–35.Google Scholar
  21. 14.
    Since more durable rent contracts are in the interest of both private parties and politicians, the intervention of third-party institutions predictably would be sought to hold legislators to their deals. The judiciary, for example, may help guarantee congressional rent-creation contracts, since courts can overrule legislators’ attempted revisions of earlier contracts by holding the changes unconstitutional. William M. Landes & Richard A. Posner, “The Independent Judiciary in an Interest-Group Perspective,” 18 J. Law & Econ. 875 (1975): Robert D. Tollison & W. Mark Crain, “Constitutional Change in an Interest-Group Perspective.” 8 J. Legal Stud. 165 (1979). Executive veto of attempted changes in legislative deals is another way to increase the amounts private parties would spend for rent creation. W. Mark Crain & Robert D. Tollison, “The Executive Branch in the Interest-Group Theory of Government,” 8 J. Legal Stud. 555 (1979). But neither guarantee system is perfect “since there will be some expectation that an independent judiciary will not support all past legislative contracts,” Tollison & Crain, supra,at 167, and because newcomers to both the legislature and the executive office have less stake in continuing bargains made by their predecessors. Crain & Tollison, supra,at 561–66.Google Scholar
  22. 15.
    For an empirical demonstration of the harm to marginal firms from minimum-wage and union-pay increases; for example, see David E. Kaun, “Minimum Wages. Factor Substitution and the Marginal Producer,” 79 Q.J. Econ. 478 (1965);Google Scholar
  23. Oliver E. Williamson “Wage Rates as a Barrier to Entry: The Pennington Case in Perspective.” 82 Q.J. Econ. 85 (1968). For discussion of other regulatory measures with different effects on firms, see the sources cited in note 9 supra.Google Scholar
  24. 16.
    Maximizing payments to politicians would require, inter alia, that all producer beneficiaries be induced to pay and that consumer-voters exert no counterinfluence on the amount of regulation imposed. Relaxing these assumptions would not alter the fundamental implications of the rent-extraction model proposed here. See, for example, Becker, supra note 2: and Peltzman, supra note 2.Google Scholar
  25. 17.
    The conditions under which rent extraction is politically preferable to rent creation are explored further below.Google Scholar
  26. 18.
    W. Craig Stubblebine, On the Political Economy of Tax Reform 1, 2 (paper presented at the meeting of the Western Economic Ass’n 1985 ).Google Scholar
  27. 19.
    One PAC director describes congressional “invitations” to purchase tickets to political receptions as “nothing but blackmail.” Sabato, supra note 13, at 86. Likewise, “[t]he 1972 reelection effort for President Richard Nixon included practices bordering on extortion, in which corporations and their executives were, in essence, ‘shaken down’ for cash donations.” Id. at 5.Google Scholar
  28. 20.
    Brooks Jackson, “House Republicans Are Pressing PACs for Contributions.” Wall St. J., June 27, 1985, at 36, col. 2. Further instances of how politicians pressure PACs for money are given in Sabato, supra note 13, at 111–14.Google Scholar
  29. 21.
    The effects of Third World government expropriations of private capital in diminishing the amount of investment made are analyzed in Jonathan Eaton & Mark Gersovitz. A Theory of Expropriation and Deviations from Perfect Capital Mobility, 94 Econ. J. 16 (1984).Google Scholar
  30. 22.
    Tullock, supra note 7, at 229 n.11.Google Scholar
  31. 23.
    The situation is thus a form of the “Samaritan’s dilemma,” in which a politician must convince private producers that he is willing to suffer losses in the short run in order to reap longer-run gains whose present value exceeds that of any immediate losses. See James M. Buchanan. The Samaritan’s Dilemma, in Altruism, Morality, and Economic Theory 71 (Edmund S. Phelps, ed: 1975). Of course, to the extent that the political threats are convincing, private parties are more likely not to call a legislator’s bluff, and he therefore will not actually suffer any short-run loss.Google Scholar
  32. 24.
    Richard A. Epstein, Takings: Private Property and the Power of Eminent Domain (1985);Google Scholar
  33. Terry L. Anderson & P.J. Hill, The Birth of a Transfer Society (1980).Google Scholar
  34. 25.
    See J. Patrick Gunning, Jr., “Towards a Theory of the Evolution of Government, in Explorations” in the Theory of Anarchy 22 (Gordon Tullock ed. 1972 ).Google Scholar
  35. 26.
    Stubblebine, supra note 18, at 2.Google Scholar
  36. 27.
    This was the pattern observed, for example, with the amendments to the Clean Air Act in the early 1970s, when the Dept. Transportation repeatedly delayed and altered standards on auto emissions in response to auto-firm lobbying.Google Scholar
  37. 28.
    The rent-extraction model thus sheds light on the recurring controversy whether bureaucratic agencies “run amuck,” free of congressional or other constraints. The most recent study of the Federal Trade Commission (FTC), for example, concludes that “the Commission remains largely unconstrained from without.” Kenneth W. Clarkson & Timothy J. Muris, Commission Performance, Incentives and Behavior, in The Federal Trade Commission since 1970: Economic Regulation and Bureaucratic Behavior 282 (1981). But Weingast and Moran present evidence of systematic congressional influence over FTC actions. Barry R. Weingast & Mark J. Moran. “Bureaucratic Discretion or Congressional Control? Regulatory Policymaking by the Federal Trade Commission.” 91 J. Pol. Econ. 765 (1983). The rent-extraction model suggests that neither view may fully capture the essence of Congress-agency relations. A politician has less incentive to monitor specialized agencies ex ante while they consider and adopt cost-imposing measures more cheaply than Congress itself could. There is more incentive for legislative surveillance of agency action ex post, in order to locate opportunities for alleviating those costs (for a fee). For a discussion and evidence of politicians’ intervention to remove the costs imposed by bureaucrats’ antitrust investigations and prosecutions, see Roger L. Faith, Donald R. Leavens, and Robert D. Tollison, “Antitrust Port Barrel,” 25 J. Law & Econ. 329 (1982).Google Scholar
  38. 29.
    Further, the appearance may not be purely illusory. Congressional monitoring of agencies is costly. See Isaac Ehrlich & Richard A. Posner. “An Economic Analysis of Legal Rulemaking,” 3 J. Legal Stud. 257 (1974). Some of what agencies do, therefore, will not be known to a legislator until constituents bring it to his attention.Google Scholar
  39. 30.
    The purpose here is to illustrate how politicians acting collectively can induce private payments not to extract rents. This admittedly leaves unaddressed public-choice problems of achieving collective political action: how to assemble political coalitions when each politician maximizes his own interest, how to divide the gains from rent extraction among individual politicians, the role of the committee system in rent extraction, and so forth.Google Scholar
  40. 31.
    Benjamin Klein & Keith B. Leffler, “The Role of Market Forces in Assuring Contractual Performance,” 89 J. Pol. Econ. 615 (1981);Google Scholar
  41. L. G. Telser, “A Theory of Self-enforcing Agreements,” 53 J. Bus. 27 (1980).Google Scholar
  42. 32.
    See, for example, Yoram Peles, “Rates of Amortization of Advertising Expenditures.” 79J. Pol. Econ. 1032 (1971): Robert Ayanian, “Advertising and Rate of Return.” 18 J. Law & Econ. 479 (1975).Google Scholar
  43. 33.
    The Magnuson-Moss Warranty—Federal Trade Commission Improvement Act of 1975 included an order to the FTC to initiate within one year “a rulemaking proceeding dealing with warranties and warranty practices in connection with the sale of used motor vehicles.” 15 U.S.C. §.2309(6). For the FTC’s initial rule, see 16 C.F.R. § 455 (1982).Google Scholar
  44. 34.
    Since Congress has always been able to annul any agency rule or regulation statutorily, the question arises why it would want a veto. Statutes to change agency action require the president’s signature. If the president must sign the statute, he then is able to exact payment for his participation in rent-protecting legislation, lowering the payments available to Congress. In eliminating the executive role, the legislative veto is hardly a check on agency action. It is an attempt to avoid splitting fees with the executive. Indeed, if Congress has a veto, it then has an incentive to fund even more rent-threatening activities by independent agencies, ceteris paribus.Google Scholar
  45. 35.
    One study, cited in Sabato, supra note 13, at 134, found that, “[o]f the 251 legislators who supported the veto resolution and ran again in 1982, 89 percent received contributions from NADA (National Auto Dealers Association], which averaged over $2,300. This total included 66 legislators who had not been backed by NADA at all in 1980, before the veto resolution vote. Just 22 percent of the 125 congressmen who voted against NADA received 1982 money, and they averaged only about $1,000 apiece.”Google Scholar
  46. 36.
    See the FTC announcement of the veto published at 47 Fed. Reg. 24542 (June 7, 1982 ). When the Supreme Court later invalidated the legislative veto. INS v. Chadha. 462 U.S. 919 (1983), and thus Congress’s overruling of the FTC’s rule. Process Gas Consumers Group v. Consumer Energy Council, 463 U.S. 1216 (1983), the FTC recalled its proposed rule and essentially gutted it. See 16 C.F.R. § 455 (1985).Google Scholar
  47. 37.
    Stigler, supra note 1, at 9–10.Google Scholar
  48. 38.
    George A. Akerlof, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” 84 Q.J. Econ. 488 (1970).Google Scholar
  49. 39.
    Both intuition and empirical data suggest that the used-car market attracts lemons…. A number of market mechanisms serve to alleviate these problems. The most visible solutions take the form of dealer guarantees and warranties, which recently have been beefed up with extended coverage backed by national insurers. Indirectly, dealers invest in brand-name maintenance (local television ads, for instance), which makes it more costly for them to renege on a reputation for quality. The reputation of the parent automakers is also laid on the line. All four domestic car manufacturers have certified the quality of the better used cars sold by their dealers. Two generations of Chevrolet dealers, for example, have designated better used cars with an ‘OK’ stamp of the dealer’s confidence in the car’s marketability.” “Can Regulation Sweeten the Automotive Lemon?” Reg., September, December 1984, at 7, 8.Google Scholar
  50. 40.
    M]embers of the tax-writing committees nearly tripled their take from political action committees during the first six months of this year, to $3.6 million, compared to the like period in the past two-year election cycle…. [T]he money is pouring in from… insurance companies that want to preserve tax-free appreciation of life insurance policy earnings, from horse breeders who want to keep rapid depreciation of thoroughbreds, from drug companies seeking to keep a tax haven in Puerto Rico, and from military contractors seeking to retain favorable tax treatment of earnings from multiyear contracts.” Brooks Jackson. “Tax-Revision Proposals Bring Big Contributions from PACs to Congressional Campaign Coffers.” Wall St. J.,August 9, 1985, at 32, col. 1.Google Scholar
  51. 41.
    One report notes that “there hasn’t been an increase in the 65-cent-a-case federal tax on beer since the Korean War, and nobody is seriously proposing one right now.” Yet the industry has organized a coalition of brewers and wholesalers to compensate key members of Congress anyway: “Members of House and Senate tax-writing committees regularly drop by the coalition’s monthly meetings to talk about budge and tax trends, [and] pick up $2,000 appearance fees.” Though new beer taxes “haven’t…generated much interest in Congress,” the president of the brewers’ trade association says they “want to be prepared.” Brooks Jackson, “Brewing Industry Organizes Lobbying Coalition to Head off Any Increase in U.S. Tax on Beer,” Wall St. J.,July 11, 1985, at 48 col. 1.Google Scholar
  52. 42.
    The banking industry contributed millions of dollars to politicians in 1982 to obtain repeal of the statutory provision requiring banks to withhold taxes on interest and dividends. There are no precise figures on contributions to politicians to stop legislation banning gender-based insurance-rate and benefit schedules, but their magnitude may be inferred from the American Council of Life Insurance’s media budget of nearly $2 million in 1983 and 1984 to defeat the legislation. Sabato, supra note 13, at 125.Google Scholar
  53. 43.
    Stigler, supra note 1, at 3.Google Scholar
  54. 44.
    Posner, supra note 7. See also Franklin M. Fisher, “The Social Cost of Monopoly and Regulation: Posner Reconsidered,” 93 J. Pol. Econ. 410 (1985);Google Scholar
  55. W. P. Rogerson. “The Social Costs of Monopoly and Regulation: A Game-theoretic Analysis,” 13 Bell J. Econ. 391 (1982).Google Scholar
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    Tullock, supra note 7.Google Scholar
  57. 46.
    James Alm, “The Welfare Cost of the Underground Economy,” 24 Econ. Inquiry 243 (1985).Google Scholar

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© Springer Science+Business Media New York 1988

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  • Fred S. McChesney

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