resilience, not stability

Rent-Seeking, The Progressive Agenda and Cash Transfers

with 20 comments

In my posts on the subject of cronyism and rent-seeking, I have drawn heavily on the work of Mancur Olson. My views are also influenced by my experiences of cronyism in India and comparing it to the Olsonian competitive sclerosis that afflicts most developed economies today. Although there are significant differences between cronyism in the developing and developed world, there is also a very significant common ground. In some respects, the rent-extraction apparatus in the developed world is just a more sophisticated version of the open corruption and looting that is common in many developing economies. This post explores some of this common ground.

Mancur Olson predicted the inexorable rise of rent seeking in a stable economy. But he also thought that once rent-seeking activities extracted too high a proportion of a nation’s GDP, the normal course of democracy and public anger may rein them in. Small rent seekers can fly under the radar but big rent-seekers are ultimately cut back to size. But is this necessarily true? Although there is some truth to this assertion, Olson was likely too optimistic about the existence of such limits. This post tries to provide an argument as to why this is not necessarily the case. After all, it can easily be argued that rents extracted by banks already swallow up a significant proportion of GDP. And there is no shortage of corrupt public programs that swallow up significant proportions of the public budget in the developing world. In a nutshell, my argument is that rent-extraction can avoid these limits by aligning itself to the progressive agenda – the very programs that purport to help the masses become the source of rents for the classes.

A transparent example of this phenomenon is the experience of the Mahatma Gandhi National Rural Employment Guarantee – a public program that guarantees 100 days of work for unskilled rural labourers in India. In a little more than half a decade since inception, it accounts for 3% of public spending and economists estimate that anywhere from a quarter to two-thirds of the expenditure does not reach those whom it is intended to help. So how does a program such as this not only survive but thrive? The answer is simple – despite the corruption, the scheme does disburse significant benefits to a large rural electorate. When faced with the choice of either tolerating a corrupt program or cancelling the program, the rural poor clearly prefer the status quo.

A rather more sophisticated example of this phenomenon is the endless black hole of losses that are Freddie Mac and Fannie Mae – $175 billion and counting. The press focuses on the comparatively small bonus payments to Freddie and Fannie executives but ignores their much larger role in the back door bailout of the banking sector. Again the reason why this goes relatively uncriticised is simple – despite the significant contribution made by Fannie and Freddie to the rents extracted by the “1%”, their operations also put money into the pockets of a vast cross-section of homeowners. Simply shutting them down would almost certainly constitute an act of political suicide.

Source (h/t to David Ruccio)

The masses become the shield for the very programs that enable a select few to extract significant rents out of the system. The same programs that are supposed to be part of the liberal social agenda like Fannie/Freddie become the weapons through which the cronyist corporate structure perpetuates itself, while the broad-based support for these programs makes them incredibly resilient and hard to reform once they have taken root.

Those who cherish the progressive agenda tend to argue that better implementation and regulation can solve the problem of rent extraction. But there is another option – complex programs with egalitarian aims should be replaced with direct cash transfers wherever feasible. This case has been argued persuasively in a recent book as an effective way to help the poor in developing countries and is already being implemented in India. There is no reason why the same approach cannot be implemented in the developed world either.

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Written by Ashwin Parameswaran

November 7th, 2011 at 2:25 am

20 Responses to 'Rent-Seeking, The Progressive Agenda and Cash Transfers'

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  1. Sure, some have popular support. But you’ve forgotten at least one that has only half-hearted support, which is one of the absolute worst when it comes to perpetuating the technological/economic status quo: Intellectual Property Rights.


    7 Nov 11 at 2:42 am

  2. Ashwin: “complex programs with egalitarian aims should be replaced with direct cash transfers wherever feasible.”

    Don’t forget: Don’t enforce claims against the value of those transfers. Otherwise lenders will quickly move to collect their full value via predatory payday lending, micro-credit, department store credit cards, whatever.


    7 Nov 11 at 7:31 am

  3. Foppe – I agree. Was just focusing on the topic of rent extraction from populist programs. IP is more of a typical Olsonian rent device where most people aren’t motivated enough to oppose it. Occupational licensing and much of the regulatory apparatus is also geared up to protect incumbent rents.

    K – Excellent point. It needs to be a transfer that the individual cannot contract away else it still ends up being gamed by the corporate system.


    7 Nov 11 at 7:49 am

  4. Sadly, there are opportunities for rent seeking even in direct cash transfers. Banks have inserted themselves as an intermediary making huge profits administering programs.


    7 Nov 11 at 2:11 pm

  5. geerussell – My suggestion is simply along the lines of either being able to collect cash or have it sent to an account. Your example if exactly the kind of thing that needs to be eliminated – food stamp debit cards from JP Morgan!

    I’m not in favour outsourcing state functions to private firms – only increases cronyist rent-extraction and introduces perverse incentives.


    7 Nov 11 at 2:32 pm

  6. So you are calling for a permanently active process which dissolves rent opportunities before they have time to be entrenched.

    In essence, that a civilization be ordered such that there is no order and all its constituent parts are in brownian motion (as in a gas in thermal equilibrium), in contrast to a social state in which such degrees of freedom are restricted (e.g. rents) so as to be analogous to a phase of matter in which we have some liquid, plus some evaporation and condensation cycle?

    I think that’s what you are saying?

    If so are your troubled by the notion that a system existing in thermal equilibrium cannot perform any actual work? Physical systems can perform work only when they move from a low entropy state to a higher entropy state.

    Though, energy can be injected into the system from without. What is this vital source of energy in your model, that allows a system of many parts in equilibrium to perform useful work, and is it possible that the application of this external energy source could be effective without in the process creating rents?


    7 Nov 11 at 5:54 pm

  7. Situations of permanent order or permanent disorder are both unrealistic and hazardous. My point is that we have tilted too far towards the order side of the equation. The majority of any system is likely (at a given point of time) to be homogeneous and in order – but the constant threat of new firm entry can provide the requisite diversity without sacrificing much in terms of efficiency. Parallel concepts exist in biology and ecology (degeneracy and weak links).

    Just like in ecological systems, when the system becomes fragile and excessively ordered the signs are not obvious in the good times. By the time the problem is obvious there is no obvious way to revert back to a healthy state without some sort of systemic collapse.

    Thermal equilibrium is not a good parallel – my view of the economic system is one of constant disequilibrium both at micro and macro levels. And yes I am not assuming that we are energy-constrained.


    8 Nov 11 at 1:41 am

  8. So in what cases might the existence of order not be a result of some rent, or vice versa? Can you give one or two examples of social and financial order which don’t confer rents on some of the players?

    My general view is that in basic social terms we may have three kinds of relationship:

    – one to one
    – many to many
    – many to one

    rents are implied in the last type. Banks, governments, firms, insurance, broadcast media etc all use this type. All of these institutions confer social benefits but also result in rents.

    Am I right in thinking you accept the concept of a permanent rent flow as long as the recipients change?

    Liminal Hack

    8 Nov 11 at 4:55 pm

  9. “Am I right in thinking you accept the concept of a permanent rent flow as long as the recipients change?”
    Absolutely – Existence of rents is not the problem, as long as the rents are contestable and contested on a regular basis.

    Obviously there are some rents which are much closer to corruption which I oppose but this is an unrelated matter.


    9 Nov 11 at 6:48 am

  10. Actually, the GSEs do not help the public at all. If they did not
    exist at all then yes, interest rates would be higher. But, then
    prices would be lower so that the net of these programs from the
    public’s point of view is zero.

    don brown

    9 Nov 11 at 2:19 pm

  11. Don Brown, I think you are wrong that rates would be higher without the GSEs.

    See here:

    and also please see Frances Wooleys post linked from the link above.

    The notion that rates would be higher implies that an infinite number of private savers can hold base money cash in preference to lending. And of course, that is impossible when the base money supply is a small fraction of the broad money supply.


    9 Nov 11 at 3:13 pm

  12. Great to see you independently arriving at a perspective that I’ve been advocating for years. Due to public choice theory generally,

    with Mancur Olson as an important thinker in this tradition, we know that government actors respond to incentives much as market actors do, with dysfunctional outcomes a predictable routine result.

    Here you call attention to the entirely predictable “Bootleggers and Baptists” phenomenon in which self-interested entities (“Bootleggers”) create an alliance with do-gooders (“Baptists”) in order to pass legislation that benefits the interested entities. If you do not already know Yandle’s article by this name and the follow-up literature you will find it richly documents the phenomena you describe above,

    An example I hadn’t thought of is the fact that the largest lobbies for the estate tax is the life insurance industry; the larger the estate tax, the more likely people are to use life insurance as a tax shelter. Timothy Carney documents how the life insurance industry spent more than $10 million a month when the estate tax was being debated to expand a business that was roughly $15 billion at the time,

    Even after studying economics and being familiar with the regulatory dynamics, it had never occurred to me that the estate tax debate was being manipulated for private gain.

    To take another example, I once spoke with the general counsel of Green Mountain Energy, the largest retailer of wind energy in the U.S., and they said that Texas (not usually thought of as the center of the U.S. environmental movement) was their best market because it had the least regulated electricity market. Everywhere else the utility regulators had created all sorts of arcane systems for regulating power companies that essentially bolstered the monopoly positions of the old coal-powered companies and made it tough for new entrants to compete.

    But simply because government regulatory systems are typically captured by the interests they regulate does not imply that we should not help the poor.

    I see it as a deep historical tragedy that economic freedom, which is necessary for prosperity, has been “branded” right-wing, when a completely consistent intellectual position may be based on the notion that governments provide money to the poor directly while also avoiding the pathological incentives inherent in government programs and regulations.

    For a practical private approach to this, a variant of which I’m working on now in Honduras, is to create free zones (or now Free Cities) and then use a portion of the resulting land value gains to create community trusts for health, education, women, children, etc. See this paper for a sketch of how to do this,

    In principle we could create thousands of profitable Free Cities around the world, create trust funds for education, health care, etc. for the poor WHILE creating millions of jobs, and thereby create a private, for-profit approach to helping the poor that is orders of magnitude more effective than anything we are doing at present.

    Contact me for details on my current Honduran Free City project or forthcoming projects in Belize and Senegal.

    Michael Strong

    9 Nov 11 at 4:51 pm

  13. Liminalhack – I think Don’s point is not so much that all rates will be higher but that the mortgage rate will be higher. Clearly Freddie and Fannie sell their insurance at far less than market rates which reduces the implicit credit spreads on high LTV mortgages.

    Don – If we remove the GSEs the fall in home prices and the rise in the rate at which refinancing can be done will both hurt existing homeowners who by themselves are quite a large “special interest”. It may cancel out for potential new homeowners of course.


    9 Nov 11 at 5:10 pm

  14. Michael – Thanks for the insights.

    I’m familiar with Bruce Yandle’s work. My examples are similar to the ‘Bootleggers and Baptists’ phenomenon but different in the sense that the recipients of the programs I’ve highlighted constitute such a large percentage of the electorate that it’s inaccurate to call them a “special” interest. It’s almost as if a program is set up that showers small amounts of subsidy on 10-20% of the population and is then managed such that it forms a stable source of rents for the “1%”.

    I share your frustration – issues like minimising regulatory barriers to entry are egalitarian concerns but they’re never taken as such. In some respect, I see countries like Denmark as much more “free market” than the United States where capitalism seems to be synonymous to crony capitalism.

    I’ve been following your work on Free Cities – will email you on that.


    9 Nov 11 at 5:29 pm

  15. I don’t think that distinction is what Don was driving at otherwise he could not have inferred that prices (in the general sense) would be lower.

    Ultimately if you have more people wishing to defer than prepone consumption, then in aggregate real rates must be negative.

    However its also perfectly valid to hope that the interest rate spread between productive investments and non productive ones would be wide.

    But then again, individual investors don’t care about that, they just need to find someone to bear a promise reliably into the future. Given that land is one of the primary, if not the primary, means of transferring wealth intergenerationally without the intervention of government, its not unreasonable to assume that in the long run, the return on land secured loans must be limited.

    As I said, the only way you can get out of that is to assume perfect risk free money, which as you have argued many times is conductive only to social collapse.


    9 Nov 11 at 5:51 pm

  16. The only protection against rent-seeking is a strict adherence to constitutional limits on government power, and a principled defense of individual liberty.


    19 Nov 11 at 10:11 am

  17. […] I think that’s stupid. I do generally believe direct cash transfers to the poor are a better form of welfare than many of the corrupt, complex programs we have in place today (including student loan subsidies), but I think, for education, what Yglesias is suggesting skips a […]


    24 Dec 11 at 3:10 pm

  18. […] when intervention is called for, we can stop the very wealthy from using middle-class retirees as human shields, and thereby create political space to adopt expansionary […]

  19. […] rein them in. Olson was almost certainly too optimistic in making this argument. In an earlier post I explained how crony capitalists can avoid these limits by piggybacking upon progressive programs […]

  20. […] circumstances of the un- or precariously employed is to first make the rich richer. The poor become human shields for the rich: if we let the price of stocks or houses drop, you are all out of a job. A high […]

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