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.
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.