Prepared for the Dublin Economics Workshop Conference,

Kenmare, 16 October 1992

Though it is confined to a single reference in the text, and quarantined behind inverted commas, "rent-seeking" is a key underlying concept in the Culliton Report, providing one of the unifying themes of the Industrial Policy Review Group's recommendations. This term has had quite a vogue in the economics literature recently, though the term was coined by development economist Anne Krueger, then Chief Economist at the World Bank, in an article she published in the American Economic Review as far back as 1974.

The literature on rent-seeking encompasses a wide range of unintended consequences of government action and shows that the damaging side-effects of well-meaning government intervention can end up far exceeding the favourable direct effects.

Many extreme examples of rent-seeking have been documented in the least performing economies of Africa, South Asia and Latin America, and I will come back to the Third World in a minute. But first I owe you a precise description of the problem. This is most easily exemplified by the case of an exclusive license granted to a monopolist. As illustrated in Figure 1, traditional analysis would measure the social or overall economic welfare cost involved in this licensing arrangement as the hatched area in the figure, representing the difference between the willingness to pay and the cost of the foregone production (the so-called Harberger welfare triangle). Traditionally we have assumed that the shaded rectangle represents the licensee's excess profits, or what we call the rent accruing to the licensee; if so, the distribution of income has changed, but no further waste of economic resources or opportunities is involved.

This last presumption is questioned by the rent-seeking approach. By broadening our focus to include what goes on around the granting of the license we can see that there is ample scope for economic waste. Indeed, competition between potential licensees should result in the entire rent being competed away. If this is done in a way which involves the use of economic resources - such as hiring more lawyers and public relations staff - then the overall economic cost of the licensing arrangement consists not only of the triangle, but also potentially includes the bulk of the rent.

The logic of the argument clearly has a much wider application than simply to licensing systems. In Krueger's words "when economic policies create something that is to be allocated at less than its value by any sort of government process, resources will be used in an effort to capture the rights to the items of value". Horror stories are told of extreme cases, such as Ghana in the 1970s, when most of the educated business class was fully occupied in endeavouring to secure rationed foreign exchange at the grossly unrealistic official exchange rate -perhaps fifty times its parallel market rate, and farmers spent their time trying to smuggle produce out of the country to avoid having to surrender it to the Cocoa Marketing Board at the world price converted at the official exchange rate. I will come back to exchange rates in a minute.

In Ireland the situation is not by any means as extreme, but (like most industrial countries) we do have a history of more-or-less well-meaning government intervention to improve growth and living standards and to reduce unemployment. The facts that we have not only conspicuously failed to catch-up in average living standards against our EC counterparts but also enjoy the highest rate of unemployment in the Western World do invite us to consider whether our particular style of government interventions have in part failed because they have not taken account of the types of consideration highlighted by the theory of rent-seeking. After all, the shift of perspective which that theory enjoins on us dramatically alters our perception of the possible, and indeed likely damage of a variety of government instruments which have been widely used in Ireland over the years.

We need to be careful about bandying around this term, rent-seeking. According to some respected viewpoints, the whole process of economic growth is based on the attempt of entrepreneurs to create and exploit rents. Thus, by developing new products, opening up new markets, and refining methods of production, firms improve productivity in order to gain competitive advantage which translates into profits, a process which modern finance theory tends to call "creating value". Imitative behaviour and competition erodes the advantage soon enough, and the benefit of the new products, markets and processes is thereby passed through to the consumer generally. As the key to growth in productivity and living standards, this whole process is protected by government through patent laws, and limited through competition legislation and regulation.

Precisely because it lies at the heart of the growth process, the subversion of value creation through government policy is especially damaging. Like the well-bred greyhound chasing the artificial hare around in circles, the small entrepreneur is easily lured by the existence of discretionary government grants into a limited perspective in which the government agency, and not the market, becomes the main focus of enterprise. Successful entrepreneurs break out of the circle; but there are too few of them. This is the vision of the jaundiced eye cast by the Culliton group over IDA and similar grants for domestic enterprise. By all means, they said, let the agencies step in to fill gaps and make up for failures in the capital market; but on a basis which does not create a rent. Likewise, the excellent skills of the agencies in marketing, and in managerial and technological consultancy can still be valuable; but preferably not on a basis which perpetuates the rent-seeking mentality.

Now I often hear the objection that grants are necessary to compensate for the high tax rates and other built-in disadvantages facing industrialists. These arguments might outweigh the Harberger triangle, but are they large enough match the Krueger rectangle? Note that the argument is not that the cash being spent on grants could be applied to such a significant reduction in tax bills as to allow a sea-change in the cost environment for industry; the numbers just don't add up for that. In fact, the Culliton recommendations don't make sense without some kind of rent-seeking argument, in this case, the diversion of scarce entrepreneurial resources through what Culliton called the "grant-mentality".

But IDA grants are not the only source of Government rent creation that we have seen in Ireland over the years. Indeed, it is a peculiar characteristic of the Irish political set-up that the creation of these rents has always occasioned a sense of pride and national well-being, at least until things go badly wrong. The failure of the Goodman Group (once held in esteem as one of the great success stories of Irish industry) is a classic illustration of this, and of the theory of rent-seeking to the extent that it suggests that much of the rent created in favour of Goodman by a variety of means was dissipated. After all, we can see that, despite all of the assistance offered to the company (admittedly not all of it paid over) by the Government, it ended in a major collapse with hundreds of millions of pounds owing.

I suppose that the case of the Hospitals' Sweepstakes, though a bit passé now, is one of the most characteristic examples, where, if some reports are to be believed, a domestic monopoly and the blessing of the State helped by legal restrictions on gambling combined to bilk thousands of gullible betters who received a far lower less favourable gambling odds than they could have imagined.

Most of the State-created monopolies have (as the rent-seeking literature predicts) channelled the rents from their activities in directions other than to the Exchequer in the form of dividends. As in many countries, overmanning or over-the-odds wage-bills have characterized most of the Commercial State bodies, though this problem is well-known and has undoubtedly been tackled in recent years. Cross-subsidies are common: the compulsory off-take of milled peat by the ESB was noted by Culliton, but there are a few more curious ways of dissipating rent and wasting resources. None was more egregious than the rent that was provided for decades to a small State-owned enterprise producing a petrol additive by making its use compulsory in all petrol refined in Ireland. The additive was worthless, and the rent (one million pounds per annum) wholly dissipated in the resource costs of this enterprise which, at least by the 1980s, was barely profitable.

The VHI (for all its good work) is another de facto monopoly whose position as such has been created by Government action. While the rent from this position - along with its community rating policies - are now under threat from competition in the single European market, it is worth recalling that in cosier times part of VHI's rent was transferred on different occasions in the past to various groups including private hospital ventures (as well as to those undertaking the largely optional costs of maternity). It is extremely unlikely that these groups would have received government support from an explicit budget line: the creation of a rent nevertheless allowed them to lobby successfully for a more covert transfer. This quasi-hidden nature of the use of government created rents has been an important and damaging feature of Irish economic policy.

Mention of lobbying brings me to the link which I believe to exist in Ireland between rent-seeking behaviour and what have, in analyses of reforming centrally planned economies, been termed "soft-budget constraints" (Kornai, 1979, 86)). A soft budget constraint is a negotiable bottom line, often implemented in practice by a government-ordered extension of bank loans, or by officially tolerated payments' arrears. Because of the consequent removal of profit-and-loss account discipline on enterprise investment and cost control, Kornai and others point the finger at soft budget constraints as a major factor in the failure of the enterprise sector in those economies. In Ireland, the phenomenon has not normally been through soft bank loans. Instead, we have seen the creation or allocation of rents by government as a response to lobbying by distressed enterprises.

Some spectacular individual cases have already been mentioned but, in fact, this process has frequently become almost institutionalized, as when the IDA grant-aids capital-deepening investments for existing firms supported by the assertion that without the grant, the firm will go under. A topical example is the recently announced curious arrangement of hand-outs to exporters who didn't bother to arrange forward foreign exchange cover. These payments are to be made on a case-by-case basis, and subject to administrative discretion, and they will be confined to companies at risk. Case-by-case, and ex post, such hand-outs may appear rational, but as a system of incentives and a business environment, the signal they are giving is not one as to encourage profitability and productivity.

In fact, this process, whereby enterprises go bust and then lobby for a rent is has precisely the textbook time sequence of rent-seeking that we began with, whereby the firm dissipates all or most of the rent before actually securing it. The more likely it is that a rent or grant will be available to faltering firms, the more likely entrepreneurs will be to push their firms close to bankruptcy, knowing that the pieces will be picked up.

You may object that this is not a true picture of Irish business today. My response is that I am not attempting to provide a rounded description of Irish business, but I am talking about a structure of incentives which exists. If we believe that incentives influence enterprise behaviour we must be concerned about their effects and seek to correct them.

Dani Rodrik (1992) has recently analyzed the consequences of governments responding to special pleading and narrow interest lobbying. He points out that even a well-meaning government, if it is known to respond to short-term pressures, will induce private sector behaviour that results in lower aggregate economic performance - despite the best short-term decisions of both government and individual firms. Indeed, such a Government (he shows) will systematically underprovide economically desirable interventions, awhile systematically overproviding politically motivated and economically harmful ones. Not all Governments respond to short-term special pleading: Rodrik applies his ideas to the Rhee and Park Governments of Korea, and adduces survey results which show that businessfolk sharply distinguished between these two regimes in regard to their responsiveness to short-run pressures. I cannot help thinking that the recent Sterling-related measures here, though designed to meet an admittedly difficult situation, are not the actions of a government which looks primarily to the long-run.

I have come to the end without any mention yet of rent-seeking in taxation and in social welfare. The first was an important factor in Culliton, the second was outside the Group's terms of reference. Critique of the web of special interest and loopholes that form our tax system was a main plank of Culliton. It was surprising, therefore, to see the Minister for Finance effectively announce within weeks of the Report's appearance that the Budget he had introduced could be considered as a discussion document. Openness in Government is one thing, but we have steadily been moving to a negotiated tax regime with all the hallmarks of the soft incentive structure I have been describing. It may not be as bad as earlier examples in that few of the concessions made in Finance Acts are designed for a single recipient, but I am convinced that economic performance would be greatly improved if business had to take the tax structure more or less as a given and stable structure. And this is one reason why I would share Culliton's castigation of the tax system as complex, for complexity is an invitation to manipulation and special pleading. A flat tax is hard to tilt.

But let us not get carried away: after all, there is no doubt that policy failures, weak governments, distorted incentive structures and rent-seeking are not uncommon around the World, and Ireland is not the worst in this regard. Perhaps the problems I have been discussing are not the most decisive causes of the economy's performance being weaker than we would like. But they are problems within the ability of Government to tackle, if not to solve.

Policy economists have done much in the past decade to point to defects in the micro as well as in the macro sphere; by looking now at rent-seeking we can take the analysis further to the policy environment itself. Getting that environment right is a more subtle and long-term matter than we may have allowed ourselves to believe.

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Kornai, Janos (1979), "Resource-Constrained versus Demand-Constrained

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Krueger, Anne O. (1974), "The Political Economy of the Rent-Seeking Society",

Krueger, Anne O. (1990), "Government Failures in Development", Journal of

Mühlen, N. (1939), Schacht - Hitler's Magician: The Life and Loans of

Rodrik, D. (1992), "Political Economy and Development Policy", European

World Bank (1984), Ghana: Policies and Program for Adjustment, (Washington,