“Rent-seeking” and the American 1 percent

Over the Labor Day weekend, I read another good book about the U.S. economy.  It is THE PRICE OF INEQUALITY: How Today’s Divided Society Endangers Our Future by Joseph Stiglitz, a Nobel economist and former chief economist for the World Bank.

Stiglitz argued that most American economic problems are due to excessive economic inequality, and to the “rent-seeking” behavior that, according to him, brought this inequality about.

Rent-seeking is a pejorative term used by economists for people who try to get income not by creating value, but by extracting wealth from others.  Conservative and libertarian economists apply the term to high-level government bureaucrats and recipients of government subsidies.  Stiglitz said the worst rent-seekers are Wall Street financiers and some of today’s corporate CEOs.

Stiglitz won his Nobel for his work on “asymmetric information,” which is about how, in the marketplace, insiders can take advantage of outsiders.  The mortgage crisis is an example of this.  My friend Marie said once told me that she assumed a banker would not lend you money unless he had good reason to think you could pay him back.  The average borrower prior to the crash had no way of knowing that this was no longer necessarily so.

Banks knowingly lent money to people they knew couldn’t pay them back, and then securitized the loans and sold them to people who didn’t understand the risk. The mortgage securitizers were rent-seekers.  They did not create value; they exploited their positions of trust and access to inside information.

The bank bailout took rent-seeking a step further.  The heads of the big Wall Street firms expected and got help from the government, both because of their influence in Washington and because of the argument that they were too big to fail without bringing down the whole U.S. economy.  Again, they weren’t creating value.  They were exploiting their positions.  Then, too, even if the banks had failed, the bankers responsible for the failure would not have suffered much.  By virtue of their positions, they would have collected enough in salaries and bonuses to walk away from the collapse and live very comfortably.

Some other examples of rent-seeking.

• Excessive compensation of CEOs.  When CEOs of failing corporations get a performance bonus, this is completely different from the success of an entreprenuer, who has created something valuable and new.
• Buying up public resources at bargain rates.  Typically rights to oil, gas and timber on U.S. public lands are granted at a fraction of their market value.  Privatizing of public services in Russia allowed insiders to acquire valuable assets for little or nothing; I wouldn’t be surprised (this is my example, not Stiglitz’s) if the same thing happened when and if the U.S. Postal Service is shut down.
• Deregulation.  This may not seem like a form of rent-seeking, so let me explain.  Suppose you are the head of an oil company drilling in the Gulf of Mexico.  If there are no regulations requiring you to adopt the best practices of industry, and a disaster happens because of your negligence, neither you nor your stockholders will have to pay the full cost.  The cost will be imposed on fishermen and property-owners in the vicinity.

If Stiglitz is right, and I think he is, the first step toward making the American economy more productive would be to change the rules so that people are rewarded for their work and their achievements, not their ability to milk the system.  Like all good ideas, this can be taken to an extreme.  The limited-liability corporation could be regarded as a form of rent-seeking, because stockholders have no responsibility for the debts and liabilities of a company beyond what they put in.  But there definitely is a need to improve corporate governance and make corporate executives more accountable.

Inequality to the degree that it currently exists in the United States is an important social problem, Stiglitz wrote.  It wouldn’t be such a problem if it were due to successful entrepreneurship  like that of Henry Ford or George Eastman in the past.  These tycoons acquired vast wealth, but they also created new wealth.  The current crop of CEOs and financiers—not all of them, but many—have enriched themselves by transfer of wealth from others to themselves.

Joseph Stiglitz

Extreme economic inequality disconnects the lives of the elite from the mass of their fellow citizens, Stiglitz wrote.  They live in gated communities, send their children to private schools and associate with each other.  They have no reason to care—at least, not in the short run—about unemployment, education or public services.   To the extent that they are in a position to influence government policy, these concerns will be neglected.

Upward redistribution of wealth made the recession worse and the recovery slower, Stiglitz wrote.  The true job creators are consumers.  Nobody will produce goods and services unless someone will buy them, and mass prosperity depends on working people and the middle-class having enough income to create a mass market.  When the mass of the public are able to buy the products of industry, everybody does well, including the upper 1 percent.

Stiglitz outlined a program for reducing inequality and curbing rent-seeking.  He thinks it is possible to reduce inequality and stimulate the economy through the tax system and still balance the budget; this would be done by shifting the tax burden upward and the benefits of government programs downward, so as to increase consumer spending.   Maybe that would work, but I doubt it.   The most valuable part of the book is his definition of rent-seeking, and how it applies to the U.S. economy.

If you don’t have time to read the entire book, I recommend you check it out of a public library and read Chapter Two.

Click on From The Price of Inequality: Joseph Stiglitz on the 1 Percent Problem for an excerpt from the book.

Click on The Price of Inequality: Interview With Joseph Stiglitz by Jared Bernstein for Rolling Stone.

Tags: Economics, Joseph Stiglitz, Rent-Seeking, The Price of Inequality, Wall Street