Monday, 3 December 2012

Who is harmed by rent seeking?

Stronger government and stable and consistent policies help an economy to grow. This could be one of the reasons apart from the Green Revolution, Afghan aid and post 9/11 war on terror aid that we registered higher growth in the martial law eras than in democracy. The first 12 years of democracy, from 1987-99, were marked with lower growth since the governments were not strong enough, apart from 1997-99 PML-N’s heavy mandate government. However, in the end we all witnessed that nothing is more powerful than the army in Pakistan.

Irrespective of the form of government in Pakistan, the elites (smaller part of the economy) have a comprehensive hold on the economy through their (personal) links with the bureaucrats and politicians. Hence, these links are used to make extra benefits using their positions. If these benefits can be translated into monetary units then it’s called ‘economic rent’.

Economic rents are used, according to firms, to create more wealth and to distribute among the workers to provide benefits to them. Thus, the society gets benefits from economic rents through wealth creation, known as beneficial rent-seeking. However, this might not be the case in real. Firms make extra rent/profit and do not distribute (fully) among the workers or society, known as detrimental rent-seeking. Firms/ entrepreneurs involved in such activities are known as rent seekers.

Lobbyists around the world hired by firms/entrepreneurs, work closely with bureaucrats and politicians, to protect the firms’ benefits that hire them. They do not care about society even though they always argue that they are doing it for the betterment of society. Sometimes, the lobbyist is a member of a big association in which all the firms are registered, such as APTMA’s representative will be a member from ATPMA, etc. The sad part is that if these lobbies are very strong and the government is weak, then they can easily exploit the government to make policies in their favour. We have seen that in such a situation, the government becomes part of rent-seeking.

The government’s role in developing countries like Pakistan is inevitable when private sectors do not invest due to lack of entrepreneurship or lack of profitability and confidence in the economy. The government’s role is vital in case of market failures. However, it may end up with worse outcomes since it will affect its own benefits as well, which will lead to rent-seeking by the government. Thus, the concept of rent-seeking is not limited to private firms/entrepreneurs and the government could be a rent seeker as well.

Licensing schemes, in general, lead to corruption by authorities as bureaucrats or the officers on duty use their discretionary power to award license to clients. This may lead to rent-seeking in two ways: the government creates its own monopoly as it’s the sole authority that provides licenses to clients. Therefore, government officials appointed to do this particular job may be involved in taking bribes from clients and if clients give a bribe then the total transaction cost of producing or importing increases. Thus, consumers are charged higher prices, more than the cost of production, which leads to their exploitation. In the 1960’s and 1970’s, several licensing schemes were introduced for investors, importers and exporters in Pakistan.

Industrialists always demand protection for their industries so that they can enjoy inefficient production by producing at a higher cost than the world. They ask for subsidies to cover the implicit cost of their product due to higher taxes and thus higher input prices are used in the production processes. They ask for bans and other kinds of restrictions on the final products as they do not want foreign goods to replace their product in the domestic market. With the same token, tariff cascading, lower on raw material and higher on final goods, restrict imports of consumer goods into the domestic market. Consequently, people are deprived of consuming better quality products. Finally, tax holiday, which was given to industries in the 1990’s helped producers to seek more profits. But the extra profit was not passed on to the consumers, which implies rent-seeking by industrialists. All these policies are demanded by the lobbies of different associations/industries from the government that have detrimental effects on the society. Wealth generated from these activities goes into a few hands instead of creating wealth within society.

Pakistan’s entire population is around 185 million. The household size is around 6.8, which makes 27.2 million households in Pakistan. If the government announced Rs1 per kg subsidy on wheat flour due to increase in the prices of wheat and demanded by the flour mills and let’s suppose that if 10 kg wheat flour is consumed on average each month in every household, then the government needs to give Rs272 million subsidy to the wheat flour mills. On the other hand, if Rs10 is given to each household, it will be evenly distributed among the 27.2 million families instead of Rs272 million distributed among a few wheat flour mill owners. Thus, whenever producers ask for subsidies, they get benefits in millions at the cost of few rupee savings of each household. These policies could be very sound politically but in the end, the society is not benefitted from them and a major chunk of money goes into the hands of rent seekers.

Among rent seekers, the automobile sector takes the top spot. They have been protected by high tariff rates for more than two decades now. They are still insisting that policymakers provide them more protection. Are they close to being competitive in the world market or is their sole objective rent-seeking? Since infant industry argument does not tell to protect the industry forever, we need to decide now whether it’s favourable to protect the auto sector or to start investing in some other industry, which will be beneficial for the country and society in the long run. Local assemblers were asked to follow a deletion programme and they were to achieve specific targets of deletion each year. However, the deletion process is quite slow and each year they ask for more protection. They have been facing little competition due to used car imports. Although the imported used cars are five years old, which have on an average close to 80,000 mileage, people sill prefer buying old cars than new locally manufactured cars. Local car assemblers are going to the National Tariff Commission on Nov 22, 2012 to discuss the tariff rate on old and new cars. It’s expected that they will ask for increasing used cars’ tariff rates and not allow the import of five-year-old used cars, instead allow the import of three-year-old cars.

Competition and distortions are two important terms here. Any kind of distortion may lead to rent-seeking by the principle (government) or the agent (lobbyist), which will not benefit the society. Similarly, anything that leads to go away from competition helps rent seekers to seek more surplus from consumers, thus increasing their own wealth by decreasing the society’s wealth.

rent-seeking can also be quite costly to economic growth. Since rent-seeking results in more returns for firms/entrepreneurs, it attracts more rent-seeking activity. rent-seeking activity takes away from competitive equilibrium, thus leading to lower output level. Therefore, it results in lower economic activity and lower growth rate. Moreover, it hurts innovation through lower expenditures on R&D. Since innovation or technological advancement is the core to economic growth, rent-seeking adversely impacts economic growth. As it’s mostly done by the elites or top 0.1 percent (according to income) people, it creates severe income inequality as wealth is not distributed among society. Some people argue that rent-seeking is analogous to theft because in theft thieves take your money with them and in rent-seeking again, certain people take a chunk of money with them and the rest do not receive anything.

Despite several problems in the economy, we need a ‘big push’ from specific investors to invest more in the country so that the economy is back on the growth track. However, this policy of development economics will lead us towards rent-seeking. Hence, there’s a need for long-term policy measures -- call it ‘slow and steady push’ -- which has regulations for anti rent-seeking and everyone has a level-playing field to contribute to the economy. In order to get rid of rent-seeking, we need to abolish the Statutory Regulatory Orders’ system, prepare a tariff rationalisation structure in such a way that we’ll drop the normal maximum tariff to zero in the next few years, give a specific timeframe to all the industries that are being protected for the last many years to become competitive, introduce no new quotas and bans on any product and finally, limit the government’s role in investing in those activities where the private investor can invest. Moreover, the government should focus on providing law and order, justice, property rights, basic infrastructure and ensure that competition prevails in the market.