CHAPTER 2

RENT SEEKING AND THE MAKING OF AN UNEQUAL SOCIETY

American inequality didnt just happen, it

was created. Market forces played a role
and also from the results of government
policy, both what the government did and
did not.

American
Inequality

During economy recession, wages, employment,

sales, and profit will fall. However, there are many
firms are making good profit. It shows something
is not right somewhere.
Americans 1 percent used their power to strengthen their
economy and political positions, or at least maintaining
it.

Precapitalist

Modern economy, Ancient

Greeks
- those at the top society - power was the origin of
were there because of divine inequality
right
- the conquers had the right
to extract as much as they
could from the conquered
Competitive forces should limit outsize profits. If the government
does not ensure markets are competitive, it will result in large
monopoly profits. Competitive forces also limit disproportionate
executive compensation.
Ways to limit inequality: Progressive tax & Expenditure policies (tax
richer more than poor and provide systems of good social protection)
Political system has increasingly working in ways that increase the inequality of
outcomes and reduce equality of opportunity.
Rent seeking; activity that getting income not as reward to creating wealth, but by
grabbing wealth without effort.

GENERAL PRINCIPLES
Adam Smiths Invisible Hand and Inequality
Invisible Hand
Definition: The unobservable market force that helps the demand and
supply of goods in a free market to reach equilibrium automatically
Adam Smith assumed that an economy can work well in a free market
scenario where everyone will work for his/her own interest. He explained
that an economy will comparatively work and function well if the
government will leave people alone to buy and sell freely among
themselves. He suggested that if people were allowed to trade freely, self
interested traders present in the market would compete with each other,
leading markets towards the positive output with the help of an invisible
hand.
Anyhow, this has lead to disastrous for society because of self-interest.
There is conspiracy amongst trade people against public to raise price.
There is role for government to correct the market failure. The government
may design policies such as taxes and regulations that bring private
incentives and social return into alignment.
However, government never corrects market failure perfectly. The
financial sector used its political muscle to make sure that the market
failure were not corrected, and that the sectors private rewards remained
well in excess of their social contributions one of the factors contributing
to the bloated financial sector and to the high levels of inequality at the
top.

Shaping Markets
i.

Private financial firms and business people act to ensure that markets dont work well.
Their focus is not to enhance societal well-being broadly understood or even to make
market more competitive. Their objective is simply to make markets work for them, to
make them more profitable.
o When markets are competitive, it is difficult to maintain profits above normal
return. This is because when a firm makes grater profit, their rivals will attempt to
steal customer by lowering price. As firms compete, prices fall and it is a disaster
for profit seeking firms.

ii.

Market transparency

The more transparent markets are, the more competitive

the market. This is the reason why less transparent is a
favorite.
Lack of transparency results in more profit for the bankers,
it leads to lower economic performance. Without good
information, capital markets cant exercise any discipline.
Money wont go to where returns are highest, or to the
bank that does the best job in managing money.

Moving Money from the Bottom of the Pyramid to the Top

i.
ii.

iii.

Those at the top make money by taking advantage of their market and political power to
favor themselves and to increase their own income.
Rent seeking
Definition: when a company, organization or individual uses
their resources to obtain an economic gain from others
without reciprocating any benefits back to society through
wealth creation.
Example: when a company lobbies the government for loan
subsidies, grants or tariff protection. These activities dont
create any benefit for society.
Those in financial sector take advantage of the poor and
uninformed, as they made enormous amount of money by
preying upon these groups with predatory lending and
abusive credit card practices.
Tax system
Those at the top managed to design a tax system which they
pay less than their fair share. They pay a lower fraction of
their income compared to those poorer.

RENT SEEKING

ADAM SMITH =

The practice of an individual, company, or

government attempting to make a profit without
making a products, producing wealth, or
otherwise contributing to society.

when property rights are weakened and the

ownership of someones wealth or goods is
debatable, people can gain more by trying to
appropriate that wealth than by producing
themselves
Rent the returns to land, the owner of land receives these payments by virtue of his ownership,
not because of anything he does.
Monopoly rents / monopoly profits the income that one receives simply from the control of a
monopoly
Quota rent if the government gave a company the exclusive right to import a limited amount (a
quota) of a good, such as sugar, then the extra return generated as a result of the ownership of
those rights
Rent seeking behavior not only in the resource-rich country (Middle East, Africa, Latin America)
but also in modern economics getting state assets at below fair-market prices
- asset could be bought or sold in a current transaction between willing parties
Selling to government products at above market prices (open government subsidies/hidden
subsidies). Private sector also can rents from public through monopolistic practices or exploiting
those who are less informed and educated. Private rent-seeking takes the form of theft, piracy,
litigation, and other forms of transfer between private parties.

RENT SEEKERS
Wealth distribution (Americas inequality) many investors or scientists who made such a large
contributors to our well being, none of them are among those most rewarded by our economics
system.
Geniuses at business, Steve Job and Mark Zuckerberg listed at Forbes list worlds wealthier
billionaires but there also have a such important people who never list on Forbes such as Tim
Berners- Lee (World Wide Web).
Carlos Slim (Mexican business, telephone industry)- able to charge price that are multiple of
those in more competitive markets, acquire large share in Mexico telecommunication.
Top flight lawyers (become wealthy by helping people) help people write the complex tax laws,
design complex and transparent derivatives market, design contractual arrangements that
generate monopoly power to loopholes.
Monopoly rents : creating sustainable monopolies.
Government sanctioned monopolies The copyright monopoly is not a natural right. It is a
government-sanctioned private monopoly, granted under the assumption that no culture would
get created if theres not a profit motive behind it, and that this profit motive can only be realized
in a monopolized setting.
Firms can create entry barriers maintaining standards, restrictions on entry.
Factors contributed to increased monopolization of markets.
i)

There was a battle over ideas about the role that government should take in ensuring
competition.

ii)

Changes in our economics

iii)

Businesses found new ways of resisting entry, of reducing competitive pressures.

Politics : getting to set the rules and pick the referee.

There are many leaders in these sector (FCC and SEC) use their political influence to get people
appointed to the regulatory agencies who are sympathetic to their perspectives.

Regulatory capture : Regulatory capture happens when a regulatory agency, formed to act in the
public's interest, eventually acts in ways that benefit the industry it is supposed to be regulating,
rather than the public. the interests the agency set out to protect are ignored in favor of the
regulated industry's interests.
Cognitive capture : For Timothy Geithner this meant relying on, and appointing to powerful
positions, financial executives from the firms he was connected to and felt comfortable with. But
then, there is no guarantee that these people would not give advice favoring their firms,
knowingly or perhaps subconsciously
Government munificence
Example case : 2008 09 crisis, the derivates market played a central role, was responsible for
the $150 billion bailout of AIG.

A provision of one of the key bills deregulating the financial derivate market ensuring
that no regulator could touch it, no matter how great the peril to which it exposed the
economy also gave derivates claims seniority in the event bankruptcy.

Another example : when Federal Reserve lend unlimited money to banks at near-zero interest
rates, allows them to lend the money back to the government / foreign government at much
higher interest rates.

Giving them hidden gift who billions and billions of dollars

Protect firm from foreign competition (tariffs, taxes) as a gift to domestic company.