Virtuous Capitalism (versus rent-seeking)

“Most people are ethical. If virtuous capitalists and entrepreneurs had higher social standing, there might be more of them, and fewer rent-seekers. In the long run, everyone would benefit.”

Every year, the federal government distributes more than $100 billion in corporate welfare. The handouts include thousands of subsidies, mandates, bailouts, and grants. Cronyism also includes favorable regulations to keep competitors out and many other types of other special treatment.

“Rent-seeking,” the term economists use to describe seeking these unethical government favors, is clearly a huge industry. But a major question remains: why isn’t there even more of it? I recently co-authored a paper with Fred Smith on this very topic.

The Tullock Paradox

Lobbying is a $3.5 billion industry resulting in $100 billion annually to its beneficiaries. That’s a 30-fold return. Not 30 percent, 30-fold. The Dow Jones averages an 8 percent annual return. It is a minor miracle there isn’t more rent-seeking than there already is.

So the question becomes: why so little rent-seeking? This is called the Tullock Paradox, in honor of the late, great Gordon Tullock, who pioneered the modern understanding of rent-seeking.

Tullock’s economic analysis offers several convincing answers for why there is so little rent-seeking, compared to what one would expect. His first theory is the lottery model of rent-seeking. If the government offers a million-dollar subsidy, a company could potentially spend nearly that much to secure it. But if 10 companies chase that subsidy by spending $100,000 each on lobbying, the winner reaps an astronomical profit. But the nine losers’ combined losses strongly diminish the total returns on rent-seeking as an investment.

The second theory involves vote-trading, also known as log-rolling. If a Member of Congress wants to do a favor for a rent-seeking constituent, he must negotiate support for that favor from other politicians, who will ask for their own favors. Since each negotiation eats away at the return on rent-seeking investment, rendering the favor—or “rent”—far less lucrative by the time the Congressman buys majority support for his proposal.

Tullock’s third theory is the need for cover stories. Most people view naked cash grabs as unseemly. Therefore, companies construct cover stories to make their cash grabs look like something else. Cover stories are not free, and reduce rent-seeking returns.

Cover stories can range from multi-million-dollar national advertising campaigns to hiring lobbyists and public relations professionals. General Motors draped itself in Old Glory when it was bailed out by taxpayers, appealing to patriotic nostalgia about American manufacturing.

Renewable energy companies paint their considerable rent-seeking activities in environmentalist green. Established companies often also seek non-cash rents such as barriers to entry, licensing requirements, and other preferential regulations. These are harder to trace than simple cash transfers, hence their ubiquity. But they have much the same effect.

Tullock called his fourth theory the transitional gains trap. Existing rents often require upkeep, which over the long run reduces the rate of return. For example, New York City taxicab medallions secured very nice rents for their owners for a long time, but now that they face viable competition in the form of ride-share services like Uber and Lyft, those rents are going away.

Medallion owners are fighting reform because even though they could thrive on a level competitive playing field, giving up their rents would require a very large upfront cost. They are trapped in a bad place, and will continue to waste resources seeking ever-lessening rents.

Rest of the Story

All of these theories—and there are others—are rooted in traditional economics. And they are valid. But there is more to the story. Most—but not all!—businessmen have a sense of decency or an implicit code of honor that causes them to refrain from rent-seeking behavior, or at least do less of it than one would expect. This virtue defies quantification, which may be why many economists defy incorporating it into their analysis.

Another point: entrepreneurs deserve praise, not just criticism, where due. Economists are quick to condemn rent-seeking, and rightly so. But they rarely take the time to praise virtue or to recognize the value of cultural restraints on unethical behavior. If abstention from rent-seeking were more widely praised, there might be more of it. To the extent economists focus on rent-seeking while paying little attention to virtuous behavior, they tell only half of the full human story.

In summary: the federal government gives out an enormous amount of corporate welfare. But the real puzzle is why there is so little rent-seeking, not so much of it.

Traditional economic analysis has a number of solutions, but an overlooked explanation is simple human virtue. Most people are ethical. If virtuous capitalists and entrepreneurs had higher social standing, there might be more of them, and fewer rent-seekers. In the long run, everyone would benefit.

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Ryan Young is a Fellow at the Competitive Enterprise Institute. He is the coauthor with Fred Smith of the CEI study, Virtuous Capitalism: Why there Is Less Corruption in Business than You Think, October 20, 2015.