Rent Seeking, Job Creation, and Why Economic Inequality Matters

"As riches increase and accumulate in few hands. . . the tendency of things will be to depart from the republican standard."-Alexander Hamilton   

        One of the things that I learned by reading Atlas Shrugged last year is that, even in the mind of America/Russia’s foremost social Darwinist, all rich people are not equal. For every Dagny Taggart or Francisco d’Anconia creating wealth wealth and adding value to the world, Rand shows us a James Taggart or a Wesley Mouch amassing a large fortune without producing anything of value. Those in the second class of millionaire create neither wealth nor jobs; rather, they harness the power of the state to distribute existing wealth in ways that favor their private interests. Rand refers to these people as “looters.”       

       I did not know until I read Joseph Stigletz’s wonderful new book, The Price of Inequality, that economists have a word for this too. Trying to profit by capturing, rather than creating wealth is called “rent seeking,” using a very old sense of the word “rent” that means something like “seeking concessions” rather than “deriving income from property.” Rent seeking refers to any economic activity that attempts to manipulate political or social conditions to lay claim to a larger share of a society’s wealth. 
        Today, rent-seeking activities include no-bid government contracts, special tax incentives, sanctioned monopolies, competitive barriers, legal immunities, infrastructural improvements, and regulatory relief that shifts resources away from one part of the economy and towards another. Rent seeking also occurs when economic activity imposes costs on others that are not charged against profits--such as, say, a company that creates air pollution but is not charged for treating respiratory diseases that occur as a result. Countless other industries--from pornographers to investment bankers to for-profit colleges--realize profits far in excess of their value by shifting costs (failed marriages, increased economic risk, and student loan defaults) to society and government, who are forced to pick up the tab.
       Rent seekers have been with us always. But Stiglitz sees rent-seeking activities as both a primary cause for, and as the inevitable result of, the most recent “great recession.” Those who profited from the real-estate bubble and from complicated financial derivatives were not, by any stretch of the imagination, creating wealth. They were reaping huge profits by transferring economic risk to the public sector while keeping nearly all of the profits in the private sector. As result, the people who have paid the highest economic costs of the recession (losing their jobs or their houses) are not the same people whose economic activities are the most to blame. 
       But what really interests Stiglitz (and me too) is what has happened since the crash of 2008. According to a certain narrative, the only way out of the recession is to cut taxes dramatically and put as much money as possible into the hands of job creators—business owners and innovators who have the intelligence and the inclination to use that extra money to create jobs and move the lagging economy forward. And, to a large extent, this is what we have tried to do.
       But it hasn’t worked very well. Look at the following chart, which shows how some key economic indicators have fluctuated in the years before and after the great crash:

	Bottom Fifth Income	Top   Fifth Income	Top 1 % Income	GDP (IN TRILLIONS) ON 6/30	UNEMPLOYMENT RATE ON JUNE 30	PERSONAL INCOME TAX AS % OF GDP	TOTAL CORPORATE TAX AS % OF GDP
2006	11,352	168,170	297,405	13.33	4.60	7.90%	2.70%
2007	11,551	167,971	287,191	13.98	4.60	8.40%	2.70%
2008	11,656	171,057	294,709	14.42	5.60	8.00%	2.10%
2009	11,552	170,844	295,388	13.89	9.50	6.60%	1.00%
2010	10,994	169,391	287,201	14.41	9.40	6.30%	1.30%
2011	11,239	178,020	311,444	15.59	9.10	7.30%	1.20%

Notice anything interesting? Here are a few things that popped for me:

•    The bottom 20% of wage earners have not yet caught up to where they were in 2006.
•    The top 20% of wage earners are much better off than they were before the recession began, as are the top 1%.
•    The GDP has recovered from the recession and continues to grow.
•    The federal tax burden remains lower than it was before the recession began.
•     Unemployment in 2011 was nearly twice what it was before the recession began.     

       Let us add to these facts a rather stunning figure that Stiglitz cites, which is that, between 2009 and 2011, the top 1% of wage captured 93% of the income growth (compared to 65% between 2000 and 2007). The (admittedly oversimplified) bottom line goes something like this: we successfully transferred a lot of money rich people, and they kept it. If Stiglitz is correct, this happened because the aforementioned rich people were engaged in economic activity aimed at capturing, rather than creating, wealth.             
        And this kind of social inequality founded on rent-seeking has real consequences, the most important being that, when wealth is simply redistributed upwards, there is nothing that can trickle down or create jobs. Neither Stiglitz nor anybody else suggests that we can or should get rid of inequality. He is not a Marxist or even a particularly committed redistributionist. He believes that markets have tremendous power to create and distribute wealth. But unregulated markets will always flow towards deep inequalities of wealth and income. Like so many other good things (chocolate, oxygen, and close relatives to name a few), capitalism works best when it is diluted.

        Inequality in America is worse now than it has been since the late 19^th century, when factory workers were paid in company script and the most important industry in the Southern states was sharecropping. The distribution of wealth in the United States (as measured by the Gini coefficient) is about as unequal as it is in Iran and far less equal than it is in nearly every other country in the Industrialized West. In the long term, this will have serious consequences for America. High levels of income inequality are incompatible with political stability, public investment, and long-term expansion. And in the process, we risk creating precisely the kind of self-perpetuating, multi-generational aristocracy that America was founded not to be. 

The Poker Economy

        In his new book, The Signal and the Noise, Nate Silver’s deals with a whole lot of things that human beings try to predict in advance: earthquakes, hurricanes, political elections, the stock market, and on and on and on. In my opinion, though, the best chapter in the book is about poker. Silver himself was once an avid online poker player who (he reports) made more than 400,000 during the years that he played the game. But his success lasted only for a few years, during what he calls “the poker bubble,” and the reason that the bubble burst is explained quite clearly in this graph found on page 318:

       You see, it’s all about the suckers--the bad players who lose heavily and whose losses allow the good players to win. Though anybody can win a single hand of poker, the people who win consistently over long periods of time have certain definable skills: they understand human nature extremely well, they are willing to realize small gains over long periods of time, and they have a deep intuitive understanding of probabilities. These skills are real, and they can lead to moderate-to-high incomes for the best players in the game.
       But whatever the final position of the players, wealth is not created during a poker game; it is merely transferred from those who do not understand the rules of the game very well and towards those who do. But this transfer of wealth only last as long as the suckers stay in the game. When they get fed up and leave, the whole game pretty much collapses until some new suckers can befound to take their place.
       And this is exactly sort of more or less what Stiglitz says in The Price of Inequality, except for “people who understand the rules of the game” read “the upper 1% of our society” and for “suckers” read “the rest of us.” It doesn’t have to be this way, of course. There really is such a thing as creating wealth, and when people do it, we all benefit by the increase in the size of the socioeconomic pie. What Stiglitz emphasizes, however, is that there is another kind of economic activity (he calls it “rent seeking”) that leverages a superior knowledge of the rules, and a higher ability to influence the game, to capture a larger share of the existing wealth without creating anything new.
       Throughout The Price of Inequality, Stiglitz presents evidence that much of the current economic activity follows the logic of the poker table, where the goal is to increase one's own share of the winnings rather than the overall size of the pot. Under such logic, strategies to create jobs by stimulating economic activity do not. New jobs require new wealth, but what we are getting is old wealth in different hands. Rich people are getting significantly richer by using their knowledge and their power to transfer more of society’s existing wealth to themselves, which is propelling income disparities to third-world levels.

       According to one narrative of the current recession, unemployment remains high because job creators are still being taxed too much. If we stop stealing their money, they will be able to do what they do best: create new wealth and produce new jobs. But this formulation only works if we are living in an economy where the highest performers are creating new wealth. If Stiglitz is right, we are living in a poker economy, one in which the top players are simply better able to game the system than the suckers. To the extent that this is the case, continuing to tilt the playing field towards the current winners is probably the stupidest thing that we can do. Even the worst poker players will often refuse to change the rules to make them lose their money even faster.

       Will the majority of Americans ever do the same? In the 1998 poker movie Rounders, Matt Damon gives us a warning: “If you can't spot the sucker in the first half hour at the table, then you ARE the sucker” (Silver, p. 317). As this is very likely the case in our economy today, isn’t it about time that we stopped playing the game?