What it means
Economists use the word rent for income that exceeds what is needed to bring a resource into use. A business that earns a rent has a protected position, such as a licence or a monopoly, that lets it charge more than a competitive market would allow.
Competition normally wears such extra returns away, which is why firms value anything that keeps rivals out. The idea was developed by economists such as Gordon Tullock and Anne Krueger in the twentieth century.
They observed that firms sometimes find it more rewarding to compete for political favours than to compete on price and quality. Their work showed that competing for a favour can use up real resources.
Typical examples include lobbying for import tariffs, for subsidies, for licensing rules that keep competitors out, and for contracts awarded without open bidding. The firm that wins the favour gains, but the customers or taxpayers who pay for it lose.
The gains are concentrated in a few hands while the costs are spread thinly across many people, which makes the problem hard to resist politically. The cost to society is large because the money and effort spent on winning the favour produce nothing useful.
Economists describe this as a waste of resources and, in extreme cases, argue that the amount spent chasing a prize can approach the value of the prize itself. This is why the pattern attracts so much attention from policy makers.
In business, rent-seeking raises practical questions for investors and managers. Profits that depend on a regulation or a protective rule are less secure than profits that come from lower costs or better products, because rules can change after an election.
Investors therefore ask how much of a company's earnings would survive if the rule were repealed. Not all lobbying is rent-seeking.
Asking a government for clear, fair rules or to correct a real market failure is different from asking for a special advantage over rivals, and the dividing line is often a matter of judgement. A useful test is whether the activity makes the whole economy bigger or only moves money from one pocket to another.
In practice
Real-world examples.
Example
A domestic steel producer spends $3,000,000 a year on lobbying for tariffs on imported steel. If the tariffs raise its profit by $20,000,000, the spend looks highly profitable to the company. Customers who pay higher prices bear the cost, and the lobbying itself adds nothing to output.
Example
A taxi company campaigns to limit the number of licences issued for ride-hailing services. Existing licence holders keep high fares and the value of their licences. A new entrant with lower costs is kept out of the market. Passengers pay more and wait longer, while the licence holders enjoy an income that they did not earn through better service.
Example
Inside a large manufacturer, two division heads spend months preparing competing presentations to win a larger share of the capital budget. The effort is not directed at improving products or processes. The chief financial officer redesigns the budget process so that funding follows measured returns. The new process also makes it harder for the best presenter to win over the best project.
Case study
Seen in the real world.
Eastgate Freight is an illustrative, fictional trucking company that dominated a regional market through a licence held by only five operators. When the regulator proposed granting new licences, Eastgate and its rivals spent a combined $4,000,000 on lobbying and legal challenges.
The new licences were delayed for three years, and freight prices stayed high throughout the period. A study commissioned by customers estimated that businesses paid an extra $18,000,000 a year in freight costs.
When the licences were finally issued, Eastgate had to cut its prices and its profits fell. In this illustrative story, the company's board concluded that its earnings had been protected by regulation rather than efficiency, and it began investing in route planning and fuel savings. It also told investors that part of its past profit had been protected by the licence system and might not repeat.
Watch out
Common mistakes.
- Treating all lobbying or political activity as rent-seeking, when requests for clear and fair rules are normal parts of business life.
- Counting profits that depend on a special rule as if they were permanent, when a change in policy can remove them.
- Confusing rent-seeking with earning rent from property, when the economic meaning is about capturing unearned gains.
Questions
People also ask.
Is rent-seeking illegal?
Not always, because much of it is lawful lobbying, although corruption and bribery to win favours are illegal.
Why do economists worry about rent-seeking?
The resources spent chasing favours could have been used to make goods and services, and the resulting protection often raises prices for customers. Economists also worry that talented people are drawn into lobbying instead of production.
How can investors spot rent-seeking?
Look for profits that rely on licences, subsidies or tariffs, and for companies with large political spending compared with spending on research or efficiency. Footnotes in annual reports often reveal how much depends on a single licence or contract.
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