Can someone explain/articulate why rent-seeking behavior is bad for an economy? Why an economy should be structured to use people’s natural greed to motivate them to create wealth.
In particular, I’m thinking about domain sharking. Ie. people who buy domain names in order to sell them rather than use it to develop a site. When the sale happens, money is just moved from the buyer to the seller with no wealth being created. In fact, the net effect is negative because it deters people from starting websites.
This article talks about rent-seeking. However, after reading it a few times, I still feel like there are some key conceptual gaps in my understanding that I’m hoping will be filled if I hear a different explanation.
Can someone explain/articulate why rent-seeking behavior is bad for an economy?
The point of the economy is to produce value (where “value” is defined as “something people want”). Accordingly you want to structure the economy in such a way as to incentivize people to produce value. Rent-seeking produces no value and, in fact, lessens the incentives for others to produce value.
Why an economy should be structured to use people’s natural greed to motivate them to create wealth.
Thanks, I really appreciate the explanations! I’m a bit confused about a few things though. I have a vague understanding, but don’t truly understand them.
1) How exactly does, say, operating a restaurant produce value?
1) How exactly does, say, operating a restaurant produce value?
Let’s say you are running a restaurant with, say, 200 customers per day on the average. This means that 200 people have voluntarily decided that the food and service your restaurant provides are worth more than the amount of dollars you have charged them. Your restaurant has produced value that is greater than your revenue. If your revenue is covering your costs (which are the value you use up in the process of running your restaurant) then you are generating positive value.
2) Why doesn’t rent-seeking produce value?
Rent-seeking is basically about redistribution of value between different people (or organizations). To take a very simple example, imagine a medieval peasant clearing a new field in the forest and growing crops there. He produces a certain amount of value. After a few years the local feudal lord learns of the new field and tells the peasant that the field is on the lord’s land and so the peasant shall pay a quarter of his crop to the lord. The amount of value produced is still exactly the same, but before 100% of it went to the peasant and now 75% goes to the peasant and 25% goes to the rent-collecting lord.
Hm, ok. I get the idea that voluntary exchange implies that the each party thinks they’re receiving something of equal or greater value in return.
I’m still a bit confused about when you can say that value is being redistributed. For example, what the lord did contributes to the precedent that land ownership is enforced, which probably has some value. How do you know when no value is being created? Are there any well accepted examples?
What do you think of the domain sharking example? I sense that it involves value destruction (rather than creation). Instead of an entrepreneur being able to buy a domain name, he has to pay a domain shark more money for it. Thus transferring money from the entrepreneur to the domain shark, discouraging entrepreneurship and wasting the domain shark’s labor.
Well, “value” is a very baseline concept. You can create value out of thin air—e.g. by singing (you can create negative value the same way :-D). For economists this concept of value is too encompassing—in most cases they prefer to talk about good and services, even better, tradeable goods and services. With these, things are easier: you can gauge their value when they trade and measure it in money. There are certain downfalls here, of course (ask an environmentalist :-/) but for most basic economics you can assume that the value of something is how much dollars/euros/gold coins/sheep you can sell it for.
So with our peasant, let’s say he was able to grow 10 bushels of rye on his forest field and their value was 100 thalers—so the “revenue” from this economic activity was 100 thalers and all of it went to the peasant. Afterwards the “revenue” was still 100 thalers, but 75 of them went to the peasant and 25 -- to the lord. Note how the total sum didn’t change—this means we’re talking about pure redistribution here.
Value destruction is also possible (you can usually treat it just as negative value). Let’s say that the cost of maintaining and working this field is 80 thalers. While the peasant was working it for himself, his “profit” was 20 thalers and that made him happy. Now, after the lord showed up, he gets only 75 thalers but spends 80 -- he’s in the red! So he abandons the field and the forest swallows it back. Our lord just destroyed some value with his rent-seeking.
You ask who benefits not from the trade, but from the agent’s existence. Let’s reason counterfactually: what would the market look like if the restaurant were removed from the equation?
If the restaurant is profitable and popular, then customers will feel sad over its absence.
If the restaurant is unprofitable and unpopular, then removing the restaurant won’t make much difference (and free up resources to be allocated elsewhere).
If the restaurant simply clears out everything from the Walmart next door, repackages it, and jacks the price, then customers will feel glad at its removal. Good riddance!
Domain Sharking is an example of Case 4. If Domain Sharks ceased to exist, then its customers would buy the website themselves at lower prices and feel glad. Domain Sharks can exist because each URL is unique by design. So if you want a specific URL, you must go through the Domain Shark. I.e. it’s a monopoly void of any positive externalities.
Contrast Domain Sharks with Stock Brokers (for lack of a better example). Stock Brokers give you personal advice for a fee. But you also have the choice of forgoing the advice for a smaller fee by trading online. Brokers in this case offer a useful service by buying stocks in bulk and dispensing advice. And if traders don’t like that, an alternative exists.
P.S. After reflection, maybe this is where you’re getting confused. You understand that value is created when you make stuff people want. But then you look at Domain Sharks and think “People are buying from Domain Sharks. Domain Sharks have stuff people want. Therefore, Domain Sharks must be valuable.” The issue is the Domain Shark is a barrier to what people want rather than a portal, but somehow profit from what looks like (if you squint) twiddling their thumbs.
Thanks! The idea to reason counter-factually is very helpful.
1) So is real-estate rent-seeking? How is it different from domain sharking?
2) What allows someone to extract rent? The only things I could think of are a) governmental power, b) ownership rights, and maybe c) physical force.
3) Are there degrees of rent-seeking? Like what if a domain shark is using the domain to host a site that has tetris, and a few of his friends play it? Is that still technically rent-seeking? What if 100 people played it? 1,000? 1,000,000? Is rent-seeking relative to what it could have been (like would it be rent-seeking if the domain could have been used by google or something?)?
This is my understanding of rent-seeking. If you wouldn’t mind, I’d appreciate any comments/elaborations. No worries at all if you don’t want to.
So is real-estate rent-seeking? How is it different from domain sharking?
Ever wondered where the ‘rent’ in rent-seeking came from? Yup, land ownership is pretty much the TropeNamer of rent seeking. Of course, land is quite special in that land-scarcity (and thus, land rent) is unavoidable, even under the most relaxed zoning rules. Still, the basic feature distinguishing unearned rent from earned returns is there: land rent goes to a private landowner, not to the surrounding society and general public that actually gave land its high value.
Disclaimer: I’m no economist. This discussion is getting out of my comfort zone, so I skimmed wikipedia. I recommend you do likewise (and maybe browse a library). Here are my two cents anyway.
So is real-estate rent-seeking? How is it different from domain sharking?
In your draft, I think you’re confusing distribution with land-development with ownership.
A Real-Estate Agent facilitates exchange. They create a market by matching buyers to sellers. They are valuable middlemen because buying and selling real estate would be more difficult otherwise.
A Land Developer takes a rotten piece of land and adds value before passing it on to a buyer; value is added to both parties (assuming a willing buyer exists).
A Domain Shark is a parasite. They just hog a resource and don’t improve it. The Shark is a middleman which benefits himself to the detriment of the rest of society.
The point is that a single person can wear many hats. But for the sake of analysis, we need to recognize distinct responsibilities.
What allows someone to extract rent?
See the bottom of wikipedia. Most seem to fall under either Law or Racketeering.
Are there degrees of rent-seeking?
Value is tough to pin down because it’s an implicit, nebulous concept. It’s supposed to be the “objective/aggregate” version of utility whereas utility is considered “subjective/personal”. But how do you measure value? If economists could just take a ruler and say “yep, commodity X is worth $Y amount of value”, value traders would be out of a job. Value isn’t actually objective, it’s just an average of what everyone likes.
Even harder is tracking the negative externalities. I think the saying goes “everyone hates lawyers, except their own”. The idea is that lawyers are good when they represent one’s self (who is clearly the hero) , but the net value to society are outweighed by costs of scummy lawyers who fight with guile and cunning on behalf of the villains. It would sure be nice if society could simply eliminate the scummy lawyers. But lawyers aren’t paid by society, they’re paid by their clients! Therefore, lawyers persist. (This was merely an example. For the record, I prefer to live in a world where lawyers exist.)
Like what if a domain shark is using the domain to host a site that has tetris, and a few of his friends play it?
About tetris. If your site hosts tetris, no one will begrudge you. You at least attempt to provide a service. So long as you can pay for it, the land-development & service will justify the ownership in most people’s minds (in a Virtue Ethics sort of way). But if you want to make a hard case for (or against) the tetris website, you’ll want to estimate all the pros and cons Utilitarian-style and tally them up. This includes things like “the carbon dioxide emitted by the powerplant which powers your server.”
Utility is in the eye of the beholder. But the Domain Shark is as ugly as sin.
Rent-seeking doesn’t produce value by definition. This means that people will argue over what actually counts as rent-seeking. I am not going to define rent-seeking, but a similar activity is fighting over the dividing a fixed pie. Dividing the pie is a zero-sum game. Effort expended towards changing the outcome does not grow the pie. If that effort could have been spent on something productive, it should be thought of as destroying value.
Why an economy should be structured to use people’s natural greed to motivate them to create wealth.
A economy isn’t structured with a purpose to use something. Economies self organize. The structure themselves and people try to provide services for prices that customer want to pay.
This means that anybody in the system who sees an inefficiency can make money by eliminating that inefficiency. In hierarchical organisations usually only people at the top can redirect resources and the people at the top often don’t have all the information.
In our system we have a plurality. We solve some problems via hierarchical organisations and others via markets. In cases of big corporations that have their own hierarchies there a mix.
Interesting points about hierarchical organizations.
I’m confused about why you say that “A economy isn’t structured with a purpose to use something. Economies self organize”. Doesn’t private ownership and other features of capitalism make it possible for this self organization?
Can someone explain/articulate why rent-seeking behavior is bad for an economy? Why an economy should be structured to use people’s natural greed to motivate them to create wealth.
In particular, I’m thinking about domain sharking. Ie. people who buy domain names in order to sell them rather than use it to develop a site. When the sale happens, money is just moved from the buyer to the seller with no wealth being created. In fact, the net effect is negative because it deters people from starting websites.
This article talks about rent-seeking. However, after reading it a few times, I still feel like there are some key conceptual gaps in my understanding that I’m hoping will be filled if I hear a different explanation.
The point of the economy is to produce value (where “value” is defined as “something people want”). Accordingly you want to structure the economy in such a way as to incentivize people to produce value. Rent-seeking produces no value and, in fact, lessens the incentives for others to produce value.
Nothing else works as well.
Thanks, I really appreciate the explanations! I’m a bit confused about a few things though. I have a vague understanding, but don’t truly understand them.
1) How exactly does, say, operating a restaurant produce value?
2) Why doesn’t rent-seeking produce value?
Let’s say you are running a restaurant with, say, 200 customers per day on the average. This means that 200 people have voluntarily decided that the food and service your restaurant provides are worth more than the amount of dollars you have charged them. Your restaurant has produced value that is greater than your revenue. If your revenue is covering your costs (which are the value you use up in the process of running your restaurant) then you are generating positive value.
Rent-seeking is basically about redistribution of value between different people (or organizations). To take a very simple example, imagine a medieval peasant clearing a new field in the forest and growing crops there. He produces a certain amount of value. After a few years the local feudal lord learns of the new field and tells the peasant that the field is on the lord’s land and so the peasant shall pay a quarter of his crop to the lord. The amount of value produced is still exactly the same, but before 100% of it went to the peasant and now 75% goes to the peasant and 25% goes to the rent-collecting lord.
Hm, ok. I get the idea that voluntary exchange implies that the each party thinks they’re receiving something of equal or greater value in return.
I’m still a bit confused about when you can say that value is being redistributed. For example, what the lord did contributes to the precedent that land ownership is enforced, which probably has some value. How do you know when no value is being created? Are there any well accepted examples?
What do you think of the domain sharking example? I sense that it involves value destruction (rather than creation). Instead of an entrepreneur being able to buy a domain name, he has to pay a domain shark more money for it. Thus transferring money from the entrepreneur to the domain shark, discouraging entrepreneurship and wasting the domain shark’s labor.
Well, “value” is a very baseline concept. You can create value out of thin air—e.g. by singing (you can create negative value the same way :-D). For economists this concept of value is too encompassing—in most cases they prefer to talk about good and services, even better, tradeable goods and services. With these, things are easier: you can gauge their value when they trade and measure it in money. There are certain downfalls here, of course (ask an environmentalist :-/) but for most basic economics you can assume that the value of something is how much dollars/euros/gold coins/sheep you can sell it for.
So with our peasant, let’s say he was able to grow 10 bushels of rye on his forest field and their value was 100 thalers—so the “revenue” from this economic activity was 100 thalers and all of it went to the peasant. Afterwards the “revenue” was still 100 thalers, but 75 of them went to the peasant and 25 -- to the lord. Note how the total sum didn’t change—this means we’re talking about pure redistribution here.
Value destruction is also possible (you can usually treat it just as negative value). Let’s say that the cost of maintaining and working this field is 80 thalers. While the peasant was working it for himself, his “profit” was 20 thalers and that made him happy. Now, after the lord showed up, he gets only 75 thalers but spends 80 -- he’s in the red! So he abandons the field and the forest swallows it back. Our lord just destroyed some value with his rent-seeking.
You ask who benefits not from the trade, but from the agent’s existence. Let’s reason counterfactually: what would the market look like if the restaurant were removed from the equation?
If the restaurant is profitable and popular, then customers will feel sad over its absence.
If the restaurant is unprofitable and unpopular, then removing the restaurant won’t make much difference (and free up resources to be allocated elsewhere).
If the restaurant redistributes storebought merchandise where it otherwise wouldn’t be sold, then customers will feel sad over its absence.
If the restaurant simply clears out everything from the Walmart next door, repackages it, and jacks the price, then customers will feel glad at its removal. Good riddance!
Domain Sharking is an example of Case 4. If Domain Sharks ceased to exist, then its customers would buy the website themselves at lower prices and feel glad. Domain Sharks can exist because each URL is unique by design. So if you want a specific URL, you must go through the Domain Shark. I.e. it’s a monopoly void of any positive externalities.
Contrast Domain Sharks with Stock Brokers (for lack of a better example). Stock Brokers give you personal advice for a fee. But you also have the choice of forgoing the advice for a smaller fee by trading online. Brokers in this case offer a useful service by buying stocks in bulk and dispensing advice. And if traders don’t like that, an alternative exists.
P.S. After reflection, maybe this is where you’re getting confused. You understand that value is created when you make stuff people want. But then you look at Domain Sharks and think “People are buying from Domain Sharks. Domain Sharks have stuff people want. Therefore, Domain Sharks must be valuable.” The issue is the Domain Shark is a barrier to what people want rather than a portal, but somehow profit from what looks like (if you squint) twiddling their thumbs.
P.S.S. I believe the canonical example is Digital Rights Management. Why go through record labels when artists can upload?
Thanks! The idea to reason counter-factually is very helpful.
1) So is real-estate rent-seeking? How is it different from domain sharking?
2) What allows someone to extract rent? The only things I could think of are a) governmental power, b) ownership rights, and maybe c) physical force.
3) Are there degrees of rent-seeking? Like what if a domain shark is using the domain to host a site that has tetris, and a few of his friends play it? Is that still technically rent-seeking? What if 100 people played it? 1,000? 1,000,000? Is rent-seeking relative to what it could have been (like would it be rent-seeking if the domain could have been used by google or something?)?
This is my understanding of rent-seeking. If you wouldn’t mind, I’d appreciate any comments/elaborations. No worries at all if you don’t want to.
Ever wondered where the ‘rent’ in rent-seeking came from? Yup, land ownership is pretty much the TropeNamer of rent seeking. Of course, land is quite special in that land-scarcity (and thus, land rent) is unavoidable, even under the most relaxed zoning rules. Still, the basic feature distinguishing unearned rent from earned returns is there: land rent goes to a private landowner, not to the surrounding society and general public that actually gave land its high value.
Disclaimer: I’m no economist. This discussion is getting out of my comfort zone, so I skimmed wikipedia. I recommend you do likewise (and maybe browse a library). Here are my two cents anyway.
In your draft, I think you’re confusing distribution with land-development with ownership.
A Real-Estate Agent facilitates exchange. They create a market by matching buyers to sellers. They are valuable middlemen because buying and selling real estate would be more difficult otherwise.
A Land Developer takes a rotten piece of land and adds value before passing it on to a buyer; value is added to both parties (assuming a willing buyer exists).
A Domain Shark is a parasite. They just hog a resource and don’t improve it. The Shark is a middleman which benefits himself to the detriment of the rest of society.
The point is that a single person can wear many hats. But for the sake of analysis, we need to recognize distinct responsibilities.
See the bottom of wikipedia. Most seem to fall under either Law or Racketeering.
Value is tough to pin down because it’s an implicit, nebulous concept. It’s supposed to be the “objective/aggregate” version of utility whereas utility is considered “subjective/personal”. But how do you measure value? If economists could just take a ruler and say “yep, commodity X is worth $Y amount of value”, value traders would be out of a job. Value isn’t actually objective, it’s just an average of what everyone likes.
Even harder is tracking the negative externalities. I think the saying goes “everyone hates lawyers, except their own”. The idea is that lawyers are good when they represent one’s self (who is clearly the hero) , but the net value to society are outweighed by costs of scummy lawyers who fight with guile and cunning on behalf of the villains. It would sure be nice if society could simply eliminate the scummy lawyers. But lawyers aren’t paid by society, they’re paid by their clients! Therefore, lawyers persist. (This was merely an example. For the record, I prefer to live in a world where lawyers exist.)
About tetris. If your site hosts tetris, no one will begrudge you. You at least attempt to provide a service. So long as you can pay for it, the land-development & service will justify the ownership in most people’s minds (in a Virtue Ethics sort of way). But if you want to make a hard case for (or against) the tetris website, you’ll want to estimate all the pros and cons Utilitarian-style and tally them up. This includes things like “the carbon dioxide emitted by the powerplant which powers your server.”
Utility is in the eye of the beholder. But the Domain Shark is as ugly as sin.
Thank you. Your comments have been very helpful!
Rent-seeking doesn’t produce value by definition. This means that people will argue over what actually counts as rent-seeking. I am not going to define rent-seeking, but a similar activity is fighting over the dividing a fixed pie. Dividing the pie is a zero-sum game. Effort expended towards changing the outcome does not grow the pie. If that effort could have been spent on something productive, it should be thought of as destroying value.
A economy isn’t structured with a purpose to use something. Economies self organize. The structure themselves and people try to provide services for prices that customer want to pay.
This means that anybody in the system who sees an inefficiency can make money by eliminating that inefficiency. In hierarchical organisations usually only people at the top can redirect resources and the people at the top often don’t have all the information.
In our system we have a plurality. We solve some problems via hierarchical organisations and others via markets. In cases of big corporations that have their own hierarchies there a mix.
Interesting points about hierarchical organizations.
I’m confused about why you say that “A economy isn’t structured with a purpose to use something. Economies self organize”. Doesn’t private ownership and other features of capitalism make it possible for this self organization?
Looking at the features of a real world system and analysing those features is different than something being structured for a purpose.