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The authors would like to thank Mohsin S. Khan, Saleh M. Nsouli, Stanley Black, Eric Clifton, and Sunil Sharma for their useful comments. All remaining errors are our own.
Rent seeking refers to all largely unproductive, expropriative activities, which bring positive return to the individual but not to society (Krueger (1974)).
One example is the establishment of state trading monopolies by government officials in which one has a stake either directly or through relatives (Murphy, Shleifer and Vishny (1991)).
This is in contrast to Grossman and Kim’s (1997) analysis of the relationship between weapons used either for predation or for defensive fortifications. An important distinction between our paper and theirs is that, here, predation and the deterrence of predation are viewed as complementary activities.
In addition to misallocation of labor, capital and talent in the economy, rent seeking activities, such as corruption and tax farming, can reduce the aggregate level of economic activity by distorting incentives and opportunities for production and investment.
A sufficient condition for gross substitutability is a separable utility function and a coefficient of relative risk aversion less than one.
Here γ can be regarded as a tax on the proceeds of market production, or, alternatively, the cost of engaging in production in a rent seeking society. In reality, this fraction may depend upon a range of factors including the rent seeking technology, the level of economic development, and law enforcement.
The description of the rent seeking sector is similar to that in Mehlum, Moene and Torvik (2000). Their paper, however, does not examine the relationship between initial wealth and occupational choice between rent seeking and production.
In the model, there is no coordination issue so a producer never gets approached by more than one rent seeker. One interpretation of this assumption is that each rent seeker implicitly provides protection against extortion by others as in Mehlum, Moene and Torvik (2000). In our model, each rent seeker can extract rent from more than one producer, but we abstract from the issue of protection.
The hoarded amounts are not used for productive investments in the economy. They can be regarded as cash drawn out of circulation (“hidden under the mattress”), consumption of luxuries, or investments abroad.
Note that the same results follow for x equal to (1- πP γ)f’(i)for any θ > 0. If x is assumed to be greater than (1- πP γ)f’(i), this leads to the uninteresting case of rent seeking always being profitable for individuals.
Note that the production function is not twice continuously differentiable, but this example is the simplest one to work with.
The burden of the fixed cost to rent seeking relative to the return from rent seeking is likely to be low when the number of rent seekers in the economy is small and therefore productive investment is also high. We relax this assumption in Section IV in order to show the possibility of multiple equilibria in this environment.
Note that the derivatives of VP and VR with respect to n are discontinuous at n = ñ.
Note that for λ sufficiently greater than 1, ñ and, therefore, n* would realistically be lower than ½, i.e., the majority of agents in the economy will be producers.
If the scores on the civil service exam actually indicate talent in rent seeking, the incentives for entering into the public sector contingent on performance in the civil service exams is even greater. See Section V for a discussion of differences in ability among individuals.
This implies that the first period consumption for a rent seeker and a producer will be the same.
We can think of lotteries as a mechanism for generating differences in initial wealth in period t = 0.
Notice that saving from youth to old age requires that u1/u2=(1−πPγ)f′(i) for a producer and u1/u2 = x for a rent seeker.
In the absence of effective monitoring and weak law enforcement, the central authority would essentially be extracting some of the rents that accrue to rent seekers. If, for instance, the specific source of bureaucratic inefficiency in the economy is corruption by tax collectors, then tax farming may be a preferred regime from the point of view of tax revenues raised.
Further, if one assumes that the link between parents’ abilities and their children’s is stronger than a purely random distribution, there will be an endogenous formation of a rent seeking class over generations since these families will on average possess more of the two key factors for entry into rent seeking—wealth and ability.
This is similar to Acemoglu and Verdier (1998) but they assume that the decreasing cost of human capital investment applies to production.
For instance, even if rent seekers extract a fixed fee instead of expropriating a proportion of market production, the model’s implications concerning the relationship between initial income and occupational choice are unchanged.