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The paper was written when Shankha Chakraborty was visiting the IMF Institute. The authors would like to thank Andrew Feltenstein and Jean-Francois Ruhashyankiko for their valuable comments.
Rent seeking refers to all largely unproductive, expropriative activities which bring positive returns to the individual but not to society (Krueger, 1974).
This paper extends earlier work by Dabla-Norris and Wade, 2002 by considering the joint determination of occupational choice between rent seeking and production and initial wealth distribution in a richer setting.
A producer never gets approached by more than one rent seeker here. One interpretation of this assumption is that each rent seeker implicitly provides protection against extortion by others as in Mehlum, Moene, and Torvik, 2003. In our model, each rent seeker can extract rent from more than one producer, but we abstract from the issue of protection.
As we show below, f′(i) > x in a positive rent seeking equilibrium when γ is high. Rent seeking competes with productive sectors for resources, resulting in a misallocation of resources in the economy.
This follows from our assumption of risk neutral agents and linear utility. Allowing for risk aversion does not fundamentally alter the insights of this paper, but does complicate the analysis, especially for rent seekers.
It is easy to see that an equilibrium in which all agents engage in rent seeking does not exist. With n = 1, πR = 0 as rent seekers crowd each other out, while πP = 1. As a result, the rent accruing to each rent seeker is zero. Moreover, marginal returns from production f′(0) will dominate marginal returns from protected investment, x.
This slope will also depend on wealth if, for example, rents expropriated depends upon the rent seeker’s own wealth as in Sonin, 2003.
One interpretation of the basic model is that differences in endowments are due to differences in first-period abilities as producers. More able agents are wealthier in period 1 as a result. Subsequent to first period production, agents face an investment choice between a productive asset (which yields f (i) from investment i) and a low productive one (with a fixed cost θ paid upfront but a low-return x in period 2 plus, possibly, rent-seeking opportunities). The productivity of this investment does not depend upon first period abilities. In this scenario more able (and wealthier) individuals will prefer the low productivity asset, resulting in smaller net output. This interpretation of the model is similar to Murphy, Shleifer, and Vishny, 1992 and Acemoglu and Verdier’s, 1998 result that rent-seeking is particularly costly because talented individuals spend time in rent seeking instead of more productive occupations.
If all agents could coordinate a simultaneous move to production, the threat of appropriation would disappear since there would be no rent seekers, and production would yield higher utility even to the wealthiest individuals.