Tuesday, October 18, 2011

Constitutional Economics: Rent Seeking, Economic Growth, Corporate Power, and Inequality

In other posts I have provided data related to income inequality and economic mobility as well as the concept of rent seeking. In his principles of economics textbook, Greg Mankiw outlines growth promoting policies such as:

1) Reducing corruption in the legal system
2) Increasing reliance on market forces
3) Increasing foreign investment
4) Encouraging trade with other countries
5) Increasing the percentage of GDP devoted to savings

In this post, I attempt to integrate many of these concepts.

While the data show that income inequality is not as severe as often portrayed in the media, and that the U.S. has one of the most progressive tax systems in the world,  income inequality still exists in the U.S.  We know that some degree of income inequality is necessary and desirable (giving us for instance innovations that lead to increased standards of living for the masses). But what are the consequences of unequal distributions of income and wealth?

We can see that negative consequences result if wealthy powerful interests (including high income individuals, wealthy individuals, or corporate interests) are able to utilize the political apparatus to their benefit at the expense of the rest of society. Here in essence we have the specter of rent seeking.  Rent seeking, or using the political apparatus to obtain special privileges or benefits ('rents') from government, diverts resources away from innovations and productive investment. It also creates a winner take all or dog eat dog environment (similar to a prisoner's dilemma or Nash equilibrium) that incentivizes everyone to participate (either on the offense to seek 'rents' or on the defense to prevent some law or restriction on activity).

Economic research (Hernando De Soto, The Mystery of Capital; Lane & Tornell, The voracity effect, American Economic Review 1999) indicates that weak political institutions in the presence of powerful special interests are related to stagnant economic growth.  How can we design institutions to minimize the prevalence of rent seeking behavior?

When we look at current issues related to the economy, such as bailouts, corporate influence on the political process, and concentrations of power and wealth, we see that these issues arise from the intersection powerful governments and corporations.

As public choice economist Dennis Mueller is quoted in the article Public Choice Revolution:
"The larger the state and the more benefits it can confer, the more rent-seeking will occur. The entire federal budget...can be viewed as a gigantic rent up for grabs for those who can exert the most political muscle."

In Federalist #10 the founders made it clear that in a free society that we would have an unequal distribution of income and wealth:

"From the protection of different and unequal faculties of acquiring property, the possession of different degrees and kinds of property immediately results; and from the influence of these on the sentiments and views of the respective proprietors, ensues a division of the society into different interests and parties." 

They were also aware that this may lead to populust uprisings, calling for policies that could be detrimental to a free society: 

"A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project…we behold a republican remedy for the diseases most incident to republican government."

Their proposed solution was a government limited in its power to bestow privilege through constitutional restraint. Economist Thomas Sowell, in his essay, Judicial Activism Reconsidered, describes how limited constitutional government serves to protect minorities and individuals from concentrated power and special interests:

"The federal Constitution is "the supreme law of the land," not because it is more moral than state constitutions or state or federal legislative enactments, but because it represents a larger and more enduring majority. Minorities receive their constitutional rights from that enduring majority to which transient majorities bow, not from whatever abstract moral rights are imagined to exist as a brooding omnipresence in the sky."