Rent-Seeking: Not Just a Public Problem

Gordon Tullock was one of the most innovative and provocative thinkers economics has ever seen. Consider that he co-authored Calculus of Consent , which revolutionized political economy, “discovered” rent- seeking (although he did not coin the phrase), helped found law and economics, and wrote extensively about the economics of bureaucracies. Tullock’s students have played a key role in raising important questions about the role of freedom and limited government in economics.He was widely recognized as one of those economists who deserved the Nobel Prize but never won it.

Chapter 10 from Tullock’s 1992 book Economic Hierarchies, Organization, and the Structure of Production is typical of Gordon’s work. It is contrarian, thought-provoking, and raises important questions about rational actor models of economics. In some ways this book was a follow-up to Tullock’s more well- known and often-cited The Politics of Bureaucracy , which he wrote in 1965. Politics of Bureaucracy is one of the first books to apply a more scientific approach to the analysis of government bureaucracies. It was ground-breaking, particularly in the face of the more naïve approaches to bureaucracies and government that were common in political science in the 1960s. Economic Hierarchies , however, focuses on bureaucracies in the private sector, particularly in large firms. As Charles Rowley notes in his introduction to the Liberty Fund Tullock collection volume that contains the book, Ronald Coase’s work on transaction costs set the foundation for Tullock’s book to look at modern firms and consider how they handled the development of bureaucracies.

The typical public choice story of government bureaucracies can be summed up quickly––bureaucracies are relentlessly focused on growing, virtually un- reformable, and largely inefficient. Libertarians and conservatives typically compare government bureaucracies to the private sector and lament the fact that market principles cannot be brutally applied to government bureaucracies in order to fire redundant employees, cut costs, and reduce regulatory overhead.

There are two problems with this story. The first problem is that it is possible to reform bureaucracies. It is not easy, and it is certainly not necessarily permanent, but as states such as Indiana have shown, political leadership like Indiana’s previous Governor Daniels can do a remarkable job cutting the size of government, and reforming several bureaucratic agencies. Most notably, Daniels reformed the Indiana Bureau of Motor Vehicles. Shocking though it may seem, it is now a relatively painless (perhaps even pleasant?) experience to visit the state Bureau of Motor Vehicles in Indiana. During my most recent visit, I arrived several minutes before the office opened, expecting a long line of weary citizens facing hours of waiting. Instead there were perhaps four or five others who entered when I did. We were greeted by all of the service employees who were standing behind their chairs to wish us good morning in unison. I thought it was a psychology experiment being taped to gauge our reactions. And we were all served in less than ten minutes.

The second problem with the story about private-sector versus public-sector bureaucracies, as Tullock notes, is even more challenging to libertarian thinking. In “Rent Seeking and the Importance of Disorganization,” Tullock tackles an interesting problem. While most research on rent-seeking has focused on public-sector bureaucracies, many private-sector firms have large bureaucratic divisions that are overstaffed and not particularly efficient. He calls this a form of rent-seeking in the private sector because these individuals are drawing rents from the profits that should be going to the firm’s managers and shareholders. So, how is it that the private sector performs much like government and tolerates this arrangement?

He asks the reader to consider a hypothetical firm, Behemoth Corporation, that is about to be taken private by a group of executives in a leveraged buyout. Tullock notes that as a result of this leveraged buyout, the capital value of the firm will have a lot more debt, and this will put the new owners, who were the same people who ran the firm before the leveraged buyout at the behest of a broader base of shareholders, under a lot more pressure to be efficient. The typical story of how managers achieve efficiency is by firing tons of middle managers and selling off assets that have value but do not add substantially to the efficiency of the organization.

Tullock’s main interest is in the “large-scale purge of the middle management” that inevitably follows leveraged buyouts. His question is, “Why would this elimination of people who previously were voluntarily hired by substantially the same management greatly increase efficiency?” In short, why did the top managers at Behemoth Corporation tolerate a lot of inefficient people in their company while they were serving shareholders? Is this a market problem?

Tullock answers the question in two ways. The first one is obvious and well- known. Because the managers have much more skin in the game, they have far more pressure to perform. Thus they make more radical decisions because of the changes in the fiscal reality of the firm. But Tullock still does not think that explains why these managers did not fire some of these people to begin with, particularly since they, unlike Governor Daniels, didn’t have to worry about government employee unions and short political time horizons.

Tullock argues that now with more skin in the game, “unpleasant decisions must be made if you want to maximize profits. You have to fire people you personally like, you have to put pressure on your inferiors even though this clearly will mean that your relations disintegrate, you may have severe fights with, let’s say, your labor union or with neighboring organizations who are competing with you.” In short, it is hard to fire people, even in the private sector.

Of course you are taking a risk by firing people because you might be making a bad decision and your competitors are nipping at your heels. You have to act quickly and you have to be right. For a privately held firm, the pain of making hard choices is “compensated for by the fact that he can take the money home with him after he has made the decision, even if he chooses to take some risk.” When it is my money and my risk, I am incentivized in a way I am not in a larger firm where risk-taking is less common and not encouraged, even a large firm that is in the private sector.

Tullock tells a story about a friend of his who was a senior officer at a large corporation. He and Tullock were talking about the frequent use of committees, and Tullock’s friend argued that “one of the real functions of the committee structure in this corporation was that it permitted people to take large risks without any responsibility. You never could trace any losses back to anyone. This protection may have offset” the problems that Tullock addressed earlier regarding a lack of risk-taking in some large corporations.

To me the take-away is that, as Tullock says, superiors in large private- sector corporations will, “if they press hard, get more efficiency out of their inferiors than if they don’t press, but they also have less in the way of pleasant relationships. This is because they don’t take the funds home.” Leveraged buyouts are like a bonus structure on steroids that motivate people to make unpleasant choices. However, it is important to realize that even in the private sector, pathologies such as rent-seeking can occur.

The post Rent-Seeking: Not Just a Public Problem appeared first on Econlib.

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