Trade barriers (e.g. tariffs, quotas) are known to harm consumers, especially when they lead to trade wars. Then, why is rent-seeking through trade barriers successful? Provide qualitative or quantitative evidence supporting your argument(s).
Rent-seeking activity is the use of resources and time wastefully to gain privilege through political process with the aim of benefitting from rents produced with the cost of social welfare loss (Krueger, 1974). Rent-seeking activities can take either a legal or illegal form. Legitimate activities may include entrepreneurs seeking preferential treatment from the government, using special policies to maintain their monopoly status; illegal acts such as bribery, smuggling and corruption.
When economic activities are restricted through government intervention, rents are generated in different forms and are demanded by economic agents. Competition for such rents is costly to the society: it leads to inefficient use of resources, welfare loss and the economy operating within its transformative curve (Soares, 2011). Using the US sugar industry as an example, the US has import tariffs and restrictions on foreign sugar to protect US domestic sugar producers. In 1985, only around 2.7 million tons of foreign sugar were imported, leading to a US sugar price four times the world level at around ten cents a pound. Significant efforts are devoted to be protected from foreign competition and receive the rents generated from these protectionist policies. The efforts and expenditure of rent-seekers refer to the expenses incurred by the economic agent in carrying out various lobbying activities, including time, financial resources… The resources spent by rent-seekers on these activities are the net loss of wealth for the whole society and a waste of resources. (Wiltgen, 2007)
Quotas are a form of trade barrier which restricts the number of imports, consequently increases consumer prices and reduces the quantity consumed. As quotas represent the right to import, it becomes valuable and there will be competition for import licenses. Rent-seeking through quotas would be the costs to the economic agents such as the value of time spent and scarce resources in order to obtain import licenses, competitive rent-seeking activities will therefore incur a loss other than the social welfare loss (Krueger, 1974). Kruger believes that when people compete for the right to import, thus obtaining the rent of import monopoly rights, causes a loss to the society. Krueger also pointed out that the rents generated from rent-seeking through import licenses in India was around 7.3 percent of national income in 1964, showing the magnitude of rent-seeking that takes place through import licenses (Krueger, 1974). Bhagwati and Srinivasan (1980) suggested that in competitive rent-seeking, the total value of resources spent on rent-seeking must equal to the total value of quota rents obtained.
Kruger (1974) argues that these rent-seeking activities to obtain import quotas will lead to social welfare losses, and identifies four wasteful licensing mechanisms that could be used for lobbying. Firstly, excess firm capacity when import licenses are awarded per the importing firm’s capacity. As import licenses are distributed by firm size, firms will therefore expand despite the fact that there may be excess capacity. In order to compete for more import licenses, firms invest their valuable resources which could be wasteful due to quantitative restrictions on imported intermediate goods. Tullock (1967) explained that rational entrepreneurs would make investment decisions depending on private returns instead of how socially desirable it is and would participate in rent-seeking activities if it is worth it. Rent-seeking would be successful if the profit brought by additional import licenses covers the cost of investment on additional capacity as firms will benefit from the additional import license obtained. Secondly, excess entry when import licenses are distributed pro rata for importing-wholesaling industries.. As there are almost no entry barriers into the industry, there is an incentive to create more firms, despite firm size being small, which allows firms to receive more import licenses. This allows the firms to gain profits through importing and reselling at high prices in the domestic market due to the import quotas imposed. Thirdly, when licenses are allocated by the government officials, rent-seeking occurs when entrepreneurs compete for more import licenses by attempting to influence the allocation of import licenses. Legal rent-seeking activities may include firms moving the firm to the capital, where time or resources are spent on reallocating. Alternatively, other illegal actions could be actions such as bribery, offering jobs to relatives… where government officials receive benefits from entrepreneurs. Fourthly, there is competition for bribes within government officials. As import licenses are a valuable commodity due to quotas, when government officials decide the allocation of import licenses, bribery can occur in order to obtain more import licenses, and could make entry into the government service more attractive. The time, effort and resources spent could also be competitive rent-seeking. However, Kruger stated that this does not mean all government officials will receive bribes.
A typical example would be the imposition of taxi license by Buchanan (1980), which is similar to the imposition of import restrictions. Buchanan suggested that rent-seeking activities could be carried out in different ways. Firstly, rent-seeking can be through selling licenses through competitive auctions. The rent generated by the limitation of number of taxi licenses is reflected in the price of the license through market competition. Secondly, once the taxi license is valuable, potential entrepreneurs will turn to the government department that manages the allocation of licenses in the hope of obtaining more licenses. Rent-seeking activities would be more successful when the government officials are able to earn the rents from auctioning taxi licenses. However, if the income of the auctioned taxi licenses goes to the government’s fiscal revenue, or the government positions are competitively employed, then rent-seeking activities in this field may be reduced, but there are high costs associated, therefore there is always space for rent-seeking. Buchanan also believes that with the imposition of taxi licenses, potential entrepreneurs may not directly enter the taxi industry, but into occupations of various political bureaucracies to carry out rent-seeking activities.
An import tariff acts like an excise tax on imported goods; the effects of tariffs are similar to quotas – raise prices, reduce demand of imported goods, and a decrease in consumer surplus, however, unlike quotas, import tariffs generate revenues for the government. The imposition of tariff allows firms to gain monopoly power in the industry, thus benefiting from reduced international competition. Bhagwati (1980) suggested that tariff-seeking, where beneficiaries of protectionism seek imposition of tariffs, could be classified as directly unproductive, profit-seeking (DUP) activities, where they yield favourable returns by undertaking directly unproductive activities. Tullock also points out that usually “governments do not impose protective tariffs on their own. They have to be lobbied or pressured into doing so by the expenditure of resources in political activity.” (Tullock, 1967). Lopez and Olson identified that as the industry is more concentrated, rent-seeking activities become easier. Moreover, firms are more able to raise prices and benefit from trade barriers that reduces international competition when the industry is highly concentrated (Mueller, 2003). Mueller also suggests that because competitive rent-seeking activities for import licenses entails a welfare cost in addition to the welfare cost that would be incurred if the same level of imports were achieved through tariffs, so tariffs might be preferred to quotas.
In conclusion, through wasteful rent-seeking activities, domestic firms are protected from foreign competition by protectionism government policies, benefitting domestic producers but harming consumers and causes social welfare losses which cannot be measured accurately as generally rent-seeking activities cannot be observed. The theory of rent-seeking is only a general theoretical analysis of many ever-changing rent-seeking activities, and this is not enough when it comes to specific practice. A large number of empirical studies and specific analysis on real life problems are required to solve the problem of rent-seeking.
Reference list:
Bhagwati, J., & Srinivasan, T. (1980). Revenue Seeking: A Generalization of the Theory of Tariffs. Journal of Political Economy, 88(6), 1069-1087.
Krueger, A. (1974). The Political Economy of the Rent-Seeking Society. The American Economic Review, 64(3), 291-303.
Tullock, Gordon (1967). The welfare costs of tariffs, monopolies and theft. Western Economic Journal, 5(3): 224-332.
Soares, F., & Moreira, T. (2011). Rent-Seeking, Trade Policy and Economic Welfare. Modern Economy, 02(01), 31-38. doi: 10.4236/me.2011.21005
Jarvis, L. (2005). The rise and decline of rent-seeking activity in the Brazilian coffee sector: Lessons from the imposition and removal of coffee export quotas. World Development, 33(11), 1881-1903.
Mueller, Dennis (2003), Public Choice III, Chapter 15.4, Cambridge University
Press
Wiltgen, Tyler James (2007) ‘An Economic History of the United States Sugar Program’. Thesis submitted in partial fulfilment, Department of Master of Science in Applied Economics, Montana State University, August.
Buchanan, J. M. (1980), “Rent seeking and profit seeking”, in J. M. Buchanan, R. D. Tollison, and G. Tullock, eds., Toward a Theory of the Rent-Seeking Society (Texas A&M University Press 1980),