Friday, August 7, 2009

Rent Seeking Is Good

Those who read the title might scream of how oxymoronic it sounds.

Well, let me say that the term rent seeking has been massively applied in public policy debates and welfare economic literatures to illustrate, in essence: inefficient, unfair and unproductive economic parasitism behaviours or activities leading towards waste and disequilibrium resource allocations. In short and in practice, it is normally associated with corruptions, crony or oligarchic capitalism, lobbying and means of seeking and exploiting unfair advantage. This is understandable given the price of government failures to, effectively and efficiently, make resource allocations for the whole economy.

I am not going to dispute the aforesaid.

But, I wish to say that rent seeking is what all private enterprises should compete and strive to achieve. In fact I cannot figure out how CEOs would function without any rent-seeking brains. The term was introduced by Ann Krueger, based on the works of Gordon Tullock that addressed active creation of monopolies, with the aim of achieving supernormal profits or market control in competitive conditions; which means that the term actually originates from studies on market and firm structures and not on public policy and welfare economics.

Back to Tullock, supernormal profit is also known as economic profit or producer surplus, which corresponds to the difference between the floor price that is incentive-able for a producer to produce and the price paid by consumers. The target is therefore, for a profit maximisation company, to bring down the floor price level by cost minimisation strategies and increase the price level by making the demand to be more inelastic and expanding i.e. differentiation strategies, which in order words, ways to enlarge the gap. In the process, firms will try to bring down the transaction costs incurred by customers in getting to know and in findings the product and hence, the sales and marketing strategies as well as the distribution plans. Also, firms endlessly endeavour to ensure high level of quantity demanded in the market place in addition to ensuring enough, efficient and flexible production capacity to meet them. When CEOs say we want to capture more values, they are actually saying we want to have more shares of the producers’ surplus either as a result from present industry or location or from growth opportunities elsewhere.

The above is what business teachers and gurus such as Porter, Peters and Hamel will tell you.
All the Poter’s competitive strategies, competitive advantages, generic cost leadership and differentiation strategies as well as other people works on barriers to entry, first mover advantage etcetera etcetera reminisce on a common ground i.e. means to achieve and protect producers’ surplus. Other teachers like Kim and Mauborgne introduce new concept such as Blue Ocean strategies for ways to find new producers’ surplus opportunities.

In essence, it is all about producers’ surplus.

Now, assuming that you are a shareholder; you will certainly expect your CEO to create values and deliver double digit revenue and profit growth. In a way, you are in agreement that rent-seeking is what is expected in industrial capitalism. When I say this, I mean by way of competitive strategies, market scanning, superb branding, excellent customer service, human capital development etcetera etcetera as I am not here to advocate corruption and illegal activities, but to shed some light that rent-seeking is good in private enterprises.

It is also good for the whole economy as other profit maximisation firms will join in the industry as soon as huge producers’ surplus is detected, assuming fluid firms’ entry and exit. As a result, customers will benefit from firms’ rivalry, leading towards higher quality goods and services with affordable pricings.

Because of the crowding out, some firms might decide to walk out and search for a better and new producers’ surplus opportunities. Thus, the whole cycle will generate fluid, regenerative and dynamic economic activities.

In conclusion, rent-seeking is good, and is expected in industrial capitalism.

No comments: