In the book Euro Tragedy, economist Ashoka Modi cites a 1993 article by Murphy, Schleifer, and Vishny where they propose a simple model to explain the underdevelopment of some Third World countries despite international aid. Modi applies their analysis to the European transfer program. This article focuses on the consequences of rent extraction in the economic sense on the level of production. Conventional political discourse focuses on another aspect: distribution. Three ways to spend your time In a simplifying framework, three economic activities and their returns A, B, or C are envisaged:
A commercial agriculture or any other declared productive activity
B the extraction of cash from declared producers
C subsistence agriculture, which allows production without confiscation
In theory, A>C. The rate of return of economic activity A is higher than productivity in autarky C because of the productivity gain due to the division of labor explained by Adam Smith. The authors are interested in the possible equilibria for different levels of profitability of rent-seeking B:
B<C The search for rent is then of no financial interest, and the total output is maximum.
C<B<A In this case, two equilibria are possible:
If there are few rent-seekers, agents become entrepreneurs to maximize their income instead of rent-seekers.
If there are too many rent-seekers, the income of the producers falls and the rational choice of the agents is the extraction of rent to a second point of equilibrium where everyone wins c.
A<B in this case, the extraction of rent is always more profitable and production also balances at the level c of subsistence agriculture.
The levels of income A, B, and C depend on technological, social, and institutional factors. These rates are not constant: respect for property rights increases A, ideological and religious factors make it possible to increase B. New technologies such as a motorized tiller, a washing machine increase C.
These factors constantly change rates of return. The consequences for growth The authors distinguish between established productive activity (large industry) and innovation. Innovators face significant risks. In a world where confiscation is socially tolerated and where they have no political support, they are more likely to have the fruits of their efforts confiscated if successful. For this reason, the authors observe less innovation in small business creation in countries where the level of administrative harassment of small entrepreneurs is high.
Underdevelopment in the Third World
The authors mention underdevelopment persistently in Peru and Equatorial Guinea. What development economist Hernando de Soto attributed to a lack of property rights would be a classic case where b>a and the wrong dynamic is taking place. Countries remain underdeveloped when international financial aid is allocated to rent-seekers to increase B. In the worst cases, food aid also has adverse effects by destroying the profitability of local production. It eliminates productive agents and makes the population dependent on a permanent transfer, thus creating a mass of rent-seekers at the Malthusian threshold.
The Decline of the Eurozone
In the book Euro Tragedy the argument of this article is taken up by the author Ashoka Modi to describe the Mezzogiorno and Greece. These regions have been clogged with subsidies. A young person in 1980 who wanted to stay in the country had better economic and social prospects by becoming a politician or public servant than by creating a local business. These would be territories where B>A.
Between 1992 and 1999, the populations and politicians of these regions were in favor of joining the Euro because it would force countries to conduct themselves economically responsibly, to make the structural reforms necessary to raise their productivity to levels competitive with Northern Europe. Convergence and "vincolo esterno" (external constraint) were the key to all official discourse. Twenty years later, the result of the entry into the Euro of France, Italy, and Greece is that it has allowed civil servants and pensioners in these countries to guarantee themselves indexed pensions in a strong currency. There has never been any effort to explain what a structural reform would consist of that would allow an adjustment of the cost of civil servants and pensions equivalent to the effect of devaluations of 3% to 10% which were certainly unpopular but regular and inexorable.
Devaluation to reestablish industry competitiveness is no longer possible. Without an adjustment mechanism, rising rents lead to deindustrialization and more dependence on transfers. After 20 years of maturation and many retirements, the new political guard proposes two ways to save Europe:
the creation of mechanisms to increase transfers to cope with short-term crises even if dependence increases in the long term,
the replacement of the productivity objectives discussed in 1992 by sustainable degrowth objectives to ideologically accompany the move towards equilibrium c with a discourse on the ecological transition of solidarity.
In the case of European social democracies, the minimum income C of subsistence agriculture in underdeveloped countries is replaced by a mixture of social transfers and hidden labor. I have observed in France small entrepreneurs who refuse a contract because they "have already made their figure for the year". They maintain their participation rate at level C to avoid administrative complications. While Spain operates with an official unemployment rate of between 15% and 25%, hidden work often improves the ordinary.
The original point of view in France was quite different. For Edouard Daladier at the rostrum of the radical congress of Nantes in October 1934 rent-seeking was a problem of distribution, with these "two hundred families (...), masters of the French economy and, in fact, of French politics", who "place in power their delegates", "control the press", and whose influence "weighs on the tax system, on transport, on credit.". Rent came from dynastic wealth. If the majority of the great French fortunes are still inherited and still control the press, rent-seeking has never been the prerogative of a class reduced to two hundred families.
The case of the United States
In the case of the United States, the number of innovative billionaires attests to A>B. The Tax Cut and Job Act (TCJA) of 2017 is a major tax reform that lowers the tax rate on corporate profits. In the absence of an increase in dividend tax, the total reduction in charge is such that an equivalent deduction, the QBI, has been granted to micro-enterprises and property income. The legislator explicitly excludes the liberal professions: law firms, accountants, and doctors are always taxed like employees. The intention is to maintain an extractive rate on all labor income, and a more competitive rate on investment income.
Would it be cynical to observe that Donald Trump and lawmakers are cutting back on their land revenue streams without easing pressure on workers' incomes?
Redistributive discourse also adapts to circumstances. Unlike Henry George's progressivism of 1879 and the radicalism of Mr. Daladier in 1934 among whom the rent-seeking is linked to a multi-generational and often idle accumulation, for the left of the Democratic Party, Mr. Sanders or Mrs. Occasio-Cortez, the rent-seekers in the United States are the founders of Microsoft or Amazon.
Democrat Lyndon B Johnson launched the most ambitious "war on poverty" program in 1964. This massive federal program did not end after three or four years like conventional wars. The administration has been in place for 55 years and according to the liberal conservative economist Thomas Sowell, a growing part of the population, far from emerging from poverty, has become dependent on this program.
The American political elite, whether Donald Trump or alternatives such as Mr. Sanders and Ms. Occasio-Cortez have chosen B as their calling. They are pushing with ardor and sincere conviction to legitimize the increase in factor B but in different directions. The case of the TCJA is unusual in that rent is generally in favor of the middle class: targeting the median voter increases the chances of winning the election. As Thomas Piketty would say, we will come back to this in a next chapter.
Solution to encourage growth
The solution proposed in the article for developing countries is for rent-seekers to be associated with the success of the enterprise by obtaining a share in its results. This could correspond to
crony capitalism during the development of the American railroad network between 1860 and 1900, where the money of small shareholders was secretly siphoned off by the overbilling of construction controlled by businessmen and their political supporters,
the market development model followed by China since 1978,
the political class of Singapore, which is remunerated in line with GDP growth. A minister Singaporean receives a salary of 1.5 million and 2.5 million euros - ten times more than a French minister.
These are systems in which the political class builds its fortune. To the extent that its interest is aligned with the enrichment of the nation, there follows a tendency towards the deployment of the most productive resources, rather than impoverishment through a cycle of extraction and concealment. There is a difference in transparency between the enrichment of politicians in Singapore and Argentina and between the confiscation of oil revenues by the Norwegian government and that of Angola. Opacity increases the risk of special interest capture.
This settles the question of the level of production but not that of distribution.
Production and Distribution
The authors do not extend to giving advice to developed countries. According to an article by Pierre Cahuc, the choice of the level of public spending in a democracy depends on the median voter and may be beyond the optimal level in the case of insufficient social capital. The combination of these two articles shows that the median voter in social democracy is constantly subjected to a temperance test: the condition of optimal productivity with B<C imposes such frugality that only unemployable people receive public funds. But the median voter who earns 1700 euros in France does not care if the minimum social benefit for unemployed people is 495 or 535 euros monthly. To interest his vote, politicians must propose projects that concern him. Some public programs, such as free primary education and free public health programs, increase the independence and productivity of all. Others, such as retirement at age 60, reduce productivity and increase middle-class dependency.
Past choices are difficult to reform when those who benefit from them have the power. An example is the Pay-as-you-go (PAYG) pension which guarantees an inflation-linked pension at a fixed age. It creates a growing mass of voters who can only defend their income through politics. The reform of tax privileges under Louis XVI shows what happens when legitimate power refuses to bow to economic reality.
Rent-seeking is a natural phenomenon because the individual must build up an income for his old age. It must be conducted in such a way as to align rather than oppose productive economic activity and innovation, otherwise, production and innovation will take place elsewhere. Without this consideration, the struggle of the extractive classes ultimately leads to everyone cultivating their own garden.
Epilogue
Janet Yellen's subliminal advice During an interview on CNBC in March 2020, former Fed governor Janet Yellen appeared at her home with books behind her. I read several of these books and his choice seemed right. I decided to read Euro Tragedy by economist Ashoka Modi, whose book barely stands out behind Ms. Yellen.