Social cost of government policy: Corruption and rent seeking

"Rent seeking" is the quest for privileged benefits from government, "sale by government officials of government property for private gain or  situations where "the power of public office is used for personal gain in a manner that contravenes the rules of the game." The rent seeking literature embodies two core ideas. First, missiles seek heat hypothesis: A contestable rent induces rent seeking activities aimed at capturing the rent. These activities involve unproductive use of real resources and cause a social loss. Secondly, the  inevitability hypothesis: Rent seeking costs are, by and large, unobserved but by applying contest theory and assumptions about the behaviour of rent seekers, the size of the social cost can be inferred from the value of the contestable rent.
Examples of contestable rents are abundant: assigning monopoly rights, protectionist trade policies, privileged budget allocations, income transfers, national resource rights, and so on. The distinguishing feature making a rent contestable is ex ante-i.e., before it is assigned to any particular economic agent-it is up for grabs. This is what makes it rational for potential beneficiaries to expend resources in contesting rents.
There is no convincing reason why those who control the legal framework and the various operations of government should be immune to corruption. Legislation as well as its enforcement and the imposition of penalties may suffer from corruption. This can result either in a powerful principal who is not benevolent (for example, a corrupt autocrat) or in one who cannot fully control the legal framework (for example, parliament or the constituency).
In case the principal is not benevolent, a definition of corruption as a violation of rules would be misleading. This can be illustrated by a case study from Thailand. It is reported that strict rules prohibit ordinary citizens from taking away anything, even leaves or pebbles, from the tropical forest of the country. But the Forestry Department is largely empowered to make regulations which it does to serve its own interests. What should have been protected has officially been converted into tourist attractions or destroyed for gas pipelines, for the benefit of the department.  Either the Forestry Department is considered to be the principal - not a benevolent one certainly, or other organisations (parliament or constituency) are considered to be the principal - but apparently with limited control.
Another example, a government official is charged with allocating mobile phone licences and the rules specify that he must select the company that makes the "most convincing case for efficient service delivery". If he follows this rule to the best of his ability, then there is no corruption. Yet, there is a lot of rent seeking. The mobile phone companies will expend vast resources on making their case for being the best for the job. Conversely, it is also possible to have corruption without rent seeking. Suppose, for example, that one of the companies pays a bribe to obtain the licence without any checks on its ability to deliver the services efficiently (and no one else makes any effort to show their fitness for the job), then there is  a situation of corruption but without any real resources having been used unproductively in rent seeking activities.
Corruption has been considered as one form of rent seeking, as a special means by which private parties may seek to pursue their interests in the competition for preferential treatment. Just like other forms of rent seeking, corruption is a way to escape the invisible hand of the market and influence policies to one's own advantage.
Corruption can be distinguished from other forms of rent seeking by referring to law. While there is certainly a point in applying this idea, it does not clearly contribute to the welfare considerations. Moreover, as legislation may be endogenous to rent seeking, such an approach may end up in a vicious circle: the self-enrichment of a ruler could not be termed corrupt because the ruler effectively created legislation to provide legal basis for his actions.
 It matters a lot from a social point of view, if the "means" of seeking preferential treatment involves the outputs or income from the production process or it involves the direct use of factors of production. In the first case, the available factors of production are employed to produce output and generate income to the factor owners, i.e., the economy is on the production frontier (maybe on a second best frontier, but nonetheless on the frontier). Some of the income thus generated may be used to seek rents and preferential treatment. This is the situation envisaged by much of the corruption literature. In the second case, factors of production, for example, labour, which could have been employed in production of output, are deployed in the process of seeking rents-people who could become entrepreneurs become lobbyists. As a consequence, the economy produces below its production frontier and output and income is lost. This is the situation envisaged by the rent seeking literature which is concerned with the efficiency losses due to unproductive use of resources in the quest for rents.
Corruption and rent seeking can be combined as instances of influence-seeking activities. Such activities can be distinguished along two dimensions: whether the gatekeeper who assigns the rent benefits from the influence-seeking activities and whether the influence-seeking activity involves a transfer of income (bribe) or unproductive use of resources.
Un-internalised and socially harmful externalities provide a prima facie case for government intervention and a benevolent government would want to impose a correction. In practice, the task of doing so is delegated to a bureaucracy. The officials of the bureaucracy will, amongst other things, be tasked with checking that the polluting firms abide by the regulations. The problem, however, is that it is impossible for the government to monitor the officials perfectly. This leaves room for collusion between the firms and the officials. Any given official may agree to accept a bribe for not reporting violations of the regulations. Or the regulator may simply come to identify with the regulated firm. The benevolent government tries to avoid this by designing institutions (monitoring, wage structures, penalties) to maximise social welfare, but it is costly to design such institutions. It may, therefore, be optimal to accept a residual of corruption and rule violation. That is, corruption within this conception is, in fact, optimal in a second best sense.
A typical "grabbing hand" scenario, is entry regulation. Suppose that there are no good welfare economics reasons for restricting entry into an industry. Yet, a corruptible government official or politician may nonetheless introduce a licence system that restricts entry. The reason is that such regulation creates rents through artificial scarcity. As a consequence, potential producers in the industry are willing to pay a bribe to obtain a licence. A leviathan-type politician would, then, issue the bribe maximising number of licences and collect the largest possible bribe income. In practice, however, institutional constraints may impose some limits of this sort of behaviour.
The level of corruption depends on given institutional structures, culture, and history and is, in general, sub-optimal. Moreover, the type of corruption is endogenous to the political regime. For example, in a dictatorship, a corrupt and low-paid bureaucracy, either of the competitive or monopolistic type, can at the same time help the dictator to maintain power and to extract rents from the economy. In contrast, in a functioning democracy, the preferred vehicle for rent extraction becomes interest group contributions to political campaigns.
Dr Muhammad Abdul Mazid is a former Secretary and
 Chairman of NBR.
 mazid.muhammad @gmail.com