More Rents May Not Be Good

As frequent travelers, we have acquired and dedicate a full desk drawer to electrical converters. We think we have found a couple that are ideal, with the perfect dials and flexible extensions that will allow us to twist or turn the various prongs into the right configuration for each country. Still, sometimes our computers vaguely vibrate as though alive as we charge them and, on occasion, a hair dryer more or less explodes in our hands. But for the most part, they work great.

Standards like electrical current characteristics or plug configurations are mostly helpful. At home, all of our appliances function every single time. Behind the scenes, however, there is often a battle royal between firms competing to own the standard. Sometimes a winning technology may be covered by patent, providing the firm in question with a near-monopoly level of dominance until the protection runs out. A commercial client in the 1980s was delighted to have his technology established as required in an emerging Asian economy, for example. High fives all around.

Sometimes “rent seeking” activity can be more subtle, and possibly damaging, to an economy. I’ve come to a halt at four-way stops in the middle of nowhere, and with unlimited visibility, and wondered if the mayor’s brother owned a sign company. The same goes for those embarrassing “bridges may ice before roadway” signs in the Deep South. There was also the rumored connection in the Chicago area many years ago—where extensive rules covering orange cones and construction areas were linked to a relative of the mayor—when it was “the city that worked.”

On a larger scale and more economically pernicious, according to many academics and other observers, are competition-limiting practices and regulations. Not unlike the courtiers of old, lobbyists can legally entertain and suggest something often enough to obtain: special tax treatment, protection from competitors or promotion of projects (or wars). Here on the desk, people initially cheered when the more than $650 million renovation of the Jefferson National Expansion Memorial National Park was announced, but on the same day in the was the normal concern over deficits and debt. It’s complicated.

We have been suspicious for quite some time that a large measure of the difficulty the U.S. economy is having is due to a larger focus on rent seeking activity over innovation and competition. There’s a message buried in the fact that Real Median Incomes today sit below the levels from 1995. To be sure, there are large contributors to innovation, especially throughout the science, technology, engineering and mathematics (STEM) oriented businesses. But this just doesn’t feel like the whole story.

Actual Evidence
Since we have to run a business and don’t have the time or resources to sift through massive databases, we were delighted to see James Bessen of the Boston University School of Law pick up this topic. In his May 2016 paper “Accounting for Rising Corporate Profits: Intangibles or Regulatory Rents,” also featured in the Harvard Business Review, he finds that since 2000 in particular, nearly half of margin expansion for non-financial companies can be accounted for by “Regulation and Lobbying.”

“…since 2000, political activity and regulation account for a surprisingly large share of the increase.”1

Of course this is not exactly a new phenomena. Humans have probably spent their entire history—ever since some sort of boss was first enabled—wheedling for a better deal for themselves. But like Eisenhower predicted in his farewell speech, the domination of a few elements of enterprise, research and the allocation of government funds, do not foretell a more dynamic and expansive economy.

There are a couple of things that I find troubling in the underlying paper. First, of course, is the apparent confirmation of my suspicions that classic rent seeking activity is driving a disproportionate share of margin increase and corporate valuation. I suspect the next step needs to follow this money down to how it impacts median income.

But the second and more troubling implication is that this trend is only getting started. While value creation, even up through the 1990s, followed research and development and capital spending trends, the dominance of rent seeking activity has accelerated since 2000. Here’s hoping that this turns around and that core innovation can again become the primary economic driver.

Until the next Daily Pfennig® edition…

Onward and upward,

Frank Trotter
EVP & Chairman
EverBank Global Markets Group