Competitive forces should limit outsize profits,[289] but if governments do not ensure that markets are competitive, there can be large monopoly profits. Competitive forces should also limit disproportionate executive compensation, but in modern corporations, the CEO has enormous power—including the power to set his own compensation, subject, of course, to his board—but in many corporations, he even has considerable power to appoint the board, and with a stacked board, there is little check. Shareholders have minimal say. Some countries have better "corporate governance laws," the laws that circumscribe the power of the CEO, for instance, by insisting that there be independent members in the board or that shareholders have a say in pay. If the country does not have good corporate governance laws that are effectively enforced, CEOs can pay themselves outsize bonuses.
Progressive tax and expenditure policies (which tax the rich more than the poor 15 and provide systems of good social protection) can limit the extent of inequality. By contrast, programs that give away a country's resources to the rich and well connected can increase inequality.
Our political system has increasingly been working in ways that increase the inequality of outcomes and reduce equality of opportunity. This should not come as a surprise: we have a political system that gives inordinate power to those at the top, and they have used that power not only to limit the extent of redistribution but also to shape the rules of the game in their favor, and to extract from the public what can only be called large "gifts." Economists have a name for these activities: they call them rent seeking, getting income not as a reward to creating wealth but by grabbing a larger share of the wealth that would otherwise have been produced without their effort. . . . Those at the top have learned how to suck out money from the rest in ways that the rest are hardly aware of—that is their true innovation.
Jean-Baptiste Colbert, the adviser to King Louis XIV of France, reportedly said, "The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing." So, too, for the art of rent seeking.
To put it baldly, there are two ways to become wealthy: to create wealth or to take wealth away from others. The former adds to society. The latter typically subtracts from it, for in the process of taking it away, wealth gets destroyed. A monopolist who overcharges for his product takes money from those whom he is overcharging and at the same time destroys value. To get his monopoly price, he has to restrict production.
Unfortunately, even genuine wealth creators often are not satisfied with the wealth that their innovation or entrepreneurship has reaped. Some eventually turn to abusive practices like monopoly pricing or other forms of rent extraction to garner even more riches. To take just one example, the railroad barons of the nineteenth century provided an important service in constructing the railroads, but much of their wealth was the result of their political influence—getting large government land grants on either side of the railway. Today, over a century after the railroad barons dominated the economy, much of the wealth at the top in the United States—and some of the suffering at the bottom—stems from wealth transfers instead of wealth creation. . . .
Rent Seeking
Rent seeking takes many forms: hidden and open transfers and subsidies from the 20 government, laws that make the marketplace less competitive, lax enforcement of existing competition laws, and statutes that allow corporations to take advantage of others or to pass costs on to the rest of society. The term "rent" was originally used to describe the returns to land, since the owner of land receives these payments by virtue of his ownership and not because of anything he does. This stands in contrast to the situation of workers, for example, whose wages are compensation for the effort they provide. The term "rent" then was extended to include monopoly profits, or monopoly rents, the income that one receives simply from the control of a monopoly. Eventually the term was expanded still further to include the returns on similar ownership claims. If the government gave a company the exclusive right to import a limited amount (a quota) of a good, such as sugar, then the extra return generated as a result of the ownership of those rights was called a "quota-rent."
Countries rich in natural resource are infamous for rent-seeking activities. It's far easier to get rich in these countries by gaining access to resources at favorable terms than by producing wealth. This is often a negative-sum game, which is one of the reasons why, on average, such countries have grown more slowly than comparable countries without the bounty of such resources.
Even more disturbing, one might have thought that an abundance of resources could be used to help the poor, to ensure access to education and health care for all. Taxing work and savings can weaken incentives; in contrast, taxing the "rents" on land, oil, or other natural resources won't make them disappear. The resources will still be there to be taken out, if not today, then tomorrow. There are no adverse incentive effects. That means that, in principle, there should be ample revenues to finance both social expenditures and public investments—in, say, health and education. Yet, among the countries with the greatest inequality are those with the most natural resources. Evidently, a few within these countries are better at rent seeking than others (usually those with political power), and they ensure that the benefits of the resources accrue largely to themselves. In Venezuela, the richest oil producer in Latin America, half of the country lived in poverty prior to the rise of
Hugo Chavez—and it is precisely this type of poverty in the midst of riches that gives rise to leaders like him.
Rent-seeking behavior is not just endemic in the resource-rich countries of the Middle East, Africa, and Latin America. It has also become endemic in modern economies, including our own. In those economies, it takes many forms, some of which are closely akin to those in the oil-rich countries: getting state assets (such as oil or minerals) at below fair-market prices. It's not hard to become wealthy if the government sells you for $500 million a mine that's worth $1 billion.
Another form of rent seeking is the flip side: selling to government products at above market prices (noncompetitive procurement). The drug companies and military contractors excel in this form of rent seeking. Open government subsidies (as in agriculture) or hidden subsidies (trade restrictions that reduce competition or subsidies hidden in the tax system) are other ways of getting rents from the public.
Not all rent seeking uses government to extract money from ordinary citizens. The 25 private sector can excel on its own, extracting rents from the public, for instance, through monopolistic practices and exploiting those who are less informed and educated, exemplified by the banks' predatory lending. CEOs can use their control of the corporation to garner for themselves a larger fraction of the firms' revenues. Here, though, the government too plays a role, by not doing what it should: by not stopping these activities, by not making them illegal, or by not enforcing laws that exist. Effective enforcement of competition laws can circumscribe monopoly profits; effective laws on predatory lending and credit card abuses can limit the extent of bank exploitation; well-designed corporate governance laws can limit the extent to which corporate officials appropriate for themselves firm revenues.
By looking at those at the top of the wealth distribution, we can get a feel for the nature of this aspect of America's inequality. Few are inventors who have reshaped technology, or scientists who have reshaped our understandings of the laws of nature. Think of Alan Turing, whose genius provided the mathematics underlying the modern computer. Or of Einstein. Or of the discoverers of the laser . . . or John Bardeen, Walter Brattain, and William Shockley, the inventors of transistors. Or of Watson and Crick, who unraveled the mysteries of DNA, upon which rests so much of modern medicine. None of them, who made such large contributions to our well- being, are among those most rewarded by our economic system.