and scholars have come to believe that institutional arrangements also play a ... It lays out the household's and firm's intertemporal optimization problems,.
Received July 1991. final verskm receibr
92
~str~~~ti~~a~ activities in me of the si pkst ~~~~~~~~~s gsowth rrtcrdcls, investment and ko byirrg. with the extent of the tatter dete tht” ~~~~r ulations in force. As a result. rate increases with the ivatecost of a ~eg~~~tiQ~,while dynamics include ti ine, as in Olson‘s theory. The empirical evidence is from Uruguay, D relatively wealthy ccluntty that has dramaticaily lagged behind. It shows that restrictive regukitions have a positive impact on sectoral output, but a ne impact at the aggregate level. which is consistent with the model.
While traditional approaches stressed the importance of thrift and demography in explaining economic growth, in recent years many practitioners and scholars have come to believe that institutional arrangements also play a key role. However, the connection between institutions and the growth rate of output remains a black box problem, at least beyond the obvious statement that political instability and poorly enforced property rights dissuade private investment. Undeniably, the rent-seeking theory has provided interesting insights into the incidence of institutions on resource allocation and welfare [see MuelIer (1989, ch. ?3)]. But these results are drawn from a static partial eqlailibrium approach, while economic growth cannot be explained out of a dynamic genera1 equihbrium framework. In ad ition to this theoretical issue, t evidence, namely: measuring rent problem in dealing with the empi seeking. Pn fact, studies relating the growt rate of output to the extent of distributional activities rely on quite d Correspondence to: Martin Rama, The World Bank, 801 t9:h Street. N.W. llrj lt1.0391 ‘Washington, DC 20433. USA. avided excc~~e~~ ie’;earc ~SSi5l;ifXX. CommentsErq *Fmxmdo Correa and Carlos Grala participants at seminars 2t the NBE Martin Paldam, an anonymous referee a MA, and DELTA. Paris, are gratefully acknowledged.
0304_3878/93,ls86.
;!: H993-Eiisevier
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( l@Il) uses indicators such as government consumption and the num revolutions and coups per year. Although the obtained coeficients have the “right’ sign, they do not provide an intuition on the met anisms theory which institutions affect the growth rate of out In an attempt to model these mechanisms, effects of talent allocation between genuine e turns to talen seeking. Because of increasing cificaQPy,they concentrate in one sector. More profits are heavily taxed, so that e~tr~~ren~~rs are anot really ta~~~t~d an innovations proceed at a slow pace. Assessing the empirical relevance of this explanation is not easy. et al. (1991) use the proportions of engineering and law college majors as indicators of talent allocation. They regress the growth rate of output on these proportions and, again, get the ‘right’ signs. But these results do not necessarily stlpport the adverse selection hypothesis: the fact that law students abound does not imply that they are highly talented. This paper aims at providing a oesrahie analytical model on the connection between rent seeking and economic growth. At the theoretical level, this is done by introducing distributional activities in one of the simplest endogenous growth models. Now, the representative firm has two control variables: investment and lobbying expenditures, which have an incidence on the capital stock and the number of restrictive regulations in force. This leads to a non-cooperative equilibrium in which all firms behave, to some extent, as rent seekers. The empiricat evidence is from Uruguay, which is an interesting case for two reasons. On the one hand, there is a great deal of casual evidence on pervasive rent seeking, particularly since the deepening of import substitution policies, in the 1930s. On the other hand, after having reached, by 1955, a per capita output similar to that of wealthy European countries, Uruguay has dramatically lagged behind.’ One can suspect this second feature to result from the first one. eoretical model requires information on endogenous regulauses the data set developed by Rama (1992), which reckons the laws, decrees and administrative resolutions that create, maintain or modify a foreign-trade restriction for the benefit of a single firm or sector. Since the promoters of these regulations can be classified at the two-digit TSIC level in almost 95% of the cases, empirical results are obtained both at tlae aggregate and sectoral levels. The paper is organized as follows. Section 2 presents the analytical model. It lays out the household’s and firm’s intertemporal optimization problems, relates the effects of distributional activities to standard results in the rent
2.1. ~~~s~~~t~~~l
The representative ofd, infinitely lived, seeks to maximize the present value iB of the utility from consumption c:
where 6>0 is the discount rate, assumed to be constant.’ For analytical convenience, suppose that the momentary utility function is u(c) = log c. Households savings are lent to domestic firms. These loans, whose amount is a, yield a real rate of return I-. The change over time in assets is given bJ
(2)
ci=ra-c.
Maximizing U subject to the budget constraint in eq. (2) yields
Therefore, consumption domestic assets.
Output
grows faster t e higher the red rate of return on
y by the representative
capital stock (k) and the sverage ca This reflects the existence of a spi ‘ln most of the paper, interpreted
as c,, eic.
the time de
ward ~~~c~~~~ of its own
fir
the rern~j~~~g firms (K). er, very muc in the tradition of
ndence PF each variable
is not explicit;
in fact,
c has
t0
be
M.
38
Rama,
Rent
seeking
and
economic
pwwth
models. An appealing explanation for this effect is that both k and K represent a composite of physical capital and knowledge, wit the latter generating a positive external effect on the rest of t [Romer ( 1989)]. Besides, output by the representative firm depends on usually a first statute without which production cannot may be th: one setting incorporation, or allocating a soci identification to the firm. Additional statutes in favor of the as a tariff barrier to foreign competition, increase its outpu get this kind of transfers, there is a loss in overall efficiency. Therefore, output decreases with the average number of restrictive regulations which favor the remaining firms (S 10). These features are captured through the following reduced-form specification:
learning&y-doing
y=Ak”‘K”‘(l
+s)“J(l +s)“”
where 0 0. Parameter a4, on the contrary, is negative. Note that in equilibrium S--S, since all firms are identical. Hence, the natural assumption that redistribution based on restrictive regulations leads to a deadweight loss is equivalent to a3 + u4 ~0.~ Rent seeking can be seen as a repeated Prisoner’s Dilemma. Cooperation, represented by s=S=O, leads to the highest social payoff. However, the number of firms being very large, strategic behavior may be disregarded. Players will generally defect (s = S > 0), so that there will be a gap between actual and potential output. Such a gap provides a measure of the monetary Harberger costs arising from restrictive regulations, for a given capital stock. Finally, in order to av,aid a long-run tendency towards the stationary state, the production function has to be characterized by non-decreasing returns to the reproducible factors [Rebelo (1991)]. Here, it is assumed that a1 +a2 + = 1. This hypothesis is not based on economic intuition but just aimed @3+a4 at analytical tractability. Otherwise, getting a bounded long-run growth rate would require additional assumptions, such as internal investment costs [as in Romer (1986)], thus leading to a complicated algebra.
At each point in time, the representative firm must decide the amount of %ore general specifications, like the one used bv Terrones (1990), would add realism to the model but prevent its analytical solution out of the Galanced growth path. ‘In eq. (i), s could be interpreted as the tariff rate protecting the representative firm, and S as the average tariff rate in the economy. But it is probably lxtter to tb~nk oi s and S as numbers of statutes, since most restrictive regulations set up non-tariff barriers.
fesoufces devoted to (I 2 0). These decision
revenues:
In eq. (6), p represents the private cost of additional capital. Units are chosen in such a way that cp= I under laissez-faire. ff government subsidizes investment in order to foster economic growth, then /t < 1. Lobbying expenditures, in turn, determine the number of restrictive regulations which favor the firm:’ (7) In eq. (7), I and s are treated as continuous variables. Parameter 0 measures the private cost of passing an additional regulation, which is iikely to depend on the prevailing institutional arrangements. Incorporating or obtaining an employer identification is assumed to be free, although this may not bc the case in some developing countries [de Soto ( 1989)J.
The first-order condition for s implies that the private marginal productivity of restrictive regulations must equal their marginal cost? d&vP(
1 + s)“3- ‘( I
+ sy4 = 6.
Since in equilibrium s= S and k = K, eq.
s = (cQA/O)
l/(1
-;I3-z.d/(
_
1.
V-9 (8)
yields (9)
‘Restrictive regulations could have been a state variable, instead of a control variable. However, this is not the current practice in the rent-seeking literature, where lobbying expenditures are recurring, rather than sunk. ‘The initial capirai stock is assumed to be high enough to avoid the corner solution 5 =Q corresponding to the ‘free-market economy’. Besides, note that the left-hand side of eq. (8) is decreasing in s. Hence, the total transfer received by the tirm is higher than OS, provided that S is &en. In terms of the partial e~~~~ibr~~rn models used in the rent-seeking literature. this reflects less-than-perfect rent dissipation.
Number
of regulations
0
1
Lobbying
(§I
Private
cost of regu?a?ions
exOenditures
(81
8
(S.81
2
Fig. 1
Therefore, the number of restrictive regulations in force is an upward function of the total capital stock, with the elasticity of S with respect to K being higher than one. Since Harberger costs depend on S, this is consistent with Olson’s (1982) theory, according to which economies become increasingly paralyzed by distributive actions as they grow wealthier. Eq. (9) implies that for any given capital stock K, the number of restrictive regulations is lower the higher their private cost 8. Total lobbying expenditures, called Tullock costs in the rent-seeking literature, depend on 8 too. However, the relationship is not monotonic anymore; instead, eqs. (7) and (9) lead to a hump-shaped pattern. Both S and S6 are represented as functions of 0 in fig.1, with the analytical expressions of critical vaiws 0, and O2 given bY
ence, for low values of parameter 0, Harberger costs may be significant in f low (or even negligible) Tullock costs.
k = K. solving t e problem faced by t
leads to
Since consumption grows t the ex~~Re~tia~ rate r--c5 [see eq. (S)], the solution of the above di~ercnt~a~equation is
(13) where K, represents the initial capital stock of the economy. According to eq. (13), when t + + m the growth rate of output approaches r-6. The rate of return r being an upward function of 6, this means that long-run growth is low (or even negative) when getting transfers by means of restrictive regulations is cheap. However, in the ‘first stages’ of economic development, the growth rate of output is higher than r-6. This is shown in fig. 2, which plots the growth paths of two countries characterized by different values of parameter 0. Consider the ‘low-8” schedule in fig. 2, corresponding to a country in which the government usually accedes to private demands for distribution. The ‘starting’ growth rate could be high (point D), and even exceed the growth rate of countries which came ‘earlier’ to economic development (point W). However, this is just a transitory srtuation: in a long-run perspective, the rise of the ‘low4 country is follot,ped by stagnation, or even y decline, as in Olson’s theory. 3. This section presents empirical evidence on the ~e~~t~~~~~~~ be?weez output and restrictive regulations in Uruguay. This country probably resents the extreme case of import substitution policies ce it became an platoon of less an three ~~l~~o~ ost closed economy in spite of a azing stagger people. This was achieved through a ‘It is assumed that the parameters of the model are such that r < 28. in order to duffel the transversality condition on households’ assets.
42 Growth
0
rate
tO
of output
t
restrictions over three decades, from the 1930s to the 1960s. However, rent seeking remained a widespread practice during the opening up of the economy, in the 1970s.’ Hence, one can suspect Uruguay to be a ‘low-8 country. 3.1. Data The production function in cq. (4) involves three variables: output, the capital stock and the number of restrictive regulations in force. While in many countries there is some information concerning the first two, quantifying the extent of rent seeking is a much more difficult task. This is why indirect indicators are generally used, such as the effective protection rates. Fortunately, in the Uruguayan case there is direct information on restrictive regulations. This information is contained in the data set mentioned in the Introduction, which includes the laws (passed by the Parliament), the decrees and the administrative resolutions (both passed by the Executive) that regulate foreign trade for the benefit of a simple firm or sector. A!though the private cost of getting these regulations approved probably depends on their legal nature. in this paper they are all added up on a yearly basis without any weighting, to minimize data manipulation. The regulations in the data set correspond to period 1925-1983, so that ecades. The starting year was chosen so as to include
tional agreements, were set
stiles
which ha
amounted to 3,973. The theoretical model a lved ~~fo~at~~~ both at the firm level (variables y_ k and s) and at the aggregate level (variables K and S). In the empirical research, such a difference is captured throu the d~st~~cti~ between sectoral and aggregate variables. ased on data availability, seven industries are considered: foods and beverage (KIC 3l), textile and apparel (32), paper and printing (34), chemical and petroleum (35), stone, clay, glass and concrete (36) metal and machinery (38) and the rest of the manufacturing sector (3R hereinafter). The statutes in the data set can be classified at the two-digit ISlC level in almost 957; of the cases. The remaining 5% corresponds to regulations having two features. On the one hand, they do not mention explicitly their promoters. On the other hand, they concern a specific import regime for a good that can be used as an input by many different sectors. In all, 3,356 foreign-trade regulations in the data set are in favor of one of the seven sectors mentioned above. As regards the two other variables in the production function, data for total output exist in Uruguay since 1935. However, they can be disaggregated at the two-digit ISIC level only from 1955 on. Concerning the capital stock, there are aggregate private investment series since 194.2, but no disaggregated data. The latter were estimated in this paper for the 13661983 period, using information collected by Stolovich (1983) and CINVE O~I the sectoral structure of equipment imports.’ 3.2. Sperfwahon in this paper depends crucially on the reduced-form production function, a key issue is to verify whether output by one sector actually increases with reg~iati~~s Since
the
theoretical
model
‘Needless to say, this concerns accumulation in physical capital onBy. not in knowledge
44
M. Rama, Rent seeking and twmomic growih
to that sector, and decreases with regulations promoted by the rerna~n~~g firms in the economy. Thus the problem is to draw a testabhs s from eq. (4), given data availability. Differentiating eq. (4) with respect to time an taking eq. Q6? into account yields .
9._yli+u21+u Y pk PK
S
%s
+a
S 41+s’
(14)
According to the discussion above, in the Uruguayan case there is information on i and I, but not directly on k and K. The latter could be inferred from the former through the permanent inventory method, but this procedure would lead to very rough estimates of the capital stock. The problem is simitar for the series on restrictive regulations, which indicate the number of ‘new’ statutes approved in the current year (S an rather than the absolute number of statutes in force (s and S). Furthermore, using the permanent inventory method in this case would be even more hazardous than for the capital stock, since there is no way to assess the relevant ‘depreciation rate’ for endogenous regulations. Therefore, eq. (14) cannot be estimated as such. However, according to the model there exists a stable relationship between the capital stock and the output level. After replacing the first-order condition represented by eq. (8) and the symmetry arguments s=S and k= K into eq. (4), the production function becomes
This equation also holds when Y and K are replaced by y and k. On the other hand, the average number of statutes per firm (s in terms of the model) is likely to be very small. Even if all the restrictive regulations in ;he data set were still in force, this would represent about 4,000 endogenous foreign-trade restrictions, compared to more than 173,000 firms in the 1Jruguayan economy [DGEC (1990)]. Hence, from a practical viewpoint, it can be assumed that S/(1 +s) ZS and $/( 1 +S) z s. This hypothesis and eq. (15) allow writing eq. (14) in the following way:
with $t >O, 4Z > 0, @3> 0 and 44 CO. Moreover, I’/y= I/Y and S-=s, eq. ( 14) ,:an be also expressed as
since in equilibrium
The ~rodMction ~~~~t~~~ is writte This is not an ~nre~~~st investment in likely to wever, the effects of restrictive regulations vable within such a short delay. On the contra distributional activities to i growth. This issue was analyzed for the r~gu~yan case by Rama t, t 92), based on aggregate time series. In that paper, innovations in the rate of approval of restrictive regulations were correlated with innovations in the growth rate of output, allowing for a la,* of up to twenty years. The results showed a significant positive impact after two or three years. But the sign changed around the fourth year, and became significantly negative a decade later. Since endogenous regulations are serially correlated, the estimation of eqs. (16) and (17) cannot include a whoie lag structure for variables s’ and 3. To deal with this problem, a grid search was performed, based on the results by Rama (1992). It was assumed that the positive impact observed after two or three years captured the effect of regulations on sectoral output (dy/ds >O), while the subsequent negative impact reflected the effect on aggregate output (dY/dS
