The present essay evidence Latin America as a rent-seeking region. Governments depend of the income generated by those activities and grant the right of exploitation in exchange for bribes. Given its highest scale of return, rent-seeking sector attracts the best and brightest people, eliminating potential entrepreneurs who are able to improvement of productivity and assure a sustainable economic growth. Finally, we propose the improvement of institutional quality as a way of solution.
1. Introduction
The allocation of talents represents a considerable source of promotion for the sustainable economic growth not studied in the proper intensity. The conventional wisdom assume this variable as exogenous, while a complementary theoretical framework allow us to analyze the endogenous process of how the best brightest people has the potential of search and select new opportunities in order to create value, innovation, technology and so on. Likewise, a wrong allocation of these best talents in unproductive sector such as rent-seeking sector would bring catastrophic consequences for the economy.
Unfortunately, Latin America poses the characteristic of being a rent-seeking region. Historically there have been deviations of talents toward rent-seeking activities, which can explain easily the lack of innovation, technology and competitive market. The rent-seeking sectors in the region are the same where natural resources are exploited. Thus without the necessity o innovation or generate high level of technology, certain people enjoy privileges from the government to have the right to exploit the rent of these natural resources, trough of bride and corruption. While this sector has the high scale of return in term of profit and salaries it is almost automatically absorb the best human capital of each country, transforming potential entrepreneurs to rent-seekers and practically eliminating all possibility of counting with a improvement of productivity and a sustainable economic growth.
The present essay is divided in four parts. The first part is the introduction. In the second part it is analyzed the characteristic of the region as a rent-seeking region based on the theoretical concepts necessary. In the third part it is evaluated institutional reforms as the main instrument to overcome the rent-seeking problem. Finally, in the fifth part we conclude.
2. Latin America: a rent-seeking economy
In Latin America, the economic growth has mainly relied on rent-seeking activities, through two primary ways: (i) the exploitation of its endowment of natural resources, and (ii) bad practices, by corrupt officials, in the inter-action between the government and the private sector. While the region lacks of entrepreneurs, who may create value, innovation, technology, etc; all essential aspects to count with a sustainable economic growth.
Some economists hold the idea that entrepreneurship is a scarce resource like other economic resources and therefore developing countries are characterized by a scarcity of it Rajan (1988). However, in the present essay, we hold a different view, that the region possesses the enough “amount” of entrepreneurship, but it is deviated toward rent-seeking activities, in a context of inappropriate and weak institutions.
Conventional theoretical framework does not allow seeing that problem clearly. For that, we need to use the definition of “entrepreneurship” in the traditional Schumpeterian meaning. Thus entrepreneurship exclusively means the value-creating force in a competitive market where the potential for rents provides the incentive for resource owners to seek out more efficient allocations of their resources Rajan (1988). Schumpeter (1911) put the entrepreneur center stage in his theory of innovation and capitalist development.
Another definition from Sanders (2009) is that entrepreneurship regards a force of change, innovation and development in modern economies, bring new and better products to markets, restore allocative efficiency through arbitrage and reinvest their profits. Entrepreneurship is widely recognized as a force of good in capitalist economies.
In terms of Dietz (2007), in turn based on Tullock (1980), rent and rent seeking emerge in a situation when an individual invests in something that will not improve productivity or will actually lower it, however raise his income because it gives him some special advantage, rights or monopoly power, given by the government.
For Dietz (2007) rent-seeking behavior involves payments made by an entrepreneur to the government to obtain the right to produce something, as an importer may bribe an official to be able to import certain goods. Thus a rent-seeking economy is one in which a great many people invest money and other resources in seeking a privilege. The state also becomes rent-seeking, while imposing legal and other restraints to make a large percentage of its population to spend resources in rent-seeking activities.
Rent-seeking activities may be efficient and rational from the standpoint of the individual enterprise or entrepreneur; however, involve a tremendous waste from the standpoint of the society as a whole. Large resources in terms of human capacity are diverted to the rent-seeking part of the government and the private sector Dietz (2007).
Baumol (1990), Mehlum et al. (2003) and Acemoglu (1995) argued that how energy and talent can also be allocated to unproductive ends and reduce total welfare, presenting models that analyze the allocation of a given entrepreneurial talent over destructive and productive activities. Thus the predatory rent-seeking activities aim at profits, which is not only unproductive, but destructive, and directly reduces welfare.
Also, what constitutes entrepreneurship cannot be directly answered from neoclassical theory, but Liebenstein (1968) listed some of the characteristics, such as the ability to search, discover and evaluate economic opportunities, marshal the financial resources, be the ultimate risk bearer, search and discover new economic information, provide leadership for the group, etc. These characteristics are not exogenous, but the product of a discovery process.
The work of Murphy et al. (1991) is one of the first to establish that in one country, when the best and brightest people become entrepreneurs, they improve the technology and productivity with positive and sustain effect on economic growth, in the most efficient way. Otherwise, if these talented people deviate their ability to rent-seeking activities, which is different from entrepreneurial, they only redistribute wealth and reduce growth. When people are free, they choose occupations that offer them the highest returns on their abilities. The author also evidences that in most countries, rent seeking rewards talent more than entrepreneurship does, and leading to stagnation.
Specifically for Murphy et al. (1991) this kind of deviation of talent could be the cause of stagnation of development in many countries in Africa and Latin America as well as could explain the development of East Asian countries. Therefore, if the proportion of entrepreneurs is crumbling, then technological progress slows and growth weakens. Conversely, according to Landes (1969), the efficient allocation of talented people in England allowed the Industrial Revolution in the eighteenth century.
The most recent evidences Ebeke et al. (2011) about the deviation on the distribution of talents in countries with natural resources, concludes that when the most talented people of a nation become entrepreneurs, they enable innovation and technology, leading to increased productivity and fostering the economic growth. Conversely, when they become rent-seekers, this hurts the economic growth because their orientation is not in favor of productive activities.
Studies concerned on rent generated by natural resources, find out that the exploitation of natural resources causes two opposing effects. First, increases the income of the country, and second causes the displacement of private agents from the most productive sectors towards the natural resource sector, inducing rent-seeking behavior. The decision to move from one category of activity to the other will depend on the profitability of each sector Ebeke et al (2011).
Baland and Francois (2000) allow us to understand why region is persistent in rent-seeking rather than in productive activities, even in situations of natural resource booms, emphasizing on the relative importance of the sector in productive activities before booms. Thus if productive activities were more important than the rent-seeking activities, then this sector will succeed in capturing this rent and there will be a dilution of rent-seeking activities. Otherwise, the activities of rent-seeking will be more important.
Despite the lack of aware about the deviation of potential entrepreneurs from productive sectors toward rent-seeking sectors, there is increasing -although not abundant- literature both theoretical and empirical to analyze the situation in Latin America. For instance, Ka (2005) analysis how the endogenous career choice between productive entrepreneurship and rent-seeking behavior can influence aggregate output. Baumol (1990) provides historical examples that the returns to rent-seeking affect the allocation of entrepreneurship. Murphy, et al. (1991) shows how agents can go to the rent-seeking and lead to a lower economic growth rate. Acemoglu and Verdier (1998) present a rich model on the endogenous choice of rent-seeking.
Ragnar (2001) build a simple model to explain why natural resource abundance lowers income and welfare. In that model with rent seeking, a greater amount of natural resources increases the number of entrepreneurs engaged in rent seeking and reduces the number of entrepreneurs running productive firms. With a demand externality, it is shown that the drop in income as a result of this is higher than the increase in income from the natural resource.
This new approach about rent-seeking vs. productive sector for countries rich in natural resources, are also coherent related with the previous studies on Dutch disease, where abundant natural resources may lower production and welfare because the composition of production is changed, and because it is the composition of production that determines the level or the growth rate of productivity.
Among the rich countries in natural resources we can mention Venezuela, Mexico, Brazil, Ecuador, Bolivia, etc with huge amount of oil and gas and Peru, Chile, Argentina, Colombia, etc. with enormous amount of mining products such as gold, copper, silver and so on. Where Latin America countries depend considerably of natural resources such as percentage of their exports or tax income.
According to the annual report of the magazine America Economy, in these countries annually petroleum and mining companies leading the raking, which evidence how these biggest enterprise are able to absorb the best human capital of these countries, given the highest salaries offered by them. Moreover, their economic power also evidences the ability to get any privilege they need from the government.
Given the scarcity of specific works on Latin American countries, is illustrative the first large scale micro-level evidence on the channels of rent-seeking for Paraguay Auriol et al. (2011), using a unique database of around 50 000 public procurement operations, covering the period 2004-2007. We can see how a large-scale network of favoritism between the government and privileged rent-seekers damages the economy.
First, Paraguay enjoys an important source of rent from its big hydroelectric dams shared with its neighbors Argentina and Brazil. The biggest one is Itaipú, the second biggest in the world. The Paraguayan government receives every year an enormous amount of royalties, equivalent to 5% of its GDP and 50% of its total government tax collection.
Then dams’ propitious source of income shaped the growth of the Paraguayan “rent-seeking economy”. That fostered a culture of intense rent-seeking and corruption and allowed a few entrepreneurs that were on good terms with the corrupt officials to become rich. Thus, huge purchasing of goods and services are attributed by corrupt officials, who distort rules to get bribes; while entrepreneurs in the rent sector make profits, while are the highest in the country. These entrepreneurs are also the most able ones, resulting in a misallocation of talents in the economy.
We have illustrated the fact that rent-seeking is costly to development, by showing how entrepreneurs’ economic incentives are distorted toward unproductive activities as the result of favoritism in Paraguay. It is showed how rent-seeking is particularly costly because mainly it destroys the development potential of the best entrepreneurs. On the other hand, it is reasonable to affirm that in the absence of rent-seeking opportunities, entrepreneurs specialize in productive activities, serving market demand competitively and make no rents in equilibrium.
Another case com from Dietz (2007), who studied rent-seeking in Latin America and took a Lima-Peru as studied case, quoting researches from the ILD of the eighties in Lima, while the rent activities rely on the owner of the land, in the productive activities predominate an informal sector with industries such as shoes, clothing, and furniture, which 90% of which are not legally registered.
There is also high level of informality for bus and taxi services in Lima and a lot of street vendors which are strictly speaking, illegal or at least extralegal. There was a estimation of about three hundred thousand individuals who are either permanent or sometime street vendors provide some rough idea as to the size and importance of such activity for the city.
From the Peruvian case, within such a state described by Dietz (2007), there is an informal urban economy, characterized as having ease of entry, reliance on indigenous resources, family ownership of enterprises, small scale of operation, labor-intensive and adapted technology, and unregulated and competitive markets will emerge as a response to the inabilities of the rent-seeking formal sector to provide employment, innovation, value and so on.
3. Toward an entrepreneurial economy
From the description depicted above, it is demonstrated how the relying on natural resources, generates welfare loss. Societies could consolidate a rent-seeking culture. In fact, repeated interactions between corrupt institutions and rent-seekers produce the absorption of entrepreneurs toward unproductive sectors. It is expected that more entrenched, in the way described, are the institutions more would be consolidated a rent-seeking society.
Rajan (1998) brought bad practices from India, where institutions make the opportunity cost of economic alertness high and that of bureaucratic alertness low. Therefore, entrepreneurial individuals rationally invest their time, energy, and resources in pursuing bureaucratic opportunities rather than economic ones. In consequence, within such institutions, entrepreneurship will get translated into socially malevolent rent-seeking activity.
For Dietz (2007) the emergence of informal sector is a response of a state and a formal economy that depends simultaneously on rent seeking instead of competition to capture a favorable place in the market to expand productivity and to assure itself of a steady supply of cheap and unregulated labor. Contrary, institutions should care the fact that there is lack of money, contacts, power, and knowledge of the system in the informal sector, while the brightest are absorbed in the rent-seeking formal sector.
According to Ka (2005) there have long been considerable aware of the problem of rent-seeking. Recent efforts have explored several important issues, due to the strategic interactions among potentially rent-seeker, there could be important the role of institutions, even in term of looking for improve the initial distribution of wealth in order to make fair the equality of opportunities and affect positively the aggregate economic outcomes.
As one of the pioneers works, we have the seminal regression of Sachs and Warner (1995), which shows a negative correlation between dependence on natural resources and economic growth. After that fact, several channels have been examined through which natural resources could undermine development. The main differences rely on the quality of institutions.
The work of Gylfason (2001) being one of the first to empirically focus on the relationship between natural resources and education. The author showed clearly how oil-producing countries tend to have low levels of education. The author explains this result by the fact that the dependence on natural resources, such as oil or minerals, neglect the necessity of improvement in human capital.
Thus natural resources-rich countries invest not enough in education, having as result poor performance in human capital. Gylfason (2001) concludes that the nations who consciously or unconsciously believe that natural resources is their greatest asset develop a false sense of security and become negligent about the accumulation of human capital.
The question about why there still poor countries even when they are rich in natural resources? Could be reasonable attributed to the work of institutions. Diverse author such as Knack and Keefer (1995) and Acemoglu, Johnson, and Robinson (2001, 2002), among others, find that higher institutional quality has a positive effect on economic growth.
Ebeke et al. (2011) develops diverse econometric exercises and based on a sample of 69 developing countries highlights that oil rents determine the allocation of talents but this effect is not linear, since it depends on the quality of governance. Thus, oil rents in well governed countries tend to orient talents towards productive activities; while oil rents in badly governed countries tend to orient talents towards rent-seeking activities.
The author seeks to provide a granular origin of this institutional approach. Moreover, oil rich and badly governed countries are more likely to fall into a bad governance quality trap due to that more talented individuals are associated with training correlated with rent seeking activities. The idea is that the bad governance quality environment is regenerated by the misallocation of talented individuals in the society, which constitute a vicious circle Ebeke et al. (2011).
Some authors such as Mehlum et al. (2006) suggest that profitability of the each sector will depend on the quality of the institutions in place. Thus, if institutions are of good quality, production activities are more profitable than rent-seeking activities. Conversely, in the absence of institutions of good quality, such as is the predominant reality in Latin America, the opportunity cost of rent-seeking activities decreases.
Hence, in the case of institutions of good quality, entrepreneurs abandon the productive sectors to engage in rent-seeking activities. This diversion from the productive sector leads to a decline in productivity throughout the economy, in turn, leads to lower growth. Therefore, natural resources will therefore be a blessing only based on good quality of the home institutions Mehlum et al. (2006).
In the same line, Baumol (1990) hold that institutions determine the pay-offs to both types of sectors (rent-seeking and productive) and hence drive this allocation of entrepreneurs. But the author also shows that there are other important factors such as the distribution of initial wealth and entrepreneurial talent, which play a decisive role in the final allocations of entrepreneurs.
There are critical arguments such as Baumol (1990), Murphy et al. (1991), Mehlum et al. (2003) and Acemoglu (1995) who argued how the same energy and talent can also be allocated to unproductive ends and reduce total welfare of the society. Given that entrepreneurs can choose between productive ventures that increase total welfare and rent-seeking activities; institutions may avoid that a rent-seeking behavior could reduce the incentive to engage in productive ventures and thereby has a negative impact on aggregate economic activity.
In fact, institutional setting must circumvent such behavior. Therefore, institutional reform is strongly suggested to prevent it. However, it is important to consider that the problem with that strategy is that institutions are not so easily built up or changed. Thus, if strong and wrong institutions exist and allow bad behavior, they are also likely to persist. From a institutional perspective, it is argued that institutions are largely historically determined, explaining in turn the persistence of bad institutions.
For Sanders (2009), even if the proper institutions are absent or weak it is not easy to just build the proper ones overnight. Therefore, in such a context pre-existing institutions have broken down and entrepreneurial talent can turn into a truly destructive force. Obviously institutional recovery helps. That should help to improve matters and help the economy move to productive entrepreneurship equilibrium.
A clear conclusion from the static analysis made by Sanders (2009) is that stronger institutions will help an economy switch to productive entrepreneurship in the long run, but unfortunately as such policies are hard to implement, strategies such as to reduce credit constraints by setting up financial intermediation and the provision of microcredits are only example of the wide measures to do.
In fact, although the proposal of institutional reforms as solution to the problem of deviation of entrepreneurship seems simple and overwhelming, however these measures require probably certain long time and its benefits could be also for the long term. The way most appropriated that emerges from the studies related to rent-seeking is to catch-up standards such as those from the OCDE countries.
Thus in the following chart, we can view the differences between Latin America countries versus OCDE countries. Those indicators belong to the Worldwide Governance Indicator (WGI) developed by the World Bank in order to evaluate the good governance of 212 countries in the world. While the value of the indicators of the region are around 50% of quality, those of the OCDE countries are much more above with levels higher that 90%. Therefore, the region has a lot of to catch up from OCDE institutions in term of regulatory quality, control of corruption, voice and accountability, political stability, government effectiveness and rule of law.
4. Conclusion
The countries of the region pose a culture of rent-seeking. These economies depend strongly of the exploitation of natural resources such as oil, gas, minerals, etc. In consequence, the economic indicators are explain by that, for example, in most cases more than 50% of export income and tax income come from natural resources. This sector is featured because does not allow creation of value, innovation or technology, therefore does not improve neither the productivity nor the economic growth in the long term. However, this sector has the highest scale of return, therefore attract the best a brightest people, who being free of their choices, select the sector with the higher profits and salaries.
While the government also pose an rent-seeking behavior due to its interaction and dependency with the rent-seeker instead of the productive and competitive part of the economy. The government receive huge amount of resources from the rent-seeking sector, at the same time that corrupt official continuously shape the law in order to benefit its network of private comrades in exchange for bribes. In the region this is a repeated process, which foster the deviation of the best and brightest people to rent-seeking activities and therefore waste of resource to promote the competitive sector, which is able to create innovation and technology in turn assuring the economic growth in the long term.
Diverse econometric methods have determined that the quality of institution represent the main tool to transform a society from a rent-seeking behavior toward and entrepreneurial one. However, given that institutions are built through a historical process both change of creation of new institutions symbolize a durable work. In the present essay propose improve the quality of the institutions though a process of catching up with those of the OCDE countries in aspects such as regulatory quality, control of corruption, voice and accountability and so on.
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