Rent Seeking and Economic Growth: Evidence from a Panel of U.S. States

Abstract

Rent-seeking behavior would include all of the various ways by which individuals or groups lobby government for taxing, spending and regulatory policies that confer financial benefits or other specific advantages upon them at the expense of the taxpayers or of consumers or other groups or individuals with which the beneficiaries may be in economic competition. --Leon Felkins A copious body of theoretical literature has developed that maintains that rent-seeking activity (RSA) inhibits economic growth by diverting resources from productive uses (Buchanan 1980; Tollison 1982; Olson 1982; Murphy, Shleifer, and Vishny 1991). Direct empirical investigation to substantiate this traditional view, however, has been neglected by many researchers. A recent exception is Harold Brumm's use of cross-sectional data from the 48 contiguous United States to indicate that RSA activity is indeed harmful to economic growth (Brumm 1999). His single-equation growth model assumes that RSA is exogenous to the growth process, yet there are plausible theoretical arguments suggesting that RSA and economic growth may be mutually causal (Murphy et al. 1991). Ignoring that possibility may lead to biased estimates of the growth effects. Also, RSA may influence some of the determinants of growth such as physical and human capital investment, implying that RSA affects economic growth through multiple channels. Those indirect effects are not captured by a single-equation approach. Furthermore, the effects of changes in the variables under study may occur with a time lag, while the approach based on cross-sectional data cannot consider the lag structure of the variables. As a result, important questions about certain intertemporal issues are left unanswered. For example, is RSA self-perpetuating over time as suggested by Garfield (1996)? Finally, the single-equation, cross-sectional approach is unable to effectively remove unobserved state-specific factors that explain differences in RSA across states and time periods (for example, differences in the strictness of enforcement of lobbying regulations). The omission of those factors may lead to an omitted-variable bias. The purpose of our study is to extend Brumm's analysis by using an approach that avoids all of the deficiencies cited above. We accomplish this through the use of panel data vector autoregressive (VAR) analysis which, unlike a correlation-based single-equation growth model, permits inferences to be made about causality. (1) We find that RSA does indeed impair economic growth and that RSA is exogenous--that is, there is no significant feedback from economic growth to RSA. Moreover, we find that RSA can indirectly impair economic growth by affecting public physical investment and public services. We conclude that past empirical studies, by ignoring the indirect effects, may have underestimated the impact of RSA on, economic growth. The Empirical Literature: A Brief Review Besides Brumm (1999), a number of other studies have offered supporting evidence for the traditional view alluded to above, while a few studies have offered evidence for a dissenting view. Murphy et al. (1991) examined the effect of the allocation of human talent between entrepreneurship and rent seeking on economic growth using data from 91 countries. Data on college enrollment in engineering were used as a measure of talent allocated to entrepreneurship, and those on lawyers as a measure of talent allocated to rent seeking. Their results indicate that when talented people become entrepreneurs, it is good for economic growth; but when the same resources are allocated to RSA, it is harmful for economic growth. Similarly, Laband and Sophocleus (1988), using U.S. time series data (1947-83) on the number of lawyers as a proxy of RSA and cross-sectional data on the number of state law firms per capita, found such activity to have a negative impact on both the growth in GNP and state per capita income. …