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Contest Essay

Property Rights, Interests Groups, and the New Economy


     
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First Prize ($2,500)

I often wonder why people ask such silly questions. “Does the new economy require a free economy?” Does new physics still have gravity? The new economy is just like the old economy, except that information is more important and everything seems to move faster. But, that does not mean that demand and supply don’t matter. It does not mean that markets do not coordinate the allocation of resources. Everything new is old and the same rules apply.

Just as the old economy had two concerns regarding the free market, so does the new economy. Will property rights be protected from people outside the government and will property rights be protected from people within the government? Will those within the government defend property rights or will they be the ones who take property?

Property Rights and Economic Efficiency

Any economist worth his salt will tell you that property rights are the key to economic growth. The newest work on growth is about institutions and particularly property rights. All of the macroeconomic evidence shows that property rights are required for economic growth. Property rights provide incentives to allocate resources efficiently, giving entrepreneurs an incentive to create new wealth. Without property rights neither of these will occur. Countries with secure property rights grow, while those that lack property rights stagnate.

Gary Libecap (1989) defines property rights as the “social institutions that define or delimit the range of privileges granted to individuals to specific assets, such as parcels of land or water.” This is a nice, simple definition, but it needs to cover much more. Property rights need to have the following characteristics: specification, exclusivity, transferability and enforceability. The rights must be specified in such a way that everyone knows who has what rights. Property rights must also be exclusive. All of the benefits of owning and using the resources should go to the owner and only the owner, either directly or indirectly through sale to others. Who would buy or create something if they could use it for free, or if they received only part of the benefits while others used it for free? Property rights must also be transferable. When they are not, the property owner’s time horizon shortens, and the owner loses the incentive to see if someone else values that property more. For property rights to be effective, they must be secure from seizure or encroachment from others. An unenforceable property right is no property right at all. This last characteristic of property rights is perhaps the most important one. How do you protect your property rights from direct government action and from the lobbying efforts of others?

Although we associate property rights with land, capital, and water, for an economy to function properly, intellectual property rights must also be protected. Traditional property rights on land and water are important because efficiency-improving trades are not made without them. Real resources will therefore not be allocated properly. Without the protection of intellectual property rights, however, entrepreneurs will not create new wealth. They will not engage in what Schumpeter calls “creative destruction.”

People must have the right to the fruits of their labor. When it is taxed or regulated away, either because government has absconded with it or because government has helped transfer it to an interest group, people do not work as hard or as creatively. This is what the new economy is really about. It is about giving entrepreneurs the incentive to go and discover new ways of doing things. It is about using and creating new information. Every appropriation of intellectual property rights reduces the incentive to create. This is true whether the appropriation is a reduction in the ability to contract with laborers to create a physical product, a reduction in the ability to enforce or transfer the intellectual property right, or a simple barrier erected by a trade group through legislation.

Rent Seeking Denies Property Rights through Legislation

The United States is supposed to be a country that protects private-property rights. Compared to most other countries, the U.S. does indeed protect private-property rights. But there are cases when it does not. There are numerous cases where the government is the direct culprit violating property rights. There are numerous cases of urban planning and environmental law where private property has been taken for use by the government. But there are also many cases where government has interfered with people’s property rights not for public use but for a special-interest group. Sometimes these cases are subtle. When the government imposes a minimum wage, it does not announce that people’s property rights to their own person and their ability to contract with respect to themselves has been abrogated to benefit union members. Of course, unions were the ones who lobbied for such a law. Such a law, of course, reduces people’s right to their own labor, but it does so in a subtle way. If the new economy can somehow reduce the ability of special-interest groups to abscond with other people’s property rights, then a real improvement in human happiness will have been made.

In the Logic of Collective Action, Mancur Olson showed us how interest groups are formed and how this logic is designed to transfer wealth from one interest group to another. Interest groups must first overcome a free-rider problem. That is, they must figure out a way to exclude everyone who does not pay for the benefits to be received. If groups cannot do this, then no potential members will bother to join because they can free ride. That is, they can get the same benefits by not joining and would therefore never pay membership dues. The interest group must also limit membership in some way. Furthermore, if membership is not exclusive, then the benefits of membership will be so diluted that it will not be worthwhile to become a member.

But lobbying the government is not free. It uses up valuable resources. Olson pointed out that this transfer is costly. Lobbyists and organizers for the interest group must be paid. Of course, the affected groups will try to resist the transfers, and government transfers act as weight on their creativity. Both of these effects on the paying group are costs to the economy. That is why economists do not approve when groups lobby the government to transfer wealth. Gordon Tullock was the first to explicitly realize this and Anne Krueger gave the activity the name, “rent seeking.”

In his book, The Rise and Decline of Nations, Mancur Olson empirically tested his thesis that interest groups lead to the decline of nations. When entrepreneurs are allowed to work freely, economies grow. When interest groups reign, however, economies stagnate. Wealth is transferred from the productive to the politically powerful. The incentive to create is diminished and the incentive to become politically powerful increases. Interest groups find that it is profitable for them to lobby the government even though this means that gross domestic product falls.

Interest groups ran rampant in the old economy. Labor unions lobbied for minimum-wage laws so that middle-aged union members would not have to compete for jobs with teenagers and unskilled urban residents. Textile companies lobbied for tariff protection. Environmental groups lobbied for strict regulations regarding people’s use of their own property. These environmental groups could purchase the right to affect other people’s behavior, but they choose instead to lobby the government. While the Audubon Society allows gas drilling on its property in Louisiana, it lobbies for zero drilling in other areas.

How is this related to property rights? When people can use their property as they wish and when they can trade as they wish, they have the incentive to create. When the rights to use and trade property are taken away, their incentive to create is diminished. Even relatively pro-government economist Andrei Schleifer has recognized that when you want innovation, the government must be hands off. Furthermore, once the precedents for lobbying are set, people’s creativity turns increasingly to lobbying. Knowledge turns increasingly towards lobbying, while knowledge relating to the creation of new products increasingly becomes diluted.

Two New Economy Cases of Difficulty with Property Rights

The reader is probably wondering about the infamous Microsoft case. A recent article in The Economist magazine suggested that Microsoft has not played fairly, and that the Justice Department was right to go after them. But others have suggested that Microsoft was unfairly harmed. Microsoft decided not to fight its prosecutors over a certain bulk discount originally designed to make it easier to calculate the number of computers that have Microsoft software installed on them. The Justice Department has since expanded its interpretation of the consent decree to imply that it can regulate virtually all aspects of Microsoft’s business. The theory of property rights suggests that Microsoft should be able to do what it wants with its intellectual property. This is the best way to encourage economic growth and creativity. Nor is it lost on most observers that Microsoft’s competitors spent tremendous amounts of money lobbying the government for relief from Microsoft’s constant innovations.

The case of Napster is another example of a problem of new-economy businesses having trouble with their property rights. Napster allows people to share music files. This effectively lowers the demand for commercial music and reduces the incentive to produce music. I am not as worried about Napster as I am about Microsoft. The Napster case encourages the music industry to discover a way to protect their property rights. So far, the federal government has done what it legally can to protect musicians’ property rights. The Microsoft case involves a hungry federal bureaucracy and an interest group of software companies that are having trouble competing.

Why the New Economy May Have Advantages over the Old

Despite the Microsoft case, I remain hopeful about the new economy. I realize that there is no way to bind Leviathan. Leviathan is a heavy burden that capitalism must drag behind it. Every time people who love liberty become convinced that Leviathan has been bound, they find it has escaped. People have been able to beat Leviathan by secession, but once there is nowhere else to go, Leviathan wins. This has happened in historical case after historical case. Unfortunately, the new economy does not appear to be enabling people to secede. Fortunately, markets work so well that they can carry this heavy burden.

There is, however, one key difference between the new economy and the old economy. This difference gives me great hope. The parts of our economic system that are based on the old economy have well-entrenched interest groups. The parts of the economy that are based on the information age are only just beginning to form special-interest groups. Yes, Netscape spent large sums lobbying the government to harm Microsoft. And of course, Microsoft turned to lobbying as well, spending 1.2 million dollars last year. But, most of the new economy is not yet made up of special-interest groups.

Will the new economy suffer from the same problems as the old economy? It is unclear. In The Rise and Decline of Nations, Mancur Olson did not paint a particularly hopeful picture. He suggested that as time goes by, interest groups will become entrenched and economic growth will stagnate. Entrepreneurs will seek to become politically connected instead of creating new wealth. But, so far interest groups have not been able to capture the high-tech sector. Software engineers are not yet unionized. Internet companies have not yet asked to be regulated so that they can form cartels or so avoid new competition, a strategy adopted by many old-economy firms and discussed at length by free-market economist Bruce Yandle, in his book, Political Limits of Environmental Regulation. Paul Portney of Resources for the Future has also explained this strategy, as has The Economist. Interest groups will lobby the government for specific rules that reduce the property rights of firms but make it easier for these interest groups to form cartels. Why would owners try to discover the best way to use their property if they are prohibited from using their discovery for profit?

But I am still hopeful. I hope that rather than make it easier to form an interest group and lobby the government, the new technologies that make up the new economy will make it more difficult to do so. My hope is that it will be easier for people to free ride on the efforts of those who attempt to rent seek. As the free-rider problem increases, people will increasingly decide that it simply is not worthwhile to lobbying the government. Instead, they will go and create their own wealth. Property rights will be more secure because potential rent-seeking groups will have more difficulty.

I am also hoping that it becomes harder for special-interest groups to appeal to the government on their own behalf. Ideally, new technologies will enable people to do their work without empowering prejudice. They will not suffer from prejudice because no one will know if they are Black, or female, or Hispanic, or Asian, or disabled. If no one knows what you look like, you might not be able to lobby the government for special privileges. Your success would be purely your own.

Nor would you have to worry about the unintended consequences of well-meaning but harmful legislation. Walter Williams has documented numerous cases of legislation intended to help a minority group but which had the perverse effect of making employers reticent to hire them. If no one knows your race, sex, sexual orientation, physical ability, or background, then no one can discriminate against you because they think that you might use your special status to win favors.

It is possible that interest groups will use the information that is newly available on the Internet to help them organize and rent seek. A recent study published in the Harvard Business Review found that rather than reduce price discrimination, the Internet might encourage price discrimination. In the same way, the Internet might provide the right information to potential interest groups that will help them organize and to lobby for wealth transfers.

But the Internet will also make the actions of interest groups more transparent. One way that interest groups work is by surreptitiously transferring wealth from one group to another. Most Americans are completely unaware of how interest groups work or the projects they favor. How many Americans know, for example, which companies stand to gain if the Kyoto accord on global warming becomes politically feasible again? Or that these companies have been lobbying the government for years? The answer is very few. But it is much easier for people to find out because we have the Internet. It will be harder for new-economy organizations to surreptitiously lobby the government without the American people knowing or understanding what is really happening.

An additional difficulty that rent seekers will have is that the nature of the new economy removes some of their tools. It is going to be increasingly difficult for rent seekers to lobby for tariffs. How do you make sure that no code was written in India? Perhaps it can be done, but it is going to be difficult. For the same reason, it is going to be difficult for groups to ask the Department of Justice or the Federal Trade Commission to enforce anti-dumping laws. If a foreigner figures out a way to sell goods at a lower price than domestic producers do, it will be hard for domestic producers to rent seek in order to prevent foreign competition.

The nature of the new economy poses another problem for rent seekers. The old economy was very capital intensive. Firms also had difficulty serving a small niche in the market. How do you set up a small specialty steel mill? It can be done, of course, but it is more difficult than setting up a small niche programming shop. This might seem irrelevant to a discussion of how free markets relate to property rights, but it is not. If a group of firms cannot keep new firms from entering their industry, then it is not profitable to rent seek for special favors because new entrants can easily come into the industry and share the rent seeking gains.

Conclusion

Does the new economy require free markets? Of course it does. Private property, including intellectual property, must be protected. It would be nice if the government would stay in check, but hope springs eternal. What is possible is that for a while at least, groups will not be organized sufficiently to successfully lobby the government for transfers. Then, perhaps, new technology will retard the formation of new groups.

Bibliography

Krueger, Anne O. 1974. “The Political Economy of the Rent-Seeking Society” The American Economic Review, Vol. 64, No. 3. (Jun.), pp. 291-303.

Jenkins, Holman W., Jr. 1997. “Business World: Washington is a Hammer and Everything is a Nail.” Wall Street Journal. Nov, 26. Pg. A15.

Libecap, Gary 1989. Contracting for Property Rights. Cambridge: Cambridge University Press.

Murphy, Kevin M.; Andrei Shleifer; and Robert W. Vishny. 1993. “Why Is Rent-Seeking So Costly to Growth?” (in New Developments in Development) The American Economic Review, Vol. 83, No. 2, Papers and Proceedings of the Hundred and Fifth Annual Meeting of the American Economic Association. (May), pp. 409-414.

Olson, Mancur 1984. The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities. New Haven: Yale University Press.

—— 1971. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, MA: Harvard University Press.

1994. “Regulate Us, Please” The Economist. Vol. 3330. Issue 7844. Jan. 8, pp. 69 –71.

Tullock, Gordon. 1967. ``The welfare cost of tariffs, monopolies, and theft.” Western Economic Journal, 5: 224-232.

Yandle, Bruce. 1989. The Political Limits of Environmental Regulation: Tracking the Unicorn. Westport, CT: Quorum Books.


David Mitchell is a Visiting Assistant Professor of Economics at St. Mary's College of California






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