Swedroe: An Economy Held Hostage

Authors Brink Lindsey and Steven Teles have written an important book, “The Captured Economy,” and it’s one all Americans should read.

Through case studies, they explain how powerful special interests capture what economists call “rent,” or excess profits, through policymaking. They also describe how the proliferation of regressive regulation works to redistribute wealth (generally upward) and stifle entrepreneurship and innovation.

Lindsey and Teles detail how subsidies and deposit insurance to the financial sector lead to excessive risk-taking, how overprotection of patents and copyrights suppresses innovation and competition, how occupational licensing limits supply and opportunity, and how restrictions on land use (zoning) drive up rents for everyone else.

The authors’ four case studies cover some of the most important sectors of the economy: finance, mass media and entertainment, health care, legal services and housing. They show how the extraction of economic rents represents the “perverse triumph of political entrepreneurship.”

For example, they show how drugmakers (through patent protection) and health care professionals and even cosmetologists (via occupational licensing requirements) have exaggerated their gains through the political process by restricting supply.

Embedded Concept

Unfortunately, as they acknowledge, such regressive rents are deeply embedded in our economic and political systems. The result is the dampening of innovation and greater obstacles to disrupting existing models. Another outcome is an exacerbation of income inequality at a time when other trends are pushing in the same direction.

Lindsey and Teles show how concentrated benefits, coupled with diffuse costs, go a long way toward explaining many of the outcomes. For example, restricted licensing of cosmetologists raises the barrier to entry, restricting supply and driving up prices. But the few dollars more for a manicure doesn’t create enough of an issue to organize against, nor does paying a few cents more for packaged goods that use sugar create enough of an incentive to fight against sugar tariffs.

But the few beneficiaries of such policies have large incentives for collective action. Zoning works in the same way, by restricting supply and driving up prices for those who would like to move to an area to take advantage of job opportunities (e.g., Silicon Valley).

Damaging Policy Images

The authors go on to show how all the restrictions are packaged with attractive policy images, which allows them to exist and persist, even when they do great damage. For example, licensing prevents quacks from practicing and deposit insurance prevents runs on banks (while preventing risky banks from having to pay higher rates). The deductibility of mortgage interest and deferral of capital gains on a sale of a home, as well as restrictive zoning, all make homes more expensive to the benefit of only the wealthy, as many get priced out of markets.

The fact that these restrictions are deeply embedded makes the changes required difficult. And Lindsey and Teles don’t offer any specific recommendations, other than to state what they think the proper direction is: reduced subsidies for financial risk-taking, lower barriers to entry into a chosen occupation, less regulatory interference that restricts housing supply, and narrower scope for, and less draconian enforcement of, copyrights and patents.

By providing an understanding of the issues and identifying their sources, Lindsey and Teles make an important contribution, as problems cannot be solved if we are not even aware of their sources. This is an important read, and I highly recommend it.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.