We don’t live in a free market economy : Case studies in rent seeking

Last week Bernie Sanders made a tweet that has marked my mind because of how perfectly fitting it was of our current economy. This is the tweet :

I didn’t know Martin Luther King had said that, and it only made me respect him more. However, I am not a Bernie bro. I do not subscribe to his economic prescriptions, neither do I to those of the late MLK.

Although we agree that our global economy, and particularly in the US, is a two tier system, and that the working class have to compete for a living when some rich crooks are completely insulated from risk thanks to the help of friends in the public sector, I believe the solution is to submit everyone to competition. Sanders and King on the other hand favor extending “socialism” to the poor.

In this piece, I will argue that some of the worst inequalities we observe today are not outcomes of the free market, but of the misuse of the sovereign. In fact, I believe that embracing a genuine market economy would be great for the destitute. To underpin my position, I will inquire into different mechanisms of rent-seeking that kleptocrats take part in to capture wealth, namely, restriction of competition by professionals, the perversion of our banking system and the patent system and how it is exploited by big pharma.

I will then provide my thoughts on what can be done about the situation, in an a attempt to kindle anew the public debate on corruption. In the mean time, enjoy the read. Or don’t, if you are a rent seeker.

Restricting competition among professionals

If you’ve ever taken an introductory class in economics, you know that scarcity affects the price of goods and services. The greater the supply, the more affordable a commodity will be, provided equal demand. The opposite is also true, the lower the supply the more expensive it will be.

Knowing that, you know that one way for you to earn more money is for you to limit the amount of people who offer the same service as you. Drug dealers do it all the time, trough violence. If you sell on a dealer’s territory, you get taken out.

Well what if I told you that several professions use this exact strategy to improve their wages, albeit using a more subtle form of violence ? They use the monopoly of legal violence, the state, to prevent people from competing with them.

Lawyers in the United States use the bar exam to restrict competition in their profession. The exam has been severely criticized for it’s alleged inability to test the skills lawyers actually need.

In civil Law countries, notaries use a state monopoly on their profession to earn their rent. The average pre-tax income for a notary in France is almost 20 000 per month, as opposed to 2000 per month in common law United Kingdom.

Notaries are not the only rentiers in the civil law system, commerce tribunal greffiers earn on average 30 000 euros per month in France, also operating a public service for private gain. Other examples are huissiers, justice administrators and legal representatives.

Amercian Medical doctors are also guilty. Seeing that retail clinics and pharmacies were able to provide routine care at a faster pace than them, they lobbied congress to restrict their activity.

The american Licensing board does not recognize physicians’ credentials if they come from abroad, even when it’s from a rich country. Moreover, Free trade deals with developing countries import low wage workers but they never import doctors. A partnership with Brazil, India or China could allow their universities to teach the american medical curriculum. Students would have to pass a standardized test to be sure they have the appropriate level to practice in the US.

This problem is extremely severe in the US, with US general practitioners earning on average twice as much as their Australian counterparts.

Other examples of this mechanism would include journalists and academics who also use licensing requirements to their advantage. The logical conclusion is that working class individuals are losing purchasing power for the services offered by these high earning professionals. Meanwhile, these high income professions can afford rising quantities of the labor of the working class.

The banking system

In the United states, the central bank is the federal reserve. Its mission is to ease inflation and ensure high employment.

Its decisions are made by the fed’s open market committee which is comprised of 18 members including the chair of the Federal Reserve. Among these 18, 12 are voting members. And among these 12, 7 are members of the fed’s board of governors, appointed by the president for 14 year terms and approved by the senate.

The other 5 voting members come from the district banks. All 12 district banks sit at the open market committee, but only 5 vote. And therein lies one of our biggest issues, The district banks committees are elected by a process largely controlled by banks in the district.

As of 2016, one-third of the 12 Federal Reserve Banks were led by someone with strong ties to Goldman Sachs. That doesn’t mean the other ones are exempt of conflicting interests, Goldman Sachs is only one of many finance industry Leviathans that lobby the Fed and other public institutions.

One of the first things that the Biden administration has done once it got to power was to meet asset manager titan Blackrock representatives. Kamala Harris’s top economic adviser is a Blackrock executive.

The corporation also met with French president Macron at the beginning of his term to argue in favor of letting them take over the French pension system.

Other that that, Blackrock has previously advised the European Central Bank against a compensation of 8 million euros, or bread crumbs for the finance group. Nonetheless, it also got something way more precious; information. The fact that this does not constitute a case of insider trading is beyond me.

These big finance groups also drive climate change by funding the fossil fuel industry. Aforementioned Blackrock is notably the largest investor in fossil fuel companies. Naturally, the European Union decided to appoint the group as their climate change policy advisor. So we have a situation where the state protects banks and asset management firms from risk, which in turn provide liquidity to fossil fuel behemots which might otherwise have gone bankrupt and been replaced by competing energy sources like nuclear, solar, wind…

The important involvement of bankers in the public decision making inevitably leads to policies that make life easier for them. It can be raising the target interest rate to make hiring cheaper for corporations in which these banks have investments, or lowering it in order to allow private banks to create more money trough credit.

As you can see in the tweet above, the average citizen’s purchasing power regarding stocks has plummeted. The exact same goes for real estate. This is due to the fact that most new money creation takes place in financial markets and never flows in the “real” economy. This phenomenon is called the Cantillon effect and entails that the people closest to the source of new money are the ones who disproportionately benefit from it.

Bankers use the argument that inflation indexes do not show any inflation, but that’s only because economists exclude real estate and financial assets when calculating inflation, only including consumer goods.

This situation seriously hampers social mobility for poor families, and therefore disproportionally hurts African Americans, Latinos and other minorities in the United States. To acquire property or to generally own assets is a good way to put your foot trough the door of the middle class, but that door is now locked thanks to our banker friends.

Private banks are institutions allowed to create money ex nihilo, or from nothing. When you go to the bank and ask for a loan of 10 000 dollars, the bank pulls that money out of thin air and gives it to you. You now have a debt and the bank a credit. When you pay it back, that money, the debt and the credit, disappear. But you also pay interest. The interests you payed on the loan are new money, that is how money is created in our current system (central banks can also create money, but they don’t “print” it like many people think).

The total amount of credit a bank can offer is a ratio of its current reserves, this is called fractional reserve banking. These reserve requirements were of 50% in the 19th century (a bank that has 100 dollars in its reserve it can loan 200 dollars) , 20% in the beginning of the 20th and were around 2-3% in the beginning of the 21st.

The reason for this is that the formula for the ratio has changed. It used to be total credit/total reserves but now it is total credit*estimated risk/total reserves. The smart readers will now ask : but who estimates that risk ?

You guessed it, banks do. The formulas used in order to calculate those risks are so complex that banking inspectors don’t even bother checking. In order words, it’s a free pass.

Oh and by the way, to offer all of that credit, banks give out your money. The risk is on you. If a bank goes bankrupt you will lose your money but the bank will get bailed out by the central bank. That is because banks have become so big that if one fails it will take down the whole system with it. This is known as the too-big-to-fail problem.

Big pharma and the patent system

In a pure market economy, patents and copyrights don’t exist. They are monopolies bestowed by the state in order to promote the sciences and useful arts.

There is a case to be made that patents do contribute to driving innovation. However, there is no evidence whatsoever that we could not innovate without them or that they are the best alternative.

The patent system is constantly left out of the public debate in spite of the humongous effects it has on our economy.

Big Pharma is a prime example of how patents can be perverted to earn a rent. Let us take a look at the case of insulin, here is a quote from t1international :

Why aren’t we seeing more companies making insulin? There are many reasons for this, but patent evergreening is a big one. Patents give a person or organization a monopoly on a particular invention for a specific period of time. In the USA, it is generally 20 years. Humalog, Lantus and other previous generation insulins are now off patent, as are even older animal based insulins. So what’s going on? Pharmaceutical companies take advantage of loopholes in the U.S. patent system to build thickets of patents around their drugs which will make them last much longer (evergreening). This prevents competition and can keep prices high for decades. Our friends at I-MAK recently showed that Sanofi, the maker of Lantus, is no exception. Sanofi has filed 74 patent applications on Lantus alone, that means Sanofi has created the potential for a competition-free monopoly for 37 years.

Patent evergreening, or exploitng loopholes to make your patent last longer than it should, is not the only trick Big Pharma has up its sleeve.

In 2007, Mylan bought the rights to the EpiPen and proceeded to jack up the prices 500%. This problem is particularly severe in the US, but also present in most other rich nations. Healthcare costs are rising faster than GDP growth, capturing a growing part of the resources we create, and the pharmaceutical lobby should take a big chunk of the blame for that.

One of the reasons why Obamacare failed is because it does not solve the problem of rising healthcare prices. Whether the burden rests on citizens or the state does not change the fact that costs are rising. In fact Singapore has tremendous health outcomes with a mostly private healthcare system.

Another serious outcome of the patent system is the “copycat research” phenomenon. When a new drug is patented by a company, other companies will spend billions trying to create another drug with similar effects because of the patent preventing them from just making the same drug. Instead of investing money to create breakthrough drugs, companies spend money creating solutions to a problem that has already been solved. Perhaps if we removed patents drug companies would actually spend that money creating new drugs, not copycat ones.

Crowdfunding could be an interesting alternative to patents. Platforms like Patreon enable content creators and artists to earn funding from their community to keep creating. Perhaps a similar model could be used for drug development ?

Additional commentary and closing thoughts

Murphy’s law states that “Anything that can go wrong will go wrong”. We also know that anything with a non zero chance of happening will eventually happen given enough time.

Well there goes Younes Kamel’s corrolary to Murphy’s law :

Any institution that can be corrupted will eventually become corrupt.

Any intervention of the state in the economy that can benefit private interests will, given enough time, be embezzled for private gain.

The manipulation of the target rate of interest by the central banks, the patent system, licence requirements for certain professionals were all tools created initially with our best interests in mind, yet as you read this piece they are being used to hurt you. Institutions rot.

To quote none other than stock trading and probability virtuoso Nassim Taleb :

No public institution or agency should be created without an expiration date.

When submitted to competition, there is always a chance of a competitor suddenly innovating a better product that yours and seizing your market shares. To earn a rent, a steady, stable income that does not require you to provide new value, you have to insulate yourself from competition. And the only institution capable of distorting the market in order to give someone that protection is the state.

The rent-seeking problem is far from new. Frederic Bastiat, perhaps the greatest liberal philosopher that ever walked the soil of France, expresses his frustration at the plunder of the people trough the power of the sovereign in his sublime essay La loi :

This fact, combined with the fatal tendency that exists in the heart of man to satisfy his wants with the least possible effort, explains the almost universal perversion of the law. Thus it is easy to understand how law, instead of checking injustice, becomes the invincible weapon of injustice.

Bastiat, to my greatest regret, has been forgotten by his compatriots. Economics curricula in France scarcely, if not never, mention the Bayonne, southern France, native. Yet they, and so would we, gain so much by embracing his core tenets.

Bastiat was a magistrate, therefore heavily involved in public life, with unwavering integrity. He opposed colonialism, rousseauism and its romanticization of ancient societies, and proudhonian anrahcism. He firmly supported welfare, but only private welfare. He was a pious catholic, yet was fiercely against state religion. He voted sometimes for the right, sometimes for the left. And that brings us to my ultimate argument.

Our societites are currently divided along a right-left cleavage. That cleavage is to me profoundly obsolete, and Bastiat seems to have thought the same 200 years before me. I staunchly believe that we should take our Swiss friends as an example and articulate the public debate on the axis of government intervention, with libertarians of the right and the left opposing statists of the right and the left.

Indeed, it is the state that committed the holocaust and the Armenian genocide, that enabled the famines of USSR, that killed tens of millions in Mao’s China and that still to this day persecutes Uighurs and orchestrates mass surveillance. It is also the state, as we have seen, that constitutes the main driver of inequality worldwide.

The examples discussed in this piece are far from being an exhaustive list and are not limited to a handful of countries. I have also mainly focused on western rich societies, where state corruption drives inequality. But in poorer countries, the hoarding of resources by dictators armed with the powers of the state is what causes hundreds of thousands to suffer from starvation. Hunger is a political choice.

In this fight against Goliath, David will not triumph without his dearest weapon. In the traditional myth, that weapon was the sling, but in our epoch, it will be decentralization and information technology. Crypto-messaging and cryptocurrencies shall be our best allies. The latter represent an insurance against keynesians, fascists, socialists and other authoritarians. May we overcome our divisions.

Appendix :

I added a few paragraphs to the article after publishing it. These are the parts on the US/Australia doctors comparison, fossil fuels and banks, copycat drug research and the crowdfunding conjecture and the paragraph at the end mentioning poor countries.

Further reading on rent-seeking :

The conservative nanny state – Dean Baker

Skin in the game – Nassim Taleb

Illusions financieres – Gael Giraud (french)

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