Oiligarchy and Capture Theory

While discussing capture theory and the work of Stigler, Peltzman, and Olson in class, I was reminded of a computer game I used to play in middle school called Oiligarchy. While the game might peddle a few unhinged conspiracy theories, it is also an accurate parody of capture theory.

As the player, you are an international oil tycoon seeking to maximize profit by passing oil-friendly taxes, subsidies, and price controls, as well as starting wars and destroying rainforests. In order to pursue these interests and to encourage "oiled" policy, you must donate to the "donkey party" or the "elephant party" during elections to capture representatives and the president. If the party you support wins the election, you can leverage your coercive power by deregulating oil production in Alaska or starting an international war to gain control of oil reserves abroad. However, you are also forced to balance these pursuits by maintaining of your favored party's popularity. If your party loses an election, you risk allowing costly isolationist and environmental policy to pass under the "eco reps".

The basic tenet of Oiligarchy aligns with Stigler's central argument that, "regulation is acquired by the industry and is designed and operated primarily for its benefit." In the game, a smart player maximizes their political donations to consistently earn political favors. At the same time, in Peltzman's terms, the game's two political parties attempt to maximize their majorities by accepting political donations from the player. In the objective function, M = (f x n) - h(N - n), the members of the Oiligarchy attempt to maximize f (the probability a beneficiary of the regulation supports the representative) and minimize h (the probability that popularity will decline). Due to the simplicity of the game, the "oligarchy" is actually a monopoly and the player is easily able to find Olson's so-called T*, or optimal amount of collective action. By donating a few hundred dollars in each election, one can expect to "capture" enough reps and the president.

An Open Letter to Railroad Executives

 Dear railroad executives, 

    Kudos to you, you're craftier than I expected. Although I knew that firms' expenditures included vying for potential government favors – like keeping shipping rates artificially high to ensure "consumer protection" – I didn't realize they also included paying to suppress competitive substitutes! Both types of expenditures, of course, are instances of rent-seeking. The specific competitive substitute I'm referencing here, in case you haven't guessed, is the American maritime industry. 

    Not only do your various Political Action Committees (PACs) contribute generously to representatives on the House Committee on Transportation and Infrastructure, but also to at least five of the fourteen representatives on the Subcommittee on Coast Guard and Maritime Transportation. And on both sides of the aisle, no less! I congratulate you on bipartisanship! 

    Now, why would railroad PACs be interested in maritime transportation? Oh, right! As I mentioned before, in seeking favoritism, you're also paying to suppress substitutes, which includes any other form of transportation – including maritime transportation! 

    At first, dearest executives, I doubted that you engaged in such dubious behavior. But upon researching those Congresspeople whom you selflessly support, I found that each of them openly supports legislation such as the Jones Act, a protectionist 1920 law that requires that all intra-U.S. maritime commerce be carried on "U.S.-owned, U.S.-crewed, U.S.-registered, and U.S.-built" ships. This act notably restricts the entire industry, to the point where "2% of American freight travels by sea. In the European Union... the corresponding statistic is 40%."

    I shouldn't have been surprised by your support for the Jones Act and similar legislation, which artificially raise shippers' costs of using an obvious substitute for your services. Such support is exactly what Chicago economist George Stigler predicted, even if his colleague Sam Peltzman added nuance to the representative's rational cost-benefit analysis. 

    I will say, though, that you are not as good at rent-seeking as the airlines. That's why you're only my second favorite group of cronies. Sorry, not sorry. 

Juliette Sellgren

Stigler, Occupational Licensure, and the Lemons Model

George Stigler argued that the licensing of occupations such as lawyers and nurses is a possible use of the political process to improve the economic circumstances of a group. While this is likely true, I also think there are benefits to the consumer as well that I would like to frame in terms of the lemons model. 

As I'm sure everyone in this class already knows, the lemons model by George Akerloff deals with asymmetric information -- if some cars are "lemons" (bad cars) and some are high quality, there are two separate markets for cars -- the lemons market and the high quality car market. Often times, however, there is asymmetric information, so you don't actually know what car you're buying, and thus have a lower willingness to pay for a car because there is a possibility of it being a lemon. The lower price discourages the sellers of the high quality cars, and once the market price hits a certain floor, they exit the market, you are only left with lemons, and efficiency is lost. 

So, imagine a world where a license is not necessary for something like, beauticians, let's say. At first, there would still be people who spent the money to get a license, because they could charge a higher price. On the other hand, however, there would also be people who do a pretty good job at hair for the most part, but do not charge much at all, because they don't have a license. Personally, if I was just going for a trim, I'd get the cheaper one -- I'm sure many of you would do the same. So -- what would be the point of spending tens of thousands to get a license at all, if those without one could easily undercut your price? It would likely eliminate the demand for licenses, and then, you never actually know what you're getting yourself into. The lemons model predicts that, due to asymmetric information in the absence of licenses, the market price is the average quality of the beauticians in the market, all the skilled beauticians leave and you are left with only bad beauticians. Imagine if this was applied to something like doctors and lawyers? The cost of actually obtaining a license takes years and hundreds of thousands of dollars. Occupational licensure eliminates the prospect of asymmetric information, because they have proven competency in that subject area through an education and a standardized exam. You know you are getting at least a certain minimum quality of care. 

Also worth noting is that those with occupational licenses are held to a higher standard in a court of law. When dealing with negligence cases, you can sue those with licenses because they are held to a higher "duty of care" standard than people without a license. If occupational licensure did not exist, this would not be the case. 

So, while Stigler's assertion that occupational licensure creates barriers to entry and thus benefits those with licenses, it is important to note that these licenses benefit the people as well, because it ensures a minimum quality of care that you are getting when you go to lawyers, doctors and the like. 

Occupational Licensing and Nursing

      Last summer I worked for an international nurse recruiting company. Although the company I worked for was very small and only consisted of 3 people, the industry is quite large and it exists mainly because of nursing shortages. This shortage is in part due to occupational licensing. Finding nurses in places like the Philippines that would like to work in the United States is not difficult, but the process a nurse must go through to legally work in the United States is a nightmare. Nurses must pass nursing and English tests, have their education verified, obtain a SSN, obtain a permit from a state board of nurses, and more. One of my responsibilities was helping nurses navigate different different state licensure boards, which was very difficult as there was little reciprocity between states and many states have only a couple employees who answer calls. For all the trouble our company went through to recruit nurses, hospitals would compensate our company with a standard payment.

The nursing industry is very interesting to look at through the lense of Stigler. The profession of nursing is high paying and stable, so the licensure in the industry is understandable. Additionally, nurses that obtain all necessary licenses benefit from the regulation. If the cost of employing an international nurse is high for hospitals, it could lead them to increase wages to attract domestic nurses to their region. The barriers to entry also negatively affect the general public, as the cost to hire nurses is reflected in the extremely high cost of healthcare in the United States. It makes sense that all these regulations were put into place as they heavily help registered nurses who make up a minority of the public, and have a very small cost to people in the majority.

Spatial location theory and economies of agglomeration

In class, we discussed Downs' spatial location theory explaining why firms will set up next to one another in order to capture the greatest portion of the customer base possible. If these two firms have identical outputs, uniform distribution, and easy spacial mobility, then they will relocate next to one another in order to limit the distance that the average customer travels in the hopes of increasing their consumers. In my Real Estate Analysis class, the central place theory and opposing centripetal and centrifugal forces were the main focuses in our discussion of the system of cities. The 3 primary centralizing forces are economies of scale, agglomeration, and positive locational externalities. Economies of agglomeration details that there are cost and productivity advantages to the clustering of firms in addition to the increased opportunity from learning from other's productivity and efficiency. Positive locational externalities occur when firms benefit from nearby locations of others without the first capturing all benefits for itself.

The development of Northern Virginia presents a prime example of the combination of economies of agglomeration and the spatial location theory from construction of homes to tech firms. Construction firms are competing to build neighborhoods close to each other to capture the best school systems hence enticing more homebuyers. Tysons, Reston, and McLean are cities competing for consulting firms and government contractors due to their proximity to DC. My internship at MITRE in McLean was located directly next to competing government contractor Northrop Grumman: a key example of Downs' spatial location theory explained by centripetal forces encouraging corporations to locate close together.

Coexistence of Economic Growth and Crony Capitalism

At the end of class on Wednesday, Professor Coppock connected Stigler’s description of noisy political channels to the term crony capitalism. Crony capitalism refers to an economic system where industry interests are protected based on relationships between business leaders and the government. Crony capitalism is used as an argument by left-leaning politicians as an argument against capitalism, but it is also used by right-leaning politicians to demonstrate the negative effects of government intervention in the economy. Emerging economies with large and relatively unregulated industries often see corruption take form via crony capitalism.

Earlier this year, The Economist published an article in which they analyzed a “crony-capitalism index,” suggesting some interesting implications about wealth and economic growth. The Economist formed the index by classifying data on billionaires into crony and non-crony sectors, with crony sectors being those that are particularly vulnerable to rent-seeking behavior, including banking, casinos, defense, and construction. A section of the article that caught my attention was the increase in India’s share of billionaire wealth derived from the crony sectors: over the past 6 years, India’s wealth from crony sectors increased from 29% to 43%. What makes this interesting is that also in the past 6 years, India’s GDP expanded rapidly (with the exception of COVID), driven strongly by growth services in the form of IT Outsourcing. The existence of these two facts demonstrates that while crony capitalism and rent seeking activities lead to inefficient outputs, nations with large amounts of wealth in crony sectors still see rapid increases in economic growth and standards of living.