Economics often presents redistribution as a trade-off between efficiency and equity.
The metaphor is familiar. Markets may produce a large pie but distribute it unevenly. Government can redistribute the pie more equally, although taxes, regulation and other interventions may weaken incentives to work, save, invest or innovate. We accept some loss of efficiency in exchange for greater equity.
But this familiar formulation leaves out an important variable: power.
Government does not redistribute resources mechanically. Someone must administer the process. And when the government controls credit, foreign exchange, imports, industrial entry, contracts, subsidies or ownership, permission to obtain those resources can itself become economically valuable.
That changes incentives.
Suppose imports are unrestricted. An import license has little value because nobody needs one. Now prohibit imports without government permission. Nothing new has been produced, yet the license suddenly possesses economic value.
People will rationally compete for it.
This raises a question that deserves more attention:
What happens when political access becomes an economically valuable factor of production?
Consider a manufacturer operating in an economy where government permission is required to import machinery, obtain foreign exchange, borrow from a state bank or expand production.
Capital and labor are no longer sufficient. The manufacturer also needs access to the institutions controlling those permissions.
From the firm's perspective, investing in political or administrative access may therefore be entirely rational.
But political access can generate a high private return without producing a corresponding social return.
Suppose obtaining a scarce license generates millions of dollars in profits. A company may rationally devote substantial resources to obtaining it. Yet navigating ministries, lobbying officials and cultivating relationships do not necessarily increase society's productive capacity. They may simply determine who captures an opportunity made scarce by government policy.
Government intervention therefore does more than redistribute resources. It changes the relative returns to different kinds of behavior.
Entrepreneurs may spend more time navigating ministries and less time understanding customers. Firms may find political expertise increasingly valuable. Existing producers may discover that preventing competitors from receiving licenses is more profitable than outperforming them.
Even occupational choices can change.
If administering economic permissions offers talented people greater security, prestige and influence than taking entrepreneurial risks in a heavily regulated economy, some will rationally choose administration.
Nobody in this story has to be corrupt.
The entrepreneur seeking a license may simply be trying to operate his factory. The graduate choosing a government career may be making a sensible personal decision. The official administering industrial policy may sincerely believe the policy promotes national development.
Individually rational decisions can nevertheless produce a collectively inefficient result.
Economists have already developed important parts of this argument.
Friedrich Hayek emphasized the knowledge problem: economic information is dispersed among millions of individuals and is difficult to centralize.
Public Choice economists such as James Buchanan emphasized the incentive problem: government officials remain human beings responding to incentives rather than becoming disinterested social-welfare maximizers when they enter public service.
Gordon Tullock and Anne Krueger showed how government-created rents can induce people to expend resources competing to capture them.
Put those insights together and another possibility emerges:
Institutions can change where society's resources themselves go.
Capital can migrate toward politically favored firms. Entrepreneurial effort can migrate from innovation toward obtaining permissions. Human talent can migrate toward administering or navigating the allocation system.
Post-independence India offers an intriguing illustration.
The Nehru era helped build formidable educational, scientific and technical capacity. India produced outstanding engineers, scientists and managers.
But India simultaneously constructed what became known as the License Raj, under which government permission affected industrial entry, expansion, imports, investment and numerous other economic decisions.
This raises an interesting possibility: India may have been highly successful at creating human capital while constructing institutions that reduced the return from deploying some of that talent entrepreneurially.
The historical magnitude of that effect deserves further investigation. But the distinction is important:
Creating productive capacity and efficiently allocating productive capacity are not the same thing.
Pakistan provides more direct evidence.
Economists Asim Ijaz Khwaja and Atif Mian examined more than 90,000 firms representing corporate lending in Pakistan between 1996 and 2002. They found that politically connected firms borrowed 45 percent more and had 50 percent higher default rates.
The most revealing finding was where the favoritism occurred: government banks. Private banks showed no comparable political favoritism.
Political connection had measurable economic value where political institutions controlled the allocation of capital.
That doesn't establish that every government allocation produces favoritism. It establishes something more modest and more important: political access can become an economically valuable asset when the government controls valuable economic opportunities.
Once it does, rational people have incentives to invest in acquiring it.
But any theory of political allocation must confront South Korea.
The Korean government intervened extensively in credit and industrial development, yet South Korea achieved extraordinary economic growth. If political discretion automatically produced stagnation, Korea would be difficult to explain.
Korea suggests an important distinction: performance discipline.
Government assistance to Korean firms was often tied to measurable objectives such as export performance. Firms competed in international markets, where foreign customers provided an unforgiving scorecard.
Political access might help obtain resources. It could not indefinitely substitute for producing something people were willing to buy.
Singapore presents an even harder challenge.
Its government has exercised considerable economic authority, and government-linked corporations have played major roles in its economy. Yet Singapore became one of the world's most prosperous countries.
That tells us something important.
Government size cannot by itself be the relevant variable. Neither can state ownership.
The more interesting questions are institutional.
How much discretion does an official possess? Are allocation rules predictable? Can poorly performing recipients continue receiving support? Are firms exposed to competition? Can political connections substitute for performance?
A large government operating primarily through predictable rules and commercial discipline could conceivably generate fewer political rents than a smaller government controlling a handful of enormously valuable licenses, concessions or contracts through individual discretion.
The variable that deserves greater attention may therefore be discretionary allocative power.
There is also a distributional consequence.
Government intervention is frequently justified by concern over concentrated private economic power. Suppose wealth has become concentrated among a relatively small group of owners. Government responds by nationalizing assets, directing credit or restricting industrial entry in pursuit of greater equality.
Economic power has certainly been taken from some private owners.
But the power to allocate those resources has not disappeared.
It has moved.
Someone now decides who receives the loan, license, contract, foreign exchange or management position. Because those decisions have economic value, people have incentives to compete for access to the decision-makers.
An elite based primarily on ownership can therefore be replaced—or supplemented—by another elite whose advantage derives from political access.
Call this elite substitution.
No conspiracy is necessary. The original intervention may have been entirely sincere. But once a system creates valuable privileges, its beneficiaries have incentives to preserve them.
The traditional efficiency-equity trade-off therefore misses something.
When the government controls economically valuable opportunities, political access can itself acquire economic value. Once political access has a price, people will invest in obtaining it. Some of that investment can come from the same capital, entrepreneurial energy and human talent that otherwise might have been devoted to production and innovation.
That doesn't mean government intervention necessarily fails. Korea and Singapore demonstrate otherwise.
It means the design of the allocation mechanism matters enormously.
The relevant question isn't simply whether the government should be big or small. It is whether institutions make it more profitable to create economic value or to acquire political access to its allocation.
Before accepting a smaller pie in the name of greater equity, perhaps we should ask not only how the pie will be divided.
We should ask who controls the knife.
