Rent-Seeking Assets

If you haven't read Slate's article on the economics of New York's taxi medallion system, it's worth the time. The tl;dr version is that the city government of New York has created an artificial set of rent-seeking assets -- taxi medallions -- where none should have existed in the first place. Specifically, the harm done to passengers and drivers by the economic rent extracted by medallion owners outweighs any possible benefit to putting an artificial quota on the number of cabs. Anyone who has tried to hail a cab in NYC between 4 and 5pm can attest to this. Rent-seeking assets -- explained quite well here -- can be positive or negative for society. Many would agree that taxi medallions are a net negative. Carbon credits, on the other hand, are an artificial class of rent-seeking assets that could be quite beneficial. If economic theory is right, carbon credits will use an auction system to allocate the right to pollute to the firms producing the most economic value per unit of pollution.

So what makes a rent-seeking asset a good thing? I would argue that three criteria need to be hit to justify this kind of asset:

• Negative externality of supply (the costs of pollution are not naturally born by the polluter)
• Lack of differentiation among supply (your ton of carbon is just as bad as mine)
• Destructive Nash equilibrium (naturally, all profit-seeking firms will pollute as much as they can get away with)

Unlike carbon credits, most products do not meet one or more of these criteria. I would argue that taxis do not meet the second and third criteria. While there may be a negative externality of supply -- namely, pollution and traffic -- there is certainly supply differentiation (some cabs are comfier, cleaner and friendlier than others), and there should not be a destructive Nash equilibrium, as in a free market taxis should only work the streets as long as it is financially sensible for their owners and drivers. Without these three criteria met, it's not appropriate for government to create a rent-seeking asset class like taxi medallions.

Supply quotas and rent-seeking behavior go hand-in-hand. The City of New York limits the supply of taxi medallions to 13,000, which leads to a fair market price for a medallions of just over $1 million. But limiting supply doesn't have to mean a quota. Professional certifications -- such as the bar and CFA credentials -- are great examples of meritocratic supply limitations. This kind of limitation is appropriate when supply is highly differentiated. In this case, not all lawyers and financial analysts are the same. These merit-based systems attempt to differentiate those truly able to provide services from the unqualified.

This kind of merit-based qualification can also work within a quota system. High-end college admissions is one example of this. There are only approximately 1,500 spots in each class at Yale, but those 1,500 are newly allocated each year on a (mostly*) merit-based system.

But even if those spots were simply sold to the highest bidders, it wouldn't be a very good example of a rent-seeking asset. Specifically, Yale acceptances are missing a key characteristic of this kind of asset: transferability.

Imagine, for a moment, that a group of 1,500 people were given the right to admit to Yale anyone of their choosing per year back when the university was founded in 1701. Yale never built an admissions office -- it simply filled each class by taking one name from each of these "Admission medallion" holders every year. Of course, since the University would greatly outlive the medallion holders, the holders were given the right to transfer or sell their Admission medallion to anyone of their choosing.

Over the course of time, the vast majority of Admission medallions were acquired by various investment funds and private equity firms, such as Admission Financial. Each year, these huge firms auction the 1,500 spots off to the highest bidders. With some parents willing to pay north of $5 million to get their kids into Yale, the Yale admissions business brings in north of $7 billion per year in economic rent to massive holding companies -- essentially a transfer payment from aspiring families to wealthy investors and funds. This is a silly example, but it paints a picture of how insane this kind of rent-seeking asset model would seem for more obviously differentiated products. Medical licenses are an even more extreme example: obviously, medical licenses should not be assets simply to be auctioned off to the highest bidder and subject to transfer or sale without restriction like carbon credits or taxi medallions.

Unfortunately, higher education accreditation often functions as a rent-seeking asset. While accreditation should in theory be a quality assurance mechanic -- licensing schools as Bar Associations license lawyers, for instance -- in practice accreditation is an asset that can be bought and sold, accumulating rent for its owners. Extremely challenging to acquire and just as difficult to lose, the treatment of accreditation as an asset rather than a qualification has played a significant role in the sad state of higher education today. Much like Medallion Financial buys and sells taxi medallions, financial institutions have seen an opportunity doing the same with colleges and their accreditations.

I do not believe that economic rents are always bad things. Rent-seeking assets have their place. But identifying that place -- and where merit may be a more appropriate filter -- is more critical than ever.

*From an economic perspective, things like athletic recruitment and legacy status count as "merit", as the spots aren't simply allocated to the highest bidder as it would be in a rent-seeking economic model. Although I'm sure there is a certain level of donation beyond which my kid is pretty much guaranteed to get in, so "mostly" applies.