Market Assumptions - Entry / Exit Barriers

What is the impact of entry and exit barriers in the real world? In the perfectly competitive market model, there are no entry or exit barriers. Buyers can enter or exit any market at any time instantly. And that is an important secondary assumption underlying the assumption of no entry/exit barriers: no time lags between entry and exit. Under such assumptions, no single buyer or seller can dominate the market. More importantly, the possibility of extra-ordinary  profits simply does not exist. If such profits are being made, new sellers will enter and drive prices down. If profits are too low, some existing buyers will exit. In all cases, the market will swiftly return to a hypothetical equilibrium point.

While economists are pontificating about such issues and teaching millions of innocent souls such theories, in the real world conditions are very different. Both entry and exit barriers exist. Also, things do not happen instantly. There is often a time lag which can be significantly long.

Entry barriers arise from many causes. They can be regulatory, financial or caused by the market size of the incumbents. A good example of regulatory entry barriers are the rating agencies in the US. The regulatory authorities demand that public companies get their bonds and stocks rated by a limited number of firms and by no other. Some markets are natural monopolies. In such cases, the nature of the market itself acts as an entry barrier. Most markets, specially digital ones, tend to have a winner take most nature. Such markets have two or three dominant firms and a bunch of niche players. The dominant firms act as strong entry barriers. Predatory practices also act as entry barriers although these tend to be discouraged by governments. Microsoft, as an example, cemented its near monopoly in the computer operating system market by penalizing hardware manufacturers who wanted to use other non-Microsoft operating systems. Copyrights and patents also serve as very strong entry barriers. These are like toll booths on a highway. Without the appropriate payment, no one else can enter. And the toll booth operator can shut down access to the highway completely. Copyrights and patents can be so lucrative that an increasing number of companies are becoming dependent on them for their revenue; a classic rent seeking action.

What about exit barriers? There are often cases of zombie companies which cannot survive on their own but which also refuse to die. Like zombies, they shuffle along consuming resources that could be put to better use elsewhere. Exit barriers often arise because of market failures. The company is unable to dispose of its assets and thus carries on its miserable existence.

What is the effect of entry and exit barriers on the economy? Does it matter if these exist? I believe that it matters hugely. These barriers distort market signals and result in a mis-allocation of resources. One of the strengths of the market system is supposed to be its ability to efficiently allocate resources through pricing signals. These kind of barriers prevent such allocation. A much more insidious effect of the entry and exit barriers is that these can inhibit innovation. The modern global economy depends on continuous innovation as a major engine of growth. These barriers inhibit this innovation. They tend to encourage the continuation of the status quo even beyond its usefulness. New ways, new product, new services tend to be undervalued and at best delayed and at worst never get to see the light of day. In the end, a few people prosper while the many suffer.

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• Barriers to entry (christopherspenn.com)

Market Assumptions - Information Symmetry?

A basic tenet of perfectly competitive markets and one that is assumed to hold for other types of markets is that of information symmetry. This is the assumption that buyers and sellers in a particular market have the same amount and quality of information regarding the transaction under process. A secondary assumption (which is still nonetheless very important in its own right) is that even if there is information asymmetry, it will exist for a very short while and the cost of acquiring the required information is low or non-existent.

Do these assumptions hold in the real world? The short answer is no. I cannot think of any market where these assumptions hold true. In any market environment, there is some form of information asymmetry. Almost always the seller has greater information regarding the product(s) on offer. What is more, the cost of acquiring information is usually large. This cost is not just monetary. There is the cost of the time required and the opportunity cost of not being able to do something else while the search for information goes on.

This particular fallacy is thought to hold particularly well for financial markets especially the stock exchanges. The efficient market hypothesis holds that any information relevant to the stock in question will immediately be reflected in the price of the stock. The reason for this being that given the large number of people playing the market, someone somewhere will analyze and act upon the new information. This is a fundamental reason why some economists insist that stock markets are efficient. However, others have pointed out a contradiction at the heart of this idea. If any new information will immediately be acted upon by someone somewhere, then there is no point in seeking out this information. This will hold true for all players. Therefore no one will have an incentive to seek out new information that may be relevant and so the price of the stock will not reflect all available information. The financial services industry has also evolved new financial products nearly all of which have one primary feature: they literally require a rocket science degree in order to understand them. The sheer complexity of these products also means that the buyer (and frequently the seller too) does not understand the basic product. Theoretically this poses no problem since such products are supposed to be sold to sophisticated institutional investors. However as we have already seen, such investors are actually not very sophisticated. The result has been that all sorts of buyers have been exposed to a high level of risk. Is this efficient? No.

Information asymmetry can be seen in many other markets. Take as an example, the market for lawyers. Why are legal fees so high? The reason is that legal documents are couched in obscure jargon which is almost impenetrable to a lay person. Ordinary people simply do not have the information required to be able to bring down legal fees. Infact virtually all professional services markets are able to command high prices because of information asymmetry. Almost all secondary markets suffer from the same malady. Why do previously owned cars sell at a steep discount? Because the buyer does not have the same amount and kind of information regarding the condition of the car that the seller has. Fear of buying a lemon brings down prices for all sellers. Assuming markets have information symmetry is not only wrong, it is actually foolish. A model based wrong assumptions will inevitably lead to wrong conclusions and wrong policy decisions. And then everyone wonders what went wrong?

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Market Assumptions - Are People Rational?

The most basic definition of markets would be a place - physical or otherwise - where people can exchange goods of equivalent value in such a fashion that all parties to the exchange are better off than before the transaction. This is an elastic definition that covers a wide range of markets. We are all familiar with traditional markets. These are places we go to shop and hang around in. These are sometimes classified as business to consumer (B2C) markets. We are also aware of business to business (B2B) markets. Then there are financial markets, commodity markets, internet markets and even virtual markets. These are all types of markets that exist in the real world.

Do the assumptions of perfectly competitive markets hold for them? Examining these assumptions one by one, we are forced to conclude that they largely do not hold true in reality. Studying perfectly competitive markets therefore may make sense at an elementary level when students need to be given a model that can be compared to the real world. When these assumptions are applied to the latter, the wrong conclusions will be drawn and these will result in misguided policy prescriptions.

Take one of the most basic assumptions of economics: rationality. Are humans rational? Economists certainly assume so. Assuming rationality is an extremely tempting simplification to make of a complex reality. After all, each of us has the power of our intelligence to make decisions that will best suit our circumstances given the information on hand. Yet, despite our powerful brains we continue to make important decisions based on emotions.

Emotions are integral parts of our personality. Our rationality is tempered by our emotions. When these two are in balance, it is only then that we make optimal decisions. Unfortunately, often our emotions overrule our rationality. This is most obviously seen in financial markets particularly the stock exchange. If any market is considered to be the closest in characteristics to perfectly competitive markets, then stock exchanges are it. Elaborate models have been built that show that we cannot beat the market and that bubbles and busts cannot happen. But they do. With annoying regularity. And often devastating effect. For example, in 1987 Wall Street crashed by 22.6%. This was the largest single drop ever and was considered to be statistically improbable. In fact its probability was calculated as happening once every 20 billion years. An event so extremely unlikely that it could not happen in any human lifetime. Nor was this a one-off. Wall Street crashed again in 2001 and then once again in 2007. Three statistically improbable events happening within a lifetime! What happened? Economic models based on rationality ignore the elements of greed and fear which play important roles on the stock exchange. When greed rules, the market goes up and a bubble can form. When fear rules, the opposite can happen and the market can crash.

Stock exchanges are not the only places where emotions sway people. Research has shown that people value possessions very highly even at the expense of rational economic calculations. People also fear loss more than they fear gain. They will make a less than optimal choice based entirely on this. So one of the most important assumptions of perfectly competitive markets do not hold in the real world. Yes, people are rational but this rationality is tempered by emotions. Marketers know this and in many markets, they take full advantage of emotional impact. Fear is a great motivator to persuade people into courses of action they would otherwise be reluctant to take. Models that do not take emotions into account simplify reality to an extent that they become useless. Relying on such models is not only pointless but can cause needless suffering and misery.

Next time - an examination of another assumption of perfectly competitive markets.

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What are Markets?

Economists love to talk about markets. Listen to them and it sometimes seems that markets are the panacea to all the ills of humanity. Whatever problems we may be facing, the best solution inevitably is deemed to be a market based solution. So here is a question that quite naturally arises: what are markets? For most people, we think we know. But do we really?

Mention the word market and the image that jumps to mind is a bucolic rural scene filled with small shops selling different things to throngs of happy people buying stuff they need. This image is reinforced for most of us by our memories of Economics 101 where we learn about perfect competition. However, markets like this do not really exist any more. Over time markets have mutated into many different forms each with their own characteristics. This has happened to such an extent that talking about perfect competition is actually a disservice since this reinforces the myth that the conditions that apply to perfectly competitive markets also apply to these other forms of markets.

Perfectly competitive markets only exist if we make a number of assumptions. Some of the most important assumptions underlying these markets are:

• Buyers and sellers have equal information regarding the good or service being sold.
• There is no cost to gathering and assimilating information regarding the good or service being sold.
• No single seller or buyer has the power to affect the functioning of the market.
• There are no entry or exit barriers.
• An efficient legal and regulatory framework exists for enforcing contracts.
• There is a minimum (ideally no) time lag between some new information becoming available and that information being assimilated and acted upon.
• The same forces (primarily supply and demand) act in the same fashion on all commodities.
• All the actors in the market are economically rational.
• Also all actors in the market are able to instantly calculate the amount of "utility" that they will obtain from buying an extra unit of a particular commodity (whether a good or a service).

Needless to say, there are no markets in the real world where such conditions exist. The reason why perfectly competitive markets are studied is that they serve as a good model to understand how an "ideal" market should work; the idea being that lessons learned in a study of this type of market can then be applied to other, more realistic markets. The problem is that most of the important assumptions that underlie perfectly competitive markets are then also implicitly assumed for these other types in more or less their original form. This results in the wrong kind of lessons being drawn. These wrong lessons are transmitted to students, especially business students and eventually percolate to policy makers where they influence policies that can result in actual harm as we have recently seen.

What are these other kinds of markets? To what extent the assumptions stated above hold in these other types? What are the actual characteristics of these other types? These are some of the questions regarding markets that I will be exploring in subsequent pots.

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Innovation

The private sector is touted as being a font of innovation. The government is derided as being ossified, a lumbering dinosaur unable to comprehend the nimble private sector. This is now taken as being a self evident truth. Which is why it is fair to ask whether this assessment can be considered true or false or perhaps partly true.

First why is innovation important? Innovation introduces new tools, methods and processes. Innovation allows us new ways of communication and new methods of consumption. The process of industrialization has placed a premium on innovation. As consumers, we have become attuned to learning new methods of consumption and production. But where does innovation come from?

The accepted answer is the private sector. If we examine this claim more closely, it becomes evident fairly quickly this is a lazy assertion. As always, the reality is more varied and interesting. Innovation does not occur in a vacuum. It requires a context to operate in. Much of that context is provided for by governments. Consider markets. Unlike what a lot of people think, markets need some essential physical and legal infrastructure to operate in. Only the simplest of markets can operate in the absence of these. Who is best positioned to provide the necessary support? Governments. Another area where governments become important for innovation is education. If the process of innovation is to become a regular part of the economy, we need a minimum mass of educated people to support it. Public education is a service that the private sector by itself will not provide on a sufficiently large scale. To fill in the gap, governments need to step in.

By its very nature, the private sector's primary focus is on the bottom line. As such, nearly all companies tend to have a short term, commercial outlook. A particular process or gadget or widget or whatever is evaluated in terms of returns. As such, the private sector is predisposed towards applied science. Basic science is being done by relatively few companies. But advances in basic science eventually lead to commercial applications. In cases where discoveries are made in applied science, these need to be backed up by some theoretical framework before full advantage can be taken of them and further development is done. Again it is primarily governments that provide much of basic science. Even in applications, there have been many commercial spinoffs of government science and government innovation. The Internet is just one of many technologies developed because of government.

To say that government has no positive role to play in promoting innovation is simply wrong. The market system is very efficient but a big flaw in it is that it is by its nature short term and generally not reliable in introducing new techniques and technologies. For that, a much longer view is required. However this does not mean that all such development can be handed over to governments. While governments often excel in basic research and in long term applied research, they frequently fail to commercialize their discoveries. This is not necessarily because government employees are idiots or evil. Usually its just that their training and experience is non-commercial. They simply do not think in a market minded fashion. For commercializing promising innovations, we often need the private sector. Innovation is the life blood of a modern economy but to make it work both the private sector and the government sector are needed.

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The Purpose of Economic Growth

An economy is meant to serve human wants. To that end it seeks to provide the appropriate mix of goods and services. Wants in turn are manifestations of more basic needs. They are a means to an end. The means can change but the wants remain the same. Economic growth arises from a number of factors. Primarily, economic growth is a measure of consumption. Greater consumption leads to greater economic growth. Growth also comes from innovation. New products and services are different methods of servicing needs which in turn create new markets.

The main concern of people lies in economic growth. Faster economic growth is good. Slower is bad. In a way this makes sense. The economy has to grow as fast as population growth in order to provide young people with the necessary jobs that they will need as they enter the work force. That at least is the theory.  However a single minded focus on economic growth essentially ignores the issue of the type of economic growth. We can have (sometimes strong) economic growth without a necessary increase in job opportunities. An emphasis on encouraging capital intensive industries will lead to economic growth but will such industries provide wide scale job opportunities? Promoting service industries will again lead to economic growth but what kind of jobs will be generated? High income? Low income? What about prospects for advancement? Also consider that focusing solely on economic growth means that we are looking at the existing mix of goods and services and the companies that provide the same. It ignores new kinds of goods and services that may develop in the future and become economically important. For example, social media as an economic activity essentially did not exist a decade ago. Today they are multi-billion dollar businesses.

Then there is the question of distributing the fruits of economic growth. In India, the BJP government oversaw 5 years of strong economic growth. Their election slogan highlighted this and emphasized the future of "Shining India". Yet they were thrown out of office. Why? The fruits of economic growth were confined to a relatively narrow segment of the Indian population. A large majority saw their lives and well being worsening in the same period. This was a case of strong but blind economic growth. Part of the roots of the recent Arab uprising in the Middle East lies in economic growth which did not trickle down. Most people assume that strong economic growth alone will result in a general improvement in living standards due to a trickle down effect. But the empirical evidence does not support this argument. Most if not all the gains of economic growth are captured by a relatively small class of people who generally speaking are not interested in much trickling down. In country after country, government intervention proved necessary in order to ensure a more equitable distribution of the benefits of economic growth.

I believe that the purpose of economic growth is not in growth by itself. Economic growth is a means to an end. The end is (or should be) minimizing opportunity inequalities. An important component of this is reducing income inequalities. Poverty not only forces people to scramble to put food on the table and a roof over the head, it also prevents people from realizing their potential. That in turn lowers long term economic growth. High levels of poverty literally act as a brake on economic growth as it limits the opportunities available. It should also be noted that very high income levels often also inhibit people from realizing their potential. This is a reverse effect of a high poverty level as very high income levels lead to a satisfaction with the status quo and the sheer number of opportunities available can have a paralyzing effect.

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Are Corporations Necessary?

Division of labor results in specialization. This was clearly established by Adam Smith more than 200 years ago and has been a central tenet of the modern capitalist economic system. We are all specialists. We depend on others for most of the goods and services that we need. For over a 150 years now, corporations have been the primary mechanism by which we have had access to these. Corporations made sense in the past. By pooling together large sums of money and bringing together people working towards a common purpose, corporations could lower the cost of providing us with what we (think we) need. Changes resulting from industrialization helped this process along. National markets became possible and cost effective to serve. International trade progressively became easier as international linkages increased and strengthened and the cost of transportation and communication steadily fell. Firms could become larger and larger in size and thus service their customers with ever greater cost effectiveness.

However, a funny thing has happened. The same factors which helped spur the rise of corporations kept developing and today increasingly favor alternative forms of business association. Transportation and communication links steadily strengthened, became cheaper and more importantly became more personal. National markets were woven more tightly together as internal trade barriers were eliminated. WTO was envisioned as a means of lowering barriers for corporations. It has had the effect of also doing the same for looser associations and individuals.

However, it is still difficult to answer whether corporations can be done away with entirely. It is now certainly possible to for smaller firms to compete successfully against larger ones in many areas of the economy. Many but not all. In some areas (like petrochemicals) size definitely matters and here larger corporations have a definite advantage. Even in these areas, there are niches where further development is possible and smaller, looser organizations are often better equipped to tackle such areas. Certainly, corporations as they have evolved have imposed liabilities on societies and individuals which are only now becoming apparent. But if corporations are to be done away with, what can replace them. To that, there is no easy answer.

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Why Corporations?

In the current series of posts regarding corporations, I have asked the question do we need corporations? In exploring this question, I then looked why the need for corporations arose in the first place. Related to this is the question of what advantages and disadvantages accrue from having corporations.

Consider two things. Most products and services today require a complex interplay of multiple factors. Corporations are also essentially large groupings of people come together for a common purpose. So in order to bring a product or service to market various tasks need to be performed. In the past, the cost of doing those tasks internally was lower than having them done from the outside. This was a major advantage to forming a corporation. However, while the costs are lower, nevertheless they are present. Also, accounting systems do not capture all the costs of internal transactions. Often, the costs that are not quantized are inherently difficult (and in the past were almost certainly impossible) to do so. So corporations incur costs when going about their business. Some of those costs are quantified by accounting systems. Others are at best estimated and still others are ignored altogether.

Globalization has greatly increased the complexity of doing business. Advances in transportation and communication technologies and a concomitant reduction in the cost of the same has resulted in long, complex supply chains that are nevertheless able to supply technically advanced products at ever reducing real costs. Corporations have taken full advantage of these trends. However these same trends have also lessened the traditional advantages of corporations. If a particular product can be manufactured overseas, what prevents it from being designed overseas as well? The question then becomes can we do away with corporations altogether?

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Why Did Corporations Arise?

If we want to explore the question do we need corporations, we need to at the very least look at the origin. Why did the need for corporations arise in the first place? Corporations are a fairly recent invention. Most economic interactions in the past featured individuals and not corporations. Even the oldest of these creatures are at most a few centuries old.

The need for corporations arose due to a combination of increasing costs, risk and complexity. The combination of these factors meant that it started to become too risky for any individual to engage in transactions particularly foreign ones. The answer was to find some mechanism with which to share the risks with others. This also meant that the rewards associated with the successful completion of the project needed to be shared as well and a mechanism for that also had to be developed. This was the beginnings of corporations.

The start of industrialization provided a big boost to corporations. Industrialization enabled new, mechanized, faster processes. At the same time, it increased the rewards of meeting a market need by steadily and drastically lowering local and international transportation and communication costs. This meant that increasingly people needed to work together in larger groups to accomplish a common purpose. This provided a major impetus to formalize this arrangement; in other words, the modern corporation was born.

The new entity adopted a command and control mechanism because at that time, this was the most efficient way of lowering transactional costs. The problems of managing a large group of people focused on a common goal had first been encountered by the development of professional armed forces and the solutions these had come up with were adapted in a civilian setting. The structure thus formed has proven to be remarkably durable. It has been adopted and adapted worldwide and still continues to thrive despite major recent technological, political and social developments. The question thus arises: has this structure become anachronistic or is it still relevant to the needs of the future?

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Do We Need Corporations?

Corporation are an important facet of our existence. We depend on corporations for nearly all the goods and services that we consume. More than any welfare system, corporations envelop us from cradle to grave. The academic discipline of Business Administration emerged as a result of the rise and increasing importance of corporations. Today, it is virtually impossible to advance in an established firm without having a Business Administration degree. Corporations are so embedded into our economic system that the vast majority of trade in the world occurs within and between corporations.

Whenever there is a debate about the global economic system, there is always this unspoken assumptions that corporations are necessary, indeed vital and permanent. Individual corporations may come and go but as a system, corporations will always be there. So perhaps it is pertinent to ask do we need corporations?

The question posed above actually embeds several questions in itself. The most important of these questions is what set of circumstances are most propitious for corporations? Other questions that arise are why did the need for corporations arise in the first place?  The particular form of corporations that generally exists today has remained unchanged for several decades now. This persistence has occurred despite major political, economic and social changes in the local and global environment within which corporations are embedded and within which they operate. Is this form still the most appropriate in today's environment? If yes, will it remain so in the future? What kind of economic structure is most appropriate for today and tomorrow's environment?

I believe that these are important questions that very few people are asking. The answers are not clear but they are bound to be multi-faceted and complex. This is an exploration that needs to be taken for the sake of our future. In future posts, I will try to explore each of these ideas in greater depth.

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The Guild System

One of the many effects of industrialization was the decline and disappearance of guilds. Guilds could be found in all parts of the world during the pre-industrial era. In earlier eras, they served an important role in preserving and transmitting knowledge of their statecraft over the years. This was a necessary steps for much of history since political structures were rarely durable. In those empires that lasted for long periods of time (e.g. Rome and China), there were long periods of turbulence within the empire. Guilds were a source of stability and protection in such times. It was primarily because of guilds that rulers in many parts of the world were able to construct grandiose structures. Since the guild system was designed to preserve knowledge and transmit it to the next generation, they were inherently conservative. This was fine before industrialization since changes came slowly and practices could persist relatively unchanged for centuries.

However, with industrialization came change at an ever accelerating pace. The inherent conservativeness of guilds became obstructive to new ways of thinking and doing things that were now required. The incentive to operate outside the guild system became greater and opportunities to do so became easier. These factors among others caused guilds to decline in importance and over time they were eventually banned in most countries.

However, has the guild system actually disappeared or has it morphed into new shapes and forms? While the basic purpose of guilds was to preserve and transmit knowledge, they were also an important control mechanism. Guilds could control who entered the system and who did not. They also controlled the means by which knowledge transfer could take place as well as the kinds of knowledge that were preserved and transferred. In other words, guilds helped to enforce and transmit an orthodoxy of thought. The question is that has this basic purpose disappeared in the modern era? If anything, control of knowledge - the kind of knowledge and the mechanism of knowledge transfer - has become even more important. In that sense, guilds have not only not disappeared, they are in fact thriving as never before!

Are Markets Moral?

A market based economy is an amazing system to behold. It is capable of taking inputs that are often available at irregular intervals and converts them into outputs that are dependably available all year round. And it does this generally at an affordable price for a majority of consumers. It is no wonder that economists generally love the market mechanism and view it with a wonder which sometimes approaches awe.

Is it a moral system? Economists by and large view interventions into the market as distortions that prevent an optimal allocation of resources. Taking this argument to its logical conclusion implies that society should not attempt to intervene in any manner for any good or service. No society past or present has been willing to do this. doing this implies that services like prostitution and goods like drugs be allowed free operation. The market system as a system makes absolutely no value judgement on any activity. Instead different societies make their individual value judgements on different goods and services on offer. Inevitably these value judgements distort the free operation of the market and thereby prevent an optimal allocation of resources.

There is also a large grey area where it is not clear if there should be an intervention in the free operation of the market. Most financial services for example tend to fall into such an area. The problem is that many if not most financial products have now become so complex that understanding them is essentially beyond the grasp of any reasonably educated, reasonably intelligent person. This is where moral values come into play. Should such products be peddled to persons who will be unable to understand what they are getting into? Keep in mind that one of the assumptions behind economist's model of the free market is equality (or at least parity) of information between the buyer and the seller. In turn, equality (or parity) of information implies an equal (or roughly similar) understanding of what the information means. However such an assumption is not necessary for a market economy to work. Remember that the market system by itself makes no value judgements. No good, service, action, information etc. is inherently right or wrong, good or bad from the system's point of view. Such judgements have to be imposed by the people who live within the particular economic structure. So should complex financial products be sold to people who have no idea what they are buying? The system by itself will not prevent anyone from doing so. The classic defense of such actions is that no one is forcing people to buy such products as well. This is true enough but this argument simply highlights the amoral nature of a market based system.

So markets are amoral. They make no value judgements. Neither do they by themselves impose any. This is what makes a market based system so seductive and at the same time so dangerous.

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Are Firms Entrepreneurial?

Most firms and business people are in my view rent seekers rather than entrepreneurs. This statement ofcourse immediately begs the question: what is the difference? According to Investopedia, rent seekers are organizations or people which use "their resources to obtain an economic gain from others without reciprocating any benefits back to society through wealth creation." Entrepreneurs by contrast are risk takers who obtain an economic gain from other but in return they give something of value back. The free market economic system depends on entities being entrepreneurial. This way new products, service and ideas percolate through the economy enriching all of us in the process.

However, what happens when entities within an economy start engaging in rent seeking behavior instead of entrepreneurial behavior? Instead of developing new products or new kinds of services, such entities increasingly seek to lock in the advantages that originally gave them the edge over their competitors. The net result is that consumers are saddled with increasingly higher prices and less advanced products and services. Often these effects take hold gradually. Consumers are then like the proverbial frog in a pot which is gradually brought to a boil. As the change in temperature is slow, the frog does not realize about the increasing danger and is thus cooked alive. Similarly, when entities start engaging in rent seeking behavior, the products and services that their consumers buy gradually deteriorate in quality. Without realizing it, the expectations of their consumers gradually diminish. What would have once been considered low quality becomes routine and what used to be routine now becomes a mark of quality. Why don't consumers realize what is going on? There are various types of rent seeking activities many of which are often difficult to distinguish from entrepreneurial ones. In any case, the change in behavior is seldom sudden but instead takes place over a period (sometimes a very long period) of time.

There are many examples of rent seeking behavior in the corporate world. Virtually the entire car industry has engaged in such behavior for much of its existence. In the 1950s and 60s, the emphasis was on producing flashy cars with tail fins and spikes and other such accoutrements. Technological development such as developing new kinds of engine technology or even improving the existing technology was a very low priority. Many manufacturers did not even seek the kind of production efficiencies that would result in increasing quality and lowering costs. Most of such companies were the industry's market leaders. Those companies that were more entrepreneurial and sought out the production efficiencies eventually usurped the pole position occupied the market leaders.

In another example, General Motors was one of the first companies to develop an all electric car back in the 1990s. What happened next is a beautiful example of rent seeking. The company not only abandoned the technology it had developed, it also recalled all the cars it had made and physically destroyed them. This despite the consumers pleading to be allowed to keep these cars.

Oil companies are another case of firms engaged in rent seeking behavior. All of them are aware that there is a finite supply of the commodity. At some point, viable alternatives will need to be developed. All of them devote far more resources to marketing and public relations than to developing alternatives to oil - a step that is going to be necessary for them to remain relevant in a post oil world.

Even technology companies which are supposed to be highly entrepreneurial and operating in a fast changing environment behave in rent seeking ways. The rush to patent and copyright software tools, algorithms and protocols is an example of this.

Economic theory insists that such behavior is unsustainable in the long run. Most business people also subscribe to a similar view. Why then would any organization, much less a profit seeking one, engage in activities that are essentially rent seeking in nature? One answer is that successful rent seeking activities act as toll gates. They will generate steady and usually large sums of money for very little effort. Another effect of successful rent seeking is that competition is stymied or at least dampened for a period of time. This allows for extra-ordinary profits which can sometimes border (or even be) monopolistic. Rent seeking activities can also be encouraged by sometimes strong network effects. Many industries have a winner take most characteristic. Once one company has established itself and taken advantage of network effects, it can be very hard to dislodge. This increases the inducement to do rent seeking. Furthermore, we must keep in mind that truly entrepreneurial activities are very hard to do on a consistent basis. They are also risky with an uncertain payoff. Rent seeking on the other hand is much easier to do with a more certain payoff. Most managers specially in public companies are evaluated on a yearly or even a quarterly basis. By the time any negative effects of rent seeking become evident, an individual manager will have moved on or retired. It is thus not surprising that organizations specially as they grow larger would engage in rent seeking activities.

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