[SOUND].

We've just argued that an important

function of government is to align
incentives of economic agents so that
private benefits would be
consistent with social gains and not
opposed to them.
The government can achieve this outcome by
using
various tool, in particular by using laws
and regulations.
And we saw how this alignment can be
accomplished in
the case of contract enforcement by making
sure that courts enact.
And then force appropriate damages paid
by contractors in case contracts are
breached.
So special mechanisms of contract
enforcement
maintained by government align incentives
of the
private parties, in this particular case
of contractors, the dose of social
interest.
Now I want to give you another
illustration of
the same very important, critical
important role of the government.
And in this case government's presence
affects
individual choices between different types
of economic activities.
Some of you might have heard that
activities and what the mechanics.
Can very crudely be divided between
different groups and types.
Different clusters and they should see
right
away that the border line, the separation
line between these two clusters that they
have in mind, is not always very clear.
Sometimes, oftentimes it might be quite
blurred.
But I'm talking about what is known as
productive activities and Rent-seeking.
A very general definition of productive
activity is that is as activity where
an economic agent and individual who is
engage in this activity
benefits from it She's better off, because
she's engaged in this activity.
But so is the society.
In other words, productive activities
benefits
individuals that carry out such
activities.
And the society simultaneously, at once,
the society and and, and individual.
Are better off jointly, as a result
of this [UNKNOWN] engagement in productual
activities.
Speaking metaphorically, productive
activity is
such that it increases social wealth.
And this increase in part, or fully Is
captured
by the individual which is engaged in such
activity.
As opposed to productive activities,
ransacking is something
which is something which is still
individually rational.
An individual who is engaged in ransacking
is still better off
because of that engagement, but the
society is not better off.
In fact the society often time is worse
off as a result of an [UNKNOWN] engagement
and ransack and simply because ransacking
does not
create new wealth, does not create new
value.
An individual is better off simply because
she distributes to herself A part
of the wealth, or part of the wealth that
was already in the society.
You can argue that productive activities
are a positive-sum
game, whereas rent-seeking, at best, is a
zero-sum game.
Oftentime, rent-seeking is a negative-sum
game.
It is a negative-sum game simply because
rent-seeking suppresses incentives Of the
individuals who would like to be
engaged in productive activities from such
engagement.
Because such individuals are suspect that
some of the return, some of the
payoffs to their productive activities
will
be taken away from them by rent-seekers.
So the damage of rent-seeking to the
society It's two-fold.
First of all the society suffers because
some
resources are redeployed from productive
use to rent-seeking.
It suffers furthermore because it reduces
the incentives of
individuals who would like to be engaged
in productive activities.
To do so.
Rent-seeking and Productive activities are
perhaps the clearest case when individual
rationality and social needs are
dramatically opposite to each other.
And therefore it for-mounts for good
governments to redirect
human resources and other resources which
exist in the economy from rent-seeking
to <<Productive activities now
the important thing to keep in mind is
that resources that are
available to the economy are most of the
time multi-purpose resources and
this is certainly the case with human
resources Individual decide in which
errors economy to operate, what careers,
what jobs, what functions, and
so forth to choose for themselves,
depending on the anticipated payoffs, and
it's very important that individuals,
while
making these choices And give preference
to productive activities verses
rent-seeking, because from what I
told you so far, it's easy for you to
realize that societies and economies were
rent-seeking were, were,
reigned supreme, where many individuals
had engaged in rent-seeking.
It should be a very poor economy.
Because very little is produced in such
economies.
And much of the energy that exists is
directed, is targeted toward
redistribution rather than to production.
Vice-versa, if the recent economy were all
of the energy talent.
Entrepreneurship, time, effort, and so
forth.
Have contributed to productive activities.
In such economies, we should expect a lot
of prosperity.
And this is a very common theme in modern
literature, and the famous American
economist William Bomore illustrated.
The choice of individuals of various
activities between
productive activities and rent-seeking
very clearly and very
vividly by by comparative analysis of
patterns observed
in histories of different countries around
the world.
>> If you look back at the history you see
certain periods of time
in certain countries features literal
explosions of
entrepreneurial activities, Industrial
Revolution in the west late
19th century in the United States, in
China you name it, you see times and
periods were Lots and lots of people are
engaged as entrepreneurs and as a result
quite clearly they advance economic
development.
On the other hand, in some countries in
some periods of history you see almost no
entrepreneurship.
It's heavily suppressed.
You see no innovations.
You see no new markets.
You see no new technologies.
You see no new ideas.
You see none of that.
So, how could you explain this differences
as normal in answers?
Well, it's not necessarily, because there
are fewer
potential entrepreneurs In country A, in
one period, then
country B at perhaps another period of
time, it's
simply because the conditions in these
countries are different.
It's simply because government policies in
these countries are different.
In country A, where we see a
lot of entrepreneurship, governments
protect property rights.
Governments provide enabling conditions
for private enterprise.
And as a result people with imagination,
with
energy, and vision, people willing to take
risks.
In other words would the entrepreneurs,
become
entrepreneurs in the productive sense of
the word?
Whereas another contrast, the very same
people People
who are creativity, energy, vision, they
are going to
be those risk-taking individuals who will
contribute all
of these qualities, all of these resources
towards rent-seeking.
And they will be searching for different
ways to do well,
to enrich themselves, not by contributing
to society, but by successfully.
More successful than others taking away
from this society by
coming up with different ideas and means
as to how
to navigate through confused regulation as
to how successful the
lobby government as to how to be more than
frauds.
Which are perhaps on the other side of the
law, but because law
enforcement is weak, people can get away
with this, so on and so forth.
So according to Balmoral entrepreneurs are
among us all the time, in all countries.
But the difference is to which areas
of activities entrepreneurs contribute
their outstanding skills.
And qualities, and this is the choice
between ransacking and protect activities.
And of course, this choice depends on the
quality of government institutions, on the
strength of government.
It depends first and foremost on
how strong the governments protect
property rights.
Property rights protection is one of the
main functions of governments.
So let me give you a very simple
illustration which shows.
How the degree of property rights
protection
affects individual's choices, between
production and rent-seeking.
And how, as a result, it contributes to
the wealth of nations.
This inequality compares outcomes,
payoffs, of
an individual's engagement in productive
activities.
Or.
Rent-seeking, where the number of people
who
are already engaged in production is x.
And as you can see,
depending on what the government does, and
the level of
property rights protection theta is in
fact the government's choice variable.
If the government's choice variable These
payoffs look differently.
If property rates are better protected,
then
productions become relatively more
attractive than grant seeking.
Still, we should expect that if that is
between zero and one,
there will always be some people in case
in, in production in.
In rent-seeking, but what matters is the
proportion, is the
number of people who are engaged in
collective activities, and
this proportion characterizes an
equilibrium, and this equilibrium,
in its turn, depends on how effectively
the government does its job.
And this equilibrium itself affects the
wealth of this economy.
Let me illustrate to you this equilibrium
by a simple diagram.
The bottom graph, I see this curve which
is the graph of the production function.
And as you see It does exhibit decreasing
returns to scale.
The total wealth of this society depends
on x and the greater
is the number of people who are in engaged
in product production.
The welfare of this society is so quite
obviously social optimum Is
is achieved when x equals1 and in that
case total gains are F of x.
No piracy in chemical engineering in this
case are two alternative activities, and
although
we respect chemical engineering much more
than
piracy, we respective [UNKNOWN] more than
rent-seeking.
What we're concerned about at this time is
the net gains.
Is the total benefits that economic agents
accrue in different equilibrium.
And, these net gains, as I said, depend
very strongly on government policies.
Let's consider a particular level of
property rights protection.
Theta.
and, in this case the payoffs to
production will be theta F prime of x.
And this is indeed the, the climbing
curve, its negatively sloped curve.
The payoff to rent-seeking will be 1 minus
theta F of x or 1 minus x.
And it's easy to to verify that this is a
positively sloped curve.
And these two curves intersect in this
particular point and this is the
equilibrium.
In this equilibrium, the level of
production is
x and the society's welfare is F of x.
Now, suppose that the protection of
property
rights for some reason has been reiterated
and
that will lead to the movement of this
curve to the left according to this arrow.
And because that is getting smaller To the
left or down, which is the same thing
here.
That is getting smaller.
And, as a result, this curve, which
describes payoffs
to rent-seeking is moving upward or also
to the left.
So the equilibrium used to be here.
And now, the equilibrium is here.
And we see that its equilibrium level Of
involvement in production is much smaller.
A larger proportion of people are involved
in piracy and much more in production, and
as a result, the new equilibrium level
will make the society quite a bit poorer.
In this equilibrium, the government is
doing much better than in this one, and as
a result, in this equilibrium the economy
is considerably more prosperous than in
this one.
And again this is a good illustration how
we can only
develop in economic conditions depend on
the quality of government and it's
also a good illustration that a important
role of government is to affect
private sector conditions in a way that
align individual incentives.
Great [UNKNOWN].
And property rights are well protected.
Capable individuals will be much better at
production than in rent-seeking.
In production is something that in the
interest of the society.
When property rights are poorly protected,
when the
government is failing to convince more
important count.
Then capable individuals will do a lot
simply better in rent-seeking than in
production activities.
And in this case, individual rationality
is
far apart from social optimality, from
social welfare.
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