So I drafted to separate blog posts on a brief economic analysis of environmental regulation and inequality within Peru and then realized that the root cause of both was the same: rent seeking. So with an eye for the economy of words and posts, I’ve attempted to join them together.
Let me start by defining rent seeking, a concept within the study of political economy. The term rent seeking was coined by Anne Krueger in 1974 and refers to the decision to spend a portion of your wealth to bring more wealth under your control by altering the social and political environment. In this context, a “rent” comes out of the ability to receive rents from increasing your control of capital and land within an economy. A classic example of rent seeking is the process of lobbying politicians for reduced taxes on the highest income brackets. It’s why I think campaign finance reform is among the most pressing issues facing the United States right now, Super PACs enable rent seeking and prevent true reform.
But this a blog about Peru, so I want to discuss how rent seeking has prevented both environmental reform and equitable growth.
Situations within Peru
Conrado, the director of the Joining Hands Network, spoke to us about how mining practices have led to environmental and water degradation in communities throughout Peru. He gave us the example of Las Congas, a region in Peru that is currently resisting a mining company seeking to move in and start mining below their lake, which would contaminate the water source.
The mining company sought to make up the difference by creating a reservoir for the people, but the community very clearly opposed this. As Conrado put it, the people did not want their arm cut off to be replaced by a prosthetic. A reservoir would not fix the consequences for the biodiversity of the area and was just an unpleasant change.
Jed told us about a similar situation in La Oroya. La Oroya is a small community in Peru that has been contaminated for decades by a local metallurgical factory owned by Doe Run Peru, which is owned by the U.S. holding company Renco Group. The factory releases numerous contaminants into the air and soil. This has resulted in acid rain and lead poisoning in more than 90 percent of the resident children.
And then there’s the fact that Peru has been shellacked by climate change and global warming. More than 77 percent of the snowcapped mountains in the Andes can be found in Peru, so much of the water system is based around mountain streams and lakes. As the average temperature of the earth rises, these snowcaps melt and the water cycle has fallen out of order and led to far less water to go around.
The answer from economics
In economics, these can all be defined as social costs or negative externalities. They are costs to society that these businesses do not have to pay. In economic theory, it is then the responsibility of the government to step in internalize that externality via regulations or taxes.
A classic example might be the carbon tax, make people pay to pollute. Another program might provide tax credits for companies that meet environmental regulations. It’s positive reinforcement instead of a punishment.
I know, I know, this feels dirty. You’re buying into the capitalist dream of being able to do anything you can pay for. But the fact is there is no limit on how high we make the tax. It must be as high as the social cost to the people of Peru, so considering how awful the consequences are, the taxes should be fairly high. Businesses will need to consider these taxes as costs in their investment decisions.
Obviously, I’d prefer that everyone changed their behavior because they realized the immense consequences of their environmental actions. Unfortunately, for some reason many leaders of corporations do not feel that way. The profits are too good to give up and it’s easy to rationalize ignoring these social costs. So internalizing externalities through taxes uses this greed to make a change and start making changes now. Maybe it’s pragmatic, but we need changes now or many consequences of climate change will be beyond our influence.
Why doesn’t it work?
So why doesn’t this happen? Obviously, it’s tricky to set a tax in just the right way or exactly internalize an externality, but it’s not impossible. There are many studies on doing this equitably and accurately. The attempt to build a reservoir in Las Congas was one such attempt. It was an additional cost to the company. The response of the people showed that this attempt fell short of truly internalizing the externality.
Or perhaps governments compete to create climates that are attractive to international investment. High taxes and regulations keeps investment out and does not lead to job creation or development. Yet, to my mind the long-term social costs of environmental degradation far outweigh the immediate benefits of international investment.
We watched videos wherein members of Las Congas and La Oroya explained why they rejected this form of development. To them it wasn’t worth sacrificing the environment, they did not place much value in development through mining investments. You might claim that they are misguided, but that would be to deny their ability to act as rational decision-makers and weigh costs and benefits. That’s an argument, but it’s demeaning and paternalistic, so I don’t support it.
So again, why hasn’t the government listened to the people and implemented these policies?
Rent seeking in Peru
I think rent seeking keeps governments internalizing these externalities. Essentially, corporations are able to alter the political climate to reduce regulations and other attempts to internalize externalities.
And this isn’t difficult to do. As Conrado put it, foreign investment has led to a decrease in poverty in Peru, though it has increased the inequality. When speaking to the government, corporations can point to the drop in poverty and say, “Look it increased the wealth of everyone and spreading the money might shrink the wealth.” (Coincidentally, this same inequality enables rent seeking. It’s a cycle.)
Additionally, the institutions of international trade facilitate “legal” rent seeking. Take the example of La Oroya.
The current Peru-U.S. Free Trade Agreement from 2009 provides Renco Group the grounds to sue Peru for enforcing a contract from 1997. The contract, which the holding company signed, required Renco Group to reduce contamination over the next ten years. They did not do this and asked for continued extensions.
When the free trade agreement passed, however, Renco Group changed their strategy. The agreement includes an article stating that a government cannot nationalize or expropriate any international company. The measure follows the logic of laissez-faire economics. Governments should not be able to interfere with or take over profitable businesses. In that sense, it is fair and promotes a more stable investment environment. Unfortunately, Renco group is using the law to claim that Peru’s continued enforcement of the contract signed in 1997 is causing indirect expropriation and demands $800 million in reparations.
You might say, well that’s dumb, the contract takes precedence as it came first. Except Chevron won a similar lawsuit against Ecuador in recent years. And the reason why? International Arbitration Courts (IAC).
These little devils exist to provide decisions on trade and commercial disputes in the international economy. Instead of placing the judiciary decision in the hands of a government’s judicial system, the IAC is meant to be a neutral authority. In theory, I love that idea. In practice though, these courts almost facilitate rent seeking.
Only a company can ask an IAC to decide on a trade dispute. A government has no right to sue a company in these courts. When a company seeks an IAC, they select the members of the deciding committee. And the kicker is, the company cannot be punished if they “lose” the suit.
So a corporation must pay the necessary legal fees for an IAC and to make their case. It’s a small price to pay for a company like Renco Group when they demand reparations on the order of $800 million. Renco Group can spend a little money to alter the political environment and increase their own wealth. Sound familiar? That’s rent seeking.
So what to do?
So what can we do? Well unfortunately, there is not much to do about the Peruvian-US Free Trade Agreement. You can write a letter to the IAC deciding on the Renco Group vs. Peru case, but other than that there is little to do. Instead, it is better to look toward the new free trade agreement on the table.
The Trans-Pacific Free Trade Agreement is currently being negotiated behind doors closed to all member countries and citizenry other than the 600 companies between the involved countries. When completed, politicians from each country will read over the agreement and vote “yes” or “no.” I mean, that’s just blatantly enabling rent seeking.
According to Jed, information leaks about this agreement are not promising. It sounds like more of the same if not more enabling of rent seeking. The best thing to do? Write a politician not to support the amendment. If you know someone who works in a company that trades on the international scale, tell them to push for better reforms within the free trade agreement.
For example, allowing international companies to operate above the laws within a country is stupid. Or perhaps there needs to be clear definitions of appropriate reasons “expropriate” or increase fees on an international country. These could include environmental laws and human rights abuses.
Or maybe arbitration courts should allow countries to step in sue companies for not following their national laws. Renco Group has not followed through on their contract and this happens all the time. Governments need to be able to enforce the laws put in place even on international investors.
The point is, rent seeking needs to be stopped. It creates a vicious cycle for inequality and prevents any real environmental reform from taking place. And who suffers? The poorest in the world and specific to my year, many I will meet in Peru.