Modeling rent seeking activities: Quality of institutions, macroeconomic performance and the economic crisis

In this paper we study the implications of institutional quality for macroeconomic performance. For this reason, we augment the standard real business cycle (RBC) model with rent seeking competition. The idea is that agents allocate a part of their effort time competing with each other for a fraction of a contestable prize. The social costs of rent seeking are incurred when resources are unproductively used in quest of this contestable prize. The better the quality of institutions in an economy, the lower the rent extraction and the subsequent social costs of rent seeking. Our analysis considers alternative contestable prizes such as firms' produced output, tax revenues, public transfers from the state, or the income of the others. The respective models are calibrated to a group of 12 Eurozone countries over the period 2001-2016. We use annual data from Eurostat, AMECO and the Federal Reserve Bank of St Louis. We first evaluate the ability of alternative ways of modeling the contestable prize to match the data and thus investigate which contestable prize choice suits each country most. This evaluation is based on the comparison of the second moment properties (volatility, persistence, co-movement with output) of the cyclical component of the actual macroeconomic time series as in the data, vis a vis the respective second moment properties of the cyclical component of the simulated time series generated by each model. Trend is computed via the Hodrick-Prescott filter. Secondly, motivated by the changes in government policy instruments observed in the data as a result of the 2007-8 world crisis, we investigate the interaction among macroeconomic performance and quality of institutions in the two sub-periods preceding and following the crisis. Two main findings are: first, the repercussions of the crisis have been milder in countries with better quality of institutions such as, for example, Germany and the core Eurozone countries; and second, countries characterized by relatively poor quality of institutions before the crisis, such as, for example, Greece as well as other Southern European countries, suffered a further deterioration in this quality in the crisis years.