Allocation of Alertness During Recession: An Extension

I now extend my model to account for the government’s fiscal expansion, which is often characteristic of governments facing recessions. I treat the fiscal expansion as a shock, or an unanticipated event, as with the recession itself.

The additional government expenditures are potential rents that people compete for, along the lines discussed by Tullock (1967) and Krueger (1974). Rents are therefore profit opportunities that incentivize rent­seeking and distract entrepreneurs from other activities—in this model, investing in new projects or reconfiguring existing factors. Entrepreneurs then have another reason to divert alertness from possible new invest­ment, which tends to drop even further compared to the previous model.

My revised model reflects the increase in the number of possible allocations of entrepreneurial alertness to three possible sectors. Instead of a two-dimensional box diagram with the total amount of alertness unchanged, the updated model therefore shows the tendencies of the allocations of alertness in response to shocks. I proceed in three steps: After starting in equilibrium (step one), step two shows how the higher rents associated with the stimulus affect the allocation of alertness. Step three combines the effects of these new rents with the insights about the allocation of entrepreneurship during the recession from the prior section.

The initial equilibrium in Fig. 2.3 represents the allocation of entrepreneurial alertness among the three types of activities: creating new

Fig. 2.3 The allocation of entrepreneurial alertness into the three types of activ­ities: new investment (NI), fixing the allocations of existing factors of production (Fix), and rent-seeking (RS) (Source Author’s creation)

investment (“NI” subscript), fixing the allocations of existing factors of production (“Fix” subscript), and securing profits through rent-seeking (“RS” subscript).

In the next step of the analysis, I assume a positive shock in the form of government expenditures that increases the rents available to entrepreneurs through the policy arena. In the model, the shock likely increases both the marginal product of entrepreneurship and the price of the marginal product. The marginal product increases because the addi­tional government expenditures likely pertain to new projects and lead to brand-new rent-seeking opportunities. But additional resources also likely flow into the already-existing rent-seeking opportunities and there­fore increase the price rewarding entrepreneurial alertness in the political arena.

As Fig. 2.4 illustrates, increases of the two variables—the marginal product and the price—pushes the Prs*MPErs curve up and to the right. This increase in the demand for rent-seeking alertness increases the opportunity cost for entrepreneurs in the other two allocations. In the resulting equilibrium, the return on entrepreneurship in all three possible allocations then has to increase. The equilibration also means that the allocation of entrepreneurial alertness to rent-seeking increases and it decreases in the other two sectors, keeping in mind the ceteris paribus assumption. The sector that matters here is, of course, that of the new investment projects. With the decline in alertness toward new investment projects, the number of such projects will decline and so will the investment, making (new) investment procyclical. The reallocation of

Fig. 2.4 The allocation of entrepreneurship into the three types of activities with an increase in the demand for rent-seeking (Source Author’s creation)

Fig.

entrepreneurship to rent-seeking is analogous to Baumol’s (1990) unpro­ductive entrepreneurship, just applied to the context of business cycles rather than to that of economic growth.

The recession causes the allocation of entrepreneurial alertness into rent-seeking projects and the repurposing of previously misallocated factors of production to more highly valued uses. The alertness allocated to new investment projects then declines, leading to a decline in new investment, which, together with other causes not included in the anal­ysis, makes aggregate investment procyclical. What happens to alertness to profit opportunities from rent-seeking and from reallocation of factors depends on the specific data. Even though the demand for alertness shifts out in both, it might be the case that only one of the two attracts more overall entrepreneurial alertness. Figure 2.5 illustrates the example where both see increased alertness.