Opening quotes, p. 130:
"Public Choice analyzes the motives and activities of politicians, civil servants and government officials as people with personal interests that may or may not coincide with the interest of the general public they are supposed to serve."
"It does not follow that whenever laissez-faire falls short government interference is expedient; since the inevitable drawbacks of the latter may be worse than the shortcomings of private enterprise."
The role of government in the economy is very large, and has grown dramatically this century, especially at the federal level (see graph page 113 - note that the values in 1929 were about the same all the way back to the 1700s).
PUBLIC CHOICE ANALYSIS
Public Choice economics looks at public or collective decision making using the economic way of thinking and an economic framework and analysis (Supply and Demand). Links economics and political science. Decisions in the economy have to either be make Privately (market, individuals, firms) or Publicly (collectively, through government), thus the title of the book: Macroeconomics: Private and Public Choice.
In the same way that there are potential "market failures," where the market fails to promote the general welfare, there are also potential "government failures," where the government may fail to serve the public. Government is an alternative method (to the market) of social organization - an institutional process through which individuals collectively make decisions and carry out activities.
Public choice economics uses economic principles and methodology to analyze the public sector. We can apply the same economic framework to study both the private and the public sector. Economists have studied the market for over 200 years, the public sector for only about 40 years. See Outstanding Economist James Buchanan, page 132, the "father of Public Choice."
For example, economists assume that individuals are self interested in either the private or the public sector, and engage in maximizing behavior in both sectors. Managers seek to maximize profits, bureaucrats seeks to maximize their budgets or the size of their agency, politicians seek to maximize votes, contributions, political power, etc.
Collective decision making involves three groups: 1) Voters-Consumers, Taxpayers and Special Interest Groups - which represent the DEMAND SIDE OF COLLECTIVE DECISION MAKING, 2) the Politicians-Suppliers representing the SUPPLY SIDE, and 3) the Bureaucrats, who carry out and administer legislation. Public choice analysis looks at the Supply and Demand for Legislation.
VOTERS-CONSUMERS
We make choices and decisions in the public sector by voting for politicians/elected officials. However, consider the difference between private choices and voting, looking at the costs and benefits.
Example: you are planning to vote in November at the same time that you are planning to buy a used car. If you make an uniformed decision on your car purchase, it could be very costly if you buy the wrong car - it could be a lemon and result in expensive repairs or you might be stuck with a vehicle that you don't really like, etc. If you make an uniformed decision in an election by voting for a candidate who might turn out to be very bad if elected, it won't be costly at all since your one "bad" vote probably won't determine the outcome of the election. The value of your single vote is : 1 / n , where n is the number of people voting. The greater n is, the lower the value of one vote.
In deciding whether to vote, voters analyze the costs and benefits of voting:
COSTS: the time to research the candidates, become informed on the issues, listen/attend debates, register to vote, go to the poll and maybe wait in line, etc.
BENEFITS: the personal value of participating in the democratic process, the satisfaction of casting the deciding vote if break a tie vote, etc.
For many voters, the COSTS of voting are greater than the BENEFITS of voting, and they make a rational decision to be politically ignorant and uninvolved/uniformed. This is the Rational Ignorance Effect. Consumers are not rationally ignorant when it comes to private decisions, but they ARE rationally ignorant when it comes to collective choices.
Potential problem of Rational Ignorance:
Informed, rational, utility-maximizing consumers who invest time and
effort to seek out value, low prices, bargains, etc. provide significant
discipline on the suppliers and producers to act efficiently. Rationally
uniformed and ignorant voters may not monitor the political process and
impose strict discipline on politicians/bureaucrats, resulting in inefficiencies
that lower our standard of living. Example: Rationally informed
Special
Interest Groups dominate the political process, and take advantage
of the rationally ignorant voters. We will come back to this.
POLITICIANS-SUPPLIERS
On the supply side, we have elected officials, legislators (politicians)
who try to maximize votes to get into office and then maximize political
power and try to re-elected. Political survival depends on vote-maximizing
strategies, votes are "the lifeblood of the politician." Activities of Politicians/Legislators once in office? Supply
legislation.
CIVIL SERVANTS: BUREAUCRATS
In many cases, after legislation is passed by politicians,
bureaucrats within a bureaucracy have to implement the legislation.
Examples:
farm price supports and other farm programs have to be administered
by the Dept. of Agriculture, environmental laws are administered by the
EPA, etc. WHEN VOTING WORKS WELL See p. 137. For public-sector
action/programs, the distribution of the benefits among voters can be either
widespread or concentrated. The costs associated with the programs can
also either be widespread or concentrated. For a Type 1 issue, both the
benefits and the costs are widespread among voters, and the political process
tends be consistent with economic efficiency for these projects. For
example, the government provision of many public goods falls into this category:
national defense, national highway system, local police protection, the legal
system for protection of property rights, public-funded education, social
security, Medicare, unemployment compensation, etc. Nearly everybody pays
and everybody benefits, think of Social Security. The political
process also works pretty well for Type 3 issues/projects/programs where both
the costs and benefits are concentrated on subgroups. Examples would be
government provision of a specific service to consumers, financed by a user fee:
government provision of electricity, water and sewer, U.S. patent office, toll
roads, Lock and Dam system, where voters-consumers pay roughly in proportion to
their consumption of the government supplied good or service. Voter
support of these programs will provide politicians with an incentive to provide
these public services, and the outcome could often be economically
efficient.
WHEN VOTING CONFLICTS WITH ECONOMIC EFFICIENCY
Goals of a lifetime, career bureaucrat might be to maximize
the size and budget of the agency they work for, which may or may not benefit
the general public, and may not be economically efficient. Bureaucrats may work to influence constituencies
and politicians to increase their programs and budgets. Example:
Dept. of Agriculture may encourage farmers and politicians to support increases
in its budget.
Four reasons why majority rule might conflict with economic prosperity (economic efficiency).
1. SPECIAL INTEREST EFFECT.
Public-choice analysis predicts that there can be serious problems (economic
inefficiency) when benefits are concentrated on a narrowly focused special
interest group, and financed by general taxation, a Type 2 issue (widespread
distribution of costs and concentrated benefits).
Compared to the unorganized, rationally ignorant voters, special interest groups are very organized, concentrated, and well-informed on issues affecting the group. Special interest groups will seek ("demand") legislation that generates substantial benefits on their very well-organized small group, while imposing a very, very small individual cost on the dispersed voters/taxpayers. Special interest groups: farmers, teachers, retired people, etc.
Example: sugar farmers. World price of sugar is 7 cents/lb. vs. 21 cents for US sugar. Why? Special interest legislation was passed (tariffs, restrictions on foreign sugar) to protect domestic sugar producers from more efficient foreign competition. At 7 cents/lb., domestic sugar producers cannot compete, at 21 cents they do very well. Who pays? Consumers and industrial users of sugar, in the form of higher sugar prices and higher prices for everything with sugar as an input.
Assume that protectionist, special interest legislation costs U.S. consumers $500m each year in higher sugar prices in the U.S., about $2/person/year. Assume that there are about 10,000 U.S. sugar growers, who each get $50,000/year on average in additional income from the $500m.
Much easier to organize 10,000 sugar producers than 250m consumers. Sugar producers have a lot more at stake per person/farm, and those concentrated benefits give them an incentive to seek special interest, protectionist legislation. Sugar farmers will engage in lobbying, or what economists call "rent seeking," and invest time, money, resources to lobby and influence legislation in their favor. There is a lot at stake for each farmer ($50,000/year), and there is very little at stake for each consumer/voter ($2/year). Who will prevail????
Let's compare the Costs vs. Benefits of Sugar protection:
Costs (to consumers) Hidden, Diffused (over 250m consumers), Delayed
Benefits (to producers): Visible, Concentrated, Immediate
How many people know that U.S. sugar prices are 3x the world price?? Very few. Why? Rational ignorance. And even if we know, the most we could save individually by ending sugar tariffs is $2/year, which is not enough to motivate us to campaign against current legislation.
POTENTIAL PROBLEM: The well-organized special interest groups will lobby effectively for programs that bestow concentrated benefits on their group, at the expense of rationally ignorant voters/consumers who will bear the diffused costs of the legislation. Since most of these programs have C > B, we as a country are worse off, our standard of living is reduced overall. Therefore, collective decision-making can lead to a misallocation of scarce resources - ECONOMIC INEFFICIENCY, because special interest groups will dominate and corrupt the political process.
Think about a typical vote-seeking politician when approached
by the sugar lobby to vote in their favor for sugar tariffs and other forms of
special interest protectionism. Voting in favor of sugar protection will
generate votes, monetary donations, campaign support, political support from the
organized sugar farmers. What about the voter-consumers? They are largely
uninformed, unorganized, and uninterested in sugar tariffs, so the politician
has nothing to lose by NOT supporting the interest of the general public (sugar
consumers), and everything to gain BY supporting the special
interest.
Most studies on protectionism show that the Costs
to Consumers are MUCH GREATER than the Benefits to Producers (C > B), resulting
in Economic Inefficiency and a reduction in our OVERALL standard of living.
Just like spending $2 to save $1 would make us worse off as an individual,
tariffs usually cost the economy $2 (paid by consumers) for every $1 in
benefit for the special interest group (producers). WHY???
Even though the tariff generates Costs > Benefits for the economy as a
whole, and is therefore counterproductive, inefficient and undesirable, it is a
POLITICAL WINNER!
2. SHORTSIGHTEDNESS EFFECT
Shortsightedness effect is another potential defect of
the political process and comes about because of the inherent short run
(shortsighted) bias of politicians. Because politicians want to maximize
votes and power, and get re-elected, there will be a bias in favor of programs
that have immediate benefits that are easily identifiable, even if the long run costs are much greater
that the benefits, especially when the costs are hard to identify. Short run solutions and outcomes will be favored
over long run outcomes. Programs or solutions with long run benefits to
society will be ignored, like ending sugar subsidies. Inherent bias for
short term results even when inefficient (C>B), and a bias to ignore long run
solutions even when they are efficient (B>C).
Example: deficit spending, where the Government
spends more money it takes in (G > T), borrows the money, runs a budget
deficit and defers taxes to a later period. The current spending
on current programs generates political support from beneficiaries of the
spending, and the costs are imposed on future taxpayers, some of whom are
not even born yet (some govt. debt is financed for 30 years).
"Politicians have a strong incentive to promote programs
providing easily observable benefits prior to the next election, even when
the true cost of these programs outweighs the benefits for citizens as
a group." Pages 141.
Example:
Program B yields $2 of future, difficult-to-identify benefits,
but generates $1 in immediate visible costs.
Even though Program B makes the country better off, and
Program A makes the country worse off, shortsighted politicians
will almost always favor Program A over Program B. The shortsightedness effect of
politicians can therefore lead to: a) Economic Inefficiency and b) Misallocation
of Scarce Resources.
3. RENT SEEKING (see P.J. O'Rourke quote, p. 142)
Rent seeking (or "favor" seeking, lobbying) is the potentially
counterproductive and wasteful misallocation of scarce resources, time,
effort and money by special interest groups, directed towards trying to
influence the political process in favor of that group. Rent seeking
leads potentially to using the political process to the plunder of wealth
by special interest groups. If the political process is not neutral,
but can be used to takes sides and favor one group over another, then more
and more resources and time will be directed toward wasteful rent seeking
and less and less time toward productive activities.
Example: Sugar farmers spending time, money,
effort and resources in wasteful rent seeking activity to get protection
legislation instead of spending time, effort, money on growing sugar, researching
new growing methods, investing in machinery, etc.
For society overall, the more resources devoted to
rent seeking and political plunder and the fewer resources devoted to creating
wealth and production, the lower the overall standard of living of the
economy. When government favors some special interest groups at the
expense of others through the legislative process, counterproductive activities
will expand and productive activities will shrink. Rent-seeking can
therefore retard economic progress.
4. INEFFICIENCY OF GOVERNMENT
OPERATIONS
If government provides goods and services (highways, housing,
libraries, education, post office, parks) instead of the market, will the
government operate as efficiently as a private firm? In the private
sector, the profit/loss system provides intense and strict discipline on
private firms to operate efficiently. Profits reward successful,
efficient firms and losses penalize unsuccessful, inefficient firms.
Firms losing money face the severe discipline of the market - become more
efficient or face economic extinction: bankruptcy. Private firms
also have an incentive to downsize if that increases efficiency and saves
money.
Public agencies do not face the discipline of the market,
are not disciplined by profit-loss system, and therefore may not have strong
incentives to operate efficiently. Public agencies are less likely
than private firms to be cost conscious, since there are no direct penalties
for inefficiency in the public sector. In fact, public agencies might
actually have perverse incentives to actually operate inefficiently.
Why? Think of a government agency that is operating very inefficiently
and is therefore unsuccessful at accomplishing the mission of the program.
What is the typical response to this situation - do we usually increase
or decrease the agency's budget in subsequent years????
Competition breeds competence, and being insulated from
competitive market forces can result in inefficient public agencies.
For example, most local governments find it more cost effective to contract
out and use private firms for trash removal instead of government run operations.
The current trend is towards greater use of private contracting for public
services. There are two issues here: a) who pays for the service
and b) who provides the service. We first decide as a society whether
local governments should provide "Public Goods" like garbage collection,
police and fire protection, roads, education, etc., and if so, we then
collect tax dollars to finance the provision of the goods or services.
Secondly, we next decide whether the public or private sector should actually
deliver or provide the goods and services.
In cases where tax money is used to finance the public
provision of goods and services, there is the potential misallocation of
resources when public agencies operate inefficiently, resulting in a reduction
of economic progress and our standard of living. The internal inefficiency
of many programs in the public sector is not based on the assumption that
government employees are lazy or incompetent, but based on the incentive
structures in place (or NOT in place) and the absence of profitability
criteria. The operation of a public-sector program/agency, and the
appointment of high level managers, may often be more influenced by political
rather than economic considerations. Also, international studies show that economies dominated
by central planning and government control are much less efficient than
market based economies. And studies that compare the efficiency of
government programs to the efficiency of private firms providing the same
service typically show that private firms are more efficient and
productive.
See Exhibit 4, p. 144. Goods/Services can be provided by a) private or b)
public sector, Goods/Services can be paid for by c) Consumers-Users or d)
Taxpayers.
Quadrant 2: Private sector supplies the good/service, using tax dollars.
Examples: contracting out for garbage collection (see p. 144), police
departments, subsidized housing, food stamps, Medicare, some road construction,
government purchases of goods and services (computers, buildings,
etc.).
Quadrant 3: Government supplies the good, consumers-users pay. Examples:
Post Office, utilities (Lansing Board of Water and Light), toll roads, lock and
dam system, some hospitals, etc.
Quadrant 4: Government supplies the good or service using tax dollars.
Examples: Public schools, national defense, law enforcement, fire departments,
streets and roads, flood control, etc.
MAIN POINTS: 1) Most economic activity (approx. 70%) in the U.S. takes
place through the market, Quadrant 1, and that is the main focus of Economics as
an academic discipline. There are some potential sources of "market
failure," economic inefficiency can be improved by government
intervention.
2) The 30% public sector is sizeable and very important to understanding how the
economy operates. Also, there are potential sources of significant
government inefficiency and "government failure" in Quadrants
2-4.
Important distinction for government spending between:
1) Government purchases of goods and services (spending on national
defense, highways, education, programs, agencies (FBI, EPA, Dept. of Labor,
etc.), administration, etc.) and 2) Transfer payments (transfers
of income (tax dollars) from working taxpayers to recipients who are not
providing current services) such as Social Security, unemployment, disability
payments, general assistance, AFDC, etc. Growth in govt.
spending since 1960 has mostly been from transfer payments, see p. 146, 13.4% of
national income goes to transfer payments. If we include benefits like
food stamps, government payments for medical care and housing, the figure would
be more than 20%. Note: The ideal distribution of income is
normative/subjective. There is nothing in positive economics that tells us
which distribution of income is ideal or optimal. Of total transfer
payments, only 1/6 are means-tested transfers for the poor (income below a
certain level to qualify), the other 5/6 are not means-tested and directed
toward well-organized special interest groups, often with above average income
(farmers, elderly, businesses, labor unions, pension recipients, etc.)
Potential problems with transfer payments:
1. Incentives - more incentive to be unproductive, less incentive to be
productive. Tax something (productivity), you get less of it; subsidize
something (unproductivity) you get more of it.
2. More transfer payments = more wasteful rent-seeking to receive transfer
payments = smaller economic pie.
3. Higher taxes to support higher transfer payments can result in more
resources being directed to shelter taxable income, and fewer resources directed
to productive activity. Misallocation of resources from efficient
uses to inefficient uses = smaller economic pie.
SUMMARY OF INSIGHTS FROM PUBLIC
CHOICE: 1. There are potential "market failures" due to
externalities, public goods, and poor information. Government
intervention/regulation may increase economic efficiency.
2. The democratic process can potentially result in economic
inefficiencies, "government failure," because of a) rational ignorance, b) the shortsightedness
effect, c) rent-seeking, d) special interest groups, and e) government
agencies operating inefficiently, that result in the general interest not
being well-served, and a reduction of prosperity. "Special interest
groups engage in excessive, wasteful in rent seeking to influence shortsighted
politicians, at the expense of rationally ignorant voters and at the expense
of economic progress."
2. Properly constructed political, constitutional rules
can improve economic efficiency by aligning interests of all parties
and minimizing the potential abuse of the political process. Point:
Incentives matter, political rules must promote the general welfare and
economic prosperity of the country as a whole.
Examples of constitutional rules that might minimize political
inefficiency: term limits, balanced budget amendment, expiration dates
on legislation, flat tax, spending limits, make people pay income tax monthly,
move voting day to April 16, etc.
See Thumbnail Sketch, page 148, for a summary of potential
Market Failures and Government Failures.
Program A yields $1 of immediate, visible benefits, but
generates $2 in future, difficult-to-identify costs.
WHO PRODUCES (Mkt. or Govt.) and WHO
PAYS?
Quadrant 1: Private sectors provides the goods, consumers
pay. Market economy: Movies, cars, gasoline, housing, groceries, clothing,
restaurants, textbooks, CDs, furniture, computers, etc.
ECONOMICS OF THE TRANSFER SOCIETY