Which is better, an imperfect market solution or an imperfect government solution? Well, it depends.
Nine Principles
1. There is no such choice as a free choice; benefit cost analysis is useful.
2. Voluntary and informed exchange benefits the traders.
7. Public policies create winners and losers. Do the gains outweigh the losses?
Why you want to know this To be an informed voter, it is important to understand the reasoning behind the decisions of bureaucrats and policy makers. This summary will help you understand the incentives of government officials as they sometimes pursue policies that go against the public interest.
Objectives:
Identify the incentives of different groups in the political arena
Use benefit cost analysis to explain the incentives of voters
Use the principle of exchange to explain the incentives of politicians
Just as markets have characteristics that prevent them from achieving efficiency, government intervention in markets may have unexpected consequences. Dr. James M. Buchanan received the 1986 Nobel Prize in Economics for the work that he did with Gordon’ Tullock on Public Choice Theory, which applies Economic principles to the political process and analyzes how government resource allocation decisions are made. Since it is assumed that private-market failure is a reason for some government intervention in markets, public choice theory considers how well the government performs when it replaces or regulates a private market. The discussion revolves around two questions: 1. What characteristics of government stand in the way of efficient outcomes? 2. Which outcome is better, the imperfect market solution or the imperfect government solution? Until these two questions have been addressed, it is not clear that government intervention is necessarily the better solution.
Applying economic reasoning to the political theater implies investigating the incentives of different political actors such as voters, bureaucrats, and elected officials. What incentives and situations exist that lead to inefficient government actions? Below, we discuss the incentives of the three groups mentioned.
■ Voters
• Rational ignorance. In California, this is a particular problem. There are often so many initiatives on the ballot that it is difficult to understand them all. As a result, many voters simply throw up their hands and say, “I don’t know.” They may then vote from a position of ignorance or not vote. The point is that the cost of expending the human capital to understand the proposition is greater than perceived benefits from the outcome of the proposition. So voters often enter the voting booth from a position of “rational ignorance.”
• Special interests. Some groups do care very much about the outcome of particular initiatives. They use their human capital to learn about the proposition and then weigh the expected advantages of the proposition for them against the expected disadvantages. Though this group may not be large, they all vote for or against the proposition disproportionately influencing e the results. A few groups that illustrate this phenomenon are the American Association of Retired People (AARP), the National Rifle Association (NRA), the National Chamber of Commerce, and the American Bar AssociationWhile some of these “special interest groups are obvious (e.g., the National Rifle Association, the American Association of Retired People) others are not. Many policies are voted on because the cost to voters is dispersed, hidden, and minimal per voter, while the benefits to particular interest groups are large, visible, and significant. Policies that protect certain producers such as automotive workers or tobacco farmers are examples. It has been estimated that it costs approximately $90,000 annually to protect U.S. automotive workers from losing their jobs to foreign automobile producers. But the typical voter never sees the dollar cost and is only slightly affected by it. On the other hand, automotive workers know very well which politicians have voted to protect them and which have not.
• Inefficient Voter Outcomes. With direct elections, it is often the case that the majority votes for issues that are, in fact, against the public interest. To illustrate inefficient voting outcomes, consider: Should the town build a new skateboard park? For simplicity, let’s use 3 voters, Jackson, Jennifer, and Jeff, to represent the town’s voting population. Each voter will share the cost of the park by paying a tax. Jackson used to skateboard and, while he wouldn’t use the park now, he thinks younger kids would and wished there had been a park when he was younger. Jennifer doesn’t skateboard, but she thinks it would be good for the town. Jeff doesn’t skateboard, doesn’t understand the need for the park, and doesn’t want to pay more in taxes. The table below represents the cost of the choice, the benefit to each voter, and whether they will vote for a new skateboard park.
COST TO VOTER | BENEFIT TO VOTER | |
Jackson | $200 | $250 |
Jennifer | $200 | $201 |
Jackson | $200 | $ 0 |
Total | $600 | $451 |
The total benefit of the skateboard park to the town is $451, the cost is $600. The park should not be built. Since the votes can’t reflect the value to each voter, however, it is not possible to calculate the total value and the skateboard park will pass. There are many instances when a simple majority vote will promote policies that actually go against the public interest.
■ Elected officials
• Logrolling. The best-intentioned elected officials can’t get much done by themselves; they will always need the votes of their colleagues to pass legislation. As a result, they will often vote for policies that they know don’t promote the general interest to obtain votes for their constituents on another issue. This is sometimes referred to as “You scratch my back, I’ll scratch yours.” Economists would call it the Principle of Exchange; I will give you my vote on this issue in exchange for your vote on an issue that is important to my constituents. In this case, voluntary exchange benefits both traders.
• Timing. Many officials must run for re-election every two years, some every four, others every six. To be reelected, they must convince voters that they can “deliver the goods.” So policies where the benefits may greatly outweigh the costs but don’t begin to pay off for a long time are less likely to be voted on. In general, a policy bias exists in favor of policies where the benefits are short run and the costs are long run.
• Benefits not identified with legislation. If the benefits are also difficult to attach to the particular legislation, the issue becomes even more difficult. An example is public funds for prenatal care for the poor. Since the poor are often unable to take the necessary health treatments during pregnancy, they are far more likely to end up requiring emergency care during birth and the baby may require emergency care afterwards. Since emergency care is far more expensive than prenatal care and since the emergency care is usually provided with public funds, it is efficient to provide the prenatal care. The problem is that the payoff from such a policy is difficult to identify. How will the number of emergency room visits avoided due to prenatal care be documented? Research on health issues is difficult to fund publicly since the payoff may be many years down the road.
• Distribution of benefits and costs. If the benefits of legislation accrue to a powerful group with a large number of members who vote, and the costs accrue to a group whose members do not vote, then policies that may be best for society may not be implemented since those who would benefit don’t vote. Since the poor tend to vote less than other groups, many policies that would benefit the poor and society in the long run do not become policy.
■ Bureaucrats
• No competition. One of the major constraints for businesses is competition. If prices are too high, customers can go to other providers for a better deal. With many government monopolies there is little competition so the incentive to lower costs is not as great as would be the case with competition.
• Pay according to number of employees. Some officials are paid according to the size of their staff. As a result, the incentive structure suggests that they should hire as many workers as possible with no incentive to reduce labor costs.
• Spend it or lose it. Since many budgets are based on one year, funds that have been allocated to an agency will be given up if they are not spent by the end of that year. The incentives suggest that all allocated funds will be spent by the end of the budget cycle, whether usefully or not. In addition, next year’s allocation is often based on this year’s spending, so further incentives exist to spend the entire budget.
■ Conclusion
When markets are not allocating efficiently, is the market outcome or the government outcome the better of the two? The proper question is not whether government is too big; the proper question is where government should be involved in the economy. The simplistic answer is that government should be involved where the marginal benefits of additional government involvement outweigh the marginal opportunity cost. Unfortunately, the estimation of those benefits and costs are far from simple.
Bottom Line:
Voters use marginal benefit/marginal cost analysis to decide whether to vote and how to vote. Some factors that influence these decisions are rational ignorance and special interests. Voting by special interests can result in outcomes that violate the will of the majority.
Elected officials face pressures to vote for policies that they feel are not in the general interest. These include logrolling, timing (benefits occur after the next voting period), inability to connect the benefits with the legislation, and the tendency to promote policies that help those who vote as opposed to those who do not vote.
Bureaucrats have incentives to take actions that violate the public interest. When government agencies have little or no competition, there are few incentives to operate efficiently. If government employees are paid according to the number of employees they supervise, there is an incentive to hire more workers than are necessary.
1. Which of the following occurs when two elected officials vote for each other’s legislation even though they dislike the other’s policy
a. Timing
b. Logrolling
c. No competition
d. Voters and non-voters
2. Which of the following occurs when bureaucrats spend more than necessary at the end of the funding cycle?
a. Pay according to number of employees
b. No competition
c. Spend it or lose it
d. Timing
3. Which of the following occurs when voters fail to use their human capital to fully understand what they are voting on?
a. Timing
b. Rational ignorance
c. No competition
d. Distribution of benefits and costs
Check with your local Assembly person or Senator and see what legislation they have written or proposed or voted in favor of. Is that legislation with which you agree? How does it affect you or your family?