The Economics of Collective Decision Making

Chapter 6

The Economics of Collective Decision Making

OUTLINE

I. Overview of Collective Decision Making

A. Public choice analysis applies the tools of economics to the political process. The goal is to provide insight concerning how the process works.

1. Self-interested behavior is present in both market and political sectors.

2. Political process can be viewed as a complex exchange process involving (1) voter-taxpayers, (2) politicians, and (3) bureaucrats.

3. The Voter-Consumer

a. Voters will tend to support those candidates whom they believe will provide them the most government services and transfer benefits, net of personal costs.

b. Rational Ignorance Effect: Recognizing their vote is unlikely to be decisive, most voters have little incentive to obtain information on issues and alternative candidates.

c. Because of the rational ignorance effect, voters will be uninformed on many issues; such issues will not enter into their decision making process.

4. The Politician-Supplier

a. Political officials: interested in winning elections. Just as profits are the lifeblood of the market entrepreneur, votes are the lifeblood of the politician.

b. Rationally uninformed voters often must be convinced to “want” a candidate.

c. Legislative bodies are something like a Board of Directors.

5. Civil Servants Government Bureaucrats as Political Participants

a. Bureaucrats (persons that handle day-to-day operations of government) seek promotions, job security, power, etc.

b. The interests of bureaucrats are often complementary with those of the interest groups they serve.

c. Bureaucrats can usually expand their own interests, as well as that of their constituents, by working for larger budgets and program expansion.

II. When Voting Works Well

A. Other things constant, legislators will have a strong incentive to support the political actions that provide voters with large total benefits relative to costs.

B. If a government project is really productive, it will always be possible to allocate the project’s cost so that all voters will gain.

C. When voters pay in proportion to benefits received, all voters will gain if the government action is productive (and all will lose if it is unproductive.) Under these circumstances, there is a harmony between good politics and economic efficiency.

III. When Voting Conflicts With Economic Efficiency

A. Special Interest Effect

1. Special Interest Issue: One that generates substantial personal benefits for a small number of constituents while imposing a small individual cost on a large number of other voters.

2. Members of an interest group will feel strongly about an issue that provides them with substantial personal benefits. Such issues will dominate their political choices.

3. In contrast, the voters bearing the cost of special-interest legislation will often be uninformed on such an issue because it exerts only a small impact on their personal welfare and because they are unable to avoid the cost by becoming better informed.

4. Politicians have a strong incentive to favor special interests even if action is inefficient.

5. Logrolling and pork-barrel legislation strengthen the special interest effect.

B. Shortsightedness Effect

1. Issues that yield clearly defined current benefits at the expense of future costs that are difficult-to-identify.

2. The political process is biased toward the adoption of such proposals even when they are efficient.

C. Rent Seeking

1. Actions by individuals and interest groups designed to restructure public policy in a manner that will either directly or indirectly redistribute more income to themselves.

2. Widespread use of the taxing, spending, and regulating powers of government that favors some at the expense of others will encourage rent seeking.

3. Rent seeking moves resources away from productive activities. The output of economies with substantial amounts of rent seeking will fall below their potential.

D. Inefficiency of Government Operations

1. In the public sector, the absence of the profit motive reduces the incentive of producers to keep costs low.

2. Neither is there a bankruptcy process capable of weeding out inefficient producers.

3. Public-sector managers are seldom in a position to gain personally from measures that reduce costs.

4. Because public officials and bureau managers spend other people’s money, they are likely to be less conscious of cost than they would be with their own resources.

IV. Economic Organization: Who Produces, Who Pays, and Why It Matters

A. The incentive to economize is influenced by who produces a good and who pays for it.

B. Economizing behavior will be strongest when consumers purchase goods produced by private firms.

1. Examples: apples, oranges, television sets.

B.  The incentive to economize is reduced when payment is made by a third party (health care) and when production is handled by the government (national defense, post office)

V. Economics of the Transfer Society

A. There is nothing in positive economics that indicates one distribution of income is better than another.

B. A large and growing part of government is devoted to transferring income, most of which does not go to poor people.

C. There are three major reasons why large-scale redistribution will reduce the size of the economic pie:

1. When taxes take a larger share of one’s income, the individual reward derived from hard work and productive service is reduced.

2. As public policy redistributes a larger share of income, more resources will flow into wasteful rent-seeking activities.

3. Higher taxes to finance income redistribution and an expansion in rent-seeking will induce taxpayers to focus less on income-producing activities, and more on actions to protect their income.

VI. Public Sector Vs. Market Sector: A Summary

A. These factors weaken the case for market-sector allocation:

1. Lack of competition

2. External costs and benefits

3. Public goods

4. Poor information

B. These factors weaken the case for public-sector intervention:

1. The power of special interests

2. The shortsightedness effect

3. Rent-seeking costs

4. Lack of signals and incentive to promote operational efficiency

VII. Implications of Public Choice: Getting More From Government

A. Both bad news and good news flow from public-choice analysis.

1. The bad news: For certain classes of economic activity, unconstrained democratic government will predictably be a source of economic waste and inefficiency.

2. The good news: Properly structured constitutional rules can improve the expected result from government.

OBJECTIVES

In this chapter, the basic tools of economics are utilized to analyze the collective decision-making process. Using the individual as the unit of analysis, we develop theories of political behavior. This chapter outlines both how we would expect the collective-choice process to work and why it will sometimes fail to allocate resources efficiently.

When the market fails to allocate resources efficiently, the public sector can potentially act to improve the welfare of all citizens—government action need not be a zero-sum game. As we discuss in the text, government action in such areas as crime prevention, national defense, provision of a stable monetary environment, and regulation of monopoly power is rooted to the potential gains from action to correct market failure.

However, there is good reason to expect that collective action will promote economic inefficiency when certain conditions are present. Special interests exert disproportionate power when decisions are made collectively. The political process is biased toward short-term solutions even if these actions cause substantial problems later. Bureaucratic decision making and the incentive structure confronted by public sector managers provide little incentive for entrepreneurial efficiency. There is often a conflict between good economics and a winning electoral strategy. Thus, it should not surprise us to find that public policy is sometimes a source of rent seeking and economic inefficiency.

This chapter provides a vivid illustration of the power and breadth of economic analysis.

IMPORTANT POINTS AND TEACHING SUGGESTIONS

1. At the outset, explain to students that the purpose of political economic theory is to expand our understanding of real-world events. Economists typically ask, “What should the government do?” The theory outlined in Chapter six asks, “What can the government be expected to do?”

2. Carefully outline how the individual welfare of both voters and political entrepreneurs is influenced by a candidate’s position on issues. Be sure to highlight the importance of voter ignorance and the information provided by candidates to voters.

3. When externalities are present, political action has the potential to improve social (total) welfare. A diagram such as Exhibit 4 in the previous chapter could help to illustrate this point.

4. The most compelling reason for public sector action is that market failure results in inefficiency relative to the hypothetical ideal. Therefore, corrective action could generate greater social benefits than costs.

5. In addition to public sector action to improve allocative efficiency, the political process may be utilized to redistribute income. Public choice analysis indicates that self-interest redistribution of income from the rich to the poor will not be particularly attractive to political entrepreneurs. Such redistribution generates unstable majorities. However, if potential income recipients were well-organized and easily identified, redistribution would become more attractive to political entrepreneurs. There is little reason to expect that redistribution of this sort (to well-organized groups) will necessarily promote greater equality.

6. The section on the “Special-Interest Effect” explains the economic logic behind these political facts of life. A classroom discussion of this topic should be of interest to students.

7. The special-interest effect is one of the major sources of government failure. Be sure to explain that the rational ignorance effect reinforces the special-interest effect since many non-special-interest voters remain uninformed on issues that are of little consequence to their personal well-being.

8. The shortsightedness effect stems from the inability of political entrepreneurs to gain from maximizing long-range future political benefits. Since future benefits (and costs) tend to be elusive and difficult to identify, in a sense the shortsightedness effect is merely a special case of the elusive nature of the benefits (or costs). The political process is biased against programs yielding elusive benefits at the expense of easily identified costs. In contrast, the process is biased in favor of programs that yield readily identified benefits at the expense of elusive costs kept hidden from the voter. As explained in the text, these factors can cause allocative inefficiency by the government.

9. The text presents the argument that public sector firms (agencies, departments, etc.) are likely to be operated less efficiently than their private sector counterparts, particularly competitive firms. However, it is important to note that this conclusion does not presume that public sector employees are lazy, incapable, and work less intensively. Rather, emphasis is placed on the incentive structure faced by public-sector managers and employees; also stressed is the corresponding lack of incentive for individuals (or small groups of individuals) to promote public-sector efficiency. The taxpayer is in an extremely weak position to identify and eliminate operational inefficiency resulting from actions designed to further the personal and political aims of the public sector administrators. There is no public sector counterpart to bankruptcy that would automatically eliminate extreme cases of operational inefficiency. In addition, collective decision making theory suggests that the widely dispersed interests of taxpayers can be expected to lose out when they conflict with the highly concentrated interests of public-sector managers, employee groups, and favored consumers, even though economic inefficiency may result. The incentives are simply perverse. Therefore, it is difficult to believe that this incentive structure does not adversely affect the operational inefficiency of the public sector.

10. The Thumbnail Sketch summarizes the major weaknesses of both the market and public sectors.

11.  Discuss the incentive structure that generates the rational ignorance effect. Ask students whether they know the positions of their congressional representatives on such issues as: (a) a reduction in national defense spending; (b) an increase in the minimum wage; (c) price controls on energy products; and (d) an expansion in the funding for higher education.

12. A good analogy to rational voter ignorance is rational student ignorance. Just as the incentives facing voters lead them to be less informed about political decisions than private ones, the incentives facing students lead them to be rationally far less informed about material that is less likely to appear on an exam.

13. A good extension of rational voter ignorance is why it leads to rational representative ignorance when it comes to bureaucratic oversight and the likelihood of bureaucratic scandals (but once public attention is focused on the subject, much political effort will be spent to show voters “tough” oversight; and to blame someone else). This incentive structure tends to result in cosmetic “reforms” that make little actual difference.

14. As a way of integrating the material in this chapter with what has gone before, it is helpful to explain that this is just another application of looking at incentive structures, with particular emphasis on the differences between the incentives facing consumers and those facing voters, between those facing sellers and those facing politicians, and between private- and public-sector bureaucrats.

15. The following analogies will help bring the concepts of “rational voter ignorance” and “rent seeking” more alive to students:

a. rational student ignorance (students recognize that it is rational to be relatively more ignorant of things thought less likely to be on the test, since the incentive to know them is less) as an analogy to rational voter ignorance, and

b. the rent seeking that goes on in class after test results have been announced (those who did poorly start lobbying for a reduction in the importance of the exam, while those who did better lobby against such “constitutional” changes in grading policy).

16. Critical Analysis Questions 2, 6, 8, and 11 should provide discussion starters related to the major issues of this chapter.

HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS

4. Rent seeking is actions by individuals and interest groups designed to restructure public policy in a manner that will either directly or indirectly redistribute more income to themselves. The incentive to engage in rent seeking is directly proportional to the ease with which the political process can be used for personal (or interest group) gain at the expense of others. When a government attempts to favor some at the expense of others, counterproductive activities will expand while positive-sum productive activities will shrink. People will spend more time organizing and lobbying politicians and less time producing goods and services. Since fewer resources will be utilized to create wealth (and more utilized in rent-seeking activities), economic progress will be retarded.