PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9 CHAPTER Supply and Demand in Political Markets

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-2 Political Markets  Analogous to private sector markets  Determine the way resources will be allocated through public sector  Why are they important?  1/3 of GDP allocated through them

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-3 Special Interests and Government Programs  Special interests provide concentrated benefits to a small group by making everyone pay  Rational ignorance keeps most voters from becoming informed  Programs are decided one at a time  Favor special interests

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-4 Special Interests and Political Exchange  Special interests don’t get everything they want  Interests exist on both sides of an issue  Politicians must weight the demands of interests on both sides of an issue  Example: Imposition of a tariff

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-5 Special Interests and Political Exchange

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-6 Representation of Interests and The Organization of Congress  Geographic nature of representation implies orientation towards special interests  Representatives are elected to represent their districts  Example: farming, military bases  Special interests thus have strong influence over local representatives

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-7 Logrolling and Political Exchange  Logrolling  The exchange of political support  Not possible in general elections  Large number of voters  Secret ballot  Possible in Legislatures  Small number of legislators  Public vote

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-8 Logrolling and Political Exchange  Legislators care strongly about some issues because of special interests  Do not care strongly about others  Can trade votes on unimportant issues for votes on important ones  Logrolling facilitates political exchange

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-9 Logrolling and Special Interests  High transactions costs between citizens and legislators  Special interests have lower transactions costs  Legislators have an incentive to favor special interests  Logrolling helps get special interest legislation passed

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-10 Logrolling and Economic Efficiency  Logrolling can lead to economic efficiency under certain circumstances  Coase Theorem applies when:  Transactions costs are low  Small number of voters  Logrolling is not source of inefficiency  Source is high cost of public involvement

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-11 Logrolling and Economic Efficiency

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-12 Agenda Control  If political markets not competitive, legislators can act monopolistically  Exhibited through control of agendas  Can move agenda closer to legislator’s preference  Example: A Referendum

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-13 Agenda Control

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-14 Agenda Control in the Real World  Model can be extended to:  Committees  Political races  Does not have to be overt  Example: Arthur Burns

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-15 Rent Seeking  Interest groups expend resources in lobbying  From a social standpoint, these resources are wasted  Resources expended to secure private benefit that do not add to social output  Examples: tariffs, price supports

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-16 The Welfare Costs of Rent Seeking

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-17 Public Sector Suppliers  No profit-maximizing incentive  Incentive to maximize budgets  Bureaucrats benefit from higher budgets because they lead to:  Higher incomes  Increased power  Better working conditions

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-18 The Public Interest and Budget Maximization  Bureaucrats tend to believe in the mission of their bureaus  Budget maximization can further a bureaucrat’s perception of the public interest  What if it budget maximization is not in the public interest?  Individual still has incentive to act in her own self-interest

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-19 The Public Sector Bargaining Process  Bureau’s output and budget are determined simultaneously  Bureau makes all-or-nothing sale  Bureau’s bargaining advantage  Specialization  Information control  Committees composition  Able to obtain budgets larger than optimal

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-20 The Bureaucratic Bargaining Process

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-21 The Government as an Interest Group  Government employees are also an interest group  Government experts exert considerable influence  Why programs perpetuate themselves

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 9-22 Fiscal Federalism  The impact of special interests can be reduced through fiscal federalism  Three reasons why:  Concentration of costs  Choice among governments  Facilitates Inter-government comparison