Public Sector Economics Explaining Government Behavior

Positive and Normative Interact The optimal policy may have to account for political reactions –SSA chairman: “a program for the poor is a poor program” –merit goods and tax incidence –government size and tax reform –Social Security reform political reactions to a policy probably depend on its efficiency consequences

Approaches to Positive Political Economy (not mutually exclusive) constitutional instrumental rational voting probabilistic voting wealth maximization social welfare maximizing interest group competition degrees of competition for public office “irrational” demand model

The Microeconomics of Voting macro questions to be answered –does voting affect policy? –does voting serve the purpose of aggregating preferences or information? –is voting instrumental? or, expressive voting? advertising/vote buying? separate political preferences? unanimity vs. majority rule properties of majority rule alternative voting rules the voting paradox

Three Tenets of Formal Voting Theory voting mutes preference intensity voting equalizes the distribution of political power policies are sensitive to the form of “the game”

Equal Distribution of Political Power Illustrated: the NIT coalition NIT: constant marginal tax rate with negative intercept (i.e., guaranteed minimum income r). what does the median person think about raising the NIT rate? –(i) pays –(ii) suffers dwc –(iii) transfer increases by Empirically, mean income always exceeds median, so the founding fathers (ignoring (ii)) were concerned that there was no limit to the median person’s preference for redistribution is an index of the intensity of that preference Meltzer-Richard: (ii) is second order at r = 0, but there exists a large enough r so that dwcs cancel the mean- median gap [Meltzer Richard missing a couple of things … more later]

What Does “Economic Theory” say about the Characteristics of Public Policy in Democracies? skewness or inequality should increase redistribution. –rejected by Peltzman, Benabou, Perotti –accepted by studies of Swiss localities democracies will have different public policies than dictatorships –rejected by Easterly & Rebelo, Jackman, Lott (health), Mulligan-Gil-Sala-i-Martin –accepted by Lott (education) form of the “game” matters participation matters –Lott & Kenny 1998 –what determines participation? intensity of preference doesn’t matter

Reject Formal Voting Theory’s Three Tenets? preference intensity can be expressed in the public sector –voter turnout –log-rolling, vote-trading –voting buying –political advertising –lobbying –noncompliance –migration –riots, coups voting does not equalize the distribution of political power. e.g., U.S. median voter has more than the mean income policies are not sensitive to the form of “the game” –voting does not occur in an institutional vacuum. Institutions arise to alleviate the inefficiencies of voting processes (Wittman) –voting is not instrumental

Is Voting Rational or Instrumental? “voter’s paradox” –the probability of going to the polls and affecting the outcome is similar to the probability of being killed in a car crash on the way to or from the polls –voting or not cannot be primary motivated in terms of affecting election outcomes –once at the polls, might voting for one candidate or another be explained in terms of affecting the outcome? rational voters would: –be influenced more by advertising than in private affairs? –be influenced more by misinformation than in private affairs? –conform more than in private affairs (even though voting is “secret”!)? –all of the above are most applicable in large elections –respond to costs and benefits that are unrelated to the outcome. eg., travel costs

Wealth Maximization and the Theory of Institutional Response “democratic markets are organized to promote wealth maximizing outcomes” –democratically determined policies are always efficient? or –institutions respond to mitigate their inefficiencies “wealth maximization”/Kaldor-Hicks efficiency defined –no one can be made better off, even with an appropriate set of lump sum taxes and transfers –almost tautological unless transactions and decision costs are ignored –example: regulating monopolies

Wealth Maximizing Institutional Response – Examples voter information political opportunism, deriving from finite political lives, and alleviated by political parties –use of committee assignments to align party and member interests –facilitate vote trading –publicizing opposing party’s opportunism excessive localism by Congress –parties again

Olson’s bandits tax revenue = the efficiency loss of redistribution is limited when governments are stable –eg., stable dictator –eg., stable democratic majority a stable government limits taxation in order to keep the tax base sufficiently large

Internationally Common Features of OA Public Pensions SS spending dominates government budgets, SS redistributes from young to old, even when the elderly consume as much or more than do the young, Benefits increase with lifetime earnings and are hardly means-tested, benefit formulas induce retirement, especially in the countries with the largest SS budgets, elderly’s net income nears or exceeds nonelderly’s, and similar public pension programs emerge and grow under very different political regime

Efficiency Theories of Social Security Social Security as risk sharing –risk of out-living one’s assets –risk of labor productivity shock –risk work disutility shock Correcting retirement market failure Preventing frugal people from being exploited by the prodigal Economize on administration costs Generational transfers as a side effect of intergenerational human capital investment Chain letters in dynamically inefficient economies

Electoral Rules District magnitude m = legislators per district –US m = 1 –in “theory” small districts “steer electoral competition towards narrower, geographical constituencies.” –eg., U.S. policy should be Florida-oriented –large-districts systems may have more overall spending Electoral formula –plurality rule = top m candidates win –proportional representation –“theory” says? Ballot structure: candidates vs. parties

Forms of Government separation of powers –between executive and legislative –nature of agenda setting confidence requirement = continuous (between election) executive support by legislature many of these differences are correlated, and summarized –“Presidential” vs “Parlaimentary”“Presidential” vs “Parlaimentary” –“majoritarian” vs “proportional”, or m –Switzerland? “theory” says: Presidential and/or majoritarian systems spend less, and in a more targeted way

Forms of Government – empirical results party lists associated with more corruption majoritarian not associated with corruption presidential systems, perhaps also majoritarian systems, spend much less –in particular, less social spending –among social spending, it’s all unemployment? are form of government correlated with the historical power of labor?

Does Political Party Matter? Theory 1: when political parties compete, they may be induced to offer much the same product (namely, what the customers want) Theory 2: