1. Assoc. Prof. Y.KuştepeliECN 242 PUBLIC ECONOMICS 1 POLITICAL ECONOMY

2. ECN 242 PUBLIC ECONOMICS2 Assoc. Prof. Y.Kuştepeli Political economy applies economic principles to the understanding of political decision-making. Political economy models assume that individuals view government as a mechanism for maximizing their self interest: 1. selfishness does not necessarily lead to inefficient outcomes. 2. while the max. assumption may not be totally accurate, just as in more conventional settings, it provides a good starting point for analysis

3. ECN 242 PUBLIC ECONOMICS3 Assoc. Prof. Y.Kuştepeli Direct democracy- how well they translate the preferences of their members into collective action. Democratic societies use various voting procedures to decide on public expenditures. 1. Unanimity (Oy birliği) Rules: If a vote were taken on whether to provide an efficient quantity of the good, consent would be unanimous as long as there was a suitable tax system to finance it. I. DIRECT DEMOCRACY

4. ECN 242 PUBLIC ECONOMICS4 Assoc. Prof. Y.Kuştepeli Lindahl Prices: When individual votes for a public good, he/she faces a personalized price per unit of public good which depends on his/her tax shares which are called Lindahl prices. Lindahl Model has two problems:  It assumes people vote sincerely.  It may take a long time to find mutually agreeable tax shares.

5. ECN 242 PUBLIC ECONOMICS5 Assoc. Prof. Y.Kuştepeli This model is similar in terms of role of taxes and market theory of demand. But there is an important difference:  instead of each individual facing the same prices, each faces a personalized price per unit of public good which depends on his tax shares. An equilibrium is a set of Lindahl prices such that at those prices each person votes for the same quantity of public good x*. Although the Lindahl model is agreeable to everyone, the problem is how to reach the equilibrium. The determination of the quantity of public goods is quite similar to the market process and it is a Pareto- efficient allocation.

6. ECN 242 PUBLIC ECONOMICS6 Assoc. Prof. Y.Kuştepeli 2. Majority voting rules (Oy Çokluğu): Unanimity is clearly difficult to attain. With a majority voting rule, one more than half of voters must favor a measure for it to be approved. Although each individual voter’s preferences are consistent, the society’s may not be consistent. This is called voting paradox. Sometimes the ultimate outcome depends crucially on the order in which the votes are taken in. Under such circumstances, agenda manipulation (process of organizing the order of votes to assure a favorable outcome) confers great power.

7. ECN 242 PUBLIC ECONOMICS7 Assoc. Prof. Y.Kuştepeli Paired voting can go on forever without reaching a decision. The process can continue indefinitely, a phenomenon called cycling. Cycling problem depends on the structure of preferences for various levels of the good provided. Peak: A point in an individual's preferences at which all the neighboring points are lower. A voter has single peaked preferences if, as she moves away from the most preferred outcome, in any and all directions, utility consistently falls.

8. ECN 242 PUBLIC ECONOMICS8 Assoc. Prof. Y.Kuştepeli Voter has double peaked preferences if, as she moves away from the most preferred outcomes, utility goes down but then goes up again. Median voter theorem: Suppose all alternatives being considered represent smaller or greater amounts of a characteristic. People rank each alternative on the basis of this characteristic.  As long as all preferences are single peaked, the outcome of majority voting reflects the preferences of the median voter.

9. ECN 242 PUBLIC ECONOMICS9 Assoc. Prof. Y.Kuştepeli  Median voter: voter whose preferences lie in the middle of the set of all voters’ preferences. Median voter theorem imperfections:  Multi-peaked preferences  May be inefficient in terms of benefits and costs.  Results may differ on the particular item being studied.  Does not allow people to register how strongly they feel about the issues.

10. ECN 242 PUBLIC ECONOMICS10 Assoc. Prof. Y.Kuştepeli 3. Logrolling: (Karşılıklı Destek) allows people to treat votes and register how strongly they feel about various issues. Vote trading is controversial. Its proponents argue that trading votes leads to efficient provision of public goods, just as trading commodities leads to efficient provision of private goods. They also emphasize its potential for revealing the intensity of preferences and establishing a stable equilibrium. With logrolling, a majority of voters can form a coalition to vote for projects that serve their interests but whose costs are borne mainly by the minority.

11. ECN 242 PUBLIC ECONOMICS11 Assoc. Prof. Y.Kuştepeli 4. Arrow’s Impossibility Theorem: In a democratic society, a collective decision making rule should satisfy the following criteria:  It can produce a decision whatever the configuration of voters’ preferences.  It must be able to rank all possible outcomes.  It must be responsive to individuals’ preferences.  It must be consistent (A to B, B to C, so A to C).  Society’s ranking of A and B depends only on individuals, ranking of A and B.  Dictatorship is ruled out.

12. ECN 242 PUBLIC ECONOMICS12 Assoc. Prof. Y.Kuştepeli In general, it is impossible to find a rule that satisfies all this criteria. A democratic society cannot be expected to be able to make consistent decisions. Arrow’s theorem states that it cannot be guaranteed that the society will be able to find a consistent decision-making rule. If members of society have identical preferences, no problems would arise.

13. ECN 242 PUBLIC ECONOMICS13 Assoc. Prof. Y.Kuştepeli Representative Democracy: Decisions are not made by individuals but their elected representatives. A realistic political economy model must study the goals and behavior of the people who govern. Models of government action based on these individuals’ motivations and behavior must be analyzed. People in government are assumed to maximize their self interest. II. REPRESENTATIVE DEMOCRACY

14. ECN 242 PUBLIC ECONOMICS14 Assoc. Prof. Y.Kuştepeli 1. Elected politicians Citizens elect representatives who make decisions on their behalf. A vote-max politician adopts the preferred program of the median voter. Two party systems tend to be stable in the sense that both parties stake out near the “center”. The replacement of direct referenda by a representative system has no effect on the outcome. Both simply mirror the preferences of median voter. Important issues to be considered: Single dimensional rankings Ideology Personality Leadership Decision to vote (free rider problem)

15. ECN 242 PUBLIC ECONOMICS15 Assoc. Prof. Y.Kuştepeli 2. Public employees The precise way a program is run is in the hands of bureaucrats. These people are target of criticism for being unresponsive, creating excessive red tape, etc. Bureaucrats provide valuable technical expertise in design and execution of programs. But a bureaucrat’s only aim is not to interpret and passively fulfill the wishes of the electorate and its representatives.

16. ECN 242 PUBLIC ECONOMICS16 Assoc. Prof. Y.Kuştepeli Niskaken (1971):In the market-oriented private sector, an individual who wants to get ahead, does so by making his/her company on items as profitable as possible but bureaucrats tend to focus on power and patronage because opportunities for monetary gains are minimal. Bureaucrats have incentives to expend effort on promotional activities to increase the sponsor’s perceptions of the office’s benefits, to shift the value of the company up. This is analogous to advertising in the private sector.

17. ECN 242 PUBLIC ECONOMICS17 Assoc. Prof. Y.Kuştepeli 3. Special interests People with common interests can exercise disproportionate power by acting together. The members of such a group may have higher voter participation rates than population as a whole, or members might be willing to spend money for campaigns. The basis for the establishment of such interest may be 1. Source of income: Capital or labor 2. Size of income 3. Source of income: Industry of Employment (sector) 4. Region 5. Demographic and personal characteristics (old-young, single- married) 6. Rent-seeking 4. Other actors Judiciary, journalists, experts.

18. ECN 242 PUBLIC ECONOMICS18 Assoc. Prof. Y.Kuştepeli 1. Citizen preferences G=f(P,I) Such a demand function can lead to an increasing proportion of income devoted to public sector. Government growth could well be a consequence of wishes of voters, who rationally take into account its opportunity cost in terms of forgone consumption in private sector. III. GOVERNMENT GROWTH

19. ECN 242 PUBLIC ECONOMICS19 Assoc. Prof. Y.Kuştepeli 2. Marxist view The private sector tends to overproduce, so the capitalist-controlled government must expand expenditures to absorb this production. The main contribution of marxist analysis is its explicit recognition as sources of economic growth. 3. Chance events External shocks to the economic and social system may require higher levels of government expenditure.

20. ECN 242 PUBLIC ECONOMICS20 Assoc. Prof. Y.Kuştepeli 4. Societal attitudes 5. Income redistribution Politicians can attract voters whose incomes are at or below the median by offering benefits that impose a net cost on those whose incomes are above the median.