Public Choice

1
Public Choice

• Economics and Politics

2
Political Economy or Public Choice

• Rosen calls it political economy, I prefer to
  call it public choice.
• Political economy was a name used by early
  economic thinkers.
• Over the years, it was shortened to economics.
• The phrase public choice came into popular
  usage in the 60s.
• The topic has now become an important part of
  every public finance textbook.
• So, what is public choice and where did it come
  from?

3
Public Choice

• Public choice developed around the work of Nobel
  Prize winning economist, James Buchanan.
• The private market is driven by self
  interestthat is, we make decisions based on
  promoting our own self interest, and in the
  process, we promote the public interest.
• Adam Smith called it the invisible hand.
• Public choice raises the question, how are
  political decisions made in the political
  market?
• Public choice applies the principles of economics
  to the understanding of political decision
  making.
• Politicians use the same mental calculus in the
  political market that they use in the private
  market. For that matter, so does everyone else
  when they vote.
• In essence, we vote our self interest.

4
Collective choice rules

• In direct democracy, society must select the
  voting procedures to decide on public
  expenditures.
• A political equilibrium is reached when the
  decision is made to provide certain public goods,
  and tax shares are assigned.
• In a perfect world, tax shares would be exactly
  equal to the value that each taxpayer places on
  the good.
• Such a system would mimic the free market and
  would be Pareto efficient.
• Can such a system exist?
• In theory, yes, using the unanimity rule.
• The result is described in the Lindahl model, and
  the resulting prices are referred to as Lindahl
  prices.

5
Unanimity rules

• Assume a two person society, Adam and Eve.
• Their choice is the number of rockets to use in a
  fireworks display.
• DrA represents Adams demand, and DrE represents
  Eves.
• Prices are expressed as shares-- of total.
• Eves demand curve slopes up because her origin
  is O'.
• First, a series of tax shares are announced, and
  Adam and Eve vote on the quantity of rockets they
  want.
• If agreement is not unanimous, another set of tax
  shares is announced and they vote again.
• The process continues until political equilibrium
  is reached.

Figure 6.1 Lindahls model

• We must assume that Adam and Eve will not
  game the system.
• What does game the system mean?

6
Other rules

• Direct democracy using unanimity rules is not
  feasible in a society involving more than two
  people.
• Any time such a scheme is used, its purpose is
  to insure that nothing is ever agreed to.
• An alternative would be the use of simple
  majority voting rule.
• Such a scheme is familiar to all of you, and we
  will discuss the implications of this rule later
  on, but first, can you think of other rules?

• Borda counts
• Condorcet elections
• Exhaustive voting

• Super majority rule
• Plurality rule
• Minority rule

• Under what circumstances might these rules be
  applied?

7
Majority voting rules

• Majority voting rules require just over 50
  approval.
• Assume the choice is between A and B B wins.
• Choose between B vs. C B wins.
• Option B wins any election against its
  opposition, thus it is the majority rule option.
• The resultstable equilibrium

• Change preferences as shown in Table 6.2.
• Choose between A and B A wins.
• A and C C wins.
• B and C B wins.
• Winner depends on how the question is presented.
• The result is not stable

8
Cyclical voting phenomenon

• Rosen calls this the voting paradox. Another
  name is the cyclical voting phenomenon.
• It is the result of at least one voter having a
  double peaked preference pattern.
• Notice Cosmo has a peak at A.
• George has a peak at B.
• But Elaine has two peaks, one at A and one at C.
• If she had had a single peak at either A, B, or
  C, then a stable equilibrium would exist.
• With multi-peaked preferences, the result will be
  never ending cycle of votes.

Figure 6.2 Graphing the preferences from Table
6.2

• Can you see how it might be important to
  control the agenda?
• Controlling the agenda means controlling the
  outcome.

9
Cyclical voting phenomenon

• This gives you a slightly different look. Here A,
  B, and C refer to voters and 1, 2, and 3 refer to
  the quantity of public goods.
• Voters A and C have single peaks.
• Voter B shows multiple peaks in the left diagram
  and a single peak in the right diagram.
• If we use single peaks for all voters, the
  outcome would be 2.
• If we use B with the multiple peaks, the outcome
  would cycle, depending on how the choices are
  presented.

Source Hyman, David N. Public Finance, A
Contemporary Application of Theory to Policy.
Harcourt. 2002.
10
The median voter theorem

• The median voter theorem states that as long as
  preferences are single peaked, majority voting
  reflects the preferences of the median voter.
• The closer an expenditure is to a single voters
  peak, the more they will prefer it.
• If 5 is proposed, all voters will vote yes.
• If we move up to 100, the vote will be 4 to 1.
• At 150, only Huey, Dewey, and Louie will vote
  yesstill a majority.
• At 160, only Dewey and Louie will vote yes, and
  the measure will lose.

• The intensity of voters preferences does not
  matter.
• Would the outcome be any different if Louies
  preference was 170 or 17,000?
• The median outcome will prevail in every case,
  unless, of course, there is an opportunity for
  logrolling.

11
Logrolling

• Notice that if each project is voted on
  independently, it will fail because each has
  negative benefits for a majority of voters.
• But what if Melanie and Rhett decide to swap
  votes? Both the hospital and the library will be
  approved, and both voters will have positive net
  benefits.
• Melanie and Scarlet then make a deal and the pool
  is approved.
• The total net benefits are positive for all three
  projects.

12
Logrolling can lower welfare

• Why does logrolling lower welfare in the second
  case?
• It depends on the intensity of preferences.
• Because negative feelings are stronger, total net
  benefits are negative.
• Sometimes the majority can steamroll a measure,
  and force the minority to help pay for an item
  for which they have negative net benefits. Both
  Melanie and Rhett are have negative benefits when
  all three projects are funded.

13
Arrows Impossibility Theorem

• Can a democratic society achieve a stable and
  consistent decision making rule?
• An important question is whether any ethically
  acceptable method for translating individual
  preferences into collective preferences is free
  of difficulties.
• It depends on what you mean by "ethically
  acceptable."
• Nobel laureate Kenneth Arrow 1951 proposed that
  in a democratic society, a collective
  decision-making rule should satisfy the following
  criteria.

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Criteria for Arrows Impossibility Theorem

• It can produce a decision whatever the
  configuration of voters' preferences. Thus, for
  example, the procedure must not fall apart if
  some people have multi-peaked preferences.
• It must be able to rank all possible outcomes.
• It must be responsive to individuals'
  preferences. Specifically, if every individual
  prefers A to B, then society's ranking must
  prefer A to B.
• It must be consistent in the sense that if A is
  preferred to B and B is preferred to C, then A is
  preferred to C.
• Society's ranking of A and B depends only on
  individuals' rankings of A and B. Thus, the
  collective ranking of defense expenditures and
  foreign aid does not depend on how individuals
  rank either of them relative to research on a
  cure for AIDS. This assumption is sometimes
  called the independence of irrelevant
  alternatives.
• Dictatorship is ruled out. Social preferences
  must not reflect the preferences of only a single
  individual.

15
Arrows Impossibility Theorem

• Arrows conclusion is that it is impossible to
  find a rule that satisfies all of these criteria.
• Eliminate one criterion and a rule can be found.
• Does this mean that democratic society cannot
  find a consistent decision making rule?
• Not really, but it does mean that there is no
  guarantee that we will.
• Not everyone agrees. See Buchanans quote on page
  116.
• Perhaps this could work if we had a society with
  a virtual uniformity of tastes.
• Could this have something to do with the constant
  struggle with the separation of church and state?
• What do you think?
• Can religion help to achieve a virtual
  uniformity of tastes?
• What role does education play?
• Could this be a reason why politicians are so
  deeply involved in schools?

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Who are the players?

• Since direct majority voting is impossible in a
  large society, representative democracy is the
  next best alternative.
• Sometimes direct majority voting
  worksCalifornia, for example.
• Or does it?
• But for the most part we rely on our elected
  representatives.
• But there are other players who also exert
  influence.
• Public employees (bureaucrats)
• Special interest
• The courts
• Journalists
• Experts of all varieties.
• Let us look more closely at these players and
  what motivates them to act the way they do.

17
Elected representatives

• What makes politicians tick?
• To maximize their well-being, they must get just
  over 50 of the vote. (true or false)
• If we assume that the population is arrayed in a
  normal distribution from right to left, where
  must the successful politician position himself?
• Take McClintock in California.
• He could never win in a regular general election
  because he would be somewhere to the right of S.
• He will garner all of the votes to the right of
  his position, and a few to the left.
• His competitor, if he stakes out the middle, will
  get all to the left, plus a few to the right.

Figure 6.3 Median voter theorem for elections

• Moral of the story?
• Run to the right (or left) in the primary to
  lock down your base.
• As the election nears, gravitate to the middle.
• Become a new democrat as Mr. Clinton did, and
  as Mr. Dean must do unless he wants to go the way
  of Goldwater or McGovern.

18
Elected representatives

• So, what happens when you replace direct
  democracy with representative democracy?
• Both approaches gravitate to the views of the
  median voter.
• Or do they?
• The world is more complex than the simple single
  dimension, liberal vs. conservative.
• Mr. Dean is a social liberal and a fiscal
  conservative, so he says.
• Guess what, so is Arnold!
• Ideology take Mr. McClintock in California. He
  is conservative, no matter what.
• Personality the operative word is charisma.
• Leadership Sometimes, a politician can actually
  sway opinion, as opposed to reading the polls and
  being whatever the voters want.
• Not all voters vote.

19
Bureaucrats

• Bureaucrats are the people who take the broad,
  generalized legislation passed by elected
  representatives and make it work.
• Bureaucrats are an integral part of the public
  choice decision making apparatus.
• They provide the technical expertise in their
  respective fields, and they are the storehouse of
  institutional memory.
• Sometimes the bureaucrats go beyond what the
  politicians intended.
• The FCC recently passed rules that raised the
  hackles of certain members of Congress.
• The FCC made certain rules, based on their
  interpretation of the law.
• Certain member of Congress are threatening a
  Congressional veto.

20
Bureaucrats

• If you analyze bureaucrats using the same
  calculus we use to analyze the private market, we
  reach some interesting results.
• And what is that calculus?
• Bureaucrat act in a way as to promote their own
  self interest.
• If we look at the costs and benefits of
  government programs, we see a benefit curve, V,
  that increases at an decreasing rate.
• The cost curve, C, increases at an increasing
  rate.
• An efficient outcome would be where MC MB, at
  Q.

Figure 6.4 Niskanens model of bureaucracy

• Bureaucrats will push for programs as long as
  TB TC, i.e., output Qbc.
• Bureaucrats tend to overproduce.

21
Focus on the margin, not the total

• In the private sector, the entrepreneur has an
  incentive to maximize wealth, thus earning larger
  income.
• In government, the bureaucrat tries to do the
  same thing by maximizing his budget.
• Bureaucrats tend to focus on the perquisites of
  office, public recognition, power and prestige.
• This diagram from Hyman shows the same thing,
  except now we can see the MCS and MSB curves.
• Not only will bureaucrats try to push output to
  the point where TC TB, but they will attempt
  to show the highest level of benefits for the
  programs the represent.

Source Hyman, David N. Public Finance, A
Contemporary Application of Theory to Policy.
Harcourt. 2002.
22
Special interests

• Special interest groups form to promote the
  interest of a small number of participants.
• They are represented in Washington by lobbyists
  whose job it is to influence the budget process
  in favor of their constituents.
• Lobbyists are well paid (Gucci to Gucci).
• Rosen refers to the Iron Triangle, made up of
  members of congress who support a program,
  bureaucrats who run it, and special interests who
  promote it.
• Special interest politics works because it allows
  decision makers to focus benefits on a small
  group of people with intense preferences, while
  spreading the cost over a large number of
  taxpayers or consumers.

23
The court system

• Decision making in a democratic society is made
  according to an agreed on set of rules.
• The constitution sets some of the rules
  legislation sets others. There are rules at the
  local, state, and federal levels.
• If participants dont like the outcome of the
  voting process, they have been turning
  increasingly to the courts, and the courts have
  become increasingly more active in public
  decision making.
• Al Gore didnt like the outcome in Florida, so he
  went to the state supreme court to change the
  rule.
• Bush didnt want the rules changed, so he went to
  the US supreme court to head off Gore.
• The examples abound
• Gray Davis in California
• The Democrats in New Jersey and Minnesota in the
  recent election.
• In Rockbridge County, voters did not approve a
  referendum for a new court house, and some judge
  overturned the decision.
• There have been innumerable attempts to overturn
  popular referenda in California.

24
Journalists and other experts(such as Babs,
Alec, Tim, and Sean)

• We have an increasingly liberal press and an
  increasingly conservative talk show network.
• Journalists sometimes go beyond the reporting of
  facts (positive statements) to making value
  judgments.
• The same is true of certain Hollywood elites who
  seem to have developed significant expertise in
  foreign policy.
• True experts can and should have input into the
  political decision making process, but their
  opinion should not be overvalued.
• This last statement is a value judgment by one
  such expert who thinks he knows more than the
  average bear when it comes to the allocation of
  resources and the distribution of income.

25
The growth of government

• Has government grown in developed countries? Yes.
• Should government grow? It depends.
• Why has it grown? Not an easy question.
• How do you measure growth? A number of ways.
• What have we done to control growth in the US?
• Gramm-Rudman-Hollings of 1985
• Budget enforcement act of 1990
• The PAYGO rules enacted in 1990 were largely
  ignored until democrats took control of congress.
• Have these schemes worked? NO!
• Why? What do you think?
• Recent example the attempt to eliminate earmarks
  (or at least make them visible) and to stop
  secret holds.

26
Any Questions?

• Next Stop?
• Continue with taxes

27
Just for fun, what does this mean?

• It my economic plan starts with tax relief.
  There's been a lot of talk about taxes in this
  campaign. And the truth is, my opponent and I are
  both proposing tax cuts. . . . I want to put a
  middle class tax cut in the pockets of 95 of
  workers and their families. My opponent doesn't
  want you to know this, but under my plan, tax
  rates will actually be less than they were under
  Ronald Reagan. -- Barack Obama

28
What about this quote from todays WSJ?

• WSJ reader Michael Segal offers the following
  prediction
• The Democrats will end up with less than 60
  seats in the Senate, and they will eliminate
  the need for 60 seats to vote on bills. As we
  discovered when we looked into this a few years
  ago, all you need is 51 votes to change
  the Senate rule. The Republicans didn't change
  the rule, for reasons that were never clear.
  The Democrats will take the opposite approach.
  People will compare it to FDR packing the Supreme
  Court, but it is fully legal, just a departure
  from tradition.