Transcript Chapter 21 power point

Chapter 21
Political Economy and
Public Choice
Second Edition
Chapter Outline
 Voters and the incentive to be ignorant
 Special interests and the incentive to be
informed
 One formula for political success: Diffuse
costs, concentrate benefits
 Voter myopia and political business cycles
 Two cheers for democracy
2
Introduction
 Why are there so many examples of bad
economic policy?
•
•
•
•
•
Price controls
Command and control regulation
High inflation
Suppression of markets
Government support of monopolies
 What’s wrong with the world?
3
Introduction
 Why do the arguments of economists fall
on deaf ears? Perhaps…
• Politicians are right to reject mainstream
economics.
• Mainstream economics is wrong about how
economies work, or,…
• Incentives are bad.
 A good incentive system aligns self-interest
with the social interest.
4
Introduction
 Critical questions of this chapter:
• When does self-interest of politicians and
voters align with the social interest?
• When do these interests collide?
 Answers may be found in public choice.
 Public choice – the study of political
behavior using the tools of economics.
5
Voters and the Incentive to Be Ignorant
 Rational ignorance – occurs when the
benefits of being informed are less than the
costs of becoming informed.
• Costs of being informed:
 High due to value of time spent studying issues and
candidates
• Benefits of being informed:
 Low for the individual voter
 Outcome of any election depends on what other
people do, not by what you do.
6
Why Rational Ignorance Matters
 Three reasons:
• If voters are ignorant of the issues, they
cannot make informed choices.
• Voters will often make decisions based on lowquality, unreliable, or biased information.
• Not everyone is rationally
ignorant: special interests
 K street, hub of special
interests in Washington D.C.
7
Check Yourself
 Would you expect more rational ignorance
about national issues among national
voters or about local issues among local
voters? Make an argument for both
possibilities.
8
Special Interests and the Incentive Be
Informed
 Why does the government harm sugar
consumers, many of whom are voters?
• Rational ignorance – most voters are unaware
of the quota.
• Costs are spread over millions of consumers.
 Costs per consumer = $5 to $6 per year
• Benefits are concentrated on a few producers
 Benefit per producer = $ millions per year.
 Who has the greater incentive to get
involved in sugar quota legislation?
9
Special Interests Are Rationally Informed
 13 of 21 (majority) senators on the
Agricultural Committee received money
from a PAC representing sugar producers.
 Many senators also received money from
other sugar lobbyists.
 Owners and executives in the industry also
donated funds individually.
 Sugar donations are bipartisan.
Take a look at the following table.
10
Special Interests Are Rationally Informed
Senators on Agriculture
Committee, 2008
Donations from American Crystal
Sugar PAC, 2006-2008
Tom Harkin, D-IA
$15,000
Sherrod Brown, D-OH
$15,000
Saxby Chambliss, R-GA
$10,000
Mitch McConnell, R-KY
$10,000
Robert Casey, Jr., D-PA
$10,000
E. Benjamin Nelson, D-NE
$8,000
Amy Klobuchar, D-MN
$7,000
Patrick J. Leahy, D-VT
$6,000
Max Baucus, D-MT
$6,000
Pat Roberts, R-KS
$3,000
Kent Salazar, D-CO
$2,000
Debbie Stabenow, D-MI
$1,000
11
One Formula for Political Success:
Diffuse Costs, Concentrate Benefits
 One reason why the self interest of
politicians does not always align with the
social interest.
• Example: Agricultural subsidies and price
supports.
 Political power of farmers has increased even
though fraction of population farming has declined.
• Greater concentration of benefits.
• Greater diffusion of costs.
12
The Bridge to Nowhere
 Proposed to replace the
Gravina Island ferry:
Ketchikan, AK to the
airport on the island.
• Cost $320 million
• Benefits concentrated on 8,950 people.
• Costs spread over millions of U.S. taxpayers.
 Residents were happy to have the bridge as
long as other people were paying for it.
• To them these are external costs.
13
One Formula for Political Success:
Diffuse Costs, Concentrate Benefits
 Formula works for tax credits and
deductions:
• Federal tax code is over 60,000 pages.
• Congress adds special interest provisions
every year.


Oil & gas drilling, mining and timber were
included as manufacturing industries.
• Worth $76 billion to firms involved.
Redefinition of coffee roasting meant of lot of
“bucks” to one famous corporation.
14
One Formula for Political Success:
Diffuse Costs, Concentrate Benefits
 With this formula resources can be wasted
on projects with low benefits and high
costs.
 Mathematics of the “formula”.
• A special interest representing 1% of the
population will benefit from any policy that
transfers $100 in it favor even if the costs to
society are nearly 100 times as much!
 Bottom line: no society can get rich by
passing policies with benefits less than
costs.
15
Check Yourself
 President Ronald Reagan set up a
commission to examine government and
cut waste. It had some limited success. If
special interest spending is such a
problem, why don’t we set up another
federal commission to examine
government waste. Who would push for
such a commission? Who would resist it?
What will be its prospects for success?
16
Check Yourself
 A local library expanded into a new
building and wanted to establish a local
history collection and room. The state
senator found some state money and had
that contributed to the library. Who
benefits from this? Who ultimately pays
for it?
17
Voter Myopia and Political Business Cycles
 Rational ignorance combined with voter
myopia can encourage politicians to boost
the economy before an election.
 Over the past 100 years the presidential
incumbent party…
• Won when the economy was doing well.
• Lost when the economy was doing poorly.
Let’s take a look at this.
18
Economic Conditions in an Election Year
Predict Presidential Votes
What’s the deal with this?
Predicted vote share was determined by three variables:
• Growth in personal disposable income
• Inflation rate
• How long the incumbent party has been in office.
19
Economic Conditions in an Election Year
Predict Presidential Votes
 The graph tells us that voters are most
responsive to economic conditions in the year
of the election.
• In other words voters are myopic.
 Implication: there is a payoff for politicians to
do things during the election year that…
• Boost personal disposable income
• Reduce inflation
 Do politicians really do this?
Let’s see.
20
Economic Conditions in an Election Year
Predict Presidential Votes
 High Social Security Payments
• Two weeks before the 1972
election President Richard
Nixon sent a letter to more
than 24 million recipients.
 Their payments were to
increase by 20%.
 They were to get annual
COLAs from then on!
 The benefits started before the election.
 Costs (taxes) hit after the election.
21
Economic Conditions in an Election Year
Predict Presidential Votes
 President’s Nixon’s policies were not
unique.
 60 years of data show:
• Growth rate of PDI is much higher in the year
before an election growth of PDI averages…
 3.01% during election years.
 1.79% during nonelection years.
 Inflation shows an inverse pattern:
• Decreases during election years.
• Increases after elections years.
22
Growth in PDI Peaks in an Election Year,
1947-2007
Average
Nonelection
years
Average in
election
year
23
Economic Conditions in an Election Year
Predict Presidential Votes
 There a limited number of things a
president can do to influence the economy.
 They can influence…
• Transfer payments
• Taxes.
 Political interference is much harder to see
in GDP growth.
24
Check Yourself
 If voters are myopic, will politicians prefer
a policy with small gains now and big
costs later, or a policy with small costs
now but big gains later?
25
Two Cheers for Democracy
 Do voters ever get their way?
 It depends of incentives.
 Special interests tend to get their way
when…
• A policy is narrow in its impact
• Difficult to understand.
• Affects a small part of the economy.
 The incentives are on the side of the
special interests.
26
Two Cheers for Democracy
 Voters will get their way when…
• The policy is highly visible.
• Has a major effect on the lives of millions of
Americans.
 Politicians have an incentive to “court” the
voters.
 Which voters get their way?
27
The Median Voter Theorem
 Median voter theorem – when voters vote
for the policy that is closest to their
preferred point on a line, then the preferred
point of the median voter will beat any
other policy in a majority rule election.
 Over time, competition pushes both
candidates toward the preferred policy of
the median voter.
Let’s see how this works.
28
Median Voter Theorem





Each voter has an preferred policy, marked by an x.
Inez is the median voter
Candidates D and R will get 2 votes: Max, Sofia.
Candidate D’ will get 3 votes: Inez, Peter, Alex
Competition will drive all 3 candidates closer to
Inez’s ideal policy.
29
Median Voter Theorem
 Implication of the theorem: Democracy
does not seek out…
• Consensus or compromise
• A policy that maximizes voter preferences
 Democracy seeks out a policy that cannot
be beaten in a majority rule election.
30
Median Voter Theorem
 Theorem does not always apply
 Some voters may decide not to vote because
no candidate is close enough to their ideal
policy.
• Result: Candidates who move too far from voters
on their wing may lose votes even if they move
closer to the median voter.
 If voters care about more than one issue:
• It is likely that there is no policy that beats any
other policy
• Politics may never converge on a stable policy.
31
Democracy and Non-democracy
 Democracies tend to be the wealthiest
countries.
 They have the best record in supporting…
•
•
•
•
•
Markets
Property rights
Rule of law
Fair government
Other institutions that encourage economic
growth.
Let’s look at some evidence.
32
Economic Freedom, Democracy, and
Living Standards
 Strong correlation between economic freedom and standard of living.
 Full democracies are among the wealthiest (shown in red)
 Exceptions: Hong Kong and Singapore are not full democracies.
33
Democracy and Non-democracy
 Freedom encourages accumulation of
wealth and favorable institutions.
 Greater wealth creates greater demand for
democracy
• South Korea and Taiwan became more
democratic as they grew wealthier.
• Some people believe China will become more
democratic as it gets wealthier. What do you
think?
34
Democracy and Non-democracy
 Public ignorance is greater in nondemocracies.
• Media are often closely controlled or censured.
• Enables special interests to control government
for their purposes.
 Greater government ownership of the press
is associated with…
• Lower levels of political rights.
• Worse regulation.
• Greater risk of property confiscation.
35
Democracy and Famine
 Many of the famines in
recent world history have
been intentional.
 Ukraine in the 1930s
• Stalin saw the Kulaks as a threat.
• Millions died as a result of
forced collectivization of agriculture.
• People who tried to escape were arrested and
sent back to starve.
36
Democracy and Famine
 Unintentional mass starvations can be
avoided in democracies.
• Bangladesh 1974 – 26,000 – 100,000 people
died
• Floods destroyed much of the rice crop.
• Lower incomes from lack of work and higher
rice prices led to starvations.
• Bangladesh in the aggregate did not lack for
food.
• Look at the next graph.
37
Food Availability per Head in Bangladesh
Why was there a famine in 1974?
38
Democracy and Famine
 So…why was there a famine in 1974?
 A poor group of laborers lacked economic
and political power.
• Lack of political power reduced incentives for
the elites to take measures to avert famine.
• Bad economic policy
 Government regulations made it difficult to
purchase the necessary foreign exchange to import
rice from Thailand and India.
 Price controls and other regulations caused rice to
be actually smuggled out of Bangladesh.
39
Democracy and Famine
 Amartya Sen – Nobel winning
economist and philosopher
 “no famine has taken place in
the history of the world in a
functioning democracy.”
 “Perhaps the most important
reform that can contribute to the elimination of
famines, in Africa as well as in Asia, is the
enhancement of democratic practice,
unfettered newspapers and—more generally—
adversarial politics.”
40
Democracy and Famine
 Economists Timothy Besley and Robin
Burgess tested Sen’s theory.
• Greater political competition is associated with
higher levels of public food distribution.
• Government is more responsive to a crisis in
food availability when newspaper circulation is
higher.
+
=
41
Democracy and Growth
 Democracies have a good record of economic
growth.
• One reason: the only way the public as a whole
can become rich is by supporting efficient policies
that generate growth.
• In nondemocratic societies small groups of elites
can get rich by taking a larger share of the pie
even if the pie gets smaller.
 Rulers in oligarchies or quasi-democracies
don’t have incentives to pay attention to costs
born by the larger public.
42
Democracy and Growth
 The incentives of ruling elites may even be to
keep their nations poor:
• Example: Mass education
 Could provide competition to the elites in terms of skills.
 An informed citizenry is harder to control.
 Bottom line: The greater the share of the
population that is brought into power, the
more likely that policies will offer something
for virtually everybody not just the few elites.
43
Check Yourself
 The free flow of ideas helps markets to
function. How does the free flow of ideas
help democracies to function?
44
Takeaway
 Incentives matter. So a good institution
aligns self-interest with the social interest.
 Voters are rationally ignorant: the have too
little incentive to be well informed.
 Rational ignorance means that special
interests can dominate parts of the political
process.
 Incumbent politicians can use their control of
the government to increase their chances of
reelection.
45
Takeaway
 Voters are myopic which allows politicians
to manipulate the economy during election
years to get reelected.
 Government failure: when the institutions
of government fail to align self interest with
the social interest.
 It is harder in a democracy for politicians
to ignore the major interests of the voters.
46
Takeaway
 The record of democracies on some of the
big issues is good:
•
•
•
•
Averting mass famines.
Maintaining civil liberties
Supporting economic growth.
Tend not to kill their own citizens.
47
Second Edition
End of Chapter 21