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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