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Externalities, Public Goods, Imperfect Information, and Social Choice (Part H)
by
Charles Lamson
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Social Choice
One view of government, or the public-sector, holds that it exists to provide things that "society wants." Our society is a collection of individuals, and each has a unique set of preferences. Defining what society wants, therefore, becomes a problem of social choice---of somehow adding up, or aggregating, individual preferences. It is also important to understand that government is made up of individuals---politicians and government workers---whose own objectives in part determine what government does. To understand government, we must understand the incentives facing politicians and public servants, as well as the difficulties of aggregating the preferences of the members of a society. The Voting Paradox Democratic societies use ballot procedures to determine aggregate preferences and to make the social decisions that follow from them. If all those could be unanimous, efficient decisions would be guaranteed. Unfortunately, unanimity is virtually impossible to achieve when hundreds of millions of people, with their own different preferences, are involved. The most common social decision-making mechanism is majority rule---but it is not perfect. In 1951, Kenneth Arrow proved the impossibility theorem [Kenneth Arrow, Social Choice and Individual Values (New York, John Wiley, 1951)]---that it is impossible to devise a voting scheme that respects individual preferences and gives consistent, non-arbitrary results. One example of a seemingly irrational result emerging from majority rule voting is the voting paradox. Suppose that, faced with a decision about the future of the institution, the president of a major university opts to let its three top administrators vote on the following options: Should the university (a) increase the number of students and hire more faculty, (b) maintain the current size of the faculty and student body, or (c) cut back on faculty and reduce the student body? Figure 7 represents the preferences of the three administrators diagrammatically.   The problem arises when we then have the three vote on A against C. Both VP2 and the dean vote for C, giving it the victory; C is actually preferred to A. Nevertheless, if A beats B, and B beats C, how can C beat A? The results are inconsistent. The voting paradox illustrates several points. Most important is that when preferences for public goods differ across individuals, any system for adding up, or aggregating, those preferences can lead to inconsistencies. In addition, it illustrates just how much influence the person who sets the agenda has. If a vote had been taken on A and C first, the first two votes might never have occurred. This is why rules committees in both houses of Congress have enormous power; they establish the rules under which, as well as the order in which, legislation will be considered. Another problem with majority rule voting is that it leads to logrolling. Logrolling occurs when representatives trade votes---D helps get a majority in favor of E's program, and in exchange he helps D get a majority on D's program. It is not clear whether any bill could get through any legislature without logrolling. It is also not clear whether logrolling is, on balance, a good thing or a bad thing from the standpoint of efficiency. On the other hand, a program that benefits one region or group of people might generate enormous net social gains, but because the group of beneficiaries is fairly small, it will not come into a majority of delegates. If another bill that is likely to generate large benefits to another area is also awaiting a vote, a trade of support between the two sponsors of the bills should result in the passage of two good pieces of efficient legislation. On the other hand, logrolling can also turn out unjustified, inefficient, "pork barrel" legislation.  A number of other problems also follow from voting as a mechanism for public choice. For one, voters do not have much of an incentive to become well-informed. When you go out to buy a car or, on a smaller scale, a laptop, you are the one who suffers the full consequences of a bad choice. Similarly, you are the beneficiary of the gains from a good choice. This is not so in voting. Although many of us believe that we have a civic responsibility to vote, no one really believes that his or her vote will actually determine the outcome of an election. The time and effort it takes just to get to the poles is enough to deter many people. Becoming informed involves even more costs, and it is not surprising that many people do not do it. Beyond the fact that a single vote is not likely to be decisive is the fact that the costs and benefits of wise and unwise social choices are widely shared. If the congressman that I elect makes a bad mistake and wastes a billion dollars, I bear only a small fraction of that cost. Even though the sums involved are large in aggregate, individual voters find a little incentive to become informed. Two additional problems with voting are that choices are almost always limited to bundles of publicly provided goods, and we vote infrequently. Many of us vote for Republicans Or Democrats. We vote for president only every 4 years. We elect senators for six-year terms. In private markets, we can look at each item separately and decide how much of each we want. We also can shop daily. In the public sector, though, we vote for a platform or a party that takes a particular position on a whole range of issues. In the public sector it is very difficult, or impossible, for voters to unbundle issues. There is, of course, a reason why bundling occurs in the sphere of public choice. It is difficult enough to convince people to go to the polls over once a year. If we voted separately on every appropriation bill, we would spend our lives at the polls. This is one reason for representative democracy. We elect officials who we hope will become informed and represent our interests and preferences.  Government Inefficiency: Theory of Public Choice Recent work in economics has focused not just on the government as an extension of individual preferences but also on government officials as people with their own agendas and objectives. That is, government officials are assumed to maximize their own utility, not the social good. To understand the way government functions, we need to look less at the preferences of individual members of society and more at the incentive structures that exist around public officials. Officials we seem to worry about are the people who run government agencies---the Social Security Administration, the Department of Housing and Urban Development, and state registries of motor vehicles, for example. What incentive do these people have to produce a good product and to be efficient? Might such incentives be lacking? In the private sector, where firms compete for profits, only efficient firms producing goods that consumers will buy survive. If a firm is inefficient---if it is producing at a higher-than-necessary cost---the market will drive it out of business. This is not necessarily so in the public sector. If a government bureau is producing a necessary service, or one mandated by law, it does not need to worry about customers. No matter how bad the service is at the registry of motor vehicles, everyone with a car must by its product. The efficiency of a government agency's internal structure depends on the way incentives facing workers and agency heads are structured. If the budget allocation of an agency is based on the last budget period's spending alone, for example, agency heads have a clear incentive to spend more money, however inefficiently. This point is not lost on government officials, who have experimented with many ways of rewarding agency heads and employees for cost-saving suggestions.  However, critics say such efforts to reward productivity and punish inefficiency are rarely successful. It is difficult to punish, let alone dismiss, a government employee. Elected officials are subject to recall, but it usually takes gross negligence to rouse voters into instituting such a measure. Also, elected officials are rarely associated with problems of bureaucratic mismanagement, which they decry daily. Critics of "the bureaucracy" argue that no set of internal incentives can ever match the discipline of the market, and they point to studies of private versus public garbage collection, airline operations, fire protection, mail service, and so forth, all of which suggests significantly lower costs in the private sector. One theme of the Reagan and the first Bush administration was "work privatization." If the private sector can possibly provide a service, it is likely to do so more efficiently---so the public sector should allow the private sector to take over. One concern regarding wholesale privatization is the potential effect it may have on distribution. Late in his administration, President Reagan suggested that the federal government sell its entire stock of public housing to the private sector. Would the private sector continue to provide housing to poor people? The worry is that it would not, because it would not be profitable to do so. Like voters, public officials suffer from a lack of incentive to become fully informed and to make tough choices. Consider an elected official. If the real objective of an elected official is to get re-elected, then the real incentive must be to provide visible goods for that officials constituency while hiding the costs or spreading them thin. Self-interest may easily lead to poor decisions and public irresponsibility. Looking at the public sector from the standpoint of the behavior of public officials and the potential for inefficient choices and bureaucratic waste rather than in terms of its potential for improving the allocation of resources has become quite popular. This is the viewpoint of what is called the public choice field in economics that builds heavily on the work of Nobel Laureate James Buchanan.  Rent-Seeking Revisited Another problem with public choice is that special interest groups can and do spend resources to influence the legislative process. As we said before, individual voters have little incentive to become well-informed and to participate fully in the legislative process. Favor-seeking special-interest groups have a great deal of incentive to participate in political decision making. A monopolist would be willing to pay to prevent competition from eroding its economic profits. Many if not all industries lobby for favorable treatment, softer regulation, or antitrust exemption. This, as you recall from part 61, is rent-seeking. Rent-seeking extends far beyond those industries that lobby for government help in preserving monopoly powers. Any group that benefits from government policy has an incentive to use its resources to lobby for that policy. Farmers lobby for farm subsidies, oil producers lobby for oil import taxes, and the American Association of Retired Persons lobbies against cuts in Social Security. In the absence of well-informed and active voters, special interest groups assume an important and perhaps a critical role. But there is another side to this story. Some have argued that favorable legislation is, in effect, for sale in the marketplace. Those willing and able to pay the most are more successful in accomplishing their goals than those with fewer resources.  Theory may suggest that unregulated markets fail to produce an efficient allocation of resources. This should not lead you to the conclusion that government involvement necessarily leads to inefficiency. In the next post, we turn our attention to reasons to believe that government attempts to produce the right goods and services in the right quantities efficiently may fail. *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 324-327* end |
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