CHAPTER 6 The Economic Role of the State PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe

CHAPTER

6The Economic Role of

the State

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe

6-2


The Economic Role of the The Economic Role of the StateState

Market economy requires that Market economy requires that property rights be well-defined and property rights be well-defined and protectedprotected

Government has 3 possible roles:Government has 3 possible roles: Protection of individual rightsProtection of individual rights Public productionPublic production RegulationRegulation

6-3


Protection of RightsProtection of Rights

A market economy presupposes A market economy presupposes rights are protectedrights are protected

Government protects rights through:Government protects rights through: National defenseNational defense Police Police CourtsCourts

Government has monopoly on Government has monopoly on legitimate use of forcelegitimate use of force

6-4


How Much Protection is How Much Protection is Optimal?Optimal?

Is not an all-or-nothing propositionIs not an all-or-nothing proposition Optimal point is where marginal cost Optimal point is where marginal cost

of protection equals marginal benefit of protection equals marginal benefit from protectionfrom protection

Provides little practical guidanceProvides little practical guidance

6-5


Government ProductionGovernment Production

Market inefficiencies lead to Market inefficiencies lead to possibility of government regulation possibility of government regulation or productionor production

Main theoretical justifications for Main theoretical justifications for government production:government production: ExternalitiesExternalities Public goodsPublic goods

6-6


Government RegulationGovernment Regulation

Regulation may be a more efficient Regulation may be a more efficient substitute for government productionsubstitute for government production

Problems with Government Problems with Government RegulationRegulation InformationInformation PoliticsPolitics

6-7


The Capture Theory of The Capture Theory of RegulationRegulation

Regulatory agencies are “captured” Regulatory agencies are “captured” by regulated industriesby regulated industries

Special interests vs. general publicSpecial interests vs. general public Example:Example: regulated utility regulated utility

General public lacks incentive to General public lacks incentive to become informedbecome informed

Special interests have incentive because Special interests have incentive because of concentrated regulatory benefitsof concentrated regulatory benefits

6-8


The Regulatory Agency The Regulatory Agency as a Cartelas a Cartel

Government regulation can create a Government regulation can create a regulatory cartel creating:regulatory cartel creating: Regulatory barriers to entryRegulatory barriers to entry Regulating prices Regulating prices

Result is inefficientResult is inefficient Lower output = higher pricesLower output = higher prices

6-9


The Regulatory Agency The Regulatory Agency as a Cartelas a Cartel

6-10


The Equilibrium Level of The Equilibrium Level of RegulationRegulation

Special interests don’t get everything Special interests don’t get everything they wantthey want

Regulation benefits some at the Regulation benefits some at the expense of othersexpense of others

Politicians must weigh marginal Politicians must weigh marginal political costs vs. marginal political political costs vs. marginal political gainsgains

6-11


The Equilibrium Level of The Equilibrium Level of RegulationRegulation

6-12


The Transitional Gains The Transitional Gains TrapTrap

Regulation provides transitional Regulation provides transitional profits profits

Profits eventually competed awayProfits eventually competed away Deregulation creates transitional Deregulation creates transitional

losseslosses Example:Example: Airline Regulation Airline Regulation

Increases difficulty of eliminating Increases difficulty of eliminating harmful regulationsharmful regulations

6-13


RedistributionRedistribution

Largest single activity undertaken by Largest single activity undertaken by United States governmentUnited States government

Many stated reasons for Many stated reasons for redistributionredistribution

Actual redistribution policies will Actual redistribution policies will reflect impact of the political processreflect impact of the political process

6-14


Reasons for Government Reasons for Government RedistributionRedistribution

Two general reasons: Provide a safety net Greater equality

Not necessarily the same thing Example: worldwide poverty

6-15


Politics and Politics and RedistributionRedistribution

Bulk of government transfers go to Bulk of government transfers go to the middle class in the United Statesthe middle class in the United States Examples:Examples:

Social SecuritySocial Security farm programsfarm programs

Product of political process based on Product of political process based on majority rulemajority rule

6-16


StabilizationStabilization

Government’s other activities may Government’s other activities may be constrained by stabilization policybe constrained by stabilization policy

Stabilization tools:Stabilization tools: Monetary policyMonetary policy Fiscal policyFiscal policy

6-17


Can The Government Can The Government Perform These Perform These

Functions?Functions? May be problems with government May be problems with government

allocation of resourcesallocation of resources Information problemsInformation problems

Limited market dataLimited market data Unrevealed preferencesUnrevealed preferences

Policy conflictsPolicy conflicts Trade-off between efficiency and equityTrade-off between efficiency and equity

6-18


Will The Government Will The Government Perform These Perform These

Functions?Functions? Public policy is not decided by expertPublic policy is not decided by expert Public policy determined through Public policy determined through

political process influenced by:political process influenced by: Special interestsSpecial interests Public sentimentPublic sentiment

6-19


The Free Rider ProblemThe Free Rider Problem

Individuals can consume collective Individuals can consume collective benefits without payingbenefits without paying

Even when individuals do contribute, Even when individuals do contribute, they have an incentive to shirkthey have an incentive to shirk Shirking reduces the production of the Shirking reduces the production of the

collective goodcollective good Incentive to understate demand for Incentive to understate demand for

collective goodcollective good Example:Example: National defense National defense

6-20


The Holdout ProblemThe Holdout Problem

Occurs when one person in a group Occurs when one person in a group has the power to prevent collective has the power to prevent collective actionaction Example:Example: Highway construction Highway construction

6-21


Solutions To The Holdout Solutions To The Holdout ProblemProblem

Private solutionsPrivate solutions Substitute to alternative locations if Substitute to alternative locations if

possiblepossible Contingency contractsContingency contracts Hiding motivesHiding motives

Public SolutionPublic Solution Eminent DomainEminent Domain

6-22


Consent and CoercionConsent and Coercion

Certain situations require Certain situations require government coercion to achieve government coercion to achieve efficiencyefficiency

If everyone is better off because If everyone is better off because everyone is coerced, everyone would everyone is coerced, everyone would agree to be coercedagree to be coerced

Incompatible within Paretian Incompatible within Paretian frameworkframework

Documents

CHAPTER 6 The Economic Role of the State PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe