Political economyGovernment growth
Today: How do people vote in a democracy?Why did the government grow so much in the 20th century?
Democracy
Political decision making is important for public finance
Two types of democracy in this “mini-lecture” Direct Indirect, or representative
Direct democracy
There are different ways to make decisions in a direct democracy Unanimity, especially of public goods purchases
Lindahl prices Majority voting rules
Possible cycling with three or more choices Median voter theorem
Arrow’s impossibility theorem
Unanimity with public goods
Suppose there are two people trying to find the efficient level of public goods purchases
Each person could decide on a quantity to purchase Free-rider problem
Each person could decide on a quantity to purchase, given what fraction he or she would pay The share paid is known as a Lindahl price
See also Figure 6.1, p. 107: Notice that by construction of graph, shares add up to one at each point
Feasibility of unanimity rules
Reaching equilibrium Time and negotiation costs are usually very high
when many people are involved Strategic behavior
One person could react to how he or she thinks the other will behave
Strategic behavior can prevent efficient results from occurring
Majority voting rules
Majority voting relies on all voters having single-peaked preferences
With single-peaked preferences… The person with median preferences can
essentially make the decision (under certain conditions)
Trading votes may or may not increase welfare Programs that lower overall welfare are known as
“pork”
Preferences
When at least one person does not have single-peaked preferences, we can get cycling Cycling occurs when no clear winner can be
established See also Figure 6.2, p. 110
Brad and Angela have single-peaked preferences Jen has double-peaked preferences
Single-peaked preferences
Each person has single-peaked preferences here Brad’s peak is at A Jen’s peak is at C Angelina’s peak is at B
A vs. B: B wins A vs. C: C wins B vs. C: B wins B is the clear winner
Voter
Choice Brad Jen Angelina
First A C B
Second B B C
Third C A A
Back to Jen’s two peaks
This example is different from the previous one Jen now has double-peaked
preferences A and C are both peaks
We now get cycling A vs. B: A wins A vs. C: C wins B vs. C: B wins No clear winner This inconsistency is part of
a voting paradox
Voter
Choice Brad Jen Angelina
First A C B
Second B A C
Third C B A
This example is the same as in the graph a few slides ago
Suppose Angelina is in charge Agenda manipulation:
Someone can decide on the order of votes to get her or his first choice Suppose Angelina
decides the order of votes to get her most-desired choice
First, A vs. C: C wins Second, B vs. C: B wins B is implemented
Voter
Choice Brad Jen Angelina
First A C B
Second B A C
Third C B A
The median voter theorem
When preferences of each person are single peaked, we can assign a “median voter”
Relative to the median voter Half of the people want more Half of the people want less
Under certain conditions, the median voter’s preferences will be approved
The median voter theorem
Voter Most desired expenditure on breast cancer
research
Abby $50
Betty $1,000
Christine $1,100
Doris $2,500
Elaine $50,000
Median voter theorem predicts that $1,100 will be voted on
Six reasonable criteria for decision making Kenneth Arrow studied six
criteria that many people would consider “ethically acceptable”
Unfortunately, there is no guarantee that all six criteria can be followed This proof is known as Arrow’s
Impossibility Theorem What are the six criteria?
Kenneth Arrow, 2004
The six criteria that Arrow proposed It can produce a decision whatever the configuration of voters'
preferences No problems due to multipeaked preferences
It must be able to rank all possible outcomes It must be responsive to individuals’ preferences
Example: If everyone prefers A to B, then society does too Preferences must be transitive
If A is at least as good as B, and B is at least as good as C, then A is at least as good as C
Independence of irrelevant alternatives Relative rankings of two goods do not depend on a third good
Dictatorship ruled out Social welfare is a function of more than one person
Representative democracy
In a representative democracy, a subset of the population votes to determine who our elected politicians are Median voter theorem applies here also,
assuming single-dimensional rankings and exactly two candidates
Ideology, personality, and leadership abilities of the politician may matter to voters
If no candidate appeals to a voter he or she may not vote
Median voter theorem in one dimension
Number of Voters
Liberal ConservativeMedian voter S
If a candidate takes position S, the opponent can take the median voter stance and get a majority of the votes
Implications of the median voter model Based on the median voter model…
Two-party systems tend to be stable Replacement of direct referenda by representative
system has no effect on outcomes
Logrolling
Logrolling is the act of politicians trading votes in order to pass legislation that is beneficial to their district Some logrolling improves welfare Some logrolling does not improve welfare
An example Suppose that Waldo, Xavier, and Zach each live
in a different congressional district Note that this example uses a different approach
than in the book
Logrolling
In each case, Waldo, Xavier, and Zach’s representatives can get together to try to pass each other’s projects
If all three projects are passed together, Waldo, Xavier, and Zach are each better off
Whether or not the logrolling leads to welfare improvements depends on the cost to others
Welfare-improving logrolling
Project Waldo Xavier Zach others Total net benefits
Park 500 -200 -250 -30 20
Beach restoration
-200 750 -300 -100 150
Tree planting
-200 -300 750 -75 175
Bring on the pork
Project Waldo Xavier Zach others Total net benefits
Park 500 -200 -250 -130 -80
Beach restoration
-200 750 -300 -350 -100
Tree planting
-200 -300 750 -275 -25
Public employees
Public employees fulfill legislated mandates and operate many government operatives Bureaucrats sometimes have interpretive power Red tape criticism
Unresponsive to reasonable requests No market-oriented incentives
Some bureaucrats want to maximize the size of their departments Niskanen’s model of bureaucracy
See also Figure 6.4, p. 120
What can the politician do?
A politician can change the quantity to Q* if he or she knows what Q* is Sometimes, only the bureaucrat knows what Q* is
Make bureaucrats’ pay dependent on quality of work Requires costly oversight
Hire bureaucrats that are reliable in determining what Q* is Probably difficult
Special interests
“Special interests” has become a politically-charged term in today’s political arena
What are some special interest groups? Labor groups Groups that favor the rich, poor, young, or old Groups that favor tax breaks for an industry Groups that want to enhance social and religious
goals Rent-seeking behavior
Attempts for a firm to have positive economic profits
Rent-seeking behavior
See Figure 6.5, p. 122 Economic rents can be received if the
government spurs competition Positive economic profits
Note deadweight loss
Other people involved
Other people help to carve the political landscape Judges have control to enforce and interpret laws Media influence
Providing information Political leanings
Experts Former politicians
Example: Al Gore
Summary: Democracy
Democracies can be direct or indirect Both types of democracies have their own
sets of problems Direct democracies
Time consuming to people Cycling Arrow’s Impossibility Theorem
Indirect democracies Bureaucrats Special interests
Growth of government spending Many western countries have had significant
growth in government spending since 1900 How is this growth justified?
Many theories examined No single theory fully explains the growth
Can government growth be controlled?
Explaining Government Growth Five theories of government growth
Citizen preferences Marxist view Chance events Changes in social attitudes Income redistribution
Citizen preferences
Take the median voter’s preferences of public sector goods and services G = f(P, I)
G represents the median voter’s demand for public sector goods and services
P is the relative price of public sector goods and services
I is income
Citizen preferences
Assume median voter theorem is true When income increases, if income elasticity of
demand is greater than one for the median voter, increased public services would be provided
Growth of the middle class may explain why government spending has grown so much
This theory predicts that voters get what they want
Marxist view
A Marxist model would argue that the private sector overproduces Government must expand expenditures to correct this
Worker discontent is curbed by social service spending
Some argue that this is not sustainable, since expenditures will eventually outpace tax revenue capacity See Figure 18.6, p. 423, for more on tax revenue capacity
Government shocks
Chance events lead to shocks on the government
These shocks require the government to increase spending substantially Examples: The Great Depression; the world
wars; the financial crisis of 2008-’09 Inertia increased spending sticks
Special interest groups try to make sure that “their” spending does not go away
Changes in social attitudes
Are people making bigger demands on government? Maybe Due to median voter theorem?
Costs and benefits may also be incorrectly perceived by the public
Income redistribution
Two views Government grows to help low-income voters
Some politicians can promise redistribution to median income and below
Incomes above the median get taxed to pay for income redistribution
Government grows to help the middle class Appeals to voters near median income With this view, the upper- and lower-income classes pay
for the benefit of the middle class
Controlling government growth Some people believe that government is not
too big Others disagree If the government is too big, how can we
make it smaller? Change bureaucratic incentives Change fiscal institutions Institute constitutional limitations
Change bureaucratic incentives Recall Niskanen’s
model of bureaucracy Bureaucrat often worries
about size of department, not what is efficient
Financial incentives for cost-cutting could backfire, however Q could be below Q*
Private provision may be more efficient
Figure 6.4, p. 120
Change fiscal institutions
Is the budget-making process undisciplined? Many people believe so Congress-imposed solution: Budget Enforcement
Act (BEA) of 1990 Spending and revenue targets are set The cap can be exceeded when an elaborate set of
parliamentary rules are followed Problems with BEA
Some “emergency” spending is known in advance 2000 census
Institute constitutional limits
If Congress cannot regulate its own spending, should there be a constitutional amendment that does limit spending?
Most economists believe “no”
Why not to impose constitutional limits Revenue and spending is usually uncertain until it
happens If tax revenue was overestimated, severe spending cuts
would have to occur mid-year Spending could be forced on states instead
States could be mandated to provide part of Social Security What would the consequences be if Congress
circumvents the law? Judicially-imposed budget? Will Congress members be punished?
Summary: Growth of gov’t spending Although political models have appeal on
government spending, they do not fully explain how governments behave
Many people believe that government spending needs more control BEA and current incentive structure ineffective No constitutional amendment for balanced budget
Probably goes too far
Problems
Lindahl model Majority voting Median voter theorem Efficient government spending
Lindahl problem
Bill and Hillary have decided to be roommates in Washington DC They decide to use Lindahl prices to determine
the amount of money they will spend on a new sofa
Q represents spending on a new sofa Bill’s share is SB = 1 – Q/500
Hillary’s share is SH = 1 – Q/400
Also note that SB + SH = 1
Lindahl problem
How do you solve this? 3 equations 3 unknowns Plug in first two equations into the third equation
(1 – Q/500) + (1 – Q/400) = 1 (1 – 4Q/2000) + (1 – 5Q/2000) = 1 2 – 9Q/2000 = 1 1 = 9Q/2000 Q = 2000/9 = 222.22
Majority voting problem
5 members on a city council 4 options: A, B, C, D
Assume each member will vote no unless specified below Frank: Will only vote in favor of A Genevieve: Will vote in favor of B; will vote for A if B is defeated
first Holly: Will definitely vote in favor of B or C if either is voted on;
will vote for A if B and C are both defeated first Ivan: Will definitely vote in favor of A or D if either is voted on;
will vote for B if A and D are defeated first Jacqueline: Will definitely vote in favor of C and D if either is
voted on
Majority voting problem
Which projects have a chance?
Frank Genevieve Holly Ivan Jacqueline
A Y ? ? Y N
B N Y Y ? N
C N N Y N Y
D N N N Y Y
Majority voting problem
Which projects have a chance? A and B
Frank Genevieve Holly Ivan Jacqueline
A Y ? ? Y N
B N Y Y ? N
C N N Y N Y
D N N N Y Y
Majority voting problem
Can we get A to pass? Yes: Have Frank to control the voting process Step 1: Vote on B Only Genevieve and Holly will vote
in favor Step 2: Vote on C We know that C will never pass Step 3: Vote on A Since B and C have both been
defeated, Holly will also vote in favor of A
Frank Genevieve Holly Ivan Jacqueline
A Y ? ? Y N
B N Y Y ? N
Median voter theorem problem In Santa Barbara, the distribution of desired
spending on beaches in the population is as follows Normal distribution Average desired spending is $600,000 per year Standard deviation is $100,000 per year
If you were a politician running for the Santa Barbara city council, what should your stance on this be?
Median voter theorem problem What should your stance be?
If you believed the median voter theorem, your stance should be consistent with the median voter
In a normal distribution, the mean and the median are the same Stance should be to spend $600,000 per year
Efficient government spending problem Q is millions of dollars spent per year on a
government project Thus, total cost is Q
Total value of the government project V = 100Q½
What is efficient? What is the output predicted by Niskanen’s
model?
Efficient government spending problem What is efficient?
Set MB = MC MB is the derivative of the total value with respect
to Q MB = 50/Q½
MC is the derivative of the total cost with respect to Q MC = 1
50/Q½ = 1 Q = 2,500
Efficient government spending problem What is the output predicted by Niskanen’s
model? Set V = C 100Q½ = Q Q = 10,000