May 26, 2006

Economic Thoughts, Part VIII: The Unspoken, But Very Real, Incentives That Drive Governmental Actions

This posting is Part VIII in a series of postings about economic thoughts.

This posting contains excerpts from a previous posting that addressed the often unspoken, but very real and deeply influential, incentives that drive government behavior - and how they compare unfavorably with the incentives that drive behaviors in a competitive capitalism system:

In the book entitled Government Failure: A Primer in Public Choice, Arthur Seldon writes:

Many economics writers and teachers still present economic systems of exchange between private individuals or firms as "imperfect" and requiring "correction" by government. Most teachers of politics, politicians, and political journalists still present government as well-meaning and able to remove such "imperfections."

In spite of this view of government, Seldon notes:

Economic systems based on exchange between individuals and on selling and buying between firms usually correct themselves in time if they are free to adapt themselves to changing conditions of supply and demand. Government "cures" usually do more harm than good in the long run because of three stubborn and too-long neglected excesses of government: their "cures" are begun too soon, they do too much, and they are continued for too long.

Gordon Tullock, writing in the same book, explains the evolution of public choice theory:

Throughout the 19th and well into the 20th century, economists assumed that individuals were primarily concerned with their own interest and worked out the consequences of that assumption. In contrast, during this same period political science largely assumed that political actors are mainly concerned with the public interest. Thus individuals who enter a supermarket and purchase items of their choice are assumed, when they enter the voting booth, to vote not for the politicians and laws that will benefit themselves, but for politicians and laws that will benefit the nation as a whole. People in the supermarket mainly buy the food and other goods that are, granted the price, found to benefit themselves and their families. However, when individuals become politicians, a transformation is assumed to occur so that a broader perspective guides them to make morally correct decisions rather than follow the course of behavior that pleases the interest groups that supported them or the policies that may lead to reelection.

Economists changed this bifurcated view of human behavior by developing the theory of public choice...

We must accept that in government, as in any form of commerce, people will pursue their private interests, and they will achieve goals reasonably closely related to those of company stockholders or of citizens only if it is in their private interest to do so...

Jane Shaw, in her article entitled Public Choice Theory, offers a more detailed explanation of how there is such a mismatch between our expectations of government and the actual performance by government:

...Economists who study behavior in the private marketplace assume that people are motivated mainly by self-interest...Public choice economists make the same assumption—that although people acting in the political marketplace have some concern for others, their main motive, whether they are voters, politicians, lobbyists, or bureaucrats, is self-interest. In [Nobel Laureate James] Buchanan's words the theory "replaces... romantic and illusory... notions about the workings of governments [with]... notions that embody more skepticism."

In the past many economists have argued that the way to rein in "market failures" such as monopolies is to introduce government action. But public choice economists point out that there also is such a thing as "government failure."...

One of the chief underpinnings of public choice theory is the lack of incentives for voters to monitor government effectively...the voter is largely ignorant of political issues and that this ignorance is rational. Even though the result of an election may be very important, an individual's vote rarely decides an election. Thus, the direct impact of casting a well-informed vote is almost nil; the voter has virtually no chance to determine the outcome of the election. So spending time following the issues is not personally worthwhile for the voter...

Public choice economists point out that this incentive to be ignorant is rare in the private sector...he or she pays only for the [purchased item] chosen. If the choice is wise, the buyer will benefit; if it is unwise, the buyer will suffer directly. Voting lacks that kind of direct result...

Public choice economists also examine the actions of legislators. Although legislators are expected to pursue the "public interest," they make decisions on how to use other people's resources, not their own. Furthermore, these resources must be provided by taxpayers and by those hurt by regulations whether they want to provide them or not...Efficient decisions, however, will neither save their own money nor give them any proportion of the wealth they save for citizens. There is no direct reward for fighting powerful interest groups in order to confer benefits on a public that is not even aware of the benefits or of who conferred them. Thus, the incentives for good management in the public interest are weak. In contrast, interest groups are organized by people with very strong gains to be made from governmental action. They provide politicians with campaign funds and campaign workers. In return they receive at least the "ear" of the politician and often gain support for their goals.

In other words, because legislators have the power to tax and to extract resources in other coercive ways, and because voters monitor their behavior poorly, legislators behave in ways that are costly to citizens. One technique analyzed by public choice is log rolling, or vote trading. An urban legislator votes to subsidize a rural water project in order to win another legislator's vote for a city housing subsidy. The two projects may be part of a single spending bill. Through such log rolling both legislators get what they want. And even though neither project uses resources efficiently, local voters know that their representative got something for them. They may not know that they are paying a pro-rata share of a bundle of inefficient projects! And the total expenditures may well be more than individual taxpayers would be willing to authorize if they were fully aware of what is going on.

...bureaucrats in government...incentives explain why many regulatory agencies appear to be "captured" by special interests...Capture occurs because bureaucrats do not have a profit goal to guide their behavior. Instead, they usually are in government because they have a goal or mission. They rely on Congress for their budgets, and often the people who will benefit from their mission can influence Congress to provide more funds. Thus interest groups...become important to them. Such interrelationships can lead to bureaucrats being captured by interest groups.

Although public choice economists have focused mostly on analyzing government failure, they also have suggested ways to correct problems. For example, they argue that if government action is required, it should take place at the local level whenever possible. Because there are many local governments, and because people "vote with their feet," there is competition among local governments, as well as some experimentation. To streamline bureaucracies, Gordon Tullock and William Niskanen have recommended allowing several bureaus to supply the same service on the grounds that the resulting competition will improve efficiency...

From the previously mentioned book, Tullock continues by explaining how public choice theory impacts public policy expectations and the broad question of what role should be played by government:

But the different attitude toward government that arises from public choice does have major effects on our views of what policies government should undertake or can carry out. In particular, it makes us much less ambitious about relying on government to provide certain services...

A deep-seated feeling that government is imperfect carries with it two consequences. The first is that imperfections in the market process do not necessarily call for government intervention; the second is a desire to see if we cannot do something about government processes that might conceivably improve their efficiency...

A final area where knowledge of public choice has an effect on people's views about policy concerns the behavior of government officials. The student of public choice is unlikely to believe that government officials are overly concerned with the public interest. Because they operate in an area where information is very poor (and the proof that the voters' information on political issues would be poor was one of the first achievements of the public choice theory), deception is much more likely to be a worthwhile tactic than it is in the marketplace. Therefore, one would anticipate much more dishonesty in government. Indeed, granted that government officials are the only people who can check on the dishonesty of government officials, the problem of curing dishonesty in government involves an infinite regression. Private businesspeople, who deal with better-informed consumers than do politicians, are also subject to surveillance by public officials who, dishonest though some may be, very commonly have no personal motive to protect a particular private businessperson. The amount of dishonesty that has turned up in private business in spite of these inspections gives a rough idea of the almost complete uniformity of dishonesty in politics...

The side effects from the pervasive belief that government can and/or must solve any imperfection in our society has led to an ever increasing presence of government in our society. That has magnified another problem which Ilya Somin of the Cato Institue discusses in his policy piece entitled When Ignorance Isn't Bliss: How Political Ignorance Threatens Democracy:

Democracy demands an informed electorate. Voters who lack adequate knowledge about politics will find it difficult to control public policy. Inadequate voter knowledge prevents government from reflecting the will of the people in any meaningful way. Such ignorance also raises doubts about democracy as a means of serving the interests of a majority. Voters who lack sufficient knowledge may be manipulated by elites. They may also demand policies that contravene their own interests...

The size of modern government is often so great that it is impossible for voters--even the most knowledgeable among them--to be adequately informed about its operations. Smaller government may actually be more democratic than that which we have now: voters would be more likely to exercise informed control over policy. Voter ignorance also suggests the value of decentralized federalism. In a decentralized federal system, citizens may "vote with their feet" by moving out of jurisdictions with policies they dislike and into those that have more favorable ones. Because each person decides whether or not to move, there is a much greater incentive to acquire relevant information with "foot voting" than with traditional voting at the polls.

Can the incentives that drive government behavior be altered for the better? An earlier posting discusses why structural problems in government create fundamentally misguided incentives that drive adverse public sector behavior.

That same posting quotes Lawrence Reed from an October 2001 speech to the Economic Club of Detroit:

Economist Milton Friedman...pointed out that there are only four ways to spend money. When you spend your own money on yourself, you make occasional mistakes but they're few and far between. The connection between the one who earned it, the one who is spending it, and the one who is reaping the final benefit is pretty strong. When you use your money to buy someone else a gift, you have some incentive to get your money's worth but you might not end up getting something the intended recipient really needs or values. When you use somebody else's money to buy something for yourself, such as lunch on an expense account, you have some incentive to get the right thing but little reason to economize. Finally, when you spend other people’s money to buy something for someone else, the connection between the earner, the spender and the recipient is most remote – and the potential for mischief is the greatest. Think about it - somebody spending somebody else's money on yet somebody else - that's what government does all the time.

Two earlier postings, (here and here), suggest that both campaign finance reform and lobbyist reform efforts will be unsuccessful because they cannot alter the fundamental structural problems that create the misguided incentives which drive government behavior.

Part IX to follow...

For previous postings on Economic Thoughts, refer to:

Part I: What is Economics?
Part II: Myths About Markets
Part III: Why Policy Goals are Trumped by Incentives They Create & the Role of Knowledge in Economics
Part IV: The Abuse of Reason, Fallacies & Dangers of Centralized Planning, Prices & Knowledge, and Understanding Limitations
Part V: The Relationship Between Economic Freedom and Political Freedom
Part VI: More on the Relationship Between Economic Freedom and Political Freedom
Part VII: The Role of Government in a Free Society

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OK, so do I have this right? The Cato Institute is suggesting we return to the Articles of Confederation, when each state in these United States was, more or less, a sovreign nation. They are advocating this at a time when the era of nation-states passed with the end of WWII. Since then, we have been in the era of the continent state: US, USSR, now China, Brazil (not a whole continent but plenty big) and India.

The Articles of Confederation lasted, what, 10 years?

Cato is also saying that most people are too ignorant to vote. What's the solution? Not let them? Reserve the right to vote for "the better sort" of citizen? Shall we finally give up on being a democracy and become a republic? I guess it's the conservatives who are the real elitists. And there have been two votes that more or less represent a sea change of gov't just in the past 30 years: the post-Watergate era of reform, and the 1994 change of congressional leadership. Are you suggesting that either of those invalid? That the people who voted these changes were too ignorant to know what they were doing?

And smaller states are easier to govern? No kidding? Guess that's why Athens worked as a city-state, and the town-hall meeting process only works in small towns in NE.

Beyond that, what exactly is the point of all of this? That people in gov't have their own interests at heart sometimes? Again, no kidding. But what is the primary interest these people have? Mainly, it's to keep your seat. Which means you need money for campaigns. Which means you have to kiss up to people with money. Who has money? People making the median wage? Sure, if you want to get it $25 at a time. And when you need tens of thousands, or of millions of dollars for your campaign, that's a lot of soliciting.

So who do you approach? People with money. Or businesses. In order to get your money, there will probably be a few strings attached. See: Cunningham, Randall "Duke", and Abramoff, Jack. So, who's interests does the congress critter end up looking after? Those of people with money. And who has the money...?

One assumption that runs through some of these threads on econ is that, somehow, purchaser and seller are more or less equal in power. Also, what's his name at the beginning talks about exchanges between individuals, and between businesses. I don't know about you, but most of my economic transactions occur when I pay a large corporation for one of their products. In such circumstances, there is nothing like an equal exchange among peers.

And I guess I just don't hang around in the right socialist bars or something. I haven't heard anyone calling for, or even suggesting, a centrally planned economy. This is sort of like the mother of all straw men. You use this as your bait to discredit all gov't activities, when it's really not on the table.

The proper role of gov't in econ transactions is one of regulator: are the products safe? Do they contain harmful ingredients? Do they do anything like what the advertising says? Is the company polluting the air that I breathe, or the Bay that I live next to? Are they violating safety regulations? It seems that coal mines may be doing with some regularity, resulting in 30 deaths so far this year. If the corporation I'm dealing with is a financial institution, is it sound? Remember RSDIC? Is it a fraud? How about the S&L Crisis?

The bottom line is that the single consumer or even a group of consumers, stands little chance against a big corporation. Like the boycotts against Disney that some religious groups organized because Disney recognize same-sex partners in their benefits. Didn't do a whole lot of damage. That sort of "market action" may work in an environment of small shops, where each customer is important, but it's a very dated concept. A certain percentage of customers are disposable; there's a percent you're just going to tick off and so be it. Unfortunately, in today's US, of 280 million people, a given company can afford to alienate a lot of people before the invisible hand really exerts a whole lot of pressure. Don't believe me? Call an 800-number for 'customer service' and see how far you get.

I guess what I'm saying is that I find this series to be a bit disingenuous. It's the straw-man argument: discredit gov't on a topic that no one is suggesting, thereby discrediting it in its legitimate role of protecting the general populace from shady business practice.

Because let's be blunt here: I agree that people in gov't act in their own self-interest rather than in the public interest. But I believe the very same thing about people in business. I'm not saying that business, or business people are evil; I'm saying they are not acting in the public interest. That is not their role, or their job.. So let's not rry to pretend otherwise.


Posted by: klaus at May 26, 2006 7:53 PM


So many words, so little substance - again.

If there are themes that run consistently through this series of postings, it is:

1. Liberty is paramount and is least threatened when economic and political power is widely dispersed. This argues for limited government and maximizing entrpreneurial capitalism.

2. People act in their own self-interest, whether in the private sector or public sector.

3. Underlying incentives define what is in every person's self-interest and therefore drive behaviors. We often forget that those incentives frequently do not align with publicly-stated goals or assumed altruism, especially in the public sector.

4. The private sector creates jobs and wealth - making it a positive sum game - while governmental intervention in the economy is a zero-sum game because government only has the option of coercively taking from Peter to pay Paul.

5. The proper role for government is to define the rules so there is a level playing field and then play ensure the rules are fairly implemented.

6. Perceived problems in the marketplace are frequently a result of unacknowledged bad incentives created by prior government actions.

7. One of the consequences of large government is that powerful private sector companies have an added incentive - and ability - to buy government favors, to the detriment of liberty for all others.

Posted by: Reader at May 27, 2006 3:28 PM