Econ 309 Lecture

July 15, 2009

Schumpeter on democracy

1. The “classical doctrine” of democracy: there is a public good and voters make sure politicians do it.

2. Alternative: democracy is a system in which governments emerge from a competitive struggle for the people’s vote.

3. The inference (which Schumpeter never quite says): socialism, lacking competition, can’t have democracy either

Typology of goods

Rival Non-rival

Excludable Private goods Knowledge

Non-excludable Parking spaces Classic public goods

Public Goods: Definition

• Non-rival. One person’s enjoyment does not preclude another persons.

• Non-excludable. Once it’s available, no one (in a particular group, e.g., those residing in a given territory) can be prevented from using it.

Public Goods: Examples

• National defense

• Clean air / Global climate

• Church bells

• Anything else?

Public Goods: Controversial

• Roads and streets• Public parkland• Public safety / crime prevention• Education• Basic science and classic literature• Stable currency• Coast guard• Army Corps of Engineers• Language

Wolf on the functions of the state

• Security of property• Sound money• Infrastructure• Basic research• Dealing with externalities• Merit goods, e.g. health, education: this involves an

ethical commitment• Regulatory and competition policy• Taxation• Redistribution

Wolf on characteristics of good governance

• Credibility, predictability, transparency, and consistency

• Policy should shape individual incentives to match objectives

• Remediability: govt. should act only when benefits exceed costs

Wolf: problems in advanced democracies

• Voters are rationally ignorant• Those who are knowledgeable about an issue are

generally:– Experts, e.g., journalists and academics– People whose livelihoods depend on the policy in question– Concerned citizens

• These groups tend to be:– Cynical– Self-interested– Fanatical

• All may have a bias towards state rather than market solutions

Wolf: catastrophes of bad governments

• Kleptocracy• Fiscal mismanagement (e.g., debt defaults)• Inflation• Corruption, including

– Administrative corruption– State capture by private interests

• Bad government is a major cause of intl. inequality

Public Goods vs. Natural Monopolies

• Electricity, water, gas, and other utilities are:– Rival. If I use this cup of water, you can’t.– Excludable. You can be prevented from accessing

water and gas pipes, electric lines.

• These are not public goods in the economic sense

• They are provided publicly because we are not content to leave them to private monopolies

Median Voter Theorem (Downs, 1956)

• Assumptions: – Two parties– One-dimensional issue spectrum– Parties maximize votes– All voters vote– Voters vote for the party closest to their preferences:

• Result: Parties move to the center

Left RightParties locate in the center

Cycling (Kenneth Arrow)

• An example of cycling:– Alice and Caroline prefer

Acapulco to Boston– Betty and Alice prefer

Boston to the Cayman Islands

– Caroline and Betty prefer the Cayman Islands to Acapulco

• Under majority voting, Alice, Betty, and Caroline could cycle forever

Alice Betty Caroline

#1 pref

Aca-pulco

Boston Cayman Islands

#2 pref

Boston Cayman Islands

Aca-pulco

#3 pref

Cayman Islands

Aca-pulco

Boston

Cycling

• Any point in ABC can be defeated by a majority coalition

• In particular, middle point D can be defeated by E, F, or G

A

B C

D

EF

G

Rent-Seeking• Suppose that the state grants a

monopoly to a firm. What are the costs?– Region B represents a “Harberger

triangle” of deadweight loss because the monopolist underprodces

– Region A is traditionally interpreted as “monopoly profit,” which consumers lose but the monopolist gains

– However, Region A can also be interpreted as a “Tullock rectangle” of social loss if private persons and firms expend valuable resources competing to get monopoly privileges

• Rent-seeking: someone seeks to grow, not the pie, but their share of it

P

Q

DMC

PM

A B

Rent-Seeking: Examples

• Lobbying for trade protection, state-sanctioned monopoly

• Queueing in stores, for rock concert tickets

• Picking up $1 bills from the street• Claiming tax refunds• Gold mining (in a gold standard world)• War• Education?

Interest Groups: The Logic of Collective Action (Olson, 1971)

• Suppose law L benefits group G1 to the tune of $X, and harms group G2 to the tune of $Y– Will the law pass?– How much will the two sides spend on rent-seeking?

• This depends not only on whether X>Y, but on the ability of the groups to organize

• Small groups can organize more easily• Mancur Olson concludes: policies with

“concentrated benefits, diffuse costs” are more likely to pass

• Does this contradict the Median Voter Theorem?

The Paradox of Voting

• Why you shouldn’t vote:– Gains to you if your candidate wins: $10,000?

$20,000?– Chances that your vote will decide the election: 1 in 1

million?– Expected gain from voting: 1¢– Cost of voting: $10 worth of gas, time?– Conclusion: It’s not worth anyone’s while to vote

• Why does anyone bother to vote, let alone 60% of eligible voters? (the “paradox”)

Rational Ignorance

• Theories about why people vote:– Very low costs are ignored– Expressive utility from voting– Tiny amounts of altruism

• With tiny incentives to make the right choice, voters will not invest in getting informed and thinking through things

• Bryan Caplan argues that systematic voter ‘irrationality’ harms democratic governance

Redistribution

1. The assumption of diminishing marginal utility implies that rich-to-poor redistribution should raise total welfare (though this is not Pareto-improvement)

2. But rich-to-poor redistribution reduces the incentive to create wealth

3. The trade-off: equity vs. equality

Ferguson

• The insurance principle: diversifying risk• Origins of insurance:

– Mathematicians– Webster, Wallace, and Scottish widows

• The welfare state: economies of scale– Origins: Bismarck’s Germany– Japan, the ‘welfare superpower’– Problems with the welfare state– Milton Friedman in Chile

• Aging populations• Hedging and derivatives

Does public choice theory help us to understand politics?

• Becker’s examples:– Attempts to manipulate oil prices– Auto insurance– Postal service– Excessive state generosity to seniors– Under-spending on genuine public goods, e.g.

roads, cops– Education and vouchers