M.Sc. in Economics (6 Credits) - uni-jena.deChoice+2016_17+_+Chapters+1_2.pdf · Public Choice...

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Public Choice

M.Sc. in Economics (6 Credits)

Winter Term 2016-2017Tuesday, 8 -10 a.m. c.t., Start October 18, 2016,

Carl-Zeiss-Str. 3, HS 9

Prof. Dr. Andreas FreytagLS Wirtschaftspolitik, FSU Jena

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Uber is represented in 570 cities, but not in Germany –

Why?

Some run-down areas in the British South-West are

rarely considered by British governments when it comes

to regional funds – Why?

Ordinary steel is produced cheapest in China and India,

nevertheless the EU protects the steel market - Why?

Low interest rate policies have never proven ineffective;

the ECB insist on its – Why?

Jacob Zuma is highly corrupt but seem to be safe - Why?

Agriculture in developed is employing less than 2 per

cent of the labor force, its contribution to GDP is about

1.5 per cent. Nevertheless, there are own ministries for

agriculture – Why?

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Announcement I:

Consulting hour: upon appointment

Time and venue of the written exam (for 3 credits):

16-02-2017, 8-10 am, HS 1

Net time is one hour

Please subscribe at Friedolin

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Announcement II: Exercise

The exercise is only needed for those students who want

to acquire 6 credits.

In the exercise, we discuss background papers to public

choice. Students write short essays (3 credits).

Three afternoon-long exercises are lead by Andreas

Freytag, Susanne Fricke and Sebastian Spiegel

respectively. Dates will be announced soon. Students are

requested to visit all three exercises.

Please sign in to the exercise with an e-mail to:

[email protected]

Launch session: Thursday, November 11, 18.00,

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Index

1. Introduction

2. Origins of the State

3. Public Choice in a Direct Democracy

4. Public Choice in a Representative

Democracy

5. Application of Political Economy Models

6. Normative Public Choice

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Description of the lecture:

The course Public Choice offers a concise and

comprehensive introduction into the positive foundations

of collective action, theoretical, empirical and political. The

lecture aims at providing the students with analytical tools

to understand the political background of economic policy.

After an introduction, the lecture covers the origins of the

state. We proceed by analyzing direct democracy. The

main part (chapter 4) of the lecture is dedicated to the

political economy of a representative democracy. Topics

are: federalism, two party competition, multi party

competition, paradox of voting, rent seeking, bureaucracy.

In a subsequent step, the theory is applied to real world

phenomena and tested empirically. Chapter 6 deals with

normative issues – how to organise a polity etc.

Basic reading is Mueller, D.C. (2003): Public Choice III,

Cambridge

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Literature (suggested Selection)

Arrow, Kenneth J. (1951), Social Choice and Individual Values, New

York.

Becker Gary S. (1983), ‘A Theory of Competition among Pressure Groups for Political Influence’, The Quarterly Journal of

Economics, Vol. 98, pp. 371-400.

Becker, Gary S. (1985), ‘Public Policies, Pressure Groups, and Dead

Weight Costs’, Journal of Public Economics, Vol. 28, pp. 329-

347. Black, Philip, Estian Calitz and Tjaart Steenekamp (eds.) (2011), Public

Economics, 5th ed., Cape Town.

Brennan, Geoffrey and James M. Buchanan (1985), The Reason of

Rules, Cambridge.

Buchanan, James M. and Gordon Tullock (1962), The Calculus of Consent, Ann Arbor.

Coase, Ronald H.(1960), ‘The Problem of Social Cost’, Journal of Law

and Economics, Vol. 3, pp. 1-44.

Downs, Anthony (1957), An Economic Theory of Democracy, New

York.Drazen, Allan (2000), Political Economy in Macroeconomics, Princeton.

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Frey, Bruno S. (2004), Dealing with Terrorism – Stick or Carrot?,

Cheltenham and Northampton.

Hibbs, Douglas A., Jr., (1977), ‘Political Parties and Macroeconomic Policy‘, American Political Science Review, Vol. 71, pp.1467-87.

Hillmann, Arye L. (1989), The Political Economy of Protection, Chur/New

York.

Holcombe, Randall (2006), Public Sector Economics, New Jersey.

Magee, Stephen P., William A. Brock und Leslie Young(1989), Black Hole Tariffs and Endogenous Policy Theory: Political Economy in

General Equilibrium, Cambridge.

Mueller, Dennis C. (2003), Public Choice III, Cambridge.Niskanen, William A., Jr. (1971), Bureaucracy and Representative

Government, Chicago.Nordhaus, William D. (1975), ‘The Political Business Cycle‘, Review of

Economic Studies, Vol. 42, pp. 169-90.

Olson, Mancur, Jr. (1965), The Logic of Collective Action, Cambridge,

MA.

Olson, Mancur, Jr. (1982), The Rise and Decline of Nations: Economic Growth Stagflation and Social Rigidities, New Haven.

Rose-Ackermann, Susan (1999), Corruption and Government,

Cambridge.

Schneider, Friedrich and Dominik H. Enste (2000), ‘Shadow Economies:

Size, Causes and Consequences’, Journal of Economic Literature, Vol. 38, pp. 77-114.

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Shughart II, Willim F. und Laura Razzolini (eds.) (2001), The Elgar

Companion to Public Choice, Cheltenham and Northampton.

Tullock, Gordon (1980), The Welfare Costs of Tariffs, Monopolies and Theft, in: James M. Buchanan et al. (ed.), Toward a Theory of

the Rent-Seeking Society, Texas, S. 39-50.

Wintrobe, Ronald (1998), The Political Economy of Dictatorship,

Cambridge: Cambridge University Press.

Basic: Dennis Mueller, Public Choice III.

Special current references will be given at the very topic.

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Websites (Selection)OECD: http://www.oecd.org

World Bank: http://worldbank.org

World Trade Organization (WTO): http://www.wto.org

International Monetary Fund: http://www.imf.org

European Commission: http://europa.eu.int/comm/

Center for the Study of

Public Choice: http://www.gmu.edu/centers/publicchoice/

Public Choice Society: http://www.pubchoicesoc.org/

European Public Choice Society: http://www.epcs-home.org/

Cato Institute: http://www.cato.org

Fraser Institute: http://www.fraserinstitute.org

VoxEU: http://www.voxeu.org

European Centre for International

Political Economy (ECIPE): http://www.ecipe.org

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1. Introduction

Mainstream economics is generally dealing with two

types of questions:

� Normative analysis: how can individual or

collective welfare be improved?

� Positive analysis: What can we learn about

human behavior? Is man indeed a utility

maximiser? How can we explain minor economic

outcome against the background of theoretical

analysis?

The latter set of questions is relevant for this lecture. We

seek to explain the incentives for policymakers, i.e.

politicians, bureaucrats and organized interests as well as

the outcomes of collective choice.

1. Introduction


3. Public Choice in a Direct

Democracy

4. Public Choice in a Representative Democracy



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� Individualistic approach, rational behavior

� Dismissal of the „benevolent dictator“

Thereby, we also try to explain the sometimes huge

difference between the policy recommendation, achieved

by thorough theoretical analysis, and political reality.

Public Choice has taken three directions:

• logical, theoretical analysis,

• empirical investigation,

• normative critique.

1. Introduction



Democracy




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It has close relations to the New Institutional Economics

and Constitutional Economics.

The new institutional economics discusses the role of

institutions in the market sphere and in the political

sphere.

“Institutions… are the rules of the game in a society, or

more formally, are the humanly devised constraints that

shape human interaction ….reduce uncertainty by

providing a structure to everyday life.” (Douglas North

1990).

1. Introduction



Democracy




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Fundamental Questions of Public Choice Analysis

• What do political science and economics have in

common?

• Why do we need the state and public decision

making?

• What is the incentive structure of decision

makers in

� a direct democracy?

� a representative democracy?

� a dictatorship?

� a cleptocracy?

• Do voting rules affect economic outcomes?

• Why do some interest groups organize

themselves better than others?

• Why do countries with a dictator sometimes

perform better than democracies?

1. Introduction



Democracy




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• Why do we observe poverty and starving on the

one hand and wealth on the other hand in similar

countries?

• Why do we observe hyperinflation?

• Why is structural change so often repressed?

• Why can we observe left governments pursuing

supply side policy?

• Why are political parties often so similar with

respect to their programs?

• Why does social spending increase in time?

• Do elections terms exert influence of

macroeconomic performance?

• Why are public enterprises inefficient?

• What are the incentives of bureaucrats?

• How can we explain the sectoral structure of

protection and subsidization?

1. Introduction



Democracy




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• Is it rational for governments to „support“

criminal activities?

• How can we explain violence and civil conflict?

• Is terrorism rational?

• How can it be combated rationally?

• What is the dictator’s dilemma?

• How can we explain the disappointing

performance of most international organizations

(IOs)?

• Why is official development aid so ineffective?

• Why do reforms not happen?

• Why do reforms happen?

• Are scientists, e.g. academic economists,

different?

1. Introduction



Democracy




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I. The state and rule enforcementII. The state and allocation

a) Externalitiesb) Asymmetrical informationc) Natural monopolies

III. The state and redistribution

Basic literature is Mueller (2003), pp. 8-63.

1. Introduction



Democracy




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I. The State and Rule Enforcement

The state is needed to set rules and take care for

enforcement on a just basis. Enforcement needs a strong

state:

� Police

� Armed forces

� Independent judiciary

� Checks and balances

� Normative statement

� Constitutional Economics (see below)

1. Introduction



Democracy




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The view of the state in Economics is that it is the

organisational structure of a polity.

The state is not regarded as standing above the human

being � Constitutional Economics or citizens vs.

(subjects) Untertanen!

Members of society agree unanimously on a social

contract or a constitution. As long as actions are made

within these rules, the outcome is perceived as being fair.

In this view, there are three types of reasons for the

existence of the state. It is necessary:

• to set and enforce rules,

• to take care for allocation, and

• to organise redistributive policy.

1. Introduction



Democracy




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Constitutional Economics: Social contracts

1) A just social contract (John Rawls)

Rawls argues with an original position with total equality;

each member of the community gives up her knowledge

about her position in society and steps behind a veil of

ignorance.

Equality in the original position leads to unanimity over

the social contact. The economic outcome is perceived

as being the result of a gamble with random results;

therefore it is not acceptable.

Two principles of justice:

• equal rights to most extensive basic liberties;

• equal distribution of social values � Maximin!

1. Introduction



Democracy




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2) Constitutional economics (James Buchanan and

Gordon Tullock)

Buchanan and Tullock (1962): no normative position,

they assume unanimity at the constitutional stage.

Homann and Vanberg have given up this assumption

� fictious consensus is satisfying the conditions.

The veil is a veil of uncertainty, as any individual can be

sure about the rules of the game, but not its outcome.

This will be accepted as long there is no betrayal.

Different types of uncertainty:

Identity, numbers and payoffs.

1. Introduction



Democracy




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II. The State and Allocation

Allocation theory shows that in general, markets are

efficient and generate welfare optima (without notice of

distribution).

However, there are cases of market failure. Three forms

can be distinguished:

• externalities,

• asymmetrical information,

• natural monopolies.

For many, these are the main reasons for the state to act

economically.

If the markets fail, governmental intervention is

necessary to care for efficient allocation.

1. Introduction



Democracy




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a) Externalities

aa) Definition:

Economic activity of one person (firm) has an impact on

the consumption or production of another person or firm.

Consumption

Ui = Ui (xi, yi, Z),

the utility function contains arguments not to be

influenced by individual i.

Production

Πx = Πx (Kx, Lx, Z),

the production function of x is influenced by an activity of

a third person (firm).

1. Introduction



Democracy




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In such a case, the government has to try to internalise

these external cost.

� Pigou tax,

� Pigou subsidy,

� property rights

Economic problem: exact measurement of cost.

Political problem: exact definition of property rights.

� Market Failure versus state failure.

State failure implies inappropriate definition of property

rights, economically inefficient internalisation of external

cost etc. It has no moral dimension.

1. Introduction



Democracy




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bb) Coase Theorem

Ronald Coase has shown that in the absence of

transaction cost and with clearly defined property rights

external effects do not exist.

In addition, it does not matter for the economic efficiency

and ecological effectiveness whether the party

responsible for damages or that party suffering from

damages has the property rights.

However, transaction cost is rarely negligible and

property rights are sometimes difficult to define.

� The Coase solution is almost impossible to reach.

Nevertheless, Coase demonstrated the irrelevance of

distribution of property rights as well as the relevance of

transaction cost.

1. Introduction



Democracy




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Normative and positive aspects of environmental policy

There are several ways to internalise external cost:

• Ordnungsrecht

� emission thresholds

� technological standards

• Pigou-tax

• Standard-price-approach

• private negotiations (Coase)

� Emission Banking

� Bubble Policy

• Emission certificates

Public choice does not analyse the normative properties,

i.e. economic cost and ecological effectiveness, but the

reason for policymakers to choose a certain environmental

policy; � again market versus state failure.

1. Introduction



Democracy




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cc) Public goods

Public goods as extreme case of (positive) externalities:

� non rivalry (jointness) in supply and

� impossibility of exclusion.

Types of goods:

• private good,

• common pool property,

• club good,

• public good,

• merit goods,

Free rider problem as the basic problem of collective

choice.

1. Introduction



Democracy




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Free rider problem

What are individuals willing to pay for the provision of a

public good?

Simple but only seemingly precise answer: nothing.

More complicated answer: it depends, on what?

• individual gains from cooperating

• differences in individual gains

• level of state activities already reached

• group size

• social conventions

Prisoners’ dilemma vs. coordination games and chicken

games

1. Introduction



Democracy




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B

A

Does not

Steal

Steals

Does not

steal

1

(10,9)

4

(7,11)

Steals 2

(12,6)

3

(8,8)

Figure 2.1: Prisoners‘s dilemma

Source: Mueller, Dennis C. (2003), …, p.10.

1. Introduction



Democracy




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D

G

Strategy

A

Strategy

B

Strategy

A

1

(a,a)

4

(0,0)

Strategy

B

2

(0,0)

3

(b,b)

Figure 2.2: A coordination game


1. Introduction



Democracy




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D

G

Contributes tobuilding fence

Does not

contribute

Contributes to

building fence

1

(3,3)

4

(2, 3.5)

Does not

contribute

2

(3.5, 2)

3

(1,1)

Figure 2.3: A game of chicken


1. Introduction



Democracy




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The prisoner’s dilemma shows the typical problem

related to the provision of public goods, namely free

riding.

The coordination game is solved, as both individuals

gain most from cooperating � dominating strategy. No

one can improve his situation at the expenses of others.

The latter game will at any rate been solved at a

maximum when it is repeated, whereas the prisoner’s

dilemma can (but not must) evolve again and again.

The game of chickens is the most tricky one, as cell 1 is

not the dominant strategy. It may be advantageous to

signal credibly not to contribute. In this case, the partner

may still choose to contribute.

� Application in international affairs

1. Introduction



Democracy




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b) Asymmetrical information

Principal-agent-problems (PAP), whether defined as

adverse selection (ex-ante) or as moral hazard (ex-post),

cause markets to fail.

Ownership and control are separated. Examples are:

• market for insurances,

• labour markets,

• quality aspects (consumer protection).

The regulation of these markets is aiming at healing the

market failure; it may, however, lead to state failure:

• insurance: overregulation, capture;

• labour market: employment protection legislation;

• consumer protection: trade protectionism.

1. Introduction



Democracy




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c) Natural monopoly

A natural monopoly exist, if (marginal and) average cost

decrease in the relevant demand areas under a given

technology. Only one firm can serve the demand without

welfare losses. Here is a need for regulation, e.g. by:

• price regulation (cost oriented, rentability

oriented, ECPR, Price Caps, Ramsey-rule);

• capital return regulation;

• competition for the market;

• prohibition of discrimination;

• structural separation of multi product firms;

• limitation of activities.

�� Problem: regulatory capture*

* Literature: Stigler, George J. (1971), „The Theory of Economic

Regulation”, Bell Journal of Economics and Management Science, Vol.

2, pp. 3-21.

1. Introduction



Democracy




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III. The Redistributive State

A Pareto efficient allocation of resources and goods may

not be just.

Society may feel the need to redistribute income and to

even out huge income differentials as well as to insure its

members against severe risks of life.

These risks include illness, unemployment, wealth

losses.

Age cannot be regarded as risk, rather as a chance!

Nevertheless, there may be the need for collective action

with respect to old age protection:

� externalities, moral hazard.

1. Introduction



Democracy




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How can the redistributive state act?

1) Redistribution as insurance/ social contract.

2) Redistribution as public good.

3) Redistribution to satisfy fairness norms.

4) Redistribution to increase allocative efficiency.

It may be possible to model these types in a way to

reach unanimity about it. Notwithstanding, governments

may go too far or exploit certain groups by purpose:

5) Redistribution as taking.

Of course, the organisation of redistribution has impact

on economic incentives � shadow economy, corruption.

1. Introduction



Democracy




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Redistribution as takingTable 2.1 Costs and benefits of the EU’s common agricultural

policy in comparison with free market outcome, 1980 (mio of US$)

country producers consumers government net

EC-9 -30,686 34,580 11,494 15,388

West

Germany -9,045 12,555 3,769 7,279

France -7,237 7,482 2,836 3,081

Italy -3,539 5,379 1,253 3,093

Netherlands -3,081 1,597 697 -787

Belgium/

Luxembourg -1,24 1,4 544 320

UK -3,461 5,174 1,995 3,708

Ireland -965 320 99 -546

Denmark -1,736 635 302 -799

Source: Mueller, p. 62.

1. Introduction



Democracy




M.Sc. in Economics (6 Credits) - uni-jena.deChoice+2016_17+_+Chapters+1_2.pdf · Public Choice...

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