Political economy Government growth

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Political economy Government growth Today: How do people vote in a democracy? Why did the government grow so much in the 20 th century?

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Political economy Government growth. Today: How do people vote in a democracy? Why did the government grow so much in the 20 th century?. Democracy. Political decision making is important for public finance Two types of democracy in this “mini-lecture” Direct Indirect, or representative. - PowerPoint PPT Presentation

Transcript of Political economy Government growth

Page 1: Political economy Government growth

Political economyGovernment growth

Today: How do people vote in a democracy?Why did the government grow so much in the 20th century?

Page 2: Political economy Government growth

Democracy

Political decision making is important for public finance

Two types of democracy in this “mini-lecture” Direct Indirect, or representative

Page 3: Political economy Government growth

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

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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

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Direct democracy: Unanimity rules

r per year0

0’

Ada

m’s

sha

re (S

A)

Eve

’s s

hare

(SE)

DrA

The Lindahl Model

DrE

r*

S*

Notice that by construction of graph, shares add up to one at each point

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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

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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”

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Jen: Double-peaked preferences

Missiles

Util

ity

A B C

Brad

Jen

Angelina

Single-peaked preferences

Double-peaked preferences

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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

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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

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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

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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

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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

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The median voter theoremVoter Most desired

expenditure on breast cancer

researchAbby $50

Betty $1,000

Christine $1,100

Doris $2,500

Elaine $50,000

Median voter theorem predicts that $1,100 will be voted on

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Niskanen’s model of bureaucracy

Q per year

$

0

VC

Q*

Efficientoutput

Qbc

Bureaucrat’s suggested output

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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

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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

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Rent-seeking behavior

tons of peanuts per year

$

S=MC

D

MR

RentsCompetitive outcome

Cartel price and quantity

Deadweight loss with a cartel

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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

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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

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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?

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Explaining Government Growth Five theories of government growth

Citizen preferences Marxist view Chance events Changes in social attitudes Income redistribution

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Institute constitutional limits

If Congress cannot regulate its own spending, should there be a constitutional amendment that does limit spending?

Most economists believe “no”

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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?

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Outcome of government spending Estimated public debt in 2010

$9.9 trillion (up $2 trillion from 2009) 67.1% of GDP (up 12.5 percentage points from

2009)

Source: Wikipedia article on US public debt

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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

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Problems

Lindahl model Majority voting Median voter theorem Efficient government spending

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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

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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

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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

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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

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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

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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 JacquelineA Y ? ? Y NB N Y Y ? N

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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?

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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

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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?

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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

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Efficient government spending problem What is the output predicted by Niskanen’s

model? Set V = C 100Q½ = Q Q = 10,000

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See you on Wednesday