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1
Public Choice
M.Sc. in Economics (6 Credits)
Summer Term 2019
Monday, 10-12 c.t., Start April 8, 2019,
Carl-Zeiss-Str. 3, HS 8
Prof. Dr. Andreas Freytag
LS Wirtschaftspolitik, FSU Jena
Announcement
June 21, 2.15 p.m., there will be a lecture by
Prof. Razeen Sally, Ph.D., Lee Kuan Yew School of
Public Policy, National University of Singapur
“Capitalism in Asia: A Schumpeterian Perspective“
Venue: Senatssaal der FSU
2
© Freytag 2019
3
Announcement I:
Consulting hour: upon appointment
Time and venue of the written exam:
tba
Net time is one hour
Please subscribe at Friedolin
4
Announcement II: Exercise
The exercise is performed by
Sebastian Schuhmann, M.Sc.
Tuesday, 16-18 c.t., Start April 23, 2018,
Carl-Zeiss-Str. 3, HS 9
Consulting hour: upon appointment
5
Uber is represented in around 570 cities, but not in many
German cities – 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 US and the EU protect the steel market -
Why?
Low interest rate policies have never proven ineffective;
the ECB insist on its – Why?
Farming in the EU is employing less than 2 per cent of the
labor force, its contribution to GDP is about 1.5 per cent.
Though, there are own ministries for agriculture – Why?
© Freytag 2019
6
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© Freytag 2019
7
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
© Freytag 2019
8
Literature (suggested Selection)
Aidt, Toke (2018), Corruption. Chapter for the Oxford Handbook in
Public Choice, Oxford.
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.
Congleton, Roger D., Bernie N. Grofman and Stefan Voigt (2019), The
Oxford Handbook of Public Choice, Volume 1 & 2, Oxford.
© Freytag 2019
9
Downs, Anthony (1957), An Economic Theory of Democracy, New York.
Drazen, Allan (2000), Political Economy in Macroeconomics, Princeton.
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. (2019), Public Finance and Public Policy, 3rd edition,
Cambridge.
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 and Bonnie J. Paflika (2016), Corruption and
Government, Causes, Consequences, and Reform, Cambridge.© Freytag 2019
10
Schneider, Friedrich and Dominik H. Enste (2000), ‘Shadow
Economies: Size, Causes and Consequences’, Journal of
Economic Literature, Vol. 38, pp. 77-114.
Shughart II, William 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.
© Freytag 2019
11
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: https://publicchoice.gmu.edu/
Public Choice Society: https://publicchoicesociety.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
© Freytag 2019
12
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
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
© Freytag 2019
13
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
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
© Freytag 2019
14
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
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
© Freytag 2019
15
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
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
© Freytag 2019
16
• 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
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
© Freytag 2019
17
• 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
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
© Freytag 2019
18
2. Origins of the State
I. The state and rule enforcement
II. The state and allocation
a) Externalities
b) Asymmetrical information
c) Natural monopolies
III. The state and redistribution
Basic literature is Mueller (2003), pp. 8-63.
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
© Freytag 2019
19
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
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
© Freytag 2019
20
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
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
© Freytag 2019
21
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
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
© Freytag 2019
22
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
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
© Freytag 2019
23
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
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
© Freytag 2019
24
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
x = x (Kx, Lx, Z),
the production function of x is influenced by an activity of
a third person (firm).
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
© Freytag 2019
25
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
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
© Freytag 2019
26
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
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
© Freytag 2019
27
Digression: 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
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
© Freytag 2019
28
cc) Public goods
Public goods as extreme case of (positive) externalities:
non rivalry (jointness) in consumption and
impossibility of exclusion.
Types of goods:
• private good,
• common pool property,
• club good,
• public good,
• merit goods Nudging
Free rider problem as the basic problem of collective
choice.
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
© Freytag 2019
29
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
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
© Freytag 2019
30
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
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
© Freytag 2019
31
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
Source: Mueller, Dennis C. (2003), …, p.15.
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
© Freytag 2019
32
D
G
Contributes to
building 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
Source: Mueller, Dennis C. (2003), …, p.16.
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
© Freytag 2019
33
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
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
© Freytag 2019
34
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
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
© Freytag 2019
35
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
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
© Freytag 2019
36
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
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
© Freytag 2019
37
How can the redistributive state act?
1) Redistribution as insurance/ social contract.
2) Redistribution as public good.
3) Redistribution to satisfy fairness norms inclusive
societies
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
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
© Freytag 2019
38
Redistribution as taking
Table 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
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
© Freytag 2019
39
3. Public Choice in a Direct Democracy
I. Unanimity Rule
II. Optimal Majority Rule
a) Choosing the optimal majority
b) Simple majority as the optimal majority
III. Majority Rule
a) Exploitation of the minority
b) Cyclical preferences
c) Multidimensional issues
IV. Log-Rolling
V. Agenda manipulation
VI. Alternatives to the majority rule
VII. Exit, Voice and Disloyality
VIII. Summary: Normative properties of majority rule
Basic Literature is Mueller, 2003, pp. 67-206
© Freytag 2019
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
40
I. Unanimity rule
To reach Pareto-optimal results for public decisions,
unanimity is needed for. Otherwise, single individual
preferences would be neglected, and the decision would
leave losers.
See following slides and Mueller (2003), pp. 67-72.
An important implication is that the rule determines
whether or not and if so where, a Pareto optimum can be
met.
Shortcomings of the unanimity rule:
• much information needed,
• much time needed, and
• strategic behaviour possible.© Freytag 2019
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
41
For decision making in a direct democracy, the choice of
a voting rule seems decisive.
Where can the voting procedure be of relevance in
today’s world?
• clubs,
• parliament (Bonn-Berlin decision),
• EU (treating member states as individuals), …
Two “rules” (Rousseau) for setting the voting rule:
• import topics demand unanimity, and
• fast decisions demand minimal majorities.
© Freytag 2019
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
42
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© Freytag 2019
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
43
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XU
GU
XU
GU
B
B
A
A
3.5
)1(/
/
/
/
tXU
GU
tXU
GU
B
B
A
A
3.6
© Freytag 2019
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
44
X
YA
G
1
0
2
A
G1 t1 t.5 t.33G0 G2
Figure 3.1: Optimal quantities for a voter
at different tax prices
© Freytag 2019
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2. Origins of the State
3. Public Choice in a
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4. Public Choice in a
Representative
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5. Application of Political
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6. Normative Public
Choice
45
t
t.5
t.33
0
1 2
A
GG1 G0 G2
Figure 3.2: Mapping of voter preferences
into tax-public good space
© Freytag 2019
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3. Public Choice in a
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
46
F
GGF
A1
A2A3
A4B1
B4
B3
B5
C
C`
B2
A5
L
E
tF
tL
tE
Percentage of tax paid by…
B A
t100
t100 t0
t0
Figure 3.3: Contract curve in
public good-tax space
© Freytag 2019
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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47
II. Optimal majority
Unanimity is not realistic, not so much because of
individual strategic behaviour but because of its
enormous cost. Buchanan and Tullock (1962) show that
the optimal majority depends on cost related to the
decision.
a) Choosing the optimal majority
Two types of cost occur:
• (external) cost C of the losers of the decision and
• cost D of achieving the required majority.
Whereas C is decreasing with the number of people who
agree on the decision, D is increasing with the number of
citizens who have to agree.© Freytag 2019
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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48
0
Expected
costs
D C
C+D
K Number of indivduals
whose agreement is
required for collective
action
N
Figure 3.4: Choosing the optimal majority
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4. Public Choice in a
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5. Application of Political
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49
Obviously, the optimal majority is not the same for all
decisions to be made.
External cost C may vary depending on the nature of the
decision and on the size N of the community.
The cost curve D associated with the number of
individuals necessary to form a consensus may shift
rightwards with increasing N.
b) Simple majority as the optimal majority
So, generally speaking, what is the optimal majority? It
can’t be below N/2.
See Figure 3.5, which shows a special case in that there
is a kink at N/2.
Approximately, N/2, i.e. simple majority can be assumed
to be the optimal majority in big communities. © Freytag 2019
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4. Public Choice in a
Representative
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5. Application of Political
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6. Normative Public
Choice
50
C+D
D
C
C+D
D
Expected
costs
Number of indivduals whose
agreement is required for
collective action
N0
N/2
Figure 3.5: Conditions favouring a simple
majority as the optimal majority
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
51
III. Majority rule
a) Exploitation of the Minority
Consider a society which is better off with a collective
good (such as redistribution) than without; consider also
two groups, the rich and the poor.
A tax introduced would finance the collective good,
depending on the kind of tax, either both groups would
gain or one of the groups would lose.
Unanimity rule would lead to one of many Pareto optima,
because either the society would remain at the status
quo ante, or both groups win.
Majority voting would not lead to a Pareto optimum, as
the majority is likely to exploit the minority.
See Figure 3.6.© Freytag 2019
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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52
UR
S
C
B
XA
Y
E
Z
W UP
Majority rule
outcomes, rich
in majority
Unanimity rule outcomes
Majority rule
outcomes, poor
in majority
Figure 3.6: Outcomes under
the unanimity and the simple
majority rule
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4. Public Choice in a
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5. Application of Political
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53
One lesson from the discussion of a collective good is to
restrict the decisions to those individuals directly involved
both in the decision and its consequences.
In other words, it is highly sensible to reduce the number
of public goods and to increase the number of club
goods.
For the European Union, this lesson is also of
importance.
As long as the unanimity rule holds for many issues – but
also if not – the process should come up with modest
harmonisation efforts to minimise the number and cost of
losers.
Subsidiarity principle, implying that measures should
be taken on the lowest possible level.
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
54
b) Cyclical Preferences
Consider three persons who shall divide 100 € among
themselves.
Possible outcome: (1): 55/45/0,
(2): 50/0/50,
(3): 0/60/40,
V1: (1) > (2) > (3) < (1),
V2: (1) > (2) < (3) > (1),
V3: (1) < (2) > (3) > (1).
Community under majority rule: (1) > (2) > (3) > (1).
The community cannot find a first best solution but
produces a cycle.
See Figure 3.7.© Freytag 2019
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5. Application of Political
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6. Normative Public
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55
X Y Z Q
U
V1
V3
V2
Figure 3.7: Voter preferences that
induce a cycle
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4. Public Choice in a
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5. Application of Political
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56
c) Median voter theorem
If society has to decide about a single issue and if all
voters have single peaked preferences, then the median
position cannot lose under majority.
Plott’s theorem (Figure 3.13).
d) The median and multidimensional issues
How does it work when multidimensional issues are
discussed? Then, the outcome depends on the number
of committee members who decide:
• committee of 1: no problem (Figure 3.8).
• committee of 2: contract curve (Figure 3.9),
• committee of 3: no solution (Figure 3.10) or like a
committee of 2 (Figures 3.11 and 3.12).
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
57
AUA
x2
x1
Figure 3.8: Outcome for a committee
of one
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
58
A
B
E
UA
UB
D
x2
x1
Figure 3.9: Outcomes for a committee
of two
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
59
A
B
C
D
Z
UA
UB
x2
x1
Figure 3.10: Cycling outcomes for a
committee of three
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
60
E
A
B
x2
x1
Figure 3.11: Equilibrium outcome for a
committee of three
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4. Public Choice in a
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5. Application of Political
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61
E
A
G
F
B
x2
x1
Figure 3.12: Outcome for a committee
of five
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5. Application of Political
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6. Normative Public
Choice
62
E
A
B
x2
x1
Figure 3.12: Plott’s theorem
FG
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63
IV. Log-rolling
The trading of votes is illegal in democracies.
Nevertheless, it happens regularly. Reasons are:
• differences in preference intensities across
issues;
• inclination to trade.
Voters Issue 1 Issue 2
A -2 -2
B 5 -2
C -2 5
The figures show net utility if the respective laws pass
the committee of three, otherwise utility is zero.
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64
Each law would fail if individually decided upon. If B and
C trade votes, both laws will pass log-rolling.
This is not Pareto-optimal. However, (under cardinal
utility), A can be compensated, and the community is
better off (net utility is +2).
Imagine A’s net utility for both issues is -4. Then, the
community faces a net utility of -2.
Policy implications are different, depending on the net
results:
too many and to generously provided public
goods (negative);
reforms are possible (general compensation);
bluffing and cheating may take place.© Freytag 2019
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4. Public Choice in a
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5. Application of Political
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65
A final judgement of log-rolling depends on the very
case.
Log rolling is not possible with transitive social
preference orderings.
In reality, log-rolling can be observed in US Congress as
well as in the European Union.
Testing for log-rolling cannot be done directly (as it is
illegal), but indirectly by analysing the voting behaviour in
single cases.
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4. Public Choice in a
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5. Application of Political
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66
V. Agenda manipulation
If individual preference ordering might produce cyclical
voting under the majority rule, a committee member in
control of the agenda of pairwise voting can manipulate
the committee.
The outcome will be the one the agenda setter prefers
most (Figure 3.14).
Policy implications:
• power of agenda setter may be substantial;
• decisions reached by committees are not
necessarily reflecting the preferences of the
median;
• agenda setters may influence distributional
issues to their advantage.© Freytag 2019
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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67
S
ZC
Z‘
AZ‘‘
UA
UB
UA
UB UC
B
x2
x1
Figure 3.14: Agenda manipulation possibilities© Freytag 2019
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68
VI. Alternatives to the majority rule
One can think of a number of alternatives to the majority
rule:
• majority rule, runoff election;
• plurality rule;
• Condorcet criterion;
• Hare system;
• Coombs system;
• Approval voting;
• Borda count;
These systems are relatively simple and easy to apply.
Indeed, many of them are regularly applied in daily life
(often without knowing).
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4. Public Choice in a
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5. Application of Political
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69
There are more complicated and tricky alternatives to the
majority rule:
• demand revealing process;
• point voting;
• voting by veto.
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5. Application of Political
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70
VII. Exit, voice and disloyalty
So far, we have concentrated on the provision of pure
public goods voice is the only option for the individual.
However, pure public goods are rare (see chapter 2).
Therefore, we turn to club goods. Clubs have an optimal
size, as the marginal benefits of additional members
decreases, whereas their marginal cost increase (James
Buchanan).
In addition, clubs are competing for members exit as a
second option becomes available (Charles Tiebout).
We may overcome problems of the majority rule by
concentrating on clubs.
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71
Under the following conditions, it is possible to ensure
global optimality of excludable public goods provision
and apply both the theory of clubs and the theory of exit:
• full mobility of all citizens;
• full knowledge of the characteristics of all clubs
• all desired public goods available in clubs
• no scale economics in production of the public
good
• no spillovers across clubs
• no geographical constraints on individual with
respect to their earnings
It can be shown that voting-with-the-feet can produce
global optimality.
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72
Empirical relevance
3 hypotheses:
1. Individuals move in response to local
government expenditure-tax offerings.
2. People with similar preferences for bundles of
public goods live together in groups.
3. Individual satisfaction increases when voting-
with-the-feet is possible.
Empirical evidence is available for the United States.
It mainly supports the Tiebout hypotheses. This
seems different in Continental Europe.
Less club goods and more “pure” public goods.
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5. Application of Political
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73
FOCJ – A normative application*
FOCJ stands for “Functional, overlapping, competing
jurisdictions” and implies that individuals select
among different clubs to meet their demand for club
goods. No one is forced to “purchase” all “public
goods” at one jurisdiction, but can select.
Entry into clubs is not free, but exit has definitely to
be free.
The authors – with a special reference to the
European constitution – suggest that the EU should
be organised according to this proposal.
* Frey, Bruno S. and Reiner Eichenberger (1995), ‘Competition
among Jurisdictions: The Idea of FOCJ’, Lüder Gerken (ed.),
Competition among Institutions, Houndsmill, Macmillan, pp. 209-
229.
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5. Application of Political
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74
Disloyalty - revolution
“When neither the ballot nor the feet constitute
adequate modes of expression, there is still
Chairman Mao’s barrel of the gun.” (Mueller 2003,
…, p. 204).
It may be rational to start a revolution, if exit and
voice are no suitable alternatives. The decision to
start a revolution and/or to participate is dependent
on the expected payoffs and the relative weight of
cost (transaction cost, imprisonment, death etc.).
For an experimental analysis of the predictions made
by an economic approach see Abbink and Pezzini.*
* Abbink, Klaus and Silvia Pezzini (2005), Determinants of Revolt:
Evidence from Survey and Laboratory Data,
http://www.nottingham.ac.uk/economics/cedex/papers/2005-
01.pdf© Freytag 2019
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75
VIII. Summary: Normative properties of the
majority rule
After discussing a number of different voting rules and
their properties, we now turn to some normative
conclusions.
Again Rousseau:
Big issues demand unanimity constitutional decision.
Urgent issues demand majority rule.
Condorcet’s Jury theorem: Assume a pairwise
comparison of two a priori equally “good” alternatives by
each voter independently. A rising (odd) number of
voters can increase the probability that the group makes
the correct decision.© Freytag 2019
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76
Assumptions are the following:
• a common probability of being “good” across all
individuals,
• independent voting,
• honest voting.
From this theorem, we can derive a normative
justification of the majority rule.
The theorem can also justify referenda.
Nevertheless, the majority rule is not favourable in every
situation.
Table 3.1 compares majority and unanimity rule with
respect to different circumstances.
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77
Example: „Condorcet‘s Jury Theorem“
Decision: „guilty or not guilty“
pi probability of the judge i to make the „correct“ decision
(assumption in this example: pi for all judges = 0.6)
Pn probability of the jury to make the correct decision under majority rule
a) One judge:
Pn = P1 = 0.6
A, B, C correct A, B correct B, C correct A, C correct
P3 = 0.216 + 3 * 0.144 = 0.648 > 0.6
b) Three judges A, B and C (intuitive example):
Correct decision if 2 or 3 judges are correct (majority)
Pn = P3 = 0.6 * 0,6 * 0.6 + 0.6 * 0.6 * 0.4 + 0.4 * 0.6 * 0.6 + 0,6 * 0.4 * 0.6.
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78
Example: „Condorcet‘s Jury Theorem“
c) 5 Judges
5
3h
h5h
5n 0,40,6h)!(5h!
5!pp
P5 = 0.3456 + 0.2592 + 0.07776 = 0.6824 > 0.648
h = 3 h = 4 h = 5
(h = (n+1)/2 = majority)
d) 11 Judges: Pn = p11 = 0.753
• 51 Judges: Pn = p51 = 0.926
• more than 100 judges: pn = pretty close to 1
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79
Table 3.1: Assumptions favouring respective rules
Assumption Majority rule Unanimity rule
1. Nature of game Conflict, zero sum Cooperative, positive sum
2. Nature of issues
Redistributions, property rights
(some benefit, some lose)
Mutually exclusive issues of a
single dimension
Allocative efficiency
improvements (public goods,
externality elimination)
Issues with potentially several
dimensions and from which all
can benefit
3. Intensity Equal on all issues No assumption made
4. Method of forming
committee
Involuntary; members are
exogenously or randomly
brought together
Voluntary; individuals of
common interests and like
preferences join
5. Conditions of exit Blocked, expensive Free
6. Choice of issuesExogenously or impartially
proposed
Proposed by committee
members
7. Amendment of
issues
Excluded, or constrained to
avoid cycles
Endogenous to committee
process
Source : Mueller, p. 141.
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80
4. Public Choice in a Representative
Democracy
I. Federalism
a) The logic
b) Why is the size of the government too
large?
c) Why is the size of the government too
large and to small?
II. Two-party competition and deterministic voting
a) Outcomes in the Hotelling-Downs-Model
b) Two-party competition in a constrained
policy space
c) Two-party competition (probabilistic
voting)
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81
III. Multi-party-Competition
a) Selecting a representative body
b) Proportional representation in practice
c) Electoral rules and the number of parties
d) Goals of parties
e) Cabinet stability
f) Strategic voting
IV. The paradox of voting
a) Rational voter hypothesis
b) Expressive voter hypothesis
c) Ethical voter hypothesis
d) Voting as duty
V. Rent seeking
a) The basic model
b) Rent seeking through regulation
c) Rent seeking through tariffs and quotas
d) The logic of collective action
e) The costs of protection
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VI. Bureaucracy
a) Budget maximization
b) Price-setting behavior
c) Slack maximization
d) The power of the agenda setter
e) The government as leviathan
f) Regulatory capture
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83
Introduction
Whereas in a direct democracy, problems of lobbying
and administration do not play a major role, in a
representative democracy they do.
Principal-agent-problem
In a representative democracy, public choice analysis is
even more adequate, as a political market can clearly be
observed. On this market, political entrepreneurs try to
sell their product, and rent-seeking groups express their
demand.
There are different levels of decision-making. This
constitutes more difficult problems.
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84
I. Federalism
Federalism can be interpreted as an application of the
theory of clubs.
The assignment problem under federalism is not about
the horizontal assignment of responsibility for e.g.
monetary policy, fiscal policy, industrial relations etc (see
below). Rather it is about the assignment of policy
responsibility to different levels of decision-making.
Following the Tinbergen-principle, each policy goal
needs an individual instrument.
Neoclassical assignment adds the requirement to have
an individual agency for each objective.
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The assignment problem
Objective Instrument Agency
growth fiscal policy govt.
stable prices monetary policy ECB
employment wages unions/
empl.
a) The logic
A simple example may illustrate the point.
Consider a community of nine, divided into sub-
communities of three, A, B and C. Two public goods,
GF as the federal and GL as the local public good, are
to be provided.
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First assume the both, GF as the federal and GL as the
local public good, are provided centrally under majority
rule.
A1 A2 A3 B1 B2 B3 C1 C2 C3
Under Plott’s theorem, B2 is the median and the amount
of both GF and GL will be provided.
In the case of the federal public good, all have to
consume the chosen level.
In the case of the local public good, the groups A, B and
C would prefer a different outcome. They would chose
A2, B2 and C2 respectively.
GF, GL
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Group A would consume less of the local public good GL,
whereas group C would like to have more of it.
The superior solution would, therefore, be to assign the
responsibility for GF to the larger community and for GL to
the local communities.
Federalism has two salient properties (compare: FOCJ):
• separate and overlapping levels of government,
• different responsibilities at different levels.
Obviously, federalism has its limits. There are least
classes of public goods provided on the same political
level, and the number of levels must not be too high; the
reason being
transaction cost.
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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88
Geographic representation vs. at large
representation
Geographic representation implies that each local
community sends one (or more) representatives to an
assembly of the higher level of government.
At large representation implies that all voters select their
candidates for the higher governmental level from one
single list.
There is not necessarily a consideration of the regional of
local minorities, depending on the individual voting
behaviour.
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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89
b) Why is the size of government too large under
federalism?
Log-rolling!
Under local responsibility, group A will consume less the
local public good GL than groups B and C.
If B and C form a coalition to provide GL within the large
community, they can reduce their tax per capita at the
expense of A.
This scenario happens under geographic
representation.
It may be different under at-large representation.
Log-rolling may hit back in the future universalism!
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
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6. Normative Public
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Intergovernmental grants under federalism
Is there a justification for grants from one governmental
level to another (normally top down)?
Positive externalities, example state highway (US), used
by citizens from all US states.
A federal grant then is a Pigouvian subsidy, financed e.g.
through lump sum taxes.
What are the effects of …
• a matching grant (Figure 4.1);
• an unconditional grant (Figure 4.2);
• an earmarked grant?
Grants can also be justified by financial differences
across communities.
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
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6. Normative Public
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91
U2
U1
B
B
B‘
GMG
G0
X0
X
G
E
F
G
EF – substition effect
FG – income effect
Figure 4.1: The effects of matching grants1. 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
© Freytag 2019
92
B
B‘
B B‘X0 XUG
GUG
G0
B‘‘U1
U2
X
G new budget constraint: BB“B‘
EF income effect, no substitution effect
E
F
U4
U5U3
switch U3 U4 not possible
switch U3 U5 possible
Figure 4.2: The effects of unconditional and earmarked
lump-sum grants1. 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
© Freytag 2019
93
Empirical evidence is contradicting the basis hypothesis
as derived from Figure 4.2: Both unconditional and
earmarked grants should be divided into an increase of
the public good and more private consumption or savings
(e.g. via tax reduction).
Flypaper effect: federal money sticks where it
lands, in the local governmental budget!
Reasons:
• fiscal illusion;
• bureaus tend to maximise their budget
(Niskanen 1971);
• an earmarked grant is treated like a matching
grant.
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
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6. Normative Public
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94
c) Why may the size of government be too large and
too small under federalism?
Assume a two level state with a government only striving
for re-election; a very simple model where median voter
theorem does not hold.
In the model, spending money increases the probability
of re-election, raising taxes decreases it
Under geographic representation, two public goods are
in the calculus of the government; GL and GF.
As a result of the optimisation process, the government
provides GL on a more then optimal level and GF on a
less than optimal one.
Figure 4.3 a) and b).
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
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6. Normative Public
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95
0 GG G0L
GGL
GL
MCL
MCGL
MVL, MCL
0 GG GGFG0
FGT
F
MCF
MVGF
MVF
MVF+MVGF
GF
Figure 4.3: Effects of grants on government
expenditures in a federalist system
(a)(b)
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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96
II. Two-party competition - deterministic
voting
With an increasing size of communities (polities), direct
democracy becomes unrealistic. Thus, decisions are taken
by representatives. These are assumed to behave
rationally and as utility maximisers.
Put differently: “…parties formulate policies in order to win
elections, rather than win elections in order to formulate
policies.” (Downs 1957, p. 28, cited after Mueller 2003, p.
230).
Three important aspects
• behaviour of representatives (campaign and office),
• behaviour of voters,
• outcome under representative democracy.
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
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6. Normative Public
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97
Much of what we learned with respect to direct democracy,
also applies to representative democracy, e.g.
• median outcome,
• cycling,
• log-rolling.
a) Outcomes in the Hotelling-Downs-Model
The basic model is the Downs model.* However, the first to
analyse political competition in a spatial model was Harold
Hotelling.**
The easiest way to think of Hotelling’s model is to imagine
a western city with a couple of saloons. Where will you find
the saloons?
* Downs, Anthony (1957), An Economic Theory of Democracy, New York.
** Hotelling, Harold (1929), ‘Stability in Competition’, The Economic Journal, Vol. 39,
pp. 41-57.
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
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6. Normative Public
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Figure 4.4: Median voter outcomes under two-party
competition
Number of
voters
Position of
candidatesL X RM
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
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6. Normative Public
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99
Number of
voters
Position of
candidates
X MNumber of
voters
Position of
candidates
M
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
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6. Normative Public
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The findings of Figure 4.4 (upper part) very much are
similar to the outcome under direct democracy (median).
However, the assumptions are unrealistic:
• one issue dimension (left or right),
• single peaked preferences,
• symmetric and unimodal preference distribution,
• all individuals vote,
• two candidate parties (the terms candidate and
party are used synonymously).
Two reasons may be responsible for a relaxation of the
assumption that all voters do vote:
• indifference and
• alienation.
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
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101
Then, still the median voter outcome holds, as long as the
preference distribution is unimodal and symmetric. The
median voter determines the outcome.
This may change if either preferences are asymmetrically
distributed (mid part of Figure 4.4) or if the distribution is
multimodal (lower pat of Figure 4.4).
In both cases, the degree of alienation is decisive; and in
both parts of the figure, it is too small to change the
median voter outcome.
Like in direct democracy, a problem of instability may arise
if the world is multidimensional, i.e. if a program
comprises of many issues.
Combined with multimodal preference distribution and
alienation, multidimensionality might cause that extreme
candidates win over the median.
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
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102
Again, log-rolling may arise, causing cycles.
Voters Issue 1 Issue 2 Issue 3
A 4 -2 -1
B -2 -1 4
C -1 4 -2
A candidate preferring all alternatives, maximises social
welfare.
However, a candidate preferring issues 1 and 2 and
preferring not issue 3 may win over the first one, as voters
A and C can gain at the expense of voter B.
Cycling, as every platform can be defeated.
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
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6. Normative Public
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103
In a representative democracy, cycles should not be
observed in single elections, as individual candidates
cannot rotate within one campaign.
However, it should be observed in a permanent change of
government (revolving doors).
Alternative hypotheses:
• random hypotheses and
• conspiracy hypotheses.
In the US (the appropriate example for two-party
competition), the incumbent party left government only in
a fourth of the cases.
Why so much stability?
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
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6. Normative Public
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104
b) Two-party competition in a constrained policy
space
Candidates may restrict their platforms only to a subset of
the policy space.
Imagine two parties and three voters (Figure 4.5) with
equally long contract curves. No point in the (x1,x2)-
diagram can defeat all others (see Figure 3.10).
It seems rational for candidates to restrict their platforms
to points close to the voters’ ideal points.
The restricted set of platforms is called the uncovered set.
These still can be defeated, but only in a cycle.
___
In figure 4.5, the uncovered set is the Pareto set ABC.
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
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6. Normative Public
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105
A
B
C
x2
x1
Figure 4.5: Cycling outcomes for a
three-voter electorate
K
I
J
H
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
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6. Normative Public
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106
Relaxing further assumptions
1) If candidates have personal preferences,
• they may only reluctantly remove policy positions,
• the number of dimension may be reduced,
• ideology may become the single dimension.
2) If candidates are not exogenously given, but can enter
and leave the contest, the result is similar. Under the
median voter outcome, it does not make sense to enter, if
one candidate has already declared her platform.
On the other hand, this relaxation shows that under two-
party elections both candidates will not have identical
platforms.
Empirical tests don’t support to the median voter outcome.
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
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6. Normative Public
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c) Two-party competition (probabilistic voting)
A B
C
M
UA UB
UC
Figure 4.6: Cycling possibilities
x
y
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
© Freytag 2019
So far, we have assumed that the voters are easily caught
by and immediately react to the candidates’ moves (see
Figure 4.6). A slight change to the left wins certain votes
and loses others.
This “jerky” response by the voters is implausible:
• the voters are unlikely to be fully informed about
the candidates’ positions;
• the candidates may not know where the voters’
optimal points are;
• there may be random events having influence on
the voters’ decisions.
If we assume probabilistic voting instead of deterministic,
i.e. if voters behave continuously instead of
discontinuously, the median voter outcome is confirmed.
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
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© Freytag 2019
The equilibrium is within the Pareto set, i.e. within the
triangle ABC. Therefore, the normative properties of the
equilibrium are desirable.
What happens if interest groups are introduced into the
analysis?
• The existence of interest groups implies a bias in
the probability of a candidate of being voted for
(see Figure 4.7);
• the candidates know the distribution of the bias
term, but not the individual bias;
• still, the Pareto set can be reached;
• however, different interest groups receive
different weights (welfare);
• “one man, one vote” does not hold any longer.
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
© Freytag 2019
0li ri bij
hi
Frequency
Figure 4.7: A uniform distribution of biases1. 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
© Freytag 2019
111
III. Multi-party competition
a) Selecting a representative body
Two party competition is not accounting for differences in voters’
preferences accurately multi party competition.
Imagine s groups with homogenous preferences each; in a
representative body there are s seats proportional
representation.
Each group sends one representative, so that all kinds of
preferences are represented in the assembly. If s still is too big,
then one could restrict the size of the assembly to m < s members.
Then m – s groups would not be represented. Alternatives
(additions) are
• runoff elections to sort out the number of votes
each of the m elected candidates has,
• randomised choice of m out of s representatives
relying on the law of large numbers.
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
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6. Normative Public
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112
b) Proportional representation in practice
Political practise is still different. In general, it is a
compromise between geographical and at large
representation.
If more than one person per geographic district is sent to
the assembly in the election, a formula to translate votes
into seats in the parliament is needed.
Largest remainders rule:
q = v/s with v (s) = total number of voters (seats),
q = Hare quotient;
vp/q = I + f with vp = votes won by party p,
I = number of seats won by party p,
f = remainder.
The seats are assigned according to the size of I and high f.
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
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5. Application of Political
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6. Normative Public
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The d’Hondt method allocates the remaining seats (after
adding I) by repeated application of the largest
remainders rule.
Alternatives to the Hare quotient are the Droop quota d:
d = v/(s+1) or
d = [v/(s+1)] + 1;
and the Imperiali I:
i = v/(s + 2).
See Table 13.1 in Mueller (2003, p. 268).
If not parties but candidates are elected, the single
transferable vote (STV) can be applied.
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
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6. Normative Public
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114
c) Electoral rules and the number of parties
Duverger’s law: under plurality rule, the number of parties
converges to two. To test this law, one can use the effective
number of parties based on the number of votes (ENV) and
the number of seats (ENS) a party receives respectively:
ENV = [(vp/v)2]-1, and ENS = [ (sp/s)2]-1.
Example Federal Election 9/24/2017
5 parties, 20 per cent of the votes each,
5 party system;
5 parties, 60, 30, 7, 2, 1 per cent of the votes respectively,
2 party system.
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
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6. Normative Public
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115
L R0 1 3 5 7 9 10
Party A Party BParty C Party D Party E
20% 20% 20% 20% 20%
Figure 4.8: Party positions with a uniform distribution
of voter ideal points
d) The goals of parties
Two aspects (levels) are of relevance:
• position on the ideological spectrum
• decision on joining a coalition or forming a
cabinet after election
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
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6. Normative Public
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116
L R0 1 3 5 7 9 10
Party A
Party B
Party C
Party D
Party E
10% 20% 24% 30% 16%
Figure 4.9: Party positions with a nonuniform
distribution of voter ideal points
It is very difficult to say theoretically how both aspects
are dealt with in politics. Parties tend to settle into certain
ideological positions and remain there (empirical
observation).
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
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5. Application of Political
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6. Normative Public
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117
A B C D E F G
15 28 5 4 33 9 6
If a single party does not hold an absolute majority, a
coalition is necessary. There are 61 possible coalitions
that form a majority in the above scenario.
A coalition is called a minimal winning coalition if the
removal of any one member (party) is changing it into a
minority coalition. These are:
BE, ABF, ACE, ADE, AEF, AEG, ABCD, ABCG, ABDG,
CDEF, DEFG.
A minimum winning coalition contains the smallest
number of seats of all minimal winning coalitions (CDEF).
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
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6. Normative Public
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118
Not all of the eleven possible coalitions are equally likely
to start existing.
First, smaller coalitions with respect to the number of
parties are easier to run, as negotiations take shorter time
and as the probability of survival is higher.
Second, there should be an ideological closeness of the
coalition members. This minimal connecting winning
hypothesis reduces the number of likely coalitions to four
(ABCD, BCDE, CDEF, DEFG).
Trade off between these two hypotheses.
Another important aspect is the number of dimensions.
With more than one issue, cycling becomes possible,
coalitions may become unstable.
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
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119
IG
IS
IF
ICCC
FF
GG
SS
GC
CF
Economic Policy
Foreign
Policy
Figure 4.8: Cabinet formation in the German Bundestag
in 19871. 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
© Freytag 2019
120
Figure 4.11: Determinants of cabinet stability
Number of parties
Number of
representatives
elected per
district
Number of issue
dimensions
Ethnic, religious and
ideological diversity
Cabinet stability
e) Cabinet stability1. 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
© Freytag 2019
121
f) Strategic voting
Why do the Free Democrats in Germany always stay in
the Bundestag, but regularly miss to meet the 5 per cent
threshold in the state parliaments?
S C F
49 47 4
49 41 10
The voters of the Christian Democratic Party have
regularly voted strategically (mainly before the
appearance of the Green Party) to ensure a victory of the
conservative spectrum over the Social Democratic Party.
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
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122
IV. The paradox of voting
“…Thus the typical citizen drops down to a lower level of
mental performance as soon as he enters the political
field. He argues and analyzes in a way which he would
readily recognize as infantile within the spheres of his real
interest. He becomes a primitive again…” Joseph
Schumpeter, quoted after Mueller (2003, p. 303).
Schumpeter concludes that human beings would relax
their moral standards and give in to prejudices in the
political arena.
Is Schumpeter right?
How rational is the voter?
And why does she vote anyway?
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
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6. Normative Public
Choice
© Freytag 2019
)1(22
32)
2
1)(1(2
N
eP
pN
123
a) The rational voter hypotheses
A rational voter will vote for the party (candidate)
according to the own expected utility derived from this
candidate’s victory (difference B between the expected
utilities of both parties victories).
It is unlikely that an individual voter’s vote is decisive
(from an individual perspective).
The formula 4.1 shows the probability that an individual
voter decides the election.
4.1
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
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124
When p = 0.5 and N = 100,000,000 P = 0.00006;
when p = 0.5 and N = 50,000,000 P = 0.000085.
P decreases with p deviating from 0.5.
Given that the probability to be run over by a car while
going to or coming back from the election, is higher than
P, one wonders why people do vote.
Three explanations can be thought of:
• redefinition of rationality,
• relaxing the rationality assumption,
• relaxing the self-interest assumption
Changing rationality can imply a taste for voting, cat and
mouse, and minimising regret instead of maximising
utility.
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
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6. Normative Public
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125
Empirical evidence for the rational voter hypothesis
One votes, if PB + D – C > 0,
with D being the benefit from the act of voting and C
being the cost of voting.
For an empirical estimation of the hypothesis we define
R = PB + D – C, to answer the question “Did you
vote?” The literature uses 5 groups of variables:
• personal characteristics,
• cost variables (C),
• strategic value of voting (P and B),
• interest in campaign (D),
• obligation to vote (D).
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
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6. Normative Public
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© Freytag 2019
Study Sample and time period P B D C E Y
Riker and
Ordeshook, 1968
4,294 questionnaires
(quest.), 1952, 1956,
1960, U.S. presidential
elections (p.e.)
+ + +
Brody and Page,
1973
2,500 quest., 1968 p.e. 0 +
Ashenfelter and
Kelly, 1975
1,893 quest., 1960,
1972, U.S.-p.e.
0 + + - + +
Silver, 1973 959 quest., 1960 U.S.-
p.e.
0 +
?
+
?
- +
Frohlich,
Oppenheimer,
Smith and Young,
1978
1,067 quest., 1964 U.S.-
p.e.
+ +
?
+
?
-
?
126
Table 4.1: Summary of studies testing the Downsian
model (with extensions) using survey data1. 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
© Freytag 2019
Study Sample and time period P B D C E Y
Perry, Moser and
Day, 1992
~1600 quest., 1984 and
1985 U.K. national and
local elections
+
?
+
?
- 0
Matsusaka and
Palda, 1993
2,744 quest., 1979 and
1980 Canadian national
elections
0 + 0
Knack, 1994 4,651 quest., 1984,
1986, 1988 U.S.
national elections
+ + +
Greene and
Nikolaev, 1999
~21,000 quest. 1972-
1993 U.S. elections
- + +
Thurner and
Eymann, 2000
1,400 quest., 1990
German national
election
+1
127
P,B,D,C are proxies for main components of Downsian model;
R = PB + D – C; E stands for education level and Y for the income of the voter.1Thurner and Eymann test whether perceived differences in party positions on key
issues increases the likelihood of the respondents voting. Only for immigration
policy was a significant effect found.
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
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6. Normative Public
Choice
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128
b) The expressive voter hypothesis
Relaxing the rationality assumption, leads to the
expressive voter hypothesis.
Instead of aiming at a certain result, the voter wants to
express an opinion of how the outcome of the election
should be;
the outcome of the election is the same as in Downsian
model.
The motivation is different. However, the result then can
also be changing:
irresponsible voting.
The hypothesis stands in contrast to strategic voting.
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
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129
c) The ethical voter hypothesis
Relaxing the self interest assumption, leads to the ethical
voter hypothesis.
The voter is seen as both ethical and selfish (Jekyll-and
Hyde view):
Oi = Ui + θ Uk with k ≠ i and 0 ≤ θ ≤ 1.
d) Voting as duty
Voting is seen as a sense of duty no theoretical
explanation. Behavioural psychology offers an explanation
for θ > 0 . Individuals learn that voting is sensible.
Therefore, ethical voting is indeed selfish.
Tautology?
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
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6. Normative Public
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V. Rent seeking
a) The basic model
Difference between rents and profits:
Entrepreneur profit seeking,
Lobbyist rent seeking.
Rent seeking is an activity to generate income without
efforts on markets for goods and services. These cause
socially wasted expenditures (social costs):
• expenditures of potential recipients,
• expenditures of third parties suffering from the
successful rent-seeking,
• efforts of governments associated with rent
seeking.
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
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6. Normative Public
Choice
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131
Figure 4.9: The social costs of
monopoly with rent seeking
MC
Price
Quantity
R
L
Pm
Pc
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
© Freytag 2019
rRn
nI
TI
RIrI
TI
RrI
IRTI
IGE
If
IfI
r
rr
r
r
r
r
n
jjj
ii
ii
2
2
11
1
)1(
01)(
)(
)(
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132
The basic rent-seeking model with a fixed number of players
(1)
(2)
(3)
(4)
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
© Freytag 2019
© Freytag 2019
rn
n
R
nI
rRn
nrR
n
nnnI
rn
n
)1(
)1()1(
1
2
133
The basic model with diminishing or constant returns, r ≤ 1.
(5)
(6)
(7)
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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134
b) Rent seeking through regulation
The normative grounds for regulation are cases of market
failure (chapter 2).
Market failure is regularly combated by taxes, subsidies
and regulation.
In addition, one finds many cases of regulation not
justified by market failure (state failure).
A utility maximising government will set a price (price
regulation) so that the marginal gain in support by the
rent-seeking group equals the marginal loss in support by
the consumers.
Therefore, the main beneficiaries of regulation are the
regulated firms (plus the regulatory office (see section 4.f).
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
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6. Normative Public
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One interesting implication is that the prices are between
competitive prices and pure monopoly prices (as the latter
would increase the loss in support by consumers above
the gain in support by the very industry).
Valuable explanation of agriculture protection and
taxicab regulation around the world.
Environmental regulation can be explained by this theory,
e.g. pesticide regulation and the number of listed species
by individual state in the Endangered Species Act in the
US.
Becker (1983, 1985) shows that the rent seeking process
can be reverted. If the costs for the consumers (or the
suffering group) increase, their rent seeking activities also
increase, and the government starts a new calculus.
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
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6. Normative Public
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c) Rent seeking through tariffs and quotas
To explain rent seeking in international trade, the Ricardo-
Viner-model with specific factors of production is adequate.
All factors employed in the country’s sectors with
comparative disadvantages lose by a change from autarky
to international trade.
Therefore, the whole industry invests into rent-seeking
activities. The calculus of the government includes again the
marginal gains and losses in support by the industry and the
consumers plus the effects of certain instruments of
protection on the international trade policy agenda.
As quotas have always been forbidden, VERs were
introduced, giving the exporting country the chance to get
the rents; after 1994, VERs also have been prohibited.
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
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6. Normative Public
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© Freytag 2019
Study Economy Year Welfare loss
Krueger (1974) India 1964 7% GNP
Krueger (1974) Turkey 1968 15% GNP
(trade sector)
Posner (1975) United States various 3% GNP
(regulation)
Cowling and Mueller
(1978)
United States 1963-9 13% GCP1
(private
monopoly)
Cowling and Mueller
(1978)
United
Kingdom
1968-9 13% GCP
(private
monopoly)
Ross (1984) Kenya 1980 38% GNP
(trade sector)
137
Table 4.2: Estimates of the welfare losses from rent
seeking1. 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
© Freytag 2019
Mohammad and
Whalley (1984)
India 1980-1 25-40% GNP
Laband and
Sophocleus (1988)
United States 1985 50% GNP
Lopez and
Pagoulatos (1994)
United States 1987 12,5%
domestic
consumption
Study Economy Year Welfare loss
138
1GCP=gross corporate product
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
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6. Normative Public
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139
d) The logic of collective action
How can we explain that some interest groups are more
successful than others in a) organising themselves and
b) obtaining rents in politics? Both questions can be
answered with:
• rent-seeking as collective (club) good free
riders,
• opportunity cost of rent seeking.
In addition, interest group formation can be enhanced
by:
• additional private goods offered by the group,
• obligations to join a group,
• different size of group members.
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
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6. Normative Public
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140
VI. Bureaucracy1. 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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141
The bureaucracy is a part of the supply side of the
political market.
The term bureaucracy has a negative connotation – the
static and conformist bureaucrat is seen as the antipode
to the dynamic entrepreneur. We use the term without
this connotation, as we want to explain the bureaus’
performance with rational behaviour and do not want to
judge them morally.
a) Budget maximization
Bureaus are budget maximizers, as income is fixed.
Bureaucrats pursue power; a basic foundation of power
is superior information PAP.
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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The output of bureaus has a non-market nature. The buyer
cannot observe the quality, as market prices do not exist.
In addition, there is a bilateral monopoly between bureau
and sponsor (government).
Output is too large and probably not efficiently produced.
Instead of the optimal output of the benefit maximising
sponsor satisfying B’ (Q) = C’ (Q), the bureau’s output is too
large satisfying B (Q) = C (Q).
At this point social surplus is zero (E = F).
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
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6. Normative Public
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143
)(')('
)()(
)('1
)('
))()(()(
0'',0'),(
0'',0'),(
QCQB
QCQB
QCQB
QCQBQBO
CCQCC
BBQBB
B
(1)
(2)
(3)
(4)
(5)
(6)
The basic model: budget maximising bureaucrats1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
Choice
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144
Figure 4.10: The oversupply of a bureau‘s output
B‘, C‘
E
C‘
B‘s
F
Q0 Q* Qs Q
B‘
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
Choice
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'1
)(
1
0
dP
dQ
Q
P
PBO
dP
dQ
Q
P
dP
dQPQ
dP
dB
PQB
145
Extensions of the model: alternative
institutional assumptions
(7)
(8)(9)
(10)
(11)
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
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6. Normative Public
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146
Figure 4.11: Options for a price setting bureau
Q
P
PH
P1
Q1
C‘H
C‘L
η>1
η=1
η<1
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2. Origins of the State
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Democracy
4. Public Choice in a
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5. Application of Political
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Alternative behavioural assumptions
So far, we assumed excessive but efficient supply of the
public good. It may also be possible that the bureaucrats
have additional objectives, e.g. the increase of personnel,
the size of the office space etc.
c) Slack maximization
X-inefficiency or bureaucratic slack slack-maximising
bureaus
It is difficult to measure efficiency of bureaus data
envelopment analysis to calculate the efficiency frontier
and compare it with the actual outcome.
In Figure 4.15, the distance between BE’ (the efficiency
frontier) and BS’ the actual outcome would be the result.
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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148
Figure 4.12: The output choice of
a slack-maximizing bureau
QB
Z
E
S
B
Y
E‘
S‘
Z‘
QS QZ
Umax
Umin
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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Empirical evidence:
Whether or not bureaucrats are able to maximise their own
objectives, depends among others on the discretionary
leeway they have agenda setter or not?
d) The power of the agenda setter
If they are agenda setter, they may force the sponsor to
approve a much higher than optimal budget.
Oregon school budget referendum process:
By offering two alternatives below and above the maximal
utility of the median voter, the school bureaucracy
managed to receive a higher budget than in the median
voter’s optimal position (Figure 4.16).
Comparison between privately and publicly provided
services (Mueller 2003, pp. 373-380).
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2. Origins of the State
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4. Public Choice in a
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5. Application of Political
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GrGm Gb G
Median voter‘s
utility
Figure 4.13: Options for the budget
maximising agenda setter1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
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151
Comparison between publicly and privately provided
services (Mueller, 2003, pp. 373-380)
20 sectors are subject to the comparison:
1) Airlines
2) Banks
3) Bus and transit service
4) Cleaning services
5) Debt collection
6) Electric utilities
7) Fire protection
8) Forestry
9) Hospitals and nursery services
10) Housing
11) Insurance business
12) Ocean tanker repair and maintenance
13) Railroads
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2. Origins of the State
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4. Public Choice in a
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5. Application of Political
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14) Refuse collection
15) Saving and Loans
16) Schools
17) Slaughterhouses
18) Water utilities
19) Weather forecasting
20) Industrial companies
In general, private provision is more efficient and
saves costs for the public!
Public firms invest more; higher capital intensity.
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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153
e) The Government as Leviathan
One can even extend the model in that sponsor and
bureau is interpreted as one joint unit ”monolith
monopolist”.
Government in this view is looked at as a malevolent
budget maximizer rather than a benevolent public good
provider.
If this view has a point, a the normative solution is to
reduce discretionary power of governments by means of a
constitution veil of uncertainty.
Figure 4.14 shows that the Leviathan would impose a
higher tax on the citizen if he is free to choose.
Consequences for the theory of optimal taxation!
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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154
Figure 4.14: Alternative strategies for
taxing income and leisureEarned
Income
Leisure
BH D
A
C
G
U1
U2U3
E
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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155
Government as Leviathan – empirical evidence
The empirical literature has focused on the systems of
checks and balances:
• constitutions constrain the legislature,
• federal structures are opposing huge
governments,
• application of the subsidiary principle diminishes
government size,
• intergovernmental competition does alike,
• government collusion (log-rolling on the EMU
level) increases government size.
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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156
f) Regulatory capture*
Bureaus do not only provide public goods. They also are
responsible for regulation in the case of market failure.
As shown above, the regulated sector normally benefits
from regulation; prices are between competitive and
monopolistic outcome.
Therefore, it makes sense for interest groups to stay in
close contact with the regulatory office.
At the same time, the regulatory office gains its status only
by regulation. It is not in its interest to give up regulation,
even if market failure cannot be observed any longer.
* Stigler, George J. (1971), The Theory of Economic Regulation, The Bell
Journal of Economics and Management Science, Vol. 2, S. 3-21.
1. Introduction
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4. Public Choice in a
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5. Application of Political
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It is sensible to assume the position of the regulated
industry.
The bureau is captured by the industry. Consequences
include longer and heavier regulation than needed for, job
offers for regulators in the very industry.
Potential examples:
Coal mining industry Ministry of Economic Affairs
Telecommunication incumbent communication regulator
Insurance industry financial regulator
Utilities energy regulator
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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158
5. Application of Political Economy
Models
I. Dictatorship
a) The origins
b) Goals of a dictator
c) Functioning and survival of the regime
d) Rise and decline of the Regime
e) Dictatorship and economic performance
II. Crisis management
III. The economics of terrorism
a) The terrorist as utility maximizer
b) Does a war on terrorism make sense?
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
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6. Normative Public
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159
IV. Populism on the Rise
a) What is populism?
b) What drives populism?
c) Potential policy responses
d) Conclusions
V. Empirical evidence: governments’ performance
a) The size of government
b) Some thoughts on distribution
c) Political business cycles
© Freytag 2018
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2. Origins of the State
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Democracy
4. Public Choice in a
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Democracy
5. Application of Political
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160
I. Dictatorship
As only a fraction of countries in the world is governed by
a full-fledged democracy, it makes sense to analyse the
economics of dictatorship, with a dictator defined as
“absolute ruler, usually temporary or irregular…; person
with absolute authority in any sphere” (The Concise
Oxford Dictionary, quoted after Mueller (2003, pp. 406ff).
Relevant topics include:
• Origins of dictatorship,
• goals and types of dictators,
• functioning and survival of dictatorships,
• rise and decline of dictatorships,
• economic performance of dictatorships.
© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
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5. Application of Political
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6. Normative Public
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161
Figure 5.1: Digression: State of Democracy 2012
© Freytag 2018
https://commons.wikimedia.org/w/index.php?curid=30548771 see also
http://www.systemicpeace.org/polity/polity4x.htm
162
a) The origins of dictatorship
Chaos and anarchy are not liberty, they end in disaster;
economically a case of prisoners’ dilemma. Therefore, some
sort of solution of anarchy is needed for.
Imagine a roving bandit who robs all wealth; in such a world,
there would be no incentive to accumulate wealth.
Community including the bandit would remain in poverty.
Solution: the roving bandit turns into a stationary bandit and
accumulates more personal wealth by giving individual
incentives to create wealth and by only taking a fraction it,
and offering public goods including security.
Olson, M., 1993. Autocracy, Democracy, and Prosperity. In: Zeckhauser,
R.E. (ed.) Strategy and Choice. London and Cambridge: The MIT Press.
Wintrobe, Ron (1998), The Economics of Dictatorship, Cambridge, © Freytag 2018
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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163
b) The goals of a dictator
A variety of goals can be thought of:
• consumption,
• power,
• ideology or religion,
• security.
Different Types of dictators have different objectives and
different tools
Repression Tyrant TotalitarianTinpot Timocrat
Loyality
Dictator’s dilemma: build up trust!
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164
The basic model
Budget constraint: t Yr = G + C with Yr = Y (1 – t)
Objective function: OD = t*Y (G) (1 - t) – G
t*(dY/dG) -1 = 0 (1)
Y - 2ηtY = 0 (2)
From these we obtain:
dY/dG = 1/t (3)
t = 1/(2η) (4)
OS/ G = dY/ dG (1-ηt) – Yη t/ G -1 = 0 (5)
OD = t Y(G) (1-ηt) – G (6)
OS = Y(G) (1-ηt) – G (7)
© Freytag 2018
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4. Public Choice in a
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165
Figure 5.2: Public goods provision under dictatorship
and the social optimum
GD GS
OD = t Y(G) (1-tη) – G
OS = Y(G) (1-tη) – G
OS,OD
G© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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166
c) The functioning and survival of dictatorships
A dictator has two instruments: loyalty and repression.
Loyalty increases with the after-tax income of the
individuals (citizens?) and is costly. Some actions of the
citizens have to be repressed; repression therefore also is
costly.
A rational dictator would raise tax revenues so that the
marginal gain from the last unit spend on repression
equals his marginal utility derived from loyalty if he left this
unit in the taxpayers’ purse.
The most prominent prototypes of dictators are the tinpot
who is only interest in consumption and the totalitarian
who is only interested in power.
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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167
The tinpot reacts to a threat to security by reducing
personal consumption to increase loyalty.
The totalitarian reacts ambiguously: he may either reduce
taxes to increase loyalty or increase taxes to raise
repression.
It is sensible that dictators are selective: the loyalty of
certain groups is aimed at, and other groups are
repressed.
© Freytag 2018
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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168
This pattern can cause a dilemma, as the dictator will face
a number of groups pretending loyalty.
Who is friend and who is foe?
The more repressive a dictator is, the more his power
decreases. He has to spend a lot of money to secure the
loyalty of his followers. These are not necessarily very
productive individuals. The repressed and exploited ones
may be more productive.
Corruption increases, GDP and wealth decreases.
As a consequence, loyalty shrinks.
An ideology or state religion may be helpful and less
expensive to tell between true and false followers.
There are obvious limits to totalitarianism.© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
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169
d) The rise and decline of dictatorships
Dictators do not survive endlessly. Indeed, many
dictatorships have been ended peacefully or violently.
It is sensible to distinguish vertical and horizontal
exchange in hierarchical organisations like a dictatorship
Vertical exchange is between the dictator and the
subordinate who in return for a reward behaves loyally; it
therefore is helpful to the success of the dictatorship. Trust
plays an important role. It may diminish over time.
Horizontal exchange takes place on the same
hierarchical level; a competitive situation emerges where
trust is not likely to exist. It therefore is contributing to
failure of the dictatorship. Cartelisation may be a way out
of this problem.
© Freytag 2018
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
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6. Normative Public
Choice
170
e) Dictatorship and economic performance
A comparison with democracy reveals that a dictatorship
can be regarded as being similar to unanimity in
democracies rather unlikely.
Which system, representative democracy or dictatorship
has the better economic performance?
The following slide shows the comparison under the
assumption that the dictator is tinpot. The results are not
so clear; if the majority is allowed to tax itself and the
minority differently, the outcome for the minority is the
same as in the case of a dictator.
Under different assumptions, e.g. interest in power
insecurity, costs of maintaining the position, the economic
performance of democracies and dictatorships are still
similar, both theoretically and empirically. © Freytag 2018
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
171
OD = t Y(G) (1-tη) – G (6)
OS = Y(G) (1-tη) – G (7)
tY (1-tη) = G+S (8)
OM = m(1-t) Y (1-tη) +S (9)
OM = m(1-t) Y (1-tη) + tY (1-tη) – G (10)
OM = m(1-tm) Y (1-tmη) +
λ[G- mtmY (1-tmη) – (1-m) tnY (1-tnη)] (11)
tn = 1/(2η) which is the same as in (4)
© Freytag 2018
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
172
The correlation
between democracy
and economic growth
is not clear*
Pro democracy
• dictators are
predatory
• competition
Contra democracy:
• vested interests
• investements
undermined
*Przeworski, A. and F.
Limong (1993), Regimes
and Economic Growth,
The Journal of Economic
Perspectives, Vol. 7, No. 3
(Summer), pp. 51-69© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
173
II. Crisis management*
Three basic characteristics of a crisis:
• unexpected;
• unpleasant;
• requires an urgent response.
It is difficult to incorporate crisis in rational choice models,
as the standard assumptions are inconsistent with the
characteristics of crises.
* Congleton, Roger (2005), Toward a Political Economy of Crisis
Management: Rational Choice, Ignorance, and Haste in Political
Decision Making, Dynamics of Intervention, Advances in Austrian
Economics, Vol 8, pp. 183-204.
* Congleton, Roger (2006), The Story of Katrina: New Orleans and the
Political Economy of Catastrophe, Public Choice 127, pp. 5-30.© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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174
These standard assumptions include:
• full information;
• complete and transitive preference orderings.
Concept of ignorance
Although the data may be complete, the dimensions
observed in the data are too few; there are missing
variables.
• Rational ignorance;
• unconsidered ignorance:
sufficient condition for a crisis to emerge,
incomplete list of responses to a crisis,
limited understanding of causal relationships.
© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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175
Simple rational choice model
U = U (C, H) with C = consumption, H = health
H = H (E, R, Z) with E = private health expenditures,
R = public health programs,
Z = unobserved variables
E* = E (H, Z) optimal private plan
R* = R (Z) optimal public plan
As long as Z remains constant, public and private plans
are effective.
As soon as Z changes, a policy crisis may emerge.
Knowledge is not sufficient to avoid the crisis.
© Freytag 2018
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Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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176
The crisis may than proliferate crisis cascade! The
consequence may be a constitutional crisis.
Other related problems:
• agency problems;
• term length and crisis prevention;
• federalism and crisis (“Katrina”);
• the media and crisis;
• rent-seeking and crisis;
Remedies
scenario building sunset legislation
constitutional design limited amendments
© Freytag 2018
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
177
III. The economics of terrorism
Terror is a widespread and long-term phenomenon (Figure
5.2), which only rarely is related to economics in public
discussion.*
Despite this neglect, terror has (among others) economic
origins and economic consequences.
* Frey, Bruno S. (2004), Dealing with Terrorism – Stick or Carrot?,
Cheltenham and Northampton.
Special issue “Middle East” in The Journal of Economic Perspectives,
Summer 2004, Volume 18, Number 3.
Wintrobe, R. (2003), Can Suicide Bombers be Rational?, University
Western Ontario, mimeo.
Special issue “Ökonomie der Sicherheit”, DIW Vierteljahrtshefte 3/2009.
Freytag,A. J.J. Krüger, D. Meierrieks, F. Schneider (2011), The origins of
terrorism: Cross-country estimates of socio-economic determinants of
terrorism, European Journal of Political Economy, pp. S.5-S.16.
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
178
Figure 5.3: World-wide terror attacks (1970-2016)
Source: https://www.google.com/search?client=firefox-b-
ab&biw=1084&bih=556&tbm=isch&sa=1&ei=Zx_9Wr3AIouRkwWqp7WYBA&q=terror+attacks+1978+-
+2018&oq=terror+attacks+1978+-
+2018&gs_l=img.3...8570.15754.0.16168.12.12.0.0.0.0.138.1052.10j2.12.0....0...1c.1.64.img..0.2.246...0i19k1j0i8i
30k1.0.bOwMKomjdt8#imgrc=XAKR5CbtXu-05M:
© Freytag 2018
1. Introduction
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
179
Issues are:
• Terror and international trade
• What drives terrorism (micro and macro)
• Financing terror
• Combating terror
• Cost of security
• Cost of terrorism
a) The terrorist as a utility maximizer
Economists assume that terrorist behave rationally to
meet certain objectives, e.g. destabilising the society,
media attention, economic losses for the country, power.
Even suicide bombing is perceived as a rational act.
The key is opportunity costs.© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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180
Opportunity costs are relevant for terrorist, their relatives,
and their leaders. High opportunity costs imply low
terrorist activities having their origin in countries or
regions.
Opportunity costs theoretically depend on several factors:
• real income per capita (+),
• (even) income distribution (+),
• growth rate of real per capita income (+),
• education level (+),
• male surplus (-),
• economic and political freedom (+),
• kind and number of independent media (+),
• religious competition (+).
Figures 5.3 through 5.5 show the individual rationality.
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
181
A
U
Figure 5.4: Optimal choice between
ruler‘s blessing and economic success
Mental Rewards
Economic
Success
Source: Freytag, A. (2005) Weltwirtschaftliche Integration und
Frieden, In: A. Freytag (ed.) Weltwirtschaftlicher Strukturwandel, nationale
Wirtschaftspolitik und politische Rationalität – Festschrift für Juergen B.
Donges zum 65. Geburtstag, Köln: Kölner Universitätsverlag, pp. 269-84.© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
182
A
C
B
U2
Figure 5.5: Changing relative price
Mental Rewards
Economic
Success
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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183
D
E
Mental Rewads
Economic
Success
U
U2
Figure 5.6: The suicide bomber
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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184
It is sensible to distinguish between terrorist leaders,
active terrorist and surrounding.
One may change the calculus of an organisation and of
the surrounding.
But it may be difficult to change an determined terrorist to
give up her plans.
Our main hypothesis is that poor socio-economic
conditions (that reflect low opportunity costs of terrorism)
are conducive to terrorism. For this study, we use a
number of correlates of socio-economic success as
proxies to indicate such linkages, where all data series
are drawn from the most recent update of the PENN
World Table (Summers and Heston 1991).
*For results see: Freytag, A., J. Krüger, D. Meierrieks and F. Schneider
(2011).© Freytag 2016© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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185
Explanatory variables used in the regressions are:
• (logged) real GDP per capita and its square.
• (logged) level of consumption
• level of trade openness (measured by the logged
ratio of exports and imports to the real GDP)
• (logged) level of investment (indicated by the
investment component of the real GDP)
• we control for the rate of economic growth which
reflects a country's short-run economic
performance.
Controls: Democracy, regime stability, government size,
population size, civil war, religion, international war,
military spending© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
Choice
186© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
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6. Normative Public
Choice
187© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
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6. Normative Public
Choice
188
It is easier to look at terrorist targets. They are rich
countries or regions in poor countries where Westerners
are regularly (as tourist or as security officials).
Costs of terrorism (and of fear of terrorism):
• Tourism ↓,
• fdi ↓,
• foreign trade ↓,
• stock prices ↓,
• urban economy less attractive, real estate
prices ↓,
• national income ↓.
The costs related to terrorist activities cannot be
neglected.
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
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6. Normative Public
Choice
189
b) Does a war on terrorism make sense?
Obviously not, as a deterrent strategy decreases
opportunity costs for potential terrorist. Israel’s army
regularly has destroyed houses of terrorist; this reduces
opportunity costs.
On the other hand, Palestinian groups have set up social
programs and house rebuilding programs for relatives of
suicide bombers and imprisoned terrorist; this also
reduces opportunity costs of potential and current terrorist.
© Freytag 2018
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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
190
Figure 5.7: Deterrence and marginal costs and
benefits of terrorism for the terrorist
Terrorism
MC, MBMB1
MC1
MC0
MB0
T0 T1Source: Frey (2004, p. 77).
© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
Choice
191
Cost of deterrence
• budgetary costs,
• political costs, e.g. reduced political rights,
• increased vulnerability due to centralisation,
• free marketing for terrorists,
• “Schumpeterian” reaction by terrorists.
How does a “successful” anti-terror policy look like from an
economist’s perspective? Stick and carrot!
• (security),
• diffusing media attention in the target countries,
• political treatment of terrorist (rule of law),
• economic integration (as opposing economic
sanctions),
• polycentricity,
• preventing illegal financial transactions.© Freytag 2018
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
192
So why do governments react economically partly
irrationally by using deterrent strategies only?
• Terrorism is costly,
• fear of terrorism is also costly (see next slide),
• integration of potential terrorist may not be a
successful strategy to be re-elected,
• security as a public good excessive provision of
deterrence,
• action gives the government a competitive edge
over the opposition.
Deterrence as an anti-terror strategy has benefits in
increasing opportunity cost partly.
However, terrorist groups are flexible. Therefore, deterrence
(= war on terrorism) has also high costs (slide 191).
© Freytag 2018
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
IV. Populism on the Rise
The West has undergone substantial socio-economic
changes since the global financial crisis. Multiple
problems have become obvious.
• Trade wars have become reality.
• Fake news and aggression shape policy debates.
• Media and elites face a wall of hatred and scorn.
• Brexit.
• Election in the Europeand particularly Italy driven by
populist tendencies.
• The (not so) new US-administration displays a
considerable lack of rationality and credibility.
*based on three blog entries on www.tutwaconsulting.com
© Freytag 2018193
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
• Turkey is on a straight path into a full fledged
dictatorship.
• Russia is playing old, well known games of distrust and
destruction.
• ANC?.
What are the the roots and causes of this phenomenon
both in the developed and emerging world?
What are appropriate strategies to combat these forms of
simplified and unhealthy policy advocacy?
Durable rule-bound policies rather than discretionary
measures!
© Freytag 2018194
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
a) What Is Populism?
Scientific definitions:
Populisms defines a homogenous group(we) against
an elite that aims at repressing and exploiting this
group (us) (Albertazzi und McDonnell 2008)
Populism is a well-defined ideology, that defines a
public will („volonté generale“), which is permanently
overlooked by a corrupt elite (Kaltwasser und
Taggart 2016)
Common characteristics:
• ”We” against “Them”
• Distrust of expertise
• Avoidance of regularities
• Clear and simple relations
• Simple solutions© Freytag 2018195
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
Figure 5.8: Political parties and populism
Demand-side
economics
Populists
Anti-
establishment
Cosmopolitical
liberals
Supply-side
economics
Source: Inglehart and Norris (2016, S. 34)© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
Often, opponents are accused of populism; examples
from the German election campaign:
• Conservative demand for tax reduction
• Social demodratic candidate Schulz plans to increase
BAFöG (study credit for students)
• The Party “Die Linke” (Left wing party, successor of
the SED) proposes regulation of international capital
flows
Not every statement that is meant to increase
popularity is populistic. Nevertheless, the cases of
populist speech or populist policies are frequent.
© Freytag 2018197
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
Often, opponents are accused of populism. Not every
statement that is meant to increase popularity is
populistic. Nevertheless, the cases of populist speech or
populist policies are frequent.
Prominent examples (EEAG 2017, 50-61):
• Populist macroeconomics (Latin America in den
1980s, Greece in 2000s)
• Immigration policy
• Trade policy (anti-globalization movement, TTIP as
conspiracy of American companies, mercantilistic
view on the trade balance)
• European integration as loss of national sovereignty
• Public debates (fracking, TTIP, migration)
Is the open society passé?
© Freytag 2018198
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
b) What Drives Populism?
Demand (Inglehart und Norris 2016):
• Losers of structural change, potential losers (fears)
(Bude 2008), behavior of elites(ENA, Deutschland
AG),
• Cultural aspects (core population has the impression
that they are neglected)
© Freytag 2018199
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
Supply:
• Abuse of the EU (“dirty work hypothesis, Vaubel
1991)
• Political correctness (ethics of responsibility vs.
dispositional ethics, Sinn 2016)
• Permanent breach of rules in the Eurozone,
monetary policy as a threat to economic order
(Freytag und Schnabl 2017)
• Alternative view: austerity? (Winkler 2017)
• Neglect of losers of globalization (EEAG 21017)
• Weak education policies (school leavers without
graduation, economic analphabets)
• Distribution problems
• Diminishing of science and expertise (;Merkel: “I do
not need an assistant, I need a minister”)
• Exaggerations (“TTIP tötet“, TTIP kills)
© Freytag 2018200
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
Vested Interests:
• Bank rescue actions
• Excessive salaries
• Subsidies on record level
„Olsonian Crisis“
Open questions
Role of Trust?
Role of indivualization?
Problems of an open society?
Role of new media?
© Freytag 2018201
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
c) Potential Policy Responses?
Three levels:
Politics
Science
Economy
Self commitments in politics to reduce populist
statements?
Wishful thinking!
Populism raises the probability that governments
move back to textbook solutions, since easy options
help populists.
In addition, populist governments show the
weaknesses of simple solutions! Renaissance of
rule-based policies?© Freytag 2018202
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2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
Economy Models
6. Normative Public
Choice
d) Conclusions
Populism is not an exogenous shock
It may well be inherently consequence of an open
society.
Aggressive debates characterized by dispositional
ethics add to it
Populism will not disappear soon
To reduce chances of populists, governments should
return to rule-based policies
Difficult, if the government itself acts populist
© Freytag 2018203
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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204
V. Empirical evidence: governments’
performance
So far in Chapter 5, public choice models’ applications
have been shown. This section is dedicated to
summarising remarks and some extensions, mainly more
evidence about government size and some evidence
about the relevance of the theory of political business
cycles.
a) The size of government
b) Some thoughts about distribution
c) Political business cycles
This section refers to chapters 21 to 22 (a) and 19 (c) in
Mueller (2003).
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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205
a) The size of government
Overall government activities and expenditures have
grown remarkably between 1870 and 1980 (see Table
5.1).
Today (1996) the average government in OECD
countries uses in roughly 45 per cent of GDP for its
expenditures. In 1870, the share was 10 per cent.
Two relevant questions:
How can this growth be explained?
How does this increase in government activities affect
social welfare?
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
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206
Source: The Economist, January
23rd-29th, 2010, title© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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Democracy
5. Application of Political
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6. Normative Public
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207
About
1870
Pre- Post-
World War IPre- Post- World War II
1913 1920 1937 1960 1980 1990 1996
General government for
all years
Australia 18.3 16.5 19.3 14.8 21.2 34.1 34.9 35.9
Austria 10.5 17.0 14.7 20.6 35.7 48.1 38.6 51.6
Canada - - 16.7 25.0 28.6 38.8 46.0 44.7
France 12.6 17.0 27.6 29.0 34.6 46.1 49.8 55.0
Germany 10.0 14.8 25.0 34.1 32.4 47.9 45.1 49.1
Italy 13.7 17.1 30.1 31.1 30.1 42.1 53.4 52.7
Ireland - - 18.8 25.5 28.0 48.9 41.2 42.0
Table 5.1: Growth of general government expenditure,
1870-1996 (percent of GDP)
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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208
About
1870
Pre- Post-
World War IPre- Post- World War II
1913 1920 1937 1960 1980 1990 1996
General government for
all years
Japan 8.8 8.3 14.8 25.4 17.5 32.0 31.3 35.9
New
Zealand- - 24.6 25.3 26.9 38.1 41.3 34.7
Norway 5.9 9.3 16.0 11.8 29.9 43.8 54.9 49.2
Sweden 5.7 10.4 10.9 16.5 31.0 60.1 59.1 64.2
Switzer-
land16.5 14.0 17.0 24.1 17.2 32.8 33.5 39.4
United
Kingdom9.4 12.7 26.2 30.0 32.2 43.0 39.9 43.0
United
States7.3 7.5 12.1 19.7 27.0 31.4 32.8 32.4
Average 10.8 13.1 19.6 23.8 28.0 41.9 43.0 45.0
© Freytag 2018
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3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
209
About
1870
Pre- Post-
World War IPre- Post- World War II
1913 1920 1937 1960 1980 1990 1996
Central government for 1870-1937,
general government thereafter
Belgium - 13.8 22.1 21.8 30.3 57.8 54.3 52.9
Nether-
lands9.1 9.0 13.5 19.0 33.7 55.8 54.1 49.3
Spain - 11.0 8.3 13.2 18.8 32.2 42.0 43.7
Average 9.1 11.3 14.6 18.0 27.6 48.6 50.1 48.6
Total
average10.7 12.7 18.7 22.8 27.9 43.1 44.8 45.6
Source: Mueller (2003, p. 503).© Freytag 2018
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210
State activities in terms of GDP cannot only be seen
when looking at expenditure, but also when looking at tax
reductions:
In fact, governments in country A and B are equally
active. They both tax the citizens with 50 per cent. Only
country B reduces tax for parents to a total of 10 per cent
of GDP.
Country A Country B
Official Full Official Full
Gov. Consumption 20 20 20 20
Transfers to pensioners 20 20 20 20
Transfers to children 10 10 0 10
Spending 50 50 40 50
Taxation 50 50 40 50
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5. Application of Political
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6. Normative Public
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211
Explanations for the size and growth of government
This is only a brief overview. For a detailed analysis see
Mueller (2003, pp. 506-534, chapter 21).
aa) The government as provider of public gods and
eliminator of externalities (section 21.2.1)
The provision of public goods is increasing if
• the price elasticity of public goods is < 1, price is
increasing,
• income elasticity of public goods is > 1, income is
increasing,
• taste variables (e.g. for social policy) exist.
The welfare state is an attempt to eliminate negative
externalities.
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
212
bb) The government as redistributor of income and wealth
(section 21.2.2)
Intuitively, one would suggest that the state is increasingly
engaging in redistribution; some argue that state activities
almost entirely are directed to redistribution, at least to
certain extent.
Application of the median voter theorem.
Empirical results are mixed. It, therefore, cannot be
claimed that it is only redistribution contributing to the
growth of governments.
cc) Interest groups (section 21.2.3)
Subsidies and transfers have enormously grown since
1870 (Table 4.5).© Freytag 2018
1. Introduction
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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213
About
18701937 1960 1970 1980 1995
Canada 0.5 1.6 9.0 12.4 13.2 14.9
France 1.1 7.2 11.4 21.0 24.6 29.9
Germany 0.5 7.0 13.5 12.7 16.8 19.4
Japan 1.1 1.4 5.5 6.1 12.0 13.5
Norway 1.1 4.3 12.1 24.4 27.0 27.0
Spain - 2.5 1.0 6.7 12.9 25.7
United
Kingdom2.2 10.3 9.2 15.3 20.2 23.6
United
States0.3 2.1 6.2 9.8 12.2 13.1
Average 0.9 4.5 8.5 13.6 17.4 20.9
Table 5.2: Government expenditure on subsidies
and transfers, 1870-95 (% of GDP)
© Freytag 2018
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4. Public Choice in a
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214
About
18701937 1960 1970 1980 1995
Australia - - 6.6 10.5 16.7 19.0
Austria - - 17.0 16.6 22.4 24.5
Belgium 0.2 - 12.7 20.7 30.0 28.8
Ireland - - - 18.8 26.9 24.8
Italy - - 14.1 17.9 26.0 29.3
Nether-
lands0.3 - 11.5 29.0 38.5 35.9
New
Zealand0.2 - - 11.5 20.8 12.9
Sweden 0.7 - 9.3 16.2 30.4 35.7
Switzer-
land- - 6.8 7.5 12.8 16.8
Average - - 11.1 16.5 24.9 25.3
Total
average1.1 4.5 9.7 15.1 21.4 23.2
Source: Mueller, p. 520.© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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215
dd) Bureaucracy and the size of government (section
21.2.4)
The Niskanen model is static and thus cannot explain the
growth of a budget. A dynamisation shows that the budget
grows faster than GDP.
Bt = αtGt with αt ≥ 1, B = budget, G = public good
α = eaBt
Gt = cent with n = constant growth rate of demand
for public goods and of national income
Bt = ceaBtent
g = ln Bt – lnBt-1 = a (Bt – Bt-1) + n > n
© Freytag 2018
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4. Public Choice in a
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216
ee) Fiscal illusion (section 21.2.5)
The government is able to “cheat” the voters. They
increase current spending via public budget deficit.
The voter – being rationally ignorant – do not see future
tax increases necessary to serve the accumulated stock
of debt.
Empirically not relevant.
ff) Tax elasticity (section 21.2.6)
A Leviathan type of government increases taxes higher
than income.
If the increase becomes unsustainable, taxes have to be
reduced.© Freytag 2018
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4. Public Choice in a
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217
gg) Government size and economic performance
This is again a brief overview. For a detailed analysis see
Mueller (chapter 21).
In general, taxes – apart from lump-sum taxes – have
negative welfare effects as they distort the allocation.
Too highly perceived taxes also drive individuals into the
shadow economy (working hypothesis).*
Empirical evidence shows an increase in the size of the
underground economy since the 1960s as well as the
level being highest in Latin America and Africa.
* Schneider, Friedrich and Dominik H. Enste (2000), ‘Shadow
Economies: Size, Causes and Consequences’, Journal of Economic
Literature, Vol. 38, pp. 77-114.
© Freytag 2018
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4. Public Choice in a
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6. Normative Public
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218
Methods to measures the shadow economy
The main problem is to measure the level and structure of
the underground economy. Measures include:
• use of currency in cash,
• electricity,
• households surveys,
• DYMIMIC.
Effects of the shadow economy
• transaction cost increase,
• the state loses tax revenues,
• it has to raise tax rates (vicious circle),
• erroneous economic policy forecasts and decisions,
• moral decline.© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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219
There is also a relationship between government size and
the degree of corruption.*
Corruption is e.g. measured via questionnaires
(Corruption perception index). It increases with the size of
governments and decreases with the intensity of
competition, e.g. religious competition.
Is it always negative? No, it can be seen as a part of the
costs of using the markets, as it contributes to solving the
PAP. Other effects are similar to underground economy.
It can be reduced on the individual level by offering the
civil servant a sufficient wage combined with fines. On the
collective level, institutions including the rule of law is
necessary.
* Rose-Ackermann, Susan (1999), Corruption and Government,
Cambridge; second edition 2018.
© Freytag 2018
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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Choice
220
Government size and economic performance
It seems clear that government and its production of
public goods are important for the total factor productivity
of the economy.
Government spending can have both positive (e.g.
education) and negative effects (e.g. social spending) for
the total factor productivity.
Therefore, the relationship seems to be non-linear,
precisely an inversed U-shape (Figure 4.25, each dot
representing a single country).
For different levels of development, different inverse U-
shaped curves are thinkable. On a low development level,
the optimal size of government may be lower than for
highly developed economies.
© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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221
Figure 5.9: Relationship between
government size and economic growth%dYt+n
Gt/Yt© Freytag 2018
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4. Public Choice in a
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Choice
222
Figure 5.10: Relationship between
government size and economic growth
on different development levels%dYt+n
Gt/Yt
L
M
H
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
223
Empirical Evidence of the relation between government size
and economic performance
In a time series analysis, the U-shape could be shown for
the US. A second approach is a cross country regression:
Dependent: growth rate of real GDP per capita (1960-
today)
Independent: real GDP per capita in 1960 (-)
secondary school enrolment rate 1960 (+)
primary school enrolment rate 1960 (+)
African nation dummy (-)
Latin American nation dummy (-)
Government consumption over GDP (-)
revolutions per year (-)
political assassination per millions of
population and year (-)
price distortion index (-)© Freytag 2018
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4. Public Choice in a
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224
All of these exogenous variables are significant. In
general, the inverse U-shape hypothesis cannot be
rejected empirically.
As mentioned before, government is not only active via
consuming but also via regulation and tariff as well as
non-tariff protection. Therefore, public consumption over
GDP as the measure for government size would
underestimate “true” government size.
Thus, indices of economic freedom or political rights are
regularly employed as proxies for government size (see
next slide).
As in the literature on dictatorship and economic
performance, the evidence is mixed.
This may be due to the problematic nature of the indices
in use.© Freytag 2018
1. Introduction
2. Origins of the State
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4. Public Choice in a
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225
hh) The index of Economic Freedom in the World
Economic freedom is measured as a weighted average of
21 criteria in five groups:
• size of government: expenditures, taxes and
enterprises,
• legal structure and security of property rights,
• access to sound money,
• freedom to trade internationally,
• regulation to credit, labour and business.*
The index is a mix of legal provisions and actual empirical
results. In addition, it is prone to the “judges’” arbitrariness
and values. Nevertheless, it is very helpful for researchers
and fosters the discussion.
* http://www.freetheworld.com.© Freytag 2018
1. Introduction
2. Origins of the State
3. Public Choice in a Direct
Democracy
4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
227
Digression: World Bank Governance Indicators
• Since 1996 calculated in this form;
• 6 separate indicators:
Voice and accountability
Political stability and absence of violence
Government effectiveness
Regulatory quality
Rule of law
Control of corruption;
• normed to -2,5 (low) to 2,5 (high)
• aggregate Indicators, consisting of several hundred
single variables (31 sources of 25 organizations) to
measure governance;
• often only one source per country;
• complex method;
• almost all data published.© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
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4. Public Choice in a
Representative
Democracy
5. Application of Political
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6. Normative Public
Choice
228
b) Some thoughts on distribution
Distribution problems cannot be judged normatively in
a comprehensive by economists.
• What is a fair distribution?
• Shall the government support certain groups at the
expense of others?
• Is the welfare loss of a poor person worse than the
welfare loss of a rich person?
• Is a farmer worth more than a worker?
Economists trust a so-called weak value judgement:
we prefer the Pareto-superior situation.
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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229
However, there are some arguments for a fair
distribution and redistribution.
Given that a nation or an economy can be seen as a
club, it offers club goods (remember: no rivalry, but
exclusion).
A fair distribution is such a club good.
How to achieve fair distribution?
• progressive taxes;
• tax breaks for families or the elderly;
• subsidies for certain groups;
• social help payments;
• free housing, education and health services for poor
people;
• tbc© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
230
Finally: “…distributional coalitions slow down a society’s
capacity to adopt new technologies and to reallocate
resources in response to changing conditions and thereby
reduce the rate of economic growth.” (Mueller 2003, p.
555).
Mancur Olson* not only explained the emergence and
persistence of interest groups, but also the reason for
economic decline and the role of shocks for nations to
rise again.
Examples are the economic rise of Germany, Italy and
Japan as well as the decline of the UK, Australia and New
Zealand after World War II and India’ long term decline
because of rigidities in the caste system. China after 1000
A.D. is also a case.
* Olson, Mancur, Jr. (1982), The Rise and Decline of Nations: Economic
Growth Stagflation and Social Rigidities, New Haven.
© Freytag 2018
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
Choice
231
c) Political business cycles
Empirical observation: the votes for the incumbent party
in the US between 1896 and 1964 were positively related
to income growth rate and negatively related with the
inflation rate.
Macroeconomic performance is relevant for elections.
This is also known to politicians. Thus, it seems plausible
and justified to create political business cycles (Mueller
2003, chapter 19)*.
The economic theoretical foundation is the Phillips trade
off between unemployment and inflation (Figure 4.27).
* Hibbs, Douglas A., Jr., (1977), ‘Political Parties and Macroeconomic
Policy‘, American Political Science Review, Vol. 71, pp.1467-87.
Nordhaus, William D. (1975), ‘The Political Business Cycle‘, Review of
Economic Studies, Vol. 42, pp. 169-90. © Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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232
Figure 5.11: The trade off between inflation (P)
and unemployment (U)
P
U
M
I1
I2
L
© Freytag 2018
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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233
Figure 5.12: The political business cycle
L
S
MM‘
U
P
© Freytag 2018
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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234
Both with myopic voters (i.e. money illusion) and rational
voters, it is possible for the incumbent to win the election
by creating a political business cycle.
This is, however, only likely if the voters do not consider
other issues and only decide because of macro data prior
to election
no party loyalty.
What happens if partisan politics matter?
Voters distinguish themselves by being more or less
concerned about issues such as unemployment or
inflation.
Political parties reflect these differences and offer
different packages with different focus on unemployment
and inflation.© Freytag 2018
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2. Origins of the State
3. Public Choice in a Direct
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4. Public Choice in a
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Democracy
5. Application of Political
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6. Normative Public
Choice
235
There is a growing literature on the topic with different
assumptions on voting behaviour, partisan behaviour and
the behaviour of the economy.
Basic results include the following:
• Business cycles are created politically, but
increasingly carefully and probably less
successfully then before because of voters’
decreasing inclination to money illusion.
• Voters behave irrationally as they only take into
account macroeconomic variables.
• Interest groups are not focused in the models.
• Nevertheless, the idea that business cycles can
be explained by political rationality, is striking.
© Freytag 2018
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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236
6. Normative Public Choice
Public Choice normally is viewed as a value-free,
positive sub-discipline. However, there are normative
lessons for the organisation of a polity with respect to:
• goals and
• ways to achieve them
The most important issue is to define a social welfare
function which allows to take into account the individual
welfare of each citizen.
Such a function is necessary to judge the effects of
economic policy measures.
This is a difficult, precisely: impossible task. Social
ordering is impossible.© Freytag 2018
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Social welfare functions are constructed on an individual
basis, implying that a social welfare function is an
aggregate of individual utility functions.
W = f (U1, U2,…, Un).
The problem is that individuals have different perception
of the welfare functions. Aggregation of individual
preferences is impossible (Arrow 1951). Arrow shows
that five conditions must hold to make a social ordering
possible.
• Pareto criterion (unanimity)
• Non-dictatorship
• Transitivity
• Unrestricted domain (range)
• Independence of irrelevant alternatives
Arrow’s theorem of impossibility of social orderings.© Freytag 2018
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5. Application of Political
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238
Alternative social welfare functions are:
• utilitarian SWF
W = U1 + U2 +… + Un
• Bernoulli-Nash SWF
W = U1 * U2 * … * Un
• Rawlsian SWF
W = min (U1, U2, … , Un)
© Freytag 2018
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2. Origins of the State
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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239
Social contracts – two different approaches
The difficulties to construct useful social welfare
functions calls for a different procedure.
This can be achieved by a social contract between the
citizens.
They agree on rules with unanimity. These rules are
perceived as fair by everyone.
Economic activity itself is taking place under the rules;
therefore, the outcome can also be assumed as fair.
1) A just social contract (John Rawls)
2) Constitutional economics (James Buchanan and
Gordon Tullock)
© Freytag 2018
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240
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!
© Freytag 2018
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241
2) Constitutional economics (James Buchanan and
Gordon Tullock)
Why do constitutions matter?*
Individual perspective: weakness of will (Ulysses
and the sirens sweetly singing!)
reduction of alternatives
Collective perspective protection against exploitation
rules as rationality
rules as default options
Buchanan argues that constitutions are normatively
superior to an evolutionarist’s naive claim that the current
evolved outcome is efficient.
*Buchanan, James (2000), Why Do Constitutions Matter?, Niklas
Berggren, Nils Karlson and Joakim Nergelius (eds), Whay Constitutions
Matter, Stockholm: City University Press. © Freytag 2018
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242
Buchanan and Tullock (1962) do not have a normative
position, except that they assume unanimity at the
constitutional stage.
Karl Homann and Viktor Vanberg have given up this strict
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.
© Freytag 2018
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5. Application of Political
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6. Normative Public
Choice
243
Table 6.1: Collective action options when external
effects are separable
1 2 3 4 5 6
ucj>0
ecj>0
ucj>0
ecj=0
ucj≤0
ecj<0
ucj≤0
ecj=0
ucj>0
ecj<0
ucj≤0
ecj>0
1urj>0
erj>0NN NN NN NN NB NO
2urj>0
erj=0NN NN NN NN NB NO
3urj≤0
erj<0NN NN NN NN NB NO
4urj≤0
erj=0NN NN NN NN NB NO
5urj>0
erj<0BN BN BN BN BB BO
6urj≤0
erj>0ON ON ON ON OB OO
Notes: N = No action required; B = ban of the action; O = obligation to act.
First letter applies to rows, second to columns.Source: Mueller, p. 618.
© Freytag 2018
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244
The main problem of this approach is that it does not
offer a normative position, except for accepting
preferences.
To the contrary, it explicitly (and correctly) argues that the
preference will lead to rules. Rules then will lead to
outcome.
Despite this strictly positive and individualistic stance, the
approach is not fully satisfactory. It is also a weak
alternative for policymakers who need guidance. In
Germany today, politicians beyond their political interests
seem to be uncertain about:
• social policy objectives and regimes,
• tax reform,
• labour market regime,
• federalist structures etc…© Freytag 2018
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3. Public Choice in a Direct
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4. Public Choice in a
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5. Application of Political
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6. Normative Public
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245
What have we learned?
Public choice theory can contribute to the explanation of
collective choice and fill gaps left by both allocation
theory and political science:
• politics is characterised by rational choice of
policymakers,
• rationality has several dimension,
• cycles in politics occur,
• spatial models do predict voting behaviour well,
• institutions matter,
With respect to normative conclusions, public choice
theory alone is not enough; allocation theory is justified.
© Freytag 2018
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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