CHAPTER 6

Political Economy

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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• We examine direct democracies and how well they translate the preferences of their members into collective action.

• We then turn to complications that arise when decisions are made not by individuals themselves but their elected representatives.

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Direct Democracy-Unanimity Rules

r per year0

0’

Ada

m’s

sha

re (

SA)

Eve

’s s

hare

(S

E)

DrA

The Lindahl Model

DrE

r*

S*

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Feasibility of Unanimity Rules

• Reaching equilibrium– A set of Lindahl prices such that at those prices

each person votes for the same quantity of public good.

• Practical problems– Strategic behavior– Time to reach equilibrium

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Direct Democracy-Majority Voting Rules

• Majority voting rule – one more than half of the voters must favor a measure for it to be approved. Selection of B is independent of the order in which the votes are taken.

Voter

Choice Brad Jen Angelina

First A C B

Second B B C

Third C A A

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Direct Democracy-Majority Voting Rules

• Voting Paradox – community preferences can be inconsistent even though individual’s preferences are consistent

• Agenda Manipulation – process of organizing order of votes to ensure a favorable outcome

• Cycling – when paired voting on more than two possibilities goes on indefinitely without a conclusion ever being reached

Voter

Choice Brad Jen Angelina

First A C B

Second B A C

Third C B A

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Graphing Preferences

Missiles

Util

ity

A B C

Brad

Jen

Angelina

Single-peaked preferences

Double-peaked preferences

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Practical Importance of Double-Peaked Preferences

• Availability of private substitutes– When private substitutes are available double-

peaked preferences might emerge.

• Issues ranked along single dimension (Alternatives do not represent more or less of a single characteristic)– Choice A is Abortion Clinic– Choice B is Bookstore– Choice C is Army recruitment office

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Direct Democracy - The Median Voter Theorem

Voter Expenditure

Donald $5

Daisy 100

Huey 150

Dewey 160

Louie 700

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Direct Democracy - The Median Voter Theorem

– How much public good to acquire?– Median Voter: the voter whose preferences lie in

the middle of the set of all voters’ preferences; half the voters want more of the item and half want less.

– Median Voter Theorem: as long as the preferences are single peaked and several other conditions are satisfied, the outcome of majority voting reflects the preferences of the median voter.

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Direct Democracy - Logrolling I

Voter

Project Melanie Rhett Scarlet Total Net Benefits

Hospital 200 -50 -55 95

Library -40 150 -30 80

Pool -120 -60 400 220

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Logrolling: The trading of votes to obtain passage of a package of legislative proposal. If each project is voted on separately none is adopted enev though each yields a positive net benefits.

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Direct Democracy - Logrolling II

Voter

Project Melanie Rhett Scarlet Total Net Benefits

Hospital 200 -110 -105 -15

Library -40 150 -120 -10

Pool -270 -140 400 -10

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Scarlet comes out behind in both project. This demonstrates how with logrolling, a majority of voters can form a coalition to vote for projects that serve their interest, but whose costs are borne mainly by minority.

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Direct Democracy - Arrow’s Impossibility Theorem

• “Reasonable” collective decision-making criteria– It can produce a decision

whatever the configuration of voters' preferences

– It must be able to rank all possible outcomes

– It must be responsive to individuals’ preferences

– It must be consistent

– Independence of irrelevant alternatives

– Dictatorship ruled out

• Arrow’s Impossibility Theorem– All conceivable voting schemes

have some potential for being unfair or producing a paradoxical result

• Meaning of theorem– consistent rule not necessarily

impossible to find, but cannot be guaranteed

• More totalitarian gov’ts make more investment on education.

• Buchanan’s critique

• Use of social welfare functions

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Representative Democracy - Elected Politicians

Number of Voters

Liberal ConservativeM S

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Implications of the Median Voter Model

• Two-party systems tend to be stable– Both parties stake out positions near the “center”

• Replacement of direct referenda by representative system has no effect on outcomes

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Other Factors Influencing Voting

• Single-dimensional rankings

• Ideology – Example: “I would rather be on the right then be president” -

Henry Clay

• Personality– Fatherly personality, charisma

• Leadership– Populist policies

• Decision to vote– Why people not vote, or why people vote?

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Representative Democracy-Public Employees

• Function of bureaucrats– Representatives don’t know much about technical

details regarding some policies.

• Goals of bureaucrats– Is bureaucrats’ only aim to interpret and passively

fulfill the wishes of electorate and its representatives?

– A bureaucrat’s objective is to maximize his or her budget.

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Niskanen’s Model of Bureaucracy

Q per year

$

0

VC

Q*

Efficientoutput

Qbc

Actualoutput

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Representative Democracy-Public Employees

• In South Africa, after the fall of apartheid, the white bureaucrats who administered previous regime continued to play predominant role in running the country. – Bureaucrats know the secrets of running the state

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Representative Democracy – Special Interests

• What are “Special Interests”?– People with common interests can exercise

disproportionate power by acting together.

• Establishment of Special Interest Groups– Source of Income: Capital or Labor-orthodox Marxism

– Size of Income

– Source of Income: Industry of Employment

– Region

– Demographic and Personal Characteristics

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Representative Democracy – Rent-Seeking

tons of peanuts per year

$

S=MC

D

MR

Rents

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Representative Democracy – Other Actors

• Judiciary

• Journalists

• Experts

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Explaining Government Growth

• Citizen PreferencesG = f(P, I)

• Marxist View

• Chance Events

• Changes in Social Attitudes

• Income Redistribution

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Controlling Government Growth

• Government growth as a non-issue

• Government growth as a problem– Commitments made in the past– Basic flaws in the political system

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Improving the Workings of the Political System

• Change bureaucratic incentives– Financial incentives– Privatization

• Change Fiscal Institutions– Budget Enforcement Act (BEA) – 1990– Balanced Budget rules at the state level

• Institute Constitutional Limitations– Balanced Budget amendment

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Provisions of a Typical Balanced Budget Amendment

1. Congress must adopt a budget statement “in which total outlays are no greater than total receipts”

2. Total receipts may not increase “by a rate greater than the rate of increase in national income”

3. “The Congress and President shall…ensure that actual outlays do not exceed the outlays set forth in the budget statement”

4. The provisions can be overridden in times of war

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Critique of Balanced Budget Amendments

• Forecasting issues

• Definitional issues

• Penalties for violation of the law

• Economic issues