utline conflict of interest does democracy work...

Outline Conflict of Interest Does Democracy Work? Controlling Politicians Market Failure vs. Government Failure

Part II: Foundation ofMicroeconomics5. Consumers and Incentives6. Sellers and Incentives7. Perfect Competition and the InvisibleHand8. Trade9. Externalities and Public Goods10. ae Government in the Economy: Taxation and

RegulationW3 Political Economy11. Markets for Factors of Production

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Web Chapter 3Political Economy

2019.11.29.

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Con�ict of Interest and Political Economy

Does Democracy Work?

Controlling Politicians

Market Failure Versus Government Failure from a Political EconomyPerspective

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Q: Do governments and politicians follow theircitizens’ and constituencies’ wishes?

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● Because the economic preferences and views ofcitizens are o�en opposed, con�icts of interestover government policies are inevitable.● aeMedian Voter aeorem stresses themoderating in�uence of themedian voter, who isthe voter with the political bliss point (mostpreferred policy) in themiddle of the distributionof political bliss points among voters.

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● In the presence of perfect political competition,which allows political candidates representingdiòerent options to freely enter and compete inelections, there will be a tendency for parties toconverge toward themedian voter’s political blisspoint.● In practice, politicians o�en do not follow thewishes of themedian voter or the electorate.

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● Some elected oõcials are politically corrupt in thatthey use the advantages of their oõce to engage inillegal and unethical actions that beneût or enrichthemselves.

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W3.1 Con�ict of Interest and PoliticalEconomy

● What determines whether, in practice, governments workfor the public good or toward diòerent objectives?

● It is diõcult to answer this question when some individualsand groups will beneût from a government policy and willthus favor it, while others will be harmed by that policy andthus will oppose it.

● aere is a con�ict of interest when there are opposingpreferences concerning policies between individuals orgroups.

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● aere are winners and losers from each feasible policy,creating con�ict of interest over policy choices.

● Political economy is the study of the con�ict of interestbetween individuals and groups, how this con�ict isresolved, and how citizens in�uence government policy andcontrol politicians.

● Political economy clariûes how to think about thepreferences of a group of individuals or of the entire society.

● Political economy also studies to what extent governments,politicians, and bureaucrats respond to these preferencesand how they can bemademore responsive.

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Monarchy, Dictatorship, and Democracy● Representative democracy is a political system inwhich public oõcials are democratically electedand empowered to act on behalf of the citizens.● A dictatorship is a regime ruled by a singledictator or a small junta consisting of a smallgroup of soldiers or rulers.● Amonarchy is a type of dictatorship in which aking, a queen, an emperor, or an empress rules thecountry and the ruling position can be passed onto the ruler’s heirs.

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● In a dictatorship, there are no elections, and thus dictatorso�en pursue policies for their own interests and not those oftheir citizens.

● In a representative democracy, leaders can be voted out ofoõce if the citizens are not satisûed with their performanceor if a better candidate emerges.

● Does voting deliver policies that citizens, or at least a largefraction of them, would agree with?

● Need to think about the preferences of citizens when there ispotential con�ict of interest among them.

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HowWell Does VotingWork? ae Condorcet Paradox

● Preferences are transitive if an individual prefers choice a tochoice b and choice b to choice c, then she prefers choice ato choice c.

ExhibitW3.1 Transitive and Non-Transitive Preferences, Panel (a)

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● Preferences are non-transitive if an individual prefers choicea to choice b and choice b to choice c, then she does notprefers choice a to choice c.

ExhibitW3.1 Transitive and Non-Transitive Preferences, Panel (b)

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● ae French mathematician and philosopherMarquis de Condorcet found that transitivity isnot guaranteed when a societymakes decisions byvoting.● ae Condorcet Paradox refers to the failure oftransitivity in collective preferences implied byvoting behavior.

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ExhibitW3.2 Policy Preferences of Adam, Bob, and Charlie

Who votes for what policy in each of the three choices:

1. Low taxes (L) v.s. intermediate taxes (I)

● Adam and Charlie for I, Bob for L, I wins.2. Intermediate taxes (I) v.s. high taxes (H)

● Adam and Bob forH, Charlie for I,H wins.3. Low taxes (L) v.s. high taxes (H)

● Bob and Charlie for L, Adam forH, L wins.15 / 55


HowWell Does VotingWork? ae Arrow Impossibilityaeorem

● How typical is the situation where non-transitivity occurs?

● Nobel Laureate Kenneth Arrow shows that if we do not putsomemore structure on individual preferences, theCondorcet Paradox is far from unusual.

● ae Arrow Impossibilityaeorem argues that anyreasonable voting scheme should satisfy the following threeconditions:

● Unanimity● Transitivity● Independence of irrelevant alternatives

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● ae result of Arrow’s Impossibilityaeorem is thatthe only way of designing a voting scheme thatalways satisûes the three conditions is to acceptthe existence of a dictator.● Put diòerently, we cannot ûnd a voting schemethat satisûes the three conditions and theadditional requirement that there should be nodictator.● However, if preferences are single-peaked, thenthe Condorcet Paradox will not hold, and thustransitivity will occur.

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HowWell Does VotingWork? Single-Peaked Preferences


● ae political bliss point of an individual is his or hermostpreferred policy option among all available policies.

● political bliss point, Adam: high taxes, Bob: low taxes,Charlie: intermediate taxes.

● What about policies that are “close to" and “far from" thepolitical bliss point?

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● An individual’s policy preferences are single-peaked if he orshe prefers policies closer to his or her political bliss point tothose that are farther away.

● In ExhibitW3.3, whose preferences are single-peaked?● ae preferences of Adam and Charlie are single-peaked,

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HowWell Does VotingWork? aeMedian Voter aeorem● aemedian voter is an individual whose political bliss point

(most preferred policy) is in themiddle of the distribution ofpolitical bliss points among all voters.

● aeMedianVoteraeorem states that when preferences aresingle-peaked, the political bliss point of themedian voterwill receive amajority of votes against any other alternativepolicy.

ExhibitW3.4 Policy Bliss Points of Voters and theMedian Voter20 / 55


ExhibitW3.5 Policy Preferences of Adam, Barbara, and Charlie

● Whose preferences are single-peaked?● Remember: An individual’s policy preferences are

single-peaked if he or she prefers policies closer to his or herpolitical bliss point to those that are farther away.

● ae answer is ?

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ExhibitW3.6 Policy Bliss Points of Adam, Barbara, and Charlie

● ae preferences of all are single-peaked.● aemedian voter is Charlie, whose political bliss point is the

intermediate tax rate.● Who votes for what policy in each of the two choices:● Low taxes versus intermediate taxes?● Intermediate taxes versus high taxes?

● An intermediate tax rate beats any alternative, and there isno Condorcet Paradox.

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Political Competition and Convergence to theMedianaeMedian Voter aeorem does not, by itself, tell uswhat policies will be chosen in a society. We need to1. translate the insights of theMedian Voter

aeorem to a representative democracy becausewe do not directly vote over policies.

2. ensure that there is perfect political competition,meaning that diòerent options or candidatesrepresenting diòerent options can freely competein elections.

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● When theMedian Voter aeorem applies andthere is perfect political competition, then thepolitical bliss point of themedian voter will be thepolicy implemented.● In this case, there will be political convergenceamong parties (or political candidates) competingfor oõce.● ais policy convergence result was ûrst noted byAnthony Downs and is sometimes referred to asDownsian policy convergence.● ae following example illustrates the result.

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● Suppose there are two parties— Red and Blue,both wishing to come to power.● Suppose also that theMedian Voter aeoremholds and a society consists of 21 voters, and thepolitical bliss point of themedian voter is a taxrate of 32%.

ExhibitW3.4 Policy Bliss Points of Voters and theMedian Voter

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● Suppose that the Red party oòers a policy platformof a 25% tax rate, and the Blue party responds witha policy platform of a 32% tax rate (which is thepolitical bliss point of themedian voter).● Who wins the election?

ExhibitW3.7 ae Blue Party Wins aMajority

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● Suppose that the Red party oòers a policy platformof a 34% tax rate, and the Blue party responds witha policy platform of a 32% tax rate (which is thepolitical bliss point of themedian voter).● Who wins the election?

ExhibitW3.8ae Blue Party AgainWins aMajority

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● So what can the Red party do? Oòering anythingother than 32%— the political bliss point of themedian voter— will lead to defeat at the polls.● If the Red party oòers 32%, both parties wouldhave the same platform, and all voters would beindiòerent between the two parties.● We would therefore expect either party to come topower with a probability of 50%, which is betterthan being defeated for sure.● ais is the Downsian policy convergence result.

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Self-Interested and Ideological Politicians:Implications of Limited Competition

● Perfect political competition is a useful benchmark but doesnot describemany real-world situations.

● In most democracies, political competition takes animperfect form for at least three reasons:

● Perfect competition in politics needs free entry— thatis, candidatesmust be able to enter the political arenawithout any special legal or technical barriers keepingthem from doing so.

● Politicians and parties have ideological biases.● Politicians are o�en highly self-interested and

sometimes even untrustworthy.

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● Politicians will o�en look a�er their own interests at theexpense of the public,meaning that they will try to furthertheir own careers, choose policies and public programs inline with their own personal and ideological biases, and atworst, engage in corrupt and illegal activities to build theirown personal wealth or to further their own interests.

● aese real-world situations restrict the applicability of theMedian Voter aeorem and Downsian policy convergence.

● If we were in a situation of perfectly political competition, athird party would spring up andmight oòer what themedian voter wanted.

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Q: Do governments and politicians follow theircitizens’ and constituencies’ wishes?

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● Data:Vote shares in House of Representatives elections in theUnited States and votes of elected representatives in theHouse. Also vote shares in Swedish local elections andpolicies chosen by local governments.

● Economists David Lee, Enrico Moretti, andMatthew Butlerfocused on narrow elections for the U.S. House ofRepresentatives between 1946 and 1995 to see whetherpoliticians chose the policies that their voters preferred.

● If elected representatives do indeed represent the wishes oftheir constituencies, these Democratic and Republicanmembers of Congress would have very similar votingrecords.

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● Lee,Moretti, and Butler found a large diòerence between thevoting record of narrowly elected Republicans andDemocrats.

● In fact, they found that a narrowly elected Republican votesin exactly the same way as an average Republicancongressperson (with a right bias), and the same applies to anarrowly elected Democrat (who votes with a le� bias).

● One shortcoming of the study by Lee,Moretti, and Butler isthat we only observe the votes that the politicians cast in theHouse. Some of these votes (for example, on the budget)may be important for overall policy decisions. However,many other votesmay not reallymatter (for example, thenaming of a federal park).

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● Economist Per Pettersson-Lidbom applied a similarmethodology to elections for Swedish municipalities, wherelocal oõcials decide local tax rates, in�uence unemploymentrates and the size of local government employment.

● He found that the policy choices of narrowly electedpoliticians were very diòerent: a le�-leaning politician chosea 2% to 3% higher tax rate and employed 4% more workers inlocal governments than a right-leaning politician.

● ae evidence suggests that politicians of diòerent partiesrepresenting more or less the same preferences support andchoose very diòerent policies.

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Political Polarization and Policy Convergence

● ae extent to which politicians from diòerent parties voteand choose diòerent polices varies across countries, issues,and time.

● Political scientists Nolan McCarthy, Keith Poole, andHoward Rosenthal developed a statistical procedure toestimate the ideological positions of Congress from theirvotes and then computed the average distance betweenDemocratic and Republican members of Congress.

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ExhibitW3.9 Polarization in theHouse and Senate, 1879-2015

● By now, the Senate is as polarized as it was in 1879, and theHouse has become even more polarized than it was then.

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W3.2 Does Democracy Work?

● In many instances, democracy doesn’t work exactly wewould have liked it to.

● Some individuals despair and question whether democracyworks at all.

● ae remarkable growth performance of China since the1980s under a highly authoritarian regime has raisedquestions as to whether some forms of dictatorship might bepreferable to democracy.

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“Democracy is the worst form of government, except for all thoseother forms that have been tried from time to time."— Former British PrimeMinisterWinston Churchill

● All of the other forms of governments suòer from the sameproblems as democracy, but onlymore acutely.

● If democracy fails at being representative,monarchy anddictatorship are certainly far less representative.

● Even though democracies sometimes fails to take decisiveaction in response to crises, there is no evidence that otherforms of governments systematically do better.

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aere are several reasons democratic governmentsmay beadvantageous:

1. Democratic form of governments represent the wishes of thecitizens, at least under perfect competition.

● Even when they deviate from this ideal, the deviation israther limitedmainly because of the existence ofreelection.

2. A group of relatively uninformed voters can collectively havemuch more knowledge than any single informed voter andtherefore can actually elect the “correct" candidate.

● ais idea goes back to Francis Galton (1822-1921).

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● To test his idea, Galton went to an agricultural fair in 1906and asked 800 people to guess the weight of a slaughteredand dressed ox.

● Galton found that themiddle estimate— the equivalent ofthemedian voter— was 1,197 pounds, while the actualweight was 1,198 pounds!

● ais result is sometimes referred to as the “wisdom of thecrowd," which is originally credited to Aristotle.

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Prediction Markets● Galton’s result has been proved further inprediction markets.● In prediction markets, people, o�en non-experts,make predictions or bets over things ranging fromoutcomes of sports contests to elections.● ae prediction markets for elections consistentlyoutperform public opinion polls and pre-electionsurveys performed by knowledgeable experts.

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W3.3 Controlling Politicians

● In a representative democracy, we the voters electpoliticians to public oõce to act as our agents.● aere is a strong presumption that they are to actin our interest or in the interest of the “publicgood."● aemisuse of public oõce for private gain—corruption— is a failure of representation.

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Politicians, Corruption, and Policies● Political corruption refers to illegal andillegitimate actions, such as bribery andmisuse ofpublic funds, for private beneût by elected publicoõcials.● Political corruption can take the form of:● Appropriation of public funds for personal use.● Bribes taken from companies in return for special

treatment, including the awarding of public contracts.● Support for policies and legislation against citizens’

interests in return for bribes and campaigncontributions.

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Political corruption is costly to society because:

1. It leads to wasteful use of tax dollars since some goes into thepockets of corrupt politicians.

2. It induces amisallocation of resources since contracts areawarded to ûrms paying bribes.

3. It potentially discourages investment since companies haveto pay bribes in order to be successful.

4. Itmay have highly distortionary indirect eòects sincepoliticiansmay erect entry barriers to protect incumbentûrms that pay bribes.

5. Itmay create a political system that attracts politicians whoare not public spirited but rather are looking to enrichthemselves through bribes.

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● Which countries exhibit a lot of corruption, and whichexhibit little?

● Data: A public sector corruption index on a scale of 0 to 10,where 0means that a country is perceived as highly corruptand 10means that a country is perceived as very clean.

ExhibitW3.10 Corruption Map of theWorld

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● Bureaucratic corruption refers to illegal andillegitimate actions, such as bribery andmisuse ofpublic funds, for private beneût by bureaucrats,judges, or law enforcement oõcers.● Bureaucratic corruption imposes an even greatersocial cost to society than political corruptionbecause it ismore widespread and pervasive.

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Value of Political Connections● Economist Raymond Fisman found that ûrmshighly connected to the former Indonesiandictator Suharto lost about 23% of their stockmarket value as a result of his death.● Economists Benjamin Olken and Patrick Barronfound that truck drivers in Indonesia had to paybribes at checkpoints accounting for 13% of thetotal cost of the trip and that bribes were highernear the end of the trip.

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Electoral Controls on Politicians● aere are two ways to think about this evidence of political

corruption:● Why are politicians o�en corrupt and unscrupulous?● Why are politicians not even more corrupt, given their

control overmillions of dollars?● While social norms of honestymight go some ways toward

explaining the relatively limited amounts of politicalcorruption, a large part of the answer lies in the fact thatelections are a good way of disciplining politicians.

● Voters can reward good behavior with reelection and punishbad behavior by casting their votes for other candidates.

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Voting Corrupt Politicians out of Power

● Economists Claudio Ferraz and Frederico Finan used a largeaudit study of the Brazilian federal government concerningcorruption at the local level.

● aey showed thatmayors who were found out to be corruptin the audit report were signiûcantly less likely to bereelected.

● aey also found that those whose corruption was publiclydisclosed by the audit study were signiûcantlymore likely tobe voted out of oõce.

● Providing more information to voters about the extent ofcorruption might help to control politicians.

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Media and Politics● One of themany roles of freemedia is to provideinformation about politicians’ behaviors.● If this is true, we should indeed observe newsaòecting voting behavior, and we should evenobserve in some cases corrupt politiciansattempting to control news andmedia outlets.● Media can aòect political views and votingbehavior not only by uncovering corruption butalso by informing voters with news andcommentary.

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ae Value of theMedia in Peru● aough originally democratically elected, Alberto Fujimori

soon set up a dictatorial regime in Peru,mounting a coupwhile still in oõce in 1992.

● Fujimori built a corrupt regime and rules through repressionand bribery.

● A Supreme court judge was worth $5,000-10,000 amonth,and politicians were also paid similar amount.

● Fujimori paid $9 million on one occasion and over $10million on another to control TV stations,

● He paid over $1 million to amainstream newspaper, andpaid amounts to other newspapers ranging between $3,000and $8,000 per headline.

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ae Fox News Eòect● Does themedia indeed aòect how people vote?● Economists Stefano DellaVigna and Ethan Kaplan studied

the expansion of the Fox News cable channel across U.S.towns from October 1996 to 2000.

● ae coverage at Fox News ismore right-wing andpro-Republican than at other TV stations andmost othermedia sources.

● aey compared the change in the vote share of Republicancandidates between the 1996 and the 2000 elections, andfound that the Republican candidates gained between 0.4 to0.7% in towns that had access to the Fox News Cablechannel.

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W3.4 Market Failure Versus GovernmentFailure from a Political Economy

Perspective

● ae distortions caused by political economycon�icts and politicians and bureaucrats acting intheir own interests rather than as representativesof the electorate and society are referred to asgovernment failure.

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● Government failures imply that an increase in theset of activities that are delegated to thegovernment will lead to more con�ict of interestamong voters about exactly what action should betaken.● aere will then bemore areas in which politicianscan pursue their own agendas or will havemoremoney to use for their own beneût.● However, turning those activities over to theprivatemarketmay not deliver a socially eõcientoutcome due tomarket failure.

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● Market failure is likely in the provision of a publicgood or the protection of a common poolresource.● ae costs ofmarket failures should be stacked upagainst the costs of government failure.● We should try to quantify both the costs ofmarketfailures and the costs of government failures.● For example, what will society lose if a factorycontinues to pollute the air with no enforcedabatement policies versus what will society lose ifelected oõcials pursuemainly their own agendas?

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