“Long-surviving democracies could therefore hardly have been dominated by the charlatans, simpletons or crooks that economists typically portray in characterizing democratic representatives.” — Thompson and Hickson (2000) The early days of public economics (at least as a distinct field) were essentially normative. The basic idea was that economists could use economic theory to examine market failures and devise policies that correct for those failures. A quintessential example is the case of externalities. Suppose, for example, that a particular type of production produces pollution. This cost is not limited to the firms or those working for firms. This cost affects (potentially) all members of society. The social cost of production is therefore greater than the private cost. Since
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“Long-surviving democracies could therefore hardly have been dominated by the charlatans, simpletons or crooks that economists typically portray in characterizing democratic representatives.” — Thompson and Hickson (2000)
The early days of public economics (at least as a distinct field) were essentially normative. The basic idea was that economists could use economic theory to examine market failures and devise policies that correct for those failures. A quintessential example is the case of externalities. Suppose, for example, that a particular type of production produces pollution. This cost is not limited to the firms or those working for firms. This cost affects (potentially) all members of society. The social cost of production is therefore greater than the private cost. Since firms are unlikely to internalize this social cost, they tend to produce “too much.” In order to correct for this, the economist would likely recommend taxing production at a sufficiently high level to reduce production to the socially optimum level (i.e. the level that takes into consideration both the entire cost). In this world, the economist largely plays the role of technocrat, identifying market failures and offering corrective policies.
James Buchanan, one of the pioneers of what is now called public choice theory, suggested that public economics should take a different approach. In particular, he suggested that public economics should concern itself with positive economics (i.e., an analysis of “what is” rather than “what should be”). The field of public choice recognized that the process through which policy is enacted requires the deliberate actions of politicians and other policymakers as well as voters and special interest groups.
One view of policymaking that emerged in the public choice literature is most closely identified with Mancur Olson. According to this view, the democratic process contains policymakers who are capable of supplying policy and the general public who have demands on policy. The general public will tend to form coalitions, which we might call special interest groups. As the name implies, these groups are organized around a common interest. These interest groups then go to politicians and other policymakers with their concerns and petition for policies that provide direct benefits to their group. This process tends to be effective for special interest groups because politicians are self-interested. A politician cares about getting re-elected. As such, the politician has an incentive to give the special interest groups want they want because the benefits are concentrated within the group, but the costs are dispersed throughout society. Since the costs are so small for the average voter and/or taxpayer, the marginal cost of taking action to oppose the policy exceeds the marginal benefit.
The usefulness of this theory is that it enables economists to explain the existence and persistence of inefficient policies. One shouldn’t be surprised to observe inefficient policies if those policies are providing concentrated benefits and dispersed costs. This is no doubt an insightful positive approach to the behavior of politicians and the process of policy determination.
Despite the theory’s usefulness in explaining “what is”, empirical applications of this theory often engage in a sleight-of-hand technique. For example, some public choice scholars studying a particular policy will start their analysis by using economic theory to examine a particular policy. If the policy is found to be inefficient in theory, it is natural to ask why the policy exists. One hypothesis is that this is simply an example of Olson’s theory. The public choice economist can then go back and analyze who benefits from the policy and what politician(s) supported the policy to see whether it is a simple application of concentrated benefits and dispersed costs. In the case of simple legislation, the public choice economist might even estimate a regression model of the likelihood that a particular legislator voted in favor of the policy using data on special interest influence.
The reason that I say that this application of Olson’s theory is a sleight-of-hand is as follows. This sort of analysis starts with the idea that the policy is inefficient and then empirically examines whether this is a case of special interest influence. But this is an empirical test used to justify a theoretical conclusion. In other words, economists identify a theoretical inefficiency and determine empirically that the reason the policy exists is due to the influence of special interests.
Why does this matter?
First, this approach to public choice is making a similar sort of mistake that early public economics was making. The economist starts with a theoretical model and analyzes the policy within the context of the model. If the policy is inefficient in the model, then the economist is left to explain why such an inefficient policy exists. But what if the model is wrong? What if the policy is correcting for an inefficiency that the economist ignored?
Second, this sort of empirical evidence can never tell us whether or not the policy is inefficient. In fact, it would be surprising if one didn’t find evidence of special interest influence on legislation. This is because special interests will promote their own interests, regardless of whether the policy is welfare-improving. So an economist will be likely to observe special interest influence both in cases when the special interests bring an inefficiency to the attention of policymakers and when they are just looking for a giveaway.
For a proper analysis of this Olson-based approach, economists need to develop a much better understanding of the black-box nature of the political process. The idea that special interests shape policy is not surprising. However, different political systems will select for particular policies. Countries with a given set of institutions might select for policies that appear to be inefficient, but in reality are efficient responses to some social problem previously ignored by economists. Other institutional structures might select for giveaways to special interests.
For the Olson-based approach to be useful for evaluating the efficiency properties of policy requires an evolutionary approach. Thus, the analysis of policy requires returning to the point at which the policy was adopted and attempting to identify what inefficiency the policy could possibly be aimed at eliminating. Did the policy persist and for how long? Then, one can look for whether other places adopted similar policies. If so, did the policy persist and for how long? Does the policy seem to have eliminated these inefficiencies? Among the places that didn’t adopt the policy, did they turn out better or worse in regard to this supposed inefficiency? Why did some places adopt the policies and not others? What are the institutional differences that explain what policies were selected for?
The answers to these questions seem substantially more important than the results of some probit regressions of yay or nay votes.