Tuesday, 17 September 2013

Why politicians don't cut spending?

A simple answer to this question comes from Learn Liberty in this short educational video.

(If the video doesn't work - some browsers could do that - 
 you can access it on You Tube.)

This here is Public Choice 101. (Btw, if you're interested, they also have an excellent explanation of the Median voter theorem, the centerpiece model of political economy). 

Lessons made in this short introductory video are actually the key principles of public choice theory and its economic analysis of politics. Since the voters are generally ignorant about the policies and the politicians they vote into office, and since they are too dispersed to organize as a group, they are unable to scrutinize their representatives more rigorously. On the other hand various interest groups representing a whole range of industries do have a strong incentive to organize and influence the political process via lobbying as their benefits are less dispersed when acting as a small, privileged group.

It pays off for an interest group to be well informed of the policies being implemented. Of course an interest group is only well informed of specific policies affecting them. The video mentions farm subsidies, but you can find a multitude of other examples. Any industry seeking protection from foreign competition is essentially an interest group attempting to lobby the government for favourable legislation to preserve their less efficient business. Of course a strong media campaign must support this to persuade the people that the government "must preserve our jobs". But not all interest groups operate under a public domain. Much more is being done behind the "revolving doors" in D.C.

And then we reach something called the Iron Triangle of the political process. It involves three parties: interest groups, politicians in power (or Congress) and the bureaucrats, where interest groups provide electoral support via their organized members to the politicians, who in return offer them friendly legislation through the bureaucrats (bureaucrats and Congress have a special relationship in itself - I wrote about it briefly). The Iron Triangle will explain to us why some laws get passed even though only a minority will support them and even though they could imply negative welfare (via tariffs, strict immigration laws, etc.). The answer is simple: interest groups are highly organized, while voters are rationally ignorant. The benefit of an interest group member is highly concentrated and it pays off for them to organize, while the same cannot be said for a large group such as the voters.

Olson's theory of collective action 

The cornerstone in the research on interest group formation was done by a brilliant political economist, Mancur Olson (one of my personal favourites, and one who, I think, deserves much more praise for his work). His theory of collective action was one of the seminal contributions of what later turned out to be a new field of public choice theory. Olson's influence on the field was as much as Coase's on new institutional economics - pivotal.

In his first and most popular book "The Logic of Collective Action" Olson stated:
"It does not follow, because all of the individuals in a group would gain if they achieved their group objective, that they would act to achieve that objective, even if they are all rational and self-interested. Indeed, unless the number of individuals in a group is quite small, or unless there is coercion [or some other commitment device], rational, self interested individuals will not act to achieve their common or group interest."
Because individuals do have an incentive to free ride, individually rational outcomes will lead to collectively irrational ones. Olson's theory of groups builds upon this crucial insight. He defines small, privileged groups on one hand, where voluntary provision of public goods occurs by one member or a sub-group of members, as the benefits of provision outweigh the cost to those members. On the other hand latent, dispersed groups are those in which voluntary provision does not occur due to too much free riding. Larger groups will fail to mobilize common interests for three reasons: (i) individual contributions are made irrelevant, (ii) there is the problem of enforcement and no social control (anonymity of members) and (iii) organization costs are too large. Smaller groups don't have these problems, particularly those more homogenous and those with many common interests. This is why small groups are able to solve the public good allocation problem. 

For those who know the work of Elinor Ostrom this will all sound familiar. Elinor's Nobel prize winning work builds upon Olson's theory in which she proves the possibility of cooperation without free riding but only in groups small enough to have social ties which will ensure that gains of cooperation will outmatch those of self-interested behaviour. These are groups which via continuous interactions and networking build a lot of social capital - think of a family unit. 

But it can go well beyond that. For example, consumers are a latent group, while producers are a privileged group. We as consumers cannot do anything if the prices of food, gas, cars or clothes go up. But the industries producing those goods can make sure that their prices stay up. They can keep competitors out (both foreign and domestic), they can lobby the government to provide them subsidies, they can demand favourable legislation etc. And in the end its the customers who lose out as we have to pay a higher price. Another example of a privileged group are labour unions. The unemployed are a dispersed  group. Labour unions can organize themselves into an interest group and lobby the government for more protection of their own jobs. They can basically use their lobbying power to keep non-members out of jobs. This disadvantages the unemployed but they can't do anything about it since they lack the incentive to organize as a group. The story is again very simple: when benefits are highly concentrated it pays off to organize as a group. When it doesn't, when a group is too large, it will lose out. 

5 comments:

  1. Excellent text, I absolutely agree! Free riding is the ultimate problem facing democratic decision making.

    Do you perhaps have any more links to some of Olson's work?

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    1. I'm not entirely sure what you mean, as he mainly wrote books. However, here you can download his great text "Big Bills Left on the Sidewalk", while here you can find his text on "Dictatorships, Democracy and Development". You can download it for free from JSTOR.

      His three main books I recommend are:
      "The Logic of Collective Action"
      "Rise and Decline of Nations" and
      "Power and Prosperity".
      Each is brilliant in its own way.

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  2. This is, for now, one of my favorites on your blog.

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  3. Amazing text.

    p.s. +1 for Petar's comment

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  4. Perfect! as you've said, public choice 101!

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