Economics,  Politics and the Law

Voting and Elections

Majority Rule

Tyranny of the Minority

Paradox of Voting

Power of the Agenda Setter

Log-Rolling

Economic Analysis of Bureaucracy

Rent-Seeking

Economics and Law

The Economics of Crime

An Economic Theory of Politics

Most of us were probably exposed as children to a cheerfully naive view of how governments work. Governments, children are told, are made up of well-meaning men and women who make personal sacrifices to serve their community. They are motivated by a concern to advance the "public interest" -- that is, the well-being of society at large. They "serve the interests of the people." This is analogous to the similarly naive view that business people are in business "to serve their customers". Adam Smith debunked this childish notion in his often-quoted passage in The Wealth of Nations where he observes that the individual producer :

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The Theory of Public Choice

What has come to be known as "public choice" theory is based on the perception that elected officials and public servants are motivated by self-interest. While they may on occasion do what they think is "right", they are more likely to do whatever they think will get them re-elected or appointed to a higher and more rewarding office. 

The public choice literature typically identifies four groups involved in the political process: the voters, elected office holders, bureaucrats, and the media. Although they may have overlapping interests (all are voters, for example), members of each of these groups have specific interests and objectives. As one contributor to the literature, the Canadian economist Douglas Hartle, has put it, they may all be thought of as playing a particular game, each of which games has its own rules.

Voters are concerned with promoting their own interests and they do so by casting their votes for whatever office-seeker offers them the "best" policies. From their  point of view, the best candidate is the candidate who will do the voter the most benefit (or the least harm). How sure they can be about this is unclear. Empirical studies of voter behaviour show that voters are remarkably ignorant about most of the facts relevant to choosing among alternative policies. This, as Downs has shown, is not surprising. It simply would not be worth the time and effort required for most voters to acquire a lot of information about what they are voting on. For most issues, the direct effect of one voter voting one way or another will have a trivial impact on that voter's particular situation. What voters do tend to know something about is where candidates stand on issues of significance to the voter. But it is not at all clear that this has anything to do with whether the candidate’s stand is in any objective sense "correct" or likely to be of benefit to those who choose him or her over a rival office-seeker. In modern societies, much of what a voter knows about candidates and their platforms is determined by the media.

Journalists, newspaper publishers, TV network managers and the like are assumed in public choice theory to be in the business they are in order to maximise their own self-interest. This means getting better jobs, earning larger profits and so on. In pursuit of these objectives, members of the media try to make their product as appealing as possible to the consuming public. This leads them to treat news as a commodity and, increasingly, to increase its popular appeal by making it entertaining. This in turn means trivialising and sensationalising the commodity. The result is that voters, even if they become "well informed" on a topic are as likely as not to be misinformed.

Office holders are in the business of appealing to voters so that they will win re-election. They consequently vote in the legislature in accordance with their perceptions of what will go down well with their constituents. Note that this is not necessarily what will be "best" for the country or even for anyone other than a minority of voters the politician recognises as being important to his or her chances for electoral success. Whether this poses a serious problem or not is a matter of some debate in the literature, but what most contributors to the study of public choice recognise is that there is no reason to believe the outcomes of any known voting procedure need be "rational". Indeed, Kenneth Arrow’s original work on this, which involved rigorous mathematical analysis of voting procedures, showed that "democracy" is impossible. 

Because of intransitivities, the influence of sequence in voting on alternatives, complex alternative orderings of preferences and the like, it is impossible to conclude that representative institutions such as those which govern the industrialized "democracies" can generate policy outcomes which meaningfully reflect the "will of the people". If there is any "reason" to be found in the policies of such governments, it may be a matter either of good luck or successfully concealed behind-the-scenes manipulation of the process. The latter, in the view of some students of the subject, implies a "hidden dictatorship".

Bureaucracy is depicted by public choice theory as a hierarchical system in which participants seek to maximise their individual benefits in the form of promotion to higher (and better-paid) positions in the hierarchy and more valuable "perks" of office. In modern bureaucracies the evidence suggests that the extent to which bureaucrats are subject to the will of their elected "masters" is negligible or non-existent. One reason for this, paradoxically, is that civil service reform has sought to reduce opportunities for elected officials to make appointments on the basis of patronage (electoral support) or nepotism. If recruitment to the civil service, promotion, and termination are handled "objectively" by an official commission or other agency (another bureaucracy) rather than directly by elected officials, the independence of the civil service is guaranteed. But it is then free to pursue its own agenda. The popular British television series, "Yes, Minister," captures the nature of this relationship with what some former civil servants report to be great accuracy.

Evidently public choice theory presents a rather jaundiced view of the political process. Like the rest of economic theory, it contains elements of both "positive" (objective) and "normative" (subjective) elements. By developing models of political behaviour which are subject to empirical investigation, public choice has served the purpose of removing much of this subject from the woolly superficialities of traditional treatments as found in the older political science literature. It also has a prescriptive component, however. If the political process is subject to the kinds of problems identified in studies of voting, committee decision-making, the role of the media, and the operation of bureaucracies, does public choice theory suggest ways of improving the process? It does. There is, in fact, a sub-discipline emerging in public choice known as "constitutional economics". Its speciality is studying alternative forms of representative government (should there be one legislative body or two, for example), different kinds of voting (proportional representation), incentive systems in bureaucracies, etc. None of this has yet produced results which command any widespread acceptance. It must be noted, however, that the general drift of constitutional economics, like the main body of public choice theory has a distinctly "conservative" direction.

If public choice theory suggests that the political process is riddled with "flaws", it is not surprising that most of those contributing to it appear to be deeply suspicious of any substitution of government direction in the economy for the operation of the market. If government cannot make choices which meet any test of rationality, what reason do we have to believe that government intervention can be a corrective to market failure? Are we made better off by substituting "regulatory failure" for "market failure"? One of the most frequently encountered prescriptions coming out of public choice inspired studies of government activity is to return functions to market controls as, for example, through "privatisation" of publicly-owned enterprises, de-regulation, and "contracting out" of government services, catch phrases of the "neo-conservative" movement which gained such wide acceptance in the UK under Margaret Thatcher and the US under Ronald Reagan in the 1970s and 1980s. While this aspect of public choice may concern those who are opposed to the neo-conservative movement, the more fundamental implications of the theory should not neglected: democratic government may be an illusion, dictatorship may be a more practical and logically-defensible system of government!
 

Politics, very often, is simply economics pursued by other means.

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Voting and Elections 

There has been a widely observed tendency for political parties in many countries to avoid adopting extreme policy positions. One explanation for this runs in terms of the way public opinion is distributed. If opinion is distributed along a spectrum ranging from an extreme "left" to an extreme "right," there is a tendency for a two-party system to emerge in which it is often difficult to identify substantial differences in the packages of policies each offers. Most of the voters are found in the middle around the "median" (an equal number to either side), with a few fanatics strung out at the two extremes. 

Suppose there are two parties, the Grits who started out as a left-wing party and the Tories who started out as a right-wing party. Suppose that initially both parties have platforms that are quite distinct, with the Tories appealing strongly to their staunchest supports on the "right" and the Grits to their strongest supporters on the "left. Suppose the Tories decide to broaden their base of support by adopting somewhat more moderate policies. Given the distribution of voters along the spectrum, this could be expected to succeed. The Tories would get more votes. But the Grits could then be expected to counter-attack by moving somewhat to the "right" so as to capture some of the more numerous moderate votes. Ultimately in such a situation the two parties end up close together, near the position favoured by the median voter. This median voter theorem is particularly plausible in the cases of countries like the US, Australia and Canada where two parties predominate and where the policies of these parties do not differ radically. It is much less applicable in countries like France or Italy where parties are numerous and have positions staked out all along the left-right spectrum. The analysis of such situations is, of course, more complex.

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Majority Rule 

Majority voting provides a compromise between two conflicting considerations involved in designing an effective and politically acceptable set of rules for making decisions when a group of people are involved. One of these considerations is the cost of gaining agreement on a particular policy or course of action to be taken. If the group is small, this may not be an important consideration, for in a small group it is relatively inexpensive to negotiate an agreement, but if the group is large, negotiations may be complex and time-consuming. The costs of getting agreement may be considerable. The other consideration is the importance of the decision to individuals in the group, the extent to which they will be affected by the decision going one way rather than another. If the matter being considered is one which will have only a small impact on the interests of particular members of the group, it will be neither important nor necessary to have a broad consensus. But if the decision will have a crucial impact on the interests of individual members of the group, it is likely that the decision rule adopted will require a large degree of agreement. 

It might be expected that a small group making a relatively minor decision (so far as its impact on individual interests is concerned) will opt for a rather weak decision rule, whereas if the group is large and the decision of great importance, the decision rule will be much stronger. Thus, a small group such as a family deciding on what brand of toothpaste to buy may adopt a decision rule that is very simple and economical of time and negotiating effort, perhaps even settling for a simple dictatorship approach in which one member is allowed to make the decision on behalf of the rest. However, since negotiating costs in such as small group are slight, it is easy to imagine some greater measure of agreement being chosen, such as a simple majority in favour. But consider the same family group when the issue is whether or not one of them should be denied any share in the inheritance of family property under a new will the parents are drawing up. In such a case the decision rule may require a much higher degree of agreement, even up to the point of requiring unanimity, in effect giving each member of the group a power of veto. This, obviously, is the opposite extreme to dictatorship. 

When large numbers of people are involved and where negotiating costs are high, even quite momentous decisions may be taken with a relatively small amount of agreement being required. Thus, in the case of a whole country declaring war, the appropriate decision-making agency, say a legislature, may require only a majority, or perhaps somewhat more (such as two-thirds in favour) to approve the decision. 

This theory is imprecise and indicates only certain broad principles involved in determining how extensive the support for a decision will be in different cases, but it suggests why, in so many situations where the outcomes are less than momentous and the costs of reaching agreement are small but not insignificant, simple majority rule is acceptable.

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The "Tyranny of the Minority" 

Consider an issue such as the legalisation of euthanasia. Two candidates are running for election. Suppose 90 per cent of the electorate would have no objection to legalisation, but are also concerned with several other issues. The other 10 per cent are so concerned about the possible abuse of euthanasia that they will vote for a candidate who supports their position whatever the candidate’s position is on other matters. If the candidate opposes legalisation he or she is certain to win 10 per cent of the votes and possibly lose only a small percentage of the others. Does the majority or the minority rule in such situations?
 

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A Paradox of Voting 

Consider a case in which three voters have to choose among three alternative policies. Call the voters A, B, and C and the policy alternatives X, Y, and Z. Suppose the decision rule under which this group works is a simple majority choice. Let the preferences of the three voters be as set out below:
 
 

It is common to revert to a modified majority choice procedure in which the voters vote on pairs of alternatives, one after the other, using simple majority voting. (This is known as the Condorcet rule after its inventor, the Marquis de Condorcet, who devised it in 1785.) In this case, in a vote on the first two options, X against Y: X wins (Voter A prefers X to Y, voter C prefers X to Y, and only voter B is contrary minded). Now the group votes on Y against Z. (Voter A prefers Y to Z, voter B prefers Y to Z, and only voter C prefers Z to Y.) Now they vote on X against Z: Voter A prefers X to Z, but both voters B and C prefer Z over X. So Z wins. But isn’t there something wrong here? If the group prefers X over Y and Y over Z does it not follow that they must prefer X over Z? Apparently not! This possibility of intransitivityin collective choice was analysed by Kenneth Arrow (1921- ) who demonstrated that it is impossible to devise a voting rule which is non-dictatorial and which also satisfies several desirable conditions including transitivity.
 

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The Power of the Agenda-Setter 

The possibilities are to buy new fire engines, buy new police cars or plant new trees. Suppose that the committee attempts to determine the preferred allocation on the basis of the familiar system of pair-wise majority voting used in the preceding example. Suppose the rank orderings of the committee’s preferences are as follows:

Suppose they begin by voting on fire engines or police cars. The outcome is that fire engines win, 2 votes to 1. Now suppose they vote to choose between fire engines and trees. Trees win, 2 votes to 1 and the budget goes to the parks department. If the fire and police representatives leave the meeting feeling that something went wrong, they may have a reason. In this example the outcome is determined by the sequence in which the voting is done. A different final outcome would have been reached by choosing a different pair of alternatives to begin the voting with. Often, the chairperson or agenda-setter can fix the outcome by choosing the sequence of such pair-wise voting. (Although this need not always be the case, for example, if all three commissioners favoured one alternative.)

Various schemes have been devised to deal with such problems: voting only for outcomes which the participant approves of or allocating points to each participant to assign to alternatives as wished (for example, all points might be given to one possibility which is intensely desired). But there is probably no perfect voting system that eliminates all elements of possible advantage or disadvantage to some participants. In practice, the outcomes of voting processes often depend on negotiation among the participants. Vote trading, or log rolling is an often important component of group decision-making.

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Log-Rolling 

If program Y is approved, voter C gains $1000 while both A and B suffer losses of $900 and $100 respectively. If program Z is chosen, voter B gains $200 and A and C each lose $100. Under simple majority voting, neither voter A nor voter B would vote for program Y because they would both be losers under it. But neither would voters A and C support program Z for the same reason. Obviously C wants program Y and B wants program Z. If these two voters, C and B, made a deal with one another so that B would vote for program Y if C voted for program Z, both programs would gain approval. Voter B would come out with a net gain of $100, C with $900, and A would suffer a loss of $1000.
 
 

The largest determining factor of the size and content of this year’s budget is last year’s budget.

Economic Analysis of Bureaucracy 

One of the best known of the economic theories of bureaucracy derives from the work of an American economist, William Niskanen. In his Bureaucracy and Representative Government, published in 1971, Niskanen explained why the interaction between elected officials, bureaucrats and voters creates an environment in which there are strong pressures to increase government spending on a broad range of services. Bureaucrats, according to Niskanen, seek to maximise the budgets of the agencies under their control. The larger the budget, the greater the career enhancement of those involved in the agency. 

In comparing alternative ways in which a desirable public service, such as education would be provided, Niskanen applied the standard analytical techniques used in conventional market analysis. If the service were to be provided by a perfectly competitive private industry, the standard analysis tells us that the amount supplied would be determined by the interaction of market supply and market demand, the outcome being an amount produced at which marginal cost equalled average revenue. Were the service being provided by a private monopolist, a smaller output would be produced at a higher price, given the monopolists cost and revenue situation as described in Topic 6. But a public bureaucracy, Niskanen argued, is in a position to maximise its own benefits by following a different decision rule altogether. It has the potential to set both output and the size of the total budget. The politicians from whom it must obtain this budget are interested only in ensuring that the total cost of providing the service does not exceed the value of the service provided. The bureaucrats (who know what it costs to produce the service) will request a budget equal to (or just slightly less than) the total value of socially optimum output: an amount equal to the value of the output a perfectly competitive industry would have produced plus all (or virtually all) the consumer surplus associated with it. The entire surplus is appropriated by the bureaucracy, which uses it to generate "slack" in the form of unnecessary travel expenses, entertainment, and the like. 

These arrangements, it should be noted, appear to be satisfactory to all concerned. The public is getting a large supply of services which is actually equal to what would have been provided under a socially optimum arrangement, the politicians are able to claim credit for supplying this large quantity of services while being protected from criticism by the auditor’s assurance that the total value of the services provided is equal to the cost of providing them, and the civil servants are able to "consume" part of the budget themselves, while also benefiting from having a larger (and hence more prestigious) department! Needless to say, it follows that such bureaucracies will continuously campaign to convince the public and elected officials that ever increasing amounts of the service they are providing are needed. Thus, the police will inflate and exaggerate crime statistics, the educational establishment will deplore declining standards and insist that more resources are needed to provide the education needed to prepare students for the future, the highway department will deplore the sorry state of traffic congestion which evidently requires the construction of new freeways ....

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Rent-Seeking  

The modern theory of monopoly has been further developed by a radical new movement in the US which has greatly expanded the scope of the analysis to include the role of government as a factor in the creation, perpetuation, or control of private monopoly power. The seminal article in this development was published by Gordon Tullock in 1967.

Tullock pointed out that monopoly, like tariffs and outright theft, had the effect of transferring income or wealth from one person or group to another. The total loss of welfare to society resulting from such transfers was larger than traditionally believed, Tullock argued, because earlier analysis had overlooked a significant fact: Possessing monopoly power (or having tariff protection from foreign competitors) confers a valuable benefit on whoever is allowed such privilege. There is a motive, therefore, to make whatever effort or to expend whatever resources necessary to get such a privilege. It becomes worthwhile to lobby governments, to wine and dine policy-makers, or to do whatever it takes to get (and to keep) monopoly or similar economic power. This competition for monopoly power, which has come to be called "rent-seeking", uses up resources that could be more productively employed. Therefore, Tullock suggested, if these costs are included with the other losses associated with monopoly, the total cost of monopoly power is larger than previously estimated. (This also raises the interesting issue of rationality in rent-seeing behaviour. Since monopoly profits inevitably attract the attention of those who would like to get hold of them, holders of such monopoly privileges must use up time and other resources to defend them. Such efforts are in the nature of additional fixed costs for a monopoly firm. The Tullock line of reasoning would suggest that over time, such additional costs will eventually become equal to the value of having the monopoly privileges in the first place, as illustrated here. If this is so, why would anyone bother trying to get them? Put another way, if the capitalized present value of the expected benefits has to be paid to get them, why are they sought after?) 

While this line of analysis has not yet led to more settled conclusions as to how large the actual cost of monopoly power and the seeking of it actually is, it leads to some important implications with respect to the role of government in the economy. As George Stigler and other members of the "Chicago School" had contended earlier, government intervention in the economy, even when intended to offset the effects of market failure, may itself become the source of inefficiencies. Much of the regulatory apparatus of government, such as imposing standards of service and equipment maintenance in the transportation industries, ostensibly in the interests of the public, actually restrict competition and create opportunities for rent-seeking behaviour. Indeed, according to Stigler and others, the chief beneficiaries of such intervention are the regulated firms themselves who find themselves insulated from unfettered competition.

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Economics and Law 

But this overlapping of law and economics in the area of economic and legal institutions had, until recently, no parallel in terms of the methods of law and economics as disciplines. Indeed, the methods of lawyers seemed to be completely unlike those of economists. While economists have always sought to discover basic theoretical principles of the broadest possible explanatory power, lawyers have tended to operate on a case-by-case basis, stressing the importance of exercising intuitive or experience-based judgement in the weighing-up of evidence. While lawyers have often been willing to listen to the expert opinions of economists in the course of building or trying a case, they have always insisted on subordinating it to a broader, more general process of determining the merits of a case, often causing economists extreme frustration when the implications of their analysis of the issues seemed to them irrefutable and beyond qualification.

Given this background it is not surprising that a textbook, with the provocative title Economic Analysis of Law, by Richard A. Posner, a professor of law at the University of Chicago, caused something of a sensation by claiming that judges actually decide cases on grounds that can be accurately predicted by standard economic theory. Legal procedure, contract law, the common law relating to damages arising out of accidents and other unintended injuries done by one person to another (tort), criminal law and family law, Posner claimed, can all be fruitfully analysed in the light of conventional economic analysis. Simply put, law has the effect of pricing and taxing a wide range of human actions. Rights and obligations as assigned by law change human behaviour. The way individuals respond to such changes can be understood, Posner and his increasingly numerous followers contend, by applying the same simple maximising behaviour studied in connection with the theory of consumer demand and the production decisions of firms.

The simplest examples of such analysis are found in the area of determining liabilities and damages. Suppose a worker in a factory is injured when a robot malfunctions and drops an engine casting on his foot. He sues the company for damages, claiming that the company had not taken adequate precautions to prevent such an injury from happening. The question before the court is what the company might reasonably have been expected to do to avoid this kind of mishap. This is easily translated into familiar marginal economic analysis. There are costs associated with ensuring that a robot cannot drop a part on a human worker’s foot. How elaborate should the electronic control systems be made, how much engineering effort should go into ensuring against possible malfunctions? But there are also real losses involved if such an event does occur. What then is the reasonable amount of safety precautions the firm should be expected to invest in? Analytically, what is at issue here is the cost of taking precautions, which increases as more precautions are taken and the risk of injury which decreases as more precautions are taken. 

When the two values are equal the "threshold of negligence" has been reached. If the court determines that the firm had taken the amount of precaution corresponding to the risk of loss, it would not be held liable for damages. Had it spent less, it would be liable.

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The Economics of Crime 

A perennial debate goes on over the effectiveness of these penalties as deterrents to further criminal activity. If the objective is to minimise the amount of crime, which kind of deterrent is most cost-effective? Here is where economics enters the world of crime and punishment. The economist’s view of criminal behaviour is carried over directly from conventional consumer theory of the kind studied in Topic 3. Criminals are assumed to be rational individuals who engage in criminal activity when the benefits of committing a crime are expected to be greater than the cost of committing it. The benefits are easily quantified in terms of the value to be derived from consuming or trading the stolen, extorted or otherwise illegally obtained commodities. The costs are the probable losses which would be incurred if caught and convicted. The estimate a rational criminal would arrive at respecting costs will be influenced by two major considerations: one, the severity of the punishment, the other, the chances of being convicted. The estimated cost will be arrived at by multiplying the penalty by the frequency with which those committing such crimes are convicted. 

Suppose the penalty for stealing a bicycle is a fine of $500 and about 50% of those who steal a bike are actually convicted. The expected cost of stealing a bike is consequently around $250. If the penalty is increased to $1000 and the rate of successful prosecution remains the same, the cost rises to $500. How do prospective criminals relate to risk factors? Are they more likely to be risk-avoiders or risk-seekers? For the sake of simplicity (and in the absence of factual evidence) assume they are neutral on the issue. If this is so, the same deterrence effect can be obtained either by increasing the conviction rate or by increasing the size of the penalty. But which of these options is least expensive for society? Economists who have studied the matter have generally concluded that increasing penalties is far less expensive than trying to increase the conviction rate. The former requires only a simple amendment of the legal provisions relating to the crime. The latter involves possibly large outlays on policing.

What about the form of the penalty—fines as opposed to imprisonment? Again, the economics of crime literature generally supports the use of fines rather than imprisonment on the grounds of efficiency. Locking criminals up is expensive and it removes them from potentially productive employment. While the empirical evidence on this is thin, there is some support for the general principle. A study of crimes against property in the UK, for example, found that it would cost ten times as much to bring about a 1% reduction in such crimes by increasing the policing effort than by simply increasing the expected penalty. (Source and a further note.)

The foregoing are only a few of the many possible applications of the methods of economics to topics peripheral to the economy itself. Some critics have reacted to this expansion of the territory economists have been exploring by charging them with a kind of intellectual imperialism, but these developments are of interest nonetheless, both for their own sake and the way they demonstrate the usefulness of distinguishing between the formal methods and point of view of a discipline and the subject matter to which it is applied.  
 

This brings us near the end of the micro-economics part of the course in which the analysis has been directed to explaining the functioning of individual markets. In terms of the historical evolution of the basic analytical framework of economics, we are at about the 1930s, a decade which was to bring a sea-change in way we think about economic life. But before we can look at the new body of macro-economic ideas which developed thereafter, two topics which fall analytically between micro and macro analysis must be dealt with. The first of these is the economics of international trade, the second, money and banking.

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