Political Economy

Political economy is a term that is used to describe the economies of states, according to Adam Smith (author of The Wealth of Nations, 1776). The passage of a given public policy reflects both politicians' and voters’ preferences. Because people differ in terms of their age, income, education, and other attributes, differences exist in terms of favoring and arguing against a given public policy. If the politician is faced with the decision to choose a position for a controversial issue, like a ban on marriage for same-sex couples, it is possible that he or she may not agree with the majority of voters. For example, suppose the politician favors the ban, but polls and communications from constituents show that voters do not support the ban. Even if the politician favors this ban, he or she should consider choosing an opposing position if a majority of voters oppose this ban on same-sex marriage.

Unanimous Consent

Public Goods and the Tiebout Model

In a mixed economy, government alters the free-market allocation of resources by shifting some resources to the production of pure public goods and quasi-public goods. Quasi-public goods are a cross between private and public. Goods that generate positive externalities may be classified as quasi-public goods because they create both private benefits and social or public benefits (e.g., education). Because drivers can be excluded from a road using a toll booth, roads are not considered to be pure public goods. Remember that pure public goods are both non-rival and non-excludable. The term local public goods refers to many of the services provided by local governments, such as K-12 public education, road maintenance, police and fire protection, and garbage removal.

The Tiebout Model relies on several basic assumptions. These assumptions include the idea that consumers are completely mobile, individuals have perfect information on benefits and costs they receive, there are many communities to choose from, an optimal sized public good exists, and there are no spillovers. The model reaches the conclusion that an efficient level of local public goods provision can be achieved if people can choose among different communities, each offering a different level of service and tax burden. However, the model assumes that families are perfectly mobile, which is generally not the case. Rather than expecting each family to keep moving to find the best community for them, our political system is designed to let voters have a voice in how the community they belong to is run. Our political system typically requires only majority consent because unanimous consent is oftetimes difficult to reach.

Problems with the Tiebout Model

1) Competition: The basic assumptions of the Tiebout model often do not hold in reality. Perfect mobility is difficult in practice because people must always be willing and able to vote with their feet which is not always the case. Also, people may not always have perfect information on the costs and benefits of a town or public good. Finally, people must be able to choose from a range of towns. In certain areas, towns are very spread out and moving would make commuting difficult.

2) Financing: The Tiebout model requires financing public goods through a lump sum tax, which is a fixed taxation amount independent of a person’s income, consumption, and wealth. It requires equal financing among all residents which is highly inequitable. Towns usually finance their public goods through a property tax which is levied in proportion to the value of homes. This causes poor people to free-ride on the rich people because the rich pay higher taxes.

3) Externalities: The Tiebout model assumes that public goods have effects only in a given town and that the costs and benefits of the public good do not spillover into neighboring towns. Under the model, when a town decides to finance a public good it will only consider the preferences of its residents, not those of other towns who might also enjoy the good. Thus people in other towns will become free-riders on that particular town's public good, and the government will then under-provide services.

Lindahl Pricing

Lindahl pricing provides a way to achieve a unanimous decision regarding the provision of public goods. It relies on using individuals’ "marginal willingness to pay", or the amount that individuals are willing to pay for an incremental unit of a public good in order to determine the amount of that good the government should provide. In Lindahl equilibrium, individuals pay for the provision of a public good according to their marginal benefits. Everyone chooses the same quantity but will pay different tax shares or prices. Lindahl pricing leads to efficient public goods provision in theory, however, it is unlikely to work in practice.

Problems with Lindahl Pricing

1) Preference Revelation Problem: The first problem is that individuals have an incentive to lie about their willingness to pay, since the amount of money they pay is tied to their stated willingness to pay. Individuals may claim their willingness to pay is low so that others can bear a much larger portion of the costs.

2) Preference Knowledge Problem: Even if individuals are willing to be honest about their valuation of a public good, they may have no idea of what the valuation actually is. This is common especially among individuals who do not shop for these goods on a regular basis (e.g. national defense and security, and fireworks).

3) Preference Aggregation Problem: Even if the two points above are achieved, how can the government aggregate individual values to a social value? This requires the government to get the opinion of everyone in the United States which is impossible.

Representative vs. Direct Democracy

In every developed democracy, people join political issues by voting or becoming involved in public projects. In a direct democracy, citizens vote for relevant public projects through a referendum or voter initiatives. On the other hand, representative democracy is one in which voters choose candidates to represent them and make important policy decisions on behalf of the people.

Representative Democracy

The median voter theory states that a representative democracy and a direct democracy lead to the same outcome, but this requires that politicians make decisions according to voter preferences.

Three Implications of the Median Voter Theory

1) Public policies will tend to be moderate middle-of-the-road policies.

2) Most people will be at least partly displeased with the policies chosen, although most people may still prefer majoritarian decision rules to all the other methods of collective choice that they are aware of.

3) Increases in the dispersion of the distribution of voter preferences (increased radicalism) will have little, if any, effect on public policies unless increased dispersion also affects the median of the distribution of voter ideal points. This implies that median voter policies tend to be relatively more stable than would have been the case if average rather than median voter opinions determined policy (Section VI. Policy Implications of the Median Voter Model. Paragraphs 2 and 3. Referenced paper).

Median Voter Theory Assumptions

1) Single-dimensional voting -- voters only care about one issue.
2) There are only 2 candidates. There is no stable equilibrium when a 3rd candidate enters.
3) No ideology or influence. Assume politicians only care about votes and not ideological positions.
4) No selective voting -- all citizens vote.
5) No money is used as a tool of influence.
6) Perfect information along 3 dimensions: voter knowledge of the issues, politician knowledge of the issues, and politician knowledge of voter preferences.

These problems of information and the advantages of money make it likely that elected representatives will be lobbied by highly interested and informed subgroups of the population. Note that lobbying is the expending of resources by certain individuals or groups in an attempt to influence a politican. Politicians find it in their interest to listen to lobbies for two reasons. First, these groups can provide relevant information about an issue to an uninformed politician. When particular subgroups have a strong interest in a complicated issue, they also typically have a thorough and deeper understanding of the issue. Second, these groups will reward politicans who support their views by contributing to the politician's campaigns and getting group members to vote for the politician, which can help the politician's overall vote maximization.

Remember that the median voter theory states that the voter gets exactly what they want -- to the extent that the elected candidate delivers on their campaign promises (Section IV. Illustration: Electoral Competition and the Median Voter. Paragraph 2. Referenced paper).

Direct Democracy

Majority voting is the typical method used to aggregate individual votes into a social decision, whereby individual policy options are put to a vote and the option that receives the majority of votes is chosen. To be consistent, the aggregation mechanism must satisfy three goals:

  • Dominance: if one choice is preferred by all voters, the aggregation mechanism must be such that this choice is made by society.

  • Transitivity: choices must satisfy the mathematical property of transitivity. If a large park is preferred to a medium-sized park, and a medium-sized park is preferred to a small-sized park, then a large park must be preferred to a small park.

  • Independence of irrelevant alternatives: choices must satisfy the condition that if one choice is preferred to another, then the introduction of a third independent choice will not change that ranking.

Arrow's Impossibility Theorem
Kenneth Arrow asserted that democracy should be able to convert individual preferences into consistent aggregate decisions, but he concluded that it is impossible to find any rule that can always accomplish this, primarily because there can be a voting paradox if one or more voters have double-peaked preferences. In response to Arrow’s Impossibility Theorem, which helped to earn Kenneth Arrow the Nobel Prize in Economics in 1972, another Nobel prize winner, James Buchanan said “Majority rule is acceptable in a free society precisely because it allows a sort of jockeying back and forth among alternatives, upon none of which relative unanimity can be obtained…It serves to insure that competing alternatives may be experimentally and provisionally adopted, tested, and replaced by new compromise alternatives approved by a majority group of ever-changing composition.” (from Fiscal Theory and Political Economy--Selected Essays, University of North Carolina Press, 1960).

For Additional Information on Political Economy

The James Buchanan Center for Political Economy: http://www.gmu.edu/jbc/

Public Choice Society: http://www.pubchoicesoc.org/

The Brookings Institute: http://www.brookings.edu/es/research/projects/cg/overview.htm

The Federal Election Commission: http://www.fec.gov/

CQ Money Line: http://www.tray.com/

The Campaign Finance Institute http://cfinst.org/

Iowa Electronic Market: http://www.biz.uiowa.edu/iem/index.html

The Political Economy Institute: http://politicaleconomy.info/