Session 5
Political Economy
6-1
Political Economy
• The field that applies economic principles to the
analysis of political decision making.
• Political economy models assume that
individuals view government as a mechanism for
maximizing their self-interest.
• 2 points are worthy noting:
• Selfishness does not necessarily lead to
inefficient outcomes
• While the maximization assumption may not be
totally accurate.
6-2
Direct democracy
• We look at various voting procedures
under democracy.
• Unanimity rules
• Majority voting rules
6-3
Unanimity Rule
• The unanimity-voting rule means that each
and every part or representative group
within a society must support a plan before
it becomes the collective decision (Black,
1999 pp 59).
• It requires that collective decisions should
take into account the interests of all parties
concerned.
• John Rawls’s theory of justice
approximates the unanimity rule.
6-4
Unanimity Rule
• The Rawlsian theory focuses on the process by
which individuals reach unanimity over the
principles of justice.
• The theory assumes that each part in the
original position is assumed to be equally risk
averse.
• The individuals will try to minimize their risk in
choosing a social welfare function. The welfare
function can be presented as follows;
• W = Minimum (Ua,Ub)
6-5
Unanimity Rule
• Social welfare in this scenario is determined by the
lower of the two individual utilities.
• If Ua < Ub then W = Ua. Therefore for welfare to
increase in this community, Ua must increase.
• All parties in the original position will adopt a maximin
strategy, favouring the party in the worse off position.
• For example if a political constitution embodies the
Ralwsian welfare function, it must be unanimously be
approved.
6-6
Unanimity Rule
• The main short-fall of the unanimity rule is
that it normally takes long to reach a
unanimous decision.
• The second short - coming is that the
unanimity rule gives the minority the right
to veto.
• However the unanimity rule will give rise to
strategic behaviour in order to gain special
benefits through vote trading (logrolling).
6-7
Eve’s share (SE)
Unanimity Rules: Lindahl’s
model
0’
DrE
Adam’s share (SA)
S*
DrA
0
r per year
r*
The Lindahl Model
6-8
Lindahl’s model
• Assume two individuals Adam and Eve and one
public good rockets for fireworks (r).
• Adam’s share of the cost of provision 30%.
• Market price per rocket is Pr.
• Let Adam’s share of the cost be SA .
• For any SA Adam demands some quantity of
rockets.
• As the tax share increases Adam demands less
rockets
6-9
Lindahl’s model
•
•
•
•
•
DAr is Adam’s dd curve for rockets.
Dd for rockets decreases as the tax share increases.
SE is Eve’s share of the costs of rockets
SA + SE = 1
SE goes up, the quantity demanded by Eve
decreases.
• DEr is Eve’s dd curve for rockets.
• In the Lindahl model each individual faces a
personalised price per unit of the plc good.
6-10
Lindahl’s model
• The tax shares are called the Lindahl
prices.
• An equilibrium is a set of Lindahl prices
such that at those prices each person
votes for the same quantity of the public
good.
• Adam’s equilibrium tax share is OS*and
Eve’s is O’S*.
• r* rockets should be provided
6-11
Feasibility of Unanimity Rules
• Reaching equilibrium
• Assume that the different set of tax shares are auctioned
while Adam and Eve are voting for the quantities of the
public good.
• The process continues until they unanimously agree on
the quantity of rockets(r*).
• Practical problems
– Strategic behavior may prevent Adam and Eve from
reaching the equilibrium.
– Time-consuming and costly to reach equilibrium
6-12
Direct Democracy-Majority
Voting Rules
• Majority voting rule – one
more than half of the voters
must favor a measure for it to
Choice
be approved
• We consider A,B and C
First
levels of missile provision.
Second
• Small, moderate and large
Third
respectively.
• The table depicts voter’s
preferences.
Voter
Brad
Jen
Angelina
A
C
B
B
B
C
C
A
A
6-13
Majority Voting Rules
• In an election is held btwn A and B, option B
would win by 2 to 1 votes.
• Btwn B and C, B would win by 2 to 1.
• There level B wins an election by majority
rule.
• Selection of B is independent of the order of
the votes
6-14
Direct Democracy-Majority
Voting Rules
• Voting Paradox – community
preferences can be
inconsistent even though
individual’s preferences are
consistent
• Majority rule does not always
produce clear-cut results.
• In the current case an election
btwn A and B, A win by 2 to 1 .
• Btwn B and C, B would win by
2 to 1
• Btwn C and A, C wins by 2 to
1.
• This creates a paradox.
Voter
Choice
Brad
Jen
Angelina
First
A
C
B
Second
B
A
C
Third
C
B
A
6-15
Direct Democracy-Majority
Voting Rules
• Agenda Manipulation –
process of organizing
order of votes to ensure a
favorable outcome.
• Can start with A and B, the
winner(A) then runs
against C. C will be the
ultimate winner.
• Cycling – when paired
voting on more than two
possibilities goes on
indefinitely without a
conclusion ever being
reached
Voter
Choice
Brad
Jen
Angelina
First
A
C
B
Second
B
A
C
Third
C
B
A
6-16
Graphing preferences
• The structure of voter preferences determine if
there will be a clear-cut winner.
• Peak- point on the graph of individual
preferences at which all the neighbouring points
have lower utility.
• Single-peaked preferences Utility consistently
falls as the voter moves away from his or her
most preferred outcome.
• Double-peaked preferences - If as a voter
moves away from his or her most preferred
outcome, utility goes down, but then goes up
again.
6-17
Graphing Preferences
Utility
Single-peaked preferences
Jen
Double-peaked preferences
Brad
Angelina
A
B
C
Missiles
6-18
Graphing Preferences
• Brad and Angelina have single peaked
preferences
• Jen has double-peaked preferences.
• Jen’s preferences lead to a voting paradox
• In the first example there was no voting
paradox becoz all voters had singlepeaked preferences.
6-19
Practical Importance of DoublePeaked Preferences
• Availability of private substitutes for a
publicly provided good(e.g. pvt parks) can
lead to multi-peaked pattern like Jen’s.
• Issues cannot be ranked along single
dimension – choice btwn goods with
different characteristics.
6-20
The median Voter theorem
• The voter whose preferences lie in the
middle of the set of all voters’ preferences.
Half voters want more of the item selected
and half want less.
• Theorem: as long as all preferences are
single-peaked and several other
conditions are satisfied, the majority voting
reflects the preferences of the median
voter
6-21
Direct Democracy - The Median
Voter Theorem
Voter
Expenditure
Donald
$5
Daisy
100
Huey
150
Dewey
160
Louie
700
6-22
The median Voter theorem
• The majority votes for $150 expenditure
on the party because its supported by
Huey, Dewey and Louie.
• Log-rolling
• The trading of votes to obtain passage of a
package of legislative proposals.
• Even with positive benefits if each project
is voted for separately, none is adopted.
With vote trading all of the measures are
adopted.
6-23
Direct Democracy - Logrolling I
Voter
Project
Melanie
Rhett Scarlet Total Net
Benefits
-50
-55
95
Hospital
200
Library
-40
150
-30
80
Pool
-120
-60
400
220
6-24
Direct Democracy - Logrolling II
Voter
Project
Melanie
Rhett Scarlet Total Net
Benefits
-110
-105
-15
Hospital
200
Library
-40
150
-120
-10
Pool
-270
-140
400
-10
6-25
Logrolling
• Melanie votes for library if Rhett votes for
hospital; and Rhett and Scarlet trade votes
for the pool and library.
• With vote-trading some projects with
negative net-benefits will be adopted
6-26
Direct Democracy - Arrow’s
Impossibility Theorem
• “Reasonable” collective
decision-making criteria
– It can produce a decision
whatever the configuration
of voters' preferences
– It must be able to rank all
possible outcomes
– It must be responsive to
individuals’ preferences
– It must be consistent
– Independence of irrelevant
alternatives
– Dictatorship ruled out
• Arrow’s Impossibility Theorem
– All conceivable voting
schemes have some
potential for being unfair or
producing a paradoxical
result
• Meaning of theorem
– consistent rule not
necessarily impossible to
find, but cannot be
guaranteed
• Buchanan’s critique
• Democracyviable
• Use of social welfare functions
6-27
Representative Democracy Elected Politicians
Number of Voters
Liberal
Conservative
6-28
Implications of the Median Voter
Model
• Two-party systems tend to be stable
• Replacement of direct referenda by
representative system has no effect on
outcomes
6-29
Other Factors Influencing Voting
•
•
•
•
•
Single-dimensional rankings
Ideology
Personality
Leadership
Decision to vote
6-30
Representative DemocracyPublic Employees
• Function of bureaucrats
• Goals of bureaucrats
6-31
Niskanen’s Model of
Bureaucracy
C
$
V
Actual
output
Efficient
output
0
Q*
Qbc
Q per year
6-32
Representative Democracy –
Special Interests
• What are “Special Interests”?
• Establishment of Special Interest Groups
– Source of Income: Capital or Labor
– Size of Income
– Source of Income: Industry of Employment
– Region
– Demographic and Personal Characteristics
6-33
Representative Democracy –
Rent-Seeking
$
Rents
S=MC
D
tons of peanuts per year
MR
6-34
Representative Democracy –
Other Actors
• Judiciary
• Journalists
• Experts
6-35
Explaining Government Growth
• Citizen Preferences
G = f(P, I)
•
•
•
•
Marxist View
Chance Events
Changes in Social Attitudes
Income Redistribution
6-36
Controlling Government Growth
• Government growth as a non-issue
• Government growth as a problem
– Commitments made in the past
– Basic flaws in the political system
6-37
Improving the Workings of the Political
System
• Change bureaucratic incentives
– Financial incentives
– Privatization
• Change Fiscal Institutions
– Budget Enforcement Act (BEA) – 1990
– Balanced Budget rules at the state level
• Institute Constitutional Limitations
– Balanced Budget amendment
6-38
Provisions of a Typical Balanced
Budget Amendment
1. Congress must adopt a budget statement “in
which total outlays are no greater than total
receipts”
2. Total receipts may not increase “by a rate
greater than the rate of increase in national
income”
3. “The Congress and President shall…ensure
that actual outlays do not exceed the outlays
set forth in the budget statement”
4. The provisions can be overridden in times of
war
6-39
Critique of Balanced Budget
Amendments
•
•
•
•
Forecasting issues
Definitional issues
Penalties for violation of the law
Economic issues
6-40
Extras: Majority voting rule
• Ordinary majority rule is the most common
social choice rule. Approval of a decision
requires that the policy receive the most
votes, in a one man one vote scenario.
Direct democracy (referendum) requires
that a winning policy proposal receives 50
per cent plus one vote.
6-41
Extras: Representative democracy
• A representative democracy requires that the electorate
choose representatives who make choices on their
behalf. Representative democracies are more common
today because they are relatively cheap to administer as
compared to a direct democracy. Public interests in a
representative democracy are represented by elected
politicians, civil servants, and interest groups. The role of
politicians is very crucial, as they strive to maximize the
number of votes they receive in the next election. To
appreciate the role of the vote-maximizing politician in
the transformation of individual preferences into logical
social preferences we need to understand the median
voter theorem.
•
6-42
Extras: Median Voter theorem
• Under what circumstances are votes maximized in a representative
democracy? The median voter is a voter whose set of preferences
divide the voting community exactly into two. The theorem states
that; under a majority voting system in which preferences are not
extreme, it is the median voter’s preferred option win the day, since
that is the option that will produce the minimum welfare loss for the
whole group. The model explains the behaviour of rational
politicians. It suggests that through interactions with the electorate,
they can identify the median voter and act upon his or her
preferences to accomplish the desires of the majority at minimum
cost.
• Reality is slightly different from what this theory predicts. Firstly it’s
difficult for politicians to identify the median voter and the different
political issues have different median voters. In addition not every
politician is a vote maximiser, some may be driven by the desire to
fulfill public interest. The assumption of rationality on the part of
voters and politicians is unlikely as they are not perfectly informed in
making choice. However, the majority rule has the advantage of that
decisions are approved much quicker than under the unanimity rule.
It is less likely that a minority veto majority decisions. There is the
danger that minority interests will be ignored under the winner take
all majority system.
6-43