POLITICAL ECONOMY
Chapter 6
Political Economy
• The field that applies economic principles to
the analysis of political decision-making.
• Political economy models assume that people
view government as a mechanism for
maximizing their self-interest. We examine
direct democracies and how well they
translate the preferences of their citizens into
collective action.
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I. Direct Democracy
• Democratic societies use various voting
procedures to decide on public expenditures.
1. Unanimity
• Let’s begin with the concept of unanimity
• With unanimity everyone must agree on the level of
public service desired
Lindahl Prices
• If we could design tax prices to charge of each
resident, perhaps we could obtain unanimity
in the desired level of public good to provide
• This is the concept of Lindahl prices, named
after Erik Lindahl in the early 20th century
Feasibility of Unanimity Rules in
Reaching Equilibrium
• Like the market outcome, one can prove that
the allocation is Pareto efficient.
• Practical problems
– It assumes people vote sincerely. Strategic
behavior may prevent people from reaching the
Lindahl equilibrium.
– Finding the mutually agreeable tax shares may
take a lot of time. Unanimity rules often lead to
situations in which no decisions are made.
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2. Majority Rule
• More typically we rely on majority rule in a
democracy
• In this case, the level of public good
supported by the majority of residents is the
quantity that is provided
Direct Democracy
Majority Voting Rules
• Majority voting rule – one
more than half of the
voters must favor a
measure for it to be
approved
• Given the voter
preferences to the right,
“B” always wins against
opponents
Voter
Choice
Brad
Jen
Angelina
First
A
C
B
Second
B
B
C
Third
C
A
A
– However, majority voting
does not always yield
clear-cut results
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Majority Voting Does Not Always Yield ClearCut Results: Double- vs. Single-Peaked Preferences
• Voting Paradox – Community
preferences can be inconsistent even
though individual’s preferences are
consistent
– Given new preferences at the
right:
• A vs. B → A wins
• B vs. C → B wins
• A vs. C → C wins
• Agenda Manipulation – Process
of organizing order of votes to ensure
a favorable outcome
• 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
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Majority Voting Does Not Always Yield ClearCut Results: Double- vs. Single-Peaked Preferences
• A peak in an individual’s preferences as a point at
which all the neighboring points are lower.
– single-peaked preferences: if, as she moves away from her
most preferred outcome in any and all directions, her
utility consistently falls.
– double-peaked preferences: if, as she moves away from the
most preferred outcome, utility goes down, but then goes
up again.
• If all voters’ preferences are single peaked, no voting
paradox occurs.
• When issues cannot be ranked along a single
dimension, multipeaked preferences are also a
serious possibility.
Graphing Preferences
Utility
Single-peaked preferences
Jen
Double-peaked preferences
Brad
Angelina
A
B
C
Missiles
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Practical Importance of DoublePeaked Preferences: Examples
• Can occur with availability of private substitutes
for a publicly provided good
– Example: public park vs. private country club
• Can occur with issues that can’t be ranked along
single dimension
– Example: abortion clinic vs.
adult bookstore vs.
Army recruitment office
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3. Median Voter Theorem
• Half the voters want more of the good than
the median voter, and half want less.
• As long as preferences are single peaked, the
outcome of majority voting reflects the
median voter preferences
Direct Democracy
The Median Voter Theorem
• Assume five voters are
deciding how large a
party to give together,
and each of them has
single-peaked
preferences over party
sizes.
• Huey’s preference of
$150 spending would
prevail in majority
voting
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4. Logrolling
• The process of representatives trading votes
with one another is called logrolling
• Proponents:
– Trading votes leads to efficient public good
provision just as trading commodities leads to
efficient provision of private goods.
– Its potential for revealing the intensity of
preferences and establishing a stable equilibrium.
Direct Democracy
Logrolling I: Welfare Improved
• Suppose a community is
considering three projects,
a hospital, a library, and a
swimming pool. The
community has three
voters, Melanie, Rhett, and
Scarlet. A minus sign
indicates a net loss; that is,
the costs exceed the
benefits.
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Direct Democracy
Logrolling I: Welfare Improved
• If each project is voted on
separately, none is
adopted even though each
yields positive net benefits.
• With vote trading social
welfare is improved.
(Melanie and Rhett,
Library and hospital)
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Direct Democracy
Logrolling II: Welfare Lowered
• With vote trading,
some or all of the
projects will pass,
which is inefficient.
• A majority of voters
can form a coalition
to vote for projects
that serve their
interests, but whose
costs are borne
mainly by the
minority.
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Direct Democracy
Arrow’s Impossibility Theorem
• “Reasonable” collective decision-making
should be logical and respect individuals’
preferences
• 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
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Direct Democracy
Arrow’s Impossibility Theorem
• Unfortunately, all conceivable voting schemes have some
potential for being unfair or producing a paradoxical result
• Meaning of theorem is that a fair, consistent rule is not
necessarily impossible to find, but it is not guaranteed a
society will find one
• Buchanan’s critique: Despite being inconsistent, majority
rule has other benefits
– it allows a sort of jockeying back and forth among alternatives.
• Arrow’s theorem implies social welfare functions are useless,
but most economists believe they provide valuable insights
– Most economists believe that a social welfare function can be used
to draw out the implications of alternative sets of value judgments.
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II. Representative Democracy
• Government is done by people. Realistic political
economy models must study the goals and behavior
of the people who govern.
II. Representative Democracy
Elected Politicians
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Implications of the Median Voter Model
• Assume voters rank all positions on the basis of
whether they are “conservative” or “liberal.” Because
all voters have single-peaked preferences and want
to maximize utility, each supports the candidate
whose views lie closest to his/her own.
– The candidate who adopts the median position (M) will
defeat the candidate who adopts the position away from
the median (S)
• Two-party systems tend to be stable because they
stake out positions near center
• Replacement of direct referenda by representative
system has no effect on outcomes
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Other Factors Influencing Voting
• Non-single-dimensional rankings
– cause median voter theorem to fall apart
• Ideology
– assumes that politicians are simple vote
maximizers, but they may care about more than
just winning elections. Ideology can play an
important role.
• Personality
– voters’ decisions depend only on issues may be
unrealistic.
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Other Factors Influencing Voting
• Leadership
– Politicians provide leadership. Leadership can
change election outcomes occurs when a
politician’s policies actually change the
composition of his/her constituency.
• Decision to vote
– ignores the costs of acquiring information and
voting. A fully informed voter evaluates the
suitability of a candidate’s platform, the
probability that the candidate will be able and
willing to keep his/her promises, and so forth.
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Representative Democracy
Public Employees
• Function of bureaucrats
– Implement policy
– Provide technical expertise in the design and execution of
programs and policies
– Provide “institutional memory”
– Provide accurate documentation to ensure
• Equal treatment for eligible citizens
• Prevent corruption
• Perhaps increasing power and their own perks
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Representative Democracy
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
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Representative Democracy
Special Interests
• Rent-seeking
– induces the government to restrict the output in their industry,
which leads to higher prices, allowing producers to earn rents.
– can use up resources
• lobbyists spend their time influencing legislators and bureaucrats,
• consultants testify before regulatory panels,
• advertisers conduct public relations campaigns.
– does not represent a mere lump-sum transfer; it is a measure
of real resources used up to maintain a position of market
power.
• The deadweight loss associated with rent-seeking is the sum of
rents+dwl.
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Representative Democracy
Other Actors
• Judiciary
• Journalists
• Experts
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Explaining Government Growth
Ratio of government expenditures to Gross Domestic Product
Year
Canada
Switzerland
United Kingdom
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
9.5
11.4
16.1
18.9
23.1
22.1
29.7
36.0
41.6
48.8
41.1
44.1
n.a.
n.a.
n.a.
15.9
19.2
19.9
17.7
21.3
29.3
30.3
35.1
34.2
14.4
12.7
26.2
26.1
30.0
39.0
31.9
41.8
45.2
41.1
36.8
50.5
Sources: Pommerehne (1977); OECD (2012a)
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Explaining Government Growth
• Citizen Preferences: G = f(P, I)
G=Median voter’s demand of public sector goods & services
P=Price of public sector goods and services
I=Income
– Only 40% of the growth in US public budgets can be explained.
– More is going on than a simple median voter story can explain.
• Marxist View
– The public sector must expand to absorb private excess production.
– The historical facts seem to contradict this analysis.
– Its explicit recognition of the links between the economic and
political systems as sources of government growth.
• Chance Events
– After the external shock (Wars, recessions) disappears, higher levels
continue to prevail because of inertia.
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Explaining Government Growth
• Changes in Social Attitudes
– Widespread television advertising creates unrealistically high
expectations, leading to a “Santa Claus mentality”
• people lose track of the fact that government programs do have an opportunity
cost.
• Income Redistribution
– Government grows because low-income individuals use the political
system to redistribute income toward themselves.
• Politician can attract voters whose incomes are at or below the median by
offering benefits that impose a net cost on those whose incomes are above the
median.
– As the difference between the median and average income grows, so
too does the amount of government-sponsored redistribution
• the more that income is concentrated at the top, the greater the potential
benefits to the median voter of redistributive transfers.
– Transfer programs that benefit different income classes can exist
simultaneously, so these various views of government redistribution are
not necessarily mutually exclusive.
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