Economic Theory of State
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University of Zurich Faculty of Law Fall Semester 2015 Law & Economics Economic Analysis of Law Public Law – Public Choice – Political Economy Prof. Dr. Rolf H. Weber / Dr. Mark Steiner lst.weber@rwi.uzh.ch Content Theory of state Philosophical theories Economic theories of state Public law – Public choice aspects Election rules Actors in legislative process Division of competencies in governments / federalism Universität Zürich 2 1 Public Law Philosophic Theories of State Aristoteles (4th cent. BC,) classicism „Man is by nature a political animal“ Niccolò Machiavelli (15/16th cent.), The power state „A prince just needs to prevail and to claim his dominion,…“ Thomas Hobbes (17th cent.), Leviathan „Protection from anarchy and insecurity“, „war of all against all“ Immanuel Kant (18th cent.), idealistic theory of state, jurisprudence „…whereby the inhabitants constituted themselves to a state, but actually just the idea of it, after that the legality of the state only can be thought, the original contract, up to which all the people surrender their external freedom to readopt it as a member of a general entity, i.e. of the people regard as state readopt it immediately.“ 3 Universität Zürich Content Theory of state Philosophical theories Economic theories of state Public law – Public choice aspects Election rules Actors in legislative process Division of competencies in state Universität Zürich 4 2 Economic Theory of State Overview The view of the economist Individual rational utility maximises Market results in Pareto-efficient allocations Requirements? Coordination (game theory) – Transaction costs Prisoners‘ dilemma Cooperation – Cooperation costs Public goods Redistribution 5 Universität Zürich Economic Theory of State: Coordination Game theory: Prisoners‘ dilemma Bartering in anarchy? Person A Not steal Person B Not steal Steal steal 10 10 6 12 12 6 8 8 What happens? Stealing is the dominant strategy Incentives for defense Universität Zürich 6 3 Economic Theory of State: Coordination Incentive for activities Activities under Hobbes‘ anarchy Productive (individual and social) Direct production Socially unproductive, individually productive Robbery Defence David Hume, A Treatise of Human Nature (1749) “Nothing but an increase of riches and possessions could bring men to quit [the state of society without government].” 7 Universität Zürich Economic Theory of State: Coordination Game theory: Agency game (contract law) second player (agent) Investment of 100 by principal (No enforcable contract law) first player (principal) invest don‘t invest cooperate (100) + 50 Universität Zürich invest don‘t invest 100 -100 0 0 0 0 second player (agent) Investment of 100 by principal (with enforcable contract law) first player (principal) retain 50 perform breach 50 (100) + 50 –50 (100) + 50 0 0 0 0 8 4 Economic Theory of State: Coordination Requirements for gains from trade Voluntary exchange – Gains from trade Specialisation (Smith) => absolute advantages Comparative advantages (Ricardo) Requirements Property rights Contract law Law enforcement State‘s monopoly on the use of force Economies of scale of the state‘s monopoly on the use of force Universität Zürich 9 Economic Theory of State: Public Goods Public goods (Samuelson) Non-rivalry in consumption No principle of exclusivity Typical public goods National defence Legal certainty / rule of law Competition Freedom (of action, speech, etc.)? Redistribution? Clear air/waters? Universität Zürich 10 5 Economic Theory of State: Redistribution? Aristoteles „When there is no middle class, and the poor greatly exceed in number, troubles arise, and the state soon becomes to an end“ Friedrich Engels „The state was created to keep the hostility of classes under control …“ Redistribution as insurance Irrationality and uncertainty regarding future prospects Redistribution as public good => Security Redistribution as fairness standards „Dictator-game“ (Eichenberger/Oberholzer-Gee 1998/2008) Fairness has value Dependant on “experiment setting” = institutional environment/laws 11 Universität Zürich Economic Theory of States State Formation; Buchanan: Limits of freedom State of law (social contract) Decrease of transaction costs Invisible hand Benefits of trade/specialization Productive state Increased wealth (e.g. GDP) Visible hand Public goods / redistribution Welfare state, redistributive state Increased benefits? Stability? Universität Zürich 12 6 Problems of the State „Quis custodiet ipsos custodes? (Juvenal 1./2. cent.) Who watches the watchmen? Principal agent problems Monitoring costs „Multi-tasking“, „Fuzzy-tasking“ Monitorability of the objectives? Fairness Rules Enforcement Market failure vs. government failure 13 Universität Zürich Content Theory of state Philosophical theories Economic theories of state Public law – Public choice aspects Election rules Actors in legislative process Division of competencies in state Universität Zürich 14 7 Election Rules Unanimity Ensures Pareto-criterion Problems High costs for decisions Strategic behavior Majorities Parteto-criterion, Kaldor/Hicks? Optimal majority? Decision costs External costs of (majority) decisions 15 Universität Zürich The Median-Voter Theorem Harold Hotelling (1929) Representative democracy Candidates – positioning of parties Distribution of preferences Main influences Competition v. concordance Party system Winning party supplies the government Coalitions Barriers to access and withdrawal Parties or candidates Universität Zürich 16 8 Rationality and Voters Voting as rational decision, Anthony Downs R=P*B+D–C B = Individual benefit of the candidate P = Probability to have the distinct vote C = Costs of voting D = Benefit of voting Controversial is D „Expressive voter“-hypothesis Why would anybody vote for someone/something? „Ethical voter”-hypothesis Who do you vote for? 17 Universität Zürich Rational voters? Poll in the Canton Schwyz on the relocation of the DMV (27. Nov. 2011) DMV Ausserschwyz today Universität Zürich Proposed new DMV 18 9 Results: Voters do optimize their own utility! 19 Universität Zürich Content Theory of state Philosophical theories Economic theories of state Public law – Public choice aspects Election rules Actors in legislative process Division of competencies in state Universität Zürich 20 10 Actors in Legislative Process: Politicians Politicians as rational utility maximisers Aim: (Re-)election Popularity with group of voters Support of lobbies/special interest groups Favouritism of „visible“ legislation Negligence of important, „invisible“ legislation What legal/democratic limitations to influence incentives? ...? ...? ...? 21 Universität Zürich Actors in Legislative Process: Bureaucrats / Civil Servants Maximisation of benefits of civil servants Budget Employees Individual benefit v. public good Maximisation of benefits => to much public goods Limitations: Politicians Measures of control v. cost of control Too much „visible“ public goods required Problem No democratic control No competition Universität Zürich High costs 22 11 Actors in Legislative Process Lobbies Size of group Large groups: Interests are public goods Small groups: easier organisation Rent seeking Subsidies Tax relief Direct Payments Legislation/Regulation Preference for own interests Disadvantages for competitors 23 Universität Zürich Rent Seeking Economic benefit I.e. natural monopoly Licensing by state Wasted resources through Efforts/expenses of potential operators Efforts by civil servants in response to operators Obstruction of third parties through monopoly and state Universität Zürich 24 12 Rent Seeking Regulation in favour or against Consumers? Example: Bridge Welfare maximizing optimal bridge toll = 0 Private bridge operator = Monopoly price Who desires regulation? Regulatory price between monopoly and perfect competition Perfect competition Monopoly Demand/effects Demand/effects Producers positive negative Consumers negative positive? 25 Universität Zürich The Theory of Economic Regulation (Stigler 1971) Demand for regulation of Subsidies Access barriers Beneficial or adverse treatment Advantages for complements Disadvantages for substitutes E.g. Butter producer Disadvantages for producers of margarine Advantage for bakers Price setting, administered prices Universität Zürich 26 13 The Theory of Economic Regulation Evidence with three examples (Stigler 1971) Obstruction of competitors Transport industry Certification of transport companies Smaller interest groups are more effective Refineries Rates of the smaller are higher Regulation protects interest groups Licensed v. unlicensed professions Higher income More secure jobs Less people employed by firms 27 Universität Zürich Content Theory of state Philosophical theories Economic theories of state Public law – Public choice aspects Election rules Actors in legislative process Division of competencies in state Universität Zürich 28 14 Economic Analysis of Constitutional Law Three aspects Unitary state v. federalist state Centralised v. decentralised Direct v. representative democracy Direct v. representative democracy + Means of control + Consideration of the preferences -- Transaction costs (population number) Solutions: Random-Selection Modern communication technology 29 Universität Zürich Federalism v. Unitary State Centralised v. Decentralised Allocation of competencies Federal: „bottom up“ => decentralised Unitary state: „top down“ => central Advantages federalism Disadvantages federalism Consideration of the preferences / local public goods Idle returns to scale Means of control Information costs Competition Spillovers – Transfers „Happy to experiment“ Direct democratic possibilities Time need for decisions? Distribution of competences – Autonomy Universität Zürich 30 15 Federalism Requirments for the Functionality Basic requirements Fiscal autonomy Regional administrative voted government Mobility Similar: Club theory Exit => „Vote with their feet“ Voice => Elections, referenda, initiatives etc. Loyalty => Pay Further development: FOCI 31 Universität Zürich Appendix Universität Zürich 32 16 Economic Theory of State Coordination Coordination in case of repeated games Signals „Tit-for-tat“ Obligations Problem: large groups Unknown counterparty No repeated games High information and und enforcement costs Collective regulation of coordination through state Universität Zürich 33 Beware (of) unlicensed casket-selling monks The Economist, May 30th 2012, 18:55 by R.A. | WASHINGTON DEBATES over the burdensome nature of regulation in America typically focus on national-level rules, on the overactive Environmental Protection Agency or the hopeless Food and Drug Administration or that oh-so-manypages-long Dodd-Frank financial reform act. In practice, the red tape that grows like kudzu at state and local levels is ofetn felt more keenly by would-be entrepreneurs. Take, for instance, the case of some Louisiana monks trying to earn their way out of financial trouble by selling handmade cypress coffins: Brown, a soft-spoken man who is only the fifth leader of a monastery that dates to 1889, said he had not known that in Louisiana only licensed funeral directors are allowed to sell “funeral merchandise.” That means that St. Joseph Abbey must either give up the casket-selling business or become a licensed funeral establishment, which would require a layout parlor for 30 people, a display area for the coffins, the employment of a licensed funeral director and an embalming room. “Really,” Brown said. “It's just a big box.” The Institute for Justice, which has been doing (ahem) the lord's work with respect to occupational licensing, recently released a paper on the scourge, which estimated that one in three workers need some sort of government permission to do their job. Rules are often sold on the basis of safety but all too often serve as nothing more than a barrier to entry to the profession, raising prices to consumers and eroding competition—and standing between willing buyers and the monk-made cypress caskets they'd like to purchase. Universität Zürich 34 17
