Part III: Political Economy
In order to operate, a government needs to
decide two things:
1) How are decisions made?
2) How are responsibilities split?
Note: This chapter covers select issues in political
economy
Part III:
Political Economy
Direct Democracy
Representative Democracy
Federal System Background
Advantages of Decentralization
Disadvantages of Decentralization
Theory - Public Choice
PUBLIC CHOICE – a field of applying economic
principles to the understanding of political
decision making
We will examine two models of democratic
decision making:
1) Direct Democracy
2) Representative Democracy
1) Direct Democracy
In direct democracy, everyone has a say in the
political decision making process, leading to a
variety of approaches and issues:
a) Unanimity Rules
b) Majority Voting Rules
c) Logrolling
d) Arrow’s Impossibility Theorem
1a) Unanimity Rules
Lindahl (1919/1958) designed a procedure to ensure
unanimous agreement on provision of public goods.
Each voter has a demand curve, where PRICE is the
fraction of the public good the voter will pay (tax
share), and QUANTITY is the resulting quantity they
will want.
Two voters will agree on provision of public goods when
their combined price equals one at a certain quantity
level.
This can be shown through the following overlay of
demand curves:
Unanimity Rules
1a) Unanimity Rules
The prices, or tax shares, where two people
demand the same amount of public goods, are
LINDAHL PRICES.
Unanimity Rules are feasible through an auction
system, where an auctioneer keeps listing
different tax schemes until everyone agrees on
one.
1a) Unanimity Rules
Unanimity Rules suffer from two problems:
1) People can still misrepresent their preferences
to free-ride
2) Unanimous decisions take a long time with
many people
 It is guaranteed that no one is exploited but…
 Historically, unanimous decisions have been
required to ensure no decision is made.
1b) Majority Voting Rule
Difficulty in unanimous decisions often leads to
the MAJORITY VOTING RULE – one more
than half the voters must favor a measure for it
to be approved.
To illustrate, assume Econ 350 had 3 different
marking options:
1) Paper – long paper and one midterm
2) Exams – two midterms and a short paper
3) Assignment – two assignments, one midterm,
and a short paper
1b) Majority Voting Rule
Voter:
Choice
House
Super Mario
egHuk
First
Exams
Paper
Assign
Second
Assign
Exams
Exams
Third
Paper
Assign
Paper
In this case, even though each person prefers a
different arrangement, in a vote:
Exams beat paper (2 to 1)
Exams beat assignment (2 to 1)
Therefore, regardless of voting, exams win
This is not always the case however…
Voting Paradox
Voter:
Choice
House
Super Mario
Chuck Noris
First
Exams
Paper
Assign
Second
Assign
Exams
Paper
Third
Paper
Assign
Exams
In this case:
Exams beat assignment (2 to 1)
Assignment beets paper (2 to 1)
Paper beats exams (2 to 1)
VOTING PARADOX – individual voter’s
preferences are consistent, but the community’s
are not
Voting Paradox
In the case of a voting paradox, the order of the
voting agenda can determine the winner
AGENDA MANIPULATION – process of
organizing the order of votes to assure a
favorable outcome
Alternately, if pair voting (option A vs. option B) is
continually used a decision is never reached.
CYCLING – when paired majority voting on more
than two possibilities goes on indefinitely
without a conclusion ever being reached.
Voting Paradox
The voting paradox arises when one agent has a
DOUBLE-PEAKED PREFERENCE – utility
moves down as you move away from a
preference, then up as you move farther way.
SINGLE-PEAKED PREFERENCE – utility keeps
moving down the farthest you move from a
preference.
If we examine the previous decision in terms of #
of non-paper components, we see a double
peak:
Double Peaked Preferences
Voter:
Choice
House
Super Mario
Chuck Noris
First
Exams (2)
Paper (1)
Assign (3)
Second
Assign (3)
Exams (2)
Exams (2)
Third
Paper (1)
Assign (3)
Paper (1)
Here, Super Mario and Chuck Noris have singlepeaked preferences while House has double
peaked preferences (3 is better than 1 (less),
but worse than 2 (less)
When choices are not based on a single
dimension, multipeaked preferences are more
common (ie: would you prefer teleportation, super
strength, or mind reading as a super power?)
Median Voter Theorem
MEDIAN VOTER – voter who’s preferences lie in
the middle of all voter’s preferences
MEDIAN VOTER THEOREM – as long as all
preferences are single peaked, the outcome of
majority voting reflects the preferences of the
median voter
Median Voter Theorem Example
Assume that the final exam could be either 2, 3,
4, 5, or 8 questions long, each with exactly 20%
of the vote.
Moving from 8 to 5 would get 80% of the vote,
and moving from 5 to 4 would get 60% of votes.
However, moving from 4 to 3 would only get 40%
of votes
4, the median voter’s preference, wins through
majority voting.
1c) Logrolling
LOGROLLING – trading of votes to obtain
passage of a package of legislative proposals
Logrolling is common in the US, and allows
laws to be passed that normally would fail
through considering how strongly people feel
for a proposal.
Consider the following table reflecting benefits
from 2 proposals:
1c) Logrolling
 Without logrolling, each proposal would fail (2v1)
 With logrolling, a hospital and pool (net benefit
315) would be supported by Melanie (net benefit
80) and Scarlet (net benefit 345)
 Although this sometimes benefits society, through
special interest groups it can sometimes harm
society
1c) Logrolling
 Without logrolling, each proposal would fail (2v1)
 With logrolling, a hospital and library (net benefit
-20) would be supported by Melanie (net benefit
160) and Rhett (net benefit 40)
 Society’s welfare decreases through a coalition of
special interests
1d) Arrow’s Impossibility Theorem
Thus far, all voting techniques we’ve examined
have been flawed
Nobel laureate Kenneth Arrow (1951) proposed
6 criteria collective decision-making should
follow in a democratic society:
1) A decision is made regardless of preferences
(ie: multipeaked)
2) All possible outcomes can be ranked
3) Must be responsive to individuals’ preferences
(if everyone prefers A to B, society must rank
A higher than B).
1d) Arrow’s Impossibility Theorem
4) Consistency (if A is preferred to B and B is
preferred to C, C must be preferred to A)
5) INDEPENDENCE OF IRRELEVANT
ALTERNATIVES – ranking of A and B cannot
be influenced by another option C.
6) Dictatorship is ruled out.
Unfortunately, Arrow’s Impossibility Theorem
shows that all 6 requirements can’t be met (5
can); a democratic society cannot be
guaranteed to make consistent decisions.
It may make good decisions often but 100% can’t
be guaranteed
2) Representative Democracy
Everyone voting on every decision is impractical
in many areas, so often politicians are
democratically elected to make decisions
 Referendums occur, but are very uncommon and
costly
If certain qualifications hold, the median voter
theorem can predict the policies of the elected
representatives:
Success of the Middle
In the case of two
candidates, M and
S:
M will get all votes
left of himself, and
some votes between
M and S
S will get all votes right of himself, and some votes
between M and S
M will win the election
The representative that most follows the median
voter will win
Middle Winning Qualifications
Although this is a surprisingly common result, it
doesn’t always hold true due to:
1) Multi-dimensional rankings – often the median
voter is different for different issues (ie: social
issues vs. taxes) – a politician may win a vote
through one policy and lose it through another
2) Ideology – some politicians may care about
more than just winning elections – they may
hold to an ideology
 Carlyle King (former Co-operative Commonwealth
Federation (CCF…now NDP) Saskatchewan
president discussed ideology vs. election appeal:
Ideology vs. Election Appeal
“The trouble is that socialist parties have gone awhoring after the Bitch Goddess. They have
wanted Success, Victory, Power; forgetting that
the main business of socialist parties is not to
form governments but to change minds. When
people begin to concentrate on success at the
polls, they become careful and cautious; and
when they become careful and cautious, the
virtue goes out of them.” – Carlyle King
Who said politics was boring and wasn’t edgy?
Middle Winning Qualifications
3) Personality – often politicians win or lose
depending on personality (many argue that
Mulroney’s low popularity came out of his
arrogance)
4) Leadership – often politicians can influence
public opinion
5) Decision to vote – not everyone votes, so the
ACTUAL median voter may not be the median
voter of those who actually vote
6) Often there are more than just 2 candidates
Federal System of Government
“A public sector with both centralized and
decentralized levels of decision making in which
choices made at each level concerning the
provision of public services are determined
largely by the demands for those services of the
residents of (and perhaps others who carry on
activities in) the respective jurisdictions.”
-Oates (1972)
But federal systems can differ greatly due to
divisions of powers and responsibilities:
Decentralization Ratio
Decentralization Ratio = {Subnational gov. expenditures
(minus grants)}/total government expenditure
Canada has a relatively decentralized
government
Note that France is not a federal state
Expenditure Changes
Provincial activity has grown over time
Expenditure changes
Centralization and Expenditure
Note that these ratios can be misleading in two
ways:
1) If the federal government heavily funds
provinces with many restrictions, the
decentralization ratio (in the table) is
overstated
 This is significant in healthcare, but insignificant
elsewhere
2) If provinces successfully lobby the federal
government, the decentralization ratio is
understated
Optimal Decentralization
Compared to many industrial countries, Canada
has a relatively decentralized system, and there
is a continual tension between provincial and
federal government over a variety of issues
Should provinces get more power? Less?
What are the advantages and disadvantages of
decentralization (more power to the provinces)?
Advantages of a Decentralized System
1) Tailoring government to local tastes
 People have differing tastes, and people with
similar tastes tend to group together
 Decentralized governments allow for different
levels and varieties of government services
 Different areas operate differently and could
benefit from different economic regulations (ie:
Sunday shopping)
2) Fostering intergovernmental competition
 Provincial and local governments can be more
efficient through implicit competition as citizens
see the results from other jurisdictions
Advantages of a Decentralized System
3) Experimentation and Innovation in regionally
provided goods and services
Many jurisdictions trying different approaches
produces data to figure out the “best” way
“It is one of the happy incidents of the Federal
system that a single courageous state may, if its
citizens choose, serve as a laboratory, and try
moral, social and economic experiments without
risk to the rest of the country.”
– Brandeis, US Supreme Court Justice
Decentralized Experimentation
Examples:
1) Saskatchewan experimented with healthcare
in 1962
2) Different healthcare models (Canada and
abroad) may yield better organization tools
3) Quebec and British Columbia are
experimenting with increased childcare
subsidies
4) Different universities have different tuition, with
differing results. Is U of A’s $6k best, or U of
Lethbridge’s $5K best?
Decentralized System Disadvantages
A) EFFICIENCY ISSUES
1) Externalities
 Often externalities are experienced across
communities/provinces (river pollution, education
and immigration, etc)
2) Public Good Economies of Scale
 Costs may decrease as provision increases,
therefore decentralization of some public goods
can have higher costs (policing, public parks)
 Communities can always contract out to keep
economies of scale (garbage collection)
Decentralized System Disadvantages
A) EFFICIENCY ISSUES
3) Tax collection economies of scale
 Tax administration costs per person can be
reduced in a centralized system (why support two
tax collection programs when you can split the cost
of one)
 Co-operation can take the place of centralization,
as in the federal government collecting provincial
sales tax (HST)
Decentralized System Disadvantages
B) EQUITY ISSUES
Communities with good social programs (ie: income
redistribution) would attract the poor…
Resulting in higher taxes…
Causing the rich to leave…
Causing the program to be abandoned
Research in this area has been mixed
Part III Conclusion
Lindahl pricing and unanimous decision making
results in efficient public good quantities
This suffers from misrepresentation of desires and
decision-making costs in large groups
Majority voting can fail in the case of multipeaked preferences
Majority voting tends to lead to the median
voter’s choice being selecting in the case of
single-peaked preferences
Part III Conclusion
Logrolling involves grouping projects and
trading votes
This can lead to minority special interests
decreasing society welfare
Arrow’s Impossibility Theorem shows a
democracy can’t be guaranteed to make
consistent decisions
Part III Conclusion
In the case of two elected representatives, the
winner will tend to be the politician best
representing the median voter
Unless the median voter varies greatly among
issues or issues are multi-peaked
Canada has a relatively decentralized system
compared to many other countries
There are advantages and disadvantages to
decentralization
Therefore some public goods and government
services are best provided locally, some nationally