Supply and Demand Conditions for Governmental Allocation

Transcription

1 Supply and Demand Conditions for Governmental Allocation We may think of political, as opposed to market, allocation systems as having similar sorts of demand/supply conditions as markets. In political allocation systems: 1) Demand occurs at a more aggregate level than for markets. Citizens, voters, political parties, interest groups, and other aggregates do the demanding. 2) Supply also occurs at a more aggregate level than for markets. Politicians, legislators, executives, bureaucracies, government contractors, and other public organizations do the supplying. Supply and demand are not a simple function of price, any more than supply and demand are simply a function of price in standard economic analyses. Private supply depends on the willingness of producers to produce, competition, etc. Private demand depends on tastes, substitutes, expectations of future income, etc.

2 In political allocation systems, demand is also a complex function of many factors. The Demand Determinants: D i =f(y, T, P, X, M, I, G, Q, F, R) where: D i =Demand for the i th Governmental Activity Y=National Income T=Tax Rate P=Price of Governmental Product or Service X=Perceived Externalities M=Degree of Monopoly or Increasing Returns I=Perceived Market Imperfections G=Perceived Need for Pure Public Goods Q=Perceived Inequities F=Perceived Unfairness or Undesirability of Market Outcome R=Rent Seeking Behavior of Economic Entities

3 In political allocation systems, supply is also a complex function of many factors. The Supply Determinants: S i =f(y, T, P, A, E, V) where: S i =Supply of the i th governmental activity Y=National Income T=Tax Rate P=Price of Governmental Product or Service A=Accuracy of Measurement of the Product or Service E=Exclusivity of Government Production V=Variance in Input/Output Relations Associated with Product or Service Technology Given these supply and demand conditions we expect an equilibrium to develop between supply and demand for governmental production and services. That is, at any point in time the amount of a good that government supplies is a function of demand for the good and the ability of government to provide it.

4 Rationale for Evaluating Governmental Allocation Systems 1) Governmental allocation systems are never Pareto efficient because of the high level of aggregation at which demand occurs. In a market allocation system each individual selects how much of a commodity to purchase. Such systems are often Pareto efficient because all individual choices are satisfied. No one is made worse off by the market equilibrium. However, in democratic allocation systems, the collectivity selects how much of a commodity to purchase. Such systems are not Pareto efficient because the minority s preferences are violated by the majoritarian equilibrium. For example, majoritarian demand for policies such as environmental protection, consumer protection, antitrust, highway programs, etc. imply that there is still a minority who might oppose such programs. Yet those who oppose these programs pay taxes, and have their taxes going for things they do not prefer. This implies a loss of Pareto efficiency, because someone is made worse off by paying taxes for the democratic equilibrium solution. More generally, taxation always implies a loss of choice and liberty over how to spend a portion of one s income. So by definition, all governmental programs that are supported by taxation imply a loss of Pareto efficiency. Governmental systems are also often less efficient than market allocation systems in other ways. Administrative costs., though not always. For example, because there is no profit in a governmental allocation system, the good may well be provided more cheaply. Examples: private trash collection is often more expensive than

5 public trash collection. Similarly, when private and public utilities compete, public utilities often end up providing services at a lower cost. 2) Governmental output is often difficult to measure. E.g., national defense, environmental health, worker safety, etc. This is inherent to governmental allocation systems because of the nature of the problems that government is called upon to solve. The more difficult it is to measure the more difficult it is to know whether governmental action is efficient or successful. 3) Governmental technologies for product and service provision may be uncertain due to the nature of problems taken on by public actors. For example, how does one measure results from governmental efforts to curtail carbon emissions that affect global climate change? It s doable, but very complex. We may not know how to address or solve the problem. For example, how does one know whether one is being effective in limiting discrimination? 4) Movement to an equilibrium is generally stickier than movement to a market equilibrium. Because demand is at a more aggregate level, and because U.S. political institutions are designed for inaction, rather than action, it may take some time for preferences to percolate upward through the system to create action. Therefore, there may be substantial periods when demand is out of kilter with supply. For example, air pollution control was strongly in demand by American citizens during the 1960s. However, it was not until 1970 that a strong legal framework was established. 5) Movement away from or to a new equilibrium is also generally stickier than movement to a market equilibrium. Because supply is at a more aggregate level, and because U.S. political institutions are designed for inaction, rather than action, it may take some time for producers to respond to changing demand. Here I argue that

6 government programs may be inertial. Therefore, there may be substantial periods when supply is out of kilter with demand. Example: Most Americans favor an increase in the minimum wage. They also favor some sort of solution for the illegal immigration problem, global climate change, etc. 6) Supply in a government oriented system may sometimes reflect the self-interest of providers. That is, politicians and bureaucrats may have their own motivations that may or may not coincide with those of demanders (citizens, voters, political parties, interest groups, etc.). These motivations of governmental actors may either increase or decrease supply. Over the long term the supply may not perfectly correspond with actual demand. Note that this is no different than in a market-oriented system. Note that this is not an overall critique. Many bureaucrats are good people who put the self-interest of their clients first. However, it can happen. Capture theory of regulation. 7) Governmental provision is typically through a monopoly, which may or may not be more efficient than private provision. Economies of scale due to monopoly can increase efficiency. However, some would argue that competition is a better approach to increasing efficiency. This is an empirical question. An alternative is privatization and contracting. Yet, there are principal-agent problems with privatization and contracting that are not present in a governmental system. 8) Unlike market systems where quantity supplied and cost of production are directly related to revenues and profits, there is a disjuncture between quantity supplied, costs, and revenues in governmental allocation systems. In a private system: Revenue=Price*Quantity Supplied. Profits=Revenue-Costs.

7 However, in a public system revenue is provided in a lump sum for provision of products and services. They do not depend critically on quantity supplied. This may result in static inefficiency in the various forms. While there are no profits in a public allocation system, there may be slack resources. Slack resources are calculated Slack=Revenues-Costs. Note: Costs are difficult to measure for some outputs. Slack resources may be used to promote dynamic efficiency. They may be used to return dividends to taxpayers. Or they may be considered waste as suggested by the libertarian ideologue, William Niskanen. In a perfectly operating governmental allocation system there are no profits or slack resources, implying the potential for reduced costs and price. 9) Internalities sometimes develop that move bureaucracies away from original goals. Goal displacement. Example: the Federal Trade Commission and the Consumer Product Safety Commission before This may be either good or bad. It may be bad to the extent that the original goals are desirable. It may be good to the extent that bureaucracies should be adaptable to changing preferences and task requirements.

8 10) Derived externalities occur when there are unanticipated consequences to government intervention. As in private markets, derived externalities can either be negative or positive. Negative: For example, regulation of illegal drugs has led to increased crime and black market activities. This negative consequence was not intended by regulators. Consider the potential negative externalities associated with regulating other things like abortion, firearms, etc. Positive: Conversely, environmental regulation has led to the development of a massive industry that relates to environmental protection. This is a positive for the economy. As in private markets, derived externalities may make government action more or less efficient. 11) Governmental action may produce inequities. Rent seeking activities often perpetuate the self-interest of private actors through public means. Rent seeking refers to private actors using the apparatus of government to their own advantage. For example, some would argue that regulation creates barriers to entry and is a form of rent-seeking. Similarly, the granting of a license is a form of rent seeking. Summary of the arguments:

9 As a democratic polity we are sovereign over markets. Because America is a system governed by majoritarian principles, we have a right to override and reject the market allocation and substitute a governmental allocation. Governmental allocations are the legitimate outcome of democratic processes. However, in choosing between the market allocation and democratic allocation we should probably weigh the considerations concerning the disadvantages of the market allocation versus the disadvantages of the governmental allocation. We don t have to adhere rigidly to these considerations. Indeed, as a sovereign polity we don t have to consider them at all. However, prudence suggests that we should.