TCS Daily


Reviving Political Economy

By Arnold Kling - January 3, 2006 12:00 AM

"One day late in April 1986, Committee Chairman Bob Packwood announced a miraculous conversion to the cause of tax reform...Within weeks, the Senate had approved a tax bill that was stunning in its boldness and fealty to the principles of equity and efficiency."
-- Alan Blinder, Hard Heads, Soft Hearts, p. 161-162

The separation of economics from what was formerly called "political economy" left twentieth century mainstream economists with a rather naive conception of the political process. Alan Blinder could describe tax reform as if it were a discrete event, an almost-accidental result of a key Senator's "miraculous conversion."

An alternative view of tax reform is that it waxes and wanes depending on the relative importance of two concerns. When politicians feel pressured to increase revenue, they reform the tax system. When they feel free to reward key constituents, they re-introduce the special favors that weaken the system. Christian Sandström has written extensively on this "public choice" theory of tax reform.

According to this alternative view, the late 1980's was a period that was relatively ripe for tax reform. The Budget was in deficit, and revenue was needed. From a revenue-generating standpoint, tax reform had considerable upside, even though it was supposed to be "revenue neutral." First, there is the fact that reform tends to raise more revenue that estimated, because greater economic efficiency enlarges the tax base beyond what the "revenue neutral" calculations assume. Second, reform reduces tax rates, which gives politicians room to raise rates later in order to raise revenues. Tax increases indeed were enacted under the first President Bush as well as President Clinton.

By the middle of the 1990's, the Budget situation was improving. As a result, the priorities shifted away from tax reform. During the Clinton Administration, the tax system once again became riddled with preferences and gimmicks, even though Alan Blinder himself was one of President Clinton's economic advisers.

From this new political economy perspective, tax policy is not an event. It is a process. The same holds true for other policies. Tax reform may be a cyclical process, with a pendulum swinging back and forth. Other processes may be prone to getting stuck in "traps," such as the Corruption Trap. Still other policy processes may tend to spiral in one direction or another. For example, in some European countries, as the ratio of welfare-state dependents to productive workers rises, the relative political power of the dependents may increase, which might lead to ever-rising tax rates and ever-falling labor market participation.

In the twentieth century, mainstream economists came to see their job as dispensing policy "prescriptions." Then, we waited for policymakers to experience the sort of "miraculous conversion" that Blinder attributed to Senator Packwood.

The mainstream approach treated economic behavior and political behavior completely differently. We viewed economic phenomena, such as a price change, as determined by an entire system. We took political decisions as arising from personal whim. We viewed market behavior as determined by contextual factors, notably tastes, technology, and competition. We treated political behavior as an independent causal force. In statistical jargon, we viewed economic phenomena as endogenous and political phenomena as exogenous. In describing markets, we used the term "equilibrium" to suggest that there is an inevitability to economic patterns. In politics, we acted as if any day policymakers could change directions at will.

Interest Group Politics

The public choice theory of the political process is that it involves the supply and demand for subsidies, tax breaks, and regulatory protection. Politicians are on the supply side. Interest groups are on the demand side. The interest groups are trying to maintain or augment economic advantages, which the theory calls "rents." The attempt by interest groups to obtain political favors is termed "rent-seeking." The economist most associated with this theory of the political process is Nobel Laureate James M. Buchanan, Jr.

Of course, it should not take a Nobel Prize-winner to notice that there are special interests in politics. However, the layman's view of special interests is that they are an arbitrary evil force, to be opposed by the forces of good. Instead, according to public choice theory, interest groups emerge naturally in an environment in which government has the power to subsidize, tax, and regulate.

The layman's view of corruption is that it is a problem of the wrong people holding office, and the solution is to elect better people. The public choice view of corruption is that is systemic, and that individual politicians make little difference.

What Causes Good Government?

According to public choice theory, bad government is a natural equilibrium. To stay in power, politicians must placate rent-seeking interest groups. Only when the forces of supply and demand shift does one observe policy change, such as tax reform.

Some scholars believe that better government can be arrived at through long-term commitments, particularly if they are embedded in a constitution. However, as Tyler Cowen writes,

"Libertarians (and contractarians) often treat the Constitution as a kind of free variable to be manipulated. We can write into it what we want, and if we fail we treat this as a kind of lament, or a sign of moral decay, rather than a problem with our basic approach. In my view, if a constitution deviates from popular opinion (or is it the prevailing structure of interest groups?) by any more than "k" percent, that constitution will be chucked."

Constitutional provisions are not barriers to government misconduct. At best, they can be speed bumps.

Many of us believe that corruption will be reduced if the ratio of voters to elected officials is low. (See We Need 250 states.) However, this is not likely to happen.

Overall, I think that the question of what causes good government is difficult to answer. It reminds me of the question What Causes Prosperity?

U.S. Government Over-rated?

Not all governments are equally corrupt. In fact, we are fortunate in the United States that most government employees are law-abiding. Other countries are stuck in the Corruption Trap, where every transaction involving the government is conducted on the basis of rewarding friends and punishing enemies.

I believe that our government is better than most. However, I think that there is a general tendency to over-rate the quality of our government.

Government services are more popular than they deserve to be. Most people believe that government schools serve the public interest. I believe that our current system primarily benefits the teachers' unions.

Most people believe that government regulation is based on public need and high principles. I believe that regulation tends to serve narrow interests. For example, professional regulation in medical practice protects the incomes of health care providers more than it protects the public.

A big reason that people over-rate government is that they treat favors to special interests, bureaucratic failures, and ordinary human incompetence as aberrations. Instead, we need to recognize that these are embedded characteristics of government, not accidents. In the private sector, the forces of competition serve to drive out the worst firms, but government enjoys a monopoly.

Difficult Work

Economists are naive to believe in the "miraculous conversion" of a single politician to tax reform or some other policy. This view leads us to over-rate the effectiveness of potential policies, because we act as if the political environment were frictionless.

If we revive political economy, I am not sure what this new discipline will look like. Instead of "prescriptions" for discrete changes in economic policy, perhaps we will describe thought-experiments for people to consider. For example, on tax policy, the Single-digit Tax Rate is a thought-experiment about how to shift both political and economic incentives.

It is much easier to come up with an idea to change economic policy than it is to come up with a workable idea to change the political equilibrium related to economic policy. That makes reviving political economy a challenge, but one that ought to be faced.

Arnold Kling is author of Learning Economics.
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3 Comments

99 The cussedness of human nature
7800 Arnold King's observation that fewer voters per government representative results in more honest government, is intuitively true, a la the New England town meeting model.

Corruption is an immutable part of us. It also is directly proportional to the amount of power each individual represenative wields. The true institutional advance to improve government would be to reduce that power, by reducing the size and power of the public sector. The wannabe aristocrats of the 'political class' of both parties will, quite naturally, resist this diminution in their influence. So it must be a truly grass-roots movement, to defang government's ability to coerce us.

corruption
"In fact, we are fortunate in the United States that most government employees are law-abiding. Other countries are stuck in the Corruption Trap, where every transaction involving the government is conducted on the basis of rewarding friends and punishing enemies."

Come on you don't realy elieve that do you. As fars as Western Govs go the USA is very corrupt. This is partly due to your gov structure but mainly to do with what the first poster said. There is a lot of money floating around on capital hill.

99
Even if most Congressmen are corrupt, the typical customs official or policeman is not. You cannot count on that in other parts of the world.

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