Public Choice - wipo.uni-jena.de

1

Public Choice

M.Sc. in Economics (6 Credits)

Summer Term 2019

Monday, 10-12 c.t., Start April 8, 2019,

Carl-Zeiss-Str. 3, HS 8

Prof. Dr. Andreas Freytag

LS Wirtschaftspolitik, FSU Jena

Announcement

June 21, 2.15 p.m., there will be a lecture by

Prof. Razeen Sally, Ph.D., Lee Kuan Yew School of

Public Policy, National University of Singapur

“Capitalism in Asia: A Schumpeterian Perspective“

Venue: Senatssaal der FSU

2

© Freytag 2019

3

Announcement I:

Consulting hour: upon appointment

Time and venue of the written exam:

tba

Net time is one hour

Please subscribe at Friedolin

4

Announcement II: Exercise

The exercise is performed by

Sebastian Schuhmann, M.Sc.

Tuesday, 16-18 c.t., Start April 23, 2018,

Carl-Zeiss-Str. 3, HS 9

Consulting hour: upon appointment

5

Uber is represented in around 570 cities, but not in many

German cities – Why?

Some run-down areas in the British South-West are rarely

considered by British governments when it comes to

regional funds – Why?

Ordinary steel is produced cheapest in China and India,

nevertheless the US and the EU protect the steel market -

Why?

Low interest rate policies have never proven ineffective;

the ECB insist on its – Why?

Farming in the EU is employing less than 2 per cent of the

labor force, its contribution to GDP is about 1.5 per cent.

Though, there are own ministries for agriculture – Why?

© Freytag 2019

6

Description of the lecture:

The course Public Choice offers a concise and

comprehensive introduction into the positive foundations

of collective action, theoretical, empirical and political. The

lecture aims at providing the students with analytical tools

to understand the political background of economic policy.

After an introduction, the lecture covers the origins of the

state. We proceed by analyzing direct democracy. The

main part (chapter 4) of the lecture is dedicated to the

political economy of a representative democracy. Topics

are: federalism, two party competition, multi party

competition, paradox of voting, rent seeking, bureaucracy.

In a subsequent step, the theory is applied to real world

phenomena and tested empirically. Chapter 6 deals with

normative issues – how to organise a polity etc.

Basic reading is Mueller, D.C. (2003): Public Choice III,

Cambridge© Freytag 2019

7

Index

1. Introduction

2. Origins of the State

3. Public Choice in a Direct Democracy

4. Public Choice in a Representative

Democracy

5. Application of Political Economy Models

6. Normative Public Choice

© Freytag 2019

8

Literature (suggested Selection)

Aidt, Toke (2018), Corruption. Chapter for the Oxford Handbook in

Public Choice, Oxford.

Arrow, Kenneth J. (1951), Social Choice and Individual Values, New

York.

Becker Gary S. (1983), ‘A Theory of Competition among Pressure

Groups for Political Influence’, The Quarterly Journal of

Economics, Vol. 98, pp. 371-400.

Becker, Gary S. (1985), ‘Public Policies, Pressure Groups, and Dead

Weight Costs’, Journal of Public Economics, Vol. 28, pp. 329-

347.

Black, Philip, Estian Calitz and Tjaart Steenekamp (eds.) (2011), Public

Economics, 5th ed., Cape Town.

Brennan, Geoffrey and James M. Buchanan (1985), The Reason of

Rules, Cambridge.

Buchanan, James M., and Gordon Tullock (1962), The Calculus of

Consent, Ann Arbor.

Coase, Ronald H.(1960), ‘The Problem of Social Cost’, Journal of Law

and Economics, Vol. 3, pp. 1-44.

Congleton, Roger D., Bernie N. Grofman and Stefan Voigt (2019), The

Oxford Handbook of Public Choice, Volume 1 & 2, Oxford.

© Freytag 2019

9

Downs, Anthony (1957), An Economic Theory of Democracy, New York.

Drazen, Allan (2000), Political Economy in Macroeconomics, Princeton.

Frey, Bruno S. (2004), Dealing with Terrorism – Stick or Carrot?,

Cheltenham and Northampton.

Hibbs, Douglas A., Jr., (1977), ‘Political Parties and Macroeconomic

Policy‘, American Political Science Review, Vol. 71, pp.1467-87.

Hillmann, Arye L. (2019), Public Finance and Public Policy, 3rd edition,

Cambridge.

Holcombe, Randall (2006), Public Sector Economics, New Jersey.

Magee, Stephen P., William A. Brock und Leslie Young(1989), Black

Hole Tariffs and Endogenous Policy Theory: Political Economy in

General Equilibrium, Cambridge.

Mueller, Dennis C. (2003), Public Choice III, Cambridge.

Niskanen, William A., Jr. (1971), Bureaucracy and Representative

Government, Chicago.

Nordhaus, William D. (1975), ‘The Political Business Cycle‘, Review of

Economic Studies, Vol. 42, pp. 169-90.

Olson, Mancur, Jr. (1965), The Logic of Collective Action, Cambridge,

MA.

Olson, Mancur, Jr. (1982), The Rise and Decline of Nations: Economic

Growth Stagflation and Social Rigidities, New Haven.

Rose-Ackermann, Susan and Bonnie J. Paflika (2016), Corruption and

Government, Causes, Consequences, and Reform, Cambridge.© Freytag 2019

10

Schneider, Friedrich and Dominik H. Enste (2000), ‘Shadow

Economies: Size, Causes and Consequences’, Journal of

Economic Literature, Vol. 38, pp. 77-114.

Shughart II, William F. und Laura Razzolini (eds.) (2001), The Elgar

Companion to Public Choice, Cheltenham and Northampton.

Tullock, Gordon (1980), The Welfare Costs of Tariffs, Monopolies and

Theft, in: James M. Buchanan et al. (ed.), Toward a Theory of

the Rent-Seeking Society, Texas, S. 39-50.

Wintrobe, Ronald (1998), The Political Economy of Dictatorship,

Cambridge: Cambridge University Press.

Basic: Dennis Mueller, Public Choice III.

Special current references will be given at the very topic.

© Freytag 2019

11

Websites (Selection)OECD: http://www.oecd.org

World Bank: http://worldbank.org

World Trade Organization (WTO): http://www.wto.org

International Monetary Fund: http://www.imf.org

European Commission: http://europa.eu.int/comm/

Center for the Study of

Public Choice: https://publicchoice.gmu.edu/

Public Choice Society: https://publicchoicesociety.org/

European Public Choice Society: http://www.epcs-home.org/

Cato Institute: http://www.cato.org

Fraser Institute: http://www.fraserinstitute.org

VoxEU: http://www.voxeu.org

European Centre for International

Political Economy (ECIPE): http://www.ecipe.org

© Freytag 2019

12

1. Introduction

Mainstream economics is generally dealing with two

types of questions:

Normative analysis: how can individual or

collective welfare be improved?

Positive analysis: What can we learn about

human behavior? Is man indeed a utility

maximiser? How can we explain minor economic

outcome against the background of theoretical

analysis?

The latter set of questions is relevant for this lecture. We

seek to explain the incentives for policymakers, i.e.

politicians, bureaucrats and organized interests as well as

the outcomes of collective choice.

1. Introduction


3. Public Choice in a Direct

Democracy

4. Public Choice in a

Representative

Democracy

5. Application of Political

Economy Models

6. Normative Public

Choice

© Freytag 2019

13

Individualistic approach, rational behavior

Dismissal of the „benevolent dictator“

Thereby, we also try to explain the sometimes huge

difference between the policy recommendation, achieved

by thorough theoretical analysis, and political reality.

Public Choice has taken three directions:

• logical, theoretical analysis,

• empirical investigation,

• normative critique.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

14

It has close relations to the New Institutional Economics

and Constitutional Economics.

The new institutional economics discusses the role of

institutions in the market sphere and in the political

sphere.

“Institutions… are the rules of the game in a society, or

more formally, are the humanly devised constraints that

shape human interaction ….reduce uncertainty by

providing a structure to everyday life.” (Douglas North

1990).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

15

Fundamental Questions of Public Choice Analysis

• What do political science and economics have in

common?

• Why do we need the state and public decision

making?

• What is the incentive structure of decision

makers in

a direct democracy?

a representative democracy?

a dictatorship?

a cleptocracy?

• Do voting rules affect economic outcomes?

• Why do some interest groups organize

themselves better than others?

• Why do countries with a dictator sometimes

perform better than democracies?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

16

• Why do we observe poverty and starving on the

one hand and wealth on the other hand in similar

countries?

• Why do we observe hyperinflation?

• Why is structural change so often repressed?

• Why can we observe left governments pursuing

supply side policy?

• Why are political parties often so similar with

respect to their programs?

• Why does social spending increase in time?

• Do elections terms exert influence of

macroeconomic performance?

• Why are public enterprises inefficient?

• What are the incentives of bureaucrats?

• How can we explain the sectoral structure of

protection and subsidization?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

17

• Is it rational for governments to „support“

criminal activities?

• How can we explain violence and civil conflict?

• Is terrorism rational?

• How can it be combated rationally?

• What is the dictator’s dilemma?

• How can we explain the disappointing

performance of most international organizations

(IOs)?

• Why is official development aid so ineffective?

• Why do reforms not happen?

• Why do reforms happen?

• Are scientists, e.g. academic economists,

different?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

18


I. The state and rule enforcement

II. The state and allocation

a) Externalities

b) Asymmetrical information

c) Natural monopolies

III. The state and redistribution

Basic literature is Mueller (2003), pp. 8-63.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

19

I. The State and Rule Enforcement

The state is needed to set rules and take care for

enforcement on a just basis. Enforcement needs a strong

state:

Police

Armed forces

Independent judiciary

Checks and balances

Normative statement

Constitutional Economics (see below)

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

20

The view of the state in Economics is that it is the

organisational structure of a polity.

The state is not regarded as standing above the human

being Constitutional Economics or citizens vs.

(subjects) Untertanen!

Members of society agree unanimously on a social

contract or a constitution. As long as actions are made

within these rules, the outcome is perceived as being fair.

In this view, there are three types of reasons for the

existence of the state. It is necessary:

• to set and enforce rules,

• to take care for allocation, and

• to organise redistributive policy.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

21

Constitutional Economics: Social contracts

1) A just social contract (John Rawls)

Rawls argues with an original position with total equality;

each member of the community gives up her knowledge

about her position in society and steps behind a veil of

ignorance.

Equality in the original position leads to unanimity over

the social contact. The economic outcome is perceived

as being the result of a gamble with random results;

therefore it is not acceptable.

Two principles of justice:

• equal rights to most extensive basic liberties;

• equal distribution of social values Maximin!

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

22

2) Constitutional economics (James Buchanan and

Gordon Tullock)

Buchanan and Tullock (1962): no normative position,

they assume unanimity at the constitutional stage.

Homann and Vanberg have given up this assumption

fictious consensus is satisfying the conditions.

The veil is a veil of uncertainty, as any individual can be

sure about the rules of the game, but not its outcome.

This will be accepted as long there is no betrayal.

Different types of uncertainty:

Identity, numbers and payoffs.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

23

II. The State and Allocation

Allocation theory shows that in general, markets are

efficient and generate welfare optima (without notice of

distribution).

However, there are cases of market failure. Three forms

can be distinguished:

• externalities,

• asymmetrical information,

• natural monopolies.

For many, these are the main reasons for the state to act

economically.

If the markets fail, governmental intervention is

necessary to care for efficient allocation.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

24

a) Externalities

aa) Definition:

Economic activity of one person (firm) has an impact on

the consumption or production of another person or firm.

Consumption

Ui = Ui (xi, yi, Z),

the utility function contains arguments not to be

influenced by individual i.

Production

x = x (Kx, Lx, Z),

the production function of x is influenced by an activity of

a third person (firm).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

25

In such a case, the government has to try to internalise

these external cost.

Pigou tax,

Pigou subsidy,

property rights

Economic problem: exact measurement of cost.

Political problem: exact definition of property rights.

Market Failure versus state failure.

State failure implies inappropriate definition of property

rights, economically inefficient internalisation of external

cost etc. It has no moral dimension.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

26

bb) Coase Theorem

Ronald Coase has shown that in the absence of

transaction cost and with clearly defined property rights

external effects do not exist.

In addition, it does not matter for the economic efficiency

and ecological effectiveness whether the party

responsible for damages or that party suffering from

damages has the property rights.

However, transaction cost is rarely negligible and

property rights are sometimes difficult to define.

The Coase solution is almost impossible to reach.

Nevertheless, Coase demonstrated the irrelevance of

distribution of property rights as well as the relevance of

transaction cost.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

27

Digression: Normative and positive aspects of

environmental policy

There are several ways to internalise external cost:

• Ordnungsrecht

emission thresholds

technological standards

• Pigou-tax

• Standard-price-approach

• private negotiations (Coase)

Emission Banking

Bubble Policy

• Emission certificates

Public choice does not analyse the normative properties,

i.e. economic cost and ecological effectiveness, but the

reason for policymakers to choose a certain environmental

policy again market versus state failure.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

28

cc) Public goods

Public goods as extreme case of (positive) externalities:

non rivalry (jointness) in consumption and

impossibility of exclusion.

Types of goods:

• private good,

• common pool property,

• club good,

• public good,

• merit goods Nudging

Free rider problem as the basic problem of collective

choice.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

29

Free rider problem

What are individuals willing to pay for the provision of a

public good?

Simple but only seemingly precise answer: nothing.

More complicated answer: it depends, on what?

• individual gains from cooperating

• differences in individual gains

• level of state activities already reached

• group size

• social conventions

Prisoners’ dilemma vs. coordination games and chicken

games

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

30

B

A

Does not

Steal

Steals

Does not

steal

1

(10,9)

4

(7,11)

Steals 2

(12,6)

3

(8,8)

Figure 2.1: Prisoners‘s dilemma

Source: Mueller, Dennis C. (2003), …, p.10.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

31

D

G

Strategy

A

Strategy

B

Strategy

A

1

(a,a)

4

(0,0)

Strategy

B

2

(0,0)

3

(b,b)

Figure 2.2: A coordination game


1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

32

D

G

Contributes to

building fence

Does not

contribute

Contributes to

building fence

1

(3,3)

4

(2, 3.5)

Does not

contribute

2

(3.5, 2)

3

(1,1)

Figure 2.3: A game of chicken


1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

33

The prisoner’s dilemma shows the typical problem

related to the provision of public goods, namely free

riding.

The coordination game is solved, as both individuals

gain most from cooperating dominating strategy. No

one can improve his situation at the expenses of others.

The latter game will at any rate been solved at a

maximum when it is repeated, whereas the prisoner’s

dilemma can (but not must) evolve again and again.

The game of chickens is the most tricky one, as cell 1 is

not the dominant strategy. It may be advantageous to

signal credibly not to contribute. In this case, the partner

may still choose to contribute.

Application in international affairs

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

34

b) Asymmetrical information

Principal-agent-problems (PAP), whether defined as

adverse selection (ex-ante) or as moral hazard (ex-post),

cause markets to fail.

Ownership and control are separated. Examples are:

• market for insurances,

• labour markets,

• quality aspects (consumer protection).

The regulation of these markets is aiming at healing the

market failure; it may, however, lead to state failure:

• insurance: overregulation, capture;

• labour market: employment protection legislation;

• consumer protection: trade protectionism.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

35

c) Natural monopoly

A natural monopoly exist, if (marginal and) average cost

decrease in the relevant demand areas under a given

technology. Only one firm can serve the demand without

welfare losses. Here is a need for regulation, e.g. by:

• price regulation (cost oriented, rentability

oriented, ECPR, Price Caps, Ramsey-rule);

• capital return regulation;

• competition for the market;

• prohibition of discrimination;

• structural separation of multi product firms;

• limitation of activities.

Problem: regulatory capture*

* Literature: Stigler, George J. (1971), „The Theory of Economic

Regulation”, Bell Journal of Economics and Management Science, Vol.

2, pp. 3-21.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

36

III. The Redistributive State

A Pareto efficient allocation of resources and goods may

not be just.

Society may feel the need to redistribute income and to

even out huge income differentials as well as to insure its

members against severe risks of life.

These risks include illness, unemployment, wealth

losses.

Age cannot be regarded as risk, rather as a chance!

Nevertheless, there may be the need for collective action

with respect to old age protection:

externalities, moral hazard.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

37

How can the redistributive state act?

1) Redistribution as insurance/ social contract.

2) Redistribution as public good.

3) Redistribution to satisfy fairness norms inclusive

societies

4) Redistribution to increase allocative efficiency.

It may be possible to model these types in a way to

reach unanimity about it. Notwithstanding, governments

may go too far or exploit certain groups by purpose:

5) Redistribution as taking.

Of course, the organisation of redistribution has impact

on economic incentives shadow economy, corruption.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

38

Redistribution as taking

Table 2.1 Costs and benefits of the EU’s common agricultural

policy in comparison with free market outcome, 1980 (mio of US$)

country producers consumers government net

EC-9 -30,686 34,580 11,494 15,388

West

Germany -9,045 12,555 3,769 7,279

France -7,237 7,482 2,836 3,081

Italy -3,539 5,379 1,253 3,093

Netherlands -3,081 1,597 697 -787

Belgium/

Luxembourg -1,24 1,4 544 320

UK -3,461 5,174 1,995 3,708

Ireland -965 320 99 -546

Denmark -1,736 635 302 -799

Source: Mueller, p. 62.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

39

3. Public Choice in a Direct Democracy

I. Unanimity Rule

II. Optimal Majority Rule

a) Choosing the optimal majority

b) Simple majority as the optimal majority

III. Majority Rule

a) Exploitation of the minority

b) Cyclical preferences

c) Multidimensional issues

IV. Log-Rolling

V. Agenda manipulation

VI. Alternatives to the majority rule

VII. Exit, Voice and Disloyality

VIII. Summary: Normative properties of majority rule

Basic Literature is Mueller, 2003, pp. 67-206

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

40

I. Unanimity rule

To reach Pareto-optimal results for public decisions,

unanimity is needed for. Otherwise, single individual

preferences would be neglected, and the decision would

leave losers.

See following slides and Mueller (2003), pp. 67-72.

An important implication is that the rule determines

whether or not and if so where, a Pareto optimum can be

met.

Shortcomings of the unanimity rule:

• much information needed,

• much time needed, and

• strategic behaviour possible.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

41

For decision making in a direct democracy, the choice of

a voting rule seems decisive.

Where can the voting procedure be of relevance in

today’s world?

• clubs,

• parliament (Bonn-Berlin decision),

• EU (treating member states as individuals), …

Two “rules” (Rousseau) for setting the voting rule:

• import topics demand unanimity, and

• fast decisions demand minimal majorities.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

42

GtYX

tGYX

BB

AA

)1(

),)1((

),(

GGtYUU

GtGYUU

BBB

AAA

dtGX

UdG

G

UdGt

X

UU

dtGX

UdG

G

UdGt

X

UU

BBBB

AAAA

)()1(

)()(

3.1

3.2

3.3

The unanimity rule

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

43

)/(

/)1(/)(

)/(

//)(

XUG

XUtGU

dG

dt

XUG

XUtGU

dG

dt

B

BBB

A

AAA

3.4

1/

/

/

/

XU

GU

XU

GU

B

B

A

A

3.5

)1(/

/

/

/

tXU

GU

tXU

GU

B

B

A

A

3.6

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

44

X

YA

G

1

0

2

A

G1 t1 t.5 t.33G0 G2

Figure 3.1: Optimal quantities for a voter

at different tax prices

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

45

t

t.5

t.33

0

1 2

A

GG1 G0 G2

Figure 3.2: Mapping of voter preferences

into tax-public good space

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

46

F

GGF

A1

A2A3

A4B1

B4

B3

B5

C

C`

B2

A5

L

E

tF

tL

tE

Percentage of tax paid by…

B A

t100

t100 t0

t0

Figure 3.3: Contract curve in

public good-tax space

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

47

II. Optimal majority

Unanimity is not realistic, not so much because of

individual strategic behaviour but because of its

enormous cost. Buchanan and Tullock (1962) show that

the optimal majority depends on cost related to the

decision.

a) Choosing the optimal majority

Two types of cost occur:

• (external) cost C of the losers of the decision and

• cost D of achieving the required majority.

Whereas C is decreasing with the number of people who

agree on the decision, D is increasing with the number of

citizens who have to agree.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

48

0

Expected

costs

D C

C+D

K Number of indivduals

whose agreement is

required for collective

action

N

Figure 3.4: Choosing the optimal majority

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

49

Obviously, the optimal majority is not the same for all

decisions to be made.

External cost C may vary depending on the nature of the

decision and on the size N of the community.

The cost curve D associated with the number of

individuals necessary to form a consensus may shift

rightwards with increasing N.

b) Simple majority as the optimal majority

So, generally speaking, what is the optimal majority? It

can’t be below N/2.

See Figure 3.5, which shows a special case in that there

is a kink at N/2.

Approximately, N/2, i.e. simple majority can be assumed

to be the optimal majority in big communities. © Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

50

C+D

D

C

C+D

D

Expected

costs

Number of indivduals whose

agreement is required for

collective action

N0

N/2

Figure 3.5: Conditions favouring a simple

majority as the optimal majority

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

51

III. Majority rule

a) Exploitation of the Minority

Consider a society which is better off with a collective

good (such as redistribution) than without; consider also

two groups, the rich and the poor.

A tax introduced would finance the collective good,

depending on the kind of tax, either both groups would

gain or one of the groups would lose.

Unanimity rule would lead to one of many Pareto optima,

because either the society would remain at the status

quo ante, or both groups win.

Majority voting would not lead to a Pareto optimum, as

the majority is likely to exploit the minority.

See Figure 3.6.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

52

UR

S

C

B

XA

Y

E

Z

W UP

Majority rule

outcomes, rich

in majority

Unanimity rule outcomes

Majority rule

outcomes, poor

in majority

Figure 3.6: Outcomes under

the unanimity and the simple

majority rule

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

53

One lesson from the discussion of a collective good is to

restrict the decisions to those individuals directly involved

both in the decision and its consequences.

In other words, it is highly sensible to reduce the number

of public goods and to increase the number of club

goods.

For the European Union, this lesson is also of

importance.

As long as the unanimity rule holds for many issues – but

also if not – the process should come up with modest

harmonisation efforts to minimise the number and cost of

losers.

Subsidiarity principle, implying that measures should

be taken on the lowest possible level.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

54

b) Cyclical Preferences

Consider three persons who shall divide 100 € among

themselves.

Possible outcome: (1): 55/45/0,

(2): 50/0/50,

(3): 0/60/40,

V1: (1) > (2) > (3) < (1),

V2: (1) > (2) < (3) > (1),

V3: (1) < (2) > (3) > (1).

Community under majority rule: (1) > (2) > (3) > (1).

The community cannot find a first best solution but

produces a cycle.

See Figure 3.7.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

55

X Y Z Q

U

V1

V3

V2

Figure 3.7: Voter preferences that

induce a cycle

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

56

c) Median voter theorem

If society has to decide about a single issue and if all

voters have single peaked preferences, then the median

position cannot lose under majority.

Plott’s theorem (Figure 3.13).

d) The median and multidimensional issues

How does it work when multidimensional issues are

discussed? Then, the outcome depends on the number

of committee members who decide:

• committee of 1: no problem (Figure 3.8).

• committee of 2: contract curve (Figure 3.9),

• committee of 3: no solution (Figure 3.10) or like a

committee of 2 (Figures 3.11 and 3.12).

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

57

AUA

x2

x1

Figure 3.8: Outcome for a committee

of one

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

58

A

B

E

UA

UB

D

x2

x1

Figure 3.9: Outcomes for a committee

of two

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

59

A

B

C

D

Z

UA

UB

x2

x1

Figure 3.10: Cycling outcomes for a

committee of three

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

60

E

A

B

x2

x1

Figure 3.11: Equilibrium outcome for a

committee of three

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

61

E

A

G

F

B

x2

x1

Figure 3.12: Outcome for a committee

of five

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

62

E

A

B

x2

x1

Figure 3.12: Plott’s theorem

FG

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

63

IV. Log-rolling

The trading of votes is illegal in democracies.

Nevertheless, it happens regularly. Reasons are:

• differences in preference intensities across

issues;

• inclination to trade.

Voters Issue 1 Issue 2

A -2 -2

B 5 -2

C -2 5

The figures show net utility if the respective laws pass

the committee of three, otherwise utility is zero.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

64

Each law would fail if individually decided upon. If B and

C trade votes, both laws will pass log-rolling.

This is not Pareto-optimal. However, (under cardinal

utility), A can be compensated, and the community is

better off (net utility is +2).

Imagine A’s net utility for both issues is -4. Then, the

community faces a net utility of -2.

Policy implications are different, depending on the net

results:

too many and to generously provided public

goods (negative);

reforms are possible (general compensation);

bluffing and cheating may take place.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

65

A final judgement of log-rolling depends on the very

case.

Log rolling is not possible with transitive social

preference orderings.

In reality, log-rolling can be observed in US Congress as

well as in the European Union.

Testing for log-rolling cannot be done directly (as it is

illegal), but indirectly by analysing the voting behaviour in

single cases.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

66

V. Agenda manipulation

If individual preference ordering might produce cyclical

voting under the majority rule, a committee member in

control of the agenda of pairwise voting can manipulate

the committee.

The outcome will be the one the agenda setter prefers

most (Figure 3.14).

Policy implications:

• power of agenda setter may be substantial;

• decisions reached by committees are not

necessarily reflecting the preferences of the

median;

• agenda setters may influence distributional

issues to their advantage.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

67

S

ZC

Z‘

AZ‘‘

UA

UB

UA

UB UC

B

x2

x1

Figure 3.14: Agenda manipulation possibilities© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

68

VI. Alternatives to the majority rule

One can think of a number of alternatives to the majority

rule:

• majority rule, runoff election;

• plurality rule;

• Condorcet criterion;

• Hare system;

• Coombs system;

• Approval voting;

• Borda count;

These systems are relatively simple and easy to apply.

Indeed, many of them are regularly applied in daily life

(often without knowing).

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

69

There are more complicated and tricky alternatives to the

majority rule:

• demand revealing process;

• point voting;

• voting by veto.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

70

VII. Exit, voice and disloyalty

So far, we have concentrated on the provision of pure

public goods voice is the only option for the individual.

However, pure public goods are rare (see chapter 2).

Therefore, we turn to club goods. Clubs have an optimal

size, as the marginal benefits of additional members

decreases, whereas their marginal cost increase (James

Buchanan).

In addition, clubs are competing for members exit as a

second option becomes available (Charles Tiebout).

We may overcome problems of the majority rule by

concentrating on clubs.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

71

Under the following conditions, it is possible to ensure

global optimality of excludable public goods provision

and apply both the theory of clubs and the theory of exit:

• full mobility of all citizens;

• full knowledge of the characteristics of all clubs

• all desired public goods available in clubs

• no scale economics in production of the public

good

• no spillovers across clubs

• no geographical constraints on individual with

respect to their earnings

It can be shown that voting-with-the-feet can produce

global optimality.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

72

Empirical relevance

3 hypotheses:

1. Individuals move in response to local

government expenditure-tax offerings.

2. People with similar preferences for bundles of

public goods live together in groups.

3. Individual satisfaction increases when voting-

with-the-feet is possible.

Empirical evidence is available for the United States.

It mainly supports the Tiebout hypotheses. This

seems different in Continental Europe.

Less club goods and more “pure” public goods.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

73

FOCJ – A normative application*

FOCJ stands for “Functional, overlapping, competing

jurisdictions” and implies that individuals select

among different clubs to meet their demand for club

goods. No one is forced to “purchase” all “public

goods” at one jurisdiction, but can select.

Entry into clubs is not free, but exit has definitely to

be free.

The authors – with a special reference to the

European constitution – suggest that the EU should

be organised according to this proposal.

* Frey, Bruno S. and Reiner Eichenberger (1995), ‘Competition

among Jurisdictions: The Idea of FOCJ’, Lüder Gerken (ed.),

Competition among Institutions, Houndsmill, Macmillan, pp. 209-

229.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

74

Disloyalty - revolution

“When neither the ballot nor the feet constitute

adequate modes of expression, there is still

Chairman Mao’s barrel of the gun.” (Mueller 2003,

…, p. 204).

It may be rational to start a revolution, if exit and

voice are no suitable alternatives. The decision to

start a revolution and/or to participate is dependent

on the expected payoffs and the relative weight of

cost (transaction cost, imprisonment, death etc.).

For an experimental analysis of the predictions made

by an economic approach see Abbink and Pezzini.*

* Abbink, Klaus and Silvia Pezzini (2005), Determinants of Revolt:

Evidence from Survey and Laboratory Data,

http://www.nottingham.ac.uk/economics/cedex/papers/2005-

01.pdf© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

75

VIII. Summary: Normative properties of the

majority rule

After discussing a number of different voting rules and

their properties, we now turn to some normative

conclusions.

Again Rousseau:

Big issues demand unanimity constitutional decision.

Urgent issues demand majority rule.

Condorcet’s Jury theorem: Assume a pairwise

comparison of two a priori equally “good” alternatives by

each voter independently. A rising (odd) number of

voters can increase the probability that the group makes

the correct decision.© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

76

Assumptions are the following:

• a common probability of being “good” across all

individuals,

• independent voting,

• honest voting.

From this theorem, we can derive a normative

justification of the majority rule.

The theorem can also justify referenda.

Nevertheless, the majority rule is not favourable in every

situation.

Table 3.1 compares majority and unanimity rule with

respect to different circumstances.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

77

Example: „Condorcet‘s Jury Theorem“

Decision: „guilty or not guilty“

pi probability of the judge i to make the „correct“ decision

(assumption in this example: pi for all judges = 0.6)

Pn probability of the jury to make the correct decision under majority rule

a) One judge:

Pn = P1 = 0.6

A, B, C correct A, B correct B, C correct A, C correct

P3 = 0.216 + 3 * 0.144 = 0.648 > 0.6

b) Three judges A, B and C (intuitive example):

Correct decision if 2 or 3 judges are correct (majority)

Pn = P3 = 0.6 * 0,6 * 0.6 + 0.6 * 0.6 * 0.4 + 0.4 * 0.6 * 0.6 + 0,6 * 0.4 * 0.6.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

78

Example: „Condorcet‘s Jury Theorem“

c) 5 Judges

5

3h

h5h

5n 0,40,6h)!(5h!

5!pp

P5 = 0.3456 + 0.2592 + 0.07776 = 0.6824 > 0.648

h = 3 h = 4 h = 5

(h = (n+1)/2 = majority)

d) 11 Judges: Pn = p11 = 0.753

• 51 Judges: Pn = p51 = 0.926

• more than 100 judges: pn = pretty close to 1

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

79

Table 3.1: Assumptions favouring respective rules

Assumption Majority rule Unanimity rule

1. Nature of game Conflict, zero sum Cooperative, positive sum

2. Nature of issues

Redistributions, property rights

(some benefit, some lose)

Mutually exclusive issues of a

single dimension

Allocative efficiency

improvements (public goods,

externality elimination)

Issues with potentially several

dimensions and from which all

can benefit

3. Intensity Equal on all issues No assumption made

4. Method of forming

committee

Involuntary; members are

exogenously or randomly

brought together

Voluntary; individuals of

common interests and like

preferences join

5. Conditions of exit Blocked, expensive Free

6. Choice of issuesExogenously or impartially

proposed

Proposed by committee

members

7. Amendment of

issues

Excluded, or constrained to

avoid cycles

Endogenous to committee

process

Source : Mueller, p. 141.

© Freytag 2019

1. Introduction



Direct Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

80

4. Public Choice in a Representative

Democracy

I. Federalism

a) The logic

b) Why is the size of the government too

large?

c) Why is the size of the government too

large and to small?

II. Two-party competition and deterministic voting

a) Outcomes in the Hotelling-Downs-Model

b) Two-party competition in a constrained

policy space

c) Two-party competition (probabilistic

voting)

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

81

III. Multi-party-Competition

a) Selecting a representative body

b) Proportional representation in practice

c) Electoral rules and the number of parties

d) Goals of parties

e) Cabinet stability

f) Strategic voting

IV. The paradox of voting

a) Rational voter hypothesis

b) Expressive voter hypothesis

c) Ethical voter hypothesis

d) Voting as duty

V. Rent seeking

a) The basic model

b) Rent seeking through regulation

c) Rent seeking through tariffs and quotas

d) The logic of collective action

e) The costs of protection

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

82

VI. Bureaucracy

a) Budget maximization

b) Price-setting behavior

c) Slack maximization

d) The power of the agenda setter

e) The government as leviathan

f) Regulatory capture

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

83

Introduction

Whereas in a direct democracy, problems of lobbying

and administration do not play a major role, in a

representative democracy they do.

Principal-agent-problem

In a representative democracy, public choice analysis is

even more adequate, as a political market can clearly be

observed. On this market, political entrepreneurs try to

sell their product, and rent-seeking groups express their

demand.

There are different levels of decision-making. This

constitutes more difficult problems.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

84

I. Federalism

Federalism can be interpreted as an application of the

theory of clubs.

The assignment problem under federalism is not about

the horizontal assignment of responsibility for e.g.

monetary policy, fiscal policy, industrial relations etc (see

below). Rather it is about the assignment of policy

responsibility to different levels of decision-making.

Following the Tinbergen-principle, each policy goal

needs an individual instrument.

Neoclassical assignment adds the requirement to have

an individual agency for each objective.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

85

The assignment problem

Objective Instrument Agency

growth fiscal policy govt.

stable prices monetary policy ECB

employment wages unions/

empl.

a) The logic

A simple example may illustrate the point.

Consider a community of nine, divided into sub-

communities of three, A, B and C. Two public goods,

GF as the federal and GL as the local public good, are

to be provided.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

86

First assume the both, GF as the federal and GL as the

local public good, are provided centrally under majority

rule.

A1 A2 A3 B1 B2 B3 C1 C2 C3

Under Plott’s theorem, B2 is the median and the amount

of both GF and GL will be provided.

In the case of the federal public good, all have to

consume the chosen level.

In the case of the local public good, the groups A, B and

C would prefer a different outcome. They would chose

A2, B2 and C2 respectively.

GF, GL

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

87

Group A would consume less of the local public good GL,

whereas group C would like to have more of it.

The superior solution would, therefore, be to assign the

responsibility for GF to the larger community and for GL to

the local communities.

Federalism has two salient properties (compare: FOCJ):

• separate and overlapping levels of government,

• different responsibilities at different levels.

Obviously, federalism has its limits. There are least

classes of public goods provided on the same political

level, and the number of levels must not be too high; the

reason being

transaction cost.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

88

Geographic representation vs. at large

representation

Geographic representation implies that each local

community sends one (or more) representatives to an

assembly of the higher level of government.

At large representation implies that all voters select their

candidates for the higher governmental level from one

single list.

There is not necessarily a consideration of the regional of

local minorities, depending on the individual voting

behaviour.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

89

b) Why is the size of government too large under

federalism?

Log-rolling!

Under local responsibility, group A will consume less the

local public good GL than groups B and C.

If B and C form a coalition to provide GL within the large

community, they can reduce their tax per capita at the

expense of A.

This scenario happens under geographic

representation.

It may be different under at-large representation.

Log-rolling may hit back in the future universalism!

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

90

Intergovernmental grants under federalism

Is there a justification for grants from one governmental

level to another (normally top down)?

Positive externalities, example state highway (US), used

by citizens from all US states.

A federal grant then is a Pigouvian subsidy, financed e.g.

through lump sum taxes.

What are the effects of …

• a matching grant (Figure 4.1);

• an unconditional grant (Figure 4.2);

• an earmarked grant?

Grants can also be justified by financial differences

across communities.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

91

U2

U1

B

B

B‘

GMG

G0

X0

X

G

E

F

G

EF – substition effect

FG – income effect

Figure 4.1: The effects of matching grants1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

92

B

B‘

B B‘X0 XUG

GUG

G0

B‘‘U1

U2

X

G new budget constraint: BB“B‘

EF income effect, no substitution effect

E

F

U4

U5U3

switch U3 U4 not possible

switch U3 U5 possible

Figure 4.2: The effects of unconditional and earmarked

lump-sum grants1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

93

Empirical evidence is contradicting the basis hypothesis

as derived from Figure 4.2: Both unconditional and

earmarked grants should be divided into an increase of

the public good and more private consumption or savings

(e.g. via tax reduction).

Flypaper effect: federal money sticks where it

lands, in the local governmental budget!

Reasons:

• fiscal illusion;

• bureaus tend to maximise their budget

(Niskanen 1971);

• an earmarked grant is treated like a matching

grant.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

94

c) Why may the size of government be too large and

too small under federalism?

Assume a two level state with a government only striving

for re-election; a very simple model where median voter

theorem does not hold.

In the model, spending money increases the probability

of re-election, raising taxes decreases it

Under geographic representation, two public goods are

in the calculus of the government; GL and GF.

As a result of the optimisation process, the government

provides GL on a more then optimal level and GF on a

less than optimal one.

Figure 4.3 a) and b).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

95

0 GG G0L

GGL

GL

MCL

MCGL

MVL, MCL

0 GG GGFG0

FGT

F

MCF

MVGF

MVF

MVF+MVGF

GF

Figure 4.3: Effects of grants on government

expenditures in a federalist system

(a)(b)

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

96

II. Two-party competition - deterministic

voting

With an increasing size of communities (polities), direct

democracy becomes unrealistic. Thus, decisions are taken

by representatives. These are assumed to behave

rationally and as utility maximisers.

Put differently: “…parties formulate policies in order to win

elections, rather than win elections in order to formulate

policies.” (Downs 1957, p. 28, cited after Mueller 2003, p.

230).

Three important aspects

• behaviour of representatives (campaign and office),

• behaviour of voters,

• outcome under representative democracy.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

97

Much of what we learned with respect to direct democracy,

also applies to representative democracy, e.g.

• median outcome,

• cycling,

• log-rolling.

a) Outcomes in the Hotelling-Downs-Model

The basic model is the Downs model.* However, the first to

analyse political competition in a spatial model was Harold

Hotelling.**

The easiest way to think of Hotelling’s model is to imagine

a western city with a couple of saloons. Where will you find

the saloons?

* Downs, Anthony (1957), An Economic Theory of Democracy, New York.

** Hotelling, Harold (1929), ‘Stability in Competition’, The Economic Journal, Vol. 39,

pp. 41-57.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

98

Figure 4.4: Median voter outcomes under two-party

competition

Number of

voters

Position of

candidatesL X RM

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

99

Number of

voters

Position of

candidates

X MNumber of

voters

Position of

candidates

M

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

100

The findings of Figure 4.4 (upper part) very much are

similar to the outcome under direct democracy (median).

However, the assumptions are unrealistic:

• one issue dimension (left or right),

• single peaked preferences,

• symmetric and unimodal preference distribution,

• all individuals vote,

• two candidate parties (the terms candidate and

party are used synonymously).

Two reasons may be responsible for a relaxation of the

assumption that all voters do vote:

• indifference and

• alienation.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

101

Then, still the median voter outcome holds, as long as the

preference distribution is unimodal and symmetric. The

median voter determines the outcome.

This may change if either preferences are asymmetrically

distributed (mid part of Figure 4.4) or if the distribution is

multimodal (lower pat of Figure 4.4).

In both cases, the degree of alienation is decisive; and in

both parts of the figure, it is too small to change the

median voter outcome.

Like in direct democracy, a problem of instability may arise

if the world is multidimensional, i.e. if a program

comprises of many issues.

Combined with multimodal preference distribution and

alienation, multidimensionality might cause that extreme

candidates win over the median.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

102

Again, log-rolling may arise, causing cycles.

Voters Issue 1 Issue 2 Issue 3

A 4 -2 -1

B -2 -1 4

C -1 4 -2

A candidate preferring all alternatives, maximises social

welfare.

However, a candidate preferring issues 1 and 2 and

preferring not issue 3 may win over the first one, as voters

A and C can gain at the expense of voter B.

Cycling, as every platform can be defeated.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

103

In a representative democracy, cycles should not be

observed in single elections, as individual candidates

cannot rotate within one campaign.

However, it should be observed in a permanent change of

government (revolving doors).

Alternative hypotheses:

• random hypotheses and

• conspiracy hypotheses.

In the US (the appropriate example for two-party

competition), the incumbent party left government only in

a fourth of the cases.

Why so much stability?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

104

b) Two-party competition in a constrained policy

space

Candidates may restrict their platforms only to a subset of

the policy space.

Imagine two parties and three voters (Figure 4.5) with

equally long contract curves. No point in the (x1,x2)-

diagram can defeat all others (see Figure 3.10).

It seems rational for candidates to restrict their platforms

to points close to the voters’ ideal points.

The restricted set of platforms is called the uncovered set.

These still can be defeated, but only in a cycle.

___

In figure 4.5, the uncovered set is the Pareto set ABC.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

105

A

B

C

x2

x1

Figure 4.5: Cycling outcomes for a

three-voter electorate

K

I

J

H

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

106

Relaxing further assumptions

1) If candidates have personal preferences,

• they may only reluctantly remove policy positions,

• the number of dimension may be reduced,

• ideology may become the single dimension.

2) If candidates are not exogenously given, but can enter

and leave the contest, the result is similar. Under the

median voter outcome, it does not make sense to enter, if

one candidate has already declared her platform.

On the other hand, this relaxation shows that under two-

party elections both candidates will not have identical

platforms.

Empirical tests don’t support to the median voter outcome.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

c) Two-party competition (probabilistic voting)

A B

C

M

UA UB

UC

Figure 4.6: Cycling possibilities

x

y

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

So far, we have assumed that the voters are easily caught

by and immediately react to the candidates’ moves (see

Figure 4.6). A slight change to the left wins certain votes

and loses others.

This “jerky” response by the voters is implausible:

• the voters are unlikely to be fully informed about

the candidates’ positions;

• the candidates may not know where the voters’

optimal points are;

• there may be random events having influence on

the voters’ decisions.

If we assume probabilistic voting instead of deterministic,

i.e. if voters behave continuously instead of

discontinuously, the median voter outcome is confirmed.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

The equilibrium is within the Pareto set, i.e. within the

triangle ABC. Therefore, the normative properties of the

equilibrium are desirable.

What happens if interest groups are introduced into the

analysis?

• The existence of interest groups implies a bias in

the probability of a candidate of being voted for

(see Figure 4.7);

• the candidates know the distribution of the bias

term, but not the individual bias;

• still, the Pareto set can be reached;

• however, different interest groups receive

different weights (welfare);

• “one man, one vote” does not hold any longer.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

0li ri bij

hi

Frequency

Figure 4.7: A uniform distribution of biases1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

111

III. Multi-party competition

a) Selecting a representative body

Two party competition is not accounting for differences in voters’

preferences accurately multi party competition.

Imagine s groups with homogenous preferences each; in a

representative body there are s seats proportional

representation.

Each group sends one representative, so that all kinds of

preferences are represented in the assembly. If s still is too big,

then one could restrict the size of the assembly to m < s members.

Then m – s groups would not be represented. Alternatives

(additions) are

• runoff elections to sort out the number of votes

each of the m elected candidates has,

• randomised choice of m out of s representatives

relying on the law of large numbers.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

112

b) Proportional representation in practice

Political practise is still different. In general, it is a

compromise between geographical and at large

representation.

If more than one person per geographic district is sent to

the assembly in the election, a formula to translate votes

into seats in the parliament is needed.

Largest remainders rule:

q = v/s with v (s) = total number of voters (seats),

q = Hare quotient;

vp/q = I + f with vp = votes won by party p,

I = number of seats won by party p,

f = remainder.

The seats are assigned according to the size of I and high f.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

113

The d’Hondt method allocates the remaining seats (after

adding I) by repeated application of the largest

remainders rule.

Alternatives to the Hare quotient are the Droop quota d:

d = v/(s+1) or

d = [v/(s+1)] + 1;

and the Imperiali I:

i = v/(s + 2).

See Table 13.1 in Mueller (2003, p. 268).

If not parties but candidates are elected, the single

transferable vote (STV) can be applied.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

114

c) Electoral rules and the number of parties

Duverger’s law: under plurality rule, the number of parties

converges to two. To test this law, one can use the effective

number of parties based on the number of votes (ENV) and

the number of seats (ENS) a party receives respectively:

ENV = [(vp/v)2]-1, and ENS = [ (sp/s)2]-1.

Example Federal Election 9/24/2017

5 parties, 20 per cent of the votes each,

5 party system;

5 parties, 60, 30, 7, 2, 1 per cent of the votes respectively,

2 party system.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

115

L R0 1 3 5 7 9 10

Party A Party BParty C Party D Party E

20% 20% 20% 20% 20%

Figure 4.8: Party positions with a uniform distribution

of voter ideal points

d) The goals of parties

Two aspects (levels) are of relevance:

• position on the ideological spectrum

• decision on joining a coalition or forming a

cabinet after election

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

116

L R0 1 3 5 7 9 10

Party A

Party B

Party C

Party D

Party E

10% 20% 24% 30% 16%

Figure 4.9: Party positions with a nonuniform

distribution of voter ideal points

It is very difficult to say theoretically how both aspects

are dealt with in politics. Parties tend to settle into certain

ideological positions and remain there (empirical

observation).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

117

A B C D E F G

15 28 5 4 33 9 6

If a single party does not hold an absolute majority, a

coalition is necessary. There are 61 possible coalitions

that form a majority in the above scenario.

A coalition is called a minimal winning coalition if the

removal of any one member (party) is changing it into a

minority coalition. These are:

BE, ABF, ACE, ADE, AEF, AEG, ABCD, ABCG, ABDG,

CDEF, DEFG.

A minimum winning coalition contains the smallest

number of seats of all minimal winning coalitions (CDEF).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

118

Not all of the eleven possible coalitions are equally likely

to start existing.

First, smaller coalitions with respect to the number of

parties are easier to run, as negotiations take shorter time

and as the probability of survival is higher.

Second, there should be an ideological closeness of the

coalition members. This minimal connecting winning

hypothesis reduces the number of likely coalitions to four

(ABCD, BCDE, CDEF, DEFG).

Trade off between these two hypotheses.

Another important aspect is the number of dimensions.

With more than one issue, cycling becomes possible,

coalitions may become unstable.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

119

IG

IS

IF

ICCC

FF

GG

SS

GC

CF

Economic Policy

Foreign

Policy

Figure 4.8: Cabinet formation in the German Bundestag

in 19871. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

120

Figure 4.11: Determinants of cabinet stability

Number of parties

Number of

representatives

elected per

district

Number of issue

dimensions

Ethnic, religious and

ideological diversity

Cabinet stability

e) Cabinet stability1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

121

f) Strategic voting

Why do the Free Democrats in Germany always stay in

the Bundestag, but regularly miss to meet the 5 per cent

threshold in the state parliaments?

S C F

49 47 4

49 41 10

The voters of the Christian Democratic Party have

regularly voted strategically (mainly before the

appearance of the Green Party) to ensure a victory of the

conservative spectrum over the Social Democratic Party.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

122

IV. The paradox of voting

“…Thus the typical citizen drops down to a lower level of

mental performance as soon as he enters the political

field. He argues and analyzes in a way which he would

readily recognize as infantile within the spheres of his real

interest. He becomes a primitive again…” Joseph

Schumpeter, quoted after Mueller (2003, p. 303).

Schumpeter concludes that human beings would relax

their moral standards and give in to prejudices in the

political arena.

Is Schumpeter right?

How rational is the voter?

And why does she vote anyway?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

)1(22

32)

2

1)(1(2

N

eP

pN

123

a) The rational voter hypotheses

A rational voter will vote for the party (candidate)

according to the own expected utility derived from this

candidate’s victory (difference B between the expected

utilities of both parties victories).

It is unlikely that an individual voter’s vote is decisive

(from an individual perspective).

The formula 4.1 shows the probability that an individual

voter decides the election.

4.1

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

124

When p = 0.5 and N = 100,000,000 P = 0.00006;

when p = 0.5 and N = 50,000,000 P = 0.000085.

P decreases with p deviating from 0.5.

Given that the probability to be run over by a car while

going to or coming back from the election, is higher than

P, one wonders why people do vote.

Three explanations can be thought of:

• redefinition of rationality,

• relaxing the rationality assumption,

• relaxing the self-interest assumption

Changing rationality can imply a taste for voting, cat and

mouse, and minimising regret instead of maximising

utility.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

125

Empirical evidence for the rational voter hypothesis

One votes, if PB + D – C > 0,

with D being the benefit from the act of voting and C

being the cost of voting.

For an empirical estimation of the hypothesis we define

R = PB + D – C, to answer the question “Did you

vote?” The literature uses 5 groups of variables:

• personal characteristics,

• cost variables (C),

• strategic value of voting (P and B),

• interest in campaign (D),

• obligation to vote (D).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

Study Sample and time period P B D C E Y

Riker and

Ordeshook, 1968

4,294 questionnaires

(quest.), 1952, 1956,

1960, U.S. presidential

elections (p.e.)

+ + +

Brody and Page,

1973

2,500 quest., 1968 p.e. 0 +

Ashenfelter and

Kelly, 1975

1,893 quest., 1960,

1972, U.S.-p.e.

0 + + - + +

Silver, 1973 959 quest., 1960 U.S.-

p.e.

0 +

?

+

?

- +

Frohlich,

Oppenheimer,

Smith and Young,

1978

1,067 quest., 1964 U.S.-

p.e.

+ +

?

+

?

-

?

126

Table 4.1: Summary of studies testing the Downsian

model (with extensions) using survey data1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

Study Sample and time period P B D C E Y

Perry, Moser and

Day, 1992

~1600 quest., 1984 and

1985 U.K. national and

local elections

+

?

+

?

- 0

Matsusaka and

Palda, 1993

2,744 quest., 1979 and

1980 Canadian national

elections

0 + 0

Knack, 1994 4,651 quest., 1984,

1986, 1988 U.S.

national elections

+ + +

Greene and

Nikolaev, 1999

~21,000 quest. 1972-

1993 U.S. elections

- + +

Thurner and

Eymann, 2000

1,400 quest., 1990

German national

election

+1

127

P,B,D,C are proxies for main components of Downsian model;

R = PB + D – C; E stands for education level and Y for the income of the voter.1Thurner and Eymann test whether perceived differences in party positions on key

issues increases the likelihood of the respondents voting. Only for immigration

policy was a significant effect found.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

128

b) The expressive voter hypothesis

Relaxing the rationality assumption, leads to the

expressive voter hypothesis.

Instead of aiming at a certain result, the voter wants to

express an opinion of how the outcome of the election

should be;

the outcome of the election is the same as in Downsian

model.

The motivation is different. However, the result then can

also be changing:

irresponsible voting.

The hypothesis stands in contrast to strategic voting.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

© Freytag 2019

129

c) The ethical voter hypothesis

Relaxing the self interest assumption, leads to the ethical

voter hypothesis.

The voter is seen as both ethical and selfish (Jekyll-and

Hyde view):

Oi = Ui + θ Uk with k ≠ i and 0 ≤ θ ≤ 1.

d) Voting as duty

Voting is seen as a sense of duty no theoretical

explanation. Behavioural psychology offers an explanation

for θ > 0 . Individuals learn that voting is sensible.

Therefore, ethical voting is indeed selfish.

Tautology?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

130

V. Rent seeking

a) The basic model

Difference between rents and profits:

Entrepreneur profit seeking,

Lobbyist rent seeking.

Rent seeking is an activity to generate income without

efforts on markets for goods and services. These cause

socially wasted expenditures (social costs):

• expenditures of potential recipients,

• expenditures of third parties suffering from the

successful rent-seeking,

• efforts of governments associated with rent

seeking.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

131

Figure 4.9: The social costs of

monopoly with rent seeking

MC

Price

Quantity

R

L

Pm

Pc

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

rRn

nI

TI

RIrI

TI

RrI

IRTI

IGE

If

IfI

r

rr

r

r

r

r

n

jjj

ii

ii

2

2

11

1

)1(

01)(

)(

)(

)()(

132

The basic rent-seeking model with a fixed number of players

(1)

(2)

(3)

(4)

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

© Freytag 2019

rn

n

R

nI

rRn

nrR

n

nnnI

rn

n

)1(

)1()1(

1

2

133

The basic model with diminishing or constant returns, r ≤ 1.

(5)

(6)

(7)

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

134

b) Rent seeking through regulation

The normative grounds for regulation are cases of market

failure (chapter 2).

Market failure is regularly combated by taxes, subsidies

and regulation.

In addition, one finds many cases of regulation not

justified by market failure (state failure).

A utility maximising government will set a price (price

regulation) so that the marginal gain in support by the

rent-seeking group equals the marginal loss in support by

the consumers.

Therefore, the main beneficiaries of regulation are the

regulated firms (plus the regulatory office (see section 4.f).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

135

One interesting implication is that the prices are between

competitive prices and pure monopoly prices (as the latter

would increase the loss in support by consumers above

the gain in support by the very industry).

Valuable explanation of agriculture protection and

taxicab regulation around the world.

Environmental regulation can be explained by this theory,

e.g. pesticide regulation and the number of listed species

by individual state in the Endangered Species Act in the

US.

Becker (1983, 1985) shows that the rent seeking process

can be reverted. If the costs for the consumers (or the

suffering group) increase, their rent seeking activities also

increase, and the government starts a new calculus.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

136

c) Rent seeking through tariffs and quotas

To explain rent seeking in international trade, the Ricardo-

Viner-model with specific factors of production is adequate.

All factors employed in the country’s sectors with

comparative disadvantages lose by a change from autarky

to international trade.

Therefore, the whole industry invests into rent-seeking

activities. The calculus of the government includes again the

marginal gains and losses in support by the industry and the

consumers plus the effects of certain instruments of

protection on the international trade policy agenda.

As quotas have always been forbidden, VERs were

introduced, giving the exporting country the chance to get

the rents; after 1994, VERs also have been prohibited.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

Study Economy Year Welfare loss

Krueger (1974) India 1964 7% GNP

Krueger (1974) Turkey 1968 15% GNP

(trade sector)

Posner (1975) United States various 3% GNP

(regulation)

Cowling and Mueller

(1978)

United States 1963-9 13% GCP1

(private

monopoly)

Cowling and Mueller

(1978)

United

Kingdom

1968-9 13% GCP

(private

monopoly)

Ross (1984) Kenya 1980 38% GNP

(trade sector)

137

Table 4.2: Estimates of the welfare losses from rent

seeking1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

Mohammad and

Whalley (1984)

India 1980-1 25-40% GNP

Laband and

Sophocleus (1988)

United States 1985 50% GNP

Lopez and

Pagoulatos (1994)

United States 1987 12,5%

domestic

consumption

Study Economy Year Welfare loss

138

1GCP=gross corporate product

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

139

d) The logic of collective action

How can we explain that some interest groups are more

successful than others in a) organising themselves and

b) obtaining rents in politics? Both questions can be

answered with:

• rent-seeking as collective (club) good free

riders,

• opportunity cost of rent seeking.

In addition, interest group formation can be enhanced

by:

• additional private goods offered by the group,

• obligations to join a group,

• different size of group members.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

140

VI. Bureaucracy1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

141

The bureaucracy is a part of the supply side of the

political market.

The term bureaucracy has a negative connotation – the

static and conformist bureaucrat is seen as the antipode

to the dynamic entrepreneur. We use the term without

this connotation, as we want to explain the bureaus’

performance with rational behaviour and do not want to

judge them morally.

a) Budget maximization

Bureaus are budget maximizers, as income is fixed.

Bureaucrats pursue power; a basic foundation of power

is superior information PAP.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

142

The output of bureaus has a non-market nature. The buyer

cannot observe the quality, as market prices do not exist.

In addition, there is a bilateral monopoly between bureau

and sponsor (government).

Output is too large and probably not efficiently produced.

Instead of the optimal output of the benefit maximising

sponsor satisfying B’ (Q) = C’ (Q), the bureau’s output is too

large satisfying B (Q) = C (Q).

At this point social surplus is zero (E = F).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

143

)(')('

)()(

)('1

)('

))()(()(

0'',0'),(

0'',0'),(

QCQB

QCQB

QCQB

QCQBQBO

CCQCC

BBQBB

B

(1)

(2)

(3)

(4)

(5)

(6)

The basic model: budget maximising bureaucrats1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

144

Figure 4.10: The oversupply of a bureau‘s output

B‘, C‘

E

C‘

B‘s

F

Q0 Q* Qs Q

B‘

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

'1

)(

1

0

dP

dQ

Q

P

PBO

dP

dQ

Q

P

dP

dQPQ

dP

dB

PQB

145

Extensions of the model: alternative

institutional assumptions

(7)

(8)(9)

(10)

(11)

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

146

Figure 4.11: Options for a price setting bureau

Q

P

PH

P1

Q1

C‘H

C‘L

η>1

η=1

η<1

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

147

Alternative behavioural assumptions

So far, we assumed excessive but efficient supply of the

public good. It may also be possible that the bureaucrats

have additional objectives, e.g. the increase of personnel,

the size of the office space etc.

c) Slack maximization

X-inefficiency or bureaucratic slack slack-maximising

bureaus

It is difficult to measure efficiency of bureaus data

envelopment analysis to calculate the efficiency frontier

and compare it with the actual outcome.

In Figure 4.15, the distance between BE’ (the efficiency

frontier) and BS’ the actual outcome would be the result.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

148

Figure 4.12: The output choice of

a slack-maximizing bureau

QB

Z

E

S

B

Y

E‘

S‘

Z‘

QS QZ

Umax

Umin

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

149

Empirical evidence:

Whether or not bureaucrats are able to maximise their own

objectives, depends among others on the discretionary

leeway they have agenda setter or not?

d) The power of the agenda setter

If they are agenda setter, they may force the sponsor to

approve a much higher than optimal budget.

Oregon school budget referendum process:

By offering two alternatives below and above the maximal

utility of the median voter, the school bureaucracy

managed to receive a higher budget than in the median

voter’s optimal position (Figure 4.16).

Comparison between privately and publicly provided

services (Mueller 2003, pp. 373-380).

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

150

GrGm Gb G

Median voter‘s

utility

Figure 4.13: Options for the budget

maximising agenda setter1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

151

Comparison between publicly and privately provided

services (Mueller, 2003, pp. 373-380)

20 sectors are subject to the comparison:

1) Airlines

2) Banks

3) Bus and transit service

4) Cleaning services

5) Debt collection

6) Electric utilities

7) Fire protection

8) Forestry

9) Hospitals and nursery services

10) Housing

11) Insurance business

12) Ocean tanker repair and maintenance

13) Railroads

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

152

14) Refuse collection

15) Saving and Loans

16) Schools

17) Slaughterhouses

18) Water utilities

19) Weather forecasting

20) Industrial companies

In general, private provision is more efficient and

saves costs for the public!

Public firms invest more; higher capital intensity.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

153

e) The Government as Leviathan

One can even extend the model in that sponsor and

bureau is interpreted as one joint unit ”monolith

monopolist”.

Government in this view is looked at as a malevolent

budget maximizer rather than a benevolent public good

provider.

If this view has a point, a the normative solution is to

reduce discretionary power of governments by means of a

constitution veil of uncertainty.

Figure 4.14 shows that the Leviathan would impose a

higher tax on the citizen if he is free to choose.

Consequences for the theory of optimal taxation!

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

154

Figure 4.14: Alternative strategies for

taxing income and leisureEarned

Income

Leisure

BH D

A

C

G

U1

U2U3

E

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

155

Government as Leviathan – empirical evidence

The empirical literature has focused on the systems of

checks and balances:

• constitutions constrain the legislature,

• federal structures are opposing huge

governments,

• application of the subsidiary principle diminishes

government size,

• intergovernmental competition does alike,

• government collusion (log-rolling on the EMU

level) increases government size.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

156

f) Regulatory capture*

Bureaus do not only provide public goods. They also are

responsible for regulation in the case of market failure.

As shown above, the regulated sector normally benefits

from regulation; prices are between competitive and

monopolistic outcome.

Therefore, it makes sense for interest groups to stay in

close contact with the regulatory office.

At the same time, the regulatory office gains its status only

by regulation. It is not in its interest to give up regulation,

even if market failure cannot be observed any longer.

* Stigler, George J. (1971), The Theory of Economic Regulation, The Bell

Journal of Economics and Management Science, Vol. 2, S. 3-21.

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

157

It is sensible to assume the position of the regulated

industry.

The bureau is captured by the industry. Consequences

include longer and heavier regulation than needed for, job

offers for regulators in the very industry.

Potential examples:

Coal mining industry Ministry of Economic Affairs

Telecommunication incumbent communication regulator

Insurance industry financial regulator

Utilities energy regulator

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2019

158

5. Application of Political Economy

Models

I. Dictatorship

a) The origins

b) Goals of a dictator

c) Functioning and survival of the regime

d) Rise and decline of the Regime

e) Dictatorship and economic performance

II. Crisis management

III. The economics of terrorism

a) The terrorist as utility maximizer

b) Does a war on terrorism make sense?

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

© Freytag 2018

159

IV. Populism on the Rise

a) What is populism?

b) What drives populism?

c) Potential policy responses

d) Conclusions

V. Empirical evidence: governments’ performance

a) The size of government

b) Some thoughts on distribution

c) Political business cycles

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

160

I. Dictatorship

As only a fraction of countries in the world is governed by

a full-fledged democracy, it makes sense to analyse the

economics of dictatorship, with a dictator defined as

“absolute ruler, usually temporary or irregular…; person

with absolute authority in any sphere” (The Concise

Oxford Dictionary, quoted after Mueller (2003, pp. 406ff).

Relevant topics include:

• Origins of dictatorship,

• goals and types of dictators,

• functioning and survival of dictatorships,

• rise and decline of dictatorships,

• economic performance of dictatorships.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

161

Figure 5.1: Digression: State of Democracy 2012

© Freytag 2018

https://commons.wikimedia.org/w/index.php?curid=30548771 see also

http://www.systemicpeace.org/polity/polity4x.htm

162

a) The origins of dictatorship

Chaos and anarchy are not liberty, they end in disaster;

economically a case of prisoners’ dilemma. Therefore, some

sort of solution of anarchy is needed for.

Imagine a roving bandit who robs all wealth; in such a world,

there would be no incentive to accumulate wealth.

Community including the bandit would remain in poverty.

Solution: the roving bandit turns into a stationary bandit and

accumulates more personal wealth by giving individual

incentives to create wealth and by only taking a fraction it,

and offering public goods including security.

Olson, M., 1993. Autocracy, Democracy, and Prosperity. In: Zeckhauser,

R.E. (ed.) Strategy and Choice. London and Cambridge: The MIT Press.

Wintrobe, Ron (1998), The Economics of Dictatorship, Cambridge, © Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

163

b) The goals of a dictator

A variety of goals can be thought of:

• consumption,

• power,

• ideology or religion,

• security.

Different Types of dictators have different objectives and

different tools

Repression Tyrant TotalitarianTinpot Timocrat

Loyality

Dictator’s dilemma: build up trust!

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

164

The basic model

Budget constraint: t Yr = G + C with Yr = Y (1 – t)

Objective function: OD = t*Y (G) (1 - t) – G

t*(dY/dG) -1 = 0 (1)

Y - 2ηtY = 0 (2)

From these we obtain:

dY/dG = 1/t (3)

t = 1/(2η) (4)

OS/ G = dY/ dG (1-ηt) – Yη t/ G -1 = 0 (5)

OD = t Y(G) (1-ηt) – G (6)

OS = Y(G) (1-ηt) – G (7)

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

165

Figure 5.2: Public goods provision under dictatorship

and the social optimum

GD GS

OD = t Y(G) (1-tη) – G

OS = Y(G) (1-tη) – G

OS,OD

G© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

166

c) The functioning and survival of dictatorships

A dictator has two instruments: loyalty and repression.

Loyalty increases with the after-tax income of the

individuals (citizens?) and is costly. Some actions of the

citizens have to be repressed; repression therefore also is

costly.

A rational dictator would raise tax revenues so that the

marginal gain from the last unit spend on repression

equals his marginal utility derived from loyalty if he left this

unit in the taxpayers’ purse.

The most prominent prototypes of dictators are the tinpot

who is only interest in consumption and the totalitarian

who is only interested in power.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

167

The tinpot reacts to a threat to security by reducing

personal consumption to increase loyalty.

The totalitarian reacts ambiguously: he may either reduce

taxes to increase loyalty or increase taxes to raise

repression.

It is sensible that dictators are selective: the loyalty of

certain groups is aimed at, and other groups are

repressed.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

168

This pattern can cause a dilemma, as the dictator will face

a number of groups pretending loyalty.

Who is friend and who is foe?

The more repressive a dictator is, the more his power

decreases. He has to spend a lot of money to secure the

loyalty of his followers. These are not necessarily very

productive individuals. The repressed and exploited ones

may be more productive.

Corruption increases, GDP and wealth decreases.

As a consequence, loyalty shrinks.

An ideology or state religion may be helpful and less

expensive to tell between true and false followers.

There are obvious limits to totalitarianism.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

169

d) The rise and decline of dictatorships

Dictators do not survive endlessly. Indeed, many

dictatorships have been ended peacefully or violently.

It is sensible to distinguish vertical and horizontal

exchange in hierarchical organisations like a dictatorship

Vertical exchange is between the dictator and the

subordinate who in return for a reward behaves loyally; it

therefore is helpful to the success of the dictatorship. Trust

plays an important role. It may diminish over time.

Horizontal exchange takes place on the same

hierarchical level; a competitive situation emerges where

trust is not likely to exist. It therefore is contributing to

failure of the dictatorship. Cartelisation may be a way out

of this problem.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

170

e) Dictatorship and economic performance

A comparison with democracy reveals that a dictatorship

can be regarded as being similar to unanimity in

democracies rather unlikely.

Which system, representative democracy or dictatorship

has the better economic performance?

The following slide shows the comparison under the

assumption that the dictator is tinpot. The results are not

so clear; if the majority is allowed to tax itself and the

minority differently, the outcome for the minority is the

same as in the case of a dictator.

Under different assumptions, e.g. interest in power

insecurity, costs of maintaining the position, the economic

performance of democracies and dictatorships are still

similar, both theoretically and empirically. © Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

171

OD = t Y(G) (1-tη) – G (6)

OS = Y(G) (1-tη) – G (7)

tY (1-tη) = G+S (8)

OM = m(1-t) Y (1-tη) +S (9)

OM = m(1-t) Y (1-tη) + tY (1-tη) – G (10)

OM = m(1-tm) Y (1-tmη) +

λ[G- mtmY (1-tmη) – (1-m) tnY (1-tnη)] (11)

tn = 1/(2η) which is the same as in (4)

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

172

The correlation

between democracy

and economic growth

is not clear*

Pro democracy

• dictators are

predatory

• competition

Contra democracy:

• vested interests

• investements

undermined

*Przeworski, A. and F.

Limong (1993), Regimes

and Economic Growth,

The Journal of Economic

Perspectives, Vol. 7, No. 3

(Summer), pp. 51-69© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

173

II. Crisis management*

Three basic characteristics of a crisis:

• unexpected;

• unpleasant;

• requires an urgent response.

It is difficult to incorporate crisis in rational choice models,

as the standard assumptions are inconsistent with the

characteristics of crises.

* Congleton, Roger (2005), Toward a Political Economy of Crisis

Management: Rational Choice, Ignorance, and Haste in Political

Decision Making, Dynamics of Intervention, Advances in Austrian

Economics, Vol 8, pp. 183-204.

* Congleton, Roger (2006), The Story of Katrina: New Orleans and the

Political Economy of Catastrophe, Public Choice 127, pp. 5-30.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

174

These standard assumptions include:

• full information;

• complete and transitive preference orderings.

Concept of ignorance

Although the data may be complete, the dimensions

observed in the data are too few; there are missing

variables.

• Rational ignorance;

• unconsidered ignorance:

sufficient condition for a crisis to emerge,

incomplete list of responses to a crisis,

limited understanding of causal relationships.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

175

Simple rational choice model

U = U (C, H) with C = consumption, H = health

H = H (E, R, Z) with E = private health expenditures,

R = public health programs,

Z = unobserved variables

E* = E (H, Z) optimal private plan

R* = R (Z) optimal public plan

As long as Z remains constant, public and private plans

are effective.

As soon as Z changes, a policy crisis may emerge.

Knowledge is not sufficient to avoid the crisis.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

176

The crisis may than proliferate crisis cascade! The

consequence may be a constitutional crisis.

Other related problems:

• agency problems;

• term length and crisis prevention;

• federalism and crisis (“Katrina”);

• the media and crisis;

• rent-seeking and crisis;

Remedies

scenario building sunset legislation

constitutional design limited amendments

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

177

III. The economics of terrorism

Terror is a widespread and long-term phenomenon (Figure

5.2), which only rarely is related to economics in public

discussion.*

Despite this neglect, terror has (among others) economic

origins and economic consequences.

* Frey, Bruno S. (2004), Dealing with Terrorism – Stick or Carrot?,

Cheltenham and Northampton.

Special issue “Middle East” in The Journal of Economic Perspectives,

Summer 2004, Volume 18, Number 3.

Wintrobe, R. (2003), Can Suicide Bombers be Rational?, University

Western Ontario, mimeo.

Special issue “Ökonomie der Sicherheit”, DIW Vierteljahrtshefte 3/2009.

Freytag,A. J.J. Krüger, D. Meierrieks, F. Schneider (2011), The origins of

terrorism: Cross-country estimates of socio-economic determinants of

terrorism, European Journal of Political Economy, pp. S.5-S.16.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

178

Figure 5.3: World-wide terror attacks (1970-2016)

Source: https://www.google.com/search?client=firefox-b-

ab&biw=1084&bih=556&tbm=isch&sa=1&ei=Zx_9Wr3AIouRkwWqp7WYBA&q=terror+attacks+1978+-

+2018&oq=terror+attacks+1978+-

+2018&gs_l=img.3...8570.15754.0.16168.12.12.0.0.0.0.138.1052.10j2.12.0....0...1c.1.64.img..0.2.246...0i19k1j0i8i

30k1.0.bOwMKomjdt8#imgrc=XAKR5CbtXu-05M:

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

179

Issues are:

• Terror and international trade

• What drives terrorism (micro and macro)

• Financing terror

• Combating terror

• Cost of security

• Cost of terrorism

a) The terrorist as a utility maximizer

Economists assume that terrorist behave rationally to

meet certain objectives, e.g. destabilising the society,

media attention, economic losses for the country, power.

Even suicide bombing is perceived as a rational act.

The key is opportunity costs.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

180

Opportunity costs are relevant for terrorist, their relatives,

and their leaders. High opportunity costs imply low

terrorist activities having their origin in countries or

regions.

Opportunity costs theoretically depend on several factors:

• real income per capita (+),

• (even) income distribution (+),

• growth rate of real per capita income (+),

• education level (+),

• male surplus (-),

• economic and political freedom (+),

• kind and number of independent media (+),

• religious competition (+).

Figures 5.3 through 5.5 show the individual rationality.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

181

A

U

Figure 5.4: Optimal choice between

ruler‘s blessing and economic success

Mental Rewards

Economic

Success

Source: Freytag, A. (2005) Weltwirtschaftliche Integration und

Frieden, In: A. Freytag (ed.) Weltwirtschaftlicher Strukturwandel, nationale

Wirtschaftspolitik und politische Rationalität – Festschrift für Juergen B.

Donges zum 65. Geburtstag, Köln: Kölner Universitätsverlag, pp. 269-84.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

182

A

C

B

U2

Figure 5.5: Changing relative price

Mental Rewards

Economic

Success

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

183

D

E

Mental Rewads

Economic

Success

U

U2

Figure 5.6: The suicide bomber

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

184

It is sensible to distinguish between terrorist leaders,

active terrorist and surrounding.

One may change the calculus of an organisation and of

the surrounding.

But it may be difficult to change an determined terrorist to

give up her plans.

Our main hypothesis is that poor socio-economic

conditions (that reflect low opportunity costs of terrorism)

are conducive to terrorism. For this study, we use a

number of correlates of socio-economic success as

proxies to indicate such linkages, where all data series

are drawn from the most recent update of the PENN

World Table (Summers and Heston 1991).

*For results see: Freytag, A., J. Krüger, D. Meierrieks and F. Schneider

(2011).© Freytag 2016© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

185

Explanatory variables used in the regressions are:

• (logged) real GDP per capita and its square.

• (logged) level of consumption

• level of trade openness (measured by the logged

ratio of exports and imports to the real GDP)

• (logged) level of investment (indicated by the

investment component of the real GDP)

• we control for the rate of economic growth which

reflects a country's short-run economic

performance.

Controls: Democracy, regime stability, government size,

population size, civil war, religion, international war,

military spending© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

186© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

187© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

188

It is easier to look at terrorist targets. They are rich

countries or regions in poor countries where Westerners

are regularly (as tourist or as security officials).

Costs of terrorism (and of fear of terrorism):

• Tourism ↓,

• fdi ↓,

• foreign trade ↓,

• stock prices ↓,

• urban economy less attractive, real estate

prices ↓,

• national income ↓.

The costs related to terrorist activities cannot be

neglected.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

189

b) Does a war on terrorism make sense?

Obviously not, as a deterrent strategy decreases

opportunity costs for potential terrorist. Israel’s army

regularly has destroyed houses of terrorist; this reduces

opportunity costs.

On the other hand, Palestinian groups have set up social

programs and house rebuilding programs for relatives of

suicide bombers and imprisoned terrorist; this also

reduces opportunity costs of potential and current terrorist.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

190

Figure 5.7: Deterrence and marginal costs and

benefits of terrorism for the terrorist

Terrorism

MC, MBMB1

MC1

MC0

MB0

T0 T1Source: Frey (2004, p. 77).

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

191

Cost of deterrence

• budgetary costs,

• political costs, e.g. reduced political rights,

• increased vulnerability due to centralisation,

• free marketing for terrorists,

• “Schumpeterian” reaction by terrorists.

How does a “successful” anti-terror policy look like from an

economist’s perspective? Stick and carrot!

• (security),

• diffusing media attention in the target countries,

• political treatment of terrorist (rule of law),

• economic integration (as opposing economic

sanctions),

• polycentricity,

• preventing illegal financial transactions.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

192

So why do governments react economically partly

irrationally by using deterrent strategies only?

• Terrorism is costly,

• fear of terrorism is also costly (see next slide),

• integration of potential terrorist may not be a

successful strategy to be re-elected,

• security as a public good excessive provision of

deterrence,

• action gives the government a competitive edge

over the opposition.

Deterrence as an anti-terror strategy has benefits in

increasing opportunity cost partly.

However, terrorist groups are flexible. Therefore, deterrence

(= war on terrorism) has also high costs (slide 191).

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

IV. Populism on the Rise

The West has undergone substantial socio-economic

changes since the global financial crisis. Multiple

problems have become obvious.

• Trade wars have become reality.

• Fake news and aggression shape policy debates.

• Media and elites face a wall of hatred and scorn.

• Brexit.

• Election in the Europeand particularly Italy driven by

populist tendencies.

• The (not so) new US-administration displays a

considerable lack of rationality and credibility.

*based on three blog entries on www.tutwaconsulting.com

© Freytag 2018193

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

• Turkey is on a straight path into a full fledged

dictatorship.

• Russia is playing old, well known games of distrust and

destruction.

• ANC?.

What are the the roots and causes of this phenomenon

both in the developed and emerging world?

What are appropriate strategies to combat these forms of

simplified and unhealthy policy advocacy?

Durable rule-bound policies rather than discretionary

measures!

© Freytag 2018194

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

a) What Is Populism?

Scientific definitions:

Populisms defines a homogenous group(we) against

an elite that aims at repressing and exploiting this

group (us) (Albertazzi und McDonnell 2008)

Populism is a well-defined ideology, that defines a

public will („volonté generale“), which is permanently

overlooked by a corrupt elite (Kaltwasser und

Taggart 2016)

Common characteristics:

• ”We” against “Them”

• Distrust of expertise

• Avoidance of regularities

• Clear and simple relations

• Simple solutions© Freytag 2018195

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

Figure 5.8: Political parties and populism

Demand-side

economics

Populists

Anti-

establishment

Cosmopolitical

liberals

Supply-side

economics

Source: Inglehart and Norris (2016, S. 34)© Freytag 2018

196

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

Often, opponents are accused of populism; examples

from the German election campaign:

• Conservative demand for tax reduction

• Social demodratic candidate Schulz plans to increase

BAFöG (study credit for students)

• The Party “Die Linke” (Left wing party, successor of

the SED) proposes regulation of international capital

flows

Not every statement that is meant to increase

popularity is populistic. Nevertheless, the cases of

populist speech or populist policies are frequent.

© Freytag 2018197

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

Often, opponents are accused of populism. Not every

statement that is meant to increase popularity is

populistic. Nevertheless, the cases of populist speech or

populist policies are frequent.

Prominent examples (EEAG 2017, 50-61):

• Populist macroeconomics (Latin America in den

1980s, Greece in 2000s)

• Immigration policy

• Trade policy (anti-globalization movement, TTIP as

conspiracy of American companies, mercantilistic

view on the trade balance)

• European integration as loss of national sovereignty

• Public debates (fracking, TTIP, migration)

Is the open society passé?

© Freytag 2018198

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

b) What Drives Populism?

Demand (Inglehart und Norris 2016):

• Losers of structural change, potential losers (fears)

(Bude 2008), behavior of elites(ENA, Deutschland

AG),

• Cultural aspects (core population has the impression

that they are neglected)

© Freytag 2018199

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

Supply:

• Abuse of the EU (“dirty work hypothesis, Vaubel

1991)

• Political correctness (ethics of responsibility vs.

dispositional ethics, Sinn 2016)

• Permanent breach of rules in the Eurozone,

monetary policy as a threat to economic order

(Freytag und Schnabl 2017)

• Alternative view: austerity? (Winkler 2017)

• Neglect of losers of globalization (EEAG 21017)

• Weak education policies (school leavers without

graduation, economic analphabets)

• Distribution problems

• Diminishing of science and expertise (;Merkel: “I do

not need an assistant, I need a minister”)

• Exaggerations (“TTIP tötet“, TTIP kills)

© Freytag 2018200

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

Vested Interests:

• Bank rescue actions

• Excessive salaries

• Subsidies on record level

„Olsonian Crisis“

Open questions

Role of Trust?

Role of indivualization?

Problems of an open society?

Role of new media?

© Freytag 2018201

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

c) Potential Policy Responses?

Three levels:

Politics

Science

Economy

Self commitments in politics to reduce populist

statements?

Wishful thinking!

Populism raises the probability that governments

move back to textbook solutions, since easy options

help populists.

In addition, populist governments show the

weaknesses of simple solutions! Renaissance of

rule-based policies?© Freytag 2018202

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

d) Conclusions

Populism is not an exogenous shock

It may well be inherently consequence of an open

society.

Aggressive debates characterized by dispositional

ethics add to it

Populism will not disappear soon

To reduce chances of populists, governments should

return to rule-based policies

Difficult, if the government itself acts populist

© Freytag 2018203

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

204

V. Empirical evidence: governments’

performance

So far in Chapter 5, public choice models’ applications

have been shown. This section is dedicated to

summarising remarks and some extensions, mainly more

evidence about government size and some evidence

about the relevance of the theory of political business

cycles.


b) Some thoughts about distribution


This section refers to chapters 21 to 22 (a) and 19 (c) in

Mueller (2003).

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

205


Overall government activities and expenditures have

grown remarkably between 1870 and 1980 (see Table

5.1).

Today (1996) the average government in OECD

countries uses in roughly 45 per cent of GDP for its

expenditures. In 1870, the share was 10 per cent.

Two relevant questions:

How can this growth be explained?

How does this increase in government activities affect

social welfare?

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

206

Source: The Economist, January

23rd-29th, 2010, title© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

207

About

1870

Pre- Post-

World War IPre- Post- World War II

1913 1920 1937 1960 1980 1990 1996

General government for

all years

Australia 18.3 16.5 19.3 14.8 21.2 34.1 34.9 35.9

Austria 10.5 17.0 14.7 20.6 35.7 48.1 38.6 51.6

Canada - - 16.7 25.0 28.6 38.8 46.0 44.7

France 12.6 17.0 27.6 29.0 34.6 46.1 49.8 55.0

Germany 10.0 14.8 25.0 34.1 32.4 47.9 45.1 49.1

Italy 13.7 17.1 30.1 31.1 30.1 42.1 53.4 52.7

Ireland - - 18.8 25.5 28.0 48.9 41.2 42.0

Table 5.1: Growth of general government expenditure,

1870-1996 (percent of GDP)

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

208

About

1870

Pre- Post-


1913 1920 1937 1960 1980 1990 1996

General government for

all years

Japan 8.8 8.3 14.8 25.4 17.5 32.0 31.3 35.9

New

Zealand- - 24.6 25.3 26.9 38.1 41.3 34.7

Norway 5.9 9.3 16.0 11.8 29.9 43.8 54.9 49.2

Sweden 5.7 10.4 10.9 16.5 31.0 60.1 59.1 64.2

Switzer-

land16.5 14.0 17.0 24.1 17.2 32.8 33.5 39.4

United

Kingdom9.4 12.7 26.2 30.0 32.2 43.0 39.9 43.0

United

States7.3 7.5 12.1 19.7 27.0 31.4 32.8 32.4

Average 10.8 13.1 19.6 23.8 28.0 41.9 43.0 45.0

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

209

About

1870

Pre- Post-


1913 1920 1937 1960 1980 1990 1996

Central government for 1870-1937,

general government thereafter

Belgium - 13.8 22.1 21.8 30.3 57.8 54.3 52.9

Nether-

lands9.1 9.0 13.5 19.0 33.7 55.8 54.1 49.3

Spain - 11.0 8.3 13.2 18.8 32.2 42.0 43.7

Average 9.1 11.3 14.6 18.0 27.6 48.6 50.1 48.6

Total

average10.7 12.7 18.7 22.8 27.9 43.1 44.8 45.6

Source: Mueller (2003, p. 503).© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

210

State activities in terms of GDP cannot only be seen

when looking at expenditure, but also when looking at tax

reductions:

In fact, governments in country A and B are equally

active. They both tax the citizens with 50 per cent. Only

country B reduces tax for parents to a total of 10 per cent

of GDP.

Country A Country B

Official Full Official Full

Gov. Consumption 20 20 20 20

Transfers to pensioners 20 20 20 20

Transfers to children 10 10 0 10

Spending 50 50 40 50

Taxation 50 50 40 50

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

211

Explanations for the size and growth of government

This is only a brief overview. For a detailed analysis see

Mueller (2003, pp. 506-534, chapter 21).

aa) The government as provider of public gods and

eliminator of externalities (section 21.2.1)

The provision of public goods is increasing if

• the price elasticity of public goods is < 1, price is

increasing,

• income elasticity of public goods is > 1, income is

increasing,

• taste variables (e.g. for social policy) exist.

The welfare state is an attempt to eliminate negative

externalities.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

212

bb) The government as redistributor of income and wealth

(section 21.2.2)

Intuitively, one would suggest that the state is increasingly

engaging in redistribution; some argue that state activities

almost entirely are directed to redistribution, at least to

certain extent.

Application of the median voter theorem.

Empirical results are mixed. It, therefore, cannot be

claimed that it is only redistribution contributing to the

growth of governments.

cc) Interest groups (section 21.2.3)

Subsidies and transfers have enormously grown since

1870 (Table 4.5).© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

213

About

18701937 1960 1970 1980 1995

Canada 0.5 1.6 9.0 12.4 13.2 14.9

France 1.1 7.2 11.4 21.0 24.6 29.9

Germany 0.5 7.0 13.5 12.7 16.8 19.4

Japan 1.1 1.4 5.5 6.1 12.0 13.5

Norway 1.1 4.3 12.1 24.4 27.0 27.0

Spain - 2.5 1.0 6.7 12.9 25.7

United

Kingdom2.2 10.3 9.2 15.3 20.2 23.6

United

States0.3 2.1 6.2 9.8 12.2 13.1

Average 0.9 4.5 8.5 13.6 17.4 20.9

Table 5.2: Government expenditure on subsidies

and transfers, 1870-95 (% of GDP)

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

214

About

18701937 1960 1970 1980 1995

Australia - - 6.6 10.5 16.7 19.0

Austria - - 17.0 16.6 22.4 24.5

Belgium 0.2 - 12.7 20.7 30.0 28.8

Ireland - - - 18.8 26.9 24.8

Italy - - 14.1 17.9 26.0 29.3

Nether-

lands0.3 - 11.5 29.0 38.5 35.9

New

Zealand0.2 - - 11.5 20.8 12.9

Sweden 0.7 - 9.3 16.2 30.4 35.7

Switzer-

land- - 6.8 7.5 12.8 16.8

Average - - 11.1 16.5 24.9 25.3

Total

average1.1 4.5 9.7 15.1 21.4 23.2

Source: Mueller, p. 520.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

215

dd) Bureaucracy and the size of government (section

21.2.4)

The Niskanen model is static and thus cannot explain the

growth of a budget. A dynamisation shows that the budget

grows faster than GDP.

Bt = αtGt with αt ≥ 1, B = budget, G = public good

α = eaBt

Gt = cent with n = constant growth rate of demand

for public goods and of national income

Bt = ceaBtent

g = ln Bt – lnBt-1 = a (Bt – Bt-1) + n > n

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

216

ee) Fiscal illusion (section 21.2.5)

The government is able to “cheat” the voters. They

increase current spending via public budget deficit.

The voter – being rationally ignorant – do not see future

tax increases necessary to serve the accumulated stock

of debt.

Empirically not relevant.

ff) Tax elasticity (section 21.2.6)

A Leviathan type of government increases taxes higher

than income.

If the increase becomes unsustainable, taxes have to be

reduced.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

217

gg) Government size and economic performance

This is again a brief overview. For a detailed analysis see

Mueller (chapter 21).

In general, taxes – apart from lump-sum taxes – have

negative welfare effects as they distort the allocation.

Too highly perceived taxes also drive individuals into the

shadow economy (working hypothesis).*

Empirical evidence shows an increase in the size of the

underground economy since the 1960s as well as the

level being highest in Latin America and Africa.

* Schneider, Friedrich and Dominik H. Enste (2000), ‘Shadow

Economies: Size, Causes and Consequences’, Journal of Economic

Literature, Vol. 38, pp. 77-114.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

218

Methods to measures the shadow economy

The main problem is to measure the level and structure of

the underground economy. Measures include:

• use of currency in cash,

• electricity,

• households surveys,

• DYMIMIC.

Effects of the shadow economy

• transaction cost increase,

• the state loses tax revenues,

• it has to raise tax rates (vicious circle),

• erroneous economic policy forecasts and decisions,

• moral decline.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

219

There is also a relationship between government size and

the degree of corruption.*

Corruption is e.g. measured via questionnaires

(Corruption perception index). It increases with the size of

governments and decreases with the intensity of

competition, e.g. religious competition.

Is it always negative? No, it can be seen as a part of the

costs of using the markets, as it contributes to solving the

PAP. Other effects are similar to underground economy.

It can be reduced on the individual level by offering the

civil servant a sufficient wage combined with fines. On the

collective level, institutions including the rule of law is

necessary.

* Rose-Ackermann, Susan (1999), Corruption and Government,

Cambridge; second edition 2018.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

220

Government size and economic performance

It seems clear that government and its production of

public goods are important for the total factor productivity

of the economy.

Government spending can have both positive (e.g.

education) and negative effects (e.g. social spending) for

the total factor productivity.

Therefore, the relationship seems to be non-linear,

precisely an inversed U-shape (Figure 4.25, each dot

representing a single country).

For different levels of development, different inverse U-

shaped curves are thinkable. On a low development level,

the optimal size of government may be lower than for

highly developed economies.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

221

Figure 5.9: Relationship between

government size and economic growth%dYt+n

Gt/Yt© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

222

Figure 5.10: Relationship between

government size and economic growth

on different development levels%dYt+n

Gt/Yt

L

M

H

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

223

Empirical Evidence of the relation between government size

and economic performance

In a time series analysis, the U-shape could be shown for

the US. A second approach is a cross country regression:

Dependent: growth rate of real GDP per capita (1960-

today)

Independent: real GDP per capita in 1960 (-)

secondary school enrolment rate 1960 (+)

primary school enrolment rate 1960 (+)

African nation dummy (-)

Latin American nation dummy (-)

Government consumption over GDP (-)

revolutions per year (-)

political assassination per millions of

population and year (-)

price distortion index (-)© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

224

All of these exogenous variables are significant. In

general, the inverse U-shape hypothesis cannot be

rejected empirically.

As mentioned before, government is not only active via

consuming but also via regulation and tariff as well as

non-tariff protection. Therefore, public consumption over

GDP as the measure for government size would

underestimate “true” government size.

Thus, indices of economic freedom or political rights are

regularly employed as proxies for government size (see

next slide).

As in the literature on dictatorship and economic

performance, the evidence is mixed.

This may be due to the problematic nature of the indices

in use.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

225

hh) The index of Economic Freedom in the World

Economic freedom is measured as a weighted average of

21 criteria in five groups:

• size of government: expenditures, taxes and

enterprises,

• legal structure and security of property rights,

• access to sound money,

• freedom to trade internationally,

• regulation to credit, labour and business.*

The index is a mix of legal provisions and actual empirical

results. In addition, it is prone to the “judges’” arbitrariness

and values. Nevertheless, it is very helpful for researchers

and fosters the discussion.

* http://www.freetheworld.com.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

226Source: www.freetheworld.com© Freytag 2018

227

Digression: World Bank Governance Indicators

• Since 1996 calculated in this form;

• 6 separate indicators:

Voice and accountability

Political stability and absence of violence

Government effectiveness

Regulatory quality

Rule of law

Control of corruption;

• normed to -2,5 (low) to 2,5 (high)

• aggregate Indicators, consisting of several hundred

single variables (31 sources of 25 organizations) to

measure governance;

• often only one source per country;

• complex method;

• almost all data published.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

228

b) Some thoughts on distribution

Distribution problems cannot be judged normatively in

a comprehensive by economists.

• What is a fair distribution?

• Shall the government support certain groups at the

expense of others?

• Is the welfare loss of a poor person worse than the

welfare loss of a rich person?

• Is a farmer worth more than a worker?

Economists trust a so-called weak value judgement:

we prefer the Pareto-superior situation.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

229

However, there are some arguments for a fair

distribution and redistribution.

Given that a nation or an economy can be seen as a

club, it offers club goods (remember: no rivalry, but

exclusion).

A fair distribution is such a club good.

How to achieve fair distribution?

• progressive taxes;

• tax breaks for families or the elderly;

• subsidies for certain groups;

• social help payments;

• free housing, education and health services for poor

people;

• tbc© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

230

Finally: “…distributional coalitions slow down a society’s

capacity to adopt new technologies and to reallocate

resources in response to changing conditions and thereby

reduce the rate of economic growth.” (Mueller 2003, p.

555).

Mancur Olson* not only explained the emergence and

persistence of interest groups, but also the reason for

economic decline and the role of shocks for nations to

rise again.

Examples are the economic rise of Germany, Italy and

Japan as well as the decline of the UK, Australia and New

Zealand after World War II and India’ long term decline

because of rigidities in the caste system. China after 1000

A.D. is also a case.

* Olson, Mancur, Jr. (1982), The Rise and Decline of Nations: Economic

Growth Stagflation and Social Rigidities, New Haven.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

231


Empirical observation: the votes for the incumbent party

in the US between 1896 and 1964 were positively related

to income growth rate and negatively related with the

inflation rate.

Macroeconomic performance is relevant for elections.

This is also known to politicians. Thus, it seems plausible

and justified to create political business cycles (Mueller

2003, chapter 19)*.

The economic theoretical foundation is the Phillips trade

off between unemployment and inflation (Figure 4.27).

* Hibbs, Douglas A., Jr., (1977), ‘Political Parties and Macroeconomic

Policy‘, American Political Science Review, Vol. 71, pp.1467-87.

Nordhaus, William D. (1975), ‘The Political Business Cycle‘, Review of

Economic Studies, Vol. 42, pp. 169-90. © Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

232

Figure 5.11: The trade off between inflation (P)

and unemployment (U)

P

U

M

I1

I2

L

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

233

Figure 5.12: The political business cycle

L

S

MM‘

U

P

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

234

Both with myopic voters (i.e. money illusion) and rational

voters, it is possible for the incumbent to win the election

by creating a political business cycle.

This is, however, only likely if the voters do not consider

other issues and only decide because of macro data prior

to election

no party loyalty.

What happens if partisan politics matter?

Voters distinguish themselves by being more or less

concerned about issues such as unemployment or

inflation.

Political parties reflect these differences and offer

different packages with different focus on unemployment

and inflation.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

235

There is a growing literature on the topic with different

assumptions on voting behaviour, partisan behaviour and

the behaviour of the economy.

Basic results include the following:

• Business cycles are created politically, but

increasingly carefully and probably less

successfully then before because of voters’

decreasing inclination to money illusion.

• Voters behave irrationally as they only take into

account macroeconomic variables.

• Interest groups are not focused in the models.

• Nevertheless, the idea that business cycles can

be explained by political rationality, is striking.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

236

6. Normative Public Choice

Public Choice normally is viewed as a value-free,

positive sub-discipline. However, there are normative

lessons for the organisation of a polity with respect to:

• goals and

• ways to achieve them

The most important issue is to define a social welfare

function which allows to take into account the individual

welfare of each citizen.

Such a function is necessary to judge the effects of

economic policy measures.

This is a difficult, precisely: impossible task. Social

ordering is impossible.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

237

Social welfare functions are constructed on an individual

basis, implying that a social welfare function is an

aggregate of individual utility functions.

W = f (U1, U2,…, Un).

The problem is that individuals have different perception

of the welfare functions. Aggregation of individual

preferences is impossible (Arrow 1951). Arrow shows

that five conditions must hold to make a social ordering

possible.

• Pareto criterion (unanimity)

• Non-dictatorship

• Transitivity

• Unrestricted domain (range)

• Independence of irrelevant alternatives

Arrow’s theorem of impossibility of social orderings.© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

238

Alternative social welfare functions are:

• utilitarian SWF

W = U1 + U2 +… + Un

• Bernoulli-Nash SWF

W = U1 * U2 * … * Un

• Rawlsian SWF

W = min (U1, U2, … , Un)

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

239

Social contracts – two different approaches

The difficulties to construct useful social welfare

functions calls for a different procedure.

This can be achieved by a social contract between the

citizens.

They agree on rules with unanimity. These rules are

perceived as fair by everyone.

Economic activity itself is taking place under the rules;

therefore, the outcome can also be assumed as fair.



Gordon Tullock)

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

240


Rawls argues with an original position with total equality;

each member of the community gives up her knowledge

about her position in society and steps behind a veil of

ignorance.

Equality in the original position leads to unanimity over

the social contact.

The economic outcome is perceived as being the result

of a gamble with random results; therefore it is not

acceptable.

Two principles of justice:

• equal rights to most extensive basic liberties;

• equal distribution of social values Maximin!

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

241


Gordon Tullock)

Why do constitutions matter?*

Individual perspective: weakness of will (Ulysses

and the sirens sweetly singing!)

reduction of alternatives

Collective perspective protection against exploitation

rules as rationality

rules as default options

Buchanan argues that constitutions are normatively

superior to an evolutionarist’s naive claim that the current

evolved outcome is efficient.

*Buchanan, James (2000), Why Do Constitutions Matter?, Niklas

Berggren, Nils Karlson and Joakim Nergelius (eds), Whay Constitutions

Matter, Stockholm: City University Press. © Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

242

Buchanan and Tullock (1962) do not have a normative

position, except that they assume unanimity at the

constitutional stage.

Karl Homann and Viktor Vanberg have given up this strict

assumption fictious consensus is satisfying the

conditions.

The veil is a veil of uncertainty, as any individual can be

sure about the rules of the game, but not its outcome.

This will be accepted as long there is no betrayal.

Different types of uncertainty:

Identity, numbers and payoffs.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

243

Table 6.1: Collective action options when external

effects are separable

1 2 3 4 5 6

ucj>0

ecj>0

ucj>0

ecj=0

ucj≤0

ecj<0

ucj≤0

ecj=0

ucj>0

ecj<0

ucj≤0

ecj>0

1urj>0

erj>0NN NN NN NN NB NO

2urj>0

erj=0NN NN NN NN NB NO

3urj≤0

erj<0NN NN NN NN NB NO

4urj≤0

erj=0NN NN NN NN NB NO

5urj>0

erj<0BN BN BN BN BB BO

6urj≤0

erj>0ON ON ON ON OB OO

Notes: N = No action required; B = ban of the action; O = obligation to act.

First letter applies to rows, second to columns.Source: Mueller, p. 618.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

244

The main problem of this approach is that it does not

offer a normative position, except for accepting

preferences.

To the contrary, it explicitly (and correctly) argues that the

preference will lead to rules. Rules then will lead to

outcome.

Despite this strictly positive and individualistic stance, the

approach is not fully satisfactory. It is also a weak

alternative for policymakers who need guidance. In

Germany today, politicians beyond their political interests

seem to be uncertain about:

• social policy objectives and regimes,

• tax reform,

• labour market regime,

• federalist structures etc…© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

245

What have we learned?

Public choice theory can contribute to the explanation of

collective choice and fill gaps left by both allocation

theory and political science:

• politics is characterised by rational choice of

policymakers,

• rationality has several dimension,

• cycles in politics occur,

• spatial models do predict voting behaviour well,

• institutions matter,

With respect to normative conclusions, public choice

theory alone is not enough; allocation theory is justified.

© Freytag 2018

1. Introduction



Democracy


Representative

Democracy


Economy Models

6. Normative Public

Choice

Documents

Public Choice - wipo.uni-jena.de