The readings this week provide a survey of the competing perspectives on the formation of public policy. Howlett and Ramesh in chapter 2 of  “ Studying Public Policy: Policy Cycles and Policy Subsystems” divide the various approaches to public policy into deductive and inductive theories, and define six broad categories of public policy theory. While, Joseph Stiglitz in his lecture “ The Private Use of Public Interests: Incentives and Institutions” provides four instances in which government failure can exist and demonstrates “how misaligned incentives can induce government officials to take actions that are not, in any sense, in the interest of the public” Stiglitz, 1998, pg.5).  In this short paper I shall highlight the key points made in the Howlett and Ramesh chapter and use their discussion of welfare economics as a bridge to the Stiglitz lecture that to me demonstrates the one-sided focus of welfare economics.

In presenting the different approaches to public policy, Howlett and Ramesh distinguish between deductive and inductive theories. They maintain that deductive theories are based on the application of general concepts or principles to specific phenomena while inductive theories are based on observation and testing of empirical phenomena (Howlett and Ramesh, 2003). Deductive theories include; Public Choice theory, Class Analysis and Transaction Cost Analysis while inductive theories include; Welfare Economics, Pluralism and Corporatism and Statism. What differentiates these theories from each is whether they focus their attention on the activities of individuals, groups or institutions (Howlett and Ramesh, 2003).

Public choice theory for instance, is based on rational choice theory and assumes “that political actors like economic ones, act rationally, that is, in a calculating fashion, to maximize their utility or satisfaction” Howlett and Remesh, 2003, ch.2, pg.22).   The authors argue that this theory is based on an oversimplification of human psychology and behavior that does not reflect reality and therefore has poor predictive capacity. Class analysis is based on Marxist Social Theory and interprets public policies in capitalist societies as reflecting the interest of the capitalist class. The weakness of this approach is that it cannot be proven that public policies are enacted at the behest of capital and it fails to explain the enactment of social welfare policies that are opposed by capitalism. Transaction cost analysis argues that institutions exist to overcome impediments caused by information asymmetries. Government should therefore not interfere in transactions related to private goods and services rather it should enforce property rights and prevent criminal behavior from undermining these transactions.

Pluralism/Corporatism is based on the assumption that the political process is dominated by different interest groups which vary in terms of the financial and organizational resources they possess as well as their access to government. Critics of pluralism argue that this is an oversimplified unclear view of government based on misconceived notion of government responding to group pressure. Statism is another inductive theory described by Howlett and Ramesh in which the state is viewed as the key agent in a political process that is influenced by other organized social actors. Critics of Statism argue that it fails to account for the existence of civil liberties or why states cannot always enforce there will. Welfare economics is based on the notion that in the presence of market failure political institutions can act to supplement or replace the market. The main criticism of welfare economics is that these theorist fail to recognize that policy decisions are ‘political’ in the truest sense of the word.

The main issue that emerges this week for me is the seemingly one-side notion of public policy presented by most welfare theorists. Welfare economics teaches that government intervention is needed when market failure exists. Howlett and Ramesh list these market failures as the existence of; natural monopoly, imperfect information, externalities, tragedy of the commons and destructive competition (Howlett and Remesh, 2003). Several theorists however, believe that market failure is but one half of the equation for effective public policy. These theorists agree that policy analysts should be aware of and indeed anticipate the potential failure of government to properly implement its decisions (Carly, 1980, Minogue, 1983 and Hogwood and Gun, 1984).  Stiglitz (1998) sites four reasons why government interventions ‘pareto improvements’ fail including: the inability of government to make commitments, the formation of coalitions and bargaining, destructive competition in the political arena, and uncertainty about the consequences of change (imperfect information).

The examples discussed by Siglitz demonstrate that some of the same failures that affect the market also plague the government in its implementation of policies to enhance social welfare. Yet in the field of welfare economics there are appears to be an obsession with market failure and a neglect of the potential failure of governments in enacting policies. A fallacy as efficiency of public policy depends on the analyst’s ability to both recognize market failure and anticipate government failure.

References

Howlett and Ramesh, Chapter 2: “Understanding Public Policy: Theoretical Approaches”, 2003

Stiglitz, Joseph, “The Private Uses of Public Interests: Incentives and Institutions”, Journal of Economic Perspectives, 12(2), 1998.

Discussions on policy analysis and the justification of government intervention and policy action often assume the existence of a benign government with the main intent of maximizing social welfare.  Based on this premise, the dominant positivist realm of policy analysis focuses on the principles of welfare economics through the identification of policy actions that would result in Pareto or near Pareto improvements. In this sense, government intervention through regulation or redistribution aims to correct widely accepted market failures such as public goods, natural monopolies, externalities, imperfect information and the tragedy of the commons. 

Increasingly during the past three decades, this somewhat overly simplistic analytical framework has been extensively criticized by later analytical paradigms such as post-positivist approaches.[1] For the post-positivists, the welfare economics framework, although elegant through its simplicity, offers a narrow analytical viewpoint that tends to neglect the harsh realities of the policy arena and sometimes, even distort and misguide policy evaluation.

In practice, there are many concerns pertaining the decision-making process. Stiglitz, reveals some of these practical issues by asking a very simple question: “Why is it so difficult to implement even Pareto improvements?”(1998: 4). He offers four hypotheses that showcase the limitations of government intervention even when Pareto improvements seem obvious:

1.     The inability of government to make commitments. This limitation stems directly from the nature of government as the prime and sole enforcer of contracts (Stiglitz, 1998). Given the fact that the government maintains the monopoly of contract enforcing, there is no possibility to control whether the government will maintain its promises.

2.     Coalition Formation and Bargaining. Through the dynamic process of decision-making and the bargaining game associated with policy, the equilibrium and power of different parties can shift. In simple words, while a Pareto improvement may seem obvious at a specific time it might not appear so later on, once balance between policy stakeholders is reconfigured.

3.     Destructive Competition. Here Stiglitz refers to the nature of the political game, which far from perfect implies destructive competition through its win/lose duality.

4.     Uncertainty about the consequences of change. This is once again a result of the zero sum nature of the political game. Similarly, this uncertainty is accentuated through the non-transparency and secrecy during the decision making process.   

Perhaps what renders Stiglitz’s argument intriguing is that, contrary to a plethora of scholars, he does not critique the limitations of the positivist approach but more so the capacity to promote welfare economic maxims in the particular environment of US policy making. In that sense, the issue is not that positivist analysis offers a narrow framework for decision-making; on the contrary, in Stiglitz’s view what appears constricted is the government policy environment that fails, through its non-transparency and adversarial nature, to truly encompass positivist arguments. Therefore, Stiglitz arrives on a similar conclusion with other post-positivist scholars, but he does so by taking a very different avenue. His analysis equally bears further repercussions in terms of how policy analysis is perceived.

For instance, if we take a classic market failure example, such as public goods, and if the assumption that government has important limitations in seeking social welfare maximization, then how can we assure that public goods and social services can be more successfully provided - especially in governance environments where the policy process is also restricted by limited capacity, corruption etc? Perhaps Ostrom’s work on collective action can provide an alternative. Ostrom (2000) argues that a key to effective governance arrangements lies in the relationships and trust among actors who have a stake in the governance of a resource (Ostrom, 2000). She notes that face-to-face communication in a public good game—as well as in other types of social dilemmas—produces substantial increases in cooperation that are sustained across all periods (Ostrom, 2000). Therefore, if we follow Ostrom’s logic, in that most contractual relationships – whether for public or private goods – have an element of assuring mutual trust, the question that becomes imminent is are there other types of institutions that can reinforce cooperation and trust better than the market or the government can?

Certainly, giving a definitive answer to the question above would be extremely difficult, as it would depend on specific circumstances. But maybe Ostrom’s proposition could eventually address some of the adversarial issues that Stiglitz reveals. Under this view, the institutional environment that policy discussions evolve in, appear as important as the actual policy debate.



[1] As Howlett et al (2009: 26) note, “drawing a blueprint of the post-positivist approach would be an anathema for its proponents.” In that sense, the post-positivist approach cannot be defined through a distinct set of characteristics but more so as reaction to the positivist approach.    

Achilles

By Andrea

Some mainstream economists argue that there is no incentive for self-interested individuals to participate to the production of a public good. According to this argument, in a market-driven economy and society, the private sector and individuals produce outputs and make decisions with efficiency and profit-making in mind. However, as Ostrum (2000) points out, this assertion is in direct contradiction of “observations of everyday life. After all, many people vote, do not cheat on their taxes, and contribute effort to voluntary associations.” She finds that individuals regularly organize themselves to gain benefits from trades, provide mutual protection from risks, and protect natural resources (137-138).

With finding this in mind, I turn to one of the examples of unproven or faulty market failure analysis presented by Zerbe and McCurdy (1999). The authors introduce the long accepted finding that land tenancy is inefficient because both landowner and tenant are dis-incentivized from maximizing the productivity of the land because neither party is motivated to make the needed investments. In counter to this, the authors find that “there is no evidence that the market value of lands under tenant cultivation were lower than the values of land under owner cultivation” (568). Although Zerbe and McCurdy examine this issue in a rural context, specifically examining agricultural land production in China and Taiwan, this finding about productivity in tenant-occupied land can be recalibrated and applied to the contemporary urban context, globally, and also particularly in the United States.

Let’s briefly frame this: As the “back to the city” movement continues to take hold in the first decades of the 21st century, increasing numbers of well-educated, upwardly economically and social mobile young people, continue to migrate to cities. Most cities in the United States, both successful cities with strong, diverse economies (New York, Washington DC), and struggling cities that experienced decline in the post-manufacturing era (Baltimore, Philadelphia), suffered economic and social challenges in the later decades of the 20th century. Neighborhoods suffered as public services (sanitation, public schools) decreased in quality and property values declined; in many places, people with higher incomes moved away from the city center. What we now call the “inner city” was born, as increasingly disenfranchised lower-income populations battled the challenges of inadequate services and general public neglect. Now, the narrative is reversing as people return to the city, once again pumping economic life into previously disinvested areas.

This story is familiar; the standard postmodern urban tale: gentrifiers are bringing neighborhoods back. But what seems to be underreported is the fact that in many changing neighborhoods, the gentry are tenants not property owners. They are a mobile, temporary population. In neighborhoods like Williamsburg, Brooklyn, and Shaw, Washington DC, young urban professionals (yuppies) are moving into middle- and working-class neighborhoods and changing the commercial and civic face and functionality of them without being landowners.

It may seem like a crude jump from rural sharecroppers to yuppies renters, but the principles of their respective situations are in some ways the same. Returning to the traditional economic framework queston: What is the incentive for them to contribute to the livelihood (the maximum economic and social production value) of the neighborhood, the land, etc.?

Here, we return to Ostrum (2000), who found that “cultural evolution” gives groups of individuals the “propensity to cooperate based on the development and growth of social norms” (154). For both sharecroppers and gentrifying renters, despite their non-landowner status, there exist significant incentives to maximize efficiency and production potential; each group has invested their own resources, and in the most literal sense, livelihood, into the place of their tenancy. Despite the fact that as tenants they may not be long-term beneficiaries of improved land productivity or property values, they are incentivized to maximize quality of life in the community, a component of cultural evolution that contributes to the public good.  

There is a perennial discussion about whether the government should intervene, and at which rate, in the market.  The discussion has become more adversarial than dialectic.  It is often argued on terms for or against an intrusion of government actions (Zerbe, 1999).  My problem with this perspective is the assumption that government functions outside and with equal power of that granted to the market.  Since the market is a social construct, an arena of trading if you will, that ceases to function without the legitimizing actions of its consumers, how can government regulation be seen as an intervention in this marketplace and not creating simply the creator of the rules of which services and goods can be traded?

Howlett, et al. (2009), in Studying Public Policy, discuss this issue at length and point out the different ideological underpinnings of policy makers and academics that study political economy.  They argue that there are several different perspectives about the role of government and their regulatory powers over markets from positivism to statism, and that they depend on the ideological position of the policy maker. This causes obvious tensions and transaction costs that create destructive competition and coalition forming which are detrimental to policy making (Munger, Stiglitz).

Joseph Stiglitz, in his article “Private Uses of Public Interests”, shows how government inefficiencies are caused by inappropriate expert advice, lack of transparency, and an inability to foretell the future.  That policymaking is more than the efficiency of the market, but has to consider many more stakeholders, and if it would work more collaboratively, through discourse rather than debate, he argues it is possible that government could accomplish more. 

For public school education, The framers of the US Constitution argued that public education is necessary for a democracy to have informed citizens who are actively engaged, which would protect the landowners from an uneducated mob.  Educated economic actors are necessary to market capitalism as people need to understand price signals in order to behave “rationally”, or be productive citizens, and in the best-case scenario entrepreneurial to develop the market.  Yet, education has been diminished in almost every state constitution to “adequate” levels, determined by each state, and an area where costs are cut when budget issues arise.  Decentralization and a privatization of the education sector in the US is a perfect example of this ideological debate about whether government is intervening in the market, or whether government uses the market to provide services.

In this case, the government heavily determines and regulates the education standards and through judicial mandate has had to provide education to all citizens.  However, if the government did not have the authority to mandate such education, and we left the market up to provide education in the most cost-effective manner, then what would become of the public education sector.  With information trickling in about charter schools failures, are we learning that now?

It seems more logical that citizens, consumers, and governments should be able to set standards and regulate the according to their social preferences, and health and wellness of society (its education, health, environment, rights and equality of its citizenry) should be held in higher accord than efficiency of the tool utilized to provide services for society.

Howlett, M., & Ramesh, M. (2009). Studying Public Policy: Policy Cycles and Policy Subsystems (3rd ed.). Oxford: Oxford University Press.

Munger, M. C. (2000). Analyzing Policy: Choices, Conflicts and Practices. New York, NY: W.W. Norton & Company, Inc.

Stiglitz, Joseph. 1998, Spring. “Private Uses of Public Interests: Incentives and Institutions.” Journal of Economic Perspectives. Vol. 12. No. 2. Pages 3-22.

Zerbe, R. O. J., & McCurdy, H. E. (1999). The Failure of Market Failure. Journal of Policy Analysis and Management, 18(4), 558–578.



Kelsey H

Zoé Hamstead

A central question in the study of public policy is: when should governments intervene? The view of welfare economics is that the presence of market failures rationalizes government intervention (Howlett & Ramesh, 2009). However, since some degree of market failure is always present and government’s ability to mitigate these failures is limited, welfare economists have also described a goods and services typology – based on varying degrees of exhaustiveness and exclusivity – to determine whether goods are best managed privately or publicly. In addition, decision types, with varying degrees of “collectiveness” of the deciders and “publicness” of those affected by the decision may bear on this question. According to Munger (2000), the government should be powerful enough to control actions which affect many people but restrained enough to avoid enforcing private choices. These deductive approaches begin with assumptions about the nature of goods and services and the functionality of governments, then apply these principles to hypothetical and real situations.

By contrast, recent empirical approaches have found that these typologies cannot consistently explain market failure nor government success in mitigating externalities. Zerbe and McCurdy (1999) argue that attempts to apply market failure diagnostic tools in public policy decisions are misguided because externalities are better defined by the transaction costs involved in their mitigation (if negative) or provision (if positive). If an externality exists, it is because transaction costs of eliminating it are at least as high as its cost to society. Classic examples of supposed market failure, such as free-rider problems associated with lighthouses, have, throughout history, been solved by a variety of institutional types with minimal government intervention. Using game theory experiments of collective action problems and empirical case studies of commons dilemmas, Ostrom has explored conditions under which people cooperate for a common good. Her experimental findings suggest that, contrary to welfare economy theory, the world is not comprised solely of rational egoists. There are also “conditional cooperators” who act for the common good, and “willing punishers” who shame non-cooperators (Ostrom, 2000). The degree to which commons scenarios become tragic depends on the relative proportion of these types, the characteristics of the good or service in question, as well as additional user characteristics and governance structure (Ostrom, 2009).

National resource management is a multidimensional commons dilemma in which resources are rarely delineated by jurisdictional boundaries. Users may have differential use rates and impacts, as well as differential incentives to maintain the quality or quantity of an open access good. An example of regional water quality management in North Carolina (NC), where a mixture of regulatory types are at play, can help demonstrate the role of market failure, collective action, and transaction costs in natural resource management.

Following roughly a century of water quality impairment, in 1997 the State devised a voluntary cap-and-trade mechanism to manage wastewater discharges of nitrogen in the Neuse River estuary. With very limited trading activity, by 2006 dischargers in the basin had reduced total nitrogen loading by more than double the State’s requirement. With the exception of setting the total discharge allocation for the group, the dischargers devised all rules of trading. Although it ostensibly formed in order to take advantage of a flexible compliance mechanism which could help some dischargers avoid costs and others earn rents, in practice the organization of dischargers functioned as a self-regulatory agency (Hamstead & Bendor, 2010), charging “non-compliers” by a system of graduated fines. In the eyes of the state, individual exceedences were not considered violations because the group as a whole remained within its total allocation. However, as a collective body, the association viewed individual exceedences as violations and used fines, peer pressure and information sharing to bring members into “compliance.”

Due to the non-excludable and exhaustive nature of the resource, the estuary may be defined as a classic example of a commons. However, the welfare economics approach does not explain dynamics involved in the policy’s success. The State’s overarching regulation was a necessary incentive for pollution reduction. Yet, the means through which overcompliance was achieved is related to user and resource characteristics; these facilitated collective action and self-regulatory practices. The design of graduated fines represents collective decision-making and norm formation by “wiling punishers.” When “violations” occurred, fines were aggregated and used for collective pollution reduction projects that would have been otherwise infeasible. Moreover, trusting relationships formed over time among utility managers facilitated information-sharing, technology-sharing and the articulation of a common purpose. These factors, alongside intimate knowledge of their challenges and abilities in improving water quality, allowed for avoided transaction costs in contrast with reduction strategies administered at a higher level. Well-defined user group boundaries, resource boundaries, monitoring ability, organizational legitimacy, and level of trust among participants, found to be associated with successful collective action (Ostrom, 2009), have all played a functional role in efficient pollution reduction. While Zerbe and McCurdy’s framing of commons dilemmas in terms of transaction costs is useful for understanding how the combination of regulatory and self-regulatory mechanisms played a role in the program’s success, Ostrom’s formulation of conditions under which collective action is possible helps explain the means through which transaction cost savings were achieved. We might then reframe the question as: How can government help facilitate the conditions under which externalities are managed effectively and efficiently?

Hamstead, Z. A., & Bendor, T. K. (2010). Overcompliance in water quality trading programs:  findings from a qualitative case study in North Carolina. Environment and Planning C:  Government and Policy, 28, 1–17.

Howlett, M., & Ramesh, M. (2009). Studying Public Policy: Policy Cycles and Policy Subsystems (3rd ed.). Oxford: Oxford University Press.

Munger, M. C. (2000). Analyzing Policy: Choices, Conflicts and Practices. New York, NY: W.W. Norton & Company, Inc.

Ostrom, E. (2009). A General Framework for Analyzing Sustainability of Social-Ecological Systems. Science, 325(5939), 419–422. doi:10.1126/science.1172133

Ostrom, E. (2000). Collective Action and the Evolution of Social Norms. Journal of Economic Perspectives, 14(3), 137–158. doi:10.1257/jep.14.3.137

Zerbe, R. O. J., & McCurdy, H. E. (1999). The Failure of Market Failure. Journal of Policy Analysis and Management, 18(4), 558–578.

Does conventional theory on collective action provide a solid foundation for understanding the causes of collection action in everyday life?

By Jmaine

One perspective on this question comes from E. Olstrom. In the article “Collective Action and Evolution of Social Norms,” Olstrom (2000) writes that there is a disharmony between what conventional theory predicts and what the actual behavior in everyday life reveals. Another perspective comes from J. Stiglitz. In the article “Private Uses of Public Interests: Incentives and Institutions,” Stiglitz (1998) argues that conventional theory does not help us understand how policies that would benefit all fail to make it into law. Stiglitz provides four key reasons why Pareto Improvements are not realized in the market economy.

Conventional economists offer a narrow view on the causes of collective action. One messenger of this school of thought is M. Olson. In the book, The Logic of Collective Action, Olson (1971) argues that individuals that are guided by self interest do not aspire to contribute to collective action, activities that would generate positive externalities. He writes that “if the number of individuals in a group is quite small, or unless there is coercion or some other special device to make individuals act in common interest, rational self interested individuals will not act to achieve their common interests.” One implication of this view is that it asserts that individuals will not work together and solve collective action challenges. What does this mean for public policy? It implies that policy must take the form of external encouragement, helping individuals meet their self interest.

Olstrom (2000) writes that there is a disharmony between what conventional theory predicts and what the actual behavior in everyday life reveals. She does this by summarizing core findings of studies on public good games. The first finding is that “subjects contribute between 40 and 60 percent of their endowments to public good in a one shot game as well as in the first round of finitely repeated games.” The second finding is that once the first round is played, the player’s level of contribution tends to fall, but does not reach zero. The fourth finding is that once players learn more about the game, they are more likely to cooperate with each other. The fifth finding is that interfacing with other players (i.e. setting strategy, punishing others) leads to an increase and sustained level of cooperation. Finally, the seventh finding is that “the rate of contribution to a public good is affected by various contextual factors including the framing of the situation and the rules used for assigning participants, increasing competition among them, allowing communication, authorizing sanctioning mechanisms.” With these findings, Olstrom comes to two conclusions. 1) Not all individuals are simply self interested. Some individuals are willing to act as anchors to spark collaboration to reach goals of collective action. 2) Olstrom finds and characterizes three types of human behavior: norm-using (findings 1-4, those who want conditional cooperation and those who are willing to punish); willing punishers (findings 5-6); and rational egoists. These form the basis of a broader view on the causes of collection action.

Olstrom then argues that evolutionary theory provides us with a more interesting approach to understanding the mechanisms that individuals rely on to reinforce collection action. Evolutionary theories allow us to model how numerous types of behavior live and thrive in the general population. The emergence of collective action generally starts with some individuals who initiate the process and the emergent group designs the rules and sets the property rights. The implication of this point of view is that evolutionary theories are better positioned to allow us to watch the endogenously driven ‘development and growth of social norms.’

The insights provided by Olstrom are supported by other economic research. In the article “The Micro-Empirics of Collective Action: The Case of Business Improvement Districts,” L. Brooks shows the full range of firm activity, from initiating to institutionalizing 32 business improvement districts in Los Angeles. In order to launch the BID, there are anchor firms that act in social ways to consolidate support from other firms and city government to create a district and generate positive externalities. In turn, they are restoring the vibrancy of downtown areas, boosting property values, and even reducing crime. This research confirms that numerous individuals and institutions are working together to solve collective action problems, without external public policy encouraging the action.

Stiglitz (1998) also argues that conventional theory does not provide a strong foundation for understanding collective action in everyday life. One major limitation of the conventional theory is that it “does not explain why policies that harm no one fail to be adopted.” To fill the gap, Stiglitz provides four key reasons why Pareto Improvements are not realized in the market economy: 1) Failure of government to fulfill commitments. One proposed policy would have strengthened the use of hydroelectricity in the country. The proposal took the form of a Pareto Improvement because the proposal was good for subsidized consumers, it was revenue generating for the budget, and made use of noncarbon alternatives for producing electricity. However, this proposal did not make it into law. 2) The formation of collaboratives and bargaining. One proposed policy that was backed by a collaborative would have strengthened the framework and standards for Superfund sites. The proposal passed the House. However, the collaborative broke up when new members of the Republican party arrived. With the arrival of new players, business leaders decamped because they thought they could get an even better deal. This sparked a stand still for reform. 3) Destructive competition. Zero sum games are an example: Senate minority leader using leverage to kill Superfund reform. 4) Uncertainty about consequences of changes. Overall, Pareto Improvements are not realized due to failure of government to fulfill commitments and dynamics with bargaining in the political arena.

Stiglitz appears to privilege the notion of Pareto Improvement but does not question that maybe this notion is not enough. Perhaps bringing about a Pareto optimal result may not be that socially satisfying (Reddy, 2012). Outcomes that are Pareto optimal don’t tell us whether mass starvation can occur. They don’t tell us whether or not there is a survival constraint: consumption of person can fall to zero. What if there is a catastrophic moral horror occurring as a result of market or government activity? Yet a Pareto Improvement is realized. Could this be a reason that collective action would reject that Pareto Improvement?

References
Olstrom, Elinor. 2000, Summer. “Collective Action and the Evolution of Social Norms.” Journal of Economic Perspectives. Volume 14. No 3. Pages 137-158.

Stiglitz, Joseph. 1998, Spring. “Private Uses of Public Interests: Incentives and Institutions.” Journal of Economic Perspectives. Vol. 12. No. 2. Pages 3-22.

Brooks, Leah and William C. Strange. 2011, July. “The Micro-Empirics of Collective Action: The Case of Business Improvement Districts.” Journal of Public Economics 95. Pages 1358-1372.

Reddy, Sanjay. 2012, Fall. Advanced Microeconomics 1 Lectures at New School for Social Research Department of Economics.

As a formal theory of how government works outside the confine of ethics and the normative role oftentimes assigned to the bureaucracy, public choice theory contributes enormously to the study of public policy. Concepts such as rent-seeking, logrolling, lobbying, to mention just three, become ubiquitous when alluding to the role of the state in the allocation of resources. A distinctive feature of public choice theory is its ability to address the existing gap between the theoretical role and the actual contribution of the state in a society, or so we are told. While the market in many instances fails to achieve pareto-improvement, the government, on the other hand, is no exception.

Joseph Stiglitz, a neo-Keynesian and staunch proponent of government involvement, seems to concur to a large extent with the existence of the gap above-mentioned. His experience in Washington, as explained in The Private Uses of Public Interests: Incentives and Institutions (1998), helped him to come to grips with some blatant characteristics of government failure to implement pareto or near-pareto improvements. Four main factors, Stiglitz (1998) observes, undermine such an implementation. These are 1) the inability of government to make commitments, 2) coalition formation and bargaining, 3) destructive competition, and 4) uncertainty about the consequences of change. Underlying these factors is the pervasive informational problem witnessed in the daily functioning of government. Why is government rife with secrecy? Stiglitz’s answer is that “secrecy is neither justified by national security interests, nor as a prerequisite for rational and thoughtful debate, nor even as a tactical necessity in a broader strategy”, but rather, he continues, “ secrecy serves as a cloak behind which special interests can most effectively advance their interests, outside of public scrutiny” (p. 16).

In this particular instance, Stiglitz’s stance seems not to be too different from Mancur Olson and Milton Friedman who are known for their pessimistic view regarding the role of government. The reason why government is inefficient, they contend, is not only because the bureaucrats are self-interested individuals who promote their selfish interests, but also because special interests are able to do their utmost to control the government apparatus. These groups, Olson (1982) argues, “ are overwhelmingly oriented to struggles over the distribution of income and wealth rather than to the production of additional output” (p. 44). “One common explanation of why government is the problem”, Friedman (1993) reasons, “is the influence of special interests. Government actions often provide substantial benefits to a few while imposing small costs on many” (p. 7). Stiglitz, however, is less pessimistic. He believes “while special interests do often dominate over the general interests, and while seeming near-pareto improvements are often resisted, these failures do not undo the great achievements of the public sector, from mass education to cleaner environment” (p. 21).

What Stiglitz eye-witnessed in Washington has been somewhat echoed in Zerbe and McCurdy’s (1999) article The Failure of Market Failure. These authors believe that market failure analysis leads to conclusions about the efficiency of government involvement that do not withstand empirical scrutiny. To demonstrate the limitations of the market failure approach, they set forth the concept of transaction costs that provides, according to them, “a more well-grounded conceptual framework for understanding issues of government intervention.” Unfortunately, Zerbe and McCurdy fail to reach their goals for two principal reasons. First, they ignore that the transaction costs, which North (1990) defines as “the costs of defining, protecting and enforcing the property rights to goods” are the exact reasons why government intervenes by establishing the proper institutional framework to facilitate exchange between parties. Without such institutional framework that is the monopoly of government in complex societies, economic exchanges that could have increased a nation’s output would not occur because of what Akerlof (1970) demonstrates in The Market for Lemons: Quality Uncertainty and the Market Mechanism.

Equating all forms of market failures with externalities is the second reason why Zerbe and McCurdy’s argument fails. To them the failure of the market to produce public goods along with many known classic failures are all forms of externalities. As it happens, externality is an actual act committed by two or more parties that has an incidence on a third party with no compensation. The failure of the market to produce public goods does not actually happen. The market fails to produce public goods because rational producers anticipate that they don’t have the necessary means to constrain citizens from enjoying these (non-rival and non-excludable) goods. They just refrain from producing them and leave the task to the state. Since the action of producing them does not actually occur, there is no externality.

However, although Zerbe and McCurdy’s transaction cost approach fails to explain the issues of government intervention, I believe that a meticulous analysis is needed when deciding upon whether the government or the market should provide/produce a particular good or service. In which sector the transaction cost is higher is an important issue to address. But even in this case, a transaction cost analysis might be insufficient to understand some issue of social justice.  The private sector might be able to do a better job in providing a better quality of education, but will this education take into account Amartya Sen’s capability approach or Rawls’ distributive justice framework? Thus, for social justice concerns, the government ought to intervene regardless the transaction cost of providing a good/service.

Ostrom’s piece is likewise an important framework to look at government intervention. While many scholars, such as Max Weber, view government as an authoritative force capable of constraining its citizens from free-riding, Ostrom believes that not all interventions are welcomed because “external rules and monitoring can crowd out cooperative behavior.” In his attempt to propose a revised theory of collective action based on field studies of collective action problems and the zero contribution thesis, Ostrom shows that the existence of two types of norm-using players – “conditional cooperators” and “willing cooperators” – make external rules in certain settings unwarranted. If the reason why government intervenes sometimes is to constrain free-rider to participate in collective action, Ostrom shows that the presence of these two norms-using players can overcome this problem, thus making government intervention unnecessary.

While Ostrom’s approach may be valid for some communities composed of small numbers of individuals, in complex societies characterized by impersonal relationship (as North argues), institutions really matter. Not just because individuals are rational egoists who are prone to free-ride, or, in contrast, because they are norms-using players (or what Gauthier calls constraint maximizers), but because institutions are, to quote Patel (2006), “information-enhancing” devices who help us knowing for sure who is who in our daily exchange. 
Claude Joseph