May 15, 2015 Show Notes: Public Choice Theory

Winston Churchill said,

Democracy is the worst form of government, except all those other forms that have been tried from time to time.

Public Choice Theory describes the extension of analysis to the political alternatives to markets. Many commentators talk about “market failure,” but far fewer ever mention government failure. Public choice theory sheds light on how government employees face incentives as much as employees in the private markets, and how these incentives can create bad policies, costly regulations, and other negative consequences.

Identify a problem to be “solved” by government. But there are no solutions, only tradeoffs.

Nobel laureate James Buchanan and Gordon Tullock, founders Public Choice Economics, insisted:

Any formula for government intervention that ignores political realities is unscientific.

Gordon Tullock wrote that public choice was “politics without romance.”

Economists are often blamed for having a religious faith in markets, but no one has pointed out more market failures than economists.

We underestimate how well markets work and over-estimate how well democracy works.

Four Insights from Public Choice Economics

1. Special-interest-group effect (concentrated benefits, diffused costs)

  • Sugar program cost each American $9.24 yet it raised each sugar grower’s annual income by an average of $617,000 in 2012

2. Rational ignorance—your vote won’t determine election

  • Put more time into developing your job skills, or a major purchase then into an election. You’ll only get small amount of benefits, or pay small amount of costs

3. Rent-seeking—lobbyists wasteful to society, redistribution transfers slices of the pie, does nothing to increase pie

4. Bundling effect—Example: shopping supermarket

  • Imagine having to pick between two shopping carts pre-filled with food. You could look, put not move items from one cart to the other
  • Outside observers cannot know that you chose that Cart A despite its offering of diapers and dog food rather than because of them
  • We can say nothing about the majority’s preferences for any individual policy
  • So politicians don’t know why they won (or why opponents lost)

The Myth of the Rational Voter by Bryan Caplan

Why are voters predictably irrational?

H.L. Mencken: “Democracy is a pathetic belief in the collective wisdom of individual ignorance.”

Voters are asked to do brain surgery and they can’t pass basic anatomy.

Democracy is a relatively inferior way of making decisions: marriage, career, state to live, home to buy, etc.

Most voters are worse than ignorant, they are irrational, according to Caplan. He claims democracy fails because it does what voters want—a built-in externality.

Wisdom of the crowds doesn’t work with voting because of systematic errors

Most voters have four biases:

  1. Antimarket bias––tendency to underestimate the benefits of the market mechanism
  1. Antiforeign bias––a tendency to underestimate the economic benefits of interaction with foreigners
  • Incessant worry about the “trade deficit”
  • Ideological purity is free! Severe biases can’t exist in betting or prediction markets, but can in voters
  1. Make-work bias––a tendency to underestimate the economic benefits of conserving labor
  • China excavating land with shovels; Milton friedman asks, why not tractors? Need jobs. Oh, then use spoons
  • We wouldn’t think this way in our household, where we love labor saving devices
  • You don’t worry how to spend the hours you save buying a washing machine
  • Saving labor is progress and responsible for our ever-increasing standard of living!
  • Illusion that employment, not production, is the measure of prosperity
  1. Pessimistic bias––a tendency to overestimate the severity of economic problems and underestimate the recent past, present, and future performance of the economy.
  • Pessimism sells: Club of Rome, peak oil, Malthus, etc.
  • As you do better, your children have to do even better, optimism declines

Analogy between voting and shopping flawed. You don’t “buy” policies with votes.

Democracy let’s people with severe biases continue to participate at no extra cost.

If people are rational consumers and irrational voters, it’s a good idea to rely more on markets and less on politics.

Other Books and Resources

An unhealthy Alliance video

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