Tag Archives: Public Choice

Why Do We Get So Much Regulation?

Over the past 60 or 70 years, levels of regulation in the United States have been on the rise by almost any measure. As evidence, in the year 1950 there were only 9,745 pages in the US Code of Federal Regulations. Today that number is over 178,000 pages. There is less information about regulation at the state level, but anecdotal evidence suggests regulation is on the rise there too. For example, the Commonwealth of Kentucky publishes its regulatory code each year in a series of volumes known as the Kentucky Administrative Regulations Service (KARS). These volumes consist of books, each roughly 400 or 500 pages or so in length. In 1975, there were 4 books in the KARS. By 2015, that number had risen to 14 books. There are many different theories as to why so much regulation gets produced, so it makes sense to review some of those theories in order to explain the phenomenon of regulatory accumulation.

Perhaps the most popular theory of regulation is that it exists to advance the public interest. According to this view, well-intended regulators intervene in the marketplace due to “market failures”, which are situations where the market fails to allocate resources optimally. Some common examples of market failures include externalities (cases where third parties are impacted by the transactions involving others), asymmetric information (cases where buyers and sellers possess different levels of information about products being sold), public goods problems (whereby certain items are under-provided or not provided at all by the market), and concentration of industry in the form of monopoly power. When market failure occurs, the idea is that regulators intervene in order to make imperfect markets behave more like theoretically perfect markets.

Other theories of regulation are less optimistic about the motivations of the different participants in the rulemaking process. One popular theory suggests regulators work primarily to help powerful special interest groups, a phenomenon known as regulatory capture. Under this view—commonly associated with the writings of University of Chicago economist George Stigler—regulators fix prices and limit entry into an industry because it benefits the industry being regulated. An example would be how regulators, up until the late 1970s, fixed airline prices above what they would have been in a competitive market.

The interest groups that “capture” regulatory agencies are most often thought to be businesses, but it’s important to remember that agencies can also be captured by other groups. The revolving door between the government and the private sector doesn’t end with large banks. It also extends to nonprofit groups, labor unions, and activist groups of various kinds that also wield significant resources and power.

The “public choice theory” of regulation posits that public officials are primarily self-interested, rather than being focused on advancing the public interest. Under this view, regulators may be most concerned with increasing their own salaries or budgets. Or, they may be focused primarily on concentrating their own power.

It’s also possible that regulators are not nearly so calculating and rational as this. The behavioral public choice theory of regulation suggests regulators behave irrationally in many cases, due to the cognitive limitations inherent in all human beings. A case in point is how regulatory agencies routinely overestimate risks, or try to regulate already very low risks down to zero. There is significant evidence that people, including regulators, tend to overestimate small probability risks, leading to responses that are disproportionate to the expected harm. For example, the Environmental Protection Agency’s evaluations of sites related to the Superfund clean-up project routinely overestimated risks by orders of magnitude. Such overreactions might also be a response to public perceptions, for example in response to high-profile media events, such as following acts of terrorism. If the public’s reactions carry over into the voting booth, then legislation and regulation may be enacted soon after.

One of the more interesting and novel theories as to why we see regulation relates to public trust in institutions. A 2010 paper in the Quarterly Journal of Economics noted that there is a strong correlation between trust in various social institutions and some measures of regulation. The figure below is an example of this relationship, found in the paper.

QJE trust

Trust can relate to public institutions, such as the government, but it also extends to trust in corporations and in our fellow citizens. Interestingly, the authors of the QJE article argue that an environment of low trust and high regulation can be a self-fulfilling prophecy. Low levels of trust, ironically, can lead to more demand for regulation, even when there is little trust in the government. One reason for this might be that people think that giving an untrustworthy government control over private affairs is still superior to allowing unscrupulous businesses to have free rein.

The flip-side of this situation is that in high-trust countries, such as Sweden, the public demands lower levels of regulation and this can breed more trust. So an environment of free-market policies combined with trustworthy businesses can produce good market outcomes, more trust, and this too can be a self-fulfilling, allowing some countries to maintain a “good” equilibrium.

This is concerning for the United States because trust has been on the decline in a whole host of areas. A Gallop survey has been asking questions related to trust in public institutions for several decades. There is a long-term secular decline in Gallup’s broad measure of trust, as evidenced by the figure below, although periodically there are upswings in the measure.

gallup trust

Pew has a similar survey that looks at public trust in the government. Here the decline is even more evident.

pew trust

Given that regulation has been on the rise for decades, a decline in trust in the government, in corporations, and in each other, may be a key reason this is occurring. Of course, it’s possible that these groups are simply dishonest and do not merit public trust. Nonetheless, the US might find itself stuck in a self-fulfilling situation, whereby distrust breeds more government intervention in the economy, worse market outcomes, and even more distrust in the future. Getting out of that kind of situation is not easy. One way might be through education about the institutions that lead to free and prosperous societies, as well as to create a culture whereby corruption and unscrupulous behavior are discouraged.

There are a number of theories that seek to explain why regulation comes about. No theory is perfect, and some theories explain certain situations better than others. Nonetheless, the theories presented here go a long way towards laying out the forces that lead to regulation, even if no one theory can explain all regulation at all times.

The Public Choice of Sustainable Tax Reform

Comprehensive tax reform has gotten a jump-start from Senators Max Baucus (D-MT) and Orrin Hatch (R-UT), the chairman and ranking Republican on the Senate Finance Committee.  The Senate’s two top tax writers announced a new “blank slate” approach to tax reform in a “Dear Colleague” letter issued last week.

The Senators describe their new, blank slate approach as follows:

In order to make sure that we end up with a simpler, more efficient and fairer tax code, we believe it is important to start with a “blank slate”—that is, a tax code without all of the special provisions in the form of exclusions, deductions and credits and other preferences…

However, under their framework, every current tax privilege has a chance to survive.  The Senators explain:

We plan to operate from an assumption that all special provisions are out unless there is clear evidence that they: (1) help grow the economy, (2) make the tax code fairer, or (3) effectively promote other important policy objectives.

This plan has drawn both praise and criticism, and rightly so.  Yes, this is a step in the right direction; however, this is unlikely to lead to any sustainable reforms for two reasons.

First, forcing Congress to defend tax privileges won’t be hard.  To become law, each privilege had a sponsor, and each sponsor had a rationale to defend it.  Each tax privilege was passed by Congress, and each was then signed into law.  It is difficult to see how privileges that have already survived this process won’t once again find a congressman willing to defend them.  So long as Congress has the power to create and protect tax privileges, it will be nearly impossible to simply wipe such privileges away.

Second, even if a blank slate were achieved, it is unlikely that a privilege-free tax code would last long under the current institutional framework.  This is best demonstrated by what happened in the aftermath of the Tax Reform Act of 1986 (TRA86).

James Buchanan, writing after the passage of TRA86, predicted that very little its reforms would remain intact.  Buchanan noted that “[t]o the extent that [political] agents do possess discretionary authority, the tax structure established in 1986 will not be left substantially in place for decades or even years.”

Buchanan was spot on.  From 1986 through 2005, the tax reform of 1986 suffered a death of 15,000 tweaks.  As reported by the President’s Advisory Panel on Federal Tax Reform in 2005, in the two decades after the 1986 tax reform bill was passed, nearly 15,000 changes were made to the tax code – equal to more than two changes per day for 19 years straight.

What insight did Buchanan have that allowed him to so aptly predict the demise of the Tax Reform Act of 1986?  Buchanan understood that institutions matter.  That is, he understood that no matter how many times the tax code was reformed, so long as the same institutions remain unchanged, political actors will continue to respond in predictable ways, and the result would be tax privileges creeping their way back into the code.  Buchanan explained:

The 1986 broadening of the tax base by closing several established loopholes and shelters offers potential rents to those agents who can promise to renegotiate the package, piecemeal, in subsequent rounds of the tax game. The special interest lobbyists, whose clients suffered capital value losses in the 1986 exercise, may find their personal opportunities widened after 1986, as legislators seek out personal and private rents by offering to narrow the tax base again. In one fell swoop, the political agents may have created for themselves the potential for substantially increased rents. This rent-seeking hypothesis will clearly be tested by the fiscal politics of the post-1986 years.

Going forward, if any sort of reforms are achieved in the tax code, this rent-seeking hypothesis will be tested again.

Senators Baucus and Hatch admit that a blank state “is not, of course, the end product, nor the end of the discussion.”  If Buchanan’s predictions remain true today, as they most certainly are, then the Senators are quite right in admitting that a blank slate is not, and will never be, an end product.  That is, of course, unless any reform in the tax code is paired with institutional reforms to ensure that special tax privileges do not creep back into the code.

James M. Buchanan: Realistic Optimist

This week we mourn the passing and celebrate the achievements of James M. Buchanan. There have already been many moving and informative tributes. Alex Tabarrok offers a nice summary here. I was fortunate to take one of the last classes Buchanan taught. Even though he was well into his eighties, I found him to be sharp, enthusiastic, and more than a little intimidating to this graduate student.

I’m sure people will be debating Buchanan’s contributions and legacy for quite some time. One aspect that seems unsettled is the degree to which Buchanan’s legacy is optimistic or fatalistic. An old exchange I had with Matt Yglesias highlights the optimism I found in Buchanan’s work:

Back in 2011, in a post titled “Against Public Choice, For Public Virtue,” Matt declared: “I don’t really “get” public choice and think I never will.” He argued:

The observation that malgovernment is a major source of human ills is quite correct, but embracing fatalism about it only exacerbates the problem. What’s needed are efforts to push societies in the direction of taking honor and civic obligation more seriously, not less so.

In a post responding to Matt, I made the case that public choice is no more fatalistic about government failure than other branches of econ are fatalistic about market failure:

Consider a problem from normal economics: the tragedy of the commons. Armed with empirical and theoretical reasons to expect that fishermen will over-fish a common pool, we should plan accordingly. We should examine the incentives of fishermen and think of ways to improve or alter these incentives (e.g., assign property rights over the pool, or impose a Pigouvian tax). To my knowledge, few if any economists would council that we ought to spend our time begging fisherman to pretty please stop overfishing. That is likely to be a fool’s errand.

The idea is much the same with public choice. Armed with empirical and theoretical reasons to think that politicians might do bad things, we should plan accordingly by placing some things—such as the establishment of religion—beyond the reach of politicians. I suppose we could ask Congress to pretty please not establish a religion but in my view it is better to make it illegal for them to do so.

James Buchanan, Gordon Tullock, and the other founders of Public Choice and its close-cousin Constitutional Political Economy didn’t stop their analysis after they found that politicians sometimes behave badly. Like James Madison before them, they thought of constructive ways to make political actors behave better, sometimes by placing certain decisions beyond their reach.

There is nothing fatalistic about that.

 

Do Taxes Affect Economic Growth?

The CRS has a new report by Thomas Hungerford that has attracted some attention. It seems to suggest that taxes do not affect economic growth. To be precise, it seems to suggest that the top marginal tax rates of two taxes in particular—the personal income tax rate and the capital gains tax rate—have little statistically significant effect on economic growth.

A few comments:

First, as William McBride of the Tax Foundation notes in an excellent post, the study only examines two taxes.

The largest tax on investment is the corporate income tax, but the CRS report ignores corporate rates, even though other studies have found corporate taxes to be the most economically damaging.

Second, Will also rightly notes that the study focuses exclusively on the statutory rates of these two taxes, ignoring their actual incidence.

Because Congress has larded up the tax code with piles of credits, exemptions, and deductions, statutory rates often have little relationship to the rates people actually pay (just ask GE). For that, we need an estimate of effective marginal tax rates. As it turns out, many (most?) researchers who study taxes in the U.S. do attempt to get at this. Barro and Redlick’s piece is one example. It employs a tax model which accounts for the “complexity of the federal individual income tax due to the alternative minimum tax, the earned-income tax credit (EITC), phase-outs of exemptions and deductions, and so on.” Using this measure, Barro and Redlick find taxes do have “significantly negative effects on GDP.”

Third, the piece makes no attempt to account for reverse-causality (what economists call endogeneity).

Put simply, tax rates do not change randomly. If they did, that’d be great for researchers because randomization is the gold standard of the scientific method. But because policy makers are not so keen to let economists experiment with the national economy, tax rates don’t change randomly. Instead, governments tend to change rates in response to changing economic conditions; they cut taxes when the economy is weak and they raise taxes when the economy is strong. This makes disentangling cause and effect quite difficult.

Imagine we studied new drug treatments this way. Instead of large scale controlled experiments with randomized treatments and placebos, what if we only had one patient, and we only gave her a treatment when her condition worsened? If, after the treatment, her condition deteriorated further, would we conclude that the drug did her in? A simple statistical test would say so: drug applied, condition worsened. But such a test would ignore the fact that she only got the drug because she was sick to begin with! The point is that it’d be irresponsible to conclude anything from such a small sample and without trying to control for reverse-causality.

That’s why economists go to great lengths to mimic the conditions of a controlled, randomized experiment. In the case of tax studies, the best example of this is the study by Christina and David Romer. They painstakingly combed the archives of presidential speeches and government documents to identify tax changes that came about for reasons other than the condition of the economy. They found that these sorts of plausibly exogenous tax changes had quite significant macroeconomic effects. In their words:

Our results indicate that tax changes have very large effects on output. Our baseline specification implies that an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent.

Fourth, I also take issue with the way the report characterizes some of the existing literature. For example, Hungerford writes that:

There is substantial evidence…to suggest that labor supply responses to wages and tax changes are small for both men and women.

This is only true if the question is whether people who already have jobs change their labor supply in response to tax changes. Increasingly, however, the literature has identified another margin that matters: lifetime decisions about schooling, fertility, and work experience. If taxes affect these things, then they still affect labor supply, even if they don’t seem to affect short-term decisions about how much labor to supply. As Michael Keane’s recent piece illustrates, taxes have a very pronounced effect along this margin, especially among women.

The CRS report is interesting. And its results should be added to the body of literature on taxes. But it is hardly reason to throw out decades of other research which suggests taxes do harm growth:

 

How Receptive is the “Left” to Public Choice Arguments About Cronyism?

Arnold Kling writes about our new project on cronyism:

You can think of the project as having two goals. One goal would be to clarify for conservatives the distinction between being pro-market and being pro-business. I think that some progress toward this goal is possible.

The other goal would be to persuade liberals that deregulation can be a way to reduce the power of big business. On that goal, I am much less optimistic. You can talk all day about regulatory capture and how big government serves entrenched interests. And what the liberals will come back to you with is, “Yes, that is why we need campaign finance reform and to elect politicians who believe in stronger regulation.”….

I picture liberals as having an unshakable belief in the power of moral authority. That is, if you exert enough moral authority, you can overcome any problem. Or, to put it in negative terms, if any problem exists, it is because not enough moral authority has been exerted to try and solve it.

A post by Matt Yglesias from last October would seem to support Arnold’s claim that liberals are unlikely to be persuaded:

The observation that malgovernment is a major source of human ills is quite correct, but embracing fatalism about it only exacerbates the problem. What’s needed are efforts to push societies in the direction of taking honor and civic obligation more seriously, not less so. You want politicians and civil servants to feel worse, not better about behaving cynically.

Call me naive, but I still think that some liberals are open-minded enough to be receptive to the public choice view. Why? Because many liberals don’t apply moral-authority arguments when they talk about conventional economic problems. There, like others, they think about incentives.

When a liberal (or at least a liberal economist) sees a tragedy of the commons, he doesn’t waste his time begging fishermen to pretty please stop overfishing. Instead, he plans accordingly. He thinks about the incentives that these fishermen face and comes up with solutions (for example, Pigouvian taxes or the assignment of property rights). As I wrote back in October:

The idea is much the same with public choice. Armed with empirical and theoretical reasons to think that politicians might do bad things, we should plan accordingly by placing some things—such as the establishment of religion—beyond the reach of politicians. I suppose we could ask Congress to pretty please not establish a religion but in my view it is better to make it illegal for them to do so.

James Buchanan, Gordon Tullock, and the other founders of Public Choice and its close-cousin Constitutional Political Economy didn’t stop their analysis after they found that politicians sometimes behave badly. Like James Madison before them, they thought of constructive ways to make political actors behave better, sometimes by placing certain decisions beyond their reach.

There is nothing fatalistic about that.

When it comes to government-granted privileges to entrenched interests, we shouldn’t wring our hands and beg governments to pretty-please stop pandering to the wealthy and well-connected.  We should plan accordingly. We should think of the incentives of politicians and come up with institutional solutions (for example, by forbidding politicians from handing out particular favors to particular firms or industries). If there are liberals who understand the power of incentives when it comes to microeconomics, I believe there are liberals who will understand the power of incentives when it comes to special interest politics.

There’s one more reason to be optimistic. My colleague Adam Thierer has assembled an interesting compendium of expert opinions on regulatory capture. The quotes show experts interested in grappling with incentives, not lecturing on the basis of moral authority. It is telling how many of the experts are more-naturally categorized as left-of-center than right-of-center.

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Update: Arnold Kling responds here.

Does UK Double-Dip Prove that Austerity Doesn’t Work?

The U.K. has slipped back into recession and Paul Krugman thinks this is evidence that austerity doesn’t work. Is it?

There are three questions with austerity:

  1. Will it work? Will it actually cut the debt?
  2. Will it hurt? Will it harm the economy or might it actually be stimulative?
  3. What mix of spending cuts and tax increases yield the best answers to questions 1 and 2.

Here is what the data says (and there is a lot of it):

  1. Sadly, most austerity efforts fail. According to research by Alberto Alesina, about 84 percent of fiscal reforms fail to substantially reduce a nation’s debt-to-GDP level.
  2. We’ve known for a while that austerity can be stimulative. Even left-of-center economists such as David Romer have acknowledged this possibility. But the evidence on this is decidedly mixed. As Alesina put it in his Mercatus working paper, austerity is about as likely to be stimulative as…well…stimulus. And we know the economics profession is quite divided on stimulus. So you shouldn’t hold your breath hoping austerity will boost economic growth. But remember, that’s not why we should be pursing austerity. We should pursue austerity because we know that we are on an unsustainable fiscal path and that in the long run, too much debt is very bad for growth. Furthermore, we know that the longer we put off reforms, the more painful they will have to be.
  3. Lots and lots of papers* have now studied this question and the evidence is rather clear: the types of austerity that are most-likely to a) cut the debt and b) not kill the economy are those that are heavily weighted toward spending reductions and not tax increases. I am aware of not one study that found the opposite. In fact, we know more. The most successful reforms are those that go after the most politically sensitive items: government employment and entitlement programs. Lastly, there is evidence that markets react positively when politicians signal their seriousness by going against their partisan inclinations. In other words, the most credible spending reductions are those that are undertaken by left-of-center governments. So slash away, Mr. Obama!

photo by: 401K/Flickr

I summarized these issues in this summary and in this presentation.

Given what we know about austerity, my advice to the UK would be: tweak your austerity measures so that they are more spending-cut-focused and less revenue-increase-focused. And go after the most politically-sensitive items. I wish I knew more about what they actually did, but my knowledge of this is limited and I’ve frankly heard conflicting reports (apparently in the UK, there are just as many arguments over the proper baseline as there are here in the U.S.!).

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*Most of the following papers directly test the question of whether spending-cut-focused reforms or tax-cut-focused reforms are more successful and more expansionary. A few test related questions but provide corroborating evidence for this question. All of them suggest that spending-cut-focused reforms work better and are more likely to aid the economy. The papers are in chronological order, but I’d recommend starting with the latest:

Francesco Giavazzi and Marco Pagano, “Can Sever Fiscal Contractions Be Expansionary? Tales of Two Small European Countries,” NBER Macroeconomics Annual, (Cambridge, MA: MIT Press, 1990), 95-122.

Alberto Alesina and Roberto Perotti, “Reducing Budget Deficits,” 1994-95 Discussion Paper Series No. 759 (1995);

Alberto Alesina and Silvia Ardagna, “Fiscal Expansions and Adjustments in OECD Countries,” Economic Policy, No. 21, (1995): 207-47;

Francesco Giavazzi and Marco Pagano, “Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience,” Swedish Economic Policy Review, Vol. 3, No. 1 (1996): 67-112;

John McDermott and Robert Wescott, “An Empirical Analysis of Fiscal Adjustments,” International Monetary Fund Staff Papers, Vol. 43 (1996): 725-753;

Alberto Alesina and Roberto Perotti, “Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects,” NBER Working Paper 5730 (1997);

Alberto Alesina, Roberto Perotti, and Jose Tavares, “The Political Economy of Fiscal Adjustments,” Brookings Papers on Economic Activity (1998);

Alberto Alesina and Silvia Ardagna, “Tales of Fiscal Adjustment,” Economic Policy, Vol. 13, No. 27 (1998): 489-545;

Roberto Perotti, “Fiscal Policy in Good Times and Bad,” The Quarterly Journal of Economics, Vol. 114 (1999): 1399-1436;

Juergen von Hagen and Rolf Strauch, “Fiscal Consolidations: Quality, Economic Conditions, and Success,” Public Choice, Vol. 109, No. 3-4 (2001): 327-46;

Alberto Alesina, Silvia Ardagna, Roberto Perotti, and Fabio Schiantarelli, “Fiscal Policy, Profits, and Investment,” American Economic Review, Vol. 92, No. 3 (2002): 571-589;

Juergen von Hagen, Hughes Halite, and Rolf Starch, “Budgetary Consolidation in Europe: Quality, Economic Conditions, and Persistence,” Journal of the Japanese and International Economics, Vol. 16 (2002): 512-35;

Silvia Adrian, “Fiscal Stabilizations: When Do They Work and Why?” European Economic Review, Vol. 48, No. 5 (2004): 1047-74;

Jose Tavares, “Does Right or Left Matter? Cabinets, Credibility and Fiscal Adjustments,” Journal of Public Economics, Vol. 88 (2004): 2447-2468;

Luisa Lambertini and Jose Tavares, “Exchange Rates and Fiscal Adjustments: Evidence from the OECD and Implicates for the EMU,” Contributions to Macroeconomics, Vol. 5, No. 11 (2005);

Boris Cournede and Frederic Gonand, “Restoring Fiscal Sustainability in the Euro Area: Raise Taxes or Curb Spending?OECD Economics Department Working Papers, No. 520 (2006);

Stephanie Guichard, Mike Kennedy, Eckhard Wurzel, and Christophe Andre, “What Promotes Fiscal Consolidation: OECD Country Experiences,” OECD Economics Department Working Papers, No. 553 (2007);

OECD, “IV. Fiscal Consolidation: Lessons from Past Experience,” in OECD Economic Outlook, 2007;

Andrew Biggs, Kevin Hassett, and Matthew Jensen, “A Guide for Deficit Reduction in the United States Based on Historical Consolidations That Worked,” AEI Economic Policy Working Paper No. 2010-04, (2010);

Ben Broadbent and Kevin Daly, “Limiting the Fallout from Fiscal Adjustment,” Goldman Sachs Global Economics Paper, No. 195 (2010);

David Leigh, Pete Devries, Charles Freedman, Jaime Guajardo, Douglas Laxton, and Andrea Pescatori, “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation,” in World Economic Outlook: Recovery, Risk and Rebalancing (Washington, DC: International Monetary Fund, 2010);

 

 

Mayor-Elect Stanton Offers an Excellent Introduction to Public Choice

Tonight on Marketplace, Kai Ryssdal interviewed a handful of newly-elected and reelected mayors about their plans and priorities. Greg Stanton, the new mayor-elect of Phoenix, gave a surprisingly honest description of his aim:

In Phoenix, we really need to be working with local entrepreneurs, with local business — we need to be working with the federal government as well — to make sure that Phoenix and Arizona get more than our fair share of the jobs program that has been introduced through Congress.

Note that the Mayor-elect doesn’t want his fair share. He wants more than his fair share. Perhaps it was a Freudian slip? I suppose we can’t blame him. He is only responding to his incentives. Though they may not be as open about as Mr. Stanton, the unfortunate reality is that when the national government is doling out money to local governments, every other mayor in the country faces the same incentive.

As Bastiat put it some 150 years ago: “Government is the great fiction through which everybody endeavors to live at the expense of everybody else.”

Matt Yglesias Should ‘Get’ Public Choice

Matt Yglesias says he doesn’t ‘get’ public choice and thinks he “never will.” He writes:

The observation that malgovernment is a major source of human ills is quite correct, but embracing fatalism about it only exacerbates the problem. What’s needed are efforts to push societies in the direction of taking honor and civic obligation more seriously, not less so. You want politicians and civil servants to feel worse, not better about behaving cynically.

Unlike Matt, I think he is sufficiently open-minded to update his prior beliefs, so here is my attempt to help him ‘get’ it. In my view, public choice does not exhort politicians to feel better about behaving badly. It just exhorts us to expect them to behave badly in certain circumstances and to plan accordingly (often by changing their incentives). In this regard it really isn’t all that different from normal economics (a point raised by one of Matt’s commenters, my friend Michael Makowsky).

Consider a problem from normal economics: the tragedy of the commons. Armed with empirical and theoretical reasons to expect that fishermen will over-fish a common pool, we should plan accordingly. We should examine the incentives of fishermen and think of ways to improve or alter these incentives (e.g., assign property rights over the pool, or impose a Pigouvian tax). To my knowledge, few if any economists would council that we ought to spend our time begging fisherman to pretty please stop overfishing. That is likely to be a fool’s errand.

The idea is much the same with public choice. Armed with empirical and theoretical reasons to think that politicians might do bad things, we should plan accordingly by placing some things—such as the establishment of religion—beyond the reach of politicians. I suppose we could ask Congress to pretty please not establish a religion but in my view it is better to make it illegal for them to do so.

James Buchanan, Gordon Tullock, and the other founders of Public Choice and its close-cousin Constitutional Political Economy didn’t stop their analysis after they found that politicians sometimes behave badly. Like James Madison before them, they thought of constructive ways to make political actors behave better, sometimes by placing certain decisions beyond their reach.

There is nothing fatalistic about that.

Purchasing Preference Laws: Who Wins and Who Loses?

Like many states, New Mexico has what is known as a “government purchasing preference law.” This is a statute that requires the state to give preference to local businesses when it purchases products and services on the market.

Many businesses in New Mexico object to the law because they feel it isn’t as strong as the laws of other states. Writing in the Albuquerque Journal (I can’t seem to find a link) business leaders Sherman McCorkle and Dale Dekker argue:

The current law has not achieved its intended purpose. Out-of-state companies are   able to easily qualify as “resident businesses” and reap the rewards of this status.

Nevertheless, local businesses are penalized when they attempt to do business in other states with more stringent residency requirements. According to McCorkle and Dekker:

Basically local companies are hit by a double whammy — they aren’t able to truly benefit from the New Mexico preference law yet they’re penalized in other states because New Mexico has a preference law.

In an attempt to “level the playing field” the state’s business and organized labor communities have met with State Senator Tim Keller to draft an updated government purchasing preference law that is modeled after other states’ laws.

According to McCorkle and Dekker, “When public money is spent in-state all New Mexicans benefit.”

Really? All New Mexicans? Of course, New Mexico businesses benefit from a leg-up against the competition. (At least in the short run; one could argue that over the long-run businesses that are sheltered from the rigors of competition eventually stagnate).

But what about the customers? Do New Mexico taxpayers really benefit when they have to pay extra for government services?

The data suggest otherwise. In an article in the journal Public Choice, economists Steven Craig and Joel Sailors studied the impact of purchasing preference laws on state expenditures. They found that states with such laws spend about 3 percent more per capita. Moreover, they found that the tax base does not rise enough to pay for the extra spending and that revenue must be raised as well. 

As far as economic theory is concerned, purchasing preference laws make little sense. The aggregate costs to taxpayers/consumers outweigh the aggregate benefits to local businesses. And when other states have similar laws, local monopolies dominate everywhere. In addition, there tend to be higher production costs when firms are sheltered from competition as well as rent-seeking costs when firms sink resources into lobbying for such protection. This was bad economics during the mercantilist era and it is bad economics today.

A real step toward reform would be a strong interstate agreement against all purchasing preference laws.