by Filip Palda
Hicks, John R. (1939). “The Foundations of Welfare Economics.” Economic Journal. 49: 696–712.
Kaldor, Nicholas (1939). “Welfare Propositions in Economics and Interpersonal Comparisons of Utility.” Economic Journal. 49: 549–52.
Keynes, John Maynard (1939). “Professor Tinbergen’s Method.” The Economic Journal. 195:558-577.
Leeson, Peter T. (2007). “An‐arrgh‐chy: The Law and Economics of Pirate Organization.” Journal of Political Economy. 115:1049-1094.
Olson, Mancur. The Logic of Collective Action: Public Goods and the Theory of Groups. Harvard University Press. 1965.
Olson, Mancur (1996). “Big Bills Left on the Sidewalk: Why Some Nations are Rich, and Others Poor.” The Journal of Economic Perspectives. 10:3-24.
Peltzman, Sam (1976). “Toward a More General Theory of Regulation.” Journal of Law and Economics. 19:211-240.
Pigou, Arthur C. The Economics of Welfare. First edition 1920. Fourth Edition 1932. Palgrave MacMillan. 2013 Kindle Reprint.
Reder, Melvin W. (1982). “Chicago Economics: Permanence and Change.” Journal of Economic Literature. 20:1-38.
Samuelson, Paul A. (1954). “The Pure Theory of Public Expenditure.” The Review of Economics and Statistics. 36: 387-389.
Samuelson, Paul A. and William D. Nordhaus. Economics, 13th Edition. McGraw-Hill, 1989.
Stigler, George G. (1971). “The Theory of Economic Regulation.” The Bell Journal of Economics and Management Science. 2:3-21.
Tollison, Robert D. (1989). “Chicago Political Economy.” Public Choice. 63: 293-297.
Tullock, Gordon (1967). “The Welfare Costs of Tariffs, Monopolies, and Theft.” Western Economic Journal. 5:224–232.
4
Total Model
THE ULTIMATE GOAL OF CHICAGO political economy was to apply the logic of market competition and equilibrium to the alien context of politics in order to create a total theory of how resources are divided between productive and predatory ends. George Stigler and Sam Peltzman laid the basis for this theory. Gary Becker completed it. The resulting product pits rival interest groups in fights over the fruits of peoples’ honest labor. Government may control these resources. Or there may not be a government, only factions fighting over spoils in a civil war.
Regardless of the context to which it is applied, Chicago theory emerges from a world in which people seek to coordinate their efforts towards productive ends. Encroaching upon this world are brigands, thieves, monarchs, tax collectors, special interest groups pleading for congressional favor. In contrast to the world of productive “makers”, this demimonde of “takers” destroys resources and discourages productive efforts. It threatens the basis of society. In Hobbes’ words “In such condition there is no place for industry, because the fruit thereof is uncertain … no arts, no letters, no society, and which is worst of all, continual fear and danger of violent death, and the life of man, solitary, poor, nasty, brutish, and short.” In more prosaic terms, predatory groups represent what economists call a “coordination problem” for society. By identifying the factors that lead to a breakdown in coordination Becker’s theory also suggests a path towards re-establishing harmony. Economists call the sort of harmony Becker had in mind “equilibrium”.
In economics, equilibrium is a fixed point towards which the behavior of groups of people converges. In markets based on voluntary exchange, this equilibrium is also an optimum for society in the sense that it represents a state in which there are no further possibilities for mutual gain from voluntary exchange. There are no “big bills left lying on the sidewalk” in the words of Mancur Olson. More technically society achieves Pareto-optimality.
These voluntary exchanges are the means by which people fruitfully coordinate much of their behavior in society. To buy a car I need to work to produce income, and to receive this income the seller needs to make an order to the factory where others work, indirectly on my behalf. The coordination is highly decentralized. There is no balloon-brain guiding all actions. It is also efficient in the sense that if there existed a different way to coordinate these actions that left at least one person better off, without harming anyone else, such an opportunity could be exploited without conflict, hence loss of coordination.
If people were to stop exchanging voluntarily and start robbing from each other, a sort of coordination would still exist. It would be the coordination of boxers correlating their footwork to avoid injury while inflicting maximum damage upon their opponents. This violent coordination cannot travel far on its own steam because soon it exhausts all its wealth in combat. Violent coordination needs to draw resources from productive coordination in order to continue its dance of destruction.
Whether applied to an exchange of goods or of blows, equilibrium is the path towards understanding where such contradictory interactions will lead and what the fallout will be. The interactions need not be mutually exclusive. There is an interface and an overlap between the world where people seek productive exchanges and the world in which they prey upon each other. Becker’s model joined these two worlds and showed how each influences the other and hence why it makes little sense to speak of “free markets” or “government control” each apart from the other.
Stigler had earlier emphasized how closely linked government and free markets were. Changes in one world could send ripples through the other, as when the great depression of the 1930’s saw regimes in Europe and the US forget their liberal traditions and restructure government to command swathes of the economy.
These changes in government in turn forced private markets to become politicized in order to defend their wealth. These political changes further influenced economic change which bounced back to influence change in politics. Eventually a new economic and political equilibrium was reached which lasted through the Eisenhower years in the US.
The extended feedback between politics and economics became the focus of Becker’s work. What many saw as a confused interplay of multiple forces, Becker saw as an amalgam of forces that came into focus when seen through the lens of equilibrium thinking. Mastering this thinking is the object of the present chapter.
The objective sounds daunting for a good reason. Economists teach equilibrium in a formalistic manner which obscures how vital the topic is to understanding interactions between people. We might try to take the formalistic route to become masters of equilibrium before exploring Chicago political economy but the effort could prove exhausting and premature. Instead, let us take a bend in the undergrowth of economics and attempt to understand equilibrium with the help of a parable.
The rise of Uber
UBER DESCRIBES ITSELF as a ride-sharing service. It does so to avoid legal battles with taxis. Uber’s rise during the age of social networking has provoked outrage in the traditional taxi industry. Its efforts to stifle Uber provide a real-world lesson containing all the elements of Becker’s abstract rendition of Chicago political economy.
Over the 20th century coalitions of taxi companies convinced local governments that the number of official permits needed to be restricted. Their public argument for blocking the growth of their industry follows a familiar script with interest groups that are seeking to reserve a market to themselves: riders need to be serviced by companies that meet exacting standards of safety and comfort. Apparently customers are too poorly informed or motivated to make sense of their riding experiences and sift the market for those companies providing desirable features. Only a government issued permit can guarantee consumer welfare. Permits must be limited because the number of satisfactory cabs and drivers is limited.
The subtext to this script is more complicated. Economically valid reasons can be found for having government control the entry of taxis into the market. Yet laws limiting entry, be they passed for taxis, or lawyers, or in agriculture, have the inevitable consequence of raising the price consumers pay above what would be paid in a market with free entry.
Over decades, cab companies were able to impose non-comp
etitive premiums on consumers because of a simple equation governing city politics. The financial interest of cab owners was far more concentrated than that of riders. In some cities the value of a taxi permit could be as high as half a million dollars. This sum reflected the value of the annualized stream of non-competitive premiums resulting from a closed market. An open market would dissolve the value of the permit and lead to the ruin of the owner. To the rider the extra hundred dollars loss of money paid in non-competitive fare premiums is like a mosquito bite in comparison to the cab owner’s multi-thousand-dollar non-competitive gain from fleecing hundreds of riders.
This asymmetry in gains gave cab owners a powerful financial incentive to organize themselves into cartels. City governments found it more politically profitable to appease small numbers of drivers by granting them entry restrictions than to care for large numbers of riders suffering from almost subliminal harm. Large gains concentrated on a small group could give it an edge over the masses suffering diffuse losses. Thus taxi policy settled into sort of pastoral calm in which taxis acted like vampire bats, discretely draining cows at night of nearly imperceptible quantities of blood. Here then was a steady state of affairs one might call an equilibrium.
Yet anyone who has studied equilibrium knows that it results from the pull of opposing forces. Concentrated gains gave taxi owners an advantage over riders but there had to be a countervailing advantage riders possessed. Without such an advantage cab drivers enjoying large gains would naturally push for even larger profits. But what if hapless riders suffered more from the additional or “marginal” gain to cab owners than the owners benefitted? In other words, what if a dollar gain to owners resulted in a two-dollar loss to riders? And what if an additional dollar gain to owners pushed the loss to riders up to three dollars? In other words, what if the gains from political pressure were constant for cab owners but the losses to riders ballooned in a manner that is technically known as exponential growth? Clearly in such a case, no matter how passive passengers might initially be, soon they would grumble enough to retaliate against cab owners.
Enter Uber, a private firm with money on its mind and politics in its blood. Noticing the exponential harm non-competitive taxi fares and general neglect of service to customers was creating, Uber decided to become the rider’s advocate. The greater loss to riders gave Uber a political edge over cab companies. Consumers could now deal with a new supplier who would help them recoup part of the excessive or “deadweight” losses they suffered from the taxi cartel.
But getting market share by diminishing the harm from excessive fares is not the whole story of how Uber rose to prominence. Harmful fares had been around for decades yet riders had never been able to mount a serious protest against them. As explained earlier, the harm to any individual rider from lack of competition, while annoying, was simply too small to motivate mass protests. In contrast, each cab owner had so much to gain by blocking entry that it was easy for them organize a powerful lobby.
To help riders, Uber could not rely simply on their diluted and dispersed feelings of victimization. It had to find some way to concentrate these feelings in some efficient manner never seen before. The cellphone apps that Uber invented using newly introduced smartphones created the virtual ecosystem in which a community of riders and ride-providers could form at little cost.
This block of newly organized voters awed local politicians into ceding ground to Uber. Some towns have completely allowed Uber to operate, others are struggling to admit Uber into the city’s regulatory framework. A few towns, especially in Europe and other countries with feeble democracies continue to deny the legitimacy of Uber. One observes a pattern where prices are falling but not to their free market potential and where the quality of services is increasing. Uber and cab companies fight for political influence but neither is able to completely dominate the other. Both groups tend to settle into some fixed way of existing alongside each other. Call it political equilibrium.
The abstract elements that Becker worked into his model of political interaction pulse in the rise of Uber. Becker was one of the most skilful economic modelers of his generation.
What this means is that he was good at extracting maximum meaning from a minimal number of assumptions about the world. In politics this approach allowed him to produce a model of total power. It encompasses all situations of mass confrontation, be it at city hall or on the marches of empires.
Because the model is built from very general assumptions it is structured to give an answer about almost any political phenomenon. Critics of such models often call them “reductionist”. Such models reduce reality to a few simplistic causes and interactions that bear little relation to the complex manner in which the world works.
Fundamental equation a mix of pressure and pain
BOTH SIDES HAVE a point but we can allow ourselves to leave the matter hanging. Ultimately, whether you find the Becker model useful is a question of taste. We can best understand this point by using our knowledge of the Uber saga to delve into the abstractions upon which Becker’s model is based.
Our effort to understand political equilibrium will ultimately lead us an assessment of the shocking claim that governments and markets may both converge towards economic efficiency.
Becker’s model has several pieces that fit together closely. It has something called variables. For once the technical jargon is understandable. A variable is some quantity that varies, either of its own free will, in which case it is called an independent variable, or under the impulse of some other quantity that is varying, in which case it is called a dependant variable. National income is a dependant variable that changes under the stimulus of independent variables such as consumption and investment.
Other bits in the model are called parameters. They do not vary. Variables and parameters can be joined into something called an equation. On one side of the equation is the dependent variable. On the other are independent variables and parameters that may combine additively, through multiplication, or exponentiation. The possible combinations are without limit. Parameters amplify or diminish the impact that an independent variable has on the dependent variable. So if consumption rises by a dollar, it may have more than a dollar’s impact on national income. This impact parameter is known as the multiplier.
The fundamental equation of Becker’s model is one which shows how an interest group will react to political pressure and seizure of its resources by another interest group. This is the relay through which all his ideas flow. If you know how cab owners react to Uber and then know how Uber will react to their reaction and so forth, you can see (or “iterate”) your way to where relations between the groups might settle down. You can also identify the conditions under which there will be no settling down to an equilibrium.
Two factors determine how a group will react to another. The first spur to action is the group’s ability to exert pressure, which is summarized by a “pressure function”. The pressure function of cab companies is a mathematical shorthand for their ability to mobilize their members to produce a practical political result. They mobilize with greater ease than riders because each cab owner has a larger money stake involved in preserving her licence than each rider. More generally, a pressure function translates the resources a group spends on political activity into changes in the probability that it will influence the government.
Pressure functions are as varied as the groups to which they pertain. Ease of mobilizing members is just one feature of this function. Ésprit-de-corps, cultural similarity, technical savvy, religion, ideology may all help to boost the power of political investments. The pressure function of cab riders was quite feeble until Uber gave them the technical means to act as consumers en bloc. The image of riders righteous with the spirit of Uber has shaken politicians. The Uber app is the most important component of their pressure function.
Pain-gain function
THE SECOND SPUR to action is the degree to which a group is either being extorted or the d
egree to which it may extort resources from it foe. Think of it as the hunger of the wolf or the anguish of its prey. Because the gains of one group reflect, but do not necessarily equal (this is perhaps the key point of this book) the losses of another group, this aspect of Becker’s model takes the form of a budget equation that binds both groups. His political budget equation is the most difficult concept in all of Becker’s œuvre.
At first one is tempted to believe that a predatory group’s gains equal the losses that victims experience. After all, if restrictions in cab competition raise the fare by five dollars, it would seem that the cab owner gains five dollars and the rider loses the same amount. Yet in the periphery of this exchange between an individual owner and a rider, an opportunity is being lost. The non-competitive premium is a price hike that discourages some people from taking cabs. Instead, they will seek out less convenient alternatives that come at a lower price, such as riding a bus. These riders suffer from being artificially priced out of an exchange with cab owners.
Economists have developed very specific mathematical tools for calculating the money value of potential exchanges that do not take place because of non-competitive price hikes. They call the value of the lost opportunity a “deadweight loss”. The term is infelicitous and largely void of meaning. “Wasted opportunity” would be more fitting. The language is flatulent but the idea is subtle and powerful. It explains why interest groups that have a strong pressure function may falter before seemingly weaker opponents.
The existence of deadweight loss raises the possibility that every dollar cab companies extract in non-competitive premiums provokes, for example, a two- dollar loss to riders, one from the premium and one dollar from the deadweight loss. This asymmetry of gains and losses gives victims a heightened incentive to invest money in their pressure functions, even if these functions are weaker than those of their oppressors. Cab companies may have less incentive to invest in activating their stronger pressure functions because the returns from such investments may be lower than those of their victims. “May” is the operational word in a verbal description that cannot do justice to the mathematical shorthand economists use to describe how people maximize their gains.