by Filip Palda
In the first stage a constitution would limit the abilities of government to tax. With Leviathan thus contained, a second stage could then be played in which political competition could nurture efficient economic outcomes.
Political competition might severely restrict the ability of scholars to influence policy in this second stage. The scholar was at his mightiest in the first stage where all founders of the nation recognized their mutual interest in getting right the rules of the political game. In the search for such truths scholars could be of great help.
Thus public choice tacitly acknowledged some of Chicago’s ideas about political competition and efficiency (second stage of the game), while at the same time finding a role for the scholar to influence policy (first stage of the game). From these insights the branch of public choice known as constitutional political economy was formed.
Efficiency through inefficiency?
THE ONLY BLEMISH on Buchanan and Brennan’s foundational essay was their rejection of public choice’s core belief in the median voter model. With a flick these fathers of the field dismissed what at the time was the only fully worked-out, logically consistent formulation of political equilibrium. Instead, they based their argument on a new and largely untested notion of the “budget maximizing bureaucrat” put forth by William Niskanen in 1971. Buchanan and Brennan’s gambit showed how easy it is to sneak in prejudices against big government by abandoning the discipline imposed by models of political equilibrium. The dangers from “Leviathan” were not based on a model, but rather on a personal conviction.
Yet it would not be productive to dismiss Buchanan and Brennan because of their recourse to an intellectual deus ex machina. They were tracing the outlines of a profound thought but lacked the theoretical tools and insights to make it stand on its own. The appearance of Becker’s 1983 article on interest group competition suggested that the Leviathan argument had legs. It was consistent with Becker’s model of political equilibrium, but in a very particular sense.
In the Buchanan and Brennan article Leviathan will attempt to maximize government revenues. To limit Leviathan, constitutional restrictions on the ability to tax must be passed in order to lower revenues governments can extract from the economy. In Becker’s model a restriction on available “tax instruments” works not by limiting the maximum that can be raised but by increasing the deadweight loss imposed by taxes. Being an equilibrium model of politics, Becker’s model postulates no tendency for government to maximize its revenues. Instead it neutrally postulates that voters will consider the direct and deadweight costs of taxation in determining the level of political pressure to exert. One cannot really speak of demand and supply in this model, but rather of the final, equilibrium levels of pressure different groups decide to exert on government given the tax plus deadweight cost of different policies.
A prediction of the model is that more of a service will be provided the lower is the deadweight cost associated with its provision. Becker and his colleague Casey Mulligan found empirical proof of this in 2003. It seems that countries with more efficient tax systems, those imposing less deadweight loss per dollar of tax, also have larger governments. Thus one could restrict the size of government by writing a constitution that only allows government to use inefficient tax instruments. By raising the deadweight loss from taxation interest groups seeking government favours would find themselves disadvantaged in the face of those seeking to resist having to pay more tax.
Yet why exactly would one wish in the Becker model to restrict anything? It is after all a model predicting the possibility that political competition may lead to the economically efficient provision and financing of government services. The model emerged from the best tradition of Chicago optimizing behavior. Why mess with the human behavior it predicts?
The answer lies in a collateral damage from politics known in public choice as rent-seeking, and in some other academic quarters as directly unproductive profit-seeking activities. When a society’s best and brightest devote their energies to carving up the nation’s wealth rather than figuring out ways of increasing it resources are squandered. Every dictator who spends half his country’s GDP to protect his position might have had a career as a scientist or an architect had the rules of the political game discouraged rent-seeking.
So how does rent-seeking enter into plans to restrain Leviathan? As Becker and Mulligan had verified, a political system that minimizes the deadweight loss from taxation encourages government to grow. The resulting large government attracts what historian William McNeill called human macroparasites who do battle to control government resources. If the tax system were inefficient, interest groups would have a weak incentive to demand a large government. The cost of increased inefficiency might be more than balanced by the resources saved from discouraging the non-productive efforts that macroparasites expend in their quest for government booty.
So who wins?
AS THIS CHAPTER must by now have made clear, the claims of Chicago political economy oppose those of public choice. Detailed examination reveals that both schools of thought agree on the tools needed to analyse politics. Individuals are assumed to maximize their well-being subject to material constraints and the result of these activities will produce an equilibrium. The schools differ in that Chicago sees political equilibrium as being Pareto-efficient and beyond the power of an individual to influence. Public choice believes that inefficiencies in the political market prevent the emergence of efficiency and that the scholar can change history. Neither school can as yet be proved to have the better argument because the data needed to verify claims about competition and efficiency in politics are scarce or entirely missing.
Is there any middle ground between these two schools of thought that might begin by acknowledging the inefficiency of political equilibrium, but that might also suggest some credible means of overcoming this inefficiency? The answer will satisfy neither Chicago nor public choice. It is called mechanism design, a field which emerged from game theory and which some call anti-game theory.
Game theory
GAME THEORY IS a copious wonderland of imagined equilibrium relations between rivals. Remember what equilibrium is, a stable set of relations between individuals or groups of people. Standard economics works mainly on the unique equilibrium that can be found at the intersection of demand and supply curves. Game theory may now have uncovered dozens of fundamentally different types of equilibria and continues to produce them. In many ways it is similar to quantum physics where new particles emerge from ever deeper theories. That is no idle coincidence. The rule of particle physics is unpredictability. Games theory also has trouble pinning down how rival individuals or groups will resolve their conflicts. The closer scientists peer at the individual components of nature, the less they seem able to say about their behaviors. Yet in this embarrassment of riches, game theory may provide just the sort of insight which could unite Chicago and public choice thinking, though not necessarily in a manner that either school would approve of.
Though game theory is now a recognized field of economics, most economists shy from it. That is no surprise. Game theory was created by mathematicians who had little point of contact with economics. Their views on equilibrium turned out to be so weird and ran so obtusely against intuition that economists ignored the field for decades. To understand what game theory is we must first understand what it is not. Nobelist John Harsanyi explained that
In principle, every social situation involves strategic interaction among the participants. Thus, one might argue that proper understanding of any social situation would require game-theoretic analysis. But in actual fact, classical economic theory did manage to sidestep the game-theoretic aspects of economic behavior by postulating perfect competition, i.e., by assuming that every buyer and every seller is very small as compared with the size of the relevant markets, so that nobody can significantly affect the existing market prices by his actions. Accordingly, for each economic agent, the prices at which he can bu
y his inputs (including labor) and at which he can sell his outputs are essentially given to him. This will Games make his choice of inputs and of outputs into a one-person simple maximization problem, which can be solved without game-theoretic analysis.
In other words, classical economics has no need of game theory because it forces the individual to accept the constraints imposed upon her while deciding how to maximize her wellbeing. In game theory the constraints are more fluid.
A person placed in game-theoretic interactions seeks, as in the standard economic analysis, to maximize some objective. But she is not like the consumer of products who must passively accept the constraints imposed upon her by the economic environment. In game theory, the constraint lies in the opponent’s mind. That mind will conceive a strategy based on its anticipation of one’s own strategy. This means that one’s own mind is shaping to some degree the constraints one faces. Unlike the passive consumer taking prices and making choices, in a game a person’s choices can influence her possibilities. She is forced into a “strategic interaction” with her environment. She does not choose the outcome, but rather a strategy that may or may not produce the outcome she wants. By taking charge of her environment she also determines in large part what the “equilibrium” outcome of the game is.
The direct interaction of the maximizer with the constraints she faces broadens the possibility for the emergence of “multiple equilibria”. It sounds like a fancy term but in fact it is bad news for economists. The researcher has trouble knowing which of the multiple equilibria people will choose. Even more vexing is the possibility that people will settle into an equilibrium which is clearly worse for all. Ignorance is not the culprit. Everyone can see the prize. But in basic game theory they are unable to abandon their strategic maneuvering. Everybody may remain stuck in a sub Pareto-optimal state.
Public choice scholars may see support for their views in the bizarre, self-damaging equilibria that emerge from game theory. Significant adherents to public choice after all maintain that government and politics are inherently inefficient. If one views politics as a game between rival interest groups one could draw succor from the woes of game theory which has labored for decades to understand how its multiplicity of pathological equilibria could be remedied. The remedy proposed, known as mechanism design, also offers support to public choice scholars because it reserves for them an important role in saving political man from himself, something which Chicago dismisses as being unlikely.
Mechanism design
AFTER THE GREAT discoveries of the 1940’s and 50’s game theory grew arid. Interest revived in the 1970’s when economists from the unrelated field of public finance started to investigate how lying and cheating degraded market efficiency. These problems plagued not only economics markets but politics as well.
Suppose government must decide between building a hospital or creating a national park, each of which will cost the same amount of money. How does it know which one to finance? Government could ask voters how much they are willing to pay, to see their preferred project go through above the per-person tax cost. The project for which people are willing to pay the most would be the one creating the most wealth in society. If all shared the cost equally then each voter would be tempted to overstate the value of her choice. By doing so she could skew the government decision towards her desired position without much of a concomitant increase in her personal cost. If the government is fooled into providing too much of the wrong project, then wealth is destroyed. The technical explanation is tedious but boils down to a situation in which a public good is provided to too many people at a cost which is above their valuation of it.
Game theorists saw in the problems of lying and cheating a useful extension of their science. By recognizing that strategic behavior in situations where some held more knowledge than others could be solved (that is, an equilibrium could be found) by using concepts from Bayesian statistics, game theorists were able to transform games of lying and cheating into games where everyone was honest and obedient. This, as you might quickly grasp, is no game at all. So in effect the theorists created a sort of “reverse game theory” in which government manipulated the rules and rewards of games to neuter all strategic comportment.
Here then was what seemed like a perfect opportunity for the social engineer to fashion clever game-theoretic suggestions on how to end lying and cheating in economics and politics. Such thinking suited public choice thinkers very nicely. The proliferation of sub Pareto-optimal equilibria that one discovered when examining relations between groups of people as game theoretic interactions gave public choice thinkers the chance to indulge their views that they had a prominent role to play in the salvation of politics. One often-cited example was provided by Nicolaus Tideman and Gordon Tullock in 1976.
Drawing on the work of previous researchers, Tideman and Tullock applied to politics the logic of something called a Vickrey-Clarke-Groves auction. It works by asking each person what the net benefit to him or her is above the per-person cost of providing the preferred alternative. You add up the dollar votes for the hospital and if the sum is greater than that for the park, the hospital gets built. But there is a catch. As well as getting charged the per-person cost of building the hospital, any voter who was “pivotal” in forcing the decision will pay an extra cost equal to the loss of net benefit to the other voters who did not see the park get created. “Pivotal” means that by announcing a high valuation on a certain outcome, it was you who tipped the political balance in its favour.
As Tideman and Tullock explained, “A nontruthful response cannot benefit the respondent, and it carries a risk of making him worse off than he would have been with the truth. If he understates his value, he may pass up an opportunity to obtain the result he desires at an attractive price. If he overstates his value, he may wind up paying more than it is worth to him to have his choice”.
Correctly revealing your preferences is an equilibrium (of the sort named after Nobelist John Nash) because if everyone is expected to tell the truth, there is no profit for any single person to deviate from the truth. If we lie to get our way and others are telling the truth, we will be punished with an extra tax. If we lie by understating our preferences while others are honest, the compensation they pay will be proportional to our understated loss and thus not really enough to compensate us for our true loss of not seeing our preferred alternative go through.
Mechanism design’s prescriptions for making politics efficient are so convoluted and difficult to understand that at present they have little hope of being found in the platforms of candidates running for office in the real world. We are perhaps closer to achieving the first human head transplant than we are to implementing anti-game theoretic rules in government.
Mechanism design however is a useful thought experiment on the manners in which we can become stuck in bad political equilibria. It also suggests how to escape these inferior states. Public choice makes similar claims yet the analogy with mechanism design is far from perfect. Both are built on completely different views of how decisions get made in society and how equilibrium is arrived at.
Conclusion
BY NOW IT should be clear that it is fruitless to judge whether Chicago or public choice have produced a better ultimate theory of power. Both share the same approach to understanding power. They apply utility maximization, monetary constraints, and equilibrium to behavior at the crossroads of politics and economics.
They differ in that Chicago political economy holds fast to the notion of political efficiency, whereas public choice heaps scorn on the concept. They differ also in their lines of attack. Public choice sees the world through the lens of the median voter model. It is freighted with assumptions, and this gives it precision. Chicago thinking is broad. It encompasses the median voter and many other possible models of political equilibrium. It applies to dictatorships as well as democracies. It dazzles researchers because it produces varied and nuanced predictions about government based on a few sim
ple assumptions.
The parsimony of the Chicago approach to modeling politics finds many admirers within public choice, but provokes outrage and disbelief further afield. Chicago focuses on motives and not upon institutional structures. Such thinking is alien to political scientists. They are brought up to believe that institutions are important determinants of mass behavior. Chicago does not ignore institutions but rather considers them as endogenous. They emerge from more fundamental forces in the model. The endogenization of most aspects of human behavior is part of the broader Chicago method of reducing the explanatory variables of life to the barest minimum.
Despite the search for an ultimate theory of power led by Chicago and public choice, the word has not really gotten out yet to economists, let alone political scientists.
The message both schools try to transmit is that government policy cannot be analyzed outside of the context in which it is formulated. Pristine economic theories of cost-benefit analysis and optimal taxation have traditionally been formulated under the assumption that governments will carry out their prescriptions to the letter. Yet higher taxes, no matter how efficient they are will provoke tax evasion. More government spending on infrastructure will attract predatory interest groups who will lobby for preferential contracts. The plans of thinkers developed in an atmosphere of what Shackleton called “high theory” will come unravelled when imposed on competing interest groups.
Chicago judges the situation on two levels. At the lowest level we have rules of the political game that restrain interest groups. Within these rules such groups may seek to minimize the damage they do to the economy in order to minimize counter-reactions from other groups, but damage will nonetheless result from the antagonistic quest to seize resources from others. That is the narrow sense in which Chicago sees efficiency in politics evolving. However, it holds out more hope for the highest level of political action where the rules of the game are written. Becker and others believe constitutions with rules that limit rent-seeking may improve the tainted efficiency of the lower level political game. Public choice also believes in the importance of getting the rules right but feels that even the best rules will leave a political battlefield where notions of Pareto-efficiency are far from being realized.