Tag Archives: political economy

Market failures and government failures

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It’s lecture preparation time of week again, and the general theme for next week is the state as a producer: nationalisation and privatisation, PFIs and PPPs, contracting out and industrial policy.

This is one of those areas where there is a vast amount written, but much of it furiously ideological, or else at the wrong focal length for undergraduate students – far too specific or detailed. However, courtesy of Alex Marsh, I have found [amazon_link id=”0801487625″ target=”_blank” ]You Don’t Always Get What You Pay For: The Economics of Privatisation[/amazon_link] by Elliott Sclar.

[amazon_image id=”0801487625″ link=”true” target=”_blank” size=”medium” ]You Don’t Always Get What You Pay for: The Economics of Privatization (Century Foundation Book)[/amazon_image]

This refers to privatisation in the US meaning of contracting out, rather than the UK sense of the sale of state assets. It starts by situating the debate in the context of the shifting tides of political beliefs over the 20th century, towards planning and the role of government as an agent of social change, and then back towards “free” markets and individual action. It then has a few chapters on the basics of markets versus administered or planned services and market failures, and also the basics of writing contracts and how hard or easy it is to specify the service and level of quality to be provided. This part has some very good and clear examples about how difficult it can be to get the incentives right in such contracts – indeed, how often there are perverse incentives due to contract structure.

The book goes on to market structures and competition, and organisational theory – the distinction between exchange in a market and a continuing relationship between individuals or organisations. The book ends with a plea for a less ideological debate about the issue, in favour of one more informed by economic and institutional analysis, by the realities of information asymmetries, moral hazard, principal-agent problems and the like. I wholly sympathise, for of course markets and governments fail in the same places for similar reasons – and this is why [amazon_link id=”0521405998″ target=”_blank” ]Elinor Ostrom[/amazon_link]’s study of the idiosyncrasies of non-market, non-state collective institutions is so interesting. But am not optimistic about shedding the ideology.

There’s no doubt what Prof Sclar’s views about contracting out are, so this is in that sense a partisan book. However, it is carefully reasoned and the economic issues are set out clearly. The writing is lively with loads of examples (albeit all American), and the book is extremely clear – perhaps it helps that Prof Sclar is an urban planner rather than in an economics department!

It’s too long, and perhaps a bit too demanding, for 2nd year undergraduates though. (One of the things I’m learning in delivering my course is that my idea of a reading list is far longer than others like the look of.) If anybody knows of anything alternative (short-ish) readings that shed more light than heat, I’d be glad to know, especially UK-centric ones.

Advice for madmen

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[amazon_link id=”0804780978″ target=”_blank” ]Madmen, Intellectuals and Academic Scribblers: The Economic Engine of Political Change[/amazon_link] by Wayne Leighton and Edward López has been out for a while but I’ve just read it. The Madmen are politicians or policy makers, the Scribblers are academics, scholars, generating new ideas, and the Intellectuals are those who translate ideas into politically digestible form, journalists, think-tankers, consultants. (I’d have found it more intuitive to reverse those last two labels, but there we are.)

[amazon_image id=”0804780978″ link=”true” target=”_blank” size=”medium” ]Madmen, Intellectuals, and Academic Scribblers: The Economic Engine of Political Change[/amazon_image]

The over-arching aim of the book is to explain why bad economic policies are implemented, why they last so long, and why they are sometimes overcome. The transmission mechanism runs from Scribblers’ ideas to decisions by Madmen, mediated by the competitive marketplace of ideas and entrepreneurs among the Intellectuals and junior Madmen.

This account, not particularly new (indeed, the title is drawn partly from the famous [amazon_link id=”1494854740″ target=”_blank” ]Keynes quotation[/amazon_link] about madmen in authority), is wrapped around some useful central chapters. These give a clear and concise history of thought that starts with the political philosophy of government (Plato, Aristotle, Cicero, through to Locke, Hume, Marx, and (as it’s an American book) the US Constitution and Pragmatism. This is followed by a chapter on the marginalism revolution in economics and the Pigouvian approach to social welfare as an allocation problem codified by Samuelson, which is contrasted with the Hayekian view of the economy as an organic entity concerned with exchange rather than allocation. It then sets out clearly Coase’s argument about the symmetry of ‘externalities’ and moves on to the start of the public choice revolution. (Including this sentence about James Buchanan: “He was determined to translate Wicksell’s [amazon_link id=”1855061570″ target=”_blank” ]forgotten book[/amazon_link] [from German] for the English-speaking world.” How marvellous to hear of such a well-rounded economist.)

The book comments: “For all its precision, the great vice of the new welfare economics [of externalities, second best theorem and so on] was to crowd out politics and philosophy. … Economists at mid-century were preoccupied with the pure theory of households and firms and busied themselves with proving equilibrium and devising optimal conditions for allocating scarce resources. Interestingly, the main problem was that many of those optimal conditions included very specific policy choices, like taxing polluters, subsidizing education and deficit spending during recessions. But the people making these policy choices – the madmen in authority – are not part of the economic model.”

A full chapter on public choice theory, voting theorems, Olson’s interest group analysis and the economics of regulation follows. The final chapters set out in more detail the argument about how ideas get turned into policies, and a description of four US examples: radio spectrum, air traffic control, welfare reform and the housing bubble and sub-prime crisis. Of these, the first example generalises most easily to other countries.

The book is very clearly written and an accessible introduction to an important strand of the history of economic thought that is still highly relevant to policy debates today. The three core chapters and the examples make it an extremely useful introductory or background resource for students, and I’ll certainly add them to my reading list for next semester. The final chapter does also end with good advice for wannabee policy entrepreneurs: “Improving the human condition should start with recognising that people respond to incentives, and that incentives are part of institutions that neither rise nor fall overnight, and that the slow emergence of both good and bad ideas can change these institutions and thus have an enduring impact on the human condition. … Ideas indeed can have consequences.”

The case for militantly moderate incrementalism

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I’ve started on [amazon_link id=”0691161623″ target=”_blank” ]Why Government Fails So Often (and how it can do better)[/amazon_link] by Peter Schuck.

[amazon_image id=”0691161623″ link=”true” target=”_blank” size=”medium” ]Why Government Fails So Often: And How It Can Do Better[/amazon_image]

He argues for ‘melioristic realism’ – modest practical improvements in outcomes – which are nevertheless ‘militantly moderate’ given the usual assumption in much policy debate that change must be sweeping and radical. “Policy makers have at best severely limited knowledge of the opaque, complex, social world that they seek to change, and meager tools for changing it.” There is a ‘remorseless’ law of unintended consequences. Incrementalism is therefore the only wise and honourable approach, Schuck argues. Indeed, it’s the only approach that increasingly cynical and distrustful voters will now accept, he thinks.

The book describes what he calls ‘moral hazard’, which is far wider than the usual definition of risk-taking behaviour in financial or insurance markets induced by the fact that somebody else bears the cost. Schuck extends it to all kinds of behaviour whose cost is partly borne by somebody else (i.e. taxpayers) – hence also welfare “dependency”, or crop subsidies, or corporate welfare dependency in sectors such as aerospace and defence sector.

I’ll review it properly when I’ve finished. It’s a US-focused book – here is the Boston Globe and an article by Peter Schuck on the Huffington Post site.

Global governance by stealth

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Last night I attended the Dimbleby Lecture given by IMF Managing Director Christine Lagarde – it will be broadcast tonight on BBC1. Her theme was reinventing multilateralism for the 21st century. What global governance structures will ensure the international system delivers mutually beneficial co-operation rather than zero-sum competition, in the face of technologies that are creating an ever-denser web of decentralised connections, significant demographic change and long-term and other environmental challenges? She also underlined the serious challenge to stability posed by the current degree of income inequality. I think all reasonable people would agree with that, but how interesting to hear the head of the International Monetary Fund speak about it in such strong terms:

“Let me be frank: in the past, economists have underestimated the importance of inequality. They have focused on economic growth, on the size of the pie rather than its distribution. Today, we are more keenly aware of the damage done by inequality. Put simply, a severely skewed income distribution harms the pace and sustainability of growth over the longer term. It leads to an economy of exclusion, and a wasteland of discarded potential.”

Her focus on reform of global governance is understandable when the US Congress recently made America pretty much the only country in the world that has failed to ratify a first step IMF funding proposal. As Mohamed El-Erian wrote for Project Syndicate:

“This is an unfortunate and regrettable outcome for both the IMF and the international community as a whole. Congressional obstinacy is forcing the Fund to miss out on an opportunity to strengthen its finances at a time when most other countries have already approved the initiative. It is also being held back from addressing, albeit modestly, governance and representation deficits that have steadily eroded the integrity, credibility, and effectiveness of this important multilateral institution.”
Nobody I know of believes global institutions do not need reform. Apart from the challenges described by Mme Lagarde, the large, growing economies – the BRICs and then the MINTs – urgently need to have a voice that reflects the weight they already have in the world economy, as Jim O’Neill has argued in his book The [amazon_link id=”1907994130″ target=”_blank” ]BRIC Road to Growth[/amazon_link]. A forthcoming (May)  book by Ian Goldin, [amazon_link id=”0691154708″ target=”_blank” ]The Butterfly Defect[/amazon_link], looks specifically at how to manage the serious new systemic risks posed by global interconnectedness, such as pandemics or new financial catastrophes. These are just two of a whole sub-genre.
[amazon_image id=”0691154708″ link=”true” target=”_blank” size=”medium” ]The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do about It: How Globalization Creates Systemic Risks, and What ot Do about it[/amazon_image]
So the need is clear. But how to get from here to there? I’ve not yet heard or read about the specifics. My hunch is that if the minor reform of existing institutions is impossible, given the almost-everywhere increasingly dysfunctional politics of different nation states, we need to look at building new institutions that can perhaps start under the radar. It could be global governance reform by stealth or not at all.

Implementation, implementation, implementation

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Over the years I’ve spent a lot of time in different non-executive public service jobs, and so have experience of two interfaces. One is between politics and non-political public service decisions, all at the technocratic end in my case. The other is between non-executive and executive action, as all of the non-exec roles have obviously relied on a full time staff to implement decisions.

Almost all of the people I’ve come across in all of these categories have felt a strong sense of public service. But it is extremely difficult going from a political choice validated (more or less) by accountability to voters to the effective implementation of those choices with accountability that is often not clear although often addressed by ‘transparency’. These categories of actors have different time scales  – from the electoral cycle to the life-long career – and constraints –  from media and electoral demands to the risk of judicial review. (The piggy in the middle position is not the most comfortable, either!) As the Duke of Wellington famously said of his first cabinet meeting, “An extraordinary affair. I gave them their orders and they wanted to stay and discuss them.” (Or as one of my favourite t-shirts, long since gone, put it: “Be reasonable. Do it my way.”)

Recently I read [amazon_link id=”1780742665″ target=”_blank” ]The Blunders of Our Governments[/amazon_link] by Anthony King and Ivor Crewe, an excellent and very readable account of many specific failures, along with an analysis of why failure occurs so often. They attribute chaotic government (this is in the UK) to a mixture of human errors and system errors.

[amazon_image id=”1780742665″ link=”true” target=”_blank” size=”medium” ]The Blunders of Our Governments[/amazon_image]

Now I’m half way through a proof copy of [amazon_link id=”0691161623″ target=”_blank” ]Why Government Fails so Often and How It Can Do Better[/amazon_link] by Peter Schuck. (I’ll review it in April when it’s officially published.) This is a US-focused book, more academic in tone. Its analysis overlaps with King and Crewe. Like them, Schuck goes on to suggest some improvements that would ameliorate the dysfunctionality of government – and my goodness, the US system looks massively dysfunctional to a foreigner like me.

[amazon_image id=”0691161623″ link=”true” target=”_blank” size=”medium” ]Why Government Fails So Often: And How It Can Do Better[/amazon_image]

The two books together are making me wonder what the prospects are for making government truly effective given our starting point, namely the accumulation of bad policies like encrusted barnacles making an old ship impossible to sail. A lot of economists are pinning their hopes on evidence-based policy, but this assumes that Mr Spock-style rationality will cut through the nexus of many people taking varied decisions for different reasons.

It’s better than not having the evidence base, but we economists need to pay more careful attention to the political economy issues (and, as I’ve argued before in last year’s Pro Bono Economics lecture, make sure we include ourselves in the analysis.)