1. Part III: Political Economy  In order to operate, a government needs to decide two things: 1)How are decisions made? 2)How are responsibilities split? Note: This chapter covers select issues in political economy

2. Part III: Political Economy  Direct Democracy  Representative Democracy  Federal System Background  Advantages of Decentralization  Disadvantages of Decentralization

3. Theory - Public Choice PUBLIC CHOICE – a field of applying economic principles to the understanding of political decision making  We will examine two models of democratic decision making: 1)Direct Democracy 2)Representative Democracy

4. 1) Direct Democracy In direct democracy, everyone has a say in the political decision making process, leading to a variety of approaches and issues: a) Unanimity Rules b) Majority Voting Rules c) Logrolling d) Arrow’s Impossibility Theorem

5. 1a) Unanimity Rules Lindahl (1919/1958) designed a procedure to ensure unanimous agreement on provision of public goods. Each voter has a demand curve, where PRICE is the fraction of the public good the voter will pay (tax share), and QUANTITY is the resulting quantity they will want. Two voters will agree on provision of public goods when their combined price equals one at a certain quantity level. This can be shown through the following overlay of demand curves:

6. Unanimity Rules

7. 1a) Unanimity Rules The prices, or tax shares, where two people demand the same amount of public goods, are LINDAHL PRICES. Unanimity Rules are feasible through an auction system, where an auctioneer keeps listing different tax schemes until everyone agrees on one.

8. 1a) Unanimity Rules Unanimity Rules suffer from two problems: 1)People can still misrepresent their preferences to free-ride 2)Unanimous decisions take a long time with many people  It is guaranteed that no one is exploited but…  Historically, unanimous decisions have been required to ensure no decision is made.

9. 1b) Majority Voting Rule Difficulty in unanimous decisions often leads to the MAJORITY VOTING RULE – one more than half the voters must favor a measure for it to be approved. To illustrate, assume Econ 350 had 3 different marking options: 1)Paper – long paper and one midterm 2)Exams – two midterms and a short paper 3)Assignment – two assignments, one midterm, and a short paper

10. 1b) Majority Voting Rule In this case, even though each person prefers a different arrangement, in a vote:  Exams beat paper (2 to 1)  Exams beat assignment (2 to 1)  Therefore, regardless of voting, exams win  This is not always the case however… Voter: ChoiceHouseSuper MarioegHuk FirstExamsPaperAssign SecondAssignExams ThirdPaperAssignPaper

11. Voting Paradox In this case:  Exams beat assignment (2 to 1)  Assignment beets paper (2 to 1)  Paper beats exams (2 to 1)  VOTING PARADOX – individual voter’s preferences are consistent, but the community’s are not Voter: ChoiceHouseSuper MarioChuck Noris FirstExamsPaperAssign SecondAssignExamsPaper ThirdPaperAssignExams

12. Voting Paradox In the case of a voting paradox, the order of the voting agenda can determine the winner AGENDA MANIPULATION – process of organizing the order of votes to assure a favorable outcome Alternately, if pair voting (option A vs. option B) is continually used a decision is never reached. CYCLING – when paired majority voting on more than two possibilities goes on indefinitely without a conclusion ever being reached.

13. Voting Paradox The voting paradox arises when one agent has a DOUBLE-PEAKED PREFERENCE – utility moves down as you move away from a preference, then up as you move farther way. SINGLE-PEAKED PREFERENCE – utility keeps moving down the farthest you move from a preference. If we examine the previous decision in terms of # of non-paper components, we see a double peak:

14. Double Peaked Preferences Here, Super Mario and Chuck Noris have single- peaked preferences while House has double peaked preferences (3 is better than 1 (less), but worse than 2 (less)  When choices are not based on a single dimension, multipeaked preferences are more common (ie: would you prefer teleportation, super strength, or mind reading as a super power?) Voter: ChoiceHouseSuper MarioChuck Noris FirstExams (2)Paper (1)Assign (3) SecondAssign (3)Exams (2) ThirdPaper (1)Assign (3)Paper (1)

15. Median Voter Theorem MEDIAN VOTER – voter who’s preferences lie in the middle of all voter’s preferences MEDIAN VOTER THEOREM – as long as all preferences are single peaked, the outcome of majority voting reflects the preferences of the median voter

16. Median Voter Theorem Example Assume that the final exam could be either 2, 3, 4, 5, or 8 questions long, each with exactly 20% of the vote. Moving from 8 to 5 would get 80% of the vote, and moving from 5 to 4 would get 60% of votes. However, moving from 4 to 3 would only get 40% of votes  4, the median voter’s preference, wins through majority voting.

17. 1c) Logrolling LOGROLLING – trading of votes to obtain passage of a package of legislative proposals  Logrolling is common in the US, and allows laws to be passed that normally would fail through considering how strongly people feel for a proposal.  Consider the following table reflecting benefits from 2 proposals:

18. 1c) Logrolling  Without logrolling, each proposal would fail (2v1)  With logrolling, a hospital and pool (net benefit 315) would be supported by Melanie (net benefit 80) and Scarlet (net benefit 345)  Although this sometimes benefits society, through special interest groups it can sometimes harm society

19. 1c) Logrolling  Without logrolling, each proposal would fail (2v1)  With logrolling, a hospital and library (net benefit -20) would be supported by Melanie (net benefit 160) and Rhett (net benefit 40)  Society’s welfare decreases through a coalition of special interests

20. 1d) Arrow’s Impossibility Theorem  Thus far, all voting techniques we’ve examined have been flawed  Nobel laureate Kenneth Arrow (1951) proposed 6 criteria collective decision-making should follow in a democratic society: 1)A decision is made regardless of preferences (ie: multipeaked) 2)All possible outcomes can be ranked 3)Must be responsive to individuals’ preferences (if everyone prefers A to B, society must rank A higher than B).

21. 1d) Arrow’s Impossibility Theorem 4) Consistency (if A is preferred to B and B is preferred to C, C must be preferred to A) 5) INDEPENDENCE OF IRRELEVANT ALTERNATIVES – ranking of A and B cannot be influenced by another option C. 6) Dictatorship is ruled out. Unfortunately, Arrow’s Impossibility Theorem shows that all 6 requirements can’t be met (5 can); a democratic society cannot be guaranteed to make consistent decisions.  It may make good decisions often but 100% can’t be guaranteed

22. 2) Representative Democracy Everyone voting on every decision is impractical in many areas, so often politicians are democratically elected to make decisions  Referendums occur, but are very uncommon and costly If certain qualifications hold, the median voter theorem can predict the policies of the elected representatives:

23. Success of the Middle  In the case of two candidates, M and S:  M will get all votes left of himself, and some votes between M and S  S will get all votes right of himself, and some votes between M and S  M will win the election  The representative that most follows the median voter will win

24. Middle Winning Qualifications Although this is a surprisingly common result, it doesn’t always hold true due to: 1)Multi-dimensional rankings – often the median voter is different for different issues (ie: social issues vs. taxes) – a politician may win a vote through one policy and lose it through another 2)Ideology – some politicians may care about more than just winning elections – they may hold to an ideology  Carlyle King (former Co-operative Commonwealth Federation (CCF…now NDP) Saskatchewan president discussed ideology vs. election appeal:

25. Ideology vs. Election Appeal “The trouble is that socialist parties have gone a- whoring after the Bitch Goddess. They have wanted Success, Victory, Power; forgetting that the main business of socialist parties is not to form governments but to change minds. When people begin to concentrate on success at the polls, they become careful and cautious; and when they become careful and cautious, the virtue goes out of them.” – Carlyle King  Who said politics was boring and wasn’t edgy?

26. Middle Winning Qualifications 3) Personality – often politicians win or lose depending on personality (many argue that Mulroney’s low popularity came out of his arrogance) 4) Leadership – often politicians can influence public opinion 5) Decision to vote – not everyone votes, so the ACTUAL median voter may not be the median voter of those who actually vote 6) Often there are more than just 2 candidates

27. Federal System of Government “A public sector with both centralized and decentralized levels of decision making in which choices made at each level concerning the provision of public services are determined largely by the demands for those services of the residents of (and perhaps others who carry on activities in) the respective jurisdictions.” -Oates (1972)  But federal systems can differ greatly due to divisions of powers and responsibilities:

28. Decentralization Ratio Decentralization Ratio = { Subnational gov. expenditures (minus grants)}/total government expenditure  Canada has a relatively decentralized government  Note that France is not a federal state

29. Expenditure Changes  Provincial activity has grown over time

30. Expenditure changes

31. Centralization and Expenditure  Note that these ratios can be misleading in two ways: 1)If the federal government heavily funds provinces with many restrictions, the decentralization ratio (in the table) is overstated  This is significant in healthcare, but insignificant elsewhere 2) If provinces successfully lobby the federal government, the decentralization ratio is understated

32. Optimal Decentralization  Compared to many industrial countries, Canada has a relatively decentralized system, and there is a continual tension between provincial and federal government over a variety of issues  Should provinces get more power? Less?  What are the advantages and disadvantages of decentralization (more power to the provinces)?

33. Advantages of a Decentralized System 1)Tailoring government to local tastes  People have differing tastes, and people with similar tastes tend to group together  Decentralized governments allow for different levels and varieties of government services  Different areas operate differently and could benefit from different economic regulations (ie: Sunday shopping) 2)Fostering intergovernmental competition  Provincial and local governments can be more efficient through implicit competition as citizens see the results from other jurisdictions

34. Advantages of a Decentralized System 3) Experimentation and Innovation in regionally provided goods and services  Many jurisdictions trying different approaches produces data to figure out the “best” way  “It is one of the happy incidents of the Federal system that a single courageous state may, if its citizens choose, serve as a laboratory, and try moral, social and economic experiments without risk to the rest of the country.” – Brandeis, US Supreme Court Justice

35. Decentralized Experimentation Examples: 1)Saskatchewan experimented with healthcare in 1962 2)Different healthcare models (Canada and abroad) may yield better organization tools 3)Quebec and British Columbia are experimenting with increased childcare subsidies 4)Different universities have different tuition, with differing results. Is U of A’s $6k best, or U of Lethbridge’s $5K best?

36. Decentralized System Disadvantages A)EFFICIENCY ISSUES 1)Externalities  Often externalities are experienced across communities/provinces (river pollution, education and immigration, etc) 2) Public Good Economies of Scale  Costs may decrease as provision increases, therefore decentralization of some public goods can have higher costs (policing, public parks)  Communities can always contract out to keep economies of scale (garbage collection)

37. Decentralized System Disadvantages A)EFFICIENCY ISSUES 3) Tax collection economies of scale  Tax administration costs per person can be reduced in a centralized system (why support two tax collection programs when you can split the cost of one)  Co-operation can take the place of centralization, as in the federal government collecting provincial sales tax (HST)

38. Decentralized System Disadvantages B) EQUITY ISSUES  Communities with good social programs (ie: income redistribution) would attract the poor…  Resulting in higher taxes…  Causing the rich to leave…  Causing the program to be abandoned  Research in this area has been mixed

39. Part III Conclusion  Lindahl pricing and unanimous decision making results in efficient public good quantities  This suffers from misrepresentation of desires and decision-making costs in large groups  Majority voting can fail in the case of multi- peaked preferences  Majority voting tends to lead to the median voter’s choice being selecting in the case of single-peaked preferences

40. Part III Conclusion  Logrolling involves grouping projects and trading votes  This can lead to minority special interests decreasing society welfare  Arrow’s Impossibility Theorem shows a democracy can’t be guaranteed to make consistent decisions

41. Part III Conclusion  In the case of two elected representatives, the winner will tend to be the politician best representing the median voter  Unless the median voter varies greatly among issues or issues are multi-peaked  Canada has a relatively decentralized system compared to many other countries  There are advantages and disadvantages to decentralization  Therefore some public goods and government services are best provided locally, some nationally