Prof. Bryan Caplan

bcaplan@gmu.edu

http://www.bcaplan.com

Econ 410

Week 14: Democracy, Dictatorship, and Markets

I. The Comparative Institutions Approach Revisited

A. Remember the Emperor's tale?

B. After a full semester of public choice, we are now in a much better position to step back and compare institutions.

II. Critically Evaluating Democracy

A. Critics of economics frequently accuse economists of having naive faith in markets.

B. Few economists actually meet this description. It is much closer to the truth to accuse most non-economists (and quite a few economists) of having naive faith in democracy.

C. Basic insight of public choice: We can critically evaluate democracy in the same way we critically evaluate markets.

III. Government, Public Goods, and the Real World

A. Economically literate defenders of democracy typically focus on government's special ability to supply public goods.

B. After analyzing how democracy actually works, what can we say about this?

C. If people voted rationally and instrumentally, this argument makes a great deal of sense.

D. However, since voting is largely expressive and not instrumental, public goods are likely to be supplied only by coincidence.

1. Ex: National defense may have expressive as well as instrumental value.

E. But: Expressive voting is likely to lead to government involvement in a wide array of "feel-good" issues that have nothing to do with public goods.

1. Care of the old

2. Health

3. Education

F. Similarly, whenever voters hold systematically mistaken beliefs, we are likely to see government wasting resources or being actively counter-productive.

1. International trade

2. Price controls

3. Labor market regulation

G. This adds up to an efficiency case for limiting the scope of democracy in order to keep "political pollution" under control.

IV. Some Political Economy of Dictatorship

A. In the minds of many, the only alternative to democracy is dictatorship.

B. Question: What is so bad about dictatorship anyway? What does the "comparative institutions approach" say here?

C. Simplest approach: Dictatorship is equivalent to democracy with a single - and perfectly decisive - voter.

D. All of the usual rules about democracy that hinge on low probability of decisiveness reverse:

1. Self-interest

2. Instrumentalism

3. Rationality

E. Thus, we should expect dictators to be highly self-interested, but more interested in rationally assessing policies' actual consequences.

F. Complication: Being dictator effectively makes someone extraordinarily wealthy. The resources of an entire nation become theirs to command.

G. Due to their extreme wealth, they may consume a lot of altruism, expressive considerations, and/or irrationality despite their high price.

H. Most definite disadvantage of dictatorship: It's a big gamble. Everything depends on the idiosyncrasies of the Leader.

I. Interesting finding: Average growth of dictatorships and democracies is the same, but dictatorships have more dispersion.

V. Constitutional Reform and Endogenous Institutions

A. Many people in public choice - most prominently, James Buchanan - have suggested constitutional reforms to "help fix democracy."

B. Example: 2/3 rule for spending. Perhaps then, pork barrel projects will fail, and only genuine public goods will receive funding.

C. Problem: Doesn't public choice apply to constitutional reform too?

D. In other words, any failure that afflicts day-to-day democracy presumably afflicts constitutional choice as well.

E. Constitutions are "endogenous institutions." They are a product of the same forces that generate other social outcomes, and no easier to change.

F. Some proposed Constitutional amendments have no obvious impact on policy. These are relatively easy to pass, but what's the point?

G. Other proposed Constitutional amendments would obviously affect policy. These are hard to pass because the policies that currently exist tend to be popular.

VI. Markets As the Alternative to Democracy

A. Churchill coined the stock rebuttal to complaints about democracy: "[D]emocracy is the 'worst' form of Government except all those others that have been tried from time to time."

B. This makes sense if the only alternative to democracy is dictatorship. True, democracy does not win "hands down," but all things considered it looks quite a bit better than dictatorship.

C. But this neglects the alternative of depoliticizing a decision entirely and leaving it to the market. In developed Western countries, at least, this is - at least by default - what happens when democracy does nothing.

VII. Market Failure Versus Democratic Failure

A. A standard textbook line is that markets work only if a long list of conditions are satisfied:

1. Perfect competition

2. Perfect information

3. No externalities

4. Etc.

B. The comparative institutions approach, however, insists that we weigh market imperfections against democratic imperfections.

C. In politics, competition and especially information are highly imperfect, though Wittman does provide some arguments that these problems have been over-rated.

1. Other economists doubt these are serious problems for markets either.

D. The externalities problems of democracy are probably much more serious. Both expressive voting and voter irrationality amount to massive externalities built into democracy at the deepest level.

1. Similarly, it is hard to overlook externalities in the free market.

E. Why do governments intervene in so many markets without serious externalities problems? My answer: These are largely the product of expressive voting and voter irrationality.

VIII. Searching for Asymmetries

A. Parallel problems afflict both markets and democracy.

B. But are these problems always symmetric?

C. Competition in both markets and politics is "imperfect," but it looks pretty fierce in both. Even where there are only two players, collusion is rare.

D. Information in both markets and politics is "imperfect." But the information problem in politics looks a lot worse. Consumers and investors lose their own money when they are misinformed; voters do not.

1. In other words, while the MC of information is positive in both cases, the MB are much greater in markets.

E. What about externalities? Many people see democracy as a great way of solving the multitude of externalities generated by the free market.

F. Returning to the week 1 notes, though, it is worth remembering that externalities in the free market tend to be significantly overrated. Benefits and external benefits are not the same, and privatization is frequently a viable solution.

G. In contrast, externalities internal to democracy - expressive voting and voter irrationality - are greatly underrated.

IX. Concluding Thoughts

A. People often see economists as "religious" proponents of laissez-faire.

B. They aren't. But most non-economists (and many economists) are "religious" proponents of democracy.

C. Traditional public choice theory has emphasized an array of inefficiencies of democracy.

D. More recent work by scholars like Donald Wittman questions these findings.

E. While Wittman makes many valid points, I doubt that many of his conclusions are sound.

F. Instead, his work suggests that the problem with voters is not mere lack of information. Rather:

1. As expressive voting theory indicates, voters aren't even trying to reward politicians for adopting efficient policies.

2. As my rational irrationality model indicates, voters tend to be irrational as well as uninformed.

G. Big puzzle for me: Why isn't policy a lot worse than it is? Once you understand voter incentives and public opinion, it is amazing that the world works as well as it does.