Not The Straight & The Narrow
By Smriti Iyer, 13 Jan 2014

With a new government coming to power in the capital and National Elections round the corner; there have been a lot of discussion over issues of government. The question of why governments do not take some obvious steps to improve governance and implementation of public policy is central to this debate. This blog aims to provide an overview on the role cast out for the government in economic theory and how this can be extended and modified to understand government behaviour. In part, it also seeks to answer why social sector schemes and activities in the economic realm do not function the way they ought to.

One extends the meaning of the term government to incorporate the political class, bureaucracy and public sector enterprise. Classic public economic theory adopts the Paul Samuelson formulation where the government is seen as a socially benevolent planner,who attempts to achieve the best result for all parties involved. Intervention by the government in case of negative externalities like pollution, missing markets and for the provision of public goods justifies this perception. Given a socially benevolent government that derives its utility from working in the interest of the public and is only concerned with social welfare, intervention would perhaps lead to socially optimal outcomes. A government that maximizes welfare will intervene on issues based on poverty alleviation, access to healthcare and education. India like most governments around the world has introduced social sector schemes such as SSA, ICDS, MGNREGA and NRHM to name a few. These schemes however are riddled with systemic inefficiencies and misappropriation of funds.

Nature of the Government: An alternative view

According to Hindriks and Myles (2006), the assumption that the government has our best interests at heart providesa misleading picture of both reality and the benefits of public policy. In addition to the systemic realities that need to be understood, looking at levels of efficiency goes a long way towards analyzing government functioning. Intervention may not be efficient, especially when information is incomplete or restricted even between the different government agencies/ officials. Public choice economists are of the opinion that there is something known as government failure. There are endogenous reasons why government intervention does not achieve the desired effect.

This theory makes room for the possibility that the government is not a social welfare-maximizing, agency. Each member of the government, be it the politician, bureaucrat or mid level official, could be governed by self-interest. It may not be in their best interest to see that a scheme is implemented efficiently. The opportunity cost of being efficient may be too high. This theory purports that individuals in the government system are constrained by political and monetary considerations and there is an inherent conflict between the duties of the government and their individual personal interest.

Unlike the government, the private sector exploits the market directly to raise income and serve their self-interest. Individuals in the government mayalso want to raise their income from the market, but for them the process is not as straightforward. In fact, Niskanen (1968) suggests that individuals in the government derive their utility from non-pecuniary goods such as power, patronage and reputation. Possibly most government officials raise their incomes through patronage of some form.

Given this hypothesis, if the government has the same information set available as the unregulated economy and is managed by at least some non-benevolent officials, subject to their own set of constraints, it may fail to correct the market failure and may also introduce a new set of costs. Socially ideal interventions or outcomes may not be achieved as a result.

A non-benevolent government and corruption

This gains greater significance given the fact that corruption exists. In India alone, over the past five years we have seen scams coming to the fore; the CWG 2010, the 2G Spectrum Allocations, Coal Gate to name a few. Corruption in the system then emerges as a consequence of government officials using their power for personal gain and some players in the market endorsing it. In some ways a non-benevolent government has the potential to cause far more welfare loss than a monopolist. A government once formed has a monopoly over the force of coercion, which underlies every intervention, and such power, plausibly can be abused. With utility defined by non-pecuniary goods, their actions can impact societal outcomes negatively. The argument in consumer theory against tax collection has always been that it creates distortions (a deadweight loss) for society. Nevertheless one pays taxes in the belief that the government will use the collected revenue to provide necessary public goods and redistribute in the form of social sector schemes to reduce inequity. Welfare loss is exacerbated when the non- benevolent planner is the recipient of the taxpayers’ money. The scope for misuse is tremendous. The allocated resources move away from productive or equity based to rent seeking occupation. It adversely affects decisions in policy, which may no longer be governed by principles of equity, justice or efficiency. It is likely to be influenced by an interest group, who the officials may favour based on political considerations. 

One of the most damaging forms of corruption is predatory regulation. In layman terms predatory regulation can be described as a method in which the government deliberately lays down very cumbersome regulatory rules that entrepreneurs/ the private sector have to pay bribes to wheedle out of. This of course raises the cost of productive activity and reduces efficiency and pushes some players out of the market. Cronyism as a phenomenon is not unheard of and predatory regulation favours its rise. The problem is more acute when several government officials autonomously create obstacles at every level so that each individual can collect a separate bribe. This has the effect of stunting economic growth and development. In the realm of public policy, corruptionleads to situations where beneficiaries of schemes are handpicked and the officials handing out the benefits receive some kickbacks. Public policy thereby suffers from several lacunae and fails to provide support on a need basis for alleviation.

Laffont (2000) offers any reader of development economic theory solace by stating that corruption is an endogenous phenomenon of society and zero corruption is observed nowhere. He suggests rather ironically that since it is observed nowhere, zero corruption is perhaps not optimal. He argues that as an economy continues to develop, new and complex systems and institutions are added, which open up more avenues for corruption. His inverted U shape hypothesis is: As an economy develops, opportunities for corruption increase, peak at a point and then begin to decline as an economy continues to develop further. He acknowledges that this relationship between corruption and development is only feasible if the government is benevolent. 

One can extend this argument to include a government, which is primarily governed by self-interest. Presumably one of the goals of the political class is to get re-elected. As a country develops and more people are educated: there is a possibility that democracy will function the way it was visualized. Potentially, the people could direct the government towards making socially optimal decisions by holding them accountable for the policy decisions they take. Irrespective of the nature of the government (benevolent or governed by self interest), one could alter the constraints a government functions within to include consequences for not moving towards socially optimal schemes or results. It would be in their best interest that they put in place better deterrents for corruption even for the non-elected officials. An optimistic view hopes that then the opportunity cost of fighting corruption will decrease, given this new set of considerations.

References:

Hindriks, Jean, and Gareth D Myles. Intermediate Public Economics.The MIT Press, 2006

Niskanen, William. "The Peculiar Economics of Bureaucracy." The American Economic Review, 1968

Laffont, J.J. ,Incentives and Political Economy, Oxford University Press,  2000