Few societies and economists believe that the “magic of markets” should apply to everything.
That’s why things like body parts, human babies and public education can’t be bought and sold. When markets cannot (or should not) effectively manage a particular aspect of society, the government often steps in.
Welcome to the 12th week of Econ 101. We’ve reached the final chapter of the Core Econ textbook “Economy, Society, and Public Policy,” which explores the government’s role in the economy. Government spending and operations — from public services to war — contribute to the economy just as the work, investment and consumption behavior of individuals, families and companies do.
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Key Takeaways
Markets work well when prices tell us something meaningful about the real scarcity or abundance of goods and services and influence people’s behavior accordingly. But when that doesn’t happen, it indicates markets have failed.
That’s where governments can step in to address the problems that relate to inefficiency or unfairness. We dipped into some of that last week.
But the textbook emphasizes that “for a government to be a successful problem solver, it must be powerful enough to potentially be a problem itself.” When decision-makers in government — policymakers, military leaders and judges — choose to further their own interests at the expense of the consumer or citizen, it can lead to “government failure.”
Economists use a simplified model of government to see how the level of political competition will impact the extent to which leaders serve the public interest over their own. It is similar to an economic model from an earlier chapter that shows how competition between firms influences the markup they can charge customers and as a result, the profits they can earn.
On the one extreme, we have dictators, who operate like “political monopolists”, but they still face limits on what they can do. Even with no political competition, they are still expected to provide a base level of services or else they risk widespread revolt. But dictators will seek to maximize their political rent, a payment above and beyond what they could receive if they weren’t in power.
Political rents are similar to employment rents, which we learned about in a previous chapter. They are wages firms pay to motivate employees to work hard and well. One key difference is that political rents aren’t useful in the economy. They merely serve as a reward to government leaders for having power.
The tax rate a dictator sets can also influence how long he or she will stay in power. In a simplified model (see the chart above), it’s possible for a dictator to make a larger total political rent by setting a higher tax rate and ruling for less time. (The blue rectangle has a larger area than the red rectangle.)
As time is finite, the trade-off for a dictator is between the tax rate he can set, which determines his political rent, and the amount of time that he can expect to stay in power. Assuming the costs of providing public services stays constant, a dictator will be indifferent as to the length of time he stays in power and the tax rate so long as his political rent is maximized.
Put it all together and we can see that the model economists use to determine how firms will maximize profits can be applied to government leaders.
In countries that operate as democracies, a governing elite, rather than just one leader, shares power. Because they are elected to power there is greater political competition, and they are less able to set higher taxes than they would be with zero competition.
In our simple model, this means the tax rates that are feasible without losing power will be lower than they would be under a dictatorship. In a perfect or ideal democracy, no political rent would exist — just like perfect competition among firms would result in zero profits. The reality is less rosy.
Ideally, democracy gives people a say in government programs and decisions through elections, while freedom of speech and a system of checks and balances limit what the government can force people to do. Indeed, there is widespread, ongoing debate about what policies governments should adopt and how far they should go. And it’s not only about money. During the COVID-19 pandemic, for instance, how much control the government should wield over our everyday lives and activities was the subject of vigorous debate.
It’s important to remember that even problems of efficiency and fairness — in real or perceived terms — can persist regardless of popular opinion or the level of political competition. The textbook gives as an example the fact that both rich and poor Americans who were surveyed in 2005 said they believed wealth should be more evenly distributed in society. However, U.S. tax policy has continued to favor wealthier individuals since then.
Important definitions
- Feasibility of economic policies: A government policy will only solve inefficiency or unfairness if it meets three criteria:
- It must be “economically feasible,” meaning the proposed policy works or results in the intended outcome.
- It must be “administratively feasible,” meaning the government has the capacity to implement it.
- It must be “politically feasible,” meaning capable of being implemented given the existing political institutions.
- Fiscal capacity: The ability of a government to impose and collect substantial taxes from a population at low administrative and other costs. One measure of this is the amount collected divided by the cost of administering the tax system.
David Brancaccio’s thoughts on Chapter 12
The price of crude oil dropped below zero for the first time ever in 2020, meaning that firms were willing to pay to get rid of the stuff. At the time, I got to thinking about what else you’d have to pay me to buy. Tickets to a Nickelback concert. Radishes.
Though repugnant to me, neither of these is an example of what economists in this chapter would call a “repugnant market.” The term doesn’t cover what I think is gross — it’s what society won’t tolerate. Repugnant markets are types of commerce we cannot abide because they violate human dignity or social norms, undermine valued institutions or just seem unfair. You could, for instance, sell and buy votes for public office. That’s a repugnant market.
In a chapter about government’s role in the economy, one of its functions would be preventing black markets from developing in spaces where monetary transactions would be offensive. Were it not for government rules, the COVID-19 pandemic could give rise to black markets.
The counterpart to repugnant markets is a concept known as merit goods. These are things so important to all of us that the government figures out how to provide them, like education or firefighting crews. A new merit good in these times is COVID-19 testing, which society believes should be available to all.
Highlighted: I always say politics is the process of assigning resources. This chapter has a sharper quote on that subject from legendary economist Joseph Schumpeter. He said a government budget is the “skeleton of the state stripped of all misleading ideologies.” That reminded me of an interview we did with Syra Madad, a senior New York City public health official who’d written about how money was running out for a program aimed at helping U.S. states fight the next pandemic.
Madad’s column wasn’t ideological, it came from a place of honest concern. But her timing was prescient; the piece ran on Dec. 27, 2019. Four days later, government officials in Wuhan, China, first reported that doctors were treating dozens of cases of a “pneumonia-like illness.”
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