G401 October 12, 1998 Professor Rasmusen, Erasmuse@Indiana.edu NOTES ON GOVERNMENT FAILURE These notes summarize ideas that we have talked about in various class sessions. Suppose Congress is thinking of passing a new law affecting a business. How should we think about the new law? From the viewpoint of the public good, the big question is: IS THE LAW EFFICIENT? which means: Does it help the winners from the change more than it hurts the losers? Even if the law is inefficient, it might still be desirable. A law against abortion, for example, would put abortion clinics out of business, and in easily measurable dollar terms might appear inefficient. The real issues in abortion, however, are not how it affects business, consumers, or workers. From the viewpoint of a business, the big question is WILL THE LAW HELP MY COMPANY? Whether an executive should support a law (e.g., sugar import quotas) which helps his company but hurts the public more is a good and hard ethical question. But he should certainly be cognizant of the law's effect. Whether a law will increase efficiency depends first on whether there is MARKET FAILURE. If there is not, no law is needed. If there is, then a law COULD be helpful, but might still be a bad idea because of GOVERNMENT FAILURE. Government failure occurs when the government does things that reduce efficiency. This may be because of incompetence, an example of MORAL HAZARD. Government workers include elected officials and civil servants. Elected officials are not monitored as carefully as business administrators, since voters are a distant boss, and so they have less incentive to find the best policies. Civil servants are monitored by the elected officials (a problem in itself, given the lack of incentive for the elected officials to exert monitoring effort), but what is more important is that `company policy` makes it difficult to punish them for poor performance. We have rigid civil service rules on purpose, however, to prevent abusive firings and demotions by the elected officials. It is worth reducing the incentives for hard work to reduce the amount of politics in government offices. There is a tradeoff between politicians being able to fire incompetent workers and politicians being able to fire workers because of their political views. Incompetence, however, is not the only problem, or perhaps the main problem. Rather, much of government failure arises because some people pay more attention to what government is doing than others do. If you see a new law, or a need for a new law because of market failure, and wonder whether government failure is likely, ask the following questions: 1. Is it easy to see who is hurt and who is helped by the law? If it is not, then politicians will not have the right incentives. 2. Are the benefits concentrated and the costs diffused? (or vice versa) If the benefits are concentrated, the beneficiaries have a strong incentive to lobby for the law. Even if it is inefficient, it may well be passed. 3. Are the benefits short-term and the costs long-term? Politicians are elected for the short-term--- even the 6-year term of senators is not very long. Thus, they are tempted to go for short-term gains. All this is not to say that politicians and bureaucrats are bad people. Any person will respond to the incentives provided them. Politicians, however, have a special problem. If a politician votes only for efficient laws, but the conditions for government failure are present, he will not last long in office. Voters will not understand that the law is efficient, the businesses on whom the costs are concentrated will work hard to defeat him, and nobody will see the benefits of the law until years after he has left office. It's ok to blame some politicians, but blame the system too. Campaign finance reform hopes to reduce the amount of government failure. Reform is very difficult, however, because the three features listed above are inherent to any government action. The basic problem is the FREE RIDER PROBLEM: that for public goods the benefits are diffused by definition, and each voter would like the get the benefit without doing the work of learning about politics.