Chapter 4: Economic theory 1: State intervention

1. Barr: Economics of the Welfare State: 4e Chapter 4: Economic theory 1: State intervention

2. Organization of the chapter 1. The formal structure of the problem 2. Why economic efficiency is one of the aims of policy 3. Intervention for reasons of efficiency 4. Intervention for reasons of social justice 5. Public choice and government failure 6. From theory towards policy: The issue of privatization 7. Conclusion: Economic and political theory

3. 1 The formal structure of the problem The objective: maximize welfare Subject to the constraints of • Tastes • Technology • Available resources

4. 2 Why economic efficiency is one of the aims of policy

5. 2.1 The concept of efficiency Cost/benefit MSC MSV Q* Quantity

6. 2.2 The relevance of efficiency to different theories of society • The concept of Pareto efficiency is not value free, its values apply widely • Welfare is increased in all theories of society by a movement from off the contract curve to a subset of points on it • All first-best socially just distributions are also Pareto efficient

7. 3 Intervention for reasons of efficiency

8. 3.1 Types of intervention • Regulation • Tax/subsidy • Public production • Income transfers

9. 3.2 The assumptions under which markets are efficient • Perfect competition • Complete markets • No market failures • No externalities • No public goods • No increasing returns to scale • Perfect information • about quality • about price • about the future

10. Rational choice in the simple Fisher model Consumption when older b d e a Consumption b when younger

11. 3 State intervention for reasons of efficiency Consumer choice is more useful • The better is consumer information; • The more cheaply and effectively it can be improved; • The easier it is for consumers to understand available information; • The lower are the costs of choosing badly; • The more diverse are consumer tastes

12. Examples • Food • Health care

13. 4 Intervention for reasons of social justice

14. 4.1 Why does redistribution occur? • Coerced redistribution (‘coercion via the ballot box’) • Marxist views • Voluntary redistribution: charity and the free-rider problem • Voluntary redistribution in a 2-person world • Compulsory redistribution in an n-person world

15. 4.2 Redistribution in cash or kind? • Economic arguments: market failure • Political economy arguments: merit goods

16. 4.3 Horizontal equity • Minimum standards • Equal access • Equality of opportunity

17. 4.4 Is there enough redistribution? • Libertarians say there is too much • Socialists say there is too little • Rawlsians generally say there is too little • Utilitarians give an equivocal answer

18. 5 Public choice and government failure Governments may fail to be fully effective for various reasons • Electoral pressures • Limited control of the bureaucracy • Improper motivation (e.g. corruption) • Lack of capacity • Incompetence • Limited information • Limited control over private responses to its actions

19. Failures connected with the political process • Direct democracy: the median voter theorem • Depends on single-peaked preferences • Depends on direct democracy (i.e. voting over a single issue) • The ‘tyranny of the ballot box’ • Representative democracy • The influence of the electorate • The influence of politicians/government • The influence of bureaucrats

20. Failures connected with the bureaucratic process • Motive 1: the social interest • Motive 2: bureaucratic self-interest

21. The middle class and the welfare state • Suppose that ‘rich’ person receives benefit BR, and ‘poor’ person benefit BP • Is this a problem? • Efficiency: BR/BP >1 could be correct • Poverty relief: BR/BP should be < 1 • Social solidarity: BR/BP should tend to 1

22. 6 From theory towards policy: The issue of privatization • Privatization is a more complicated concept than is often realised • Its various dimensions are illustrated by a series of questions • Who produces the commodity? • Who finances it? • Who decides on total production? • Who decides how much each person will consume?

23. 7 Conclusion: Economic and political theory

24. 7.1 The borderlines between government and markets No easy answer: market failure as a counter-point to government failure

25. 7.2 Achieving policy aims: A liberal view • Distinguish (a) aims from (b) methods • Note that these arguments about public versus private institutions are largely technical, rather than ideological

26. Two propositions • If the standard assumptions hold, market allocation will be efficient; in this case social justice should generally be pursued via income transfers (e.g. so that poor people can buy food at market prices) • Suppose that the standard assumptions fail in ways that justify public production and allocation on efficiency grounds; social justice may then appropriately be pursued through transfers in kind (e.g. free school education)