Evolution of Market and Governmental Allocation in Society
Society's method of allocating scarce resources has evolved over time, transitioning from communal to hierarchical structures. Historical developments show the role of government in shaping market systems and the shift towards wage labor. The balance between market economy and government intervention continues to adapt to address economic disparities.
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MARKETS VERSUS GOVERNMENTAL ALLOCATION Normative Discussions
Historical Synopsis Our historical treatment of government and the economy should have produced the understanding that the market economy is not the only means of allocating the scarce goods and resources of society. Indeed, in order for exchange and accumulation to occur in the first place, it was necessary for government to exist and establish the parameters of exchange. Indeed, market allocation systems such as we have today were preceded by other types of systems. Allocation by Tradition Allocation by Hierarchy Combinations of Tradition and Hierarchy Fully developed market allocation systems only developed with the industrial revolution in the early 19thcentury.
We can view the method of allocating scarce resources of a society as evolving through time. It has been a social learning process, and one that is ongoing. Adam Smith was not the beginning and the end of understanding. Prior to the development of nation-states there was only the community, either clans, tribes, or other local units. Nation states evolved over time. The claim to power was often religious. Prior to the 18thcentury the only large organizations were the church and the state. The church and the state discouraged the development of large organizations that would compete for power. Power centers in Europe and elsewhere continued to discourage the development of large organizations that would compete for power. However, a weak national government in the U.S. was unable or unwilling to discourage the development of large organizations.
At the beginning of the 19thcentury in the U.S. and elsewhere most exchange was local and most production was agricultural. Most production was for home consumption; what little surplus there was was sold in market towns. Elites in the American colonies turned states could only grow in economic power by developing large economic organizations to support their desire to accumulate surplus and extract resources from society. They kept government weak through most of the 19thcentury to enable the development of elite economic power. By the latter part of the 19thcentury the economy had become less communal and more hierarchical. There were no companies employing more than 1000 employees in 1787. By 1900 there were many. Now large companies and corporations are the dominant mode of employment. Where in 1787 there was very little wage labor, in 2009 virtually everyone works in wage labor.
What has been dubbed by sociologists as wage slavery has evolved. In the 18thand 19thcenturies the idea of selling one s labor was viewed as a detestable practice. The ideas of freedom and liberty meant that one should work for ones self, rather than sell one s labor to a business or elite. Indeed, this was the basis of Jeffersonian ideals, and early partisanship. Obviously, now America is fully inculcated in the tradition of wage slavery . We do it so routinely that it is done without thinking or question. Governments have become increasingly involved in market economies to adjust anomalies resulting from the increasingly hierarchical nature of the American economy. Government has increasingly become a counter balance to market hierarchy. The modern economy is not characterized by the ideal of pure market competition depicted by Adam Smith in the Wealth of Nations. Rather, it is characterized by economic hierarchy.
What Hierarchies? --Large economic organizations relative to workers. --Large economic organizations relative to communities. --Large economic organizations relative to production chains. Monopoly, pricing. --Large economic organizations relative to small economic organizations. --Large economic organizations relative to government. All participants in these hierarchies are driven by self-interest. Large and small economic organizations want higher profits. Workers want higher wages. The community wants economic growth. Intervention in economic hierarchies is made possible in the U.S. by popular government. We intervene in markets for a variety of reasons we discussed earlier.
The overarching question facing citizens and what divides the political parties is how much intervention should there be? The answer is often based on blind unthinking ideology. Another matter that separates partisans concerns what level of our government should be used to intervene in markets?
Which Level of Government is Appropriate for Implementing Particular Policies? An often suggested approach, often grounded in partisan ideology, is that many federal roles (welfare, health care, environmental regulation, etc.) should be devolved to the states and localities. Republicans favor/Democrats oppose. The argument typically is that states and localities are closer to the people, so the people s preferences are better honored by local officials. States and localities are also closer to most problems, so they may have more knowledge in solving problems, relative to the so-called federal bunglers . While these arguments may seem compelling, they are again ideological, and not rooted in a rational analysis of the incentives and constraints facing federal, state, and local governments. Paul Peterson in City Limits offered an economic theory for which level of government is best equipped to handle different types of policies (based on the Tiebout thesis of economic incentives and constraints). Peterson defined three policy types: Allocative, Developmental, and Redistributive.
Allocative Policies are those policies distributing benefits to everyone in the community, regardless of income or wealth level. Examples: police and fire protection, garbage collection, sewer systems, water systems, public electric utilities, etc. Developmental Policies are those policies aimed at enhancing the well-being of everyone in the community by promoting economic development. Examples: highway construction, transportation systems, rivers and harbors management, public education, public hospitals, subsidies to attract businesses, etc. Redistributive Policies are those policies which shift resources from one group to another. Typically, they are targeted toward disadvantaged segments of society such as the poor, the disabled, the elderly, or those who are somehow weaker than other members of the community. Many regulatory policies are also considered redistributive in nature in that they shift economic advantage between segments of society. Examples: Welfare spending, disability benefits, publicly provided health care, air pollution regulation, worker safety regulation, consumer product safety regulation, etc. The three levels of the Federal system are each uniquely equipped, based on their economic incentives and constraints, to manage each policy type.
AllocativePolicies Localities have the strongest economic incentive to provide efficient goods and services to citizens. This is because of the ever-present threat of people voting with their feet. See Albert Hirschman s Exit, Voice, and Loyalty. If localities are inefficient in satisfying citizen preferences, then people leave. If people leave, then local tax revenue declines, and along with that comes a local inability to provide services to those who remain. Strong incentive for local efficiency. For example, White flight and upper income exit from the inner cities to the suburbs in the 1950s and 1960s left the inner cities unable to provide basic infrastructure and services. Not based on efficiency, but other factors. Inner cities crumbled, leaving mostly under-served low-income citizens. Facing the continuing threat of exit, large cities became more efficient, slowing or halting the exits. A similar phenomenon has occurred more generally across localities nationally, but along different dimensions. See for example, Gary Miller s book Cities by Contract, which is a study of the many localities in California that arose to satisfy local citizen preferences for different levels of taxation and services. If people were unsatisfied with their taxes or services, then they could easily move to a different locale. Many new incorporated cities arose in response to these economic incentives.
All of this implies that localities are best equipped to provide police protection, garbage collection, sewer systems, water systems, public electric utilities, etc. And, they have a strong incentive to provide these efficiently (to keep taxes low) and to satisfy citizen preferences. CONCLUSION: LOCALITIES ARE BY FAR THE BEST LEVEL OF GOVERNMENT TO MANAGE ALLOCATIVE POLICIES.
Developmental Policies Developmental policies are best promoted by the states, relative to the federal and local governments. States face no race to the bottom (the Tiebout thesis explained below) with developmental policies. Indeed, they face a race to the top. Competition to provide the best possible infrastructure gives states a strong incentive to compete with other states in developing highways, transportation systems, public education systems, subsidies to attract business, etc. And, this is healthy. States can increase their tax revenue through these means, and provide greater benefits to all of their citizens. States also have more access to revenue than localities. They often receive federal revenues in the form of block grants, and can also tax the same base as localities. CONCLUSION: DEVELOPMENTAL POLICIES ARE BEST PURSUED BY STATE GOVERNMENTS.
Redistributive Policies States and localities are constrained by an overriding necessity to improve their market position (relative to other states and localities), while having few resources at their disposal for the enactment of redistributive policies. Economically, states and localities must attract business in order to maintain jobs, capital investment, and tax revenue. In order to do so, they compete with other states and cities for favorable tax climates, favorable regulatory climates, and other incentives conducive to state and local economic expansion. Thus, they face economic constraints when taxing, regulating, and redistributing. Tiebout calls this conundrum the race to the bottom. Economic competition among states produces an inability to provide certain types of policies. If states and localities were to be solely responsible for redistribution and regulation, then there would be little because they face economic and political constraints. This is similar to our earlier argument about the tragedy of the commons. Without cooperation, the economic self-interest (of states, localities, and the interest groups therein) will drive behavior and everyone will be made worse off.
Such conditions existed in the 19thCentury in the absence of federal involvement. Politically, states and localities face powerful interest groups (business, industry, labor unions, etc.) advocating for low taxes, little regulation, etc. And these groups power generally outweighs the influence of those representing the disadvantaged and larger public. In other words, there are strong state and local incentives to not regulate or redistribute. CONCLUSION: THE FEDERAL GOVERNMENT IS BEST EQUIPPED FOR ACCOMPLISHING REGULATORY AND REDISTRIBUTIVE ENDS.
All of these arguments are normative, but grounded in economic analysis, rather than ideology. There is an empirical regularity here too that validates Peterson s argument. Most responsibility for allocative policies is local; most responsibility for developmental policies is at the state level; and most redistributive policies are primarily federal. For many policies there is also a cooperative aspect, likely due to partisan bargains. Examples: Welfare (TANF) is a joint federal/state program. Food Stamps (SNAP) is a purely federal program, but with state offices for distribution. Does the shared welfare program responsibility explain why state welfare spending as a percent of state GDP is higher in Northeastern states than in Southern states? Yet, food stamps allocations are about equal across states based on income. Highway spending is also a joint federal/state program. Yet, there is no significant difference between Northeastern and Southern states in what states devote toward transportation. Spending on water and sewer systems is heavily subsidized by the federal government. The quality of these systems is pretty uniform across all cities in the nation.
Supply and Demand Conditions for Governmental Allocation We may think of political, as opposed to market, allocation systems as having similar sorts of demand/supply conditions as markets. In political allocation systems: 1) Demand occurs at a more aggregate level than for markets. Citizens, voters, political parties, interest groups, and other aggregates do the demanding. 2) Supply also occurs at a more aggregate level than for markets. Politicians, legislators, executives, bureaucracies, government contractors, and other public organizations do the supplying. 3) Demand is not a simplistic function of price, any more than demand is simply a function of price in standard economic analyses. Rather, it is a complex function of many factors.
The Demand Determinants (from our earlier economic analysis): Di=f(Y, T, P, X, M, I, G, Q, F, R) where: Di=Demand for the ithGovernmental Activity Y=National Income T=Tax Rate P=Price of Governmental Product or Service X=Perceived Externalities M=Degree of Monopoly or Increasing Returns I=Perceived Market Imperfections G=Perceived Need for Pure Public Goods Q=Perceived Inequities F=Perceived Unfairness or Undesirability of Market Outcome R=Rent Seeking Behavior of Economic Entities
The Supply Determinants: Si=f(Y, T, P, A, E, V) where: Si=Supply of the ithgovernmental activity Y=National Income T=Tax Rate P=Price of Governmental Product or Service A=Accuracy of Measurement of the Product or Service E=Exclusivity of Government Production V=Variance in Input/Output Relations Associated with Product or Service Technology Given these supply and demand conditions we expect an equilibrium to develop between supply and demand for governmental production and services.
Rationale for Rejecting Governmental Allocation Systems 1) Market allocation systems generally provide greater freedom of choice. 2) Market allocation systems are generally more efficient than systems with government intervention or government provision. Indeed, governmental allocation systems are never Pareto efficient because of the high level of aggregation at which demand occurs. In a perfectly functioning market allocation system each individual selects how much of a commodity to purchase. Such systems are often Pareto efficient because individual choices are satisfied. Few are made worse off by the market equilibrium. However, in democratic allocation systems, the collectivity selects how much of a commodity to purchase. Such systems are never Pareto efficient because the minority s preferences are ALWAYS violated by the majoritarian equilibrium.
For example, majoritarian demand for policies such as national defense, environmental protection, consumer protection, antitrust, highway programs, etc. imply that there is still a minority who might oppose such programs. Yet those who oppose these programs pay taxes, and have their taxes going for things they do not prefer. This implies a loss of Pareto efficiency, because someone is made worse off by paying taxes for things they don t want, i.e., the democratic equilibrium solution. More generally, centralized taxation (whether federal, state, or local) always implies a loss of choice and liberty over how to spend a portion of one s income. So by definition, all governmental programs that are supported by taxation imply a loss of Pareto efficiency and an absence of choice for some segment of the community.
3) Governmental output is often difficult to measure. This is inherent to governmental allocation systems because of the nature of the problems that government is called upon to solve. The more difficult it is to measure, the more difficult it is to know whether governmental action is efficient or successful. Governmental action may, therefore, result in an endless quagmire. 4) Governmental technologies for product and service provision may be uncertain due to the nature of problems taken on by public actors. We may not know how to address or solve the problem. Therefore the time may not be ripe for governmental intervention.
5) Movement to an democratic equilibrium is generally stickier than movement to a market equilibrium. Because demand is at a more aggregate level, and because (uniquely) U.S. political institutions are designed for inaction, rather than action, it may take some time for preferences to percolate upward through the system to create action. Therefore, there may be substantial periods when demand is out of kilter with supply. 6) Movement away from or to a new equilibrium is also generally stickier than movement to a market equilibrium. Because supply is at a more aggregate level, and because U.S. political institutions are designed for inaction, rather than action, it may take some time for producers to respond to changing demand. Here we argue that government programs may be inertial. Therefore, there may be substantial periods when supply is out of kilter with demand.
7) Supply in a government oriented system may sometimes reflect the self- interest of providers. That is, politicians and bureaucrats may have their own motivations which may or may not coincide with those of demanders (citizens, voters, political parties, interest groups, etc.). These motivations of governmental actors may either increase or decrease supply. Over the long term the supply may not perfectly correspond with actual demand. Note that this is no different than in a market oriented system. Note that this is not an overall critique. Many bureaucrats are good people who put the self interest of their clients first. However, it can happen. 8) Governmental provision is typically through a monopoly, which may or may not be more efficient than private provision. Economies of scale versus competition effects. The alternative is privatization and contracting. Yet, there are serious principal-agent problems with contracting that are not present in a purely governmental system. Hence, governmental allocation systems may be more efficient than those involving privatization. An empirical question. See Charles Wolfe, Markets or Governments, Choosing between Imperfect Alternatives.
9) Unlike market systems where quantity supplied and cost of production are directly related to revenues and profits, there is a disjuncture between quantity supplied, costs, and revenues in governmental allocation systems. In a private system Revenue=Price*Quantity Supplied. Profits=Revenue-Costs. However, in a public system revenue is provided in a lump sum for provision of products and services. They do not depend critically on quantity supplied. This may result in static inefficiency in the various forms. While there are no profits in a public allocation system, there may be slack resources. Slack resources would be calculated Slack=Revenues-Costs. Costs are difficult to measure for some outputs. Slack resources may be used to promote dynamic efficiency, they may be used to return dividends to taxpayers, or they may be considered waste . In a perfectly operating governmental allocation system there are no profits or slack resources, implying the potential for reduced costs and price.
10) Internalities sometimes develop that move bureaucracies away from original goals. Example: Goal displacement. This may be either good or bad. It may be bad to the extent that the original goals are desirable. It may be good to the extent that bureaucracies should be adaptable to changing preferences and task requirements. 11) Derived externalities occur when there are unanticipated consequences to government intervention. As with market externalities, derived externalities can either be negative or positive. For example, regulation of illegal drugs may lead to increased crime and black market activities. This negative consequence was not intended. Conversely, environmental regulation has led to the development of a massive industry that serves environmental protection. Air pollution scrubbers and other technologies; water purification technologies, etc. This is a major positive for the economy. Thus, derived externalities may make government action more or less efficient from the standpoint of the entire society.
12) Governmental action or inaction may produce inequities. Rent seeking activities can perpetuate the self interest of private actors through public means. Rent seeking refers to private actors using the apparatus of government to their own advantage. For example, some would argue that regulation creates barriers to entry and is a form of rent-seeking by regulated industries. Similarly, the granting of a license is also a form of rent seeking. One could also argue that it was rent-seeking behavior by the Founders that led to our Constitution. They sought to protect and expand their wealth through the design of the new government and its policies.
Final Overview of the Arguments As a democratic polity we are sovereign over markets. Because America is a system governed by majoritarian principles, we have a right to override and reject the market allocation and substitute a governmental allocation. Governmental allocations are generally (though not always) the legitimate outcome of democratic processes. However, in choosing between the market allocation and democratic allocation we should probably weigh the earlier considerations concerning the disadvantages of the market allocation versus the disadvantages of the governmental allocation presented in this section. In making these calculations, we don t have to adhere rigidly to a set of rules. Indeed, as a sovereign polity we don t have to consider them at all. However, prudence suggests that we should.
The Socratic Paradox Plato described an interaction with his wise teacher, Socrates, in The Apology. He said that Socrates told him that the beginning of knowledge is understanding: ONE THING ONLY I KNOW, AND THAT IS THAT I KNOW NOTHING. What did Socrates mean???? Food for thought that I hope you will carry from this course.
