Markets and Politicians. Politicized economic choice

Transcription

1 Markets and Politicians Politicized economic choice

2 STUDIES IN PUBLIC CHOICE Series Editor: Gordon Tullock University of Arizona Tucson, Arizona, USA Previously published books in this series: Bowman, Mary Jean Collective Choice in Education Buchanan, James M. and Wagner, Richard E. Fiscal Responsibility in Constitutional Democracy McKenzie, Richard B. The Political Economy of the Educational Process Auster, Richard D. and Silver, Morris The State as a Firm Kau, James D. and Rubin, Paul H. Congressmen, Constituents, and Contributors: The Determinants of Roll Call Voting in the House of Representatives Ordeshook, Peter and Shepsle, Kenneth Political Equilibrium Tullock, Gordon The Economics of Special Privilege and Rent Seeking The intersection of economics and politics is one of the most important areas of modern social science. "Studies in Public Choice" is devoted to a particularly crucial aspect of this intersection -- the use of economic methods and analysis on matters which are traditionally political in nature. Prominent scholars, such as Duncan Black, Kenneth Arrow, Mancus Olson, Vincent Ostrom, William Riker, and James Buchanan, have contributed to the development of the study of public choice. The aim of this series is to promote the growth of knowledge in this important and fascinating field.

3 Markets and Politicians Politicized economic choice Edited by Arye L. Hillman Bar-Ilan University, Israel Springer Science+Business Media, LLC

4 Library of Conllress Cataloginll-in-PubUcation Data Markets and politicians : politicized economic choice I edited by Arye L. Hillman. p. cm. - (Studies in public choice) ISBN ISBN (ebook) DOI / Economic policy. 2. Politicians. 3. Social choice. I. Hillman, Arye L. II. Series. HD87.M dc CIP Copyright 1991 by Springer Sciclllce+Buain_ Media New York Originally published by KIuwer AI:adcmic Publishen in 1991 Sofh:over reprint or1he Iwdeover Ist edition 1991 Ali rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher, Springer Science+Business Media, LLC Printed an acid-free paper.

5 CONTENTS CONTRIBUTING AUTHORS INTRODUCTION vii xi I: ECONOMIC POLICIES AND POLITICAL MOTIVES A. Theoretical Perspectives 1. Economic policies and political competition 1 Heinrich W. Ursprung 2. Voluntary collective action 27 Joel M. Guttman 3. Factor income taxation in a representative democracy 43 Wolfgang Mayer and Jun Li B. Policy Choices 4. Macroeconomic stabilization policy: Does politics matter? 63 Martin Paldam 5. Accidental freedom 93 Gordon Tullock 6. Europe 1992: From the common to the single market 113 Peter Holmes II: MARKETS AND SOCIALISM A. Market Socialism in Eastern Europe 7. Markets and ownership in socialist countries in transition 137 Manuel Hinds 8. Socialism in less than one country 169 Adi Schnytzer B. Transitionary Policies 9. Restoring property rights 179 Marton Tardos 10. Liberalization dilemmas 189 Arye L. Hillman C. Economic Change in China 11. The failure of recentralization in China: Interplays among enterprises, local governments, and the center 209 Kang Chen 12. Market-oriented reform and fiscal policy 231 Mario I. Blejer and GytJrgy Szapary

6 vi Markets and Politicians III: INTERNATIONAL ECONOMIC POLICY A. International Trade 13. The political-economy perspective on trade policy 263 Robert E. Baldwin 14. The economics and political economy of managed trade 283 Wilfred J. Ethier 15. Changes in trade-policy regimes 307 James H. Cassing B. International Monetary Transactions 16. Foreign-exchange markets and central-bank intervention 319 Manfred Gl1rtner 17. The political economy of the international debt crisis 339 Ngo Van Long 18. Foreign-exchange market liberalization: Anatomy of a failure 357 Ben-Zion Zilberfarb

7 CONTRIBUTING AUTHORS Robert E. Baldwin, University of Wisconsin, U.S.A. Mario I. Blejer, International Monetary Fund, Washington, D.C. James H. Cassing, University of Pittsburgh, U.S.A. Kang Chen, The World Bank, Washington, D.C. Wilfred J. Ethier, University of Pennsylvania, U.S.A. Manfred Gartner, St. Gallen School of Economics, Switzerland Joel M. Guttman, Bar-Han University, Israel Arye L. Hillman, Bar-Han University, Israel Manuel Hinds, The World Bank, Washington, D.C. Peter Holmes, University of Sussex, U.K. Ngo Van Long, McGill University, Canada Jun Li, University of Cincinnati, U.S.A. Wolfgang Mayer, University of Cincinnati, U.S.A. Martin Paldam, Aarhus University, Denmark Adi Schnytzer, Bar-Han University, Israel Gyorgy Szap<1ry, International Monetary Fund, Washington, D.C. Marton Tardos, Hungarian Academy of Sciences Gordon Tullock, University of Arizona, U.S.A. Heinrich W. Ursprung, University of Konstanz, FRG Ben-Zion Zilberfarb, Bar-Ilan University, Israel

8 ACKNOWLEDGEMENTS Many of the papers in this volume were presented at the Bar-Ilan Conference on Markets and Politicians at Bar Ilan University, Israel, in June Joel Guttman was co-organizer of the conference, and Gershon Alperovitch as departmental chairman was also instrumental in organization.

9 INTRODUCTION Arye L. Hillman There has been much economic theorizing directed at providing the politician with guidance in the design of policies that will amend market outcomes in ways that achieve specified efficiency or equity objectives. It has been common practice in economic models to portray the politician who implements the policy recommendations as a mechanistic individual who behaves as would a benevolent dictator to maximize a prespecified conception of social welfare or the utility of a representative consumer. The self-interest and discretion that is attributed to firms and consumers as optimizing agents is absent from the motives of such a politician. Economic policy choice is thereby depoliticized. How well depoliticized economic theory fares in explaining or predicting economic policy choice depends naturally enough upon how politicized is the economic system in which economic and political agents function. The papers in this volume recognize that politicians may exercise sufficient discretion so as not to behave mechanistically in correcting market inefficiencies or in pursuit of a somehow specified just income distribution. Since politicians are viewed as self-interested optimizing agents, just as are utility-maximizing consumers and profit-maximizing producers, the choice of economic policies is politicized. Coverage is provided of a broad spectrum of economic policy choice where markets and politicians interact. Section I is concerned with policy determination in western market economies, Section II with the introduction of markets into economies in transition from socialism, and Section III with international transactions. Heinrich Ursprung (Chapter 1, Economic policy and political competition) begins by reviewing how in past literature political influences on policy choice have been integrated into models of representative democracy. The role of political competition in the determination of economic policies is developed in a model of contenders for elective office

10 xii Markets and Politicians who make policy pronouncements to maximize the value of their campaign contributions relative to contributions received by opponents, and thereby maximize their probabilities of election. The model encompasses recognition of the public-good nature of the economic benefits and costs associated with candidates' policies. The preferences of voters, or the median voter, do not here directly determine policy outcomes, which are responsive to campaign contributions. The campaign contributions in turn are sought to influence voters' perceptions of the attractiveness of the candidates and the policies they propose. Joel Guttman (Chapter 2, Voluntary collective action) compares explanations for the observed conjunction of cooperation and self-interest in individuals' collective behavior. Such collective behavior is central to the activities of political coalitions of individuals seeking to achieve common economic objectives. Wolfgang Mayer and Jun Li (Chapter 3, Factor income taxation in a representative democracy) demonstrate how individual interests are reflected in political choice of taxes levied on factors of production, when individuals differ with regard to the tax system that they regard as optimal and seek different patterns of expenditures of tax proceeds. Martin Paldam (Chapter 4, Macroeconomic stabilization policy: Does politics matter?) looks at macroeconomic policy. A literature on "political business cycles" has proposed that macroeconomic policies are subject to political manipulation that is directed at maximizing probabilities of reelection of incumbent governments. Two types of business cycles have been described, election cycles over one election period, and partisan cycles that encompass two election periods under different governments. Paldam reviews theories of the political business cycle, and presents empirical results of tests in seventeen countries. Gordon Tullock (Chapter 5, Accidental freedom) uses an historical account to make the case that economic freedom in the U.S. arose fortuitously. The U.S. did not proceed free of attempts to regulate domestic market activity and protect domestic producers. Tullock recounts how the constitutional guarantee of free trade among the states thwarted attempted state-imposed monopolies, including state socialism, and how domestic regulation of economic activity and U. S. international trade policy have been subject to different influences over time. Peter Holmes (Chapter 6, Europe 1992: From the common to the single market) sets out the political motives underlying the economic policies aimed at creating a post-1992 single European market. Since the intent of the policies underlying the post-1992 "single market" is to all intents and purposes the same as that of the Treaty of Rome that sought to establish the "common market", why should the single-market conception

11 Introduction xiii succeed when the common market was only realized in a limited way? Holmes addresses this question, demonstrating how the success of the single-market conception is predicated on political credibility. Manuel Hinds (Chapter 7, Markets and ownership in socialist countries in transition) reviews the experience of attempts to introduce markets in a socialist framework and sets out the internal contradictions that arise in such attempts. The question is whether markets can be relied upon to yield efficiency under enterprise self-management and other organizational forms in the absence of private ownership of the means of production. In the context of Eastern European reforms, Hinds considers how market price indicators replace centralized resource allocation; how financial markets function; how individual incentives influence supply responses to market prices; how incentives affect investment decisions; and how fiscal discipline is related to ownership of enterprises. Hinds makes the case that the inadequacies of decentralized market socialism derive from the absence of private ownership, and concludes that, without private property rights to capital, factor markets cannot perform their allocative roles -- so a market economy cannot be established, and paradoxically there is a need for the political allocation from which the socialist economies seek to escape. Adi Schnytzer (Chapter 8, Socialism in less than one country) expands the distinction between socialism "in one country" and "in more than one country" to the dimension of an economy in transition that does not or cannot dispense with a dominant socialist sector notwithstanding the introduction of markets to replace the planner. Schnytzer describes such an economic system and proposes that the conjunction of incentives and economic structure can trap the economy in the transitional system. With Hungarian "market socialism" as background (Hungary having abandoned central planning but not socialism in 1968), Marton Tardos (Chapter 9, Restoring property rights) evaluates various means whereby private property rights might be assigned in the transition from socialism to a western market economy. Tardos notes that market socialism in Hungary did not yield the benefits of efficiency, because of the associated property rights specification that sustained, and was sustained by, political monopoly. Privatization of socialist industry is considered via selfmanagement and assignment of rights to enterprise capital to workers; after noting past experiences in Yugoslavia, Poland, and Hungary, Tardos proposes that this scheme is best confined to theoretical models of the labor-managed firm. Under a "Personal Social Property" conception, individuals would bid for the right to manage social property. Or state property could be directly allocated to citizens without payment.

12 xiv Markets and Politicians Alternatively, management of state property could be assigned to state-regulated investment trusts, or ownership transferred to foundations, insurance companies, and pension funds. Consensus on a program is hindered by the income-distribution consequences of the different approaches to assigning property rights. My paper (Chapter 10, Liberalization dilemmas) is concerned with the policy dilemmas that arise, and also the rents that are threatened, when liberalization of international trade and domestic transactions is sought in a market economy with significant workers' collective or socialist industry and wherein preeminence is assigned to workers' job security. Israel here provide the background, although there is comparative reference to the experience of Hungarian market socialism. In private-property-rights market economies, private claims to factors of production underlie protectionist policies; but the absence of such claims does not make for liberal trade policies in "market socialist" systems. The socially conscious enterprise protects its workers from the market, and is itself protected by the state against less socially conscious cost-minimizing competitors. Two further papers deal with China. Kang Chen (Chapter 11, The failure of recentralization in China: Interplays among enterprises, local governments, and the center) recounts the role of local governments in the process of economic change in China. Local officials "captured" decision making power that via decentralization was intended to establish enterprise autonomy. The outcome has been an "aristocratic economy" ruled by "dukes" and "princes" who protect local interests, pursue regional expansion, and bear no consequences of macroeconomic instability. The changes brought about by decentralization and other reform measures reinforced one another in a manner that inhibited both recentralization and further reform. Mario Blejer and Gyorgy Szapary (Chapter 12, Market-oriented reform and fiscal policy) adopt a macroeconomic policy perspective on reform attempts in China. The focus is on the manner in which fiscal policy instruments that indirectly affect agents' economic decision making in market transactions come to replace the directives of the planner. Robert Baldwin (Chapter 13, The political-economy perspective on trade policy) begins Section III on international economic policy with a description of the approaches taken by economics and political science to incorporating political discretion into the analysis of choice of trade policies. Baldwin sets out a model that encompasses elements central to both approaches. Economic choice is expressed directly in the marketplace, and indirectly by voting and political contributions to secure desired policies. Individuals are "rationally informed" and "rationally ignorant" in

13 Introduction xv the acquisition of knowledge - they acquire the knowledge which they believe to be to their best advantage, and subject to knowledge acquisition make choices under uncertainty. This framework is applied to explaining how economic and political choice interact in the determination of international trade policy. Wilfred Ethier (Chapter 14, The economics and political economy of managed trade) pursues this theme, observing that although the benefits of free trade are almost universally acknowledged, nonetheless Western international trade has become increasingly regulated or "managed", in particular via the instrument of voluntary export restraints that circumvents GATT regulations. Ethier describes the characteristics of managed trade, and formulates models that describe the consequences of such trade in both competitive and imperfectly competitive markets. James Cassing (Chapter 15, Changes in trade-policy regimes) observes that protectionist policies may be introduced as the response to a change in comparative advantage, but when the impetus for change is reversed or disappears, the policies are nonetheless sustained. Policies therefore persist in the absence of the circumstances that gave rise to policy intervention in the first instance. In Cassing's words: "What seems curious is not so much that large shocks engender regime changes, but that the regime thus enfranchised then seems to win the day after the shock has disappeared and to persist in the very same economic environment that had previously supported an alternative policy regime". Cassing demonstrates how such hysteresis in the conduct of international trade policy can occur. Manfred Gartner (Chapter 16, Foreign-exchange markets and centralbank intervention) examines the incentives underlying intervention by central bankers in foreign exchange markets. In principle, a system of flexible exchange rates implies that exchange rates are to be market-determined. Yet in the post-bretton Woods flexible exchange-rate regime, central bankers have continued to intervene in foreign exchange markets. Gartner proposes that the behavior of central bankers can be described with reference to an optimizing objective that combines accommodation of the interests of the domestic constituency with the requirements of international agencies such as the International Monetary Fund. This implies respectively achieving purchasing-power-parity and exchange-rate smoothing. Since these objectives may be contradictory, central bankers in formulating the optimal interventionist policy may be obliged to trade off domestic goals against compliance with international guidelines for permissible exchange-rate intervention. The predictions of the model are compared with the observed behavior of a number of central banks. Literature on the international debt crisis has had a macroeconomic

14 xvi Markets and Politicians orientation and has tended to avoid direct confrontation with the question as to how individual agents' motives relate to the "crisis". Ngo Van Long (Chapter 17, The political economy of the international debt crisis) introduces self-interest motives of the agents and agencies into an analysis of the "crisis": banks which made the loans in the first instance; the debtor country governments which have the responsibility for repayment; the creditor country governments whose involvement derives from the effect that default would have on their domestic banking system; international agencies as dispensers of policy advice and intermediators; and the domestic interest groups in the debtor and creditor countries who stand to lose or gain from the different proposals for resolution of the crisis. A game-theoretic framework that incorporates discount rates and time horizons is used to analyze the interdependencies among agents' objectives and behavior. Ben-Zion Zilberfarb (Chapter 18, Foreign-exchange market liberalization: Anatomy of a failure) investigates the reasons for failure of policies directed at the liberalization of the foreign-exchange market in Israel subsequent to the change of government in The new government professed adherence to free-market principles. The underlying economic structure of the economy and precedent confined liberalization possibilities to the foreign exchange market. Zilberfarb describes how inappropriate macroeconomic policy undermined this limited liberalization program, thereby ending the free-market "economic revolution" of the new government and discrediting market-oriented change.