Public Choice (1960s – Present):

Public Choice is generally said to have started when James Buchanan and Gordon
Tullock wrote Calculus of Consent: Logical Foundations of Constitutional Democracy
(1962), which is considered one of the landmark publications in public choice. The book
focuses on positive-economic analysis as to the development of constitutional
democracy but in an ethical context of consent. The consent takes the form of a
compensation principle for making a policy change and unanimity or at least no
opposition as a point of departure for social choice.

Ultimately, we are choosing to be governed in order to solve some social problems, like
overcoming the free rider problem in the production of public goods (like rule of law).
However, we must choose how to make our collective decisions. We need to construct a
rule about what threshold of agreement the group must have before a decision can be
made (that all group members must abide by).

In selecting this threshold, we face a tradeoff between the cost of reaching an agreement
and the likelihood that people will be disappointed by the outcome.

In the extreme of unanimity – it will be very costly to get every single person in society
to agree on policy decision. It might even be impossible. However, once everyone does
agree, the likelihood that anyone will be upset with the outcome will be low.

In the other extreme of a dictatorship – it will be low cost to make the decision, the
dictator can just implement their preferred policy without consulting others. However,
this produces a high chance that lots of people will be upset with the outcome.

We generally use majority rule, which has a relatively low cost to make a decision (the
threshold can be reached easily in most cases) but there is a chance that a sizeable
minority of people will be disappointed with the result.

For very important decisions, like amending the constitution or impeaching the
President, we have a higher threshold for agreement before such an action is permitted.

What is public choice? Essentially, it’s the application of economic way of thinking to
the political decision-making process.

It assumes that

1. ALL human are self-interested regardless of the institutional context in which they are
making their decisions. We cannot assume that individuals are self-interested in their
market choices, but somehow suspend that self interest in order to promote the general
good of society when making their political choices.

This was a challenge to the traditional view of political scientists and mainstream
economists whose models assumed that government actors are benevolent and

1
omniscient and are out to implement economically efficient policies that maximize the
public’s welfare.

2. Like Austrian and Neoclassical, it adheres to methodological individualism and

assumes that only individuals choose. Political outcomes are a result of the rational
decisions of the individual political actors.

The individual becomes the fundamental unit of analysis. Public choice rejects the
construction of organic decision-making units, such as “the people,” “the community,”
or “society.” Groups do not make choices; only individuals do. The problem then
becomes how to model the ways in which the diverse and often conflicting preferences
of self-interested individuals get expressed and collated when decisions are made
collectively.

3. Like the Austrian school, Public choice focuses on the institutions that shape our
political decisions.

The outcomes of public and private choice processes differ, not because the motivations
of actors are different, but because of stark differences in the incentives and constraints
that channel the pursuit of self-interest in the two settings. The institutional settings are
different so the outcomes we observe will be different.

This means that changing the people in office is unlikely to alter the outcomes of the
political process all that much. What will change the outcome is changing the rules of
the game.

For example, most basketball games play out the same way. Changing the players
changes minor aspects of the game, but the goal is the same, the set of feasible actions is
the same, the incentives that players face are the same. If you changed a rule, such as
allowing people to travel with the ball, we would see completely different playing
strategies. It would become a different game.

4. Public choice does relax the rationality assumption a bit, in that political
decisionmakers do not have full information when making choices (not when casting a
vote at the polls, not when voting to support a bill as a member of Congress, and not
when determining new environmental regulatory standards). HOWEVER, Public Choice
economists view the lack of information itself as the result of a rational decision process.

Another way of thinking about public choice is the study of politics, without the
romance. It provides a theory of government failure, one that is analogous to the theory
of market failure. It compares the imperfect market process with the imperfect political
process.

Public choice, in other words, simply transfers the rational actor model of economic
theory to the realm of politics.

2
Method- In the beginning, it was mostly a lot of logical arguments, and description,
case studies, and very little formal mathematical modeling. Tullock called it
“understanding.” More recently, public choice economists incorporate a lot of formal
models of voting. Game theoretical models of voting and of coalition forming. A lot of
applied econometric studies (comparing the welfare results of countries with different
types of democratic political institutions). Case studies of what happens when rules
change. Lots of different methods are employed here.

View of Human Nature: not dramatically different from that of neoclassical

economics or of Austrian economics. They are closer to neoclassical economists in their
assumption (mostly because a lot of Public Choice economists were trained at University
of Chicago in rational choice theory).

• Only individuals choose- methodological individualism

• Humans are self-interested and rational in both market interactions and in political
interactions. There is no reason to believe that individuals are any more publicly
spirited in government than they are as owners of firms.
• Politics can be viewed as an exchange process.
• The only way to guarantee that the majority will not take advantage of a minority is
to hold society to the standard of unanimity… but this is costly. There is a trade off
between reducing the cost of decision making (by establishing a decision criteria that
is less than unanimity) and ensuring that we get a result that is pareto efficient (that
doesn’t improve the outcomes for some individuals at the expense of the welfare of
others).
• Political institutions play a major role in determining how people allocate their
efforts into productive, unproductive, or destructive activities.

Theory of Economic Growth:

While many public choice economists don’t explicitly focus on economic growth- they
focus on analyzing the political process, there are conclusions to be drawn.

Similar to the Austrian school (and the institutional school/new institutional school)
institutional setting will determine how people behave. So, if there are high rewards for
lobbying government for favors, they will do that instead of being productive in a
traditional sense.

The more a government is plagued by the “government failures” that we will discuss
shortly, the more likely there will be problems in terms of long run growth potential.

Creating rules that constrain the behavior of governments- to prevent them from
predating on their citizens, to discourage them from being short-sighted and
accumulating massive amounts of debt…

These things will help channel efforts towards growth enhancing activities.

3
The better the feedback between voters and decision makers, the more likely the
government will pass policies that are efficient. That is, things like federalism allow
individuals to vote with their feet and punish government actors for not providing goods
and services that are desired by their citizens, and that are worth the taxes they must
pay to receive them.

Theory of Business Cycles – They do not really have one. However, they do talk
about how political cycles influence policy decisions. We are leading up to an election
year, and incumbent politicians have a higher chance of being re-elected when the
economy looks strong. There is an incentive for politicians to try to pass policies that
improve GDP in the short run in order to increase their election chances – with
disregard for the long term implications of the policy (since voters will likely forget).

Theory of Government Failure

Like the theory of market failures that comes from neoclassical economics, there public
choice provides a theory of government failures.

First. let’s consider the different actors in a political sphere and think about what they
are trying to accomplish (goals) and how these goals might be accomplished.

Voters – customers/consumers of policy – try to vote for policies the bring them high
benefits relative to costs

Politicians – providers of policy/creators of policy – incentive is to get elected/re-

elected or else they would cease to be a politician.

Bureaucrats – carry out the day-to-day operations of government. They run all of the
agencies and departments (FDA, HUD, DOJ, DHS, all of the acronyms). They have an
incentive to maximize their budgets in order to increase their salaries and build prestige.

Voters are trying to select candidates that bring them benefits that exceed their tax bill.
We can make two assumptions about the way voters vote:

1. instrumentally – they vote according to their personal costs and benefits. or they vote
This requires you to have knowledge about the policies each candidate plans to support
as well as their expected costs and benefits to you.

2. expressively- they vote signal to others that they are a good person, or that they are a
member of the red team vs. the blue team. This requires no information.

The costs of voting include gathering information about all of the candidates to make
sure you know who they are, what they stand for, and what that can mean fo

4
Lets also consider how decision making in the political realm might differ
from decision making in the marketplace.

When you go to the store, how do you determine what you want to buy? You evaluate
the costs and benefits of each individual item and determine whether you want to
purchase it.

When you go to the voting booth, how do you determine which candidates you want to
“buy”?
Are you going to agree with any given candidate on all every stance they take? Probably
not. In general, when you choose a candidate, you have to accept them as they are, you
have to accept their stances on every policy- you are voting for a bundle of policies when
you vote for a candidate, you do not vote for individual policies.

So you have to find a candidate that best fits your views (even if they have several
abhorrent policies that you can’t stand), and you purchase the whole package with your
vote.

But even at that, you ultimately have to “consume” the policies of the candidates that the
majority voted for.

Individuals also rationally choose how much information to gather about candidates.
Gathering information is costly. If you are purchasing a car, you want to gather very
accurate information about the costs and benefits of that purchase. If you make a poor
choice, you are the only one who will be suffering the consequences of that choice-
directly.

This is not the same for voting. Voting is a collective decision. If the “bad” candidate
wins, no one is going to single you out for being the sole person responsible for electing
that candidate. There was shared responsibility. Thus no real ownership of the
consequences because it was a majority decision. And even if you suffer the
consequences of bad policies passed by this candidate, you are still only one small
fraction of the populace that voted for the candidate.

So individuals have no real incentive to become highly informed because they recognize
that 1. the cost of gathering lots of information is really high and 2. they are unlikely to
be the deciding vote in an election so the chances that any one individual will be
responsible for a bad outcome is virtually zero.

The likelihood that you will decide an election depends on two things 1. how many
people are voting (the smaller the number the more your vote “counts), and 2. how close
the public opinions are (50% and 50% would be the best odds of deciding the vote)

If you are working with larger numbers (like in the thousands) and if there is a 45/55
split or 40/60 split, or really any split away from 50/50, you have a better chance of
getting struck by lightening on the way to the voting polls than you do of being the
decisive vote in an election.

5
So basically, there is very little incentive to be informed about the policies of candidates
because the costs are high and the benefits are pretty non-existent. So you only see
people who are interested in politics becoming highly informed. And even those people
tend to be highly informed only about a particular area of politics (like health care policy
or regulatory reforms, or some other issue).

Government Failure Source 1: Rational Ignorance Effect

As such, there is a Rational Ignorance problem- where disorganized voters are

uninformed about politicians- and this is a completely rational choice because their vote
does not change the outcome of the election on the margin. The value of information is
worthless.

Rational ignorance opens the door for the special interest effect, the second type of
government failure

Government Failure Source 2: Special Interest Effect

The special interest effect is this issue where very well organized interest groups will
petition the government to pass policies that will provide the organized group with very
clear benefits that are concentrated on members of their group (like a subsidy, or a law
that limits competition in their field, or a tariff that prevents foreign competition etc).
And the costs of the policy will be widely dispersed among all of the disorganized
voters. The costs will be so small that no one will notice them (barely), and the costs of
fighting the legislation will exceed the benefits of doing so they won’t bother.

Most voters will not even be aware that these forms of legislation exist (did you know
that Americans pay more for sugar than other countries because of our protection of the
sugar farmers?)

E.g. a policy costs $1,000,000 to implement and provides a benefit of $1,000 to 1,000
well organized members of a special interest group.

The 2,000,000 people in the state implementing the policy have to pick up the tab. It
costs them $0.50 per person.

Even if the 2,000,000 people knew that this policy was in effect, and knew that a small
number of people were benefiting, they would really have no incentive to incur the cost
of fighting the legislation to save a measly $0.50.

The special interest effect predicts that politicians will basically cater to special interest
groups because they are well organized and the promise large blocks of votes if the
candidate promises to pass one specific policy. The politicians will find this to be a
winning election strategy- it’s easier to get guarantees from organized groups than it is
to persuade the disorganized masses to vote for them.

6
Pork-barrel spending is a form of special interest effects- where politicians spend
federal dollars on very local projects. They try to bring home the bacon so to speak to
provide visible benefits to their local constituents (like bridges to nowhere, turtle
tunnels, peanut festivals) that are funded from the common pool of federal resources. So
if the senator from Texas wants to bring a project home to the state, he might vote in
favor of pork barrel projects for other senators in the hopes that they will support their
projects. This type of vote trading, is called log rolling.

Suppose we have the following three projects up for a vote and the costs/benefits to each
are listed for each project.

Project A Project B Project C

A 25/50 25/10 25/10
B 25/10 25/50 25/10
C 25/10 25/10 25/50

Project A, for example, costs each district $25, and provides $50 in benefits to district A
and only $10 of benefits for districts B and C. The total costs is $75 and total benefits are
$70. The costs exceed benefits.

The total costs of each of these projects is more than the benefits, so from an efficiency
standpoint, none of these should be adopted. From a majority rule standpoint, none of
them would pass, but if the senators promised to trade votes and support the project of
each other, then we can arguably get all three proposals passed. Each senator has an
interest in making such a deal in order to be able to gain federal funds to bring back to
their constituents and increase their odds of getting re-elected.

Logrolling, or vote trading, is a tool that legislators use to help get majority support for
the special interest projects they would like to get passed. Senator A can promise to vote
for Senator B’s project and Senator B can promise the same for A. This allows both
senators to get majority support on their inefficient, special interest projects.

Government Failure Source 3: Rent Seeking

Rent-seeking is the act of investing time, money, and other resources to influence the
political process and to shape the rules to benefit your group. Special interest groups
will engage in rent-seeking behavior. But it’s not limited to interest groups, a lot of very
wealthy businesspeople fund political campaigns, and send lobbyists to DC in the hopes
of influencing the political process. This allocates the talents of the best and brightest
people towards redistributing benefits to themselves instead of engaging in production
that benefits a lot of consumers.

During the aftermath of the financial crisis, most industries were doing poorly. But in
DC, the hotel and restaurant business was booming because of how many people flocked
to DC to try to get a slice of the stimulus package, or to influence the rules that were up
for debate (financial regulations, bailouts, health care package)

7
We are seeing the same thing happen now with the current stimulus package being
debated. It is a feeding frenzy where lobbyists are working hard to make sure the
industries and organizations that they represent capture some of the benefits being
distributed in that package.

Government Failure Source 4: Short-Sightedness Effect

This stems from the fact that politics has short time horizons. You’re constantly trying to
get reelected (2, 4, or 6 year cycles) you are in favor of passing policies that provide
short-term benefits, but the costs of which will be pushed off to future generations. You
can appear to be “doing something” about the country’s problems and not worry if the
effects of policy will be positive or negative because the effects won’t happen until
further down the road (you notice how all of the politicians will take credit for the health
of the economy during an election, and will blame the bad outcomes on other parties).

This results in a tendency for democracies to accumulate debt. Why pass policies and
pay for them with higher taxes now, when you can borrow instead and then the costs
will be felt way further down the road where they are much less visible to voters.

Government Failure Source 5: Bureaucratic Inefficiency

Since government bureaus are not governed by prices and a profit & loss mechanism,
bureaucrats have very little information about whether or not their activities generate
value for society or if they are a net cost. The do not have to worry about winning over
customers by enticing them with great customer service or innovative products – there
is typically no competition as these bureaus are usually monopolies.

In addition, their operating budgets are tied to a Congressional allocation decision.

Congress approves a budget. It does not depend on having customers and obtaining
revenue to stay open and in business. Bureaus will not be in danger of being closed due
to low profits. They have no incentive to cater to consumer demands and preferences

Further, there is no incentive to control costs in a bureau. Bureaucrats are self-

interested and desire promotions, pay increases, more prestige, expanding the scope
and power of that agency. All of which can be accomplished by a bigger budget. So
bureaucrats will be focused on convincing Congress to increase their budget. If the cut
costs and come in under budget this year, that will convince Congress that they are not
in need of more resources at all. Their budget should be cut so that these scarce funds
can flow to an agency that actually needs it. You get punished for cutting costs.

Constitutional Rules and other modifications to the political institutions

that might alleviate some sources of government failure.

Constitutions are rules about how we make or change rules. They are meta rules. They
lay forth the types of issues we are allowed to make rules about, they set out the rule
making process, they divide the rule making powers among different government
actors… they need to be amended in order to be changed.

8
 1. Super Majority- bring us closer to unanimity- change the rules about how much
consent is necessary to make a law

But this raises the question of how effective constitutional rules are when the views of
individuals change regarding whether or not those rules should actually be constraints.
The constitution of the US has been reinterpreted, and it seems to depend on the
prevailing ideology of the country.

2. We could take certain rules off the table – Congress is not allowed to impose
taxes or tariffs on imports or exports. Congress is not allowed to impose rules
governing voluntary exchange. The government is not allowed to use regulatory
powers to take private property for the public use without paying the owner the
fully market value of the property taken- or not allowed to do it at all.

3. We could impose rules on the Fed, to try to reduce the incentive to inflate or
deflate the currency. For example, any price increase or decrease of more than
4% annually would result in the automatic resignation of the entire Fed Board.

These are not actual rules, but they are some ideas about how we could alter the
rulemaking procedures of government in such a way that it might mitigate some of the
incentive problems in government.

Changing the “ideology” of populace. Influencing the position of the median voter.
A lot of public choice scholars argue that what good are constitutions if they are not
binding. i.e. We had a constitution, and it gets reinterpreted and amended. Are these
meta rules really binding if no one wants to follow them. India has a written constitution
that is similar to the US constitution, but you don’t see a US style government in India.
What is different?

Norms matter. The beliefs of the citizens matter. It used to be the case that politicians
automatically balanced the budget during good times. The only time we ran deficits was
during recessions/depressions and wars. There was no written rule forbidding deficit
spending during other times, we just didn’t do it. The norm constrained behavior. Then
attitudes changed.

Many individuals argue that constitutions are only a check on behavior as far as the
citizens support the constitutional rules. Once the citizens start to demand changes to
the written constitution, and demand rules to be made that were typically off the table
before… the written constitution ceases to be binding.

9
Role of Government:

There is a wide range of opinions among public choice economists. They are primarily
concerned with highlighting the inefficiencies of government, but at the same time, they
are not tossing the role of government out the window due to some systematic
inefficiencies.

Given the potential for government failures, they argue that a simple market failure is
not enough of a reason to get government involved as a corrective device since
government failures may be as costly, or more costly than just living with the market
failure.

However, they support the role of government for protective functions (property rights
enforcement, courts, etc.)

They also see the potential to change the political institutions (by doing things like
creating constitutional rules) to result in more efficient government outcomes.

10