Transforming Post-Communist Political Economies (1998) / Chapter Skim
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16 The State in a Market Economy
16 The State in a Market Economy
Pages 411-431
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From page 411... ...
The next section briefly reviews the history of controversies concerning the relation between the state and the economy; the discussion includes consequences of the economic theory of incomplete markets and imperfect information for our understanding of this relation. The following section examines three classes of principal-agent relations: between govern An earlier version of this paper was originally prepared for the Seminar on "State Reform in Latin America and the Caribbean," organized by the Ministerio da Administra,c 0 Federal e Reforma do Estado, Brasilia, May 16-17, 1996.
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From page 412... ...
In the presence of these "failures," markets no longer allocate efficiently. This was the observation underlying the doctrine of state intervention enshrined in the 1959 Bad Godesberg Programme of the S.P.D.: "markets whenever possible, the state when necessary." The general prescription that emerged from this observation was that markets should be left alone to do what they do well allocate private goods in those cases where the private rate of return does not deviate from the social rate while the state should provide public goods, facilitate transactions, correct externalities, and regulate monopolies due to increasing returns.
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From page 413... ...
delegating decisions subject to dynamic inconsistency to independent bodies that have no incentives to yield to political pressure. Public administration should be reduced because the state is "bloated," and the productivity of public services is allegedly lower than that of the private sector.1 The public sector should be privatized because governments are supposed to be more responsive to political pressures from public than from private firms.
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From page 414... ...
put it bluntly: "The standard neo-classical model the formal articulation of Adam Smith's invisible hand, the contention that market economies will ensure economic efficiency provides little guidance for the choice of economic systems, since once information imperfections (and the fact that markets are incomplete) are brought into the analysis, as surely they must be, there is no presumption that markets are efficient." When some markets are missing, as they inevitably are, and information is endogenous, as it inescapably is, markets need not clear in equilibrium, prices do not uniquely summarize opportunity costs and can even misinform, externalities result from most individual actions, information is often asymmetric, market power is ubiquitous, and"rents" abound.
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From page 415... ...
But the consequences of the neoliberal punch still linger: will the state do what it should and not do what it should not? PRINCIPAL-AGENT RELATIONS Once we understand that markets are inevitably incomplete and economic agents have access to differing information, we discover that there is no such thing as "the" market, only differently organized economic systems.
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From page 416... ...
Government and Economic Agents (Regulation) The role of the state is unique since the state sets the incentive structures for private agents by exercising its legally qualified coercive power: mandating and prohibiting some actions by law or changing relative prices through the fiscal system.
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A good intervention one that maximizes consumer surplus is then one in which the government subsidizes investment if the firm has high costs in period 1, and the government does not pay for investment otherwise. A bad intervention is one in which the government fails to subsidize investment by a firm with high costs, or subsidizes a firm with low costs and splits the rents with the firm.3 The institutional problem is then twofold: (1)
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From page 418... ...
Suppose the firm expects that the government may change, and the new government will tax away its increased profits. Then the firm will not invest even if it receives the subsidy, and knowing that the firm will not invest, the optimal intervention for the period 1 government will be not to subsidize investment, even thought it is socially beneficial.4 Hence, to be able to intervene well, the government must be committed to not confiscating the firm's profits during the second period.
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Hence, a central institutional issue of state reform is how busing data based on interviews with entrepreneurs in 28 countries, Weder (1995) found that the rate of economic growth is significantly lower where entrepreneurs report having to cope with unexpected changes of laws and where they do not expect governments to adhere to major policy pronouncements.
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State intervention can be superior to nonintervention when governments have some information about private agents, when they have legal or fiscal instruments to regulate, and when the institutional framework allows credible commitments. Yet none of these conditions guarantees that governments will intervene n the public interest.
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Yet public bureaucracies differ in some important ways from private ones. One difference stems from the difficulty of setting criteria by which not only individual agents, but also teams of them, could be evaluated in the public sector.
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Even with the difficulties involved in monitoring individual efforts of team members, the principal can create incentives for the agents by (1) setting wage levels sufficiently high to attract agents of high quality, who have higher opportunity costs; (2)
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Citizens' control over the bureaucracy can be only indirect, since democratic institutions contain no mechanisms that would allow citizens to sanction directly the legal actions of bureaucrats. Citizens can at most consider the performance of the bureaucracy when they sanction elected politicians.
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Even though the legal authority rests with the elected politicians, fire alarm oversight is a mechanism for the accountability of the bureaucracy to the citizens. Fire alarm oversight requires institutional arrangements that facilitate citizens' monitoring of the bureaucracy, transmission of information, and sanctioning of violations.
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, then, anticipating the retrospective judgments of voters, governments will choose policies they believe will be positively evaluated by citizens by the time of the next election (Downs, 1957; Fiorina, 1981; Manin, 1995~. Yet asymmetric information between governments and voters makes representation difficult to enforce.
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From page 426... ...
And if opposition parties inform citizens about the misdeeds of the government or just about the sources of incumbents' money, they lower the cost of information to voters.~3 Second, the mechanisms of accountability are not only "vertical" of elected politicians to voters but also "horizontal" of different branches of the government to each other (O'Donnell, 1991~. Elections are inevitably a plebiscitarian device: however informed voters are, their choice is only intermittently to ratify or reject decisions made by competing and cooperating teams of their representatives (Bobbio, 1989:116~.
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Under these assumptions, the legislature informs citizens truthfully about the objective conditions, and citizens enforce representation through retrospective voting. Yet this is true only if the two powers cannot collude.
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From page 428... ...
But the neoliberal state is at best a benchmark against which to measure the quality of state intervention: given that market allocations are not efficient, disabling the state is not a reasonable goal for state reform. State intervention can be superior to nonintervention when the institutional design allows governments to intervene in the economy, enables politicians to control bureaucrats, and enables citizens to control governments.
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Paper presented at the World Bank's Annual Conference on Development in Latin America, June 12-13, Rio de Janeiro.
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From page 430... ...
American Journal of Political Science 28:165-179. Manin, B
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From page 431... ...
Pp. 63-79 in Modern Political Economy, J.S.
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