Course 2.2 AE/IES

'Public Finance and Public Choice'

Code 1316

Faculty of Economics and Business Administration

University of Maastricht

October-December 1998

Opening Lecture, 4 November 1998

1a. Introduction to the Course

1b. Theory of Public Goods

Dr J.G.A. van Mierlo

Associate Professor of Public Economics

University of Maastricht

1A. INTRODUCTION TO THE COURSE

1. Purpose of the Lectures

1. Illustration of the literature and the theory

2. Supplementary to the text book and the course book

3. Explanation and clarification of problems

4. Question/answer hour

2. Program of the Lectures

1a. Introduction to the Course

1b. Taxonomies of Private/Public Goods

Explanation on the Assignment on Public Production/Provision

2. Question/Response Hour

3. Taxes, Expenditures and Income Distribution

Handing in Paper on Public/Production/Provision

4. Question/Response Hour

Feedback on Paper on Public Production/Provision

5. Government Failure and the Constitution

6. Question/Response Hour

3. Philosophy of the Course

LOCUS

Economic Problems of

the Public Sector

FOCUS LITERATURE

Knowledge Pool of Cullis and Jones

Economic Science Many Others

4. Old and New Public Finance

Confrontation of:

1. 'classical public finance' and 'modern public choice';

(PUBLIC INTEREST) (PRIVATE INTEREST)

2. integration in:

'(new) economics of the public sector'.

5. Public Finance and Public Choice

Differences between (old) public finance and (new) public choice:

-public interest versus private interest;

-holistic versus atomistic organisation perspective;

-intra- versus inter-organisation perspective;

-from taxation (revenue side of the budget)

.via public expenditure and public policies

.to institutions (new economics of organisation);

-applied macro-economics versus applied micro-economics;

-normative prescription (policy advise) versus

positive analysis and explanation (policy study).

6. The Integration Problem

1. Originally: two sperated fields

2. Origins of Public Choice

.Buchanan and Tullock;

.bifurcated man;

.public versus private interest;

.political science versus economic science;

3. Expansion of Public Choice in many fields of economic science:

.new economics of organisation;

.law and economics;

.constitutional economics;

.social choice and public choice;

.criticisms of hegemonism!

4. Integration problem.

1B. THEORY OF PUBLIC GOODS

1. Markets and Governments are Institutional Arrangements

1. Markets and governments are alternative institutional arrangements:

-markets: coordination of economic decisions by the price system;

-governments: coordination of economic decisions by the budget system.

2. Important distinction:

a. On a market, decision-making, consumption and payment are combined in one hand: the consumer.

b. In the government, these three elements are separated:

-decisions on pubic provisions are made by politicians: who decides?

-products of public provisions are consumed by policy-consumers/clients: who profits?

-finance of public provisions is provided by the tax payers: who pays the taxes?

c. this separation has fatale consequences: rational cost benefit calculations and individual optimalisation are not longer possible

3. Tragedy of the Public Economy:

Multiple Theory of the Public Household:

-allocative efficiency;

-distributive justice (equity);

-stabilisation of economic development.

4. Dilemmas:

-conflicting policy objectives;

-the Big Trade Off between Efficiency and Equity;

-problems of the Social Welfare Function;

-economic versus technical efficiency.

2. Market Failure and Government Intervention

1. In theory, the market produces an efficient allocation of resources:

-Model of Perfect Competition;

-Pareto optimality;

-Marginal Pareto conditions;

-Overall condition.

2. Characteristics of Perfect Competition and

Theory of Market Failure:

-imperfect information;

-imperfect competition;

-artificial monopolies;

-scale economies;

-natural monopolies;

-existence value;

-externalities;

-pure collective goods.

3. Consequence:

inefficient and suboptimal allocation.

4. Conclusion:

starting point for Government Intervention in the market process

-correcting the market;

-complementing the market;

-substituting the market.

3. Economic Theory of (Public) Goods

1. Two technical characteristics of goods are important:

-excludability of consumption: yes/no;

-rivalness in consumption: yes/no.

2. Combination of both characteristics in matrix

results in following TYPOLOGY/TAXONOMY

of goods and services:

Excludability of consumption

High Low

High 1. 2.

Individual Common pool

goods resources

Bread and butter Water and energy,

nature and environment

Rivalness in

consumption

Low 3. 4.

Club or Toll (Pure) collective

goods goods

Roads and bridges, Defense, dykes,

swimming pools, legal protection

telephone system,

infrastructure

3. Externalities (De)merit goods/wants!

4. Elaboration

1. Caveats:

-ideal typic distinction according to technical characteristics;

-no direct consequences for specific delivery systems;

-no policy implications for provision schemes;

-individual/collective goods versus private/public goods.

2. Individual/collective refers to technical charateristics;

Private/public refers to mechanism of provision.

3. Mixed categories 2 and 3 cause serious problems of analysis and policies.

4. Category 2: COMMON POOL RESOURCES

-high rivalness but low excludability:

-jointness of supply;

-should be priced from an economic perspective: MC > 0;

-cannot be priced from a technical perspective;

-technological developments may help in the near future to solve the pricing problem?

5. Category 3: TOLL OR CLUB GOODS

-low rivalness but high excludability;

-indivisibilities, constant costs/returns and scale economies;

-can be priced from a technical perspective;

-should not be priced from an economic perspective: MC = 0;

-other ways of finance? (tax revenues?)

-but: limited by the maximum of full capacity;

-rising crowding and congestion costs: MC > 0;.

-congestion costs as pricing device?

5. Government Failure: the Public Choice Perspective

Question: Does the government do it always, apriori and automatically,

better than the market? No Sir!

1. Government does not function efficiently either:

failure as (public) provider of goods and services!

2. Theory of 'Government Failure':

-redundant and rising costs (X-inefficiency);

-'internalities': development of own internal standards

and organisational goals;

-derived externalities of government intervention;

-unequal distribution of power positions and privileges.

3. Consequence:

-government intervention may also produce an inefficient allocation of resources!

-back to market provision?

6. Alternative Arrangements

1. There are more alternative institutional arrangements and service delivery systems between government and market:

-no dichotomy;

-no bi-polar contradiction;

-mixed arrangements.

2. Distinguished elements of provision systems:

-ARRANGEMENT: who arranges (decision-making)/provides?

-PRODUCTION: who takes care of the production?

-PAYMENTS: who pays the producer?

-CONSUMPTION: who takes the actual consumption decision?

Note: QUESTIONS to be answered in the assignment!

3. Different questions may result in different answers in different cases:

there is no unique solution!

4. This analytical distinction yields:

-a complex and real type framework;

-of institutional arrangements;

-for the provision of goods and services.