Course 2.2 AE/IES

'Public Finance and Public Choice'

Code 1316

Faculty of Economics and Business Administration

University of Maastricht

October-December 1998

Sixth Lecture, 2 December 1998

Dr J.G.A. van Mierlo

Associate Professor of Public Economics

University of Maastricht

1. Market Failure Revisited

1. Theory of Market Failure (model of perfect competition):

-market imperfections;

-perspective of allocative inefficiency;

-individual preferences respected: consumer sovereignty;

-government intervention to improve/correct/substitute the market.

2. Other arguments:

-perspective of distributive justice;

-limits of pareto-optimality and paretian welfare economics;

-impossibility of interpersonal comparisons of utility;

-various Social Welfare Functions;

-the trade-off between efficiency and equity.

3. Violating consumer sovereignty:

-concept of merit/demerit wants;

-the benevolent dictator;

-ex post justification by democratic decision-making?

2. Government Failure: the Public Choice Perspective

Problem:

The government does not do it always, apriori and automatically

better than the market!

1. Government does not function efficiently either:

failure as (public) provider of goods and services!

2. Theory of 'Government Failure' (Charles Wolfe jr.):

-redundant and rising costs (X-inefficiency);

-'internalities': development of own internal standards

and private organisational goals;

-derived externalities of government intervention;

-unequal distribution of power positions and privileges.

3. Causes for government failure:

-demand side characteristics of the public sector;

-supply side characteristics of the public sector;

-in general: INFORMATION PROBLEM of the public sector.

4. Consequence:

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

-return to the market?

5. Conclusion:

-there is no stable and final solution;

-decision of delivery system depends on costs and benefits of alternative institutional arrangements:

-technical characteristics of products/production process;

-political-economic evaluation of costs and benefits.

3. The Problem of Bureaucracy

1. Characteristics of bureaucracy

1. internal organisation: vertical hierarchy, top down;

2. external organisation: monopoly.

2. Economic models of bureaucracy

1. behavioral assumptions: what makes Sammy run?

-budget maximisition;

-maximisation size department;

-mixed motives/utility functions.

2. incentive structure: reward/punishment system

-of the organisation;

-of the bureaucrat;

-fit between the two?

3. financial structure:

-sponsoring by politicians: budgets;

-income earning by market transactions;

-compliance of conflict between the two?

3. Institional characteristics of bureaucracy determine its outcome in terms of Pareto efficiency as measure for collective welfare!

4. The Niskanen Model (x 2-bureau)

5. The Fight against Bureaucracy

1. Three Solutions

2. Classical solution:

-more political (external) control

Problems:

-does it work? span of control

-more bureaucracy!

3. Radical solution:

-privatisation to the market

Problems:

-from public to private monopolies?

-market failure around the corner!

4. Modern solutions:

-competition in the public sector

-competition with the private sector

-public entrepreneurship!

Problems:

-cream skimming and cherry picking

-cross subsidiation

-unfair competition with the market (level playing filed!)

6. Imperfect Alternatives

1. How to deal with the problem of 'imperfect alternatives'?

2. Possible comparisons:

Market Government

Model A: B:

perfect competitive perfect command

capitalism economy

Muddle C: D:

practice of practice of

mixed/market real existing socialism

economy

A-B, C-D, A-C and B-D

3. Danger of 'methodological fallacy': A-D and B-C!