67. Public Choice Theory

Note: This post is the sixty-seventh in a series about government and commercial ethics. Click here for the full listing of the series. The first post in the series has more detail on the book 'Systems of Survival' by Jane Jacobs which inspired this series.

Here's Wikipedia on Public Choice Theory,

'In economics, public choice theory is the use of modern economic tools to study problems that are traditionally in the province of political science. From the perspective of political science, it may be seen as the subset of positive political theory which deals with subjects in which material interests are assumed to predominate.

In particular, it studies the behavior of politicians and government officials as mostly self-interested agents and their interactions in the social system either as such or under alternative constitutional rules. These can be represented a number of ways, including standard constrained utility maximization, game theory, or decision theory. Public choice analysis has roots in positive analysis ("what is") but is often used for normative purposes ("what ought to be"), to identify a problem or suggest how a system could be improved by changes in constitutional rules.'

In discussing Public Choice Theory, we need to be careful to remember the two different self-interests that we discussed a while back:

1) Self-interest in the sense that people just want to accumulate more money and more stuff for themselves and,
2) Self-interest in the sense that when people decide to do something, they choose to do whatever it is they prefer to do.

Now, the first definition of self-interest clearly is not accurate as a description of human behaviour, especially in political contexts, and the second definition is a fairly useless tautology, so the question is then how this concept of self-interest can be made useful.

James Buchanan, one of the founders and most famous advocates of social choice theory takes on the tricky question of self-interest in this summary of public choice theory, stating,

"The source of this charge lies in the transfer of the two hard-core elements, methodological individualism and rational choice, directly from economic theory to the analysis of politics. At one level of abstraction, these two elements are themselves relatively empty of empirical content. To model the behavior of persons, whether in markets or in politics, as maximizing utilities, and as behaving rationally in so doing, does not require specification of the arguments in utility functions. Economists go further than this initial step, however, when they identify and place arguments into the categories of 'goods' and 'bads.' Persons are then modeled as acting so as to maximize some index of 'goods' and to minimize some index of 'bads.'

More specifically, economic models of behavior include net wealth, an externally measurable variable, as an important 'good' that persons seek to maximize.
The moral condemnation-criticism of public choice is centered on the presumed transference of this element of economic theory over to political analysis. Those who find themselves in roles as public choosers, whether as voters, as legislators, as political agents of any sort, do not, it is suggested, behave in accordance with norms that are appropriate to behavior in markets. Persons are differently
motivated when they are choosing 'for the public' rather than for themselves in private choice capacities. And it is both descriptively inaccurate and morally questionable to assign self-interest motives to political actors. Or so the criticism runs.

At base, this criticism stems from a misunderstanding of what the whole explanatory exercise is all about — a misunderstanding that may have been fostered by the failure of economists to acknowledge the limits of their efforts. The economic model of behavior, even if restricted to market activity, should never be taken to provide
the be-all and end-all of scientific explanation. Persons act from many motives, and the economic model concentrates attention only on one of the many possible forces behind actions. To employ the model for prediction does, of course, require the initial presumption that the identified 'goods' that are maximized are relatively important in the mix. Hypotheses that imply that promised shifts in net wealth modify behavior in predictable ways have not been readily falsifiable empirically.

At issue here is the degree to which net wealth, and promised shifts in net wealth, may be used as explanatory incentives for the behavior of persons in public choice roles. Public choice, as an inclusive research program, incorporates the presumption that persons do not readily become economic eunuchs as they shift from market to political participation. The person who responds predictably to ordinary incentives in the marketplace does not fail to respond at all when his role is shifted to collective choice. The public choice theorist should, of course, acknowledge that the strength, and predictive power, of the strict economic model of behavior is somewhat mitigated as the shift is made from private market to collective choice. Persons in political roles may, indeed, act to a degree in terms of what they consider to be the general interest. Such acknowledgment does not, however, in any way imply that the basic explanatory model loses all of its predictive potential or that ordinary incentives no longer matter."

You can see the dilemma Buchanan faces. On the one hand, he acknowledges that people are less inclined to be self-interested in a public setting than they are in a private marketplace, but he can't concede too much on this front or the theory won't really be able to predict anything because it is too unsophisticated to be able to account for the non-monetary motivations people might have (whether for the public interest, or even for self-interest in non-monetary form (e.g. glory or praise).



One element that sometimes gets mentioned and sometimes seems to get lost in public choice work is the very different role played by self-interest in the political realm vs. the private realm.

Within the economic realm, assuming it is contained within the sort of bounds we discussed earlier in our recounting of the work of David Gauthier and Walter Schultz (be honest, shun force, come to voluntary agreement, invest for productive purposes, excluding interactions within a corporation etc.) the pursuit of self-interest can be seen to lead to a socially optimal outcome.

But within the political realm, the pursuit of self-interest is almost always a bad thing. Any attempt to personally make a material gain via politics is almost by definition trading and thus a violation of the 'shun trading' precept which is one of the most critical in the guardian syndrome.

One of the weaknesses of public choice theorists (visible in the quote above from Buchanan) in my opinion, is that they bring over an idea about how commonplace the pursuit of self-interest is from their work in economics without recognizing just how different the political world is.

You can see this in the quote above, where Buchanan says,

"The public choice theorist should, of course, acknowledge that the strength, and predictive power, of the strict economic model of behavior is somewhat mitigated as the shift is made from private market to collective choice."

Buchanan is sophisticated enough to pay lip service to the difference between politics and the marketplace, but he is unable to admit more than that the pursuit of self-interest might be 'somewhat mitigated' by the move to a political world. He himself realizes the moral difference between self-interest in the marketplace and self-interest in politics, and I suspect that he believes that he would not take advantage of political office to enrich himself, yet he theorizes on the basis that most people make little distinction between serving the public and serving themselves. He comments that critics of 'public choice theory' think "We should, therefore, proceed with analysis of politics under the illusion that persons do indeed become 'saints' as they shift to collective choice roles."

At it's best, work in public choice theory resembles the sort taken on by Elinor Ostrom - empirical work that attempts to model how people accomplish collective action and what works and what doesn't, neither neglecting the role played by the pursuit of monetary gain by individuals, nor treating it as the only factor at work.

At it's worst, work in public choice theory resembles wingnut internet diatribes about how all government is evil and every government employee cares for nothing about scamming the system for their own gain, and if we only lived in an anarchist society, all would be well.

Near the end of 'Systems of Survival', Jane Jacobs recounts a poem by Lao Tzu,

"When people lost sight of the way to live
Came codes of love and honesty
Learning came, charity came
Hypocrisy took charge;
When difference weakened family ties
Came benevolent fathers and dutiful sons
And when lands were disrupted and misgoverned
Came ministers commended as loyal"

Jacobs was worried that her own analysis was just a symptom of moral decay, with what was once too obvious to be worth analyzing, now becoming clearer in its absence. Sometimes I think Public Choice Theory is another step down the same road, a study of corruption in politics that treats the corruption as 'reality' with moral behaviour just a fantasy world inhabited by 'saints'.

Ethical Confusion

I've been reading commentary on the recent U.S. supreme court decision (full text) that the government can't ban corporate spending on candidate elections because this is a violation of corporations' constitutionally protected right to free speech.

Aside from the (in my opinion) craziness of the decision itself, what I've noticed in the commentary is a striking inability of commenters to distinguish between the commercial and the government (guardian) realm.

Most clearly, here is Glenn Greenwald,

"So I'll ask again -- of you and anyone who claims that since corporations are not persons, they have no rights under the Constitution:

Do you believe the FBI has the right to enter and search the offices of the ACLU without probable cause or warrants, and seize whatever they want?

Do they have the right to do that to the offices of labor unions?

How about your local business on the corner which is incorporated?

The only thing stopping them from doing this is the Fourth Amendment. If you believe that corporations have no constitutional rights because they're not persons, what possible objections could you voice if Congress empowered the FBI to do these things?

Can they seize the property (the buildings and cars and bank accounts) of those entities without due process or just compensation? If you believe that corporations have no Constitutional rights, what possible constitutional objections could you have to such laws and actions?

Could Congress pass a law tomorrow providing that any corporation - including non-profit advocacy groups -- which criticize American wars shall be fined $100,000 for each criticism? What possible constitutional objection could you have to that?"

Notice that all the question Greenwald asks relate to commercial matters. He doesn't ask if corporations should be eligible to vote, to hold office, to serve as judges, or to lead the army.

Or take Julian Sanchez,

Why is it that so many people who clearly do think books and magazines and talk radio shows enjoy unambiguous constitutional protection, despite being corporate funded or operated, are simultaneously absolutely sure that paid broadcast spots are in an utterly different category? ... My hunch is that it has something to do with the imagined audience.

No, it's because the first group falls under the category of art, whereas commercials, much like corporations, are under the category of commercial activity - which should be kept separate from the political world as much as possible.

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Very rarely in what I've read on the case (and then only in the comments to posts) has anyone made the simple point that a corporation is a commercial entity, created for a solely commercial purpose. Therefore it makes perfect sense that this commercial entity should be kept out of the political world as much as possible. Yes, a corporation should have property rights, and be protected from theft, but that doesn't mean it should have full political rights as well, there's no slippery slope and there is a clear line to be drawn.

Even if people haven't read and been persuaded by Jane Jacobs' argument that systematic corruption is the inevitable result of mixing commerce and politics, I feel that we used to have a stronger intuitive moral sense about these things.


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Update: Here's an honourable exception, Justin Fox.

The Home Ownership Scam

Worth repeating, Willem Buiter on the social benefits of home ownership:

Home Loans in the U.S. the Biggest Racket Since Al Capone:

...Why do politicians of all political colours and parties get their knickers so twisted about people losing their homes? In the case of the Tories in the UK and the Republicans in the US, the answer is obvious. Both parties believe that home owners are conservative. Not it the sense that people who are inherently conservative are more likely to become homeowners (although they may believe that as well). This is not a selection story but an osmosis story. Home ownership makes people more conservative. So both Tories and Republicans do everything they can to encourage home ownership. But so do (New) Labour in the UK and the Democrats in the US, so it’s no longer a left-right thing.

The one argument for encouraging home ownership that makes sense is that owner-occupiers look better after their property and its immediate surroundings than would a tenant. This is a simple principal-agent story where it is costly for the principal (the owner) to monitor the care and attention the agent (the tenant) bestows on his property. Add some neighbourhood externalities (I don’t want to live next door to a place where they don’t mow the lawn or paint the exterior of the house), and you have an argument for encouraging owner-occupancy, say by subsidising it.

But a subsidy for owner-occupancy is something completely different from subsidising borrowing using residential real estate as collateral. If they exist, the benefits from owner-occupancy are there regardless of whether the owner-occupier has a mortgage or not. It doesn’t matter whether she borrowed to buy the house, paid in cash, stole it, inherited it from her parents, or built it with sweat equity on land won in a raffle. The US does not encourage owner-occupancy directly, say by paying each head of household who is an owner-occupier, a given amount of cash each year. Instead it encourages and subsidises a particular form of borrowing, regardless of what that borrowing is spent on. Funds, after all, are fungible. I can withdraw equity from my house by taking out a first or second mortgage against it, or by increasing the size of an existing mortgage, and spend the proceeds on Cuban cigars.

All this is rather insane. Through the deductibility of mortgage interest from taxable income, the US tax payer gives vast subsidies to borrowing secured against a particular type of collateral - residential real estate. What so special about this borrowing and this collateral? Fortunately, the UK has abolished this boondoggle. In the US, other forms of preferential treatment for home ownership are piled on top of the mortgage interest-deductibility. Over half the stock of home loans, and virtually all new home lending in the US are heavily subsidized by the lending and guarantees of Fannie Mae, Freddie Mac, Ginnie Mae and assorted smaller smaller government agencies. The direct interventions of the Fed and the Treasury in the market for residential mortgage-backed securities, announced as part of the credit-easing policies of the Fed represent further quasi-fiscal subsidies to housing finance.

This is on top of the creation by the Fed of at least a dozen facilities that accept RMBS as collateral for Fed loans in the earlier stages of the financial crisis. All these quasi-fiscal interventions by the GSEs and the Fed are deeply non-transparent as regards the magnitude of the subsidies involved. They also evade the normal scrutiny and accountability to Congress that is associated with explicit subsidies by the Treasury. The only priviliged treatment of residential housing that makes a modicum of sense from the perspective of encouraging owner-occupancy (as opposed to borrowing to fund whatever expenditures using residential housing as collateral), is the ability to postpone capital gains taxation on the sale of one’s principal residence, and to have one capital-gains-tax-free realisation during one’s lifetime (taken generally when people size down on retirement or when the kids have flown from the nest).

The extreme fiscal largesse bestowed on residential housing, directly and indirectly through mortgage interest deductibility, has led to a massive misallocation of investment in the US. There has been overinvestment in the private residential housing stock and underinvestment in just about every other form of fixed capital: infrastructure, public amenities of all kinds (sports facilities, public recreational facilities, parks etc.), commercial structures, plant and equipment. It is time to correct the distorted incentives that are at the root of this misallocation. The easiest way to do this, in the current tax system, is to end the deductibility of mortgage interest in the personal income tax, close down Fannie and Freddie and end the role of the US government in the provision of residential mortgages. A focused social housing program is of course a legitimate activity of the Federal government. It should be on-budget, that is, fiscal rather than quasi-fiscal.

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But really, you should read the whole thing...

Buiter does a great job exposing the madness behind out-of-hand government promotion of home ownership, but he doesn't really get into the question of why governments act this way.

And it's not just the U.S. - Canada has gone down the same road with CMHC and a host of other incentives.

And over here, Steve Keen catalogues the extensive list of government interventions in Australia and again has little explanation for the magnitude of the government intervention in this particular area.

I do have a theory on why governments find this area particularly irresistible, but I'll have to save it for a few weeks until I've developed the appropriate background material first.