How We Failed Our Economics Students and Caused Low Government Approval Ratings

It should be no wonder the average U.S. college-educated citizen feels this way. Examining our principles of economics textbooks, one finds the following type of logic: Markets have systematic failures such as externalities, monopolies, business cycles, and public goods, and there is a benevolent omniscient government that can and will come in, properly identify, and correct these things by imposing the ideal solution to the problem. What a disservice we as economists have done to our students! For those readers who have had this type of education in your principles of economics curriculum, I apologize. We, as a profession, have misled you. And for any economics instructors reading, let me tell you how you can do a better job for your students.

Moving on from the Benevolent Social Planner Mindset

In 1986 the Nobel Prize in Economics was awarded to James M. Buchanan for his contributions to our understanding of the political process using the tools of economics, a field now known as public choice theory. The power of economics is that it helps us to understand the world around us by examining how individuals are predictably influenced by incentives, and how the institutions of society shape those incentives. Using those basic tools, scholars in public choice theory have now worked out the reasons government, like markets, may sometimes work well, and may sometimes fail. That is—there are systematic failures of government action that we can term government failure.

These shortcomings happen when individuals in the public sector (voters, bureaucrats, legislators, government employees, etc.) face a structure of incentives that leads them to take actions in their personal interests that are not aligned with the public interest. For example, government agency budgets are often given as fixed amounts for each fiscal year. At the end of the year, any remaining money in the budget is usually taken back and next year’s funding is likely to be reduced because the agency did not need all the money it was allocated. To avoid this outcome, managers in government agencies are notorious for rapidly spending their remaining budgets on questionable items at the end of each fiscal year. After all, why let the money go to waste, and have your future budget cut? The point is that a person who was very careful and frugal with their money at home, or at a job in a private corporation, would behave differently under this different set of incentives that are present in the government sector.

The problem with underperforming government is not always the individual people; it is the poor or distorted incentives they face. You cannot solve the failures of government simply by electing the ‘right’ people. Anyone, from any political background, and of any level of fiscal discipline would behave in the same way under these perverse incentives. They would spend the excess budget money on something rather than losing it and having their budget cut next year. Thus, the fact that government operated garbage collection, utility services, or health care, tend to have higher costs than do private alternatives is not some rare occurrence—it is a systematic problem caused by the structure of incentives within the public sector.

The “nirvana fallacy” is the logical error of comparing actual things with unrealistic, idealized alternatives. For instance, some might see a problem in the current health care system and propose that because of this, we should have a government-run health care system, based on the logic that this ideal government-run system would overcome all the problems. This tendency to idealize the outcomes of potential future government policies and programs is a persistent bias in public perception of government and in government policy-making. No wonder this leads to widespread disappointment with the actual outcomes of government!

Both markets and government action have their limitations—neither is perfect, and there will be particular problems under either alternative. To help overcome this fallacy, there is one simple reminder, or test, that should be remembered when considering new government policies or programs. Simply ask which current government agency you want running or administering the program you have in mind. For example, the attractiveness of a government-run health care system is more realistically viewed by imagining the nation’s health care system being run by FEMA, the Department of Defense, the Internal Revenue Service, or a state agency such as the Department of Motor Vehicles, Department of Education, or the Department of Social Services. Does that sound ideal?

Only through careful thought about real-world alternatives, by comparing the likely true limitations of both the private and public sectors, can good judgments about policy be made. Assuming some benevolent government will institute quick and perfect Keynesian business cycle corrections that maintain full employment, or that government provision or regulation will result in ideal outcomes in other markets, leads to unwise policy making—and to public displeasure with the outcomes of government. It even leads some young individuals into believing that an entirely government-run economic system (e.g., socialism) controlled by democracy would magically work better than our current economic system to solve all our problems.

What Your Professor—I Mean Your Textbook—Didn’t Tell You

Unfortunately, very few of the leading principles of economics textbooks on the market integrate an understanding of public choice into the material. A study by economists James Gwartney and Rosemarie Fike surveyed the 23 leading principles textbooks and found that only about half provided any coverage of public choice or recognized the presence of government failure, and that even in those half, the coverage of market failure is nearly six times longer that of the coverage of government failure.2 The textbook I coauthor with Gwartney, Stroup, and Macpherson (Economics: Private and Public Choice) contains the most balanced coverage, and others by McEachern, Arnold, Cowen and Tabarrok, and McConnell also include a good deal of material integrating public choice. Perhaps quite surprisingly, many others, including those by Mankiw, Krugman and Wells, Hall and Lieberman, Gottheil, Baumol and Blinder, and Schiller et. al. provide very little coverage, if any, of the idea that governments may fail or be anything other than benevolent, ideal, and proficient correctors of market imperfections. Krugman and Well’s textbook completely ignores the issue and never once mentions government failure or public choice. Like most economists, he sees government intervention as being a quick, efficient, and fail-proof response to any problem he sees in the marketplace. The widely used Gregory Mankiw textbook contains only one page of coverage of government failure that mentions the problem of bureaucratic inefficiency in government, despite devoting 56 pages to explaining the potential failures of private markets. Students simply deserve better.

Given the size and scope of government in the U.S. economy, it is important that students of economics understand that the powerful tools of the discipline can help us to understand both the actions of individuals in private markets and in government. Political allocation and market allocation, both the shortcomings and successes, can be understood with the powerful tools of methodological individualism, incentives, opportunity costs, and marginal decision-making. The major instances of government failure documented by public choice theorists include the special interest effect, the shortsightedness effect, rent seeking and government favoritism, bureaucratic inefficiency, and the weak incentive for voters to acquire information (rational ignorance effect). We can also use these tools to know when government actions are likely to work best, and how to improve them through alternative voting rules, proper alignment of funding sources, the use of broad-based policies, and constitutional constraints.

Politics without the Romance

For those of you who may have had one of these textbooks that provide unbalanced coverage let me briefly explain what you need to know. In all walks of life individuals respond predictably to the incentives (costs and benefits) they face in decisions. For example, because their vote is unlikely to alter the outcome, voters have little incentive to become informed on political issues or to participate in the political process. Can you, for example, name the people who are the current elected representatives for you in your local and national government; or what issues these individuals are voting upon today? Most people cannot. If it makes you feel better, a viral video from 2013 showed a reporter from the Harvard Crimson asking students on campus what the capital of Canada was, and the vast majority of Harvard University students did not know it was Ottawa.3 The point is that even smart people are smart enough to know there are some things that are not worth spending time to learn and remember. Our limited brainpower is better spent on things that matter more to our daily lives.

In public choice theory this is known as the rational ignorance effect. Given the low probability a voter will decide the outcome of an election, they simply have very little incentive to stay informed about all the issues currently being debated or considered, all the candidates running and their platforms, and so forth. Most importantly, however, as the rational ignorance effect encourages voters out of the political process, it gives politically powerful and concentrated special interest groups an upper hand.

If you were an elected representative, seeking re-election and needing votes, would you, for example, support a bill that costs everyone in the U.S. $2 but would transfer benefits of millions to a concentrated and motivated group such as steel workers or an industry that would return the favor with millions in campaign contributions and thousands of workers’ votes? Given that most other rationally ignorant voters wouldn’t even know about the widespread costs you are imposing while those steel workers who receive the concentrated benefit do know and care a lot, this is easy political calculus. The political process is biased toward actions that generate concentrated benefits to interest groups and impose widespread costs on the general (and rationally ignorant) public. It’s a winning election strategy even when it results in inefficient outcomes that generate more costs than benefits.

Many students ask their instructors questions like, “If tariffs are inefficient and ‘bad’ like you are teaching us, why do governments adopt them?” The special interest effect, a well-established and important part of public choice theory and one of the systemic failures of government action, is precisely the explanation. Even though these tariffs harm consumers by more than they benefit producers, and therefore reduce economic efficiency, they are political winners that are in the political self-interest of elected officials to support!

This same logic also helps us to understand why big economic development subsidies are given out to firms like Amazon, and why Congress orders and funds planes and tanks—like the F-22 fighter4—from large politically connected manufacturers in important political districts, even when the military does not want those planes and tanks. It is also why tax breaks are given to specific favored firms or industries, and it’s why your local governments attempt to ban or impose special taxes on Uber to keep them from competition with the powerful taxi industry. These are not isolated problems; they are the systematic failures of government action that should be always assumed to be present when we substitute political resource allocation for market resource allocation. Most economics textbooks, and therefore instructors, fail their students by not giving them the tools to understand (and expect!) these real-world outcomes.

The case of these failures in military funding provide a good example to tease out further. The provision of national defense is often used in principles textbooks as a case of market failure. That is, if left to the private market, free-rider problems would plague the private provision of this collective consumption good. The standard argument then proceeds that the government steps in and provides it perfectly as a substitute. The reality is the government steps in and provides it, also with some failures. In every case the proper way to view the decision is to ask which of these two imperfect mechanisms can do a better job, even though neither does it perfectly when compared to some standard of ideal economic efficiency.

In some cases, the imperfect government outcome will be better than the imperfect market outcome, while in others the imperfect market outcome will be better than the imperfect political outcome. The more important point is that just because the market outcome does not meet some theoretical ideal does not automatically mean government intervention can improve on the outcome. In many cases, it may simply make matters worse.

The weak incentives for government employees to spend money carefully, and their desire to grow their budgets, means that when government gets involved the costs of provision are usually more, not less, due to these poor incentives for internal efficiency. For those who favor expanded government intervention in health care, you need to know this failure exists, and question your assumption that costs would fall under a government run system—at least for the same level and quality of care. It is a choice between two imperfect outcomes. Many economists would go further and argue that some problems in the current system are the result of existing government interventions into the health care system so less government intervention, not more, is the way to move toward a more efficient system.

From public choice theory, we also know that government actors have an incentive to pursue shortsighted policies that create highly visible benefits to voters now and impose uncertain costs at some point in the future. After all, voters want things now, like ‘free’ college education or ‘free’ health care, and if you can deliver it to them by running up a national debt that won’t come due for a generation and that some future politician will have to raise taxes to fund, why wouldn’t you? That’s how you win elections. And, for those of you reading this who had the Mankiw or Krugman textbooks, now you know why our national debt is huge and keeps growing uncontrollably. It’s an easy way to push the costs of providing these special interest group benefits into the future to win elections now by providing voters with what appears to be a ‘free lunch’. This is precisely why both Republican and Democrat controlled Congresses (and Presidents from both parties) have continued to run up the debt and will continue to do so unless stronger constitutional constraints are imposed upon their actions. Contrary to what your textbook likely told you, debt isn’t something that real-world political actors run only during recessions to properly conduct ideal Keynesian counter-cyclical fiscal policy. Over the past 60 years, the U.S. federal government ran deficits in 90 percent (or 54) of those years, despite the economy only being in a recession 13 percent of the time during that period. We are even currently running near record-high deficits in the middle of a sustained economic boom with record low unemployment! Again, it is simply an inexcusable failure to not provide students with the tools to understand the real-world budget and debt problems so that we may work to solve them.

Occupy Which Street?

You may know that the ‘Occupy Wall Street’ type groups hate the role of big interest group money and lobbying in politics, but you may be surprised to hear that public choice economists feel the same way. The two groups differ drastically, however, in the blame (and solutions) for this widespread phenomenon.

In 2018, almost $3.5 billion was spent lobbying the U.S. federal government and there are over 11,000 registered and active lobbyists trying to influence federal government policy.5 This is in addition to the almost $3 billion spent on campaign contributions and election spending by U.S. Congressional candidates, another $1.4 billion in spending on campaigning in presidential elections. Those don’t count the state and local levels, which would comprise at least another $2 billion in campaign contributions and $1.5 billion of lobbying expenditures. The private prison industry alone spent over $26 million in six years lobbying lawmakers in just 16 states.

In public choice theory this is known as ‘rent-seeking’. It is caused by having a government that gives away favors and that attempts to regulate and influence trillions of dollars of private economic activity. Suppose, for example, that college professors at a particular school readily gave away grades if you came and begged and cried at their offices at semester end. What would happen? The lines at faculty offices would be long and filled with deserving recipients of higher grades. The way to solve all that favor seeking is clear, don’t give out free grade ‘bumps’—have constraints and stick to them. Seeing these long lines would you blame the students or the professors for this failure and who would you look to if you were going to implement a solution? To solve the problem of widespread lobbying and favor seeking in government, public choice theory suggests placing stronger constitutional constraint on the scope of government action and forcing policies to be broad based and not so selectively beneficial.

Quite simply, government can break the link that is normally present in private markets between paying for a good or service and receiving it. In the private economy if you want a cup of coffee, you must pay for it. Government allows you to get the cup and force others to pay for it. If your local coffee shop would give you free coffee, how much would you consume? Of course, when others are paying, we demand more than we would if we considered the true cost. So those who benefit from government without paying much for it always demand increases in the size and scope of government. The trend toward more and more individuals (now over 40%) having no positive federal income tax liability, has obvious implications—more voters wanting government to spend and provide more things at taxpayer expense. What we know from public choice theory is that these problems can be minimized when we try to better align those who pay with those who benefit (with user charges for example) and using voting rules that require more than simple majority voting on important decisions.

Don’t Worry, Be Happy!

With your newfound appreciation for the fact that both markets and governments sometimes work well, and both sometimes fail, I hope you will not be as disappointed in government action in the future. You should expect less than ideal responses. More importantly, when considering whether government should step in to regulate or replace private markets, you should not compare the market outcomes to some ideal, and immediately declare the need for government action. Sometimes less than perfect market outcomes are far better than less than perfect government outcomes. To be a productive force in an economy, government must do some things (like protect people and their property, enforce contracts in an unbiased manner, and provide a limited set of ‘public goods’) but refrain from doing others, especially when government action produces an even less efficient outcome than would happen under private markets.

Footnotes

[1] For data see https://news.gallup.com/poll/1600/congress-public.aspx

[2] Fike, Rosemarie and James Gwartney, “Public Choice, Market Failure, and Government Failure in Principles Textbooks,” Journal of Economic Education 46 (2015): 207-218.

[3] To watch the entertaining video see https://www.youtube.com/watch?v=r0fdYhgJIeE.

[4] See for example, https://www.americanprogress.org/issues/security/news/2009/07/09/6309/a-jet-even-the-military-doesnt-want/

[5] For national data see The Center for Responsive Politics available at https://www.opensecrets.org/ and for state and local data see http://www.followthemoney.org/.