Transcript The Making of Economic Policy: A Transaction

The Making of Economic Policy: A
Transaction-Cost Politics Perspective
Avinash K. Dixit
MIT Press, 1996
Motivation
• The reality of most countries’ trade policies is
so blatantly contrary to all the normative
prescriptions of the economist that there is no
way to understand it except by delving into
the politics.
Transaction-Costs
• In economics, it has come to mean a very general class of
information, negotiation, and enforcement problems that
affect the internal organization of firms and the outcome of
market and nonmarket relations among firms, workers and
so on.
• A similar and even more severe class of transaction costs
(which deals with principal-agent problems, commitment
and credibility) pervades political relations and affect
political outcomes.
• The policy process can be better understood and related to
each other by thinking of them as the result of various
transaction costs and of the strategies of the participants to
cope with these costs.
Common Agency
• Within this general framework, a particularly
important feature of the political process of
making economic policy is the “common
agency,” where several players in the political
game try to influence the actions of one
decision-maker.
• It leads to a severe diminution of the power of
the incentives that can be offered to this
decision-maker.
Market versus Government
• The tradition dichotomy of market versus
government, and the question of which system
perform better, largely lose its relevance.
– Both of them are facts of the imperfect economic life,
and they unavoidable interact in complex ways.
• The most we can do is to understand how the
combined economic-political system evolves
mechanisms to cope with the variety of
transaction costs it must face that precludes a
fully ideal outcome.
Principal-Agent Model
The players in the Regulatory Process and
their inter-relations
Regulatory
agency
The players in the Regulatory Process and
their inter-relations
Regulatory
agencies
Firms and
Investors
The players in the Regulatory Process and
their inter-relations
Regulatory
agency
Firms and
Investors
Consumers
The players in the Regulatory Process and
their inter-relations
Executive
Congress
and
Committees
Regulatory
agency
Firms and
investors
Consumers
The players in the Regulatory Process and
their inter-relations
Executive
Congress
and
Committees
Regulatory
agency
Firms and
Investors
Consumers
The players in the Regulatory Process and
their inter-relations
Executive
Regulatory
agency
Firms and
investors
Voters
Congress
and
Committees
Consumers
The players in the Regulatory Process and
their inter-relations
Bureaucracy
and other
agencies
Executive
Regulatory
agencies
Firms and
Investors
Voters
Congress
and
Committee
s
Consumers
The players in the Regulatory Process and
their inter-relations
Bureaucracy
and other
agencies
Executive
Courts
Regulatory
Agency
Firms and
Investors
Voters
Congress
and
Committees
Consumers
The players in the Regulatory Process and
their inter-relations
Bureaucracy
and other
agencies
Courts
Executive
Regulatory
agency
Supreme
Court
Firms and
Investors
Voters
Congress
and
Committees
Consumers
Set of Principal – Agent Models
Bureaucracy
and other
agencies
Executive
Court
Supreme
Court
Regulatory
Agencies
Firms and
Investors
Interest
Groups
Consumers
Voters
Congress and
Committees
Principal-Agent model:
• It is relevant to analyze relationships with
following conditions:
– Delegation
– Asymmetric information
– Imperfect relation between the effort and its
results
– High costs of monitoring
– No alignment of preferences or objectives
Principal-Agent model:
•
In general terms, there exist two solutions to
the principal-agent relation:
1. Involves a structure of remuneration aiming at
approaching the incentives of both parts
involved (paying a tip).
2. Rules and institutions capable of avoiding
opportunistic behavior of the agent.
Positive versus Normative Political Theory:
• To what extent those theories are excluding,
complementary, or competitors?
• Both are based on the premise that agents are
rational and look for the own interests.
• Dixit suggests a synthesis, labeled
‘transaction-cost politics’ that views
policymaking as a process in real time.
Normative Political Theory:
• Market failure (i.e. natural monopoly)
• Requires a criterion to fix with the “best” way this
failure aiming at maximizing the social welfare.
• Pareto-optimality (efficiency criterion)
• First-best and second-best solutions (overcome the
market imperfections)
– Moral hazard (level of effort of the firm)
– Adverse selection (the regulator has no complete
information about the costs of the firm)
– The regulator is obliged to pay informational rents.
Normative Political Theory:
• As a consequence of asymmetric information
Laffont and Tirole offer as a solution a menu
of contract:
– Price-caps
– Repartition of profits
• Thus, the firm would have incentives to revel
its true effort
Normative Political Theory
• The normative solution is rarely observed in the real life
• The normative solution requires a high level of discretion of
the regulator. This generates incentives for opportunistic
behavior
• Dixit (1996) observes that the normative theory understand
the formulation and implementation of policies as a technical
or organizational problems. As if political failures could be
avoided through good management, namely, giving power to
make and implement economic policy to an economist…
• In other words, it does not take into account political and
economic institutions.
• The benevolent, omnipotent, and omniscient dictator would
maximize the social welfare.
Positive and Normative Political theory
• Dixit 1996
• Dictator benevolent, omnipotent and
omniscient
second-best
literature
Positive and Normative Political theory
• Dixit 1996
• Dictator benevolent, omnipotent and omniscient
second-best
literature
Informational
Economics
literature
Positive and Normative Political theory
• Dixit 1996
• Dictator benevolent, omnipotent and omniscient
PPTR tries to
relax
this unrealistic
premises
second-best
literature
Informational
Economics
literature
Positive and Normative Political theory
• Dixit 1996
• Dictator benevolent, omnipotent and omniscient
Economic relations
Usually involves
Multiple principals
second-best
literature
Informational
Economics
literature
Positive and Normative Political theory
• Dixit 1996
• Dictator benevolent, omnipotent and omniscient
Economic agents,
Including regulatory agencies,
Bureaucracy, and government
are made by people that try to
Maximize their own interests
second-best
literature
Informational
Economics
literature
Positive Theory
• Also starts from a market failure
• Regulation necessarily leads to a redistribution.
Rarely there are Pareto-optimum corrections or ways
of implementing compensations (side-payments)
• Given the behavioral premises, individuals and
groups would try to influence this redistribution.
• Their capacity to do so would depend on the
institutions (i.e. property rights)
Positive Theory
• Many situations apparently inefficient could be
understood as a consequence of restrictions imposed
by transaction costs among agents. The great
majority of the PPTR tries to explain why such
inefficient situations are observed even when there
are obvious and better ways to deal with that. This
involves to identify the source of restriction which
are generating transaction costs and to show how it
affects the agent choices. Almost always it requires
to take into account the political institutions.
Why does the regulation (government
intervention) tend to be inefficient?
• Economic reasons:
– Asymmetric information
– Uncertainty about effects, costs, and benefits
– It does not mean that the regulation is not
necessary; however, those problems should be
taken into account
Why does the regulation (government
intervention) tend to be inefficient?
• Political reasons:
– Regulation necessarily means income redistribution
– Quotas, licenses, subsides, establish a price, etc. transfer
rents and incomes
– Interest-groups will demand this redistributions and
politicians offer
– Generally, the regulation tends to be inefficient
– Rent-seeking
– Few beneficiaries and lots of opponents
A Synthesis: A Policy Process in ‘Real Time’
• Constitutions are incomplete contracts:
– The constitution never lays down the clear, firm,
and comprehensive set of rules that the
contractarian approach depicts; so there is room
for maneuver in individual acts.
– Inability to foresee all the possible contingencies
and to adjust to them
– Last longer than most business relationships
• Constitutions are not made behind a veil of
ignorance
Coase’s Theorem
• Once the property rights over a disputed
resource (ex. Rents of a monopoly) have been
established, and given that the transaction
costs are equal to zero, the private
negotiations between agents approaches to
the efficient level of allocation. (Coase,
Ronald, (1960) The problem of social cost.
Journal of Law and Economics, 3, 1-44).
Example:
• A firm pollutes a river which provides a cost of
$500 to a farmer along the river.
Example:
• A firm pollutes a river which provides a cost of
$500 to a farmer along the river.
• It costs $300 to the farmer to build a station to
purify the water.
Example:
• A firm pollutes a river which provides a cost of
$500 to a farmer along the river.
• If costs $300 to the farmer to build a station to
purify the water.
• The firm can eliminate the harmful effect of
pollution changing its production process at
the cost of $100.
Questions:
• Should be allowed the firm to pollute the river?
• Should the firm be obliged to change its production
process?
• Who should pay for that?
• What are the economic implications if the firm would
have the property rights of polluting and the farmer
would have to compensate him in order to not
pollute?
Example:
• And, if the property rights belong to the
farmer?
The Coase’s Theorem:
• Coase argues that, for the economic efficiency
point of view, the result would be the same
regardless the of the property rights given that
the transaction costs are null.
Numeric Example I:
• Cost of pollution over the farmer = $500
• Cost of cleaning from the farmer = $300
• Cost of cleaning from the firm = $100
– Case I:
• The farmer has the property rights.
• The firm will pay for the right to pollute, It pays $100 at maximum
• The farmer would accept more than $300 only since he/she would
have to clean the water in order to avoid the cost of $500
• Thus, the is no agreement and the firm purifies the water itself.
Numeric Example I:
• Cost of pollution over the farmer = $500
• Cost of cleaning from the farmer = $300
• Cost of cleaning from the firm = $100
– Case II:
• The firm has the property rights.
• The farmer will pay for the firm to not pollute. It pays $300 at
maximum
• The farmer would accept to pay no more than $100 since he/she
could clean the water at this price.
• Thus, the farmer pays between $100 and $300 and the firm
purifies the water itself.
The solution is the same in both cases
• The solution is economically efficient
Efficiency vs. Equity
• Although the reached solution are not
affected by the property rights the distribution
between the parts involved would be.
Efficiency vs. Equity
• When the property rights belong to the
farmer, the firm has a cost of $100.
Efficiency vs. Equity
• However, when the property rights belong to
the firm, the farmer pays at least $100 and
part of the exceeding of $200. This “rent” of
$200 will be allocated by negotiations
between the parts.
What is the fairest solution?
• Coase recommends that we should not
conclude too fast.
• He calls our attention to the reciprocal nature
of the problem.
Graphic Example.
MB for the firm
to pollute
MC of the
pollution over
the farmer
c
a
d
b
1
2
3

If the firm has PR it pollutes until 3. The farmer can convince the firm to
pollute until 2 offering more of ‘d’. The farmer would thus win c+d.
MB for the firm
to pollute
MC of the
pollution over
the farmer
c
a
d
b
1
2
3

If the farmer has the PR he/she prefers 1 (if there is no
negotiation). The firm can compensate the farmer to pollute at 2
offering more of ‘b’.
MB for the firm
to pollute
MC of the
pollution over
the farmer
c
a
d
b
1
2
3

Necessary conditions to reach the
negotiated result:
• Well defined property rights. It implies
political and judicial institutions that work
well.
• Low transaction costs
• Information about all costs of each possible
result for each part involved.
Polemic Implications of the
Coase’s Theorem
• In many cases there are no necessity of
governmental interventions in order to solve
problems of externalities since the private
negotiations reach the economically efficient
solution.
Limitations of the Coase’s Theorem:
• The transactional costs usually are not small,
especially when several players are involved.
• There exist public and private externalities. In the
public ones there are the free-ridding problem.
• There exist the problem of inter-temporal
transactions with future generations.
• The initial distribution of the property rights can
affect the capacity of negotiation of each part.
• Even when the theorem fits there are room for
government role.
Role of the government is to help greasing
the private negotiation
• Property rights have to be well defined and allocated clearly.
• The government has to monitor the environment aiming at
identifying who are the polluters and who are victims of the
pollution. This information has to be publicized for all parts
that have been affected.
• The government must establish, quantify, and publicize the
legal rules that regulates the environment in order to make it
easier the private negotiations.
• Access to the judicial system has to be facilitated and cheap
Regulation and the
Coase’s Theorem
• As in practical terms those conditions are rarely
found, the coase’s solution is not viable (this is
exactly what Coase claims!)
• Therefore, the regulation becomes necessary.
• The transactions costs are the key. Whose are the
political property rights? What are the political
transaction costs?
• The results usually are not efficient
Regulation and the Coase’e Theorem
• Reasons why it is difficult to make side
payments:
– Informational problems, uncertainty, difficulties of
measuring costs and benefits
– Collective action problems
– Inexistence of a market of political property rights
(political risks)
Delegating Powers
A Transaction Cost Politics Approach
to Policy making under Separate
Powers
David Epstein & Sharyn O’Halloran
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Executive Discretion
Average Discretion of the Executive in the EUA
40
35
30
25
20
15
10
5
0
Puzzle
• Why does Congress delegate broad authority
to the executive in some policy areas but not
in others?
• Can Congress perfectly control delegated
authority through administrative procedures,
oversight, and administrative law?
Question
• When does Congress specify the details of policy in
legislation, and when does it leave these details to
regulatory agencies?
• What are the implications of this institutional choice for
policy outcomes?
 Basic question of policy making in a
separation of powers system.
Transaction Cost Politics
• Policy can be made (i) in Congress, (ii)
through delegation authority to the
executive agencies, or a (iii) mixture of these
two.
• When deciding where policy will be made,
Congress trades off the internal policy
production costs of the committee system
against the external costs of delegation
• (make-or-buy decision).
Theory:
• A policy will be made in the politically most
efficient manner; that is, maximizing
legislators’ political goal: reelection.
• Legislators will prefer to make policy
themselves as long as the political benefits
they derive from doing so outweighs the
political costs; otherwise, they will delegate
to the executive
Abdication versus delegation?
• Implications:
– To what extent can Congress control unelected regulatory
agencies when delegating authority?
• Lowi (1969)
– Congress has surrendered their legislative authority to
bureaucrats
• MCNOLGAST (1987, 1989)
– Legislators can control bureaucrats through oversight,
administrative procedures and enfranchising third parties into
the decision-making process.
Authors’ Claim:
• A theory of oversight divorced from a theory
of delegation will overlook the fact that those
issue areas in which the executive makes
policy differ from those in which Congress
makes policy itself.
Legislative organization and delegation
• Distributive versus informational theories
– This is a false dichotomy (whether committee
serves pork barrel projects or legislators’ desire to
avoid the consequences of ill-informed policies):
• Some policy areas are more characterized by
informational concerns and other by distributive. The
first ones tend to be delegated and the second tend to
be made in Congress
Divided Government and Delegation
• To what extend will an opposing Congress delegate
more powers to the executive?
• Mayhew (1991): the same number of legislation get
passed under unified and divided government. It
doesn't lead to gridlock.
– However, the authors call our attention to the quality of bills
passed:
• Congress delegate less and constrains more under divided
government: procedural gridlock, that is, producing executive
branch agencies with less authority to make policy and
increase oversight from congressional committees.
What does Transaction Cost mean?
• Anything that makes reality deviate from this
Coasian world:
– “anything that impedes the specification,
monitoring, or enforcement of an economic
transaction is a transaction cost” (Dixit 1966).
Common elements of the Transaction Costs
analysis:
1. The contract is the unit of analysis
2. The contracts are enforceable by some neutral thirdparty
3. Assumes the existence of multiple governance
structures
4. Economic actors are assumed to be boundedly
rational (agents cannot eliminate transaction costs by
simply contracting)
5. Holdup problems
Contracts are incomplete and ambiguous
Theory of Transaction Cost politics
• Delegation to a bureaucracy is subjected to
the political equivalent of a holdup problem;
so Congress will delegate to the executive
when the external transaction costs of doing
so are less than the internal transaction costs
of making policy through the normal
legislative process of the committees.
Reasons not to delegate
• With transaction costs equal to zero Congress might like
to delegate broad discretionary authorities and agencies
might like to receive such authority (please everyone).
However,
–
–
–
–
Difficult to control and monitoring
Incomplete contracts
Uncertainty of future opportunistic behavior
Impossibility of binding the actions of agency successors
Reasons to delegate
•
•
•
•
Save time/Reduce congress workload
Take advantage of agency expertise
Protect special interests
Blame-shifting (avoiding the inefficiencies of committee
system)
– Delays, logrolling, informational inefficiencies, etc.
These do not explain why delegate in
some policy areas rather than others.
Neither alternative is perfect…
• However, in some specific cases delegate or
not (how mach delegate) would be relatively
more attractive than from the median
legislator’s preference.
Basic Assumptions
• Two alternative modes of policy making
– Congress:
• Committee System
– Regulatory Agencies:
• Delegation to Executive
• Legislators decide where policy is made.
• Legislators’ primary goal is reelection
– Authority will be allocated across the branches
in a politically efficient manner
Division of Labor
• Each alternative mode of policy making has its own
set of inefficiencies:
– Legislative Policy Making (Committees)
• Logrolling, delay, informational problems
– Agency Policy Making (Delegation)
• Principal-agent problems of oversight
So when deciding where policy will be made,
legislators trade off these internal and external
inefficiencies.
Make-or-Buy
• Congress’s decision to delegate is like a
firm’s make-or-buy decision.
– Legislators can either produce policy internally,
OR
– Legislators can subcontract out (delegate) to
the executive.
Discretion Continuum
Legislative
Policymaking
Low Discretion
D
Agency
Policymaking
High Discretion
Discretion Continuum
Legislative
Policymaking
Low Discretion
Trade Off:
D
Agency
Policymaking
High Discretion
Legislative vs.
Agency
Policymaking
Policymaking
Discretion Continuum
Legislative
Policymaking
Low Discretion
Trade Off:

D
Agency
Policymaking
High Discretion
Legislative vs.
Agency
Policymaking
Policymaking
Amount of discretion delegated to the executive
balances these costs at the margin.
The formal decision to delegate:
1. The legislation (bill) is the unit of analysis
2. There exist enforceable mechanisms for inter-branch
contracts
3. Multiple possible governance structures
4. Bounded-rationality
5. Holdup problem
6. Internal transaction cost of production
7. A decision mechanisms predicting which governance
structure will be chosen
Model Elements
• Actors: Floor, Comm., Pres., Agency
• Policy space: X = 1, status quo x0=0
• Preferences: –(x-xi)2 xF=0, xP>0
– Implies that all actors will be risk averse
• Outcomes: x = p +  ,  ~ U[-R,R]
– Agencies have perfect information of 
– Committees only know sign of 
– Floor knows ex ante distribution of 
Model:
• Players:
– Median floor voter in Congress (F)
– Congressional Committee (C)
– President (P)
– Agency (A)
• One-dimension policy; single-pick preferences, median voter (pivotal)
• Each player has a most-preferable policy or ideal point and are riskaverse (dislike uncertainty)
• Policy outcomes are not necessarily the same as the policies that
emerged from the policymaking process.
– That is, X = p + 
Model:
• The players start the game with probabilistic
beliefs about the value of .
• These beliefs are uniform in some interval [-R,
R].
• During the game, players will try to gather
more information (expertise) about the exact
value of 
Game Tree
Floor sets policy pF
Committee
learns  >0 or  <0,
reports bill (b)

N
Don't
Delegate
C
x=pF+
F
F
Delegate
P
F
Floor sets
discretion (d),
status quo (SQ)
Institutional Choice
A
President sets
Agency ideal
point xA
Policy Making Process
x=SQ+pA+
Agency learns
exact value of  
sets policy pA s.t.
|pA|  d
Final
Outcomes
Sequential Signaling game:
1. Institutional choice
–
While the agency observes the exact value of , the
committee observes only whether  lies in the interval range
[-R, 0] or the range [0. R]; that is, the committee sees only the
sign of .
2. Policy-making Process
–
Choice of buying or making the policy.
3. Final outcome
–
–
Committee: X = p + 
Agency: X = SQ + pa + 
Solving the Game
• Agency sets policy as close to its ideal point as
possible, given limits on discretion.
• President sets Agency’s ideal point to equal her
own: xA=xP.
• Congress sets status quo and discretion:
– Set SQ to get its ideal point in expectation, given beliefs
about ;
– Set discretion d=R-xP.
Theoretical Propositions
• In equilibrium, Congress will delegate more
discretionary authority to the executive:
1. The lower the level of congressionalexecutive conflict;
2. The higher the level of committee-floor
conflict;
3. The higher the level of uncertainty in the policy
environment.
Deliberate Discretion?
The Institutional Foundation of
Bureaucratic Autonomy
John Huber & Charles Shipan
What this book is about?
• How elected officials use the statutes to
establish policy details in effort to achieve
desired outcomes.
• Develop and test a theory of delegation that
explains the choice of how to delegate aiming
at understanding how institutional context
affects delegation strategies.
Two types of designing statutes:
1. To write long statutes with extremely
detailed languages in a effort to
micromanage the policymaking process.
2. To write vague statutes that have many
details unspecified, thereby delegating
policymaking authority to other actors,
usually bureaucrats.
Vague (Germany) versus specific (Ireland) statutes
about sexual harassment:
• Why has the same policy issue been treated
differently by politicians in distinct political
systems?
• Why these choice matter?
• Is the transferred discretion a deliberate
choice?
Delegation as double-edge sword
• “the central reason for granting policymaking autonomy
to bureaucrats – their technical expertise – also creates a
big problem, as bureaucrats can use their knowledge
against politicians. Bureaucratic expertise is thus a
double-edge sword, creating both the incentive for
legislatures to give policymaking power to bureaucrats
and the opportunity for these bureaucrats to act counter
to legislative preferences” (Peters 1981)
Two prevalent views:
• Bureaucratic discretion (bureaucratic
dominance)
versus
• Deliberate discretion (politicians dominance.
That is, politicians would have capacity to
control bureaucrats and achieve their goals by
delegating)
Alternative view:
• Rather than asking to what extent politicians control
bureaucrats, the authors assume that in any political
context there typically exists a politician who has
greater opportunities than other political actors to
influence bureaucratic behavior.
– In parliamentary democracy = Cabinet
– In presidential system = president or governors
4 factors that affect politician’s incentives to
micromanage policymaking
1. Level of political conflict between politicians who
adopt the statute and bureaucrats who implement
them
2. The capacity of politicians to write detailed statutes
3. The bargaining environment (e.g. the existence of
vetoes or bicameral conflicts) in which the statutes are
adopted
4. The politicians’ expectation about non-statutory factors
such as the role of courts or legislative oversight.