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Political Economy (Aggregating Preferences (Consistent aggregation needs…
Political Economy
Aggregating Preferences
Consistent aggregation needs to fulfill 3 conditions:
- Pareto criterion: If all voters prefer A to B, social choice rule should choose A over B
- Transitivity: If A is preferred to B, and B is preferred to C, then aggregation must be such that A is also preferred to C
- Independence of Irrelevant Alternatives: If A is preferred to B, and C is added to the choice set, then A should still be preferred to B
Gibbard-Satterthwaite: Even before we confront preference aggregation, voting rules are subject to preference revelation concerns.
Condorcet Paradox: Majority voting does not lead to stable outcome.
- Through majority outcome, we can get a majority cycle
- We cannot find a stable equilibrium because we have non-single-peaked preferences, and thus, there is not one level that is preferred to all other levels
Single-peaked preferences
A group of agents is said to have single-peaked preferences if:
- Each agent has an ideal choice in the set
- For each agent, outcomes that are further from his ideal choice are preferred less.
With single-peaked preferences, you will select the median quantity for an outcome.
Arrow's impossibility theorem: The only choice rule that satisfies the Pareto criterion, transitivity, and IIA, is dictatorship2 key assumptions to ensure existence of equilibrium
- G is unidimensional (only choose between 2 options)
- Preferences over G are single-peaked
Median voter theorem: With single-peaked preferences, majority voting produces equilibrium.
- Equilibrium outcome is the median of the distribution of preferred G.
- However, this equilibrium may not be Pareto efficient, i.e. it does not satisfy the Samuelson condition.
Preference Revelation
Need to be able to elicit truthful revelation of preferences
- Achieved through price mechanism in competitive private markets
- However, in many contexts (e.g. public goods), this is infeasible
If one knows how much people value a public good, one can implement Lindahl tax. However, people may under-report their value because of the free-rider problem
Certain mechanisms (e.g. Clark-Groves mechanisms) can help by "internalising" the externality implicit in free-rider problem via side-payments
Gibbard-Satterthwaite Theorem
For any voting rule, one of the following must hold:
- Only 2 options are considered
- Voters will not truthfully state their preferences
- Rule is dictatorial
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Corruption
Olken (2006), Betrand et al (2007), Ferraz & Finan (2008)
Electoral Accountability
- Theoretically, electoral accountability can reduce corruption
- However, it depends a lot on the institutions and on politicians' motivations and incentives structures
- Also, if people stay in office for too long, they can become more knowledgeable and work around the system
Special interest politics
- Politicians can have the incentive to implement policies in which they have special interests (e.g. lobbying)
- Many policies create concentrated benefits for a few well-defined groups, and with cost diffused in society at large
Scope of Government
- Incomplete contracts are prevalent
- Ownership is defined by residual right of control: who gains the benefits/bears the costs of actions taken outside scope of a contract
New Contract Theory
Emphasises importance of ownership for incentives to invest:
- To reduce costs
- To improve quality and innovate
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Case for privatisation is stronger when:
- Quality-reducing cost reductions can be controlled by contract
- Innovation is important and competition effective
- Government suffers from patronage and inefficiency
- E.g. mail services
Case for privatisation is weaker when:
- Cost reductions likely to lead to a non-contractible deterioration of quality
- Innovation is relatively unimportant. Competition is weak and consumer choice is ineffective
- Reputational mechanisms are ineffective
- E.g. police
Hart, Shleifer & Vishny (1997) has a good chart on privatisation. Look at lecture notes.