Chapter 16 Public Choice: Politics in Government and the Workplace 9 including both city and suburbs, could spread the tax burden over all those who benefit from city services. Consolidation can be a mixed blessing, however, if it reduces competition among governments. A large government restricts the number and variety of alternatives open to citizens and increases the cost of moving to another locale by increasing the geographical size of its jurisdiction. Consolidation, in other words, can increase government’s monopoly power. As long as politicians and government employees pursue only the public interest, no harm may be done. In fact, the people who run government have interests of their own. So the potential for achieving greater efficiency through consolidation could easily be lost in bureaucratic red tape. Studies of consolidation in government are inconclusive, but it seems clear that consolidation proposals should be examined carefully. The Economics of Government Bureaucracy Bureaucracy is not limited to government. Large corporations like General Motors and AT&T employ more people than the governments of some nations. They are bigger than the major departments of the federal government—although no company, of course, is as large as the federal government as a whole. Yet corporate bureaucracy tends to work more efficiently than government bureaucracy. The reason may be found in the fact that it pursues one simple objective—profit—that can be easily measured in dollars and cents. Certainly the reason cannot be that stockholders are better informed than voters. Most stockholders are rationally ignorant or their companies’ doings, for the cost of becoming informed outweighs the benefits. Even in very large corporations, however, some individuals hold enough stock to make the acquisition of information a rational act. Often such stockholders sit on the company’s board of directors, where their interest in increasing the value of their own shares makes them good representatives of the rest of the stockholders. The crucial point is that this informed stockholder has one relatively simple objective—profit—and can find out relatively easily whether the corporation is meeting it. The voter, on the other hand has a complicated set of objectives and must do considerable digging to find out whether they are being met. Because most corporations function in competitive markets, the stockholder’s drive toward profit is reinforced. General Motors knows that its customers may switch to Toyota if it offers them a better deal. In fact, stockholders can sell their General Motors stock and buy stock in Toyota. Thus corporate executives make decisions on the basis of the consumer’s well being—not because they wish to serve the public good but because they want to make money. Government bureaucracies, on the other hand, tend to produce public goods and services for which there is no competition. No built-in efficiencies guard the taxpayer’s interests in a government bureaucracy. Both government bureaucrats and corporate executives base their decisions on their own interests, not those of society, but competition ensures that the interests of corporate decision makers coincide with those of consumers. No such safeguards govern the operations of government bureaucracies. Bureaucracies are constrained by political, as opposed to market, forces. Chapter 16 Public Choice: Politics in Government and the Workplace 10 From the economist’s point of view, one of the advantages of the profit- maximizing goal of competitive business is that it enables predictions. Although some business people pursue other goals—personal income, power, respect in the business— their behavior can generally be well explained in terms of the single objective, profit. There is no single goal like profit that drives the government bureaucracy. Different bureaucracies pursue different objectives. We do not have time or space to consider all the possible objectives of bureaucracy, but we will touch on three: monopolistic profit maximization, size maximization, and waste maximization. Profit Maximization Assume that police protection can be produced at a constant marginal cost, as shown by the horizontal marginal cost curve in Figure 16.2. The demand for police protection is shown by the downward-sloping demand curve D. If individuals could purchase police service competitively at a constant price of P 1 , the optimum amount of police service would be Q 2 , the amount at which the marginal cost of the last unit of police service equals its marginal benefit. The total cost would be P 1 x Q 2 (or the area 0P 1 a Q 2 ), leaving a consumer surplus equal to the triangular area P 1 P 3 a. Police protection is usually delivered by regional monopolies, however. That is, all police services in an area are supplied by one organization. These regional monopolies have their own goals and their own decision-making process, which do not necessarily match the individual taxpayers’. If police service must be purchased from such a profit-maximizing monopoly, service will be produced to the point where the marginal cost of the last unit produced equals its marginal revenue: Q 1 . The monopolist will set that quantity above cost at price P 2 , making a profit equal to the rectangular area P 1 P 2 ed. _________________________________________ FIGURE 16.2 Bureaucratic Profit Maximization Given the demand for police service, D, and the marginal cost of providing it, MC, the optimum quantity of police service is Q 2 . A monopolistic police department interested maximizing its profits will supply only Q 1 service at a price of P 2 , however. (A monopolistic bureaucracy interested in maximizing its size would expand police service to Q 3 .) Chapter 16 Public Choice: Politics in Government and the Workplace 11 At the monopolized production level, there is still some surplus—the triangular area P 2 P 3 e—left for consumers, but they are worse off than under competitive market conditions. They get less police protection (Q 1 instead of Q 2 ) for a higher price (P 2 instead of P 1 ). This analysis presumes that the police are capable of concealing their costs. If taxpayers know that P 2 is an unnecessarily high price, the outcome will be the same as under competition. They will force the police to produce Q 2 protection for a price of P 1 . Size Maximization In fact, a government bureaucracy is unlikely to take profit as its overriding objective, if only because bureaucrats do not get to pocket the profit. Instead, government monopolies may try to maximize the size of their operations. For if a bureaucracy expands, those who work for it will have more chance of promotion. Their power, influence, and public standing will improve, along with their offices and equipment. What level of protection will a police department produce under such conditions? Instead of providing Q 1 service and misrepresenting its cost at P 2 , it will probably provide Q 3 service—more than taxpayers desire—at the true price of P 1 . The bill will be P 1 x Q 3 , or the area 0P 1 b Q 3 in Figure 16.3. Note that the net waste to taxpayers, shown by the shaded area abc, exactly equals the consumer surplus, P 1 P 3 a. By extending service to Q 3 , the police have squeezed out the entire consumer surplus and spent it on themselves. _________________________________________ FIGURE 16.3 Bureaucratic Waste Maximization Given a demand for police service D and a marginal cost of providing it MC 1 , the optimum quantity of police service will be Q 2 . A monopolistic bureaucracy, however, may seek to maximize waste by inflating its costs to MC 2 . It will supply Q 2 units of police protection at a tax price of P 2 instead of P 1 . The shaded area abc shows the waste created, which exactly equals the consumer surplus P 2 P 3 a. Waste Maximization Instead of maximizing the amount of service they offer, bureaucrats may choose to maximize waste. They can increase their salaries, improve their working conditions, or Chapter 16 Public Choice: Politics in Government and the Workplace 12 reduce their workloads. All such changes increase the cost of providing a given amount of service. Figure 16.3 shows how far a bureau can go in increasing the cost of, or budget for, its services. The marginal cost curve MC 1 is the minimum cost of providing additional police protection. The optimum quantity of police protection is therefore Q 2 , the same as in Figure 16.2, but if the police pad their costs, the marginal cost curve will shift up to MC 2 . The bureau’s budget climbs from P 1 x Q 2 to P 2 x Q 2 . Note that beyond Q 1 , the marginal cost of additional police service is now greater than its marginal benefit, indicated by the demand curve. Again, the police are wasting taxpayers’ money, as shown by the shaded triangular area abc. By moving their cost curve to MC 2 , they have managed to extract all the consumer surplus (shown by the triangular area P 2 P 3 a) and to spend it on unnecessary frills. In real life, most bureaucratic monopolies may pursue both size maximization and waste maximization. For each unit of service they provide, they will try to expand both the size of their operation and the funds spent on it—but they do have to make tradeoffs between the two objectives. Whenever they expand their size, they must forgo a certain amount of expansion in their cost per unit of service. There is, after all, only so much consumer surplus that can be extracted from the system. Figure 16.4 shows one possible combination of size and budget maximization. In this case the department chooses to expand its service from Q 1 to Q 2 . Having done so, it can expand its cost per unit only to MC 2 . Again, the shaded triangular area that indicates waste, abc, just equals the consumer surplus P 2 P 3 a. Fortunately government bureaucracies do not usually achieve perfect maximization of size or waste. For one thing, most legislatures have at least some information about the production costs of various services, and bureaucrats may not be willing to do the hard work necessary to exploit their position fully. If bureaucracy does not manage to capture the entire consumer surplus, citizens will realize some net benefit from their investment. ___________________________________ FIGURE 16.4 Size and Waste Maximization Combined The monopolistic bureaucracy may choose to increase both its size and the cost of its service. Any increase to one must come at the cost of the other, however, for together the two increases must not exceed the consumer surplus. Here net waste, shown by the shaded triangular area abc, is divided between size and cost increases. The area between the two marginal cost curves MC 1 and MC 2 represents waste maximization. The are below the marginal cost curve MC 1 represents size maximization. The whole area abc exactly equals the consumer surplus P 2 P 3 a. Chapter 16 Public Choice: The Economics of Government Making Bureaucracy More Competitive What can be done to make government bureaucracy more efficient? Perhaps the development of managerial expertise at the congressional level would encourage more accurate measurement of the costs and benefits of government programs. Cost-benefit analysis alone, however, will not necessarily help. As long as special-interest groups, including those of government employees, exist, the potential for waste can be substantial. A better solution to bureaucratic inefficiency may be to increase competition in the public sector. In the private marketplace, buyers do not attempt to discover the production costs of the companies they buy from. They simply compare the various products offered, in terms of price and quality, and choose the best value for their money. A monopoly of any kind, of course, makes that task difficult if not impossible, but the existence of even one competitor for a government bureaucracy’s services would allow some comparison of costs. The more different sources of a service, the flatter the demand curve faced by each source, and the more efficient it must be to stay in business. How exactly can competition be introduced into bureaucracy? First, proposals to consolidate departments should be carefully scrutinized. What appears to be wasteful duplication may actually be a source of competition in the provision of service. In the private sector, we would not expect the consolidation of General Motors, Ford and Chrysler to improve the efficiency of the auto industry. If anything, we would favor the breakup of the large firms into separate, competing companies. Why then should we merge the sanitation departments of three separate cities? A second way to increase the competitiveness of government services is to contract for them with private producers. Many government activities that must be publicly financed need not necessarily be publicly produced. In the United States, highways are usually built by private companies but repaired and maintained by government. Competitive provision of maintenance as well as construction might reduce costs. Other services that might be “privatized” are fire protection, garbage collection, and education. Finally, competition can be increased simply by dividing a bureaucracy into several smaller departments with separate budgets, thus increasing competition. Such a change would reduce the costs citizens must bear to move to an area that offers better or cheaper government services. The loss (or threat of loss) of constituents can put pressure on government to improve its performance. MANAGER’S CORNER: Why Professors Have Tenure and Business People Don’t Tenure is nothing short of a Holy Grail for newly employed assistant professors in the country’s colleges and universities. Without tenure, faculty members must, as a general rule, be dismissed after seven years of service, which means they must seek other academic employment or retreat from academic life. With tenure, professors have the Chapter 16 Public Choice: Politics in Government and the Workplace 14 equivalent of lifetime employment. Rarely are they fired by their academies, even if they become incompetent at teaching and/or researching. Business people rarely, if ever, have the type of tenure protection that professors do. Why the different treatment? Is it that universities are stupid, bureaucratic organizations in which professors are able to obtain special treatment? Maybe so, but we would like to think not. (Indeed, we think our universities have shown great wisdom in granting us both tenure in our current positions, from which we could not be dislodged with anything short of a direct nuclear hit!) We suggest that our explanation for why professors have tenure will help us understand why some form of tenure will gradually find its way into businesses that have begun to rely progressively more on “participatory management” (with low-ranking managers and line workers having a greater say in how the business is conducted). The Nature of Tenure Professors do not, of course, have complete protection from dismissal, and the potential for being fired is surely greater than that reflected in the number of actual firings. However, when professors are fired it is generally for causes unrelated to their professional competence. The most likely reasons for dismissal are “moral turpitude” (which is academic code for sexual indiscretions with students) and financial exigencies (in which case, typically, whole departments are eliminated). Most proponents and opponents of academic tenure like to think of it in emotional terms: “Tenure is stupid” or “Tenure ensures our constitutional rights.” We would like to suggest that tenure be treated as a part of the employment relationship. It amounts to an employment contract provision that specifies, in effect, that the holder cannot easily be fired. To that extent, tenure provides some employment security, but by no means perfect security. A university may not be able to fire a faculty member quickly, but it can repeatedly deny salary increases and gradually increase teaching loads until the faculty member “chooses” to leave. 5 Clearly, tenure has costs that must be suffered by the various constituencies of universities. Professors sometimes do exploit tenure by shirking their duties in the classroom, in their research, and in their service to their universities. However, tenure is not the only contract provision that has costs. Health insurance (as well as a host of other fringe benefits) for professors imposes costs directly on colleges or universities and indirectly on students. Nonetheless, health insurance costs continue to be covered by universities because the benefits matter too, not just the costs. Health insurance survives as a fringe benefit because it represents, on balance, a mutually beneficial trade for the various constituencies of universities. Universities (which can buy group insurance policies more cheaply than individual faculty members) are able to lower their wage bills by more than enough to cover the insurance costs because they provide health insurance. 5 Accordingly, the degree of protection tenure affords is a function of such variables as the inflation rate. That is, the higher the inflation rate, the more quickly the real value of the professor’s salary will erode each time a raise is denied. Chapter 16 Public Choice: Politics in Government and the Workplace 15 By the same token, professors pay for tenure just as they do other fringe benefits; presumably tenure is worth more to them than the value of the foregone wages. Why tenure? Any reasonable answer must start with the recognition that academic labor markets are tolerably, if not highly, competitive, with thousands of employers and hundreds of thousands of professors, and wages and fringe benefits respond fairly well to market conditions. If, in fact, tenure were not a mutually beneficial trade between employers and employees, universities -- which are constantly in search of more highly qualified students, faculty at lower costs, and higher recognition for their programs -- would be expected to alter the employment contract, modify the tenure provision, increase other forms of payment, and lower overall university costs. 6 The analysis continues with the recognition that jobs vary in difficulty, in time and skills required, and in satisfaction. “Bosses” can define many jobs, and they are generally quite capable of evaluating the performance of those they hire for these jobs. In response to sales, for example, supervisors in fast food restaurants can determine not only how many hamburgers to cook but also how many employees are needed to flip those hamburgers (and assemble the different types of hamburgers). Where work is relatively simple and routine, we would expect it to be defined by and evaluated within an authoritarian/hierarchical governance structure of firms, as is generally true in the fast-food industry. Academic work is substantially different, partially because many forms of the work are highly sophisticated, its pursuit cannot be observed directly and easily (given the reliance on thinking skills), and it involves a search for new knowledge which, when found, is transmitted to professional and student audiences. (Academic work is not the only form of work that is heavily weighted with these attributes, a point that will be reconsidered later.) Academic supervisors may know in broad terms what a “degree” should be and how “majors” should be constituted at any given time. However, they must rely ultimately and extensively (but not necessarily completely) on their workers/professors to define their own specific research and classroom curriculums and to change the content of degrees and majors as knowledge in each field evolves. Academic administrators employ people to conduct research and explore uncharted avenues of knowledge that the administrators themselves cannot conduct or explore because they lack knowledge of a field, have no time, or are not so inclined to do so. Fast-food restaurants can be governed extensively (but not exclusively) by commands from supervisors, and there is an obvious reason why this is possible. Again, the goods and services produced are easily valued and sold, with little delay between the time they are produced and the time the value is realized and easily evaluated. Workers in such market environments would be inclined to see supervisors as people who 6 Granted, tenure may be required by accrediting associations. However, there is no reason that groups of universities could not operate outside accrediting associations or organize their own accrediting associations without the tenure provision -- if tenure were, on balance, a significant impairment to academic goals. In many respects, the accrediting association rules can be defended on the same competitive grounds that recruiting rules of the National Collegiate Athletic Association are defended. See Richard B. McKenzie and T. Sullivan, “The NCAA as a Cartel: An Economic and Legal Reinterpretation,” Antitrust Bulletin, no. 3 (1987), 373-399. Chapter 16 Public Choice: Politics in Government and the Workplace 16 increase the income of stockholders and workers mainly by reducing the extent to which workers shirk their agreed upon duties. Academe, however, is a type of business that tends to be worker managed and controlled, at least in many significant ways. This aspect of the academic marketplace solves many decision-making problems but introduces other serious problems of unstable, if not volatile and uncertain, decisions over time and circumstances from which professors will seek contractual protection. Professors are extensively called upon to determine what their firms (universities) produce (what research will be done, what courses are required, and what will be the contents of the various courses, even who will be taught). In addition, they help to determine who is hired to teach identified courses and undertake related research, how workers are evaluated, and when they are fired. Our argument can be stated without using the examples of fast food and academe, but those examples enable us to deduce a managerial principle of sorts: the simpler it is to accomplish a job, the more likely it is that managerial control will be delegated to a supervisor. The more sophisticated, esoteric, and varied the job to be done, the more likely managerial control will be relegated to the workers themselves and the more democratic the decision-making will be. 7 Again, why academic tenure? We think the forces of supply and demand for tenure are at work. Economists have argued that universities have reason to “supply” tenure. 8 The reason given: professors are called upon to select new members, which stands in sharp contrast to the way similar decisions are made in business as well as in sports. In baseball, the owners through their agents determine who plays what position on the team. Baseball is, in this sense, “owner managed.” In academe, the incumbent professors select the team members and determine which positions they play. Academe is, in this sense, “labor managed.” In baseball, the owners’ positions are improved when they select “better players.” On the other hand, in academe, without tenure, the position of the incumbent decision- makers could be undermined by their selection of “better professors,” those who could teach better and undertake more and higher quality research for publication in higher- ranking journals. 9 Weaker department members would fear that their future livelihoods (as well as prestige) would be undermined by revelation of their honest evaluations of candidates who are better than themselves. Thus, tenure can be construed as a means employed by university administrators and board members -- who must delegate decision-making authority to the faculty but 7 Of course, not all academic environments share the same goals or face the same constraints. Some universities view pushing back the frontiers of knowledge as central to their mission, while others are intent on transmitting the received and accepted wisdom of the times, if not the ages. Some universities are concerned mainly with promoting the pursuit of usable (private goods) knowledge, that which has a reasonable probability of being turned into salable products, while other universities are interested in promoting research the benefits of which are truly public, if any value at all can be ascertained. 8 H. L. Carmichael, “Incentives in Academics: Why Is There Tenure?” Journal of Political Economy, vol. 96, no. 2 (1988), pp. 453-472. 9 “Loosely, tenure is necessary,” Carmichael concludes, “because without it incumbents would never be willing to hire people who turn out to be better than themselves” (Ibid., 1988, p. 454). Chapter 16 Public Choice: Politics in Government and the Workplace 17 who still want to elevate the quality of what is done at their universities -- to induce faculty members to honestly judge the potential of the new recruits. In effect, university officials and board members strike a bargain (with varying degrees of credibility) with their professor-decision-makers: If you select new recruits who are better than you are, you will not be fired. Universities have reason to supply tenure, but what reason do professors have to demand it? We don’t buy the argument that most faculty members want to be protected from the broader political forces outside the ivy-covered walls of their universities. Too few faculty members ever go public with their work or say anything controversial in their classes for them to want to give up very much for such protection from external forces. Rather, we believe tenure is designed to protect professors from their colleagues, acting alone or in political coalitions, in a labor-managed work environment operating under the rules of academic democracy. That is, faculty members demand tenure so that there will be little or no incentive for other faculty members to run them out of the decision-making unit. Academic work is often full of strife, and the reasons are embedded in the nature of the work and the way work is evaluated and rewarded, a point one of the authors has discussed in detail elsewhere. 10 Suffice it to say here that tenure is a means of putting some minimum limits on political infighting. It increases the costs predatory faculty members must incur to be successful in having more productive colleagues dismissed. More importantly, academic decisions on the worth of colleagues and their work are often made by the rules of consensus or democracy among existing incumbents. Certainly, most professors understand both the esoteric nature of their work and the problems of short-term evaluations. At the same time, they understand that in an academic democracy, ever-changing groups of colleagues have a say in how the work of each professor is evaluated. They recognize implicitly, if not explicitly, that how their work is evaluated by a changing group of colleagues can depend, at the time, on what their work is being compared with. A microeconomics scholar can appreciate the fact that the relative ranking of his or her research depends upon whether it is being judged relative to the work of macro or public policy scholars. In addition, professors understand that the relative standing of their positions and ranking of their research can change over time with changes in the cast of decision- makers, who are likely to adjust their assessments from time to time. The ranking of their research can also change with shifts in the relative merit department members assign different types and forms of academic work. For example, a macro person understands that even though his or her publications may now be highly valued (relatively) within the department, the ranking can easily change, because changes occur in the way evaluations are made, existing department members periodically reassess the relative worth of different types of work, and the cast of decision-makers changes. When the decision-making unit is multi-disciplinary, shifts in the relative assessments of the worth of individual professors’ work in the different disciplines can fluctuate even more 10 Richard B. McKenzie, “The Economic Basis of Departmental Discord in Academe,” Social Science Quarterly, no. 1 (1979), pp. 653-664. Chapter 16 Public Choice: Politics in Government and the Workplace 18 dramatically, given that each professor is likely to have allegiance first to his or her own discipline and then to other closely related disciplines. Within schools of business, for example, accounting faculty members may have, on the margin, an incentive to depreciate the work of marketing professors, given that such depreciation may shift positions to accounting -- and vice versa. Even more fundamentally, organizational theorists steeped in behavioral psychology may have an incentive to depreciate the work of professors in finance -- which is grounded in economics -- given that negative shifts in the relative evaluation of economic-based work can marginally improve the chances of positions being shifted to, say, accounting. Like- minded faculty members can be expected to coalesce to increase their political effectiveness in shaping decisions that can, in turn, inspire the formation of other coalitions, thus motivating all coalitions to increase their efforts. The inherent instability of coalitions can, of course, jeopardize anyone’s job security and long-term gains. Professors have understandable reasons for demanding tenure. One is that the esoteric nature of their work (which they may undertake at the behest of their universities) may diminish the market value of their skills because the narrow focus of their work might not translate into alternative future job opportunities in the market place. Another reason is that there are political problems inherent within all democratic processes, and professors want, in effect, to be protected from the process and from their colleagues. If their work is intensely specialized, they want some assurance of job security to protect against the changing assessments by ever-changing majorities. Universities can be seen as willing to provide tenure because they must delegate decision-making power to those who have the requisite knowledge and information of different disciplines if they want faculty members to specialize their efforts. Universities also realize, given the nature of academic democracy and the threat it poses, that faculty members have inherent reasons for demanding tenure, and these make it possible to recoup the cost of tenure by reducing professorial wages to less than what they would have to be if the professors did not share a need for job security. Of course, this line of analysis leads to a number of deductions: • If the work of professors were less specialized, professors would be less inclined to demand tenure. For example, in colleges in which the emphasis is on teaching rather than research, tenure would be less prevalent, or less protective. • As a group of decision-makers or a discipline becomes more stable, we would expect faculty to consider tenure less important and to be less willing to forgo wages and other fringe benefits to obtain tenure. • If there is a close to even split on democratic decisions related to employment, merit raises, and even tenure, faculty members will assign more value to tenure, given that a more or less evenly split vote may change with slight shifts in the composition of the decision-makers. • The further below market are the wages of faculty during the probation period and the further above market are wages after tenure, the more valuable tenure is to faculty members. . stockholders are better informed than voters. Most stockholders are rationally ignorant or their companies’ doings, for the cost of becoming informed outweighs. generally quite capable of evaluating the performance of those they hire for these jobs. In response to sales, for example, supervisors in fast food restaurants