Chapter 16 Public Choice: Politics in Government and the Workplace 19 • As the diversity within a decision-making unit increases (more disciplines included with more divergent views on how analyses should be organized and pursued), the demand for tenure will increase. • Should universities become more constrained in their capacities to fund established faculty positions, tenure may be perceived as even more valuable. Financial exigencies can translate into the loss of faculty positions (with non- tenured positions becoming prime targets), so it should not be surprising that faculty will seek with greater diligence to redistribute remaining positions and rents. It also means universities will probably have to spend considerable resources seeking to instill academic values -- not the least of which will be the pursuit of honest dealings and academic excellence. This emphasis may cause faculty members to shun an important incentive inherent in the political process (especially in large group settings), that is, the tendency to pursue strictly private objectives at the expense of larger university goals. 11 Why Business People Don’t Have Tenure If professors have tenure, why don’t business people have provision for the same kind of job security? The quick answer to that question is that businesses, unlike universities, typically are not labor managed. (Those that are like universities should be expected to use some form of tenure.) As noted, in business, goals are usually well defined. Perhaps more importantly, success can usually be identified with relative ease by using an agreed-upon measure, that is, profit (or the expected profit stream captured in the market prices of traded securities). The owners, who are residual claimants, have an interest in maintaining the firm’s focus on profits. Moreover, people who work for businesses tend to have a stake in honest evaluations of potential employees, given that their decisions on “better” recruits can increase the firm’s profits and the incomes and job security of all parties. Admittedly, real-world businesses do not always adhere to the process as described. They use, to a greater or lesser degree, participatory forms of management, and for some businesses, profit is not always the sole or highest priority goal. “Office politics” is a nontrivial concern in many firms. The point is, however, that in business there is not as great a need for tenure as exists within academe; employees in businesses do not have the incentive to demand tenure that professors have, primarily because these employees do not experience the problems inherent in democratic management that derive from imprecise and shifting goals and from esoteric and ill-defined research projects. Tenure is seldom found in firms, for the simple reason that in business, employers and employees cannot make mutually beneficial trades (similar to those made in tenure arrangements). Now, let’s suppose that political institutions and problems were as well entrenched in a firm as they are in academe, to the point of significantly undercutting 11 As Miller (1992) has shown, the benefits of “corporate organization” eventually break down when the parties follow completely rational, individualistic precepts [Gary J. Miller, Managerial Dilemmas: The Political Economy of Hierarchy (New York: Cambridge University Press, 1992)]. Chapter 16 Public Choice: Politics in Government and the Workplace 20 firm profits. What would happen? Clearly, some smart coalition of managers or outside investors would see a potential for increasing their wealth. They would buy the firm’s stock at a low price depressed by the political encumbrances and reform management practices, suppressing the power of destructive politics and refocusing the managers’ and workers’ attention on the bottom line. They would clarify the extent to which the workers’ long-run gains would be a function of their contributions to profits. The price of the stock could then rise. Voila! The takeover investors would have a wealth increase, and the workers would have less need for tenure, as professors know that form of job protection. Tenure as a Tournament We also suggest that the granting of tenure can be seen as another form of the tournament we have discussed earlier in other contexts. Tenure decisions are a way of allowing faculty members to reveal their skills. An employer cannot depend on a potential employee to be fully objective or honest in presenting his or her qualifications. The graduate school records of new doctorates provide useful information on which to base judgments of potential recruits for success as university teachers and researchers. However, such records are of limited worth in instances where a professor’s research is at the frontier of knowledge in his or her discipline. The correlation between a person’s performance as a student, as a prospective professor, as a teacher, and as a researcher is, at best, imperfect. In order to induce promising faculty members to accurately assess their abilities and to confess their limits, the competitors (new assistant professors) are effectively told that only some among them will be promoted and retained. Since standards for tenure differ from one university to another, universities offer prospective faculty members an opportunity to, in effect, self-select and go to a university where they think they are likely to make the tenure grade. The prospects of being denied tenure will cause many (but certainly not all) weak candidates to avoid universities with tough tenure standards, given the probability that they would have to accept wages well below market during the probation period. The lost wages amount to an investment that probably will not be repaid with interest (in terms of wages above the market after the probation period when tenure is acquired). Thus, the tenure tournaments can reduce to some extent the costs universities incur in gathering information and making decisions, because they force recruits to be somewhat more honest in their claims. Competition for the limited number of “prized positions” often will drive new faculty members to exert a level of effort and produce a level of output that exceeds the value of their current compensation. To induce prospective faculty to exert the amount of effort necessary to be ability revealing, universities must offer a “prize” that potential recruits consider worth the effort. That is, the recruits must expect the future (discounted) reward to compensate them for the extra effort they expend in the tournament and for the risk associated with not “winning.” One approach universities can use to encourage recruits to exert a reasonable level of effort in the competition is to offer those who win the prospect of substantially greater compensation in the future (at least enough to repay the costs of assumed risk and of interest lost on delayed Chapter 16 Public Choice: Politics in Government and the Workplace 21 compensation). Another approach that offers future compensation as an incentive is to increase the security of continued employment and compensation once the tournament has ended and the winners have been determined. That is, tenure can be offered as the “prize.” In the absence of tenure (or some similar device), universities would find it difficult to make a credible commitment that prospective recruits, who make the necessary competitive investment during the probationary period by accepting below- market wages for above-market effort, will receive an income stream that compensates them for all costs, including the required risks. We have stressed the instability inherent in academic democracies that, by its nature, reduces the credibility of virtually every commitment universities might want to make at employment time. Tenure is a practical means universities use to provide a reasonable level of job security -- to make a credible commitment -- that is, to overcome institutional instabilities and thereby enable them to pick the “best” professors for continued employment. At the same time, tenure is part of a mutually beneficial trade between new professors and their universities, primarily because it is a feature of the employment contract that new self-selected faculty members will demand before they agree to participate actively and honestly (in the sense that they will reveal the limits of their true abilities) in what amounts to a risky and underpaid employment tournament, albeit short-run. 12 After all is said and done, tenure is nothing more than another contract provision that faculty members prize, universities provide -- and just about everyone else criticizes. Business people could also have tenure. All they would have to do is “pay” for it in terms of lost wages. However, business people typically don’t have the same strong reasons for wanting tenure as do professors. Tenure survives in the academies of the country mainly because faculty members aggressively demand it (even those who believe strongly in the value of markets) and because universities voluntarily negotiate it. Tenure’s long-term survival and the competitiveness of university labor markets suggest that the trade is mutually beneficial. Concluding Comments This chapter has used cost-benefit analysis to develop an economic model of government. In government as well as private industry, producers in a monopolistic market position will tend to exploit the lack of competition for their service. A government bureau that has no competitors is in an enviable bargaining position vis-à-vis legislators and taxpayers. As the sole producer of a service, it can charge higher prices and deliver poorer service than competitive producers would. 12 After tenure is awarded, faculty efforts should be expected to decline, while, at the same time, their pay rises. In the midst of the tournament, the new faculty members will exert unduly high amounts of effort, simply because of the prospect of being rewarded in the future by higher pay and greater job security. Also, the rise in compensation and fall in effort that accompany tenure may correlate with the fact that the added money makes it possible for faculty members to buy more of most things, including great leisure (or leisure-time activities). If we did not expect new faculty members to anticipate relaxing somewhat after attaining tenure and enjoy, to a degree, being “overpaid,” we could not expect the tenure tournament to be effective as a means to an end, which is disclosure of the limits of new faculty members’ true abilities. Chapter 16 Public Choice: Politics in Government and the Workplace 22 In many cases, then, the performance of government bureaucracies can be improved by the introduction of competition for their services. Where possible, alternative sources of a government-provided good or service should be encouraged. If government bureaus have to compete with other producers by lowering their prices or increasing the quality of their service, they will be forced, like private producers, to reveal not just what they want to do, but the limit of what they will do for the consumer’s business. The democratic system provides checks and balances to control the exploitation of power in government. Voters can vote not to re-elect officeholders who abuse the public trust. They may not do so reliably, however, because of imperfect information. The fact that democracy is not a completely efficient system does not mean that a non- democratic form of government is preferable. We have noted, however, that people will also seek protections from the problems intrinsic to democratic governance. They can do this with constitutional restrictions on what governments can do. Inside firms, workers can protect themselves from workplace democracies through contract restrictions like tenure. Owners of firms need to be mindful of the fact that if they move toward “participatory management,” they will have to provide worker protections from the majorities’ abuse of democratic governance in the workplace, or else the firms will have to pay higher wages. Review Questions 1. Is it desirable, in your opinion, that government generally adopts policies intended to please the median voter group? Why or why not? 2. It is sometimes said that a rational decision must be based on perfect information. Would it be rational for a voter to acquire perfect information about politics? Would it be possible? 3. What effect does increased competition have on the slope of an individual firm’s demand curve? Why? How does a change in the slope of a firm’s demand curve affect its efficiency? How do these effects apply to government bureaucracy? 4. “Competition forces producers to reveal what they are willing to do at the limit, not just what they want to do.” How does this statement apply to government bureaucracy, and to legislators’ ability to control it? 5. Write down all the government-provided services you can think of. Which of them must be provided by government bureaucracy? Which could be provided through competitive contract? Why? 6. When would workers want and don’t want democratic governance in the workplace? Chapter 16 Public Choice: Politics in Government and the Workplace 23 READING: The Mathematics of Voting and Political Ignorance Gordon Tullock, University of Arizona Public problems are normally more important than private problems, but the decision by any individual on a private problem is likely to be more important than his decision on a public problem, simply because most people are not so situated that their decision on public matters makes very much difference. It is rational, therefore, for the average family to put a great deal more thought and investigation into a decision such as what car to buy than into a decision on voting for president. As far as we can tell, families, in fact, act quite rationally in this matter, and the average family devotes almost no time to becoming informed on political matters but will carefully consider the alternatives when buying a car. Why is that the case? In order to address the question we need first to ask a more basic question: What is the payoff to the individual from voting? Assume that you are in possession of some information and have decided that you favor the Democratic Party or, if is a primary, some particular candidate. The payoff could be computed from the following expression: BDA - C v = P B = benefit expected to be derived from success of your party or candidate D = likelihood that your vote will make a difference A = your estimate of the accuracy of your judgement (-1<A<+1) C v = cost of voting P = payoff Certain aspects of this expression deserve a little further discussion. The B refers, of course, not to the absolute advantage of having one party or candidate in office, but the difference between the candidate and his or her opponent. The factor labeled A, the estimate of the accuracy of the voter’s judgement, is included here because we are preparing to consider the amount of information held by the individual, and the principal effect of being better informed is that your judgement is more likely to be correct. The factor labeled A can take any value from minus 1, which represents a certainty that the judgements will be wrong, to a plus 1, which indicates that the voter is sure he or she is right. The choice of this rather unusual way of presenting what is really a probability figure is due solely to its use in the particular equation, not to any desire to change the probability notational scheme. For the equation to give the right answer, it is necessary that A have a value of zero when the individual thinks that he has a fifty-fifty chance of being right. The factor labeled D is the likelihood that an individual’s vote will make a difference in the election; that is, the probability that the result if he were to vote would be different than it would be if her were not to vote. For an American presidential election, this is less than one in 10 million. C v is the cost, in money and convenience, of voting. For some people, of course, it may be negative. They may get pleasure, or at least the negative benefit of relief of social pressure, from voting. If we view voting as an instrumental act, however—something we do not because it gives us pleasure directly but because we expect it to lead to some desirable goal—then our decision to vote or not will depend on weighing the costs and benefits. Let us put a few figures into our expression. Suppose I feel that the election of the “right” candidate as president is worth $10,000 to me. I think I am apt to be right three times out of four, so the value of A will be .5, D will be figured as .000,000,1. Assuming that my cost of voting is $1.00, the expression gives ($10,000 x .5 x .000,000,1) - $1.00 = $.9995. It follows from this that I should not bother voting. It will, however, be worthwhile to consider a few variations on the expression. In the first place, it is frequently argued that this line of reasoning would lead to no one voting. This is not true. If people began making these computations and then refraining from voting, this would raise the value of D, since Chapter 16 Public Choice: Politics in Government and the Workplace 24 the fewer the voters, the more likely that any given vote will affect the outcome. As more and more people stopped voting, D would continue to rise until the left side of the expression equaled the right. At this equilibrium there would be no reason for nonvoters to begin to vote or for voters to stop. Presumably the people voting would be those among the population who were most interested in politics, since D would have the same value for everyone but (B x A) would approximate a positive function of political interest. The equation, if it is thought to be in any way descriptive of the real world, would imply that people would be more likely to vote in close elections. This hypothesis has been tested and found to be correct. Let us now complicate our model. An additional factor, C i , the cost of obtaining information, has been included in the first equation. BDA- C v - C I = P This, of course, the cost of obtaining additional information, since the voter will have at least some information on the issues as a result of his contact with the mass media. Of course, A is a function of information (A = ƒ(I)), and hence each increase in information held will increase A and thus raise both the benefits and the costs. The problem for the rational individual contemplating whether or not he or she should vote would be whether there are any values of C I that would lead to a positive value payoff. Suppose, for example, that the investment of $100.00 (mostly in the form of leisure forgone) in obtaining more information would raise the value of A from .5 to .8. Using the same amounts for the other values as we used previously, P = -$100.9992. Clearly, this is even worse than the original outcome. Furthermore, these figures are realistic. The cost of obtaining enough information to significantly improve your vote is apt to very much outweigh the effect of the improvement. This is particularly true for the average voter, who does not have much experience or skill in research and who would put a particularly high negative evaluation on the time spent in this way. A further implication of our reasoning must be pointed out. There may be social pressures that make it wise for the individual to make the rather small investment necessary for voting. In terms of our equation, C v may be negative. In these cases, voting would always be rational. Becoming adequately informed, however, is much more expensive. Further, it is not as easy for your neighbors (or your conscience) to see whether you have or have not put enough thought into your choice. Thus, it would almost never be rational to engage in much study in order to cast a “well-informed” vote. For certain people (and presumably most readers of this book will fall within this category) A may already be quite high. For intellectuals interested in politics, the amount of information acquired about the different issues for reasons having nothing to do with voting may be quite great. Further, for this group of people, the value put on the well being of others may be higher than in the rest of the population. It may be, then, that these people would get a positive payoff from voting even though the average citizen would get negative returns from taking the same action. Thus, for many of the readers of this book, voting may be rational. I have my doubts, however. The value put on the well being of others must be extremely great. Further, my own observation of intellectuals interested in politics would not confirm that A is high for them. They may have a great deal of information, but this seems to have been collected to confirm their basic position, not to change it. Excerpted with revisions and permission from Gordon Tullock, Toward a Mathematics of Politics (Ann Arbor, Mich.: University of Michigan Press, 1972), pp.111-114 CHAPTER 17 International Trade and Finance It can be of no consequence to America, whether the commodities she obtains in return for her own,, cost Europeans much, or little labor; all she is interested in, is that they shall cost her less labor by purchasing than by manufacturing them herself. David Ricardo ations never really trade; people do. This simple point is important, for international trade allows us to approach international trade as an extension of models already developed, rather than a completely new topic. Earlier discussion focused on the local or national marketplace. In this chapter, our marketplace will be the world. We divide our discussion of international economics into its major subdivisions, international trade (mainly dealing with the exchange of real goods and services across national boundaries and their terms of trade) and international finance (mainly dealing with the exchange of national currencies and their exchange rates). INTERNATIONAL TRADE Of course, there are differences between international and domestic trade—enough to make international economics an important subdiscipline of the profession. Some differences are obvious, like the many different national currencies, cultures, institutions, laws, languages, artificial barriers (tariffs, quotas, embargoes, health regulations), and countercyclical domestic policies, involved in international exchange. Others go largely unrecognized. An intangible but significant factor is the difference in people’s attitudes toward domestic and international trade—call international trade nationalism. As Abraham Lincoln is supposed to have said, “Domestic trade is among us; international trade is between us and them.” Yet people all over the world trade with each other for the same reason: They stand to gain from the transaction in spite of the politics. There is much greater immobility of resources than commodities between nations. International trade is the substitute for the international movement of human and property resources, especially people. Understanding that trade is between people, not nations, is important for another reason. If we focus solely on gains from trade to nations taken as unified political entities, we may overlook the distributional effects of international commerce—the gains and losses to individuals. As we will see, while international trade increases a nation’s total income, international trade reduces some individual’s incomes and increases others’. To evaluate objections to free trade among nations in proper perspective, we must recognize these hidden gains and losses. N Chapter 17 International Trade and Finance 2 Objections to free trade can be explained easily in terms of market theory. A major principle of economic theory is that each individual competitor has a vested interest in reducing competition. Competition forces product prices down and spurs product development and, in the long run, restricts business profits to only the risk- adjusted profit opportunities available elsewhere. Thus it is natural for domestic firms to seek protection from their foreign competitors—but protection only increases the prices consumers must pay. Carried to an extreme, protection based on the narrow interests of particular sectors of the economy can reduce everyone’s income. On this basis rests the case for free international trade. After examining the advantages of international trade from a purely national perspective, we will look at the distributional, or individual, effects. The chapter closes with a discussion of the pros and cons of protectionism. Collective Gains from Trade Most of the gains from trade result from allocating resources in the most efficient manner and from the reduction in the social opportunity cost—each geographic area produces and exchanges those things for which it is best suited to produce. With nations selling those things with the lowest opportunity costs, joint output is maximized and consumption opportunities are enhanced. Adam Smith told us more than two hundred years ago about the nature of the gains from trade: It is a maxim of every prudent master, never to attempt to make at home what it will cost him more to make than to buy.” 1 Trade also allows a greater variety and wider choice of available products. The gains from it are clearest when there is no domestic substitute for an imported good. For example, the United States does not have any known reserves of chromium, manganese, or tin. For those basic resources, which are widely used in manufacturing, American firms must rely on foreign suppliers. The gains from trade are also clear for goods that are very costly or difficult to produce in the United States. For example, cocoa and coffee can be raised in the United States, but only in a greenhouse. Obviously it is less costly to import coffee in exchange for some other good, like wheat, for which the United States climate is better suited. Foreign competition also offers benefits to the American consumer. By challenging the market power of domestic firms, foreign producers who market their goods in the United States reduce product prices and expand domestic consumption. Foreign competition also increases the variety of goods available. Without competition from the twenty or more foreign automobile producers who sell in the American market, the three U.S. automakers would each get a much larger percentage of the market. They would be loess hesitant to raise their prices if consumers had fewer alternative sources of supply. Collusion among major manufacturers would also be much more likely without the presence of foreign competitors. International trade also promotes specialization, whose benefits are fairly clear. By concentrating on producing a small number of goods and selling to the world market, a nation can reap the benefits of greater efficiency and economies of scale. Resource 1 Adam Smith, The Wealth of Nations (New York: Random House, Modern Library edition, 1937), p. 422. Chapter 17 International Trade and Finance 3 savings that are not initially obvious may be gained. Indeed, after considering the following example, some readers may doubt that international trade can be mutually beneficial. Consider a world in which only two nations, the United States and Japan, produce only two goods, textiles and beef. Assume that the United States produces both textile and beef more efficiently than Japan. That is, with the same resources, the United States can produce more beef and more textiles than Japan can. It has an absolute advantage in the production of both goods. An absolute advantage in production is the capacity to produce more units of output than a competitor can for any given level of resource use. A comparative advantage in production or cost is the relative advantage based on comparative ratios such that either the absolute advantage is greatest or the absolute disadvantage is smallest. Comparative advantage is more important for trade than absolute advantage. As long as the relative productivities or costs differ between individuals, regions, or nations, the participants can engage in mutually beneficial trade. Let’s see how these differences work out for people. Suppose that Lisa is worth $100 an hour in market work and only $10 an hour in home or household work. Her husband Gary is worth $8 an hour in the market and $4 in the home. Lisa has an absolute advantage in both tasks, but a comparative advantage in market work. She is ten times more productive in the market than at home; he is only twice as productive. Her comparative advantage (largest advantage is in the market; his comparative advantage (smallest disadvantage) is in the home. She should work in the market; and he should work at home. Their combined productivity would be $104 per hour (her $100 market rate plus his $4 home rate). If instead Gary worked in the market and Lisa worked at home, their combined productivity would be $18 (his $8 market rate plus her $10 home rate). They would be $86 (equal to $104 -- $18) better off by utilizing their comparative advantage, with Lisa working in the market, where her comparative advantage lies (her greatest absolute advantage, $92 over his) and Gary working at home, where his comparative advantage lies (his absolute disadvantage is smallest, $6 less than hers). Table 17.1 shows these absolute and comparative differences for nations. With the same labor, capital, or other resources, the United States can produce thirty units of textiles; Japan can produce twenty-five. If the same resources are applied to beef production, the United States still outproduces Japan, by ninety units to twenty-five. Under such conditions, one might think that trade with Japan could not possibly benefit the United States. The relevant question is not how efficient the United States is in absolute terms, however, but whether the people of the United States can make a better deal by trading with Japan than they can make by trading among themselves. This is determined by examining the comparative advantage, or the ratios of advantage or differences in relative efficiencies. A nation has a comparative advantage where (1) its absolute advantage is greatest or (2) its absolute disadvantage is smallest. Generally, a nation will have a comparative advantage in those products that require in their production a large proportion of factors that are relatively abundant and inexpensive in that nation and a comparative disadvantage in those productions that are relatively scarce and expensive in that nation. It is a technological fact that different products generally require in their production different proportions of the factors. Chapter 17 International Trade and Finance 4 TABLE 17.1 Comparative Cost Advantages, Beef and Textiles, United States and Japan Maximum Units of Textiles (Zero Beef Units) Maximum Units of Beef (Zero Textile Units) Domestic Cost Ratios In Each Nation Mutually Beneficial Trade Ratio, Both Nations United States Japan 30 25 90 25 1 textile costs 3 beef 1 textile costs 1 beef 1 textile trades for 2 beef To determine which is the better deal, we must compare the costs of production. We know that there is an uneven distribution of economic resources among nations. This produces differences in productive capacities based on these differences in relative factor endowments. If each nation produces and trades the products in which it has a comparative cost advantage, trade can raise both their incomes. Remember that a comparative advantage is the capacity to produce a product at a lower cost than a competitor, in terms of the goods that must be given up. The United States may have an absolute advantage in the production of both beef and textiles, but it may have a comparative advantage only in the production of beef. In other words, the United States must forgo fewer units of textiles to obtain a unit of beef than Japan. Although a single nation could theoretically have an absolute advantage in all commodities, it could not have a comparative advantage in all commodities. With two nations and two commodities, if a nation has a comparative advantage in one commodity it must have a comparative disadvantage in the other commodity. Having a comparative advantage in beef necessarily means the United States cannot have a comparative advantage in textiles—a point that will become clear shortly. In a sense, the United States trades with itself every time it producers either beef or textiles. If it produces beef, it incurs an opportunity cost; it gives up some of the textiles it could have produced. If it produces textiles, it gives up some beef. In Table 17.1, every time the United States produces one unit of textiles, it gives up three units of beef. (It can produce either thirty units of textiles or ninety of beef—a ratio of one to three.) Thus the United States can benefit by trading beef for textile if it can give up fewer than three units of beef for each unit of textiles it gets from Japan. Japan, on the other hand, gives up an advantage of one unit of beef for each unit of textiles it produces. If Japan can get more than one unit of beef for each unit of textiles it trades, it too can gain by trading. In short, if the trade ratio is greater than one unit of beef for one unit of textiles but less than three units of beef for one unit of textiles, trade will benefit both countries. The United States will gain because it has to give up fewer units of beef—two, perhaps, instead of three—than if tried to produce the textiles . the effort. That is, the recruits must expect the future (discounted) reward to compensate them for the extra effort they expend in the tournament and for. value payoff. Suppose, for example, that the investment of $100.00 (mostly in the form of leisure forgone) in obtaining more information would raise the