My previous column (bit.ly/3O1XGqi) had presented empirical evidence on the political business cycle to show how economic life vibrates to the rhythms and rituals of politics. That policymaking is influenced by the forces of realpolitik is clear. To truly understand this, we require a model of the political economy where policy takes shape. Luckily for us, several such models have been developed by economists.
My previous column (bit.ly/3O1XGqi) had presented empirical evidence on the political business cycle to show how economic life vibrates to the rhythms and rituals of politics. That policymaking is influenced by the forces of realpolitik is clear. To truly understand this, we require a model of the political economy where policy takes shape. Luckily for us, several such models have been developed by economists.
Broadly, models of the political economy can be classified into four main categories: normative models, public choice theory, the Chicago political economy approach and the transactions cost view.
Broadly, models of the political economy can be classified into four main categories: normative models, public choice theory, the Chicago political economy approach and the transactions cost view.
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Normative models view policymaking as a technical or an engineering problem where a policymaker seeks to maximize some sort of a social welfare function with an optimal policy. This approach is similar to most rational-agent models in economics. The only innovation in this approach is the introduction of constraints to maximizing social welfare, such as the ability to raise taxes or make transfer payments. However, it ignores the actual policymaking process and the institutional and political forces that act upon it. It assumes that policymakers will ascertain and implement the policy that best maximizes benefits within constraints.
Public choice theory offers a much richer understanding of the political economy. Influenced by the views of Knut Wicksell and pioneered by Nobel laureate James M. Buchanan and Gordon Tullock, this theory, in the words of Alistair Cooke, incorporates the obvious but often-ignored view in academia that politicians are no less selfish than the rest of us. The main argument of this school is that as soon as a policy enters the political arena, it ceases to be judged on its economics by policymakers and starts being pushed to serve the interest of politics. Therefore any policy emerging from the morass of political transactionalism is likely to be suboptimal and fail the Wicksellian test of pareto efficiency. This leads to government failure in the form of rent seeking, policy manipulation, distributional politics, log rolling, legislative bargaining and institutional corruption. The sources of such government failure are voter ignorance, quality of leadership and institutional weakness. Adherents of this school believe that policymaking is less an optimization exercise, but more about solving a problem of designing a constitution, processes and institutions that prevent government failure.
Closely related to but distinct from public choice theory is the Chicago political economy (CPE) pioneered by Gary Becker, Sam Peltzman and George Stigler. This school views politics as a game of competition for the support of voter groups, which leads politicians to formulate policies that maximize their political base either through a transfer of votes or via direct monetary transfers. Policymaking in this school is seen through the prism of price theory and the government is essentially modelled as a mechanism that redistributes wealth.
Perhaps the most interesting characterization of the political economy is by Avinash Dixit, who views the policymaking process through a game theory lens of transaction costs. He posits that the state is an imperfect system and the constitution and laws that guide actions of the state are essentially incomplete contracts between citizens and special interest groups on one side and politicians, administrators and policymakers on the other. This contract is for the implementation of a policy or programme by politicians in return for votes and financial contributions. Policymaking thus is a game between many participating principals (citizens plus special interest groups) who try to influence the actions of the agent (policymakers) for their own benefit. This is a dynamic game with each policy being a play in a game whose players try to maximize their gains. What makes this dynamic game of policymaking even more complex is the fact that its rules are made up by participants as they move along and each participant tries to manipulate these rules. What leads to government failure in this policymaking game are transaction costs, often stemming, from information asymmetry, lack of contract enforceability, moral hazard, adverse selection and low incentive power. In Dixit’s view, a political contract is just like the one between the management of a company and its shareholders, but even more incomplete and suffering from greater degrees of bounded rationality. A classic example of this game was provided by America’s Reagan administration. Ronald Reagan had campaigned on an agenda of unfettered trade, but was also seen as one of the most protectionist US presidents of the late 20th century. His administration renewed and tightened the anti-trade Multifiber Agreement, forced Japan to accept ‘voluntary’ restraints on automotive exports to the US, and imposed import quotas on motorcycles, steel and other goods. According to Dixit, this gap between what was promised and what was delivered was the result of multiple principals playing a dynamic game of policymaking to further their own interests.
Thus the field of political economy has a cornucopia of models and frameworks with which to evaluate the performance of a government and understand the political economy of a country. My next column will attempt to check how some of these models apply to India and analyse the Indian government’s performance in the context of our unique political economy.
