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Public choice and economic inefficiencies

There is a branch of economics that deals with the operations of the political process called public choice theory.

Often credited to the economist James Buchman who won a Nobel Prize in economics, it deals with a theory linking individual behaviour to ultimate political action.

In general, the political process works very well when there is a close and transparent relationship between the receipts of benefits and payment of costs.

There are numerous situations where sound economics and good politics fail to coincide.

I'll briefly discuss one of these concepts: Inefficiency of Government Operations.

Inefficiency of Government Operations

First it's important to clearly state that professional pride and the desire to do an excellent job exists in the public sector as well as the private sector. The argument on inefficiency within government is not one that assumes employees of the bureaucratic government are lazy or incapable.

Rather it is mainly the environment of informational asymmetry and of perverse incentives under which these workers toil. There are very talented and hardworking members of the civil service workforce but their incentives and environment differs immensely from that of the private sector worker.

For example, there is a very high incentive within the private sector to produce goods or service efficiently because in doing so costs are controlled and profits are made.

If you do not make a profit in the private sector and sustain continued losses it is likely your enterprise with become a business failure.

There is, of course, no such mechanism in the public sector.

There is very little in terms of a metric except maybe the level of debt or budget deficit incurred. There is really no imminent threat of bankruptcy ... at least initially.

Ironically, poor performance and a failure to succeed in an endeavor are often used as arguments sited to increase funding in the public sector.

There is also very little incentive for a public manager (if any) to gain from reducing costs.

In fact it is generally the opposite.

You often see this in the games public divisions play with budgets.

If a total amount is not spent in any given year by a department it often means its allocation will be reduced in subsequent periods.

Thus near the end of the budget year there is a rush to spend to use up their appropriation.

Without any form of private ownership, the department's level of wealth cannot be altered significantly by changes in the level of efficiency.

Public officials and civil servants spend other people's money and they may be less conscious of the costs than they would be if there was a direct correlation to their own resources.

The private sector is often measured by the capital markets.

Poor decisions on strategy or profit issues can be reflected almost immediately in stock prices. There is no such transparent and readily observable real-time measuring stick in the public sphere. This, of course, makes inefficiencies and waste far more difficult to detect.

There is also a breakdown in free market dynamics within government as there is very little effect from competition. Absent is the threat of a competitor trying to take customers or “build a better mouse trap”.

As a result narrow interests and goals of some bureaucratic departments are often pursued without regard to a cost-benefit analysis.

This reminds me of a cartoon where a young child rushes into the house and demands his parents buy him a metal detector to find the quarter he lost on the beach.

The quarter is so important to this child that the cost of the $100 metal detector is simply not an issue.

Competition is really a key ingredient for lower costs and efficient production.

This is why governments often outsource or privatise certain operations.

A joint report by the Washington Roundtable and Washington Research Council found that more than 70% of state agency heads report outsourcing contracts to deliver services.

They found that there is overwhelming evidence that it saves money.

For example, Jeb Bush (former Florida Governor) used privatisation and competitive sourcing more than 130 times during his eight-year tenure which amounted to saving more than $500 million in current costs and avoided more than $1 billion in estimated future costs.

On the extreme side is the City of Weston Florida, with 65,000 residents, which contracted out 100% of its services.

The entire city now has a staff of about 9, a budget of $121 million and some of the lowest property tax rates in Florida.

Empirical evidence supports these aspects for developed economies.

Economies dominated by governments tend to perform poorly and exhibit slower growth.

Their output per level of input tends to be low. In fact a paper by Bergh Andreas and Henrekson Magnus from the Research Institute of Industrial Economics, suggests that an increase in government size by ten percentage points is associated with a 0.5% to 1% lower annual growth rate.

There are many aspects in the political realm where cost-benefit analysis is easy and straight forward.

Unfortunately a large part of public choice economics is saddled with systematic inefficacies born from a poor incentive structures.

This is not the fault of the workers but mainly the environment and system that can be changed for the better of all cities, states or countries involved.

Saving millions: Jeb Bush, the former Florida Governor, used privatisation and competitive sourcing more than 130 times during his eight-year tenure which amounted to saving more than $500 million in current costs.

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Published September 03, 2013 at 9:00 am (Updated September 02, 2013 at 6:55 pm)

Public choice and economic inefficiencies

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