Political Economics: Explaining economic policy.

By Torsten Persson and Guido Tabellini.

Cambridge, MA: MIT Press, 2000. Pp. xix, 533. $55.00.

This book contains a succession of models of public sector decision making. In every case, the actors in the models are rational economic agents. In virtually every case, they play noncooperative games, the rules of which are specified by political institutions. In virtually every case, the actions chosen by the agents or the consequences of those actions are government economic policies. Anyone who wants to learn how to construct tractable models of this sort must read this book.

Why would we want to construct such models? We are economists, and constructing models is what we do (a habit that often causes consternation to our students, acquaintances, and families). Some of us have declared a specialization in public sector economics and so have to consider the determination of government economic policy. To a large degree, "pure" public economics practitioners have tended to ignore diligently the political process. Several explanations can be given for this practice. One is that explicit consideration of political institutions would complicate analysis of many problems without adding any significant insights. Another is an "as if" argument: The outcome of the political process can accurately (or adequately) be represented by some sort of representative welfare function. A third is the weakness of the resources on which we could draw: the sterile formalism of the social choice literature and the inelegance, specificity, lack of rigor, and ideological baggage of much of the public choic e literature.

Persson and Tabellini really do demolish quite powerfully my first and third arguments. They show an extraordinarily deft touch in finding exactly the assumptions that work. Again and again, they start with elegant but highly stylized models, then add complications one by one, and are still able to find economically meaningful closed--form solutions. Their ability to distinguish between baby and bathwater is impressive. They show this ability both in presenting examples from their own vast collection of recent published work in the area and in summarizing other people's work.

This work also demonstrates that the many important strengths of the Virginia school of public choice can be preserved, even when some of the less attractive features are excised. These strengths, acknowledged by the authors, include an understanding of the importance of interest groups, an emphasis on the manner in which lobbying affects policy, a concern with the procedural rules of the electoral process, and a recognition of the role of incomplete information. In the introduction, the authors trace the roots of the work presented to three approaches, the Chicago school of rational expectations macroeconomics and the Rochester school of political science being the other two. They also seem quite loathe to identify the book with public economics, either in its roots or in its applicability. Nonetheless, I would describe the book as a very important text for public economists, despite the fact that Atkinson, Auerbach, Diamond, Meade, Mirrlees, Stern, Stiglitz, and Vickrey merit one mention among them in a bib liography of some 500 or more references. In the introduction, the authors define their goal as explaining policies such as "the size and form of redistributive programs, the extent and type of public good provision, the burden of taxation across alternative tax bases, the size of government deficits, the extent of corruption by public officials, the structure of labor market regulation, the stance of monetary policy during the course of the business cycle or the electoral cycle" (p. 1). Except for the last item, that seems to be what public economics is about.

That last item is one of the authors' major concerns. The book contains five parts, an introductory part on "The Tools of Political Economics," and then four parts in which these tools are applied to substantive problems. But the specific issues to which the most attention is devoted tend to be macroeconomic issues or public finance issues that macroeconomists have made their own. One whole part is devoted to monetary policy, predominantly the issue of credibility. Individual chapters are devoted to the capital tax levy problem, to the determination of the public debt, and to growth. On the other hand, a little less attention is devoted to more microeconomic issues. The analysis of pensions, of regional transfers, and of unemployment insurance is all contained in a single chapter, the one titled "General Interest Politics."

To a large degree, the emphasis in the book reflects the progress made in the recent literature in political economics. A lot of important new testable predictions have been made in the past 20 years about the effect that political structure of countries has on the macroeconomic policies in the countries and on the consequences of those policies for the countries' growth rates. Many of these predictions have been subjected to empirical testing and have not been rejected by the data. The effects of (existing) economic inequality on (future) economic growth, the effects of central bank independence on inflation, and the effects of the timing of elections on the business cycle are examples discussed at some length in the book.

On the other hand, the accomplishments of this new literature in the analysis of more microeconomic policy issues look perhaps less gaudy. Existing anecdotal arguments have been made more rigorous. Clear models have been formulated specifying how institutional rules should affect policies--other things equal. But there are perhaps fewer new theoretical developments that we would like to convey to intelligent laypeople and that we would not have been able to convey a few years ago.

For example, what do we know about agricultural policy? Governments of many different forms, in many different places, at many different times, seem to have favored agricultural interests. Why have agricultural lobbies been so successful? Is their success inefficient? Earlier analyses of this phenomenon have emphasized the importance of intense minorities and perhaps the overrepresentation of rural constituencies in many representative democracies. Often this sort of analysis did not rest on a very firm analytic foundation. Chapter 7 of this book, titled "Special Interest Politics," presents a much more satisfying analysis. It presents three different types of model: a model of structure-induced equilibrium in legislatures (drawing on work by Baron and Ferejohn and by Epple and Fiorina), a common-agency model of lobbying (due to Grossman and Helpman), and a model of electoral competition by parties (due to Lindbeck and Weibull and to Dixit and Londregan). In each case, the characteristics of the special inter est group most likely to succeed are derived. The structure-induced equilibrium model suggests that legislation will favor districts with a small number of voters, districts whose representatives care more about government spending in the district, and districts for which the status quo level of government expenditure, should no new legislation be passed, is fairly small. The common-agency model is not really used to explain which groups succeed in lobbying but does show how competition for politicians dissipates lobbyists' rents. The model of electoral competition suggests that parties' platforms will favor groups that are not wedded strongly to any particular political ideology and that are more homogeneous in their ideological views.

The authors have succeeded in saying a great deal about special interest politics in a few pages. They have presented quite a selection of different models and presented them far more simply and coherently than my hectic precis in the previous paragraph would suggest. Each of the models presented has implications. Many of these implications are not obvious without formal modeling, and many of these implications can be examined empirically. In some cases, they seem at odds with casual empiricism. Simple structure-induced equilibrium models, in which some individual legislator gets the power to set the agenda, predict that groups that are well treated in the status quo will not be part of a majority coalition. It is too expensive to offer them a policy that they will prefer to the status quo. In other words, last year's winners should be the most vulnerable in this year's legislative process. The fact that sacred cows are not accounted for by the very simplest models itself points out the need to build on these models. One of the strengths of the book is that, in every chapter, the authors take great pains to point out extensions and modifications. Each chapter contains many references to the recent literature. At the end of each chapter are precisely five problems for the reader, most of which involve extensions of the models presented within the chapters. The book can be used as a convenient reference to a large literature and as a text.

The success of agricultural interests can be defined relative to other comparable special interest groups or relative to some ideal benchmark. The first sort of comparison, positive political economics, is the approach emphasized in the book. In the introduction, the authors state, "We primarily want to know why policy is the way it is, not what it ought to be" (p. 4). In a great number of cases, they succeed in this goal. An excellent example is the chapter on "Political Regimes," in which they present several models, mostly from their own work, that demonstrate clearly why parliamentary regimes tend to spend more, and to spend more on public goods, than do American-style democracies, with their separation of power between executive and legislative branches. The key distinction is in the formulation of taxing and spending proposals. In each case, one legislator is in charge of setting the tax rate, and one is in charge of expenditure. In the parliamentary system, each legislator belongs to the majority party , and each has veto power over legislation. The legislature only votes on (and passes, in equilibrium) a combined tax-expenditure package that has been approved by both agenda-setting legislators. In Persson's and Tabellini's model of a congressional system, the legislature votes twice. First, one agenda setter proposes tax legislation, and then, after this proposal has been passed or defeated, another agenda setter proposes spending legislation. In a sense, the fact that there are two different votes means that it is easier for agenda setters to play off individual legislators against each other. In equilibrium, fewer rents have to be transferred to individual legislators in a congressional system. While the authors are forthright in mentioning the fairly limited empirical confirmation for these predictions, the chapter provides a convincing lesson on why and how legislative rules matter for public economics.

Returning again to special interest politics, are the authors as successful in providing a new and compelling explanation for the success of agricultural lobbies? The more specific the question, the more difficult it is, and here I think we must be satisfied with more modest success: an understanding of the sort of forces involved and how they can be modeled.

Of course, in referring to the success of agricultural policy, I am implying that agricultural interests get more than they deserve, in some sense. In political economics, it is easy to slide down the slippery slope into normative economics. The authors should be commended for their resolve in trying to concentrate on positive economics. They adhere to the agenda of examining the consequences of political institutions for policies implemented. They are aware of several obvious questions that might be raised. If institutions matter, how do they evolve? If the institutional structure is taken as given, what is an appropriate measure of the efficiency of the outcome? The first question they wisely avoid, acknowledging that "a positive analysis of how institutions evolved is certainly an interesting area of research" (p. 4).

They do, in quite a few instances, use a benchmark measure of an efficient allocation to compare with the outcome of the political process. They use the Benthamite utilitarian optimum for this task, pointing out clearly in the introduction the potential problems with this approach. They also, in most of the models they use, choose utility functions for individual agents that are linear in income. This certainly provides tractability. But, together with their use of the Benthamite benchmark, it leads to a lot of attention being paid to transferable utility games. To Persson and Tabellini, transferable utility is an analytic simplification, not an article of faith. But how many transferable utility games can one smoke without inhaling? For example, consider again the analysis of special-interest lobbying. In chapter 7, Persson and Tabellini present the model of lobbyists as many principals competing for a single political agent, using a menu auction. The use of the menu auction means that the single agent can s uccessfully extract rents from the principals. They conclude (p. 174) that the equilibrium will be socially suboptimal if not all lobby groups are organized and if the government cares at all about lobbyists' contributions. All three conclusions presented in this section are normative. The other two are the result that organized groups will get too much expenditure on their preferred good and that there may be too much or too little aggregate public expenditure. Contrast these conclusions with those derived by Dixit, Grossman, and Helpman (1997), in which the extension to nontransferable utility is emphasized and in which it is shown the equilibrium to the lobbying game must be efficient in the sense that there is no other feasible policy yielding a higher payoff to each lobbyist and to the government. As Dixit, Grossman, and Helpman take great pains to demonstrate, this constrained efficiency of equilibrium is not a tautology. Their results suggest that it may not be enough simply to be aware of the difficul ties in doing normative political economics. In some instances, Benthamite benchmarks might best be avoided altogether.

Reference

Dixit, Avinash, Gene Grossman, and Elhanan Helpman. 1997. Common agency and coordination: General theory and application to government policy making. Journal of Political Economy 105:752-69.