Element 3.4: Understand Political Pressures

“The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”⁽⁸⁵⁾

The political process is an alternative form of economic organization. It is not a corrective device that can be counted on to provide a sound remedy when problems arise. Even when it is controlled by elected political officials (as opposed to, for instance, an autocratic regime), there is no assurance that government actions will be productive, or at least as productive as they could be. This is particularly true when governments become heavily involved in allocating scarce resources toward favored sectors, businesses, and interest groups. As mentioned in the introduction to Part 3, public-choice analysis provides considerable insight into the operation of democratic political decision-making.

Policies favored by the majority do not always make a society better off. Here’s a thought experiment: Consider a simple economy with five voters. Suppose three of the voters favor a project that gives each a net benefit of $2 but imposes a net cost of $5 on each of the other two voters. In aggregate, the project generates net costs of $10 against net benefits of only $6. It is counterproductive and will make the five-person society worse off. Nonetheless, if decided by majority vote, it would pass by three votes to two. Now, let’s scale up. Increasing the number of voters from five to five million or two hundred million will not alter the general outcome. As this simple example illustrates, majority voting can clearly lead to counterproductive projects, actions that are, on balance, harmful to society.

It is useful to compare markets with democratic political allocation as an alternative form of economic organization. While making the comparison, keep the following four points in mind.

First, in a democracy, the basis for government action is majority rule. In contrast, market activity is based on mutual agreement and voluntary exchange. In a democratic setting, when a majority—either directly or through their elected representatives—adopts a policy, the minority of voters are still forced to pay for its support even if they strongly disagree. For example, if the majority votes for a new football stadium, housing subsidy program, or bailout of an automobile company, minority voters are forced to yield and pay taxes for support of such projects. Whether they benefit or not, they pay higher taxes, suffer loss of income, and may be harmed in other ways. It is important to realize that in this context, the term “minority” does not refer to an ethnic minority, although it may. It would be tempting in an unconstrained democracy for the citizens below the 60th percentile of income, let us say, to vote for a benefit such a generous health care or public pensions and pay for it by “taxing the rich,” despite the fact that, as we have already seen, becoming rich is frequently the result of providing goods and services that consumers (including the poor) value.

The power to tax and regulate makes it possible for the majority to coerce the minority. There is no such coercive power when resources are allocated by markets. Market exchanges do not occur unless all parties agree. Private firms can charge a high price, but they cannot force anyone to buy their products. Indeed, private firms must provide consumers with benefits that exceed the price charged to attract customers.

Second, in a democracy, there is little incentive for voters to be well-informed about candidates or issues. An individual voter will almost never decide the outcome of an election. It is more likely that a voter will be struck by lightning on the way to the polling place than cast a decisive vote in an election! Therefore, most voters spend little, if any, serious time and energy studying issues and candidates to cast well-informed votes. Economists refer to this as the rational ignorance effect. Voters are poorly informed, and their failure to obtain information is rational because it is a virtual certainty that their individual vote will not determine the winner or decide the issue. The data are consistent with this view. According to official results, the percentage turnout among all registered voters in national elections held in 2020 and/or 2021, ranged from 52 to 62 percent in the following countries: Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Moldova, and North Macedonia. Surveys indicate that most voters do not even know the names of their representatives, have little or no idea where candidates stand on issues, or what impact government actions or policies (such as agricultural subsidies and trade restrictions) have on the economy. It is an open question whether voters would be better informed in electoral systems where they vote for specific candidates or where they vote for party lists. Even though economists are often accused of placing too much emphasis on rationality, please do not take our analysis as indicating that you should avoid your civic responsibility of understanding issues and taking every opportunity of making your preferences known, whether through the ballot box or other (peaceful) means.

In sharp contrast to their political decision-making, consumers in the marketplace individually bear the consequences of their decisions on how to spend their money. If they make unsound choices, they directly experience the impact. That fact gives them the motivation to spend their money wisely. When consumers consider the purchase of an automobile, personal computer, gym membership, or thousands of other items, they have a strong incentive to acquire information to make informed choices.

Third, in a democracy, the political process generally imposes the same outcome on everyone, or at least everyone covered by that policy. Markets, on the other hand, allow for diverse representation. Put another way, government allocation results in a “one size fits all” outcome, while markets allow different individuals and groups to “vote” for and receive their desired options. This situation can be illustrated with schooling.

In some countries, students attending government-operated schools are assigned to specific schools based on their residential areas, and a standardized curriculum is mandated by the state. In contrast, when allocated by markets, those willing to pay the price find the option that best fits their preferences. As a result, there is diversity in their choices. While some parents will choose private schools, others will opt for homeschooling. Some will choose schools that stress religious values, while others will opt for education that emphasizes basic skills, cultural diversity, or vocational preparation. This ability to choose makes it possible for more people to obtain goods and services more consistent with their preferences. Markets also avoid the conflicts that inevitably arise when the majority imposes its will on various minorities. None of this analysis says that, to the extent, that education is a public good, it should not be paid for from public funds, whether through education vouchers or government grants that are allocated according to demand from parents for particular schools.

Fourth, in a democracy, market decision-makers and political decision-makers face different incentives. As previously discussed, the profit-and-loss mechanism of a market economy tends to direct resources toward productive projects and away from counterproductive ones. The political process does not have a similar mechanism, and thus it cannot be counted on to direct resources toward productive activities. This is true even when political decision-makers are controlled through voting, because, unless they are constrained by constitutional limits, elected officials will tend to “buy” votes by providing favors to some of their voters at the expense of others. As the saying goes, if you take from Peter and give to Paul, you can usually count on support from Paul.

To a large degree, the modern democratic political process can be viewed as a series of “exchanges” between coalitions and politicians. Concentrated interest groups provide politicians with votes, financial contributions, high-paying jobs in the future, and other forms of support in exchange for subsidies, spending programs, and regulatory favors often financed by taxpayers. The rational ignorance effect—the fact that voters choose not to spend the time required to be well-informed—facilitates this process because most voters are unaware of these “political deals.” As a result, resources are moved toward lobbying and other favor-seeking activities and away from production and development of better goods and services.

Only very rarely, when these deals get too far out of hand, do populations resort of extra-ordinary actions to change the situation. The various “color revolutions” in several post-communist countries provide good recent examples.

As explained in elements 3.2 and 3.3, while economic analysis indicates there are cases where markets will fail to allocate resources efficiently, it is also true of the political process. Put another way, there is government failure as well as market failure. Government failure is present when the incentives confronted by political participants encourage counterproductive rather than productive use of resources. Like market failure, government failure reflects a situation in which there is a conflict between what is best for individual decision-makers and what is the best use of resources. For example, government failure can be observed in the case of Venezuela's economic crisis, particularly in the management of its oil industry. Venezuela possesses one of the largest oil reserves in the world and heavily relies on oil exports for revenue. When the oil industry was nationalized in 1976, the state took control of oil production, refining, and distribution. While high oil prices initially allowed the government to finance social programs and subsidies, mismanagement, corruption, and a lack of investment in infrastructure and technology led to a decline in oil production over time. As Venezuela's economy became increasingly dependent on oil revenues, it became more vulnerable to fluctuations in global oil prices. When oil prices plummeted in the early 2010s, Venezuela's economy went into a downward spiral, characterized by hyperinflation, shortages of basic goods, and a severe economic recession. Thus, Venezuela's economic collapse, which has now lasted for many years, illustrates the consequences of government failure in resource management and economic policy. Once repressive, authoritarian kleptocratic governments are in place, with control of the public purse and the military and financial favors to keep their cronies happy, they can be very difficult to dislodge. Even death of the dictator didn’t work. Nor did it work for Zimbabwe.

Let’s look at a somewhat different example. After significantly liberalizing economic policy in Georgia, the framers of the Rose Revolution were aware that even a democratic and liberal-oriented government might undertake counterproductive actions. Thus, in 2010, the Constitution incorporated restraints on the economic role of government. Article 94 specified what taxes were permissible (the number of taxes, and their rates) and allocated the power to change tax rates or introduce new taxes to the people, via referendum. Furthermore, under the so-called “Liberty Act,” the government budget deficit was restricted to less than 3 percent of GDP, and debt to no more than 60 percent of GDP. As time passed, however, and governments changed, the majority party in Parliament initiated changes aiming to release this restriction and restore the power to initiate new taxes and/or change existing rates.

Perhaps we have been overly zealous in pointing out the possible problems with democracies, but we agree with Winston Churchill who said to the UK Parliament in 1947:

“Many forms of Government have been tried ,and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all-wise. Indeed, it has been said that democracy is the worst form of Government except for all those other forms that have been tried from time to time.”⁽⁸⁶⁾

In the remainder of Part 3, we will examine the operation of the democratic political process in more detail and consider modifications that might bring political decision-making into greater harmony with economic growth and prosperity.