Kessler: The Role of Government

August 27, 2015

by John Kessler

As a city councilman, you cannot address the questions on any agenda until you have decided the role of government: What should government do or not do? Economists, of course, have been thinking about this question for a long time. They can tell you two things that the government should do and a few that they shouldn’t.

What the government should do falls into two categories: the “protective” function and the “productive” function.

  1. The protective function — Government should protect our property rights through the legitimate use of force (police, military) and enforce contracts through the legal system. When the government does this well, citizens can be economically productive because they know they can reap what they sow.
  1. The productive function — Government should provide certain kinds of goods that have special characteristics that make them difficult for the market to provide. These are called “public goods” (i.e., broadcast television, national defense). Public goods have two characteristics: a) non-rival, i.e., making the good available to one person makes it available to others and one person’s use of it does not diminish someone else’s use; and b) non-excludable, i.e., you can’t prevent people from using it, making it difficult to limit it to only paying customers.

The reason markets have difficulty providing these public goods is the “free-rider problem.” That is, when people can benefit from resources, goods or services without paying for them, it results in an under-provision of those goods or services. The “free-rider problem” is why we may want to consider government production, if the market cannot find another way to pay for it (as with advertising for broadcast television).

Now that we know what the government should do, let’s look at some of the problems government faces when it tries to do something. It is important to point out two economic concepts: incentives matter and opportunity cost.

Incentives matter — It is important to realize that politicians and voters are people, and we know that people respond to incentives.

We all, it is hoped, grew up learning about the tyranny of the majority. The reason we don’t have a direct democracy in America is because the Founding Fathers recognized the potential harm of the tyranny of the majority. So instead we have a representative democracy. What many of us did not grow up learning about is the tyranny of the minority — when a small group of people inflicts its will on the majority of people. This is when the economics of Public Choice Theory is helpful. It helps explain why we get some of the public policies that we do. In a representative democracy, special-interest groups have a disproportionate influence over the system, resulting in a) benefits to a few, usually the wealthy; and b) costs to the many, usually the poor.

When policy outcomes lead to benefits to a few and the costs of the policy are spread out over many, then the tyranny of the minority can happen. Let’s illustrate this by looking at an example of an economic-development proposal through the lens of what we’ve discussed so far.

A favorite proposal of economic-development committees is construction of a sports stadium. Indeed, Scott Walker, a GOP presidential candidate and the governor of Wisconsin, recently voiced his support for a nearly $500-million subsidy to the Milwaukee Bucks to pay for a new stadium.

First, is this something that government should be involved in? Is it a protective function? Is it a public good? That is, is it non-rival and non-excludable? The answers are all no. So why would a savvy politician like Governor Walker try it? Because of those benefits to the few (the Bucks owners) and those costs to the many (taxpayers).

In a direct democracy, if someone said we are going to vote on whether to take some of your money and give it to another person, you would simply vote no. It wouldn’t happen. But in a representative democracy, it might.

For the reason why, ask yourself two questions: What incentive do owners have to lobby in favor of the stadium? What incentive do taxpayers have to lobby against it? The owners are obviously set to make millions of dollars from the deal, but each individual taxpayer will only pay a small amount of that. So the owners spend a lot of time and resources lobbying in favor of the stadium, and taxpayers spend very little time and resources lobbying against it. And these incentives lead to policies that help the rich and hurt the poor being put into action by our government every year.

Opportunity cost — This is the observation that when the government or anyone for that matter decides to do something, there is always an alternative use for the money and resources.

What else might the taxpayers have done with the money if it hadn’t been taken from them? What other public issue might have been better served with the money? It is difficult for the government to spend money and create economic development that wouldn’t have happened somewhere else instead. In the world of economic development, government involvement, as a rule, just shifts where money is spent without creating more economic activity (only a different kind).

To summarize, as a councilman, when thinking about what kind of activities government should pursue, you should limit yourself to those things that fall into the protective function category or are clearly public goods that are non-rival and non-excludable in nature and in which there is no alternative for the market to provide it alone.

Elected officials, of course, are continually tempted to go outside of these bounds because of the incentives of the political process. No matter what you choose to do, you should try to focus on the opportunity cost of your decisions in order to do the most good that you can with the limited resources of your community.

Finally, if you must subsidize something, subsidize the consumer and never the producer. A producer will take the subsidy and lose the incentive to give a quality product at a low cost. A consumer, though, will take a subsidy and shop around for the best deal, and the market will force producers to give them (and indirectly, the government) good quality at low cost.

John Kessler, an adjunct scholar of the Indiana Policy Review Foundation and head of the IPFW Center for Economic Education, is an economics instructor at Indiana University-Purdue University in Fort Wayne. This is based on remarks delivered to the foundation’s summer seminar.

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Kessler chart



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