Backgrounder: How Boondoggles Happen

August 16, 2017

“City Councilman Jason Arp, who routinely votes against city-funded economic development incentives, was the only commissioner to oppose the loan approved Monday.” — Kevin Leininger, “Finances in Place, Work on ‘The Landing’ to Begin this Fall,” Aug 15 Fort Wayne News-Sentinel

by John Kessler

Economists who study Public Choice Theory are not surprised by the influence of special-interest groups in politics today, as detailed in any number of today’s headlines.

When our Founding Fathers looked at the history of democracy around the world they were rightly concerned about the tyranny of the majority. The tyranny of the majority is a situation where a large group of people can vote to take benefits for themselves from a smaller group of people. This is why we ended up with a representative democracy in the United States with institutions like a bicameral legislature with equal representation in the Senate and the Electoral College. Efforts were made to allow for protections of the rights of smaller groups from the tyranny of larger groups in society.

In the politics of today, though, we should fear the tyranny of the minority — a situation where a small group can take benefits for themselves from a larger group. How is that possible, you might ask. After all, the larger group should be able to outvote the smaller group and prevent this. Well, like most things in economics, it’s all about the incentives.

As our local governments have begun to pass out more and more of the taxpayers’ money, we have created an environment where small special-interest groups can force their will on the larger group of taxpayers. This is known as the Special Interest Effect. It comes about because there are large benefits going directly to a few people but the costs of those benefits are spread out over many people so that the cost to any single person is not much.

For example, let’s assume there are around 150 million taxpayers in the United States. If I could lobby Congress and get them to hire me to teach economics for $150 million a year that would be a large direct benefit to me. But the cost to any individual taxpayer would only be $1 a year.
Look at the incentives we have created:

Any elected officials want to make this deal with me? I’ll donate $100 million to your reelection campaigns — give me a call, nobody will stop us.

From the specific examples in the fall issue of The Indiana Policy Review you can see the Special Interest Effect by looking at the correlation between donations and government contracts. Engineering companies donating to the campaign of a typical incumbent mayor predictably saw a return on their investment by receiving a government contract with an r-squared value of 59 percent and with a p-value of close to zero.

The legal profession showed an even higher correlation between contributions and contracts: r-squared of 90 percent and with a p-value of close to zero. This means that 59 percent of the contract dollars that engineering firms received and 90 percent of those received by attorneys can be attributed to their campaign contributions. Attempting to predict human behavior is typically a difficult business but this data fits the theory nicely and unsurprisingly.

The key to understanding this Special Interest Effect is to look at who pays and who gains. We, the taxpayers, pay the costs — after all it is our money that is being spent. The politicians benefit because they get funding for their reelection campaigns that pretty much guarantees them a position for life. Businesses win if they get the government goodies.

In this situation, business leaders look at campaign donations as an easy way to garner support from and influence with politicians at all levels of government. This creates a vicious cycle of money being given to incumbent politicians and then given back out to those special-interest groups just to have more money given to incumbents to keep the cycle going. And now you know why incumbents almost always win their bids for reelection. In this kind of environment it becomes difficult to make any meaningful political change as incumbents have war chests full of money ready to be used to defeat any upstart who might challenge them.

Of course, the special-interest groups want the incumbents to stay in power because they have already developed a mutually beneficial relationship with one another, and who is to say that the next person elected will give them the same benefits. It is important at this point to clarify that I am not blaming any one particular political party for this problem. I am blaming both parties for playing this same game. The only difference between the two parties is which set of friends are going to receive the benefits. This also explains why business leaders will often hedge their bets and donate to the campaigns of both parties candidates in a close election.

When the government is involved in handing out other people’s money to special-interest groups it can be difficult to stop them if we don’t like what they are doing because of these perverse incentives. It would be better for us all if we didn’t play this game of passing out other people’s money; it creates a loss for the economy as a whole.

The primary question in our economy is how are we going to allocate scarce resources. We can either allow the market to do so using prices to give the information to people about what to do or we can use the political system to distribute the resources as politicians see fit. If we choose the political route, politicians get to shift where resources are being spent and we end up with booms and busts in the economy as we either overinvest or underinvest in different areas of the economy. If we allow the political system to allocate resources, then business leaders have an incentive to do what they can to get their piece of the pie.

Either way, the business leader has to decide where they are going to spend their time and effort. Will they work toward putting out a better product or service at a better price than their competitors or will they spend their time lobbying the government for a handout. Inevitably, the more money the government starts to pass out the more time and energy will be spent on lobbying and less will be spent on the job of doing business. This is an obvious overall loss to the economy as not all who lobby will be given a contract and all of the time and money spent on the lobbying effort will have produced no benefit at all to society. The businesses that don’t win the government handout would have been better off spending those resources working on improving their business.

In this environment of competing for the taxpayers’ money it makes sense that the business leader would start to see making campaign contributions as a great investment in the bottom line since it increases the likelihood of getting that handout.

As long as we allow government to keep playing this game of handing out other people’s money, the special-interest groups will continue to have a major impact on the policies and actions we pursue. The only way we can win is if we don’t play.

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.

Readings

William F. Shughart II. “Public Choice: The Concise Encyclopedia of Economics.” Library of Economics and Liberty. (Last viewed Aug. 15, 2017.)

Roy Cordato. The Special Interest Effect: Increasing The Size, Scope and Cost of Government.” John Locke Foundation, July 25, 2017.

James M. Buchanan and Gordon Tullock. The Calculus of Consent: Logical Foundations of Constitutional Democracy. The University of Michigan Press, 1962.



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