Endogenous Public Policy and Contests

223 Pages·2007·2.926 MB·English

by  Gil S. Epstein, Shmuel Nitzan (auth.)

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shmuel nitzan
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Endogeneous Public Policy and Contests
·
Gil S. Epstein Shmuel Nitzan
Endogeneous
Public Policy
and Contests
123
ProfessorGilS.Epstein
ProfessorShmuelNitzan
Bar-IlanUniversity
DepartmentofEconomics
52900Ramat-Gan
Israel
[email protected]
[email protected]
LibraryofCongressControlNumber:2007929500
ISBN 978-3-540-72242-7 SpringerBerlinHeidelbergNewYork
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To Ayelet, my mother Laura
and my precious children Ofir, Noga, Inbal and Eitan.
G.S.E.
To Dorrit.
S.N.
Preface
This book sets out to analyze the question of endogenous policy determin-
ation, taking into account basic economic and political considerations that
are relevant in a variety of institutional and political environments, in lib-
eral democracies as well as nondemocratic political environments. Focusing
on the role of interest groups and their lobbying and rent-seeking efforts in
the determination of public policy, we apply strategic contest theory as our
basicmethodologyandclarifythefundamentalparametersthatdeterminethe
behaviorofthegovernment(therulingpoliticianand/orthebureaucrats/civil
servants)andoftheinterestgroups–thecontestantsfortheprizesassociated
withpublicpolicy.Ouranalysisfocusesontherelationshipbetweenthesefun-
damental parameters (the objective of the government, political culture, the
contest success function, the stakes of the interest groups and their charac-
teristics–lobbyingpower,preferences)andpublicpolicy,thecontest-winning
probabilities of the interest groups and their efforts – the resources they ex-
pend.Weprovidecomprehensiveillustrationsoftheusefulnessoftheproposed
approachinfivespecificcases:thedeterminationofmonopolyprice,privatiza-
tionpolicy,migrationquotas,minimum wageandpromotionin tournaments.
Thebookhastwoalternativefunctions.Itcanbeusedasatextforacourse
onendogenouspublicpolicyforadvancedundergraduateorgraduatestudents.
Itcanalsobeused(partlyorasawhole)aspartofanadvancedundergraduate
or graduate course in public economics, political economy or public choice.
The book consists of an introductory chapter and five parts containing
15 chapters. The introduction provides a brief overview of the literature on
public-policydetermination,clarifiesthedistinctivecharacteristicsofourpro-
posed approachand its advantages and disadvantages.
PartA,The Basic Contest,introducesthebasiccontestthatweapplyand
rationalizes its existence. This part has two chapters. Chapter II, The Policy
Contest, describes the basic policy contest and derives its equilibrium under
the two most commonly assumed contest success functions that specify the
winning probabilities of the contestants, corresponding to their efforts (rent
seekingorlobbyingexpenditures).ChapterIII,Contest Rationalization – Mi-
VIII Preface
crofoundations, providesamicrofoundationforthe public-policycontest.Our
rationalizationhingesontheexistenceofgovernment(politicians’)preferences
thattakeintoaccountthe lobbyingoutlaysofthe interestgroups,inaddition
to public well being.
Part B, The Extended Contest: With Government, introduces our first
modelofendogenouspublicpolicy,wherethegovernmentdeterminesthepro-
posed public policy and the contest success function (CSF) is of the simple
lottery (logit) type proposed by Tullock (1980). By this most popular CSF,
acontestant’swinningprobabilityisequalto the ratiobetweenhis owneffort
and the total efforts made by the contestants in attempting to win the prize
implied by the proposed public policy. The effect of political culture on the
proposedpublicpolicy,thecontestants’effortsandtheirwelfareisthenexam-
ined. We also study the effect of political culture on relative rent dissipation
and on the nature of the proposed policy (is it compromise enhancing, rela-
tivetothe policysupportedbytheinterestgroups),assumingalternativeand
moregeneralCSFs. PartB hasthree chapters.ChapterIV, Endogenous Pub-
lic Policy, presents the extended game that has two stages.In the first stage,
abureaucratproposesapolicy.Inthesecondstage,theothertwoplayers,the
interest groups, compete for, or against, approval of the proposed policy by
the electedpolitician. The second-stagesubgame is the standardrent-seeking
rent-avoidancecontestpresentedinPartA.Inthiscontest,theinterestgroups
competeforbenefitsassociatedwiththeapprovalorrejectionoftheproposed
policy,expendingresourcesthatare(partly)receivedbythe rulingpolitician.
Thepoliticianandthebureaucratarenotnecessarilyextremerentseekers.De-
pending on the political culture, they may also care about the enhancement
of the aggregate welfare of the interest groups. The bureaucrat’s objective
function hinges on a single parameter: the weight assigned to social welfare
relative to the total rent-seeking or lobbying outlays. This parameter repre-
sents the political culture or the degree of politicization of the government.
Our analysis in this chapter focuses on the effect of changes in the degree
of politicization on the proposed public policy and, in turn, on the lobbying
efforts by the interest groups and their expected welfare. In Chapter V, Cul-
ture, Politicization and Relative Rent Dissipation, we focus on clarifying the
relationship between political culture and relative rent dissipation; the ratio
between the total rent-seeking outlay and the expected prize in equilibrium.
Chapter VI, Lobbying and Compromise, is concerned with the possibility of
lobbying that is not compromise enhancing. Specifically, the objective of this
chapteris to specify sufficient conditionsfor lobbyingthat givesrise to a pro-
posedpolicythatismoreextremethantheproposalspreferredbytheinterest
groups taking part in the extended contest.
PartC,The Policy Effect,investigatesageneralclassoftwo-playerpublic-
policycontestsandexaminestheeffectofachangeintheproposedpolicythat
may affect the payoffs of one or both of the contestants, on their effort and
performance. In particular, we focus on the role of three types of asymme-
try between the contestants on their effort and performance. This part has
Preface IX
three chapters. Chapter VII, Effort and Performance, presents a comprehen-
sive comparative-statics analysis of the public-policy contest. In particular,
it is concerned with the clarification of the role of three types of asymmetry
betweencontestantsonthe sensitivityoftheireffortandtheirperformanceto
the proposed public policy. Chapter VIII, Prizes (Size and Distribution) and
Efforts, further clarifies the effect of changes in public policy that determine
the prize system on the total effort invested by the contestants. In partic-
ular, we clarify why more restrained government intervention that directly
reduces the prizes of the two contestants may have the “perverse” effect of
increasing their total exerted efforts. Chapter IX, Asymmetry and Corrective
Public Policy, is concerned with the conditions that ensure the existence of
an effective corrective tax-transfer policy that complements an existing inef-
ficient public-policy proposal. Effectiveness of corrective policy means, first,
that it secures an efficient contest outcome. Secondly, that given the existing
inefficient policy proposal, it is optimal from the viewpoint of both interest
groups.
Part D, The Extended Contest: Without Government, introduces our sec-
ondmodelofendogenouspublicpolicy,wherethegovernmentdoesnotdeter-
mine the proposed public policy. Rather, the two competing policies are de-
termined by the interest groups.This part has two chapters. Chapter X, The
Social Cost of Rent Seeking when Consumer Opposition Influences Monopoly
Behavior, presents a simple version of the extended contest where the pol-
icy is determined endogenously, not by the government, but by one of the
contestants. To clarify the relationship between this model and the existing
literature and to illustrate its significance, we present the model applying
a monopoly–consumer context. Chapter XI, Strategic Restraint, presents the
secondgeneralextendedcontestwherepublic-policyproposalsaredetermined
by the two interest groups. The objective of this chapter is to establish that
competition over endogenously determined policies reduces polarization and,
in turn, wasteful lobbying activities.
The last part E, Applications, presents five illustrations of the usefulness
of the extended contests presented in Parts B and D. These applications are
presented in Chapters XII, XIII, XIV, XV and XVI that deal, respectively,
with Monopoly Price Determination, Privatization, Migration Policy, Mini-
mum Wage and Tournaments.
The book is based on joint research that has been presented in papers
that appeared in print since 2002; see Epstein and Nitzan (2002a), (2002b),
(2002c),(2003a),(2003b),(2004),(2005),(2006a),(2006b),(2006c),(2006d),
(2006e)andDruk-Gal,EpsteinandNitzan(2004).Wearegratefultothepub-
lishers of these works for permission to republish all or part of the material
they contain. We are also grateful to Ira Gang, Mark Gradstein, Nava Ka-
hana, Martin Kolmar, Kai Konrad, Ed Lazear and Wolfgang Leininger, who
made useful suggestions for improvement in various parts of this work. Part
of our joint research was completed while visiting CESifo and IZA. We are
X Preface
most grateful to these institutions for their warm hospitality and supporting
researchenvironment.
Gil S. Epstein is on the faculty of the Department of Economics at Bar-
IlanUniversity,Israel.He is anAssociateEditor oftheJournal of Population
Economics and a Research Fellow in IZA. His papers on migration and pub-
lic policy, public choice, political economy and labor economics have been
published in leading journals in economics.
Shmuel Nitzan is the incumbent of the Sir Isaac Wolfson Chair in Eco-
nomics at Bar Ilan University, Israel.He has published extensively in leading
economics journals on various topics in political economy, collective decision
making, social choice, voting theory and public economics. He is the author
of Collective Decision Making: An Economic Outlook (with Jacob Paroush)
and Collective Preference and Choice.
September, 2007 Gil S. Epstein
Shmuel Nitzan
Contents
Notation.......................................................XV
I Introduction.............................................. 1
Part A The Basic Contest
II The Policy Contest....................................... 9
1 Policy and Stakes ........................................ 9
2 Contest Equilibrium...................................... 11
a The Logit (Generalized Lottery) CSF .................... 12
b The All-pay Auction ................................... 13
III Contest Rationalization − Microfoundations.............. 15
1 The Public-policy Contest................................. 17
2 The Condition for Preferred Randomness ................... 18
3 Applications............................................. 21
a The Most Common CSFs............................... 21
b Comparison of the Common CSFs ....................... 23
4 Summary ............................................... 24
Part B The Extended Contest: With Government
IV Endogenous Public Policy ................................ 29
1 The Public-policy Game .................................. 31
a The Contest Between the Interest Groups ................ 32
b Example: Public-good Provision......................... 35
c Public Policy and Rent-seeking Outlays .................. 36
d The Government: Bureaucrats and Politicians............. 36
2 Politicization and Welfare................................. 39