ECON Lecture 11.2: Sources of Government Failure: Corruption, Rent Seeking, Logrolling, and Deadweight Loss

Government Failure Due to Corruption or Kleptocracy

  • Definition of Government Corruption: This occurs when government officials deliberately make the "wrong" decision to obtain bribes or other forms of compensation.

  • Criteria for "Wrong" Decisions: In economics, a wrong decision is defined as one that is economically inefficient. This implies a failure in one or both of the following:

    • Productive Efficiency: Producing goods or services at the lowest possible cost.

    • Allocative Efficiency: Producing the right mix of goods and services most highly valued by society.

  • Practical Example: Road Construction (Interstate I-75):

    • The Scenario: Two qualified road-building firms are competing for a contract to widen Interstate I-75 in Atlanta.

    • Contractor A: Submits a bid of 20,000,00020,000,000.

    • Contractor B: Submits a bid of 23,000,00023,000,000 for the exact same work.

    • Assumptions: Both contractors are of equal quality and fully qualified; Contractor B's higher price does not reflect higher quality, but rather the competitive bidding process.

    • Efficiency Requirement: Economic efficiency (specifically productive efficiency) requires the government to award the contract to Contractor A, saving the public 3,000,0003,000,000.

    • The Corrupt Alternative: An official may grant the contract to Contractor B in exchange for a bribe. This bribe can be initiated by the contractor (offering to split the extra 3,000,0003,000,000) or the official (demanding payment for the contract).

    • Outcome of Failure: The road is not built at the lowest possible cost, and the wrong firm is chosen, leading to economic waste.

  • Bureaucracy and Honesty: While more honest bureaucracies suffer less from corruption, the presence of "big money" in major deals makes it easy to corrupt government systems.

  • Kleptocracy:

    • Etymology: Derived from the Greek root "klepto" (as in kleptomaniac, meaning a person with a compulsion to steal).

    • Definition: A state where corruption is not the exception (a few "bad apples") but the norm. It is effectively a country run by thieves.

    • Impact: In a kleptocracy, every government action requires a bribe. Decisions are made based on connections and payoffs rather than efficiency, leading to stagnation.

  • Anecdote: Building Inspectors and Construction:

    • The Power of Inspectors: In construction, inspectors must certify work at every stage: foundation (proper depth, reinforcing rods, concrete quality), roofing, wall thickness, bracing, electrical (ground wires), and plumbing (ensuring pipes slope downhill for drainage).

    • Bribery Scenario: An inspector has the power to stop a project. Even if work is legal, they might demand a bribe of 200200 to 300300. For a contractor, paying the bribe may be cheaper than fighting "city hall" in court, which could cost thousands in delays.

    • Consequences of Cutting Corners: Low-quality builders may seek out corrupt inspectors to sign off on substandard work (e.g., improper materials or plumbing). Because these flaws are hidden behind walls, homeowners may only discover them 10 years later.

  • Perceived Corruption Index: As discussed in Chapter 3, this index measures the level of corruption in different countries based on surveys of business people. High corruption levels correlate with lower economic efficiency, lower growth, and lower average income.

Government Failure Due to Rent Seeking

  • Specialized Economic Meaning of "Rent": In economics, "rent" does not refer to apartment payments. It refers to the attempt to manipulate the government to collect more than competitive levels of income.

  • Definition of Rent Seeking: The effort by individuals or firms to use the political process to gain extra income at the expense of others without creating any added value.

  • Example: Wine Tariffs:

    • Method: California wine growers might lobby Congress to pass a $10\$10 per bottle tariff on French wine.

    • Effect: French wine becomes $10\$10 more expensive, causing its sales to fall (due to the Law of Demand). Consumers switch to California wine.

    • The Rent: California wineries can now sell more wine at higher prices without improving the quality of their product. This is a "rigged market."

    • Distinction from Quality Improvements: Charging more for a Mercedes than a Chevy is not rent seeking because the higher price reflects higher quality. Rent seeking is charging more for the same quality via government interference.

  • Historical Example: US Auto Industry (1980s):

    • American car manufacturers faced heavy competition from high-quality Japanese cars. They lobbied for tariffs to protect their market share. Congress eventually passed tariffs on Japanese pickup trucks but refused to do so for Japanese cars.

  • Impact of Rent Seeking: It allows people to avoid competition, which is typically "hard" to navigate for profit. By rigging the market, they make money at everyone else's expense.

Government Failure Due to Logrolling and Rational Ignorance

  • Logrolling (Vote Trading):

    • Definition: The process of trading votes between representatives in a political system.

    • Mechanism: Representative A votes for a project favored by Representative B (even if it hurts A's own constituents) in exchange for Representative B voting for a project favored by Representative A (even if it hurts B's constituents).

    • Metaphor: Often described as "back-scratching" ("If you scratch my back, I'll scratch yours").

  • Rational Ignorance:

    • Definition: The decision by voters to remain uninformed because the cost of obtaining information (time, energy) exceeds the potential benefit.

    • The Individual Voter's Problem: No single vote can change the outcome of an election decided by thousands or millions of votes. Therefore, investing time to research a representative's complex actions feels unproductive.

    • Public Awareness Statistics: The speaker estimates that 99%99\% of the population cannot name their US Congressional representative, US Senator, local state representative, and local state senator.

    • Behavioral Contrast: People spend significant effort on things they can control (education, jobs, family budgets, researching air conditioners or cars) but very little on monitoring political representatives.

  • The "Boondoggle" Project: Representatives use voter ignorance to swap favors for useless or inefficient projects. By delivering these benefits "free" to their home constituents while spreading the cost across all taxpayers, they secure re-election despite the overall economic damage to the country.

Government Failure Due to Deadweight Loss from Taxes

  • Definition of Deadweight Loss (DWL): A loss to one party that is not simultaneously a gain to another party. It represents the loss of economic welfare caused by a market distortion, such as a tax.

  • Mechanism: Taxes impose a deadweight loss because they reduce the size of the market for the good being taxed.

  • Example: The Marietta Swimming Pool:

    • The Goal: Raise $500,000\$500,000 for a local high school swimming pool.

    • The Tax: A $1\$1 tax per slice of pizza.

    • Market Before Tax (Equilibrium):

      • Price: $3.50\$3.50

      • Quantity Demanded (QQ): 10,00010,000 slices per day.

      • Point where Marginal Benefit (MB) = Marginal Cost (MC).

    • Market After $1 Tax:

      • The supply curve (representing cost) shifts vertically upward by $1\$1. This is the "effective supply."

      • New Price to consumers: $4.15\$4.15

      • New Quantity demanded: 5,7505,750 slices.

      • Tax incidence: The $1\$1 tax is split. Consumers pay $0.65\$0.65 more per slice ($4.15−$3.50\$4.15 - \$3.50), and producers receive $0.35\$0.35 less ($3.50−$3.15\$3.50 - \$3.15).

  • Visualizing the Deadweight Loss (Triangle Analysis):

    • Area 'e' (Consumer DWL): Represents the lost pleasure of the 4,2504,250 people (10,000−5,75010,000 - 5,750) who no longer buy pizza because the price exceeds their valuation. Neither the state nor the producer gets this benefit.

    • Area 'f' (Producer DWL): Represents the lost profit/benefit to pizza shop owners who would have been willing to provide pizza at the original cost but no longer have customers. Some shops may go out of business.

    • Total Deadweight Loss: The combined area of triangles 'e' and 'f'. It is a loss to all parties with no one gaining from it.

  • Determinants of DWL Magnitude:

    • Tax Size: Small taxes (e.g., 6%6\%, 7%7\%, or 8%8\% sales tax) cause small discouragement. High taxes (e.g., 50%50\% or rates seen in parts of Europe) significantly choke off business activity and market size.

    • Unrelated Funding: Most projects are financed by taxing unrelated goods (e.g., pizza taxes for swimming pools), which inevitably reduces the total size of the economy for that sector.

Conclusion of Chapter 11

  • The Role of Government: While governments are necessary for providing public goods, solving externalities, and regulating monopolies, they are rarely "perfect."

  • Scope of Study: This course identified seven major sources of government failure that prevent society from achieving perfection in economic efficiency.

  • Definition of Failure in Economics: Unlike a failing grade (getting less than 60%60\%), economic failure is defined as any deviation from perfect efficiency, even if the error is only 1%1\%.