Markets and Politicians Politicized economic choice STUDIES IN PUBLIC CHOICE Series Editor: Gordon Tullock University of Arizona Tucson, Arizona, USA Previously published books in this series: Bowman, Mary Jean Collective Choice in Education Buchanan, James M. and Wagner, Richard E. Fiscal Responsibility in Constitutional Democracy McKenzie, Richard B. The Political Economy of the Educational Process Auster, Richard D. and Silver, Morris The State as a Firm Kau, James D. and Rubin, Paul H. Congressmen, Constituents, and Contributors: The Determinants of Roll Call Voting in the House of Representatives Ordeshook, Peter and Shepsle, Kenneth Political Equilibrium Tullock, Gordon The Economics of Special Privilege and Rent Seeking The intersection of economics and politics is one of the most important areas of modern social science. "Studies in Public Choice" is devoted to a particularly crucial aspect of this intersection -- the use of economic methods and analysis on matters which are traditionally political in nature. Prominent scholars, such as Duncan Black, Kenneth Arrow, Mancus Olson, Vincent Ostrom, William Riker, and James Buchanan, have contributed to the development of the study of public choice. The aim of this series is to promote the growth of knowledge in this important and fascinating field. Markets and Politicians Politicized economic choice Edited by Arye L. Hillman Bar-Ilan University, Israel Springer Science+Business Media, LLC Library of Conllress Cataloginll-in-PubUcation Data Markets and politicians : politicized economic choice I edited by Arye L. Hillman. p. cm. - (Studies in public choice) ISBN 978-94-010-5728-8 ISBN 978-94-011-3882-6 (eBook) DOI 10.1007/978-94-011-3882-6 1. Economic policy. 2. Politicians. 3. Social choice. I. Hillman, Arye L. II. Series. HD87.M275 1990 338.9-dc20 90-19545 CIP Copyright © 1991 by Springer Sciclllce+Buain_ Media New York Originally published by KIuwer AI:adcmic Publishen in 1991 Sofh:over reprint or1he Iwdeover Ist edition 1991 Ali rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher, Springer Science+Business Media, LLC Printed an acid-free paper. CONTENTS CONTRIBUTING AUTHORS vii INTRODUCTION xi I: ECONOMIC POLICIES AND POLITICAL MOTIVES A. Theoretical Perspectives 1. Economic policies and political competition 1 Heinrich W. Ursprung 2. Voluntary collective action 27 Joel M. Guttman 3. Factor income taxation in a representative democracy 43 Wolfgang Mayer and Jun Li B. Policy Choices 4. Macroeconomic stabilization policy: Does politics matter? 63 Martin Paldam 5. Accidental freedom 93 Gordon Tullock 6. Europe 1992: From the common to the single market 113 Peter Holmes II: MARKETS AND SOCIALISM A. Market Socialism in Eastern Europe 7. Markets and ownership in socialist countries in transition 137 Manuel Hinds 8. Socialism in less than one country 169 Adi Schnytzer B. Transitionary Policies 9. Restoring property rights 179 Marton Tardos 10. Liberalization dilemmas 189 Arye L. Hillman C. Economic Change in China 11. The failure of recentralization in China: Interplays among enterprises, local governments, and the center 209 Kang Chen 12. Market-oriented reform and fiscal policy 231 Mario I. Blejer and GytJrgy Szapary vi Markets and Politicians III: INTERNATIONAL ECONOMIC POLICY A. International Trade 13. The political-economy perspective on trade policy 263 Robert E. Baldwin 14. The economics and political economy of managed trade 283 Wilfred J. Ethier 15. Changes in trade-policy regimes 307 James H. Cassing B. International Monetary Transactions 16. Foreign-exchange markets and central-bank intervention 319 Manfred Gl1rtner 17. The political economy of the international debt crisis 339 Ngo Van Long 18. Foreign-exchange market liberalization: Anatomy of a failure 357 Ben-Zion Zilberfarb CONTRIBUTING AUTHORS Robert E. Baldwin, University of Wisconsin, U.S.A. Mario I. Blejer, International Monetary Fund, Washington, D.C. James H. Cassing, University of Pittsburgh, U.S.A. Kang Chen, The World Bank, Washington, D.C. Wilfred J. Ethier, University of Pennsylvania, U.S.A. Manfred Gartner, St. Gallen School of Economics, Switzerland Joel M. Guttman, Bar-Han University, Israel Arye L. Hillman, Bar-Han University, Israel Manuel Hinds, The World Bank, Washington, D.C. Peter Holmes, University of Sussex, U.K. Ngo Van Long, McGill University, Canada Jun Li, University of Cincinnati, U.S.A. Wolfgang Mayer, University of Cincinnati, U.S.A. Martin Paldam, Aarhus University, Denmark Adi Schnytzer, Bar-Han University, Israel Gyorgy Szap<1ry, International Monetary Fund, Washington, D.C. Marton Tardos, Hungarian Academy of Sciences Gordon Tullock, University of Arizona, U.S.A. Heinrich W. Ursprung, University of Konstanz, FRG Ben-Zion Zilberfarb, Bar-Ilan University, Israel ACKNOWLEDGEMENTS Many of the papers in this volume were presented at the Bar-Ilan Conference on Markets and Politicians at Bar Ilan University, Israel, in June 1989. Joel Guttman was co-organizer of the conference, and Gershon Alperovitch as departmental chairman was also instrumental in organization. INTRODUCTION Arye L. Hillman There has been much economic theorizing directed at providing the politician with guidance in the design of policies that will amend market outcomes in ways that achieve specified efficiency or equity objectives. It has been common practice in economic models to portray the politician who implements the policy recommendations as a mechanistic individual who behaves as would a benevolent dictator to maximize a prespecified conception of social welfare or the utility of a representative consumer. The self-interest and discretion that is attributed to firms and consumers as optimizing agents is absent from the motives of such a politician. Economic policy choice is thereby depoliticized. How well depoliticized economic theory fares in explaining or predicting economic policy choice depends naturally enough upon how politicized is the economic system in which economic and political agents function. The papers in this volume recognize that politicians may exercise sufficient discretion so as not to behave mechanistically in correcting market inefficiencies or in pursuit of a somehow specified just income distribution. Since politicians are viewed as self-interested optimizing agents, just as are utility-maximizing consumers and profit-maximizing producers, the choice of economic policies is politicized. Coverage is provided of a broad spectrum of economic policy choice where markets and politicians interact. Section I is concerned with policy determination in western market economies, Section II with the introduction of markets into economies in transition from socialism, and Section III with international transactions. Heinrich Ursprung (Chapter 1, Economic policy and political competition) begins by reviewing how in past literature political influences on policy choice have been integrated into models of representative democracy. The role of political competition in the determination of economic policies is developed in a model of contenders for elective office xii Markets and Politicians who make policy pronouncements to maximize the value of their campaign contributions relative to contributions received by opponents, and thereby maximize their probabilities of election. The model encompasses recognition of the public-good nature of the economic benefits and costs associated with candidates' policies. The preferences of voters, or the median voter, do not here directly determine policy outcomes, which are responsive to campaign contributions. The campaign contributions in turn are sought to influence voters' perceptions of the attractiveness of the candidates and the policies they propose. Joel Guttman (Chapter 2, Voluntary collective action) compares explanations for the observed conjunction of cooperation and self-interest in individuals' collective behavior. Such collective behavior is central to the activities of political coalitions of individuals seeking to achieve common economic objectives. Wolfgang Mayer and Jun Li (Chapter 3, Factor income taxation in a representative democracy) demonstrate how individual interests are reflected in political choice of taxes levied on factors of production, when individuals differ with regard to the tax system that they regard as optimal and seek different patterns of expenditures of tax proceeds. Martin Paldam (Chapter 4, Macroeconomic stabilization policy: Does politics matter?) looks at macroeconomic policy. A literature on "political business cycles" has proposed that macroeconomic policies are subject to political manipulation that is directed at maximizing probabilities of reelection of incumbent governments. Two types of business cycles have been described, election cycles over one election period, and partisan cycles that encompass two election periods under different governments. Paldam reviews theories of the political business cycle, and presents empirical results of tests in seventeen countries. Gordon Tullock (Chapter 5, Accidental freedom) uses an historical account to make the case that economic freedom in the U.S. arose fortuitously. The U.S. did not proceed free of attempts to regulate domestic market activity and protect domestic producers. Tullock recounts how the constitutional guarantee of free trade among the states thwarted attempted state-imposed monopolies, including state socialism, and how domestic regulation of economic activity and U. S. international trade policy have been subject to different influences over time. Peter Holmes (Chapter 6, Europe 1992: From the common to the single market) sets out the political motives underlying the economic policies aimed at creating a post-1992 single European market. Since the intent of the policies underlying the post-1992 "single market" is to all intents and purposes the same as that of the Treaty of Rome that sought to establish the "common market", why should the single-market conception