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Many intelligent and sensitive people in the world today have an optimistic view of their democratic government. They expect it to lead them toward prosperity. They are predisposed to favor government over the market as a provider of goods and services. They tend to look favorably on central economic planning, like that of the Soviet Union before its breakup. The main problem, as they see it, is to elect and appoint competent and trustworthy government officials. Other people have opposite predispositions. Extreme free marketeers believe that a government cannot improve matters. They favor a minimal role for government, expecting markets to provide goods and services as efficiently as possible.

The statement that "the market provides goods" is a shorthand way of saying that when there are private property rights and free enterprise, individuals have an incentive to produce goods for others in order to earn money to buy the goods that they want. "The market" thus refers to the producers who economists predict would emerge under certain conditions. We discuss the market economy in depth in Chapter Three.

Public Choice tries to avoid preconceptions on the issue of government vs. the market in general. To evaluate these institutions, it regards both as tools for helping people get what they want. If we aimed to evaluate one hammer in relation to another, we would compare the two with respect to the task we want to accomplish. The same is true when we evaluate government in relation to the market. Our first step is describe the wants we feel these institutions should aim to satisfy.

We can identify several broad classes of wants that people would like to have satisfied. First, people have wants that hardly anyone expects either the government or the market to satisfy. These include personal commitments from loved ones, spiritual peace, and religious fulfillment. We are not interested in such wants in this book. Other wants can be divided into two broad classes: security and worldly goods. We discuss each in turn.

The want for security is most evident when it is absent. Faced with a prospect of being oppressed, people have a strong want for security. No one wants to be killed or violated by foreign invaders or bullies. It is difficult to see how security, in the broadest sense, can be provided by the market. People can certainly buy locks, build walls, and hire security guards to protect their durable goods. However, if they were free to produce highly destructive weapons or other killing devices, there would be a great increase in the fright level. People would worry that such devices would be used for theft and extortion or to help set the stage for a revolution or foreign invasion. The want for security in modern times can only be fully supplied by a government.

Worldly goods include food, shelter, clothing, roads, bridges, vehicles for transportation and recreation, clean air and water, education, good health, insurance, entertainment, vacation holidays, and countless other goods that we have come to associate with life in the modern world. It is in the supply of these goods that practically all disputes over market vs. government supply arise. Fortunately, economists have devoted a great deal of effort to the problem. First they have developed an image, or model, of a pure market economy. This imaginary economy does not contain all of the goods that we know exist. It only contains goods that the private individuals in the market would excel in supplying. Then they have classified the other kinds of goods and situations in which private supply through the market is not likely to be optimal, or efficient. A more efficient means of supply can be imagined. They call these cases market failure. This is where Public Choice begins.

Market failure: on the basis of their economic models, economists can envision that individuals would be better off if free market interaction was hampered in some way by government.

In Public Choice, we compare market with government supply in the following way. We first identify some kind of market failure. Then we ask whether it is best to try to correct it through government or to let it continue. Our judgment must be based on what we regard as the benefits and costs of making the correction. We shall see that using a democratic government to provide goods is likely to entail substantial waste and inefficiency. In the economist's view, government waste and inefficiency add to the costs of government supply. When we judge that such costs are high, we say that there is government failure. If we think that the government will also fail, we may be better off accepting the market failure. We might like to live in a world that is completely without market failure. But, like the discomfort of a thunderstorm, our best option may be to protect ourselves individually rather than look to the government for a solution. This entire book is devoted to developing a framework for making informed judgments about whether government intervention in the supply of worldly goods is likely to improve matters or make them worse. The aim of this chapter is to introduce the problem of comparing a market with a democratic government.

To compare the market with the government, many students must overcome a longstanding bias. Throughout the years, moralists have taught that people engaged in politics should be ruled by motives that are morally superior to those that rule ordinary choices. Ordinary choices are ruled by self-interest. But in politics, say the moralists, individuals should act in the public interest instead of in their self interest. The moralists may be right about the way people should act. However, if we want to make judgments about the likelihood of government failure, we must consider how people are likely to act. For this reason, Public Choice assumes that voters, politicians, and bureaucrats act in their self interest.

We begin this chapter in Part one by discussing the assumption of self interest. In Part two, we introduce the idea of market failure. Part three discusses the problem of comparing the market with government.

Let us try to project ourselves back about 250 years ago, before people began to study political economy. At that time, many discussions of production and distribution emphasized social duty. Business people were supposed to charge a "just price," loan their money without asking for interest, and perform various other social duties such as caring for the poor and disabled. The crass, profit-seeking businessperson was often condemned because he placed his own interests above those of other people and his religion. A great achievement of the English Enlightenment (in particular of Adam Smith) was to change this viewpoint. Through carefully reasoned argument, the founders of modern economics demonstrated that even if businesspeople are self-interested, their actions ordinarily benefit others. We now call this the invisible hand theorem – the idea that in a private property system individuals are led, as if by an invisible hand, to promote others' interests, even though they act in their own self-interest.

Invisible hand theorem: the idea that in a private property system individuals are led, as if by an invisible hand, to promote others' interests, even though they act in their own self-interest.

Some people confuse self-interest with selfishness. The two are quite different. A person may act in his self-interest without being selfish. The opposite of selfishness is altruism, a desire to help other people. To understand the difference between self-interest and selfishness, let us compare two altruists. It is reasonable to assume that the altruists will have different views about who is deserving of their help. One may want to benefit one group of people, while another will want to benefit a different group. Or if both want to benefit the same group, they will likely differ in the benefits they believe different members of the group should receive. For example, you may give some of your money to the Boys' Club while your friend gives hers to the Girls' Club. You are both altruistic but your views about who should be helped are different. You probably would like your friend to give some of her money to the Boys' Club and she would like you to give some of yours to the Girls' Club.

Moreover, although you both are altruistic, your altruism is unlikely to extend to your business dealings. It is unlikely that either of you is willing to pay the supermarket owner more than the sticker prices for your groceries. Both of you are likely to believe that your favorite charity (your self-interest) is more important than the interest of the supermarket owner.

To act in your self interest: to make choices according to the interests, wants, or desires that you have.

To act selfishly: to thinks only of yourself and not of others when you acts.

Thus, even though you are altruistic, both of you are acting in your self-interest. To act in your self interest means only that you are making choices according to the interests, wants, or desires that you have. If you have a desire to help others, then your choice to help others is in your self-interest. Selfishness means that an individual thinks only of himself and not of others when he acts.

Public Choice assumes that people act in their self interest, whether they are consumers in the market, voters, teachers, owners of businesses, employees of private companies, or government officials. Moreover, it assumes that the wants of a given individual do not change as she shifts from one role to another. Suppose that a businessperson who has been very successful as head of a large firm takes a job as head of a government department. Is there any reason to believe that he will stop acting in his self interest? The conditions under which he operates change, and this should lead to some change in his behavior; but he is essentially the same person.

The notion that action in politics is as self interested as it is in business is a simple idea. It is part of our common sense. Yet it provides the basis for a radical departure from the theory of democracy that was presented by most writers on politics before Public Choice.

To say that people act the same in politics as in business does not mean that they are not charitable. Gordon Tullock once surmised that the average human being is about 95 per cent selfish in the narrow meaning of the term.

People who work in business, like people everywhere, often sacrifice their well-being for the benefit of others. But they do not sacrifice very much. We can expect people in government to do the same.

The important point, however, is not whether people are charitable, as pointed out above. It is that they act in their self interest. Even if people were only 50 per cent selfish, each would still have distinct views about who should receive help and how much they should receive. And each would act according to his own views. This applies to government officials as well as to private individuals and businesspeople.

The scientific attitude refers to an approach toward understanding phenomena that intentionally disregards the rightness or wrongness of the phenomena in a moral, spiritual, or religious sense. Because early political economists assumed that people act in their self-interest, they had an important advantage over the other students of society in their day. They could begin their studies by studying how people do act, instead of how they should act. As political economy progressed, the new political economists increasingly focused on action and choices rather than moral philosophy. This fundamental focus on realistic behavior is the reason the scientific attitude developed more quickly in economics than in other social sciences. It is not surprising that economists brought the scientific attitude to the study of democratic politics.

Market failure is a situation in which economists we can envision that individuals would be better off if the freedom to produce and/or exchange in the market economy was hampered in some way by government. When we say that there is market failure, we believe that taxing, subsidizing, or regulating some activity may cause the interests of the various individuals to be better served.

David Hume, writing in the mid-18^th century, was one of the earliest writers on market failure. He used the example of a meadow with poor natural drainage.

Improving the drainage could increase its value by much more than the cost. If one man owns the meadow, there is no problem. He improves the drainage and earns the full value of his actions in profit. If the meadow happens to lie across the property of two people, they can agree between themselves on a drainage plan. There is still not much of a problem. If many people own the rights to use the meadow, however, agreement becomes difficult. Each person knows that if he does not contribute, his abstention would only slightly reduce the resources available for drainage. Further, he will get his share of the benefit anyway, since he cannot be excluded. Accordingly, he may decide either to not contribute and become a "free-rider" or to engage in hard bargaining. But if everyone did this, no agreement may be reached and the meadow will continue to be poorly drained.

Free-rider problem: a state of market failure due to individuals' incentives to avoid paying for benefits from which they cannot be excluded.

Hume recommended the use of government in such circumstances. Recognizing the "free rider" problem, farmers might agree to let the drainage decision be made by an agent who they think is "impartial." Ideally the agent would impose taxes on the farmers based on the size of their benefits and then use the tax money to finance the drainage. But the agent would not have perfect knowledge about the benefits to the individuals. As a result, his decision would probably be inferior to the best result we can imagine. Nevertheless, it may be better than the status quo.

There are only 20 people or so in Hume's example of the meadow; in modern government activities there may be millions. Consider another example, that of air pollution. This is an especially serious problem in highly populated, rapidly developing Asian and South American cities. A major cause of pollution is exhaust fumes from gasoline-using engines. If everyone changed to no-lead gasoline or to a cleaner gasoline substitute and if everyone kept their motor vehicles in good repair, practically everyone would benefit. However, no individual could noticeably profit by changing. This is because the reduction in the total amount of polluted air that he could cause would barely affect him yet he must pay the full cost of making the change. A private agreement in which everyone would change is impossible. Thus, we might turn the job over to a government agency. The agency would be responsible for taxing and otherwise arranging for the reduced pollution.

For a long time, economists have pointed out that the market does not reach perfect solutions in the case of market failure. Before Public Choice, it was typical for economists to argue that where the market is imperfect, the government should deal with the problem. Hardly anyone believed that the government could reach a perfect solution, but they often recommended government action without considering the possibility of government failure.

This was clearly a mistake; we should compare government and the market and use the institution that we believe will cause the least inefficiency. Under some circumstances, we would anticipate that the private market would not do well. We must then consider whether the government will do better, or be less imperfect.

There is a legend of a Roman emperor who, being asked to judge a contest between two singers, heard only the first and gave the prize to the second, assuming he could not be worse. This is not an optimal selection procedure. We must ask: what are the defects in practice of both. We must compare the market and the government by making a careful calculation of all effects, good and bad. Public Choice studies how collective decisions are made in a democracy. By doing so, it aims to help us make the comparison easier, more complete, and more accurate.

Common errors made in comparing market supply with government supply:

1. Underrating Market Solutions

2. Overrating the Government Solution

3. Neglecting Conformity

4. Neglecting Potential Abuse of Coercion

5. Neglecting Technology and Other Changes

People who compare the government with the market are often predisposed to make errors. In the rest of the chapter we shall discuss five of these.

The market is a vast network of interrelated individuals, each trying to find ways to earn money by producing goods and services that he believes others will buy. There are often large differences in peoples' abilities to succeed. Some people are dull and look to others to provide guidance in finding jobs, investing savings, and even spending money. Others are extremely clever. Some are so clever that practically no one, including economists, can understand how they are able to discover workable solutions to problems. After the solutions are found, they are often easy to understand. Beforehand, however, they may seem impossible. Two hundred years ago, only the most venturesome would have predicted interplanetary travel; no one had thought of the telephone, television, computer, and many other electronic and motorized utilities and gadgets. Today we take them for granted.

When we identify what we believe is a market failure, such as the common meadow or pollution, we should not jump to conclusions. Although we may not be able to conceive of a market solution, it is possible that some clever businessperson will find one. Moreover, although no one may think of a market solution in the near future, one may be found in the more distant future. Anyone who doubts this should spend a few hours reading business history.

Consider the pollution problem. There are a variety of government policy alternatives. First, the government can make regulations to prevent or reduce emissions of toxic gasses from cars, factories and trash-burning households. Second, the government can impose taxes on polluters or on products whose production causes pollution. Third, the government can try to find an optimal amount of the different pollutants and then auction off rights to emit them. The economist would presumably choose the best of these alternatives and recommend it. But for the government of a democracy, the choice is not so easy. Real politicians ordinarily want a policy that will help them get reelected or help their political party, not one that is most economically efficient. The policy they choose may be the one that best pleases the majority or that appeals to particularly influential pressure groups even though it is not the most efficient. Moreover, once the policy is chosen, there is no reason to believe that the government officials who are charged with administering it will act efficiently or fairly. Indeed, government bureaucrats are notorious for inefficiency, favoritism, and corruption (although there are means of keeping these at tolerable levels).

Many defects of government supply are discussed in detail later in this book. But we can deal with one obvious one quickly. It is simply that government, of necessity, buys the same thing for everybody. When we buy something in the private marketplace, we can decide how much of it we want and its quality and style. If we club together democratically with our neighbors to correct for a market failure, we have to accept the decision of the majority.

In a representative democracy, one person may prefer to pay higher taxes and have a larger police force with the expected lower crime rate; another may prefer a lower tax rate, a smaller police force, and a higher crime rate. Similarly, one person may want the police to reduce burglary, another to reduce rape, and a third to reduce drug use. If it were possible to buy police services efficiently in the private market, we could each have our optimal quantity and type. If people buy them collectively, however, they must reach a compromise. The compromise may be one person's optimum, another person's optimum, or in between. There is no way for each to have her own optimum, as she could if she bought in the private market.

The principal advantage of government in correcting for market failure is that it can coerce individuals into giving up their private bargaining strategies and accepting an imposed solution. But giving agents the power to coerce can also be a disadvantage. To enable a government agent to raise the funds needed to drain a meadow, for example, citizens must give her the power to imprison people and/or confiscate property. But she may use this power to subjugate or extort wealth from the very people who give her the power. There are ways to minimize the chances of this kind of damage and we will discuss them in Chapters Four and Five. However, the risk cannot be eliminated completely.

There is no reason why the choice between government and market should be permanent or unchanging. For example, technological changes could increase the harm due to common resources and pollution, or perhaps make it easier for the government to produce a good solution. In either event, we may want to transfer a service previously provided through the market to the government. On the other hand, if there was a sharp fall in pollution or a development that made it harder for government to make an optimal decision, we may want to transfer an activity from the government to the market. In a well-functioning polity, activities that had been private 50 years ago may not be private now; and activities that had been conducted by the government 50 years ago may not be governmental now.

If the size and general vigor of human civilization grow within a given physical space and technology, we can expect that people will exert more harmful external effects on each other. The members of a small community surrounded by wilderness can afford to dump all their waste into a stream, while collecting all their drinking water upriver. As the population around the stream increases, this procedure becomes costly. Since the government's method of dealing with the problem will not be perfect, it is not sensible to introduce the government until the pollution in the stream becomes considerable. At some stage in this supposed growth process, the current expected costs of pollution may become greater than the expected costs of a ponderous government. Government intervention would then become preferable. Until then, the community members would be content to tolerate the relatively lower costs of the pollution externality.

Suppose that someone invents a small, compact, and inexpensive waste treatment procedure that converts all the waste at very low cost into saleable fertilizer. Since this is a superior system, households and businesses begin switching to it from their traditional methods of disposal. As more people make the change, the time may come when the costs of government intervention in waste disposal exceed the benefits. At that time, the activity should be shifted back to the market.

Such a waste treatment procedure may never be produced, but technological improvements often call for reduced governmental control. Immediately after the second World War, when new television stations were being started by private companies in the United States, there was a strong likelihood that they would interfere with each other. This is because their watching areas overlapped on the same wavelength. The regulatory institution chosen to deal with the problem was the Federal Communications Commission (FCC), which had been performing the same function for radio. At first, the policy was a success and interference diminished. As time passed, however, the FCC used its coercive power to restrict entry into the TV industry and to restrict programming. As a result, Americans had markedly less choice of TV programs than they could have had.

Another way of transmitting a TV signal to people's homes is by cable. There is no reason why cable signals should be regulated nationally. But by the time cable TV had become a viable competitor to network TV, the agents at the FCC felt an obligation to protect the existing networks against the new competition. There is no doubt that this protectionist attitude greatly retarded the development of TV viewing opportunities. The original regulation of TV wavelength allocation seems to have been sensible, if not optimal. With the development of new cable technology, the market should have replaced government.

A government institution can become obsolete in two ways: by a change in technology, which we discussed here, and by a fall in demand for the service. Politicians are often reluctant to eliminate an institution that has become obsolete. We discuss this reluctance in Chapter Sixteen on rent seeking and in Chapter Seventeen on privatization.

Of course, it is possible that government institutions will exist that never had an economic purpose. The new democracies of Eastern Europe and Asia have typically inherited many institutions that were useful only to a former dictator or dominant political party. The best examples are government-owned enterprises and agencies created to restrict trade and travel. These businesses and agencies have no foreseeable use, given that conditions exist for the development of markets. In such cases, the problem is not a choice between market and government, but how to get rid of anti-market remnants of the dictatorship. In other words, the problem is how to privatize.

2. We can regard the government as a means of helping ordinary people get what they want. Assuming at first that there is no government, identify two broad classes of wants that people may want the government to help them satisfy.

3. People want (1) personal commitments and religious fulfillment, (2) security, and (3) worldly goods. Ordinarily, who do they expect to supply the goods and services needed to satisfy these three broad classes of wants?

4. Briefly tell the difference between pre and post-enlightenment attitudes toward businesspeople.

7. It is sometimes argued that businesspeople are selfish while people who work in government are interested in the public. Discuss this argument.

8. According to the text, why did the scientific attitude develop more quickly in economics than in the other social sciences?

10. Identify three errors made by observers in their efforts to compare government with the market in correcting for market failure.

11. Traditionally, economists have identified a market failure and recommended a solution, or perhaps several solutions, to the government. But the democratic government has not implemented the solution. Explain why by giving an example. (Do not use the example of pollution.)

12. Is everyone likely to be fully satisfied with a collective decision to supply some public good? Explain why (or why not) be referring to the concept of conformity.

Gunning’s Address
J. Patrick Gunning
Professor of Economics/ College of Business
Feng Chia University
100 Wenhwa Rd, Taichung
Taiwan, R.O.C.
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