Sunday, October 13, 2013

Incentivizing Honest Preference Revelation for Public Goods


EPA: How much is environmental protection worth to you?
Erin: Around $400 a year
EPA: Please pay us $400 a year
Erin: Oh, in that's only worth $100 a year

Here it is from the horse's monkey's mouth...
And here as well...
"departing from his indoctrinated rules" = lying
"give false signals" = lie



























Friday, October 11, 2013

S Is Never Going To this rate...

None of the vulgar libertarians (VLs) I showed my last drawing to managed to figure out who S is.  So I added another "clue" to the drawing.  Plus, I added myself to the drawing.  I'm the guy saying, "The stupid monkey is over here!!!"  S is actually a I'm being rayshist (a bit racist).

Ummm...I suppose for some it might not be obvious that I'm channeling quite a bit of Ayn Rand in this drawing.  "S Is Never Going To Shrug" instead of "Atlas Shrugged"...and "Who is S?" instead of "Who is John Galt?".

Thursday, October 10, 2013

Libertarians: Riding a Moral High Horse and Tilting at Windmills

Most libertarians don't know who "S" is.  We can refer to these libertarians as Vulgar Libertarians (VLs).  Because VLs don't know who S means that whatever it is they are sure isn't S.  Does it matter that VLs aren't attacking S?  Of course.  S is the person who provided the model that our current system is based on.  So by not attacking S...they are in fact doing their darndest to keep him safe.  They use their precious resources to throw others off the trail.  They go door to door handing out directions to the windmill.  They aren't intentionally sabotaging themselves...but it's just a logical consequence of riding a moral high horse.  A moral argument is a mental crutch that makes it entirely unnecessary to make the effort to learn anything about public finance.

If you don't want to be a VL anymore...then read my last blog entry...The Logical Absurdity of Libertarianism - Partial Omniscience...and see if you can't figure out who S is.

Monday, October 7, 2013

The Logical Absurdity of Libertarianism - Partial Omniscience

  1. Our current system is based on the assumption that congresspeople are omniscient (see below)
  2. The political process does not adequately communicate the preferences of citizens (source)
  3. Therefore, the provision of public goods is suboptimal (source)

With the help of equations and diagrams, Samuelson showed how the planner would derive for each individual his demand function and the collective consumption goods that would contribute to his utility maximization. In this system, the planner is expected to have an omniscient presence and be able to ascertain individual preferences even when they are not voluntarily revealed. Samuelson attempted to show the combination of public and private goods and their distribution that would maximize social welfare. His concern was with the total community's welfare and with all goods; it did not have much to do with the central reality of the budget in the ordinary world. - A. Premchand, Government Budgeting and Expenditure Controls: Theory and Practice
"Market failure" has always been defined as being present when conditions for Pareto-optimality are not satisfied in ways in which an omniscient, selfless, social guardian government could costlessly correct. One of the lessons of experience with development is that governments are not omniscient, selfless, social guardians and corrections are not costless. - Anne O. Krueger, Government Failures in Development
The traditional social welfare approach implicitly and often explicitly assumes an omniscient benevolent dictator (see Brennan and Buchanan 1986; Buchanan 1991). The dictator has the power to put all political ideas into action. He is completely informed and has the best of intentions. He wants to help individuals to reach the highest utility possible according to their own evaluations. - Bruno S. Frey and Alois Stutzer, Mispredicting Utility and the Political Process
When arguing that government intervention is needed to correct market failures when public goods, externalities and other sorts of market failures are present, the economics literature often makes the implicit assumption that these failures can be corrected at zero cost. The government is seen as an omniscient, benevolent institution that dictates policies in order to achieve a Pareto-optimal allocation of resources. The public choice literature challenges this utopia model of government by examining not how governments may or ought to behave, but how they do behave. It reveals that governments, too, can fail in certain ways. - Camilla Bretteville Froyn, International environmental cooperation: the role of political feasibility
Surprisingly, prior to 1957, economists stopped short when confronted with political markets, abandoned homo economicus, and fell back upon notions of impartial, omniscient, public interest motivated government, despite millennia of history that clearly invalidated such premises. In large part, this bifurcation in the research program reflected the utility perceived by economists from their role as philosopher-kings, an elite with acknowledged special access to their sovereign. Juvenile as this perception now seems, it was the dominant view among economists prior to the public choice revolution. It remains the dominant view, unfortunately, among the Ivy League elite that still controls the debate on the economics of underdevelopment. - Charles K. Rowley, Institutional Choice and Public Choice: Lessons for the Third World
Samuelson, laying particular emphasis on the problem of preference revelation, takes as a premise the existence of an omniscient planner. - Christian Bastin, Theories of Voluntary Exchange in the Theory of Public Goods
Under this condition the key difficulty of getting voters to reveal the relative intensities of their preferences for various public goods is virtually eliminated through the free exchange of votes in markets, and vote trading becomes a decentralized way for obtaining information on public goods, which is just as efficient as the private goods market is at obtaining information about consumer preferences. The omniscient benevolent dictator so frequently invoked in social welfare theory can be replaced by a system of decentralized markets. - Dennis C. Mueller, Geoffrey C. Philpotts, Jaroslav Vanek, The Social Gains From Exchanging Votes: A Simulation Approach
The new welfare economists view private markets as failing extensively because of perceived weaknesses in property rights, pervasive externalities and public goods and widespread asymmetries in information. In contrast, they view democratic government as benevolent, omniscient and impartial in its role as the White Knight riding to rescue individuals from unavoidable private market failures (Baumol and Oates, 1988). The public choice revolution redressed this bias by analysing government as it is and not as a figment of some excessively cloistered imagination. - Donald Wittman, Efficiency of Democracy?
In what follows we shall assume an omniscient planner who seeks to maximize social welfare subject to the scarcity constraints of the economy. This is standard practice in normative economics. - Elisha A. Pazner, Merit Wants and the Theory of Taxation
Standard theory pronounces these situations to be cases of market failure because that theory, blandly assuming a perspective of imagined omniscience (and skillfully side-stepping the problems of interpersonal comparisons of utility) believes it possible to identify the resulting market outcomes as socially inferior to patterns of resource alocation attainable through government intervention. From this perspective the market must, in such situations, fail to achieve that which is its assigned function to achieve, viz. a socially optimal pattern of resource allocation. - Israel M Kirzner, The Driving Force of the Market: Essays in Austrian Economics
The complexities of modern politics and bureaucracy should not, however, conceal the underlying realities, and gross misunderstanding can result if individual participation in, and reaction to, public decisions is either neglected or assumed away. The omniscient and benevolent despot does not exist, despite the genuine love for him sometimes espoused, and, scientifically, he is not a noble construction. To assume that he does exist, for the purpose of making analysis agreeable, serves to confound the issues and to guarantee frustration for the scientist who seeks to understand and to explain. - James M. Buchanan, Public Finance in Democratic Process
The possible advantages are, however, greatly increased when the unrealistic assumption of omniscient planning is relaxed and the preference-revelation problems in a world of diverse preferences are explicitly recognized. - John G. Head, Public Goods and Multi-Level Government
The traditional approach describes the allocation and distributive failures of the market, and the normative role of government in correcting those failures. Tax revenues from several sources are put into a single pot, a general fund, from which public services are provided. Equity in raising taxes is judged by ability to pay rather than by the benefit criterion on which earmarking is based. In the orthodox account, the government is shown to act as an omniscient and benevolent institution which improves on the market outcome and achieves an efficient allocation of resources. Traditional theory employs the device of a 'social welfare function' which guides an independent decision-taking budgetary authority. Critics of this account argue that in this approach, 'the government' is a black box into which voter preferences are fed and from which outcomes, which are claimed to be welfare-maximizing, emerge. - Margaret Wilkinson, Paying for Public Spending - Is There a Role for Earmarked Taxes
In Samuelson’s model, the optimum value of public goods expenditure is determined by an ethical observer who has information on the preferences and incomes of all individuals in the economy. - Marianne Johnson, Public Economics, Market Failure, and Voluntary Exchange 
The well-known Samuelson (1954, 1955) public goods articles offer a good example. Samuelson titles his first article “The Pure Theory of Public Expenditure,” indicating that his analysis of a possible market failure in the production of public goods is, in fact, not a theory, but the theory, of public expenditure even though the article contains no analysis of how government would succeed in producing public goods where the market would fail. The only way Samuelson's public good theory can be a theory of government expenditure is if the government is an omniscient benevolent dictator. - Randall G. Holcombe, Make Economics Policy Relevant: Depose the Omniscient Benevolent Dictator
Though an old theme, Samuelson's rigorous analysis of public goods in a general equilibrium setting (Samuelson, 1954) captured the attention of a wide range of theorists, and soon became the center of fiscal theory. Wicksell's concern with how to secure preference revelation was noted, but was set aside as unmanageable by economic analysis. Implementation of budget choice was again left to an omniscient referee. - Richard A. Musgrave, Public finance and the three branch model
The problem would disappear if government were omniscient, as implicitly assumed by Hotelling, but government is not omniscient and throughout his career Coase has insisted very sensibly that in evaluating the case for public intervention one must compare real markets with real government, rather than real markets with ideal government assumed to work not only flawlessly but costlessly. - Richard A. Posner, Nobel Laureate: Ronald Coase and Methodology
The essential point is that, in the standard formulation, the omniscient economist-observer (Graaff 1957, p. 13) is presumed to advise a benevolent despot (4.4). That the observer cannot 'know' the disparate desiderata of individual, autonomous agents is clear (Chapter 6). That the benevolent despot formulation unrealistically suppresses narrowly construed self-interest is also clear. In the event, both because the observer can only presume to know the relevant preference (and value) structures, and because any 'index of group welfare just inevitably make normative judgements in which the gains to some are weighed against the losses to others', it is plausible to argue that, in fact, 'measures of group welfare used by practitioners have been developed in an ad hoc manner with little or no welfare economic justification' (Slesnick 1998, p. 2137). - Timothy P. Roth, The Ethics and the Economics of Minimalist Government
PPB analysis rests upon much the same theoretical grounds as the traditional theory of public administration. The PPB analyst is essentially taking the methodological perspective of an "omniscient observer" or a "benevolent despot." Assuming that he knows the "will of the state," the PPB analyst selects a program for the efficient utilization of resources (i.e., men and material) in the accomplishment of those purposes. As Senator McClelland has correctly perceived, the assumption of omniscience may not hold; and, as a consequence, PPB analysis may involve radical errors and generate gross inefficiencies. - Vincent Ostrom and Elinor Ostrom, Public Choice: A Different Approach to the Study of Public Administration

The Provision of Public Goods is Suboptimal

  1. Our current system is based on the assumption that congresspeople are omniscient (source)
  3. Therefore, the provision of public goods is suboptimal

How, then, are demand functions revealed? It would be disingenuous, to say the least, in an exercise whose object is to discover how demand is revealed, to assume that, ex ante, centers of power know the preferences of consuming households. We must then begin our analysis of the forces that motivate citizens to reveal their preferences by focusing on a fundamental information problem. I therefore assume that as a consequence of imperfect information concerning the preferences of citizens, centers of power will provide, except by accident, goods and services in quantities that will be either larger or smaller than the quantities desired by consuming households at the taxprices they confront, and I show that these departures from optimality inflict utility loses on these households. - Albert Breton, Competitive Governments: An Economic Theory of Politics and Public Finance
There are many problems with this public good argument. The most glaring problem that should be noted immediately is that, assuming that education indeed cannot be provided optimally by private means, what in the world would move someone to believe that government can better determine the optimal amount? Buchanan (1975) correctly notes that many economists, as soon as they believe that they have diagnosed a public good, fail to consider critically the role that government can play: "It was as if the alternatives for public choice were assumed to be available independently from some external source; there was no problem concerning the behavior of [government] suppliers and producers." - Andrew Young and Walter Block, Enterprising Education: Doing Away with the Public School System
One aspect of public goods that prevents the government making efficient decisions is the government's lack of knowledge of households' preferences and willingness to pay for public goods. - Gareth D. Myles, Public Economics
Prices must also play a more important role as a mechanism for revealing the true demand for - and therefore, indicating the efficient supply of - public infrastructure. The current disconnect between payment by users and services provided by specific infrastructure assets has led to too much public capital in some sectors and too little in other sectors. - Harry Kitchen, Physical Infrastructure and Financing
Thus, the revised definition allows us to see that public goods do not only face the long recognized risk of under-provision; they may also suffer from mal-provision – providing positive utility only for some and for others nothing, or sometimes even, only costs. A way to reduce the risk of such mal-provision could be to grant all concerned population groups a more direct say in selecting and shaping public goods, i.e. to better match publicness in consumption with publicness in decision-making. More issue-specific policy dialogue among all concerned actors and stakeholders could help achieve that. - Inge Kaul, Public Goods: Taking the Concept to the 21st Century
Because of the coercive nature of government activity, two additional results come forth. First, by voluntarily purchasing an item on the market, an individual demonstrates that he values the item more than the money price. But in paying taxes, he makes no such demonstration. The government does not know, as a business does, the value individuals place on its activity. Since government cannot obtain the information and incentive by demonstrated preferences of individuals, they cannot efficiently serve individuals. - Jeffrey Herbener, Austrian Methodology: The Preferred Tax Type
One cause of inefficiency in the provision of collective goods is familiar from the theoretical writings in welfare economics and public finance, but rarely mentioned in the PPB or cost-benefit literature. That is the difficulty of getting consumers to reveal their preferences concerning a collective good or externality, and preferences must of course be known to determine how much it is optimal to provide. - Mancur Olson, Evaluating Performance in the Public Sector
But this argument generates far more difficulties than it solves. It proves too much in many directions. In the first place, how much of the deficient good should be supplied? What criterion can the State have for deciding the optimal amount and for gauging by how much the market provision of the service falls short? Even if free riders benefit from collective service X, in short, taxing them to pay for producing more will deprive them of unspecified amounts of private goods Y, Z, and so on. We know from their actions that these private consumers wish to continue to purchase private goods Y, Z, and so on, in various amounts. But where is their analogous demonstrated preference for the various collective goods? We know that a tax will deprive the free riders of various amounts of their cherished private goods, but we have no idea how much benefit they will acquire from the increased provision of the collective good; and so we have no warrant whatever for believing that the benefits will be greater than the imposed costs. The presumption should be quite the reverse. And what of those individuals who dislike the collective goods, pacifists who are morally outraged at defensive violence, environmentalists who worry over a dam destroying snail darters, and so on? In short, what of those persons who find other people's good their "bad?" Far from being free riders receiving external benefits, they are yoked to absorbing psychic harm from the supply of these goods. Taxing them to subsidize more defense, for example, will impose a further twofold injury on these hapless persons: once by taxing them, and second by supplying more of a hated service. - Murray Rothbard, The Myth of Neutral Taxation
One problem with the government's redistributional activities is that because the government is not run by an omniscient and benevolent despot, but rather by democratic decision-making, there is no underlying principle that determines how redistribution will occur. Rather, as Stigler noted, benefits are transferred to those with political power. This leads interests to engage in rent-seeking, with the attendant political costs. And because benefits go to those with political power rather than to those who, according to some justification, deserve them, it is unlikely that the ultimate result of government redistributional activity will satisfy any reasonable criteria for efficiency or equity. Meanwhile, the rent-seeking and political costs remain. - Randall G. Holcombe, Taxation, Production, and Redistribution
If a revenue source is earmarked but has no logical connection with the expenditure function it supports, then from an efficiency perspective the amount of the public service supplied will almost certainly be either too great or too small. - Richard M. Bird and Thomas Tsiopoulos, User Charges for Public Services: Potentials and Problems
Since these policies are bundled together and voters cannot evaluate them individually, the election margin cannot reveal which of these interpretations is correct, nor can the election reveal the specific amount of resources voters want to devote to each of the three policy areas. Yet for political parties to allocate resources to satisfy social preferences, parties must determine which interpretation accurately describes voters’ preferences. For if a party were elected to power because voters wanted the party to alter foreign policy—but not any of the other policies—and the party did not realize this, the party could allocate resources in ways that did not reflect social preferences. - Samuel DeCanio, Democracy, the Market, and the Logic of Social Choice
Voting and other democratic procedures can help to produce information about the demand for public goods, but these processes are unlikely to work as well at providing the optimal amounts of public goods as do markets at providing the optimal amounts of private goods. Thus, we have more confidence that the optimal amount of toothpaste is purchased every year ($2.3 billion worth in recent years) than the optimal amount of defense spending ($549 billion) or the optimal amount of asteroid deflection (close to $0). In some cases, we could get too much of the public good with many people being forced riders and in other cases we could get too little of the public good. - Tyler Cowen, Alex Tabarrok, Modern Principles of Economics
Because most public goods and services are financed through a process of taxation involving no choice, optimal levels of expenditure are difficult to establish. The provision of public goods can be easily over-financed or under-financed. Public officials and professionals may have higher preferences for some public goods than the citizens they serve. Thus they may allocate more tax monies to these services than the citizens being served would allocate if they had an effective voice in the process. Under-financing can occur where many of the beneficiaries of a public good are not included in the collective consumption units financing the good. Thus they do not help to finance the provision of that good even though they would be willing to help pay their fair share. - Vincent Ostrom and Elinor Ostrom, Public Goods and Public Choices
Nevertheless, even without perfect knowledge, the government must decide whether or not to provide the public good. It also must decide how much of the public good it should provide. Finally, the government must decide, all without guaranteed information, on a tax schema. Under such circumstances, it is not possible for the government to reach an optimal solution and a Pareto distribution of taxes for the public good. - Wilfried Eecke, Ethical Dimensions of the Economy

Thursday, October 3, 2013

Evaluating Mistakes on an X Y Graph


Infactum: How do you define the word "mistake"?

Xero: How many different ways can you allocate the resources that you now have? Each possible allocation is going to provide you and others with a different amount of value. Because values are subjective, an allocation that might create value for you...might destroy value for others. So we're dealing with an x y graph...your value is on the x axis and other people's values are on the y axis. Can you figure out where mistakes would be on this graph?

Context: Are Congresspeople Omniscient?


I decided to create the x y graph...

At any given time you have a finite amount of resources at your disposal.  Just having these resources though isn't as important as how you use them.  Each particular use (allocation) of your resources will provide you with x amount of value and others with y amount value.  Given that that no two allocations of your resources will create/destroy the same exact amount of value, every single possible allocation of your resources can be plotted on a different point on this graph.

Where would you plot the following?

Forgetting to wear deodorant
Helping your friend move
Realizing after it's too late that there isn't any toilet paper
Donating $100 to your favorite cause
Pranking your friend
Going to a party instead of studying for an exam
Having sex with your best friend's significant other
Curing cancer
Losing $1000 at the race track
Starting WWIII

When you compare any two points on the graph, whichever point is closest to (10,10) is the more efficient (less wasteful) allocation.  A mistake is when the less efficient allocation is chosen.  The size of the mistake can be determined by subtracting the shorter distance from the longer distance.

We're all fallible, but we're not all equally fallible.  It's a given that some people are going to make less mistakes than other people.  Markets work because people can give you positive feedback (money) if your resource allocations create value for them.  As a result, the more value that you create for others, the more influence you'll have over how society's limited resources are used.  This fail safe device limits the amount of resources that end up in the hands of the people who make the most mistakes.

If we can't give people feedback on how well they are using society's limited resources, then too many resources will end up in the wrong hands.  Even when resources do happen to end up in the right hands...producers will be decentivized because the size of the carrot will not depend on their effort to research and accurately predict the most valuable allocations.

If anybody is interested in a critique of dollar voting please read On the Phenomenon of Bullshit Jobs by David Graeber.  For a short and sweet rebuttal please read BS Jobs and BS Economics by Alex Tabarrok.  For a longer, but relatively accessible, rebuttal I highly recommend reading Democracy, the Market, and the Logic of Social Choice by Samuel DeCanio.