Rent-seeking and the distribution of surplus

Rent-seeking and the distribution of surplus

DEVP 233

Spring 2017

 

Rent is one of the most important concepts in economics. It is the amount paid for a factor of production above and beyond what it needs to be economically viable. Practically speaking, if you operate a firm with labor, machines, and space, the difference between your revenue and the cost of the inputs in a competitive market is the rent for the unique resource which is your entrepreneurship. The economic rent is what people would consider above ‘normal’ profit. The textbook model in economics is a competitive system with the right properties (technology with decreasing returns to scale, many agents, full information) where at the equilibrium, firms operate with normal profit. But, economics realizes that some agents have unique capacities. So, they obtain rents for these capacities. For example, if you have farmers with different degrees of productivity, for farmers operating at the margin, price will be equal to average cost, which will include return on investment and cover operating costs, while other farmers will gain additional surplus, i.e. rent. So, we can relate the notion of rent to the that of producer surplus, and one can even expand it and interpret consumer surplus as the rent for the consumer who is not at the margin, where the price paid is smaller than the marginal utility.

 

To understand the concept of rent seeking better, let’s look at simple graphs comparing monopoly with perfect competition. Under perfect competition, social welfare, which is the sum of consumer and producer surplus, is higher than under monopoly. Moving to monopoly results in deadweight loss (DW) in social welfare because the monopoly reduces production from  to  , which results in a price increase from   to  . In this movement, consumer surplus declines significant, but producer surplus increases. If a government issues a policy that provides a company monopoly power, it creates rent. This happens often – for example, government issues business licenses for an exclusive right to import wheat, Coca Cola, computers, etc to one firm. There are of course international agreements that try to circumvent these policies, but governments will pursue these policies anyway. So the policy that prevents competition is a simply policy that reduces social welfare, but generates rent to the monopolist. In many cases, the politician will benefit through this type of policy and may get a kickback. We can envision a situation where policy makers would be for sale. He will give someone a monopoly to sell a product in his country for both direct kickbacks and campaign contributions.

 

One can develop a model to determine optimal design of a bribing scheme by a regulator or politician. The regulator may have an agreement with the industry that would establish a regulation that would control overall supply. The interaction is complex because there is a negotiation between the regulator and the industry. Let’s take a simple case (which is still complex) where government regulation moves the output of the industry from the competitive outcome, , to a lower level, which we will call . This means that the regulation doesn’t move it to a monopoly, but restricts quantity nevertheless. The gain to the industry  is a function of   that is determined by the politician and the industry. This gain is increasing the smaller is  and reaches its maximum when . But the industry has to pay a certain amount to the politician, which we denote by X. Since consumers may lose from higher prices, the politician may lose political support, and this loss is a function of the reduction in consumer surplus, which is .

Let’s consider a simple case where the politician and industry have an agreement that they will share the total gain generated by the regulation. This gain includes increased revenue and reduced cost, , but it may lead to increased likelihood of losing power, and in this case, the politician will use their gain from power, which we denote as . The probability of loss of power is affected by reduction in consumer surplus, but ultimately it is a function of the new supply level, and we denote it as . The probability of loss of power increases as  is declining, and therefore , is a decreasing function and is likely to decline faster as  decreases. The total net expected gain for the two parties is , which is expected gain from higher producer surplus, minus , which is the loss from losing of power. The optimization problem of the two parties is

 

 

Obviously, if the politician is a safe in power, then =0 for every  and the optimal outcome will be the monopoly that maximizes the producer surplus. If any regulation would lead to loss of power, , and  is large relative to consumer surplus gain, then there will be intervention and . In case that higher price increases the risk of losing power, there may be an internal solution where the first order condition that determines  is

 

 

For simplicity, we didn’t write explicitly in all the functions (i.e.  ). We can rearrange terms and the first order condition becomes

 

 

At the optimal solution, the marginal expected gain in producer surplus from reducing supply is equal to the expected economic loss associated with the marginal increase in the probability of losing power due to restricted supply. This expected economic loss is the product of the marginal increase in probability of losing power,  times by the loss of both producer surplus and benefit from holding power for the regulator, .

 

This model suggests that as the producer gain from restricting supply is increasing, for example when demand is more inelastic, or when the vulnerability to lose power due to restricted supply is low, then restrictions on supply will be stronger. The more politicians gain from their power and the more vulnerable they are, the less they engage in introducing cartels and monopolies. This model suggests that manipulation of power to benefit the few is less likely in a democracy where consumers are aware of the political process and are able to mobilize their power against artificial restriction of supply.

 

The sharing of the spoils between regulator and industry can be modeled by a complex negotiation framework, but we will simplify it. Let  be the share of the gain received by the politician and  be the share of the gain received by the industry. The stronger the politician, the greater is . In many cases, the politician will share the gains by having themselves or a family member become a partner in a company with monopoly power. For example, Putin may be one of the richest people in the world.[1]

 

We can expand the model in many ways. For example, the probability of losing power may be a function of the politician’s share in the spoils. In this case, one can show that if the politician makes the regulatory decision they will tend to distort the market less. One can go a step further and show that when politicians lose when people know about kickback, we begin to see cover-ups. This is the reason it is important to have effective media and freedom of press.   

 

The politician is gaining extra income X but it may lead to the loss of position due to unsatisfied consumers. The probability of losing the position is increasing with the function of consumer surplus loss due to the decreased supply, , which we defined as . The politician’s loss in case of losing his position is denoted by . The gain for the politician is the transfer amount X, so the net gain is . The industry gains  as long as the politician stays in power, but it loses transfer payment X with certainty. So, the net gain of the industry .The  determination of  and X is result of negotiation between the two parties.

 

Let’s assume a simple model, where the politician and the industry negotiate to maximize a weighted sum of their gains from a combination of contributions (X) and regulations (). Their joint objective function is

 

where  is the relative power of the politician and  is the relative power of the industry.

 

Assuming an internal solution, , the first order condition with respect to is

Leading to

The right-hand side presents the weighted marginal gain to the coalition from reduction in quantity-expected increase in producers’ surplus, while the left hand side is expected marginal cost from marginal reduction in regulated output. A reduction in probability of winning will reduce the well-being of both politician and industry. At the optimal level of regulation, the marginal benefit is equal to the marginal cost.  One can show that the greater is the industry power ( the more strict is the regulation (the lower Q is). For example, when a politician depends strongly on domestic manufacturers, he may set regulations that limit import opportunities. This was a key element in the export substitution strategy in Latin America.

 

The first order condition with respect to  is

Leading to

  • =

The left hand side reflects the marginal gain to the politician from increased donation, weighted by its relative political power . The marginal gain from increased donation is a dollar in income plus the expected extra political gain from higher spending (remember that  is negative; the more you spend on elections, the less likely you are to lose). The right hand side reflects the marginal cost to the donor. This marginal loss is the expenditure of money (1 unit) minus the gain due to reduction in expected political risk due to donation . When  is higher, the politician has more political power, and thus can negotiate a larger contribution from industry for a given level of extra surplus he provides the industry by regulation. Similarly, when the marginal effect of campaign contribution is larger, the bigger will be the donation.

 

 

 

 

The impact of power distribution among sectors on political choices

 

There are many models of political economy- each highlighting various aspects of politics. The political economic framework is used to determine a certain policy variable- for example Grossman and Helpman (1992) studied determination of level of protection of domestic producers from trade through say a protective tariff. One can use it to analyze the negotiation to establish a pollution control policy.  In each case the negotiation between parties aim to establish a level of policy parameters. The first time in the analysis is to compute how various levels of the policy parameters will affect the welfare of different parties that may participate in the political process.  For example- in negotiation to establish the level of a defensive tariff, it is important be able to compute how the level of the tariff affects (relative to free trade) the consumer surplus of domestic consumers (who are likely to lose from a higher tariff), surpluses of domestic producers and workers who may gain, surplus of foreign producers who may lose etc. In a case of a pollution control policy – say pollution tax- it is important to assess how various levels of the tax will affect consumers’ surplus, producers’ surplus, government expenditure, environmental surplus etc.

Here we present a simple model where political decisions are viewed as outcomes of parties that vary in their power. This model can reflect a situation where we have a government that includes a coalition of labor and environmentalists, so they will have a higher wage than business. It may also reflect a situation where government is composed of individuals from one tribe, and so their concerns are weighed more heavily than other tribes. Another possibility is having a ruler that worries more about the welfare of urban poor and middle class, and therefore gives them more weight in decision making. But the model itself is very simple in structure but can be used to tell many stories, and can rely on economic models that we develop in other classes.

We will assume that the economy consists of N identified groups. These groups can be divided according to functions in the economy (consumer, producer, environment, government) as well as location. One of the groups may be corn producers in Iowa and another can be meat consumers in Ghana. Each group has its welfare, measured in dollars, that depend on policy variables. Let the welfare of group i be denoted by  as function of the levels of the policy parameter . We will consider the case where welfare is measured in dollars and is equal to economic surplus. Let  be the weight of group i and let’s assume that  and the sum of . Standard welfare analysis assumes that when we have i groups, then  . But in political economy, these weights may differ.

To conduct political economy analysis that determines the value of a policy parameter x, for example tax on import, upper bound on pollution or subsidy to farmers in a given region, we first solve the economic model that allows us to calculate  and then solve the optimization problem.

 

Let the optimal political economy policy parameter be denoted by . The first order condition is

In a political economy context, the weighted sum of the marginal welfare over all groups is equal to zero. In contrast, the efficient policy parameter which is a result of standard welfare analysis is denoted by  and it is determined where

 

Let’s illustrate how to solve the political economy equilibrium with two simple cases. First, a policy maker has to determine the quantity of output the industry can produce. The two groups are consumer surplus, where  is  and producer surplus, where  is . Now let’s assume that x is quantity produced and demand is  and supply is .

Let’s suppose that the government sets a quantity and supplier must provide this quantity to the market. The consumer surplus, in this case, is the area of the triangle, which is equal to . The producer surplus is equal to the trapezoid of revenue, , minus costs, .), which together are . Let’s suppose the political weight of consumers is  and producers is .

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The political economy optimization problem is

The output under this scenario, , solved from the first order condition is

 

This means that

                                     

Leading to

Note that when , and we are in the welfare optimization problem, the  is equal to the socially optimal solution, , that is achieved under competition. When  and all the power lies with the producer, we get the monopolistic solution, . If  is greater than 1, and consumers have more power, then  and consumers benefit from lower prices and producers lose. Similarly, if  is positive but less than 1, then .

            We see in this simple example that relative power distribution among groups in the political process affect policy making and distribution of welfare. The analysis here can become more complex. For example, if we have an externality problem, and a policy maker needs to determine the level of tradable permits of pollution x. In this case, we can calculate consumer surplus , producer surplus , and environmental surplus . If  is consumer power,  is producer power and  is environmentalist power, then

where .

We will not solve this problem here, but as the power of the environmental group increases, the political economy equilibrium, , gets smaller; as the power of the consumer increases, increases; and as producer power increases,  tends toward . In many real-world situations, the parties affected by policymakers vary significantly. For example, producers can be divided in different groups based on, say, region, soil quality, or size. Consumers may be divided by region and income, for example. In considering a policy like taxation, the government becomes part of the decision-making framework.  Thus, one key element of political economy analysis is to identify the affected parties, their respective weights in the decision-making, and have a quantitative model that will allow assessing the impact of policies on each group.

            One can conduct two types of political economy analysis. If one has capacity to compute the impact of various policies on different groups and the weight of these groups, then the political economy model can help determine the optimal policy. Alternatively, if one knows policy choices and how they affect various groups, then they can use it to assess the implied power of each group that contribute to the emergence of a decision.

 

Determination of the political power of groups

The alpha coefficient of each group may be affected by several variables. These values are not stable – they may change over time, especially during regime change. When in the US the democrats win, the influence of labor and environmentalists increase and business declines.

 With Reagan, California had a lot of influence. With Bush, Texas had more influence. In Nigeria, for example, division of power is more often between Christians and Muslims. Obviously, we are aware that in Syria the Alawite, representing a minority of the population, were in power, while the majority of Sunni felt denied access to power. In Iraq, the Sunni majority was dominant. Obviously, some of the factors may complement one another. For example, in the US, presidents selected by Midwestern states will tend to have more sympathy towards agriculture.

            The influence of different groups in a given government depend on several factors: (i) how many voters they control, in the case of a democracy, (ii) their ability to donate contributions, (iii) capacity to recruit volunteers, and (iv) capacity to cause trouble or unrest. Government may not engage policies that totally alienate non-supporters because they want to avoid strong negative responses. Opposition groups may have a threshold of tolerance, and if it is exceeded, they may resort to destructive activities (rebellion, violence, war, civil disobedience). Thus, the political economy models can be expanded to introduce constraints that may reflect thresholds of tolerance of different groups and their behavior.

            Furthermore, the literature of political economy has identified several important factors that affect the power of different groups. First, Olson (1965) suggested that small groups, where each individual has a large stake in a policy, may have significant political power compared to larger groups where each member is affected little by a policy. To illustrate, when we have a few producers that each gain significantly from agricultural support programs, and many consumers that lose from it, but the loss per person is relatively low, the producers will organize more effectively to push the support program through the government. They will have a much higher alpha coefficient than the consumers. Small groups with strong interests in a certain policy agenda may be more effective in the political arena because they will have lower transaction costs to organize and achieve their goal.

            Second, the structure of the political system matters. The US has a bicameral legislative system, where the representation in the House of Representatives is proportional to population per state, and representation in the Senate is equal across states. Representatives of small states need to address fewer issues and therefore can use their vote more effectively to achieve outcomes desired for their state. This is especially important given that states partake in “horse trading” where state representatives trade votes with other states in order to achieve gain support for their agenda. So, the many agricultural states in the US are able to gain support for their policies, even though they represent a small portion of the overall population. Furthermore, in the case of agricultural policy, there exists a coalition between agricultural and urban states where urban states support agricultural subsidies while the agricultural states support welfare reform. The agricultural sector has strong support in many developed countries because in most of these countries the national system allocates representation based both on regions as well as number of people. In many developing countries, especially in the past, government might have been concerned more with satisfying the urban population than the rural population, and agriculture had a relatively low alpha coefficient and was taxed, explicitly or implicitly.

            Thus far the political economy analysis we considered was static. But, political economy is a dynamic phenomenon and there are recent studies that recognize it. Policymakers engage in policies both the provide gain to their supporters as well as to be elected in the future. Furthermore, while members of the population have some political affiliation, they change their mind as reality changes and performance of policymakers is revealed. So voter behavior is affected by both what they see as well as what they learn from the media and otherwise. In the next lecture, we’ll go over decision-making under uncertainty and about models of learning in more detail. Generally speaking, the Bayesian formula provides a foundation of how people should update their probabilistic belief about outcomes based on observed reality, as we saw in an earlier lecture. For example, if people think that there is a 75% chance of economic prosperity under a republican, and there are several years of recession under a republican president, then viewing this reality, they the formula suggests that they should adjust their assessment and estimate that the probability of economic prosperity under a republican is now, say, 25%. If we have another person that believes there is a 90% chance of prosperity under republicans, after several years of recession, his belief will move to, say 30%. The reality is that people don’t follow the Bayesian formula rigorously, but the idea that people update believes based on performance and news is evident, and there are empirical studies that show it. Different people are influenced by different information, and update their belief and choices differently. Campaigning, to some extent, is a process where politicians aim to affect voters’ beliefs with new information. Since campaigning requires resources, candidates will engage with potential donors in order to obtain resources in exchange for favorable policy consideration if they are elected. But it is clear that donors will contribute to candidates that have views or operated in the past in a manner consistent with their interests. The understanding of the dynamics of voting, campaigning, and the role of the media are important topics in political economy.

 

Qualitative analysis of political economy

 

The bottom line is that political systems affect economic systems by various regulations that reflect the political structure, the intensity of impact of polices on interest groups, the political strength of these groups and their ability to affect the political debate.  Political power is changing, and regulation and policy change too, but political economic analysis starts with identifying who are the parties affected by a policy. This analysis will also consider their intensity of concerns, their economic and political power, and their credibility with the public. Once we understand the players and their interests we can start developing quantitative models and analyze specific developments. Historical analysis of development of policy issues are very instructive to understand political economy and development. Path dependency is crucial element of development.

 

One simple example to illustrate the difference between economics and political economics is trade policy. First, the simple economic analysis. Suppose that there are two countries, China and the US. US has relative advantage in computers and China in textiles. Overall, they will gain from trade. Before trade, China under-produced textiles and over-produced computers, while the US over-produced textiles, and under-produced computers. With trade, China will export textiles and the US will export computers. Obviously, this is a simple model, which removes dynamic factors and others. The economic literature suggests that, overall, there will be gains from trade, consumers gain (more computers and more textiles), and producers in both countries gain. But, producers and workers in textiles in US and in computers in China may lose. The overall gain is greater than the loss for these groups, but we need some compensation in order to have everyone happy. And this is what we call safety nets.

 

 

Political economy models suggest that the power of different groups is different. If, for example computer producers in the US and textile producers in China are dominant groups, and then consumers will form coalitions that will be pro-trade. But what happens if we don’t have appropriate compensation to the losers, and they have strong political power, then the anti-trade policy that they support may win.

 

If we look at the world today, there is something to this story. In countries like Mexico, where the gains from trade were well distributed, there is general support for NAFTA. In China, while there is protectionism, there is support for trade. In the US, because of the political system, there is a strong anti-trade movement. Personally, I think that people don’t realize how much they gain from trade (e.g. low-income people in the US gain immensely from cell phones and clothes produced internationally). Many job losses are the result of automation and other factors, although today unemployment is low. And the opening to China, which is the result of peace between the US and China, increases the labor pool and reduces the value of low-skilled labor. Still, the basic model suggests that political power may lead to outcomes that may not be consistent with basic economic logic.

 

References

Grossman, Gene M., and Elhanan Helpman. Protection for sale. No. w4149. National Bureau of Economic Research, 1992.

 

Olson, Mancur. Logic of collective action public goods and the theory of groups. Revised edition. 1965.

 

 

[1] http://www.forbes.com/sites/kerenblankfeld/2016/03/01/forbes-billionaires-full-list-of-the-500-richest-people-in-the-world-2016/#68fdcb6a6c24

On the economic discipline: How political economy and development economics fit

On the economic discipline: How political economy and development economics fit

DevP 233

Spring 2017

 

This segment of the course is about political economy. Political economy is an important part of economics and our analysis aims to be relevant to issues of development, agriculture and international relations. Economics is a scientific discipline, and political economics has evolved over the years. This chapter aims to provide some background about scientific disciplines in general, and economics in particular. It addresses the notion of disciplines and how they evolve as well as the key elements of the mechanisms of a scientific discipline. At the end, we will discuss some of the sub-disciplines of economics, and in particular, political economics and development economics.

 

Why do development practitioners need to know about the working of science?

Practitioners frequently test new research results, and conduct and initiate research. While their work is not at an academic setting, they benefit from an understanding of how universities and research works. They need to recognize that the research establishment is not given but it is changing and to understand the political economic factors affecting these changes. 

 

Science consists of many disciplines. Some of them are older, like mathematics and philosophy, while others emerged more recently, like computer science and chemical engineering. But scientific disciplines are not set in stone and they evolve over time. Moreover, much of the research that is done today can be classified as ‘interdisciplinary’ and ‘multidisciplinary.’ Interdisciplinary research integrates approaches and knowledge across disciplines to solve complex problems. For example, knowledge from biology, physics, ecology, soil science, and statistics are integrated to design crop management systems. Individuals may become interdisciplinary by incorporating knowledge and methods from different disciplines to their work. Some disciplines are interdisciplinary by nature, for example agronomy that incorporates knowledge from multiple disciplines to understand and manage agricultural systems. Multidisciplinary research occurs when people from different disciplines work in parallel to analyze the same problem. For instance, National Research Council (NRC) studies bring together experts from many fields to study the challenges of managing agricultural biotechnology. This multidisciplinary research may, at the end, generate interdisciplinary knowledge.  

 

The notion of interdisciplinary is relative. The knowledge generated by a collaboration between a soil physicist and soil chemist trying to explain soil properties is considered interdisciplinary as is the integration of economics, physics, sociology, statistics, and biology to analyze climate change. So it is useful to distinguish interdisciplinary research within a discipline, like soil science, and between branches of science, like some research on climate change.

 

Disciplines evolve over time. Emergence of major problems or discoveries beget new disciplines. For example, the discovery of DNA led to several fields, including genomics, bioinformatics, and genetic engineering. Similarly, infectious diseases that emerged in crowded cities led to the study of public health and sanitation engineering. Furthermore, some disciplines are disappearing. For example, astrology and alchemy (even practiced by Newton) are no longer considered scientific disciplines (but astronomical practices are still a viable business – just walk down Telegraph Ave).

 

Reality does not know disciplinary borders. New solutions most often integrate approaches from multiple disciplines. For example, Integrated Pest Management (IPM) merges economics, biology, entomology, climatology, and plant science. Geography by nature is interdisciplinary drawing on many physical and social sciences. Science advances when methods are imported between disciplines. For instance, economics was revolutionized by the use of advanced tools of mathematics (calculus, topology, game theory), statistics, and more recently psychology. Modern biology relies more and more on advances in mathematics, statistics, and computer science. Furthermore, applications in specific disciplines may enhance other disciplines. Many of the basic principles of mathematics were inferred or refined by research in physics or biology. Finally, interdisciplinary research leads to new disciplines.

 

Until the 1950s, the main model of research was of Archimedes – sitting in his bathtub and having a ‘eureka’ moment. But since then, we realized that innovation is affected by economic considerations and the induced innovation hypothesis is presented formally and demonstrated statistically in Hayami and Ruttan (1984). Here I’d like to argue that innovations are also induced by political economy considerations. Political considerations are crucial in investments in research and its application. The military establishment has been a major investor in research in most countries. Political considerations and agendas affect the direction of research. For example, disciplines like African Studies, to a large extent, were financed by the Belgian and French colonialists, and later on by the CIA, through the National Security Education Program, that needed to have objective research to understand Africa better. Similarly, schools of public health and research in the field were proliferated after the establishment of social security programs.

 

Multidisciplinary education forms interdisciplinary people. Exposure to several disciplines leads to flexible, creative thinking and expands opportunities. Almost all scientists need math and computer skills, and scientists must gain exposure to decision theory. Doing so allows a scientist to make socially meaningful discoveries and manage them effectively. At the same time, social criticism is more likely to be socially beneficial when it is based on sound scientific reasoning and basis. Some key disciplines, like business and engineering, are interdisciplinary by nature because they seek to provide practical solutions based on knowledge from social and physical sciences. We expect MDP students to become interdisciplinary individuals and to feel comfortable talking about several disciplines, and hopefully specializing in one or two.

 

Economics is a social science that aims to explain the behavior of individuals, institutions and states emphasizing resource allocation, trade, and valuation. Economics has a strong emphasis on rational behavior and markets. But economics is evolving in response to changes in reality, analytical tools, and insights from other disciplines. There are multiple approaches and perspectives on economics. First there is a division between micro and macro, where microeconomics analyzes individual and market behavior while macroeconomics analyzes the behavior of aggregate parameters, like unemployment, inflation, currency. An area that is between micro and macro is international trade that investigates trade and financial relationships between nations. The neoclassical theory that has been a dominant approach to microeconomics for a long time emphasizes positive modeling (i.e. behavior resulting from maximization of profit or utility subject to constraints) and normative analysis (i.e. behavior that derives from maximizing social welfare, narrowly defined). But over the past few decades, some of the neoclassical predictions were not borne out in reality; this led to the emergence of behavioral economics that borrows from psychology. Another line of economics is institutional, where emphasis is to understand the role and impact of institutions on the performance of the economy.

 

The techniques of analysis have evolved over time. Early researches relied heavily on logical arguments; mathematical tools were brought in later to refine theory and introduce new concepts like gaming and strategic behavior. Economics has always been about numbers, but with improved computing capacity, economic models rely more heavily on statistics and econometrics is a branch of statistics developed for economic analysis. Predictions frequently are based on complex numerical and statistical simulations, and there are attempts to use machine-learning and quantum computing in economics.

 

Because economics applies to many spheres of life, it has many subdisciplines that are by nature multidisciplinary. They include environmental economics, law and economics, labor economics, health economics, and agricultural and resource economics (ARE). ARE applies tools and concepts of economics to issues of agriculture and natural resources. To be effective in this area, one must embody the knowledge of economics with the sciences and practices of the natural and human systems they are investigating. To be an effective researcher, one needs to understand the problems of agriculture and natural resources, be familiar with their reality and history, and identify important issues that require economic treatment. Over time, agricultural economic research has been used to analyze and provide policy solutions to the relatively low income of farmers, to the challenges of management of farm inputs and adoption of new agricultural technologies, to the management of natural resources like water, soil, as well as pest control strategies in a way that will be economically and environmentally viable, to the regulation of new technologies, and to the new applications of agriculture and forestry to produce fine chemicals and fuel.

 

Agricultural economics, and other subdisciplines, also provide new tools and concepts to economics. For example, agricultural economics introduced the concept of human capital and the theory of technology adoption. Environmental economics introduced the technique of non-market valuation. Economic theory and thinking are evolving by interaction of the main discipline with its subdisciplines; and while ARE economists mostly publish on agricultural and resource issues, once in a while they make contributions to the mainstream and the wider profession.

 

Development economics is one of the largest subfields of economics. It aims to understand the economic reality in low-income countries and to develop strategies for development and growth. It is one of the oldest areas of economics and it is being refined all the time. It has been inspired and influenced by other areas of development studies, and has been changing in response to changes in reality, economic thinking, and the need of policy makers and other players in development. Development economics can be divided to micro and macro studies. Micro studies emphasize smallholder behavior, microeconomy of rural regions under different regulatory and institutional systems (feudal to market systems, cooperatives and collective action), economics of innovation and technology adoption, etc. Micro studies emphasize smallholder behavior, microeconomy of rural regions under different regulatory and institutional systems (feudal to market systems, cooperatives and collective action), economics of innovation and technology adoption, etcOne of the major challenges in economic development is to link between micro and macro and between static and dynamic processes.

 

It is useful to distinguish between institutional, historical, and descriptive analysis, which was very prominent in development in the past, to theoretical analysis, and now to quantitative analysis, which is very important in the present. There are several major techniques that have been used in development economics, including input-output analysis, social accounting analysis, and computable-general equilibrium analysis. Econometrics has been a major element of development economics. The type of problems addressed evolve with technology and data. In the past, there was much more emphasis on aggregate studies, but with increasing data and computing power, we have moved towards more nuanced microeconomic studies that frequently rely on GPS, which allows more dimensions of heterogeneity and better identification. There is also growing reliance on randomized control trials to better estimate impact. In spite of improvements in data and computer capabilities, our capacity to identify patterns and predict outcomes is limited. Basic statistical assumptions are approximations, and new phenomena and patterns emerge. Furthermore, numerical data tells only part of the story, and one of the major challenges of analysis is to incorporate narrative and institutional with quantitative data.

 

One important emerging field is environment and development economics, which addresses the intersection of environmental issues in the context of development. The notions of climate smart agriculture and payments for ecosystem services are key elements for this body of literature. A key issue is to what extent the economics of development is unique. At least my perspective is that basic patterns of human behavior are the same, but in developing countries there are distinct institutional and technological constraints that require special attention. Furthermore, several issues, e.g. food security, poverty, etc, are much more acute in the development context. But models of development economics may apply to many situations in developed countries. For example, parts of the Central Valley in California can be understood better with tools drawn from development economics.

 

Development economics provides many important tools for economics. A few key elements are the notions of human capital, social capital, and natural capital. Other elements include the behavior of households, economics of collective action, migration, and the use of tools like social accounting matrices. Study of development economics emphasizes the role of institutional economics and recognizes that it is one among many disciplines. It also emphasizes the importance of governance and political systems.

 

Political economy is becoming a new, and very important part, of economics. Increasingly, people realize that market outcomes are not the only mechanism that affect resource allocation in real life, and the world is not ruled by economics, and constraints are crucial to understanding reality. Political economy aims to integrate both ideas from political science as well as aspects of the political reality that economists model and introduce to their analysis. Political economy is becoming a fertile area for multidisciplinary collaboration. Many concepts of economics and game theory were introduced to political science. And many notions of political science have been incorporated in economics. For example, political economy analysis emphasizes the important role of political systems like voting, in resource allocation. Different voting systems result in different outcomes. And furthermore, we recognize that economic mechanisms aim to affect political outcomes, and that both outcomes co-evolve.

 

In the next lecture, I will speak in more detail, but one key element in political economic analysis is to look at the economic behavior of a political who wants to win elections and gain power, as well as to be well-off economically. This decision maker is maximizing his well-being subject to constraints. He knows that people vote, and he must affect their behavior but that costs money, so the politician also must satisfy and recruit donors. At the same time, there is also analysis of voter behavior and how much they are influenced by pocketbook outcomes, identity politics, beliefs, as well as promotion. The interaction between politicians and voters result in political outcomes, and these outcomes affect economic reality. So political considerations make analysis of economic reality more complex.

 

Thus far, I have described political economy analysis in the context of a democracy, where political outcomes are affected by votes. But political economy operates differently in different political systems. It will be different in a democracy versus a dictatorship, and within democracy, between a presidential vs parliamentary system. Political economy analysis has elements of theory as well as quantitative analysis. Econometric models try to estimate the different parameters of political choice and how they affect economic outcome, and vice versa.

 

The term political economy is old. David Ricardo, in On the Principles of Political Economy and Taxation (1821), established basic principles of international trade and economics uses the term political economy because he realized that economic forces affect political reality. The University of Chicago economics journal is the Journal of Political Economy, even though it was the flagship of neo-classical economics. In the 1960s, the radical left used the term ‘radical political economy’ and started an association called the Union of Radical Political Economics, with a journal, other media, and conferences. Modern political economics that combined political science and economics emerged as a major field in the 1970s. An important book on political economics is “Political economics: explaining economic policy” by Peresson and Tabellini. Leading writers of political economics, like Gerard Roland at Berkeley, publish in mainstream economic journals, like American Economic Review, as well as the Journal of Comparative Economics and European Journal of Political Economy and Economics of Transition, which emphasize political economics. They also publish in journals like American Journal of Political Science. The field of political economics is becoming prominent in development as people realize the importance of institutions in politics, and one of the most important contributors to this field is Daron Acemoglu. Much of the research support in political economics is by the World Bank as well as different foundations that have various agendas, such as the Heritage Foundation.

 

On the organizational structure of a discipline

 

To understand the working of economics, it is important to recognize that someone has to pay for economic research and that people need means to communicate it. Because reading most of the economic research is work, not fun, someone has to pay people to read it and/or people to recognize the value of it in their work. The same is true of other scientific disciplines. To be viable, a scientific discipline needs three elements: an association, journals, and benefactors (‘sugar daddy’). The association organizes professional meetings that include presentations as well as labor markets. It also sponsors journals. Participation in conferences and publications are crucial for the viability of an academic. The research that scientists are doing depends on support from individuals, organizations, and government. In a large discipline, there are international, national, and regional associations, as well as associations of subdisciplines. Research is supported, in part, by tuition since professors at universities are paid to teach as well as do research. But much of the research in every field comes from government agencies or foundations. For example, much of medical research is supported by the National Institute of Health as well as various foundations and donors. Some research is supported by royalties for patents and by service to private industry. The most important service that the benefactors of a discipline are doing is hiring credentialed professionals from relevant disciplines. The prices and demand for professionals in every discipline affect the investment universities are making in programs and faculty salaries in each discipline. No wonder that professors of business earn more than those in English.

 

The evolution of disciplines is based on the demand for research and education in each discipline. Some disciplines may die because they are proven wrong, but most rise or fall because of demand for the practitioners and knowledge produced by the discipline. The journals are used as mechanisms to communicate results and thus enhance knowledge generation, to educate, and to allow members of the discipline to demonstrate their skills. The associations are used as leadership of a discipline, set the direction of their research, and lobby for budgets. The structure that we portray for academic disciplines, with publications, associations, and benefactors, is typical for almost all professions. For example, teachers in every country have unions, which are very strong, the unions have publications and training, and then there are buyers of the services, which are governments, churches, and individual families. Teacher associations also support schools of education that provide training and principles of operation. The same thing can be said about doctors and lawyers. One of the challenges of development practice is the develop an institutional set up like this.

 

In the case of economics, we have a major association (the American Economic Association) that publishes several journals, including the American Economic Review (AER) and the Journal of Economic Perspectives (JEP) and now three subject journals. The specialized econometrics society publishes the prestigious journal Econometrica. Furthermore, there is an association for agricultural economists (the Agricultural and Applied Economics Association, AAEA), which owns the American Journal of Agricultural Economics (AJAE), which is more academic, as well as the Applied Economic Perspectives and Policy (AEPP), which is policy oriented, and the Choices magazine, which appeals to a broad public audience. Similarly, there is an Association of Environmental and Resource Economics (AERE) and an association of energy economists with their own journals. And then there are European associations of economics, agricultural economics, environmental economics, and their respective journals. Furthermore, within the US we have Atlantic, Western, and Southern regional associations with their own journals in each of these subdisciplines.

 

The multidisciplinary nature of agricultural economics lead scholars in this field to publish in specialized publications. They may include special natural resources journals like Water Resources Research or Natural Resources Modeling, the prestigious Nature Biotechnology or Nature Climate Change. Sometimes agricultural economists are able to publish to the general journals like Science, Nature or the Proceedings of the Natural Academy of Science.

 

The proliferation of journals and associations reflect that there are many people doing research and many research topics are covered. Publications in journals both convey information and signal the quality of individual researchers and research groups. Different journals vary in their prestige – the major association journals more so than regional ones. And in addition to association-sponsored journals there are journals sponsored by universities and industry. In the case of economics, the prestigious Quarterly Journal of Economics is sponsored by Harvard and the Journal of Political Economy is sponsored by University of Chicago. The RAND Journal of Economics is sponsored by RAND. Frequently publishers initiate a journal when they identify a gap in an area of research not covered proficiently by existing journals.

 

Economics is a paper-based discipline where economists publish their work in journals after being reviewed by referees (i.e. peer-reviewed). Sociology is book-based and the status of the book depends on the publisher as well as the reviews of the book. The electronic age is changing the way professions operate. Journals are evaluated by their impact factor. Individuals are evaluated by number of citations (in websites like Google Scholar and the Web of Science), and the prestige of journals where they are published. In some disciplines, key publications are the proceedings of conferences. There is a growing movement towards internet-based journals and with the low cost of publication, some predict that relatively soon, scholars will issue their papers on the web and key criteria for evaluation will be downloads and responses. This means that the refereeing process of journals may play a diminished role and will be replaced by open-access reviews. Understanding the supply chain of papers will be an interesting topic of research.

 

Basic research in Economics is supported by the National Academy of Science. Various government agencies, at federal and state levels, support economic research and employ economists on their staff. The Federal Reserve is a major supporter of economic research and employer of economists as is the World Bank. The USDA has a large unit conducting agricultural and resource economics research called the Economic Research Service (ERS), which supports the National Institute of Food and Agriculture (NIFA). NIFA is a major source of funding for academic research in agricultural economics.  Many firms in the private sector hire economists to analyze market outcomes, to assist with trading and resource allocation, etc. There is a growing demand for economists as legal consultants to assess damages or testify in antitrust law cases. Agricultural and resource economists are employed by agribusiness, land and resource developers, mineral companies and water utilities, and NGOs active in the environmental areas.

 

The segment on political economy in this course emphasizes its emergence as a hybrid between economics and political science, as well as the interaction between markets and political organizations. The political economics literature is rather young, and it still relies on some of the basic work of economics and political science – in order to conduct political economic analysis, it is important to have basic understanding of welfare economics as well as the foundations of political systems. Political economics emphasizes understanding policy transitions, economic growth, and processes of development. Therefore, the early work in this field compares the economic performance of capitalist and socialist systems, and emphasized understanding the economics of liberation after colonialism, and since the 1980s emphasized understanding the process of political transition in China and Eastern Europe. The political upheaval of the current period opens new frontiers for political economic research.

 

 

References

Ricardo, David. On the principles of political economy, and taxation. John Murray, 1821.

 

Ruttan, Vernon W., and Yujiro Hayami. “Toward a theory of induced institutional innovation.” The Journal of Development Studies 20, no. 4 (1984): 203-223.

 

DevP 233
 Syllabus: Law, Politics, and Policymaking

DevP 233 
Law, Politics, and Policymaking

SPRING 2017

Tu, Th. 2-3:30 311 Wellman Hall

 

Zilberman Addendum

 

3/7 – Lecture 17 – On the economic discipline: How political economy and development economics fit

The purpose of the lecture is to enhance students’ understanding of scientific disciplines and how they evolve, as well as the mechanics of science. Political and development economics illustrate this point.

 

Development practitioners need this understanding because they will be consumers of science, will engage in applied science, and will work with scientists and academic institutions.

 

3/9 – Lecture 18 – The economics of voting

The purpose of this lecture is to increase student understanding of the calculus of achieving and maintaining power. This includes how to think systematically about building an agenda, fundraising, and positioning. We will also understand different voting systems and recognize that voting is not synonymous with democracy.

 

3/14 and 3/16 – Lectures 19 and 20 – Rent-seeking and the distribution of surplus

The purpose of the lecture is to introduce students to differences in allocation between political and economic systems, and how politics affects economics. The emphasis will be on how political and economic considerations affect the differences in distribution of rent between groups. We will emphasize that there are two ways to look at distribution of income – (i) statistics, using notions like Gini coefficients, which are useful descriptions, but lack operational meaning, and (ii) political economics, which analyzes distribution of surplus among groups within regions. This approach is much more operational, and can identify how policy and political factors may shift rents between groups, and develop mechanisms to identify sources of losses in efficiency due to corruption and political considerations.

 

3/21 and 3/23 – Lectures 21 and 22 – Professor Leo Simon on Polarization

The purpose of the lecture is to illustrate how society may be polarized among different groups that maintain different views of the world. The result is, at times, malfunction of the government. This phenomenon has occurred throughout history, and in all regions of the world. Polarization may be based on class, beliefs, tribal identities, etc. The recent resurgence of populism in the US, Europe, and elsewhere are recent examples.

 

4/4 – Lecture 23 – How risk and uncertainty affect choices

This lecture will familiarize students with basic theory of risk and their impact on policy making. We will start with safety rules, which were used heavily in development analysis. We then move to expected utility, meaning risk aversion, the role of insurance, diversification. Then we move to behavioral economics, which means loss aversion, and its implications. Finally, we move to perceived self-efficacy, which leads to the economics of self-esteem.

 

4/6 – Lecture 24 – Principal-agent problem and political economy

This lecture will focus on operating in a world of incomplete information. Mechanisms include signaling, sorting, discrimination, alternative mechanisms for learning and adaptive behavior, moral hazard, and self-selection. There will be several examples.

 

4/11 – Lecture 25 – Professor Gerard Roland on China

 

4/13 – Lecture 26 – Professor David Roland Holst on political economy of corruption

 

4/18 – Lecture 27 – Lecture on Law

 

4/20 – Lecture 28 – Lecture on Law

 

4/25 – Lecture 29 – Zilberman on political economy of agriculture

 

4/27 – Lecture 30 – Zilberman on Political economics of Research & Development and Conclusion

  1. Assessing the problem of underinvestment in research and public goods
  2. Alternative mechanisms to finance research
  3. Issues of regulatory capture
  4. Intellectual property rights
  5. Applications in agriculture and medicine; access to innovations in developing countries

 

I may have two pizza and policies. One will be on reforming UC Berkeley in mid-March and the other will be on the economics of chocolate.