Throughout his career, Earl Thompson often argued that we needed a more Pascalian theory of political economy. His argument was based on the following quote from French mathematician Blaise Pascal: “The heart has its reasons of which reason knows nothing.”
Based on this idea, Thompson developed a theory of what he called “effective democracy.” The central idea behind effective democracy was a sort of “wisdom of crowds” argument. Namely, he argued that the collective decision-making that takes place through the electoral process is very often efficient – even in ways that are not immediately obvious to economists.
Economists who are reading this are likely already rolling their eyes at this idea. Economists tend to think of collective decision-making as difficult. When the social benefits of a particular good exceed the private benefits, the market will tend to under provide the good. When the social costs associated with a good exceed the private costs, markets will tend to overprovide the good. If individuals cannot be excluded from using a particular good or service, the good will tend to be under-provided or over-consumed. Principles of economics textbooks are filled with examples of these sorts of scenarios and the optimal policy response. Yet, when we look at the world, there are many instances in which democracies fail to adopt the appropriate policy responses.
Economists are also likely rolling their eyes because voters often have very different opinions on issues than economists. For example, economists tend to think that free trade is a net benefit to society. The general public is less inclined to believe that statement.
What made Thompson’s work interesting, however, is that he often argued that democracies tend to understand externalities and collective action problems better than economists realize. For example, he noted that we don’t see factories at the end of a neighborhood. Why not? Well, we typically don’t see factories at the end of a neighbor because of zoning restrictions. But why zoning restrictions? Why not just have Pigouvian taxation to internalize the social costs? In general, economists don’t tend to advocate quantity regulations, so why does it occur?
What Thompson argued is that Pigouvian taxation is insufficient. A factory imposes a social cost beyond the private cost (a negative externality) because it creates pollution (and possibly even because it is not fun to look at). Given this additional social cost, standard economic theory would suggest imposing a welfare-improving Pigouvian tax on the factory. This would force the factory to internalize the cost associated with the pollution thereby giving society the optimal amount of pollution. What Thompson pointed out is that this tax is inadequate. People in society might not just want to reduce pollution, they might want to limit their proximity to the pollution. A Pigouvian tax doesn’t solve this latter problem. To understand why, consider the following. Suppose there is a neighborhood that is not yet completed. Society imposes a Pigouvian tax to limit pollution. A company decides to open a factory in town and wants to put it in this near-complete neighborhood. The people who live in the neighborhood do not want the unsightly, noisy, smelly, polluting factory next to their homes. However, even if the Pigouvian tax bill would result in losses, the company has the incentive to purchase the land in the neighborhood and tell the neighborhood that they intend to build their factory unless the individuals in the neighborhood agree to buy the land back from them. As a result, democratic societies have adopted zoning restrictions to prevent factories from being built in neighborhoods. (As empirical evidence for this, something similar to this happened in my neighborhood, where in certain parts of Mississippi the word “zoning” is considered profane. So perhaps effective democracy hasn’t yet reached Mississippi.)
Thompson had many other examples of what he called effective democratic institutions. He argued, for example, that the lives of individuals tend to produce positive externalities for their friends and family and that this can explain why we subsidize health insurance and have costly safety regulations in the workplace, that the Interstate Commerce Act of 1887 was an efficient democratic response to the transaction costs of complex state regulations and corresponding local lawsuits for firms (especially railroads), and that Workmen’s Compensation Laws were democratically efficient responses to the significant transactions costs associated with the slew of private lawsuits brought by workers against firms.
Whether or not one accepts Thompson’s arguments, they are unique in the sense that they provide efficiency-based arguments for policies that, in general, economists see as inefficient. It is easy to follow Thompson’s intellectual development. He first began by developing his theory of effective democracy. His theory was motivated by the Pascal quote above. Namely, that democracies tend to produce efficient policies even if the constituents of that democracy have a hard time articulating why the policies are efficient. He then went out in search of empirical evidence that supported his view. In doing so, he would examine policies that economists often considered inefficient and he would try to understand why an effective democracy would adopt such a policy. In other words, he would ask: what characteristics would have to exist in order for an economist to consider the policy efficient? This is in sharp contrast to the typical way that economists examine policy, which is by starting with a basic model and determining whether the policy is efficient within that model.
I am writing about this because I believe that there is a critical element to Thompson’s analysis that should be incorporated into political economy – regardless of whether one believes that Thompson’s effective democracy theory is correct. The critical element is the presumption that there is some underlying reason that a particular policy emerged and that the policy might be an efficient democratic response. In other words, the working assumption when any policy or institution is analyzed is that the policy or institution was designed as an efficient response to some problem. Note that this doesn’t mean that economists should always conclude that the policies and institutions are efficient. The tools used by economists are the precise tools needed to determine whether something is indeed an efficient response to the problem. Thus, rather than start with a generic standard model and consider whether the policy is efficient in that context, perhaps economists should ask themselves: what would have to be true for this policy to be considered a constrained efficient response? In some cases this will be difficult to do – and that in and of itself might indicate the inefficiency of the policy. Other times, however, certain conditions might emerge that could justify a particular policy. These conditions would then generate testable hypotheses.
A Pascalian approach would hopefully lead to more humility among economists. For example, the minimum wage is a very popular policy despite the standard economic arguments against it. But why does the minimum wage exist? Even if one believes that the disemployment effects are small enough for the benefits to exceed the costs, this still begs the question as to why the minimum wage is chosen over other attempts to help low-wage workers, such as the Earned Income Tax Credit. Economists typically explain away the existence of the minimum wage as way for politicians to signal that they care about low-wage workers without bearing the cost. But this argument is rather weak. If there is a better alternative, wouldn’t the public eventually realize this? At the very least would the signal sent by the politician eventually be seen for exactly what it is? All too often, economists simply conclude that the general public just needs to learn more economics (how convenient a conclusion for economists to reach). My brief sketch of a theory of why the minimum wage exists (here) was an attempt to approach the topic from this Pascalian perspective.
Most recently, a seeming majority of economists (as well as financial and political pundits) expressed absolute shock at the decision of U.K. voters to leave the European Union. As a result, many have concluded that those who voted to leave did so because they don’t understand the costs (again, the argument is that the dullards just need to learn economics). Others have concluded that the decision to leave is just a manifestation of xenophobia. But perhaps economists are wrong about the costs associated with leaving. Or perhaps economists have miscalculated the long-run viability of the European experiment. Or perhaps individuals place values on things that are often left out of standard cost-benefit analysis because they’re hard to measure or hard to identify. Of course it is also possible that those who supported the decision to leave are indeed economically ignorant bigots. But even if this is the case, shouldn’t we fall back on this conclusion only after all other possible explanations have been exhausted?
A Pascalian view of political economy takes as given that we have imperfect knowledge of the complex nature of economic and social interactions. Studying the emergence of policies and institutions under the presumption that they were designed to efficiently deal with a particular problem forces economists to think hard about why the policies and institutions exist. But the tools at any economist’s disposal are up to the task.
Rather than seeing ourselves as the wise elders passing down advice and judgment to those who fail to understand price theory, let’s be humble. Let’s take our craft seriously. And let’s realize that we might be somewhat ignorant of the complex nature through which democracies create policies and institutions.
The Everyday Economist 