This course offers an introduction into the public economics theory. It does not aspire to cover theories of taxation, public expenditures, regulation etc. at length and in-depth. Rather, our ambition is to give a bird's-eye view of central themes of public economics and related disciplines, and teach concepts, logic, and ideas, rather than methods of analysis, which would require an entirely different course format. Our choice of topics covered by the course reflects a trade-off between salience and centrality, on the one hand, and suitability for a brief online introductory course, on the other. The course content is neither comprehensive (which would be a "mission impossible" for virtually any public economics course"), nor representative of other such courses. With these limitations and caveats in mind, we encourage our students to continue their public economics studies in a more regular fashion, and see our role inter alia in motivating interest in such "continued education". The central theme of the course is the role of government as a mechanism of resource allocation which complements and augments markets. Governments are viewed as public agencies set to correct market failures. Such agencies however are prone to failures of their own, and hence markets and governments are two imperfect alternatives. We deal with government's limitations, with particular emphasis on those that have to do with informational asymmetry, limited administrative capacity, and imperfect accountability to society. Otherwise the course's man themes are economics of taxation, regulation, politics of public economics, incentives in government, and government vis-à-vis (civil) society.
1.1. Markets and governments
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Do curso por National Research University Higher School of Economics
Public Economics
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Government in a Market Economy
In this lecture we discuss reasons calling for government presence in market economies. We stress key advantages of markets over governments which make privately taken decisions highly efficient in the absence of externalities. The latter significantly distorts the work of market mechanism and lead to inefficient outcomes. We consider possible solutions to this inefficiency which are based either on coasean agreements or on public coercion (governements) and discuss conditions, advantages, and disadvantages related to these solutions.
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Leonid PolishchukProfessor
Department of Applied Economics
[SOUND].
Hello.
The topic of this course is public economics.
Public economics is a part of economics which
deals with the wrong presence of government in economies and societies.
As you know, economists boldly take upon
issues which are sometimes outside of the narrow confines of economics proper
such as production, consumption, exchange
if they feel that the methods of economics are applicable in these areas.
Public economics actually is a good example of such expansion
of public field of economic analysis because when we talk about governments,
and public economics, as I said, is about government's presence in economies,
we necessarily touch upon issues and problems which are normally dealt
by political scientists, legal experts, anthropologists, so on and so forth.
And I expect that some of these disciplines will be reflected in our course.
First of all, I would like to talk to you about why governments
are present in modern economies and in market economies, in particular.
What are functions of governments?
What are roles of governments?
Why governments are required to complement markets?
And a good way to discuss these issues is to view governments and
markets as two alternative mechanisms of resource allocation.
Let's recall definition of economics.
Economics sometimes is defined as a science about resource allocation.
Other definition, which goes back to Adam Smith, is that economics is a science about
the wealth of nations.
Let's combine these two definitions and
discuss how resource allocation affects the wealth of nations.
Nation's successes, prosperity or poverty, and
demise are not necessarily predetermined by availability of resources.
Some nations do very well despite of lack of resources,
others have abundant resources and
despite that still poor, and unstable, and
underdeveloped. So, the availability of resources is not a key to success.
In fact, as you might have heard, sometimes natural resources could be
a source of serious problems for economic and political development, and
this is something that is known as the resource curse.
And in this course I expect to talk to you about the resource curse in due course
among other things.
But primarily successful nations are the nations that are able to
allocate their resources properly.
And, as I said, we have two mechanisms for resource allocation:
the first one is market, another one is government.
Market allocations are outcomes of individual decisions because in market
economies decisions are made by private agents such as individuals,
households, firms.
These agents own resources, they decide how these resources should be used.
As opposed to markets, governments are public agencies, and
they move resources by decrees, by commands.
This is what is known as by fiat.
So, we have two alternative means of recourse allocation.
The question is why in modern economies
these two means are combined with each other.
They co-exist although in different proportions,
and that means that probably they have some comparative advantages and
comparative disadvantages, and let's talk about what these advantages and
disadvantages are, and that will give us an opportunity to
visualize the role of government in economies.
Let us first talk about comparative disadvantages of market economies.
Now, market economies, as I said, are economies based on private decision making,
and economic assets in market economies are predominantly privately owned.
These two features of market economies – private decision making and private
ownership – are sources of two great advantages of market economies.
The first one is incentives,
and the second one is information.
Incentives in market economies are based on private ownership.
Private ownership in its turn is based on private property rights. And
what are private property rights or property rights in general?
Economists define property rights as bundles of rights which include
the right of control, the right to returns, and
the right to transfer the above two rights among individuals.
The right of controls means that private owners
are free to do with their assets whatever they like.
Of course, there are some constraints:
legal constraints, contractual constraints, but
within these constraints, you're free to use your assets the way you see it fit.
On the other hand, the right to returns is the right to keep the profit
that you earned by using your assets.
Assets generate some income. Of course, you incur some costs.
And the difference between the income and the costs is your profit.
And as private owner, you are [COUGH] entitled to keep the profit.
And this combination of the control rights and
of the return rights is a source of very powerful incentives.
You decide what to do with your resource,
and you are interested in putting this resource in the best possible use because
that will maximize the profit.
It internalizes decision making
and aligns this decision making with the needs of,
with the objective of efficiency.
Let's add to these informational advantages.
People that own assets, that operate assets,
they are usually the best informed about what these assets are:
what are their strengths,
what are their weaknesses,
what are the areas where these assets can be best used.
So, we have a wonderful combination of being informed, being able to act upon
this information, and being interested in acting in the best possible way.
What else to desire?
And indeed, as a result, markets are known for
being very, very efficient in resource allocation.
In particular, markets are believed to be more efficient in resource allocation than governments,
than bureaucrats
because bureaucracies lack the market incentives, and
oftentimes they are less informed than market agents.
And this is actually the rationale for
privatization that swept much of the world in the late 20th century.
In fact, appreciation and disappreciation of markets as an alternative to government
exhibited considerable fluctuation in the course of recent history.
The prevailing moods, the prevailing sentiments in the late 1970s, 1980s, and
much of the 1990s was that markets are far
superior to governments and, therefore, the motto of the day was privatization, and
deregulation, and liberalization.
In the developed world, the sentiments were usually linked with
Margaret Thatcher, British prime minister in the United Kingdom,
and US president Ronald Reagan.
And they influenced a wave of reforms in the developing world,
in the former communist world.
And they produced sort of mixed results.
And, as a result, the prevailing thinking at the time
is that small government is beautiful, and the less government you have is better,
[COUGH] and government is a necessary evil that has to be confined to very narrow
parts of the economy.
I think today the approaches somewhat more balanced. Then you see a
great appreciation of big, strong, and efficient governments.
Of course, on the one hand, the demise of communist command economies
very clearly illustrate what happens to nations that marginalize markets,
that destroy markets, that press markets out of their economist primarily for
ideological reasons.
Such economies were bound to fail, and
they indeed failed just in the course of a few years.
But the other extreme that there is no place for government except for
some very limited functions is probably also not the best guidance.
I will recall a well known distinguished economist
who in the mid-1990's in a private conversation said that
everything that was not privatized has to be privatized
because every public enterprise is bound to be inefficient,
is bound to be corrupt, is bound to be inferior to private enterprises.
And when he was asked by his colleagues
are there really any areas of societies or economies that should not be privatized,
he thought quite a bit and he said: "Well probably yes, there is one."
And this one is armed forces because when people maximize profits using
heavy armament that's probably not a very good thing for the society.
But failing that everything else has to be made private.
Well, as we know in reality,
we have a combination of private markets and public governments.
And they differ across societies and nations in different proportions.
But if we use a crude measure of government's presence in economies and
measure by the share of public sector or the budget in GDP,
it varies from anywhere from 20% to over 50%.
So, and so in some economies, and their not the worst economies in the world,
governments directly control half of the economy, and
indirectly control the rest of the economy, and
that means that probably governments have also their own advantages.
Big governments are back and, as I just told you, the views of the 1980s and
1990s that the smaller the better have given way to
greater appreciation of a government which is big and strong.
So, the big question now is what explains the persistent need for
government in a free-market economy?
Societies make choices between different mechanisms of resource allocation.
And social choices are different from individual choice.
They are far more complex, far more nuanced, and controversial.
But nonetheless, if one of the mechanisms of resource allocation such as
market is unconditionally superior to governments than,
little by little, if nothing else, by some process of natural selection
a governance would be driven out of life.
As you see, exactly the opposite is happening, and
that means that governments should probably also be considered as a means of
resource allocation which under certain circumstances is superior to markets.
So, the big question now is under what
conditions governments are doing better than markets?
Apparently, governments have some advantages over markets and
because of these advantages they're required to support markets,
to augment markets, and sometimes to even replace the plan markets.
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