WHY GOVERNMENT POLICIES ARE A CONSTANT
SOURCE OF FRUSTRATION FOR ECONOMISTS

Why do governments so often pursue policies that defy basic and widely agreed principles of economics that, if followed, would benefit everyone? Writing in the latest issue of the Economic Journal, Professor David Romer suggests that the answer to this question may lie in the simple fact that most voters know little about economics and other subjects that are relevant to government policies.

In a democracy, each individual's chances of affecting outcomes are extremely small, and so individuals' incentives to become informed are minimal. Thus, as Romer puts it, 'it is plausible that in the political arena, individuals support the candidates or policies that a superficial examination of the evidence suggests will produce the more desirable outcomes.'

Romer points out just how many government policies are a source of frustration to economists. For example, governments control pollution through bureaucratic regulations when systems based on tradable permits or effluent fees would be much more cost-effective. They restrict international trade even though one of the oldest messages of economics is that free trade is beneficial. They attempt to help the poor through such clumsy, roundabout means as rent control and minimum wages when such direct means as targeted housing subsidies, tax benefits and direct transfers would be much more efficient. And on and on.

Policies like these are a source not just of frustration to economists, but also of puzzlement. When there are more efficient means of reaching a goal, it is in everyone's interest to adopt those means and divide the resulting gains. Why then are inefficient policies so common?

A key feature of individuals' imperfect understanding of economics and other policy-relevant fields is that it is not random. More individuals underestimate than overestimate the benefits of free trade, the distortions and inefficiencies caused by price controls and regulations, and so on. The clearest evidence that imperfect understanding is systematic comes not from economics but from physics, where it is possible to pose clear questions whose answers are not in dispute. As Romer points out, not only do most individuals do poorly in answering basic physics questions, but they do so in consistent, predictable ways.

(Further evidence of systematically imperfect knowledge is provided by another Economic Journal article, 'Systematically Biased Beliefs about Economics' by Bryan Caplan, which appeared in April 2002. Caplan shows that economists and the general public give consistently different answers to economics questions, and that these differences are not due to ideology or self-interest.)

After showing that systemically imperfect knowledge can lead to harmful policies, Romer turns to the implications of his analysis for political institutions. A natural solution to the problems that arise when each individual has only a small influence on decisions is to let decisions be made by a small number of people. But simple concentration of power (as in dictatorship or oligarchy) has two drawbacks. First, it eliminates the satisfaction that most individuals derive from political participation for its own sake.

Second, it means that the idiosyncratic components of decision-makers' imperfect understanding - which are cancelled out when there are many decision-makers - can affect policy decisions, with potentially disastrous consequences. And Romer shows that letting decisions be made by a small number of individuals via representative democracy is also not enough to solve the problems created by imperfect understanding. Even if candidates for office are drawn from those who have studied the issues the most, there are sure to be potential candidates who support the policies that the majority of voters find most appealing - and it is these people who will be elected.

Romer finds that two other types of institutions are likely to be more successful. The first are ones that provide potential representatives with information not before they run for office, but after they are elected. Examples of institutions that can play this role are formal training programmes for representatives, legislative hearings, official roles for panels of experts and a professional civil service.

But when representatives switch their positions in response to information they acquire after they are elected, they may be switching to positions that most voters oppose. In such situations, institutions that lower the benefits of pleasing voters, such as term limits and long terms of office, may improve policy choices.

The second promising type of institution that is likely to help overcome the problems of imperfect understanding are ones that promote the dissemination and acquisition of information. When individuals acquire more information, political decisions are better. Thus, the benefits of information acquisition extend beyond the individuals acquiring the information; in the language of economics, information acquisition has 'positive externalities.' This means that left to themselves, individuals obtain less information than is socially desirable, and it is appropriate for the government to intervene. This can take the form of promoting either general education about subjects relevant to public policy or the exchange and dissemination of ideas about specific political issues.

ENDS

Notes for Editors: 'Misconceptions and Political Outcomes' by David Romer is published in the January 2003 issue of the Economic Journal. Professor Romer is in the Department of Economics, University of California, Berkeley, California 94720-3880.

For Further Information: contact David Romer on +1-510-642-1785 (fax: 1-510-642-6615; email: dromer@econ.berkeley.edu); or RES Media Consultant Romesh Vaitilingam on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com).