COMPETITION AMONG RENT SEEKING GROUPS IN GENERAL EQUILIBRIUM

Transcription

1 Bulletin Numbe 90-2 Septembe 1990 ECONOMIC DEVELOPMENT CENTER I L L COMPETITION AMONG RENT SEEKING GROUPS IN GENERAL EQUILIBRIUM Tey L. Roe Theodoe Gaham-Tomasi ECONOMIC DEVELOPMENT CENTER Depatment of Economics, Minneapolis Depatment of Agicultual and Applied Economics, St. Paul UNIVERSITY OF MINNESOTA

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3 COMPETITION AMONG RENT SEEKING GROUPS IN GENERAL EQUILIBRIUM Tey L. Roe and Theodoe Gaham-Tomasi Authos ae membes of the Depatment of Agicultual and Applied Economics, Univesity of Minnesota. Pepaed fo the Westen Agicultual Economics Association's Invited Pape Session, Advances in Public Choice Modeling, August 4-8, 1990, Vancouve, Bitish Columbia. The Univesity of Minnesota is committed to the policy that all pesons shall have equal access to its pogams, facilities, and employment without egad to ace, eligion, colo, sex, national oigin, handicap, age, o vetean status.

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5 COMPETITION AMONG RENT SEEKING GROUPS IN GENERAL EQUILIBRIUM ABSTRACT A two secto geneal equilibium model is developed in which households can influence the govenment's choice of the elative pice of taded goods and the level of public goods supplied to each secto. The model is used to illustate key poblems addessed by the political economy liteatue, modeling issues that aise, and the natue of insights that can be obtained that taditional appoaches cannot discen. Key wods: Geneal equilibium, political economy, ent seeking, lobbying.

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7 COMPETITION AMONG RENT SEEKING GROUPS IN GENERAL EQUILIBRIUM I. Intoduction Capital accumulation and technological change in human, bio-physical, and mechanical capital, combined with the efficient allocation of esouces to meet final demands, emain vitually unchallenged in economic thought as the keys to economic gowth. In much of the analysis of these issues collective action, via the state, is esticted to two oles: addessing the pesence of maket failues and achieving distibutive justice. Until faily ecently, the behavio of govenments in fulfilling these oles has been incopoated into economic models lagely in the fom of benevolent activity to coect maket failues, and to edistibute income using instuments designed to have minimal effects on efficiency. It now is becoming appaent that these taditional neoclassical views alone cannot povide adequate desciptive insight into the pocess of attaining economic gowth and distibutive justice, no can they meet the challenge of poviding pesciptive guidance to thei attainment. It is well-known that govenments use policy instuments that distot thei economies and ae wasteful of esouces. Taditional models have difficulty addessing questions concening why counties pesist in thei pusuit of policies that yield an inefficient allocation of esouces and exacebate adjustments to extenal shocks. Ae these inteventions the esult of policy mistakes? If this is so, why have counties failed to lean fom thei mistakes? A patial explanation is that policies ae the outcome of political pessue exeted by domestic inteest goups. These goups seek to achieve outcomes that povide them with some advantage, but which may be socially wasteful. This explanation has been fowaded unde the ubic of-models of "ent seeking" (Kuege). The ent seeking liteatue has focused on a vaiety of souces of "govenment failue" and the social costs imposed when, acting in thei own self-inteest, individuals seek a diffeential economic advantage though collective action and the powe of the state. This ecognition of ent seeking behavio and its costs has led some 1 Othe labels ae "diectly unpoductive pofit seeking activity" (Bhagwati) o moe geneally "political economy" (Colande).

8 analysts to conclude that govenment activity should be seveely esticted. Fo example, Buchanan (p.14) states: "As long as govenmental action is esticted lagely, if not entiely, to the potection of individual ights, peson and popety and enfocing voluntaily negotiated pivate contacts, the maket pocess dominates economic behavio and ensues that any economic ents that appea will be dissipated by the foce of competitive enty." Howeve, this view may be excessively naow, since it does not ascibe legitimate concen to the maket failues o distibutional justice which povide a ationale fo collective action. Pehaps moe ich in its implications fo policy analysis is the view that societies ae faced with a tade-off between the need to edess the maket failues and unfainess inevitably associated with maket economies, and the fact that the means by which to do so inevitably admit manipulation of the ent-seeking sot. As with poductive efficiency in input use, societies ae challenged to achieve institutional efficiency, i.e., to design public institutions which identify and esolve poblems ceated by maket failues and injustice in ways that minimize that sacifice of economic efficiency. aea. In this pape we seek to povide an intoduction to ecent wok in this Howeve, this is not a liteatue eview. Rathe, following a bief pespective on the scope of the govenance liteatue, we fowad a simple geneal equilibium model in which agents can influence govenment policy. The model seves to illustate key poblems addessed by the political economy liteatue, the modeling issues that aise, and the kinds of insights that can be obtained that taditional appoaches cannot discen. Then, using this stuctue, we attempt to tie togethe selected issues addessed in the liteatue that concen foeign tade, voting, bueaucacy, coalition fomation and the fee ide poblem, and endogenous economic gowth. Clealy, within the confines of this pape we can only sketch some of the essential elements of these additional consideations. fomal appoaches to political economic behavio ae necessaily Since the abstactions of complex social systems, thei acceptability may not evolve aound whethe they tue o false depictions of eality. Instead, as Aumanns (p. 37) emaks in his discussion of game theoy, "we cannot ask, is it ight o is it wong? Rathe, we must ask, how often has it been useful? how useful has it been?" It is in this spiit that we poceed. 4

9 II. Relation to Liteatue The beadth of the liteatue on political economy depends on whethe the topic is naowed to fomal mathematical models o boadened to include the numeous non mathematical contibutions of, fo example, Pasons, Holt and Tune, Bates and othes that have studied the elationships between economics, polity and political stuctues. We povide a bief oveview by selecting only epesentative o leading contempoay contibutions fom fou diffeent schools, namely, (i) collective choice, (ii) public choice, (iii) political science and (iv) intenational tade and egulation. The impotant contibution of the collective choice school lies in the ecognition that goup behavio is way of aggegating individual pefeences, that a coalition is an oganization that devises ules govening membe behavio, and the oganization consumes esouces. Olson concludes that boad based coalitions ae likely to pessue govenments to intevene in ways that ae less wasteful of esouces than ae naow based coalitions. And, stable societies ae likely to accumulate moe coalitions ove time with the esult that policy decisions ae made moe slowly, thus slowing down society's capacity to intoduce technical change, adapt to shocks and to decease a county's ate of economic gowth. Bates, eflecting the political science view, daws on coalitions to 2 explain economic policy in a boade context. He suggests that the inteests of uban consumes in developing counties coincide with those of domestic industialists who view low-piced food as seving to decease the pessue on wages. At the same time, the ual secto is highly divesified and, fo easons of fee iding, oganization and infomation costs, it is willing to expend fewe esouces to influence policy than is the uban secto. The outcome is policies which tend to suppot impot substitution, industialization and low cost food to uban households. The same agument applies to developed economies whee the food shae of the consume's budget is small, so that consumes ae less willing to expend esouces to influence food pices. Agicultue becomes a smalle component in the economy, fams tend to be moe specialized so that income becomes sensitive to commodity policy. Within thei aea of specialization, fames also face lowe oganizational costs because of the elative ease of ovecoming the 2 The liteatue on voting and economic policy is biefly discussed in Section VII.

10 fee ide poblem compaed to uban goups. eceives potection elative to the industial secto. 3 The esult is that agicultue The public choice school includes the contibutions of Buchanan, Tolluck and thei followes. The key ecognition is that since policy choices (whethe in public o pivate oganizations) affect individual utility, it is ational fo individuals to withdaw esouces fom the poduction of goods and sevices and allocate them to lobbying, o to othe effots to gain access to political authoity and effect policy choice. Economic losses can include policy-induced dead weight losses plus the welfae loss fom the esouces consumed in alteing policy. This focus shifts attention to institutions outside of the typical maket place concept and places it on legal and illegal activities such as licensing, tax avoidance and so on. The public choice school has touched on a boad ange of issues, including log olling and the behavio of bueaucats (Tullock, and Niskanen). The intenational tade and egulation school begins with the seminal contibution of Kuege and includes Bhagwati, Bhagwati and Sinivasan and moe ecently, Appelbaum and Katz (1986, 1987) and Young and Magee. Othe impotant contibutions include Becke and a host of studies on political systems and egulation that have ecently been epinted in a volume edited by Stigle. Geneally speaking, these effots place emphasis on the motivation fo allocating esouces to unpoductive pofit seeking (DUP) activities, the consequent shinking of an economy's poduction possibilities, and implications to facto etuns and tade. Examples of DUP activities ae taiff seeking, taiff evasion, seeking of taiff evenues, and licenses. Applebaum and Katz focus on ent seeking and ent avoidance and late, on an envionment whee egulatos of instuments induce ent seeking. Young and Magee combine the appoach of Findlay and Wellisz, who studied how esouces contibuted by inteest goups affected tade potection, with that of Maye's model whee tade policy is detemined by fully infomed 5 votes. Becke investigated the pesence of political pessue goups that 3 This geneal line of easoning is also povided by Hayami and Honma, and Andeson. 4 The appoach and scope of this school can be gleamed fom the volume edited by Rowley, Tollison and Tullock. 5 Peltsman is a fequently cited contibution that was among the fist to

11 allocated esouces to influence cental authoity to countevail taxes and povide subsidies in thei favo. This stuctue allows fo competition among goups and, dawing upon Olson, allows fo the ising cost of lobbying by lage goups. Late we discuss some of these contibutions in the context of the base model pesented below. III. The Model In this section we pesent a geneal equilibium model of an economy with two distinct pats: (i) a small open economy with two households (ual and uban), two goods (food and non-food), and two factos, labo and secto specific input; and (ii) a govenment which povides a public good to each secto, and sets the elative pice of the two goods in esponse to lobbying by households. The Household Households ae indexed by i = (ual), u (uban). Households choose levels of food q and non-food (qu) to consume. They also choose the amount of labo (L ) allocated to the poduction of the ual good (y ) and uban good (y ); the amount of land (x ) and plant and equipment (x ) to u u ent in o out; and the amount of labo to hie in o to wok out side of the secto. They ae given endowments of labo (Li), and land and plant and equipment (x.). Maket failue is captued by the pesence of a ual and 1 an uban public good (Gi) that is supplied by the public secto. These goods may be teated as oads, electification, and othe activities which incease the poductivity of labo. A depatue fom this neo-classical tadition comes about late in the development of the model when households ae allowed to allocate esouces to influence the govenment's choice of the levels to set policy instuments. The household's optimization poblem is, fo i - (1) V.(p,i.) Max U(qi,q ), 1( 1 LR TT uii,u,: X -(q (,q,l i x ) i i ui' i R + I H i - pqi + q}"). qi ui Disposable income II depends on pofits ai fom the poduction of the i-th good, etuns to the endowments of labo (L ) and secto specific factos (x.), and popotion 7 of the tax bill T. Denote pices by p, w and c fo the ual good, labo and the secto specific facto, espectively. The fomulate voting ules in a theoy of maket egulation.

12 pice of the uban good is taken as numeaie. Then, (2) nl - R(pwcG ) + w[l - 1] + c x + 7 T i i ii i pyi(li,x ;G ) + w(l - L - l ) + c (xi - x ) + 7 T S i ± i i i i i i i i i fo values in X that maximize (1). Initially, we teat the household's lobby level 1 as a paamete. The i diect utility U(-) and poduction functions yi(.) ae assumed to be continuous, stictly concave and inceasing in the household's choice vaiables. In this situation, the household's poblem is sepaable (Jogenson and Lau) so that it can be stated in its dual fom, denoted hee by the "conditional" indiect functions fo utility V (-) and pofit w (). These indiect functions ae conditional in the sense that the ule fo choosing the lobby level i emains to be detemined. Letting E denote excess domestic demand, commodity and facto maket j balances ae, (3.a) 2iq j- y j E j =, u (3.b) - L - Z , ii ii ii i i (3.c) x - i x i - 0, fo the ual and uban goods, and fo labo and the secto specific factos espectively. The 2 1 tem in the labo balance equation accounts fo the i i amount of labo the govenment allocates to the poduction of the ual and uban public goods. Teating p, 1, and the govenment's policy instuments p,1, 1l as i u exogenous vaiables, (3.b) and (3.c) ae a system of thee equations in the thee vaiables w, c, c. It is assumed that an equilibium of the economy 4 4 exists and is unique. In this case, let w - w(e ), and c - c (e ) denote _0 1 1i i 1 the esult, 0 whee e- (p,,1 0,1 8,1,L,L,x,x ). The Govenment 1 u u u u We assume a govenment that foms pefeences ove the utility of households in the economy, and then chooses policy instuments as though it sought to maximize its pefeences subject to the condition that it cannot incu a fiscal, and hence a tade, deficit. The govenment's policy instuments ae the elative pice p, and the amount of labo I 8 to allocate to the poduction of the ual and uban public goods (G,G ). u govenment is assumed to solve That is,

13 (4) Max U - I (p,p )V + I (p,p )V, X - ((p,1',1) E R }. g u u u Maximization takes place subject to the poduction function fo public goods, (5) G - G(1) and the equiement that fiscal expenditues (6) C - - we1' + (p - pw)e ii equal the lump sum income tansfes (T) to households, i.e.,t = C. assume y is continuous, quasi-concave and inceasing in 1'. We The values I ae weights that define the govenment's pefeence odeing. They ae specified as influence functions whose aguments ae detemined by the political pessue (p.). 1 The influence functions epesent the end poduct of pessue geneated by special inteest goups. Diffeent counties use diffeent methods to define the powe of the state. A fundamental chaacteistic of vitually all political systems is that they ae subject to pessues fom special inteests. Hence, we allow households to lobby fo puposes of geneating political pessue (p.) that yields influence I ; i.e., households lobby in 1 1 ode to alte the paametes of the govenment pefeence function, and hence the choice of instument levels in X. This stuctue is vey much a "educed fom" appoach. Details of the institutions fo establishing laws, politicians, political paties, mechanisms fo enacting laws and defining policy instuments fom a set of possible instuments eceive no paticula attention. The basic esult is that policy instuments can be used to aise the welfae of the moe influential goups. Unlike the ent seeking liteatue in which, absent of othe distotions in the economy, ent seeking is an activity that educes efficiency (Buchanan), it is now possible fo lobbying to incease an economies poduction possibilities, albeit at a cost of allocting labo fom poduction to lobbying activities. Fiscal effects of tade ae (p - pw)e - (P /P - u P /Pw)E + (P /P u u u - pw/p )E. u u u An altenative appoach to individual household lobbying is to specify a thid secto to the economy that specializes in the poduction of political influence as a function of the esouce cost equied to poduce it and the willingness of the households to pay these costs. This appoach would captue the activities of, fo example, law fims that lobby on the behalf of thei clients. Howeve, this tends to complicate the analysis with out adding significant insights beyond the appoach followed hee.

14 Following Becke, political pessue is poduced in an envionment of ules and institutions that map lobbying into pessue, i.e., a pessue poduction function, (7.a) p - pi(11z ). Simila to a technology, p is positive, continuous and quasi-concave, in the amount of labo i allocated to lobbying. Fo the moment, z is a vecto i i of exogenous vaiables that summaize the state of the political economy; they affect the efficiency of conveting lobbying into pessue. This function epesents a political technology, pehaps one of a set of possible technologies that ae available to households to poduce political pessue. The end esult of lobbying is a set of weights (7.b) I - I.(p,p ). i i u It follows fom the lineaity of (4) in I that it is elative changes in I., and not thei absolute magnitudes that matte. We assume that elative 1 influence, I - I /I, is continuous, positive and concave and inceasing (esp. convex and deceasing) in p (esp. p ). Since 8 1/ap Qp u u a I/8p Qp, if 8 I/ap ap is positive at p*, p*, then in the neighbohood of u u u this point, an incease in p inceases the maginal poduct of p so that an incease in.p deceases the absolute effect of p on I. These conditions u imply that an incease in the political efficiency of the i-th household, e.g., 8p /8z > 0, can decease the elative influence of the j-th household and induce the latte to countevail the inceased efficiency of i with moe labo allocated to lobbying, all else constant. IV. The Govenment's Decision Rules Fo household choices (q,q UL.,X) E R+, the value of the govenment's pefeence function (4) eithe (i) declines beyond some point p*, Il*, I*, o (ii) eaches an uppe bound. In the case of (i), u futhe distotions in the economy lead to an incease in taxes T to the point whee the poduct of the govenment's pefeence weight and the decline in the i-th household's utility exceeds the poduct of the incease in the j-th household's utility and the govenment's pefeence weight fo this household. Boundedness of (4) comes about because of the govenment's budget constaint, i.e., it is not pemitted to obtain fee esouces fom the est of the wold. Since the govenment cannot incu a budget deficit, If the coss deivatives ae negative at p*, p*, then an incease in p u u deceases the maginal poduct of p on I. 10

15 the j-th household's income is also bounded fom above by the amount of income that is possible to tansfe fom the i-th household. The bound is appoached when the i-th household's budget appoaches zeo. Poposition 1I If the Negishi condition holds, i.e., I - 1/V, and w if E is non zeo, then a maximum to (4) is chaacteized by p - p and,p s 9 i G il i = w. See Appendix fo sketch of poof. i,g il i i Unde these conditions, the govenment chooses a pice that would also pevail unde fee tade. As well, labo is allocated to the poduction of public goods to the point whee the poduct of the maginal value poduct of the public good, n., and the maginal physical poductivity of labo in poducing the public, G i s in the i-th secto equals the wage. If each i secto has seveal agents, G is a pue public good in the secto. In this case, unde the conditions of poposition 1, public goods supply satisfies the Sammuelsonian efficiency condition in each secto as well as being efficiently allocated between sectos. does not peclude a fee tade - Hence, by constuction, the model efficient public good esult. Fo the case of an inteio solution to (4), let the govenment's policy decision ules be denoted by: (8.a) p - p(e 2) and (8.b) 1-1i s i i 2 S w o o whee, e (p,,1,l,l,x,x,z,z ) 2 u u u u Poposition 2: If the tax buden is bone by uban households, 7-0, pice distotion is detemined by: (p - p") - (l-i)[(y - q ) + (L - L )w ]}/E p,p when L - L > 0, and L u u - L < 0 and by (p- p) (-I)[(y - q ) - (L - L )w ])/E u u p,p when L - L < 0, and L - L > 0, whee L - L - 1 and I - I V /IV u u i i i,ni u " u See Appendix fo a sketch of the poof. 9 Unless othewise indicated, notation V denotes 8V /i. 10 Noted that p and I1 ae homogeneous of degee zeo in I. i i 11

16 Fo the case of a nomal good, E is negative, and w is positive,p p The diection of pice distotion depends on whethe elative infulence favos ual households, I > 1, and whethe households ae labo suplus, (L - L ) positive, o deficit. If infulence favos labo suplus ual households that poduce a maket suplus, (y - q ) positive, then p > pw. If the ual household poduces a suplus and is labo deficit (hence, uban households supply suplus labo to the ual secto and to the govenment), an incease in domestic pice inceases poduction costs. The sign p - p is indeteminant in this case, though, a labo deficit almost suely seves to decease the level of pice distotion. The sign is also indeteminant when ual households ae deficit poduces of the ual good, and have a labo suplus. Thoughout this section, vitually identical esults ae obtained when 7-1. Also, these esults ae easily genealized fo the case of two feely mobile factos of poduction, except in this case, the sign of w p depends on the Stople Samuelson condition. Poposition 3: If the tax buden is bone by uban households, 7-0, the diffeence in the maginal value poducts of the public good ae detemined by: 1 SG G - G l - (1 - I)((L,G,l L )(wls u,g u,i - wig) + 1 G g,) 1,G -,i u u u 11 fo L - L > 0, and L - L < 0, and u u (p - p )(E g - E g), u G G - GI s - (I - )((LU- L )(wl8 - W) - G 18) -,G, u,g u, u u w1,g,1 u u u (p - p )(E g - E u g), u fo L - L < 0, and L - L > 0. See Appendix fo sketch of poof. u u If infulence is unbiased, I - 1, then the maginal poducts equal wage, as shown in poposition 1. If infulence favos ual labo suplus If, athe than a Ricado-Vine type of model, anothe feely mobil input wee specified, then the sign of w would depend on the Stople-Samuelson condition. If E positive, (the ual is good impoted) then fo nomal goods E < 0 (Dixit and Noman, p. 224). If E negative, the sign of E,p,p cannot be unambiguously detemined. If the income effect is "small" then E,p is negative, hence the same esult (Woodland, p.153). 12

17 households, then all else constant, (L - L )(w l g - W 1 g) positive will encouage the allocation of public goods to the ual elative to the uban secto. The diection of biase in public good allocation in this case is detemined by the wage effect of labo allocated to the poduction of public goods in the ual elative to the uban secto, i.e., (Wlg - Wig) positive. It can be shown that (wlg - wig) positive depends on the maginal poduct of the public good in u the poduction of yi and the maginal poduct of labo used in the poduction of the i-th sectos public good, i.e., (y /ag )8G /a g > (ay /8G )8G //al > 0. In this case, the ual household u benefits fom inceased poductivity fom public good allocation and fom the incease in wage income to suplus ual labo. Howeve, if (wgl - wig) u is negative, then allocation of the public good to the uban secto also benefits the ual labo suplus household thus deceasing the bias in allocation of the public good to the ual secto. labo deficit, then the convese of these esults apply. u If the ual secto is The tems Elg ae the effects on excess demand fom an allocation of i labo to the poduction of the i-th public good. It entes the above expession because allocation of the public good altes excess demand and hence taxes. This tem can be shown to be negative when G IG > w, 1i i othewise its sign is indeteminant. If the conditions fom poposition 2 pevail that yield p > pw fo a labo suplus household, and (E 1 g - E.g) u positive, then pice distotion in favo of ual households also induces the allocation of public goods to the ual secto. Othewise, pice distotion in favo of the ual secto is not necessaily in the same diection as the "bias" in the allocation of the public good to the secto. The maginal value poduct of the public good, w,g G,1 s, appeaing on the ight hand side, suggests that if infulence favos the ual household, then, all else constant, an incemental incease in the poductivity of the ual public good induces an additional incement of public good to be u allocated to the ual secto. Convesely, if infulence favos the uban household, an incemental incease in the poductivity of the ual public good induces an allocation of the public goods towad the uban secto. An impotant implication of these esults is that if the maginal poduct of labo allocated to the poduction of the public goods is small elative to the gains to the i-th household fom distoting p fom its 13

18 bode pice, then the govenment may "pefe" to distot the elative pice athe than investing in public goods as a means of tansfeing income to households. V. The Household's Decision Rules Assuming that the i-th household takes the actions of the j-th household as given, coectly peceives the objective of govenment, equation (4), knows the political pocess though which lobbying is tansmitted to influence, equation (7) and (8), the household, in pinciple, can solve the poblem 12 (14) Max V (p, ), i e R I i subject to the govenment's decision ules fo p and 1 s. Substituting the i policy decision ules into (14), and assuming diffeentiability of p(e ) and c (e ), the FOC fo the ual household is: 1 2 s (15) [y - q ]p + [L - L - 1 ][w p + w ] + G 1 + ]P p 1 1 G,1, y [TpI + TG G 1 w. p 1 G,l,1 See the Appendix fo this deivation. Condition (15) povides insights into the ual household's willingness to pay, i.e., lobby, to influence policy in its favo. Essentially, this condition is one of equating the maginal etuns fom lobbying to maginal costs. To ease exposition, suppose that 7 is eithe zeo o that the household is not awae of the tax implications of its lobbying behavio. Suppose also that p and [w p + w ] ae positive. I p 1 Conside the fist tem. If the household poduces in excess of consumption, (y - q ) positive, and its lobbying effots esult in an incease in the pice of y elative to the uban good ( 8 p/ 8 1 positive), then the household ealizes a gain fom lobbying. This esult has seveal implications. Fist, it suggests that the moe specialized is the household, i.e., (y lage elative to q ) the moe willing it is to allocate esouces to influence policy. Second, the availability of a cost-educing technology (e.g., an incease G ) also tends to incease the household's willingness to influence policy. Effectively, a cost-educing technology tends to incease the household's maket suplus and thus the 121f can be shown fom the envelope theoem that to constain the choice of i to the household's budget constaint is edundant. i 14

19 etuns to a maginal incease in the esouces allocated to lobbying. When the ual good (food) is an impotant component of household expenditues, the maginal cost of a pice incease, given by the poduct - q ap/al, implies an incease in expenditues on food. Hence, the willingness to lobby fo an incease in the pice food is loweed in this case. This esult is consistent with the obsevation that in counties whee food accounts fo a elatively lage shae of disposable income, political pessues tend to favo cheap food policies. Typically, in the pocess of development, maket suplus inceases while the popotion of income spent on food deceases. Then, ual households ae moe willing to influence policy that favos the ual good. In this case, Uban households tend to be less willing to influence food policy since less of thei income will be affected by the lobby esouces allocated fo this pupose. Hence, this esult is consistent with the obsevation that in developed counties, whee food is a small component of expenditues and y is lage, pessues tend to favo policies that subsidize food poduction. The ual household's net labo position is given by (L - L- 1 ). A negative net labo position contibutes to the household's pefeence fo a cheap wage policy. Households with a small endowment of the secto specific facto would likely be labo suplus, and hence they, along with labo suplus uban households, would tend to pefe policies which incease eal wages. Of couse, an incease in wages due to highe ual good pices pesents uban labo suplus households with a tade-off between inceased expenditues on ual goods and highe wage income. The maginal value poduct of the public good, C~ G 1 8, can be viewed as the "social good" side of the lobbying pocess. The moe efficient is the govenment in poducing the public good, and the moe impotant is the public good to inceasing the poduction of y, the moe willing is the ual household to lobby. Whethe the govenment esponds by inceasing the supply of the ual public good, howeve, o inceasing output pice, all else constant, depends on poposition 3. Still, as this poposition suggests, when infulence favos ual households, public good allocation to the ual secto is enhanced fo lage values of ig G,1s Note that the maginal poduct of the public good also depends on the household's endowment of the secto specific facto x. Thus, the value of economic policy gets built into the value of these factos. Had the model accounted fo a skewed distibution of the secto specific factos among 15

20 households, then the willingness to lobby fo polices that incease the ents to these factos would depend, in pat, on whethe a household is a suplus o deficit use of the facto. In the context of economic gowth and capital accumulation, policies which distot the value of secto specific assets ae likely to alte a county's gowth path. Wage (w) is the oppotunity cost of the labo allocated to lobbying. An incease in output pice will tend to incease wages. typical ent seeking esult (Bhagwati, Sinivasan) that the This is the allocation of esouces to influence pices, and away fom the poduction of public goods, can decease a county's poduction possibilities. Futhe, these esults suggest that facto maket impefections that lowe w, such as impefect labo mobility between the ual and uban sectos, will affect the willingness to lobby. The efficiency with which lobbying activity is conveted into influence is evealed by the patial deivatives p and l s in (15). If i i,l1 occupation, age, o othe changes incease the efficiency of conveting 2 lobbying into pessue i.e., a p./aliaz > 0,(o the changes in the efficiency of conveting pessue into influence), i i then it can be shown that, all else constant, an incease in z can yield an incease in the household's lobby level since a p/ai az > 0, and a21 /ai 8z > 0 depending on popositions 2 and 3. VI. The Game Component of the Model In the pevious discussion, the i-th household chose its lobbying level assuming a fixed lobbying level of the j-th household. The households' commodity and facto demands ae conditional on these fixed lobbying levels. In addition, the govenment's decisions egading elative pices and public good povision, as specified in (8.a) and (8.b), depended upon the paamete vecto e, which included these fixed levels. how lobbying levels might be jointly detemined. In this section, we conside The modeling of lobbying itself natually is appoached using game theoy. This simple statement immediately eveals the complexity involved in this effot, since a vey wide vaiety of game-theoetic appoaches is available, each of which makes some sense in the cuent context. The most staight fowad model has thee agents: the govenment and the two households in the economy. Cae must be given to the usual intepetation of the households in the two sectos as "epesentative" of lage numbes of agents in this context, as we discuss in moe detail 16

21 below. The govenment acts as "natue" and sets, exogenously, and once-and-fo-all, the decision ules specified as functions of lobbying accoding to (8). The households take these as given, and then play a noncoopeative game against one anothe. It is impotant to note that the decision ules in (8) actually ae a kind of "educed fom" fo the moe elaboate institutional setting defined by (7.a) and (7.b); fom the game-theoetic pespective, it is moe natual to focus on (8). The simplest appoach at this level is to posit a one-shot game, with Nash behavio, and to seach fo Nash equilibia in lobbying levels. Even with this simple setup, the existence of a Nash equilibium is not tivial; fo moe on this issue see Coggins et al. Assuming stict concavity of (14) in ii, let (16.a) 1-1i(e ) denote the household's lobbying ule obtained fom (15), whee e - i W (p, 1,L,L,X,X,Z,Z ). Equation (16.a) is the i-th household's best j u u u esponse to the j-th household's action. Then 10 ae a Nash solution if, i and only if, (16.b) av /a -, 8av /a i (e ) u ul (e ) u u Of couse, thee need not be a Nash solution to this game, and if thee is, it need not be unique. Suppose, howeve, that a Nash solution exists. Then we can state (16.a) as (16.c) i - i (e ) i i 3 whee e = (p,l,l,x,x,z,z ). Substituting fo i in the govenment's 3 u u u i policy decision ules yields: (17.a) p - p(e ) 3 and (17.b) I' - i( ). i i 3 e Hence, both the lobby and policy decision ules ae functions of vaiables exogenous to both households and the govenment. Condition (16.b) is also the definition of equilibium. If (16.b) does not hold, then it is possible fo the i-th household to eallocate lobbying esouces to countevail the lobbying effots of the j-th household, which then esponds accodingly. so doing, the households also change thei level of choices (q,q,l,x ). Of couse, it is not necessaily the case that Nash behavio is most natual hee. An altenative would eplace the Nash assumption with eaction functions such that an incease in lobbying by one agent diectly In 17

22 would call foth a change in lobbying by the othe (eithe an incease o a decease). The natual equilibium concept fo this game is a consistent conjectues equilibium (Beshnahan). In some cases, the patial deivatives in (16.b) can be eplaced by total deivatives, but in othe cases, moe complex estictions need to be placed on the eaction functions if equilibia ae to exist. Within the static context, it is natual to conside next the way in which the govenment can be bought into the game. The govenment may ecognize that the agents in the economy espond in thei lobbying to altenative foms of the decision ules in (8). Moeove, the govenment may have its own pefeences ove these outcomes. The fom that these pefeences may take is discussed in the public choice liteatue. Fo example, the govenment may act benevolently in its choice of (8)so as to mitigate any potential negative welfae effects of lobbying, o it may act to incease its influence (the Leviathan postulate) via its choices. Note that this discussion concens the functions in (7), and hence the functions in (8), and not the specific level of I which defines the govenment pefeences ove agents fo any given level of lobbying. The pevious paagaph posited that the govenment acted as a Stacklebeg leade, able to announce the decision ules (8) as its "stategy," and then act to sustain the economic outcome afte households lobbying levels ae chosen. In the next level of complexity within the class of static games, thee exists a diect feedback mechanism fom the households to the govenment decision ule. An example of such a feedback mechanism is a voting stuctue, such that the announced decision ules seve as "platfoms" in elections among competing govenments. O, one might think that the agents in the economy could ovethow the announced decision ule if it teated them sufficiently badly, theeby limiting the scope of choice of decision ules by the govenment. These consideations concen an expansion of the stategy space fo households in the economy, and/o an altenative view of the institutions defined by (7). We biefly addess this issue fo the case of voting in the next section. One of the concens that would have to be addessed in all of these static game-theoetic teatments of lobbying is how the households and the govenment ae able to find an equilibium in cicumstances in which it is not unique. As well, thee ae othe natual absences of infomation that should be confonted in this potion of the model. All of the foegoing discussion was diected to static models. Of 18

23 couse, it is moe "ealistic" to assume that the agents know that they ae playing a dynamic game. As is well known, the move to dynamic games will have impotant consequences fo the outcomes unde the model. Fo example, let us evet momentaily to the case in which the govenment acts as natue and sets the decision ules in (8) once-and-fo-all. Suppose futhe that these functions define a Pisone's Dilemma fo the households. In a static wold, the dominant stategy (Nash)equilibium yields a non-efficient outcome fo the game. Howeve, if the agents ecognize that play will epeat indefinitely, they may achieve a coopeative outcome. Similaly, in a dynamic setting, it may be easonable to invoke altenative equilibium concepts that ule out cetain Nash equilibia. Fo example, with multiple Nash equilibia, some equilibia may involve non-cedible theats, and one might appeal to the notion of subgame pefection (Selten). The dynamic setting similaly would enich the moe complex static games discussed above which incopoate govenment behavio and institutions. Clealy, it is beyond the scope of this pape to exploe the numeous amifications of altenative game foms fo the basic model elaboated above. Suffice it to say hee that investigation of the elationship between the institutions in (7) and the stategies in (8), and of the natue of the game defined between the households and the govenment, povides a vey ich souce fo futhe eseach. VII. Extensions: Relation To Selected Liteatue This section focuses on foeign tade, voting, bueaucacy, coalitions and the fee ide poblem, and endogenous economic gowth. The intent is to tie selected othe issues that have been addessed in the political economy liteatue mentioned to models of this type and to suggest the natue of the insights that esult. Foeign Tade Extending the concept of ent seeking to foeign tade aises the types of game theoy questions mentioned above to tade elations among nations. To see this, note that the net tade condition (3.a) fo the case of K counties becomes: ki qi(p (e) n )) - y(e)) - 0, i,j - u,. whee the tem in ({) is the k-th county's excess demand fo the j-th commodity. If makets clea at elative wold pice p, then, assuming.w w-1 ->2. K monotinicity, elative wold pice p -= (e,e,***,e ), is, potentially, p*~2. 2.Z 2 s ptnily detemined by lobbying (ik, 1 ) in each of k counties. We biefly mention u 19

24 thee implications of ent seeking in the context of the the Uuguay ound of the GATT negotiations. Tade negotiations can be viewed as an effot by govenments to seach fo a teaty that will leave the k-th county no wose off, in tems of (4), than in the cuent state. Equation (4) defines the k-th county's payoff to teaty outcomes. Hence, studies, (such as Haison et al) that investigate possible outcomes using net social gains as the payoff ae likely to be misleading, since the estimated gains need to be weighted by the elative influence of the inteest goups epesented in (4). The pape by Johnson et al. illustates this point. Using the policy instument set common to the US and the EEC's 1986 agicultual policies and estimates of the pefeence weights in (4), they found that the 1986 pogam was a Nash equilibium. When the instument set was changed to allow fo decoupled payments to those inteest goups with the lagest political influence, a Nash equilibium fo libealized tade esulted, fee tade did not. A second implication is that if a teaty unde GATT is to be sustained by the body politic, then tade negotiations need to take into account the eaction functions (16.a) of special inteest eaction goups in the home and othe lage tading counties. This point was made by Paalbeg (p. 255) when he citicized those ecommending a U.S. negotiation position that advocated fee tade as being too ideological with the esult that **"libeal-minded agicultual policy makes ae cuently lavishing thei scace policy esouces on the impobable option of a "coodinated" libealization though GATT." A thid implication is that a coalition may fom among, fo instance, agicultual inteests in the lage expoting counties. Inteest goup in counties k and k* lobby with knowledge of the othes eaction functions (16.a). The coalition can be viewed as a leade in a Stackelbeg game with a possible esult that negotiations esult in illibeal tade. Paalbeg (p. 180) also noted this tendency when he emaked that "When the intenational "coodination" of OECD agicultual policies takes place unde such cicumstances,** (i.e., the pesence of ent-seeking goups).*, the illibeal tendencies in those individual policies can be stengthened athe than weakened." Voting A pevasive issue is how vaious political pocess seve to aggegate individual pefeences. Since Aow showed that a majoity ule social 20

25 welfae function has the undesiable popety of being intansitive, numeous othes have found that voting outcomes ae lagely dependent on the conditions o ules unde which voting takes place. Fo instance, Black showed that simple majoity voting as a means of econciling diffeing individual pefeences will poduce continual cycling so that outcomes depend on whee the cycling stops. Rike, in esponse to Downs model of vote maximizing political paties, agued convincingly that paties seek only sufficient votes to ensue minimally winning coalitions. Still othes have shown that in the pesence of limited and costly infomation, it is not wothwhile fo votes to become well infomed on most issues o even to vote, and that elections atificially skew decision-making in favo of pogams with obvious benefits but no so obvious costs. Empiical evidence on voting behavio also yields counte intuitive esults. Fo example, Pletzmen finds eithe no connection o a pevese connection between the inteests of constituents and the votes of thei senatos. Hence, models of voting behavio ae only likely to povide geneal insights into questions of special inteest goup influence ove economic policy. In this spiit, we biefly eview the appoach taken by Young and Magee and then suggest an appoach of ou own. Young and Magee conside two lobby goups, two political paties, two goods and two factos. The two political paties align with thei espective capital and labo constituencies and set tade taxes (subsidies) which, though the Stople-Samuelson affect, benefit capitalists (labo) because it inceases (deceases) the elative pice of the capital (labo) intensive good. Effectively, this appoach eplaces equations (4), (7.a) and (7.b) by a voting mechanism which posits that the po-capital paty's odds of victoy ae detemined by an exogenously given log linea function log{(/(l-w))} e + K log K - A log L - a log S + log T whee unit values ae assumed fo the paametes n,a,a,, e is set to zeo and K, L, S and T denote subsidy and tax on the domestic pice of the labo and capital intensive good, espectively. Capitalists (labo) allocate a potion of thei capital, K (labo, L) endowment to thei espective paty. In tun, the po capital (po labo) paty sets the subsidy (tax) to maximize its pobability i (1-w) of being elected and hence, though 1 3See John Ray fo a discussion of empiical findings that special inteests pefe tade potection suppoted by policy instuments whose costs ae not easily discenible. 21

26 Stople-Samuelson, augment (decease) the income of capitalists (labo). Each paty leads one lobby in a Stackelbeg fashion, but adopts Nash behavio towads the othe two playes while each lobby adopts Nash behavio towads the othe thee playes. solution to the game. Conditions ae deived fo an inteio The model is diven by facto endowments. As in the case of the model pesented hee, key esults include (i) facto endowments ae impotant deteminants of agent's willingness to expend esouces to influence policy outcomes, (ii) an incease in a secto's endowment aises its aveage ate of etun since it inceases the willingness of the secto to expend moe esouces to influence policy, (iii) all goups can be made wose off when account is taken of the esouces absobed by the political activity binging about the distotion, and (iv) changes in technical and taste paametes that make facto etuns moe sensitive to the politically manipulated pices, induce less exteme choices in pices. Howeve, agent's ae willing to expend moe esouces to influence policy outcomes. We now sketch how the model pesented hee can be modified to include the pesence of political paties and how this affects the willingness to lobby. Fom equation (4), let U m denote the pefeence function of the m-th 8 paty which posses influence functions Im, i.e., each paty is endowed with a diffeent influence function. Let n denote the numbe of ual and uban i households, i -,u. Following Nash behavio, each household is assumed to solve (14) fo the case of each paty, and then to vote fo that paty fo which its utility is the lagest. Effectively, the m-th paty's "platfom" is defined by the policy ules such as those in (8). The paty eceiving the lagest numbe of votes becomes the paty that maximizes (4) to detemine the policy ules ealized. While a numbe of outcomes ae possible, an inteesting outcome that seems consistent with obsevation is that by voting, the masses limit the ability of the othewise poweful lobby goups to influence policy outcomes. That is, the masses can limit the willingness of those who can alte the influence I" of the m'-th paty with elatively few esouces because, depending on the numbe of votes n elative to n, the m' paty can be eliminated fom powe theeby leaving an In that is less esponsive i (poductive) to the loosing goup. Effectively, the ual masses bound the lobbying powe of the uban elite. 4Since the paametes of the influence functions eflect the undelying 22

27 Bueaucacy In the pesence of maket failue, a common view is that govenment is the appopiate agent fo taking coective measues to attain Paeto supeio outcomes. Tullock focusing on the ewads and penalties facing a bueaucat located in a hieachy, concluded that bueaucats seek to expand the size of thei bueaus, since salay and othe pequisites of office ae elated to the size of the budgets they administe and contol. Niskanen's model of a budget maximizing bueaucacy showed that a bueaucacy could succeed in expanding budgets to a point whee tax payes wee no bette off than they would be in the absence of the public good. Casting the spiit of Niskanen's appoach into a geneal equilibium famewok povides boade insights than he was able to povide. In the context of ou model, we sketch how the behavio of bueaucats can be intoduced. Pesently, the govenment chooses the instuments p, I, and li without a bueaucacy to implement them. Bueaucats ae defined as U a thid inteest goup whose conditional indiect utility V (p,n ), pessue g& p (1,z ) and influence I (p,p,p ) functions coespond to (1), (7.a) and g g 8 8 u g (7.b) espectively. In the spiit of Niskanen, the bueaucat implements and manages the govenment's policy instuments in exchange fo a budget b to pefom this sevice, whee the size of the budget has a positive effect on the bueaucat's income. function of the level of the policy instuments, The budget, exclusive of labo costs, is a b - b(p - pw,1,19). 9 u Budget costs ae a monotonicaly convex and inceasing function of the wedge between domestic and wold pices, Il allocated to the poduction of public goods. (p - pw) I and the amount of labo Labo equied to implement and manage policy is given by the bueaucat's labo endowment L plus labo 8 obtained fom the labo maket, ZL. The bueaucat's income is ± gi I - (b ) + WL whee w b > 0 indicates that the size of the budget has a positive impact 8 on this goup's income. The bueaucat faces an advantage in that no loss in wage income occus fom time allocated to lobbying since lobbying occus while employed. Anothe advantage may by be that less lobbying time is equied to obtain influence elative to othe households. Equations (3), stuctue of a county's legal stuctue, incentives exist fo the poweful to attempt to alte this stuctue in ode to cicumvent this outcome. 23

28 (4) and (6) also need to be modified to eflect the addition of a thid secto to the economy. The key esult of this modification is the possibility fo a coalition to fom between bueaucats and eithe ual o uban households. Fo instance, it can be shown that if the gain to the bueaucat's income fom an incease in the wedge between domestic and wold pice, Hl( lage elative to gains fom the poduction of public goods, I HI, wpp )l, is and w is negative, then bueaucats will lobby fo p - p' < 0. This policy can be in the inteests of uban households. Hence, the uban household may be able to obtain what was not othewise obtainable in the absence of bueaucats. Effectively, uban households fom a coalition with bueaucats in a noncoopeative game with ual households. As in the case of Niskanen, anothe paameteization of the model can yield the esult that bueaucats will tend to lobby fo the poduction of public goods G to the point whee thei povision can leave households no bette off than with some initial endowment of public goods so that 7 i G l 8 < w, i -,u. The poduction possibilities fo the economy can i,g i, 1 i i also be educed as moe labo is dawn into the poduction of bueaucatic sevices. Coalitions and The Fee Ride Poblem Olson noted that even though agents have some inteests in common and can be expected to lobby fo thei inteest, in the absence of special aangements, ational individuals will not act in the goups inteest. Sevices of a lobby ae like a public good, thei povision to anyone in the goup means povision to eveyone. individuals to fee ide. Consequently, thee ae incentives fo In spite of incentives to fee ide, lobbies exits. The key to ovecoming the fee ide poblem lies in the ability of an oganization to institute a set of selective incentives to individuals depending on whethe they contibute to the povision of the collective good. This easoning in the context of ou model is that a naowly based coalition would pefe to lobby to seek thei diffeential advantage though pice policy in contast to expenditues on the public good G. As we noted, in the pesence of maket failue, lobbying can, in pinciple, expand 1 5 Stuctuing incentives and the fee ide poblem ae typically dealt with in the theoy of oganizational design (see Maschak). 24