Key Concepts of Policy-making and Policy Outcomes

Or, You, too, can talk like a policy wonkVolume II

Moral Hazard ….a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. In other words, it is a tendency to be more willing to take a risk, knowing that the potential costs or burdens of taking such risk will be borne, in whole or in part, by others.

It’s closely related to the idea of “perverse incentives”.

Perverse Incentives• The AFL-CIO, American Rights at Work and the National

Employment Law Project (NELP) released a joint paper yesterday which shows that Bush-era immigration enforcement tactics created a “perverse economic incentive for employers to employ undocumented workers.” In other words, employers systematically deny undocumented workers “the most basic workplace protections” and escape responsibility “by simply calling for an immigration inspection.”

Some argue that the “bailouts” of AIG and other financial entities created perverse incentives for the future.

The Adverse Selection Problem• Adverse selection is

often related to insurance, which will not be profitable when buyers have better information about their risk of claiming than does the seller. But it can relate to any sort of benefit that depends on the participants being more or less randomized.

Asymmetric information• When somebody knows more than somebody else. Transactions

involving asymmetric (or private) information are everywhere. A government selling broadcasting licenses does not know what buyers are prepared to pay for them; a lender does not know how likely a borrower is to repay; a used-car seller knows more about the quality of the car being sold than do potential buyers. This kind of asymmetry can distort people's incentives and result in significant inefficiencies.

“The Law of Unintended Consequences”*

• Quite often the actions of people—and especially of government—have effects that are unanticipated or unintended.

*Often, but not always, these are perverse incentives that were not anticipated.

Stark Data On Women: 100 Million Are Missing in China

• By NICHOLAS D. KRISTOFNew York Times, November 05, 1991

• …..A stark statistic testifies to women's continuing unequal status: at least 60 million females in Asia are missing and feared dead, victims of nothing more than their sex. Worldwide, research suggests, the number of missing females may top 100 million.

• ……While the discrimination is widely seen as a relic of outdated attitudes, in fact the problem appears to be getting worse in Asia. Recently released census data in China and India show that in both countries the sex ratio of the population became more skewed over the course of the last decade.

This is an old article, but the problem is much greater now than it was when Nicholas Kristof wrote this famous piece. All over Asia, sex ratios are skewed…

In 2005, a new study found, births of boys in China exceeded births of girls by more than 1.1 million. There were 120 boys born for every 100 girls.

Nobel prize winner Amartya Sen asserts that the shortfall is getting worse in some areas is that girls are not allowed to benefit as much as boys from the improvements in health care and nutrition that are lowering death rates in developing countries.He and others further argue that gender imbalance has serious negative consequences for all of society in the middle and long run, as it leads among other things to increasing violence among men, bride trafficking and prostitution, deteriorated labor markets, solitude and mental illness etc…

• 26 October 2010• UN warns on Vietnam birth ratio• By Ha Mi BBC Vietnamese Traditional preferences for sons means

fewer daughters are being born • Sex ratios at birth are becoming increasingly imbalanced in Vietnam,

with far more boys being born than girls, the UN Population Fund says.

Ten provinces in Vietnam have a gender ratio at birth of 119.7 boys per 100 girls and 18 provinces and cities have recorded a ratio of at least 115 boys per 100 girls.

EquityA measure of a policy’s

fairness:Horizontal Equity: similar

people in similar positions are treated equally.

Vertical Equity: Do the rich pay more or vice versa?

Intergenerational Equity: Are the young supporting

the old, or vice versa?

The Efficiency-Equity Trade-off• The Poster child for the

Efficiency-Equity problem is certainly the collective farm: imposed by Stalin and Mao the collective farm is pretty clearly an equity model that doesn’t work.

Absolute vs Relative Well-Being• 1974, Richard Easterlin "Does

Economic Growth Improve the Human Lot?

• Easterlin raised the possibility that what really matters to most people is not their absolute level of income, but their income level relative to others in society. If relative income is what matters, then an overall rise in incomes doesn't make me any better off relative to others, and so my happiness does not increase. ...

Relative Well-Being• An old Russian joke tells about a poor peasant

whose better-off neighbor has just gotten a cow. In his anguish, the peasant cries out to God for relief from his distress. When God replies and the peasant demands, “I want you to kill my neighbor’s cow.”

The Principal-Agent Problem• How does the “principal”, the boss, the company,

the school, the bureau…. get someone who implements the work to act in the best interests of the “principal” rather than in his or her own interests?

“Creative Destruction”• A term coined by Joseph

Schumpeter in his work entitled "Capitalism, Socialism and Democracy" (1942) to denote a "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one."

• Creative destruction just down the street.

Luddites ~ Often policy arguments are made around the extent to which obsolete industries and workers in

those industries should be protected.

• Two centuries later, the word 'Luddite' is still familiar all round the English-speaking world, meaning people who want to halt industrial or technical progress to protect their livelihoods. (Or sometimes it simply means someone who does not know how to work his or her computer.)

The Luddites, armed with hammers, pistols and a desperation to protect their livelihoods, seized the imagination of the British public in the early-nineteenth century.

Creative Destruction, calls for protecting industries and workers..

• To what extent should fading industries be protected?

Gary, Indiana

Paternalism

• When should the government protect people from themselves?

• How far should the government go in protecting people from smoking?

• Many states have outlawed pay day loans at enormous interest rates, but are people better off?

• “Libertarian Paternalism”~ mentioned in class by speaker, Julian Jamison

Policy Matters• “Big Bills Left on the Sidewalk; Why Some Nations are Rich, and Others Poor”, by

Mancur Olson• “…... It is embodied in the familiar old joke about the assistant professor who, when

walking with a full professor, reaches down for the $100 bill he sees on the sidewalk. But he is held back by his senior colleague,who points out that if the $100 bill were real, it would have been picked up already.

• “There are hundreds of billions or even trillions of dollars that could be—but are not– earned each year from the natural and human resources of countries”.

• Their policies and institutions are what hold them back.

Mancur Olson and the importance of Policy

• Countries' endowments of natural and human resources do not explain any significant part of the variation in incomes and the mobility of capital assures that it is impartially available to all countries.

• National differences in the quality of policies and institutions across countries mainly account for differences in per capita incomes.

Cost–Benefit analysis (CBA)• A cost–benefit ratio is determined by

dividing the projected benefits of a program by the projected costs.

• In general, a program having a high benefit–cost ratio will take priority over others with lower ratios. Both quantitative and qualitative factors must be taken into account, especially when dealing with social programs. For instance, the monetary value of the presumed benefits of a given program may be indirect, intangible, or projected far into the future.

Critique of Cost-Benefit Analysis• Since the 1960s, cost–

benefit analyses have been used in all aspects of government planning and budgeting.

• But critics of cost–benefit analysis argue that reducing all benefits to monetary terms is impossible, and that a quantitative, economic standard is inappropriate to political decision making.

Priceless Benefits, Costly Mistakes:What’s Wrong With Cost-Benefit Analysis?

Frank Ackerman (Global Development and Environment Institute, Tufts University, USA) 2004

• In practice, cost-benefit analysis of health and environmental protection rests on an implausible process of monetization of priceless benefits. Human life, health, the natural world, and the well-being of future generations are priceless – not infinite in value, but fundamentally incommensurable with money:

• It is not meaningful to put a dollar value on human life.

• Valuation of non-fatal health hazards is conceptually and technically flawed.

• The natural world has a very large but nonquantifiable value to many people.

• Discounting distorts and trivializes future health and environmental outcomes.

• Precise estimates of future environmental impacts are frequently unavailable.

Poisoned for Pennies shows how the misuse of cost-benefit analysis is impeding efforts to clean up and protect our environment, especially in the case of toxic chemicals. According to Ackerman, conservatives—in elected office, in state and federal regulatory agencies, and in businesses of every size—have been able to successfully argue that environmental clean-up and protection are simply too expensive.

Stakeholder AnalysisStakeholder Analysis (SA) is a

methodology used to facilitate institutional and policy reform processes by accounting for and often incorporating the needs of those who have a ‘stake’ or an interest in the reforms under consideration.

With information on stakeholders, their interests, and their capacity to oppose reform, reform advocates can choose how to best accommodate them, thus assuring policies adopted are politically realistic and sustainable

“Stationary” and “Roving” Bandits

• In his final book, Mancur Olson distinguished between the economic effects of different types of government, in particular, tyranny, anarchy and democracy.

• Olson argued that "roving bandits” (Viking raiders, for example) have an incentive only to steal and destroy.

• A "stationary bandit” has an incentive to encourage a degree of economic success, since he or she will want to be in power long enough to take a share of it.

The stationary bandit takes on the basic function of government - protection of his citizens and property against roving bandits. He doesn’t do it out of altruism, but it’s the beginning of what develops into a fully legitimate government.

• http://www.youtube.com/watch?v=KW5FKNpgg6I&playnext=1&list=PL1472861CAD072D41&feature=results_main

De Soto's plan is, quite simply, to make homeowners out of the world's poor squatter, and to grant secure property rights to indigenous people in rural Peru. Neighborhood by neighborhood, slum by slum, tribe by tribe he wants to formalize the vast extralegal world by dotting it with individual property titles.

Once that's done, he promises, the poor will have access to credit, loans, and investment, as their dead assets are transformed into live capital. Secure property rights probably are as he puts it, the "hidden architecture" of modern economies.

But attempts to put these ideas into action have not always worked as well in practice as they do in theory.

Questions to consider….• Agree or disagree: a

benevolent monarch would do an better job of protecting society’s most important resources than a democracy.

• Who are some modern social equivalents of the “roving bandit”?

• Who are some modern equivalent of “stationary bandits”?