The Economic Role of the State (EP&E 327)
Fall 2004
James Raymond Vreeland


Students visiting this page for the first time should read through the entire syllabus: the course description, the course requirements, the reading and the course outline. Beyond this initial reading, this web-based syllabus is designed to be used throughout the semester. Below you will find the assignments for each class session. If you have any questions or comments about the web page or the course, please contact me.

[ Course description ]   [ Requirements ]   [ Reading ]   [ Course Outline ]   [ Contact Instructor ]

1. Introduction. STATES & MKETS CHAPTER 1 (9/6/04)
2.  Are markets efficient? Not quite. STATES & MKETS CHAPTER 2 (9/13/04)
3. Problems for decentralized mechanisms of allocation. STATES & MKETS CHAPTER 3 (9/20/04)
4. Forms of State and Their Consequences. STATES & MKETS CHAPTER 5 (9/27/24)
5. Governments and Private Agents: Regulation STATES & MKETS CHAPTERS 4 & 6 (10/4/04)
6. Politicians and Bureaucrats: Oversight STATES & MKETS CHAPTER 7 (10/11/04)
7. Median Voter Models. STATES & MKETS CHAPTER 8 (10/18/04)
8. What can governments do? Structural dependence of the state on capital (10/25/04)
9. What Should Governments Do? I: Promote Growth STATES & MKETS CHAPTER 9 (11/1/04)
10. What should Governments Do? III: Redistribute STATES & MKETS CHAPTER 10 (11/8/04)
11. What should Governments Do? II: Insure Well-Being STATES & MKETS CHAPTER 11 (11/15/04)
12. Overview. STATES & MKETS CHAPTER 12 (11/29/04)


Course description
The overarching question we will address in this course is what is the appropriate role of the government in the economy.

First we will cover controversies over the proper role of the state in the economy. Then we examine constraints facing the state: the limits of state intervention in a market economy. What can the state do? We review central issues in the theory of regulation, the politics of regulation, and the various principal-agent relationships within the economy.
 
The pace of the course will be brisk. Each week students are expected to study one model, read some background materials, and read the accompanying chapter in the course textbook.

The mathematics will not be difficult but students will need to know at least static maximization techniques to follow course.

In Part I of the course, we will consider whether there is a role for the government in the economy. The arguments are arranged like a four round boxing match: The market comes out in Round I with a powerful blow – a beautiful model of the economy where best outcomes result from individual actors pursuing self interest without the intervention of a centralized authority. No role is left for the state in the economy. Round I goes decidedly to the market.

The state battles back in Round II as we learn about the traditional market failures: areas where the actions of self-interested individuals do not produce best outcomes. We discover that there is room for improvement – a welfare-maximizing government can beneficially intervene in the economy. The state manages to take Round II. But if economic actors are self-interested, why should we assume that the government is altruistic? The question presents a devastating blow to the state. In Round II we learned that the actions of self-interested individuals do not produce best results, but now we realize that this does not necessarily mean that the state can do any better. There is room for improvement, but a self-interested government may actually make matters worse. The market wins Round III.

Round IV: With its back against the ropes, at it goes down for the count, the state (with the help of Stiglitz) delivers a powerful punch to the belly. In this round, we discover that there is no single monolithic “market” at all, but rather markets. And they may suffer from imperfect information, uninsurable risks, moral hazard, and adverse selection. Under these conditions, there is no guarantee that markets are efficient. Markets are incomplete and there is ample room for even a self-interested government to improve outcomes by intervening in the economy.

Having learned that there is a potential role for the government to play in the economy, we will study the constraints facing governments (PART II). Will a self-interested state do what we want it to do? By viewing the government as a series of principal-agent relations with self-interested actors, we can examine whether the state can do what it “should.” When can state intervention bring about pareto improvements? When should markets be left to operate on their own?

When the government does intervene in the economy, what should the government do (PART III)? We will consider three categories of objectives that the government may pursue: (1) promote economic growth, (2) redistribute, and(3) provide insurance. We will address each of these areas in this part of the course.


Requirements

(1) Take-home midterm: (40%)
THE MID-TERM WILL BE DISTRIBUTED OCTOBER 13. IT IS DUE OCTOBER 18 BY 5:20PM IN CLASS.

(2) Take-home final questions (50%)

(3) Class Participation (10%)

Quality counts more than quantity here. All students will be given the opportunity to participate. Students will be evaluated in terms of their thoughtfulness and preparation (not on presentation skills).
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Readings
Items under “Read” provide general treatments of particular topics; those under “Study” will be discussed in class. Students interested in the “Recommended” and “Background” readings should acquire them on their own. If possible, read in the order indicated. Note that you may wish to re-read the “Study” items after they have been discussed in class.

You must have:
Przeworski, Adam. 2003. States and Markets: A Primer in Political Economy. New York: Cambridge University Press.
This is the new textbook for this course. Almost each week you will read a chapter from this book.

We will also extensively cover:
Dixit, Avinash. 1996. The Making of Economic Policy: A Transaction-Cost Politics Perspective. Cambridge: MIT Press.

Johansson, Per-Olov. 1991. An Introduction to Modern Welfare Economics. Cambridge: Cambridge University Press.

Macho-Stadler, Ines, and David Perez-Castrillo. 1997. An Introduction to the Economics of Information. Oxford: Oxford University Press.

Stiglitz, Joseph. 1994. Whither Socialism? Cambridge: MIT Press.
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Course outline
1. Introduction. STATES & MKETS CHAPTER 1
Decentralized versus centralized mechanisms of allocation. Markets and states as mechanisms for allocating resources and distributing incomes. Political- economic equilibria. Endogenous regulation. Questions to be asked about equilibria: positive and normative. Preview of the course.
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2. Are markets efficient? Not quite. STATES & MKETS CHAPTER 2
Market allocation. Equilibrium. Efficiency. First theorem of welfare economics. Distribution. Second theorem. “Traditional” market failures: divergence between private and public rates of return, increasing returns, natural monopolies, public goods (rivalry vs. excludability), externalities, transaction costs.

Study:
(intermediate) Johansson, Per-Olov. 1991. Appendix, STATES & MKETS CHAPTER 2, Chapter 5 (in that order) of An Introduction to Modern Welfare Economics. Cambridge: Cambridge University Press.

Other recommended texts:
(easy) Buchanan, Allen. 1985. Chapters 1 and 2 of Ethics, Efficiency and the Market. Totowa, NJ: Rowman and Allanheld.

(difficult) Campbell, Donald E. 1987. Chapters 3 and 7 and Appendix 2 of Resource Allocation Mechanisms. Cambridge: Cambridge University Press.

(difficult) Silberberg, Eugene. 1978. Chapter 15 of The Structure of Economics. New York: McGraw-Hill.

(difficult) Varian, Hal R. 1984. Chapters 5,6, and 7 of Microeconomic Analysis. New York: W.W. Norton & Company.

Background: (These are classical articles on market failures)
Bator, Francis M. 1958. “The Anatomy of Market Failure.” Quarterly Journal of Economics 72: 351-379.

Musgrave, Richard A. 1971. “Provision for Social Goods in the Market System.” Public Finance 26: 304-320.

Coase, R.H. 1960. “The Problem of Social Cost,” The Journal of Law and Economics 3: 1-44.
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3. Problems for decentralized mechanisms of allocation. STATES & MKETS CHAPTER 3
Equilibrium and efficiency. Why are markets incomplete? Why is information imperfect? Why are some risks uninsurable? Moral hazard and adverse selection. Soft budget constraints. Economy as a network of principal-agent relations. Importance of institutions.

Read:
Stiglitz, Joseph. 1994. Chapters 3 and 4 of Whither Socialism? Cambridge: MIT Press.
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4. Forms of State and Their Consequences. STATES & MKETS CHAPTER 5
Forms of state. Property rights and decision rights. What do different states maximize? How are rulers controlled?

Read:
Cheibub, Jose Antonio, and Adam Przeworski. 1996. “Democracy, Elections, and Accountability for Economic Outcomes.” Paper presented at the Conference on Democracy and Accountability, New York University, April 26-28.

Lane, Frederic C. 1979. “Economic Consequences of Organized Violence (1958).” In Profits from Power: Readings in Protection Rent and Violence Controlling Enterprises. Albany: State University of New York Press.

Background:
Findlay, Ronald. 1990. “The new political economy: Its explanatory power for the LDCs.” Economics and Politics 2: 193-221.

McGuire, Martin C., and Mancur Olson. Jr. 1996. “The Economics of Autocracy and Majority Rule.” Journal of Economic Literature 34: 72-97.
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5. Governments and Private Agents: Regulation STATES & MKETS CHAPTERS 4 & 6
Information asymmetries. Methods of regulation. Varieties of incentives. Monetary transfers vs. price controls. Marginal vs. average pricing. Regulation in practice. Moral hazard of the principal. Good commitments and bad commitments. Politics and commitment. The paradox of credibility.

Study:
Laffont, Jean-Jacques, and Jean Tirole. 1994. Introduction (you can skip Section 3) and Sections 1.1, 1.2, 1.3, 1.5 from Chapter 1, section 9.1 from Chapter 9, and Sections 16.1, 16.2, 16.4, and 16.5 from Chapter 16 of A Theory of Incentives in Procurement and Regulation. Cambridge: MIT Press.

Read:
Macho-Stadler, Ines, and David Perez-Castrillo. 1997. Chapters 1 and 2 of An Introduction to the Economics of Information. Oxford: Oxford University Press.

Background:
Spiller, Pablo T. 1995. “Regulatory commitments and utilities' privatization: implications for future comparative research.” In Jeffrey S. Banks and Eric A. Hanushek (eds.), Modern Political Economy. Cambridge: Cambridge University Press. Pages 63-79.
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6. Politicians and Bureaucrats: Oversight STATES & MKETS CHAPTER 7
Why is control over politicians problematic? Elections and control over politicians. Prospective and retrospective mechanisms. Institutional conditions that foster control. Informational requirements for accountability. Empirical evidence.

Who controls bureaucrats? When do politicians want to control them? How can they be controlled? Should they be controlled? How do public bureaucracies differ from private firms? Modes of oversight.

Study:
Laffont, Jean-Jacques, and Jean Tirole. 1994. Chapter 11 (you can skip Section 11.7), including “Bibliographic Notes” of A Theory of Incentives in Procurement and Regulation. Cambridge: MIT Press.

Ferejohn, John A. 1986. “Incumbent performance and electoral control.” Public Choice 50: 5-25.

Read:
Przeworski, Adam.  1997.  “The State in a Market Economy.”  In Joan M. Nelson, Charles Tilly, and Lee Walker: Transforming Post-Communist Political Economies.  Washington DC: National Academy Press.  Pages 411-431.

Moe, Terry M. 1990. “Political Institutions: The Neglected Side of the Story.” Journal of Law, Economics, and Organization 6: 213-253.

Recommended:
Kiewiet, D. Roderick, and Matthew D. McCubbins. 1991. Chapter 2 of The Logic of Delegation: Congressional Parties and the Appropriation Process. Chicago: University of Chicago Press.

McCubbins, Matthew, and Thomas Schwartz. 1984. “Congressional Oversight Overlooked: Police Patrols versus Fire Alarms.” American Journal of Political Science 28: 165-179.

Prud'homme, Remy. 1995. “The Dangers of Decentralization.” The World Bank Research Observer 10: 201-220, with comments by Charles E. McLure, Jr. and David O. Sewell.

Tirole, Jean. 1994. “The Internal Organization of Government.” Oxford Economic Papers 46: 1-29.

Wood, B. Dan, and Richard W. Waterman. 1994. Chapter 7. of Bureaucratic Dynamics: The Role of Bureaucracy in a Democracy. Boulder: Westview Press.

Ferejohn, John A. 1995. “The Spatial Model and Elections.” In Bernard Grofman (ed.), Information, Participation, and Choice. Ann Arbor: University of Michigan Press. Pages 107-124.

Manin, Bernard, Adam Przeworski, and Susan C. Stokes. 1997. Introduction and Chapter One to Democracy, Accountability, and Representation. Ms. New York University.

Fearon, James D. 1996. “Elections as choosing a good type versus elections as a mechanism of accountability.” Paper presented at the Conference on Democracy and Accountability, New York University, April 26-28.

Przeworski, Adam, and Susan Stokes. 1995. “Citizen Information and Government Accountability: What Must Citizens Know and What Can They Do to Control Politicians? Paper prepared for delivery at the 1995 Annual Meetings of the American Political Association, The Chicago Hilton, August 31-September 1.

Powell, G.B. Jr. 1990. “Holding Governments Accountable: How Constitutional Arrangements and Party Systems Affect Clarity of Responsibility for Policy in Contemporary Democracies.” Manuscript.

Background:
Barro, Robert J. “The Control of Politicians: An Economic Model.” Public Choice 14: 19-42.
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7. Median Voter Models. STATES & MKETS CHAPTER 8
Direct and representative democracy with homogeneous citizens. Conditions for the existence of majority rule equilibrium. The median voter model. Party competition. Deadweight losses. Policies chosen by the median voter.

Read:
Przeworski. 1990. Section 2, Chapter I of The State and the Economy Under Capitalism. Chur: Harwood Academic Publishers.

Dahl, Robert A. 1989. Chapter 10 of Democracy and Its Critics. New Haven: Yale University Press.

Mueller, Dennis C. 1989. Chapter 6 from Public Choice II. Cambridge: Cambridge University Press.
   
Study:
Meltzer, Allan H. and Scott F. Richard. 1981. “A Rational Theory of the Size of Government.” Journal of Political Economy 89: 914-927.
Available online at:
http://www.jstor.org/

Recommended: (These readings apply voting models to study various forms of redistributive politics.)
Roemer, John E. 1994. “A theory of policy differentiation is single issue electoral politics.” Social Choice and Welfare 11: 355-380.

Roemer, John E. 1997. “Political-economic equilibrium when parties represent constituents: The unidimensional case.” Social Choice and Welfare 14.

Roemer, John E. 1997. “The democratic political economy of progressive income taxation.” Working Paper Series #97-11. Davis, CA: Department of Economics. University of California.

Benabou, Roland. 1996. “Inequality and Growth.” Paper presented at the Eleventh Annual Macroeconomic Conference of the NBER, Cambridge.
 
Krussell, Per, and Jos‚-Victor R¡os-Rull. 1996. “Vested Interests in a Positive Theory of Stagnation and Growth.” Review of Economic Studies 63: 301-329.
    
Background:
Bowen, Howard R. 1943. “The interpretation of voting in the allocation of economic resources.” Quarterly Journal of Economics 58: 27-48.
 
Davis, Otto A., Melvin J. Hinch, and Peter C. Ordeshook. 1970. “An Expository Development of a Mathematical Model of the Electoral Process.” American Political Science Review 64: 426-448.

Coughlin, P. 1992. Probabilistic Voting Theory. New York: Cambridge University Press.

Wittman, Donald. 1990. “Spatial strategies when candidates have policy preferences.” In James M. Enelow and Melvin J. Hinich (eds.), Advances in the Spatial Theory of Voting. Cambridge: Cambridge University Press.
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8. What can governments do? Structural dependence of the state on capital.
Study:
Przeworski, Adam and Michael Wallerstein. 1988. “Structural Dependence of the State on Capital.” American Political Science Review 82: 11-29.
Available online at: http://www.jstor.org/
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9. What Should Governments Do? I: Promote Growth STATES & MKETS CHAPTER 9
Optimal size of the government. Consumption services and production services. Where and when should governments intervene? Education, health, targeted subsidies. Income protection. Structural dependence. Capital and labor. Why do governments use inefficient policies?

Read:
Grossman, Gene M. 1990. “Promoting new industrial activities: a survey of recent arguments and evidence.” OECD Economic Studies. No.14. Spring.

Barro, Robert. J. 1990. “Government Spending in a Simple Model of Endogenous Growth.” Journal of Political Economy 98: S103-S126. (Note: This is a difficult text and you do not need to study it: just get the main point.)
Available online at: http://www.jstor.org/
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10. What should Governments Do? III: Redistribute STATES & MKETS CHAPTER 10
Back to efficiency. Market failures and political failures. Welfare justifications for redistribution. What, if anything, should governments redistribute?

Read:
Roemer, John E. 1996. “Introduction” to Theories of Distributive Justice. Cambridge: Harvard University Press.

Dasgupta, Partha. 1982. Utilitarianism, information, and rights.” In Amartya Sen and Bernard Williams (eds.), Utilitarianism and Beyond. 199-218. Cambridge: Cambridge University Press.

Recommended:
Sen, Amartya. 1992. Inequality Reexamined. Cambridge: Harvard University Press.

Atkinson, Anthony B. 1970. “On the Measurement of Inequality.” Journal of Economic Theory 2: 244-263.
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11. What should Governments Do? II: Insure Well-Being STATES & MKETS CHAPTER 11
Welfare as insurance. Welfare as solidarity. Welfare as redistribution. Universalistic vs. targeted programs. Endogenous welfare policies.

Study:
Barr, Nicholas. 1992. “Economic Theory and the Welfare State: A Survey and Interpretation.” Journal of Economic Literature 30: 741-804.
Available online at: http://www.jstor.org/

Read:
Moene, Karl Ove, and Michael Wallerstein. 1997. “Political Support for Targeted versus Universalistic Welfare Policies.” Revised paper presented at the 1996 Annual Meeting of the American Political Science Association, San Francisco, CA.
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12. Overview. STATES & MKETS CHAPTER 12

Read:
Dixit, Avinash. 1996. Chapters 1 and 2 of The Making of Economic Policy: A Transaction-Cost Politics Perspective. Cambridge: MIT Press.
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Professor Vreeland's Contact Information:

James Raymond Vreeland
Assistant Professor, Department of Political Science
email: james.vreeland@yale.edu
web: http://www9.georgetown.edu/faculty/jrv24/
tel: 203-432-6220

Office location: 124 Prospect Street (Brewster Hall) - Room 305. For directions, use this link.

Office hours: Wednesdays 10am-12pm *By appointment only - see the sign up sheet on my office door*

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