As the new year rolls in and a new state legislative session begins, we would all do well to remember an important principle of government: Nobodys perfect.
Policymakers can sometimes improve the outcome of markets, reduce the risks we face and resolve differences between neighbors. But governments are themselves imperfect institutions.
It is hard to miss the two most recent examples of the problems with government. Washington politicians have had the worst time trying to avoid the so-called fiscal cliff. In Idaho we continue to wrangle over health insurance exchanges and other aspects of Obamacare. The difficulty in finding compromises for these issues doesnt mean our system is broken. No perfect system exists, and economic theory shows what to look out for given this imperfection.
Political economy is the study of government using the analytic methods of economics. Over the past half century, political economists have shown us the limitations of our democratic institutions.
Nobel prize-winning economist Kenneth Arrow published a landmark study in 1951 explaining why no perfect voting system exists.
Arrow postulated what is known as the Impossibility Theorem. He first explored what society would want from its democratic way of government. He assumed that society wants a voting scheme that satisfies, at the very least, the social properties unanimity and transitivity. The property of unanimity implies that if everyone prefers choice A to choice B, then A will always beat B. The property of transitivity says that if choice A beats B, and B beats C, then A should also beat choice C.
Unfortunately, both of these properties can be easily violated in modern society. The property of unanimity can be violated by just one pivotal voter who changes his or her preference. Transitivity can be violated by groups.
Suppose voter 1 prefers A to B and B to C, voter 2 prefers B to C and C to A, and voter C prefers C to A and A to B. This is a case of cyclical preferences, not transitive. In this case the group as a whole prefers A to B, but one majority (2 of 3) prefers B to C, and another majority prefers C to A.
Arrow proved that no voting system can satisfy these and other properties of voter preferences. The Impossibility Theorem implies that no matter what voting scheme we use to identify the preferences of all members in society, one way or another it will be a flawed mechanism for social choice.
Nobodys perfect, and in most situations our democratic process produces an outcome desired by the median voter, regardless of what everyone else thinks. This median voter, and the politicians who listen to them, is likely to be motivated more by self-interest than national interest.
This is the biggest lesson of political economy. We have to guard against results that promote only the limited self-interest of a few voting groups.
In the national debate over fiscal policy, every line item in the budget should be considered for cuts, and the tax base should be broadened. In the state debate over how to implement the new health care laws, the interest of the local insurance industry and health care providers should not trump the interest of local citizens.
Churchill said democracy is the worst form of government except all those other forms that have been tried from time to time. Our system isnt broken. We just have to be careful how we use it.
Peter Crabb, professor of finance and economics at Northwest Nazarene University in Nampa. firstname.lastname@example.org