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Inefficient Lobbying, Populism and Oligarchy

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Jan 2, 2007, Francisco H.G. Ferreira and Filipe R. Campante
Forthcoming Article, Journal of Public Economics

Does lobbying – the employment of private resources towards the purpose of influencing public policy – cause inefficiency? Across the world, private groups routinely band together to lobby the government in pursuit of favorable treatment: trade protection, regulatory benefits, lower taxes, or preferred public expenditures. Lobbying is sometimes illegal – through corrupting elected politicians – but legal forms abound in almost all countries. Farmers in the European Union and the United States have often successfully lobbied their governments for protection and subsidies; as have computer manufacturers in Brazil and other “infant industry” entrepreneurs in developing countries. In federal countries, such as Brazil, India or the United States, local businesses and governments often lobby the central government for infrastructure projects and other investments.

But does all this (costly) activity simply redistribute resources from a given pie, or are there aggregate efficiency losses, that reduce the overall size of the pie, as a result of lobbying? Clearly, if the resources transferred to government agents by the private lobbies are seen as a deadweight loss, then lobbying is inefficient by definition. But government employees and politicians are part of society too, so perhaps one should not treat their gains as social losses. One can have views about the distributional desirability of lobbying transfers to politicians, but they do not bear on economic efficiency.

In fact, a central result in the economics literature on lobbying is precisely that, under a set of assumptions about how lobbying takes place, the outcome is Pareto efficient.   In other words: lobbying may redistribute resources among agents in society, but it does not cause any aggregate losses to society. While very influential, this result has also met with considerable surprise. After all, the common perception is that lobbying is a more distortionary form of political action than voting, and electoral outcomes have been shown to be generally prone to inefficiency.

Against this background, Campante and Ferreira’s “Inefficient Lobbying, Populism and Oligarchy” makes three contributions. First the paper shows that the Pareto efficiency of truthful equilibria in lobbying games only applies to a production economy if there are perfect commitment mechanisms. If capital markets are imperfect or if contract enforcement problems exist, then lobbying will, in general, lead to an inefficient allocation of resources.

The intuition is simple: in a truthful equilibrium, private agents offer contributions that transfer back to the government agent the full value of the policy actions they are lobbying for. This enables the government to appropriate the full surplus generated by policy. It therefore chooses the policy which maximizes social surplus. But this requires that private groups are able (in addition to willing) to transfer the full surplus. What if they are credit constrained, and can only make the transfer after production takes place? If a set of agents can not credibly commit to contributions that exhaust their gains from a particular policy, the government no longer has an incentive to maximize the full surplus, and the Pareto efficiency result breaks down.

The second contribution of the paper is a characterization of the nature of the inefficiency generated by lobbying when commitment mechanisms are imperfect. The authors consider two groups that use different publicly provided goods as inputs into private production (say, roads and irrigation), along with private capital. They ask whether the composition of public spending (between roads and irrigation, in this example) is efficient (i.e. whether it maximizes output). Under imperfect commitment, not only is the allocation almost always inefficient, but it is also the case that it is biased against the group with the highest marginal productivity of private capital (in equilibrium).

This is a result of specialization in accordance with comparative advantage: those who are most productive tend, on the margin, to allocate more resources towards private capital, and fewer towards political contributions. The reverse is true for those who are less productive. This outcome is consistent with a world in which declining sectors (in which their countries never had or no longer have a comparative advantage) spend more resources in lobbying than vibrant emerging sectors, which tend to channel more resources towards productive investment. One would thus expect lobbying from groups such as farmers in Europe, steel employers and workers in the United States, and computer makers in Brazil, but not from farmers or steel producers in Brazil, or computer makers in the US.

Finally, the paper considers the implications of this more nuanced understanding of  lobbying for the distribution of wealth. A couple of recent papers have suggested that lobbying tends to distort resource allocation in favor of the rich, who have more resources at hand (e.g. Esteban and Ray, 2006). This paper shows that this depends on what makes the rich rich. If they are rich because they inherited their wealth (and wealth and productivity are independent, and the rich have an advantage in politics), then one obtains Esteban and Ray’s result. An alternative set up is modeled here: if the rich are rich because they are more productive, then it may be that lobbying distorts the composition of public spending against the rich. On the margin, there will be “too much” spending on transfers and bad public schools, and too little on goods valued by the rich (such as security and universities, for example). This is consistent with higher absolute expenditures that benefit the rich: it is the ratio of public spending to the private capital of the rich that is too low.

Such a “populist equilibrium” may be reversed, however, if the rich are better able to organize themselves. If the rich are more effective lobbyists, they may turn out to have a comparative advantage in lobbying after all. In that case, the composition of public spending will be inefficiently biased against the poor. This is an oligarchic equilibrium, similar in essence to those modeled by Esteban and Ray (2006) and Acemoglu et al. (2006).

The upshot is that the reassuring theoretical result that lobbying is efficient is only valid in highly restrictive situations. In general, the existence of lobbying is highly likely to create economic inefficiencies – a result with implications for the design of political systems, including governance and campaign finance reforms in developing countries. Those inefficiencies are likely to favor less economically productive groups (such as lagging sectors or regions), at the expense of more productive ones. And in societies where there is mobility, and wealth depends more on one’s own productivity than on inherited privilege, there should be no presumption that lobbying need necessarily benefit the rich. Under those circumstances, populist distortions are even more likely.

References:

Acemoglu, Daron; Phillippe Aghion and Fabrizio Zilibotti (2006): “Distance to Frontier, Selection and Economic Growth”, Journal of the European Economic Association, 4 (1), 37-74.

Bernheim, Douglas and Michael Whinston (1986): “Menu Auctions, Resource Allocation, and Economic Influence”, Quarterly Journal of Economics, CI (1), 1-31.

Dixit, Avinash; Gene Grossman and Elhanan Helpman (1997): “Common Agency and Coordination: General Theory and Application to Government Policy Making”, Journal of Political Economy, 105 (4), 752-769.

Esteban, Joan Maria and Debraj Ray (2006): “Inequality, Lobbying and Resource Allocation”, American Economic Review, 96 (1), 257-279.


Note

1 The result, due to Dixit, Grossman and Helpman (1997) and drawing on Bernheim and Whinston (1986), relies on an equilibrium concept know as "truthful equilibrium" in a common-agency game.  While there are a number of alternative ways to model lobbying, some of which generate inefficiency, truthful equilibria have a number of highly desirable properties, and the approach has been dominant in the theoretical literature.
 




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