Hybrid Public Policy Innovations

Contemporary Policy Beyond Ideology

Mark Fabian, Robert Breunig

• Publisher: Routledge
• Year: 2018
• Print ISBN: 9780367592066
• eBook ISBN: 9781351245920
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Comparative Politics
• Index: Politics & International Relations

Political discourse in much of the world remains mired in simplistic ideological dichotomies of market fundamentalism for efficiency versus substantial socialism for equity. Contemporary public policy design is far more sophisticated. It blends market, government and community tools to simultaneously achieve both equity and efficiency. Unlike in the twentieth century, this design is increasingly grounded in a deep evidence base derived by way of rigorous empirical techniques. A new paradigm is emerging: hybrid policies.

This volume provides a thorough introduction to this technical side of public policy analysis and development. It demonstrates that it is possible to go beyond ideology, and find there some powerful answers to our most pressing problems. An international team of experts, many of whom have experience with the design or implementation of hybrid policies, helps cover the behavioural, institutional and regulatory theories that inform the choice of policy objectives and lead the initial conception of solutions. They explain the reasons why we need evidence-based public policy and the state-of-the-art empirical techniques involved in its development. And they analyse a range of in-depth case studies from industrial relations to health care to illustrate how hybrids can intermingle the strengths of governments, markets and the community to combat the weaknesses of each and arrive at bipartisan outcomes.

Hybrid Public Policy Innovations is geared to scholars and practitioners of public policy administration and management who desire to understand the analytical reasons why policies are designed the way they are, and the purpose of evidence-gathering frameworks attached to policies at implementation.

Part I

Theory

1 The Ends and Means of Public Policy

Mark Fabian

Introduction

How to appropriately balance the state and the market in public policy was arguably the defining question of the twentieth century. The Western experiment with communism ended symbolically with the fall of the Berlin Wall in 1989. By that stage, public policy in the capitalist countries had grown quite sophisticated, and was much more than unchecked free markets. Notably, many of the liberal economies of the West had extensive welfare states with public health, education, transport and social security. These ‘social wages’ could be paid in large part because the use of markets to efficiently allocate resources to their most productive use in these economies had the led to the accumulation of significant wealth that could be redistributed by government. Liberal-democratic and social-democratic institutions ensured that this wealth was actually redistributed, or at least provided an avenue for protest when it wasn’t. Citizens of these societies could have their cake and it eat it too – they could enjoy both the private wealth of a market system and the social protections of a socialist one.

The success of these economies derived in no small part from the application of an analytical framework for thinking about public policy that had been hashed out in the halls of universities over the course of the twentieth century. Economics was ascendant in this discourse, building on earlier work in political and social theory, extending it into the economic realm and formalising it into mechanistic tools of analysis. This chapter is an introduction to that framework. It explains in broad terms the strengths and weaknesses of markets, states and communities for ensuring an efficient and equitable allocation of resources in society. In many ways, it is an introduction to the economic way of thinking, but the student of politics, sociology or any other social science should recognise the influence of their own discipline.

Some are starting to question whether the framework outlined in this chapter has outlived its usefulness, at least as far as the advanced economies of the developed world are concerned (for example, Quiggin 2012). The framework is arguably struggling to meet the challenge of climate change, reap the full benefits of new technologies, and provide enough succour and security to citizens to prevent the re-emergence of xenophobia and nationalism. This may well be the case, but it is nonetheless important to be familiar with this paradigm if one wants to get to grips with modern policy making. The question of ‘where to next’ is taken up somewhat by Chapter 14 in this volume.

Efficiency as a Criterion for Good Public Policy

Public policy is substantially a question of how to allocate scarce resources in the context of imperfect information, limited power, competing claims and essentially unlimited wants, in order to maximise social welfare. Opportunity cost – the cost of forgone alternatives – is omnipresent in public policy. There are many things a society would like to do, like fund free tertiary education and a world-class defence force, but inevitably we have to choose only a subset of these things because we have a limited pool of resources. How are we to choose between policy options? In this context of scarce resources, efficiency is a relevant criterion for deciding allocations. If resources are scarce, then we don’t want to be wasteful with them. If we allocate our resources efficiently, then we get maximum bang for each buck, which minimises opportunity costs, ensuring the maximisation of welfare.

Classical microeconomics is essentially the study of how to efficiently allocate scarce resources so as to maximise welfare (Sowell 2007). However, before taking a single step further, it is important to emphasise that economics does not explicitly value efficiency (Samuels 1988; Weston 1994). Economics is not normative (or at least tries not to be). It endeavours to model the allocation of resources to show how efficiency can be obtained and what the trade-offs are if society values something else instead, like equity. Some economists certainly value efficiency and will trade-off other things in order to maximise it. But these individual economists should not be mistaken for the economic paradigm or the profession as a whole.

Economics links efficiency and welfare through the concept of Pareto efficiency. A Pareto-efficient outcome is one where nobody can be made better-off without making someone else worse-off. Pareto-efficient outcomes need not be equitable. An early step in public policy design is to identify any Pareto improvements that can be made. These are welfare enhancing without hurting anyone, and thus win–win. A subsequent step is to identity any so-called ‘potential’ Pareto improvements. These are cases where some group can be made so much better-off that they can compensate those made worse-off by the change such that the end result is still a net improvement in social welfare. These are so-called ‘positive sum’, and such efficiency is sometimes called Hicks–Kaldor efficiency.¹

Markets as Efficient Allocators of Scarce Resources

Efficiently allocating scarce resources is an extremely difficult task for policy makers because they lack the requisite information (Hayek 1945). Consider the case of tractors. In a centrally planned economy, the government decides the means of tractor production, the price of those tractors and the quantity that is produced. How is the government to know how many tractors people want? If they produce too many, the surplus will sit idle. The inputs to production used to make those surplus tractors could also have been used to produce something else, like cars. Furthermore, there are hundreds of inputs that go into a tractor – rubber for the tyres, copper for the electronics, steel for the chassis etc. – all of which involve design decisions, ongoing technological improvement and their own supply chain. It is a monumental task for a bureaucracy to manage the production of these inputs and coordinate their interconnected supply chains as they come together to make a tractor.

Markets are relatively more efficient at managing this allocation of resources than the state apparatus because they can tap into a lot more information through the price mechanism. Prices simultaneously communicate demand and supply, which reflect the utility people gain from consuming certain goods relative to others and the cost of producing those goods relative to others respectively. In order to understand how prices achieve this and how this results in welfare maximisation, we will need to take a brief look at some basic principles of economics.

The primary concept in economics is utility (Bruni and Sugden 2007). Individual agents attempt to maximise their utility by consuming subject to their budget constraint. Goods are typically traditional consumables like food, dishwashers and holidays, but the concept can be extended to more ephemeral goods like leisure and family time. The key thing is that constraints, whether financial or temporal, mean that people necessarily make trade-offs, and rational actors will trade-off such that they get as much utility as possible.

What is utility? Economists don’t engage with this question. It’s just a vague positive (+) while disutility is a negative (–). Utility is not happiness or wellbeing or anything descriptive like that. As soon as you try to define it you start to make value judgements, and economists want to avoid that. We can’t measure utility, so attempting to predict behaviour based on the power of feelings is a dead-end (Robbins 1938). Instead, economists infer from individuals’ behaviour that they must have expected their choices to result in more utility than some alternate course of action. This is called revealed preferences. This approach to utility maximisation does not require computing precise quantities of utility, but rather a rank-ordering of preferences, for example, apples over oranges over pears.

Individuals communicate their preferences to producers of goods in the form of demand for certain goods, which manifests as ‘willingness to pay’. This willingness is derived from the trade-offs individuals make across goods when subject to their budget constraint. For example, I am willing to pay $3 for an apple, but only if oranges cost $4 and only if I don’t already have three apples, at which point I start to be more interested in getting an orange than a fourth apple. Producers compare their cost base (which determines their ‘willingness to accept’) to consumers’ willingness to pay to determine how much profit they can make selling a particular good. Private producers will not produce a good in the long run unless they can make a profit, and they will produce the goods that are the most profitable. Profit is the difference between the price received for output and the costs associated with producing that output. As such, profit-maximising producers will seek to produce the most desired and thus highest-priced good at the lowest possible cost. Their profit-maximising behaviour forms the supply side of the market.

Supply and demand find their equilibrium at the market clearing price. At this point, the price of a good ensures a quantity of it is produced that balances the utility people get from consuming it with the costs involved in producing it, all relative to other goods. The last consumer to enter the market derives close to zero net benefit from the good because their willingness to pay for it is almost exactly its price, but still gets more utility from this good than any other they could consume. And the last firm to enter the industry – the marginal firm – turns close to zero profits, but couldn’t get more profit in a different industry given its production technology. Thus, no further demand or supply is attracted to the sector and we can say that the market has cleared.

Markets are sometimes described as having a rationing and allocative function. The rationing function channels goods to the consumer who is most willing to pay for those goods, which has an element of fairness to it (provided that everyone has capacity to pay for the good). The allocative function channels inputs to producers who can most productively use those inputs to produce goods, thereby maximising society’s output.

Markets also have a creative function. The profit motive incentivises competition amongst firms for custom, which spurs innovation and ongoing cost reductions (Smith 1776; Schumpeter 1942). Firms make larger profits when they secure a larger market share, and they secure market share by providing a higher quality good at a lower price than their competitors. They achieve this by streamlining their management practices, improving their production technology and attracting the most talented workers. If they don’t constantly improve their systems then their advantages over their rivals will gradually be eroded along with their profits until they become a loss-making enterprise and are forced out of the industry, releasing their resources to more productive firms. Competition thus drives ongoing increases in productivity, which is our ability to create more with less. Productivity is what makes us materially richer as a society. In the absence of competition, the impetus for firms to improve their productivity is significantly diminished, and productivity growth declines, as it has in all centrally planned economies to date.

The reason why markets are described as ‘welfare maximising’ is because they produce what people want at least cost and drive reductions in this cost over time. A classical utilitarian might see this outcome as a just one because as much utility as possible is generated. Moreover, the people who most want a good get it but also pay the most for it. These two points – welfare maximisation and willingness to pay – are the basis of the ethical principle of ‘market justice’ (Hayek 1978). One advantage of this doctrine is that it avoids engaging with what goods ought to be produced, leaving such decisions up to individual preferences. A hole in the theory is that it assumes that everyone has an equal capacity to pay for any particular good, which is unlikely for all but the most basic of goods in a free market economy.

Market Distortions

The ability of markets to efficiently allocate scarce resources is undermined by interventions that distort the prices operating in those markets. Many regulations have this effect, notably subsidies, price floors and price ceilings (Von Mises 1940; see Bhagwati and Panagariya 2012 for a practical discussion in the Indian context). These include distortions of wages and the interest rate, which are the price of labour and capital respectively. In all cases, price distortions lead to information signals that do not reflect the true social cost and benefit of an activity. For example, if you subsidise water for farmers, this encourages them to use water-intensive farming technologies and grow water-intensive products because water is artificially cheap (Roodman and Peterson 1996). This does benefit the farmers and people who want to consume water-intensive crops. However, from a society-wide, utility maximising point of view, there are likely to be more efficient ways of allocating the water resources available.

In general, while price controls might seem useful for equity reasons in many cases, the efficiency costs typically outweigh the equity benefits. A post- or pre-market intervention may be able to improve equity without so dramatically undermining the efficiency of the market. For example, simply transferring money to the farmers to spend as they wish would see them allocate that capital towards the most efficient production technologies in the context of the true cost of water (Jha et al. 2013). The financial benefit to the farmers is the same, but it is attained without the misallocation of water resources. This idea of using markets for efficiency and operating around the market to achieve equity is a major theme of this volume and especially the case studies in Part III.

Market Failure

If free markets are functioning well in terms of delivering efficient outcomes, there is no case on efficiency grounds for government intervention. What are the prerequisites for a well-functioning market? The theory outlined above concerning the efficiency of markets requires certain basic assumptions to be met. These are:

• Competition: there must be a large number of buyers and sellers in the market.

• Information: actors must be well informed regarding the price and quality of different suppliers and alternative goods.

• The market must be for a private good. These are rivalrous and excludable. Rivalrous means that consumption of the good by one person prevents it being consumed by another person. The simplest example is food. If I eat an apple, you cannot eat that apple. Excludable means that the consumption of a good can be prevented. If consumption cannot be prevented then people can consume without payin...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright page
• Table of Contents
• List of Figures
• List of Tables
• Notes on Contributors
• Preface
• PART I Theory
• PART II Evidence
• PART III Case Studies
• PART IV Extensions to the Core Themes
• Index