Economic Policy, Planning

and Programming
Why Economic Policy?
• Why should we be interested in Economic Policy Analysis (EPA)?
There is at least 3 big sets of reasons why you should study EPA.
• 1. as a citizen
• 2. as a future practitioner
• 3. as a student
As a Student
• EPA is typically the end point for many other subfields
of economics (Macro, development, labor, or
corporate finance questions often ultimately
motivated by a public economics issue).
• EPA is going to give you the empirical tools &
theoretical skills reusable not only in economics, but
in many other fields of social sciences and everyday
life:
As a Future Practitioner
• Most of you are going to have jobs in which you have to take
decisions affecting others:
• Social Choices! EPA is the toolkit to understanding social choices
• Some of you may well end up working for/in a public administration:
There you are going to learn critical insights about a wide range of
economic policies (taxes, education policies, social insurance, etc.),
but also about how gvt/public administration are structured and
work.
Economic policies are everywhere !
Economic policies constantly affect our everyday
life:
•Through price interventions through taxes
•Transfers (Pensions, Subsidy etc.)
• Public provision of public goods
•Regulation
4 Questions of EPA
• Why should the Government Intervene ?
• How should it intervene ?
• What are the effects of its intervention?
• Why is the Government acting this way?
Market failure
• Public goods -No private incentives to provide
• Externality – Positive and Negative
• Imperfect market -Monopoly
• Asymmetric Information – adverse selection and
moral hazards.
 Question 1 Why should the Government
intervene?
• Fundamental theorems of welfare economics: I
• Competitive markets are Pareto-efficient
• Any efficient allocation can be reached by a competitive equilibrium
Then why government intervention?
• 4 main reasons:
• 1. Creation/Definition of markets
• 2. Correction of market failures
• 3. Solutions to limited rationality of individuals
• 4. Redistribution
Functions of the Government –Allocation
role
Underlying role of the competitive market is the notion
of property rights which give an individual the right of
ownership over some commodity and thus the right to
exclude others from enjoying the benefits that
commodity provides .
Types of property rights ( Private, common & open
access)
Distribution function
• Distribution of wealth depends upon the distribution of
rights to inherited wealth and accumulation of wealth over
individual’s life time and the distribution of earnings will
depend upon the initial distribution of skills, subsequent
training and the market price of these skills.
• The resulting distribution of income wealth and welfare may
not be in accordance with what the society considers to be
socially just.
• This may be due to inefficient market for factors
endowments.
• Therefore distribution of income may not be acceptable.
Distribution function
• Thus, the Government may design a distributive
policy to address the problem.
• It may distribute income and welfare by using
progressive taxes to finance cash benefits, subsidies
and also publicly provided goods and services.
• E.g public health, public education, welfare services,
housing etc.
Regulation Role
• Regulation limits the discretion and freedom of
individuals through the imposition of rules.
• Public regulation refers to implementation of rules by
an administrative agency that is backed up by law.
• Why regulation? To protect the public interest against
the dysfunctions of certain unregulated market
outcomes. (Increasing the welfare of certain groups
within the society by protecting their interests. (Is the
regulation efficient? Under or over regulation?).
Stabilization Role
• Markets fail to produce a Pareto –efficient outcome or an
ethically acceptable distribution of welfare.
• Thus, the Government has to intervene with a view to
correcting the inefficiency of the market.
• However the Government does not have the capacity to fine
tune and achieve a feasible objective. But it does it
indirectly through setting up of interest, money supply,
exchange rates, public expenditures, taxes etc.
Challenges - Government failure
• Government is served by a bureaucracy that is expensive to
administer (transaction costs should be compared with market
transactions).
• Government interventions results in changes that are often not
predictable.
• Rent seeking behaviour of the bureaucrats politicians
• Not possible to state clearly the ends of the Government policy.
• Implementation failures exists
Challenges
• Is it morally acceptable to aggregate individual preferences
(Sen’s critique)?
• Needs perfect information from social planner ( because
people do not have interest in revealing private info, cf.
Lindhal pricing for instance)
• Even when preferences are well established and well known,
it’s not possible to determine a well-behaved social objective
based on individual preference aggregation (Arrow’s
impossibility theorem). Fundamental conflict here between
social choice and individual values/freedom.
Income Inequality
• Why the interest in the distribution of income?
Because of its relation to poverty:
Holding the average level of income fixed, a more
unequal income distribution means more poverty
Income Inequality
• An example: In 1995, Per Capita Income in Paraguay ($4,670)
was twice PCY in Egypt ($2,960).
• But 19.4% in Paraguay had a PCY less 1$ compared to 3.1%
in Egypt.
• The difference was in the ID: Egypt has relatively equal
Income Distribution, while Paraguay is one of the most
unequal countries in the world.
• Income Distribution is also intimately tied with the process
of economic growth.
• Reducing inequality is frequently an important goal of
governments.
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Source of Income Inequality
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Effects of Income Distribution
• Investment in human capital vs. physical Capital
• Political Unrest
• Taxation reduces the overall efficiency or productivity of the country
• The effect of income inequality is not clear (some claim it has a bad
effect while others claim it has a positive effect).