Economia Del Sector Publico PDF

ECONOMIA DEL SECTOR PUBLICO CHAPTER 1 In the first chapter we will analyze the main features of the public sector in the economy. We can identify two main lines of thought: 1)​ The classical perspectives: individualistic, liberal, laissez-faire. 2)​ The collectivist perspectives: planned...

ECONOMIA DEL SECTOR PUBLICO CHAPTER 1 In the first chapter we will analyze the main features of the public sector in the economy. We can identify two main lines of thought: 1)​ The classical perspectives: individualistic, liberal, laissez-faire. 2)​ The collectivist perspectives: planned, centralized, interventionist, directive, protectionist. The public sector is the set of administrative agencies through which the State enforces the policy expressed in the laws of the country. The State is the institution of the different powers and the Government is the authority of the executive power. The country's economy is the sum of the activity of the public sector plus that of the private sector. If the public sector is in deficit, it means that public revenue is less than public sector spending. If the country's trade account is in deficit, it means that the country's residents consume more than they produce, and they have to import the difference from other countries. Two fundamental characteristics of public organization are: 1)​ The obligation to be a member of the organization; 2)​ The capacity of coercion that the public organization has. The XIX century The classical perspective of the economy had hegemony during the 19th century, especially in the most industrialized countries. According to the classical perspective, real growth is obtained through savings and investment. Moreover, the role of the State is to maintain the stability of the general price level, which could be obtained through budgetary discipline and monetary control. The Gold Standard was a system where the value of money was tied to a fixed amount of gold, which controlled the money supply. Countries with trade deficits had to pay debts in gold, reducing their gold reserves and money supply. This led to lower prices and wages, theoretically boosting exports to restore balance. Eichengreen argues that the Gold Standard mainly benefited wealthy creditors, while debtor countries were forced to implement deflationary policies, which harmed workers. Since 1971, the Gold Standard has been replaced by fiat money, which is not backed by gold or any physical commodity. The XX century During the XX century the size of the public sector grew gradually and some think that this growth can be attributed to the World wars that forced the State to intervene directly in the production processes, and simultaneously increase the Public Administration to manage these processes. The Great Depression There could be different reasons for the Great depression, a crisis that started after the 1929 Wall Street crash, mainly due to rising inequality and trade problems. The Gold Standard made the crisis spread to other countries. Banks didn't have enough money, and without an organization like the International Monetary Fund to help, many banks failed. Strict government budgets and high interest rates made the situation worse. The New Deal The New Deal was a set of fiscal and monetary intervention to overcome the economic crisis. Due to the success of this intervention, they started to attribute more importance to the public sector, introducing three ambitious projects: -​ The use of fiscal policy to moderate fluctuations in aggregate demand. Governments can and should pursue a counter-cyclical fiscal policy, that is, increase public spending and reduce taxes during a recession, and return to a budget surplus when the economy recovers. Likewise, the central bank could increase the money supply during a recession, to reduce interest rates and make banks liquid, and could raise interest rates again during a boom to control the inflation rate. -​ Redistribution of income -​ The creation of social security program Public Sector Reforms In the 1980s, many economists started to criticize both market failures and problems in the public sector. They thought the government had become too big and could slow down economic growth. One main point was that actions like raising taxes on the wealthy might seem fair, but could discourage people from working or investing over time. Also, problems like lack of competition in the private sector could still happen in government organizations. Another criticism looked at how taxes and government programs affect people's choices. Redistribution of money wasn't the main goal, but a way to make the economy work better. Government actions should help without creating bad incentives. Why was the public sector growing? In the second half of the 20th century, public spending increased significantly in most developed countries for various reasons: 1.​ Political ideology: Some ideologies supported a stronger role for the state in the economy, leading to increased public spending. 2.​ Lack of productivity measures: Without tools to measure public sector productivity, more resources were allocated instead of improving efficiency. 3.​ Electoral cycle and populism: Politicians often increase spending before elections, expecting that voters will forget later tax hikes or spending cuts. 4.​ Decentralization: Shifting power to regional governments increased spending, sometimes leading to inefficiencies and mismanagement. 5.​ Societal demands: As societies develop, people demand more public goods and services like education and healthcare (Wagner’s Law). 6.​ Universal suffrage: As more lower-income people gained voting rights, there was more demand for income redistribution through social policies. 7.​ Financial illusion: Voters tend to focus on the benefits of public spending without recognizing the costs, pushing for more services. 8.​ Historical events: Events like the World Wars increased demand for public services, which persisted afterward. 9.​ Baumol’s cost disease: In sectors like healthcare and education, where technology can't improve productivity as much as in other sectors, costs rise faster, increasing public spending as a percentage of GDP. These factors combined have driven the long-term growth of public sector spending. CHAPTER 2 The economy is the system that deals with a series of problems regarding the production and consumption of goods and services like the allocation of economic resources, the production of goods and services, the quantity of production of each type of good and service and the distribution of income. Resource allocation is efficient when society achieves the best possible outcome given limited resources, using the combinations of factors of production of lower cost and maximizing consumer satisfaction. Any institution, be it a private company, a market or a public company, has to fulfill two fundamental functions: 1) the institution must provide sufficient information to all individuals to coordinate their actions 2) the institution has to motivate them to achieve the desired objectives. Markets are a way of coordinating economic activity, in which private property and competition are central elements. Market prices indicate to producers which goods and services are most in demand and inform consumers on the relative cost of production of goods and services. If each acts in his own interest, the market system maximizes the total welfare of society (the "invisible hand" theory). This theory assumes that there are no "externalities". DEMAND The demand curve is a hypothetical construction that represent the value perceived by consumers for each unit of the product. The demand curve shows the maximum price that the consumer would be willing to pay for each additional unit of the product. The quantity demanded depends on various factors such as consumer preferences, their income and the prices of related goods. The demand curve is downward sloping since there is an inverse demand between price and quantity. SUPPLY The supply curve is the quantity of the product that the company is willing to produce for each level of the price of the product in the market. If markets are competitive, the supply curve is determined by production costs. In a competitive market, the cost of producing one more unit of the good, called the marginal cost, represents the minimum price that the company is willing to accept for producing and selling one more unit. The firm's production costs depend on the prices of the factors of production, its productivity, and the firm's technology. In perfect competition, each company is price-accepting. A high price encourages companies with the highest production costs to enter the market while If the market price falls it is convenient to reduce production or exit the market. The supply curve is positive since there is a direct relationship between price and quantity. THE MARKET EQUILIBRIUM The market equilibrium is a situation in balance when no individual could improve by doing something different. The market balances two opposite elements: to buy more, consumers need the price to drop. to sell more, companies need the price to rise. There is a price and a quantity that makes these items compatible. SOCIAL WELFARE Social welfare can be defined as: Total market welfare = consumer welfare + producer welfare CONSUMER SURPLUS Each consumer's surplus is the maximum price they are willing to pay, V, minus the market price P, multiplied by the quantity they consume, q. Consumer surplus = (V –P)*q Consumer surplus is an estimate of consumer satisfaction, utility or well-being given the price of the good in the market. PRODUCER SURPLUS Producer surplus = (P – C)*q. C is the marginal cost when producing the quantity q. The producer surplus is an estimate of the profit generated by the companies given the price of the goods in the market. The market maximizes social welfare→ The sum of consumer and producer surplus is an estimate of the total social welfare generated by the production and consumption. THE INCIDENCE OF TAX Sales tax increases costs for producers, and therefore in a perfectly competitive market, the market price increases, and if the price increases, consumers demand a lower quantity of the good, generating a new equilibrium. DEADWEIGHT LOSS DUE TO A TAX By establishing a tax, both consumers and producers receive a lower surplus, however, in principle, the collection of the tax itself does not correspond to a loss for society in general, because the government will invest these revenues on public goods and so on. However, the tax causes another type of loss, known as the deadweight of the tax. CHAPTER 3a MARKET FAILURES A situation in which the market is not efficient is called market failure. Market failures include: externalities, lack of provision of public goods, over-exploitation of common resources, imperfect competition, and information asymmetry. EXTERNALITIES Externalities involve costs or benefits for a third party derived from the consumption or production of a good or service that are not included in the market prices. There is a "negative externality" if the impact on the third party is adverse. There is a "positive externality" if the impact on the third party is beneficial. When there are externalities, market equilibrium is not efficient. In the case of negative externality, the market produces an amount of the good that is greater than the socially optimal quantity, and in the case of a positive externality, the market produces an amount of the good that is less than the socially optimal quantity. Both positive and negative externalities are examples of market failure. An example of negative externality is the irresponsible alcohol consumption where external costs are registered. We can differentiate two types of external costs: tangible and intangible: - Tangible external costs are predictable costs and easy to quantify in monetary terms. - Intangible external costs are unpredictable and difficult to measure. The socially optimal point is the quantity of production and consumption of the good that maximizes total social welfare. Also, it is the point where the social marginal cost is equal to the social marginal value. We can find this point by drawing the social marginal cost curve and the social marginal value curve. However, when there are negative externalities, the social marginal cost is above the private marginal cost. Total market welfare = consumer welfare + producer welfare+positive externalities – negative externalities SOCIAL MARGINAL COST AND SOCIAL MARGINAL VALUE The social marginal cost is the cost to society of producing and/or consuming one more unit of good. In the case of a good that does not produce externalities, the social marginal value corresponds to the demand curve and the social marginal cost corresponds to the private marginal cost. In the case of a good that produces a negative externality, the social marginal cost associated with the good is greater than the private marginal cost: Marginal social cost = private marginal cost + external marginal cost The private marginal cost is the additional cost to the producer of producing one more unit of the product. In a perfectly competitive market it is represented by the supply curve. The external marginal cost is the cost of negative externality, i.e. the negative impact of the production or consumption of one unit more of the good on the third. Also, in the case of a good that produces a positive externality: Social marginal value= private marginal value + external marginal value Social marginal value is the value for society at large to consume one more unit of good. In a competitive market the private marginal value is represented by the demand curve. The external marginal value is the additional benefit of the consumption of one more unit of good over a third party. It is important to understand that when there are externalities, the socially optimal point does not correspond to the market equilibrium. In the case of a negative externality, the market produces a quantity greater than the socially optimal amount. When there are externalities, market forces do not maximize overall well-being. We analyze some proposed policies to correct problems caused by negative externalities: -​ Regulation -​ Corrective taxes→ Pigouvian taxes -​ Private solutions -​ Tradable permits to pollute. REGULATION→ Regulation is the intervention of the state to prohibit the emission of the pollutant, prohibit the production or sale of the good, or dictate maximum levels of contamination. The prohibition of good is a good solution when even a small amount of the contaminant causes disproportionate damage. CORRECTIVE TAXES→ An ideal corrective tax would be one with a value equivalent to the external cost The Pygouvian tax applies to the price of the final product, not to the amount of pollution produced. A corrective tax, like the Pigouvian tax, is designed to cover the external costs of harmful products, such as pollution. In the example, a €2 tax per liter is applied to the final price of a product. This shifts the supply curve left, raising the price and reducing consumption to a socially optimal level. The revenue collected can be used to fix damages, support health services, or fund cleaner technologies. However, there are issues with such a tax: (i) it's hard to calculate the exact external cost, (ii) all consumers pay the tax, even those who drink responsibly, (iii) it could push people to cheaper, riskier alcohol options, and (iv) it might encourage a black market to avoid the tax. THE COASE THEOREM According to the theorem of Coase, in some circumstances private parties may negotiate the level of production and consumption and reach an agreement without the need for state intervention. To reach an agreement, Coase argued that two conditions are necessary: -​ Transaction costs" for the parties are low. -​ Those who own the resources can identify the cause of the damage to their property, and prevent them by legal means. Transaction costs are the costs incurred by parties in the process of entering into an agreement or complying with the law. The application of Coase's theorem to the problem of factory noise in Granada offers two scenarios, depending on who holds the rights: Scenario A: Neighbors' Rights (Noise-Free Rest)​ Here, the neighbors have the right to quiet at night, and the factory exceeds noise limits. Legally, the factory could be forced to stop its night operations. However, a better solution for both the company and its workers would be for the factory to continue operating but compensate the affected neighbors, possibly reducing its output. Scenario B: Factory's Rights (Right to Operate)​ In this case, the factory has the right to operate, as it existed before the neighboring homes were built. The neighbors could negotiate with the company to reduce night-time production or relocate to an industrial zone, but they would have to compensate the factory for the costs of doing so. Coase’s theorem suggests that, as long as there are clear rights and low transaction costs, the parties can negotiate to find a mutually beneficial solution, regardless of who holds the initial rights. In complex cases like acid rain, where Coase’s private negotiation, Pigouvian taxes, or regulations are ineffective, state intervention may be necessary. People affected by acid rain are scattered and can’t negotiate with polluting power plants, and a corrective tax doesn’t incentivize cleaner technologies. Instead, a system of negotiable emission permits has proven effective. In the U.S. during the 1990s, the government set a cap on sulfur dioxide emissions which is a cause of acid rain and auctioned emission permits to power plants. These permits were tradeable, allowing companies to sell any unused permits. This approach encouraged companies to invest in cleaner technology to reduce the need for permits, making it a cost-effective solution for reducing pollution and acid rain. POSITIVE EXTERNALITY Production/consumption sometimes generates "external benefits": a transaction between a buyer and a seller also indirectly benefits a third party. If the production or consumption of the good produces a positive externality, the social value of the good or service in question exceeds the private value. COST BENEFIT ANALYSIS Cost-benefit analysis is a methodology for estimating the social costs and benefits associated with a given project or proposal. The steps are: identify project alternatives list the positive and negative, tangible and intangible consequences of each alternative evaluate in monetary terms these consequences identify the option with the most expected social benefit. CHAPTER 3b: Market failures public goods and common goods Market failure, in the case of public goods, regards the quantity produced. In the case of public goods, the private market tends to underproduction, while in the case of common resources, the non-intervention of the state causes an over-exploitation of them. Ostrom classifies the goods in this way: -​ excludable goods→ are goods in which producers can prevent those who do not pay for the goods from consuming them. This type of good is not available to everyone. -​ non-excludable good→ one in which the owner cannot limit or charge another individual for the use. -​ Rival goods→ those in which the good cannot be consumed simultaneously by two people -​ A non-rival good→ is one in which the use of the good by one person does not subtract from the quantity available to others. Private goods are excludable and rival in consumption. Common resources are non-excludable but rival goods. The individuals and companies that exploit these resources, often illegally, tend to ignore the fact that the use of those resources reduces the amount that remains for the others. For example, for companies that exploit rain forest illegally, the cost of reforesting the cleared area is an external cost, which the illegal company does not pay. Since the private marginal cost of illegal logging is below the social marginal cost, this activity generates a negative externality. The intention of the Law is to prevent the production or sale of products from unsustainable sources, one way in which they try to do so is to increase the awareness about the problem. Theoretically, the laws of the producing country also protect common resources, but in practice a series of problems may prevent the correct application of the Law, such as the influence of interest groups and industry on politicians, a growing population who demands land and work, and the difficulty of monitoring the resource. Elinor Ostrom made a distinction between common resources and a common property system. -​ A common resource may be formally private, state owned, or none. In any case, due to its enormous size, it is difficult to control access to the resource by outsiders. Thus, not legally but in practice, the use of a resource is not excludable. -​ In a common property system, the resource is legally owned by a community and the members have the right and the obligation of usufruct. Access to the resource is not free in the sense that they are neither free goods nor free of obligations to users. Access is relatively free but controlled and regulated to community members. Communal property systems originate in situations in which users realize that if they act independently in relation to a given resource, they will obtain less general and individual benefit than if they act in coordination. In administrative law, a public good is one that belongs or is provided by the State at any level: central, municipal or local government, for example, through state. However, in contemporary economics the meaning of the term "public good" is different: A good that is available to all and for which use by one person does not decrease use by others. Public goods are non-excludable and non-rival in consumption. It should be noted that the definition does not strictly refer to the property system: a good will be for public use -in this conception- regardless of who owns it, as long as its use “is available to all and the use by one person does not diminish the use that others can make”. A principle of economics is that people consume goods and services because they obtain some "utility" or satisfaction from them. The demand curve values this profit in monetary units. It represents the private marginal value to the consumer. In the case of a rival good in consumption, each consumer exclusively uses the good they acquire, so market demand is obtained by adding the demand curves of each consumer “horizontally”. A "private good" is rival in consumption and also excludable, that is, companies can charge the consumer for each unit consumed. It is important to understand that all companies in a competitive market charge the same price to all consumers, regardless of their willingness to pay, it means they are price-accepting. In a perfectly competitive market, price equals marginal cost. If we consider non-rival good in consumption, two or more people can watch the same channel simultaneously. Unlike a rival good, in the case of a non-rival good, the consumer "demand curve" is the "vertical" sum of the amount that each person is willing to pay for each unit. A public good is non-rival in consumption but is also non-excludable. In practice rational consumers would not pay for them, since they would try to take advantage of other individuals who have paid or think that they will pay for them (called the parasite problem). If a good or service is not excludable, the manufacturer cannot charge the consumer for the cost of supplying it, and will not produce it. In general, and unlike a private good, markets produce an insufficient quantity of public goods. Public goods are provided to society in different ways. The solutions are similar to those for goods that generate positive externalities: 1. Direct provision of public goods by the State financed through taxes 2. Public goods financed by State subsidies to private companies 3. Public goods financed through voluntary donations to non-profit foundations 4. Provision of public goods by private companies financed by advertisements 5. Public goods become exclusive and a price is charged for them CHAPTER 4 In addition to the market failures, inequalities in the distribution of income and wealth are another reason why the government may decide to intervene in the economy. Utilitarianism, Bentham, Hume→ This currently advocates maximizing the sum of profits, that is, weighting all individuals equally. The "utility" is the satisfaction or well-being of the individual derived from his economic activity and the consumption of goods and services. Egalitarianism, John Rawls's Theory of Justice→ In this view, the most equitable distribution is the one that maximizes the well-being of the worst placed person in society. Global well-being will only increase when the position of the worst-off person in society is improved, even if this means greater inequality. Libertarianism→ This line of thought maintains that what is really important is not equality of income, but the opportunities to generate it. Therefore, rather than establishing a socially desirable amount of inequality, this current argues that the government must ensure that the rules of the game allow all individuals to have the same opportunities to achieve success. The Lorenz Curve shows graphically the relationship between the accumulated proportion of the population, ordered according to their income level (from lowest to highest), and the accumulated percentage of income they receive. If the income distribution were totally equitable among all the members of the study population, the graphical representation of the Lorenz Curve would be the bisector of the 90º angle formed by the coordinate axes. This line is called the equidistribution line. Since in reality there is no equality in the distribution of income, the Lorenz Curve does not coincide with the equidistribution line, and is always below the line that divides the plane from two 45º angles. The Gini coefficient = A x 2 The Gini coefficient is a synthetic indicator of income inequality based on the Lorenz Curve. It corresponds to the area between the Lorenz Curve and the equidistribution line. This number is then multiplied by 2 to ensure that the coefficient fluctuates between 0 and 1 The closer to 0, the lower the income inequality, while the values closer to 1 are indicative of a higher degree of inequality. Gini coefficient = 0: Maximum equality. All members of society receive the same income Gini coefficient = 1: Maximum inequality. All income goes to the hands of a single individual. Problems in measuring inequalities Question 1: Should income, consumption or wealth be measured? In developed countries, income is normally the best indicator of household purchasing power. The differences in consumption are usually less than the differences in income, because people save money and borrow money to try to moderate fluctuations in consumption throughout the life cycle. In low-income countries such as India, inequality in consumption is measured, because in these countries wage income is not a reliable indicator of household purchasing power. Poor people in these countries practice self-sufficiency or barter. Question 2 Should inequality in market incomes or inequality in disposable income be measured? Market rent is the income of the household before paying taxes and receiving state aid. Disposable income is the household income after paying taxes and receiving aid. The difference between the Gini coefficient on market income and the Gini coefficient on disposable income shows the effectiveness of the tax system in reducing income inequalities. CHAPTER 5 PUBLIC CHOICE For many people market failures justify public sector intervention in the economy. However we have to consider that the government is also an imperfect institution. The study of public sector behavior is called “Political Economy” and it is an application of the economist's own methods to study how institutions and institutions in the public sector, politics and government behave. There are 3 important theories in the field of public choice: 1)​ The theory of principal and agent: Politicians and officials are also people with interests which may differ from those of society as a whole 2)​ No voting system is perfect 3)​ Rent-seeking: Interest groups are dedicated to capturing economic privileges (income) through the manipulation of the political system. THE PRINCIPAL AGENT THEORY This theory gives us an idea about how public sector institutions, contracts and decisions should be organized. Unlike classical theory, we can see an organization as a legal fiction that serves as a nexus of contractual relationships between individuals who do not have the same information and pursue their own interest. The principal of an organization is the person or group of people who determine the objectives of the organization, its structure (centralized or decentralized) and the rules of the game (wages, supplements, working conditions, promotions, etc.). -​ A high level of centralization concentrates almost all important decisions on the owner, a hierarchy.  -​ A high level of decentralization disperses decision-making rights throughout the organization. In a company, the principal is usually the owner or manager. Agents are parties that are contracted to promote the interests of the principals, in exchange for an income or other remuneration. For example, workers are the "agents" of the company in which they work. The principal-agent theory takes into account two problems that the classical theory of the firm does not consider: -​ The information is asymmetrical→ agents often have better information than the principal -​ The principal and agent have inconsistent objectives→ and they often pursue their own objectives, which doesn’t match the company’s. Agency problems arise when principals lack sufficient information to monitor agent behavior, or they may not incentivize desired behavior, or may not sanction irresponsible behavior. In these situations the agent relaxes, or attempts to manipulate the system to suit his own interest above the organization's goals. In general, the greater the degree of decentralization in the organization, the more difficult it is to execute control. The remuneration of agents can be monetary or non-monetary. In principle, the principal can design a system of remuneration and incentives for the agent. In practice any remuneration system has advantages and disadvantages. APPLICATION OF PRINCIPAL-AGENT THEORY IN THE PUBLIC SECTOR We will analyze two applications of this theory: the relationship between voters and politicians and the civil servant’s employment contract. THE PROBLEM OF VOTERS AND POLITICIANS Voters have to choose politicians. Of course, the principals are the voters and the agents are the politicians. We remember the two agency problems: first, information asymmetry: politicians have better information about the functioning of government than voters. Second, the interests of politicians are not the same as the interests of voters. Voters are interested in the good governance of the country. The politician likes to be re-elected. These manipulations can manifest themselves in different ways. One can be “Gerrymandering” which is a US political science term referring to a manipulation of electoral districts in a territory that produces a particular effect on election results. In many countries, parties with greater funding for their election campaign will be more likely to be elected. Politics can become a mechanism to capture resources to finance election campaigns rather than work for general well-being. In the absence of transparent funding systems for parties, politicians will have a strong incentive for corrupt practices. To avoid this problem and eliminate the incentive to manipulate the voting system in their favour, in many countries the constitution allows politicians to serve only a maximum of twice. In Mexico, the constitution allows mayors to serve in office only once. THE PROBLEM OF PUBLIC ADMINISTRATION We can apply the principal and agent theory to the employment contract between the state and the civil servants. In this case, we consider the official as an "agent" and the government is the "principal". The purpose of the official's employment contract is to ensure the official's loyalty to the proper performance of his duties. The lifetime contract may incentivize responsible conduct on the official's side, if otherwise that official would surely be dismissed and may not find a job with such good conditions again. The lifetime contract also allows the official some independence, since his contract is outside of election cycles. The official is compensated with a regular salary and the possibility of progress in his career based on their productivity.. However, in some areas of public administration, the productivity of the official is not evaluated The introduction of free primary education has brought many more children to school in developing countries. However, there are often not enough state-employed teachers because of limited budgets. This leads to overcrowded classrooms and makes it hard to ensure good teaching quality. One solution is to hire local teachers paid less than state teachers, called "contract teachers." A Dutch organization called ICS helped 140 schools solve this problem by funding the salaries of these contract teachers. These teachers earned a quarter of what state teachers made but had the same qualifications. Schools, with the help of committees made up of parents and teachers, hired these contract teachers and could replace them if they didn’t perform well. Contract teachers attended school more regularly than state teachers, and their students achieved better grades. However, the best results happened when the program was well-organized. For example, when school committees were trained to monitor the teachers, the program worked better. Also, setting up a class to support weaker students improved the grades of all students. In summary, hiring contract teachers can be a good solution to improve education, but it is important to organize the program properly and provide extra support for both schools and students with special needs. OFFICIALS AND GROWTH PUBLIC SPENDING William Niskanen’s analysis suggests that officials often seek to maximize their budgets because their importance and self-esteem are tied to the funds they manage and the number of employees they oversee. Since officials understand the administrative system better than politicians, they can exploit this knowledge to exaggerate problems and justify higher spending. As a result, civil servants may encourage unnecessary growth in public spending, beyond what society actually needs. NO VOTING SYSTEM IS PERFECT Every policy has both positive and negative consequences, and people may evaluate these differently. For example, some prioritize price stability over unemployment, while others focus more on national income growth than on redistribution. In a democracy, the government is expected to understand voter preferences and make decisions accordingly. However, the challenge is: how can we accurately know voter preferences? How can the preferences of thousands be effectively combined? And, how do we define general interest or social welfare? These are difficult questions, as no voting system can perfectly reflect the diverse views of all citizens. VOTING SYSTEM A voting system determines how voters express their preferences and how those preferences are combined to reach a final decision. The simplest system is the majority rule, where the option that receives more than half of the votes wins. However, when there are more than two options (e.g., Party A, Party B, Party C), voting systems often require more complex rules. Choosing an electoral system is a key decision for any democracy. Yet, according to Arrow's theory (developed by economist Kenneth Arrow), there is a fundamental issue: "No matter what voting system society adopts, it will always have some flaw in how it aggregates the preferences of its members." This suggests that every voting system has inherent limitations in reflecting the true preferences of society. ARROW’S THEOREM Arrow's theorem addresses how to combine individual preferences into a collective social preference. The challenge is how to aggregate individual choices in a way that reflects the overall preference of society. To tackle this, Arrow defined the properties that a perfect voting system would need to have: 1.​ Unanimity: If everyone prefers A over B, then A must win. 2.​ Transitivity: If A beats B and B beats C, then A must beat C. 3.​ Independence of irrelevant alternatives: The ranking of A and B should not change if a third option, C, is added. 4.​ No dictators: No single person should have the power to decide the outcome without considering others' preferences. Arrow mathematically proved that no voting system can meet all of these conditions at once. The proof is complex, but it shows the inherent flaws in any method of aggregating preferences. A simpler case of Arrow's theorem is the Condorcet Paradox, which we will explore further. According to Condorcet's analysis (by French philosopher Marie-Jean-Antoine Nicolas de Caritat, Marquis de Condorcet), when there are more than two options to choose from, democracy can face problems in selecting the best outcome. Specifically, Condorcet showed that a majority voting system does not always guarantee transitivity. This means that even if A beats B and B beats C, it is not guaranteed that A will beat C in a majority vote, leading to intransitive preferences. This creates a situation where the collective choices are inconsistent, making it difficult to determine the "best" option. The Median Voter Theorem is a model in political science that explains how, in a majority voting system, the policy chosen is the one most preferred by the median voter. The theorem assumes several key points: 1.​ Voters can rank the options from left to right or from smallest to largest. 2.​ Voters choose the alternative closest to their most preferred option. 3.​ Voters always vote according to their true preferences. 4.​ The option that receives more than 50% of the votes (an absolute majority) wins. According to the Median Voter Theorem, if two political parties are competing to maximize their votes, both will adjust their positions to appeal to the median voter, the voter whose preferences are in the middle of the political spectrum. This leads to both parties moving toward more centrist policies. it relies on assumptions that may not always hold in reality: 1.​ It assumes voters can rank candidates along a single left-to-right political spectrum, but in reality, political issues are often more complex and multidimensional. 2.​ It assumes voters always choose candidates based on their true preferences, but in practice, some voters may select a party simply to prevent another party they view as worse from winning.  3.​ The theorem also doesn't explain what happens when more than two parties compete for votes, which can lead to more varied outcomes that don't follow the predictions of the model. Rent-seeking refers to the practice of individuals, organizations, or companies trying to earn income by capturing economic privileges through manipulation or exploitation of the political system, rather than through creating value in the market. In the 19th century, these privileges were called "rents." Examples of rent-seeking include: ​ An agricultural lobby pushing for tariff protection ​ An entertainment industry lobby seeking extended copyright laws ​ A politician granting public contracts to a company in exchange for campaign donations While rent-seeking benefits a few, it can impose significant costs on society. For example, tariff protection leads to higher prices for consumers Voters often do not mobilize against these activities because the individual loss from a lobby's political influence is small, even though the collective loss to society is large. Each person expects others to act, a situation known as the "parasite problem." In contrast, smaller groups with a shared interest (like pressure groups) can organize more effectively and have more influence than large groups of diverse individuals. CHAPTER 6 HEALTH CARE In the case of health insurance there are three actors that coexist, which are: insurers, providers and patients. This triangular relationship of contracts, rights and obligations gives rise to a great variety of models and systems of the organization of health services. Financing concerns the origin of the funds. There two models for financing health: -​ Non-universal model→ used in the USA and South Africa. Under this approach the individual pays a fee to the private insurer directly or indirectly through their employer. It is not mandatory to have health insurance, for this reason it promotes competition and freedom of choice. -​ Universal model→ this approach requires all people to have approved health insurance, so it provides coverage for almost the entire population. It could be financed by contributions from private insurance companies, social security contributions or general taxes. Obamacare was a reform implemented in the health insurance system in the USA that guaranteed health coverage for the whole population. Before this reform the health system was not universal and there were 4 ways to get health insurance: Medicare which a health insurance provided by the state for retirees, Medicaid a type of public insurance for particularly vulnerable people, private health insurance paid by large companies and the rest of people had to buy the insurance on the free market if they wanted it. There were three main problems with purchasing the health insurance on the free market: -​ Private insurance companies do not want to offer coverage to people who are ill or are likely to be ill in the future. The Obamacare reform forces private insurance companies to offer health insurance to everyone. -​ Not so many young people buy health insurance, but insurance companies would go out of business if they were obligated to insure only sick people and cover all of their expenses.  For this reason Obamacare requires all citizens to enroll in a health insurance policy. -​ private health insurance was very expensive so Obamacare offered subsidies for low-income people who do not have the option to benefit from Medicaid. Public health insurance is efficient because it has two important characteristics. First, it covers all citizens, regardless of their income level and health status. Second, the contribution to public health insurance must be mandatory for all citizens, regardless of whether one has private insurance or not. Moral hazard of insurance→ over-utilization of health services. It can originate from two sources: the patient uses the service when sick (FREE BUFFET EFFECT), in some health systems, the provider's remuneration is conditional on the health services consumed by the patient. The free buffet effect→ when the patient uses the service for free when he is ill and the insurer pays for it. It can cause several problems because the emergency department can collapse if many patients go to this department with minor problems. Both in the private and public health system it is necessary to take into account corrective measures to avoid inappropriate use of some services.​ Information asymmetry and inappropriate incentives for physicians→ There is asymmetry of information between the patient and the doctor but this is not a problem if the physician always act in the best interest of their patient. However like every agent he has his own interests, for example in the USA the doctor is paid according to the costs incurred in treating the patient. Regulatory measures In some countries the patient cannot make an appointment directly with the specialist in the hospital. The GP filters the patient’s access to hospital care and specialists. Some countries produce clinical guidelines in which a commission of experts evaluates the costs and efficacy of new drugs proposed by the industry. These cost-benefit evaluations are intended to identify and exclude high-cost but dubious efficacy treatment. One drawback of regulatory measures is the lack of freedom of choice for the user of their specialist or hospital. Market measures Some Health systems require the user to contribute a proportion of the price, a process called copayment. It is possible that these payments reduce both inappropriate consumption and the unnecessary use of health services. There are different models of contract and payments between a provider and an insurer: FIXED BUDGET→ in this model the provider receives an annual, global perspective and fixed remuneration from the insurer that is not related to the activity carried out during the year. The advantage of this system, from the insurer's point of view, is that a ceiling is guaranteed for global healthcare spending. The downside is if the budget is less than the need or demand, this financing model could result in long waiting times for the patient or cuts in the service provided. Used in Spain and the UK until 1990. PAYMENT PER ACTIVITY→ the hospital bills the insurer for each admitted patient. These payments vary according to the complexity of the disease. An advantage of this system is to channel the financing to the services with the greatest use. One drawback is that it could be difficult for the insurer to set a cap on overall healthcare spending. Used in the UK, France and Germany. The market for “simulated competition” between suppliers The underlying idea in this approach is to configure a supply market in which public and private providers act under a public monopoly for the purchase of services. That is, the funding is public, but hospitals can be public or private or both. In any case, hospitals compete to care for patients, and the insurance company would pay them for this activity. Competition between providers, whether owned by public, private or mixed, introduces elements of the market into the public system. The possible advantages are: -​ It could expand the range of healthcare providers so that the patient has more options. -​ Better information for patients. -​ Professional management, whether privately or publicly owned, tend to place greater emphasis on measuring and evaluating results and assigning responsibilities. The possible downsides are: -​ Does not take advantage of economies of scale -​ Possibility of adverse selection -​ In order to choose their care center well, the user has to be informed about alternative providers and their results. -​ A simulated competition system is complex and has to be regulated by the government, which entails administrative expenses and a substantial investment in information and control systems. -​ Systems with greater user freedom of choice also often require a substantial user copayment. Public-private partnership The debate focuses on "public-private partnerships" (PPPs) in healthcare, where public institutions collaborate with private companies. Two models stand out: the Private Finance Initiative (PFI), where private companies build facilities and manage non-medical services, leaving healthcare provision to the public sector; and the Alzira model in Spain, where private companies handle both infrastructure and healthcare delivery for a specific population. Advocates argue that PPPs are more efficient, offer cost savings, and share financial risks. Sustainability of universal healthcare, like Spain’s SNS, depends on balancing income (mainly from taxes and economic growth) with expenses. Rising costs stem from an aging population, requiring more care, and the increasing price of medical technologies and treatments, which outpace inflation. Balancing these factors is key to preserving universal healthcare. CHAPTER 7 POVERTY Poverty in absolute terms is a minimum threshold of income, or consumption below which the individual or the family are considered poor. The UN has estimated that people living on less than $1.25 are considered absolute poverty. Poverty in relative terms considers those whose income does not reach 60% of society's median income level can be considered poor. That is, they are relatively poor, compared to the rest of the population in their country. In some counties the threshold is defined according to the needs of the household both absolute and relative. The classical and neoclassical economy states that people are poor because their work is underproductive, and not profitable. The Solow model is a theory according to which poor people can free themselves from poverty on their own, in fact poor countries should grow faster than the rich because they have a greater potential. In their book “Rethinking Poverty” Benerjee and Duflo stated that this argument may be valid in some circumstances but doesn't consider that some people are trapped in a cycle of poverty. It is basically a self-maintained mechanism that causes poverty to persist. SOLOW’S MODEL For those who believe in the neoclassical growth model there's here the graphical representation of it. Along the diagonal, today's revenue is equal to future revenue. The curve of the figure is a production function, and in the Solow model, it has the concave shape. This means that if the person invests in something productive (e.g. fertilizer for his or her garden), his future income will be higher than the one. A poor person (with incomes less than C) as time passes has the ability to invest and becomes richer, at least to some extent. In this model, a one-time aid received will only be redistributive. It will not increase the income of the poor permanently. At best this help will allow you to move somewhat faster, but it won't allow you to change the final destination point you're going to (point C). For those who believe in the poverty traps here’s the representation. Similar to Figure 1, along the diagonal, today's revenue is equal to future revenue. As in Figure 1, the curve shows a production function, but in this case it is S-shaped. for example, we assume that a farmer today has income of Y_1 (an income below point B). We assume that this person gets a credit to invest in fertilizer to improve the productivity of their garden. According to this chart, this investment will not be profitable, and due to interest payments on credit, it will end up with future income Y_2, i.e. income below today's. However, for those starting with incomes today above point B (e.g. X_1), an investment will produce higher future income than current ones, thereby making time richer, at least to some extent (X1, X2 and so on, to point C). THE OFFER AND DEMAND FOR EDUCATION AND HEALTH Without education and health children will probably be the poor of tomorrow. In many undeveloped countries, governments and non-governmental organizations have made considerable efforts to bring basic social services to poorer regions. That is, there's a supply of education. However there are important barriers to consider such as the high cash outlays in uniforms, school materials, transportation and others. In many rural areas, children work instead of attending school. Child labour increase the cycle of poverty for the children concerned, their family and their communities. ANTI POVERTY PROGRAMS There are three example of anti-poverty programs: 1)​ In-kind transfer programs: These provide goods or services directly, like distributing food or subsidizing fossil fuel prices. 2)​ Cash transfer programs: These give people money directly, such as cash subsidies for those with low monthly incomes. 3)​ Conditional cash transfer programs: These provide cash to individuals, but only if they meet specific conditions, like enrolling their children in school or attending health checkups. Some countries provide free or subsidized food to customers like in Egypt and Mexico. It is a redistributive policy, since we know that poor people spend a greater amount of their income on food with respect to rich people. However, these types of programs have received a lot of criticism. They’re inefficient because they distort market incentives and prices. In fact If the government imposes a maximum price on the sale of goods to help consumers, it discourages good producers, who could also be poor. If the government tries to distribute free or subsidized food directly to the poorest consumers, it will have high transaction costs. The government needs to supervise the storage of the goods and control its distribution in the right amount to the household. Giving cash subsidies is usually cheaper than distributing food, as they can be sent directly to bank accounts, reducing the risk of fraud. However, these programs often face criticism. While cash subsidies help reduce poverty, they don’t address its root causes. In some cases, they can even trap people in poverty. For example, if someone gets a job, they might lose part or all of the subsidy, which can discourage them from seeking work. Social security systems in many countries are complicated. This complexity means some people get double benefits by mistake, while others who really need help are left out. An example of a cash conditioner transfer program is PROGRESA. The main goals are: Increase incomes and alleviate poverty in the short term, Breaking the cycle of intergenerational poverty thanks to the increase in human capital. PROGRESA→ a program that provides each family with cash subsided on the condition that they regularly take their children under the age of six to health services and keep the children between the ages of 6 and 17 in school. Once people who need help are identified and all the information is delivered, they start to receive the payments. Benefits are roughly equivalent to one-third of the poverty line. If the benefit is too low, the program may not be able to keep children healthy or in school; if it is too high, the opportunity to favor more families is lost. It is necessary to check regularly that these people continue to comply with the conditions. Those who do not comply must be suspended or removed from the program. Payments are usually delivered to the mother. Studies have shown that the PROGRESA programme is highly effective, both in increasing school attendance and improving the health of children. EVALUATION OF PUBLIC PROGRAMS It is important to assess whether public programs are effective and to do so it is essential to compare the difference in the result before and after. It is also important to compare the results between those who received the program and those who did not. An appropriate method to ensure that individuals in the control group and intervention group are comparable is to design an experiment in which the researcher can randomly assign the intervention to half of the trial participants and compare their results over time with those of the other group who did not receive the intervention CHAPTER 8 TAXATION Taxable event: the legal or economic activity that gives rise to the obligation to pay the tax. Examples: having a salary, owning a home Taxable person: the natural or legal person required to pay the tax. Example: the worker, the owner of the house Tax base: the economic valuation of the taxable event, a figure expressed in monetary units. Examples: the amount of the rent, the cadastral value of the house. Deductions in the tax base: a subtraction of a fixed amount from the tax base. Ex: payments to pension plans, or to disability related private insurance Taxable Income: is the result of subtracting from the tax base the deductions established in the Law. It's taxable income. Tax rate: the figure, coefficient or percentage applied to the tax base to obtain the full amount as a result. Tax liability: That amount represents the levy. The result of applying the tax rate to the liquidable base, unless it is a fixed amount. Tax credits: A subtraction from tax liability. Examples: maternity deductions, or large family deductions Regular tax liability: the result of subtracting from the full quota the deductions (incentives, bonuses) in the quota permitted by the Law Surcharges and fines: Late interest, penalties, etc. Tax debt: It constitutes the tax debt, the result of reducing the liquid quota with taxes already paid ("withholdings on account") and increasing it with possible surcharges (legal, late interest, penalties) AVERAGE RATE→ The total tax paid between the total income MARGINAL RATE→ the extra taxes paid for each additional monetary unit of income A STEPWISE TAX FEE The income tax establish quote bands that are determined by the individual’s revenue. In this way, the percentage to which the taxpayer is taxed increases in each band depending on the income he has earned, that is, as the salary plus the income for his investments. The highest incomes are those that are taxed with a higher tax. EQUITY A progressive tax: "High-income taxpayers pay a higher proportion of their income in taxes than a low-income taxpayer." A regressive tax: "Taxpayers with high incomes pay a smaller proportion of their income in taxes than a low-income taxpayer." A proportional tax: "High-income taxpayers pay the same proportion of their income in taxes as a low-income taxpayer" The principle of equity usually requires that the tax system should be progressive THE EFFECT OF A TAX SAVINGS ON THE PROGRESSIVENESS OF THE TAX SYSTEM A deduction in the tax base or a deduction in the quota (tax credit) results in a "saving" in taxes for the taxpayer, which is equal to the amount of money that the Tax Agency stops receiving. A deduction reduces the progressiveness of the tax system if, given the same amount to deduct, high-income taxpayers save more than a low-income taxpayer CHAPTER 9 TAXATION, EFFICIENCY AND EQUITY The tax system is the legal, administrative and technical organization that the State creates in order to effectively and objectively exercise tax power. A tax can be: -- - coercive→ imposed unilaterally but according to constitutional principles - pecuniary→ tax liability in capitalist countries is always realized in the form of money According to James Mirrlees in his report on the reform of the British tax system, the design of any tax system should be guided by four tax principles: Neutrality or efficiency→ Taxes should alter the activities of consumers and businesses as little as possible. Correct externalities→ The tax system should promote social and environmental purposes, for example the Pigouvian tax. Equity→ The tax system must be progressive, i.e. it must redistribute income from the richest to the poorest. The tax system must be conceived as a whole→ It is important to understand how each individual element of the system fits together. For example, tax systems and the social security system must be integrated. Nor do all taxes individually have to be progressive. The tax system as a whole must be progressive. PRINCIPLE OF NEUTRALITY AND EFFICIENCY The fundamental goal of a tax system is to collect revenue for the state in the most efficient way. It should collect the necessary amount of income without causing problems to businesses and taxpayers. A tax system generates three types of damage: 1) Raising money. Paying the tax implies a reduction in taxpayers' disposable income At the macroeconomic level, tax collection reduces the disposable income of households and thus consumption and savings. However, the effect at the macroeconomic level is nullified when the State spends this revenue on public programmes, investments and social programmes. 2) Transaction costs: System management should not be costly for both the taxpayer and the Administration Transaction costs are the costs of managing the system and monitoring compliance with the Law. They include the costs of civil servants, inspectors and administrative staff. They also consist of opportunity costs for taxpayers (e.g. time spent filling out paperwork, hiring managers, waiting in line at the bank to settle tax debt, etc.). The more complex the tax law, the higher the transaction costs. 3) Unrecoverable loss of efficiency. Compliance with tax obligations causes a change in the economic behavior of businesses, workers and consumers to avoid tax Depending on the circumstances, it can harm employment, production, investment, savings or consumption since a tax raises the price of goods and services. THE LAFFER CURVE When a tax is added to a product, its price usually rises, reducing demand and creating what economists call an "efficiency loss." On a larger scale, raising a country’s overall tax rate could potentially lower its GDP. In extreme cases, higher tax rates might even reduce total tax revenue, as tax collection depends on economic activity. This concept is illustrated by the "Laffer Curve," a theory developed by economist Arthur Laffer. The Laffer Curve shows that when tax rates are low, a small increase has little impact on people’s behavior, such as how much they work, spend, or produce, so tax revenue rises. While tax increases may be unpopular, they can effectively raise more money at these lower levels. However, if tax rates become too high, they discourage economic activity, such as working or investing. At a certain point, raising taxes further reduces total revenue because people and businesses are less motivated to earn or spend. This point, shown as "T" on the curve, is where taxpayers are "on the wrong side" of the Laffer Curve. Neoliberal economic theory argues that lowering taxes creates incentives to work, invest, and grow businesses, leading to higher economic activity—and, in some cases, even higher total tax revenue. THE NEOLIBERAL HYPOTHESIS The neoliberal view highlights the importance of upper-class productivity for economic growth, which is strongly influenced by income tax rates. In progressive tax systems, marginal tax rates for high earners are very high—up to 57% in Sweden, 50% in France, and 45% in Spain in 2016. This reduces the reward for extra work, as nearly half of additional earnings go to taxes. Marginal rates, not average rates, are key to work decisions. High-income earners often have flexibility in their work choices, such as working extra hours or balancing public and private roles. Higher marginal taxes may discourage such effort. Additionally, since top earners often lead businesses, their productivity directly affects organizational performance. Thus, increasing taxes on the wealthy could harm overall economic growth. analyzing the data we evaluate that they don’t support the Laffer Curve, this mainly because of two reasons: tax morale and the different effects of taxes on different groups of the society in particular married woman and people receiving social benefits. TAX MORALE→ Laffer’s theory argues that higher taxes lead to more tax evasion, as people view taxes as a cost without benefit. However, data contradicts this idea. For instance, tax evasion is high in Mexico, where tax rates are low, but relatively low in Spain, where tax rates are higher. This suggests other factors influence tax evasion, one of which is tax morale, the motivation to pay taxes. Tax morale improves when citizens trust their government, see taxes used efficiently, and perceive public services as valuable. In societies with strong democratic institutions and effective public administration, people are more willing to comply with taxes, regardless of tax rates. EFFECTS OF MARGINAL TAX RATES FOR CERTAIN POPULATION GROUPS→ Some economists argue that while reducing overall tax rates usually lowers revenue, certain groups may be "on the wrong side" of the Laffer Curve. Research highlights the impact of marginal tax rates on: ​ Married women: High marginal taxes can discourage participation in the workforce by reducing the financial benefit of working. ​ Low-income individuals on social benefits: Higher taxes or benefit withdrawal reduce incentives to work. ​ Low-income earners in some Latin American countries: High taxes or informal penalties can discourage formal employment.