Session 5: New Public Management – PDF

Session 5 New Public Management A. State, Society and Market Prof. Govinda Bhattacharjee  Session Structure Social contract between the State and citizens State and the market – market failure and state intervention Increasing Role of the State and Its Eff...

Session 5 New Public Management A. State, Society and Market Prof. Govinda Bhattacharjee  Session Structure Social contract between the State and citizens State and the market – market failure and state intervention Increasing Role of the State and Its Effects New Deal Washington Consensus Structural reforms - withdrawal of the state from market Part I: State and Society  Nature of the State and Public Policy "During the time men live without a common power to keep them all in awe, they are in that condition called Warre; and such a Warre, as if of every man against every man. To this Warre of every man against every man, nothing can be unjust. The notions of right and wrong, justice and injustice have there no place. Where there is no common power, there is no law, where no law, no injustice. Force, and fraud, are in Warre the cardinal virtues. No arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death: and the life of man, solitary, poor, nasty, brutish and short.” - Leviathan, Thomas Hobbes (1651)  State and Individual Liberty State is the most powerful actor in society. State and only the state has unfettered coercive power, can inflict violence to force change in behaviour for collective welfare of society. At the heart of the state, there is violence. Driving, lockdown, respect for law Collecting taxes Infringing upon individual liberties In India government runs temples, restaurants, banks, railways and until recently airlines Sometimes they do it pretty well Amma canteens, Kumbh melas, elections Societies that value individual freedom can best harness the energy of their people. Most prosperous countries are liberal democracies. Liberal democracies limit the state violence in a controlled, predictable and just manner. They also build trust in society.  Social Contract between State and Citizens The state of nature was one in which there were no enforceable criteria of right and wrong and human life was “solitary, poor, nasty, brutish and short”. It was a state of war, which could be ended only if individuals agreed (in a social contract) to give their liberty into the hands of a sovereign, on the sole condition that their lives will be safeguarded by sovereign power, whose authority is absolute, and whose will is law. Social contract is an implicit (or explicit – Magna Carta) agreement between the ruler and the ruled defining the rights and duties of each. In primeval times individuals were born into an anarchic state of nature. They then, by exercising natural reason, formed a society (and a government) by means of a social contract. The social contract allows individuals to leave the state of nature and enter a civil society. Power of Leviathan (the political state) is uncontested, and its collapse, though very unlikely, occurs only when it is no longer able to protect its subjects. In a democracy, the ruler will rule by the consent of the ruled till that consent is withdrawn due to its non-performance. Performance will be measured by the success of the public policies framed and implemented by the ruler. State has to ensure fundamental rights and liberties along with justice for all citizens and provide basic public goods and services, ensuring a basic minimum standard of living for all, failing which citizens will overthrow it peacefully, or otherwise. Citizens will pay taxes and abide by the law.  Social Contract in Modern Times State has to step in to alleviate people’s sufferings. New Deal, domestic program of the administration of U.S. Pres. Franklin D. Roosevelt between 1933 and 1939, which took action to bring about immediate economic relief as well as reforms in industry, agriculture, finance, waterpower, labour, and housing, vastly increasing the scope of the federal government’s activities. The term was taken from Roosevelt’s speech accepting the Democratic nomination for the presidency on July 2, 1932. Reacting to the ineffectiveness of the administration of Presisenr Herbert Hoover in meeting the ravages of the Great Depression, American voters the following November overwhelmingly voted in favour of the Democratic promise of a “new deal” for the “forgotten man.” Opposed to the traditional American political philosophy of laissez-faire, the New Deal generally embraced the concept of a government-regulated economy aimed at achieving a balance between conflicting economic interests. Great depression was ended by applying Keynesian countercyclical policies on the demand side. An overreach of public policy is social engineering. When a government tries to redesign society to create a new man, this is overreach. We know too little in order to safely meddle into human society in most areas other than market failures. Example: China’s one-child policy, demonetization.  Keynesian Economics The British economist John Maynard Keynes (1883–1946), accepted the capitalist market as the only reliable agency for generating wealth and its regulation by macroeconomic means as the best prescription for correcting the distortions caused by the market for creating the conditions for full employment. Keynesian economics is based on the simple premise that aggregate demand - the sum total of spending by households, businesses and government - is the major driver of economy. Recession and unemployment are caused only by inadequate demand. Aggregate demand can be boosted only through purposeful government intervention in public policies in order achieve price stability with full employment. Further, the fiscal policy of the government should be countercyclical, so that during the boom times, government needs to intervene to moderate the impact high growth by increasing taxes (Fiscal policy) and arrest high inflation (Monetary policy) when the growth is demand-driven. During economic downturns, Keynesian prescription is to increase government spending, especially on labour-intensive infrastructure projects to increase employment. 8  High Growth and Keynesian Economics Between post-War years, that is from the mid-1940s to early 1970s, when Keynesian ideas were applied by West European economies, they experienced prolonged periods of economic growth averaging nearly 5 percent, accompanied by continuous improvement in the living standards of people. As higher budgets were being allocated to welfare expenditure, focus was turned towards efficient delivery of the welfare services, like education, healthcare, social security etc. The Nordic countries followed a model of high level taxes combined with efficient delivery of public goods and services at a very affordable cost. Successes following from these policies pushed social democracy in these countries to pursue the goals of social reform with ever more vigour and to integrate welfare as one of its abiding principles to reduce inequality and improve the lot of the working classes, while still retaining the capitalist structure of the economy. The sectors identified as vital for attaining the welfarism objectives were increasingly brought under government control. This process culminated in creation of a public sector, following from Keynes’s ideas of government intervention in the economy. Failure of Keynesian Economics: 1973 Arab-Israeli War, the price of oil quadrupled from $2.90 a barrel before the embargo to $11.65 a barrel in January 1974. NPM became the new mantra of governance. 9  Neo-liberalism Neoliberalism refers primarily to the 20th-century resurgence of 19th-century ideas associated with laissez-faire economic liberalism. Those ideas include economic liberalisation policies such as privatisation, austerity, deregulation, free trade and reductions in government spending (Washington Consensus) Increased role of the private sector in the economy and society These market-based ideas and the policies they inspired constitute a shift away from the post-war Keynesian consensus which lasted from 1945 to 1980. New Concepts Minimal state: Minimum state intervention in delivery of public services, Rightsizing of Government and Private sector participation through various mechanism NPM and NGM Good Governance  Washington Consensus The term “Washington Consensus” comes from a simple set of ten recommendations identified by economist John Williamson in 1989: 1) fiscal discipline; 2) redirecting public expenditure; 3) tax reform; 4) financial liberalization; 5) adoption of a single, competitive exchange rate; 6) trade liberalization; 7) elimination of barriers to foreign direct investment; 8) privatization of state owned enterprises; 9) deregulation of market entry and competition; and 10) secure property rights. It was based on a firm belief in the market’s “invisible hand,” the rationality of economic actors’ choice, and a minimalistic vision of the states’ regulation of economies. The Washington Consensus’ recipes were prescribed as universal and equally applicable to both developed and developing countries, even if it caused uneven terms of trade for the latter. 11  Washington Consensus and Dependence of Developing Countries on External Loans The Washington Consensus has resulted in structural reforms, with the goal of making developing countries more competitive. The three main thrusts of these reforms have been the deregulation of domestic markets, the privatization of public firms, and the liberalization of trade and financial flows. These policies were applied for more than two decades in Africa, Latin America and Asia, and in countries emerging from Soviet control in Eastern Europe and Central Asia. There were usually two major stages of intervention: (1) macroeconomic stability and structural adjustment programs, and (2) improving institutions, reducing corruption or dealing with infrastructure inefficiency. The conditionality exercised by IMF/WB forced the indebted countries to push through macroeconomic stabilization reforms and structural adjustment programs. The debt crisis in Latin American, African and Asian countries in the 1970s and 1980s further increased their dependence on external loans, leaving them no other option than to follow the prescriptions that enabled them to access financing. 12  Disastrous Consequences Structural adjustment (SAP) and macroeconomic stabilization programs had a disastrous impact on social policies and poverty levels in many countries. The first wave of reforms undertaken by debt-affected African and Latin American countries – which included public expenditure cuts, introduction of charges for health and education, and reductions in industrial protection, led to high unemployment, poverty rise and unequal income distribution. Even UNICEF’s report Adjustment with a Human Face (1987) called for “meso-policies” to be redirected towards protecting social and economic sectors that were essential to the survival of the poor, through the introduction of social protection programs. But in the developed world and many middle income countries, it led to rapid economic growth, especially during the fist decade of the 21st century, accompanied by expanding trade and investment, offsetting the worries of the financial markets which ignored the signs of the impending storm. In 2008, massive and uncontrolled financial speculation would produce the worst global economic crisis since the Great Depression, revealing a number of structural “diseases” that the Washington Consensus just ignored. 13  Growing Income Inequality The Washington Consensus has been compared to a Shock therapy- that sudden, dramatic changes in national economic policy can turn a state-controlled economy into a free-market economy. The general consensus among economists is that it has failed. Domination of the financial sector over the real economy had led to the creation of bubbles, unpredictability for the future of economies, and increased vulnerability of populations, simultaneously increasing unequal income distribution and widening gap between rich and poor. It called into question the prevailing economic theories that served as a basis for formulating policies by the Bretton-Woods institutions at global level, in particular structural adjustment programs. There is now more awareness of growing inequalities and the scandalous concentration of income – with the richest 20% getting 83% of the global income. In the current structure of power, economic growth, even when generated by technological innovation, benefits the financial intermediaries that pursue short-term maximization of profits rather than any long-term growth process. 14 Part II: State and Market  Public or Social Goods A social good or common good, is something that benefits the largest number of people in the largest possible way, such as clean air, clean water, healthcare, education, etc. Social good creates a positive impact on individuals and society. Unlike private goods, their use must not be restricted and government interventions are often needed to make them available to all at affordable costs. Once produced, they can be consumed by another individual at no additional cost – consumption by one does not decrease its availability for others - Non-Rivalrous. Also Non- Excludable – consumption by one does not result in excluding others like the private goods. Differentiating between private and public goods may pose challenge, their status may also change over time. Private goods are generally produced more efficiently by the private sector Excludable Non-excludable Rivalrous Private goods –food, clothing, cars, Common pool resources, fish, drinking furniture, etc. water Non-rivalrous Club goods, Cable TV Public goods - Roads, street lighting, national defence, clean air  Merit and Demerit Goods Merit goods are thought to be 'good' for society, but unlike public goods they can be provided by the private sector. The problem is that if they are provided solely by the private sector, then they tend to be under-consumed. Market cannot correct this, and the government has to step in to correct the market failure in this regard. Examples of merit goods include education, health care, welfare services, housing, fire protection etc. In contrast to pure public goods, merit goods could be, and indeed are, provided by the market, but not necessarily in sufficient quantities to maximise social welfare. Demerit goods are thought to be 'bad' for society, e.g. alcohol, cigarettes. If left to the free market, the market fails because these goods tend to be over-consumed. Again, the government must step in to stop this over-consumption by imposing heavy taxes to reduce consumption. But these goods have highly inelastic demand, the fall in demand is small relative to the tax rise. While merit goods provide positive externalities that the government wanted to encourage, demerit goods cause large negative externalities that the government wants to discourage. The additional costs of demerit goods include increased crime and reduction in labour productivity, which is bad for the economy as a whole.  Allocation of Resources for Public Good Public good is for collective consumption. As different individuals have different preference for a public good, decision making for collective consumption of a public good is not easy. Demand for public good differs in terms of preference, income and taxes. The rich consume more public and private goods, but if more provision of public good increases their taxes, then they may want lower level of public expenditure. The critical difference between public and private resource allocation is that in case of private good, the decision maker knows his preferences, but for a public good, the decision maker has to ascertain the preferences of those on whose behalf he is making a decision. Collective decision-making rule helps us in deciding which goods are to be provided in the public sector and what taxes are to be imposed. Such a decision affects the individual’s welfare (W) which depends on the distribution of utilities in the community. This, in turn, depends on the allocation of resources, goods and services. Bowen’s Model  State and the Market When should the state intervene and formulate a public policy? “The important thing for government is not to do things which individuals are doing already and to do them a little better or a little worse, but to do those things which at present are not done at all.” - John Meynard Keynes State should intervene only when there is a market failure. Market failure occurs in four situations: Absent markets Externalities Asymmetric information Market power Public goods Externalities occur when people impact upon each other in ways that are not negotiated through a market process. Pollution emitted by a factory (Negative externality) Setting up a university, creating a biodiversity park (Positive externality)  Modes of Government Intervention Legislation and regulation Direct provision of goods and services Fiscal policy intervention Through budget, by revenue, expenditure and borrowing policies Direct and indirect taxes Subsidies to lower the price of merit goods Welfare payments and taxation to redistribute income and wealth Other interventions Import and export policies Non-tariff barriers: Quotas, embargoes, sanctions, levies etc. Price support and income support Price caps and production quotas Contracting preferences  Wagner’s Law of Expanding State Activity Behavioural Theory of Government Expenditure – Adolf Wagner, 1890, 1893 As the economy grows over time, the activities and functions of the government increase automatically due to an inherent tendency for expansion of its activities - both intensively and extensively. There is a functional relationship between the growth of economy and government activities, with the result that government sector grows faster than the economy. Thus Government expenditure G is an exponentially increasing function of the national income Y; or, G = f(Y) = G= αYβ : α and β are growth parameters defining the nature and shape of growth.) 22 Empirical Evidence of Wagner’s Law 23  Empirical Evidence of Wagner’s Law in the Indian Context Govt. Expenditure Vis-a-vis GDP Growth rate (%) 40 Avg. GDP Avg, Govt. Avg. Fiscal 35 Growth Exp as % of Deficit 30 Rate GDP Ratio 25 1970 3.08 18.14 4.21 20 1980 5.56 22.76 6.76 15 1990 5.59 23.82 5.50 10 2000 7.41 34.12 4.69 5 2015 6.74 35.79 4.62 0 1970 1980 1990 2000 2015 Growth Rate Govt. Exp as % of GDP 24  Wagner’s Squared Hypothesis Based on US data, Buchanan and Tullock (1977) related public expenditure to the output of public goods alone and observed discrepancies between the growth of expenditure and the growth of output. They termed the phenomenon as “Wagner Squarred”. Major reasons are twofold: More rapid growth of expenditure on administration (i.e. on civil servants) than that on the output of state activities; Increasing proportion of population covered by social security and other transfer payments. Limitation: Output of civil servants cannot be measured with any degree of accuracy. Peacock gives an alternative explanation: An individual does not relate his tax payments with the receipts of government services, but strives for additional benefits from making government services and not for reducing taxes. The politicians, to win their votes, try to expand government services and therefore impose more taxes. The government expenditure keeps on increasing without any reference to the productivity cost of government services. 25  Positivist Theory of Displacement During the 1950s and 1960s, empirical studies made international comparisons in expenditure growth. The results showed that increases in public expenditure during wartime exceeded the limitation on taxation, leading to higher postwar civilian expenditures. This increase in expenditure would have a displacement effect, a concentration effect, and an inspection effect. The displacement effect primarily consisted of shifting public revenues and expenditures to new higher levels, where they would be accompanied by changes in the relative importance of central and local governments, with the former assuming new functions and taking over functions of the latter (concentration effect). Simultaneously, these shifts would force the attention of governments to problems of which they were formerly less conscious (inspection effect). A full understanding of government expenditures and their growth over a period of time requires a greater recognition of social and political factors. Studies showed that five set of factors — environmental, technological, economic, political and administrative—influence the growth of public expenditure. A fiscal crisis would emerge from time to time because of the tendency of expenditure to outstrip revenues. 26  Peacock-Wiseman Displacement Theories More recent studies by Peacock & Wiseman (UK, 1967), Fabricant (US, 1952) have revived interest in the determinants of public expenditure. Peacock & Wiseman showed that govt. expenditure in UK (1890-1955) grew not at a uniform rate but in punctuated steps and the movement from one step to the other coincided with the two world wars. G= α (1+δ) Yβ where δ is the increase in the level of govt. expenditure during and after the war or other calamities. G Y 27  Causes and Effects of Increases in Govt. Expenditure Colin Clark’s Critical Limit Hypothesis When the share of the government sector exceeds 25 percent of the total economic activity of the country, inflation occurs even under a balanced budget. As government’s share of the aggregate economic activity reaches the critical limit of 25 per cent, the firms affected by reduced incentives (due to high tax incidence) suffers from lower productivity. They produce much less than what they are capable of, leading to a curtailed supply and hence inflation even under a balanced budget which otherwise restricts demand. Baumol’s Cost Disease: Govt. may not be productive but yet in response to wage increases in the private sector is forced to hike up the salaries even though there is no increase in productivity, unlike the private sector. This leads to growth of govt. expenditure. Leviathan Theory: Governments try to get as much control over the economy (and on the lives of their citizens) as possible. Increases in government spending would necessarily lead to increase in government size: Rise in protective and administrative services: security, defence, tax administration; welfare expenditure, empire building view of bureaucrats: Taking over private industries, not always for reasons of inefficiency; Higher cultural and welfare services: Sports, old age pension and social security, subsidy Red Queen Effect Cage of Norms Thank You