Public interest theory (economics)
Public interest theory in economics, developed by British economist Arthur C. Pigou, advocates for government regulation through taxes and subsidies to protect the public from market failures and inefficiencies. Central to this theory is the concept of externalities—costs or benefits of economic activities not reflected in market prices. For instance, pollution represents a negative externality, while education can be seen as a positive externality. Pigou suggested that government intervention is necessary to address these externalities, promoting the use of Pigovian taxes to discourage negative behaviors and subsidies to encourage positive actions.
Public interest theory has influenced modern public economics and is particularly favored by socialist and left-leaning policymakers, leading to increased regulation in democratic countries to establish safety standards and control monopolies. However, it faces criticism from proponents of public choice theory, who argue that markets can often self-regulate and that government intervention may exacerbate problems due to issues like corruption and inefficiency. The dialogue between public interest and public choice theories reflects a broader debate about the roles of government and markets in ensuring economic efficiency and addressing social needs.
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Public interest theory (economics)
Public interest theory is a theory of economic regulation developed by Arthur C. Pigou. It holds that regulation in the form of taxes and subsidies is necessary to protect the public from unfair or inefficient market practices. It is also known as the welfare-theoretic theory of regulation.
British economist Pigou made his reputation on his work related to welfare and economics. In his 1932 book, The Economics of Welfare, Pigou lays out the basis of what has become known as public interest theory. Pigou develops his mentor Alfred Marshall's ideas regarding the concept of externalities, which are costs and benefits that are not necessarily experienced by the person taking the action. Pollution is an example of a negative externality, or cost, of some activities. An example of a positive externality, or benefit, is a person becoming more useful to society by gaining education. Pigou argued that the existence of externalities justifies government intervention. He backed taxes on negative externalities to discourage them and subsidies for positive externalities to encourage them. They are known as Pigovian taxes and subsidies. Pigovian taxes, according to many economists, are a more efficient way of dealing with pollution than standards imposed by government.
Background
Since the release of Pigou's book, public interest theory has become a foundation of modern public economics. Socialist and other left-leaning politicians are particularly supportive of public interest theory. Democratic countries have applied this theory in many walks of life and government regulation has increased. Examples include establishing safety standards to prevent accidents, regulating security issuances to protect the consumer, and controlling prices so natural monopolies cannot overcharge. Since the early twentieth century, government regulation throughout Europe and America has grown greatly. During the same time period, these countries have grown substantially richer.
Despite its widespread acceptance, critics of public interest theory abound. The critics—many associated with the Chicago School of Law and Economics—believe that markets and the private sector can handle most market failures without government intervention or regulation. In those cases where markets may not work perfectly, conflicts experienced by market participants can be handled through litigation. Those problems that markets and courts cannot solve perfectly are still preferable than having to deal with government regulators. The critics believe regulation makes things worse because of corruption and incompetence.
The critics say public interest theory exaggerates the extent of market failure and does not appreciate the capability of competition and private orderings—nongovernmental parties voluntarily working together—to handle alleged problems. Critics argue that labor competition ensures good working conditions for employees. Failure to do so would lead to competitors attracting employees with lower wages but better conditions. Private markets also ensure safety levels in products and services because failure in this area means losing market share to competitors. Finally, they believe that if competition forces are not sufficiently strong, private orderings will work to handle possible market failures.
Overview
Public interest theory assumes that markets are fragile and are not likely to operate efficiently if left alone. The belief is that governments can act as a neutral arbiter. For example, governments regulate banks to facilitate their efficient functioning, which proves beneficial for society. The banking system serves the public interest when its resources are allocated in a socially efficient manner. This would maximize output and minimize variance. Ultimately, Pigou believed government regulation should be provided as a response to the public's demand to correct inefficient or unbalanced market practices. Regulation should be for the benefit of society and not for particular or special interests, and the regulatory body operates with this in mind.
A rival economic theory to public interested theory emerged during the 1950s, primarily constructed by James Buchanan and Gordon Tullock. Public choice theory applies the same principals used to analyze individuals' actions in the marketplace and relates them to individuals' actions in making collective decisions. Economists assume that behavior in the private marketplace is inspired primarily by self-interest. Public choice economists say the same drive of self-interest is true in the political sphere. Politicians, bureaucrats, lobbyists, and voters act out of self-interest. Therefore, to count on government action to rein in "market failures" ignores the fact that government intervention often does not bring about its desired effect. Unlike public interest theory, public choice theory does not see government as the answer to economic problems.
Public choice theory further believes voters lack incentives to effectively monitor government and are largely ignorant of political issues other than those they feel directly impact them. This comes about because individuals feel their votes in elections are insignificant, and they have little incentive to become well informed prior to an election. In contrast, individuals feel motivated to be well informed when decisions, such as large purchases, impact them directly. Public choice economists also believe that legislators, though elected to pursue the public interest, are not motivated by efficiency. This is because they are spending the taxpayers' money and not their own. Incentives are ineffective against powerful interest groups that can also provide campaign donations and workers. Ultimately, politicians tend to at least hear out special interests. This combination of legislators' power to tax and voters' lackluster monitoring of lawmakers leads to legislators acting in ways that prove costly to citizens.
The debate between the efficiency of the market and the need for government intervention is longstanding. Each side has its supporters and detractors. The debate over governments' role in the market and smoothing out efficiencies emerges in the United States during political campaigns, particularly presidential election campaigns. While public interest theory and public choice theory are opposites, they can work together. The government can be relied on to handle some functions more efficiently, with public interest at heart, while other functions seem to work best when left to the market.
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