Bureaucrats and Public Goods

Bureaucrats and Public GoodsAuthor(s): Walter HettichSource: Public Choice, Vol. 21 (Spring, 1975), pp. 15-25Published by: SpringerStable URL: http://www.jstor.org/stable/30022795 .

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2

Bureaucrats and Public Goods

WALTER HETTICH

Ever since Anthony Downs published his pioneering work on political action in a democracy, it has been widely acknowledged that assumptions about maximiz-

ing behavior can successfully be extended to the public sector. In 1975, eighteen years later, the student of public economics can draw on a large and rapidly growing literature dealing with voters, politicians and bureaucrats whose behavior is

analogous to that of maximizing consumers, resource owners or producers in models of the private sector. Those who have followed the development of this literature will be aware, however, that it still lacks integration. Voters or their

representatives seldom appear together with bureaucrats in the same article. As a result, the production of public goods fails to be considered in most models of

output determination. In much of the recent literature on public choice, the median voter is king and the bureaucrat remains his largely invisible servant.

In his recent book, Bureaucracy and Representative Government, William Niskanen [1971] attempts to remedy the situation. While much of the book is devoted to what may be called the theory of the bureau as a firm, Niskanen

proceeds in later chapters to combine his conclusions on production with those of a

rigorously formulated model of the demand for public goods. On the demand side, he goes beyond the common median voter model, describing a process of government by legislative committee which leads to quite different and novel results.1

Although Niskanen considers both the demand and the supply side, he does not use the integrated analysis throughout the book. In this paper, we show that some of his conclusions cannot be sustained if this is done. A simple diagrammatic

*Charleston University, Ottawa 1Niskanen's work on the economics of bureaucracy does, of course, not stand alone.

Similar ideas can be found in Tullock [1965]. Niskanen is the first to develop a fully formalized model, however.



16 PUBLIC CHOICE

analysis is developed and used to demonstrate that bureaus do not necessarily produce too much output. In addition, we make some critical remarks on Niskanen's treatment of mixed bureaus.

I. Efficiency of Resource Use

Niskanen is interested in the influence of bureaucratic decision making on the

efficiency of resource use. He approaches the question through a comparison of

organizational forms.2 Output decisions of bureaus are contrasted with those of

monopolies and competitive industries. The rather lengthy analysis can be sum- marized with the use of Figure 1. DD' represents the demand and AC the average cost curve faced by all three organizational forms. The bureau, however, is able to

appropriate its sponsor's consumer surplus. As a result, it looks upon DD' as its

marginal budget curve. Average budgetary revenue is shown by line DR. Since Niskanen specifies that bureau production cannot exceed OD', DR has been drawn as a solid line up to point G and as a broken one beyond G.

Given the assumptions of Niskanen's model, the bureau will produce QB' setting average budgetary revenue equal to average cost.3 If it also succeeds in

appropriating producer surplus, it will produce Q'. The competitive industry, on the other hand, will generate QB with marginal cost (MC) equal to average revenue

(DD'), while monopoly production will amount to Q M4 Since the monopolist sets

marginal revenue (DM) equal to marginal cost, he will have the lowest output among the three. One may note that Figure 1 implies a cost-constrained solution for the bureau. The diagram could easily be redrawn, however, for an average cost curve intersecting DR below point G. The bureau would then produce OD' while

output for the other organizational forms would be derived as before and with

analogous results.5 The analysis presented in Figure 1 leads to the conclusion that bureaus

produce too much. Output by the competitive industry provides the reference

point, being the economically efficient level of production. Monopoly output is, not surprisingly, too small. If we assume the simplest possible case, where the

2Niskanen, Bureaucracy and Representative Government, Ch. 7.

jThe algebraic formulation of the model consists of a total budget function (B), a total cost function (C), and a constraint. Niskanen uses the following expressions:

2 a B = aQ- bQ , O <Q <b

2 C = cQ + dQ2, O < Q B '> TC

See Ch. 5. DD' in Fig. 1 should be regarded as the bureau's marginal revenue curve. DR is the average revenue curve associated with DD'

4QC is the short-run output of the competitive industry. In comparing organizational forms, Niskanen switches the argument to the long run, however, arguing that AC would be the long-run supply curve for a group of competitive firms. As a result, he determines competitive output by setting AC equal to DD' (p. 60). He gives no reasons as to why long-run average cost for the competitive industry should increase rather than be constant. Furthermore, there is no discussion up to this point in the book of long-run decision-making.

5In this case, there is "fat" in the bureau, i.e., both economic and technical inefficiency are involved.



BUREAUCRATS 17

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18 PUBLIC CHOICE

average cost curve is horizontal and intersects DR above point G, a bureau which does not discriminate in factor markets will produce exactly twice the optimal output. (The monopoly will produce one-half of it.)

Niskanen places considerable emphasis on the conclusions derived from comparing organizational forms. Some probing of implicit assumptions raises questions about the validity of the analysis, however. Problems would seem to arise on two accounts. On the cost side, one may question whether it is legitimate to assume that different organizational forms face the same average cost curve. On the demand side, the problem is similar but more involved. It is far from clear that DD' is the relevant demand curve for the discussion of optimal output.

In the analysis presented so far, no explicit distinction between short and long run has been made. The distinction becomes important, however, if it can be argued that bureaus make long-run decisions which differ from those of profit- maximizing firms. Niskanen advances such an argument. Bureaucrats will be short- sighted in making capital expenditure decisions because of limited tenure in office.6 In attempting to maximize budgets during their period of tenure, they will favor projects with a rapid pay-back over projects that yield returns further in the future. If this is the case, bureaus must have higher long-run average cost than profit- maximizing firms. On the other hand, their short-run average cost may be higher or lower at any point in time.7

In analyzing the demand side, one must inquire into the demand mechanism. In the review committee system, developed by Niskanen, bureaus determine maximum obtainable budget on the basis of the median legislator's tax share and his demand curve. As a result, their estimate of total demand does not coincide with aggregate demand for the good by all legislators in the system.

The point at issue may be understood more easily with the help of Figure 2. The diagram contains three demand curves, labelled dLd, dMd, and dHd. Since we are dealing with a public good, total demand is equal to the vertical summation of individual curves (indicated as Dd). According to the competitive rule for output determination, optimal production for the system is QO where marginal cost interects aggregate demand.

The bureau sees the situation differently. In the review committee system, Dd is not relevant for decision making. Starting from the median legislator's tax share and his demand curve (dMd), the bureau constructs BB', the average budget curve. Since budget proposals must be approved by at least two of the three decision makers in the model, assent of the median demander will be required. He will just be indifferent if he is equally well off with, or without, provision of the good. He reaches a position of indifference when his tax contribution for the service equals the area under his demand curve up to the point of production. The median demander's maximum tax payment will thus correspond to the area under dMd. His average tax payment can be shown by drawing a straight line connecting the points dM and B'. (One may consider dMd his marginal tax curve having an average tax curve associated with it.) In order to derive the average budget line for the bureau

6Niskanen, Bureaucracy and Representative Government, Ch. 12. A very similar argument has been advanced by Louis DeAlessi [1969].

7Comparison of short-run cost raises conceptual problems since assets with unequal service lives and different patterns of depreciation may be involved. Results will depend on the time period specified for comparison.



BUREAUCRATS 19

(BB'), we need additional information on the division of the tax burden among the three individuals. In Figure 2, it has been assumed that the total cost of the bureau's operation is shared equally among the three individuals.8 The distance OB is therefore equal to three times OdM. The line BB' corresponds, of course, to DR in the first figure. It should be noted that the analysis abstracts from income effects which are not incorporated into the diagram or into Niskanen's algebraic analysis.

Figure 2 also shows d d, the demand schedule for the high-demand individual. It is the latter with whom the bureau must deal directly since he embodies the review committee in the simplified model'with three legislators. With

average cost as indicated, the output solution is cost-constrained. The bureau will

propose to produce QB and request a total budget of QB times AC. The review committee will support the request. While it would have preferred output Qf, it knows that Qg represents the largest output that will be approved by the legisla- ture.9 The case depicted in Figure 2 has an interesting aspect with regard to resource allocation. The bureau produces too little; its output lies below the

"optimal" amount-i Q0O. The reader will realize that this is not a necessary but

merely a possible outcome of the analysis. Other diagrams yielding QB > Q can

readily be devised. It shows, however, that a comparison of organizational forms may be an uncertain guide to the effects on resource allocation.

So far, the discussion has been carried on strictly within the limits of Niskanen's model. It should be pointed out, however, that the review committee model is at best an incomplete depiction of the political process. Legislators must be elected by citizens. Thus we must ultimately ask how Dd, the aggregate demand curve in Figure 2, compares to the total demand of all citizens. It is likely that the electoral process will have its own peculiar impact on the aggregation of demand within each district.10 Output QO in Figure 2 could thus be both above or below

economically efficient output in a more completely specified system. In the absence of a theory about how the demand for public goods is revealed through the electoral process, optimality must remain an elusive concept.

8The analysis assumes a fixed tax-sharing arrangement and public goods, Bureau and review committee cannot collude to provide better service to the high demander than to the others since all must consume output equally by assumption.

The degree of "exploitation" of the median and low demander is closely linked to the tax-sharing arrangement. If HIGH must bear a very large proportion of costs, situations may arise where he desires a lower output than MEDIAN or LOW. Niskanen offers no theory of how tax-sharing arrangements are arrived at. In a more general framework, the median and low demanders could presumably protect themselves against exploitation through the choice of an appropriate sharing agreement.

9QH is determined by drawing in the tax curve for the high demander which will intersect his demand curve at point R.

10In his review of Niskanen's book in Public Choice (Spring 1972), Tullock argues that the owners of factors hired by the bureau will increase the demand for the bureau's output through political action. He does not supply a theoretical model, but provides only a suggestive discussion in order to back up his contention. A more systematic examination of his hypothesis would require a well-defined model of the electoral process.



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BUREAUCRATS 21

II. Mixed Bureaus

In Part IV of his book, Niskanen subjects the basic model of a bureau to several variations. The extensions are made by introducing minor changes in assumptions about the operation of bureaus. Niskanen does not alter his assumptions about the nature of output-bureaus continue to produce only public goods.

The so called mixed bureau is perhaps the most interesting variation on the basic theme.11 This organization sells its output both to a sponsor and, at a price, to consumers in the market. Two separate demands are thus relevant for decision making. Output will be set so that the sum of total budget and sales revenue is maximized. As before, the bureau is constrained by a no-deficit rule.

The behavior of mixed bureaus can be analyzed with the help of Figure 3. Questions regarding the demand mechanism are set aside for the moment and it is assumed that the bureau can exercise perfect discrimination against the sponsor. DR in the lower diagram represents the average budget line, derived from the sponsor's demand, Market demand, shown separately in the upper right-hand corner as MA, has been added vertically to DR in the main figure, resulting in the composite kinked average revenue curve. Bureau output can be determined if the latter is combined with various possible average cost curves. Assume first that the bureau faces AC1. It will set output at Q , charging the sponsor Q1W per unit while selling the same units at WN in the marklet. If average cost should amount to AC2, on the other hand, the bureau will produce Q2. In this region, maximum combined revenue is obtained where the first segment of the kinked average revenue curve has an elasticity of one, i.e., at point G1. The next average cost curve, AC3, yields an output of Q3. Here, only the sponsor is charged. (Total budget OQ3PS must, of course, exceed OQ2G1L. Otherwise, the bureau will continue to produce Q2.) The final average cost curve, AC4, will result in Q4, the output associated with the largest possible budget that can be achieved.

What conclusions can be drawn from Figure 3? Niskanen interprets the analysis as a further indictment of bureaus. He points out, for example, that a situation where average cost equals AC1 would result in no production if demands remained separated.1 Up to Q "the output of a mixed bureau is much larger than would be supplied if the sponsor and customer demands were not combined."13 Analysis of the remaining output regions results in long and cumbersome algebraic expressions yielding no conclusions of equal simplicity.

11Niskanen, Bureaucracy and Representative Government, Ch. 10. 12Niskanen, Bureaucracy and Representative Government, pp. 88-89. Niskanen uses a

total budget function derived from the sponsor's demand, a demand function for market customers and a total cost function of the following kind:

B= Q- blQ , a0 <Q < 1

a2 P = a2 - 2bQ 0 < <

2 2 2b

TC = cQ + dQ2, 0 < Q He then says, "If both al and az are less than c, but (al + a2) is larger than c, the output of this service would be zero unless the sponsor and customer demands were combined." The sentence forms part of an argument that bureaus produce too much (p. 89).

13Ibid.



22 PUBLIC CHOICE

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BUREAUCRATS 23

Niskanen comes to the general assessment, however, that mixed bureaus are

nonoptimal forms of organization and that goods and services which can be marketed should be supported by per unit grants on the part of collective sponsors rather than by total budget grants. Niskanen supports this conclusion by a comparison of organizational forms similar in character to the one already discussed.

While bureaus may be the villains of the piece, they should get a fair trail in court. In his analysis of mixed bureaus, Niskanen seems to forget the implications of one of his major assumptions. Mixed bureaus produce public goods, i.e., goods which are consumed equally by all. If both sponsor and customers in the market consume the same output, their demands must be combined (added vertically) in order to determine the economically efficient output. The relevant basis for

comparison in Figure 3 when cost conditions are represented by AC1 is not a situation where the two demands are kept separate. The case where market demand is combined with the sponsor's average budget curve must be contrasted with one where MA is added to the sponsor's demand curve. 14 If this is done, output, while

being smaller than Q1, will be greater than zero. Bureaus combining production for a budget with sale in the market are of

considerable interest for the understanding of the real world. An analysis which restricts them to the production of public goods can yield only limited insights, however. In reality such bureaus produce mostly goods of mixed or even purely private character. Admission of such goods into the model would complicate the

analysis since vertical addition of demand curves is no longer legitimate. Niskanen does not deal with this problem; in his algebraic treatment, demand curves are

simply aggregated vertically. The conclusions of his chapter on mixed bureaus come as something of a surprise therefore. It seems dubious that pure public goods could be supplied on the basis of a per unit subsidy arrangement. It is also telling that his

examples of goods that could be so financed fall clearly into the mixed or private category.

III. Conclusion

Niskanen's discussion of bureaucratic behavior must be faulted in an important respect. In introducing and elaborating the model, he fails to devote sufficient attention to the sponsor's motivation and decision making. Niskanen assumes that bureaus are able to appropriate the full consumer surplus of their sponsor but does not offer any convincing reason as to why a bilateral bargaining process should have

such a one-sided outcome. When the demand mechanism is introduced in the second half of the book, the reader discovers that the review committee system

provides one possible justification for the initial assumption. The analysis also

implies, however, that the bureau's position depends on the political mechanism

through which demand is expressed. Legislatures with review committees are only one such mechanism among many possible ones. Unless a particular system is

specified, the bargaining range between sponsor and bureau cannot be properly defined. While review committees may allow the bureau to appropriate consumer

surplus of the median demander, there are other systems precluding such exploitation. It seems most unlikely, for example, that bureaus could get away with

14The sponsor's demand curve is not shown in Figure 3. It would be a straight line connecting points D and

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24 PUBLIC CHOICE

perfectly discriminating behavior in a referendum setting such as has been used in the recent literature for the analysis of public education.15

The demand mechanism must also play a role in the discussion of economic efficiency. Given a review committee system, bureaus will estimate their budgets on the basis of the median legislator's demand and tax share. "True" demand, on the other hand, consists of the -sum of all individual demand curves in the system, thus being unrelated to the budget curve. Once this is recongized, Niskanen's most popular and widely cited conclusion is no longer logically necessary. While bureaus

may produce too much, one can also imagine situations where they produce too little output in relation to efficiency norms.

The review committee system is an interesting addition to the literature on public choice. One should recognize, however, that Niskanen deals only with a part of the political process. Legislators are elected by voters who must be considered the final consumers of the bureau's output. They attempt to express their demand by casting votes for political representatives. Niskanen develops no analysis of the electoral process but starts his discussion directly with the representatives and the demand that they express. A more comprehensive theory would have to include voter action as an integral part.

A final criticism relates to Niskanen's assumptions regarding the character of publicly produced output. In his treatment of the demand side, he consistently sticks to public goods which are consumed equally by all. While the assumption simplifies his algebraic models, it also limits the range of admissible conclusions. It has been shown in the discussion of mixed bureaus that Niskanen is not always aware of what pure public goods imply for the analysis. Given the narrow concept of output, one should hesitate to draw conclusions about actual situations from his model of mixed bureaus.

Niskanen's work opens up several areas for further research. Of particular interest is the investigation of alternatives to the review committee system. The relation between bureau and sponsor should be studied in different political models and under different assumptions about the aims of the main participants. The analysis could also be extended by the introduction of mixed and private goods and by specific assumptions about their availability in the private sector. Finally, the model can be used to study the distributional consequences of various tax-sharing rules and to derive predictions with regard to the treatment which different groups may expect from bureaucratic producers.

Gordon Tullock has pointed out how Niskanen's approach to bureaucracy differs from that of the Wilsonian tradition, which has so far dominated public administration.16 One can agree with his wish for a revolution in the literature on bureaucratic institutions along the path opened by Niskanen. If successful, such a development would finally integrate the theory of public demand and public production. Niskanen's book is a first and much needed step toward that goal.

15See, for example, Robin Barlow, "Efficiency Aspects of Local School Finance," Jour. Pol. Econ., 78 (Sept. -Oct. 1970), and the "Symposium on Efficiency Aspects of Local School Finance" in the Jan. -Feb. 1973 issue of the same journal.

16See his review of the book in Public Choice (Spring 1972), p. 120.



BUREAUCRATS 25

REFI E EN CES' 1. DeAlessi, Louis. "Implications of Property Rights for Government Invest-

ment Choices." Am. Econ. Rev., 59 (March 1969), 13-24. 2. Niskanen, William A., Jr. Bureaucracy and Representative Government.

Chicago and New York: Aldine-Atherton, 1971. 3. Tullock, Gordon. The Politics of Bureaucracy. Washington, D. C.: Public

Affairs Press, 1965.



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Bureaucrats and Public Goods