As the good folks in Washington sort through the financial crisis, they want to know what happened and how to prevent it from happening again. What happened is that public choice economics proved to work flawlessly while other theories, about free and efficient markets, fell down on the job. So what is this public choice theory?

It’s a theory dreamed up by James Buchanan, a professor at George Mason University. He won the Nobel Prize for economics in 1986 for “for his development of the contractual and constitutional bases for the theory of economic and political decision-making”.  In simpler terms, he figured out exactly how money and influence work in our political system. His theory, known as public choice, says that those who have a key stake in particular legislation lobby hard for the change they want; the rest of us make the rational decision not to get involved because we really don’t have the time or energy to worry about something like safety considerations for hospital-based x-ray facilities.

Now, of course, we the people have weird issues that will get our dander up. For some, it’s broad things like health insurance reform, but they can also be tiny. Like here’s one: I’m a member of the CFA Institute, and the organization has lobbied hard so that members can be excused from different licensing requirements. To people in the investment business, it’s a huge incentive to taking the CFA exam and paying membership dues. Does anyone else even care? Is it a matter for huge public debate? Probably not. All of these special cases add up and create a system where business regulations are hard to fathom, the tax laws are a mystery, and no one knows what to do when things go wrong. However, those with money and influence know how to work the system to get what they want.

Buchanan’s victory struck a lot of people as odd. (Yes, there are people who follow the Nobel Prizes in Economics, not just me.) First of all, George Mason isn’t a hotbed of economic theory in the way that University of California, University of Chicago, Stanford, and Yale are. Second, Buchanan wasn’t explaining traditional economic activities like inflation, unemployment, or interest rates; he was trying to explain the market for political change. That seemed like an odd use of economics back then, especially because the field was becoming really mathematical.

Public choice isn’t a theory so much as an explanation.  Other economic theories tell people what to do. An economist in the monetarist school would recommend managing the economy through the money supply; the economist’s research would look at the effects that these changes had. But with public choice, we’re left with the explanation but not so much of an idea about how to solve problems or how to measure what happens. Buchanan said that public choice explained why politics failed.

There are two ways to counter public choice. The first is to be a hyper-involved citizen, and that’s hard. We allow regulation to be finely detailed; our development programs are highly specific. If you are in a state capital or in Washington, DC, pay attention to the advertising on local television. It’s often about programs and issues that you never know existed, paid for by a PAC or trade group, urging you the viewer to let your legislator know. That’s to create the illusion that these ads are being run elsewhere.  But they aren’t. They buyer of the ad is hoping that the viewer is a lawmaker or member of a lawmaker’s staff who will be inspired to do whatever it that we the people supposedly demand.

The second counter to the problems of public choice is to reduce the role of the government. That’s less likely, because people want the government to intervene when things go wrong. Whether the hot button is prayer in the public schools or investment advisor registration, someone somewhere wants the government to do something now. Sure, these same people would probably say that they want the government out of their health care or out of the markets or whatever; that’s because human nature trumps political ideology.

About the Author

Ann Logue

Ann Logue is a freelance writer and consulting analyst who is fascinated by business and technology. She has a particular interest in regulatory issues and corporate governance. She is the author of "Emerging Markets for Dummies" (Wiley 2011), “Socially Responsible Investing for Dummies” (Wiley 2009), “Day Trading for Dummies” (Wiley 2007), and “Hedge Funds for Dummies” (Wiley 2006), and has written for Barron’s, Institutional Investor, and Newsweek Japan, among other publications. As an editor and ghostwriter, she worked on a book published by the International Monetary Fund and another by a Wall Street currency strategiest. She is a lecturer in finance at the University of Illinois at Chicago. Her current career follows 12 years of experience as an investment analyst. She holds a B.A. from Northwestern University, an M.B.A. from the University of Chicago, and the Chartered Financial Analyst designation. How's that for deathly dull?

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