This chapter and the next use the transactions approach to explain the institutional choices the enacting legislature makes when it turns to tax-financed bureaus to supply goods and services or distribute resources. This chapter focuses on the budget. It examines the nature of expenditure control and why so much expenditure is mandated and therefore cannot be changed without a change in the law. Chapter 5 focuses on the employment arrangements in bureaus. It examines the decline of patronage and the emergence and persistence of civil service rules that effectively constrain legislative influence over bureaucrats. It also examines the characteristic features of this merit-based system and explains those features in terms of the approach described in Chapter 2.

Tax-financed bureau production and distribution has a number of distinctive characteristics that help shape the transaction problems legislators face and the potential institutional solutions available. The taxpayers who fund the bureau are a very large group with a relatively small per capita stake in the operation of any particular bureau. The beneficiaries of bureau activity are typically in a similar position. The whole citizenry benefits from the provision of public goods like justice, foreign relations, and defense, from the provision of policy advice and from the maintenance of the social security system. Because private per capita costs and benefits of this production are often very small, there is less incentive for private interests to monitor provision or to participate in agency decision making.

Considerable academic and popular criticism is directed at the way public administration is organized and how it functions. Many claim that the public sector lacks the incentives for effective performance and that there is a disturbing lack of accountability to the elected representatives whom administrators are supposed to serve. Given these common perceptions, it is a real puzzle to find that the administrative arrangements that shape administrators' incentives and determine their accountabilities are so common and so persistent. It is even more of a puzzle given that the lack of any neat separation between policy and administration means that administrative decisions influence policy outcomes. If these arrangements are so bad, why do we find them in so many jurisdictions and why have they persisted for so long? This book develops a theory to explain key institutional characteristics of the modern administrative machinery of government. It is part of a growing appreciation of the role of institutions in both political science and economics.

Just as the private sector includes corporations, partnerships, and non-profit organizations, the public sector is made up of different forms of organization, each with its distinctive characteristics. In the regulatory arena, laws can be administered by the courts, independent regulatory commissions, or executive agencies. When it comes to the production of goods and services, legislators typically turn to tax-funded bureaus with personnel policies determined by civil service legislation. Sometimes, however, they use state-owned enterprises (SOEs), which are primarily funded by sales revenues and organized along more commercial lines.

The previous chapter sought to explain why legislators preferred public to private enterprise in certain, well-defined situations. Public enterprise is not, however, the only alternative. Legislators could have formed a government bureau to provide electricity, gas, rail and air transportation, or telephone and postal services. Although some countries have used bureaus to provide these services during some periods of their history, they are typically provided by state-owned enterprises (SOEs). A complete explanation for the distribution of SOEs must answer this question: If the government does want to own the producer of these goods and services, why does it choose the SOE form of organization rather than the bureau form?

DISTINGUISHING PUBLIC ENTERPRISE FROM BUREAUS

Aharoni suggests that SOEs have three distinguishing characteristics: “First… they must be owned by government. Second,… [they] must be engaged in the production of goods and services for sale… Third, sales revenues of SOEs should bear some relationship to cost” (1986, p. 6). By comparison, Niskanen defines bureaus as “nonprofit organizations which are financed, at least in part, by a periodic appropriation or grant” (1971, p. 15). Nonprofit organizations are defined as those in which neither managers nor owners can appropriate the difference between costs and revenues as personal income. A public bureau is one that is owned by government and is primarily tax-financed.

The Cambridge series on the Political Economy of Institutions and Decisions is built around attempts to answer two central questions: How do institutions evolve in response to individual incentives, strategies, and choices, and How do institutions affect the performance of political and economic systems? The scope of the series is comparative and historical rather than international or specifically American, and the focus is positive rather than normative.

Murray Horn has combined his academic insight and practical experience to fashion a major advance in transactions cost theories of institutional design. He starts with a frequently described situation in which issue complexity and the consequent desire to take advantage of specialization lead representative assemblies to rely on the opinions and actions of bureaucratic agents. Since the exchanges between legislators and their constituents are typically not simultaneous (flows of benefits to legislators are often more immediate than to constituents), he argues that legislators when creating agency missions need to add durability to their deals with forward-looking constituents by protecting the agency against subsequent legislative modification, while protecting themselves against agency actions detrimental to legislative interests.

Horn theorizes that enacting coalitions in this situation design agencies by solving an instrument assignment problem to minimize the transaction costs they face.

This chapter presents the theory that will be used to explain different forms of public sector organization in the rest of this book. It discusses the assumptions that underpin the analysis, the transactions theory that is used to explain institutional choice, and the way that this theory will be applied and tested. It also places the approach adopted here in the context of the relevant economic and political science literature.

ASSUMPTIONS

The key assumptions describe the nature of decision making and the roles and motivations of the three main actors: legislators, administrators, and constituents.

Nature of decision making

Assumptions about the nature of decision making used here are characteristic of most economic literature and of the “rational choice” literature in political science. Decisions are assumed to be made by individuals who act as if largely self-interested and rational in pursuit of this interest.

Self-interest does not imply that individuals do not care for others, but rather that individuals put their own interests ahead of others when these conflict. The implication is that we cannot rely entirely on “good nature” to ensure that individuals act in the interests of others. It is therefore possible to fashion incentives to improve the alignment of individual interests with wider objectives. For example, while people may be attracted to the civil service by a desire to serve the public, they are likely to devote greater effort to this service if they think that increased effort will enhance their chances of promotion.

This chapter uses the approach described in Chapter 2 to explain the administrative choices the enacting legislature makes in the regulatory arena. Regulatory activity has a number of distinctive characteristics that help shape the mix of transaction problems legislators face and the potential institutional solutions available. In particular, the very nature of regulation often allows for direct participation of affected private interests in administrative decision making. The private benefits of this participation are often higher – and the informational costs of effective participation lower – than they are for other forms of public administration. Moreover, there is often a close professional link between public regulatory administrators and private lawyers; indeed, they can work on opposite sides of the same case. This makes it easier for outsiders to judge the performance of individual regulators, which means that the external labor market can exert a strong influence.

Most of this chapter is devoted to the way in which these two influences are used to control various types of agency problem. This does not deny the importance of the different aspects of ongoing legislative intervention that have received so much attention in the literature: legislative oversight, the budgetary process, appointments, and legislative direction. Rather, it helps clarify the role that these various interventions play.

The discussion in this chapter is confined to regulatory agencies in the United States.

Legislators make very deliberate choices about the boundary between private and public sectors and the institutional characteristics of the many different types of organization that make up the modern public sector. They typically take an active and detailed interest in the specific institutional arrangements they will employ in any given situation, like governance, financing, and employment arrangements; the extent to which decision making is delegated to the administrative level; and the procedures governing private participation in this decision making.

The controversy often associated with these institutional issues suggests that much is at stake in how they are resolved. Their importance is demonstrated time and again in those areas where concentrated private interests are affected by a particular piece of legislation. Wider institutional questions can also be among the most important of their time; witness, for example, the controversy in many countries at different times about civil service reform and about nationalization and, latterly, privatization. For many, these institutional questions are the key to determining “who gets what” from legislation.

These decisions are made at the political level and are driven by a common underlying political calculus. Electoral competition encourages legislators to take decisions that will increase their net political support and to protect their preferred policies from administrators and future legislators. It is no surprise that regularities appear in the way legislators draw the boundary between public and private sectors and in the institutional arrangements they impose across the public sector.

This chapter uses the transactions approach to explain the characteristic features of the merit civil service. These features have defined the administrator's conditions of employment in many countries during this century.

The conclusions reached in this chapter will be controversial. It is common for students of public bureaucracy to suggest that its institutional arrangements undermine incentives for bureaucratic efficiency, responsiveness, and accountability. This leaves us at a loss to explain the persistent and widespread use of these arrangements. Part of the problem is that few critics are explicit about the problems these institutional arrangements have been designed to solve: “What” is public bureaucracy supposed to be efficient at doing, and “to whom” is it supposed to be responsive and accountable? It is difficult to believe that institutional arrangements that are so common and persistent are a clearly inefficient way of addressing the problems faced by the legislators who continue to use them. It is more likely that these problems have not been correctly identified.

The transactions approach suggests that civil service arrangements survive because they help enacting legislators solve the transaction problems they face, especially commitment and agency problems. In addressing the agency problem, the enacting legislature will look for arrangements that promote the selection of administrators who have the incentives to administer legislation in the way the enacting legislature intended. In addressing the commitment problem, the enacting legislature will also want administrative arrangements that explicitly limit the extent to which future legislatures can control administrative outcomes.

While the production of goods and services for sale is typically the preserve of the private sector, most countries use state-owned firms to some degree. The appropriate boundary between public and private ownership is often the center of intense political debate, most recently over privatization. The experience with privatization demonstrates that legislators make very deliberate choices in setting this public–private boundary. The controversy that often surrounds privatization and nationalization suggests that ownership matters – indeed, that much is at stake.

It is very difficult to construct a simple explanation for SOEs that captures the great diversity of situations where legislators in different countries, and at different times, have chosen public over private enterprise. Despite this diversity, however, there are some striking empirical regularities. In particular, public enterprises are concentrated in the same sectors – like postal services, railways, telecommunications, electricity, gas, and airlines – across many different countries. There has also been a worldwide move toward privatization since 1980 that stands in marked contrast to the postwar growth in state-owned enterprise. These regularities suggest that not only is the choice of public ownership very deliberate, but also that many of the factors that are important in determining this choice are common to a large number of countries. Country-specific factors may be important in certain circumstances, or at certain times, but any explanation of these regularities has to apply to countries with very different histories, cultures, and ideologies.

This book documents two sets of interrelated changes that have taken place since the early 1980s. One resulted in a dramatic transformation of the international political economy. The political divisions of the world shifted significantly, while economic interdependence increased sharply. The second led to a rapidly growing differentiation among third world countries. The average per capita GDP of the East Asian newly industrialized countries (NICs), for example, now exceeds $8,000, more than that of some European nations. At the opposite extreme, per capita GDP in Sub-Saharan Africa is only around $300, and it has been shrinking for more than a decade. Indeed, the differences are now such that the composite term “third world” has become an anachronism.

The aim of this final chapter is to suggest an approach to specify the causal relationships between the international changes and third world performance. It centers on the role of geography and regions. “Region” is admittedly a vague concept; the geographic boundaries of a region can be drawn or redrawn at the whim of an observer. Nonetheless, geographic location is important because it is associated with shared historical and contemporary experiences. Especially important for our purposes here are links with external actors and processes. The argument is that groups of countries sharing a geographic space will be exposed to international influences through a regional prism. The result leads to characteristics that skew chances of achieving development, defined as rapid economic growth with relative equity of distribution.

As the world watches the horror of endemic violence, state disintegration, refugees, and starvation in Somalia and Rwanda, it is worth noting the more disquieting fact that an increasing number of African states are tottering on the brink, threatening to follow Somalia and Rwanda into the abyss. These now include Liberia, Chad, Zaire, Sudan, Togo, and Angola. Nor is the postindependence record elsewhere encouraging. Previous African “success stories,” like Ivory Coast and Kenya, are now assailed by chronic political and economic problems. Flickers of hope are few, small, and far between – Botswana, Mauritius, and, perhaps, Ghana, Zambia, and Zimbabwe. And, of course, great hopes are held out for South Africa, but it too can be expected to encounter many difficulties on the road from apartheid to a nonracial democracy.

Against this backdrop, economic performance of most African states south of the Sahara in the past two decades gives little cause for cheer, particularly to the ordinary citizens of the region. After registering average annual per capita growth rates of 2.9 percent in the immediate postindependence period (1965–73), the rate has since experienced consistent decline, stagnating at 0.1 percent between 1973 and 1980, and falling by 0.8 percent on average between 1980 and 1992. At best, therefore, most Africans are as poor as they were at independence 30 years ago.