When Ideas Trump Interests: Preferences, World views, and Policy Innovations; Dani Rodrik (2014)

Journal of Economic Perspectives—Volume 28, Number 1—Winter 2014—Pages 189–208

This page is a work in progress. It contains a selection of extracts from Dani Rodrik’s paper. Highlighting the role of ideas as well as self interest is I think an important point but I need to do more work to properly process and comment on it.

Ideas are strangely absent from modern models of political economy. In most prevailing theories of policy choice, the dominant role is instead played by “vested interests”—elites, lobbies, and rent-seeking groups which get their way at the expense of the general public. Economists, political scientists, and other social scientists appeal to the power of special interests to explain key puzzles in regulation, international trade, economic growth and development, and many other fields.

Any model of political economy in which organized interests do not figure prominently is likely to remain vacuous and incomplete. But it does not follow from this that interests are the ultimate determinant of political outcomes. Here I will challenge the notion that there is a well-defined mapping from “interests” to outcomes. This mapping depends on many unstated assumptions about the ideas  that political agents have about: 1) what they are maximizing, 2) how the world works, and 3) the set of tools they have at their disposal to further their interests. Importantly, these ideas are subject to both manipulation and innovation, making them part of the political game.

While hidden assumptions play a role in all economic models, I will argue that the failure to recognize the role of ideas in shaping interests (and their pursuit) the failure to recognize the role of ideas in shaping interests (and their pursuit) has especially serious implications in political economy.

The paper

  • begins by providing a taxonomy of the ways in which ideas make their way, more often than not implicitly, into established models of political economy.
  • focuses specifically on models professing to explain economic inefficiency and argues that outcomes in such models are determined as much by the ideas that elites are presumed to have on feasible strategies as by vested interests themselves.
  • discusses how new ideas about policy—or policy entrepreneurship — can exert an independent effect on equilibrium outcomes even in the absence of changes in the configuration of political power.
  • concludes by discussing the sources of new ideas.

Making the Role of Ideas Explicit

Every rational-choice model is built on the purposive behavior of individual decision makers. Typically, behavior is determined by assuming individuals solve a well-defined optimization problem. At least three components must be specified in such an optimization exercise: 1) an objective function (like a consumer utility function); 2) a set of constraints (like a budget constraint); and 3) a set of choice variables (like the quantities of consumption to be chosen).

Political economy models in the rational- choice mold translate this framework into the political arena. Political agents —voters, lobbies, elites, congressmen—are represented as rational individuals who solve explicit optimization problems. This means: 1) they maximize a utility function defined over consumption, rents, or political benefits; 2) they operate within constraints imposed by the rules of the game, both economic and political; and 3) they choose a set of actions—which in various models may include votes, political contributions, rebellion, and suppression—that maximize their objection function given the constraints. For example, business lobbies decide how objection function given the constraints

Ideas enter this problem in several distinct ways that are rarely recognised. In fact, each of the three components of the optimization problem—preferences, constraints, and choice variables—rely on an implicit set of ideas. I discuss these in turn below. I emphasize that I am not contesting rationality or the utility of the basic optimizing framework in the political arena. My goal is to explore the role of ideas in shaping how interests are defined and pursued.

Preferences: Who Are We?

Self-interest presumes the idea of a “self ”—that is, a conception of who I am and what my purpose is. In many economic applications, the maximand is clear. It is reasonable to assume households want to maximize their consumer surplus and producers their profits, although these assumptions are not always entirely uncontroversial. In the political sphere, the choice of what is to be maximized is much less evident: depending on context, honor, glory, reputation, respect, income, power, durability in office, and “good of the country” are all plausible.

As Elster (2000) has written in a critique of political economy frameworks attempting to explain has written in a critique of political economy frameworks attempting to explain historical political developments, the nobility in 17th-century France may have been interested in honor and glory as much as in material benefits. Much human behavior is driven by abstract ideals, sacred values, or conceptions of loyalty that cannot be reduced to economic ends.

Studies by anthropologists and psychologists suggest “humans will kill and die not only to protect their own lives or defend kin and kith, but for an idea—the moral conception they form of themselves, of ‘who we are’” (Atran and Ginges 2012, p. 855)—a point that should not be controversial.

How we evaluate different social states and judge whether they advance our “interests” depends crucially on how we define ourselves. We might view ourselves as a member of a social class (“middle class”), ethnic group (“white majority”), religion (“evangelical”), nation (“global citizen”), demographic cohort (“baby boomer”), profession (“educator”), or a myriad of other possible identities. As Sen (2006) has suggested, we might even combine all these identities in varying degrees.

Economists have rarely ventured that far, but the role of ideas in determining preferences has crept into various strands of research in economics. For example, the partisan-politics literature in macroeconomics endows political parties with explicit ideologies, typically represented as different preference weights on inflation versus unemployment (Alesina and Rosenthal 1995). These differences in preferences are typically imposed exogenously, with little explanation.

The work of Akerlof and Kranton (2000; 2005 in this journal) on the economics of identity is particularly relevant here. Akerlof and Kranton consider models where individuals associate themselves with specific social categories and their desired behavior derives from the attributes of those categories. Workers, for example, may acquire identities that moderate the incentive compatibility constraint vis-à-vis their employers (leading them to behave in greater conformity with the objectives of firms). In turn, employers may seek to alter such identities to enhance workplace performance. Such models could explain a range of “anomalous” political action, including voting against immediate material interests.

The Model: How Does the World Work?

Policymakers operate under certain working assumptions about how the world works. Their worldviews shape their perception of the consequences of their and others’ actions in both economic and political domains. These ideas may fall on either side of some of the biggest controversies in the history of economic thought:

  • Does the economy work better under laissez-faire or planning?
  • Are economic growth and development more rapid under free trade or under protection?
  • Does macroeconomic stability require Keynesian countercyclical policies or Hayekian nonintervention?

Each of these positions presumes a particular model of how the economy works and therefore has different implications for political behavior. In recent decades, a succession of economic ideas (think of Keynesianism, monetarism, rational expectations, the “Washington consensus”) have served to change elites’ understanding of “economic reality” and thereby altered the political equilibrium.

Economic research is all about sharpening our ideas about the “right model.” Yet actors in political economy models live in worlds where these questions have been effectively resolved. They believe that they know how the world works, if not precisely, at least probabilistically. Rational expectations mean agents base their expectations, and hence behavior, on how the world really works. Even if they disagreed for a time, adherents of this view argue, agents would eventually reach agreement on the “right model” as events and reactions to policy choices unfold. In practice, however, people often downplay evidence that seems inconsistent with their model of the world. Anomalous outcomes are dismissed as a fluke

A more realistic representation may be that cognitive and other limitations force political agents to live in a world of Knightian uncertainty with respect to their understanding of causal relationships (see, for example, Denzau and North). Their view of the world could be wrong and could remain so even in the face of new evidence if that evidence is just used to confirm past beliefs. Conversely new information may present realities previously not considered.

Consider the experience of the global economic and financial crisis in recent years and the extent to which it has altered beliefs. Many observers, such as Johnson and Kwak (2010), have argued that the policies that produced the crisis were the result of powerful banking and financial interests getting their way, which seems like a straightforward application of the theory of special interests. Still, without the wave of ideas “in the air” that favored financial liberalization and self-regulation and emphasized the impossibility (or undesirability) of government regulation, these vested interests would not have gotten nearly as much traction as they did. After all, powerful interests rarely get their way in a democracy by nakedly arguing for their own self-interest. Instead, they seek legitimacy for their arguments by saying these policies are in the public interest. The argument in favor of financial deregulation was not that it was good for Wall Street, but that it was good for Main Street. Other observers have argued that the financial crisis was a result of excessive government intervention to support housing markets, especially for lower-income borrowers. These arguments were also grounded on certain ideas—about the social value of homeownership and the inattentiveness of the financial sector to those with lower incomes. Again, ideas apparently shaped politicians’ views of how the world works— and therefore their interest in acting in ways that precipitated the crisis. Finally, although all parties have observed the same Great Recession taking place, relatively few have altered their fundamental beliefs about whether the financial sector is over- or underregulated as a result.

The Strategy Space: What Can Political Actors Do?

The Political Economy of Inefficient Policy Choice

Explaining why political systems end up making economically inefficient policy choices is a major preoccupation of the political economy literature; it can even be said to be its original raison d’être. Taking ideas explicitly into account, especially in terms of policy innovation, can shed substantial new light on existing approaches. I will show how widely accepted results often rest on arbitrary restrictions on political actors’ strategy space. More positively, I argue that an ideas-based perspective allows us to better understand the circumstances under which political systems are, in fact, able to move towards more efficient outcomes.

Political economy models that generate equilibrium policy inefficiency rest on several building blocks:

  • 1) interests determine policy preferences;
  • 2) political power determines whose interests matter (more); and
  • 3) political institutions, or “rules of the game,” determine the specific political equilibrium among many.

However, while these three postulates can explain redistribution from less-powerful to more-powerful groups, they do not explain inefficiency.

To generate inefficiency, political economy models must add one or both of two additional features, each of which restricts the feasible set of elite actions:

  • 4) more efficient redistributive mechanisms, including lump-sum transfers, are unavailable; and
  • 5) political power is endogenous, and outcomes that move the economy closer to the efficient frontier may reduce the power of elites.

The other argument, which posits a feedback from economics back to politics, opens up the possibility that elites avoid efficient policies for fear that such policies may undercut their political power and hence their ability to determine future policies.

This type of argument has been invoked in the work of Acemoglu and Robinson (2006, see also Acemoglu 2003) to explain, for example, why some states have blocked policies that would foster industrialization and economic growth during the 19th century in Europe. Because economic growth uproots people from their traditional rural base and facilitates collective political action, it can destabilize entrenched elites. Forward-looking elites will prefer to ensure their power is not challenged, even if that means more ineffi ciency and less growth.

While the claim that elites block enhanced economic opportunities so that they can maintain their own power seems to make sense, it too may imply an unreasonable restriction on feasible strategies. In particular, it denies elites the creativity to devise strategies that would allow them to take advantage of enhanced economic opportunities without losing power.

To develop this point, I introduce the heuristic device of a “political transformation frontier,” akin to the economic transformation constraint.

The Political Transformation Frontier and Relaxing Political Constraints

I define the “political transformation frontier” as the set of maximal economic outcomes achievable by those currently in power, the elites. It depicts the maximum level of rents that elites can extract in political-economic equilibrium taking into account, in particular, the endogeneity of their political power.

Achieving Industrialization without Losing Power

Acemoglu and Robinson (2006) discuss how several governments evaded the trap of blocking industrialization for fear of being replaced, and in doing so, they illustrate the feasibility of strategies that shift the political transformation frontier outward.

Consider why the Japanese elite decided to spur industrialization and economic development after the Meiji restoration circa 1868. Acemoglu and Robinson note that “the drive for modernization in Japan took a special form, strengthening the centralized government and increasing the entrenchment of bureaucratic elites. In terms of our model, this can be viewed as a strategy to industrialize while also minimizing the probability of replacement . . .” They add that this was similar to what happened in Britain and Germany where “the nonindustrial elites maintained their political power despite the process of industrialization”

Dual-Track Reform in China

During the 1970s, China was a centrally planned economy in which administered prices were a mechanism of generating rents and transfers to groups favored by the Communist regime. Price liberalization and the removal of obligatory grain deliveries to the state would generate significant efficiency gains in the country-side, where the bulk of the population lived. But it would come at the expense of depriving the state of its tax base, and urban workers of their cheap rations. By the standards of basic political economy models, these strong redistributive consequences provide an adequate explanation of why efficiency enhancing reforms were resisted by the Chinese leadership.

But the Chinese government was able to devise a shortcut. Starting in the late 1970s, it made use of policy innovations such as two-track pricing and special economic zones that effectively delinked market-oriented incentives from their usual distributive implications. Consider, for example, how agriculture was reformed. Instead of abolishing the planned grain deliveries at fixed prices, the state simply grafted a market system on top of the centralized allocation system. Once the planned deliveries were made at state-set prices, farmers were free to sell additional amounts at any price the market would bear.

China’s special economic zones functioned similarly. Rather than liberalize its trade regime in the standard way, which would have decimated the country’s inefficient state enterprises, China allowed firms in special economic zones to operate under near-free-trade rules while maintaining trade restrictions elsewhere until the late 1990s. This enabled China to insert itself in the world economy while protecting employment and rents in the state sector. The Chinese Communist Party was strengthened and enriched, rather than weakened, as a result.

Where Do Policy Ideas Come From?

Political Entrepreneurship

In their recent book, Leighton and López (2013) place special emphasis on political entrepreneurship in making policy reform possible. For new ideas to overcome vested interests, they write (p. 134), it must be the case that “entrepreneurs notice and exploit those loose spots in the structure of ideas, institutions, and incentives.”

Learning-by-doing

Entrepreneurship is linked to learning. Just as firms travel down their cost curves as a result of accumulated experience, public organizations such as bureaucracies can learn about opportunities to reap efficiency gains. A large literature examines the potential trade-off between learning and obsolescence as organizations age (Sørensen and Stuart 2000).

Similarly, politicians might learn from their past successes and failures. The evolutionary approach to economics, based on trial and error by boundedly rational agents, provides a useful complementary perspective on learning, which also remains unexploited in political economy Policy Mutations

The idea for dual-track policies in China arose not from the planners themselves, but from black markets in the Chinese countryside where farmers sold grain illegally. Planners were simply wise enough to understand that these markets-at-the-margin enriched farmers without harming the state, as long as the plan quotas themselves were enforced, and then to build public policy on that understanding.

Similarly, experiments with “supersaver fares” in California and Texas greatly facilitated US airline deregulation during the 1970s by revealing the sizable price benefits of greater competition and freer entry

Crises

Times of crises are occasions for reconsidering existing policies. This is both because prevailing interests may lose some of their legitimacy and because incumbents may be open to trying new remedies. The need for a new narrative is greater and so is the willingness to experiment. “In moments of uncertainty,” writes Blyth (2007, p. 762),  “crisis-defining ideas not only tell agents ‘what has gone wrong’ but also ‘what is to be done’.”

While the association between crises and new ideas seems plausible, much remains to be explained. Why are some crises much more prone to new ideas? What explains the type of ideas that take hold? The Great Depression spawned the New Deal in the United States, fascism in some parts of Europe, and socialism in some other parts of Europe. Were these outcomes preordained by the structure of interests? To what extent did political entrepreneurship and ideas play an autonomous role?

Emulation

Perhaps the single most important source of ideas and policy innovation are practices that prevail elsewhere. The fact that a policy has worked—or at least is perceived to have worked—somewhere can be a powerful reason to copy it. Social security privatization in Chile, conditional cash grants in Mexico, and special economic zones in China are some examples of policy innovation that gained adherents around the world following implementation in their native settings.

Much legal and regulatory reform in the developing world is modeled after existing models in North America or Western Europe. The appeal of “imported ideas” is clear. Ready-made policies eliminate or reduce the cost of home-grown innovation and experimentation. The perception of their success elsewhere can also act as a counterweight to powerful vested interests at home.

Conclusion: What Do Economists and Policy Analysts Gain by Considering the Role of Ideas?

The main argument of this paper is that, for all the emphasis placed on them in contemporary models of political economy, vested interests play a considerably less-determining role than appears at first sight. Indeed, because of their neglect of ideas, political economy models often do a poor job of accounting for policy change.

There is frequently an after-the-fact feel to this brand of theorizing: if reform happens despite vested interests, it must be because those interests were not sufficiently well entrenched to begin with or reform didn’t hurt them.

It is instructive to contrast my argument with that of Acemoglu and Robinson (2013), who argue in this journal that well-meaning reforms often fail or produce unintended consequences because they overlook the changes in political equilibrium the reforms generate. In much of policy advice, they write, politics is “largely absent from the scene.” Acemoglu and Robinson maintain that “economic analysis needs to identify, theoretically and empirically, conditions under which politics and economics run into conflict, and then evaluate policy proposals taking this conflict and the potential backlashes it creates into account.”

I agree with them on the need to take politics into account. But Acemoglu and Robinson take vested interests largely as given, and as a result, they are rather pessimistic about what policy can achieve.

In contrast, I have argued that successful policy ideas work precisely because they take politics into account. I suggest that it is possible to do better than simply avoid political conflicts; ideas can be useful to relax political constraints. Just as ill-conceived economic ideas can produce disastrous political effects, politically well-informed ideas can move us closer to the efficiency frontier in a manner that is consistent with underlying political realities.

Raising the profile of ideas in political economy models would also help alleviate the tension that exists today between political economy, on the one hand, and normative economics and policy analysis, on the other. Political economy seeks to explain political-economic outcomes. However, if policy outcomes are pinned down by the structure of interests, it is futile to make policy recommendations: there will be no takers for the recommendations, and such recommendations will be of no consequence. At best, they will constitute ideological fodder for vested interests

Finally, a focus on ideas provides us with a new perspective on vested interests too. As social constructivists like to put it, “interests are an idea.” Even if economic actors are driven purely by interests, they often have only a limited and preconceived idea of where their interests lie. This may be true in general, of course, but it is especially true in politics, where preferences are tightly linked to people’s sense of identity and new strategies can always be invented. What the economist typically treats as immutable self-interest is too often an artifact of ideas about who we are, how the world works, and what actions are available.