A government department or bureau which is the sole source of supply of a non-marketed product appears to be in a similar position to that of a monopolist in the private sector. If this is so, the analysis of monopoly previously presented in Module 3 may be a useful point of departure for analysing the behaviour of a bureau. This parallel is actually quite a useful one. Figure 7.1 is a version of Figure 3.1 and presents in very simple form the effects of the actions of a monopolist on price and output. Imagine that MC is an industry supply curve with average costs (AC) equal to marginal costs (MC). If the industry demand curve takes the usual form, i.e. is downward-sloping, then the ‘competitive solution’ would be reached when MC = price. In our diagram, price is oa and associated output is oq2. The consumers' surplus – the difference between what customers would be willing to pay and what they have to pay in order to obtain units of the good or service – will be represented by the area aed. If the industry were suddenly monopolised and no change in the cost curve or the demand curve occurred, then the monopolist would maximise profits by equating marginal cost and marginal revenue (represented by the steeper sloping curve) making price (op1) higher and output (oq1) lower than in the case where competition obtained. Consumer surplus would fall by the area cbd. As repeatedly emphasised, such a diagrammatic representation is only a first approximation, but this one raises the important question as to whether there is a parallel between monopoly and bureau behaviour. This question, which consists of several parts, will now be examined in some detail.
Figure 7.1 Bureaucracy as a monopoly supplier
This seems to be frequently the case. For example, the supply of police services is commonly monopolised by government. However, it should be noted that two interesting problems of definition are raised by this kind of example.
It is a well-known fallacy in economics to suppose that the sole seller of a separately identifiable product or service necessarily has monopoly power. Monopoly power can only be defined in terms of market power, i.e. sensitivity of the quantity demanded of a product to a change in price. Even in the case of police services, whose purpose is presumably to reduce crime, there are other government services, i.e. social work departments, which may ‘compete’ in trying to achieve the same end.
It is difficult to arrive at consensus on the definition and measurement of the output of government services which are not sold in the market. Consider the definition and measurement of output for police services. Should output be defined and measured in terms of the numbers of criminals caught or the reduction in the number of crimes committed?
The very fact that the service is by definition not priced suggests that no demand curve can be drawn for, say, police services. However, the government or the sponsoring agent appointed by government to decide on its budget must have some evaluation of the service, and it is reasonable to suppose that, for any given budget level, it would prefer a higher output to a lower one. It is therefore not misleading to draw the ‘normal’ demand curve, although the absence of prices has led to the adoption of the term ‘marginal evaluation curve’.
There must be a crucial difference here between the position of a monopolist in the private sector and the bureaucrat manager. The latter cannot appropriate net profits over and above the costs of producing any given level of output. The manager has to derive his utility in other ways, such as by minimising the ‘hassle’ of the job. He may therefore derive utility from a variety of actions such as the prestige of controlling a large staff, the consolations derived from his perquisites of office (subject to the constraints placed on his salary and expenses claims by the Ministry of Finance) and the reputation he gains amongst his employees for making their employment congenial. It is for this reason that, in the analysis of bureaucracy, the manager is assumed to maximise the bureau's budget rather than to maximise profits. By so doing all the components in his utility function are increased.
Mr Leslie Chapman, formerly a regional director in the British Ministry of Works with the rank of Under Secretary, summarised his conclusions on ‘maximising the bureau's budget’:
Another common cause of continually increasing expenditure is that most ordinary human beings have a not unreasonable wish to keep and if possible to improve what they already have. Within the limits of the time and money available to them, for example, most private householders try to improve and embellish their property and guard it against attempts by others to take bits away. How much more tempting it is, therefore, for the controller of an organisation, funded by the public, to fight off all attempts to reduce the size or scope of his establishment and to enlarge it wherever possible? It is not his time and not his money which brings about the ‘improvements’. All that he has to do is to suggest them and argue for them and in the fullness of time they come about.
Time and time again survey teams found that if they looked at the history of an establishment or a service over the years, there was a remorseless and apparently irresistible increase in the amount of money being spent, the standards being observed, the facilities being provided, and as a consequence an increase in the total cost to the taxpayer.
Yet another pressure to spend came from the need to uphold prestige. This argument was used endlessly to justify lavish accommodation, luxurious furniture, bigger cars, better-kept lawns and flower-beds and even higher staff gradings and salaries. Prestige in this context meant competing with other departments and also with the private sector, so that all the elements exist for a continuous series of leapfrogging claims. These claims could be given a further fillip if by some stretch of the imagination justification could be found for involving visitors from overseas. It then became a matter of national prestige and pride that our establishments should be bigger and better, glossier and more expensive than had been the case heretofore. The underlying assumption was that the foreigners would go back to their own countries dazzled by the display of power and wealth which they had seen and would quite forget the drifting pound, the adverse balance of payments and our lagging growth in national productivity.
Closely allied to the prestige argument was the one related to recruitment. In the middle 1960s recruitment both into the armed services and into the Civil Service was not going very well. To attract recruits, my colleagues argued, it was necessary to show splendid surroundings and well-furnished buildings impeccably maintained. No one ever demonstrated that anyone was ever recruited for these reasons, but as an argument it enjoyed a boom for a number of years; and, of course, entirely incidentally, it helped to make life very pleasant for those already in.
Another very human characteristic which in the public sector can lead to continually increased spending and waste is the desire to do good. In the public sector the scope for doing good is endless, and the desire to do it, given that those who desire it are going to do it at the public expense, is equally unlimited. It is always possible to improve the staff rest room or sports facilities, standards in the living quarters and the decorations in the hospitals and the churches. The list is as varied as it is long and there is something for every taste, so that each item has its own enthusiastic supporters and advocates and none is completely without merit.
Outside the public sector a system of choices has to operate. Either the money is spent for this purpose or for that. But all too often in the public sector only a moderate case for more expenditure is all that is necessary and there is no regard for the gradually increasing total cost. It is exasperating, even though inevitable, that although it is the taxpayers' money that is being spent those who advocate any such expenditure are regarded as warm-hearted, forward-looking and generous and those who oppose it are thought of and described as mean. Whether in the House of Commons or in the local Council Chambers, this phenomenon can be witnessed in most debates involving economies.
Source: Chapman (1979)
It will be noted that we now appear to have an example of bilateral monopoly, with the government as the sole purchaser of the bureau's services and the bureau as the sole supplier, subject to the qualifications mentioned in Section 7.2.1 above. Determining the price and output of a good or service under conditions of bilateral monopoly may be difficult and while the limits of the bargain may be set, it is usually claimed by analysts of such situations that bargaining skill may be crucial; a factor which it is very difficult to incorporate into a model. However, it is possible to develop our simple macroeconomic analysis further, provided that it is accepted that the bureau chief has one further weapon at his disposal. The bureau knows the preferences of the principal – the government – but the principal can only obtain information on the bureau's cost curve from the bureau itself. Here we have another example of the ‘asymmetric information’ problem (see Section 1.4). In the short run at least, the bureau has an advantage which can only be eroded through time if the principal considers it in its interests to check on whether the information supplied on the relation between costs and output – which is in any case difficult to define is satisfactory. Reasons have already been advanced for concluding that the incentives to exercise detailed and continuing surveillance of the ‘production functions’ of bureaux are weak.
The analysis in Figure 3.1 and Figure 7.1 is developed further in Figure 7.2. The first stage in the analysis is to determine the maximum budget available to the bureau. The bureau will endeavour to bargain for the maximum size of grant compatible with the credibility of its submitted estimates of the cost of the services that it provides. The principal must have some notional upper limit of the size of the grant, perhaps guided by the officials of the Ministry of Finance. Given the asymmetric information problem, we can fix this at the upper limit itself. This is represented by the area oeq3 which is the maximum amount that the sponsoring agent will allocate consistent with its valuation of the output. It will be prepared to pay up to the point where the marginal benefits of an extra unit of output would be zero. This is reached at q3. The second stage is to ascertain the level of output which will be chosen by the bureau manager, given that he can rely on an allocation of funds equal to the area oeq3. As he cannot appropriate any surplus over cost for himself, then his choice will depend on the weight given to the various influences on his ‘ utility function’. If the manager derives satisfaction primarily from maximising output (because in so doing he maximises the number of employees working for him), the manager can choose a position on the minimum cost curve compatible with two conditions: (a) the size of the budget; and (b) the marginal valuation of output must not be negative. The chosen output will then be oq3, provided that dfq3 ≤ aed. Instead of under-producing like the monopolist in private production, he is overproducing, in order to capture the maximum amount of consumers' surplus. However, if the manager of the bureau derives satisfaction primarily from leading a quiet life, then his control over the information about the cost function can afford him the opportunity to do so. Assuming that the same budget is available to him, costs may be disguised and this will allow him to choose a point, say g, where output would be lower and reported costs per unit higher than would be the case in the output maximisation case, always supposed that a1gq4o ≤ oeq3. Again, consumer welfare as measured by consumers' surplus would be below that represented by competitive supply.
Figure 7.2 The budget maximising bureau
The theory therefore predicts that the action of a bureau chief will result in allocative inefficiency and/or technical inefficiency. The sponsoring authorities are supplied either with ‘too much’ output or output produced at above minimum cost or a combination of both. The bureau ‘captures’ a significant part of the consumers' surplus which would otherwise accrue to consumers if the competitive optimum were achieved (check against Figure 7.2).
There seems at least a prima facie case for concluding that the sponsoring agent, the government in power, would be concerned about this result if it were a true reflection of what happens in the supply of publicly provided goods. If the theory applied ‘across the board’, then taxpayers would be paying more than would appear to be necessary for services which are not supplied in the amounts that they require. Additionally, those departments with direct contact with the public, e.g. social security offices, might not be as responsive to public requests to help them as would be the case if the services were provided by competing suppliers. However, before examining whether governments have both the incentive and the machinery to appraise and monitor the performance of bureaux, reference must be made to how the predictions might be tested. An analysis of the problems of testing is also of relevance to any situation where a principal contracts for services to be delivered by a single supplier in exchange for a budget. This situation is frequently found in large commercial companies producing a wide range of products requiring devolution of control over budgetary outlays.
