Public policy and economics

Public policy is a composite of ideas, perceptions and theories. Overtly and covertly, a number of social sciences make their contributions in making public policy to take shape. Politicians, bureaucrats and social scientists-turned policy makers make use of these sources of knowledge in varying degrees.
In public policy making it is economics that has become pervasive. In inter-disciplinary public policy formulations public administration, sociology, even behavioural psychology play a part. But in actual policy formulation economics his considered as the most influential discipline. The dominance of economics has been criticized for neglecting other social sciences. It is contended that other disciplines in humanities provide a wide variety of perspectives which should be brought to bear on policy making. But even the critics of economics never fail to acknowledge its influence and usefulness in public policy making.
Economics is not an unified subject. It is divided into macro and micro economics. Macroeconomics focuses on broad economics aggregates such as total output (gross domestic product), total employment, the price level (inflation) and the rate of economic growth. Microeconomics focuses not on broad aggregates but on particular sectors of the economy and the relations among them. Microeconomics seeks to determine how scarce resources are allocated among competing sectors and among competing societal ends and who gets the goods and services provided.
Macroeconomics policy seeks to keep inflation and unemployment low and economic growth high. On the other hand, policy-oriented microeconomics usually want to change the mix of goods and services produced by the economy so as to satisfy consumers more efficiently. Typical policy concerns of microeconomics are government's inefficient regulation, management of transportation and communications, inefficient control over minimum prices and inefficient design of environmental policies.
Growth, unemployment and inflation, the subjects of macroeconomics are more important. But microeconomics is concerned with more than technical details at the firm level. Most importantly microeconomics affect macro problems. For instance, micro policies that discourage savings and investment hurt economic growth. Similarly laws requiring minimum wages increase unemployment among the unskilled workers. Thus good solutions to macro questions should take into account the forces of micro economics that are relevant. It is a paradox that in academy circle there are more micro than macro economists. Micro economists have spun off from micro economics such as welfare, benefit-cost economics, public finance and public choice.
In public policy formulation macro economics has been used more often than micro economics. Only public finance as a subject of micro finances find frequent use in public policy making. Welfare, benefit-cost economics and public choice are seldom mentioned while public policy is discussed and formulated. This makes the formulation of public policy somewhat incomplete and one sided. Prices of individual products are as important as the composite of prices embodying inflation. Similarly, costs of production provide the basis for capital-output ratio on which aggregate growth is calculated.
A departure from the conventional policy making from the point of view of macro economics should combine both macro and micro economics for robust and comprehensive analysis. This can take place either through separate exercises covering the whole spectrum of economics. Alternatively, macro-micro underpinning of policy formulation can be applied in the same exercise covering both aspects. The objective in both is to take a holistic approach.
Policy formulations using macro economics is a familiar exercise. The use of micro economics being rare a brief discussion on it is in order. This will not only shed light on the subject but also indicate its relationship with the other field i.e. macro economics.
    There are two types of policy guidance that may be provided by micro side of economics. In respect of resource allocation micro finance provides this guidance through the instruments of opportunity cost, marginalism and economic incentives. Opportunity cost indicates that since resources are scarce and ends multiple to worry about costs is to care about benefits, that is benefits forgone in other sectors. This simple fact is not usually understood by politicians and bureaucrats without a background in economics. Marginalism shows why neither the intrinsic importance of a public function nor a ranking of problems provides much guidance for public expenditure choice. Marginalism suggests looking at the details, to understand that most budgeting decisions concern spending a little more or a little less. After looking at the details it may be fund that added expenditures will have little effect on the relatively most important but complex problem while another most important problem could be addressed more effectively by budgetary expenditures. When a number of such important problems are selected for budgetary expenditures result progresses from micro to macro economics, establishing the relationship between the two aspects of economics.
As regards economic incentives, a subject within micro finance, it shows how a number of public goods can be achieved more cheaply if more attention is paid to private self-interest when designing a government programme. Here also micro and macro considerations take place as part of the same exercise. Government may introduce regulatory programme, say for worker safety or environmental protection by changing the behaviour of individuals and business firms through laws and regulation. A superior approach may be to change material incentives to make individuals and business firms willing to take actions that are consistent with public interests. Economic incentives working at micro level may yield results at the macro level when such response becomes universal.
The concept of opportunity cost, marginalism and economic incentives are not very ambitious. They do not provide comprehensive framework for policy formulation. But taken together with macro considerations these can useful. They are ideas and factors to be kept in mind and to be weighed against other factors when formulating a policy. Though these micro concepts are less ambitious they are not less useful. This is elucidated below to some extent.
At present most economists are in favour of market system and are sceptical of the economic role of government. But market is not infallible, it fails in some situations and these are discussed in public finance and welfare economics, both included in micro economics. Reflection on market failure, particularly on externality (negative effect on third party) can lead decision about the desirable scope of government programme. The principles of welfare economics provide guidance about the appropriate agenda for government. Benefit-cost economics, the applied branch of welfare economics (micro economics) goes further and gives indication about how much money should be spent on certain functions by government. The benefits of a government programme are entirely dependent on the preference of consumers as reflected by their willingness to pay for the programme. It is possible to estimate the willingness of consume to pay for such programmes.
The above discussion shows there are ways of improving public policy by economists. Along with aggregate output, employment and inflation of macro economics opportunity cost, marginalism, economic incentives, externalities (welfare) and benefit-cost analysis of micro economics have to be used where required. For instance, while writing about the state of the economy such a combination of two sides of economics will be in order. For a comprehensive public policy economics should be used in a holistic manner. To use only macro economics in all cases, as is usually done, is to opt for an incomplete public policy.
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The writer is a former secretary to the government and a regular
columnist of the FE.
E-mail: [email protected]