Summary of Private Uses for Public Interest

This lecture by Stiglitz is about how and why Pareto or near-Pareto improvement is hard to achieve, through his experience in Council of Economic Advisors for the United States government. First, Stiglitz writes about Adam Smith's invisible hand theory as an explications of conditions under which market equilibrium will be Pareto efficient, and discusses about the importance of government intervention by writing that in presence of imperfect information or incomplete market, there will always be some intervention by which government can make everyone better off. Stiglitz as an economist thought that if he can contribute anything, it would be to implement Pareto improvement. However, he found it extremely difficult to even pursue even near-Pareto improvement and throughout the whole lecture, he gives out the reasons of why it was difficult.

Before he goes on to explain his four hypotheses about how misaligned incentives can induce government officials to take action that are not in public interest, Stiglitz talks about the two reasons critics of role of government gives which are inconsistent. One is coasian bargaining will lead to efficient solution, so government intervention is not needed. Stiglitz criticizes this reason by writing about how this doesn't work in public sector. Another reason the critics give are government is rife with inefficiency. Then he goes to critic the way everything is done in the white house. He writes about how government lacks empirical evidence and theoretical analysis at many times, and not only do bad arguments drive out good arguments, but good economists adopt bad arguments for the incentive.

Then, Stiglitz explains the two successful pareto improvement which the government was able to achieve while he was in White House. One was the pension reform, where government made a model to show companies to follow where the maintenance of pension will not be as high as it was before and will work efficiently. Since this led to more companies having pensions, this was a pareto improvement. Second example he gave was the inflation induced bond, where government benefits due to low interest rate, and the risk for people purchasing the bond is less because if there is an inflation, the value in real terms will be the same because it is inflation-induced. However, in order to implement this bond, Stiglitz had a hard time because - 1. People didn't understand that risk is small, because people just looked at if inflation happens, interest payment is large, although tax receipts went up with inflation; 2. Misguided “inflation hawks” thought that this meant that government was not fighting inflation although inflation will actually impact directly on government due this bond so will give more motivation to government to fight inflation and 3. Treasury turned to bond traders and gave negative opinions. These three reasons show how even such a pareto improvement, where some people gain and no one loses, are hard policies to implement.

Then, he goes on to give and explain 4 hypotheses for reasons why potential Pareto improvement fails. The first reason is inability of government to make commitments. This comes from a fact that a reform can be favorable to everybody in the earlier stages of change, but can be a disadvantage to one or few groups' interest in the later stage, and the group that might get disadvantage will oppose to the reform which seemingly is a pareto improvement. He gives example of how Clintion government tried to change the coal-generated power which is expensive and cost-inefficient to hydro-electricity, by selling the rights to private company to change it and instead let them sell the extra electricity price at market price. There were people getting subsidized electricity, and the plan was for them to get the electricity at the same price. However, people who got subsidized worried that this would make subsidy more visible and government will stop the subsidy eventually. Government could not make commitment saying that they were going to continue subsidy because there is always a chance that government will change its mind and “agreements” can not be enforced. Stiglitz makes 3 arguments about this commitment issue by stating 1. There are ranges of forms of actions which affect transaction costs and thereby make change difficult; 2. These transactions costs can impede what would be Pareto improvement difficult, and 3. while some transactions costs may be desirable, changes in the world may make them obstacles to efficient reform. Then Stiglitz goes to explain how this inability to make commitments are shown in other examples and even in the Congress too.

The second hypothesis Stiglitz gives is about coalition formation and bargaining. Stiglitz's objection against coalition formation being not efficient because imperfect information will cause suboptimal outcome. Stiglitz also