We should never ignore the politics

An interesting paper by Acemoglu and Robinson, who have long discussed the interaction between economics and politics. The basic point is that economists cannot afford to ignore politics when they make policy prescriptions. It’s well-known that policy prescriptions based on partial equilibrium models can be risky. A&R take that a step further and point out that economic policies can affect political equilibria in unpredictable ways that may end up being counter-productive. For example,

Faced with a trade union exercising monopoly power and raising the wages of its members, most economists would advocate removing or limiting the unions’ ability to exercise this monopoly power, and this is certainly the right policy in some circumstances. But unions do not just influence the way the labor market functions; they also have important implications for the political system. Historically, unions have played a key role in the creation of democracy in many parts of the world, particularly in Western Europe; they have founded, funded and supported political parties, such as the Labour Party in Britain or the Social Democratic parties of Scandinavia, which have had large impacts on public policy and on the extent of taxation and income redistribution, often balancing the political power of established business interests and political elites. Because the higher wages that unions generate for their members are one of the main reasons why people join unions, reducing their market power is likely to foster de-unionization. But this may, by further strengthening groups and interests that were already dominant in society, also change the political equilibrium in a direction involving greater efficiency losses. This case illustrates a more general conclusion, which is the heart of our argument: even when it is possible, removing a market failure need not improve the allocation of resources because of its impact on future political equilibria.