MACROECONOMICS MID-SEMESTER

Hanushavardhini.S
HS18H019
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THE PECULIAR ECONOMICS OF BUREAUCRACY

A. William Niskanen

Short Overview of the Paper:

In this paper, I will be briefly discussing about the Niskanen model of budget maximisation. Followed by
which I will be putting forward my agreements and critiques of the model. I would be concluding the paper
with the relevance of it in contemporary times.

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The quality of governance and economic growth of a nation are positively correlated. Economic growth can
be interpreted as a quantitative expansion of the economy over time through resource accumulation or
improvement in productivity and, most commonly, through improvement in GDP. The most important
characteristic of governance is the predominance of state. All the metrics of growth require government
intervention vis-à-vis implementation through the bureaucracy. Niskanen begins his paper by quoting the
lack of attention given to the economic aspect of the system. So, Niskanen came up with the first formal
economic theory for the behavior of bureaucracies. It was later compiled in his book named "Bureaucracy
and Representative Government," which theorizes an elegant model of bureaucratic supply of public
output.

This is a pioneering paper, and it is one of the most cited results from public choice literature. The model
rests on two central assumptions of standard neo-classical behavioral economics. Firstly, bureaucrats
maximize the total budget of their bureau subjective to the budget constraint for the equilibrium output.
Secondly, bureaus exchange a specific output or a combination of outputs for a particular budget. He
characterizes the power of the bureaucrats as a monopoly with an all-or-nothing choice and has the
possibility of acquiring the entire consumer surplus. In short, he depicts bureaucrats as monopolists
capable of imposing their preferences on the governing political party. I felt there is a fundamental flaw in
the assumptions; when he characterizes bureaus as simple bureaucrats, the counter assumption is that the
politicians/ruling party are entirely passive. I have expanded this aspect in a later part of the paper.

Comprehensively, the greater the number of resources under their control, the higher the chances of they
exercising their power over people who are dependent on these resources. The more services the
department supplies, the higher it's budget will. In this maximization process to a break-even of social
welfare, the deadweight loss generated by excessive estimation should not be higher than the consumer
surplus. He compares bureaucracy to a typical utility-maximizing private sector, which expects the
department to expand its services and budget to a point where marginal costs and benefits are equal. But
here, Niskanen would equate average costs and benefits instead of the margins.

Going by his theory, it would be possible to market a product without a contradictory market process. The
commercialization of the product by the bureaucracy is interpreted as the price set by a planning authority
and not from a free-market approach. So these economic calculation has to be understood as a public
allocation process with parameters.

There are many places where I find the model confusing and disagree.

Firstly, he presents a static model for a system where time is a crucial factor. Secondly, his model being the
lack of clarity on the utility function of the bureaucrats when he is definitive on the fact that they are budget-
maximizers. He does not derive this hypothesis from a general utility function; instead, he starts from
empirical evidence and data where the parameters: salary, status, discretionary power, are positively
related to the budget. As mentioned in the central assumptions, he theorizes the monopoly, which is
bureaucracy, in a binary of 'all or nothing choice .' He does not present any significant alternatives, which is
very far from reality. As in governance and budgets, it is never black and white, and there are many grey
areas that this model fails to address. If that was the case, no preferences could have been established.

So it leads to my next point where this model fails to set a clear distinction between the role of the
politicians and bureaucrats. He emphasizes the bureaucrats' behavior, and the role of the politicians or the
ruling party seems confusing. It appears that they have no stake in this exercise of budgets. But in reality,
the Government has the power to make 'take it or leave it' budget proposals to the legislative. Under these
conditions, the ruling party has the discriminating monopoly power and not the bureaucrats. Then logically,
it leads us to a point where If an excess budget and output occur, it can be attributed to a considerable
extent to the political behavior, rather more to the Government's behavior than to the working of the bureau.
So, Niskanen's power allotted to the bureaucracy is excessive, especially the hypothesis that the
bureaucracy holds "the same type of bargaining power as a profit-seeking monopoly that discriminates
among customers or that presents the market with an all-or-nothing choice.

On the other side, I think the reason for Niskanen giving excessive power to bureaucrats over any other
agent is their absolute control over information regarding costs of resources, various activities, and their
preferences. I think this asymmetric distribution of the information leads to realizing the intentions
(overprovision of public resources) of the bureaucrats over other agents. Many economists have critiqued
this very conclusion.

This model looked very generalized to me. Speaking of all, it is essential to note the legislative context in
which the model has been written. Niskanen wrote in a congressional context. So, naturally, the question
arises of whether the model is universal? It is very much evident where this assumption of monopoly
discrimination will stand inconsistent in a democratic political system. There is no space for bargaining
under a discriminating monopoly, where the reality in a democracy is different. Naturally, the model fails to
consider the complex possibility that the final result of budget approval is in the hands of both the governing
party and bureaucrats in a bargaining context. The process of formulating the budget can be seen as a
game between both the players, while the model gives a perception of a one-sided equilibrium.

I feel this is not an explanatory model of bureaucracy as it does not highlight the dynamicity of the
bureaucrats and their intentions behind their actions—the bureaucracy tries to balance its actions to strike
an equilibrium. I connected this to the conception of violence by Galtung, who theorizes the need to
understand the roots and understand the past and present action patterns to get a complete picture.
Similarly, No action of a bureaucrat can be looked at alone; both the pre and post-actions of the same
should be analyzed, giving at least a partial view of the entire picture. If there is a discriminating monopoly
that maximizes the budget, an excess budget and output will occur in this bureau, but it will be
counterbalanced by reducing the budget and the production of the other non-discriminating bureaus, which
will see their budget.

Niskanen, towards the end of the paper, talks about the implications of the policy. I think parallels can be
drawn between elasticity and the model. In this budgeting model, the demand for public services looks
elastic, but it is not supported by empirical research. I spoke of various points in which I cannot entirely
agree with the model, but I think it is vital to ask this question. Is the model relevant today?

Theoretically speaking, in 1980, this model was rejected by Dunleavy through his Bureau shaping model,
which quotes that Rather than maximizing budget, bureaucrats shape their careers intangibly, i.e., bureau
shaping is preferred over budget maximizing. In addition to this, Niskanen’s model is not relevant in
contemporary times due to the development of new types of budgeting like-new performance budgeting,
zero-based budgeting, and outcome budgeting, increasing the accountability and transparency of the
bureaucrats. Various institutional mechanisms have been set up which does in-depth scrutiny of budgets.
But realistically speaking, we could point out instances that prove the Niskanen model wrong, and at the
same time, some cases fit in his model.
I want to start with an example of the European Union. It is an extreme, particular case that is the opposite
of the Niskanen model. I admit that taking an extreme case for a generalized model and rejecting it is not
fair. But I would like to highlight the differences. The central premise of the Niskanen model will stand
irrelevant here as that ninety-five percent of the budget of the EU institutions; already tiny compared to
public expenditures in the member countries, is passed on to other actors. Dunleavy writes that "If budget
maximization was indeed the dominant bureaucratic motivation then EU officials should pursue direct
implementation strategies so as to create large budget agencies with many personnel. Instead EU officials
remain a tiny fraction of the overall numbers of member state personnel."

As I said before, we have a majority of instances that prove that all the budgets are not maximizing. Budget
Minimising bureaucrat in US Defence Secretary Robert Gates who reduced defense expenditure in 2010
However, some cases of budget maximizing remain, although not precisely in the same way as Niskanen
had theorized. For example, ARC-II analyzed that over 40 ministries and departments had exaggerated
their budget estimates to show savings after the year. This indicates that budget inflation continues.

Now speaking in the Indian context, data from RBI State of State finances reveal that the state
governments have been spending less than their original budgeted amount between 2011-12 and 2015-16
where they have expected to receive more grants, and they have consistently overestimated their revenue
targets from taxation. In 2016-17, states collectively budgeted to receive Rs4.67 trillion from the center,
while the center has budgeted to provide only Rs3.47 trillion to all the states. This is an overestimation of
34%. This fiscal deficit ultimately affected their spending. Revenue expenditure, which includes committed
liabilities such as salaries and interest payments, saw a shortfall of 4% from the budgeted targets.
Consequently, capital expenditure, which is spent on creating infrastructure, saw a significant shortfall
(12%) compared to budget estimates.

So this example points out the shortcomings of budget maximization. From the above examples, I infer that
the Niskanen model is still relevant, and it is necessary to accept that the exceptions to the model also
exist.

I want to conclude by bringing in Weber's conception of bureaucracy. According to him, bureaucracy is the
most efficient and rational way to organization of human activities. He quotes that it is the organized
hierarchies that maintain order and maximizes efficiency. But I felt this model does not align with these
conceptions because with budget maximizing comes personal over collective, favoritism, exploitation of
power. Then he furthers to quote the rewarding system for the bureaucrats for shifting their demand
functions. I agree with the point where he mentions, "A more important suggestion is that a bureau
operating in a highly competitive output market would be relatively efficient." The expansion of new bureaus
would reduce the collusive behavior that would prevent the dominance of one bureau in a single product.
the incentives of bureaucrats could be changed to encourage them to minimize the budget for a given
output or set of outputs

I think these suggestions are to change the widespread perception that bureaucracies are inefficient and
work very slowly. They are highly resistive to the global changes around. Going by Solow's Model, the
primary determinant of growth is productivity. So, bureaucracies will grow when they enrich their model and
functioning, ultimately allowing them to adapt and let technology expand overtime in their organizational
setup.
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