The logic of collective action

There are a lot of government policies, like airline bailouts, that from an economic perspective

don't make any sense at all. Politicians have an incentive to keep the economy strong as

incumbents are reelected at a much higher rate during booms than busts. So why do so many

government policies make such little economic sense?

The best answer I've seen to this question comes from a book that is almost 40 years old. The

Logic of Collective Action by Mancur Olson explains why some groups are able to have a larger

influence on government policy than others. I'll give a brief outline of The Logic of Collective

Action and show how we can use the results of the book to explain economic policy decisions.

Any page references come from the 1971 edition of The Logic of Collective Action. I'd

recommend that edition for anyone who is interest in reading the book as it has a very useful

appendix not found in the 1965 edition.

You would expect that if a group of people have a common interest that they'll naturally get

together and fight for the common goal. Olson states, however, that this is generally not the case:

"But it is not in fact true that the idea that groups will act in their self-interest follows

logically from the premise of rational and self-interested behavior. It does not follow,

because all of the individuals in a group would gain if they achieved their group

objective, that they would act to achieve that objective, even if they were all rational and

self-interested. Indeed unless the number of individuals in a group is quite small, or

unless there is coercion or some other special device to make individuals act in their

common interest, rational, self-interested individuals will not act to achieve their

common or group interests."(pg. 2)

We can see why this is if we look at the classic example of perfect competition. Under perfect

competition there are very large number of producers of an identical good. Since the goods are

identical, all firms end up charging the same price, a price which leads to a zero economic profit.

If the firms could collude and decide to cut their output and charge a price higher than the one

that prevails under perfect competition all firms would make a profit. Although every firm in the

industry would gain if they could make such an agreement, Olson explains why this does not

happen:

"Since a uniform price must prevail in such a market, a firm cannot expect a higher price

for itself unless all of the other firms in the industry have this higher price. But a firm in a

competitive market also has an interest in selling as much as it can, until the cost of

producing another unit exceeds the price of that unit. In this there is no common interest;

each firm's interest is directly opposed to that of every other firm, for the more the firms

sell, the lower the price and income for any given firm. In short, while all firms have a

common interest in a higher price, they have antagonistic interests where output is

concerned."(pg. 9)

The logical solution around this problem would be to lobby congress to put in place a price floor,

stating that producers of this good cannot charge a price lower than some price X. Another way

around the problem would be to have congress pass a law stating that there was a limit to how

much each business could produce and that new businesses could not enter the market. We'll see

on the next page that The Logic of Collective Action explains why this will not work either. The

Logic of Collective Action explains why if a group of firms cannot reach a collusive agreement in

the marketplace, they will be unable to form a group and lobby the government for help:
"Consider a hypothetical, competitive industry, and suppose that most of the producers in that

industry desire a tarrif, a price-support program, or some other government intervention to

increase the price for their product. To obtain any such assistance from the government, the

producers in this industry will presumably have to organize a lobbying organization... The

campaign will take the time of some of the producers in the industry, as well as their money.

Just as it was not rational for a particular producer to restrict his output in order that there might

be a higher price for the product of his industry, so it would not be rational for him to sacrifice

his time and money to support a lobbying organization to obtain government assistance for the

industry. In neither case would it be in the interest of the individual producer to assume any of

the costs himself. [...] This would be true even if everyone in the industry were absolutely

convinced that the proposed program was in their interest."(pg. 11)

In both instances groups will not be formed, because the groups cannot exclude people from

benefiting if they do not join the cartel or lobbying organization. In a perfect competitive

marketplace, the level of production of any one producer has a negligible impact of the market

price of that good. A cartel will not be formed because every agent within the cartel has an

incentive to drop out of the cartel and produce as much as she possibly can, as her production

will not cause the price to drop at all. Similarly, each producer of the good has an incentive not

to pay dues to the lobbying organization, as the loss of one dues paying member will not

influence the success or failure of that organization. One extra member in a lobbying

organization representing a very large group will not determine whether or not that group will

get a piece of legislation enacted that will help the industry. Since the benefits of that legislation
cannot be limited to those firms in the lobbying group, there is no reason for that firm to join.

Olson indicates that this is the norm for very large groups:

"Migrant farm laborers are a significant group with urgent common interests, and they have no

lobby to voice their needs. The white-collar workers are a large group with common interests,

but they have no organization to care for their interests. The taxpayers are a vast group with an

obvious common interest, but in an important sense they have yet to obtain representation. The

consumers are at least as numerous as any other group in the society, but they have no

organization to countervail the power of organized monopolistic producers. There are multitudes

with an interest in peace, but they have no lobby to match those of the "special interests" that

may on occasion have an interest in war. There are vast numbers who have a common interest in

preventing inflation and depression, but they have no organization to express that interest." (pg.

165)

In the next section, we'll see how small groups get around the collective action problem

described in The Logic of Collective Action and we'll see how those smaller groups can take

advantage of groups which are unable to form such lobbies.

In the previous section we saw the difficulties larger groups have in organizing lobbies to

influence the government on policy issues. In a smaller group, one person makes up a larger

percentage of the resources of that group, so the addition or subtraction of a single member to

that organization can determine the success of the group. There are also social pressures which

work much better on the "small" than on the "large". Olson gives two reasons why large groups

are inherently unsuccessful in their attempts to organize:

"In general, social pressure and social incentives operate only in groups of smaller size, in the

groups so small that the members can have face-to-face contact with one another. Though in an

oligopolic industry with only a handful of firms there may be strong resenment against the

"chiseler" who cuts prices to increase his own sales at the expense of the group, in a perfectly

competitive industry there is usually no such resentment; indeed the man who succeeds in

increasing his sales and output in a perfectly competitive industry is usually admired and set up

as a good example by his competitors.

There are perhaps two reasons for this difference in the attitudes of large and small groups. First,

in the large, latent group, each member, by definition, is so small in relation to the total that his

actions will not matter much one way or another; so it would seem pointless for one perfect

competitior to snub or abuse another for a selfish, antigroup action, because the recalcitrant's

action would not be decisive in any event. Second, in any large group everyone cannot possibly

know everyone else, and the group will ipso facto not be a friendship group; so a person will

ordinally not be affected socially if he fails to make sacrifices on behalf of his group's goals."(pg.

62)

Because smaller groups can exert these social (as well as economic) pressures, they are much

more able to get around this problem. This leads to the result that smaller groups (or what some

would call "Special Interest Groups") are able to have policies enacted which hurt the country as

a whole. "In the sharing of the costs of efforts to achieve a common goal in small groups, there is

however a surprising tendency for the "exploitation" of the great by the small."(pg. 3).

In the last section we'll take a look at an example of one of thousands of public policies that take

money from many and give it to few.

Now that we know that smaller groups will generally be more successful than large ones, we

understand why the government enacts many of the policies it does. To illustrate how this works,

I'm going to use a made-up example of such a policy. It's a very drastic over-simplification, but I

think you'll agree it's not that far out.

Suppose there are four major airlines in the United States, each of whom are near bankruptcy.

The CEO of one of the airlines realizes that they can get out of bankruptcy by lobbying the

government for support. He can convince the 3 other airlines to go along with the plan, as they

realize that they'll be more successful if they band together and if one of the airlines does not

participate the amount of lobbying resources will be greatly diminshed along with the credibility

of their argument.

The airlines pool their resources and hire a high priced lobbying firm along with a handful of

unprincipled economists. The airlines explain to the government that without a $400 million

dollar package they will not be able to survive. If they do not survive, there will be terrible

consequences to the economy, so it's in the best interest of the government to give them the

money.

The congresswoman listening to the argument finds it compelling, but she also recognizes a self-

serving argument when she hears one. So she'd like to hear from groups opposing the move.

However it's obvious that such a group will not form, for the following reason:

The $400 million dollars represents around $1.50 for each person living in America. Now

obviously many of those individuals do not pay taxes, so we'll assume that it represents $4 for

each tax-paying American (this assumes everyone pays the same amount in taxes which again is
an over-simplication). It's obvious to see that it's not worth the time and effort for any American

to educate themselves about the issue, solicit donations for their cause and lobby to congress if

they'd only gain a few dollars.

So other than a few academic economists and think-tanks, nobody opposes the measure and it is

enacted by congress. By this we see that a small group is inherently at an advantage against a

larger group. Although in total the amount at stake is the same for each group, the individual

members of the small group have much more at stake than the individual members of the large

group so they have an incentive to spend more time and energy trying to change government

policy.

If these transfers just caused one group to gain at the other's expense it wouldn't hurt the

economy at all. It wouldn't be any different than me just handing you $10; you've gained $10 and

I've lost $10 and the economy as a whole has the same value it had before. However it does

cause a decline in the economy for two reasons:

1. The cost of lobbying. Lobbying is inherently a non-productive activity for the economy.

The resources spent on lobbying are resources that are not being spent on creating wealth,

so the economy is poorer as a whole. The money spent on lobbying could have been

spent buying a new 747, so the economy as a whole is one 747 poorer.

2. The deadweight loss caused by taxation. In my article The Effect of Taxes on the

Economy we saw that higher taxes causes productivity to decline and the economy to be

worse off. Here the government was taking $4 from each taxpayer, which is not a

significant amount. However the government enacts hundreds of these policies so in total
 the sum becomes quite significant. These handouts to small groups cause a decline in

economic growth because they change the actions of taxpayers.

So now we've seen why so many small special interest groups are so successful in organizing

and collecting handouts which hurt the economy and why a large group (taxpayers) are generally

unsuccessful in their attempts to stop them. If you'd like to ask a question about special interest

groups, taxation, or any other topic or comment on this story, please use the feedback form.