Democracy v/s Economics

(Is democracy the best solution?-An economic perspective)

                                                                                                                -Deepika Sharma

The proponents of democracy would support this vociferously; the opponents would be shouted down and accused to be orthodox mavericks. No doubt, democracy is much better than authoritarian rule and there are countless real life examples to prove that. But is democracy the ideal and the best solution to the world’s problems? Let’s examine by comparing the basic principles of democracy with the fundamental rules underlying economics...

A basic principle of economics is sacrificing present consumption for future benefits. However, in a democracy, the government is required to deliver the results today or at least before the next elections. Hence there is a huge pressure to formulate policies in a way that they have a wide impact in the present with a partial disregard for long-term growth. Even the formulation of these policies is plagued with problems, as they are a stark contrast to economic principles. In every reform, there are losers and gainers. Economics tells us that the reforms where the gains to the gainers exceed the loss to the losers are the most viable. However, in a democracy the magnitude of the impact is usually neglected, those with more political clout manage to swing the policies in their favor by effective lobbying. The problem worsens with corruption but the problem still exists even if we assume a clean and ideal democracy.

In democratic societies, the government is expected to enact redistribution of wealth from the rich to the poor.

·        Firstly, this encourages more people to stay on the receiving end to keep getting the benefits and discourages earners from striving to stay on the rich end. This creates a moral hazard problem and thus impedes growth.

·        Secondly, the policies enacted to effect such redistribution have inefficiencies of their own and cause distortions. If a good is subsidized for the poor in the name of equity it directly causes deadweight losses. Also, the subsidy has to be financed by taxing some other good, which also has its own set of distortions. Hence, this forms a sort of vicious circle with a certain distortion causing more widespread ones.

·        Thirdly, by deciding the legal incidence of the policies, the government cannot decide the actual economic incidence of its policies as that is determined by the market forces. If by legislation it is required that the tax incidence be fifty-fifty on the buyers and the sellers, economics tells us that the burden of the tax wouldn’t be equally shared .The burden will fall more heavily on the side of the market that is less elastic. For example, if a luxury tax is imposed on the rich in a way to raise taxes from those who could afford to pay; it seems a logical way to redistribute income. However, the incidence of the tax would lie more on the supply side, which are less elastic and hence more economic hardships for the poor.

·        Fourthly, this may lead to policies like distribution of freebies, which hinder economic growth.

To validate this argument lets take a real world example. The world prices of oil have been defying gravity and rising upwards since a long time. Keeping the interests of the majority in view the government might either put a price ceiling or an oil subsidy. Economics dictates that after a brief period of turmoil, in the long run both supply and demand would become more elastic. Demand will sufficiently fall due to development of more fuel-efficient engines and discovery of alternate fuel. Supply will rise, as producers of oil would respond to the high prices by increasing oil exploration and by building new extraction capacity. If the price is artificially kept low because of political compulsions, there is no incentive to discover new sources or to become more fuel-efficient.

Hence, bowing to the will of the majority which wants present benefits is what a populist democratic government is supposed to do; its effect is hindrance of long term growth and development. Hence, as long as the principles of democracy contrast with those of basic economics, all democracies would be plagued with problems and inefficiencies.