Interest group activity and government growth: a causality analysis.

Author:Sobel, Russell S.
Position:Report
 
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The special interest group model of government, employed throughout public choice theory, models the outcomes of government as a function of special interest group activity. Early work in this area by authors such as Stigler (1971) and Peltzman (1976) focused on the role of interest groups in securing regulation beneficial to the regulated industry. Subsequent formulations--including McCormick and Tollison (1981), Yandle (1983), Mueller and Murrell (1986), Shughart and Tollison (1986), Becker (1983), Sobel (2004), and Holcombe (1999)--use the interest group model to explain not only a wide variety of individual government programs and policies, but also the overall growth of government spending. (1) Even the passage of child labor laws has been attributed to interest groups such as owners of steam-driven mills, physicians, and teachers. (2)

In contrast, the large literature on rent seeking beginning with the seminal paper by Tullock (1967), and continuing with the contributions of Krueger (1974) and Posner (1975), explains how interest groups will expend resources to capture the economic rents created by government policies. In its most basic form, the argument goes that when a $20 bill is up for grabs through a bidding process, the maximum amount of resources a group would devote to capturing that gain is $20. Whether the rents created by government policy are over, under, or perfectly dissipated has been the subject of debate and exploration, but the general consensus is that the amount of rent seeking that is visibly measured is far less than would be expected given the size of government rents up for capturing (i.e., the "Tullock paradox"), although some of this differential may be explained by less visible and hard to measure in-kind rent-seeking activities. (3) But merely the idea that rent-seeking activity falls below what would be expected given the transfers created by government implies a direction of causality in the opposite direction of the literature on the special interest group theory of government. Some extensions within this literature actually model government as trying to maximize the opportunities for politicians and regulators to "rent extract." (4) In this literature, governments pick policy targets and regimes that maximize the amount of rent seeking created by their actions.

Far from being a purely academic exercise, the ambiguity of the implied direction of causation between interest group activity and the size of government has both social and policy implications. On the policy side, reformers who want to slow the growth of government can be broken into two camps. The first is those who want to constrain interest group activity as a route to lowering government spending. Suggesting that campaign finance reform or PAC disclosure rules, for example, would be an effective way to help get government spending under control is an argument that takes for granted that it is the interest group activity that causes government spending. If the causality worked in the opposite direction, these types of reforms would be ineffective as the total rents created by policy would remain unchanged, and the means of competing for them would simply change to other avenues similar to how under rent controls side payments for items such as furniture could be used to compensate the landlord in alternate means. In other words, if government spending causes interest group activity in the vein of the rent-seeking model, these reforms would simply be ineffective as they target the consequence not the cause. On the other side are those who suggest that we can curb interest group activity and rent seeking by limiting the power and spending of government through items such as constitutional restrictions, a line-item veto, or a balanced budget amendment, for example. By constraining government spending, this argument holds, there would be less interest group activity. But this conclusion relies on the direction of causality: if interest groups cause government, and not vice versa, the only means to constrain government is to first constrain interest group activity.

Nowhere is this causal distinction more blurred than in the current debates about the significant 25 percent increase in lobbying and interest group activity in the 2007-2010 period and how it relates to the federal government's greatly expanded budget including the $700 billion Troubled Asset Relief Program (TARP) program in October 2008, and the $797 billion "fiscal stimulus" legislated in the 2009 American Recovery and Reinvestment Act (ARRA). Lobbying by the finance, insurance, and real estate sectors alone has been over $450 million per year since 2008. The industry now has approximately 2,500 individual registered federal lobbyists and increased donations directly to federal political campaigns from $287 million during the 2006 election cycle to $503 million during the 2008 election cycle. Other sectors, such as energy, have followed similar paths of this period, with a 66 percent increase in federal lobbying expenditures, over 2,200 registered federal lobbyists, and increases in campaign contributions from $51 million during the 2006 election cycle to $81 million during the 2008 election cycle (Center for Responsive Politics 2013). Office space in Washington, D.C., has now become the highest priced in the country and many businesses have opened or moved their offices to the Washington, D.C., area, and the popular logic clearly relies on an argument that these responses have been caused by the expansion in government activity. (5) Thus, while some argue that programs such as TARP have caused the increase in bank lobbying, others argue that it was the increase in bank lobbying that caused the passage of TARP (Allison 2013).

Interestingly, while the so-called "Occupy Movement" and conservative/libertarian leaning scholars both argue against what they see as a large recent increase in bailouts and crony capitalism, the root cause each group identifies can be separated by the direction of causality. Followers of the "Occupy Movement" blame big, well-funded corporations and die political activity they fund for an out of control government, while the other side blames the out of control government for the rise in crony activity among firms.

The recent strand of literature on productive and unproductive entrepreneurship first elaborated by Baumol (1990, 1993, 2002), and expanded by Boettke (2001), Boettke and Coyne (2003), Coyne and Leeson (2004), and Sobel (2008), not only incorporates the government causes interest group logic, but provides it a theoretical underpinning. In this literature, the allocation of a society's entrepreneurial talent between productive, market-based entrepreneurship and unproductive political and legal entrepreneurship (e.g., lobbying) is driven by the relative profitability of the two activities, which is a function of the quality of a country's institutions. In countries with institutions providing secure property rights, a fair and balanced judicial system, contract enforcement, and effective limits on government's ability to transfer wealth through taxation and regulation, the returns to unproductive entrepreneurship are low, while the returns to productive market entrepreneurship are high, thus causing fewer resources to be devoted toward interest group activity. In areas without strong institutions, entrepreneurial individuals are instead more likely to engage in attempts to manipulate the political or legal process to capture rents as the returns to unproductive activity are relatively higher. Again, in this literature it is the actions and undertakings of government that come first, and the amount of political interest group activity and lobbying is simply a consequence caused by die policies of government.

Of course, it is clearly possible that both are true--that is, bidirectional causality. Exogenous changes in government spending may subsequently cause changes in interest group activity, while exogenous changes in interest group activity may subsequently cause changes in government spending. This simultaneous equations-type logic implies a theoretical relationship similar to the relationship between club membership and output modeled in Buchanan's (1965) "Theory of Clubs" in which there is an optimal membership for every given club output, and an optimal club output for every given club membership size, and only one point at which both are simultaneously satisfied. Here, however, the argument would be that for every given level of government spending there is some optimal level of interest group activity that dissipates these rents, while for every given level of interest group activity there is a level of government spending produced by that special interest group activity, and an equilibrium would be reached at the point where both relationships are simultaneously satisfied. Under bidirectional causality, the problem of growing government and interest group activity can be effectively controlled by changes to either side, implying that constraints on government and restrictions on interest group activity both potentially can be effective tools.

In this article, we present a theoretical and empirical treatment of this issue of the direction of causality. We begin with the presentation of models that capture each side of the argument individually, and also a bidirectional simultaneous equation model. We then continue with an empirical examination of data on government spending and interest group activity to see if the nature of the causality can be identified empirically employing Granger Causality tests. We use data on total federal expenditures and two different measures of interest group activity, expenditures on lobbying, and the payroll of political organizations in Washington, D.C., and confirm the presence of a bidirectional causal relationship.

The Competing Models: A Theoretical Framework

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