This paper outlines the interest group or the capture theory of the government. This theory rests on two fundamental premises:

The first is that the same behavioral assumptions of maximization of self-interest that explain decision-making of the market should be used to explain the behavior of the public policy makers as well. While firms maximize profits; consumers maximize utility, public policy makers also maximize their interest (i.e. political support)

The second premise is that policy outcomes should not be explained away as errors or ignorance but should be seen as actual effects.

Government Failure

Goods that have positive or negative externalities are not produced at the optimum price or at the optimum amount if left to the market. The Pigouvian solution to this problem of market failure was government intervention. This assumes that the government benignly pursues the objective of maximizing social welfare. If this were true developing countries would have long solved their problems. Interest group theory looks at the wide divergence between the actual and intended effects of government intervention to understand why public regulation policies rarely benefit the consumers.

Market for Wealth Transfers

Interest-group theory explains how the monopoly power of the state can be mobilized selectively to benefit one group at the expense of the other. George Stigler (1971) formalized this notion by explaining that typically producer groups are smaller than consumer groups. Therefore they find it profitable to organize themselves into coalitions to lobby the public regulators for gain. On the other hand, consumers are a larger and more diverse group, and hence the cost of organizing themselves to lobby would be larger than the resulting gains.

The paper then explains the dynamics of the market for wealth transfers and the point of intersection P* is the political equilibrium. The demand and supply curves could be interpreted as the follows:

Demand: Assuming n individuals in the economy and 2n-1 possible groups, each groups bid price is the price that it would be prepared to pay to receive a transfer of $1. This price would be $1 minus the costs of organizing/lobbying/collecting information/overcoming the free-rider problem. This gives a downward sloping demand curve, which shows that groups that have lower costs of organizing demand more wealth transfers.

Supply: The net supply curve S-f is upward sloping and shows the price that each group would pay to avoid expropriation of $1 after netting the costs of organizing. The curve shows that it is cheaper to expropriate $1 from groups that have high costs of organizing.

Social Waste

The distance between the S curve and the S-f curve is f, which is the political brokers fee. These resources used for fee are a waste for the economy, as they do not create new wealth. The crucial point here is that there are information or transaction costs to collective action. The existence of a market for wealth transfers is due to the cost differentials of organizing where the political representatives effect redistribution. Hence they have an incentive to seek out issues on which prospective winners are better informed and well organized while losers remain ignorant about the transfers. Thus smaller groups have a comparative advantage in transfer-seeking activity, as their rate of return to information is higher.

Economic Regulation

Research shows that government intervention rarely achieves its announced goals. Interest group theory suggests that in the market for regulation, smaller, well-organized groups stand to gain from the controls imposed by regulation, which creates incentive for them to use the regulatory mechanism. This is good for the regulators as well as it increases f.

The paper then explains Sam Peltzmans model showing how private and not public interest drives regulatory policies. The model looks at a vote-maximizing regulator. The analytic used is similar to that of a utility-maximizing consumer trying to attain the highest indifference curve of utility subject to a budget constraint. Here the regulator is trying to reach the highest iso-majority curve showing political support, subject to a price-profit trade off. (Higher prices bring on more consumer resentment and lower prices bring more producer resentment). The regulator seeks the price that maximizes political support subject to profit constraint. Stronger producer coalitions would shift the price higher towards Pm.

Extensions of the Interest Group model

Rent extraction: All human action is motivated by a rent-seeking behavior. Regulators could allow themselves to be captured by producer groups they are regulating. They could also threaten to impose costs on that group in order to extract more rent.

Heterogeneous firms: Interest groups need not be monolithic and each sub-group could further try to use the regulatory agencies to further its limited interests.

Economic Development: Trade protectionism and state ownership of enterprises also arises from the same regulatory motivation of maximizing rents, in spite of their obvious inefficiency.

Population growth: Child bearing and higher value of a male offspring could also be explained by interest group theory as a rational effort to expand in order to control the wealth-distribution levers.

Political successions: The theory explains how autocratic governments initially expand the government while trying to build a coalition to dilute the powers of those loyal to the previous ruler.

Conclusion

Interest group theory is an effort to understand why social welfare is not maximized when governments step in to deal with market failure by regulating. The theory is positive and not normative, in seeking to only explain why regulation fails. The key step forward would be to frame regulations in such a way that there is synergy between the vote-maximizing objective of the politician and the utility-maximization of society. The question however would be: who if not the politician would frame that regulation?