Trust in government and policy effectiveness


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Presentation by Mario Solis-Garcia at the OECD Workshop on “Joint Learning for an OECD Trust Strategy” on 14 October 2013. Mr. Solis-Garcia discusses why trust matters and uses a simple economic model to see how government trust influences environment, government, households and timing.

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Trust in government and policy effectiveness

  1. 1. Trust in government and policy effectiveness Mario Solis-Garcia Department of Economics Macalester College October 14, 2013
  2. 2. “The government says not A. Therefore A.”
  3. 3. Why government trust matters Can trust in government have incidence over policy effectiveness? Use simple economic model to show answer is: “yes.” In the model, government’s tax policy announcements have very different effects depending on trust.
  4. 4. Why government trust matters Bottom line: A government policy that is intended to have a particular effect can generate a very different outcome depending on how trustworthy households/firms/agents believe the government is.
  5. 5. A simple economy: environment Economy lasts for one period. Large number of household-producers and a government. Households can produce for formal or informal sectors. Consume profits. Government taxes formal households’ output. Expenditure is wasteful.
  6. 6. A simple economy: government Taxes output of formal households at rate τ ∈ [0, 1]. Impossible to tax or impose penalty to informal households. Government is committed to tax plan τ . Key: households do not perceive it this way.
  7. 7. A simple economy: households Households identical except for productivity. Endowment is one unit time to be used as labor. No capital. Households have level of trust for government, λ ∈ [0, 1]. Two production technologies: formal and informal.
  8. 8. A simple economy: households Formal technology combines labor with capital to produce output. Larger scale of production: high-productivity households benefit more. No capital endowment: need government “quality seal” to access credit market. Implies formal households can’t avoid taxation. Formal households believe government will keep policy τ with probability λ, confiscate output with probability 1 − λ.
  9. 9. A simple economy: households Informal technology uses labor to produce output. Informal households cannot rent capital but don’t pay taxes.
  10. 10. A simple economy: timing 1. Households observe productivity value. 2. Government announces tax plan τ . 3. Conditional on productivity, tax plan, and government trust, households decide technology to operate. 3a. Formal households rent capital and produce. Government taxes according to plan. 3b. Informal households produce.
  11. 11. Results Result 1 If there is no trust in government, all households operate informal technology (regardless of productivity).
  12. 12. Results Result 2 If λ ∈ (0, 1], households with productivity higher that some cutoff will operate formal technology. Cutoff depends on government trust and is given by θF = A + B ln(λ) where A > 0, B < 0 are constants that depend on model parameters.
  13. 13. Results 14 12 Productivity cutoff 10 8 6 4 2 0 0 0.1 0.2 0.3 0.4 0.5 0.6 Government trust 0.7 0.8 0.9 Figure: Productivity cutoff and trust in government. 1
  14. 14. Results Result 3 Proportion of households choosing to operate informal technology falls as trust in government increases.
  15. 15. Final remarks Presented a simple model where government trust influences household decisions. Results depend on households’ perceptions and not on actual government behavior. More elaborate models should exhibit richer set of implications; do not think main conclusion will change.