Decision Externalities, Economic Efficiency and Institutional Response

The paper examines the application of the concept of economic efficiency to collective decision processes and public sector institutions. We show that the existence of transactions costs and of collective decision-making procedures requires a broader framework for judging policy processes and institutions than has traditionally been adopted. Next we develop the concept of institutional response and argue that many public decision structures and institutions may already embody counterbalancing features designed to deal with potential efficiency problems. We then propose a diagnostic procedure for finding potential efficiency problems by looking for situations where the major decision-makers do not bear all the costs of their actions or capture all the benefits that these actions create. The paper identifies examples of such decision externalities in three areas of public members of the bureaucracy. The discussion is given specific empirical content by relating it to recent major institutional or policy initiatives taken in Canada.