Reproduced with kind permission from Steven Spadijer at Australian National University:

What is Direct Democracy?

Direct Democracy allows a prescribed number of citizens’ to veto an existing law or enact a constitutional amendment or statute independent of the legislature at a referendum. Today, these procedures complement the day-to-day representative government found in Switzerland and its 26 cantons, 7 German Länder, Liechtenstein, 24 American states and parts of Latin America.

Readers might notice that these regions are some of the wealthiest, well-governed and most stable countries in their region today. But do constitutions matter for economic performance? In particular, does the use of direct democracy matter from an economic perspective?

The Swiss Experience

Authors Feld and Savioz (see references below) found that per capita GDP in cantons which use Direct Democracy more frequently, and have easy access to these rights, are some 5 percent higher than in cantons which have infrequent use (even when controlling for income and other demographic variables). Feld also shows that direct democracy is associated with sounder public finances, lower levels of public debt, better economic performance and higher satisfaction of citizens.

Schaltegger with Feld then reveal centralization of public resources is more likely to occur under representative government while direct democracy is more likely to decentralize the provision of public resources, concluding that :

the empirical analysis provides evidence that referendums induce less centralization of fiscal activities.

In turn, such decentralization prompts vigorous tax competition between the cantons of Switzerland attracting capital from aboard as well as better education outcomes for all.

More recently, Funk and Gathmann find using Swiss data from 1890 to 2000 that a mandatory budget referendum reduces canton expenditures by 12 percent while lowering signature requirements for the voter initiatives by 1 percent reduces canton spending by 0.6 percent.

Pommerehne then examines the effects of direct democracy on the efficiency with which government services are provided. He finds that waste collection in Swiss towns having both a private contractor for the service and direct democratic elements is provided at lowest cost. Additional efficiency losses materialize if waste collection is provided in towns without direct democratic elements.

So far as its economic impact in Switzerland, direct democracy has brought with it unparalleled economic prosperity, despite the country being far from resource-rich.

Progressivism and Direct Democracy

It is important to note that Direct Democracy per se does not lead to lower spending. Rather, it accords with what citizens require given the context. If your infrastructure is state-of-the-art, then there is no need for lavish expenditure. Conversely, if it is dwindling (try taking a train from Western Sydney to the city), then it is a gun behind the door.

In Uruguay, for example, voters repealed privatization of the countries water supply and oil companies, “Norwegian-izing” their natural resources via the initiative process. Matsusaka noted that during the first half of the twentieth century in the United States, which was characterised by massive urbanisation and movement of people from rural to urban areas all of which required railways, roads and schools to be built), initiative states spent more — both statewide and locally, but lower state and higher local expenditure after controlling for income and other demographics.

This was used to bypass the legislature dominated by farmers and allowed the US to urbanise itself. Together with existing evidence from later in the century which shows its ‘libertarian’ streaks, suggests that the voter initiative does not have a consistent effect on the overall size of state and local government.

However, in all cases Direct Democracy systematically leads to more decentralized expenditure. Indeed, Blume and Voigt note in Germany that the introduction of direct democratic elements in local constitutions led to higher rates of expenditures on local infrastructure. For example, Bavaria – one of the most efficient, well governed parts of Germany – has had over 1500 referendums locally from 1995 to 2005.

Reasons?

But why does direct democracy deliver results far superior to that of representative government? There are 3 broad reasons:

1. In a principal-agent framework, citizens are the principals and can only very imperfectly control their agent — the government.

In this situation, direct democratic institutions can have two effects, namely a direct effect, which enables the principals to override the decisions of an unfaithful agent, and an indirect effect, where simply the threat of override is sufficient to compel the agent to behave according to the principal’s preferences.

Potentially, reducing the principal-agent problem by way of direct democratic institutions could affect all of the economic variables discussed in this paper: if citizens prefer an expenditure level that is higher/lower than that preferred by the government, they should be able to achieve it via direct democratic institutions.

2. James Buchannan attributes the poor performance of representative government due to the theory of “adverse selection”:

[S]uppose that a monopoly right is to be auctioned; whom will we predict to be the highest bidder? Surely we can presume that the person who intends to exploit the monopoly power most fully, the one for whom the expected profit is highest, will be among the highest bidders for the franchise.

In the same way, positions of political power will tend to attract those persons who place higher values on the possession of such power. Is there any presumption that political rent seeking will ultimately allocate offices to the ‘best’ persons?

Genuine public-interest motivations may exist and may even be widespread, but are these motivations sufficiently passionate to stimulate people to fight for political office, to compete with those whose passions include the desire to wield power over others?

Under these monopolistic conditions it is entirely predictable that the system will adversely select odious politicians who act in their own interests, with secondary regard for the subjects they rule or that of the opposition. It is inevitable that the dishonest politicians will deliberately misrepresent the state of affairs to the public in their desperate attempts to secure votes, buying off special interest groups and powerful lobbies piecemeal with gifts from the public purse.

And it is only a matter of time before the megalomaniacs pursue some expensive, harebrained, self-serving scheme (like the EU, the Euro debacle, or a war – all of which were rejected by the people) that brings down disaster on their subjects. Does anyone, for example, believe Ireland would be in the position it is today if it had the Swiss system of government, handing over your own sovereignty to the EU? I doubt it.

3. By contrast, direct democracy allows one to serve no one but their own community and families. Buchannan further notes:

…direct democracy [acts as] an add-on or addendum to existing decision rules and procedures, as carried out through legislative bodies or through executive-administrative agencies, provisions for popular initiatives and referenda can operate so as to forestall collective actions that might otherwise be implemented.

And such provisions may exert an influence as a potential check even if no popular efforts toward actual organization of an electoral test are made. Legislators, executives, bureaucrats, and judges will keep arbitrary actions within tighter boundaries when they are subjected to potential reversals through popular referenda.

In sum, the effects of direct democracy add-ons to existing decision rules surely work toward reducing the range and scope for politicization, a result supported by classical liberals.

Conclusion

We can see there is a powerful case for direct democracy from an economic perspective. We can also see that direct democracy, like Switzerland, is a “neutral” force: when governments go too far toward the right, the initiative reverts government back to the left forcing them to spend on infrastructure to avoid unnecessary and crippling bottlenecks.

When the government goes too far left, direct democracy reverts the government to the right, decentralizing expenditure. Presumably, in Australia direct democracy would decentralize taxation and result in competitive federalism (note most centralized power proceeds undemocratically) – perhaps giving [Australia] a fighting chance to compete with Singapore!

References

Lars P. Feld and John G. Matsusaka, ‘Budget Referendums and Government Spending: Evidence From Swiss Cantons’

Lars P. Feld and Marcel Savioz, ‘Direct Democracy Matters for Economic Performance: An Empirical Investigation’

John G. Matsusaka, ‘Fiscal Effects of the Voter Initiative in the First Half of the Twentieth Century’

Lorenz Blume and Stefan Voigt, ‘Fiscal Effects of Reforming Local Constitutions: Recent German Experiences’

Christoph A. Schaltegger, ‘Tax Competition and Income Sorting: Evidence from the Zurich metropolitan area’

Patricia Funk and Christina Gathmann, ‘Does Direct Democracy Reduce the Size of Government?’