The *State* Capacity Crisis
TLDR:
State and local governments routinely fail at their core job: providing Basic Services
One of the primary reasons for this poor performance is the Oversight Problem: the median voter has little effective power to hold state and local elected officials accountable
While voters struggle to effectively hold officials accountable, shareholders have an easier time holding company management accountable to them. Voters should start adopting the tools shareholders have developed to solve the Oversight Problem. We can do this by:
Funding liquid democracy
Improving public sector performance reporting norms
TOC:
Background: The Oversight Problem in Public Company Governance
(Part 2) Performance Reporting: Shareholders vs Voters
In this post, we apply the wisdom in David Schleicher’s and Nicholas Bagley’s excellent recent commentary on the ongoing state capacity crisis to improving government in New Jersey. In the midst of the ongoing Abundance debate in wonk circles about why government can’t do even basic things well, theirs is the most perceptive assessment of the problem we’ve come across, so everyone should check it out. We start by briefly summarizing their piece below, but they also have a nice TLDR here.
The State Capacity Crisis Summarized
Schleicher and Bagley make two main contributions. First, they posit that the key Abundance battleground is state and local governments, not the federal government. We agree.
They then argue that at minimum, governments are responsible for providing a basket of nearly-universally agreed basic services, and the widespread failure to do so tells us that our governance regime is fundamentally failing. They land on three key drivers of the failure: (1) weak public oversight (the Oversight Problem); (2) an inflexible and complex administrative state that favors special interests and (3) a restrictive fiscal regime that stymies intelligent investment. They’re pretty clearly on to something, and both Abundance advocates and skeptics would do well to think deeply about their diagnosis.
In this post, we propose some solutions for the Oversight Problem. (We think the Oversight Problem is the key to solving (2) and (3), but we’ll save that for another post)
Our proposal for solving the Oversight Problem: shareholders have better tools for holding company management accountable than voters have for holding public sector management accountable. Voters should use those tools. Specifically, voters should (i) substantially boost public investment in oversight and (ii) simplify oversight by reforming public sector performance reporting. In this post, we cover (i). We’ll cover (ii) in the next post.
The State Oversight Problem
High capacity governments competently provide Basic Services. Low capacity governments don’t. Residents get stuck with low capacity governments when the key decision-makers in those governments cease to be accountable to the median voter. Zeroing in on state and local governments as the “leaders” in driving the state capacity crisis, Schleicher and Bagley trace the state and local Oversight Problem to its roots: (a) the nationalization of state and local elections and (b) interest group capture.
Nationalization of State and Local Elections
State and local policy decisions are often quite divorced from federal ones, so a candidate’s participation in a national coalition is frequently a weak signal of candidate quality for state or local office. Yet, the “leading determinant of which party wins state and local elections—whether it is for a state legislator, county district attorney or whatever else—is which party won that district in national elections.” A strong incentive for state and local politicians then is integration with the national party, even if that means they’re a poor fit for the actual problems their state or locality faces.
Interest Group Capture
Special interest voters thrive in low-turnout elections, which is a particular problem for state and local elections because they overwhelmingly draw low voter turnout. Examples abound of a chamber of commerce, a powerful homeowner group or a public sector union threatening to whip votes against politicians that take stances against their interest, even if their interest is clearly inconsistent with the majority’s interest.
When considering a decision with diffuse but positive net benefits to society on one hand, and concentrated costs on the other, a politician may have little incentive to risk her career by irritating the potentially aggrieved. For example, in deciding whether to convert off-street public parking in a dense environment into a bike lane, she may think that while the benefit of expansion is substantial in the aggregate, the benefit is spread across enough bike riders that few will be motivated to reward her at the polls, where she may find herself at the mercy of an angry driver group. While we might decry her decision to prioritize the interest group, it’s naïve (and perhaps unfair to our legislator) to assume that career public sector employees wouldn’t value job security.
Solving the State Oversight Problem
Schleicher and Bagley are less decided on how to solve these problems. They don’t commit to particular solutions but do briefly explore the possibility of subsidizing local newspapers, among other possible responses. We think this solution is on the right track and should be fleshed out. To understand why, we turn to a context where governance is strong in spite of low stakeholder participation: public company governance.
Background: The Oversight Problem in Public Company Governance
The US capital markets are unquestionably the world’s most robust and have a strong claim to being the most efficient and best governed. This is in spite of the fact that few stakeholders actually participate in overseeing company performance. The majority of American households have a portion of their savings invested in public companies, yet we rarely feel the need to actually check in on whether those managers are acting in our best interest! Only 30% of individual investors participate in corporate governance, which is less than the 40% of voters that participated in the 2021 New Jersey gubernatorial election and is about as many as participated in the 2021 33rd assembly election.
The key question then is why governance is so much stronger for public companies than for state and local governments, when both have similarly low participation. We think corporate governance is successful because shareholders have some built-in governance advantages over voters: (i) more liquid democracy and (ii) stronger financial reporting norms.
Liquid Democacy
Shareholders: Strong Vote Delegation
While individual investors don’t vote at a high rate, institutional investors, basically professional money managers, who control 70% of shares, have an 80% turnout. Because institutional investors pool money from many individual investors, they have the budgets to hire professionals to research past management performance and assess management’s prospects for the future. Individual investors who don’t participate can thus effectively benefit from the quality control that institutional investors impose.
On average, of every $100 invested in public companies, 35 cents is for oversight. If Jersey City residents invested in oversight at a similar rate to oversee city and county services, our oversight budget would be at least $6M per year (out of a total $2.2B annual budget). Our preferences are clearly revealing that we think investment on this scale is necessary for a good governance result, and we shouldn’t ignore that signal!
Shareholders: Strong Bounty System
Beyond shareholding institutional investors, other actors are strongly incented to find and potentially replace underperforming or corrupt managers. Activist investors, for example, are paid to find companies whose management they believe isn’t acting in shareholders’ best interests. They then pressure those managers to re-align with shareholders’ interests or risk being terminated. Investors are usually willing to reward such delegees with 10-20% of the value of the opportunities for improvement they find and are able to have implemented. While it’s an open question whether in 2025 activist investors improve average company returns, the threat of an activist takeover undoubtedly influences management to think very hard about maximizing their alignment with shareholders.
Voters: Weak Vote Delegation & No Bounty System
By comparison with investors, voters have few tools to hold government accountable. Instead of powerful delegees, voters are primarily left to rely on muckraking local media. Local news can highlight public sector failures in ways that motivate politicians. The nonprofit sector (e.g., think tanks and universities and sometimes broad-based interest groups) also contributes on this front.
Unfortunately, however, these pseudo-delegees are usually badly overmatched. Local media in particular is tethered to the whims of the advertising business model, which does not correlate with the value of the critical muckraking services that media can deliver. Consequently, local media ends up substantially underfunded relative to its private sector delegee counterparts and so has no hope of delivering a similar level of impact.
From an informal survey, we believe that between local news and non-profit organizations, the oversight budget in Jersey City is less than $100,000 per year, nearly 60 times short of the $6M target! Incidentally, the pool of most active voters and interest groups will likely spend more than that $6M to influence the outcome of this year’s Jersey City mayoral election, placing the median voter at a substantial resource disadvantage. Jersey City has the largest economy in New Jersey, so tragically we believe the story is even bleaker in other municipalities in the state.
Median Voter Resource Disadvantage
Solution
To summarize, we suggest that government entities in New Jersey:
Fund muckraking at a level comparable to what shareholders deem sufficient to effectively oversee company management
Ex: a municipality could buy ads from local publications based on how much engagement those publications were found to driven on local government issues the prior year
Experiment with letting voters more formally delegate their vote to professional muckrakers
Ex: a municipality can permit non-voters to delegate their vote to a professional delegee, which delegee would be rewarded financially out of the city’s oversight fund for earning each such delegation
Experiment with paying bounties to reformers that identify operational improvements
In Part 2, we’ll cover issue (2), the weak public sector reporting norms in New Jersey.
