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PUBLIC CHOICE, CONSTITUTIONAL POLITICAL ECONOMY

PUBLIC CHOICE, CONSTITUTIONAL
POLITICAL ECONOMY AND LAW AND
ECONOMICS
Ludwig Van den Hauwe
Brussels, Belgium
© Copyright 1999 Ludwig Van den Hauwe

Abstract
The various subdisciplines within the emerging ‘new institutionalism’ in
economics all draw special attention to the legal-political constraints within
which economic and political agents choose and therefore represent a return
of economics to its appropriate legal foundations. By changing the name of
his research programme to constitutional political economy Buchanan
distanced himself from those parts of the public choice literature that
remained too close to the traditional welfare economics approach. This
chapter draws lessons for law and economics from recent developments in
the re-emerging field of constitutional political economy. CPE compares
alternative sets of institutional arrangements, in markets and the polity, and
their outcomes, using ‘democratic consent’ as an internal standard of
comparison. The chapter discusses the methodological foundation of the
CPE approach, presents Buchanan’s reconstruction of the Coase theorem
along subjectivist-contractarian lines and gives an overview of recent
contributions to the literature.
JEL classification: B41, D70, H10
Keywords: Constitutional Economics, Constitutional Political Economy,
Public Choice, James M. Buchanan, Methodological Foundation

A. The Manifold Legacy of Adam Smith

1. Introduction

As the title of this chapter suggests, the new law and economics movement
on the one hand and the now rapidly emerging field of constitutional
political economy - as well as the somewhat older public choice branch of
economics from which it emerged - on the other hand, are research traditions
that are in some respects genuinely related. In other respects the differences
between them are sufficiently important, however, to warrant a more
or less detailed discussion.

Both exemplify the ‘extension’ of economics beyond its traditional
boundaries - from market to non market behaviour - and both belong to a set
of subdisciplines that draw special attention to the legal-political constraints
within which economic and political agents operate. Both constitute complemental
facets of the emerging ‘new institutionalism’ in economics.

Both may have drawn substantial inspiration from the encompassing
theoretical perspective and the reformist attitude that were characteristic of
Adam Smith’s approach. Indeed, CPE can be considered to be an important
component of a more general revival of the classical emphasis, particularly
as represented in the works of Adam Smith. Among the various approaches
to the new economic institutionalism, constitutional economics is probably
the one that comes closest to what in Adam Smith’s time was called ‘moral
philosophy’. It seeks to bring closer together again the economic, social,
political, philosophical and legal perspectives that were once part of the
study of moral philosophy, and which the process of specialization in
modern academia has fragmented into separate fields. Buchanan’s
constitutional economics is the modern-day counterpart to what Smith called
‘the science of legislation’, an academic enterprise that is concerned with a
comparison of the working properties of alternative sets of rules, and
ultimately aims at guiding our efforts to improve the social order in which
we live by improving ‘the rules of the game’.

On the other hand, Coase, in his 1991 Nobel Memorial Lecture (Coase
1992, p. 713), made the claim that during the two centuries since the
publication of The Wealth of Nations, the main activity of economists -
including, by implication, a very substantial part of his own work - had been
to fill the gaps in Adam Smith’s system, to correct his errors, and to make
his analysis vastly more exact.

The new law and economics field is usually said to have started in the
early 1960s, when Guido Calabresi’s first article on torts and Ronald
Coase’s article on social cost were published (Calabresi 1961; Coase 1960).
Coase’s article was without any doubt the more significant for the long-run
development of the new law and economics field.

Modern public choice - or the economics of politics - is usually said to
have been founded by such classics as Black (1958) - following earlier
papers published in the late 1940s and early 1950s - Arrow (1951), Downs
(1957) and the precursory inquiries in Schumpeter (1942) - though elements
of public choice analysis can already be found in the work of Pareto (see
Backhaus, 1978). The major breakthrough, however, came with Buchanan
and Tullock (1962). The Calculus of Consent was a seminal work in several
respects. The public choice perspective is usually characterized as combining
two distinct elements: the extension of the economist’s model of utilitymaximizing
behaviour to political choice and the conceptualization of
 ‘politics as exchange’. The Calculus was the first book that integrated these
two elements into a coherent, logical structure. Moreover, the Calculus
differed from the precursory works in that it embodied justificatory
argument. It sought to outline, at least in very general terms, the conditions
that must be present for an individual to find it advantageous to enter into a
political entity with constitutionally delineated ranges of activity or to
acquiesce in membership in a historically existing polity. It was recognized
that, if one remains within the presuppositions of methodological
individualism, the state or the polity must ultimately be justified in terms of
its potential for satisfying individuals’ desires (see also Buchanan, 1987, p.
133).

Furthermore, The Calculus of Consent confronted the market failure
presumption of the new welfare economics by demonstrating that the
problems associated with markets were ubiquitous, indeed entered into the
calculus of political consent arguably with far greater significance because of
the indivisibility of collective action (Rowley, 1993, p. xiii; Goetz, 1991, p.
10). The market failure concepts were applied evenhandedly to the
alternative institutional arrangements, especially those of political control,
and for the first time various policy arguments could benefit from a
consistent and balanced approach.

Finally, the Calculus contained the germs of the recent developement of
the research programme of constitutional political economy. It seems that
Tullock’s complaint about the lack of further research along the lines
suggested in the Calculus was premature (Tullock, 1987, p. 139). The
boundary between public choice, in its non-constitutional aspects of inquiry,
and constitutional political economy may seem somewhat fuzzy. It is
generally considered that public choice, in which attention is concentrated
on analyses of alternative political choice structures and on behaviour within
those structures is, through its focus on predictive models of political
interactions, a preliminary but necessary stage to the more general
constitutional inquiry.

On the other hand, law and economics remains somewhat closer to
orthodox economic theory than either constitutional economics or public
choice. The standard efficiency norm remains central to the law and
economics subdiscipline, both as an explanatory benchmark and as a
normative ideal.

The complex relationships between law and economics and public choice
were carefully analysed in (Rowley, 1989). A masterly survey of the public
choice literature is contained in Mueller (1989). Equally recommendable is
Rowley’s (1994) essay on ‘Public choice economics’ in Boettke (1994). In
the present chapter we propose to draw some lessons for law and economics
from recent developments in the re-emerging field of constitutional political
economy.

At a time of major worldwide constitutional change, it will come as no
surprise that the focus of public choice discussion is shifting away from
ordinary political choices to the institutional-constitutional structure within
which politics takes place.

2. Leading Journal

The leading journal of the sub-discipline is Constitutional Political
Economy. Some preliminary and intuitive understanding of what CPE is all
about can be gained from explaining the logic behind the logo of the journal,
which is drawn from Greek mythology. CPEs logo is a representation of the
familiar Homeric account of how Ulysses heard the Sirens singing, and
survived (see Brennan and Kliemt, 1990). Ulysses wanted to hear the
exquisite voices of the Sirens. He was passing close by and, in principle,
there was nothing to prevent him from listening to them while continuing
his journey. However, he recognized that the power of these voices was such
that he would steer the ship ever closer to the rocks where the Sirens were
located. The ship would be wrecked and he would be unable to continue his
journey.

Formally, Ulysses faced a problem of time inconsistency in his optimal
plan. His optimal plan was to listen to the Sirens and then continue his
journey. But this was time inconsistent, because once he had embarked on
the plan by listening to the Sirens he would not be able to implement the
later part of the plan, the rest of his journey. By contrast, a time consistent
optimal plan is one that specifies a sequence of actions (At, At+1, At+2 and
so on), one for each moment in time (T, T+1, T+2 and so on), which enjoys
the property that the individual will actually choose in each time period the
action specified by the plan. Thus, when T+1 occurs, having undertaken At
in T, the individual will still choose At+1 as the best action rather than some
other, and so on.

The time-inconsistency arises because the Sirens affect Ulysses’
preferences. His perception of the best action changes in the middle of the
plan and this leads him to deviate from the original version. Ulysses
implemented his optimal plan by denying himself freedom at the later stage
of the plan. Having instructed his men to tie him to the mast and to ignore
any orders to do anything other than sail past the rocks, he told them to plug
their ears and row.

Thus, Ulysses established for himself a private constitution, a set of more
or less binding rules that constrained his future choices. By exploiting
elements of his natural and social environment, Ulysses was able to subvert
certain inclinations of his future self, inclinations that he knew would be
destructive to his overall interests but which would nevertheless prove
irresistible when they arose.

Though the theory of private constitution is a - small - part of the domain
of constitutional political economy (Buchanan, 1990, p. 3), the principal
issue for constitutional political economy is that of forming a mutually
agreeable constitution for social arrangements among a community of
persons. Ulysses is therefore to be seen not merely as a single actor but more
particularly as representing society as a whole, and the mast and rope are to
be identified as the rules by which ordered society is governed.

As Brennan and Kliemt (1990, p. 125) point out, some care must be
taken in interpreting any such image. Following the individualist
methodology, ‘social action’ must be decomposed into the actions of the
individuals of whom society is made up. The exercise of social binding,
specifically, must be seen as an intrinsically multilateral activity. Each
agrees to a set of rules and procedures because this is the price each must
pay to restrict the conduct of others. ‘Weakness of the social will’ will arise
precisely because it is opportunistically rational for any individual to depart
from the collectively agreed rules and procedures.

Moreover, in the setting with which CPE is concerned, there is no
external technology available that is totally effective or not excessively
costly. The tools of enforcement and maintenance must themselves be
socially constructed. Human beings are not bound by nature to pursue rules:
they are endowed with the capacity to deviate from rules if it is profitable to
do so. Accordingly, we must search out rules which so order individuals’
behaviour that it is individually profitable for most people to keep and
enforce those rules most of the time. The gains from violation should not be
too great. The analysis of the kind of rules and the associated institutional
apparatus that exhibit these properties represents a centrepiece of
constitutional political economy as an area of inquiry.

As far as dynamic choice theory in the strict sense is concerned, mention
must certainly be made of the promising and in-depth analysis of the
problem of dynamic consistency offered in McClennen (1990a). McClennen
develops his argument in the context of a critical examination of the
principles that constitute the cornerstone of the modern theory of expected
utility and subjective probability: the weak ordering and the independence
principles. McClennen argues for an alternative to the myopic and
sophisticated approaches to the problem of dynamic consistency: the theory
of resolute choice. The resolute chooser achieves dynamic consistency by
regimenting ex post choice to his ex ante evaluation of plans, thus achieving
a ‘cooperative arrangement’ between his present self and his relevant future
selves that satisfies the principle of intrapersonal optimality. Technically
speaking, resolute choice characterizes a commitment to dynamic
consistency (DC) and normal-form/extensive-form coincidence (NEC) at the
expense of separability (SEP). Reference should also be made to McClennen
(1993).

The problem of time inconsistency is addressed formally in Klein (1990).

B. The Theoretical Foundations of Constitutional Political Economy

3. Constitutional and Sub-Constitutional Choice

One solution to the problem of defining ‘constitutional political economy’
would consist of characterizing it simply as ‘the economic analysis of
constitutional law’ (see Backhaus, 1995). The examination of real-world
constitutions using the perspective of modern constitutional political
economy is certainly an interesting exercise and can provide a kind of test
for the usefulness of the CPE approach. In addition to Backhaus (1995),
reference should be made to several case studies. Holcombe (1991) analyses
the role of constitutional rules as constraints on government using three
United States constitutions: the Articles of Confederation (1781), the
Constitution of the United States and the Confederate Constitution. Brennan
and Pardo (1991) examine the Spanish Constitution (1978). Sobel (1994)
analyses the evolution of two international constitutions: the League of
Nations Covenant and the United Nations Charter. However, the aforesaid
definitional strategy may tend to be somewhat misleading. The use of the
term ‘constitutional’ in the self-description of the subdiscipline is largely
metaphorical.

CPE as a scientific subdiscipline is characterized by a particular kind of
orientation in social analysis. Whereas orthodox economic analysis attempts
to explain the choices of economic agents, their interactions with one
another, and the results of these interactions, within the existing legalinstitutional-
constitutional structure of the polity, constitutional economic
analysis attempts to explain the working properties of alternative sets of
legal-institutional-constitutional rules that constrain the choices and
activities of economic and political agents. The emphasis is on the rules that
define the framework within which the ordinary choices of economic and
political agents are made. Thus, CPE involves a ‘higher’ level of inquiry
than orthodox economics. CPE examines the choice of constraints as
opposed to the choice within constraints.

A preliminary example can be drawn from the theory of ‘market failure’.
We know that under some conditions, and given the legal order of the
protective state (the protection of property and the enforcement of contracts),
‘markets fail’ when evaluated against idealized ‘efficiency’ criteria. But in
examining allocative institutions, the economist should ask ‘As compared to
what?’ (Goetz, 1991, p. 10). We know today that ‘politics fails’ when
evaluated by the same criteria. The analysis and comparison of the working
properties of underlying sets of rules or constraints constitutes the domain of
constitutional economics.

A market is always a system of social interaction characterized by a
specific institutional framework, that is, by a set of rules defining certain
restrictions on the behaviour of the market participants. ‘Market failure’
arguments sometimes tend to ignore that the rules upon which a market is
based may well be variable and that an adjustment in these rules is possibly
a better way to deal with alleged shortcomings than to replace market forces
by a political mechanism.

When it is said that the rules upon which a market is based may well be
variable, this should not be misunderstood. It means that the rules can be
varied at the level of constitutional choice. At the level of sub-constitutional
(or post-constitutional) choice, the rules are parameters: they are items that
single economic entities cannot adjust and, indeed, must adjust to. Coase’s
(1960) tradable property rights are not really rules as the constitutional
economist defines them. Coase’s tale was about trading defined rights, about
private rearrangements of rights within a given legal structure, not about
redefining the rights that the market participants hold. We will take a closer
look at Coase’s contribution in the next section.

Elementary to any constitutional analysis is therefore the explicit
recognition of a notion of hierarchy. Any constitutional analysis will
distinguish between at least two levels of choice - constitutional choice and
sub-constitutional (or non-constitutional) choice - and correspondingly also
between constitutional and sub-constitutional preferences. Constitutional
choices are choices among alternative rules (constraints). Sub-constitutional
choices are among alternative strategies available within rules (constraints),
such as ordinary market choices.

4. Methodological Individualism

Only individuals choose and act. CPE is informed by an explicit
methodological individualism (Buchanan, 1990, p. 13). Whatever phenomena
at the social aggregate level we seek to explain, we ought to show how
they result from the actions and interactions of individual human beings
who, separately and jointly, pursue their interests as they see them, based on
their own understanding of the world around them (Vanberg, 1994, p. 1).
An aggregative result that is observed but which cannot, somehow, be
factored down and explained by the choices of individuals, stands as a
challenge to the scholar rather than as some demonstration of non-individualistic
organic unity.

5. Homo Economicus

Orthodox public choice models usually contain the postulate of homo
economicus: they go beyond the logical presuppositions of individualism to
incorporate non-tautological models of individual utility maximization.
Individuals are assumed to seek their own interests, which are defined so as
to retain operational content. It is increasingly recognized, however, that at
least a part of the traditional public choice emphasis has been wrongly
placed. Thus the emphasis is shifted away from the motivational postulates
for political actors to the incentive structures of politics. In Buchanan
(1993a, p. 69) it is argued that the seminal Alchian (1950) analysis of the
market’s analogue to evolutionary selection can be extended to politics in
relatively straightforward fashion, the difference between the two
evolutionary models lying in the compatibility with overall efficiency. The
structure of the politics in which politicians act requires them to act contrary
to public interests if they are to survive at all. For the constitutional
economist the relevant question then becomes: ‘How can Constitutions be
Designed so that Politicians who Seek to Serve “Public Interest” can Survive
and Prosper?’ (Buchanan, 1993b).

6. Normative Individualism

The whole exercise of CPE is ultimately aimed at offering guidance to those
who participate in the discussion of constitutional change. In other words,
constitutional economics is meant to offer a potential for normative advice in
constitutional matters and to provide a normative framework for
comparative institutional analysis. As a normative enterprise, CPE is
informed by normative individualism: the presumption that the evaluations
of the persons involved, their interests and values, provide the relevant
criterion against which the merits of alternative sets of rules are to be judged.

7. Excursion: The Wicksellian Ancestry

The distinguishing feature of the Buchanan and Tullock (1962) approach to
the study of political institutions from a normative viewpoint was to treat the
political process by which individuals advance their interests as one of
exchange. In adding this second element - ‘politics as exchange’ - to the
utility maximizing models for individual choice behaviour in politics, they
were directly influenced by the great work of Knut Wicksell.

CPE could be characterized as ‘Wicksellian’ political economy.
Wicksell’s influence is discussed in Wagner (1988). In his basic work on
fiscal theory Wicksell (1896) called attention to the significance of the rules
within which choices are made by political agents, and he recognized that
efforts at reform must be directed toward changes in the rules for making
decisions rather than toward modifying expected results through influence
on the behaviour of the actors.

In order to take these steps, Wicksell needed some criterion by which the
possible efficacy of a proposed change in rules could be judged. He
introduced the now-familiar (near to) unanimity or consensus test. Thus for
Wicksell ‘the consent of the governed’ was the point of departure for the
evaluation of government activities.

This ‘Wicksellian’ idea has had considerable influence on Buchanan’s
approach. According to Buchanan, politics must be understood in terms of
the model of market exchange. Thus, the political proces is conceptualized
as one of mutually beneficial exchange. It is for this reason that he is drawn
to unanimity as a collective decision rule. Since the choice among rules is
more a social choice than an exchange, the form of voluntary exchange is
political consent. Through the emphasis on ‘consent’ or ‘agreement’ as a
normative yardstick, the research program of CPE became closely related to
the contractarian tradition in political philosophy. As Buchanan sees it, contractarian
political institutions typically exhibit three attributes. Central to
the contractarian vision of the political process is the place of the individual.
Individuals’ own - and necessarily subjective - evaluations, their interests
and values constitute the relevant benchmark against which the efficiency or
desirability of alternative rule-regimes or institutions are to be judged.
Contractarianism complies with this criterion by according each individual
equal treatment at the constitutional stage. The unanimity rule serves to
protect the individuals’ rights and thereby ensures that those rules and
institutions that become imbedded in the constitution will also treat
individuals equally and impartially. Second, there is the fundamental
distinction between actions taken within the constitutional rules, and
changes in the rules themselves. The latter are to occur only at the
constitutional stage and ideally are made using the unanimity rule. The
image of political activity as a two-stage process, first developed in The
Calculus of Consent, has recurred in many of Buchanan’s later writings as a
sort of normative benchmark or yardstick by which to measure the quality of
a community’s political institutions. Third, actions taken in the second stage
of the political process should be effectively constrained by the rules written
in the first, constitutional stage, and this is true not only for the individual
citizen, but also for the elected representatives, and the bureaucrats and
jurists who administer the system.

Recapitulating and summarizing, we can say that the two most important
aspects of Buchanan’s position are his emphasis on ‘rules of the game’ and
his analysis of efficiency as involving consent. At the most fundamental
level of constitutional choice, consent serves as the basis of justification. It
provides the ultimate criterion of efficiency. Unlike other economists who
have emphasized either the efficiency or rationality of rules, Buchanan is
concerned exclusively with whether or not people consent to them.

It should be noted that Buchanan and traditional economic analysts
develop the relationship between autonomy and efficiency in exactly
opposite ways (Coleman, 1990, p. 141). Traditional economists believe that
efficiency can be defined as a property of social states independent of the
process of voluntary exchange. For example, the perfectly competitive
market is efficient, but the outcome of the prisoner’s dilemma is not. And
given the logic of the relevant concepts - especially Pareto superiority - it
follows logically that people would consent to efficient rules. Consent
follows from efficiency. Buchanan puts the matter exactly the opposite way.
What people consent to is efficient. Efficiency follows from consent.

In contrast with Paretian ‘optimum resource allocation’, a situation of
‘Wicksellian efficiency’ will be characterized by the fact that citizens are
satisfied that the existing system of rules, institutions and policies of their
society is free from improper coercion (Wiseman, 1990, p. 110).

The Wicksellian criterion of social efficiency focuses on subjective choice
processes, in marked contrast to the Paretion optimality condition of
neoclassical welfare economics, which permits an external observer to use
individual utility as an objective measure of welfare. Social efficiency is too
complex a notion to be reduced to a set of technical propositions concerning
resource-use. Efficiency is not a property of social states that could be
specified or defined independently of the actions of individuals and the
process of voluntary exchange.

The limitations of conventional Pareto criteria in assessing efficiency are
also discussed by De Alessi (1992).

However, Wicksell did not move beyond the development of criteria for
evaluating policy alternatives one at a time.

Buchanan and Tullock (1962) operationalized Wicksell’s (1896) insights
and extended the applicability of the unanimity or consensus criterion from
the level of particular proposals to the level of rules - to constitutional rather
than post-constitutional or in-period choices.

For Buchanan and Tullock (1962, Chapter 6) constitutional design was a
matter of determining which voting rule or choice mechanism would be
specified by the constitution for each state activity. The best public decision
rule for each activity was the one that minimized interdependence costs. It
was specified that the representative individual perceived interdependence
costs for an activity as the sum of the anticipated external costs levied on
that individual if not part of the decision set, and the anticipated decision
making costs experienced by the individual if part of the decision set.
External costs arise because some individuals cash in the benefits of
collective decisions but shift the costs to other individuals. The group forces
an individual to contribute to collective action that is not wanted by that
individual (at that price). From the point of view of the individual in
question, external costs are the result of wrong decisions. The higher the
percentage required for a group decision, the lower the chance of wrong
decisions being made, so that the corresponding curve will show a declining
trend. Decision-making costs are the individual investment of time and
energy in the process of negotiation, expressed in money value. The closer
the requirement of unanimity comes to being met, the higher the decision
costs will be because, among other reasons, strategic behaviour of
individuals becomes more profitable. The corresponding curve therefore has
a rising trend. The sum of both external costs and decision costs was shown
to have a unique minimum somewhere between the extremes of individual
rule and unanimity rule, the exact position depending on relative external
and decision costs.

The shift of the Wicksellian criterion to the constitutional stage of choice
has some remarkable consequences. It becomes conceivable to allow for the
possibility that preferred and agreed-on decision rules might embody sizable
departures from the unanimity limit, including simple majority voting in
some cases and even less than majority voting in others (Buchanan, 1987, p.
135). The constitutional calculus suggests that both the costs of reaching
decisions under different rules and the importance of the decisions are
relevant. Since both of these elements vary, the preferred rule will not be
uniform over all ranges of potential political action. The in period Wicksellian
criterion may remain valid as a measure of the particularized efficiency of
the single decision examined. But the in period violation of the criterion
does not imply the inefficiency of the rule as long as the latter is itself
selected by a constitutional rule of unanimity.

As a consequence, while it was recognized that unanimity and not
majority rule is the pivot of constitutional democracy, it was equally
demonstrated that ‘at best, majority rule should be viewed as one among
many practical expedients made necessary by the costs of securing
widespread agreement on political issues when individual and group interests
diverge’ (Buchanan and Tullock, 1962, p. 96).

The appropriate degree of inclusiveness of the collective decision-making
rule - for example qualified majority rule - as an instrument to cope with
perverse forms of uncertainty about the incidence of collective decisions is
discussed in Pinto Barbosa (1994).

8. The Rent Seeking Trap

It has become common to model the choice situation at the constitutional as
well as the post-constitutional stage with potentially conflicting interests
between rational persons as a classic Prisoner’s Dilemma (Wagner and
Gwartney 1988, p. 32; Buchanan, 1993b, p. 2). The Prisoner’s Dilemma
game depicts a situation in which private interests and the search for individual
gain, when generalized, become the source of mutually harmful results.
In other words, private interests cannot be generalized without losses.
But what can be generalized (moral codes) does not obey private motivations.
Conflicting interests are clearly involved, since everybody wants to be
the only defector.

Classic Prisoner’s Dilemma

 

B

 

C

D

A

C

33

14

D

41

22

 

In ‘generalized Prisoner’s Dilemma situations’, that is, social constellations
under which individuals, in separate and rational pursuit of their
own interests, unintentionally but systematically contribute to an overall
outcome that is undesirable for all of them (or in any case less desirable than
some alternative outcome that could be realized by concerted, organized
action) there is a possible potential for mutual gains by collective action
(collective organization).

In this way the constitution is essentially a contract intended to secure
mutual gains from social cooperation and to avoid the dominant defective
strategy in the Prisoner’s Dilemma game which leads to a socially inefficient
Nash equilibrium solution. Since the mutual gains from social cooperation
constitute a public good, the maintenance of the constitutional contract gives
rise to a problem that will not resolve itself naturally.

Even when it is supposed that agreement on appropriate rules can be
achieved at the stage of constitutional contract formation, it should be
recognized that individuals and interest groups inevitably will attempt to
engage in post-contractual opportunism (problem of constitutional
maintenance). Therefore the agreement, once achieved, must be enforceable.
This opportunism takes several forms. First, each individual may have an
incentive to defect from the cooperative agreement after it has been
concluded (compliance or unilateral defection problem). Whether or not it is
rational for persons to comply with rules that they constitutionally may agree
on is a matter of contingent, factual circumstances. It depends on whether or
not the constraints that persons face after the agreement, that is postconstitutionally,
make it rational for them to comply with previously agreedon
rules. As Vanberg has pointed out repeatedly, their constitutional
interests and their compliance interests are not necessarily in congruence
(Vanberg, 1994, passim, for example, pp. 21-23).

A second form of post-contractual opportunism consists of rent seeking
and special interest plundering, which ultimately reduce the value of postcontractual
cooperation and undermine the constitution itself. Groups of
individuals have an incentive to seek and capture the instruments of state
power and to use them as vehicles to enrich themselves in ways that are
unattainable for private citizens.

Rent-seeking is a term used by economists to describe actions taken by
individuals and groups to alter public policy in order to gain personal
advantage at the expense of others.

The incentive to engage in rent-seeking activities is directly proportional
to the ease with which the political process can be used for personal (or
interest group) gain at the expense of others. In other words, distributional
politics is viable and tends to become dominant to the extent that differential
treatment is constitutionally permissible (Buchanan, 1993b, p. 6).

Tullock (1959) had already shown that under any voting system which
requires less than unanimous approval to implement policies, majority
coalitions of interest groups will seek to obtain public provision of special
interest projects. A few years later Tullock (1967) independently published
his innovative ideas on what came to be called rent-seeking, which he
argued entailed social costs. The latter were called ‘rent-seeking costs’ or, by
some, ‘Tullock Costs’. Tullock Costs have been re-analysed recently by
Spindler (1990).

The dominant strategy for any organized interest group in a majoritarian
polity is to lobby for policies which provide large benefits to its members and
disperse the costs over everyone else. This tendency exists even in liberal
democracies. Through implicit vote-trading, a coalition of interest groups,
comprising a bare majority of voters, can get all or at least most of their
favoured projects approved for public provision. Under certain conditions,
the total costs of these projects can exceed their total benefits, while cost
spreading through the ‘fisc’ induces a rational ignorance of this process on
the part of the disadvantaged majority. On the other hand, the asymmetric
distribution of cooperative benefits leads subgroups of the collective to invest
energy in the struggle for access to the government’s coercive power. But the
effort may turn out to cost more than it is worth and the end result will be
that the collective’s loss purchases the subgroup’s gain (Schmidtz, 1991, p.
91).

Buchanan and Lee (1991) demonstrate that the gains from politically
generated restrictions on markets, even to organized producing interests, are
more apparent than real. The analysis demonstrates that under plausibly
realistic assumptions concerning coalition sizes, excess burdens,
organizational costs and rent seeking outlay, a genuine utility-maximizing
calculus may dictate support for constitutional prohibition of all market
restrictions, by all members of the polity, including those producer interests
that might be considered to be potentially identifiable beneficiaries of
cartelization.

Principal-agent theory has been used to examine the rent-seeking
problem (Anderson and Hill, 1986; Merville and Osborne, 1990). The
principal, also the citizen, grants the agent (the government) the power of
coercion. In exchange, the agent supplies the principal with public goods.
Since the capitalized value of public assets is owned collectively, publicgood
outputs of the government are like communal resources with widely
diffused benefits. It soon becomes evident to vote-maximizing agents or
legislators that they can maximize their political support by significantly
reducing the provision of public goods to the population at large in favor of
greater transfers to interest groups. These transfers are financed by general
tax collections and provide concentrated benefits to designated groups. Such
collusion between agents and special interest groups will invariably lead to
the development of a Leviathan state.

Merville and Osborne (1990) use agency theory to demonstrate formally
that, in majority-rule political systems, coalitions of minority factions will
induce politicians to systematically break the constitutional contract in order
to supply special interest projects. Unlike contracts in private markets,
political contracts are much more susceptible to this kind of opportunism.

Is the rent-seeking trap inescapable? A serious consideration of this
question will take us a long way to the understanding of constitutional
political economy.

By far the most important problem with respect to ensuring the selfenforcing
character of a constitutional contract is that it must successfully
constrain the power of the Leviathan state itself. Whereas Brennan and
Buchanan (1980) endow Leviathan with the objective of revenue maximization,
La Manna and Slomp (1994) argue that Hobbes’s political construct
envisages a sovereign-principal who devises rules and incentives to
induce his subjects-agents to contribute to his own preservation and glory.
Leviathan is a glory seeker instead of a revenue maximizer.

Generally speaking substantive constraints on government have been
dismissed as ineffective precisely because of the wide latitude they allow for
reinterpretation. Wagner and Gwartney (1988, pp. 44-49) make a strong
case for procedural rules designed to uphold decentralization of
governmental powers and to prevent the formation of legislative coalitions.
Procedural rules will provide more effective mechanisms for self-enforcement
than will substantive restraints on government. In their view, the
weakness of substantive restraints derives from the politicization of the
Supreme Court and the ease with which legislatures can find alternative
ways to implement any given policy. They propose procedural rules
requiring larger legislative majorities for legislative action at higher levels of
government, thereby diffusing the power of the state to regional and local
governments.

Several other ‘solutions’ have been proposed in the literature.

9. Judicial Independence

Does independence of the judiciary serve the long-term public good? The
traditional view of the purpose of judicial independence has been attacked as
naive by law and economics and public choice scholars. Unlike many legal
contracts, it is argued, there is no third-party enforcer, external to the
contract, who can ensure that defectors are caught and forced to comply with
the terms of the agreement. Though many countries have a nominally
independent Supreme Court whose purpose is to enforce the constitution, the
Supreme Court can only do this imperfectly in most cases, because the
judges themselves are not totally immune from political pressure by groups
wishing to subvert the original intent of the constitution. Thus, given the
unreliability of third-party enforcement, and given the strong individual
incentives to defect from social cooperation, the constitutional contract
should somehow be self-enforcing if it is to be maintained.

The interest group theory first advanced by Landes and Posner (1975)
makes the independent judiciary an integral part of the system of rentseeking
engineered by Congress. However, the debate goes on. A very
detailed criticism of the Landes-Posner theory is contained in Boudreaux
and Pritchard (1994). They argue that the Landes-Posner theory is seriously
deficient and conclude that the United States federal judiciary is truly
independent of Congress and the President, and that this independence was
designed by the Constitution’s framers as a means of furthering sound
government.

Blankart (1994) compares the legal rules for private clubs with the
constitutions of representative governments. A nearly perfect laboratory case
for a club government can be found in the example of Switzerland. The
Swiss do not have a constitutional court, but have developed instead a
system of popular voting rights serving as a substitute for a judicial review
by a constitutional court. Though this system does not work perfectly, it has
relative advantages in comparison to constitutional courts, which often tend
to become political decisionmakers thereby circumventing the control of
citizens-as-principals.

Moser (1994) carefully analyses the contribution of the Swiss and the US
constitutions to protect economic liberties, and compares the different
strategies that both constitutions rely on to achieve this goal. It is argued that
the substantial constitutional changes that did occur in both countries
followed strikingly similar patterns: the constitutional protection of
economic liberties was eroded in both countries, especially as far as federal
legislation is concerned, due to changes in the interpretation of the
constitution through the courts, or by formal amendment. Tucker (1992)
looks at the impact and the judicial philosophy of the now dominating
Conservative group of justices on the Supreme Court. Rowley (1992)
examines the erosion of the economic liberties of US citizens with special
reference to the takings-clause provisions of the Fifth Amendment. It is
noticed that the Court changed direction during the late 1980s as justices
appointed by Presidents Reagan and Bush gained ascendancy.

10. A Rule of Law in Politics

According to Buchanan (1993b) the direction of constitutional reform is
obvious. If, somehow, the potential for differential treatment is reduced, so
will be the inducement to rent-seeking behaviour. The off-diagonal solutions
should simply be made impossible to achieve by the introduction of some
rule or norm that prevents participants from acting or being acted upon
differently, one from the other.

If the off-diagonal attractors are eliminated, then the players operate with
the following reduced matrix:

 

B

 

C

D

A

C

33

X

D

X

22


Thus the constitutional reform measure modifies the original Prisoner’s
Dilemma game into a reduced setting in which each player, as a member of
a political coalition, knows that any choice of an action or strategy must
involve the same treatment of all players or constituencies (Buchanan,
1993b, p. 3).

If and to the extent that differential treatment is replaced with equal
treatment, or with the principle of generality in politics - analogous to that
present in an idealized version of the rule of law - mutual exploitation will
be avoided and politicians who seek to serve the ‘public interest’ will survive
and prosper (Buchanan, 1993b, p. 6). Therefore it seems at least conceivable
that rational persons, at the stage of entering into the agreement, may recognize
the ‘rent-seeking trap’ and engage in concerted efforts to escape.

However, in the hypothetical matrix construction above, the interaction
was in fact assumed to occur in a state of nature, with each person holding
equal prospects for membership in the majority and minority coalitions. This
means that membership was assumed to be symmetrical among all
participants. But this assumption may turn out to be too heroic with respect
to real world settings.

The prospects may differ among persons and groups of persons so as to
create divergences in interests which may become a source of disagreement.
Thus the question remains whether it is possible to modify the constitutional
choice setting so as to reconcile such possible divergences. It appears that, at
least from the perspective of potentially-conflicting interests among
constituencies, the general problem of constitutional efficiency and
survivability does not resolve itself naturally.

11. Veil of Uncertainty and/or Ignorance Versus the Availability of Exit
Options

Is it possible to specify the conditons under which constitutional agreement
may be facilitated in real, non-hypothetical choice situations? Is it possible
to modify the constitutional choice setting so as to reconcile divergences in
interests?

In this respect, two lines of reasoning have been pursued in the
contractarian and neo- contractarian literature.

The first line of argument focuses attention on the need for a ‘veil of
uncertainty and/or ignorance’ as a precondition for an efficient constitution.
Buchanan and Tullock (1962) had to present a convincing positive argument
that unanimous consent at the constitutional level was possible at all. How
can agreement be achieved on rules among persons with potentially
conflicting constitutional interests? Buchanan and Tullock’s (1962)
characteristic way of approaching this issue consists of emphasizing the
uncertainty confronting all individuals taking part in constitutional
deliberations. The existence of ‘a veil of uncertainty’ induces individual
participants in a constitutional process to prefer rules that do not systematically
favour any particular subset of citizens.

The proposed remedy involves the introduction of some means of
insuring a person’s inability to foresee reliably their future particularized
interests, as these may be affected by different rules, thereby inducing
persons to make constitutional choices on some assessment of the general
working properties of alternative rules, and divorced from particularized
interests. Thus, agreement is facilitated by whatever increases a person’s uncertainty
about the particular effects that alternative rules can be expected to
have on them. In fact the assumption of a ‘veil of uncertainty’ was also
hidden in Buchanan (1993b), discussed above.

Buchanan’s approach has affinities with John Rawls’s (1971)
construction, who utilizes the veil of ignorance along with the fairness
criterion to derive principles of justice that emerge from a conceptual
agreement at a stage prior to the selection of a political constitution. Thus in
Rawls’s construction the prospect of agreement is secured by defining
certain ‘ideal’ conditions under which constitutional choices are hypothetically
made. The choosers are assumed to be placed behind a ‘veil of
ignorance’, that makes it impossible for them to know anything specific
about how they will be personally affected by alternative rules. Ignorant
about their prospective specific interests in particular outcomes, they are
induced to judge rules ‘impartially’. Potential conflict in constitutional
interests is not eliminated, but the veil of ignorance transforms potential
interpersonal conflicts into intrapersonal ones (Vanberg, 1994, p. 170).

However, the constitutionalist notion of a veil of uncertainty is not very
operational. It is not clear how genuine uncertainty could be achieved in
real-world constitution formation. Moreover, in certain parts of the rentseeking
literature there is a certain tendency to suggest that conflicts of
interest are no less characteristic for choices among rules at the
constitutional stage than for choices within rules and that therefore the idea
of some genuine constitutional agreement is a mere illusion when placed in
a real-world context. This view seems to be espoused by, for example, Sutter
(1995).

Therefore, it has been argued that the availability of exit options can
ensure a competitive setting for participants in constitutional deliberations
and can even substitute for a veil of uncertainty. This condition for efficiency
can be given operational substance in processes of real-world constitution
formation (Lowenberg and Yu, 1992).

In order to produce an efficient social contract or constitution,
deliberations must be carried out in a competitive ‘constitutional
environment’. This condition is satisfied if an exit option exists for each
contracting party. As will be argued later on, this conclusion is quite
consistent with the Wicksell-Buchanan-Vanberg contractarian consensus
test. Only in a competitive setting does unanimous agreement acquire
operational substance (normative content).

The notion of exit has thus been invoked to give more operational
substance to the concept of voluntary agreement. It is derived from
Hirschman’s (1970) classic distinction between exit and voice. Exit (and
entry) is an important means by which individuals are able to express their
preferences, and is precisely the method through which preferences are
revealed in competitive markets for private goods.

An exit option introduces an element of market-like competition into the
contracting process, which limits the ability of any party to wield power over
another party. It is not even necessary that this exit option be exercised,
since merely the threat of its use should be enough to restrain rent
appropriation. The scope for opportunism is effectively constrained by
competition, actual or potential.

Furthermore, it is argued that exit options can help to solve the
constitutional maintenance problem by establishing a competitive
environment for post-constitutional political and market exchange
(Lowenberg and Yu, 1992).

12. Federalism, Once Again

The strengthening of regional and local government relative to national
government has been advocated by many scholars as an effective way to
restrain the growth of legislative redistribution. The existence of separate
jurisdictions with some protected powers within a constitutional federation
inhibits coercive behaviour by the government. Such an arrangement
facilitates migration at low cost between federal sub-regions and thereby
enhances competition between these sub-regions. The resulting mobility
forces competitive governmental units to supply public goods in preferred
quantities and to ‘price’ them broadly in line with relative marginal
evaluations.

The foregoing is related to the Tiebout effect (Tiebout, 1956), which says
that individuals will sort themselves across communities in accordance with
their preferences for the packages of taxes and public goods provided in each
community. The ability of the owners of property rights to move to
competing jurisdictions protects them from potential rent appropriation by a
coercive government. Therefore, it is argued, a federalist constitution can
effectively constrain the power of the state. In a federal system, citizens
seeking political relief can vote with their feet.

The preceding paragraphs suggest that post-contractual exit
opportunities might be characterized in terms of Tiebout competition
between different political groupings. If the constitution permits mobility
and political plurality, it will help establish and maintain a competitive
political postconstitutional environment.

The unifying theme in the preceding approach to constitution formation
and maintenance is generally that of exit (or entry).

C. Outline of a Reconstruction of the Coase Theorem from a
Subjectivist-Contractarian Perspective

13. Buchanan on the Irrelevance of Transaction Costs

One way to interpret the Coase (1960) analysis consists of seeing it as a
contribution to the externality literature, though Coase would presumably
object to any use of the term ‘externality’. Put in externality language, Coase
was essentially arguing that all Pareto-relevant externalities would tend to be
eliminated in the process of free exchange contract among affected parties
(Buchanan and Stubblebine, 1962).

According to Buchanan (1984) Coase did not like the Buchanan-
Stubblebine externality paper and Buchanan conjectures that Coase’s
objection may have stemmed from a certain ‘ambiguity in perspective’
(Buchanan, 1984, p. 11, footnote 6).

The ‘ambiguity in perspective’ Buchanan refers to is related to the fact
that there are two profoundly different conceptions of competition and the
competitive process. In the objectivist perspective, there is an efficient
allocation of resources independently of any process through which it is
generated. From this supposition, it follows that institutional arrangements
can be directly evaluated in terms of their relative success or failure in
attaining the desired pattern of resource use. Normative argument in support
of competitive institutions emerges, in this perspective, only because such
institutions tend to be relatively superior ‘devices’, ‘instruments’, or
‘mechanisms’ in generating independently derived results. Where
competitive institutions do not seem to exist, as defined by some
independently derived structural criteria (for example, the number of firms
in an industry, concentration ratios, and so on), there emerges a normative
argument for direct intervention with the voluntary exchange process as a
means of moving results toward the externally derived allocative norm or
ideal.

In the subjectivist-contractarian perspective, ‘efficiency’ cannot be said
to exist except as determined by the process through which results are
generated, and criteria for evaluating patterns of results must be applied only
to processes. In this perspective, voluntary exchanges among persons, within
a competitive constraints structure, generate efficient resource usage which
is determined only as the exchanges are made. Competitive institutions in
this perspective are not instruments to be used to generate efficiency. They
are, instead, possible structures, possible rules or sets of rules, that may
emerge from generalized agreement. The role of the political order, of law or
government, is to facilitate agreement on institutional arrangements, and to
police rights assigned under such agreements.

In Buchanan (1984) it is argued that Coase, despite his own earlier
contribution to what can be called the subjectivist theory of opportunity cost
(see Buchanan, 1969, pp. 26-29; Coase, 1960) presented his argument -
through a series of hypothetical and historical examples - largely in terms of
presumably objectively-measurable and independently-determined harm and
benefit relationships. It is suggested that Coase was, indeed, applying
outcome criteria for allocative efficiency to results of the exchange process
rather than limiting his attention to the process itself. Therefore the whole
analysis becomes vulnerable to the critique mounted by Cooter (1982) and
others who suggest that the Coase theorem fails in non-competitive settings.
Small-number bargaining settings will necessarily fail to guarantee
efficiency due to the presence of incentives for strategic behaviour,
independently of any communication-information failures. In large-number
settings, all parties may have free-rider motivations. In both of the latter
cases, interpreted in terms of satisfying outcome criteria for efficiency, free
exchange and contract among parties do not necessarily generate an
allocation of resources to their most highly valued uses. ‘Externalities’ that
are Pareto-relevant may remain in full trading equilibrium. Parties to
potential exchanges who are rational maximizers of expected utilities may
fail to reach the presumed objectifiable Pareto efficiency frontier. However,
Buchanan contends that if the whole Coase analysis is interpreted in
subjectivist-contractarian terms, the critique can be shown to be without
substance.

Buchanan (1984) is an explicit attempt to re-interpret the Coase (1960)
theorem along consistent subjectivist-contractarian (or, if preferred,
Austrian-Wicksellian) lines.

If there is no objective criterion for resource use that can be applied to
outcomes, as a means of indirectly testing the efficacy of the exchange
process, then as long as exchange remains open and as long as force and
fraud are not observed, that upon which agreement is reached is, by
definition, that which can be classified to be efficient. The Coase theorem
thus seems to become a tautology. How could, in this construction,
inefficiency conceivably emerge? Is that which is always necessarily
efficient?

Of course it is not. Already in Buchanan (1959) it was suggested that
agreement is the only ultimate test for efficiency, but that the test does not
need to be confined in application to the allocative results or outcomes
generated under explicitly existing or defined institutional-structural rules.
The agreement test for efficiency may be elevated or moved upward to the
stage of institutions or rules, as such.

The proper role for the normative political economist is that of
discovering potential rules changes that might yield general benefits and
then presenting these changes as hypotheses subject to the Wicksellian
contractual-consensus test. If, when presented with a suggested change in
rules, agreement among all potentially interacting parties is forthcoming, the
hypothesis is corroborated. The previously existing rule is proven to be
inefficient. Agreement on a change in the rules within which exchanges are
allowed to take place is a signal that patterns of outcomes reached or
predicted under the previously-existing set of rules are less preferred or
valued than the patterns expected to be generated under the rule-as-changed.
Hence, the new rule is deemed more efficient than the old. If disagreement
emerges on the proposed rules change, the hypothesis is falsified. The
existing rule is classified as Pareto-efficient. And, given this institutional
setting, any outcomes attained under free and open exchange processes are
to be classified as efficient.

Let us consider as an example the classic externality case from welfare
economics, the setting in which ordinary economic activity within well
defined legal rights imposes noncompensated damages on a sufficiently
large number of persons so as to insure failure of a bargained solution due to
free-rider motivation. The ‘uncorrected’ outcomes in this setting should still
be classified as ‘efficient’ as long as all members of the relevant community
remain free to make intervening offers and bids to those traders whose
activity is alleged to generate the spillover harms. The institutional structure
may not be efficient, however. The political economist may hypothesize that
general agreement can be secured on some change in institutional structure
and that explicit political or governmental decision rules may come to be
accepted by all parties as being preferred to the decision rules of the market.
Even though the outcomes reached may still be classified to be ‘efficient’ -
given the assignment of rights, and given the institution of exchange - the
institution of voluntary exchange, as ordinarily understood, may not, in this
case, be efficient. This implication may sound somewhat paradoxical but for
the subjectivist-contractarian it creates no difficulty since he does not
acknowledge the uniqueness of the resource allocation that is properly
classified to be efficient: it depends necessarily on the institutional structure
within which resource utilization-valuation decisions are made.

There is a second seeming paradox. That political-governmental decision
rule upon which agreement is reached may not require consent of all parties
to reach particular outcomes, either explicitly or implicitly. The efficient
decision rule may be such that specific outcomes need not meet the
consensus test. The analysis contained in Buchanan and Tullock (1962),
which is essentially an analysis of the choice among political decisionmaking
rules had highlighted the fact that the costs of reaching agreement
increase significantly as the size of the group required to agree is expanded.
However, this situation need not imply that the unanimity principle for
constitutional changes is inapplicable. The members of the group may be
observed to agree on changes in the rules that produce results which, when
classified by the orthodox Pareto criterion, are clearly ‘nonoptimal’. In other
words, ‘optimal rules’ may generate results that may be classified as
nonoptimal.

With majority rule, or any less than unanimity rule, for politicalgovernmental
decisions, the decision structure can itself be efficient while at
the same time the particular outcomes attained under the structure are to be
presumed inefficient, at least in some situations, for those who are directly
coerced. Buchanan believes that to introduce ‘transactions costs’ as a barrier
to the attainment of efficiency confuses rather than clarifies the complex set
of issues involved. The several so-called transaction costs barriers to
efficiency in resource allocation - information and communication
constraints, free rider constraints, strategic behaviour ... - can be more
appropriately analysed in the context of hypotheses about institutional
reform (Buchanan, 1984, p. 23).

D. Refinements and Applications: A Survey of Contributions

14. Foundational Explorations

One of the major discussions in contemporary institutional economics
concerns the relation between rationality and rule following. The problem is
akin to what philosophers will recognize as an unresolved issue in the
history of ethics. As several authors have recognized, the problem was posed
at the very beginning of the history of philosophizing about the justification
of moral rules, in Plato’s Republic (McClennen, 1990a, p. 262). In Plato
(1992, pp. 34-35, Book II, sec. 359) Glaucon challenged Socrates to prove
that being just is rational even if we suppose that the material rewards of
being just accrue exclusively to the unjust. The story of the ring of Gyges
seems to drive a wedge between the concept of rational choice and that of
choice that respects the usual kinds of moral constraints. In the language of
public goods theory, the challenge is to show that when the material payoff
of being just is a public good - enjoyed by everyone but its producers - there
is nevertheless a hidden private benefit that makes it rational to produce this
public good (Schmidtz, 1991, p. 165).

There appears to be an essential tension between the notion of rational,
self interested behaviour - as postulated in economics - and the notion of a
viable moral order. In the relevant literature this problem is referred to as
the ‘Hobbesian problem of social order’ or simply the ‘Hobbesian problem’.

Vanberg (1993, 1994) presents an interpretation of the rational choice
and rule-following perspectives which allow their consistent integration into
a common theoretical framework. Hayek had already argued that man is ‘as
much a rule-following animal as a purpose-seeking one’ (Hayek, 1973, p.
11). Generally speaking, Vanberg’s program can be characterized as a
systematic and transdisciplinary integration of J.M. Buchanan’s contractarian
perspective with F.A. Hayek’s evolutionary approach, making use of
insights from a wide range of fields. The contractarian element in Hayek’s
thought has also been identified by Sugden (1993a). The contrast between
Hayek’s and Buchanan’s systems of ideas is highlighted by, for example,
Gray (1990).

Vanberg (1993a, p. 187) distinguishes maximizing and adaptive forms of
rationality and argues that an evolutionary perspective using the concept of
adaptive rationality ‘may help to systematically account for observed
behavioral tendencies which appear to defy explanation in standard
rationality terms’. This argument is related to Hayek’s notion that rule
following is a response to humankind’s imperfect understanding of their
environment. Rules are not chosen as a result of a full rational appraisal but
can best be seen as more or less reasonable adaptations to a complex world
and not necessarily as optimal in their functioning.

On one occasion, Vanberg argues that rule-following behaviour, while
relatively unresponsive to variations in particular situational circumstances,
‘is quite compatible with choice and ‘calculation’ at the rule level’
(Vanberg, 1994, pp. 16-17), thus suggesting that the problem can be thought
of in terms of a rational maximizing choice on a metalevel. However, if
maximizing itself is subject to, say, information costs, the choice of rule
cannot be seen in optimizing terms. There seems to be no alternative to
separating the concept of rationality from the notion of optimization. In this
way Simon distinguished procedural from substantive rationality (Simon,
1976). Simon argued that the orthodox neoclassical concept of rationality as
maximizing implies an unrealistic view of man’s cognitive abilities, of his
access to information and his computational capacities. The alternative
concept of rationality which Simon proposes, namely that of bounded,
procedural or adaptive rationality, is in essence a theory of behavioural
learning, a theory which seeks to understand a person’s current behaviour in
terms of his or her past experience. Simon’s theory of human decision
making views an actor’s choice-behaviour as based on a repertoire of
behavioural patterns, routines or programmes.

An extension of the bounded rationality problem has been provided by
Ronald Heiner (1983, 1990, among others). Formal economics is a theory of
perfect choice that assumes agents always make best decisions based on
available information. The latter may itself be inaccurate or incomplete, but
no further imperfection enters into the analysis about the agents’ ability to
decide optimally. In a sequence of articles, Heiner has made an effort to
develop a theory of imperfect choice which provides an argument for why
rational, but imperfect agents may profit from following rules instead of
attempting to maximize advantage on a case-by-case basis.

Heiner’s argument is that there is often a gap between an agent’s
competence at problem solving and the difficulty of the decision problem
faced. Given such a ‘C-D gap’, which will tend to exist in complex decision
problems, agents will be subject to unpredictable errors and mistakes in
selecting the most preferred alternative. The extent of these errors possibly
means that an agent will do better by following a simple rule rather than by
attempting to maximize in each case. Heiner’s analysis implies that
imperfect agents benefit from being governed by rules adapted only to
recurrent situations and from ignoring relevant, even costlessly available
information. The Heiner (1990, pp. 39-40) analysis also suggests a basic
tradeoff between reaching initial agreement over constitutional rules and the
stability of future compliance to them once they are put into practical
application. There is a basic tradeoff between ignorance and uncertainty that
promote consensus over ex ante rules (that is, before anyone has had any
actual experience living under them), and the reliability of any such advance
agreement in avoiding rules that turn out destabilizing ex post due to errors
that are self-recognized through the very ongoing experience generated by
following the rules.

Thus, maintaining allegiance to previously agreed social rules can be a
far more difficult challenge than reaching initial agreement about which
rules to begin following - especially if the initial agreement was achieved
under a veil of ignorance about the practical consequences of applying rules
to future conditions.

15. Contractarianism and Evolutionism

In the modern research programme of Constitutional Political Economy two
strands of thought are systematically interwoven: a subjectivist-contractarian
strand of Austrian-Wicksellian origin, on the one hand, and an
evolutionistic strand, which essentially works out the implications that
follow from Popperian evolutionary epistemology for the issues of socioeconomic-
political organization.

For recent discussions of contractarianism, and apart from Buchanan’s
and Vanberg’s own contributions, reference is made to Binmore (1990),
Hardin (1990), Mueller (1990) and Sugden (1990). Coleman (1990)
contains a valuable comparison of Buchanan’s form of contractarianism
with that of the philosophers John Rawls and David Gauthier. Sugden
(1993a) outlines a procedural or contractarian formulation of rights. Gaus
(1991) sketches an account of political authority and democracy that depicts
them as responses to our moral disagreements and our inability to rationally
resolve them on their merits.

The constitutional contract is often interpreted as a device to overcome
the hypothetical state of anarchy (see, for example, Buchanan, 1975). How
can, in a pre-constitutional setting that lacks any institutional forms, a
unanimous agreement on the rules and the agency enforcing the rules be
imagined to emerge? Witt (1992) conceptualizes the problem in game
theoretic terms and explores the logical basis of the dilemma that turns up in
this context. While the protective agency has to be endowed with sufficiently
powerful coercive means to prevent anyone breaking the social contract, this
concentration of power may itself induce a violation by making the protective
agency usurp its power.

The implications of subjectivism are equally remarkable. Traditionally,
the subjectivists par excellence within economics were the Austrians.
Vanberg (1994, Chap. 13) has consistently worked out the implications of
subjectivism for the theory of organized, collective action. The normative
focus is shifted from endstates or outcomes, as such, to the process through
which these outcomes or endstates emerge. The relevant question becomes
whether the process by which outcomes and endstates are brought about can
reasonably be assumed to reflect the preferences of the individuals
concerned, as revealed in their actual choice behaviour. Thus the approach is
incompatible with criteria that - as is true for Benthamite utilitarianism - are
individualistic in the sense of measuring the goodness of social matters in
terms of individual utilities, but do so without reference to individuals’
choices. It can be characterized as choice-individualism, as opposed to the
utility-individualism that underlies the whole tradition of the concept of a
social welfare function.

Vanberg clearly recognizes that the true problem with the agreement
criterion is not that it is too demanding but, instead, that it has too little
normative content. A criterion needs to be specified which allows one to
distinguish between constraints that are judged to render the respective
individual choices involuntary, and those that do not. His analysis reaches
the conclusion that a consistent normative-individualist approach needs to
rely on a combined and simultaneous application of a purely procedural, rule
oriented, as well as a substantive, avoidance/exit-cost criterion. The avoidance/
exit cost perspective arguably provides a more operational specification of
the contractarian norm than the notion of a hypothetical contract to which
Buchanan (1975, 1977) as well as Rawls (1971) appeal. The exit perspective
is consistently followed by, for example, Lowenberg and Yu (1992) and
Mbaku (1995).

The evolutionistic strand of thought in fact consists of a complex set of
more or less interrelated theses some of which are more controversial than
others. The least problematical ingredient is reflected in the idea, related to
Hayek’s ‘limits of reason’ insight, that, in the realm of rules and institutions
no less than in other areas, we can never know ex ante what the best
solutions to our problems will be, if alone - as Popper has pointed out in his
critique of historicism - because we cannot know today what we will know
tomorrow. In fact, we cannot know ex ante what our future problems will be.
Therefore, we need to rely at least to some extent on the explorative
potential of open ended, competitive processes and on the kind of experience
that accumulates in trial and error learning. But there is no reason to expect
that what survives necessarily coincides with what is desirable in the sense
of being responsive to the interests and preferences of the persons involved.
It would seem entirely unfounded to expect an unqualified evolutionary
process generally to produce such favourable conditions. On the other hand,
a recognition of ‘the limits of our reason’ should not imply that we cannot
say something about the kinds of conditions and process-characteristics that
enhance responsiveness to the interests and preferences of the persons
involved. Indeed, creating and maintaining such conditions has to be the
primary task for deliberate constitutional design. There is room for both
evolutionary learning and constructive design, not only as compatible, but
also as indispensible and complementary elements of an appropriate socioeconomic-
political order. This insight leads Vanberg to develop the notion
of ‘constitutionally-constrained evolution (or competition)’, a combination
of deliberate design and evolutionary learning: the design of a framework of
meta rules - the idea of a meta constitution - within which efforts in
constitutional construction are subject to a kind of evolutionary competition
that promises to make selections in favour of rules that serve the interests of
the respective constituencies. The programme culminates in a theory of
institutional competition among jurisdictions viewed as a knowledgecreating
discovery process (Vanberg, 1994, p. 284; Vanberg and Kerber,
1994).

Institutional competition has been analysed from a variety of
perspectives. Wiseman (1990) argues that analysis of voice and exit
dimensions of a fiscal constitution is a means of appraising the efficiency of
social arrangements. Marlow (1992) argues that one’s view toward the
design of voice and exit options is affected by one’s perception of the
appropriate size of government. It is recognized that the design of voice and
exit options in the fiscal constitution exerts a predictable influence on policy.
Sinn (1992) analyses competition among governments on the basis of a
model that views countries as clubs.

Evolutionary themes are further explored in the following contributions.
Parisi (1995) contains a sophisticated outline of a theory of spontaneous law.
Wohlgemuth (1995) contrasts the neoclassical and the market process
conceptions of economic and political competition and develops an
alternative agenda for many fields of public choice. Gruner (1995) examines
evolutionary stability of social norms in a formal socioeconomic equilibrium
model. The institutional evolution of the Icelandic Commonwealth (930-
1264 AD) is discussed in Solvason (1993).

It has almost become a commonplace to state that game-theoretic notions
and approaches capture essential elements of the evolutionary paradigm.
Most of the arguments can be related to repeated coordination (Warneryd,
1990), Prisoner’s Dilemma (see Axelrod, 1984) or hawk dove (Sugden,
1989) games. Generally speaking, the extension of the market analogy to the
constitutional level, that is, to the rules and institutions within which market
coordination takes place, is not corroborated by the game-theoretic analysis
of invisible-hand processes. This analysis does not warrant the conclusion
that invisible-hand processes will operate to generate efficient results, except
under a highly restrictive set of conditions. This point is illustrated by, for
example, Warneryd (1990). Warneryd discusses the evolutionary game
theoretical approach to the emergence of conventions, that is, institutions
that solve recurrent coordination problems. It is argued that conventions
may be said to minimize transaction costs, but that they need not be
efficient.

16. Compliance, Renegotiation, Secession

Constitutional preferences, like any other preferences, can be assumed to
embody two conceptually distinct components, an interest-component and a
theory-component. Rational actors will have reasons to be concerned, not
only about the interest dimension, but also about the theory dimension in
constitutional choice.

Both concerns have certain implications for the kinds of ‘procedural
constraints’ that can be expected to facilitate actual agreement, implications
that need not be in perfect accordance.

So far as the interest dimension is concerned, it has been a central tenet
of constitutional political economy at least since Buchanan and Tullock
(1962) that constitutional deliberations must take place behind a veil of
uncertainty in order for a constitution to be efficient. The prospects for
reaching constitutional agreement are enhanced by whatever tends to
increase persons’ uncertainty about the particular effects that alternative
rules can be expected to have on them, that is, by whatever tends to thicken
the veil. The veil notion can be seen as a summary label for factors that, by
increasing uncertainty, tend to alleviate potential conflicts in constitutional
interests.

It should be noted that potential knowledge-based disagreement
obviously requires the opposite cure. The prospects of agreement on
desirable or efficient rules and the prospects for adopting such rules are
enhanced, not by creating uncertainty, but, on the contrary, by raising the
level of mutually-shared information and knowledge on the general working
properties of alternative rules. The Buchanan-Tullock ‘veil of uncertainty’
and the Rawlsian ‘veil of ignorance’ are assumed to render persons
uncertain or ignorant about their particularized interests while not inhibiting
their capability accurately to anticipate the general effects of potential
alternative rules. In other words, their constitutional theories are supposed to
be perfect and non-controversial. Informational problems with regard to the
general working properties of rules do not exist.

This section is concerned with the interest dimension, that is, with the
difficulties involved in any attempt to achieve agreement on rules among
persons with potentially-conflicting constitutional interests. Moreover, once
agreement has been achieved, the agreement must be enforceable because
each individual has a subsequent incentive to defect from the cooperative
agreement.
It is recaIled that in the contractarian and neo-contractarian literature
two lines of reasoning have been pursued which focus central attention on
the interest-component in constitutional choice with a view toward
modification of the constitutional choice setting so as to reconcile potential
divergences. Both are concerned with the general problem of constitutional
efficiency and survivability.

The first line of argument, which is discussed in this section, focuses
attention on the need for a ‘veil of uncertainty’ as a precondition for an
efficient constitution. The second line of argument adopts an exit (entry)
perspective.

Though Rawls’s idea of constitutional choice ‘behind the veil of
ignorance’ and Buchanan’s notion of ‘conceptual agreement’ cannot be
expected to provide a workable criterion upon which actual normative
judgements on existing social arrangements could be based, they do serve a
useful heuristic function by directing attention to the question of whether -
based on our general understanding of the nature of human choice - it can be
plausibly assumed that some existing set of rules could have been voluntarily
agreed upon by all participants at some original stage of decision.

A notion that is typically used in this respect in contractarian theories is
fairness. Fairness can be induced by two independent factors: (1)
uncertainty, as has been indicated already, and (2) the concern for stability,
which will be discussed below.

In real-world settings persons are typically not totally ignorant about
their particular constitutional interests. But they are not perfectly certain
about these interests either. They typically find themselves behind a veil of
uncertainty that prevents them from accurately anticipating the particular
ways in which they will be affected by the prospective working properties of
alternative rules.

The veil’s thickness may vary, depending on certain characteristics of the
actual choice situation. As the veil’s thickness increases so will the prospect
of achieving agreement. The variables that affect the veil’s thickness can to
some extent be manipulated and rational actors can take deliberate measures
designed to put themselves behind a thicker veil, thereby enhancing the
prospects of realizing potential gains from constitutional agreement.

In this respect the following observations are made. The degree of
uncertainty is, in part, a function of the sort of rules that are under
consideration. The essential dimensions here are the generality and the
durability of rules. The more general rules are and the longer the period over
which they are expected to be in effect, the less certainty persons can have
about the particular ways in which alternative rules will affect them. They
will therefore be induced to adopt a more impartial perspective and,
consequently, they will be more likely to reach agreement. The veil of
uncertainty works by moderating the differences among identifiable
constitutional interests, thus inducing fairness or impartiality and facilitating
agreement in constitutional choice.

There is an additional factor through which fairness can be induced,
independent from the uncertainty factor, but working in the same direction.
This factor is the concern for stability. The possibility of realizing gains by
operating under constitutional constraints is not just a matter of securing
some initial agreement; it is also a matter of a sufficient level of ongoing
agreement, of continuing acquiescence in an ongoing co-operative
arrangement. Stability refers to the viability of a constitutional arrangement
over time. Rational actors can be expected to take considerations of stability
into account when engaging in constitutional choice. To the extent that
fairness and stability are interrelated, the concern for stability will induce a
concern for fairness or impartiality even in persons who may be perfectly
aware of the particular effects that alternative rules will have on them. It is
not the uncertainty about one’s own particular position that will induce
impartiality, but the anticipation that a constitutional arrangement is
unlikely to be stable if it is only designed to serve one’s own particular
interests.

How precisely are stability and fairness interrelated? Two aspects of the
stability problem should be distinguished. They are not always sufficiently
separated in discussions on the issue: the compliance problem and the
renegotiation problem.

First, in order for a constitutional arrangement to be stable over time it
has to command a sufficient level of compliance. However, compliance with
rules is certainly not a direct function of their fairness. The fact that rules
are perceived as fair by the relevant group of persons does not, per se,
guarantee a willingness to comply with those rules. The compliance problem
results from the fact that there may be potential gains from defecting.
Whether such gains exist or not is not per se dependent on the fairness
properties of the arrangement. To the extent that such gains exist, a
compliance or unilateral defection problem is present even with perfectly
fair rules.

Second, constitutional arrangements should also command a sufficient
level of ongoing agreement. A constitutional agreement that favours
particular interests may be achievable under ‘suitable’ conditions, but such
agreement can be expected to be less robust with regard to potential changes
in circumstances than fair arrangements. Unfair arrangements may tend to
give rise to the renegotiation problem. It is especially with regard to
renegotiation rather than with regard to compliance that the concern for
stability can be expected to induce a concern for fairness. There is a much
more direct relation between the fairness issue and renegotiation than there
is between fairness of rules and compliance with rules.

For further discussion on the foregoing and related issues, reference is
made to the following contributions.

Several fundamental issues relating to the problem of constitutional
stability are discussed in Ordeshook (1992). Twight (1992) assesses the
extent to which consensuality is likely to characterize the process of
constitutional revision. Theoretical and empirical grounds are provided for
concluding that non-consensual constitutional revision is often the rule
rather than the exception. The endogeneity of politically relevant transaction
costs and their manipulation by self-interested political actors in a postconstitutional
environment are central to the analysis. The theory of
constitutional maintenance is equally examined in Niskanen (1990).

Constitutional renegotiation may end in impasse. Young (1994)
examines the political economy of secession. Special reference is made to
the case of Quebec. The author explains why secessionist movements have
not been successful in industrialized welfare states, even when the structural
preconditions are largely present, as in cases like Scotland and Belgium. A
formal analysis of constitutional secession clauses using game theory is
made in Chen and Ordeshook (1994).

17. The Common Law and its ‘Efficiency’

Buchanan (1977) criticized Posner (1972) for its failure to make the vital
distinction between the two functional roles in which lawyers may find
themselves: Posner appears to offer potential advice and counsel to future
judges and legislators alike. But, recalls Buchanan, the judge should not
change the basic law because by such behaviour he would be explicitly
abandoning the role of jurist for that of legislator. In his role of jurist he
should enforce existing law instead of enacting new legislation. Buchanan
referred explicitly to Leoni’s (1961) distinction between law and legislation.
It follows from Buchanan’s argument that there is no justification at all for a
judicial introduction of the putative efficiency norm, presumably to be
imposed independently of the political process. This view is implied by the
adoption of the subjectivist-contractarian consensus or unanimity rule as a
benchmark for efficiency. The normative economist can advance alternative
sets of rules as a hypothesis to be tested in the political exchange process,
but he should never be allowed to take the arrogant stance of suggesting that
this or that set of institutions is or is not more efficient.

In a similar vein De Alessi and Staaf (1991) argue that the law and
economics view of the common law as an efficient process that promotes the
evolution of efficient rules through an auction-like mechanism is flawed
because it fails to cope with the problem of aggregating preferences. They
argue that the belief that the efficiency of the common law is enhanced by
assigning disputed rights so as to lower transaction costs is also flawed. The
common law provides a form of unanimity by allowing individuals to
contract around the rule and provides order by maintaining transitivity,
through the use of precedent, in the application of the rule to new situations.
Aranson (1992) highlights another problem: in the neoclassical approach
to law and economics, the common law judges, in rendering decisions that
maximize wealth, are placed in the position of calculators of comparative
values. However, this task confronts the courts with an insoluble economic
calculation problem, analogous to the problem faced by central economic
planners. Therefore, courts should prefer to stay as close by as they can to a
rights-based jurisprudence.

Wagner (1992) argues that social processes regarding the formation of
rules should be assessed in terms of their ability to provide a framework of
stable rules guaranteeing the stability of expectations and allowing people to
plan their economic activities. The dichotomy between statutory and
common law is overdrawn, because both derive from the same source in a
setting where there are no longer polycentric sources of competing authority,
since the contemporary nation-state - presumably Wagner has the United
States of America in mind - has the capacity to absorb all alternative sources
of authority into itself.

More radically Benson (1992b) argues that the government-backed
common law system is more likely to adopt inefficient rules than a genuine
customary law system. Though he recognizes that much of common law was
simply a codification of the basic norms common to Anglo-Saxon society,
Benson recalls that common law was also royal law and that even during its
earliest periods of development some aspects of it were legislated and
imposed by authoritarian kings. Furthermore, when a government’s judges
make new law through precedent, it becomes enforceable law for everyone in
the society whether it is a mutually beneficial law or not. Common law
precedents are backed by the coercive power of the state and, therefore they
take on the same authority as statute law.

Yandle (1991) develops a vision of the Common Law as an ‘organic’
Constitution, reflecting evolved social norms, a result that causes ordinary
people to accept the authority of judges.

18. Studies in the History of Ideas

There now is a fair number of review articles on Buchanan’s thought.
Besides those already mentioned, reference can be made to Brennan (1987,
1990), Congleton (1988) and Yeager (1990).

In Germany, institutional analysis has a long and autonomous tradition,
which has not been given proper international recognition. This applies
especially to the neoliberal Ordnungstheorie, of which Walter Eucken is
generally acknowledged to be the leading representative. Leipold (1990)
examines the methodological and theoretical similarities and differences
between Eucken’s Ordnungstheorie and Buchanan’s Constitutional
Economics. Though there is no tradition of pluralism in German history,
some German thinkers developed ideas which came remarkably close to
later English and American pluralists. This development, particularly as
exemplified in the work of Georg Beseler, Otto Gierke and later Hugo
Preuss, is dealt with in Dreyer (1993).

Aranson (1991) argues for the coherence of Calhoun’s political thought,
when read in the light of modern public choice theory and contrary to earlier
interpretations.

Madison’s constitutional political economy is carefully examined in
Dorn (1991). James Madison was instrumental in the design, ratification,
and implementation of the American Constitution. He also was the major
force behind the Bill of Rights. It is in the light of these accomplishments
that Madison has been called ‘The Founding Father’. Because he focused on
the rules or principles of a liberal order rather than on the outcomes, James
Madison can properly be viewed as a pioneering constitutional political
economist. Drawing on the political theory of Locke and the economic
theory of Smith, Madison successfully combined the two to form a coherent
theory of constitutional economics. Adopting a self-interest postulate, he
showed that social and economic order are best achieved by allowing open
competition to prevail under a rule of law protecting private property and
freedom of contract. Thus, he clearly recognized the close relation between
political order and economic order, and he anticipated many of the themes
in the public choice/constitutional economics literature.

One of the insights of Madison and other framers of the US constitution
was that a bicameral legislature might function as a device to limit the
power of legislative coalitions. The idea was that each house would be
elected differently and consequently would represent different interests. The
requirement of a simultaneous majority in both houses in order for
legislation to be enacted would then guarantee a broad social consensus. It
should be noted that the differences between the two chambers have been
eroded subsequently. However, the argument for bicameral legislatures on
efficiency grounds and the urge that the two houses be elected by radically
different methods, was at the theoretical level revived in this century by
Tullock (see Buchanan and Tullock, 1962, Chap. 16, written by Tullock; see
also Tullock, 1987).

Elazar (1991) argues that the work of an early political scientist,
Johannes Althusius, who developed his theory of the polity on the eve of the
modern epoch at the end of the sixteenth century, offers an important
starting point for building a postmodern theory of political and social
organization. Althusius (1991) is a collection of excerpts from his Politica
Methodice Digesta (1603/1614).

Sir Edward Coke’s role as a constitutional entrepreneur in seventeenth-
Century England is highlighted in Yandle (1993).

19. Variations on Hayekian Themes

Constitutional political economy shares much of the spirit of Hayek’s
inquiry into the interrelation between the order of rules and the order of
actions, and of his message that changes in the order of rules are the
principal means by which we can hope to improve the socio-economicpolitical
order under which we live (Vanberg, 1994, passim). It will come as
no surprise, then, that several contributions elaborate explicitly on Hayekian
themes. Buchanan’s personal recollections of F.A. Hayek are set out in
Buchanan (1992).

Streit (1993) brings out clearly how Hayek’s approach to the social
sciences, especially to economics, is rooted in his epistemological position,
particularly as he set it out in Hayek (1952). Butos and Koppl (1993) outline
a theory of expectations based on Hayek’s cognitive theory. The central tenet
of the theory, which is intended to have both policy implications and testable
empirical content, is that economic expectations will serve as reliable guides
to action only when certain ‘filtering conditions’, that is certain constitutional
constraints such as the atomicity of the market process and the
stability of the rules governing that process are satisfied. A failure of either
condition creates a loose ‘system constraint’ and thus a loose link between
environment and expectation, as the theory of ‘big players’ illustrates. Big
players, of which central bankers are a prototypical example, introduce a
wedge between epistemic knowledge and social reality. The theory
highlights the connection between the choice of constraints and its epistemic
consequences. The big player theory also suggests a possible direction for
future empirical work in a Hayekian tradition. Within the adopted
framework ‘neoclassical’ economics and ‘radical Keynesianism’ may be
seen in a sense as limiting cases. When certain filtering conditions are in
place, the results of the market process may be described by ‘neoclassical’
models of rational maximizing and action will seem predictable at least at
some aggregate level. To the extent that these conditions fail, the market
process will be influenced by animal spirits and the like and action will seem
unpredictable to the observing economist. Thus the evolutionary logic of
Hayekian economics provides the general theoretical foundations for special
empirical theories, such as the big player theory, which may identify the
precise causes and consequences of observed deviation from the neoclassical
model.

It is to be regretted that the recently developing literature on, say,
monetary constitutionalism has largely failed to incorporate these Hayekian
insights. Recent events in the European Monetary System on the one hand,
and monetary disintegration in the former Soviet Union on the other, have
revived interest in the question of how to design and choose a monetary
regime that ensures monetary stability for both parts of Europe. Even among
economists who are otherwise considered staunch advocates of laissez-faire
policy, money is still regarded as the prime and uncontroversial example of
a good that has to be provided by government. Buchanan (1962), accepting
the premise that money is a public good that can only be provided by
government, derives its optimal properties from a constitutional perspective.
In the same vein Spinelli and Masciandaro (1993) argue for a
constitutionalization of the target of monetary stability in Italy.

Hefeker (1995) has argued that the objective of monetary stability can be
achieved either by complete monetary union or by currency competition and
that both regimes may be viable solutions depending on the circumstances.
His paper makes the case for monetary union in Western Europe, even
though he recognizes that monetary union is no alternative for Eastern
Europe and the former Soviet Union.

We believe that the critical examination and evaluation of the properties
of alternative monetary regimes constitutes one of the most interesting and
exciting lines of future research within the field of constitutional economics.

Choi (1993) offers a critical evaluation of Hayek’s ‘atavism of social
justice’ thesis, suggesting an alternative explanation for the widespread
demands for social justice in contemporary society, based on the analysis of
the nature of entrepreneurship and its tendency to incite envy.

Tuerck (1995) re-interprets Hayek’s theory of mind in the light of
contemporary philosophy of artificial intelligence.

20. Towards a Constitutional Economics of the Firm

Vanberg (1992a) compares four theoretical approaches to the study of
organizations that can be identified in the relevant literature: the goal
paradigm, the exchange paradigm, the nexus of contracts paradigm, and the
constitutional paradigm. It is argued that the latter provides the more fruitful
theoretical perspective in that it reconciles an individualist methodology
with an account of organizations as corporate actors, as units of collective
action.

In search of a more decisive argument in the controversy concerning
alternative forms of ownership of firms and allocation of capital, Pelikan
(1993) complements and qualifies the standard incentive argument by an
argument considering a less well explored factor: the competence with
which firms are organized and managed. Alternative forms of ownership of
firms are assessed according to their impact on this competence. The general
conclusion is that private and tradable ownership of firms is a necessary
condition for efficiency of supply. The competence argument strengthens the
neoliberal defence of private ownership and market competition. It is in
allocating the authority to organize supply to agents of high relevant
competence, and in demoting from this authority agents of low competence,
that private and tradable ownership of firms is shown to have its decisive
comparative advantage.

Kiser (1994) rationalizes public enterprise by analysing the constitutional
choice between private and public ownership of production arrangements.
Arguing that results depend on who does the choosing, the article compares
choices by self-governing citizens with choices by self- directed
governmental officials. The resulting institutional theory identifies four
conditions that cause citizens to favour public over private ownership:
natural monopoly, output and process invisibilities, the production of
consumer necessities, potential producer moral hazard. None of the
conditions refers to the standard concept of economic efficiency, which
guides most economic comparisons of public and private enterprise.

Langlois (1995) argues that Hayek’s theory of spontaneous order can in
fact include the case of such apparently purposive and extramarket forms as
the business firm. In other words, Hayek’s theory of the market as a
spontaneous order has implications for the theory of the firm that the
mainstream Coasean approach has yet fully to absorb. Langlois picks up a
number of suggestions in Hayek’s evolutionary theory of social institutions
and uses them to draw a picture of the firm that is somewhat different from
that drawn by neoclassical transaction-cost analysis. In the Hayekian picture,
firms and markets are both systems of rules of conduct. Both are systems for
economizing on knowledge in the face of economic change, albeit quite
different kinds of knowledge and change. Moreover, there is a sense in
which the firm exists not in order to centralize control over knowledge but -
like the market - precisely to decentralize the use of knowledge. In the end,
it is argued that the firm is no model for political planning for one very
simple reason: the firm does not plan.

Adelstein (1991) draws upon the contractarian distinction between
constitutional and operational levels of personal choice and an evolutionary
analysis of the growth of firms to illuminate the complex issues surrounding
the emergence of large-scale economic organization in the United States in
the years since 1870.

21. Redistribution

There have been two recent attempts to provide a rationale for redistribution
within the scope of constitutional political economy. Kliemt (1993b) argues
that redistribution can be institutionalized at the constitutional level to attain
a ‘minimum welfare state’ without violating basic principles or incurring
risks beyond those that are present in the minimal state itself. Wessels
(1993) describes a situation in which individuals may unanimously agree to
transfer income at the constitutional stage on the grounds that redistribution
provides income insurance. Both are criticized, invoking the usual
arguments, by Pasour (1994).

22. European Integration

Streit and Mussler (1994) analyse the changes in the economic constitution
of the European Community since its foundation in 1958. It is argued that as
far as the economic constitution is concerned, the Treaty of Maastricht is
dominated by traits which are characteristic of modern welfare states. The
editors of Constitutional Political Economy took Vibert (1995) as a starting
point to devote the 1996 Vol. 7 No. 4 issue of their journal to the theme
Europe: A Constitution for the Millennium. This special issue includes
articles by Blankart (1996, pp. 257-265), Buchanan (1996, pp. 253-256),
Frey (1996, pp. 267-279), Holcombe (1996, pp. 281-291), Mueller (1996,
pp. 293-302), Ostrom (1996, pp. 303-308), Sobel (1996, pp. 309-316) and
Vaubel 1996, (pp. 317-324).

23. Other and Related Subjects

A constitutional approach to international private law is contained in
Schmidtchen and Schmidt-Trenz (1990). Constitutional issues concerning
transition in Eastern Europe and the former Soviet Republics are discussed
in Sunstein (1991), Apolte (1995) and Ordeshook and Shvetsova (1995).
Brunetti and Weder (1994) argue that establishing strategies for the control
of state discretionary power is a crucial precondition for overcoming
credibility problems and generating long-term economic growth in less
developed countries. Kratochwil (1992) suggests an alternative approach to
the study of international politics. A critical examination of the Clean Water
Act from a constitutional perspective is contained in Meiners and Yandle
(1992). Pauly (1994) examines the concept that social insurance for medical
care may represent a kind of constitutional choice.

Kuran (1993) argues that public opinion breeds tyranny by forcing
individuals to refrain from voicing their genuine thoughts and feelings.
Several devices to cope with the emergence and persistence of certain social
taboos are discussed. Lipford (1992) applies constitutional economics to the
constitutions and rules that govern seven of the eight largest US Christian
denominations. A positive theory of economic fairness is constructed in
Isaac, Mathieu and Zajac (1991). Public debt repudiation is analysed, using
Jefferson’s model in Gunter (1991).

E. Conclusions

Throughout the writing of the present article we constantly had in mind the
editors’ aim of providing the readers of the Encyclopedia of Law and
Economics with a well-informed overview of the existing literature. Some
readers may find that our strategy of favouring ‘comprehensiveness’ at the
expense of ‘structure’ has to some degree distracted from the flow of
argument. However, we are reasonably confident that the unifying theme
underlying the whole will be clear. The various subdisciplines of Public
Choice, Law and Economics, Constitutional Political Economy and others
all represent, as opposed to the independence-isolation of economics, a
return of economics to its appropriate legal foundations. But this theme only
loosely connects the subparts and sections of this article. In fact the four
subparts and even most of the subsections can be read largely independently.
This can only add to the reader’s convenience

Admittedly, and strictly from the title, the public choice element was
somewhat neglected, relative to the constitutional political economy element.
This bias is explained by our own priorities, but only in part. It was
Buchanan himself who in the 1980s changed the name of his research
program to constitutional economics. Early on, Buchanan had made it clear
that he regarded the traditional approach to economic policy advice based on
welfare economics as a scientifically flawed and politically alarming
development. Welfare economics draws its conclusions from a comparison
of the working properties of real markets with idealized criteria. Then,
confronted with the inefficiencies of reality compared to the idealized model,
the market failure approach proceeds to suggest alternative measures which
consist in real government interventions which are assumed to eliminate the
inefficiencies. Thus, welfare economics runs the danger of becoming a
‘nirvana approach’ (Demsetz, 1969), meaning that it fails to identify the
relevant alternatives for drawing its conclusions. First, in judging the real
economy in order to arrive at policy advice, the relevant alternative is not an
idealized market but ‘another’ real economy, one that would emerge under a
different set of constraints. This means one has to compare alternative
institutional arrangements, in markets and the polity, and their outcomes.
Second, such a comparison requires a criterion that is equally apt in
evaluating the economic as well as the political order, that is a non-ideal,
internal standard of comparison. For Buchanan, democratic consent
provides this kind of criterion (Pies, 1996, p. 26).

Despite its general direction towards a comparison of alternative
institutional arrangements, large parts of the public choice literature seem
like an empirically oriented welfare economic analysis of the political sector
and use the welfare-economic concept of normative efficiency as a benchmark,
thus more or less duplicating the ‘nirvana approach’. The term
‘constitutional economics’ clearly distanced Buchanan’s paradigm from
those parts of the public choice literature that make welfare economic
efficiency the measure of all things. The term more adequately describes the
topic of his institutional, rules-directed analyses.

 


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