Prof. Bryan Caplan

Econ 849

Fall, 2001


Week 14: The Economics of Anarchy

I.                     The Comparative Institutions Approach Revisited

A.                 Remember the Emperor's tale?

B.                 After a full semester of public choice, we are now in a much better position to step back and compare institutions.

C.                Economically literate defenders of democracy typically focus on government's special ability to supply public goods.

D.                After analyzing how democracy actually works, what can we say about this?

E.                 If people voted rationally and instrumentally, this argument makes a great deal of sense.

F.                 However, since voting is largely expressive and not instrumental, public goods are supplied only by coincidence. 

1.                  Ex: National defense may have expressive as well as instrumental value.

G.                But: Expressive voting is likely to lead to government involvement in a wide array of "feel-good" issues that have nothing to do with public goods.

1.                  Care of the old

2.                  Health

3.                  Education

H.                 Similarly, whenever voters hold systematically mistaken beliefs, we are likely to see government wasting resources or being actively counter-productive.

1.                  International trade

2.                  Price controls

3.                  Labor market regulation

I.                     This adds up to an efficiency case for limiting the scope of democracy in order to keep "political pollution" under control.

II.                   Some Political Economy of Dictatorship

A.                 In the minds of many, the only alternative to democracy is dictatorship.

B.                 Question: What is so bad about dictatorship anyway?  What does the "comparative institutions approach" say here?

C.                Simplest approach: Dictatorship is equivalent to democracy with a single - and perfectly decisive - voter.

D.                All of the usual rules about democracy that hinge on low probability of decisiveness reverse:

1.                  Self-interest

2.                  Instrumentalism

3.                  Rationality

E.                 Thus, we should expect dictators to be highly self-interested, but more interested in rationally assessing policies' actual consequences.

F.                 Complication: Being dictator effectively makes someone extraordinarily wealthy.  The resources of an entire nation become theirs to command.  Due to their extreme wealth, they may consume a lot of altruism, expressive considerations, and/or irrationality despite their high price.

G.                Most definite disadvantage of dictatorship: It's a big gamble.  Everything depends on the idiosyncrasies of the Leader.

1.                  Interesting finding: Average growth of dictatorships and democracies is the same, but dictatorships have more dispersion.

III.                  Constitutional Reform and Endogenous Institutions

A.                 Many people in public choice - most prominently, James Buchanan - have suggested constitutional reforms to "help fix democracy."

B.                 Example: 2/3 rule for spending.  Perhaps then, pork barrel projects will fail, and only genuine public goods will receive funding.

C.                Problem: Doesn't public choice apply to constitutional reform too? 

D.                In other words, any failure that afflicts day-to-day democracy presumably afflicts constitutional choice as well.  Constitutions are endogenous institutions.  They are a product of the same forces that generate other social outcomes, and no easier to change.

E.                 Some proposed Constitutional amendments have no obvious impact on policy.  These are relatively easy to pass, but what's the point?

F.                 Other proposed Constitutional amendments would obviously affect policy.  These are hard to pass because the policies that currently exist tend to be popular.

IV.               Are the Functions of the Night-Watchman State Really Public Goods?

A.                 If you remain dissatisfied with democracy, reject constitutional reform as a solution, and abhor dictatorship, what is left?

B.                 What about anarchy?  A number of economists have explored the possibility.

C.                Analytical procedure: Start with the functions of the night-watchman state (dispute resolution, rule formation, and enforcement) and work backwards.

D.                Specifically: What aspects, if any, of these functions are actually public goods?

V.                 Dispute Resolution as a Private Good

A.                 Two people have a contract dispute.  The night-watchman state takes it upon itself to adjudicate.  For disputes it labels “criminal,” the NWS goes further by handling the prosecution.

B.                 Why?  Where is the public good?  Why couldn’t the parties (or their insurers) simply put an arbitration clause in their contracts, which the night-watchman state enforces?  And why does the NWS have to handle the prosecution itself?

C.                Hard case for arbitration: complete strangers.  Night-watchman state could still minimize its role by compelling defendant to choose from an approved set of arbitrators.

D.                Hard case for private prosecution: indigent defendants.

VI.               Rule Formation as a Private Good

A.                 The NWS also takes it upon itself to pass civil and criminal laws.

B.                 Why?  Where is the public good?  Private arbitration firms could (and already do to some extent) ex ante woo customers by offering the most efficient set of rules. 

1.                  Efficient rules give parties incentives to maximize joint wealth of signatories, factoring in expected cost of disputes.

C.                Landes and Posner argue that lack of intellectual property rights in precedents leaves little incentive for rule formation. 

D.                In practice, though, public courts often defer to expert judgments of arbitrators.  Intellectual property rights in rules could be strengthened, and non-patent incentives are often effective.

VII.              Enforcement as a Private Good

A.                 The NWS also tries to monopolize enforcement.

B.                 Why?  Where is the public good?  Once an arbitrator makes a decision, why can’t it be enforced by ostracism, bonding, or private security guards?

C.                An unconventional solution to the problem of indigence and crime: indentured servitude and private prisons.

D.                NWS could again mechanically defer to arbitrators’ decisions.

VIII.            Moderate versus Radical Privatization

A.                 To a surprising extent, markets already share the supposedly exclusive turf of the NWS.

1.                  Private security

2.                  Arbitration

3.                  Arbitrators’ codes of rules

B.                 It would be easy to drastically expand the role of the market in these areas, while leaving the state as the final authority.  Let us call this moderate privatization.

C.                But this is hardly an alternative to democracy, because the state remains.  What about radical privatization - getting rid of the last remnants of the NWS state?

D.                What would this even look like?  Standard picture:

1.                  Individuals subscribe to services of a defense firm.

2.                  Defense firms arbitrate their disputes in private courts.

3.                  Private courts issue monetary judgments.

4.                  Reliable people unable to pay their debts have their earnings attached.

5.                  Others, especially criminals, become indentured servants and work off their debt in private prisons that bid for inmates.

IX.               Main Objections to Radical Privatization

A.                 Obviously, free-market anarchism is not a popular proposal.  What are the main objections?

B.                 "It would lead to violent chaos."

1.                  Reply: Why? It is cheaper to negotiate than to fight, especially since police companies repeatedly interact with each other. Also, police company employees, unlike conscripts, have to be paid more for a riskier job.

2.                  Turnaround: Existence of government leads to wars, which are far more serious than police agency shoot-outs because governments control the resources of the whole society.

C.                One strong agency would take over and become the new government." (Alternate version: Agencies would merge until they had a monopoly).

1.                  Reply: This would only be possible if there were a large MES relative to the demand for defense services. In the current U.S., there are already about 10,000 security guard companies, so there is little reason to fear the dominance of one strong agency.

2.                  Turnaround: A much bigger risk from governments, since their MES scale is much larger than for mere police agencies.

D.                “Police agencies would build up demand by defending their clients to the death."

E.                 Reply: This would create a severe "adverse selection" problem, just like the one that insurance companies face. If you announce that you will protect your clients to the death, you encourage all of the riskiest, lawless people to hire you, raising your costs enormously.

F.                 “People would have no incentive to prosecute crimes."

1.                  Reply: Monetary restitution provides the incentive; the ability to impose indentured servitude ensures that almost all convicted persons will be solvent.

2.                  Turnaround: This is true today: the only incentive of victims to cooperate with prosecutors is desire for revenge. E.g. rape victims often better off staying quiet.

G.                “Criminals would be over-punished."

1.                  Reply: In many ways, profit-making prisons would be more humane: there is an incentive to protect the safety of workers; to separate workers by size and strength; and to provide useful job training. Legal codes could incorporate prisoner protection as well.

2.                  Turnaround: Numerous non-violent offenders currently sentenced to harsh prison conditions.  At the same time, many serious violent criminals get light sentences to make room for drug offenders.

H.                 Others?

X.                 Cowen, Anarchism, and Collusion

A.                 Tyler Cowen has a novel objection to free-market anarchism: Defense is a network industry.  Collusion is relatively easy to orchestrate in such industries due to the threat of expulsion. 

1.                  There might seem to be a lot of firms, but for practical purposes there will only be one.

B.                 In such industries, some forms of collusion (relating to product standardization) are actually beneficial; but this opens the door to the traditional forms of inefficient collusion (like price-fixing).

C.                According to Cowen, this leaves basically two possible cases:

1.                  Case 1: Transactions costs are low enough to make collusion work.  Then both the efficient and inefficient forms of collusion thrive.  The public faces a profit-driven monopoly defense firm, a great example of Hobbes’ Leviathan.

2.                  Case 2:  Transactions costs are too high to make collusion work.  Then neither the efficient or the inefficient forms of collusion appear.  The public faces chaos, a great example of Hobbes’ “state of nature.”

D.                Stringham and I have a reply to Cowen forthcoming in the RAE.  Main argument: Cowen conflates coordination problems with prisoners’ dilemmas.

E.                 Product standardization is a self-enforcing coordination problem.  Once firms expect certain standards to prevail, it pays to conform.

F.                 Price-fixing, extortion, etc. are prisoners’ dilemmas.  If other firms are changing high prices and mistreating customers, it pays to stay honest and gain their business.

G.                Historically, network industries do not seem to have been especially able to achieve collusive outcomes, but they have solved a lot of coordination problems:

1.                  After anti-trust: Credit cards

2.                  Before anti-trust: Clearinghouses