Prof. Bryan Caplan

Advanced Public Choice


Lecture 8: Constitutions and Anarchy

I.             The Comparative Institutions Approach

A.           The Emperor's tale.

B.           Dictatorship has obvious problems.  How do the problems of democracy compare?

C.           Economically literate defenders of democracy typically focus on government's special ability to supply public goods.  After analyzing how democracy actually works, what can we say about this?

D.           If people voted rationally and instrumentally, the public goods argument makes a great deal of sense.

E.           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.

F.            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

G.           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

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

I.             Still, if dictatorship and democracy are our only choices, democracy seems like the lesser evil.

II.            Alternatives to Democracy and Dictatorship

A.           Is democracy the only alternative to dictatorship?  Most countries that we call “democracies” have many undemocratic elements, including:

1.            Supermajority rules

2.            Division of powers

3.            Limitations on the scope of democracy

4.            Federalism

5.            Franchise restrictions – most notably the restriction that only citizens get to vote!

6.            Plural voting

7.            Judicial review

8.            Disproportionate representation

9.            Lifetime appointments

10.         More?

B.           Non-economists often insist, “This is a republic, not a democracy.”  Strictly speaking, they’re right, even if unpopular restrictions on democracy tend to disappear.

1.            Alternate formulation: “There are many different kinds of democracy.”

C.           Whether or not you call them “democratic,” couldn’t many of these restrictions mitigate democracy’s political failures?

D.           Ex: Supermajority rules (2/3 vote for price controls), limitations on the scope of democracy (“Congress shall pass no law infringing the freedom of production and trade”), and federalism could all mitigate anti-market bias.

E.           Ex: Giving two votes to college grads could mitigate anti-foreign bias.

F.            Ex: How about giving the CEA veto power over trade restrictions?

III.          Constitutional Reform and Endogenous Institutions

A.           Many people in public choice – most prominently, James Buchanan – advocate constitutional reforms to improve upon the status quo.

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

C.           Problem: It seems like any public choice problem that afflicts day-to-day democracy will afflict constitutional choice as well. 

D.           In other words, constitutions are endogenous institutions.  They are a product of the same forces that generate other social outcomes, and no easier to change.

1.            French/U.S. switch thought experiment.

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.

G.           Note: This doesn’t mean that direct democracy always prevails, just that invoking “constitutional changes” as a solution to problems with the status quo is probably wishful thinking.

IV.          Are Constitutional Politics Different?

A.           Still, Buchanan and others insist that constitutional politics are different.  Their central argument:

B.           Constitutional politics operates behind a real (not merely hypothetical) “veil of ignorance.”  This leads people to selfishly favor socially efficient policies.

1.            Buchanan’s favorite example: Auto accident liability rules.  At the constitutional level, no one knows whether he’ll be a plaintiff or defendant, so we can get unanimous (or “virtually unanimous”) support for efficient policies.

C.           This whole argument rests on the discredited SIVH, but it fails even on its own terms.  There may be some constitutional rules where a veil of ignorance applies (though even Buchanan’s favorite example overlooks lawyers).  But most constitutional rules are about permanently locking in existing political advantages.

D.           Consider a few examples from the U.S. Constitution.  Cui bono ex ante?

1.            The purpose of the Senate is to permanently give small states disproportionate influence.

2.            The purpose of the slave trade provision is to make sure that the slave trade remains legal until 1808.

3.            The purpose of the three-fifths compromise is to reduce the total influence of the South, but increase the influence of Southern whites.

E.           Or consider modern some Constitutional decisions.  Cui bono ex ante?

1.            The purpose of court rulings on religion is to prevent the religious majority from doing what it wants to the secular minority.

2.            The purpose of court rulings on abortion is to prevent states with pro-life majorities from restricting abortion.

3.            Others?

F.            In each of these cases, it is obvious ex ante who will benefit and who will lose.  The point is to reassure the winners of today that they will continue to get their way even if political conditions change to their disadvantage.

V.           Futarchy

A.           The most original and thoughtful suggestion for constitutional change in decades, if not centuries: Robin Hanson’s “futarchy.”

B.           Background: Empirically, prediction markets (a.k.a. betting markets) are the best way to estimate the future.  They are the turbo-powered version of “Put up or shut up.”

C.           Any question that eventually has a verifiable answer can be turned into a financial instrument – and its market price will efficiently aggregate all available information. 

D.           This includes contingent instruments such as…

1.            A stock price conditional on firing the CEO.

2.            The unemployment rate conditional on Obama winning.

3.            Terrorism deaths conditional on invading Iraq.

4.            Tax rates in 2020 conditional on TARP.

E.           Do betting markets give perverse incentives to make bad things happen?  We rarely worry about this for traditional financial instruments, and in any case there is a simple solution: Register the bettors, and/or cap the bets.

1.            9/11 Commission found no evidence that anyone used prior knowledge of the attacks to profit.

F.            Do betting markets encourage manipulation to mislead people using the market price to make decisions?  No.  Manipulation just provokes arbitrage.  See the Hanson-Oprea experiment.

G.           Robin’s innovation: A constitution could require decisions to be based on betting market prices.

H.           Moderate example: A corporate charter could include a “fire the CEO” provision that says that if the value of the firms’ stock conditional on firing the CEO ever exceeds its value conditional on retaining the CEO, the CEO gets fired.

I.             Robin advocates turning this approach into the basis for a whole system of government.  He calls it “futarchy.”  Slogan: “Vote on values, but bet on beliefs.”  This means that:

1.            The political process defines an objective function, such as “maximize GDP” or “maximize GDP plus the market value of leisure” or “maximize GDP per capita times life expectancy.”  As a short-hand, Robin calls the maximand GDP+.

2.            If betting markets say that a policy has a higher expected value of GDP+ than the status quo, the constitution requires the adoption of that policy. 

J.            Ex: Someone proposes TARP.  Betting markets on GDP+|TARP and GDP+|~TARP go online.  If and when the value of the former exceeds the latter, TARP gets adopted.  Critics can then set up betting markets about the expected effect of abolishing TARP.

K.           Most criticisms of futarchy argue that betting market odds are not to be trusted.  These criticisms are weak, and often ignore extensive, specific counter-evidence and simple fixes.

1.            Will the marginal suicide bomber change his mind if he add $100 to his will?

L.            My main concern is with the definition of GDP+.  A key weakness of central planning was that managers were given maximands that sounded good at the time, but gave perverse incentives.

VI.          The Paradox of Public Good Provision

A.           Isn't monitoring the government to act in socially beneficial ways itself a public good?

B.           The Paradox: If citizens can voluntarily produce the public good of monitoring government, why can't they solve other public goods problems without government?  If they can't voluntarily solve this problem, what reason is there to expect government to improve matters?

C.           Cowen and Kavka (2003) offer several solutions to this paradox:

1.            The tying hypothesis.  This is very similar to the stationary bandit model: As long as leaders have a reasonably long time horizon, socially beneficial policies are a private good for government leaders.

2.            Altruism and noise hypothesis.  Governments can leverage a small initial altruistic donation.  “The establishment of a government… may require a smaller number of acts of altruistic support than non-monopolistic mechanisms for producing public goods would require. Unlike a competitive firm, once a monopolistic government obtains a certain amount of initial support, it can use its monopoly power to induce continued support in the future.”

3.            Bootstrap hypothesis: Support for government is really a coordination game, not a Prisoners’ Dilemma, because if most people support a state that provides public goods, it is selfishly optimal for you to do so as well.

D.           From discussion with Tyler: Unless anarchy is better than government, government must on net produce public goods.

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

G.           OK, so what about anarchy? 

H.           If you remain dissatisfied with democracy, reject constitutional reform (even futarchy!) as a solution, and abhor dictatorship, anarchy is all that’s left. 

I.             There is a surprisingly large economic literature on the possibility of “free-market anarchism” or “anarcho-capitalism,” beginning in 1849 with Gustave de Molinari’s article, “The Production of Security” in the Journal des Economistes.  See Stringham’s Anarchy and the Law for a broad survey.

J.            Our analytical procedure: Start with the functions of the night-watchman state (NWS) – dispute resolution, rule formation, and enforcement – and work backwards.

K.           Specifically: What aspects, if any, of these functions are really public goods?

IX.          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.

X.           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 to some extent already do) 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.

XI.          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.

XII.        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

4.            Bonding

5.            Credit ratings

6.            Ostracism

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 government, because the state remains – and decides how far the alternatives are allowed to go. 

D.           What about radical privatization - getting rid of the last remnants of the NWS state?

E.           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.

XIII.       Main Objections to Radical Privatization

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

B.           "Externalities of defense services.”

1.            Reply: These have more to do with current policy than the nature of the product.  If police only help paying customers, if judges charge for adjudication, if victims who prosecute win restitution, where is the externality?

2.            Turnaround: Government defense has lots of externalities.  Bureaucrats who make the world safer get paid the same as those who don't.  Oftentimes "crusaders" become very popular by causing the crime they claim to be fighting (e.g. Prohibition).

C.           "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.

D.           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 is much larger than for mere police agencies.

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

1.            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 high-risk, 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 are 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 are currently sentenced to harsh prison conditions. 

XIV.      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 reply to Cowen in the RAE.  Main argument: Cowen conflates coordination problems with prisoners’ dilemmas.

E.           Product standardization is a 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

XV.        National Defense

A.           What about national defense?  Isn’t that clearly a public good? 

B.           Answer: It depends.  “National defense” is not a public good for the world because if no country had “national defense,” no country would need it! 

C.           Implication: Countries’ “national defense” programs are often a public bad – and the losers typically include their own citizens.

D.           Simplest reply to the national defense objection: Our country’s national defense is a public bad, and both we and the rest of the world would be safer without it.

1.            This argument became far more convincing after the fall of the Soviet Union.

E.           Still, how would a free-market anarchist society defend itself against invasion by an aggressive state?  Surely that would be a public good.

F.            Answers:

1.            Voluntary charity.  Members of the anarchist society could volunteer both money and their labor to defend their society from attack.

2.            Ideology.  A successful anarchist society would have many external sympathizers, making it difficult to rationalize aggression.  Look at how little the capitalist world did to crush the Soviet Union in its infancy.

G.           If this seems naïve, consider a Tullockian challenge: “Give me one good reason not to invade Brazil.”

XVI.      The Transition Problem

A.           The biggest challenge to anarcho-capitalism: The transition problem.  How do we get from here to there?

B.           Most radical movements consider violent revolution.  But even if this were feasible, what are the odds that violent revolution would create a freer society, much less a free society?

1.            David Friedman’s quip: “Revolution is the hell of it.”

C.           From a libertarian point of view, most revolutions are a complete disaster.  Even the American Revolution is greatly overrated by libertarians – government didn’t really shrink, and the rights of slaves and Indians would have been better protected by the British. 

1.            Question: Are revolutions a good example of the idea trap?

D.           Other options are viable for marginal change, but offer little hope of radical change in the foreseeable future:

1.            Persuasion

2.            Infiltrating the political system to take advantage of slack

3.            Coordinated movement to change the median voter (e.g. the Free State Project)

E.           What about just creating a new society?

1.            “Create your own country” projects end in failure or conquest by neighboring old country.

2.            Paul Romer’s solution: Charter cities

3.            Patri Friedman’s solution: Seasteading

F.            My case against fatalism: Radical change is very difficult to achieve, but what sensible person ever thought otherwise?  To quote Tollison, “We’re all part of the equilibrium.”  You can still make a marginal difference – and do good while doing well.