With the death last week of Nobel laureate economist James Buchanan, the freedom movement has lost one of its most important thinkers. Unfortunately, Buchanan’s work often gets boiled down to the seemingly trivial observation that politicians are self-interested. Put that way, it’s too easy for people to respond, “Everyone knows that!”
Although it’s true that the assumption of self-interested politicians is crucial to the work of Buchanan (and his co-authors in the Public Choice school, such as Gordon Tullock), when seen in the context of the history of economics, it is far from obvious or trivial.
To understand why, we need to see what much of economics was like in the middle of the 20th century. Mainstream economics had adopted the so-called perfect-competition model as their description of how an ideal free market should operate. With its highly restrictive assumptions of perfect knowledge and large numbers of small competitors, all of them selling identical products at the same market price they cannot influence, the model showed that markets would produce a perfectly efficient result. Unsurprisingly, real-world markets almost always failed to live up to the ideal. The imperfections were termed “market failures,” and the remedy was to have the state adjust costs and benefits in order to bring markets closer to “perfection.”
Putting aside that these are “imperfections” or “failures” only with respect to an unachievable ideal — a point Austrians have made — Buchanan and his colleagues made their mark by going after the claim that the state could improve things. Economists who argued for state solutions came up with clever and sophisticated models showing how political actors could adopt corrective policies. For example, pollution was seen as a “market failure” caused by polluters who imposed costs on third parties rather than bearing them directly, implying that the perpetrators were producing more pollution than was optimal. Governments would correct this by taxing the polluters an amount that matched the social cost of the pollution, thereby discouraging their behavior while providing the revenue needed to compensate the victims. On the blackboard, this solution would bring about the efficient result the market could not achieve.
On the macroeconomic side, economists made a similar argument about recessions and budget deficits. Recessions were seen as a kind of system-wide market failure — or “unemployment equilibrium,” as Keynesians termed it. The solution was to have government engage in deficit spending to make up the supposed lack of private-sector aggregate demand. If governments could run deficits in bad times and run surpluses in good times to offset the earlier deficits, the budget would remain balanced over the business cycle.
The problem with both these scenarios is what Buchanan called a “behavioral asymmetry.” Market actors were assumed to be self-interested, hence their unwillingness to consider the external costs of pollution. However, political actors were assumed to do precisely what the blackboard model said they should do, and no one asked if doing so was actually in their self-interest. Buchanan’s innovation was not to claim that politicians are self-interested; it was to say that people in markets and politics are the same. And, with that point recognized, his second great contribution followed. Politics, like the market, he said, can be understood as a process of exchange in which people attempt to become better off.
Those insights then prompted this question: Are the incentives facing actors in current political institutions such that they will do what the blackboard models say they should? Buchanan said no. On the deficit side, spending more without raising taxes would always be a winner with voters, while raising taxes and cutting spending, as required during the good times, would be a vote loser, resulting in permanent deficits.
For other policies, seeing political actors like market ones raised the possibility that people who would be affected by new taxes or transfers might lobby legislators, promising them votes in exchange for favorable policies that deviate from the blackboard ideal. The realization that political actors engage in self-interested exchange just like market actors do led to the term “government failure,” a reference to the ways that political outcomes fail to match the blackboard ideal.
As a result, the market’s inability to meet the ideal of perfect competition was no longer an ipso facto case for expanding state power. Now we had to compare the performance of markets and politics. Imperfect markets might still be much better than an even more imperfect political process. For mainstream economics this was a revolutionary insight, far deeper than just saying that politicians are self-interested. By destroying the automatic resort to government and forcing economists to recognize the imperfections of politics, the work of Buchanan and his colleagues changed economics and eliminated one of the key justifications for state power.