On January 9 the world of political economy and the community of libertarian academics lost one of the 20th century’s most important thinkers with the death of James Buchanan at age 93. Although he was not as well known as Mises and Hayek, or even Milton Friedman or perhaps Robert Nozick, his work belongs with theirs in any discussion of the central contributions to libertarian thought in the last 100 years. Buchanan’s work, much of which was published with a variety of co-authors in the Public Choice school of economics, is somewhat less accessible to the average reader than the others named above, which may explain why he is not the household name among libertarians that the others are. However, in terms of the importance and impact of his work, his contributions are essential.
In much of the coverage of his death, his work was summarized in two ways: politicians are self-interested, and constitutions are necessary to constrain governments. Put that simply, both seem rather obvious, leaving some to wonder why he was so important and why he deserved the Nobel Prize in economics (which he won in 1986).
Underneath those two aphorisms was a much more complex set of arguments that need to be understood in the context of how economists thought about the economic role of government in the first half of the 20th century. Buchanan’s work was responsible for dismantling a form of argument that took the imperfections of the market as an ipso facto case for government intervention. He did so by showing that government intervention was susceptible to imperfections just as the market was, imperfections that were arguably greater. Once the imperfections of intervention were clear, the case for it became much weaker. From there, Buchanan and his colleagues could argue the case for constitutional restraints on government. To see how their argument works, we need to explore the historical context into which Buchanan stepped.
By the middle of the 20th century, mainstream economics had adopted the so-called perfect competition model as its preferred description of how an ideal free market would operate. Given its highly restrictive assumptions of perfect knowledge and a large number of small competitors all selling identical products at the same market price they cannot influence, the model showed that such markets would produce the “perfectly efficient” result. It is no surprise that real-world markets almost always failed to live up to that ideal. Their imperfections were termed “market failures,” and the remedy was to bring the state in to adjust costs and benefits in such ways as to remove or reduce the imperfections.
The term “market failure” is problematic, as Austrian economists pointed out at the time and have ever since. Features of real-world markets, such as differentiated products or a small number of large firms, could be understood only as “failures” or “imperfections” in comparison to the unachievable ideal of perfect competition. As Hayek argued in the 1970s, the correct comparison is between real-world markets and what we could achieve if markets were absent.
While the Austrians argued that the language of market failure was mistaken, the contribution of Buchanan and his colleagues was to go after the idea that the state could remedy such failures that exist. Economists who argued for state solutions came up with clever and sophisticated models for how political actors could adopt corrective policies. For example, pollution was seen as a “market failure” caused by polluters imposing costs on third parties, rather than bearing them directly, which implied that they produced more pollution than was optimal. To correct that, governments would tax the offenders an amount that matched the social cost of the pollution, thereby discouraging their behavior and providing the revenue needed to compensate those harmed. On the blackboard, that 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 systemwide market failure, or “unemployment equilibrium,” as Keynesians termed it. The solution was for governments to engage in deficit spending to make up the supposed lack of private-sector aggregate demand. If governments could borrow and deficit-spend in bad times, and run offsetting surpluses in good times, the budget would remain balanced over the business cycle and the economy would run smoothly.
Buchanan made two claims about the nature of political activity that suggested governments would be unable to improve on the market. The problem with the scenarios above is that they entail what Buchanan called “behavioral asymmetry.” In the perfect-competition model, people were assumed to be motivated by self-interest. By contrast, people in the political world did not think about self-interest but simply acted in the “public interest” the way the blackboard models said they would. No one ever asked whether doing so was in the interest of political actors. To be precise, Buchanan’s contribution was not to say that “politicians are self-interested,” but to simply demand that we treat economic and political actors symmetrically. That is, doing political economy responsibly means making the same assumptions about the motivations of people in both the political and economic realms. That is what Buchanan meant when he called for a “politics without romance.”
The extension of that observation is the realization that politics, like the market, could be analyzed as a forum for exchange among broadly self-interested actors trying to improve their well-being. For Buchanan, markets and politics were alternative processes by which individual persons could make themselves better off. The difference between the two was whether the unintended consequences of that exchange behavior made society better off or not. Market exchange was mutually beneficial and socially beneficial; political exchange often had socially destructive consequences. Buchanan and his colleagues modeled elected politicians as vote-seekers, the public as seekers of net benefits from government, and bureaucrats as seekers of power and money to spend. In the middle of everything were the various private actors seeking government benefits, that is, engaging in what came to be called “rent-seeking.”
By viewing politics as exchange, Buchanan was able to explain why the government solutions to market imperfections so consistently failed to work the way they do on the blackboard. Take the running of deficits during recessions and surpluses during good times. If politics is about exchange, then politicians who spend more and refuse to raise taxes would get more votes, while those who raised taxes and cut spending, as required during good times, would lose votes and not get reelected. With institutional incentives always favoring deficits over surpluses, no matter how good budget-balancing over the business cycle looked on the blackboard, we would almost always have deficits. The history of the last 75 years confirms that argument.
If people were to be regarded the same in both the economic and political realm, it followed that those affected by new taxes or transfers might lobby legislators, promising them votes in exchange for favorable policies that deviated from the blackboard ideal. For example, if a pollution tax were proposed, firms subject to the tax would be willing to spend a great deal of money to prevent its passage. People in the private sector might also ask the government for special treatment even in the absence of any “market failure.” Once we understand politics as exchange among broadly self-interested actors, we see that government policies will never align with the blackboard models.
Buchanan referred to the systematic inability of the political process to produce the ideal generated by economic models as “government failure,” in parallel with the “market failure” discussed earlier. No longer could economists do what they had been doing for decades: assume that imperfections of markets were a sufficient cause for government intervention. Once Public Choice theory introduced the possibility that institutional incentives would generate perverse political outcomes, the question of state intervention became comparative. Both market exchange and political exchange were incapable of perfect efficiency, so which one was better?
Buchanan and his co-authors generally argued for the superiority of market exchange, and their arguments can be found in a variety of his writings. With a few exceptions, such as his brilliant short letter to the editor “Order Defined in the Process of its Emergence,” most of Buchanan’s work on why markets are good was pretty conventional, and the exceptions were often very much influenced by the Austrian school.
The rules of the game
With government failure a serious possibility and the imperfections of the political process most likely to be much greater than those of the market, the next question was how to limit the state’s ability to make mischief. Buchanan’s answer was to focus on “the rules of the game.” Like Hayek, he viewed the market process as a kind of game structured by rules. The rules, in the form of institutions such as property rights and contract law, create incentives that make it more likely that people will behave in some ways rather than others. Strong protections for property rights, for example, will make people more likely to invest, trade, and think about the long-run implications of their choices.
The same is true of politics. The institutions of the political process create incentives for certain types of behavior. If we wish to discourage continual deficits, we need to change the rules of the game that encourage deficit spending. If we wish to reduce rent-seeking by private interests, we need to understand what rules encourage it and how they might be changed.
His emphasis on rules led Buchanan to his work in constitutional political economy. What a good constitution could do is create rules that prevented the self-interest of politicians from generating undesirable unintended consequences. Like Ulysses lashing himself to the mast, binding ourselves to constitutional constraints is a way to avoid the Sirens’ song of political self-interest and the destruction it can cause. Constitutionally requiring a balanced budget changes the rules and takes the ability to act on self-interest away from political actors. Other constitutional rules, such as requiring a super-majority for tax increases, can similarly prevent self-interest from being the cause of government failure. As James Madison, Buchanan’s favorite of the Founders, put it, “If men were angels, no government would be necessary.” For Buchanan, constitutional rules recognize that we are risen apes, not fallen angels.
One of the fascinating questions that Buchanan’s work raises is whether constitutional rules (in the sense of basic rules of the game, including the economic game) must, as he believed, be imposed from outside. Buchanan did not believe that market processes could generate all their own rules. Rules that prevented destructive self-interest or channeled it into productive uses had to be the product of political deliberation. A younger generation of scholars is challenging that view. Although they accept all of Buchanan’s analysis of the problems of politics, they are exploring whether markets and other nonpolitical processes can endogenously generate rules and norms that lead to effective self-governance in the absence of the state. In this work, the word “constitutional” refers not to a literal constitution, but to the ability to generate self-enforcing norms of that sort. Buchanan himself was skeptical of the possibility of a stateless society, but his work, like Hayek’s, might point in a more radical direction.
Buchanan’s work fundamentally challenged long-standing presumptions of economists about the benefits of government intervention and provided a way to think about the need for constitutional constraints on government. His work guides much libertarian political economy and has opened new avenues of research that point in directions more radical that Buchanan’s own ideas. He was one of the 20th century’s champions of liberty.
This article was originally published in the April 2013 edition of Future of Freedom.