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The importance of constitutional economics

Hector McNeill1

James M. Buchanan

An important aspect of constitutional economics is public choice theory. That is, a study of the mechanisms whereby the people of a country can express their freely-formed views on how we should advance, as a nation, and how the constitution can support the mechanisms that give a fair voice and levels of participation to the population in the decision-making that moulds that advance. Public choice theory points out that it is close to impossible to satisfy the majority through the current constitutional mechanisms that exist where the assembly (Parliament) taking decisions is centralised and, in addition, its members are identified and act in line with the wishes of political parties rather than constituents.

James Buchanan, the leading international developer of constitutional economics, did however define important principles that cause us to work harder to prevent the limited vision of MPs intellectually-shackled by their membership, and by the whips, of political parties from causing yet more economic damage to the fabric of the economy and to the prospects of the people of this country.

According to Buchanan the ethic of constitutionalism is where the individual who is expressing preferences for social and economic conduct, together with others in society, adopts the moral law as a general rule for behaviour. He rejects any organic conception of the state as superior in wisdom, to the citizens of this state. This philosophical position forms the basis of constitutional economics. Buchanan believed that every constitution is created for at least several generations of citizens. Therefore, it must be able to balance the interests of the state, society, and each individual.

The sophistication of Buchanan's analysis related to his making sense of "Political Economy" by making a distinction between politics and policy. Politics sets the rules of the game, whereas policy is focused on strategies that players adopt within a given set of rules. Questions about what are good rules of the game are in the domain of social philosophy, whereas questions about the strategies that players will adopt given those rules is the domain of economics, and it is the play between the rules (social philosophy) and the strategies (economics) that constitutes what Buchanan refers to as "constitutional political economy”. Buchanan, did much to introduce ethics, legal political thinking, and social thinking into economics and therefore set out a more rational canvas upon which to found a better future.

Milton Friedman

Chicago, Chicago

A couple of years ago, James Buchanan have a short lecture to clarify a confusion that has arisen where people blame the Chicago school (University of Chicago) for the current economic fiasco. Buchanan was at Chicago in the late 1940s and he made a clear distinction between that Chicago School and what appeared later in the form of Milton Friedman's monetarism. The main difference was that the older Chicago people would never have seen themselves as "running the economy" on the basis of a blind faith in "free markets". In those days it was well established that to run efficiently markets required appropriate institutions, structures and rules, a constitutional setting if you will. The later Chicago simply believed markets are by their very "nature", efficient. An important constitutional failure causing the free market ideology to fail is that market institutions and the rules were set by the rent seekers in specific markets with political parties allowing them to do this.

Paul A. Samuelson
Indeed, constitutional economics assumed politicians are not altruistic but self- or group-seeking (political party, power, influence, wealth) so one ends up in a situation where the "benefits" of "free markets" go to a specific group of influential participants and not to the rest of the people in the market or to society in general. Although trumped up and proclaimed to be super-efficient the monetary system, including macroeconomic policy and near money transactions (derivatives, interest rate swaps and hedging models) all created an excessive leverage which essentially undermined any policy control.

I would add that this would be virtually impossible in any case because the central institutions are not in fact run by the governments but by banks and various types of financial intermediaries largely concerned with trading. Indeed the whole monetary system from international institutions to local economies is controlled by the specific interests of a private banking sector dominated by fewer than 30 major banks2. It needs to be remembered that in the USA it was the big institutions that failed whereas the slack could have been taken up by the literally thousands of smaller banks whose balance sheets and standing had not been corrupted by transactional assets and high frequency trading positions.

Buchanan was of the opinion that Paul Samuelson, of MIT, did important work in the 1950s on developing a taxonomy to classify types of goods in markets in relation to private divisible goods valued by individuals and public goods which we commonly considered to be useful and nonpartitionable. Public goods are non-exclusive and not costless and yet most in society agreed on the need to have them. A good example mentioned by Buchanan is that law and regulations are an important public good, designed and recognized by all to protect everyone.

So Buchanan, in this short lecture, reminded us than in spite of the fact so much intellectual effort has gone into economics, many things get overlooked. More importantly, the constitutional context that establishes the quality and nonpartitionable character of public capital in the form of laws and rules overseeing markets is a vital asset in preventing the biased and destructive self-serving behaviour of corporations who have a significant power over the political establishment. Understanding all of this and moving towards a system that can help defend freedom and democracy is likely to take place, if at all, within a structure that comes closer to Buchanan's view that constitution must be able to balance the interests of the state, society, and each individual. The fact that large corporations and political parties have not picked up on this should not discourage those hoping for a better foundation for participatory democracy. This is why talking about constitutional economics and investing time and effort to make it more understandable through the demonstration of feasible propositions is an important pursuit in support of a happy and peaceful future for all.

1 Hector McNeill is director of SEEL-Systems Engineering Economics Lab.

2  Note: 9th May 2013 - there was a major PR thrust being organized by the main banks in the USA and elsewhere to "repair their image" as a basis for discouraging governments from requesting increases in capital requirements. Their preference, as in the case of media control, is to have extra-constitutional solutions where those who the oversight organizations monitor also run, or have excessive influence over, the decision-makers in such organizations.