Buchanan for the 21st Century*
Wayne T. Brough
Citizens for a Sound Economy Foundation
1250 H Street, N.W., Suite 700
Washington, D.C. 20005
Faculty of International Studies
Hiroshima City University
Submitted for the celebration of the 80th birthday of Professor James M. Buchanan.
Wayne T. Brough, a Ph.D. from George Mason University, is currently Chief Economist at Citizen for a Sound Economy Foundation, Washington, D.C. Tel: 202-942-7627. E-mail: email@example.com
Shigeto Naka, a Ph.D. from George Mason University, is currently an Associate Professor of Economics, Faculty of International Studies, Hiroshima City University, Hiroshima, Japan. Tel: 011-8182-830-1540. E-mail: firstname.lastname@example.org
Buchanan for the 21st Century
"One is grossly mistaken ... when he accuses a person who studies ... homo oeconomicus ... of
neglecting, or even scorning, ... homo ethicus."
A self-proclaimed philosophical anarchist, James Buchanan, has been, at the same time, an ardent social constructivist. There is a dichotomy between Buchanan as theorist and Buchanan as preacher. This paper argues that this dichotomy is not the result of a methodological inconsistency, but may be attributed to his deep-rooted conviction that the emergence of the modern welfare state, coupled with the development of highly industrialized societies, may generate a "spontaneous disorder" rather than a "spontaneous order." The invisible hand, which guides productive activity may be replaced by an evolutionary process that fosters the growth of government and loss of economic liberty. If this conviction is true, Buchanan=s argument has great significance for the 21st century. At the same time however, the paper raises the question of whether the market can adapt to the changing institutional framework of modern society. There is evidence to suggest that the market has responded to changes in ways that continue to promote the traditional values underlying a productive market economy. It remains to be seen, however, whether the market is resilient enough to thwart the steady onslaught of government growth.
2. The Conviction of Professor Buchanan
Modern, market-based economies have demonstrated powerful capabilities to allow their average members to obtain more goods than before given the same amount of resources. For Buchanan, this is possible for two reasons. First, a market economy establishes stable reciprocal behavior with respect to the protection of property rights. This social convention or norm, which evolved spontaneously, enables us to engage in mutually beneficial exchanges. Second, once such a social norm emerges and permeates society, the expansion of markets or the market nexus occurs if and only if we all work hard naturally.1 This "we all work hard naturally" is also a social norm, a spontaneous order.
At the heart of Buchanan=s worldview lies the invisible hand envisioned by Adam Smith. Buchanan's interpretation of Smith is that market expansion is not only a byproduct of market participants merely seeking their own self-interests within a stable spontaneous order, but also a byproduct of positive spillover effects created by economic actors who willingly provide their inputs into an existing market. Without this willingness on the part of market participants, technology does not progress and the market does not expand. Therefore, for Buchanan, the "wealth of nations" requires two social normsCa cooperative (reciprocal) ethic and a work ethic. Yet, Buchanan sees these two social norms diminishing in our modern, industrialized world.2
The emergence of the modern welfare state and the concomitant expansion of government in both economic and social spheres have increased both the opportunity for, and the relative pay-off of, income redistribution activities. Rather than providing inputs into productive market activities, individuals may now invest in rent seeking, rent protection, and rent avoidance (Buchanan and Tullock, 1965). Further, given a majoritarian, representative, democratic governance system, Buchanan sees that both citizens and politicians are apt to weaken their fiscal discipline by resorting to debt-financed government expenditures (Buchanan and Wagner 1977). All this suggests, to Buchanan, an erosion of the "social capital" underlying the success of market-based societies (Buchanan, 1974). Weakened cooperative and work ethics generate a greater demand for external social controls on individual behavior. This further expands the role of government, leading to a vicious spiral of increased government and less individual liberty.
What Buchanan finds disconcerting is that this erosion of social capital also may be the result of a spontaneous order. Buchanan argues that a spontaneous order that evolved under one institutional setting may not yield the same results in a different institutional setting: A normatively good spontaneous order may not continue to evolve if the institutional setting changes (Buchanan, 1994; 1977). According to Buchanan, social norms arising spontaneously in the modern, industrialized, welfare state are replacing the traditional social norms that foster economic growth. The new norms are less conducive to promoting the wealth of nations.3 Therefore, such an order should be regarded as a spontaneous disorder.
Reciprocal Norms in the Welfare State
To clarify Buchanan's point concerning the cooperative or reciprocal norm, recall that in elementary economic theory one's strength is modeled using a budget constraint that defines the limits of an individual=s choice set. Buchanan (1994) poses a question: Setting aside legal, external constraints, what makes an individual respect his trading partners' endowments or rights? In a two-person exchange, the most preferred outcome for either actor is, AI take what you have in exchange for nothing.@ The socially optimal outcome is, AI take yours in exchange for giving you mine.@ Without ethical constraints or institutional sanctions, both players will choose their dominant strategies, resulting in the socially sub-optimal outcome demonstrated in the familiar prisoner=s dilemma. For Buchanan, self-interest and the willingness to work hard, set in a framework that protects individual property rights, generates the beneficial outcomes that define a market order.
From the above perspective, how do we describe a rent-seeking society? Quasi-thieves who legitimize their robbing or stealing through the majoritarian authority of government would dominate this society. In effect, the winner of this game imposes a forced exchange upon the loser that expands the winner=s choice set beyond his budget constraint. Losers see their choice sets reduced in a manner markedly different from the positive sum game of mutually beneficial exchange. Moreover, this phenomenon may be exacerbated through fiscal deficits that create inter-temporal wealth transfers: The winner imposes a forced exchange upon not only current losers but on future generations, resulting in a further expansion of the winner=s choice set.
The problem is that the winner neither feels guilty nor feels that long-term interests are in danger. Thus, the expanded role of government in society, as manifested in an expanding welfare state and weakening fiscal discipline, means nothing less than an erosion of internal constraints of individual social participants. The problem is that this erosion is often cloaked in legislation in the name of Ademocratic justice.@ The institutional setting of the modern welfare state is quite different from that of a traditional market-based society where the role of government was much smaller.4
The Work Ethic in the Welfare State
One can readily imagine a situation where one party of an exchange invests resources to alter the other party=s value system in a way that generates more favorable terms of exchange. Such an investment, if successful, makes one party feel no worse off even though she receives fewer gains in the exchange. If this kind of investment allows one party to receive a greater benefit whenever he engages in exchange with others, it will be in his self-interest to invest resources "programming" or persuading others to give him goods without a reciprocal payment (Buchanan, 1994, Chap. 3). Yet, if it is in the self-interest of one party to invest resources in programming others, it is equally rational for all actors to do so. Should such investments be successful, no party feels they are being exploited by anyone; in fact, if they do not offer additional exchange benefits to each other, they would feel guilty.
This logic can be extended to the origin of the work ethic: Economic actors invest resources to encourage others to work harder while making them feel guilty if they do not. This yields extra exchange benefits derived from their extra work. In turn, this prompts an expansion of the market nexus, resulting in an increase in real income. If this originally selfish behavior permeates society, the overall effect is that no one feels disadvantaged when providing an external benefit for others through working harder. A work ethic emerges, spontaneously. All market participants internalize the positive externality promoted by the work ethic through prevailing reciprocal norms. These contractarian or reciprocal ethical norms assure that mutually beneficial exchange is possible without incurring high transaction costs. In addition, the prevalence of this work ethic ensures the existence of a dynamic positive externality in this regime, enabling increasing returns and an expansion of wealth.
In the modern welfare state dominated by rent seeking and weak fiscal discipline, Aliving-off others@ has become the prevalent behavioral guide for many, which weakens the work ethic as a social norm.5 The logic of free riding suggests that in such a society there would be an under-supply of the positive externality of the work ethic in equilibrium, slowing economic growth. In the individual calculus, it may become more rational to invest in politics than to invest in productive work, and it becomes less rational to invest in the inculcation of a work ethic. The full potential of society cannot be attained because it fails to capture these positive externalities.
The perseverance of rent-seeking behavior in a society dictated by the modern majoritarian logic will inevitably alter prevailing social norms that should, in turn, alter the dominant strategy of randomly distributed individuals. The strategy is likely to shift from the positive-sum game of mutually beneficial exchange to, at best, a zero-sum game that imposes forced exchanges on others.
Changing Social Norms: The Market Responds
Social norms are not imposed by some authority, but are the result of social evolution. This means that individual actors, prevailing laws, and existing institutions are all interrelated with each other, influencing one another interdependently to determine the direction of overall social evolution. One evolutionary criterion advocates the doctrine of "Whatever survives is efficient". This doctrine ultimately must be true: The environment defines, and therefore adopts, the fittest strategy, not the other way around (Alchian, 1950). But, this doctrine is contextually empty because it merely describes what is.6 A caveat is needed. As the environment changes while its component variables change and vice versa, the normative meaning of efficiency itself changes, giving rise to a puzzling possibility. Namely, efficient behavior under one environment can be inefficient in another.
The concept of efficiency becomes relative under the survivor criterion. To bring some context into this otherwise empty concept, one needs to fix the environment. If we assume, for example, the constant existence of a competitive order promoted by a private property rights regime, the statement that "Whatever survives is efficient" becomes contextually or normatively meaningful since it implies that the survivor is likely to be the least-cost provider, saving scarce resources. Yet, as noted above, and as empirical observations of modern welfare states indicate, assuming the existence of a competitive order may not be valid. A fatal mistake may be made if one believes that the same normative efficiency criterion of survivorship will apply under different environments.7 Consequently, Buchanan (1996, p.417) has challenged Alchian's survivor criterion by arguing; "the normative status of this criterion may be quite different in differing institutional settings." Much the same criticism can be applied to the concept of spontaneous order advocated by Hayek (see Buchanan, 1977).
It is important, therefore, to have some concept that can be used to evaluate the relative efficiency of various possible institutional settings. Such a mechanism must be able to evaluate the "desirability" of alternative social orders or alternative constitutions. But who is in the position to evaluate the relative efficiency of different regimes? A philosophical anarchist, Buchanan maintains that each individual should evaluate. How should we weigh each individual's opinion? Buchanan insists that each should be weighed equally. What should be the essence of such an evaluation? Buchanan says that it should be based on a broadly defined Pareto principle (Buchanan, 1977). From these convictions, the calculus of Aagreement" or Aconsent" emerges. It is well known that Buchanan has built his theory of the contractual state from these foundations.
3. Buchanan=s Relevance in the 21st Century
In this section, we shall argue that Buchanan=s insight has great significance for the world in the coming century if his conviction is true. We shall, however, argue that whether his conviction is true depends on the strength of countervailing forces that the market system itself spontaneously produces. In essence, we see that the transformation of a traditional market society to a modern industrialized society has resulted in a change in the structure of ethical investments made by market participants. Ethical investments made to support a traditional market society have become increasingly inefficient due to a change in the institutional setting caused by the expanded division of labor.
The expansion of the market has fostered an increased population, increased diversity of tastes, increased mobility, increased wealth, increased role of corporations, and, consequently, an increased role for government. It is ironic that market expansion can weaken the very foundations of the traditional market systemCwhat Buchanan identifies as "reciprocal norms" and a strong "work ethic."8 Buchanan suggests a spontaneous disorder is likely to emerge in our modern settings. But is it possible that the loss of what Buchanan has identified as the foundation of the market system may be held in check by other market forces? Further, is it possible that the market expansion itself contains the elements to create a new spontaneous order? It is important to realize that in a modern setting, traditional personal reputation capital such as honesty has been increasingly replaced by name-brand capital for a product or an organization=s reputation.9 Also, it is important to realize that even in a modern setting, the consumer in the product market is, at the same time, a supplier of a specialized input. Therefore, the individual=s reputation capital in the labor market has become increasingly important, since a firm is likely to select its members based upon the same ethical qualities as before, in order to maintain its reputation capital in the market.10
Imagine a simple circular flow diagram. In a traditional market society (a society of proprietors such as bakers, brewers, and so forth), the buyer and seller interact with each other to obtain goods and services in exchange for payments. In this setting, a buyer of brewed bottles of beer may be an independent seller of loaves of bread, and vice versa. That is, a person is at the same time a consumer as well as a producer. Both buyers and sellers have an incentive to invest in ethical behavior to regulate the actions of one another. A buyer needs an honest and knowledgeable seller in return for his or her continuous deals. A seller needs his personal reputation not only as a good person but also as a good firm. In this society, it is required for market participants to invest in ethical norms if they want to improve overall exchange efficiency.
In our modern, industrialized society, mass retailers selling clothing, toys, books, groceries, hardware, music, and so on, have emerged in the product market, taking advantage of economies of scale and scope. As a result, consumers can obtain "standardized" products with higher qualities at lower prices than before.
Yet, the emergence of these large-scale organizations has made analysis of the normative implications of traditional contractual relationships less relevant, because consumers no longer exchange directly with experts who simultaneously acquire and sell a good or service. Instead, consumers more often engage in Aindirect@ exchange with organizations owned by multiple and various owners.11 Though it is true that a store clerk still provides service to the consumer, he is not responsible at all for the availability of that good. The organization, which has numerous specialists, is responsible. Therefore, consumers are interested in the organization as a legal entity and how it behaves.12 Consumers have no incentive to spend their own resources to alter the behavior of a retail person, since they can go to another store if they do not like his attitude. However, consumers have an interest in regulating the behavior of the firm. Whether they will spend their own resources to regulate its behavior is a different matter.13
For the sales clerk, there is an incentive to maintain good behavior toward customers because such behavior is most likely to be noticed and appreciated by his colleagues, his boss and his employers. Since the anonymous and impersonal setting of the transaction makes an exit decision by any customer of the supermarket easier (provided that enough competition exists)14, this supermarket must make efforts to maintain its customers. One way to do so, for instance, is to instill a name-brand loyalty among customers by providing specific brands that consumers like. Another is to establish company=s reputation. In any case, this firm must maintain goodwill toward its customers. Constrained by this requirement, the firm=s managers have an incentive to recruit its members carefully and screen out undesirable and unreliable employees. This means that the supermarket is likely to recruit its members based upon the same ethical qualities underpinning traditional markets.
Trust, honesty, or loyalty, as traditionally conceived, become less useful in these Aindirect@ contractual relations between the buyers and sellers of final goods and services because specialization has transformed many of the sellers into complex organizations that are Alegal@ persons. Thus, like Buchanan, we predict a general decline of personal investments in certain types of ethical behavior. But the rise of indirect contractual relationships does not mean an absolute decline in Adirect@ contractual relationships. Rather, it means that those direct contractual relationships have decreased in one area while they have increased elsewhere. As we have implied in the above scenario, a decline in traditional ethical behavior will be offset by an increase in the need to create Aclubs@ in different areas of the market that adopt their own standards of ethical behavior when selecting members.15 These clubs are subjected to the survival process of Atrial, error and imitation" in the market (Alchian, 1950). So long as individuals prefer more to less and the market continues to expand, this selection mechanism will spontaneously function to maintain the basic ethical norms of society by screening out those organizations that adopt inefficient ethical standards. For this reason, this general decline of ethical behavior is limited.
The above argument may be summarized as follows. First, all consumers in modern economies are also input suppliers whose behavior is likely to be disciplined by increased possibilities that they need to belong to a corporation or organization (a club) to derive income. Second, corporations and other organizations have become increasingly important in production and distribution due to increased specialization. Competitions among these corporations or organizations results not only in the survival of certain trade names and reputation capital, but the survival of certain corporate or organizational rules or constitutions.16
4. The Importance of New Institutional Economics: New Ways to Enforce Old Values
Is it merely coincidental that when the traditional ethical norms were weakened by an expansion of markets, many new ways of doing business and new organizations emerged spontaneously in the market? Their appearance may be technically explained by the very fact of increased specialization. For instance, when the person who acquires commodities from a wholesaler is no longer the one who retails these goods to consumers because of increased specialization, these activities must be coordinated through a new, but stable set of rules. These rules are likely to describe a set of authority relationships and establish a hierarchy of authority. Without such rules, the negative effects of specialization, such as difficulty maintaining communication, cannot be overcome; the costs of negotiations would increase prohibitively (Coase, 1937; Arrow, 1977; Williamson, 1985; Klein et al, 1978). As Coase has suggested and others have elaborated, an organization will spontaneously emerge in the market to economize on these communication difficulties whenever such difficulties manifest themselves. A firm is characterized as a Ahierarchy" of authorities.
Yet, another strand examining why the firm has emerged focuses on the issue of Ajoint-supply@ among specialists, with the technologies of increasing returns (Alchian and Demsetz, 1972). The benefit and nature of specialization imply that the marginal cost of producing a given good will fall faster than its average cost so that it becomes beneficial for each specialist to jointly supply goods through team production.17 This means that each of them must honestly commit to the cooperative venture to maximize joint production. Profit becomes a joint good. However, in some situations, it may be difficult to measure precisely each specialist=s contribution (effort) to a given output. As a result, a metering problem arises (Alchian and Demsetz, 1972). If this problem cannot be resolved, an incentive to free ride may produce inefficient outcomes. An ultimate monitor, who can assign and enforce rewards and punishments, must be established to eliminate free riding and maximize joint production.18 Once such a system is established, it becomes a firm. The firm emerged spontaneously to take advantage of joint-supply in the market wherever metering became a problem. In this view, the firm is characterized as a contractual entity with the largest stakeholders as enforcers of rules.19
The theory of the firm suggests that firms will emerge spontaneously in certain market situations ultimately because the division of labor increases. The firm establishes a set of authority relationships in an area of the market where, previously, only traditional contractual relationships, based upon traditional ethical norms, prevailed. Why are authority relationships needed? Fundamentally, the presumption is that a market with an increased division of labor is institutionally different from a market system with a lesser division of labor. An increased division of labor tends to give rise to more opportunistic behavior.
It is important to stress that a rise in opportunism does not mean that human beings have become less ethical. If society became less ethical the emergence of a firm as such would not be feasible, unless the authority relationship were particularly strong.20 If we agree with Hart (1995), that the source of such authority resides purely in the ownership of assets (not political force, such as internal police and dictatorship), authority can never be strong enough to allow a firm to survive with unethical members. The fact that we can observe the emergence of various firms implies, therefore, that the members of the firm are to some extent voluntarily submitting to the firm=s authority. It then follows that the traditional enforcement mechanismCethical normsCbecomes a less efficient means for promoting cooperation in the new institutional setting. The emergence of new organizational structures is a spontaneous, evolutionary response to this new institutional setting.
A similar argument can be made with respect to metering and joint production. A contractual entity with an ultimate monitor is needed to promote efficiency in joint-supply ventures among specialized persons, because traditional ethics have become less capable of promoting efficient outcomes. Again, not because human beings have become less ethical, but because the efficiency of traditional ethics has declined due to a change in the institutional setting. If human beings were truly unethical, the firm itself could not be sustained. In this view, too, the emergence of the firm implies a system of ethics guiding individual behavior.
The argument can be put as follows. From the perspective of the supply side in the product market, an increase in the division of labor means an increase in the variability of market situations. For whatever reasons, one situation calls for establishing a firm while the other situation does not; but, on average, the need for establishing firms has increased in modern times, as empirical observation suggests. The increase in variability implies that the solution to the problem of cooperation also becomes variable; in one circumstance a strong authority relationship must be established, while in the other, an efficient monitor should be established; further, in some situations, traditional market transactions suffice. From the perspective of demand side, this means also that efficient solution to the problem varies from situation to situation.21 In other words, in the modern setting, the correct solution (efficiency) to the problem of cooperation becomes variable; there would be many equally efficient solutions, depending upon a specific moment and circumstance. But, the fact that we observe the emergence of voluntarily collective arrangements implies that all these solutions are still based upon fundamental ethical norms.
5. When Is Buchanan=s Conviction Relevant?
It seems then, from the above argument, that Buchanan=s conviction becomes very relevant when political forces intervene with the evolution of the market in a way that persistently hinders the emergence of firms or distorts the Atrial, error and imitation@ of firms discovering their own rules. Government intervention takes two forms. First, it occurs when government takes over functions previously left to market. A second form of intervention occurs when government protects existing firms by establishing entry barriers. In either case, the essential functions of the price system is eliminated or distorted.
The price system in the market has two functions in the present context: informing market participants about the value of scarce resources, and informing existing and potential owners of firms about which mode or type of contractual relations is best suited for a given activity. This guides the division of labor and asset ownership (who should own a given or potential firm).22 When government takes on these functions, it becomes impossible to impute the value of scarce resources or ascertain the correct division of labor. Firms are an instrument that allow self-seeking individuals to reap individual benefits by promoting fundamental ethics in a modern setting. Therefore, the suppression of the price mechanism by government, which hinders the emergence of firms, will lead to an absolute deterioration of fundamental ethics. Government=s establishment of monopolies will produce similar results due to the same reasons.
The modern welfare state is aptly described as a rent-seeking society. This means that interest groups in a polity will attempt to reap their own benefits at the expense of others by using government. The trend toward deregulation and liberalization, which began in the late 1970s in industrialized democracies throughout the world, suggests that the occasion and frequency of government=s takeover of market functions may have reached its high water mark. From our perspective, this is a good sign. However, Aderegulation@ often means re-regulation, merely reconfiguring the winners and losers of rent-seeking games. Attempts to establish monopoly power through government ordinances and regulations are still ubiquitous.
In a simplified model, then, the political process of modern democracies generates two opposing forces; one to sustain a free, liberal order based on the market (the rule of law); and one to establish a personal regime for personal gains (the discretionary rule of men). If the presumption is that the latter force will dominate the former force in a democracy, our argument above implies that we will see an absolute decline in fundamental ethics within society.23 In this case, what Buchanan has argued becomes a great significance. The impartial Arule of law@ is crucial for our ethical system to remain salient in a modern, high technology society. The question is whether democracy generates such a spontaneous order.
6. Institutions, Order, and Evolution in the 21st Century
Professor Buchanan has demonstrated the important link between social values and economic organization. In the tradition of Adam Smith=s political economy, Buchanan=s work incorporates not only economic behavior, but also the institutions and values that shape that behavior. The invisible hand, or spontaneous order that guides economic activity relies heavily on these other elements of social organization. With the proper institutions and social values, the market economy has proved to be a great engine of economic growth.
At the same time, the growth of government has been a significant feature of the 20th century. Government intervention in the marketplace has weakened the underpinnings of the market economy through legislation and regulation that alter the institutional setting of market activity as well as the incentives facing individuals. These changes reduce economic liberty and restrict economic growth as individuals begin to invest in wealth transfer activities instead of wealth creation activities.
Professor Buchanan suggests that the growth of government may, unfortunately, be a direct result of the evolving order that guides economic activity. As political entrepreneurs crowd out economic entrepreneurs, society shifts from the positive-sum game of wealth creation to the zero-sum game of wealth transfers. Without institutional constraints to protect the foundations of the market economy, it becomes questionable whether we can discuss the market as a spontaneous order that coordinates society=s activities in a wealth-enhancing manner.
Others have also raised concerns that the market=s ability to create wealth may ultimately sow the seeds of its downfall. The simple fact that the market has enriched society may weaken the social values that promote a market-based society. Newly found affluence allows market participants to engage in more consumptive behavior, some of which may contribute to social ills such as increased rates of divorce and illegitimacy (Goff and Fleisher 1999).
Weakened social values and government policies that inhibit market-based institutions may suggest that the liberal economic order may face substantial challenges in the next century. As society evolves, there is a real question as to whether we face a spontaneous order or spontaneous disorder. However, markets are robust, and in the past they have adapted well to change. New modes of economic organization tend to reinforce the traditional values that allowed market activities to thrive. For example, as economic production transformed itself from small proprietorships to large corporations economic productivity increased dramatically. Firms found ways to replace the more personal relationships that characterized business prior to the industrial revolution with new business practices that continued the social values underlying economic progress. Most importantly, many of the direct relationships between customers and producers were replaced with indirect relationships where the firm itself established practices that required traditional social values in its employees. Concerned for the value of the firm, employers would seek out only those employees that could add value to the firm and enhance its reputation with customers.
It appears, then, that the evolution of the market has not abandoned the values that provide its strength. The relationships between economic actors have been altered, but the all-powerful consumer sovereignty of the marketplace continues to promote wealth-enhancing values. Further changes to economic organization must also contend with this point.
In fact, the economy is currently facing the most sweeping transformation since the industrial revolution. The turn of the last century saw new business forms emerging to take advantage of economies of scale and scope. Production processes became more mechanized, allowing businesses to mass-produce quality products at low prices. The standardized output may have weakened the consumer=s incentive to carefully monitor transactions with producers.
However, the technology revolution that is unfolding at the turn of the 21st century is empowering consumers through greater access to information. As Kevin Kelly (1998) states, we are entering an era of Amass customization.@ Consumers will have the knowledge and access to numerous providers of goods and services that accurately fit their specific demands. As Kelly notes, expertise will not necessarily reside in firms anymore; knowledgeable consumers with access to information and in communication with firms will have a much stronger say in the products being produced. Companies will have to strive even harder to meet the varied demands of different customers. Which suggests that traditional values will remain strong assets in the new economy.
While firms and the marketplace continue to rely on social values and institutions that promote wealth creation, Professor Buchanan=s concerns over the future remain valid. The government continues to grow, and economic activities face more challenges from taxation, regulation, and restrictions imposed by government at all levels. This growth must be reconciled with the market=s resiliency in the face of expanding government. Perhaps the most fruitful avenue of research is on the role of property rights, the most fundamental institution for a market economy. Firms have shown remarkable adaptability to evolutionary and institutional changes. However, this adaptability was premised on clearly defined property rights that provided the correct incentives for economic actors. Recent government growth may be questioning this fundamental institution in ways that make it far more difficult for firms to adapt. As the welfare state expands and property rights become more attenuated, Professor Buchanan=s fears may be all too true, for it is at this point that the ethics of the Hobbesian jungle supplant the ethics of the market, making predation more rational than production.
1 Market expansion allows a further division of labor among factor inputs. as more specialized inputs are supplied, the market expands, changing its technological conditions and enabling further specialization. In economic jargon, "increasing returns result (see Buchanan and Yoon, eds., 1994).
2Buchanan (1979, p.102) says; "Artifactual man, along with his institutions of social order, was embodied in the wisdom of the eighteenth century, a wisdom that modern man has seemed in danger of losing altogether."
3Buchanan (1994b, p. 29 says; "And we should make no mistake about the consequences; the growth in the productivity of the economy must decline."
4Buchanan (1996, p. 417) argues: " Specifically, think about the possibility that many of the behavior traits that we now observe may well have evolved in commercial settings in which survival depend on the maintenance of mutual trust among traders. My concern is whether such standards of trust and respect are dictated by the technological and political superstructure in the modern economy.
5It is interesting to note here that Lindbeck, Nyberg, and Weilbull (1999) have proposed a model in which a social norm of "living-off others" itself is a function of an increasing number of citizens of a welfare state who behave so.
6Upon discussing the normative implication of "efficiency" of spontaneous order, Buchanan (1977, p.30) says: "The principle of spontaneous order, as such, is fully neutral in this respect." (Italic added). Similarly, Binmore (1994, p. 98) argues, "It then becomes yet another tautology that which ever of the two strategies happens to achieve a larger payoff in the game, given the current population mix, will expand at the expense of the other. The tautology is usually expressed in terms of Spencer's 'survival of the fittest'."
7Donald Wittman (1995), for example , views the outcome of the democratic process under a broad rubric of efficiency. However, the limited role of institutions in the analysis trends to subject his research to the criticisms described in this paper. See, for example, Charles K. Rowley (1997).
8Buchanan (1965b) has argued that the maintenance of ethical norms is a negative function of the size of interacting groups in that society: as the size enlarges, the norm will weaken, since such norms are considered as collective goods. This argument further implies that as the market extends, ethical norms will naturally weaken. It appears that Buchanan attributes the decline of ethical norms in modern society to two factors, namely the political structure and the market structure.
9We are not arguing here that Professor Buchanan has overlooked this aspect. Buchanan (1994c), p. 125) says; " It should be noted, that the influence of potential exit on behavior occurs only if the large-number anonymity of the stylized market is not descriptive of reality. And, as markets become more extensive geographically, the anonymity of dealers across sides of the market tends to increase, to be replaced only in part by the emergence of trade names and reputation capital." For the role of reputation in the market see Klein and Lefler (1979).
10Whether one views a firms as a hierarchy of authority relationships or as a technological relationship of joint-supply venture, a firm should have an incentive to recruit ethically commendable members.
11The same argument can be made to the factor market exchange. I, as an input supplier, am no longer exchanging with you, as an input buyer as a person. Instead, I am contracting with a legal entity, a huge manufacturing corporation, for instance. The current president of this corporation may personally assure your employment status; but, such a promise is not credible if the president is replaced, it is no longer certain whether the promise will be enforced.
12Inevitably, the emphasis shifts from ethics to contracts.
13Clearly, one has an incentive to free ride on others' investments to regulate business because a socially amenable behavior of these organizations is a public good. As a result, there emerges a niche for a political entrepreneurship whose function is to lobby for a business regulation. These lobbying groups are subject to the logic posited by Olson (1965).
14In the traditional setting, an idiosyncratic relational capital is formed between the buyer and seller. This capital investment, including that in ethics, made by both parties is considered a sunk cost should the relationship between them terminated. By contrast, in the modern setting, such investments are not likely to be made by customers.
15Since we view the firm as a nexus of contractual relationships among individuals to reap a collective benefit, we use the term "club" in the sense of Buchanan (1965).
16Ceteris paribus, a firm consisting of less ethical members is likely to lose against a firm consisting of more ethical members, because the cost of monitoring should be higher in the former than in the latter.
17This is not a necessary condition, but a sufficient condition.
18The ultimate external monitor is one whose stake in and whose share of cost of forming a given joint-supply venture is the largest. While he has the largest share of claim to profit made by this joint venture (residual claimant), he is empowered with the credible threat to dissolve the venture.
19This view of the firm is closer to the one advocated by Jensen and Meckling, who state that the firm is a "nexus of contracting relationships among individuals" (Jensen and Meckling, 1976)
20To create credible authority itself must be very costly. Even if it can be established, maintaining it should be also very costly. Then the net effect to specialization may produce a negative value. In this case, promoting specialization is irrational. Moreover, we may have to wonder where such a powerful authority came from when the market transforms from a traditional to a modern system. We cannot assume that it pops up suddenly ion the market. If such an authority existed, we should have observed it.
21We are sure that you will behave quite differently when you go to your favorite four-star Italian restaurant in your neighborhood compared to a visit to a McDonald's
22This view is an extension of Hayek (1945). Clearly, implied here is that those who could best utilize these assets measured by the market success should own by the assets.
23Professor Buchanan seems to believe that democracy will generate a spontaneous disorder without establishing some constitutional constraints upon the conduct of government. This may be a fundamental reason why Buchanan seems to suggest a decline in ethical norms. But, if we see such constraints are indeed created through a democratic process in near future, then, democracy is said to have generated a spontaneous order.
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