The Domain of Constitutional Economics (Buchanan, 1990)

In this essay, James M. Buchanan explains the research program of Constitutional Political Economy (CPE) as an inquiry regarding the study of rules, how rules work and how rules might be chosen.  Buchanan defines it as follows: "Constitutional Political Economy is a research program that directs inquiry to the working properties of rules, and institutions within which individual interact, and the processes through which these rules and institutions are chosen or come into being".  He argues that the central elements of CPE are: (1) methodological individualism; (2) rational choice.

First, Buchanan distinguishes CPE from conventional economics in that orthodox economics is about choice within constraints, whereas constitutional economics focuses on the choice among constraints.   Second, he separates constitutional economics from constitutional politics.  Constitutional economics focuses on cooperative over conflictual human interaction.  Politics is related to a distributional game, which involves transfers of value between coalitions of persons.  Constitutional economics involves the comparison of alternative sets of rules and the analysis of the process through which agreements on rules may be obtained (the cooperative model is rescued).

Constitutional economics is influenced by two traditions: (1) classical political economy; (2) contractarian political philosophy.   Under the classical political economy of Adam Smith, the existing politicized regime is described and an alternative regime is presented.  As a consequence, the laws and institutions that define the economic-political order can be subject to reform.  Under the contractarian political philosophy, the individual exchanges his own liberty with others who also give up liberties in exchange for the benefits offered by a regime.

Buchanan concludes that constitutional economics rests on the faith on "man's cooperative potential": "Persons are independent units of consciousness, capable of assigning values to alternatives, and capable of choosing and acting in accordance with these values.  It is both physically necessary and beneficial that they live together, in many and varying associations and communities.  But to do so, they must live by rules that they can also choose."

The following questions arise from reviewing the article:

(1) Why are the reciprocal exchanges of liberties central to the domain of constitutional economics?

(2) What reasons does Buchanan give for the failure of conventional economics to use their analytical devices to the derivation of institutional-constitutional structure?

(3) What does Buchanan means by stating that the analysis under constitutional economics is consistently individualistic?

(4) According to Buchanan, why an exchange and not a maximizing paradigm describes the research program of constitutional economics?

(5) Why is methodological individualism the foundational position for constitutional economics?

The article can be found here:

http://www.walkerd.people.cofc.edu/400/Sobel/2A-8.%20Buchanan%20-%20Constitutional%20Economics.pdf

El Uso del Conocimiento en la Sociedad (Hayek, 1945)

Friedrich A. Hayek inicia su ensayo presentando la pregunta: "¿Cuál es el problema que queremos resolver cuando tratamos de construir un orden económico racional?"  Si se asume que todos los datos referentes a las preferencias de toda la sociedad son dados y que se posee un conocimiento completo de los medios disponibles, el problema económico se reduciría a un problema de optimización.  Hayek enfatiza que éste no es el problema económico al cual nos enfrentamos.  El problema radica en que el conocimiento se encuentra disperso entre los diferentes individuos.  Hayek afirma: "se trata más bien de un problema referente a cómo lograr el mejor uso de los recursos conocidos por los miembros de la sociedad, para fines cuya importancia relativa sólo ellos conocen."  El problema a resolver es qué método puede usarse para que ese conocimiento disperso pueda ponerse a disposición del mayor número de personas posible.

Hayek menciona que hay diversos tipos de conocimiento. El predominante en la modernidad es el conocimiento científico.  Sin embargo, existen conocimientos fundamentales que se encuentran "desorganizados", tales como el conocimiento de las circunstancias particulares de tiempo y lugar.  Cada individuo dispone de información única (conocimiento de oportunidades temporales, experiencia en tareas específicas) que puede ser de mucha utilidad, "pero sólo si se dejan a él las decisiones dependiendo de dicha información o éstas son tomadas con su activa cooperación". 

Al reconocer que el problema económico está relacionado con los cambios continuos y la adaptación a los mismos según las circunstancias particulares de tiempo y lugar, se puede concluir que las decisiones finales deben ser realizadas por los individuos que se encuentran familiarizados con estas circunstancias.  La descentralización es necesaria para el aprovechamiento de ese conocimiento.

Hayek argumenta que el problema de cómo asignar los recursos productivos para lograr el máximo bienestar posible, en condiciones de conocimiento disperso y asimétrico, se resuelve mediante el sistema de precios.  Los precios relativos permiten la síntesis y comunicación de información, así como la coordinación de las acciones separadas de los diferentes individuos.  Hayek describe la economía de conocimientos que permite el sistema de precios: "mediante una especie de símbolo, se comunica sólo la información más esencial y sólo a quienes les concierne."  El mecanismo de precios permite transmitir eficientemente la información sobre el cambio.

El sistema de precios es producto de un orden no deliberado. No se trata de una invención humana.  Hayek afirma que "el sistema de precios es precisamente una de esas formaciones que el hombre ha aprendido a usar" y con él ha sido posible la división del trabajo y el uso coordinado de los recursos basado en un conocimiento fragmentado.  Con este ensayo, Hayek establece el planteamiento del problema económico como un problema de conocimiento.

Algunas preguntas relacionadas con el ensayo son:

(1) ¿Cómo podríamos definir el término conocimiento? ¿En qué consiste el conocimiento científico?  ¿Por qué es predominante en el imaginario del hombre moderno?
(2) ¿Cuál es la importancia del conocimiento de las circunstancias particulares de tiempo y lugar?

(3) ¿Por qué Hayek menciona que los problemas económicos surgen como consecuencia del cambio?
(4) ¿A qué se refiere Hayek cuando describe al sistema de precios como una especie de maquinaria para registrar el cambio?
(5) ¿Qué significa la siguiente cita de Whitehead presentada por Hayek: "La civilización avanza al aumentar la cantidad de operaciones importantes que podemos realizar sin pensar acerca de ellas"? ¿Cómo se relaciona esta frase con el sistema de precios?
(6) ¿Cuál es la crítica de Hayek hacia la economía matemática?

El artículo se puede encontrar aquí:

http://www.hacer.org/pdf/Hayek03.pdf

What Should Economists Do? (Buchanan, 1964)

In this essay, James Buchanan argues that the economist should focus in "the theory of markets", instead of the "theory of resource allocation" or "theory of choice".  He criticizes the vision of Lord Robbins, who considered that the economic problem involves the allocation of scarce means among alternative or competing ends.  Buchanan considers that following Robin's path is to acknowledge the study of economics as one of applied maximization, where the utility function of the choosing agent is defined in advance and choice becomes purely mechanical.  According to Buchanan, the central idea of the discipline should be the cooperative association of individuals (behaviour of exchange, trade or agreement).

Buchanan considers the model of perfect competition to have limited explanatory value except when changes in variables exogenous to the system are introduced.  There is no place within this model for the internal change driven by the Smithean propensity of men. Furthermore, he considers the market as "the institutional embodiment of the voluntary exchange process that is entered into by  individuals in their several capacities" and defines economics as the study of the whole system of exchange relationships.  Finally, Buchanan emphasises that economists should be "market economists".

Several questions arise from revising this essay:

(1) What is the main criticism of Buchanan to the definition of economics stated by Milton Friedman?

(2) According to Buchanan, what is the paradox within the theory of choice?

(3) Why Buchanan considers that the use of the term "catallactics" or "symbiotics" is preferable to the use of the word "economics"?

(4) Why the model of perfectly competitive general equilibrium excludes the social content of the individual behaviour in market organization?

(5) Why is there no explicit meaning of the term "efficiency" when applied to aggregative or composite results?

(6) What is the basic distinction between economics and politics regarding the nature of the social relationships among individuals examined by each field of study?

The essay can be found here:

http://mx.nthu.edu.tw/~cshwang/teaching-economics/econ3171/References/01-Buchanan=What%20should%20Economists%20Do.pdf

Corporate Control, Insider Trading, and Rates of Return (Demsetz, 1986)

In this article, Harold Demsetz presents the hypothesis that the differences in ownership concentration observed across firms respond to the benefits and costs of monitoring management.  Demsetz and Lehn (1985) find that ownership is more concentrated in firms exhibiting higher firm-specific risk. 

A higher firm-specific risk implies a larger demand for controlling shareholders.  These controlling shareholders require a compensation for assuming greater firm-specific risk.  An important part of this compensation comes from the acquisition of a comparative advantage in exercising control, which allows for the possibility of pecuniary and nonpecuniary returns.  Furthermore, Demsetz argues that insider trading offers a secondary compensation to controlling shareholders.  According to Demsetz, the wealth transfers generated by the insider trading can be viewed as a cost borne by minority shareholders to promote more effective monitoring of the firm.

Some questions related to this article are:

(1) Do institutional owners have the incentive to monitor management in the absence of investment specialization?

(2) What benefits motivate investors to specialize their investment in a single firm with high firm-specific risk?

(3) Why do firms with lower firm-specific risk exhibit a higher dispersion in ownership?

(4) How is the firm-specific risk related to the profit potential of insider trading?

(5) What are the equity problems that arise from insider trading profits?

(6) Are controlling shareholders entitled to a higher rate of return than the one of minority shareholders?

(7) Is Demsetz's argument that legislation seeking to reduce insider trading profit makes it more difficult to maintain controlling ownership interests so useful for monitoring purposes, valid?

The article can be found here:

http://www.jstor.org/discover/10.2307/1818787?uid=3737952&uid=2129&uid=2&uid=70&uid=4&sid=21100653701196

Politics without Romance: A Sketch of Positive Public Choice Theory and its Normative Implications (Buchanan, 1979)

In this essay, James Buchanan presents the "Public choice theory" as a "theory of governmental failure" comparable to the "theory of market failure" that emerged from theoretical welfare economics.  Buchanan defines public choice as the analysis of the behavior of individual actors in the governmental sector (voters, candidates, elected representatives, members of political parties and bureaucrats) and the composite outcome observed.  He presents two distinct areas of research: (1) economic theory of constitutions and (2) theory of political institutions.  First, the economic theory of constitutions raises questions about how governments may be constrained.  Second, the theory of political institution analyses the demand and supply for government goods and services under different rules (theory of voting and voting rules, theories of electoral and party competition and theories of bureaucracy).  Afterwards, Buchanan proceeds to explain these two set of theories.

Public choice scholars have started to model governments in monopoly terms.  The electoral competition is viewed as a competition among prospective monopolists, bidding for an exclusive franchise.  Moreover, the successful bidder behavior is assumed to be profit maximizing.

The following questions arise:

(1) Why is it important to use the methodological individualistic approach in Public choice theory?

(2) What causes the complexity in political exchange?

(3)  Are the constitutional guarantees for free and periodic elections enough to control the range an extent of governmental action?

(4) What political decision structures should be adopted at the constitutional stage?

(5) What are some examples of the majority cycle problem discovered by Black? Under which configuration of preferences, the majority cycle problem will not arise?

(6) What is the Arrow impossibility theorem?

(7) Do the re-election possibilities keep the self-interests of politicians within reasonable range of those of the median voter?

(8) How can the conflicts of interest between the representative or agent elected to act for the group, the bureaucracy in charge of the policy implementation and the group members themselves be reconciled?

(8) Can the Leviathan be limited?

The essay Public Choice: The Origins and Development of a Research Program can be found here:

http://www.gmu.edu/centers/publicchoice/pdf%20links/Booklet.pdf

Separation of Ownership and Control (Fama and Jensen, 1983)

In this article, Eugene Fama and Michael Jensen explain the survival of organizations characterized by the separation of ownership and control.  Fama and Jensen argue that the separation of risk-bearing and decision making functions survive because of two reasons: (1) the benefits of the specialization in risk bearing and management; and (2) the approach to controlling the agency problems that arise from the separation of ownership and control. The main hypothesis stated in the article is that the contract structure of an organization in this context must separate decision management from decision control.  The contract structures "distinguish organizations from one another and explain why specific organizational forms survive."

In the following, some questions related to the article are presented:

(1) When do agency problems arise in an organization? How can they be addressed?

(2) Are the initiation and implementation of decisions necessarily allocated to the same agents?

(3) What factors make the combination of decision management, decision control, and residual risk bearing efficient?

(4) What factors make the separation of these three functions efficient?

(5) What is the relationship between specific knowledge and the degree of complexity of an organization?

(6) What are the costs of restricting the residual claims to the important decision agents?

(7) In what aspects do the agency problems within a family business differ from the ones faced by other types of organizations?

(8) What are the implications of unrestricted residual claims in the cost of capital of the firm?

(9) How can the agency problems related to diffuse decision and diffuse residual claimants be addressed?

(10) Under what assumptions is the following statement made by Fama and Jensen valid? "Separation and diffusion of decision management and decision control limit the power of individual decision agents to expropriate the interests of residual claimants."

(11) What are some of the market and organizational mechanisms for controlling the agency problems of specialized risk bearing derived from the unrestricted nature of common stock residual claims?

The article can be found here:

http://are.berkeley.edu/~antinori/prclass/FamaJensen.pdf

The Nature of the Firm (Coase, 1937)

Ronald Coase begins this article with the concept of the economic system as being coordinated by the price mechanism and society becomes not an organisation but an organism.  As Sir Arthur Salter mentions, the economic system "works itself".  Nevertheless, Coase agrees with Robertson in that we find "islands of conscious power in this ocean of unconscious cooperation like lumps of butter coagulating in a pail of buttermilk". Then, Coase presents the following question: "If production is regulated by price movements, production could be carried on without any organisation at all, well might we ask, why is there any organisation?" Why is the price mechanism superseded?

Coase assumes the task of attempting to discover why a firm emerges at all in a specialised exchange economy and concludes that the main reason why it is profitable to establish a firm is that there is a cost of using the price mechanism (marketing cost).  This cost includes the costs of discovering the relevant prices, the costs of negotiating and concluding a separate contract for each exchange transaction, the desire to make long-term contracts under uncertainty.

Some of the questions that arise when reviewing the article are:

(1) What is the distinguishing mark of the firm?
(2) What forces determine the size of the firm? Why is not all production carried on by one big firm?
(3) Can the decreasing returns to the entrepreneur be avoided? Is Market-based-management one approach to accomplish this purpose?
(4) Why do we observe an increasing vertical integration in the Latin American countries?
(5) Is Coase's criticism of Knight theory valid?

Coase's article can be found in the following link:

http://www.sonoma.edu/users/e/eyler/426/coase1.pdf

Public debt, cost theory, and the fiscal illusion (Buchanan 1964)

In this essay from Public Debt and Future Generations, Buchanan explains how public debts probably generate fiscal illusions of both the Vickrey and the Puviani sort.  Individuals probably do undervalue the future tax liabilities that an issue of debt embodies, and, even if they do not, they should probably still prefer debt to the current tax alternative.

Some questions arising from the essay are the following:

(1) What is a public debt illusion?
(2) To what extent does the presence or absence of a public debt illusion affect the temporal location of debt burden?
(3) What is an individual's share in the liability that an issue of interest-bearing public debt represents?
(4) What determines the individual's undervaluation of future tax liabilities in the presence of  a public debt illusion?
(5) Why when facing a pure Ricardian choice between the levy of an annual tax in perpetuity and an extraordinary tax, the individual will prefer the debt-annual tax alternative?
(6) Is the fiscal illusion a part of the explanation for the debt accumulation in the U.S. and Europe?

James Buchanan's text The Fiscal Illusion can be found in the following link:

http://www.econlib.org/library/Buchanan/buchCv4c10.html