The Online Library of Liberty

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• Foreword
• Preface
• The Reason of Rules
• 1.: The Constitutional Imperative
• I.: Introduction
• II.: Reasons For Rules
• III.: Rules of Games
• IV.: Rules of the Road
• V.: Rules of the Market Order
• VI.: Rules of Political Order
• VII.: The Importance of Rules
• 2.: The Contractarian Vision
• I.: Introduction
• II.: Noncontractarian Constitutionalism
• III.: Individuals As Sources of Value
• IV.: Contract and Exchange
• V.: Politics In the Exchange Perspective
• VI.: Unanimity As the Contractual Ideal
• VII.: Agreement On Rules and the Veils of Ignorance and Uncertainty
• VIII.: Conclusions
• 3.: The Myth of Benevolence *
• I.: Introduction
• II.: Private Good and Public Good
• III.: Science, Truth, and Politics
• IV.: The Authoritarian Imperative
• V.: Majoritarian Democracy In the Noncontractarian Paradigm
• VI.: The Aim of Politics
• 4.: Modeling the Individual For Constitutional Analysis
• I.: Introduction
• II.: Homo Economicus In Politics: the Argument For Symmetry
• III.: Science and the Empiricist Defense
• IV.: A Methodological Defense of the Differential Interest Model of Behavior
• V.: Social Evaluation and Quasi-risk Aversion
• VI.: Gresham’s Law In Politics
• VII.: Summary
• 5.: Time, Temptation, and the Constrained Future *
• Preface
• Part 1.: Individual Private Choice
• I.: Introduction
• II.: The Ultimate Z ’s
• III.: Preferences For Preferences
• IV.: Past, Present, and Future
• Part 2.: Individual Public Choice
• I.: Introduction
• II.: Society With a History
• III.: Temporal Interdependence
• IV.: An Illustration
• V.: Moral Rules And/or Constitutional Commitment
• 6.: Politics Without Rules, I: Time and Nonconstrained Collective Action
• I.: Introduction
• II.: The Social Discount Rate
• III.: The High-tax Trap
• IV.: The Inflation Trap
• V.: The Public-debt Trap
• VI.: Other Examples
• VII.: Conclusions
• 7.: Rules and Justice
• I.: Introduction
• II.: Just Conduct and the Notion of Desert
• III.: Justice and Promise Keeping
• IV.: Justice Among Rules
• V.: Just Rules, Agreed-on Rules, and Just Conduct
• VI.: Conclusions
• 8.: Politics Without Rules, II: Distributive Justice and Distributive Politics
• I.: Introduction
• II.: Distributive Justice: the Conventional View
• III.: The Constitutional Perspective and Institutional Incidence
• IV.: The Incidence of Unrestricted Majoritarianism
• V.: Tax Rules and Distribution Under Majority Rule
• VI.: Direct Constitutionalism and Distributive Justice
• VII.: Summary
• 9.: Is Constitutional Revolution Possible In Democracy?
• I.: Introduction
• II.: Pareto-superior Change and Wicksellian Unanimity
• III.: Distributional Limits and Prospective Rules
• IV.: Status Quo Entitlements and Distributional Envy
• V.: Constitutional Change and Free Riders
• VI.: The Role of Norms
• VII.: Toward a Civic Religion

V.

Rules of the Market Order

Our purpose in Sections II and III was to isolate several elements of rules through the familiar examples of ordinary games, on the one hand, and rules of the road, on the other. As noted, however, our central concern is with rules of economic-political order. In this section we shall introduce rules of the market, or economic, order and in Section VI we shall examine rules of political order.

In both of our earlier examples, the need for rules became apparent immediately upon reference to the interaction; one cannot conceptualize either ordinary games or traffic without thinking about rules. With respect to the far more important economic interaction among persons, however, the rules governing individual behavior within such interaction are often ignored. Economists, themselves, have been notoriously negligent in this respect. Complex analytic exercises on the workings of markets are often carried out without so much as passing reference to the rules within which individual behavior in those markets takes place. Adam Smith was not party to such neglect; he emphasized the importance of the “laws and institutions” of economic order.

The departure from this Smithian and classical emphasis is perhaps best illustrated in the “market failure” analytics of theoretical welfare economics, as developed in the middle decades of this century. “Markets” were alleged to fail when compared with the stylized, formal models derived from the economists’ mathematical exercises. Analysis proceeded as if institutional constraints were totally irrelevant to the way in which individuals interacted within market structures.

The relevance of rules is perhaps best exemplified by reference to the familiar example of common-property resource utilization, sometimes referred to as the “tragedy of the common.” If straightforward utility maximization is postulated to describe the behavior of users, the common will be predictably overgrazed. The market is alleged to “fail” in generating efficient usage of the scarce resource. As is by now familiar, however, the problem here is not with the workings of the market process, but with the rules within which the users operate. A change in the rules so that the scarce resource is separately and privately owned, along with means for enforcing and protecting individuals in rights of ownership, will remove the inefficiency. The example suggests that economists’ proclivity to look at outcomes rather than at the rules that generate such outcomes has been a source of profound confusion. Reform of results or outcomes comes about through reform of the rules rather than through manipulation of the outcomes directly.

The normative thrust of the theoretical welfare economists was that of providing an argument for governmental or collective intervention in markets. A comparable pervasive oversight of the importance of rules characterizes the attitude of a group of economists who support market institutions in a normative sense. These economists have tended to neglect the importance of rules under the sometimes naïve presumption that the “market will out,” regardless of institutional constraints. The presumption is that market solutions are sufficiently robust to swamp any institutional constraints that may exist. There seems to have been some confusion here between the robustness of economically motivated behavior within given constraints and the possible robustness of economically motivated behavior in modifying the constraints themselves. It seems quite possible that market outcomes may be robust within given institutions, while at the same time these institutions may be relatively insensitive to change without explicit and direct attention being brought to bear on their design and possible reform.

To return to a common-property example, there may be well-functioning markets in fish in which demand and supply forces operate to generate fully satisfactory allocative-distributive outcomes (given the resource and institutional parameters), while at the same time the absence of property rights in the fishing grounds fails to define a set of rules that are in any sense normatively ideal.

A second aspect of market rules deserves attention. In our earlier analysis of road rules, we found that the essential function of rules was to prevent individuals from inhibiting one another’s actions: Rules had the essentially negative function of preventing disastrous harm. This is basically the task Hobbes assigned to the rules of social order that keep anarchy at bay. Within the Smithian vision of the market order, however, there is a significant positive aspect of human interaction. In Smith’s view of the world, the division of labor mobilizes mutual gains from cooperation among traders, gains that each trader secures but that are beyond the capacity of any one person to comprehend fully. At each succeeding phase in the division of labor, each actor responds to his environment by exercising his creative imagination directly in his own interests and thereby indirectly in the interests of his fellows. The succession of such creative acts establishes an order that both reflects the enormous advantages of human cooperation and provides scope for additional creative acts to occur. At any point, one can contemplate the prevailing market order and recognize the nature and magnitude of the gains from human cooperation under the division of labor. But one cannot predict ex ante what the nature and magnitude of those gains will be. To do so would require the analyst to possess all the creative imagination currently spread over the entire set of economic agents.

Two things follow from this view. First, there is something necessarily nonteleological about the choice of market rules. How can the rules be chosen in the light of the particular outcomes to which those rules give rise if the precise nature of those outcomes is discovered only as they emerge? Second, when market institutions are inadequately defined, or some alternative rules apply that do not have the market’s benign features, the true dimensions of normative “failure” cannot entirely be known. We can conjecture that the engine for harnessing human cooperation has not been fully operative—but what might have otherwise been necessarily remains a matter of speculation.