One of the things that has frustrated me throughout my career as a political economist is the inability of people to incorporate into their thinking with respect to public policy some elementary principles of public choice. We are so conditioned in the modern era to think in terms of ideal social planning schemes that even the most cynical of thinkers toward state-planning nevertheless commit the sin of pro-offering advice as if to a benevolent despot when advocating market-friendly programs. In this sense, we get -- in my opinion -- a lot of very fragile proposals for suppposedly market-friendly policies.
This is not meant to pick a fight with any particular scholar, or those of a particular "school of thought", but instead to raise the quesiton about why it is so difficult to think persistently and consistently through matters of public policy from the strict economic way of thinking.
Here is an example of the move that is often taken -- in this particular instance by Scott Sumner:
No previous monetary regime, no matter how “foolproof,” has lasted forever. Voters and policymakers always have the last word. However, before beginning to address public choice concerns, it is necessary to think about what sort of monetary regime is capable of producing the best results, at least in principle. Only then will it be possible to work on the much more difficult question of how to make the proposal politically feasible. (emphasis added)
Ignore the contradiction that Scott in this paper had already brushed aside the abolition of government's monopoly status over currency as unrealistic, but now is asking us to unrealistically assume away public choice problems. The issue I want to raise is different.
Once one really gets the public choice logic, I always thought, you must endogenize politics into any analysis of public policy. This wasn't really a new insight of Buchanan and Tullock. Of course, Wicksell's foundational contribution in his A New Principle of Just Taxation was, as Buchanan has argued repeatedly, that once the incentives that real actors face with respect to fiscal policy are accounted for then economists cannot continue to view themselves as “proffering advice to nonexistent benevolent despots.” Along similar lines, I recommend everyone to read Milton Friedman's review of Abba Lerner's The Economics of Control. Friedman concedes that Lerner's logic is flawless on its own terms, but he argues that when it comes to matters of public policy Lerner's analysis procedes as if there are zero administrative costs. And Friedman insists that a proper economic analysis would have to take into account the administrative costs. In short, Lerner treats economic policy as if it is done inside of a frictionless vacuum, but it is not. As a result, according to Friedman, Lerner's analysis falls short of what is needed.
The confusion occurs because folks confuse the claims about the market order generating through the invisible hand mechanism an order that would result had an omniscient and benevolent being decided to order the economy, with the ability of a social planner to assume the role of the omniscient, omnipotent and benevolent being. The invisible hand proposition is of course the bold analytical claim of mainline economics from Adam Smith onward --- the private property market economy operating within a system of freedom of contract embodied in the rule of law with its array of prices and lure of profit and penalty of loss, will guide the decisions of the multitude of economic actors such that resources will be allocated to their highest valued use, that least cost technologies will be employed, and that all the potential gains from trade will be exploited. The agitation of the market will be ceaseless if left alone until the point where these conditions are met. In the end, God could do no better. Or as Edwin Cannan put it: “The reason why it pays to do the right thing – to do nearly what an omniscient and omnipotent benevolent Inca would order to be done – are to be looked for in the laws of value.”
Economic forces at work will continually impact decisions to shuffle resources and adjust decisions on multiple margins to the point where the result of the market agitation is exchange efficiency, production efficiency, and allocational efficiency. In this way the underlying variables of the market --- tastes, technology and resource availability --- come to be aligned and reflected in the induced variables of the market -- prices and profits/losses. I stress at work because tastes change, new technologies are introduced, and discoveries of new supplies of resources or of new uses of resources are constantly occuring, and thus setting in motion once again the continually shuffling and adjusting by economic actors guided by the incentives of property rights, the information of prices and the inducement of profits. The free market system does this with such regularity that we often take it for granted, rather than stand in awe of its miraculousness. The failure to appreciate the mystery of the mundane leads to attempts to command and control over the economic system. As F. A. Hayek argued: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." Unfortunately, as I am suggesting here, it turns out it is really hard to get even well informed folks to understand that lesson of economics.
An omniscient, omnipotent, and benevolent social planner should never be invoked in discussions of public policy --- even to figure out so-called "first best solutions" before proceeding to another round. Institutions and the incentive structures and informational flows they provide can never be ignored in a proper economic analysis of the situation. To do so, is to commit the intellectual error that Friedman indicted Lerner with. Those administrative costs must be part of the comparative institutional analysis from the start. They are not footnotes, or afterthoughts, but a critical component to any economic analysis.
Now think about this a bit more. Rather than introducing distinction between 1st best, 2nd best, and Nth best worlds, once we incorporate the sort of Austrian knowledge problems, and public choice incentive problems into our analysis in comparative political economy, then the 1st best world of an omniscient and benevolent social planner simple does not exist for human beings. We live instead in a world of imperfect beings existing in a world of imperfect institutions, trying to find their way to muddle through. In such a world, a robust political economy must treat men as they are, and see institutions for what they are in terms of their capacity to provide the framework for the economic and social processes that are working to resolve conflicts and induce social cooperation (or the opposite).
In my mind, this means efforts to assume away for sake of the analysis public choice issues in political decision making are intellectually illegitimate moves. It doesn't matter if we are talking about rent-controls, antitrust law, environmental regulations, trade legislation, fiscal policy, or monetary policy. Robust political economy demands that from the first stage of analysis we confront the problems that the relaxation of the assumptions of omniscience, omnipotence and benevolence entail. This is how we will strive to pursue the economic way of thinking persistently and consistently from our analysis of individual decision making to our understanding of the global economic system.