Public Choice Foundations of Macroeconomics

|Peter Boettke|

Tyler Cowen regrets the direction that the IS-LM debate (in the blogosphere) has gone, and suggests that an alternative to the particular set of "technocratic curve-shifting" could be public choice economics (which he adds is still underrated by today's profession) as an alternative starting point of macroeconomic analysis.

Tyler lists others, including New Institutionalism, but I think his suggestion for public choice economics is spot on.  If the crisis has taught us anything, I would argue that it has taught us about the necessity to treat politics as endogenous to the model of policy choice.  Buchanan and Wagner's Democracy in Deficit still represents the best starting point for understanding what went wrong with the Keynesian model of technocratic economic management.  And Wagner's work on political manipulation and the boom-bust cycle is the most underrated of the public choice contributions to macroeconomics.

If you treat politics as endogenous, then I believe even many of the more market oriented proposals for macroeconomic policy will meet with frustration.  Imagine, just imagine if you will, what fiscal and monetary policy would have to look like if we took seriously the Humean dictum that in designing governmental institutions we must presume that all men are knaves.  Just imagine if you will, if the Hayek-Buchanan focus on the generality norm and politics by principle, not interest, were widely accepted. Just imagine what the implications are of Milton Friedman's argument in Capitalism and Freedom, when he says that in reference to the Fed and the Great Depression: 

It may be that these mistakes were excusable on the basis of the knowledge available to men at the time – though I happen to think not. But that is really beside the point. Any system which gives so much power and so much discretion to a few men that mistakes – excusable ornot – can have such far-reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic – this is the key political argument against an "independent" central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an "independent" bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers. (emphasis added)

When will we catch up to Milton Friedman?  Let alone James Buchanan?  Or even F. A. Hayek?  The path to a robust political economy must begin with treating political decision making (and the incentives and information embedded in that process) in the realm of policy making not as a footnote caution, but at the very beginning of the analysis.

 

Comments

[Roger Koppl]

Pete,

You are right, I think, and it's a vital point. Somehow the lesson is hard to learn. The way scientism really unfolds in people's minds can make your point even harder to learn, I think, because you end up focussed on the curves (or whatever) and not the real social processes the curves should represent. It can be a kind of optical illusion, whereby you sit above the system and imagine that you can move the pieces about like chess pieces. (HT: A. Smith) It is harder to look at things from within, modeling the knowledge and incentives of *all* actors, including oneself. It is hard to put yourself in the model. One of the reasons I am keen on the computability stuff I keep touting is that it is really helpful in working out the logic of analysis from within the model.

[Mario Rizzo]

This is all true. But there is also a point in trying to discover what the first-best policies are regardless of political feasibility. I always thought there is a tension between W.H. Hutt's admonition that economists should be courageous and propose the best (that is, free market) policies regardless of political feasibility (at the present?) and the public choice admonitions about real incentives in the political, regulatory process.

The problem continues at different levels: policies within the current political framework and changes in the framework as well.

Consider that there is a propensity to finance government spending through borrowing. Consider also that a constitutional amendment to balance the budget either won't pass or will be evaded because of the same incentives.

I do not say that there is an inconsistency between the Hutt argument and the public choice perspective but I do think that there is as-yet an unresolved tension.

[Adrian Ravier]

Very interesting. I think that this public choice fundations of macroeconomics open some big problems for any rule (Hayek Rule, Friedman Rule, Taylor Rule, Inflation Targeting, etc). The problem is not the rule, the problem is that we cannot find any argument to show that the Fed, or any Central Bank, will follow this guide.

[Mattheus von Guttenberg]

Although he would kill himself before admitting it, I think Hoppe's "Democracy: The God That Failed" is one of the best ventures into public choice economics in recent years. It takes different turns (obviously) than Hayek, or Tullock, or Friedman - but he presents devastating insights against our traditional understanding and perspective on democracy.

[Pietro M.]

Hoppe's book is interesting. Mancur Olson's "The rise and decline of nations" got a similar point in a more "public choice" style and it has been one of my favorite read this year.

[Harry David]

@Mario,

I see what you mean. I would put it that there’s normative constitutional analysis (post-constitutional also) and also you can do positive constitutional analysis. In some situations it’s not politically profitable for any set of individuals to organize to produce a liberal constitutional rule – in this case, a rule that constrains the incentives of politicians and central bankers to collude to mutual benefit and to the harm of the broader economy/polity.

And we can also imagine the conditions for when constitutionalizing the central bank might be in the mutual interest of a set (some set) of financial sector players and voters and members of the opposition, among other possible possibilities. What direction of change would we like the politics of constitutional ‘design’ (emergent politics of constitutions?) to go? We know that already. But I’m not sure at all how the normative and the positive analysis interact (as economists currently do the analysis or as they might ideally analyze it).

[Harry David]

It's so true....

And Tyler's comments on other alternative paradigms for viewing macroeconomic phenomena are both promising and related to public choice, too. Financial Asset Pricing Theory, for one. Different assets, or rather, assets with a different bundle of claims embedded in them, may be institutionally constrained to sell at the same price, as Tyler seems to have noted in his post. Central bankers purchase assets, including Treasury bonds of various maturities and also create other financial claims such as discount loans and (at times of acute financial sector turbulence, especially) privately issued bonds.

At times, such as when the Fed set a pattern of interest rates over the yield curve in the years immediately after WWII and also today, the discrepancies between underpriced and overpriced assets create profit opportunities for banks and, presumably and seemingly empirically, opportunities for interest groups working in cooperation with these banks.

In post-WWII episode, for instance, long-maturity T-bonds would be bought cheap and held to maturity by banks (if I recall correctly). This monetary policy program generated inflation, among other consequences. Consumer price inflation, in particular. Truman initially, at the time of the Korean War, profited from this policy and implicitly from the central banking institutions that made that policy feasible for the governors of the Fed.

But at some point, towards the end of the (Korean) War or perhaps shortly afterward, the heads of a few key Congressional subcommittees (Paul Douglas for one) decided to support the former Chairman of the Board of Governors in his public activity to attack the Administration's active influence over the Fed. What followed is called central bank independence, and the informal contract between Treasury officials and Fed officials (the 'Accord') supposedly is responsible for the shift in monetary policy and the purported shift in monetary institutions.

A public choice perspective might ask why the incentives and information available to political officials changed around 1952. It might start by looking at the relative influence of the relevant Subcommittees (in Congress) and any possible shift in the procedures that govern Congress.

A Financial Asset Theory perspective might, complementary to the public choice perspective, ask how the relative prices of financial assets contributed to the profitability of various chairs and positions within Congres.

Hope I didn't get carried away in this response. I get excited when anyone brings up Buchanan and Wagner, Buchanan and Tullock, *Constitution of Liberty* (implicitly), and *Capitalism and Freedom* in one place. Haha.

[Daniel Kuehn]

re: "Imagine, just imagine if you will, what fiscal and monetary policy would have to look like if we took seriously the Humean dictum that in designing governmental institutions we must presume that all men are knaves."

Isn't this exactly what the constitution does take seriously? Don't we take this seriously?

When I first read Buchanan as an undergrad I fell in love with public choice theory. Since then, reading more broadly, it's been more disappointing. The literature seems like if you're not coming out guns blazing for libertarianism there's a sense that you're not doing public choice theory or you're ignoring public choice theory. No wonder others have stayed away too.

When Pennington came out with his work recently my reaction to it was "this is dead-on - this is why constitutional systems and federalized systems and decentralized systems are good governance". It was a rigorous statement of robust governance. But then in all the commentary on Pennington it got turned into sloganeering for libertarianism.

If the claim is "federalism is robust", "constitutionalism is robust", and "decentralization is robust" I am fully on board. But too often public choice theory in practice instead is just a very inappropriate cudgel to be used against Keynesianism or liberalism.

When public choice theory gets to the point where it gets past this idea that decentralized constitutionalism is incompatible with Keynesianism or modern liberalism and that decentralized constitutionalism does not imply libertarianism, perhaps I'll take a deeper interest in it. For the time being there seems to be a lot wrong not with public choice theory so much as the way that it is practiced.

[Allan Walstad]

Daniel, doesn't the Public Choice paradigm necessarily tend to deflate assumptions (articulated or unarticulated) that government constitutes the public interest personified? And doesn't that necessarily point in the general direction of libertarianism? Yes, the Constitution takes seriously the need to treat the motives of politicians and bureaucrats with the same suspicion that we might direct toward the mercantile class, but haven't the knaves of politics long since overrun much of the intended bounds on their power?

I'd suggest that there is an extent to which decentralized constitutionalism does imply libertarianism, or at least is congenial to it: namely, in a federal system with a strictly limited central government, people can vote with their feet. Those for whom liberty is a priority can fairly easily move to where they are freer. Given the general correlation between freedom and prosperity, freer jurisdictions will likely thrive while the less free stagnate.

[Troy Camplin]

Actually, doesn't public choice explain beautifully why governments would accept a crackpot theory like Keynes's General Theory? I can see why Daniel would reject it in favor of his faith.

[Daniel Kuehn]

re: "Daniel, doesn't the Public Choice paradigm necessarily tend to deflate assumptions (articulated or unarticulated) that government constitutes the public interest personified?"

Yes.

re: "And doesn't that necessarily point in the general direction of libertarianism?"

I don't see why it would. Perhaps you could explain. Certainly you could get to libertarianism from the view that government does not represent the public interest personified, but it seems to me you could get to a whole lot of other places too.

re: "I'd suggest that there is an extent to which decentralized constitutionalism does imply libertarianism, or at least is congenial to it"

Congenial to it, yes. I'm not saying libertarians aren't in favor of these things. I'm just saying all you need to do is look around you to realize that you don't need to be a libertarian to support decentralized constitutionalism.

[Daniel Kuehn]

Troy -
I should have been more careful in how I phrased my comment. I don't reject public choice theory, and I agree with Peter's sentiments about Friedman, Buchanan, and Hayek. What I object to is how it often seems to be practiced and how politically insular it seems to be.

Ultimately I think there's a lot of work under the heading of "political economy" and "public economics" that does much the same thing as public choice theory without the baggage. My major regret is that that work doesn't include a lot of the constitutionalism that Buchanan emphasizes.

I have no problem with public choice theory. What I would like to see is a greater degree of integration between people who call themselves "public choice theorists", "public economists", and "political economists", and less of this tendency to act like the theory's purpose is to endorse a political agenda. I think it's purpose ought to be to explain the behavior of politicians and the public sector.

[Allan Walstad]

Daniel, I think Public Choice points in the direction of libertarianism because the basic alternative is government-imposed decision-making versus individual decision-making in non-coercive interaction. To the extent that government-as-public-interest is deflated, libertarianism gains credence.

I agree that it's not only libertarians who support decentralized constitutionalism (at least, at any given time), but my point was that if you have many individual, largely autonomous jurisdictions and a strictly limited central government, the situation will tend to favor libertarianism because people can vote with their feet, and typically this will lead to more productive people moving to freer jurisdictions, which will become more prosperous. Over the long run, libertarians will likely favor decentralized constitutionalism more consistently than others, who play the federalism card when their opponents have more clout with the central government, but employ the power of central government institutions when they can.

[Rafe Champion]

Taking up Roger's first comment, I am profoundly skeptical of heavy mathematics (I can't understand it) and would like to see Roger's modelling applied to something that I can understand like decision-making in a game like baseball or cricket. That is just because I think game theory was applied to the wrong games.

On Mario's comment on Hutt, he had a more nuanced position which involved first and second best options. That is in "Politically Impossible". http://www.the-rathouse.com/Revivalist4/RC_Huttachieve.html

"Friedman's maxim implies that the economist's role is to do this (the ideal) and not to do that (the expedient). I suggest it is the economist's role and duty (in public policy discussions) to do both. Why should not advice proferred typically take the form of saying to the politicians (and indirectly to electorates) with complete candour, something like the following?"

'In our judgement, the best you will be able to get away with is programme A along the following lines; but if you could find a convincing way of really explaining the issues to the electorate, our advice would have to be quite different. We should have to recommend programme B along the following lines'."

"I am not suggesting that economists ought ever close their eyes to political realities. On the contrary, when they are concerned with the practical applications of their science, they ought in every instance to bring voting prospects into the picture - but explicitly."

Hoppe has taken aim at a particlar theory of democracy, that democracy equals majority rule. That is really silly and unhelpful. The minimal theory of democracy expounded by von Mises and Popper is simply a system where the leadership can be turned over without violence. After that it is up to democrats to do the best they can, which form our point of view is limitd government under the rule of law etc. And especially making a distinction between government by rules vs government by discretionary orders. Blaming democracy for faults of "democratic" systems is unhelpful without proposals to improve the situation, which Hoppe may have, but his shotgun abuse of democracy needs to be refined.

Hutt was an early pioneer of public choice theory because he identified the vote-buying motive as the Achilles heel of democracy, based on his study of the trade union movement and the kind of policies that governments pursued as the franchise widened in England. That ran parallel to the dramatic death of intellectual liberalism late in the 19th century discussed here a few weeks ago.

Hutt devoted a book "Economists and the Public" to the intellectual forces that destroyed the influence of liberal economists. The book was press when Keynes’ "General Theory" appeared but he managed to insert some brief comments on it, predicting "that The General Theory would have a quite unparalleled influence by reason of what I judged to be its demerits as a contribution to thought".

[Troy Camplin]

One should not be surprised that one's views on how the economy works affects one's political point of view, since government is so involved in the economy. I would not doubt that if the government were equally involved in literary production, what one believed about how literature is produced and consumed would affect one's politics as well.

[McKinney]

Troy, right! And Marx did think that, not only about literature but any other endeavor.