The liberal appraisal of constitutional rules
Neoclassical economics considers social welfare as the mere aggregation of individual choices. The liberal view is that the evaluation of social welfare regards only rules and procedures, as outcomes cannot be compared and ranked.
In the liberal tradition, the two main views on the constitutional organization of modern democracies were put forward by Friedrich von Hayek and James Buchanan, who trace back the origin of constitutions to spontaneous evolution and intentional construction, respectively.The Hayek view
According to the Coase theorem, the parties could succeed in devising and implementing all the contract clauses, including the optimal definition and assignment of legal rights by voluntary actions. Yet, positive transaction costs may cause the bargaining performed by individuals in their social interactions to result in an inefficient outcome. The main source of transaction costs is strategic behaviour, which creates reciprocal externalities. Individuals interacting in the markets will then be unable to reach a Pareto-efficient equilibrium on the contract curve of the general equilibrium analysis. The Chicago school argues that the legal production may be instrumental in overcoming contractual failures, as transaction costs can be reduced by imposing the correct allocation of property rights. The complementary role played by institutions such as the judiciary and the legislation - which drive individuals to internalize the externalities and realize the ‘core’ of the efficient equilibrium exchanges - helps the free market to be the fundamental institution of every economic system.
The liberal vision of the society and the economy affirmed by the Chicago school is also endorsed by the constitutional theory put forward by Hayek. The Austrian economist and philosopher thinks that the evolutionary process of selection rules consists not only in the informal institutions created by market forces, but also in the constitutional architecture emerging from the common law produced by judges.
In the atomistic market organization, the dispersed actions of individuals reaching unknown ends, guided by signals represented by market prices, make the aggregate outcome at the same time unintentional and efficient. Similarly, a competition process between jurisdictions for the best performance in terms of social welfare amounts to the selection of their preferred rules and procedures according to the method of evolutionary learning (Vanberg, 1994). Any existent equilibrium is efficient by definition, because it derives from the evolutionary nature of the spontaneous market order framed inside the traditional set of rules and customs. However, differently from the evolutionary nature of the spontaneous order of the market resulting in the equilibrium prices, the intentional institutional ‘competition as a discovery procedure’ - that is, the competition for the best performance among different institutional structures - lacks the necessary conditions for comparison: first of all, complete information (Hayek, 1979). Hence, constitutional and, more generally, public law ‘merely organises the apparatus for the better functioning of the more comprehensive spontaneous order’ (Hayek, 1973; 1978: 79).Following his conception of society as a spontaneous order, Hayek conceives institutions as ‘the result of human action but not of human design’. He observes that sometimes constitutions no longer represent the coercion needed to limit the liberties of the individuals, but implement general principles of ‘social justice’ which might jeopardize the efficient outcome produced by the spontaneous order of the market. The tendency of the legislative bodies to deal with both the promulgation of laws devoted to regulate specific matters of interest to particular groups, and the general legislation concerning universal norms of behaviour, has led to excessive ‘demoralisation’. Therefore, governments should not manipulate the overall income distribution resulting from individuals’ decentralized decisions (Hayek, 1976).
Constitutional law should recognize that uncertainty and risk may negatively affect the efforts of the individuals operating in the market, so that a threshold in terms of ‘minimum income’ has to be provided against ‘bad luck’. Yet, the dividing line must be precisely drawn between this universal ‘safety net’ as a general principle which is valid for everyone, and the pernicious legitimization of any general principle of redistributive justice which any interest group in society could advocate. In general, ‘democratisation’ should be limited, as the public intervention into the economy must only devise rules and procedures to cope with financing public goods, and their provision has to be organized by private companies. In the following, ‘public goods’ is a blanket name, including merit goods and social protection - such as education, unemployment and poverty subsides, health care, pensions - whose supply and/or demand suffer from moral hazard and adverse selection, or produce externalities.The Buchanan view
The constructivistic approach endorsed by Buchanan alternatively views the constitution as the conscious effort by the individuals of a community to engage in the formalization of a ‘social contract’. A constitution is that particular kind of formal institution whereby the state is legitimated by the fundamental principles a community has unanimously agreed on. Individuals have to agree on those values and principles setting the constraints within which they could act and markets operate. The constitution recognizes the property rights to be negotiated and enforced, so that uncertainty is reduced and economic incentives strengthened. Economies of scale make the state - as the organization of the cooperative games between the government and the citizens - superior to private associations in the definition and protection of property rights.
In competitive markets for private goods, whatever the number of individuals, the bargaining remains bilateral and the ‘invisible hand’ is capable of setting the optimal price.
In the political markets, which concern the production of public goods and the cooperative solution to PD situations, the more the number of participants in the social community increases, the more the ‘political exchange’ among individuals is burdened by opportunistic behaviour (Buchanan, 1975). The constructivistic approach aims at fighting the ubiquitous interpersonal conflicts of interest characterizing non-market interactions (for example, public goods provision). In a vision that founds the existence of society on the adhesion to the social contract by each individual, any constitutional rule must comply with everyone’s interests. Since the social contract must be justified to all citizens, a constitutional rule should be approved by unanimity rule (Wicksell, 1896). The strategy towards limiting the opportunistic behaviour which jeopardizes social interactions relies on the distinction between constitutional and post-constitutional choices.The conception of the state underlying the ‘market incompleteness’ approach assigns the constitution the task to cope with the impossibility of foreseeing all future contingent states of the world. A community agree on a constitution as a set of rules - both for the private markets and the political relations - to which they resort once relevant information is revealed. Similarly, constitutional rules should aim at constraining individual behaviour in interactions taking place in the post-constitutional stage. Individuals are sufficiently informed to be able to evaluate costs and benefits of alternative institutional organizations. Yet, they are constrained by a veil of uncertainty in assessing which constitutional rules will most aptly serve their own postconstitutional interests. Since the redistributive consequences of constitutional choices concerning political and economic questions will unveil only in the long run, it is individually rational to agree on a certain set of constitutional rules and procedures.
For this reason, a unanimous agreement among citizens can be expected (Buchanan and Tullock, 1962).Buchanan traces back the many kinds of impasse from which in the real world social contracts suffer to the ‘non-market failures’ of modern democracies. Although constitutional rules set the framework for the political process enacted by a government, the devolution of individual rights to a political authority may result in the absolute command of a Leviathan. Individuals should point to the cooperative Pareto-optimal outcome yielding net benefits to all by sharing the tax costs towards the financing of public good provision. Instead, although benefits for all parties are potentially available in the PD game over the state provision of public goods, each group points to the freeriding pay-off. The main question about majority decision making is that social games among parties are plagued by rent-seeking behaviour. An example is the practice of ‘log-rolling’. By reciprocating the endorsement of laws aimed at boosting their respective self-interest, political representatives end up approving laws which may undermine social welfare. More importantly, due to the rotation among majorities, any governing coalition of parties is in a position to pass by majority voting laws protecting its own interests, and burdening the other groups with the costs. By means of simple PD game examples, Buchanan shows that the succession of redistributive processes generates a ‘present value’ pay-off corresponding to the status quo of no collective action. In the long run, the legislation as a repeated game ends up with the worst aggregate pay-offs on average. Collective-action mechanisms are needed for individuals to protect themselves from ‘the tyranny of the majority’. Unless a constitutional constraint prevents differential treatment (so that constitutional limits are posited on the off-diagonal pay-offs of the PD game matrix), politics under majority rule is bound to become increasingly distributional.
Buchanan is a subjectivist-contractarian who conceives the ‘optimality’ condition in the perfect competition market not as the consequence of objective production and exchange conditions, but as maximization criteria stemming from the ‘consensus’ among the participants (Buchanan, 1991a). He refuses the allegation of a unique efficient allocation of resources claimed by standard welfare economics. Also, market exchanges are ruled by strategic interaction, so that there is no objective criterion to determine the efficiency of a market outcome. Since this distributive compromise makes a given set of voluntary market exchanges a Pareto optimum, efficiency and distribution are the joint outcome of bargaining on gains from trade in the market interaction. On the basis of the existing institutional organization of property rights, each party bargains with another party to convince it to accept compensation in exchange for gains for a trade favouring the first party (Buchanan, 1991b).
Therefore, Buchanan thinks that self-interested individuals can reach cooperative agreements in their non-market relations (for instance, public goods provision), but this does not imply that a Pareto-optimal equilibrium represents the fulfilment of a collective optimum. According to the Buchanan contractualist view, there is no ‘common good’ to which a government could finalize the maximization of a social welfare function (Buchanan, 1991a). Many principles of justice typically make some individuals better off and others worse off, thus falling short of satisfying the criterion of unanimity voting on constitutional rules by rational and self-interested individuals. Buchanan endorsed the implementation of horizontal equity, which in principle does not rely on a conception of justice, as everyone’s right to equal treatment. The liberal approach to state intervention bans redistributive policies that could not be justified to all individuals participating in the social contract. However, redistribution as a byproduct might be legitimate. Provided that a flat tax rate is imposed upon a generality rule, and is accompanied by a set of demogrant (equal per head) transfers equally available to all, no allegation of infringement - either of individual liberties, or of the principle of ‘negative freedom’ - can be invoked (Brennan and Buchanan, 1985; Buchanan, 1993). Since these instruments of fiscal policy produce net gains for the poor and net losses for the rich, the resulting redistribution occurs on an ‘equal treatment’ basis.
The constraints imposed by constitutional rules on social interactions - first of all, the existing organization of property rights and the threat power of enforcement - are instrumental for the stability of social and market equilibria. However, any constitutional agreement is sustainable until individual revenues equal social revenues. Whenever the balance between benefits (and positive externalities) and costs in terms of taxes (and negative externalities) turns out to be negative, the constitutional rules are no longer unanimously agreed on and a reform is required. By comparing alternative institutional organizations, the individuals unanimously agree on substituting the existing set of rules, as the previous market outcome is considered suboptimal. The allocation of property rights resulting from new rules allows either the exploitation of some reciprocal interdependencies among individuals or the avoidance of some wasteful investment of resources in predation and defence (Buchanan, 1991b). The unanimous consensus accompanying market relations of production and exchange corresponding to the new property rights organization implies a new Pareto-optimal equilibrium (Buchanan, 1985). Therefore, the objective of any constitutional reform should consist in the design of new governmental institutions to provide citizens with a more efficient system of incentives, on which economic growth, technical change and the expansion of social welfare all depend.