The rules of the game
This section will examine the main rules of the game which constitutions make explicit: the horizontal and vertical separation of powers; voting mechanisms for constitutional rules, election rules, and forms of government.
The horizontal separation of powers
The division of powers among constitutional bodies can be organized both at the horizontal and the vertical levels. The horizontal separation of powers was first conceived by Locke (1640 [1988]) to protect the freedom of citizens by constraining rulers within the limits of the law, and then theorized by Montesquieu (1748 [1955]), as a system of ‘checks and balances’ whereby authority is horizontally divided among the three constitutional bodies: the executive, the legislative and the judiciary.
James Madison, one of the leading framers of the US Constitution, believed that institutional competition is the key instrument to prevent both the horizontal and the vertical division of powers from being jeopardized by a constitutional body acquiring excessive bargaining power. In the US, the efficiency-enhancing use of competition applies to competition both between and within constitutional bodies. In order to represent competing interests, horizontally the two legislative branches have different criteria of representation, and vertically the division between the federal and the state government rules is the self-enforcing mechanism protecting citizens from the central government. Unlike the English tradition of common law, where the judiciary’s independence is guaranteed against the lawmakers’ interference, the preservation of freedom by checks and balances implies that elected judges are confronted by elected representatives (La Porta et al., 2002). Therefore, winning an elective post entitles one to compete as the representative of a specific interest.
The economic analysis of political institutions maintains that the separation of powers between the executive and the legislative bodies creates the correct incentives, provided that the system of checks and balances respects the following two conditions: (i) a conflict of interest between the bodies must be created by putting the elected representatives in competition in order to impede collusion (for instance, by attributing the agenda-setting power over the size of the budget to one of them, and over its composition to the other); and (ii) policies must be jointly decided and implemented in order to improve their accountability (Persson and Tabellini, 2000).
This institutional setting also allows voters to elicit private information about the activities of elected representatives and public officials, thus undermining their efforts to extract rents from asymmetric information (Persson et al., 1997). However, the modern ‘incomplete contracts’ interpretation underlines the uneasiness stemming from the divide between a constitution which is not a complete contract, and elected representatives delegated to make decisions while not necessarily sharing the same preferences as the social planner who wrote the constitution. Therefore, in all cases not foreseen in the constitution, discretionary choices by elected representatives and/or public officials are to be limited in order to minimize welfare losses. Appropriate and optimally interconnected incentive schemes must be envisaged for the principals of the various bodies (Laffont and Tirole, 1990).Incomplete information and opportunistic behaviour may also generate the problem of moral hazard by self-interested politicians. The separation of powers has to cope with the moral hazard problem in the economic policy decisions. As for fiscal policy, moral hazard is manifested as the political pressure to expand public expenditures. The fear that the fiscal stance will drift towards a ‘soft balance constraint’ has inspired specific legislation aimed at limiting the expansionary tendencies of public expenditure by the fiscal authorities, such as the Graham-Rudman law in the US, which impedes further expenditures in the case of failure to meet the limit for the public budget deficit.
Similarly, as confirmed by the empirical evidence of a positive relationship between central bank independence and inflation (Grilli et al., 1991), in many countries the constitution protects the independence of the central bank, so as to shield monetary authorities from pressure by elected representatives. The objective is to make monetary policy both more effective and more credible, thereby avoiding a situation in which improved output and employment levels would result in a permanently higher inflation rate.
The theoretical underpinnings of this tenet consist in the presumption that monetary stability is a public good overriding any other objective assigned to monetary policy. However, a prolonged tight monetary stance may create a hysteresis problem in the unemployment rate. Therefore, a value judgement is always at the root of the macroeconomic governance of the unemployment-inflation tradeoff (Stiglitz, 1998). The conduct of monetary policy is influenced by lobbies in society, where industrialists and trade unions oppose inflation much less than financial institutions do (Posen, 1994). In fact, the tendency to use tight monetary policy as a rule serves the vested interest of financial markets’ operators to increase profits by being shielded from uncertainty and price instability.The independence of the central banker rests on less-objective underpinnings than suggested by mainstream economics. The notion of independence may be at odds with democratic legitimacy. Whenever a constitutional rule protects the central bank’s independence, a democratic deficit occurs inside the institutional organization of the state. The lack of democratic legitimacy of the monetary authorities’ power may be mitigated by their obligation to accountability. In the European Union (EU), the elected representatives of the European Parliament may comment on the European Central Bank’s monetary policy, but they are not empowered with enforcement devices. However, in the US, the Federal Reserve is obliged to present an annual report to Congress, which has the right to express an opinion about the consequences of monetary decisions on the employment level, and could in principle enforce the sanction of passing an amendment changing the central bank’s powers and prerogatives. Since this control power might influence the decisional process about the monetary stance, accountability may partially counterbalance independence in the behavioural function of monetary authorities.
The vertical separation of powers
The vertical separation of powers allows the devolution of powers from central government towards lower-level jurisdictions.
A multi-level constitutional organization is created by attributing legislation and taxation prerogatives to their elected representatives. According to the ‘market-preserving view’, decentralization ensures that the central government has the task of policing the market, of ensuring mobility of goods and factors across lower-level jurisdictions, and of complying with a ‘hard budget constraint’ (Weingast, 1993, 1995; Rodden and Rose-Ackerman, 1997).In a multi-layer constitutional organization, the central government experiences a tradeoff between policy coordination - the internalization of all the jurisdictions’ reciprocal externalities - and accountability, as local communities can observe the welfare level of their jurisdiction. Yet, as verifiability is impossible to implement, the central government cannot be punished for inefficient decisions (Seabright, 1996). To cope with this problem, Inman and Rubenfield (1997) laid down a blueprint for ‘democratic federalism’ aimed at the middle way between a decentralized government, which conveys advantages in terms of close monitoring on politicians, and a centralized government, which conveys advantages in terms of efficient public goods provision and internalization of spillovers. The constitutional organization as a multi-tier system stems from the interpretation put forward by Brennan and Buchanan (1985) of fiscal decentralization as an instrument to keep to a small size the public sector to avoid burdening the fiscal stance with excessive deficits. The separation between the local fiscal instruments and the centralized power of money creation should guarantee that the hard budget constraint is met (McKinnon and Nechyba, 1997). Yet, by gearing the majority rule to the logrolling method of reciprocation, the representatives of the lower-level jurisdictions may indulge in policies financed by pooling the common taxes but benefiting single jurisdictions. Therefore, responsibilities in the domains with large externalities among lower-level jurisdictions should be assigned to the central government in order to make decentralization inefficient.
Voting mechanisms for constitutional rules
The institution-building process of a federation implies a group of countries voting on a constitutional agreement. If constitutions were complete contracts, unanimity would be the best rule in the approval of constitutional rules, as it is the most demanding and should guarantee ex post compliance with obligations undertaken in the agreements. By the adoption of this voting mechanism, each country would credibly manifest its intention of abiding by the contract. In other words, countries would be signalling that any ex post deviation is unlikely, as it is perceived to be Pareto suboptimal from the ex ante viewpoint. The choice of the unanimity rule would then reflect a successful bargaining resulting in a perfect contract. Yet, the contractual incompleteness view demonstrates that all contracts - constitutions included - are incomplete, as all possible future contingencies cannot be specified and ex post verified by a court. Since ex post compliance is not credible, there is no point in searching for unanimity in constitutional voting. After its approval, a constitution is always exposed to the possibility of future demands for modifications, a right explicitly acknowledged by a section of many constitutions. In order to increase the probability of unanimity, a clause can be inserted that recognizes the right of all participants to revoke some articles of the agreement after a certain number of years.
One unanimity mechanism, aimed at increasing the chances of unanimous agreement in the light of the shortcomings of the Wicksellian procedure for unanimity voting (first of all, strategic behaviour in preference revelation), is ‘veto voting’, suggested by Mueller. This mechanism is composed of the following steps: (i) each participant puts forward a proposal (by trying to internalize the other participants’ preferences, by anticipating their proposals in order to minimize the probability that its own proposal will be vetoed); (ii) a ranking among the other participants is then set up; and (iii) through a sequence of veto voting, a proposal that nobody has vetoed will eventually be accepted (Mueller, 2003).
Provided that the number of participants is sufficiently large to avoid strategic ranking, veto voting has the virtue of forcing convergent proposals, by incorporating the incentive to skip those proposals that are too far removed from the other participants’ expected preferences. Other voting mechanisms particularly relevant in institution-building processes are the various majority rules, which are the most used voting mechanisms. These rules range from a simple majority (50 per cent of the votes plus one), to a super-majority (for instance, the so-called ‘min-max’ rule, which is the closest to the simple majority rule without the Condorcet cycles), to a qualified majority (usually, 66 per cent of the votes).Election rules and forms of government
A constitution frames the political institutions representing the ‘rules of the game’ played by voters and political parties. In the literature, two important types of political institutions capable of influencing the economic outcomes have been investigated: election rules and forms of government (Persson and Tabellini, 2003).
With regard to the electoral system, policies can be seen as equilibrium outcomes of delegation games. The agency problem formalized by this game is characterized by the double conflict between the principals and their elected representative and among the principals themselves. Empirical evidence seems to show that majority rule systems guarantee more accountability to the voters, and a more direct link between the representative’s performance and his/her probability of being reappointed. As a consequence, the government has a stronger incentive under majority rule, than under a proportional rule system, to perform well - for instance, not to augment public expenditures in the period preceding a general election and so on. Representation is better preserved under proportional than under majority rule, because with more than two parties it is very common to have a single-party government empowered by less than 50 per cent of the voters. In addition to this flimsy democratic legitimacy, the sharp division of the electorate under majority voting makes the electoral rule less conducive to the needed provision of public goods.
Regarding the forms of government, a presidential regime may stimulate more competition among politicians and be more accountable to the voters than a parliamentary regime, where collusion is easier and larger rents are extracted by politicians (Persson and Tabellini, 2000). However, in the presidential regime the formation of vote-by-vote coalitions, caused by the weakness of the party system, puts the legislation in the hands of all sorts of lobbies. As a consequence, similar to majority rule, earmarked taxes finance a small provision of public goods targeted to small communities. The dispersion of power within a government seems to be a significant predictor of public deficits and eventually public debts. Sound public budgets are considered the most important advantage of single-party majority governments, whereas coalition governments present higher public deficit/GDP ratios. According to the ‘weak government hypothesis’, fragmented governments are less keen to keep the tendency to high public deficits under control than governments with one dominating party (Roubini and Sachs, 1989). The proposed reform against fragmentation consists of super-majority rules, that is, constrained procedures to prevent differential treatment and maximize consensus. Qualified majorities are particularly needed for constitutional changes, in order to prevent government decisions that exacerbate distributional conflicts (for instance, exempting heirs from inheritance taxes). The proportional system, which often comes with the parliamentary regime, generates coalition governments more oriented towards large programmes of social protection aimed at obtaining consensus among larger social groups. The empirical evidence shows that the average tax rate is higher and the distribution of income less unequal in countries where coalition governments have been formed following elections under a proportional representation system, than in countries using a majority system with two parties (Austen-Smith, 2000).
Therefore, there is a relationship between electoral rules and forms of government, in terms of both the tradeoff between accountability and representation, and the amount of social expenditures. The presidential regime more often has a single-party government elected by majority voting, while the parliamentary regime usually has a coalition government elected under the proportionality rule. Majority rule electoral systems and presidential regimes are associated with a variable degree of accountability (depending on the percentage of voters in general elections) and a small welfare state, while proportional rule electoral systems and parliamentary regimes have better representation and maintain a constant role of social expenditures.