Jonathan Giardina Econ B205

"Violence and Social Orders" by Douglass North, John Wallis and Barry Weingast is an excellent book loaded with many surprising facts. It both challenges many assumptions and reinforces economists' beliefs about decentralization and competition. The book compares "natural states" to "open access societies." While natural states "regulate economic competition" in order to control violence and "establish social cooperation," open access societies "regulate economic and political competition in a way that uses the entry and competition to order social relations."i One of the characteristics of open access societies is "bigger, more decentralized governments." According to the authors, "High-income countries create and sustain a much denser network of subnational government organizations."ii In countries with per capita incomes between $300 and $2000 annually, the subnational government percent of all government is only 4% while in countries with per capita income of over $20,000 annually, the same figure is 30%. This data is consistent with the theories of the Austrian economist F. A. Hayek. According to Hayek, because knowledge is dispersed, decisionmaking should be decentralized. The problem of the division of knowledge, he wrote, "seems to me to be the really central problem of economics as a social science."iii The central question of all social sciences is "How can the combination of fragments of knowledge existing in different minds bring about results which, if they were to be brought about deliberately, would require a knowledge on the part of the directing mind which no single person can possess?"

Incredibly, "income and the size of the central government are not related." What really matters is the size of the subnational governments: "[T]he strongest pattern is the positive relationship between income and the size of subnational governments."iv Could Hayek's analysis explain this data? Statements like the following suggest that it explains quite a lot: Open access orders appear to be better at coping with change over the long run. Decision makers in an open access society are widely decentralized and include leaders in economic and political organizations. They reach decentralized decisions within the organizations they represent.v Because knowledge is divided among the population, no one person or one group has all the facts. As Hayek put it, "The peculiar character of the problem of a rational economic order is determined precisely by the fact the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess."vi In open access societies, "all the separate individuals" have a wide discretion when it comes to the plans that they make and the revisions of those plans. The alternative to this system of "decentralized planning by many separate persons" is central planning - "direction of the whole economic system according to one unified plan."vii Hayek argued that central planning would be inefficient because "the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place." For this reason, "it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot except that this problem will be solved by first communicating all this knowledge to a

central board which, after integrating all this knowledge, issues its orders."viii Hayek instead advocated the price mechanism as a way to coordinate economic activity. By depending on the price mechanism instead of central planning, open access orders are able to function more efficiently. "Planning" would be unfeasible for any given population but would be even more difficult for a heterogeneous population. As Hayek argued, Planning, or central direction of economic activity, presupposes the existence of common ideals and common values; and the degree to which planning can be carried is limited to the extent to which agreement on such a common scale of values can be obtained or enforced It is, after all, only common sense that the central government in a federation composed of many different people will have to be restricted in scope if it is to avoid meeting an increasing resistance on the part of the various groups which it includes There seems to be little possible doubt that the scope for the regulation of economic life will be much narrower for the central government of the federation than for national states.ix According to North, Wallis and Weingast, the scope of the federal government in the nineteenth century was small compared to what it is today. They wrote, [T]hroughout most of the nineteenth century, economic regulation in the United States was undertaken by the states rather than the national government. Focusing on the national government leads to the erroneous conclusion that laissez-faire government policies promoted economic development. The conclusion depends on the inaction of the national government (laissez faire by default rather than by design) and on ignoring state governments that were not laissez faire but that actively promoted both democracy and economic growth.

This system had its advantages: "The system of federalism induced competition among the states, including competition for solutions to common problems."x In the market economy, intense competition leads to innovations. Similarly, competition among political units puts at least some check on the behavior of rulers and may even spur more enlightened ones to do what is in the public interest. As we'll see, conventional wisdom among economists concerning competition can be used as a tool for understanding historical events. In the market economy, the profit motive incentivizes businessmen to please their customers and serve them better still in the future. Israel Kirzner explained this process: [I]n the course of the market process the participants are continually testing their competitors. Each inches ahead by offering opportunities a little more attractive than theirs. His competitors, in turn, once they become aware of what they are competing against, are forced to sweeten still further the opportunities they make available to the market; and so on.xi Competition of a different kind on the world scene, likewise, resulted in, from the standpoint of free market economics, good policies such as more secure property rights and freer competition: International military competition has two closely related effects. The first is economic: thriving markets in open access orders provide the resource base from which these societies sustain longterm international struggles with hostile rivals. Open access orders that compromise their economies also compromise their ability to survive against hostile international rivals.xii When it comes to raising revenue for armed conflict, natural states are at a disadvantage. According to the authors, they have a "schizophrenic relationship to specialization and division of labor." As long ago as 1776, Adam Smith explained how specialization and division of labor made abundance possible. Natural states, however, have to balance their need for

revenue with their desire to keep the peace among the different factions. "[I]ncreasing specialization and division of labor," the authors explain, "often requires opening entry and access, and doing so dissipates rents, thus threatening the stability of the dominant coalition."xiii According to the economist Joseph Schumpeter, "the important kind of competition in the market system is competition from the new commodity, technology, source of supply and type of organization."xiv Similarly, competition among hostile nations is competition from new military technology and organization. Understanding this, it should not be surprising that "opening access was not forced on elites, but was in part driven by elites who found it in their interest to expand access."xv As the authors put it, "states had to grow or die Increasing military scale created demands for more resources. Better enforcement of property rights for capital and commerce emerged as political elites realized that they could capture more resources from cities in exchange for honoring rights and privileges. The economic success that followed allowed more resources to be devoted to the military."xvi Even more analogous to the marketplace is a democratic election. The phrase "vote with their dollars" has been used by numerous economists. In theory, officials are held accountable for their actions by voters on election day just as businessmen are held accountable by consumers by their abstention from buying. According to Kirzner, "The pure entrepreneur proceeds by his alertness to discover and exploit situations in which he is able to sell for high prices that which he can buy for low prices."xvii The entrepreneur is not "a source of innovative ideas ex nihilo" but is "alert to opportunities that exist already and are waiting to be noticed."xviii "Political entrepreneurs who lead parties," on the other hand, "seek to advance new ideas and programs in ways that increase the likelihood of success over their rivals."xix What separates entrepreneurs in the market from political "entrepreneurs" is what they are competing for: one

for customers, the other for power. The competition for customers drives managers to keep costs down and even reduce them if it wise to do so. Price competition, according to Hayek, is "one of the most important forces which in a truly competitive economy brings about the reduction of costs to the minimum discoverable." Cost curves, as he points out, are not objectively given facts: [T]he method which under given conditions is the cheapest is a thing which has to be discovered, and to be discovered anew, sometimes almost from day to day, by the entrepreneur The force which in a competitive society brings about the reduction of price to the lowest cost at which the quantity salable at that cost can be produced is the opportunity for anybody who knows a cheaper method to come in at his own risk and to attract customers by underbidding the other producers.xx Contrast this with the scenario facing politicians in liberal democracies: Democracy in open access orders sustains competition among political parties for the exercise of power. Competition for power induces parties to offer competing visions for addressing the society's principal problems. As with other forms of competition, innovators who devise more attractive ways of dealing with problems have advantages over those who do not.xxi This, of course, is the ideal version of democracy. It is in their discussion of democracy where their grasp of economics leads them astray. Politicians are not businessmen. While the incentives of the capitalist system do cause businesses to "build better mousetraps," it is far from obvious that the incentives of the democratic system cause politicians to "devise more attractive ways of dealing with problems." The history of the United States seems to be telling us a quite different story. While the statement "Competition for power induces parties to offer competing visions for

addressing the society's principal problems" can be interpreted as true, it nevertheless white washes most of the history of the twentieth century. Competition for power has more often than not induced parties to label as many situations as possible crises in order to grab more powerxxii, to fume about "unscrupulous money changers" and "economic royalists"xxiii and to engage in appalling dirty tricks and skullduggeryxxiv, among other things. To be fair to the authors, it isn't untrue that when there is a problem, "[p]olitical competition provides those in power with strong incentives to adapt policy in ways that address the problem; failing to do so risks losing power."xxv However, as Thomas Sowell made clear, democratic institutions have a serious defect: "Political systems provide some feedback via the electoral process, so that laws can be amended, repealed, or given varying amounts of financial support. This feedback is neither as fast nor as universal, nor as immediately coercive as in economic market processes."xxvi While comparing the market with democracy may be a useful teaching tool, the similarities should not be exaggerated.

Douglass C. North, John Joseph Wallis and Barry R. Weingast, Violence and Social Orders (Cambridge University Press, 2009), xi ii Ibid, 11 iii F. A. Hayek, Individualism and Economic Order (University of Chicago Press, 1948), 50 iv North, Wallis and Weingast, Violence and Social Orders, 11 v Ibid, 253 vi Hayek, Individualism and Economic Order, 77 vii Ibid, 79 viii Ibid, 83 & 84 ix Ibid, 264 & 265 x Violence and Social Orders, 120 & 229 xi Israel M. Kirzner, Competition and Entrepreneurship (University of Chicago Press, 1973), 12 xii Violence and Social Orders, 131 xiii Ibid, 41 xiv Kirzner, Competition and Entrepreneurship, 125 xv Violence and Social Orders, 131 xvi Ibid, 178 xvii Competition and Entrepreneurship, 48 xviii Ibid, 74 xix Violence and Social Orders, 116 xx Individualism and Economic Order, 196 xxi Violence and Social Orders, 125 xxii Robert Higgs, Crisis and Leviathan (Oxford University Press, 1987) xxiii Robert P. Murphy, The Politically Incorrect Guide to the Great Depression and the New Deal (Regnery, 2009), 116 & 118 xxiv Kathleen Hall Jamieson, Packaging the Presidency Second Edition (Oxford University Press, 1992), 279 xxv Violence and Social Orders, 145 xxvi Thomas Sowell, Knowledge and Decisions (Basic Books, 1980), 36