CONSTITUTIONAL POLITICAL ECONOMY, VOL. 1, NO. 1, 1990
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CHARLES WOLF JR. (1989) M a r k e t s or Governments: Choosing B e t w e e n Imperfect Alternatives. Cambridge, Massachusetts: M I T Press. 222pp.; $18.95 Charles Wolf, Dean of the RAND Graduate School of Policy Studies, has produced a short book on institutional failure. Wolf (p. 12) focuses on nonmarket failure because "the policies advocated by many economists and most other social scientists and policy analysts, [have] generally placed more analytic emphasis on the shortcomings of the market than on those of the nonmarket. Redressing one imbalance requires another." Those who agree with this point of view will welcome Wolf's work. Markets or Governments consists of short chapters which suggest how to better compare markets to governments. Wolf argues that although markets are vulnerable to problems of externalities, non-market institutions are often plagued by problems arising from what Wolf(p. 66) dubs 'internalities'. Internalities are the internal goals which guide, regulate, and evaluate the performance of the organization. Sources of non-market failure arising from internalities include budget maximization, the desire to implement inefficient technological 'advances', and the desire to increase information acquisition and control beyond its optimal point (pp. 70-77). Wolf's analysis of these points is clear and succinct and reflects his considerable experience with public policy studies. Scattered throughout the work are also numerous interesting suggestions and insights. For instance, in a short but effective discussion, Wolf demonstrates the fallacy of using government spending as a percentage of gross domestic product as a measure of governmental activity. The inability of this measure to capture off-budget regulations and governmental activities is illustrated by a few simple facts. The share of government spending in GDP in India, for instance, is only 15%, as compared to 18% for South Korea. Yet, the vitality of the market sector in South Korea is considerably greater than in India. Developed Western nations with even stronger market sectors have governmenffGDP shares of forty to fifty percent. Other interesting insights in WoWs book can be found in his discussion of non-profit organizations (e.g., p. 89) and his "exit, voice, and loyalty" analysis of Coca-Cola's experiment with the new Coke (pp. 130-131). The readability and reasonableness of Wolf's book make it an excellent choice for a supplementary text for almost any course taught at a public policy school. On a deeper level, however, Wolf's book is difficult to judge. The author does not clarify where his original contribution is supposed to lie. Readers 129
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familiar with public choice theory and the literature on the economics of bureaucracy will find little novelty in this work. Neither does it appear, however, that Wolf attempted to summarize extant theories of non-market failure. Wolf's claim that many economists have neglected theories of non-market failure is true, but Wolf himself seems guilty of this charge. This book, for instance, does not discuss the theories associated with Tullock, Tollison, Mises, or Hayek; indeed, these names do not even receive entries in the bibliography (although Tullock is cited for Calculus of Consent with Buchanan). Buchanan receives two entries, but none for his more recent ideas on economic constitutions. Wolf's comparative method utilizes single industry or 'partial equilibrium' considerations of relative productivity when comparing the merits of market and non-market sectors. The market is to be preferred when it can supply the relevant good or service at lower cost; otherwise, recourse to non-market modes of provision is recommended. However, Wolf finds that market institutions are usually more efficient than non-market institutions. Although I am sympathetic with Wolf's conclusions, I find that he does little to address many of the most important arguments for a large governmental sector. Wolf's analysis is restricted to partial equilibrium considerations and the related methods used by standard cost-benefit analyses. If institutional choice were so simple, however, we would expect the sheer weight of available evidence to shift the balance away from modern Leviathan and towards a more modest role for the public sector. It is Wolf's unwillingness to consider deeper levels of analysis which I find disappointing; if the strongest arguments for the market economy are found at a system-wide or constitutional level, we might expect that the strongest arguments for an activist state with discretionary power are at the constitutional level as well. The following three constitutional-level arguments for large government, for instance, would require analysis in a deeper study of institutional choice. First, consider the 'rent-seeking is good' argument, which asserts that a large government may be necessary to insure that a very small number of public sector activities are done properly. 1 Perhaps 'nightwatchman' functions, for instance, are the only areas where the state is more efficient than the market. Restricting state activity to the provision of nightwatchman public goods, however, could lead to an underprovision of effort and low quality services because of the absence of profit incentives. Those features of big government which are commonly regarded as undesirable (e.g., waste, pork barrel, corruption, etc.) may perform the valuable function of providing incentives for politicians to produce needed public goods. If
1 A version of this argument is considered in a paper I have co-authored with Amiahi Glazer and Henry McMillan entitled "Rent-Seeking Promotes the Provision of Public Goods." (Working Paper, Department of Economics, University of California at Irvine, 1988). Dwight Lee at the University of Georgia has also written a number of papers on this theme. 130
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a politician's ability to benefit personally from big government is positively related to his public service efforts, political rents will serve a function analogous to the role of profits in a market economy. Both political rents and market profits may be necessary to motivate public-service entrepreneurs; in the absence of excess returns nothing gets done. Under this hypothesis, big government is necessary to give hard-working politicians a playground in which they can benefit at public expense. The second argument, the argument from stability, asserts that we have big government to prevent government from becoming even bigger. Ludwig yon Mises (among others) argued that there was an 'interventionist dynamic', through which one state intervention leads to another, continually increasing the size of government. There may, however, be another interventionist dynamic which prevents very rapid increase in the size of government. Big government creates special interests and bureaucracies with a vested interest in the status quo. Although these interests often favor government growth, they may strongly oppose a too-rapid growth in government which would threaten their positions of privilege. In contrast, a nightwatchman state may not create enough vested interests to protect against an ideological revolution. An incrementally growing government may thus be the price we pay to avoid a government which occasionally grows by leaps and bounds. David Stockman, in his memoirs The Triumph of Politics, frequently laments the failure of the Reagan revolution to defeat the bureaucracy and other entrenched interests in Washington. American politics is portrayed as slowmoving and difficult to change. At the end of the book, however, Stockman wonders if it was not better that the Reagan Revolution failed; although a successful Reagan Revolution may have benefitted the American citizenry, the next series of radical reform plans emanating from the Executive Office may be considerably less desirable. 2 The third argument, the 'observed monopoly' principle, 3 asserts that discretionary government power appears inefficient only if we do not consider the costs of imposing rules on the government. A world with less government discretionary power might be unambiguously better, perhaps just as a world without floods would be better, but policy considerations should consider the costs of getting from here to there. Perhaps dismantling discretionary government power would require the institution of processes which advocates of
2 Conversely, it could be argued by a liberal Democrat that it was good that the New Deal was not more successful. If Roosevelt could have been more successful, so could have Reagan. 3 David Levy of George Mason University has written a stimulating essay titled "Is An Observed Monopoly Inefficient?" (Working Paper, Center for Study of Public Choice, 1982) Some particularly ingenious second-best arguments for the efficiency of discretionary government power are considered in Amihai Glazer's unpublished manuscript "Voters, Candidates, and Policy". (University of California at Irvine, School of Social Sciences). 131
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constitutional constraints could not adequately control. We could imagine, for instance, that calling a convention for constitutional reform could lead to the outlawing of abortion, the repeal of the Bill of Rights, or other undesirable results. Preventing such outcomes perhaps involves very high costs or is impossible altogether. Discretionary government power may thus be a pest that is tolerated because the relevant fly-swatter is too heavy and too dangerous. Each of these arguments strikes me as more intersting than the so-called 'public goods theory of the state' which Wolf and others address. 4 Unfortunately, the partial equilibrium cost-benefit framework adopted by most economists is inadequate for examining these arguments. Further progress may instead require analyzing the rules and system-wide incentives embedded in different economic constitutions; the study of constitutional political economy, however, is still in its infancy. Tyler Cowen Assistant Professor of Economics George Mason Unviersity Fairfax, VA 22030-4444
ROBERT H. FRANK (1989) Passions within Reason. The Strategic Role of the Emotions. N e w York and L o n d o n : W. W. N o r t o n Comp.; xiii, 304 pp.; $19.95 According to most traditional views man is conceived as a member of two worlds, the world of reason and the world of emotions. Further, it is presumed that reason should rule the passions. Robert Frank's book views the world in a different light. He argues that it may be reasonable under certain circumstances to let the passions rule, because only then we can reach equilibria in the game of life that are preferable to those that could be reached should reason alone determine our choices. This may sound as a revival of romanticism, but it is not. Frank argues strictly in terms of the strategic role that emotions might play in furthering our long run interests. The author starts his analysis with Thomas Schelling's well known example of the kidnapped person who would like to promise not to reveal the identity of the kidnapper in exchange of his freedom, but who faces the difficulty of making credible his commitment to keep the promise. Kidnapper and kidnapped both know that after the victim is set free he will have a dominant strategy not
4 In closing, let me plead guilty to having committed Wolf's sin as well: I have recently edited a collectionof writings criticizing the public goods rationale for many state activities--The Theory of Market Failure(George Mason University Press, 1988).These 'others' thus include myself. 132
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to keep the promise. The kidnapped cannot make any future decision to keep the promise at the time of making the promise. It is common knowledge that what is opportunistically rational in the situation of promise making is not opportunistically rational in future situations of promise keeping. To overcome his 'commitment problem' the kidnapped needs a strategic equivalent to the mast of Ulysses. Frank's "claim is that specific emotions act as commitment devices that help resolve these dilemmas" (4 f.). It is important to note here that the problem does not arise because of "weakness of the will" but rather because of the strength of reason. The human ability to make future-directed opportunistic choices instead of being programmed by a past decision is at root of the problem. The author makes this perfectly clear. It is regrettable, however, that he misses the chance to put it in the proper game theoretic perspective of Reinhard Selten's seminal papers on the concept of (subgame) perfect equilibrium. 1 The rest of the book is elegantly organized around the basic commitment problem. Besides introducing the commitment problem, the first chapter gives some illuminating examples of how human behavior dominated by retributive emotions may violate the assumption of opportunistically rational behavior in the pursuit of individual self-interest that underlies the bulk of standard economic theory. The second chapter gives an account of what the author calls the "altruism paradox," and puts it into a biological and a supergame perspective as well. The third chapter outlines a theory of moral sentiments that is central for the whole book. It tries to establish a plausible explanation for the emergence of behavior that is not self-serving. Classes of problems that might be solved if people adopted moral sentiments of a certain type are introduced, and it is shown how the adoption of moral dispositions (virtues) might be stabilized in principle against subversion by mimicry. The three following chapters discuss mechanisms to check via "reputation," "signaling," and "telltale clues" whether individuals truly adopt moral sentiments, and do not only pretend to be so committed. The seventh chapter sums up the previous discussion and again draws attention to what the crucial issue is: " I s it possible...to learn something about the likelihood that a person will behave opportunistically? If so, then predispositions to eschew selfinterest will emerge and prosper under the terms of the commitment model" (144). In the rest of the book (chaps. 8-12) a positive answer to the question cited before is taken for granted, and the explanatory power of the commitment model is weighed against diverse empirical evidence. It is argued that the model fairs better than standard economic models confined to the assumption of opportunistically rational individual behavior. A formal version of the commitment model is attached to the book as an appendix. Summing up, I should like to suggest that every reader of this journal should take an interest in Robert Frank's stimulating book. His ideas may prove extremely helpful in addressing the fundamental question of how "fixed rules"
1 e.g. Selten, R. (1975) " Reexamination of the Perfectness Concept for Equilibrium Points in Extensive Games." International Journal of Game Theory 4:25 IT. 133
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of a collective constitution can emerge and be maintained in a world of individuals who are able to behave opportunistically. Analyzing the strategic role of the emotions indicates how in principle collective constitutional commitments can be traced back to individual ones--and this is exactly what the individualistically minded constitutional economist should hope for. Hartmut Kliemt University of Duisburg West Germany
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