The Nobel Series: The political economist

The Nobel Prize in Economic Sciences in 1986 was awarded to James Buchanan for extending the economic analysis to political decision making. He is also credited for being a leading researcher in public choice theory which attempts to explain decision-making in the public sector just as pure economic theory explains consumer and producer behaviour. As the Nobel website says, Buchanan was awarded the prize:

for his development of the contractual and constitutional bases for the theory of economic and political decision-making

Buchanan studied at the University of Tennessee before going to the University of Chicago to do his PhD in economics. At Chicago, he was influenced greatly by Frank Knight and the Swedish economist Knut Wicksell. Knight was largely responsible for turning him into an ardent believer in the free market. Buchanan progressed with his initial career at Florida State University (1951-56) and then moved to the University of Virginia (1956-68). At Virginia, he developed his ideas in political economy and also founded the Thomas Jefferson Centre for Studies in Political Economy. From Virginia, Buchanan moved to UCLA for a while before settling in at George Mason University from where he retired.

In this article, we will review the main works of Buchanan and see how they continue to be relevant for public policy across the world even today.

Main works

Buchanan is commonly thought to have begun a new field in economics variously titled "The New Political Economy" or "Public Choice". Basically, Buchanan began with the standard assumptions of the neoclassical model, namely rationality and utility maximization and applied it to the area of political decision-making. However, unlike the neoclassical model which takes political and bureaucratic decision-making to be a black box, Buchanan sought to explain such decision-making in terms of utility maximization and gains from 'political exchange'. For Buchanan, political exchange is a means to engender cooperation between players, with each player maximizing his utility. In short, Buchanan examined the processes of collective action under the assumption that individuals act in a self-interested manner in the political process, just as they do in the market process. Such a political exchange proceeds as per 'rules of the game', which are typically laid out in the Constitution.

Buchanan not only applied tools of economic theory to the political and bureaucratic world, but also suggested that political behaviour would mimic market behaviour. As the Nobel website tells us:

Buchanan has extended the parallels between economic and political decision-making even further. Market behaviour is based primarily on voluntary agreements and the exchange of goods and services which give rise to mutual advantages for the agents in market transactions. A pre-requisite of the market system, however, is the establishment of a legal system that protects ownership rights and the realisation of contractual agreements. The political system may also be regarded as a system based on voluntary agreements.

In his public choice theory, Buchanan was inspired by the work of Wicksell on public expenditure and taxes. This theory is based on the principle of unanimity, whereby, the 'political exchange' is voluntary just as market exchange is voluntary. Hence, the political process is not a tool for redistribution as was the popular notion, but a way of voluntary and mutual cooperation, leading to a Pareto-optimal equilibrium. The unanimity is of course ensured by everyone's adherence and belief in the Constitution. Buchanan even laid the foundations of a sub-field of public choice called 'constitutional economics' which addressed the efficiency properties of political checks-and-balances such as constitutions, bicameral parliaments, federalism, and even fiscal and monetary policy rules.

Buchanan's best-known work is 'The Calculus of Consent' which he co-authored with the well-known political scientist Gordon Tullock in 1962. In this book, the authors have provided a model of constitutional decision-making: that is, the rules of the game, within which 'political exchange' plays out. The book deals with the collective action problems faced in political decision-making, lobbying and bureaucratic action and how individual self-interest leads to a 'political equilibrium'. The authors also attack majority voting procedures and recommend unanimity rules as mentioned above.

Another of Buchanan's lesser-known works is 'Cost and Choice' in which he defines the parameters of opportunity cost. He suggests that the costs to individuals determine what the price of a good or service is. His other works include 'Public Finance in a Democratic Process' (1966), 'The Demand and Supply of Public Goods' (1968), 'The Limits of Liberty' (1975) and 'Freedom in Constitutional Contract: Perspectives of a Political Economist' (1977), 'The Power to Tax' (1980; with G Brennan) and 'The Reason of Rules' (1985; with G Brennan). In addition to these, Buchanan had published numerous articles in scientific journals; collections have appeared in 'What Should Economists Do?' (1979) and 'Liberty, Market and State' (1986).

Buchanan and Public Policy

Buchanan's work on public choice is basically the analysis of public policy and how it is made. When Buchanan uses rationality, utility maximization and methodological individualism to the problems of decision-making in the political arena, he applies economic tools to public policy. For example, in the analysis of public finance, and hence, the appropriate size of the state, Buchanan looks at public policy whereby government supplies public goods or services, which are paid for with tax revenues. This is done under unanimity rules and a constitutional framework.

While Buchanan's ideas were not in the traditional neoclassical framework and therefore removed from the core of the economics discipline, the public choice theory had a strong influence on government policies. Further, Buchanan gave a central role to the political and bureaucratic decision making in his theory, unlike the neoclassical model which saw the government as a black box and a disinterested neutral agency. The following quote from the Nobel website underlines the importance of Buchanan's work:

Developments over the last few decades have confirmed Buchanan's realistic view of the scope of economic policy and the importance of continuously reconsidering fundamental rules of the game, while retaining stable rules. Economists now working in the area of stabilisation policy are much more interested in fixed rules than they were a few decades ago when "fine-tuning" was in fashion. Earmarked taxes and qualified majority as methods of achieving better correspondence between public expenditures and taxes are now considerably more topical questions than they were 20 years ago when attempts were made to restrict the political-administrative decision-making process as little as possible.

For Buchanan, politics was a game and the Constitution encompassed the rules of the game. He famously remarked "We must have a strong government. But we can restrict it within constitutional limits, by division of power, by federal structures, by competition among local units."

Buchanan's emphasis on the Constitution as the rules of the game had a profound impact on the post-socialist countries that were coming out of the shadow of the erstwhile Soviet Union. These countries were grappling with the questions of type and form of government that they should have, and what checks and balances were necessary. Buchanan's ideas about constitution-making gave them a good starting point. His comment below illustrates this well:

In the political process, a constitution must be able to balance everyone's interest, trying to agree on a set of rules under which we can carry on our separate activities, and not have too much negative influence on each other.

Buchanan's work also found resonance in the issue of the economic integration of the European Union. Buchanan was in favour of full integration but felt that European countries were not willing to let go of their sovereignty in the 1980s. He felt that Europe needed a strong central authority to enforce monetary integration.

Conclusion

Buchanan has often been accused of economic imperialism for pushing the frontiers of economics and taking it to areas that are not amenable to the tools of economic analysis. However, this is an unfair criticism since his work has forced us to think about issues such as the supply of public goods and also enriched economics by taking it closer to the real world of decision making.

The value of Buchanan's work lies in the fact that he was the first economist to marry economics and political science and use this synthesis to answer questions such as the structure and the role of government in decision-making. Economics had the concept of rationality and utility maximization, but political behaviour was not analysed in the same way. Knowing that someone who behaves selfishly in other areas of life will do so in their political life as well, Buchanan emphasised that democracy couldn't always work as perfectly as predicted. He, therefore, suggested setting up constraints on the authority or the power of politicians.

Buchanan's work inspired a lot of work in the area of decision making and in other areas such as elections, judiciary and international relations. His work is also closely related to the field of social choice which was founded by Kenneth Arrow and dealt with issues of instability and cyclicity of majority voting systems. Arrow's impossibility theorem is particularly well known. (I have covered this literature in earlier articles of this column: particularly the works of Condorcet, Anthony Downs, Duncan Black, MCelvey, Mancur Olson and others).

The writer is an IAS officer, working as Principal Resident Commissioner, Government of West Bengal.

Views expressed are personal