Rediscovering Buchanan’s Rediscovery

January 14th, 2013 by Edward Lopez

As I claimed in a post last Thursday, the recent flurry of commentary about Jim Buchanan is most welcome and impressive, but it fails to capture his deepest contribution and the breadth of its relevance. In this post I will try to convey in plain language what I think those are.

This is a long post, long enough to try the patience of most readers. So, for your convenience, let me first summarize: While Buchanan is best known for the economic analysis of constitutions and politics, these bodies of work are but one branch of Buchanan’s approach—although there can be no doubt that constitutional political economy and public choice are the most developed branches. In this post, I will emphasize that Buchanan’s approach is not merely to think of political agents (politicians, voters, bureaucrats, etc.) as self-interested. It is instead to think of all human interaction as forms of exchange in the pursuit of mutual gain. To be clear, Buchanan means “exchange” in the sense of Adam Smith and other political economists of the Scottish Enlightenment, a subtle point on which I elaborate below. In my view, three of Buchanan’s papers (one famous, two neglected) best express his argument that this earlier, Smithean tradition of political economy had been forgotten by the mainstream of mid-twentieth century economics (namely, the economics of scarcity and allocation), and economists needed to rediscover this earlier tradition in order for economics to make progress. In turn, we should not forget that this approach, while having laid the foundation for his best known work, applies quite generally to the human experience. If public choice theory is viewed as a revolution that overturned neoclassical welfare economics, it is only insofar as Buchanan was successful in this deeper task of re-establishing economic theory as the science of exchange rather than of allocation.

Now for the argument.

In Buchanan’s 1963 presidential address to the Southern Economic Association, “What Should Economists Do?” (un-gated versions can be found online), we have a multi-faceted critique of the dominant mode of thinking among economists at the time.

In this paper, Buchanan seeks to persuade the practitioners of economics that they are going about their craft in ways that are elegant but ultimately irrelevant and, in the case of social welfare analysis, also logically incoherent. In particular, Buchanan has in his sights the constrained optimization approach to individual choice, the general equilibrium model of competition, and the social welfare functions used to determine optimal resource allocations. Part of the problem has been the gradual preoccupation with mathematical modeling that had become the convention among mid-century economists (and remains so today).

However, Buchanan’s critique goes deeper than to argue that words are better than equations. It is not mathematical formalism, per se, that is the problem. In fact, he says repeatedly that these models he’s criticizing have their place in the economist’s craft. The core problem is in making these models our central focus. The related problem is to exaggerate the relevance of these models to the social world. Solving the system of simultaneous equations in a general equilibrium model is an impressive feat, but it is not to be confused with learning anything about how humans coordinate competition. Likewise, each person’s daily routines, their buying and selling decisions, and their cooperation with each other outside of commercial life, are not mere computational problems with unique solutions. And public policies that may appear to be beneficial within the confines of a social welfare function might actually exacerbate imperfections in the real world, where men are not behavioral computers but instead have natural propensities to truck , barter, and exchange.

In order to understand Buchanan’s deepest contribution, it is worth spending a few more lines on his particular critique of using conventional welfare economics to plan resource allocation in the real world. Buchanan says that measuring an individual’s well being is one thing, but mainstream economists have become all too accustomed to taking that extra step, or crossing that bridge, over to measuring societal well being. For all its mathematical beauty, the neoclassical model of welfare fails to grapple with one timeless truth: there is no way to add or subtract the subjective value of multiple individuals. As Jeremy Bentham himself confessed, one man’s happiness will never be another man’s happiness,” but we must allow ourselves to pretend it is so, because “without the allowance of which all practical reasoning is at a stand.”* While social welfare theory was no longer utilitarian in this additive sense at mid century, Buchanan says something directly similar plagues it: economists inescapably must substitute their own value judgments for the subjectively perceived yet objectively unobservable value of their subjects. Eager to be of practical relevance to social engineers, economists do cross that bridge, knowing deep down that its foundations are wobbly, and winking at each other along the way under the false confidences of their mathematical elegance. “Get back,” Buchanan summarizes, “and stay on the side of the bridge where you belong.” [p.215]

By contrast, what is Buchanan’s approach? In other words, what should be our central focus, here, on the proper side of the bridge? Here Buchanan’s begins with rediscovering what has been forgotten from Adam Smith. First, treat individuals as naturally (that is, self-interestedly) prone to truck, barter, and exchange. Second, treat competition as a catallactic or symbiotic process through which people who might otherwise be in conflict with each other instead come to “exchange,” “trade,” or “agree” with each other to their mutual gain. In Buchanan’s words:

This mutuality of advantage that may be secured by different organisms as a result of cooperative arrangements, be these simple or complex, is the one important truth in our discipline. [p.218, emphasis added]

And we ought to study this as an emergent, spontaneous order, not as a unique solution to a set of mathematical problems.

A general solution, if there is one, emerges as a result of a whole network of evolving exchanges, bargains, trades, side payments, agreements, contracts which, finally at some point, ceases to renew itself. [p.218]

Third, the catallactic or symbiotic approach should be used to understand the range of human cooperation—in commerce, in politics, and in all other areas of collective action where people seek mutual gain through cooperation.

Buchanan flushes out these points clearly in his later work on increasing returns. Two neglected papers, both co-authored with Yong Yoon, offer particularly vivid accounts:

1. “Generalized Increasing Returns, Euler’s Theorem, and Competitive Equilibrium,” History of Political Economy, 1999.
2. “A Smithean Perspective on Increasing Returns,” Journal of the History of Economic Thought, 2000. [un-gated copies can be found]

Buchanan and Yoon first point out that Smith’s famous pin factory draws primary attention to the benefits of specialization—namely increasing returns, or the production of more value for the same quantity or cost of inputs. However, the pin factory example is also misleading because it lures economists into focusing on the production single goods, one at a time. Instead, Buchanan and Yoon focus more broadly on the entire catallaxy of market interaction—that is, on the global nexus of arrangement and rules through which different people coordinate their productive activities in pursuit of mutual gain. As the extent of the market (so conceptualized) increases, so do opportunities to specialize. And as more specialization takes place, “the value of the output bundle relative to inputs necessarily increases.” [p. 514 in (1)] Herein lie improvements in social welfare.

The argument is simple, but also profound. It sheds much needed light on a phenomenon of central importance, one that had “disappeared for more than three-quarters of a century” [p.512 in (1)], as economists perfected models of constrained optimization, general equilibrium, and social welfare. Even as economists “returned to increasing returns” around the early 1980s, most of this work restricted itself to single-good (or single-industry) analysis instead of generalized, or economy-wide, increasing returns. This in turn confused economists into thinking that social welfare suffers when governments do not subsidize those industries that generate increasing returns. Here, again, we find Buchanan telling us to be careful about crossing that bridge.

There has been a general failure to recognize that there are two separate levels or stages of prospective scientific knowledge involved in any effort to generate normative consequences of the analysis of increasing returns. [p.46 in (2)]

At the first level, an economist either acknowledges or rejects generalized increasing returns. If acknowledged, then economists at the second level must decide whether it is necessarily feasible to prospectively identify industries or sectors where increasing returns will become concentrated. If, like Buchanan and Yoon, you say that the process of achieving increasing returns is an emergent, spontaneous one, then you will agree that those industries or sectors can only be observed ex post.

If you want to make sense of the long-term decline of employment-population ratios; if you want reassurance that robots will not turn us into paupers when they take over manufacturing; if you want to know why governments (that is, us, acting collectively through the coercive power of the state) should not try to advance-pick economic winners; if you cannot see why we should be relying more on markets, not less—then Buchanan’s deepest contribution, the focus on exchange and the spontaneous emergence of generalized increasing returns—is your best bet.

Finally, as mentioned, Buchanan’s deepest contribution is also his broadest. The catallactic or symbiotic approach applies to the range to human interaction. Fundamentally, this is because man’s propensity to truck, barter, and exchange (or, in Buchanan’s words, to exchange, trade, or agree) is a natural one. It is not confined to certain times of the day or particular places in town. And certainly if people can collectively agree to rules in commercial and political settings, we can expect these same people to seek to do so in other arenas of life where there is potential for mutual gain.

In addition to markets and governments, just a few examples of institutional settings that are amenable to Buchanan’s approach would be: courts of law, family, church, mafia, sports, scholarship, science, forensics, education, all sorts of voluntary associations (relief, professional, home-owner, etc.), prisons, international commercial disputes, foreign policy, space exploration, and more. These are all areas of exchange, not all in the market sense of being mediated by money prices, but in the deeper Smith-Buchanan sense of which market exchange is one manifestation. In all these areas and more, people bring with them their natural (that is, self-interested) propensities, and they seek out (not always with success) rules of interaction that avoid mutual harm for the prospect of mutual gain—for increasing returns.

Again, while he may be best known for the economic analysis of constitutions and politics, his approach can be applied to the range of human interaction. As I have observed, the breadth of Buchanan’s approach has been mostly missing from recent commemorations of his work. He goes beyond the economics of constitutions and politics.

My title suggests that rediscovering Buchanan’s rediscovery means first appreciating this point, and then applying his approach to fields besides markets and governments.

Note: * The Bentham quote is from p.108 of Anthony de Jasay’s The State (1985).