INSTITUTIONAL ECONOMICS: GOVERNMENT

We shall discuss collective action and public policy. We shall discuss two key approaches to the state: a liberal and minimalist model based largely on new institutional economic analysis, and a pro-regulatory model, based on old institutional economic analysis.

The approach adopted here is one of liberalism. One version of liberal basic principles is the ‘order policy’, which emphasises the importance and defence of private property, freedom of contract, responsibility and liability for one’s commitment and actions, open and free markets, monetary stability and stability of economic policy. Adhering to such a style of public policy precludes legislative and regulatory activism. It requires tolerance of some outcomes and caution of redistributional policies.

Three elements, drawing from new institutional economic analysis, run through the liberal welfare state that functions to establish public policy to support and enhance social and economic order (‘order policy’).

• people’s cognitive abilities are limited (Lecture 2);
• freedom of individual action (autonomy) is a precondition for competition (Lecture 6);
• people have asymmetric information, and are tempted to act opportunistically (Lecture 8).

According to the liberal model, there are three main functions of the state.

First, its protective function, that facilitates order and gives individuals and private firms and associations confidence by making their coordinative tasks easier in the face of ignorance. The protective task may at times require the use of legitimate force to prevent free riding and principal-agent opportunism, and to enforce the rules if necessary. Importantly, in practice, the liberal theory of the state requires a coercive (strong) authority, since it provides a minimal (weak) account of the civil society (i.e. institutions (e.g. trade associations, vested groups, communities, social movements) between the state and the market), relying mostly on market coordination. Paradoxically, the liberal state suppresses voluntarism and free action by instituting a strong state to overcome free-riding.

The obvious protective function of the government is to prevent the coercion of some citizens by others. At the same, it has to ensure that the government does not use its powers against the citizens, its principals. For this, it is necessary to establish and enforce a system of rules that apply to all citizens equally, and which prevent them from pursuing their purposes by force, deception or other forms of violence. Protection is thus closely related to the preservation of individual freedom. A considerable part of the protective function of government is implemented through regulations; e.g. health and safety.

Second, its productive role, that is a case is made for the government providing citizens with access to certain goods (especially public goods). However, the matter of the provision of goods and services from public resources is separated from how such common goods should be produced. It is not necessary for access to common goods that they be produced with socialised property; e.g., public education can be provided by private schools and universities.

There may be reasons why the state chooses to organise and fund production by employing publicly-owned property. For example, the nature of the industry is such that there are indivisibilities, so making it uneconomic for the private sector. Certain services (police, legal services) come under the direct political control of the authorities. Certain sectors (alcohol and tobacco) can be valuable sources of revenue. Finally, management of the business facilitates redistribution of wealth and income.

Increasingly, in many sectors (e.g. health, security, care, leisure and education) in advanced industrial societies, the government uses the public funds to acquire the goods and services, and acts a quality controller, not the producer. There are some reasons for this shift, including that private production is more open to competition, and offers citizens more choice, and that the private competitive sector addresses the difficulty of monitoring and controlling agent opportunism better than the public sector.

Third, its redistribution of incomes and wealth, that is confiscation of property rights of some and their re-allocation to others. This act is based on the concept of ‘social justice’. Redistribution can be attempted by two categories of policy instrument: neutralise and change the outcomes of the competitive markets (e.g. taxes and transfer payments); and altering the functioning of markets and their opportunities through institutional and social measures (e.g. regulations, social and political rights).

Strong (neo-) liberals argue that the government’s functions fails to address the problems of knowledge, rational ignorance, moral hazard and self-interest of political agents. Many government activities are justified by the argument that they address ‘market failure’ (i.e. imperfect markets). Yet, the model of ‘perfect competition’ has little bearing on the evolutionary market processes. In addition, this model ignores the knowledge problem and the role of internal institutions in tackling the problems. The case for government activities assumes that the government knows best and the agents are good and benevolent. Both assumptions are questionable.

Public policy always have unintended side-effects, which require further intervention so that more and more complex rules and actions are prescribed and proscribed, eventually leading to an establishment of an authoritarian state. Modern societies are so complex, and evolve so unpredictably that only relatively general and simple government rules and programmes can be comprehended by those in charge. Complex intervention programmes invariably get enmeshed in unpredictable contradictions. Analysts who have not thought through the knowledge problem are often overly optimistic about what discretionary collective action can achieve.

For these reasons, the fundamental advice to public policy makers is to making the protective function the main focus of government, particularly by fostering and settling institutions conducive to competitive economic system. Competitive systems deserves to be defended because they have essential knowledge-generating and controlling functions that alternative, collective systems cannot match in the context of a modern complex economy.

However, there is a strong criticism of the liberal model of the state. Liberalism was a minimalist (weak) theory of the state that has become instead a minimalist (weak) theory of civil society. Government could be weak, according to classical liberal theory, only because civil society was strong. In contemporary advanced industrial societies, however, the opposite has occurred: civil society has become so weak that government, by necessity, has become strong. For example, the provision of child-care was often provided within the civil society (usually by household members). Yet, now the state provides this service because civil society has become weak, largely due to market pressures (e.g. household members don’t have enough spare time to look after their children). In practice, the liberal theory of the state fails to explain the development of government activities.

A major theme of this approach is to challenge the core assumption of orthodox economic theory that both the tastes and preferences of individuals and the characteristics of production are given and fixed to the theoretical system. It is characteristic of an old institutional approach that tastes and preferences become a focus of enquiry.

One prominent feature of institutional economics is to look behind the individual and to take its institutional circumstances into account. Institutions are regarded not merely as rigidities or constraints, but as structures and routinised activities that affect the dispersal and cognition of data, and mound individual preferences and actions in many other ways.

Some liberal and new institutional economists are worried by the apparent policy implications of this line of argument. If humans are malleable (flexible and changeable) and the supremacy of their expressed preferences is denied, will this not lead to dictator-state to interpret needs according to its ideology, and to disregard all opposite expressions of need? There are concerns of paternalism, centralism and authoritarianism. However, an old institutional approach to needs and the assertion of some degree of malleability and flexibility of human needs give no reason for thinking that a dictator will emerge, or that it knows what is wanted by its people.

There are two approaches to human needs.

Maslow’s ‘hierarchy of needs’. Maslow argues that at the first and lowest level of the hierarchy each individual has a number of basic physiological needs (e.g. air, water and sleep). These needs must be satisfied in order to survive. Once a basic need is satisfied, then the individual can concentrate on a higher need. The next higher needs are material needs, such as safety and security. Once all material needs are relatively satisfied, then the individual seek for social needs such as belongingness, love, affection and acceptance. A higher social need is the need for self-esteem, and recognition and respect from others.

Once the physical and mental health is assured, and the basic material and social needs are satisfied, then the individual reaches the top of the hierarchy, and seeks ‘self-actualisation’. Here, the individual moves on to creative and spiritual phase of personal development.

A problem, however, with this theory is that it excludes the historical dimension in the analysis of needs, and how needs evolve over time in different social contexts.

Doyal and Gough’s theory of human needs. Doyal and Gough point out that needs are crucially linked with goals, and they define ‘basic individual needs’ as those goals which must be achieved if any individual is to achieve any other goal. These basic needs include survival and autonomy. Under these categories come an array of further needs relating to physical and mental and personal development.

Individual needs such as these generate a further category, ‘basic societal needs’. These are social preconditions for the achievement of the individual needs. Consequently, there is a ‘basic human need’ for food and ‘societal need’ for an economic system that can produce and distribute food to the entire population. Further to this, as autonomous self-development is another basic human need, there is also a ‘societal need’ for a child-rearing and education system that enables people to learn and develop their own capacities.

Unlike Maslow’s work, Doyal and Gough do not rank needs in a simple one-dimensional hierarchy. They distinguish ‘basic human’ and ‘societal’ needs, and argue for a complex, inter-active system of needs. Whilst some needs are self-evident, the best arrangement for satisfying ‘societal needs’ and the character of other needs are to some extent open-ended and subject to continuing debate. Doyal and Gough offer a dynamic and sophisticated approach to the theory of human needs. A feature of their analysis is that it is open-ended, in that they do not claim to provide a formula to understand the totality of human needs, but to build an analytical framework that has scope to adapt and change in the light of evolving debate. While there is flexibility in this approach, there is still an over-riding goal of healthy, educated individuals struggling equally together to look after themselves and each other in ways that fairly maximise their creative potential.

The approach adopted here is fundamentally different from both authoritarian (or paternalistic) state and classic liberalism. The ‘state model’ presumes that all or most needs can be known and evaluated by a central authority. Classic liberalism, on the other hand, assumes that there is little possibility of any general knowledge of needs, and on all matters the individual remains the best judge of its welfare. The ‘state model’ is normally associated with the policy prescription of comprehensive central planning, and liberalism with the policy of free market.

In contrast to the state model and liberalism, Doyal and Gough’s approach is both analytic and educative, and the general analysis of needs is dynamic and open-ended, depending in part on the education and self-awareness of the individual. Thus, there is a societal need for a fully participatory politico-economic system. Participatory democracy requires a type of institutional framework within which people can become educated and self-aware as to their needs.

Thus, the economic framework within which human needs can best be satisfied requires participatory democracy. It is not simply a question of markets and the state; it is also a matter of enhancing democracy within society so that an educative process can flourish.