Introduction

This chapter examines the process of financial market globalization and its relationship to financial systems and monetary and financial policy. It focuses on the financial systems of Germany, France, Japan, the U.S., and the U.K. These financial systems have been categorized as being either (1) capital market-based, Anglo-Saxon, or exit-dominated systems (U.S. and U.K.) or (2) bank-based or voice-dominated systems (France, Germany, and Japan). Here, following Pollin (1995), these systems will be referred to as either exit-dominated or voice-dominated systems. It has previously been claimed that, as globalization of financial markets proceeds, a convergence will occur toward the exit-dominated model. This chapter highlights findings regarding the convergence of these financial systems along the dimensions of patterns of sources and uses of funds. It then discusses the monetary and financial policy implications of these results, and proposes policy alternatives to reduce the tendency toward speculative finance and increase the amount and stability of productive investment. These are policies designed for stability in light of the observed globalization trend and its implications.

The convergence of voice systems toward the exit model in the area of credit allocation and monetary policy has been substantial in recent years. Countries with voice-dominated systems have made their central banks use increasingly similar instruments of monetary policy in more liberalized and speculative financial environments.

In the past, monetary authorities often conducted monetary policy by directly controlling either the price or the quantity of credit or both.

Globalization: “then” and “now”

The interplay of continuity with change makes historical parallels imperfect. Nevertheless, by highlighting both the similarities and the differences, they may help us understand better complex processes in contemporary history. The process of economic globalization through the expansion of business and commerce, which is proceeding now at a spectacular pace, resembles in many ways a similar process that was underway when the Gold Standard was at its height (approximately 1890–1913). Of the three main economic aspects of globalization usually discussed, namely, expansion in international trade, investment, and finance, at least in the first two aspects globalization “then” under the Gold Standard is comparable with what is going on “now.”

Since World War II, international trade has grown rapidly, from a meager 6 percent of world gross domestic product to over 15 percent by the early 1990s; the countries of the OECD (Organization for Economic Cooperation and Development) exported 17 percent of their aggregate GDP in 1992. And yet, these numbers are not unprecedented. In the year 1900, the 16 most industrialized countries exported 18 percent of their GDP, a figure that rose to 21 percent in 1913. Roughly speaking, industrialized countries export one out of every 5 dollars of output they produce today, as they did just before the outbreak of World War I (Maddison 1989).

Although these aggregative pictures of international trade remain comparable, the details are different between “then” and “now” in two interesting respects.

“Politics by principle” is that which modern politics is not. What we observe is “politics by interest,” whether in the form of explicitly discriminatory treatment (rewarding or punishing) of particular groupings of citizens or of some elitist-dirigiste classification of citizens into the deserving and nondeserving on the basis of a presumed superior wisdom about what is really “good” for us all. The proper principle for politics is that of generalization or generality. This standard is met when political actions apply to all persons independently of membership in a dominant coalition or an effective interest group. The generality principle is violated to the extent that political action is overtly discriminatory in the sense that the effects, positive or negative, depend on personalized identification. The generality norm finds its post-Enlightenment philosophical foundation in Kant's normative precept for a personalized ethics and its institutional embodiment in the idealized rule of law that does, indeed, set out widely agreed upon criteria for the evaluation of legal structures.

In one sense, it is surprising that the generalization principle has not been applied directly to politics. But except in those settings in which politically driven action impinges upon the generality precept promoted in law, there has been little recognition of the potential relevance of the generalization norm. Such failure or oversight has been due, in large part, to the residual dominance of a romanticized and idealized vision of “the state” – an entity that remains benevolent toward its citizens while providing citizens with opportunity for full self-realization. In this vision, any principle must act to constrain the collective-political enterprise and may prevent the state from “doing good,” as defined in its own omniscient discovery.

In reality, democratic politics is complex. We participate, directly or passively, in politics that we also observe, read about, and watch on our television screens. We confront an intricate and interlinked institutional jumble involving elections, candidates, referenda, parties, legislative bodies, executives, administrators, bureaucrats, regulations, decrees, mandates, program benefits, transfer payments, taxes, traditions, conventions, practices, and, of course, seemingly endless talk, almost always with a robust rhetoric of “public interest.” We tend to be overwhelmed by politics, as if it is too much with us, late and soon. Perhaps it is as well that we should be because politics controls almost half of the aggregate allocation of economic value in the United States and more than one-half in the welfare states of Europe.

The complexity of politics makes analysis aimed at genuine understanding difficult to commence. It is almost as if we ask the question: How do we analyze “the world?” The task of understanding must be tackled in small steps, in bits and pieces, and undertaken by those who specialize in separate scientific disciplines. By necessity, the enterprise is analogous to the fable in which several blind men feel the elephant with each one subsequently trying to understand the whole animal.

Historians try to identify major events in the political record, and they seek to discover causal forces, both human and nonhuman, that help us explain those events. Political scientists examine the formal and informal institutional structures of politics, and they try to understand the actual functioning of these structures. Public-choice economists are more individualistic in their methods.

Life in a community is characterized by a variety of relationships with one's fellow community members. In a small community, these relationships may be entirely informal. Trading partners and neighbors may acknowledge mutual spheres of influence and trust which are understood only by the participants. Casual acquaintances may similarly acknowledge reciprocal duties of courtesy, assistance, and distance. Strangers may also interact within fairly well understood, if limited, rules of conduct. In a larger community, many of these informal relationships are formalized as law and regulation, and the somewhat less discerning, but stronger, sanctions of the village constabulary or state police replace those of neighborly disapproval and vendetta.

Although life within a community takes place within a complex web of rules and regulations, it is generally acknowledged to be superior to the life of a solitary unaffiliated person, a hermit, who escapes from the various rules governing life in a community. A community offers numerous opportunities for realizing increased personal wealth derived from trade among specialized producers as well as richer opportunities for consumption, fellowship, and education. These advantages evidently more than compensate individuals for the various formal and informal restrictions of life in a community.

Although adhering to the various rules and regulations associated with life within a community is clearly a burden for most individuals, the origins of many of those rules is based on mutual advantage. That is to say, many of a community's formal and informal regulations are not simply an unfortunate cost of life within a community, but rather a significant part of the reason why life in a community can be advantageous.

The highly stylized and abstract models of small-number interactions introduced at the end of Chapter 2 suggest the possible efficacy of constitutional constraints in reducing the size of the set of outcomes attainable under majority voting rules. By appropriate definition of the dimensions that describe the vector of outputs under collective action, the distinction between positions on and off the diagonals in the simple matrix illustrations facilitates precision in the classification of positions in accordance with the generality principle. In the stylized models to be used further throughout the book, positions on the matrix diagonals embody symmetry or generality in the collectively imposed behavioral adjustments among the interacting parties; positions off the diagonal embody asymmetry or differential adjustments along the separate dimensions, thereby a violation of the generality criterion.

Section A relates the matrix construction to the more familiar analyses of majority voting in conventional public choice theory. In Section B we extend the model to three parties, and we specify more carefully the elements of the matrix construction. In the process we clarify the meaning of the distinction made between solutions on and off the diagonals. In this section we assume that all participants are identical in the sense that the public good is equally productive for all and that the supply of inputs to produce this good is equally costly. In Section C we examine the incentives for rent seeking under unconstrained and constrained majority rule. In Section D we drop the assumption of identical evaluation. Section E discusses the effect of the on-diagonal constraint on majority stability.

In Chapter 8, we suggested that general taxation is an efficient revenue-raising institution in majoritarian democracy. We did not explicitly relate the analysis to the outlay or spending side of the fiscal account. Implicitly, however, the presumption was that revenues raised by taxes are devoted to the financing of public or collective consumption goods and services, which, as provided, are available to all members of the political community. That is to say, the analysis of tax alternatives proceeded on the presumption that spending benefits are, themselves, general in this publicness or availability sense. Individual evaluations of publicly financed goods and services may, of course, differ widely, but the stylized model, as examined, involved no explicit politically determined differentiation among beneficiaries. As in the simple exercises of earlier chapters, the classic example is David Hume's meadow that needs to be drained to the prospective benefit of all adjacent farmers. The subject matter to be examined in this chapter includes other types of government services as well. We propose to analyze the workings of majoritarian politics in a constitutional setting that allows government spending that is not limited to the financing of technologically defined public goods but is directed also to the financing and production of goods and services that may be partitioned among separate users. We hold off analysis of direct monetary transfers until Chapter 11.

There are many distinctions between an individual's effective demand for services acquired via market exchange transactions and goods and services that may be acquired through governmental–political auspices.

In this final chapter, we return to the abstracted arguments developed in the first part of the book. The several applications examined in Chapters 6 through 13 of the text should have been sufficient to demonstrate the normative relevance of the generality principle in the turn-of-the-century politics that we now experience. Policy arguments in support of free, open, and nondiscriminatory trade; flatter and more uniform taxation; nonparticularized standards for environmental regulation and public goods provision; devolution of political authority to more adequately defined areas of special benefits and against means testing for transfers – indeed, against discriminatory treatment of any sort – these arguments find common philosophical grounding in the rule or norm for political generality.

There is a categorical distinction to be drawn between arguments for depoliticization, per se, and the application of the generality principle over those sectors of interaction that are politicized, although there are relationships that stem from feedbacks between prospects for discriminatory exploitation and the range of politicization itself, some of which will be discussed later in this chapter.

Specifically, this book is about the constitutional structure of those sectors of social interaction that are politicized; it is not directly about drawing some borderline between these (public) sectors and the private (market) sectors. We recognize, of course, that arguments in support of many of the same policy thrusts noted (e.g., free trade and nondiscriminatory taxation) may be derived from the classical liberal precept of minimal coercion, or its obverse, maximal individual liberty from collective intrusion. This second normative impulse has been much more central in modern discourse than the normative inferences from generalization that we have stressed here.

This chapter concentrates on the politics of taxation. The interdependence between the workings of majoritarian democracy, as it is observed to operate in the United States in the 1990s, and the distribution of tax shares among persons and groups becomes our focal point of attention. The emergent results of this interdependence are, of course, affected by the constraints of the effective constitution – the rules of politics – as these are interpreted and enforced. And it is necessary to emphasize that the effective fiscal constitution, as it exists, does embody constraints that prevent many arbitrary departures from generality in tax treatment among persons and groups. It is widely acknowledged that the tax system, as observed in the United States near century's end, is less discriminatory than the expenditure system-the distribution of public spending benefits on the complementary side of the budget. That is to say, implementation of any generality norm may be closer to realization on the taxing side of the account. The question reduces to whether improvements can be made by moving toward further generality in treatment.

In a sense, our whole normative enterprise consists in constitutional evaluation, criticism, and suggestions for basic reforms. We ask, and try to answer, the question of whether changes in constitutional constraints on the taxing authority of governments, and notably those implied by moving toward implementation of the generality norm, can be expected to generate a more desirable pattern of outcomes. We suggest that movements toward generality in taxation will be “efficient,” even if attainment of some ideal remains far from reach.

In this chapter we demonstrate that in a federal system some programs that are ruled out by a generality constraint at one level of government may be permitted at another. A well-functioning federal structure of government can allow some departures from structure-wide uniformity while retaining the political efficiency advantage of adherence to the generality principle. Some services that fail to be sufficiently general at a more inclusive level of membership in political community may be acceptable at less inclusive levels of government or within smaller self-financing and autonomous service districts. A federalized structure of government can provide heterogeneous services while satisfying the strictures of generality.

The proponents of federal systems of governance have long touted the various efficiency-enhancing properties of decentralized political institutions. It has often been argued that federalism is a good solution to public service provision in cases in which ordinary economic efficiency requires nonuniform services across various regions of the country insofar as preferences, wealth, or circumstances vary significantly. Our generality defense of federalism is largely consistent with this conventional analysis, but it differs in approach and implication for assignment of tasks. Federalism allows generality to be adhered to at the level of every governmental body responsible for making collective program decisions while it allows departures from uniformity in the federation as a whole. Federalism allows political transactions costs to be minimized while realizing the advantages of locally heterogeneous service levels. In this sense, federal systems may be said to be a first-best institutional arrangement that produces outcomes that cannot be replicated even by an idealized democratic central government.

Preceding chapters have been aimed to provide a foundational understanding of and an elementary appreciation for the principle of generality in the politics of democracy. The argument has been developed largely through a series of highly abstract and grossly simplified examples; many critics would perhaps reject the reductionism involved. The purpose of this chapter is different. We shall discuss the relationship of generality to the agenda of political democracy. What conception of politics, as an inclusive enterprise, is required for the generality norm to become a relevant attribute? How does this conception differ from alternative, and possibly more familiar, understandings? Why has the unnatural feature of generality been neglected? What have been the implicit assumptions that have allowed analysts to presume generality where it does not, and indeed cannot, exist?

Responses to these and other like questions suggest a direct linkage between the generality norm and constitutional structure. Although it may seem to be a digression, critical attention must be paid to the implicit understandings in theoretical welfare economics and particularly in the implications for constitutional politics. How can “choices among social states,” a central focus of orthodox analysis, be related to the generality precepts stressed in this book?

The discussion may prompt an offsetting inquiry. Given the unnatural relationship between generality and majoritarian politics, along with the failure of analysts, engaged in both positive and normative exercises, to place such an attribute in any central role, why do we observe any adherence to the principle of generality at all in the politics that we observe?

Here we once again return to the intersection between law and politics. Political action is effectuated through legal action, through changes in laws.

In this chapter we analyze the generality norm as it might act to constrain political interferences with trade or exchange, whether such interferences are promotive or restrictive in purpose and whether trade is exclusively among citizens (internal or domestic) or between citizens and persons or firms in other political jurisdictions (external or foreign).

The thrust of the argument is dramatic in its demonstration that any interference with market allocation that is exclusively motivated by political purpose must reflect a violation of the generality norm. This result, in its turn, implies that the precise decision rule for making political choices becomes irrelevant if a constitutional requirement for generality is in place. Majoritarian politics is, of course, systemically organized to produce departures from generality in treatment among groups, but if all departures from generality are prohibited by effective constitutional constraint, majority decision rules operate much as alternative rules in maintaining emergent market allocation. The economists’ normative argument in support of the superior efficiency of resource allocation generated in nonpoliticized markets is reinforced by the argument concerning the political efficacy of the generality norm. This norm, if operative as a constitutional constraint, ensures that the “all-encompassing interest,” reflected in the maximal value of produce, as evaluated by the preferences of participants and subject to the transfer proviso discussed later, will be chosen as preferred by any coalition in a position of collective authority. In effect, the constitutionalization of generality in treatment indirectly amounts to the constitutionalization of market allocation in settings in which public goods and externalities are not present.

In Chapter 10 we examined how the generality principle might be applied to constrain the productive state. In this chapter we examine the majoritarian politics of the transfer state. Here the role of government is not always so evident as in arguments supporting the production of public goods. Generality, narrowly conceived, cannot really apply to the transfer state insofar as transfers, by definition, involve unequal treatment in the sense that transfers imply the existence of net taxpayers and net transfer recipients. On the other hand, transfer programs can be more or less general and can run more or less afoul of the political inefficiencies associated with nongeneral programs. Can an argument comparable to that developed in support of general taxation and the production of public services be made to the effect that the generality norm should be extended to the transfer side of the fiscal account? And what would generality mean in this context? What is the transfer side equivalent of the flat-rate income tax? And, given the possible constitutional enforcement of generality, could the modern welfaretransfer state remain both majoritarian in its politics and viable in its economics? Or does the welfare-transfer state depend for its very survival on discriminatory departures from any generality principle?

We propose to analyze the working of majoritarian politics in a constitutional setting that allows government spending that is not limited to the financing of public goods but is directed explicitly to particular individuals and groups in the form of monetary transfers.

Introduction

As noted at the beginning of Chapter 2, we have considered it necessary to engage in “ideal theory” in order to establish the analytical foundations for the book's whole enterprise. We make no apologies for the use of the highly stylized, grossly simplified, and extremely abstracted models that have informed the preceding four chapters. We have sought to secure a generalized understanding of the generality principle before plunging into the complexities that any effort at application must introduce.

With Chapter 6, however, we move, perhaps abruptly, beyond reductionist exercises. In this and the following chapters in Part Three, we discuss familiar subject matters: externality, regulation, taxation, deficits, public goods, transfers, social insurance, and federalism. These policy-relevant categories of modern political economy offer the menu for application of the normative analysis of Part Two.

As the separate treatments will make clear, difficulties emerge in each case if we expect application of the generality norm to yield clear and unambiguous directions for specific constitutional change. As we note on several occasions, however, generality or nondiscrimination can offer criteria that allow proposed or observed political actions to be evaluated positively or negatively, without any satisfactory definitional determination of some idealized end point for politics. Recall that our subtitle is “Toward Nondiscriminatory Democracy.”

Social sciences analyze the relationships between and among persons, groups, and organizations. This inclusive definition incorporates economic, legal, political, and social interactions. In ordinary market exchange, the individual is simultaneously a demander and supplier, a buyer and seller. In social arrangements, the person may be both a care giver and a care receiver, a lover and a beloved, a gift taker and gift giver, a friend and a befriended. By comparison, in law and in politics such reciprocity need not be present. The individual is subject to the law, but he may or may not be a member-participant of the organized entity that makes-changes or enforces the law. In fiscal politics, the individual is subject to the coerced exaction of taxation and to the possible nonexclusive benefits of governmental programs, but he may or may not be a member-voter-participant in the collectivity that makes basic political choices. In either of these cases, in which the individual is subject to but not a participant in the process, reaction rather than explicit reciprocation describes behavior.

Our concern in this book is exclusively with those structures of social order that qualify as “democratic” in some ultimate participatory sense. We shall not analyze the relationships between individuals and an externally existing maker-enforcer of law and political authority. Critics may suggest that the authority of convention and tradition, especially in law, places any subject-person in a position that is not different, in kind, from that which is present under externally imposed rules. But the individual, as a participant in a continuing process, also plays some part in constructing the order itself.

As we have previously noted, the analytical structure of this book is simple and involves a single theme. We have repeatedly used the two-person matrix metaphor to demonstrate that, by its own logic, majoritarian politics must violate the generality precept. Outcomes tend to be off the diagonal, and only the potential rotation of majority coalitions indirectly legitimizes the whole process. The economic argument for imposing a generality constraint constitutionally is based on predictions about the relative inefficiency of off-diagonal outcomes, as measured both in the orthodox allocative sense of neoclassical economics and in the public-choice, rent-seeking sense of minimizing resource wastage.

We have discussed only briefly (Chapter 6) temporal characteristics of the political setting, despite the obvious fact that, even as stylized, majoritarian rotation requires a time sequence. Implicitly, it is as if we assume an inclusive constituency of long-lived participants, whose effective planning horizons are sufficiently extended to allow for nonbiased expectations concerning membership in successful and unsuccessful political coalitions.

The two-person (or coalition) matrix metaphor is useful in this postulated setting. To the extent that rotation among the off-diagonal positions generates a pattern of outcomes that is deemed to be relatively inefficient, all parties to the collective interaction may be persuaded to agree on a constitutional constraint that requires generality – a constraint that dictates in-period equality in political treatment, at least as an idealized objective. The separate applications discussed in the immediately preceding and following chapters can all be brought within this analytical umbrella.

This chapter departs from the common analytical structure, and the argument is necessarily more complex.