In an early paper (1929), Harold Hotelling studied the equilibrium of spatial economic competition between two firms that first chose locations and then price. His conclusion was that the firms would locate right next to each other, since each could gain by moving in the direction of the other and thereby increasing market share. It was assumed that consumers were uniformly distributed over an interval and paid the cost of transportation, so that each one would buy from the least-cost source, taking account of both price and transportation. Under these assumptions, the common equilibrium location would, he asserted, be found at the center of the interval, which is, in this case, the location of the median consumer.

Hotelling was especially concerned about this outcome because, as can easily be seen, the optimal locations of the two firms would be at the two quartile points, that is, at one-quarter of the interval length from each end. Hence, the competitive system led to a suboptimal outcome.

At the end of his paper, Hotelling argued that the tendency of competitors to become identical is applicable more generally. Spatial differentiation can be a metaphor for quality differentiation of products and for differences of political programs. Hence, Hotelling concluded, political parties tend to offer programs that resemble each other closely, instead of offering clearly separated alternatives, the latter, he thought, leading to superior outcomes.

Introduction

In Chapter 6, we studied the economics of organizational forms in the firm. The firm was broadly defined as a nexus of contracts, but the interlocking webs of contractual relations made it impractical to nail down a more precise definition. Our subject thus became the economics of contracts. In Chapter 7, we go beyond questions relating to the nature of the firm and apply transaction-costs analysis to various organizational forms and market practices. The coverage is not exhaustive. Rather it serves as an illustration of Neoinstitutional Economics in action. We hope to demonstrate, through our examples, that the relative economic advantage of alternative contractual forms is rooted in transaction costs and cannot be explained in terms of frictionless neoclassical economics.

The topic of endogenous social and political institutions is reserved for the fourth and last part of the book. In the present chapter, the community's legal framework and social conventions are taken as given, and in most cases the framework is Demsetz's laissez-faire economy: the neoclassical competitive market plus transaction costs.

In Section 7.2, we begin our exploration of market practices by looking at the problem of measuring the quality of goods and services. Various market arrangements are seen as ways of minimizing measuring costs and lowering the effective price to buyers. The examples are drawn mostly from the market for consumer goods, but the basic analysis applies to all types of exchange.

Political theories based on the spatial model have enjoyed a dual existence. As reflected in the title of Duncan Black's (1958) famous volume, the spatial model provides a foundation for the analysis of electoral phenomena and committee decision making. It does this by providing an abstract characterization of the outcomes and preferences common to electoral and committee choice. In each setting, outcomes are represented by points in a Euclidean space. Preferences over outcomes are represented by voter (legislator) utility functions defined on points in this space. Whether an actor is called a “voter” or “legislator,” and whether a point in the space is designated a “voter's [legislator's] preferred policy,” the “policy of a candidate,” or a “legislative bill,” is little more than a labeling convention. It indicates the substantive domain of interest to the researcher.

The spatial theory of elections and the spatial theory of committees, however, have followed different paths of development as subfield-specific scholars have charted distinctive research agendas. And yet, a question pursued in one subfield – for example, is there a spatial location for a candidate that cannot be beaten by a candidate at any other location? – typically has a dual in the other subfield – for example, is there a motion that cannot be successfully amended? It is from this perspective that we explore multicandidate competition and entry in spatial models of elections. We see these phenomena as duals to agenda-setting activities in legislatures.

Introduction

In Chapter 9, we examined the system of property rights in stateless societies, particularly how informal rules, values, and taboos constrain behavior and limit the waste associated with open access to resources. However, the embryonic institutional structure of prestate societies is not capable of supporting the complex exchange relationships among unrelated individuals that are associated with highly developed specialization in production and large markets, advanced technology, and time-intensive production patterns.

Without the state, its institutions, and supportive framework of property rights, high transaction costs will paralyze complex production systems, and specific investments involving long-term exchange relationships will not be forthcoming. But the state is a two-edged sword: “The existence of a state is essential for economic growth; the state, however, is the source of man-made decline.”

Section 10.2 elaborates North's (1979) theory of the state, which was introduced in Chapter 3. His approach is based on the modern theory of the firm (see Chapters 5 and 6) and emphasizes how transaction costs and agency problems affect political behavior and the structure of property rights. We present a formal version of a North-type model of the state (due to Findlay and Wilson), and consider various ramifications of the approach.

Section 10.3 is given to empirical applications of the theory. Our purpose is primarily to outline critical variables and suggest a research agenda rather than to settle debates in economic history and development.

This book grew out of my interest in organizational forms and institutional arrangements and their impact on economic outcomes. Price theory or microeconomics, in its conventional form, treats organizations and institutions the same way as it treats the law of gravity: These factors are implicitly assumed to exist but appear neither as independent nor as dependent variables in the models. Such economy in model making can be eminently reasonable. It enables us to isolate critical relationships and simplifies the use of mathematical tools in the analysis. However, unlike the law of gravity, organizations and institutions are not invariant; they vary with time and location, with political arrangements and structures of property rights, with technologies employed, and with physical qualities of resources, commodities, and services that are exchanged. In fact, production involves not only the physical transformation of inputs into outputs but also the transfer of property rights between the owners of resources, commodities, and labor services. In the transfer of rights, whether within firms or across markets, agents maximize their objective functions subject to the constraints of organizations and institutions.

Once our research questions involve variable organizations and institutions, either as exogenous or endogenous variables, conventional microeconomic analysis becomes a rather blunt instrument. Our traditional tools are not well suited for examining the nature of the firm, the variation in industrial organization, institutional change in economic history, the organization of exchange in formal markets and nonmarket settings, or comparative economic systems.

The problem of instability in social choice is often thought to be eliminated when the possible set of choices is one-dimensional, and voters have single-peaked preferences over this set. This is Duncan Black's (1958) famous median voter result. Yet, even if votes are determined solely by preferences, instability may still result. If linkages exist in the voters' minds between each possible choice along this single dimension and a future choice on other dimensions, the choice taking place in the voter's mind is multidimensional in nature. Thus, the instability that affects multidimensional social choice can afflict a social choice problem that is nominally one-dimensional. The question that arises is: Are these instabilities inevitable?

One answer is for an equilibrium point to exist in the multidimensional space, but the requirements for such an equilibrium are generally quite restrictive. A different answer comes from placing restrictions on the linkage, or predictive mapping, w that maps each possible choice in the nominal, one-dimensional set P of possible choices into an anticipated choice in the larger multidimensional space X. This second approach to studying stability conditions is the one taken in this essay. For each nominal contest between two elements pA and pB in P, the contest in the voter's mind is between w(pA) and w(pB), which are two points in X (or two probability distributions over points in X). Preference between pA and pB is then derived from the voter's preference between w(pA) and w(pB).

Introduction

In this chapter we contrast the economics of exclusive and nonexclusive ownership of resources and examine the consequences of alternative sets of social rules. Section 4.2 introduces the economics of the common pool, and explains how competition among users of common property can result in a dissipation of the potential rental income from the common asset. Examples from U.S. economic history are used to explain the concept of de facto common property.

In Section 4.3, we examine the costs of assigning and enforcing exclusive rights. In fact, the establishment of exclusive rights uses up resources just as does competition for a nonexclusive asset. The transfer of public timberland to private ownership in the Pacific Northwest during the late 1800s and early 1900s is taken as an example of a relatively costly privatization process. The section ends with a demonstration (in terms of a general equilibrium model) of our inability to make positive statements about the impact on aggregate welfare of the establishment of exclusive property rights, even when the change leads to an increase in net output. The reason is that the impact depends on the true nature of individual utility functions which we do not know and cannot measure.

Section 4.4 takes the discussion beyond the dichotomy of exclusive or nonexclusive rights and examines, in light of Coase's theorem, the interplay between transaction costs and conflicting uses of resources.

Introduction

In Chapter 5 we study how the ownership structure of the firm affects economic outcomes. Continuing the discussion begun in Chapter 2, we see the firm as a nexus of contracts involving in various ways the owners of inputs and the buyers of commodities. An examination of the economic logic of these contractual arrangements and their relation to the costs of transacting is reserved for Chapter 6.

We begin this chapter with a digression on property rights and production functions and go on to look at some major types of firms that are found in modern market economies. These include not only privately owned firms, which often are subject to various forms of government regulations and restrictions on the right to contract, but also “political firms,” that is, firms owned by the state.

Rights, incentives, and production functions

Why do we expect that the economic outcomes of productive activities organized within firms depend on the internal rules of the firms and, more generally, on the external structure of property rights? In answer to this question, Jensen and Meckling (1979) have argued that production functions depend on the structure of property rights just as they depend on the state of technology. They define the firm as a network of contracts specifying the rewards and costs that arise out of the cooperation of individuals in production.

There is no commanding reason to suppose that a clear and accurate understanding of modern politics really is available to human beings at all. But those who earn a living by purporting to teach others how to understand it must at least try, as best they can, to understand it first for themselves. More pressingly and less parochially, those who choose to take political action need at least some conception of what they are attempting to do, and it is hard to see how they can hope to sustain such conceptions without some sense of what politics today is in fact about or what its human significance now really is.

This collection of essays focuses upon a single key issue in the somewhat groggy history of modern political thinking: the limits set to what is now politically possible by economic structures, processes, and activities. These limits have been a pressing preoccupation, for those in quest of practical just as much as theoretical understanding, for at least two centuries. They have prompted the most ambitious and confident of modern attempts to explain political processes and political development. In the eighteenth and nineteenth centuries, in the heyday first of liberal and then of socialist political ideologies, they underpinned the boldest expectations of moral and material progress and inspired great social and political movements devoted to bringing such progress about.

Any coherent modern political theory must contain, at a minimum, three elements. It must contain in the first place an articulated conception of individual good. It must add to this, in the second place, a constitutional theory of how power can be institutionalized, not merely to acknowledge formally the status of this conception of individual good, but also to promote its effective implementation in practice. And it must round these two elements out with a third and equally indispensable element: a conception of sound economic policy that can reasonably hope to prove effective through time. Each of the elements in this inventory could do with some glossing, and no one should mistake it as, even in intention, an exhaustive list. But it does, I trust, focus helpfully the three most problematic and least dispensable elements in modern political theory and brings out immediately the still more problematic relations that obtain between them. One feature which is rather evidently missing from the three elements is a determinate (and essentially prepolitical) conception of a community of membership which furnishes many of the most significant components in the several conceptions of individual good held by its members, lends a natural and compelling form to the constitutional theory of how power can best be institutionalized to do justice to these conceptions, and fosters (or at least fails to militate drastically against) the devising and sustaining of dependable modes of economic policy.

World politics both creates opportunities for modern governments and imposes constraints on the range of actions that it is feasible for them to pursue. One way to think about these opportunities and constraints is to analyze the operation of the contemporary international political–military system, or the world political economy, and to consider how these systems affect state action. Much of the modern study of international relations is devoted to this task. Yet another perspective on the impact of world politics on states can be gained by asking how perceptive observers of politics have reflected on these issues in the past. This approach, which looks to the history of political thought for insights into contemporary international affairs, will be pursued here. Although the form and intensity of the constraints and opportunities created by the contemporary world system are different from those in earlier centuries, the impact of international politics and economics on state action has been evident for a long time, and has occasioned a great deal of sophisticated commentary.

At some risk of blurring differences between thinkers of broadly similar inclinations, three major Western schools of thought on this subject can be identified: Marxist, realist and liberal. Each has been influential, although it is probably fair to say that realism has been the creed of Continental European statesmen for centuries, and that since World War II it has been predominant in the United States as well.

There are many kinds of economic limits to politics, by no means all of them distinctively a product of the “modern age.” Here we shall consider only the specific limit to politics set by the imperative need of modern nations to succeed in international trade, arguing that this particular limitation in substantial territorial states came into existence only when a number of European countries were transformed into what eighteenth-century political economists called “commercial societies.”

In the 1660s the former English ambassador William Temple, in his influential analysis of its politics and commerce, observed that Holland was then facing an entirely novel adverse situation in international markets, one which he predicted would soon put an end to the country's miraculous development. He did not advance the familiar moralistic analysis in terms of the impact of luxury and the decline this must inevitably promote. He predicted the decline of Holland not because all good things must at some point come to an end or because of the supposedly corrupting impact of increasing opulence. Rather, he insisted upon the reality of a transformation in the world trading regime which was wholly independent of the practical merits or demerits of Dutch trading policy.

How is it possible to understand modern politics, say, the modern politics of the United States and Britain, of Japan and North Korea, of the Philippines and Burkina Faso, of the Soviet Union and Brazil?

It is, of course, impossible to understand the politics of anywhere at any time without knowing a great deal about that place at that time. But in addition to such immersion in the particular it is also always helpful to consider techniques of understanding or approaches towards understanding: how to understand, not what is the case. In this respect at least, in its comprehension of the scope and limits of its own techniques of understanding and its own approach, the academic discipline of political science has been a fairly unmitigated intellectual disaster. This is no doubt, so far as it goes, an occasion for legitimate merriment. But it reflects a much wider cognitive failure (a failure which runs in some measure through the entire citizenry and governmental circles of nation states across the world today). In this form it seems exceedingly unlikely that the limits on the intelligibility of modern politics are to any degree a good thing: not least, because it is now apparent even to such reluctant learners as the political leaders of the United States and the Soviet Union that only a drastic and imaginative extension of its collaborative political skills can give the human race a reasonable prospect of protracted survival in the world in which we now live.

What is “political economy”? The term was coined early in the seventeenth century by Antoine de Montchrétien (a now largely forgotten dramatist) to explain to the French king how the management of a family household could serve as a good model for the management of the polity. His once influential Traicté de l'oeconomie politique (1615) inaugurated a tradition of urging rulers and legislators to become “economists,” to base policy on the assumption that among the first aims of government were the proper understanding and management of a market economy just in the process of emerging. (Adam Smith's Wealth of Nations [1776] was, among other things, the masterwork in that tradition.) Today the study of political economy is sometimes defined – more clearly, if less ambitiously – as an attempt to link the subject matter of political science with the methods and theories of neoclassical economics. But that definition is misleadingly narrow. Indeed, the concept of political economy that the contributors to this volume address describes a broad field of inquiry in which historians and philosophers, as well as economists and political scientists, now make contributions of shared and equal interest. It is arguable, too, that their interdisciplinary research and theorizing represent a recovery and replenishment of political economy as it first emerged in early modern Western thought – namely, an inquiry distinctively concerned with the conduct, institutions, and values of market societies, but always ready to borrow from history, jurisprudence, moral philosophy, and political theory.

To speak of “the economic limits to modern politics” suggests that the modern state operates in a context, and within limits, set for it by modern economics; that there are economic limits to what the state can do. What, then, were things like before there were modern economics? Could “the state,” or some other kind of political structure, do more than it can now that modern economics have arisen to condition it? I intend to show that this was by no means the case: that the efficacy of modern politics, its power and perhaps also its justice, have increased concurrently, though not exactly proportionately, with the increase in the efficacy of economic(s) arrangements: and particularly, with the increased efficacy of market mechanisms in human society. This is a major development in social history, and like all such developments it is attended with problems. We may be able to advance our understanding by some consideration of the way things used to be before they became what they are now.

Before I proceed with this subject, I had better explain the way in which I shall be presenting it. I look at the general history of society from the viewpoint not of an economic or even a social historian, but of a historian of social theory; a historian, that is, of the ways in which people have tried to understand and present the things that were happening to them in society.