¹ This essay is drawn from work leading to a book length manuscript: The Market Paradigm, Oxford University Press, forthcoming. The book is an account of what happens when welfare economics and public choice meet political and legal theory. It is an effort to explore the extent to which welfare economic and rational choice models can account for political institutions, including constitutions, courts, and legislatures, and the extent to which markets themselves presuppose such institutional arrangements.

² There is a difference between maximizing the satisfaction of one's preferences, and maximizing one's welfare, well-being, or utility. The Pareto-criteria can be expressed in terms of all four. For ease of exposition, I shall write mostly in terms of preference satisfaction, because nothing in the argument I advance depends on the differences, and because it is common in welfare economics to treat these interchangeably – though in many contexts, doing so is a mistake.

³ Recent work by “catstrophe,” “chaos,” or “disequilibrium” theorists has raised doubts about whether even the first theorem of welfare economics obtains. Their view is that the core is empty. The seminal piece is Ostroy, J., “The No-Surplus Condition as a Characteristic of Perfectly Competitive Equilibrium,” Journal of Economic Theory, vol. 22 (1980), pp. 183–207.CrossRefGoogle Scholar The absence of a core in the voting context has been demonstrated by both Norman Schofield and Richard McKelvey. Both prove that simple majority voting rules create cycles under conditions that almost always obtain. See Schofield, N., “Instability of Simple Dynamic Games,” Review of Economic Studies, vol. 45 (1978), pp. 575–594CrossRefGoogle Scholar; and McKelvey, R., “General Conditions for Global Intransitivities in Formal Voting Models,” Econometrica, vol. 47 (1979), pp. 1085–1111.CrossRefGoogle Scholar Both papers are extremely technical. The general view, expressed best by Schofield, is that both politics and economics are chaotic – marginalism is out, and anything can happen.

⁴ Within limits. There is a tension between claims (2) and (3). If one advances a Nozickian account, then there exists no way of moving the economy along the frontier that does not create injustice. So an economy can secure both (1) and (2) only by restricting or constraining the competitive mechanism somewhat, i.e., by violating (3). Alternatively, we might consider simply redistributing property rights ex ante to satisfy (1), (2), and in a weaker sense (3). This approach follows naturally from what Sen refers to as the Converse Theorem of Welfare Economics, which is roughly: for any point on the frontier, there exists an initial allocation of property rights capable of securing it as a unique outcome of the competitive mechanism. Following the dicates of the Converse Theorem may be no less troublesome to a “noninterventionist” than would be ex post redistribution, however. See A. Sen, “The Moral Standing of the Market,”Social Philosophy & Policy (this issue).

⁵ For a more complete discussion, see Infra, subsection entitled “Pre-Market Market Failure and the Problem of Rational Agreement.”

⁶ It is worth distinguishing between two notions of equilibrium: Nashian and dominant. The Prisoner's Dilemma is a dominant equilibrium. That means, in equilibrium no agent will alter his strategy no matter what anyone else does, because his current play constitutes the best he can do no matter what others do. In Nashian equilibrium, an agent might change his play if others do, but he is unwilling to change his play alone. The difference is important. In several approaches to solving the Public Goods Prisoner's Dilemma, it turns out that honestly revealing one's preferences for public goods will not be a dominant strategy. Only a weaker, Nashian equilibrium emerges, for example, under a Groves-Ledyard incentive-compatible mechanism.

⁷ Hardin, Russell, “Collective Action as an Agreeable n-Prisoner's Dilemma,” Behavioral Science, vol. 16, (1971), p. 473.CrossRefGoogle Scholar

⁸ The seminal piece is Coase, R., “The Problem of Social Cost,” Journal of Law and Economics, vol. 3 (1960), pp. 1–30.CrossRefGoogle Scholar

⁹ Exchange-as-Prisoner's Dilemma

¹⁰ This highlights the importance of demand revelation mechanisms. All such mechanisms seek to induce individuals to reveal information, making honesty in each individual's rational self-interest. Bargaining in the absence of such incentives will be swamped by strategic behavior.

¹¹ Calabresi, G. and Malamed, D., “Property Rules, Liability Rules and Inalienability: One View of the Cathedral,” Harvard Law Review, vol. 85 (1972): pp. 1089–1128.CrossRefGoogle Scholar

¹² It is doubtful that there can be indefinitely increasing economies of scale. Consequently, the argument works only for groups of certain sizes.

¹³ My claim is not that for each person in the state of nature the rational strategy is to engage in both attack and defense strategies. Instead, my claim is the weaker one – given the assumptions of the argument, for those who engage in both attack and defense, the expected payoff of doing so is H – (p + a). These individuals have an incentive to collectively provide protection, provided the costs of doing so are less than (p + a) for each. Others in the state of nature may seek membership in the coalition that provides protection on other grounds.

¹⁴ My original interest in this project grew out of my work in law and economics. Advocates of the economic approach to law typically claim that the law should seek to promote both efficiency and wealth distribution, but they give no foundation for that claim. The market-contractarian account of rational political association provides the missing foundation.

¹⁵ The following argument was much influenced by several discussions with James Buchanan.

¹⁶ Here is one argument for constitutional constraints on budgets that goes in the opposite direction from the standard one. Usually, those who advance the cause of a constitutional amendment want to limit spending to collected revenues. The argument here is to restrict collected revenues so they do not exceed the sum of provision and administrative costs necessary to provide optimal levels of public goods.

¹⁷ Coleman, J. L., “Economics and the Law: A Critical Review of the Foundations of the Economic Approach to Law,” Ethics, vol. 94 (1984), pp. 649–679CrossRefGoogle Scholar, especially pp. 664–667.

¹⁸ Gauthier, D., Morals By Agreement (Oxford University Press, forthcoming 1985).Google Scholar

¹⁹ For a contrasting view, see Gauthier.

²⁰ Alternatively, one could argue that the outcome is efficient because it has secured everyone's consent, whether or not it is efficient in the standard economic sense. This is Buchanan's view. For a discussion of its motivations and its problems, see below, “Unanimity as Efficiency.”

²¹ The claim here is that even a fair bargain is subject to rent-seeking efforts. That is because self-interested actors abide by fair bargains only if they view the fairness of the bargain as working to their advantage.

²² Even then it is not clear that fairness of the point of departure suffices to stabilize bargains. Indeed, I want to go so far as to say that bargaining – even from a fair status quo point – will yield stable outcomes only if the parties already have a sense of fairness or a commitment to the ideal of fairness. It is a further question whether commitment to the ideal fairness or to being bound to one's bargains can itself be grounded on the rational self-interest of bargainers.

²³ A. Feldman, Social Choice and Welfare Economics.

²⁴ For a fuller discussion of demand revelation mechanisms, see the special supplement to the Spring 1977 issue of Public Choice, vol. XXIX–2.

²⁵ K. Wicksell, “A New Principle of Just Taxation,” Finanztheoretische Untersuchungen (Jena: 1896).

²⁶ Lindahl, E., “Just Taxation – A Positive Solution,” Musgrave, R. and Peacock, A. T., eds., Classics in the Theory of Public Finance (New York: St. Martins, 1967), pp. 168–176.Google Scholar

²⁷ Mueller, D., Public Choice (Cambridge: Cambridge University Press, 1979), p. 29.Google Scholar

²⁸ The lens defines the range of Pareto-improving tax packages.

²⁹ Cf. Buchanan, J., The Limits of Liberty: Between Anarchy and Leviathan (Chicago: University of Chicago Press, 1975).Google Scholar

³⁰ Barry, B., Review of Limits of Liberty: Between Anarchy and Leviathan, in Theory and Decision, vol. 12 (1980), pp. 95–106CrossRefGoogle Scholar, esp. page 96.

³¹ Coleman, J. L., “The Foundations of Constitutional Economics,” in Constitutional Economics: Containing the Economic Powers of Government, ed. Richard, McKenzie (Lexington, Mass.: D. C. Heath and Co., 1984).Google Scholar

³² See Samuelson, P. A., “The Pure Theory of Public Expenditure,” Review of Economic Statistics, vol. 36 (1954), pp. 386–389.CrossRefGoogle Scholar

³³ The inefficiency of majority rule is neatly discussed in Mueller, Public Choice, esp. pp. 31–47.

³⁴ I have a conjecture that I argue for in The Market Paradigm, and it is a follows: All institutional mechanisms for solving the public goods problems – from Lindahl-Wicksell taxes to Groves-Ledyard incentive-compatible mechanisms – are subject to problems precisely analogous to those that arise in the private provision of public goods. Therefore, they also tend to solve the public goods problem under the same conditions the private market does, i.e., iteration or honest preference revelation.

³⁵ Because of the incentives for strategic behavior in the collective choice and cooperative contexts, economists have been driven to develop demand-revealing mechanisms that seek to solve the problem of demand revelation noncooperatively. An example of a noncooperative, demand-revelation mechanism is the second-bid auction. In a second-bid auction, the high bidder wins but he pays a price determined by the second highest bid. Therefore, he has no incentive to behave strategically. His best strategy is to reveal his true preference.

³⁶ The problem is that the unanimity rule gives a special standing to the status quo. To see this, consider two allocations, R₁ and R₂. First, let R₁ be the status quo. Then, unless everyone agrees to R₂, R₁ obtains. Suppose, however, we treat R₂ as the status quo. Now unless everyone agrees to R₁, R₂ obtains. If R₁ is in fact the status quo, it obtains if not everyone agrees to R₂, even though, from another perspective – the vantage point of persons at R₂ – R₁ is not itself efficient. The only justification for giving R₁ a privileged status is the belief that it somehow emerged from a series of Pareto-improvements. In general we see no reason to hold such a belief.

³⁷ This is just the question of whether rational bargaining also provides a theory of “moral bargaining”: whether, in my terms, market contractarianism can also yield a version of “moral contractarianism.” I take this issue up in the final section of The Market Paradigm.

³⁸ Buchanan, Limits of Liberty, pp. 78, 82–83.

³⁹ Consider a simple illustration of cycling, when a rule of simple majority is used for redistributive purposes only. Suppose, A, B, and C are to split $10,000 among them. A and B form a winning coalition to omit C and split the $10,000 as follows: $7,000 to A (it was his idea), $3,000 to B. Now C offers B a different split, say, 6,000 to C, 4,000 to B. B accepts, and B and C are a winning coalition. Now A is left out, so he offers B or C a split favorable to either, and so it goes.

⁴⁰ See M. de Condorcet, Essai sur l'Application de L'sAnalyse à la Probabilite des Decisions Rendues à la Pluraliste de Voix (Paris: 1785).

⁴¹ Michael Trebilcock has pointed out to me that this objection may not be a fair one in the context of developing a market theory of collective choice in which we assume individuals act to advance the satisfaction of their interests.

⁴² See J.L. Coleman, “The Unsteady Foundations of Liberal Democracy” (unpublished manuscript).