Social Choice: An Overview

1. Social Choice: An Overview Michael Munger Duke University Public Choice Outreach GMU, Fairfax, VA July 2006

2. Why Study Social Choice? • Isn’t a society just a bunch of people arguing? • B&T: Origin of Government is disagreement, capturing gains from “exchange”

3. Why Study Social Choice: Contract? Discussion must be concentrated on the "margins" of variation in political institutions, not on the "totality" of such institutions, and the relevant question becomes one of criteria through which the several possible marginal adjustments may be arrayed. The contract theory, in this context, may be interpreted as providing one such criterion. Adopting the criterion implicit in the contract theory, the analysis of political institutions asks: On what changes in the existing set of rules defining the political order can all citizens agree? This embodiment of the unanimity rule for all basic, structural reforms in political institutions, in the constitution, reflects the individualistic ethic in its broadest sense. (Calculus, Buchanan Appendix)

4. Why Study Social Choice? • What does justice mean? Fairness? Do these words just mean whatever the speaker wants, or do they have objective meanings? • Is it more important to have • Liberty? • Justice? • Security? Justice Security Liberty

5. Common Heritage, Though Different “Schools” • In fact….. What about it, Dad?

6. “The” Right Thing • There may not be any one right thing to do. It depends. • It is the nature of collective choices that they are unitary: One defense budget, one standard for pollution, and so on. • Asking “What Will We Do?” begs the question. The real question is… Why Do You Think There is a ‘We’? • Buchanan and Tullock’s “Two Levels”: Can’t let the majority decide what the majority gets to decide

7. Coherence and Legitimacy Can a group of people who disagree come to a consensus? How would this work? Why would we believe that the “consensus” is any more than an imperfect choice? Do the choices of majorities tell us anything about “the right thing to do” in the face of disagreement? Is there such a thing as “the majority,” which we just have to discover through voting or some political process? I want…you want…what do we want?

8. Institutional Design • Institutions are the humanly devised rules of the game that shape and direct human interactions. • Institutions reduce uncertainty by shrinking the choice set of all of the “players.” If the rules are not formalized, the players spend too much time arguing over the rules, and less time in productive activities. The actual choice of institutions, however, is hard, since there are countless ways of choosing. What makes some institutions better than others? • In particular, is democracy a “good” institution? How would we know? What are the alternatives?

9. Tacoma Narrows Bridge

10. THE PROBLEMS OF SOCIAL CHOICE“Overview”: Absolved!! • I. Problem of Unintended Consequences • II. MetaSocial, or MetaChoice • III. Three sources of legitimacy/authority • IV. Transactions Costs and Markets—Coase, Kaldor/Hicks, Hayek. • V. Politics—Three problems: Buchanan, Hayek, Condorcet

11. THE PROBLEMS OF SOCIAL CHOICE“Overview”: Absolved!! • I. Problem of Unintended Consequences • II. MetaSocial, or MetaChoice • III. Three sources of legitimacy/authority • IV. Transactions Costs and Markets—Coase, Kaldor/Hicks, Hayek. • V. Politics—Three problems: Buchanan, Hayek, Condorcet

12. I. Unintended Consequences (Part the First) Unexpected aggregate consequences of individual choice • Hog cycles • Keynes’ paradox of thrift • Hobbesian SoN/Prisoner’s Dilemma

13. I. Unintended Consequences(Part the Second): Social Choice is Different Unexpected individual consequences of aggregate choices • Auto safety: Are Safer Cars Safer? • Alliances: Most Fail When Attacked... • Pigou vs. Coase

14. Ind’l reactions:Some Examples... Auto Safety: Peltzman claimed people choose their own risk level. Tullock’s “Modest Proposal”:

15. Ind’l reactions:Some Examples... Alliances: Clearly, alliances are worthless. Nearly all alliances fail when attacked, in fact. So an alliance agreement is of no value in deterring attack or protecting one’s citizens. Right? No.

16. Ind’l Reactions:Examples--Pigou vs. Coase Pigou’s Conjecture: Markets are inefficient, as a means of allocating resources, to the extent that the (social) opportunity cost of a resource diverges from its price, or private cost to the user. Coases’s Counter-Conjecture: If property rights are clearly and exclusively defined, and the cost of writing and enforcing contracts is not too high, market forces will make the opportunity cost and the price of a resource converge.

17. THE PROBLEMS OF SOCIAL CHOICE“Overview”: Absolved!! • I. Problem of Unintended Consequences • II. MetaSocial, or MetaChoice • III. Three sources of legitimacy/authority • IV. Transactions Costs and Markets—Coase, Kaldor/Hicks, Hayek. • V. Politics—Three problems: Buchanan, Hayek, Condorcet

18. II. Social metaChoice or MetaSocial Choice? • Choice of rules creates “the” society…The society is constituted by its constitution. • Choice of basic allocations, distributions of power and wealth • Partition of choice authority / legitimacy

19. Social metaChoice or MetaSocial Choice? • Choice of rules creates “the” society…The society is constituted by its constitution. • Constitutional Political Economy

20. Social metaChoice or MetaSocial Choice? • Choice of basic allocations, distributions of power and wealth PPF Bergson-Samuelson SWF Secular Deism

21. Social metaChoice or MetaSocial Choice? Roses PPF 2 PPF 1 Guns

22. Social metaChoice or MetaSocial Choice? Bergson-Samuelson Roses PPF SWF Guns

23. Social metaChoice or MetaSocial Choice? Bergson-Samuelson: Deism Two Welfare Theorems Roses Guns

24. Social metaChoice or MetaSocial Choice? Arrow: No SWF!!! Buchanan: Ontology Roses Guns

25. THE PROBLEMS OF SOCIAL CHOICE“Overview”: Absolved!! • I. Problem of Unintended Consequences • II. MetaSocial, or MetaChoice • III. Three sources of legitimacy/authority • IV. Transactions Costs and Markets—Coase, Kaldor/Hicks, Hayek. • V. Politics—Three problems: Buchanan, Hayek, Condorcet

26. Legitimacy/Authority: Hobbes or Hume? The origin of civil government and the major influences in its development may be almost wholly nonrational in the sense that explanation on a contractual basis is possible. Societies form governments and change governments for a variety of reasons, many of which remain mysterious and far below the level of objective, scientific analysis. Political institutions, like languages, get changed, almost beyond recognition, by the gradual and largely unconscious modification imposed on them by the movement through time. In this sense political society can be said to develop and to grow organically; and, if the purpose of investigation is solely that of explaining such growth, there is perhaps little purpose in inventing anything like the contractual apparatus. (Calculus, Buchanan Appendix)

27. Legitimacy/Authority:Hobbes or Hume? Partition of choice authority / legitimacy My own view: Three sources of authority, or legitimate decision-making, in any society • Politics/Democracy • Experts/Bureaucracy • Markets Munger (2000), Analyzing Policy, W.W. Norton

28. Markets Experts Politics

29. Markets • Efficiency Policies • Market Structure • Control Externalities • Public Goods • Information Asymmetry • Equity Policies • Income Redistribution • Resource Distribution • Control Externalities • Institutional Reform Policies • Information • Values (Efficiency v. Equity) • Institutional Design Experts Politics

30. Markets • Efficiency Policies • Market Structure • Control Externalities • Public Goods • Information Asymmetry • Equity Policies • Income Redistribution • Resource Distribution • Control Externalities • Institutional Reform Policies • Information • Values (Efficiency v. Equity) • Institutional Design Experts Politics Poli Sci (election / campaign finance reform, etc.)

31. Markets From whence? To what effect? • Efficiency Policies • Market Structure • Control Externalities • Public Goods • Information Asymmetry • Equity Policies • Income Redistribution • Resource Distribution • Control Externalities • Institutional Reform Policies • Information • Values (Efficiency v. Equity) • Institutional Design Experts Politics

32. THE PROBLEMS OF SOCIAL CHOICE“Overview”: Absolved!! • I. Problem of Unintended Consequences • II. MetaSocial, or MetaChoice • III. Three sources of legitimacy/authority • IV. Transactions Costs and Markets—Coase, Kaldor/Hicks, Hayek. • V. Politics—Three problems: Buchanan, Hayek, Condorcet

33. Focus for a moment on Markets…. • Markets are not the absence of other sources of authority. Markets do not just happen. • On the other hand, unless the other sources of authority actively prevent market development, then at least some rudimentary market processes will nearly always spring up. • Active markets tend to drive prices down toward production costs. Corporations and firms prefer profits go up, not down. So the self-interest of firms is generally to try to suppress the workings of markets. • Fortunately, markets are robust enough that they are not easily suppressed, without the active complicity of one of the other sources of authority.

34. Preconditions for Markets(Necessary Conditions) • Differences in goals, tastes, or desires (diverse preferences) • Differences in endowments of productive resources and personal talents (diverse endowments) • Declining average costs as more output is produced (economies of scale) • Declining average costs as the scope of action of one producer is decreased (specialization and division of labor)

35. Gains From Trade • Gains from trade: Differences in endowments, or differences in preferences, result in improved welfare for all participants, as long as trades are informed and voluntary. This is a benefit in consumption, since by rearranging the consumption bundles among citizens, we can make everyone better off, even though there is no increase in the total amount of goods available for consumption. Magic? No, just markets.

36. Gains in Productive Efficiency • By allowing entrepreneurs to take advantage of economies of scale, or economies accruing to increased specialization, markets foster economic growth. An increase in the level of economic activity means growth in the total amount of consumption goods available to citizens. Increased efficiency in production means that more can be produced with the same resources, again creating the potential for everyone to be better off.

37. Bonus: Reductions in transactions costs, using information transmitted by prices Quite separate from efficiency in the allocation of consumption goods (i.e., ensuring all gains from trade are exhausted) and efficiency in the allocation of productive resources, markets also provide the important service of providing information. Prices convey information about relative scarcity in a concise, yet effective way.

38. Information, Tastes, and Culture “The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.” (F.A. Hayek, 1945, AER).

39. Four Ways to Allocate Resources in the Face of Scarcity 1. Price System (market): Resources are directed to their highest-valued use, so that whoever is willing to pay the most (either in terms of other valuable goods, or in currency) gets to control the resource. Big winners: People with lots of money, or with talents or resources the society values highly. Disadvantages: There are two. (a) Poor people may get too little, creating ethical problems of equity. (b) Independently of their basis in justice, market allocations may be politically untenable, if democratically-based authority is in a position to impose redistributive or confiscatory taxes.

40. Four Ways to Allocate Resources in the Face of Scarcity 2. Queuing: A queue is a line. Queuing means a system of allocation based on waiting your turn. So, first in line is first in priority. If all the resource is used up before your turn, you lose out. Big winners: People with lots of time (actually, a low opportunity cost of time spent waiting in line). Disadvantages: There are two. (a) People standing in line incur lots of “deadweight losses,” or time wasted, for no gain in consumption or productivity. (b) There is no reason to believe that resources are directed to their highest valued uses: “black” markets 

41. Four Ways to Allocate Resources in the Face of Scarcity 3. Chance: Lotteries, drawings, or other random selection processes mean everyone has an equal chance of winning. Big winners: No individual is a winner from the process, because in terms of expected value everyone is treated the same. From an ethical perspective, however, this may be an advantage. Disadvantage: By definition, allocation is random. The person who actually gets the resource may value it at only a fraction of its worth to someone else. Opportunity cost is explicitly ignored in random processes. Consequently, chance allocations evoke secondary markets for reallocating by price.

42. Four Ways to Allocate Resources in the Face of Scarcity 4. Authority/Discretion: Allocations can be made by experts, party officials, elected leaders, or central planners. This sort of allocation process is also called a “command” system. Big winners: Guess who: the party officials, their friends, and family! Alternatively, the beneficiaries of the policy may be those targeted by the policy, if discretion is used to avoid corruption and follow the rules. Disadvantage: There are two. (a) Lose the information inherent in prices. (b) Corruption is irresistible.

43. Can Markets “Plan” the Economy? Adam Smith’s “invisible hand” Social planner, and the farmer

44. My Plan + Your Plan  Our PlanSocialist Calculation Debate “This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals. Planning in the specific sense in which the term is used in contemporary controversy necessarily means central planning—direction of the whole economic system according to one unified plan. Competition, on the other hand, means decentralized planning by many separate persons. The halfway house between the two, about which many people talk but which few like when they see it, is the delegation of planning to organized industries, or, in other words, monopoly.” (Hayek, 1945).

45. Division of Labor It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than buy. The taylor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employes a taylor. The farmer attempts to make neither the one nor the other, but employs those different artificers. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbours, and to purchase with a part of its produce, or what is the same thing, with the price of a part of it, whatever else they have occasion for. (WoN, p. 485).

46. Specialization To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. ... the important business of making a pin is, in this manner, divided into about eighteen distinct operation, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of middling size. Those ten persons, therefore, could make among them upwards of forty eight thousand pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day. (WoN, pp. 4-5).

47. Division of Labor is the Most Powerful Force for Social Change the World has EVER Known • Division of labor is limited by the extent of the market • Globalization would result from DoL regardless of colonialization or any other conscious policy of governments • But, is it good? Is it just? Is it inevitable? Would we CHOOSE it, if the choice were presented? Or, is it just the aggregate unintended consequence of ind’l choice?

48. Markets…. • Coase • Kaldor-Hicks • Potential Pareto • Hayek

49. THE PROBLEMS OF SOCIAL CHOICE“Overview”: Absolved!! • I. Problem of Unintended Consequences • II. MetaSocial, or MetaChoice • III. Three sources of legitimacy/authority • IV. Transactions Costs and Markets—Coase, Kaldor/Hicks, Hayek. • V. Politics—Three problems: Buchanan, Hayek, Condorcet

50. Step back for a moment….The Fundamental Human Problem(according to Munger) How can we construct or preserve institutions that make individual self-interestnot inconsistent with the common good?