A Generalized Economic Theory of Constitutions: The Veil of Ignorance

1. The Calculus of ConsentCh 6: A Generalized Economic Theory of Constitutions

2. The Veil of Ignorance • In order to decide what actions should be decided collectively, free and rational individuals need to know the costs of government action but we can’t know these costs before we know how government will be organized. • In Chapter 6, B&T look at what constitutional rules,rules to govern future decisions, that free and rational individuals would adopt behind a “veil of ignorance” or at a “constitutional moment.” • The language is due to John Rawls but the idea is the same as “justice is blind.”

3. Choosing the Rules • Choice of the rules to govern the future game is by unanimity. • Once again, this is partly an intellectual exercise to see what rules are just but the assumptions may also be roughly accurate at certain times and places, such as the US constitutional convention of 1789. • Other constitutional moments may suffer precisely because the veil of ignorance was pierced. • US constitutional rules certainly suffered because at the time of the constitutional convention a great exception to the veil of ignorance was that everyone knew their color and who was slave and free.

4. The Coercive External Costs Function • The coercive external costs are the expected costs of being in the minority – having a collective decision go against one self. • These costs are a function of the number of individuals who are required to be decisive. • Expected external costs will be higher the lower the decision rule. • Note that these are the costs of a rule that will govern many future choices. Expected External Costs (present value) Higher expected external costs when decision rule is less than unanimity C At unanimity, expected external costs are zero N Number of Individuals required to take collective action

5. Decision Making Costs Expected External Costs (present value) At unanimity, expected decision costs are very high • Decision making costs are the costs of discussion, organization, bargaining etc. • Decision making costs rise with the decision rule. Why? • Holdouts and transaction costs. D Lower expected decision costs when decision rule is less than unanimity N Number of Individuals required to take collective action

6. Choose the Decision Rule to Minimize Total (C+D) Costs • Note that the minimum of the C+D curve is not necessarily the crossing point! • K/N is the ideal voting rule. • Important! The ideal voting rule is not necessarily majority rule! Costs C+D Costs Decision costs C (External Costs) K N Number of Individuals required to take collective action

7. Choose the Decision Rule to Minimize Total (C+D) Costs Costs • The optimal decision making rule will vary depending on the cost functions. • An area of choice involving potentially very high external costs, such as that involving religion, free speech, basic property rights, or the modification of the constitution itself will have very external costs that will not fall until near-unanimity is reached. • As a result the optimal decision rule will be near-unanimity. Examples? C+D Costs C (External Costs) Decision costs K N Number of Individuals required to take collective action

8. Near Unanimity Requirements • The first amendment clause in the Bill of Rights – “Congress shall make no law respecting an establishment of religion…” • Amendments to the constitution require 2/3rds of House and Senate and 3/4s of the States. • Further implications – it makes sense to have a constitution – not just majority rule. • In what sort of societies will the external cost function be high?

9. What Decisions Should be Made Privately and When Collectively? • Recall the costs of different alternatives A, B, G. • We now know more about the G costs and how they vary with the decision making rule. • Thus, now let’s put it all together.

10. What Decisions Should be Made Privately and When Collectively? Costs • Even assuming an optimal decision making rule of K/N it could be the case that the costs of leaving the activity in private hands (A) is lower. • Thus the higher the C+D costs (for whatever reason) the greater the likelihood that an activity should be left private. C+D Costs A K N Number of Individuals required to take collective action

11. What Decisions Should be Made Privately and When Collectively? • More generally, we could have a situation where it would make sense to undertake an activity collectively if the decision rule were in some “optimal” range, say between Q and Q’ but not otherwise. Costs C+D Costs A Costs of leaving private Q Q’ N Number of Individuals required to take collective action

12. Hetereogeneity and the Optimal Constitution • What is the effect of greater heterogeneity on the optimal constitution? • External costs rise because the fear of being in the minority increases. • In a homogeneous society people are less worried about collective action because no one wants to exploit themselves. • If everyone is the same religion you need not require a near-unanimous rule to make collective choices about religion – instead you can trust that what other people think is in their self-interest will also be in your self interest. • Similarly, it’s hard to exploit you if you are just like everyone else.

13. Hetereogeneity and the Optimal Constitution • The external cost function will be high if the society is heterogeneous in income, religion, ethnicity or other factor • Decision making costs increase because it is more difficult to get agreement in heterogeneous group than in a homogeneous group. • The optimal decision making rule could go either way depending on whether the increase in the external cost or decision making cost function is greater. It’s probably the former so the decision making rule increases. • Total C+D costs increase for certain so fewer decisions should be made collectively.

14. Hetereogeneity and the Optimal Constitution • In a profound statement Buchanan and Tullock write: “Many activities that may be quite rationally collectivized in Sweden, a country with a relatively homogeneous population, should be privately organized in India, Switzerland, or the United States.” • Compare Buchanan and Tullock with standard stories about how “market failure” implies a role for government – these are one size fits all rules that are very misleading and potentially dangerous guides to policy. • The optimal policy rule is time and place dependent.

15. Hetereogeneity and the Optimal Constitution • What happens when a society becomes more heterogeneous but the decision making rule does not change? • Opportunities for exploitation • Rent seeking • Acrimony and rivalry

16. Group Size and The Optimal Constitution • It’s easier to get agreement among 55 of 100 than among 550 of 1000. i.e. decision making costs increase in the number of people required to agree for any given decision rule. • Thus, C+D costs increase in group size. What happens to ideal K/N? • Goes down. • This implies a theory of the optimum group. Since decision costs increase with group size you want collective decisions to be made by the smallest group consistent with the size of the externality/public good problem that is to be addressed. • More generally, extend size of group so long as the expected benefits of solving the externality/public good problem for a larger group exceed the increase in decision making costs. • We will take these issue up in greater depth when we discuss Federalism.