A Better Kind of Violence

by Filip Palda

  When the social accounts fall too far out of balance the ties that bind people to each other dissolve. Revolution or civil war may ensue. A new set of social ledgers and method of social accounting will have to be devised in order for society to form again.

  History can be seen as the search for functional systems of social accounting adapted to different settings. To date there seem to be three types of accounting that cover most situations. Karl Polanyi called them reciprocity, redistribution, exchange. Reciprocity is usually enacted within the system of the village, or the tribe. You scratch my back, I scratch yours. No money is needed because accounts can be kept in the mind and enforced by the simple expedient of expelling anyone who violates them. Redistribution is a form of social accounting generally realized through an institutional structure known as central planning. Exchange generally takes place in a free market with private property under the rule of law. Describing Polanyi’s work, Temin explains that “Reciprocity is an informal system in which people aim toward a rough balance between the goods and services they give and receive, with relative values determined by social obligations and traditions that change only slowly. Redistribution is a system in which goods are collected by a central authority and distributed by virtue of custom, law or ad hoc decision. Exchange is the set of economic transactions in which people voluntarily exchange goods and services either in barter or for money.” Each system presents its members with different rules for calculating the advantages and costs of cooperating with others. Each system lasts only so long as a critical number of people calculate that the advantage of working in society exceeds the costs of staying in it.

  Pareto’s big idea

  PRIVATE PROPERTY UNDER rule of law produces a form of social accounting that has a very specific quality. No exchange of property happens unless it profits at least one person and harms no one else. Such exchanges are said to be “Pareto-improving”. Once all mutually profitable exchanges have been exhausted, society attains an equilibrium which is “Pareto-efficient”. This is another way of saying that social accounts are in balance in such a manner that there is no room left for mutually enhancing increases in wealth.

  To see how this efficient balance comes about, economists worked out the elements of supply and demand analysis. When a valued product is scarce, consumers are willing to pay more for it than it costs to make. Producers and consumers can split the difference. Such a difference is the sign that further mutually benefitting exchanges are possible. Producers continue to increase their output until what consumers are willing to pay for the last unit produced falls to just slightly above the cost of production. But before the price settles to that “equilibrium” level at which no further consumption or production takes place, money continues to change hands so long as consumers feel they are paying less than the maximum they are willing to pay. Producers are making profits because they are selling at prices above their minimum acceptable level (i.e. their costs). All these trades take place by mutual agreement and harm no one. At the equilibrium price all trades have been exhausted. No redistribution of resources can take place to benefit one person without harming at least one other person. The lack of further opportunities for mutual gain is what makes equilibrium efficient in the sense of Pareto.

  Supply and demand analysis induces somnolence in undergraduates. Their interest would spark if professors boasted. The discovery of the Pareto-efficient property of market equilibrium is the first rigorous statement in the history of thought about the forces that keep a society together. For all his bombast, Marx could never put a slide-rule to his soliloquies about social injustice. Measuring their social preoccupations also defied French physiocrats, British mercantilists, Machiavelli, Cicero, and Plato. They wrote with erudition but only words came out, not numbers. Market equilibrium analysis puts social accounting on a mathematical footing. Economics professors would ignite a bonfire of interest if they further explained that social accounts exist to coordinate behavior between people. Whether we speak of reciprocity, redistribution, or exchange, people orient their efforts towards activities that show a positive balance in the ledger. Thus the state of a ledger that concerns many people becomes a guide to mass, coordinated action.

  Pigou has a thought

  THE NEW TALK of economic efficiency made possible by Pareto, and the maturing concepts of demand and supply allowed Pigou to launch his attack on the efficiency of markets.

  Efficiency relied on everyone feeling the costs of their actions. Profit and loss motivated and chastened market actors. That was the only way to preserve resources and guide them to where they were most valued. A market failure blinded the entrepreneur to the true cost of her actions. Pigou said that government could correct that lack of insight through a tax. Supply equations showed the cost to producers of making their product and how they would react when prices changed. Pigou showed that these selfish reaction functions could be repurposed to reflect a social need. All you had to do was to “hack” into the private supply (cost) curve a corrective tax reflecting the monetary damage wrought by a market failure such as pollution. The supply curve then shifted and a new optimum could be calculated. Based on this blackboard reasoning, governments could impose an “optimal tax” that would guide the market back to an efficient state. Put differently, if government could identify where market prices had gone awry, then in supply and demand curves it had an advance warning system pointing to situations where coordination between masses of people seeking wealth might unravel. “Optimal” taxes and subsidies would point people once again in a direction of balanced social accounting that respected Pareto efficiency.

  The above sounds somewhat technical, but nothing less than the soul of economics was at stake. Pigou was quietly laying claim to the golden formula for guiding society to prosperity. The eccentric don was putting himself in the front rank of social philosophers. Mathematics of the optimal society was nothing to be sneered at. Even Plato had not given that a shot.

  Enter Coase

  COASE THOUGHT THAT Pigou was prescribing a false remedy for an imaginary illness. The famous “Coase theorem” states that no matter who owns a property subject to pollution, the final level of pollution will be optimal in the sense that neither polluter nor polluted could benefit from any change in the level of offensive emission. If a train casts sparks that burn a farmer’s crops, should the government fine the firm so that it is made aware of the imbalance in social accounts it may create? Coase said not at all. If property rights are such that the farmers are entitled to compensation from burnt crops the railway will continue to run engines that burn crops, provided the profit from these runs exceed the compensation required to farmers. This situation is Pareto efficient because no one is hurt in this scenario and at least one party gains. If railways own the right to cast sparks will they burn crops wantonly? Not at all was the answer. Farmers will be willing to pay the railways to reduce runs so long as the value of burnt crops is larger than the loss from reduced traffic. This was another Pareto efficient scenario. Even if there is no government to impose a fine or corrective tax, the farmer who resists sparks mindlessly forgoes potential payments by the railway. Economists call these lost revenues opportunity costs.

  Here then is the crux of the Coase argument. Opportunity costs make themselves felt no matter who owns the land provided property rights are clear. Even without any government to uphold property rights the incentive remains for those who devastate some property to restrain themselves in reaction to payments offered by those who suffer.

  To many economists then and even now it has never been clear what the big fuss over the Coase theorem is. Markets tend towards efficiency. So what? This is a valid question. The answers remain tentative to this day. The first is that the theorem alerted economist to the concept of a “Coasian bargain”. Roughly what this means is that some sort of mechanism such as a market with well-defined laws about property, can be used to smooth the way to negotiations between parties disputing some resource. Th
e Coasian agenda is one of identifying institutions, such as property rights, that will smooth the way towards agreements. In the jargon of the literature, institutions influence the transactions costs associated with disagreements over the use of property. In early history when the institution of property was ill defined, stable agreements were difficult and a great deal of fighting and nastiness causing needless harm was associated with disagreements over property. In the Coasian perspective, institutions evolved to minimize the costs associated with resolving such disputes.

  Another reason for the importance of Coase was that he provided practical validation for something known as the second welfare theorem of economics. This theorem had been proved ten years before Coase by Kenneth Arrow and Lionel McKenzie. Their version was a highly abstract proof showing that no matter how property rights are assigned, a Pareto optimum will eventually be reached. More formally, any Pareto-efficient allocation of resources can be “supported” by a competitive equilibrium.

  What economists took home from this was that economies based on markets were like self-sealing tires. Every time some shock came to upset claims to ownership, such as might happen in war or times of rapid innovations that put in question who is the rightful inventor of some great new product, eventually people will exchange their property rights or negotiate new rights in a manner that attains Pareto-efficiency. The insight was of great importance to economists of post-Soviet countries making the transition from state to private ownership. They learned that a redistribution of ownership shares in the economy would initially be inefficient but would tend towards an efficient outcome through Coasian deals between owners of these shares.

  Perhaps Coase’s greatest contribution was the habit of thought he inculcated by tracing the path from property rights to efficiency. He heightened the economist’s awareness of what might today be called the “ecology” of markets. Under the smooth curves of supply and demand lay institutional crags. The principles of the social calculus of mass coordination lay in supply and demand, but the details of how those principles were enacted depended on the means available for people to meet, agree, enforce contracts, and disseminate information between them on where the best deals were to be had.

  This ecology could be so complex that any attempts at government intervention to correct a perceived “market imperfection” had to be thoroughly worked out to be justified. If a Coasian saw a smokestack she had to muffle her cry for government to intervene with some tax on emissions or an anti-pollution regulation. Perhaps the costs to government of figuring out the correct tax were costlier than if private interests were allowed to work out some deal with each other to mitigate the “negative externality” from pollution.

  To Coase the academic knee that jerked at every seeming market failure needed a brace. One had to be sensitive to market inefficiencies of course, but one also had to be sensitive to the imaginative abilities and creative possibilities of solutions to externalities arrived at by private negotiation and consent. There was no doubt that private markets might get the calculations wrong. But so might governments. When neither could manage you might get a complete breakdown of civil order.

  Organizing large numbers of people to cooperate with each other is a costly and complicated business. Sometimes the “coordination costs” are so large that chaos ensues. Coase wanted people to think about what sorts of institutions would at very least avoid chaos, and at best minimize the costs people face when trying to negotiate some use of resources that appears to be in everyone’s interest. Was voluntary cooperation or coercion the answer?

  Coasians and government

  IN ASKING HOW transactions costs molded private institutional structure Coase advanced to but did not cross the fringes of the study of government institutions. His main concern had been with private firms. Supply and demand remained in the picture, though somewhat in the background. They represented the forces of cost and desire that drove people to exchange resources with each other. Coasian analysis sought out the most efficient framework in which these exchanges could take place. In fact, it was narrow and sterile in Coase’s view to talk of supply and demand without imagining the buildings, contracts, laws, infrastructures, and social customs in which voluntary exchanges played out and social accounts found their balance.

  But what of the involuntary exchanges of resources, if this phrase even makes any sense? Did Coase’s method apply? The question had to be asked because a good case can be made that people do not get to use all their resources as they please. Rather, some, or perhaps even all, resource allocation takes place under the ultimate threat of force. British historian John Keegan gives this view elegant expression in The Mask of Command where he writes “But, remote though the battlefield is from the marketplace and the court of law, its pre-existence, or the potentiality of recourse to it, underlie all assumptions citizens make about the order of things as they find them. Force … provides the ultimate constraint by which all settled societies protect themselves against the enemies of order, within and without (pages 311-312)”.

  Clearly the use of force removes us from the world of mutual understanding where Pareto-efficient, voluntary exchanges are the norm. Perhaps though, the deviation is not quite as extreme as we might imagine. After centuries of conflict with Mongols raiding their borders the Chinese empire gradually settled on a mix of bribes to Mongol leaders and threats of violence by Chinese armies that had raised their level of military competence. These bribes can be seen as “Coasian deals” that protected Chinese rice paddies while enhancing the revenues of Mongols. These deals were not possible in the initial phases of conflict between the two peoples because Chinese and Mongols had no clear way to communicate with each other. Diplomatic channels were “noisy” and problematic. In economic terms the “transaction costs” of doing business were prohibitive. The result was needless destruction of Chinese property by Mongol raiders in search of wealth, and a consequent reduction in booty available to the horse warriors. The orderly transfer of taxed income from China to Mongol lands evolved through lengthy trial and error as did the institutions for reducing the transactions costs of coming to mutual agreement. But once these patterns were established they proved remarkably stable and both people managed to exchange ideas for improving each other’s conditions.

  A multiplicity of examples can be found to push the controversial message that even in politics there is an impetus for institutions to evolve in order to minimize needless conflictual entanglements between determined opponents in conflict over resources. It emerged that when Coase’s analysis of private markets was applied to governments, the outlines of a remarkable “post-Coase” theorem emerged. There were forces prodding governments to seek interventions that tended towards Pareto-efficiency, the hallmark of what markets strove to achieve. History did not follow doctrines imagined from an armchair by Marx or by fist-pumping idealists manning the barricades in 1848 and 1968. It followed the dollar. That was the fundamental force pushing governments towards Pareto efficiency. Political scientist and historians did not want to hear this. Economists by and large lacked the culture to even begin to grasp the issue at stake. Yet there it was. Economics put politics in a box. Pareto-efficiency was the natural, ecological goal of society. All of politics and power relations had to be seen through that lens. History could be seen as the progressive creation of institutions that would minimize the most toxic side effects of conflicts between factions warring over the use of society’s resources. But “seen” by who was the question that needed to be asked.

  The next wave

  THE FIRST TO see the potential application to government in Coase’s approach were George Stigler, Samuel Peltzman, and above all Gary Becker. They grafted their theories upon Coase’s method to provide an ultimate theory of power.

  The irony of their quest was that by using powerful tools from economics and mathematics, these economists arrived, after heroic effort, to the conclusions that Pigou had championed all along. Whether dictated from top-do
wn by government or whether rising from bottom-up by markets and politics interacting, the result was the same. Economies converged, within the constraints of market forces, and the bludgeoning of predators, towards some Pareto-efficient outcome. This brings to mind the old joke about scientists scaling the mountain of knowledge. Once on top they find a group of theologians and philosophers drinking tea and wondering “what took you so long?”

  We shall not be drinking this celebratory tea yet but rather exercising ourselves on a long climb. The first serious application of Coasian institutional thinking to the structure of government was undertaken by George Stigler in 1971 in what has become one of the most cited articles in economics. That is not too bad a record for a piece of research that took the recondite method of Coasian reasoning and applied it to understanding what sorts of institutions will evolve to determine how resources are distributed by force. The next chapter shows how Stigler’s article became the springboard for what was to become Chicago political economy. This next chapter will be the final preparation we need to understand Becker’s formal mathematical model of all power relations between interest groups in society.

  Further reading

  Becker, Gary S. (1983). “A Theory of Competition Among Pressure Groups for Political Influence.” The Quarterly Journal of Economics. 98:371-400

  Cantor, Norman F. In the Wake of the Plague: The Black Death and the World it Made. Harper Perrenial. 2002.