NEW PERSPECTIVES ON
POLITICAL ECONOMY
A bilingual interdisciplinary journal
Vol. 13, No. 1–2, 2017
A bilingual interdisciplinary journal 3
NEW PERSPECTIVES ON POLITICAL ECONOMY
A bilingual interdisciplinary journal / Vol. 13, No. 1–2, 2017
New Perspectives on Political Economy is a peer-reviewed semi-annual bilingual interdisciplinary
journal, published since 2005 in Prague. The journal aims at contributing to scholarship
at the intersection of political science, political philosophy, political economy and
law. The main objective of the journal is to enhance our understanding of private property-,
market- and individual liberty-based perspectives in the respected sciences. We also belive
that only via exchange among social scientists from different fields and cross-disciplinary
research can we critically analyze and fully understand forces that drive policy-making and
be able to spell out policy implications and consequences. The journal welcomes submissions
of unpublished research papers, book reviews, and educational notes.
Published by CEVRO Institute Academic Press
EDITORIAL ADDRESS:
New Perspectives on Political Economy
CEVRO Institute, Jungmannova 17, 110 00 Praha 1, Czech Republic
Manuscripts should be submitted electronically. All manuscripts and correspondence
should be addressed to nppe@vsci.cz.
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Authors submitting manuscripts should include abstracts of not more than 250 words and
JEL classification codes. New Perspectives on Political Economy edits for clarity, brevity,
and in accordance with the Chicago Manual of Style. Authors should use footnotes rather
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Authors should include information on their titles and professional affiliations, along with
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ISSN 1801-0938 (on-line)
ISSN 1804-6290 (print)
New Perspectives on Political Economy4
EDITOR-IN-CHIEF:
Josef Šíma, President, CEVRO Institute, Prague
MANAGING EDITOR:
Pavol Minárik, CEVRO Institute, Prague
ADVISORY EDITOR:
Ladislav Mrklas, CEVRO Institute, Prague
ASSOCIATE EDITORS:
Pavel Pšeja (political science), Masaryk University, Brno
Michal Kořán (international relations), Institute of International Relations, Prague
Alena Zemplinerová (political economy), Institute of Economics, Academy of Science,
Prague
Roman Cardal (political philosophy), CEVRO Institute, Prague
Jakub Kříž (law), CEVRO Institute, Prague
BOOK REVIEW EDITORS:
Jan Jireš CEVRO Institute, Prague
LANGUAGE EDITOR:
Anthony Hennen
EDITORIAL BOARD:
Terry Anderson, Hoover Institution,
Stanford University
Peter Boettke, George Mason University
Hardy Bouillon, Trier University
Enrico Colombatto, University of Turin
Christie Davies, University of Reading
Frank van Dun, Ghent University, Faculty
of Law
Richard Ebeling, Northwood University
Richard Epstein, New York University
School of Law
Robert Higgs, The Independet Review
Jesus Huerta de Soto, Universidad Rey
Juan Carlos
Jorg Guido, Hulsmann Université Anger
Zdeněk Kühn, Charles University, Faculty
of Law
Miroslav Novák, CEVRO Institute
Svetozar Pejovich, Texas A&M University
David Schmidtz, University of Arizona
Gerald Steele, Lancaster University
A bilingual interdisciplinary journal 5
THE ILLOGICAL FEAR OF AUTOMATION, FALLING
WAGES, AND FALLING PRICES
ANTÓN CHAMBERLIN1
, WALTER E. BLOCK2,3
ABSTRACT
There is a hoary tradition in economics to the effect that automation will to unemployment.
Ned Ludd might have started this, but in the modern era there are numerous supporters
of this fallacy (Frank, 2012; Karphal, 2017; Ford, 2016). The present paper is an attempt
to allay the fears of many that breakthroughs in technology will promote joblessness. Our
method is to consider both historical and modern-day examples of innovation that have
led to this fear. Ned Ludd dreaded the knitting loom. At present, self-driving automobiles,
taxis, trucks, have driven to despair people who, realizing that jobs in these industries will
be lost, over-generalize and think that all employment will cease. Our overall message is
that we need not fear robots or automation or innovation. Rather, they will enhance our
economic wealth.
KEYWORDS
Automation, deflation, unemployment
1	 Joseph A. Butt, S.J. College of Business, Loyola University New Orleans, 6363 St. Charles Avenue, New
Orleans, LA 70118, amchambe@loyno.edu; ironhead0125@gmail.com.
2	 Harold E. Wirth Eminent Scholar Endowed Chair and Professor of Economics, Joseph A. Butt, S.J. College
of Business, Loyola University New Orleans, 6363 St. Charles Avenue, Box 15, Miller Hall 318, New Orleans,
LA 70118, wblock@loyno.edu.
3	 We thank two very helpful referees of This Journal for many important suggestions. The usual caveats of
course apply: the present authors are responsible for all remaining errors and infelicities.
New Perspectives on Political Economy6
1. INTRODUCTION
Legend has it there was a man by the name of Ned Ludd who lived in England in the 18th
century (Palmer 1998). While it is disputed whether Mr. Ludd ever actually existed — perhaps
under the name of Edward Ludlam — a group of individuals emerged in the 1810s with
the name “Luddites.” What was the story of Ned Ludd? The tale usually goes as follows.
Ned Ludd was a weaver in England around 1779 (Hammond 1919). The invention of the
loom was disastrous in his opinion. The work of many weavers could now be done by just
a few of them, and unemployment was the result. Thus, in an attempt to fix the economy,
Ned Ludd took it upon himself to destroy the looms, lest the town fall victim to unemployment
and poverty. Similarly, a group of frame-breakers became known at Luddites in 1812,
attributing Ned Ludd as their namesake (Alsen 2000).
This is a rather extreme tale, but nonetheless one that still gets told today, just in different
ways. Fear of automation stems from the same logic. It is believed by many that, while
technology can be very beneficial, eventually we will innovate ourselves out of employment
and into poverty. Falling wages are viewed in the same light — something deleterious to the
economy. This fear arises in the immigration debate. This paper seeks to explain why these
things are not only nothing to fear, but something to wish for whole-heartedly. Automation,
falling wages, and falling prices — deflation — are not the Boogiemen they are made out to be.
In section II we discuss automation. The focus of section III is on falling wages and of
section IV on deflation, yet another irrational fear. The burden of section V is to deal with
the objection that only people who own capital will gain and all others will lose. We conclude
in section VI.
2. AUTOMATION
On October 26, 2016, we gained word of the first successful commercial trip of a self-driving
truck. On that day, a Budweiser semi-truck made a 120-mile beer-run to Colorado (Cava
2016). What should have been received as a momentous advancement in human history
was quickly coupled with a sense of fear. Such an improvement can only mean disaster
for the estimated 3.5 million professional truck drivers in the United States (All Trucking
2016). This innovation, assuming it becomes widespread in the country, is sure to shake up
the trucking industry in the United States. That being said, this advancement should not be
dreaded in the slightest.
As humans, we feel trepidation when it comes to change. We wish things would remain
the same. Most of us, at least those who “have it made,” long for a static world that we can
prepare for, but alas, our world is most certainly dynamic. This is the indisputable reality
in which we live. Thus, technological advances that threaten anyone’s livelihood are seldom
met with total applause. However, we must not ignore the tremendous possibilities
and progress that innovation offers. Let us take the automobile for example. We could not
A bilingual interdisciplinary journal 7
live today without the amazing, life-changing occurrences that have come into existence
because of and as a result of the car. But this invention made serious waves in the transportation
industry. Those who worked in the horse-drawn carriage industry were not all too
pleased, more than likely, but the positive effects of the automobile far outweighed the negative
effects. Yes, it is true, those who drove carriages probably had to change professions.
Were there indeed any negative effects? It depends. If we look at this from the point of
view of the horse trainers, bridle makers, blacksmiths, and saddle manufacturers, then yes,
of course there were, and serious ones. However, there is an entirely reasonable alternative
perspective from which to view this technological advance, from the viewpoint of this aphorism:
The market benefits all participants. Why is this true? It is because the market consists
of all, and nothing but, voluntary trades: buying, selling, renting, lending, borrowing, etc.
And yet in each and every such case, all participants necessarily gain, at least in the ex ante
sense. But what of the labor force in the horse and buggy industry? Simple: With the advent
of the horseless carriage, they were no longer market participants. They could no longer
make commercial offers to others that were acceptable to them. To wit, the authors of the
present paper herein now make an “offer” to all readers: We are each willing to sell you a
pencil for $1 million. Are we market participants in this regard? Of course not: No one will
take up our offer. Ditto for those put in the shade by the advent of the automobile.4
At any given moment, we as a society are only capable of producing enough to satisfy
a certain small amount of our unlimited wants and desires. Technological advances allow
us to move further down our “wish list,” if you will. The same occurred with the invention
of the car. Our transportation needs were now capable of being met in a different way.
Our options were either keep the current amount of transportation, or increase it. Since
the amount of transportation provided via horse and buggy could be provided with fewer
people via automobiles, choosing this route meant the loss of employment for carriage drivers
if we wanted to keep the same amount of transportation. But this would not mean they
would be unemployed forever. Rather, they could shift their occupation to other parts of
the economy where transportation was more heavily needed since the necessary amount of
laborers in that field had dropped significantly. Since our desired amount of transportation
could be provided at a lower cost than before, labor would be reallocated as we moved down
our “wish list.” While there could be some pain in the transitional stage, society would advance
further. Keeping people in jobs that were no longer needed would be a drain on the
economy and a waste of resources. Nor would this transition by any means be confined to
transportation. The ex-horse trainers, whip and bridle makers, blacksmiths, etc., might find
employment in any number of industries.
4	�������������������������������������������������������������������������������������������������������������What happened to those in the horse and buggy industry after the advent of the horseless carriage? It is difficult
to say. The easy answer is that they took up other occupations. For more on this, see Motavalli, 2015;
Chiu, 2008. At one time, early in the history of the U.S., most of the labor force was in agriculture. Nowadays,
that figure has fallen to a miniscule proportion. Where did all the farmers go? This, too, is difficult to answer.
Presumably, into engineering, teaching, psychology, medicine, literature, music – all the things that make life
very different, and far more pleasurable, in the modern era.
New Perspectives on Political Economy8
A common counter-argument is that the invention of the car did not completely render
human-provided transportation obsolete — in essence, the horse and buggy industry simply
turned into that which manufactures the automobile. However, complete automation
would make these people unemployed without offering them any alternative industry to
enter. This argument ignores the fact that these people are now freed up to enter the labor
market in other industries where they would now be needed more than the transportation
industry. Moreover, even for those who are made worse off by automation, their wages will
have increased via enhanced purchasing power. The automation of something, including
transportation, means that the costs of production for that product has fallen. Budweiser
can now deliver their product to consumers at a lower cost, allowing that firm to do one of
several things. They can offer their alcohol at a lower price, they can increase the quality
of their product, or they can funnel the money into research and development. All of those
would mean that the consumers’ relative wage as it pertained to Budweiser would have
gone up. What should not happen, however, is for this technology to remain idle and the
economy static.
We live in a world of scarcity. We as a people have unlimited wants and desires, but the
world is one of limited resources. These two things are incompatible, so sacrifices and decisions
have to be made. Increases in technology allow us to make fewer sacrifices. Refusing
to utilize new technology when it is available would make all of us poorer, and would be a
waste of resources. Cars driven by people commercially 100 years from now will more than
likely be viewed in the same way that we view the horse and buggy industry — a quaint relic
from the past that we outgrew. If something can be produced at a lower cost, then these
technologies ought to be adopted lest we fall victim to Frederic Bastiat’s “Candlestick Makers’
Petition.”5
If the Sun is providing light for free, it would be a waste of resources to ask
the French people to board up their windows during the day and use only candles for light.
Refusal to accept automation embodies the identical line of illogic.
But if everything is automated, will not widespread poverty and unemployment result? If
everything is automated, there will not be any jobs left for people! But the wants and desires
of each and every single person on Earth are unlimited.6
There will always be something in
demand, for we are not capable of being static. In Nicomachean Ethics, Aristotle argues that
we as humans do not wish merely to live, but to live well (Aristotle and Ross (translator)
1999). We are not content with mere existence. Thus, we are called upon by our desires to
act in a way that we perceive will improve our conditions — that would move us out of the
realm of living, and into the realm of living well. Austrian Economist Ludwig von Mises
wrote about this in his magnum opus, Human Action. “His mind imagines conditions which
5	��������������������������������������������������������������������������������������������������������������Frederic Bastiat wrote a satirical petition to the French government asking for special privileges for candlestick
makers since they had befallen grotesque competition from a competitor dumping its product onto the
French people for free. It is revealed at the end of the essay that the competitor to the candlestick makers was…
the Sun. You can read the petition at: http://bastiat.org/en/petition.html
6	 Multiply this by some 7 billion people, and the goals of our entire species are truly gargantuan.
A bilingual interdisciplinary journal 9
uit him better, and his action aims at bringing about this desired state. The incentive that
impels a person to act is always some uneasiness (von Mises 2008 [1949]).” Since we are
naturally inclined to act, we will all find things to do. What greater automation would mean
is that we could focus on tasks that we actually want to get up and do every day. If we do
not need anyone to drive trucks cross-country, if we do not need anyone to make our food
anymore, then people can focus on jobs other than truck driving and food preparation. If
the production process of the majority of our needs were automated, then people would be
free to focus on music or art or sports. We would have more free time, not only to do those
activities, but we’d have more time to frequent them. We’d be able to go to more concerts,
more musicals, visit more museums, and attend more NASCAR races.7
Consider, arguendo, that machines in some far distant future can do all the jobs we need
done. They can cure all disease, enable us to live forever, ferry us to distant solar systems,
etc. Would not this be a curse, not a blessing? For there would then, under this heroic assumption,
not be the need for any more employment. We would all be unemployed! No,
this would not be the disaster feared by many. For we do not really want jobs. Rather, the
desiderata are the goods and services that work produces (Hazlitt, 1946). However, per assumption,
we already have those to our heart’s desire. Thus, there would be no more need
for labor; we could all play, e.g., have fun, instead.8
3. FALLING WAGES
That leads us to another idea that strikes fear into the hearts of most: falling wages. That
fear is misplaced, however, since it ignores the economic distinction made betwixt real
and nominal wages. The common response to a drop in wages is enmity. That is coupled
with the questioning of one’s financial security. Responding to the dollar amount on your
paycheck is reacting to your nominal wage, not your real wage. The distinction here is extremely
important.9
Assume that due to union activity, wages exceed productivity levels. Typically, the best
way to cut costs is to decrease the cost of labor.10
Employers will try to reduce the salaries
of their laborers as close to their marginal value product as possible. (In other words, as
7	 Or whatever pastime you fancy. NASCAR is the number one spectator sport in the United States, QED.
8	 Even now, at the beginning of this 21st century, there are numerous people who play, and get paid for it, rather
than work, which is defined as something we only do for the money and do not intrinsically enjoy. For example,
professional athletes, singers, dancers, actors, etc. In this science fiction-ish future we depict in the text,
everyone would be in this position.
9	 For more on this concept of money illusion, see Boes, Lipp, and Winkelmann, 2007; Fair, 1971; Fehr and
Tyran, 2001, 2007; Schmeling and Schrimpf, 2011; Shafir, Diamond, and Tversky, 1997.
10	 This is because labor accounts for over 60% of the GDP; https://fred.stlouisfed.org/series/LABSHPUSA156N-
RUG
New Perspectives on Political Economy10
close to the worker’s productivity as possible — the amount of added value they add to the
company per hour.) The obvious criticism of that statement in the text is that no, the firm
wishes to pay the employee as little as possible. The rejoinder to that objection is that if it
does so, it will tend to lose its labor force to other companies who set wages closer to productivity
levels. (Of course, if an employer pays above that level, it will lose profits and tend
to become bankrupt.) If one company is able to lower its prices by reducing input costs this
way, they will become more competitive. That will incentivize their competitors to follow
suit, sending ripples throughout the economy. Therefore, while workers may have taken a
reduction in pay, goods will become less expensive. While their nominal wage may have fallen,
their real wage may have stayed the same, or perhaps even increased. (This, of course, it
not to deny that the real wages of some laborers might have fallen. But, if productivity rises,
the presumption is that on average we are all better off, economically speaking.) That also
has positive benefits, saliently, for those people in the economy not in the industry under
consideration. Perhaps not the laborers who specifically took the wage cut, but virtually
everyone else in the economy registered an increase in real wages because prices had fallen.
With everyone’s income increasing, this would allow them to increase both spending and
saving in the economy. The rise in expenditure would boost the economy in the short run,
while a similar movement in saving would do so in the long run. Both of those would cause
further economic progress, which would repeat this entire cycle again. What matters is real
wages, not nominal wages. (All this, of course, is with a running assumption of a genuinely
free market economy, which we do not have in the United States. In the “mixed” economy,
those improvements would be greatly attenuated.11
)
The same reasoning applies to immigration.12
There is the very popular narrative that
immigrants are taking jobs away from Americans, and if we allow too many of them into
the country, then the market will become over-saturated with laborers, driving down their
wages. The notion that jobs are being stolen relies on the fallacy that the amount of jobs
available is fixed.13
To think that the job market is fixed ignores economic logic as well as
history. The number of jobs available today is not the same as 2,000 years ago. A statistic
11	 For critiques of the mixed economy, see Mises, 2008; Rothbard, 2004.
12	 There is a gigantic literature as to the effects of immigration on various cohorts in the labor force, particularly
the unskilled, of which this is only a very small sample: Abowd and Freeman, 1991; Bhagwati, 1991;
Blackburn, Bloom, and Freeman,1990; Borjas, 1990, 2003, 2006; Borjas, Freeman, and Katz, 1997; Borjas,
Grogger, and Hanson, 2008; Butcher and Card, 1991; Card, 1990, 2001, 2007; Card and Lewis, 2007; Cortes,
2008; D’Amuri, Ottaviano, and Peri, 2010; Dustamnn, Frattini, and Preston, 2008; Friedberg and Hunt, 1995;
Friedberg, 2001; Jaeger, 1996; Longhi, Nijkamp, and Poot, 2005; Markusen, 1983; Mundell, 1957; Murphy
and Welch, 1992; National Research Council, 1997; Ottaviano and Peri, 2006, 2008; Peri and Sparber, 2009;
Samuelson, 1948. Our point is totally separate from this. We are not at all interested, at least not in the present
paper, in how immigration impacts the economic welfare of the poor. We only maintain that as long as irrelevancies
such as crime, welfare, voting, etc., can be ignored, and as long as the marginal revenue product of
the average immigrant is above what is necessary to feed, house, and clothe him, etc., that necessarily GDP
per capita will rise.
13	 For an antidote to this basic economic fallacy, see Hazlitt, 1946.
A bilingual interdisciplinary journal 11
beloved of all politicians is job creation. Those who stress that issue are blind to their selfcontradiction
when they then turn around and claim immigrants are stealing our jobs. To
believe that the job market is fixed is to believe that the economy and the world are static,
which cannot be further from the truth. In a free market, there is room for everyone thanks
to scarcity and the division of labor. There is always something that someone is comparatively
better at than everyone else, thus inclining them to undertake that task. There is
always something that someone wants but does not have, “thanks” to scarcity. It is therefore
baseless to fear immigrants on the grounds that they will steal our jobs.
Basic supply and demand analysis tell us that an increase in supply will necessarily lower
price. When it comes to the labor market, this price is the wage paid for labor. An influx
of immigrants is no exception. Costs of production per labor would fall, causing prices to
decrease, which would in turn lift average real wages.14
4. DEFLATION
Then there is the Boogieman of deflation. There are a couple of different arguments that
people such as Paul Krugman make against deflation.15 The first is that when people expect
prices to fall, they tend to spend and borrow less. Why buy something today when it’s going
to be cheaper tomorrow? Second, falling prices necessitate either falling wages or unemployment
by workers refusing to take a pay cut.
Let us first deal with the first criticism. Consumption will fall, sending the economy into
a depression. According to Spendmatters.com, computer prices are continuing to fall (Contributor
2015). Not only computers, but technological products in general, have continued
to decline dramatically over the last 20 years.16 This is the deflation Krugman speaks of.
Yet, in spite of this deflation, as of June 30, 2016, roughly 89% of the American population
used the internet and about 50% of the world population can say the same (Internet World
Stats 2016). The reason is simple: We cannot postpone consumption ad infinitum. Yes, it
is very true that we would prefer to pay less as opposed to more, but eventually the cost
of not owning the product outweighs the gain of forgoing consumption. We purchase the
laptop, the cell phone, etc., knowing full well they are going to drop in price in a couple of
months. The value obtained by using those items, whether it be because of the pleasure it
gives or the necessity of having it to function in our modern world, outweighs the gain we
14	 Obviously, we are assuming a free market economy in making this claim. If there are regulations preventing
such market activity, then all bets are off.
15	 http://krugman.blogs.nytimes.com/2010/08/02/why-is-deflation-bad/?_r=0
16	 See also Byrne, et. al, 2017; Schreyer, 2002. And long before that as well. For example, the automobile, the air
conditioner, the television set, etc., were all far more expensive in real terms when they were first introduced
to consumers than at present.
New Perspectives on Political Economy12
would receive if we waited. It is specious to believe that deflation would have the effect Paul
Krugman says it would.
It is also believed that deflation is bad for businesses in that firms will make less profit,
which will send ripples throughout the economy. This is not true either. Just because the
price may have fallen does not mean that the ratio between the cost of production and
revenue changes. If the difference betwixt revenues and costs hasn’t changed, nothing has
happened to profits, so businesses are in the same boat they were in as before.17
5. MICROECONOMICS VERSUS MACROECONOMICS
A referee of This Journal makes the following remark regarding an earlier version of this
paper: “The argument is clear regarding efficiency or aggregate impact but less so regarding
distribution. If all labor is replaced by capital and we are all unemployed — well, it is certainly
nice to have all that leisure time — but only the capital-owners will have any income.
The proletariat will be in trouble, wouldn’t it?”
We respond that the “proletariat” would not be in trouble at all under these assumptions.
If we are all “unemployed,” this means that our marginal revenue product is zero, or below.
If this is true, we have banished scarcity: We are no longer unemployed, but, rather, have no
need of our own labor services. In this post-scarcity world, there will be riches for everyone.
No one’s desires will go unmet. Of course, this is highly problematic from an economic
point of view. Even when we think of science fiction-ish super-robots, we cannot imagine
they will fulfill our every desire. We will not be able to live infinitely long lives.18
We may
all wish to bed the same heart-throb of the day.19
Robots may be as good as, or even better
than, real people in this regard. But if we all wish to involve ourselves with an actual person,
automation, necessarily, will fail.
States Newman (2017) on this matter:
“The robophobic are also worried about income inequality — all the greedy capitalists
will take advantage of the increased productivity of the automated techniques
and fire all of their employees. Unemployment will rise as we run out of jobs for
humans to do, they say.
17	 If deflation is unexpected, it transfers wealth in much the same way as inflation, just in the opposite direction.
We owe this point to a referee of This Journal.
18	 We are tempted to also assert that “We will never be able to be in two places at the same time. No one will ever
be able to draw for us a square circle” but will resist this temptation. These are merely philosophical fallacies,
similar to asking if God can create a stone so big that He will not be able to carry it.
19	 The future Marylin Monroe? Lady Gaga?
A bilingual interdisciplinary journal 13
“This fear is unreasonable for three reasons. First of all, how could these greedy
capitalists make all their money without a large mass of consumers to purchase
their products? If the majority of people are without incomes because of automation,
then the majority of people won’t be able to help line the pockets of the
greedy capitalists.
“Second, there will always be jobs because there will always be scarcity. Human
wants are unlimited, diverse, and ever-changing, yet the resources we need to satisfy
our desires are limited. The production of any good requires labor and entrepreneurship,
so humans will never become unnecessary.
“Finally, Say’s Law implies that the profitability of producing all other goods will
increase after a technological advancement in the production of one good. Real
wages can increase because the greedy robot-using capitalists now have increased
demands for all other goods. I hope the following scenario makes this clear.”
Let us look back in history to gain some more perspective on this issue. Before the advent
of the automobile, the rich man had a carriage and six horses, and the poor man had the
use of his two feet. Afterward, the former can drive a Rolls Royce, the latter a Smart Car.
Both gain. But who benefits more relatively? Although as a matter of technical economics
we of course cannot say, a common-sense approach will see, clearly, that it is not the
wealthy whose well-being is more greatly improved. Similarly, before the light bulb, the
well-to-do had chandeliers filled with candles. The poverty-stricken went to bed in the dark.
Afterward, both had light, albeit that of the former was more ornate and luxurious than
that of the latter. But who benefitted more relatively? It does not strain the imagination too
much to claim that the poor gained more. If the future resembles the past in this manner,
the spaceships of the affluent will be better than those of their impecunious fellows, but we
will all be able to dash off to Mars, or wherever.
6. CONCLUSION
The world is full of economic fallacies and alas, they tend to be widespread and their purveyors
elected into office. Those beliefs are superficially plausible, but a shallow dive into
the field of economics and logic dispel them rather quickly. Among those myths are the
fears of automation, declining wages, immigrants,20
and falling prices. There is nothing
logical in fearing them. Automation merely frees up labor to shift to areas in the economy
20	 On purely economic grounds. For the libertarian case in favor of immigration as a matter of rights, see Berg,
2010; Block, 1983A, 1983B, 1988, 1990, 1998, 2004, 2011A, 2011B, 2013, 2015, 2016, Forthcoming; Block
and Callahan, 2003; Ebeling, 2015A, 2015B; Esplugas and Lora, 2010; Friedman, 1973, 2006; Gregory and
Block, 2007; Hornberger, 2016; Hudson, 1986; Krepelka, 2010; Rothbard, 1962; Rozeff, 2005; Salin, 2000, ch.
11; Schoolland, 2001; Todea, 2010.
New Perspectives on Political Economy14
where it is more greatly needed and allows us to move further down our “wish list.” A fall
in nominal wages is nothing to dread, for it is real wages that matter, not nominal ones.
Immigration is just an extension of the groundless fear of falling wages. Deflation, lastly, is
something to be cheered, not denigrated. Goods and services becoming less expensive is
invariably good for society.
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Abowd, John M. and Richard B. Freeman (eds.) (1991) Immigration, Trade, and the Labor
Market. Chicago: University of Chicago Press.
All Trucking (2016). http://www.alltrucking.com/faq/truck-drivers-in-the-usa/, accessed November
21, 2016.
Alsen, Eberhard (2000) New Romanticism: American Fiction. Routledge.
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A bilingual interdisciplinary journal 19
SUBJECTIVE POLITICAL ECONOMY
DARCY W. E. ALLEN1
, CHRIS BERG2
ABSTRACT
We extend the Institutional Possibility Frontier (IPF) – a theoretical framework depicting
the institutional trade-offs between the dual costs of dictatorship and disorder (Djankov et
al. 2003) – by incorporating the notion of subjective costs. The costs of institutional choice
are not objectively determined or chosen by a society; rather, they are subjective to the
political actor that perceives them. Our methodologically individualist approach provides a
new, highly adaptable extension of the IPF enabling examination of the political bargaining
process between dispersed actors, the bounds and evolution of institutional innovation and
discovery, and follower-leader dynamics in long-run institutional changes. Our new Subjective
Institutional Possibility Frontier (SIPF) helps to integrate ideas into the economics of
political systems, creating the foundations for a more subjective political economy.
KEYWORDS
Institutional Possibility Frontier, Political Economy, Subjective Costs, Austrian Economics,
New Comparative Economics
1	 School of Economics, Finance and Marketing, RMIT University, Melbourne.
darcywilliamallen@gmail.com
2	 School of Economics, Finance and Marketing, RMIT University, Melbourne.
christopher.berg@rmit.edu.edu.au
New Perspectives on Political Economy20
1. INTRODUCTION
Choices have costs and those costs are subjective to the individual making the choice
(Buchanan 1969). Furthermore, given that the economic and political spheres of activity
are entangled, individuals must make choices both about the goods and services they consume
and the institutional framework in which those exchanges occur (Smith et al. 2011;
Wagner 2014; Wagner 2016). While economists have had much to say about the factors that
determine the set of choices available, they have had comparatively less to say about what
influences the final preference among that set.3
This paper integrates preference formation
into a new framework of political economy that, through the lens of Austrian subjective
costs, enables analysis of political choice over institutional constraints.
An individual’s institutional preferences are underpinned by their ideas and beliefs about
the material, physiological, and emotional costs of institutions to themselves and to social
groups (e.g. families, ethnic blocs, fellow citizens) that they believe have a just stake in their
institutional choice. Yet institutional analyses of politics lean heavily on the construct of
rational utility maximising agents (McCloskey 2010; McCloskey 2016; Smith 2012). While
“ideology” has been part of positive political economy at least since Downs (1957), and
ideas—‘shared mental models’ of norms and custom—have been a part of institutional economics
since its conception (Denzau and North 1994; North 1993), their integration into
analysis is tentative at best. Indeed, most institutional analyses rely on explanations for
political action grounded in the material interests of the relevant agents, rather than seeking
to uncover the underlying ideological contests.
McCloskey (2016) writes that economists ought to pay more attention to the “ideas,
rhetoric, ideology, ceremonies, metaphors, stories, and the like” that influence and direct
human behavior within a given institutional framework. For Rodrik (2014), “context, honor,
glory, reputation, respect, income, power, durability in office, and ‘good of the country’”
all drive agent preferences. López and Leighton (2012) argued that ideas shape the institutions
in which political action occurs, while Tarko (2015) recently outlined that the direction
in which institutions change depends on the ideas, beliefs, and values of those who
change them.
Our framework is based on the new comparative economics of the institutions of capitalism
developed by Djankov et al. (2003) (see also Shleifer 2005; Shleifer and Vishny
2002). In the Institutional Possibility Frontier (IPF) framework, institutional choices are
depicted as a trade-off between dictatorship costs and disorder costs. Given that institutions
comparatively economize on those costs, and that they do so in imperfect ways, the entire
suite of institutional possibilities can be arrayed graphically along a convex function, the
IPF. The IPF represents institutional trade-offs, and thus choices, in a world of imperfect
3	 Hausman (2011), for instance, identifies four sources of preferences: a) means-ends reasoning, b) attributebased
reasoning, c) emotional influence, which directs and motivates information acquisition at the individual
level, and d) physiological needs.
A bilingual interdisciplinary journal 21
property rights. The IPF has variously been applied to policy settlements around productivity
and red tape (Berg forthcoming; Davidson 2013), the environment (Davidson 2014),
media regulation (Berg and Davidson 2015), freedom of speech (Berg and Davidson 2016),
innovation (Davidson and Potts 2015; Davidson and Potts 2016), education (Lane 2017),
democracy (Allen et al. 2017), and tobacco control (Davidson 2016).
In this paper we extend the IPF framework in two ways. First, we acknowledge and incorporate
the reality that institutional dictatorship costs and disorder costs are subjective to
the actors which impose them and to the societies which endure them. Characterizing the
costs underpinning the IPF as subjective helps avoid the hand-waving and often tautological
reasoning about norms and customs characterizing much contemporary comparative
political economy. But introducing subjective costs must be coupled with a second extension—disaggregating
institutional choices down from the level of society to groups, factions,
parties, and ultimately individuals. Given that costs are subjective, societies do not make
institutional choices, individuals do. The dynamics of individual disagreement and bargaining
over institutional costs ought to be front and center of any institutional analysis.
The resulting subjective and disaggregated framework – which we call the Subjective
Institutional Possibility Frontier (SIPF) – can be applied to a large range of political and
economic phenomena. It is sufficiently flexible, nuanced, and adaptable to describe and
explain institutional changes over time, the function of ideas on policy settlements, political
bargaining, and the effect of institutional knowledge. By allowing the ideas and knowledge
production of intellectuals to be explicitly included in an analysis of institutional choice we
have developed an “Austrian” approach to new comparative economics based on institutional
processes, methodological individualism, and knowledge coordination. This paper
is not meant as a critique of the IPF framework in the same line as other critiques (e.g.
Rosser and Rosser 2008; Dallago 2004; Van de Klundert 2010), but to resolve some of their
critiques and extend the explanatory power of the framework.
2. THE INSTITUTIONAL POSSIBILITY FRONTIER
The IPF was first offered by Djankov et al. (2003) as the analytic framework of an institutional
theory of regulatory choice. The authors begin by assuming that “society” wishes
to control the activity of a private firm and then considers the alternatives – ranging from
social or market discipline to nationalization – arrayed along a spectrum of control. Institutions
structure human interaction and pull us out of the nasty, brutish, and short life of
Hobbesian anarchy. Institutional controls are implemented because the perfect application
of property rights does not exist. However, institutional controls also bring with them
the threat of government expropriation and coercion. The underlying premise of the IPF
framework is both that all institutions impose social losses to some degree – because no
institution perfectly prevents social losses – and that all institutions control the dual costs
of dictatorship and disorder in comparatively effective ways.
New Perspectives on Political Economy22
FIGURE 1: THE INSTITUTIONAL POSSIBILITY FRONTIER
Costs of dictatorship arise from state-based expropriation. In the words of Djankov et al.
(2003, p. 598) this is the “risk to individuals and their property of expropriation by the state
and its agents in such forms as murder, taxation, or violation of property.” Some dictatorship
costs are obvious, such as an oppressive regime, but also include more subtle forms
of using the power of state coercion to control others through regulatory capture. Costs of
disorder, in contrast, are the costs private individuals impose upon each other. Djankov et
al. (2003) describe disorder costs as the “risk to individuals and their property of private
expropriation in such forms as banditry, murder, theft, violation of agreements, torts, or
monopoly pricing.” The common elements of the costs of disorder are private appropriation
stemming from too much power combined with the threat of opportunism.
The IPF depicts the trade-off between the costs of disorder and dictatorship as a convex
function (see Figure 1). The central benefit of the IPF framework is that it allows comparative
institutional analysis around the focal point of an economic problem (such as the
regulation of business shown in Figure 1 above), rather than beginning with the nature of
an institution (e.g. top-down or bottom-up). For instance, in Davidson and Potts (2016)
and Allen (2017) the institutions of innovation are depicted through the IPF framework,
ranging from the private orderings of innovation commons all the way down to public
science. In this way, all institutional possibilities – including organizations such as firms,
markets, clubs, hybrids, and commons, and other institutions such as social norms – can
Social losses 
due to private
expropriation
(Disorder)
Social losses due to state
expropriation (Dictatorship)
Private orderings
State orderings
45°
Independent judges
Institutional possibility frontier (IPF)
Total loss
minimization
Regulatory state
A bilingual interdisciplinary journal 23
be represented as points within the IPF space. Furthermore, the convexity suggests a point
where the costs of dictatorship and disorder are minimized. This cost-minimizing point of
institutional efficiency is found where the IPF is tangent with a 45-degree line because this
represents the efficient cost-minimizing institutional solution closest to the origin.
In the short run, the location and shape of the IPF is fixed. In a longer historical context,
however, the location and shape of the IPF is influenced by changes in civic capital, technology,
and institutional and economic constraints. Shifts in the IPF, in the same way as the
more widely understood Production Possibility Frontier, are a result of multiple complex
factors, many of which are out of our control (Boettke et al. 2005). For example, prior
institutional choices constrain and direct future institutional choices. Glaeser and Shleifer
(2002) and La Porta et al. (2008) look at the economic significance of legal traditions as
those traditions are transplanted through colonization or conquest. There is a recognized
tension in Djankov et al. (2003) between the argument that societies choose an efficient
control strategy on the IPF and that legal origins explain why some societies choose certain
strategies over others. It is here that an Austrian subjectivist approach to the IPF bears fruit.
3. The idea of subjective institutional costs
At first it is unclear what value a subjectivist approach adds to the context of institutional
choice. But as Hayek (1955) once wrote, “it is probably no exaggeration to say that every
important advance in economic theory during the last hundred years was a further step in
the consistent application of subjectivism.” What we find below is that many of the analytic
shortcomings of the IPF, such as the supposed lack of applicability to real-world institutional
scenarios, can be ameliorated through a central insight of Austrian economic theory:
that value and costs, including opportunity costs, are subjective perceptions (Buchanan and
Wagner 1977; Menger 1871; Stringham 2010; Yeager 1987).
Methodological subjectivism is well known to be the bedrock of the Austrian tradition
(Boettke 2002b; Vaughn 1998). A subjectivist understanding of human action rejects the
claim that the criteria on which choices are made are externally objective.4
Subjective costs
have broad implications for perspectives on the economic system (DiLorenzo 1990) because
it forces the scholar to focus on the interactions of exchange between individuals
(Buchanan 1979). Indeed, social phenomena derive meaning from the mental states of participants
in that society (Lachmann 1990), which plays out through time and in ignorance
(O’Driscoll et al. 1996).
While the claim that institutional costs are subjective is a simple observation, it has
major implications for the application of the theory and for the usefulness of the new comparative
economics approach more generally. Across the IPF literature the idea that the
costs of dictatorship and disorder are centered on preferences is only mentioned once, to
the knowledge of the authors. That is, in Whitford and Lee (2012, p. 8) when they attempt
4	 While of course the level of subjectivism adhered to by the scholar changes the scope of application (for
instance, see radical subjectivist accounts including Lachmann 1976; Shackle 1983; Shackle 1992), the
“degree” of subjectivism is not relevant for our purposes here.
New Perspectives on Political Economy24
an empirical analysis of the perception of government effectiveness and state: “We want to
be very clear that this indicator measures subjective perceptions regarding government effectiveness
in different countries.” While some of the literature, such as Rosser and Rosser
(2008, p. 87), attribute some cross-country differences to preferences within those countries
and allude to subjectivity, the remainder of the literature proceeds either assuming
some objective optimum institutional set, or assumes objective costs for tractability.
In mainstream economics, subjective preferences are usually treated as both fixed and
exogenous. But preferences should not be treated as an unexaminable black box (Haus-
man 2011). For example, Becker (1996) emphasizes that future consumption is closely
related to past consumption. The marginal analytical point is that a preference for wine on
Sunday is related to the consumption of wine on Saturday. A preference for a variety of wine
is dependent on past experiences with that variety, and strength of expectation that those
past experiences provide information about future satisfaction. Rather than been seen as
fixed, preferences can be seen as an evolutionary information discovery mechanism.
Indeed, as Buchanan (1969, p. 43) taught us, cost “exists in the mind of the decision
maker and no-where else.” That is, by the subjective stock of knowledge by the individual
acting in a social world (Schutz and Luckmann 1973). It follows that the dictatorship and
disorder costs underpinning the IPF are subjective by their very nature because they rely
on opportunity costs of institutional implementation as perceived in the minds of the individual
agent, and are revealed by their action. They are not objectively determinable by
an external observer or external criteria. Those costs consist of the alternative institutions
foregone.
Dietrich and List (2011) offer a critique of the rational choice approach to preference
change – which sees observed preference changes as simply a reflection of new information
on fixed, underlying preferences – by offering an alternative where preference change
is the result of shifts along motivationally salient dimensions. Agents have different ideas
about the relative importance of the characteristics of the objects of their choices. Observed
preferences change when some characteristics become more or less salient – when a wine
drinker becomes a wine connoisseur, and they move from a preference for red over white, to
a preference for pinot noir over merlot, from a preference for New Zealand pinot noir over
Napa Valley pinot noir. Dietrich and List argue these shifts are distinct from the Bayesian
information approach, as the existence of New Zealand pinot is known to the wine drinker
but they lack the motivation salience to appreciate it. But in a subjective framework, this
distinction isn’t clear.
While information reduces uncertainty (Shannon 1948), that uncertainty relates to mental
states, not objective truths. Our drinker has still experienced a process of information
discovery and learning – not about the existence of New Zealand wines – but of the relative
subjective benefits of choosing to consume wine from that region. Likewise, for Dietrich
and List’s capitalist businessman who lives through a plane crash and then devotes his life
to charitable works, it is not that he has necessarily abandoned his affection for wealth, but
the near-death experience has given him more information about the desirability of a life
dedicated to altruism.
A bilingual interdisciplinary journal 25
This information approach has particular importance when we apply it to institutional
preferences. What is usually reduced to “ideology” is in fact a complex set of normative
and positive perceptions about the world. Indeed, there are a large number of definitions
of ideology, with one survey identifying 27 distinct definitions (Hamilton 1987). Downs
(1957, p. 97) began the study of the economic function of ideology as purely normative,
describing “a verbal image of the good society and the chief means of constructing such
a society.” Ideologies reduce transaction costs for voters facing a large number of possible
issues on which political parties might disagree (see also Hinich and Munger 1996; Laborit
1996). However, ideologies also have a descriptive function. A model of the ideal society
is by necessity a critique of the current order – of the costs of the institutional status quo
and alternative institutional arrangements. In the moral foundations theory, an individual’s
ideology is constructed by that individual’s intuitive response to mixture of five values and
their opposites – care/harm, fairness/cheating, loyalty/betrayal, authority/subversion, and
sanctity/degradation (Federico et al. 2013; Haidt 2012; Haidt and Joseph 2004). Each value
pair can be seen as costs on a dictatorship/disorder axis.
From the perspective of moral foundations theory, the subjective approach to dictatorship
and disorder costs can be intuitive and aesthetic. Consider the ideological politics of
urban planning. Individuals will have different perspectives as to the desirability of a clean,
rationally planned model of the urban environment – represented at its extreme by Le
Corbusier’s planned cities of Ville Radieuse, Brasilia, or Chandigarh – as compared to the
messy, unplanned, and evolutionary urban orders elucidated by Jane Jacobs. Le Corbusier
was “offended by [the] disarray and confusion” (Scott 1998, p. 106) he saw in unplanned
urban environments, and saw linear symmetry as not merely practically but aesthetically
superior. Jacobs reaction against high modernist urban design was, at least in small part, a
reflection of her anti-authoritarian preferences (Kanigel 2016).
Individual institutional preferences reflect in part different intuitive preferences (or, to
put it another way, intuitive tolerances) for disorder or dictatorship costs. This is one vector
through which one can see McCloskey’s rhetoric, ceremonies and metaphors – as mechanisms
through which societies make sense of, communicate, and coordinate beliefs about
the dictatorship and disorder costs of social institutions.
While dictatorship and disorder costs are subjective in our analysis they are held by the
agents themselves to be reasonable representations of the world around them. At the first
instance, events, ideas, or experiences affect perceived dictatorship and disorder costs. For
example, the Global Financial Crisis of 2007–2009 provided information about the subjective
disorder costs of the financial regulatory framework. Richard Posner (2010) and Alan
Greenspan both subsequently said they had been mistaken to support banking deregulation
in the lead-up to the crisis, based on information they had now acquired from observing
events. The evolution of ideas can likewise be seen as an exogenous event that feeds into
subjective costs. The sustained disequilibrium posited in Keynes’ General Theory can be
seen as increasing knowledge about the disorder costs of the free market in employment
and production, and the socialist calculation debate can be seen as increasing knowledge
about the dictatorship costs of a planned economy.
New Perspectives on Political Economy26
3.1 SUBJECTIVE COSTS AND THE PROBLEM OF MOTIVE
The basic public choice critique of economics is that it treats the state as a unit outside the
analysis – as a benevolent and omniscient external force that can be deployed to resolve
market failures, rather than a human organization subject to the same incentive and agency
problems as an organization operating in the market. Contrasting the romantic “public
interest” motivation where political action is driven by notions of the greater good, they
provide a public choice motivation where human action in the political sphere is shaped
by institutional incentives (Buchanan and Tullock 1962). However, as Boettke and Lopez
(2002) note, while the public choice school has relaxed the benevolence assumption embedded
in much economic policy analysis, it has been reluctant to relax the assumption of
omniscience – that is, to integrate the subjective analysis of the Austrian school into its
approach. Austrian economics has, for its part, been reluctant to abandon the benevolence
assumption. Programs like robust political economy (Boettke et al. 2007; Leeson and Sub-
rick 2006; Pennington 2011) and Wagner’s entangled political economy (Becchio 2014;
Wagner 2014; Wagner 2016) sought to relax both assumptions, building a program that is
compatible with both Austrian subjectivism and public choice analyticHowever, the rational
actor model that underpinned the public choice critique of the benevolent state has meant
that the strength of its critique was dulled. Both public interest and public choice models
have at their base the assumption of an externally-verifiable objective ideal of action. Yet
what an observer might consider to be publicly interested political action or self-interested
political action by an agent is in fact a reflection of the mental state of the observer. While
Pareto efficiency is commonly used as a criterion by which publicly interested motives can
be judged, it is not necessarily the case that the agents charged with public interest institutional
choices share that criterion. Observing that banking regulation differs substantially
between jurisdictions, Barth et al. (2006, p. 19) point out that the “social efficiency” implied
by a public interest argument for banking regulation does not necessarily mean Pareto
efficiency. Rather, “national tastes determine the degree to which the specific focus is on
output maximization, variance minimization, or broadening access to capital.”  Some defenses
of the public interest model have explicitly made the claim that public interest action
is subjective. For example, Mikva (1988, p. 173) argues that the public interest is “fashioned
by people…who are thinking of the public interest (as they see it)” (see also Udehn 1996).
Both agents and observers have a positive description of the world that may differ from
others’ descriptions, and have a normative vision of what institutions would maximize social
welfare. Their institutional preferences could be starkly different while the intellectual
coherence of the public interest model is maintained.
The significance of this is clearer if we add a temporal dimension to our positive analysis
of political action. The analytic challenge is not to explain political choice in equilibrium,
but to see how political choices are made in historical time. Pareto improvement cannot be
a threshold for publicly interested action before the publication of Pareto ([1906] 2014).
Levy and Peart (2009) have shown that the analytical egalitarianism underpinning economic
analysis is one which was developed in historical time. What agents have conceived
as the public interest has variously focused on individual happiness, social welfare, national
A bilingual interdisciplinary journal 27
glory, racial dominance, imperial expansion, and civilizational virtue. Those normative ideals
form institutional preferences long before any public choice analyses of incentives and
rational irrationality. If voters vote expressively, then what are they trying to express? It is
recognized in market analyses that individuals have different preferences as to aesthetics
and that these preferences are both meaningful and are shaped by exogenous and endogenous
forces. The same is surely true of institutional preferences.
Public choice models fare little better when they turn to self-interested motivations. The
neoclassical public choice position is that political agents are maximizers constrained by
bounded rationality. This skips over what agents seek to maximize when they engage in the
political system. Self-interest is mediated through ideas about what forms that self-interest
(Boettke 2002a; Evans 2014; Mises 1957). For example, it is not clear what the relevant unit
of analysis is when accounting for self-interested institutional preferences. Do individual
agents seek to maximize the welfare of themselves, or of groups they form a part of? There
is a non-trivial distinction between maximization strategies focused on individual welfare
and the welfare of that individual’s family. Likewise, agents could be seeking to maximize
the welfare of an organization or an ethnic bloc. At some margin this self-interest becomes
hard to distinguish from the “public interest” if the unit of analysis is drawn wide enough.
The function of ideas about what constitutes self-interest in the formation of self-interested
behavior is key.
If the hard core of public choice analysis is the observation that the agents are subject
to incentives in both the economic and the political sphere, then the subjectivity
of preferences is no challenge. In a market transaction, the price system reduces complex
changes in the factors of production and in individual taste to a single end-user
price (Hayek 1945). Similarly, the subjective “costs” of an institution of social control
reduces complex ideas about how the preferred institution will benefit the chooser as
an individual and any group – their family, their neighbourhood, their ethnic bloc, their
(or a) economic strata, the aggregate inhabitants of the political jurisdiction, the global
citizenry, etc. – that they deem ought to have a call on the benefits of the institutional
framework. While this approach might seem reductive, it has a number of distinct advantages
over the traditional public choice approach. The degree to which preferences
are self-interested or public-interested is neither objectively determined nor objectively
verifiable. Self-interested institutional preferences are rarely publicly admitted. While it
is tempting to peer inside announced preferences and seek underlying motives for those
preferences, this can only be accomplished with attention to a broader appreciation of
the function of ideas. The famous claim that what is good for General Motors is good for
the country and vice versa is only explicable within a framework of Austrian knowledge
constraints and McCloskeyian rhetoric and metaphors.
Djankov et al. (2003) note that exogenous factors, such as technology and social trust,
will shift the shape of the IPF, but it is not immediately obvious how this happens given
that the curve is fixed in the short run. Our explanation is that these factors change the subjective
perception of costs, and therefore shift the range of institutional possibilities. High
social capital lowers subjective disorder costs as individuals are less fearful that their neigh-
New Perspectives on Political Economy28
bors will expropriate their wealth. The development of technology enabling more stringent
government surveillance raises dictatorship costs as individuals become more fearful about
the possible loss of their privacy. Such a change may also decrease disorder costs by increasing
the transparency of state institutions. Likewise, changes in ideas about the role of the
state and civil society alter the institutional trade-off. It is possible to explain the rise of
religious toleration, for example, as a shift in perceived dictatorship costs.
4. DISAGGREGATING THE INSTITUTIONAL POSSIBILITY FRONTIER:
INTRODUCING POLITICS AND SOCIAL CHOICE
In Djankov et al. (2003) society “chooses” the point on the IPF that minimizes institutional
costs. Readers attuned to a methodological individualist approach will object that society
does not consciously choose anything. Brada (2009, p. 11) notes that the framework of new
comparative economics “take(s) no account of policy differences. Outcomes are largely
explained by institutional differences, themselves the relatively immutable forces such as
colonial past, location, etc.” This objection to the IPF framework is fundamentally an aggregation
problem. As Hayek (1945) argued, aggregate measures (and indeed any aggregate
representations) lose the detail of individual preferences.
The Austrian subjectivist approach is particularly fruitful in examining such problems
because of its focus precisely on how individuals with different preferences and perceptions
coordinate their actions (Horwitz 1994). By introducing subjectivism into the IPF, new
comparative economics can be based on a disaggregated SIPF down to the level of the
individuals who make up the polity. Each agent has a subjective view of the costs trade-off
of a given institution (i.e. of the position of points within the IPF space in Figure 1), and
therefore each agent has an SIPF with a different shape and slope. While in aggregate this
appears to be a single, society-wide IPF, the IPF observed by Djankov et al. (2003) is in fact
the outcome of an inter-agent bargaining coordination process.
Almudi et al. (2015) describe civilization as the result of a contest between competing
utopian visions. Consider for example a society made up of two individuals, Capitalist and
Socialist, with equal political power and a fully-formed and ordered SIPF representing their
different ideas about the costs of various institutions. Each conceive of the cost-minimizing
institution as “market ordering” and “nationalization,” respectively. Figure 2 shows their
two SIPFs. In this highly stylized example, their SIPFs cross at the regulatory state, providing
a potential institutional compromise between the Capitalist and Socialist. As this
shows, what Djankov et al. (2003) claim to be the cost-minimizing position might well in
fact be a compromise position solely created as a function of the relative subjective costs of
two individual SIPFs. As there are no “real” dictatorship and disorder costs – institutional
costs are mental states rather than objective facts – any observed institution “emerges” as
a function of both a diverse range of ideas about the costs of those institutions and a social
bargaining process.
A bilingual interdisciplinary journal 29
FIGURE 2: THE SUBJECTIVE INSTITUTIONAL POSSIBILITY FRONTIER WITH TWO AGENTS
WITH EQUAL POLITICAL POWER
In this depiction, neither Capitalist nor Socialist are completely happy with the institutional
compromise, seeing the regulatory state as imposing more costs than their preferred
institution. Their dissatisfaction can be shown as the distance between their perceived costminimization
lines and their 45-degree line that intersects the regulatory state. (The two
45-degree lines have been removed from Figure 2 above.) In this highly stylised example,
market ordering and nationalization are equidistant from the regulatory state. Both Capitalist
and Socialist are equally dissatisfied with the compromise position. Institutional stability
is only maintained to the extent that they continue to have equal influence over the choice
of institution, that the relative perceived costs of the institutional set are stable (unaffected
by exogenous or endogenous changes), that the costs of dissatisfaction are less than the benefits
of maintaining the constitutional order, that alternative institutions are not invented
which would change the relative perceived costs and therefore the shapes of the SIPFs, and
that the number of participants in the decision making group are stable. Relaxing these
stabilizing assumptions produces an evolutionary framework of institutional choice.
For example, how close the observed institution is to an agent’s institutional optima will
be a function of the political power they wield and the institutional framework in which
decisions are made. The observed social institution need not be the intersection between
Disorder
Dictatorship
Socialist subjective institutional possibility frontier
Capitalist subjective
institutional possibility
frontier
Nationalization
Regulatory state
Market
ordering
New Perspectives on Political Economy30
the two SIPFs. Rosser and Rosser (2008) object that the IPF is unable to account for institutional
differences between North Korea and South Korea. Our SIPF is easily able to
accommodate these differences. It could indeed be true that there are different underlying
preferences between the two polities – that state control is less costly in the North than
the South. Alternatively, and more likely, North Korea’s institutional form can be seen as
the result of the political “bargaining” regime in that hereditary dictatorship results in an
institution being “chosen” that is far from the compromise intersection. For example, in a
two-agent political system where the Socialist holds absolute political power, nationalization
will be the chosen institution. For the Capitalist this will represent a substantial institutional
inefficiency. How high do dictatorship costs have to be for the Capitalist to reject
the constitutional order? In a n > 2 system the transaction costs of institutional change will
differ agent by agent, and suffer from Olson’s collective action problem.
One of the costs of dictatorship is the distribution of political rents and concentration of
political power. Rent-seeking behavior – such as regulatory capture (Dal Bó 2006; Laffont
and Tirole 1991; Stigler 1971) – is an endogenous dynamic that influences the social choice
of institutions, pushing it the right on the SIPF. Similarly, in a market order private interests
might be able to wield disproportionate influence over the system of social choice through
political donations or the buying of votes.
The subjective political economy framework is neutral as to the system of social choice.
The starting point is that individuals have individualized preferences about what institutions
of social control they believe society should adopt. The method of aggregating those
preferences through politics is itself an institutional choice. The process of choosing institutions
of social control can itself be seen through an institutional lens, with (for example)
direct democracy and totalitarianism providing the outlying institutions.
Likewise, institutional costs can be seen as partly endogenous in the subjective political
economy framework. Ideas are fundamentally sociable. Mill’s (1859) argument for freedom
of speech is that ensuring the truthfulness of an idea requires testing against other ideas.
Collins (2009) goes further by arguing that an “idea” is only meaningful if seen in the context
of communicating that idea. Individuals do not enter the system of social choice with a
fixed set of preferences and perceived institutional costs. We are not born with fixed notions
of the harm of disorder and dictatorship. These are worked out through interaction with
other individuals within that system, and subject to continuous adjustment. The acquisition
of information about institutional costs is not truly exogenous – it has to be learned and
interpreted through social interaction (Berg 2017; Searle 1995).
5. INNOVATION AND IGNORANCE
Knowledge of institutional costs exists in relation to time (Loasby 2001), and for analytic
purposes can be sequenced in relation to other knowledge and possibilities. As new knowledge
emerges it changes the institutional choice structure, that is, changes the shape of an
A bilingual interdisciplinary journal 31
individual’s SIPF and the relative costs of alternative institutions. However, the curve as
depicted in the Djankov et al. (2003) IPF is complete and well-ordered. Agents know and
can assess the relative subjective costs of each institutional arrangement. Figure 1 shows
the cost-minimization curve at a halfway point between independent judges and regulatory
state. But this raises an important question: what institution does society choose under such
circumstances? Likewise, under our subjective approach, the point of intersection between
the Capitalist’s curve and the Socialist’s curve might not have a corresponding institution.
If the institutional set is static – in an equilibrium outside historical time – the prevailing
institution (assuming that each agent has equal political power) will be that which is closest
to the intersection. To the extent that the chosen institution is not equidistant from the
intersection, one agent will perceive higher subjective costs than the other agent.
The discontinuity of the SIPF provides opportunities for endogenous institutional innovation.
The choice of institutions is not fixed. New forms of social control can be invented
or adapted through intellectual and ideological endeavor. It is not solely that the need for
social bargaining is a spur to institutional innovation – it is that institutions are not conceivable
without that underlying bargaining process in the first place. Buchanan et al. (1982)
argued that the market order emerges from the process of its generation – that is, the voluntary
interaction of individuals. Likewise, institutions as social facts are only created in
the context of a bargaining process around diverse perceptions of the costs of the existing
institutional set. Given that choices along the SIPF are relative to each other, the creation
of new institutional alternatives will likely have an effect on the subjective costs of legacy
institutions. Further, the process of political secession to private governance mechanisms
(e.g. Stringham 2015; Leeson 2014) or collective action in the commons (Ostrom 1990,
2005) can similarly be seen as a process of institutional evolution over subjective costs. In
this view, the process of secession is a process of interaction between individuals with similar
perceptions of the IPF and the loss-minimizing institutional solution.
One further consequence of viewing institutional costs as socially formed is the function
of ignorance and certainty. In Djankov et al. (2003) the IPF is convex toward the origin,
reflecting society’s knowledge about the costs of the institutions on the curve. However, it
has been observed that agents are not always well-informed about policy alternatives (Caplan
2011; Somin 2013). Of course, in a subjective political economy all agents are equally
ignorant of “true” or “objective” costs. Not all agents may feel they are able to produce a
well-formed, well-ordered, and complete ranking of institutional alternatives in the SIPF
space relative to other agents. The convexity of the SIPF curve is a function of the relative
certainty of subjective costs. The perfectly uncertain agent is unable to distinguish any difference
in disorder and dictatorship costs between market ordering and nationalisation.
Their “curve” in that case is perfectly straight and perfectly equal to the cost-minimization
line. Convexity increases as agents more intensely distinguish the costs of institutional
choices and are spread institutions across the space.
Agents are keen observers of the preferences of other agents (Earl and Potts 2004).
There are transaction costs incurred while spreading ideas – that is, perspectives about the
subjective costs of a given institution – from agent to agent. The spread of an idea is a func-
New Perspectives on Political Economy32
tion of the influence of the agent that holds it. In this sense social learning would be shown
by the movement of the SIPFs of followers toward the SIPFs of leaders. A stylized two-party
democracy can be seen as clustered SIPFs where subjective costs are aligned by the need to
maintain in-group solidarity. The persuasive technique of exaggerating the subjective costs
of the institutional preferences of an opponent is self-reinforcing to the extent that agents
come to believe their own rhetorical claims. This conception allows for the framework to
integrate our emphasis in the previous section on the production of new institutions with
the social diffusion of those institutions. The lessons of the Global Financial Crisis were
not immediately obvious to all actors in its aftermath. The institutional settlement which
emerged in its wake was the result of social learning and persuasion. Multiple possible
explanations for the crisis and multiple possible policy responses competed among each
other. The diversity of SIPFs is a function of the influence and persuasiveness of idea entrepreneurs
(López and Leighton 2012).
The SIPF provides a complex and adaptable framework through which to understand
political disagreement and institutional change over time. By recognizing that costs are
subjective the SIPF resolves the problems raised by critics of Djankov et al. (2003). It also
helps more deeply integrate ideas into political economy while still enabling the analytical
constructs of cost and trade-offs to be utilized. In the following section we apply the SIPF
approach to the deregulation of the financial sector and the rise of the regulatory state.
6. APPLYING THE SIPF: THE DEREGULATION MOVEMENT IN AUSTRALIA
As Kroszner (1999) notes, economists have used the insights of public choice to explain
the existence of heavy regulation in the developed world, but have struggled to apply the
economic theory of regulation to the deregulation movement that swept the developed
world since the 1970s and 1980s (see Keeler 1984). In those decades, developed countries
such as the United States, United Kingdom, New Zealand, and Australia reduced legacy
regulatory controls – such as fixed prices and restrictions on competition – on sectors such
as transport, energy, telecommunications, and finance, privatized government-owned businesses,
and reduced centralized industrial relations power. Peltzman (1989), applying the
economic theory of regulation, concludes that deregulation was caused by changes in the
“politics” and “economics” of economic control, where politics describes the relative balance
of interest group power and economics describes the gap between the regulated equilibrium
and a laissez-faire alternative and the wealth available for redistribution. However,
the political economy regime that replaced the heavy state intervention of the mid-20th
century was not a laissez faire one, but what has been described as a “regulatory state,”
where social control is wielded still by regulation, but increasingly through “arms-length” independent
regulatory agencies that were intended to approach policy questions from a procompetition
perspective (Berg 2008; Braithwaite 1999; Glaeser and Shleifer 2003; Moran
2003). The Djankov et al. (2003) IPF is well suited to describe the institutional set available
A bilingual interdisciplinary journal 33
to policy makers and describe the trade-offs faced by society before and after the deregulation
movement. While each sector differs in the detail and effect of state control, in broad
strokes, the political economy changes in these decades represented a shift along the IPF
to the left, trading off the dictatorship costs of nationalization and direct regulation against
the disorder costs of more competitive service and goods provision. This trade-off is shown
in Figure 1. Djankov et al. (2003) also provide some tools to explain the shift. Exogenous
changes in civic capital, particularly that of technology and organizational innovation, create
inefficiencies that undermine the existing institutional control. In their description of
the rise of the first regulatory state in the United States at the end of the 19th century, they
describe how industrialization and commercialization made litigation through the courts
an inefficient mode of social control, driving the shift toward regulation. A similar explanation
is often advanced for regulatory reform in the at the end of the 20th century – the
combination of technological change and macroeconomic factors meant that the regulatory
framework no longer functioned efficiently (Kasper and Stevens 1991). Regulatory reform
disrupted the institutional equilibria and necessitated further regulatory reform, with a cascading
effect through the economy.
However, societies do not move seamlessly from one mode of social control to another.
Alternative institutional choices have to be identified, negotiated, and implemented. Djankov
et al. (2003) allow for political factors and path dependency to account for observed
institutional inefficiencies in the real world. The subjective approach focuses on the act of
institutional choice and the subjective and intersubjective ideas of institutional costs as they
affect the choices faced by policymakers.
Berg (2016a) offers an account of the early institutional choices made during financial
liberalization in Australia. A crisis in the Australian building society sector between
1974 and 1976 caused, for the most part, by the macroeconomic upheavals of those years,
presented the Commonwealth government with demands for reform of building society
regulation, as the IPF framework would predict. However, the Commonwealth government
was faced with two distinct reform directions. It could increase regulatory controls
on building societies so that they were aligned with the heavy regulation imposed on the
private banking sector, or it could move the entire financial system toward market control.
The private banks were noncommittal on whether they would rather be freed from restrictions
or whether they would prefer their more-nimble competitors to be restrained (Pauly
1987). The eventual choice of deregulation was not foreordained. Cabinet documents show
that Prime Minister Malcolm Fraser favored the former option. This choice, the debate
surrounding the choice, and the final institutional settlement, are readily comprehensible
through a subjective frame.
New Perspectives on Political Economy34
FIGURE 3: APPROACHES TO REGULATORY REFORM IN BANKING, AUSTRALIA 1976–78
There were two distinct perceptions of the costs of the regulatory choices within the Fraser
cabinet. The pro-regulation advocates understood the costs of the existing institutional structure
to suffer from sub-optimally high disorder costs – the relatively light-touch regulatory
control imposed on building societies and other non-bank financial intermediaries were
attracting business away from the highly regulated banks. This both encouraged risky financial
practices and led to unacceptably high interest rates. In this perspective, any reduction
of control would increase those disorder costs. The pro-deregulation advocates understood
the current institutional settings to have high dictatorship costs, that that the institutional
differences between banks and non-banks were a problem brought about by financial repression,
and that Australia’s financial sector was inefficient. The resulting institutional
arrangement brought about the introduction of a deposit-insurance scheme for building
societies (the short-lived Australian Building Societies Share and Deposit Insurance Corporation)
and the development of a more general program of deregulation in line with “the
government’s free enterprise objectives” (Committee of Inquiry into the Australian Financial
System 198, xxiii). This institutional arrangement was a compromise between the two
conceptions about institutional costs rather than a coherent statement about the efficiency
of that arrangement. Analyzing this institutional choice through an objective, society-wide
IPF both misses the substance of the decision and would impose a coherence that the final
settlement lacked.
Disorder
Dictatorship
Pro-regulation
Pro-deregulation
Further regulatory
control
Deregulatory approach plus
deposit insurance scheme
Market
control
A bilingual interdisciplinary journal 35
Thus, the SPIF, in this case, introduces both politics – the foremost advocate of the deposit
insurance scheme was Prime Minister Fraser – and the content of that political clash
(the different ideas about institutional costs). The result is more than just a fall-back onto
“ideas” as a catch-all explanation for change (Kroszner 1999). Support for deregulation was
not uniform and the resulting settlement was not uniformly deregulatory. Likewise, any account
of the rise of financial regulation – particularly focused on prudential regulation – after
the deregulation period requires both a recognition of the institutional demands of new
competition and the enduring perception, which dated back until at least the Second World
War, that depositors required a safe haven for their deposits (Berg 2016b). The resulting rise
of the regulatory state was not “chosen” but was the result of a diverse range of changed and
fixed perceptions about institutional costs.
8. CONCLUSION
The costs of dictatorship and disorder, which are inevitable in implementing institutional
controls on society, are subjectively perceived by individuals within a society. We extended
the Institutional Possibility Frontier from new comparative economics by incorporating
this Austrian notion of subjective costs. This forms what we called the Subjective Institutional
Possibility Frontier, a framework enabling the dynamics of ideas and politics, and
schools of thought underpinning them, to be explained from a base of methodological
individualism. In addition, such an approach incorporates the potential for institutional
entrepreneurship as discovering previously untested points within the SIPF space. We demonstrated
the applicability of the SIPF framework through an application to the deregulation
movement in Australia.
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A bilingual interdisciplinary journal 41
NATIONAL DEFENSE AS A PRIVATE GOOD:
FREEDOM AS A POSITIVE EXTERNALITY
YOULIY NINOV1
ABSTRACT
The standard anarcho-capitalist suggestion for defense against foreign aggression leads to
numerous systematic built-in problems which prevent it from being more widely accepted.
The most prominent one is the anarcho-capitalist defense being a public good. Additional
problems can be identified with regard to the incentives/motivation and knowledge of the
anarcho-capitalist defense companies. A new, stateless, free-market-based system is offered
which makes national defense a private good and brings the incentives and knowledge issues
in line with the standard way free market is organized. The suggested system, which
represents an alternative of anarcho-capitalism, lets the aggressor pay entirely for the respective
society’s defense, thus freeing the private property owners from the obligation to
provide for their own defense. In this way national defense becomes a private good and the
respective society’s freedom, a byproduct and a basic human right.
KEYWORDS
Austrian economics, anarchism, national defense
1	 youliy.ninov@gmail.com
New Perspectives on Political Economy42
1. INTRODUCTION
How to protect your nation/community/society against foreign invasion is one of the hard
questions posing before the supporters of anarcho-capitalism. Several solutions to this problem
have been offered, which are stateless and market-based by their nature. However, all
of them suffer from the same ethical and economic problems. From an ethical perspective
they force people to pay for their own protection, which, in fact, as will be shown, contradicts
the essence of libertarian beliefs. From an economic perspective, they keep the public
good structure of national defense and create additional problems with the incentives and
knowledge of anarcho-capitalist private defense agencies. Conflicts of interest, unaligned
interests and insufficient incentives of the defense companies can be identified from a motivational
point of view. There are also problems with regards to how they disseminate and
use information.
The suggested anarchic system of defense resolves the above-mentioned ethical problem
by making the very aggressor pay entirely for the respective society’s defense. It makes the
aggressor the true client of private defense agencies and releases private property owners
from the obligation to pay and from their client status. In the process, it makes national
defense a private good, since private property owners will not receive services and thus the
free-rider problem will be avoided entirely. The suggested system avoids the conflicts of
interest and aligns the interests of the private defense agencies toward the common goal,
i.e. fighting the aggressor, thus making the structure of this economy branch the same as
any other one. It ensures knowledge is collected and used efficiently by the market organizations
providing defense against foreign aggression. In effect, the respective society will
gain its freedom as a byproduct of the market for defense against foreign aggression. In
economic terms: freedom will become a positive externality.
2. OVERVIEW
There are two typical ways for providing protection against foreign aggression offered in
anarcho-capitalist literature. As the most common solution to this problem it is suggested
that protection against foreign invasion be implemented with the help of a combination/
fusion of private insurance and private defense companies (Tannehill and Tannehill 1970;
Hoppe 1999). With this solution, private property owners buy private property insurance
and the insurance companies in turn make sure their clients are secured against foreign
invasion by employing private defense companies to fend off the aggressors. A separate
and somewhat different view is the one offered by David Friedman (1989). It suggests
that militia forces recruited voluntarily from the general population are led by a small
elite of professional soldiers paid from voluntary donations. In what follows both systems
will be critically evaluated and compared with the suggested system from an ethical and
economic perspective.
A bilingual interdisciplinary journal 43
3. ETHICAL PROBLEMS
I. In the most wide-spread anarcho-capitalist suggestion on how to deal with foreign aggression,
people/companies would buy insurance to protect themselves. While this resembles
very closely the way people buy insurance to protect themselves from natural disasters (earthquakes,
floods, etc.), there is one significant difference – that is, why they do it. In both cases,
i.e. natural disasters and foreign aggression, people would act out of fear that they may lose
what they have. However, only in the latter case would there be any aggression initiated. Earthquakes
and floods cannot initiate aggression since they are not human beings and thus their
occurrence is not a matter of choice. They are a force of nature. As a comparison, however,
foreign aggression is not and as such it is avoidable if the potential aggressor decides not to
wage their war. It should be stressed out that when people insure themselves against natural
disasters, they act out of fear, but not due to initiated aggression. In the case of foreign interference,
people would insure themselves again out of fear. However, this time this fear would
be caused by initiated aggression. Since people would take part in this market out of fear of
initiated aggression, this market would not be a free one. A free market is a market in which
none of the transacting parties acts under initiated aggression or a threat thereof. It must be
noted that it is irrelevant who has caused the aggression at a particular market. The aggression
needs not come from any of the parties in the market transaction. It may come from an
external entity which is only indirectly related to the particular market exchange. Assuming
the opposite for a moment would lead us to the bizarre situation to call markets, such as the
one for “green” energy or the one for any type of state-imposed compulsory insurance, free
just because neither the energy supplier/insurance supplier nor their clients aggress against
each other. A corollary from the above is that a completely free market is not possible as long
as aggression exists. Thus markets, such as the one for bike locks, or the one for personal guns
(when bought for self-defense), are not free by definition. Their very existence is based on the
presence of the credible threat of initiated aggression.
This shows that the standard anarcho-capitalist suggestion to defend an anarchist society
against foreign aggression by using insurance and private defense agencies is not a freemarket
one, i.e. it contradicts the basic way the free market operates.
II. The ethical argument above applies to the “voluntary” solution suggested by David
Friedman as well. While this solution appears to function without force being initiated,
since funds would be donated voluntarily, this is not so in reality. The reason is that if people
do not pay “voluntarily”, they would suffer, i.e. the threat of initiated aggression would
be the motivating factor for people to donate funds. It is not just simple fear that would
motivate them to donate, but a fear of initiated aggression.
III. National defense in anarcho-capitalism is a public good in general (Murphy 2010; Hummel
1990). As such, there may be people who get protection without paying for it, i.e. the
free-rider problem will be present. The latter is practicably unavoidable for the simple reason
that even if everyone agreed to pay for defense (which is unlikely to happen in practice), not
New Perspectives on Political Economy44
­everyone could afford it. Thus, there will always be people who get services (protection) paid
by other people, i.e. people who obtain something at somebody else’s expense. The latter could
be treated as an economic problem and/or an ethical one depending on one’s personal views.
4. ETHICAL SOLUTIONS
In order to avoid the aforementioned problems, i.e. acting out of fear of initiated aggression
and the free-rider problem, one must organize the anarchist society in a different way. From
an ethical perspective, the one who must pay for defense against foreign aggression must be
the very aggressor. After all, he is the one who has caused the problem, not the private property
owners suffering from his actions. It is the aggressor who must logically pay, not his victims.
In view of the above, the ethically clean solution would be the defense forces of the particular
anarchist society to get fully paid by the aggressor only. So in case of war the defense companies
would have the right to be compensated entirely from the property/resources of the
aggressor (reparations). This would guarantee that private property owners would not have
to pay for protection if they do not wish to do so, and also that the public-goods problem can
be avoided entirely. Note that one does not expect the aggressor’s economy to suffer significant
damages due to war, i.e. resources would be available to indemnify the attacked country.
At the same time, the public-goods problem will be avoided entirely, since it will not be the
private property owners in the particular society who will obtain a service, but the aggressor
himself. The public will get the byproduct, which in this case is their freedom.
Thus, a new type of market is suggested, where the aggressor himself is on the demand
side, and on the supply side - the respective defense company. Since national defense is a
sub-case of the more general problem of defense against any aggression, one could use the
same arguments as given in Ninov (2016) to justify the existence of such a market. What
needs repeated emphasis is that such a market would be a free one, since neither the defense
company nor the aggressor will act under initiated aggression. The defense companies’
actions will be justified as a response to/defense against initiated aggression and will be
motivated by the prospect of making profit.
5. ORGANIZATION OF THE SYSTEM
PREREQUISITES
A necessary and sufficient condition for the suggested system to function is the existence of a
pre-established, monopolistic body of law governing a certain land area, the sole purpose of
which would be to ensure the protection of private property. An extended justification of the
latter requirement can be found in Ninov (2016). A short summary will be presented here.
A bilingual interdisciplinary journal 45
The existence of monopolistic laws over a given territory is not synonymous with the
existence of a state. Monopolistic laws can exist without a state or, in general, without any
force being initiated. What we have nowadays is monopolistic laws imposed by the usage of
initiated aggression by the state. It is, however, the initiated aggression that is the problem,
not the monopolistic structure of the laws. The same monopolistic laws can exist if imposed
by private property owners without initiating force. The latter is entirely possible when all
the property within certain territorial borders is entirely private. And the reason is that it is
the private property rights which determine if a particular application of force is aggressive
(bad) or non-aggressive (good). For example, a land owner has the right to ban the possession
of guns on his private land. And the reason is that he owns the particular land and has
the right to dispose of it as he sees fit. Thus, if this particular land owner punishes a person
owning a gun on his property, this will not be an act of aggression, but an act of defense,
because his private property rights were violated. Taking the above into consideration, the
existence of groups of private land owners who agree to impose the same set of laws over
their combined territory is entirely possible and admissible from a libertarian point of view.
Thus, monopolistic laws can exist without a state or, in general, without force being initiated.
Note that such monopolistic laws require/lead to homogeneous societies, i.e. societies
composed of people with a shared moral code (Ninov 2016). One must add that the existence
of ethically homogeneous societies is not a limitation of the system, since it is a natural
tendency among human beings to form groups espousing the same ethical views.
OVERALL STRUCTURE OF THE SYSTEM
Similarly to the case of anarcho-capitalism, there will be many competing defense companies
seeking to profit from the act of foreign aggression. These companies will be funded by
private investors seeking to profit from war and in particular, from the aggressor himself.
The companies need not be local ones only, i.e. belonging to the particular society under
attacks, but can operate on an international level. The opportunity to earn profit will be
the force attracting them to provide services for national defense. The society under attack
will offer them a moral justification for taking part in the war and will provide them with
the services necessary for profiting from it. In particular, it will provide court decisions
about the transfer of resources obtained from the aggressor and the subsequent protection/
recognition of defense companies’ newly acquired property under the laws of the particular
society.
The number and size of the companies involved will be determined by the opportunity
for profit, i.e. the system will adjust its size and organization to the aggressor in order to
defeat him. For example, if there is a threat of a terrorist attack, then small, agile, focused
defense companies will be formed to counter the problem. In the opposite case, if the aggressor
is big and strong, then a major part of the society will organize itself against it. The
latter will prove possible, because the prospective of profit from a war will outweigh the rest
of the available economic alternatives. In fact, a thorough economic restructuring would
ensue lead by the market forces. Thus, the size, number and organization of the defense
companies will be determined entirely by market forces.
New Perspectives on Political Economy46
The traditional “subscription-based” defense companies could co-exist with the suggested
“reparation-hunting” companies, but it is highly unlikely that they will be able to compete
with the latter. Private property owners would not want to pay for something which
they could normally get for free. Thus, the essential and most important difference between
the discussed systems of national defense is that in the suggested system, the defense companies
will be paid only and exclusively by the aggressor, whereas in anarcho-capitalism
the defense companies are paid by two sides - by the private property owner subscription
payments and by reparations (compensations) from the enemy.
COMPENSATION OF DEFENSE COMPANIES
Let us now discuss how defense companies will be compensated for their effort in fighting
and defeating the enemy. This requires a preliminary discussion. The problem is the following:
for a market to work, the goods/services exchanged must be privately owned. A government
as such, however, is not a private entity. So, when a country attacks a given society,
there is no clear-cut private “villain”, so to speak. As a result, it is not clear who exactly
must compensate the defense companies when the attacking country has been defeated.
Should this compensation be imposed on the whole country-agressor itself, i.e. through
taxation? Or perhaps the soldiers who took part in the offensive must be held financially
responsible? Or the politicians who sent them? A simple and straightforward way to handle
this problem would be to apply the laws of the respective libertarian society under attack.
This way, the following could be expected to happen: if, during war, hostages were taken
or any private property was appropriated (this could include private companies, plants,
infrastructure, personal belongings/funds), the owner of this property would be considered
responsible for compensating the defense companies for defeating the country-aggressor.
All that belongs to the state-aggressor would be considered non-owned and thus subject to
direct sale/appropriation. The latter could include: war machinery, state-owned buildings,
state infrastructure, etc. With that in mind, we could outline how the compensation of the
defense companies could be organized. In particular, if private property was captured, it
would be subject to court proceedings to determine how it should be used for compensating
the defense company. Both sides, namely the respective defense company and the property
owner whose property was appropriated, will have to turn to a judge to settle the issue. The
procedure will be practically the same as suggested in (Ninov 2016) for cases dealing with
common criminals. As to the state property being appropriated: as it will be considered
non-owned, it will simply have to be recognized as property of the respective defense company
that appropriated it. Actually, it is up to the society to decide how to proceed in such
a situation. There may be alternative ways to dealing with the problem. When something is
not private, no particular rules apply to it. Taking all that has been said into consideration,
one can organize a way for the defense companies to be compensated for their efforts.
RESTITUTION
What proves harder is to find a way to compensate private property owners who have suffered
damages due to the war, i.e. to organize restitution. And the reason is that it is not
A bilingual interdisciplinary journal 47
always clear who exactly damaged what. For example: an army attacks a particular city razing
many homes. Who exactly is to blame for razing the home of citizen X? If the respective
army was a private one, then one knows who is to blame and be held responsible, i.e. the
army’s owners/investors with all of their property/funds. Thus, the indemnification procedure
mentioned above could be used, this time to compensate the private property owners
who suffered damages due to the war. However, if the army is organized by a government,
who is to blame? Every soldier separately? All soldiers together? The politicians who sent
them? The attacking country as a whole?
Please note that this specific problem is not limited only to the suggested system. It
is an integral part of anarcho-capitalism. In anarcho-capitalism, an insurance company is
supposed to have the right to be indemnified for its expenses for capturing a particular
criminal by the criminal himself. Since, however, national defense is a sub-case of this
more general case of protection against any aggression, then one must expect that national
defense companies under anarcho-capitalism must also be compensated by the defeated opponent.
What this means is that the mentioned problem is a common one for both systems.
The real problem is that market solutions to economic problems require the existence of
private property. When public property is at play, the situation has no clear resolution from
an ethical point of view. Thus any reasonable solution to this problem could be deemed
acceptable. For instance, the private property owners could be compensated from the appropriated
state (public) property of the aggressor.
6. ECONOMIC CONSIDERATIONS
THE PUBLIC-GOODS PROBLEM
As already mentioned, while the public-goods problem is present under anarcho-capitalism,
it is entirely absent in the suggested system because of its different organization. Since
private property owners are not the clients and do not pay for their own protection, then
free-riding will be impossible as such. We could say that all people in the society will “freeride”,
since freedom will become in fact a side product of the defense market , i.e. freedom
will become a positive externality. The latter fact is the most important feature of the suggested
system and a solid answer to the most prominent objection against a free-market for
defense.
INCENTIVES/MOTIVATION
Motivation under the suggested system
The defense companies to be formed in the suggested system will be motivated by the prospect
of making profit. Since their profit will directly depend on how much of the enemy’s
resources they manage to win, they will be highly motivated to keep these resources as
intact as possible, so that they can gain the maximum possible profit from them. Destruc-
New Perspectives on Political Economy48
tion will be the last thing such companies would wish. Therefore, the usage of weapons
of mass destruction (atomic bombs for instance) would be in practice non-existent.Any
defense company based in a libertarian society will have to follow its rules/customs, since
this society will be a homogeneous one. Thus, if the society espouses the view that wars of
aggression are impermissible, then the particular defense company will not be allowed to
initiate an attack on another country. Otherwise, it would immediately be labeled a criminal
and thus become a target for its competitors, as discussed in (Ninov 2016).
A possible objection against the suggested system could be expressed as: “Who should
pay for a successful deterrence?”. We must note, first and foremost, that in the particular
case the word deterrence does not fit properly, since no “deterrence” service was requested
or obtained. As has already been mentioned, freedom is a positive externality in the suggested
system. What could, in fact, happen is the potential aggressor might refrain from
attacking, because it fears the military strength of the respective society. In that case the
defense companies will have no prospects of obtaining income. Thus, the problem is how to
fund defense activities which do not result in the collection of reparations. In other words,
defense companies have expenses for investment and support of their troops in peacetime,
which may be so high as to make the whole undertaking unprofitable.
In order to provide a solution to this potential problem, one must note first that it is the
profit that motivates the businessmen, but profit is the difference of revenues and costs.
As long as revenues surpass costs by a sufficient margin, the particular businessmen will
be motivated to invest in and support defense companies. Furthermore, it does not matter
how these revenues are obtained as long as they are high enough. Thus, it may be the case
that wars do not happen often, but, when they do, one could obtain a really huge amount
of money if successful in them. So huge as to compensate the peacetime losses. Put in
mathematical terms: revenues can be represented as a mathematical expectation, which is
the probability of a profitable event to happen multiplied by the amount of money to be
obtained from it when it does happen. If this mathematical expectation is big enough, businessmen
will invest in defense. Such is, in fact, the mode of operation of drug companies at
present. They invest in many different drug research activities of which they already know
they will lose. However, if just one new drug proves successful, it could compensate and
overcompensate all the investment.
Taking all of the above into consideration, if the defense companies are allowed to
obtain a big enough part of the aggressor’s resources after the aggressor was successfully
defeated, they will be motivated to support and invest in defense. In addition, the large
fixed costs for defense we have at present are not representative of what could happen
if there were a free defense market. Nowadays, armies are state-run, but the state is not
motivated enough to optimize costs. We should expect that the fixed costs for defense
would fall significantly if left to the market. It must be noted that the defense companies,
although based in a particular society, could function internationally and thus, would be
able to profit from defensive wars abroad. As an example from real life for the profitability
of the suggested system, one could point out the fact that piracy has existed and still
exists. It has been profitable enough to outweigh the risk and the investment. Another
A bilingual interdisciplinary journal 49
example is privateering Sechrest (2003). Both piracy and privateering as such are paid
exclusively by the opposing parties if defeated.
Specific issues of incentives/motivation
Insurance/defense company approach
I. The anarcho-capitalist insurance/defense company solution has a distinct and very specific
problem. It is a general one which applies not only to national defense, but to defense
from any initiated aggression. It stems from the fact that what is suggested is a fusion between
the general economic fields of insurance and police protection. Let us first see how
the insurance branch of the economy normally functions. An insurance company typically
offers compensation for occurrences such as: natural disasters (earthquakes, hurricanes,
floods, etc.), loss of productive ability (health insurance), loss of property (robberies, car
insurance), etc. What is common among all of the mentioned cases is that from the point of
view of the insurance company, these occurrences are unforeseeable. They can be predicted
only through statistical means, but cannot be controlled by the company itself. In short:
an insurance company has no control and cannot have any control over earthquakes, for
instance. It can only estimate the probability of having one and bet against its clients on its
happening/not happening.
What the anarcho-capitalist insurance/defense company approach offers is a fusion between
insurance and defense. I.e. an insurance company insures against some event and at
the same time protects you from it by using its defense branch. What this, however, suggests
is that the insurance company will obtain control over the particular insurable event. This
way, it will be able to exert control over its happening/probability. Once this control is available,
there is no doubt that it will be used in the best interest of that company.
What is typically suggested in the relevant literature is that such control will have a positive
outcome for the company’s clients, because the insurance company will try to minimize
its costs [Tannehil]. For example, if you are insured against robbery, the company will try to
protect you, so that it does not have to pay you compensation in case you are robbed. What
seems to have been overlooked in this simplistic view is the fact that companies on the
market try to maximize their profits in the first place. Minimizing their costs is part of the
profit motive, but it is not the whole one. Another part is maximizing their sales revenues.
In particular, an insurance company would want to win customers who are highly motivated
to insure themselves and thus willing to pay a high price for the company’s service. But
what motivates people to insure themselves against aggression in general? This is the fear
of being robbed/mugged/killed/etc. If this fear is high, people will be motivated to pay a
lot for insurance services. However, if the same fear is low, people will not be willing to pay
much to protect themselves from aggression. Thus, from the point of view of the insurance
company it is better when its clients are afraid. Their legitimate concerns over their security
will translate into bigger insurance sales. People, however, are afraid only if such crimes
happen from time to time to them or to their neighbors. From such a standpoint the lack of
crime/aggression in a society will be the worst thing that can happen to such an insurance
company. If there is no crime, people will not insure themselves against it, so no clients
New Perspectives on Political Economy50
and consequently no revenues for the insurance companies. Note that if one has no clients,
one cannot minimize costs in the mentioned way, because these costs exist only if there are
clients. All of the above means that it is in the best interest of any insurance company there
to be crime/aggression. However, in the anarcho-capitalist solution it is the insurance company
which is able to control the occurrence of these offences, since it is given control over
them. There is no doubt that this control will be used in the best interest of the company,
but this interest may not coincide with the one of its clients. So, crimes may be allowed to
happen, because this will be beneficial for the owners of the company. Examples of such
crime can be found in some of the former Eastern Bloc countries after the 1989 changes
from socialist to capitalist economy. In the early years of the transition, the said fusion of insurance/defense
companies existed (protection/extortion/ racketeering). For instance, unless
one insured oneself against car theft, one’s car was guaranteed to disappear. However, if
one was insured, the likelihood of such an occurrence decreased dramatically (CDS 2007).
It must be noted that such a situation can happen because of the fusion of the insurance
and executive functions. If such a fusion does not exist, the said problems will not be
present. And the reason is that the insurance company will not be able to control the particular
insured event the same way it cannot control the occurrence of an earthquake. Thus,
from the suggested solution to combine insurance and defense companies so that foreign
aggression be fought against, significant problems will arise. The fusion of two separate and
originally independent branches of economy will have adverse consequences for the society.
The above argument is valid even for plain defense companies, since they are affected
by the same incentives. In particular, they will also have control over the event they protect
against. Thus this argument is a general one which affects not only the anarcho-capitalist
defense against foreign aggression but the anarcho-capitalist defense against any aggression.
From an incentive/motivation point of view, the defense companies have two self-opposing
motives: on the one hand, to stop the crime, because only then will they be employed
and paid by their clients; on the other hand, they will have motivation not to prevent the
crime, because only then will their clients be afraid and therefore willing to pay for their
services. This is a classical situation of a conflict of interests.
In contrast, in the suggested system such a problem does not exist. The interests of the
defense companies will be one-sided, namely to win the war only. And what is more, the
interest of any defense company will be to capture more of the enemy’s resources than their
competition.
II. Under anarcho-capitalism, every private insurance/defense company gets paid by the
private property owners it insures/defends. Thus, if we accept that it will be driven by the
same market incentives as any other company on a free market, we must acknowledge that
the particular company will care primarily about the interests of its clients, not about those
of its non-clients. In effect, there will be many different companies which protect different
clients in the same country. Thus, if the clients of company A are being attacked, this is a
problem for company A only, but not for company B, C, D, etc. The rest of the companies
need not join company A in its fight against the aggressor. They do not have the direct in-
A bilingual interdisciplinary journal 51
centive to do so because they will not be paid for this. To put it in another way, the interests
of the insurance/defense companies under anarcho-capitalism are different; they do not coincide,
because they serve different pools of clients. Due to this fact, if an anarcho-capitalist
society is attacked, only the companies whose clients are affected will have the incentive to
defend them. The ones whose clients are not attacked will not have the motivation to undertake
any counter-action. What is more, the “free-rider” problem will be present. It would
be extremely profitable for a company to let the others carry the burden of defense, while it
sits on the sidelines. Due to the obvious threat (of war) it could raise its prices, while doing
nothing in the meantime.
Let us now compare the above with the suggested system. There will again be many
defense companies, but since their client will be the aggressor himself, they will be highly
motivated to fight the aggressor together or independently in a search of profit. It would not
matter who exactly is attacked as long as he/she belongs to the respective society. They may
unite if they deem such a strategy more promising, or, alternatively, undertake a guerrilla
tactic alone. In any case, their interests will be aligned (to fight the same aggressor) and
their decisions will be made based on the best option to earn a profit.
David Friedman’s approach
In the voluntary militia and professional army approach suggested by D. Friedman, the
professional part of the army is funded through donations. Getting money from donations,
however, is not a market mechanism. As such, it lacks the traditional free-market incentives.
In particular, the money which will be obtained will have to be distributed/managed by
other people, not by the original owners of the funds. Basically, the organization which will
make use of the funds will have to manage money which does not belong to it. The problem
with that is that if it loses or mismanages this money, it will not have lost personal funds. In
comparison, a businessman in the same situation loses his own money if he uses it incorrectly.
The situation is similar to the usage of public funds by the government nowadays.
Since money from taxes does not belong to the government itself, the motivation to use it
efficiently is low or entirely missing. The same problem will occur in Friedman’s solution.
In the suggested system, however, the money to organize the defense will come directly
from big investors who will either organize their own defense companies or invest in existing
ones, thus becoming owners in them. So, if they lose, they will lose their own money
which is what motivates them to use it as efficiently as possible. Thus, the motivation of the
defense companies in the suggested system will correspond exactly to the one existing on
the free market.
Specific issues with regards to knowledge
Insurance/defense company approach
Under anarcho-capitalism, the insurance/defense companies will be dependent on private
property owners for their money. I.e. if private property owners think that a danger is imminent,
they will be willing to spend more money on insurance against foreign aggression,
but if they do not think so, they will spend less. The real problem here is that the individu-
New Perspectives on Political Economy52
als are not always willing or able to objectively assess the situation. If one wants the whole
society to spend more, it must be convinced somehow that the threat is real and imminent.
Thus, a whole propaganda network must be organized somehow to handle this problem.
I.e. an organization for collecting, processing and distributing information will have to be
established, so that this particular market can work somehow.
While such an undertaking can be organized by a government very well, because the
government is a centrally run organization with almost unlimited funding, this will not be
the case in an anarchist society. We should not expect that such an advertising campaign
will have more success than it usually does on the free market. Let us take, for example, the
closely related situation of the traditional insurance companies in their function as insurers
against natural disasters. Experience says that they are not able to convince all or even most
of the people that having an insurance against earthquakes or floods is meaningful. In a free
market, however, this failure to insure themselves will be borne personally, i.e. just the people
who refuse to protect themselves against the particular natural disaster which happened
will suffer. The ones who have prudently insured themselves will be compensated. Thus,
the inability to convince people will not be a joint problem. This will not be the case with
the war effort, however. A failure to convince at least the majority of the people will be fatal
for all of the society, because the consequences will be borne jointly. The suggested way for
spreading information and convincing people (advertising), however, is not guaranteed to
succeed, because there is no existing market mechanism to ensure its success. If there had
been one, it would have already been used by the free market.
As a comparison in the suggested system, what the general public knows, believes or
is convinced of will be irrelevant. The defense companies will collect the relevant data,
estimate the level of risk themselves and since they would not rely on the general public for
money, they would make the necessary investment (arms, soldiers, etc.) themselves out of
private funds. They would be funded by big investors willing to take the risk and looking for
profit. The information about the level of risk of foreign invasion will be gathered and used
only by people motivated to profit from it as is typically the case at a free market. The result
will be that the necessary preparations will closely match the level of risk, because a market
mechanism for this will be in place.
David Friedman’s approach
In the voluntary militia and professional army approach suggested by Friedman the professional
part of the army is funded through donations. Since donations do not represent a
market mechanism, it will be impossible to determine how to use the particular funds, how
much to pay for the specific parts of the service, what exactly this service must be and how
it must be organized. This is the general problem of lack of knowledge characterizing all
non-market-based systems.
Let us take a look at an example how the market normally functions. In a market situation,
when a consumer spends some money to buy a particular good/service, he transfers
information by paying for it. He expresses his willingness to buy the particular good/service
along with his abilities to pay for it. The seller/producer obtains this information and uses it
A bilingual interdisciplinary journal 53
to better adjust to the preferences of the consumer. Thus, the producer/seller is informed by
the market what he must produce, how it must be produced and what the optimal structure
for production must be.
In the case of donations, however, most of this information is missing. The person who
donates the money simply expresses his preference that the money be used for a particular
purpose, but he does not say how. In such a way, the organization that obtains the money
from donations is in the dark about how to use the donated funds. It will be clear that the
money must be used for the cause that they have been donated for, but the question of how
is left unanswered. The consequence from the above is that the respective organization will
have to make decisions on its own. It will, however, have to make decisions about a group
need. And how does one evaluate a group need? One cannot simply average over the needs
of his clients in a society. All needs are specific and thus, individual. In effect, the decisions
about how to protect the particular private property owners will be simply arbitrary.
The problem can be exemplified with the contemporary police service: it is impossible
to know what its organization must be, how much money must be spent on it and how this
money must be allocated. In the case of police, money comes from taxes, but the situation
is absolutely the same from an informational point of view. No info is given to the police on
how to use these funds. Friedman’s solution is plagued by the same problems.
Such a problem will not be present in the suggested system since, the defense companies
will adjust their size and organizational structure to the particular enemy, i.e. they will be
guided by the market.
7. CONCLUSIONS
A new system for organizing national defense has been offered. The proposed system is
an anarchic and a free-market-based one. However, it differs significantly from the one
suggested by anarcho-capitalism. In it, it will be the aggressor himself who will pay for the
defense services, not the private property owners. Thus, the service will be provided to
the aggressor himself, avoiding entirely the public-goods problem by which the standard
anarcho-capitalist proposal is plagued. The proposed system will ensure the defense of its
citizens against foreign aggression for free, since they will not pay for it. Freedom will become
a positive externality.
REFERENCES
Center for the Study of Democracy (CSD) (2007) ‘The Vehicle Theft Market’, In Organized
Crime in Bulgaria, Market and Trends. Retrieved from: http://www.csd.bg/artShow.
php?id=9120
New Perspectives on Political Economy54
Friedman, David (1989) ‘The Hard Problem: Part 2’, In The Machinery of Freedom: A Guide
to A Radical Capitalism.Open Court Publishing Company
Hoppe, H. H. (1999) ‘The Private Production of Defense’, Journal of Libertarian Studies
14 (1), 27–52.
Hummel, Jeffrey R. (1990) ‘National Goods Versus Public Goods: Defense, Disarmament
And Free Riders’, Review of Austrian Economics 4, 88–122.
Murphy, Robert P. (2010), Chaos Theory, Ludwig von Mises Institute, Auburn
Ninov, Youliy R. (2016) ‘A Free Market Alternative To Anarcho-Capitalism’, New Perspectives
On Political Economy, 12(1–2), 89–109
Sechrest, Larry J. (2003) ‘Privateering and National Defense. Naval Warfare for Private
Profit’, In The Mith of National Defense. Essays on the Theory and History of Security
Production. Ludwig von Mises Institute
Tannehill, Morris, and Linda Tannehill (1970) The Market for Liberty. Lansing, Michigan:
self-published.
A bilingual interdisciplinary journal 55
BOOK REVIEW
FRAGILE BY DESIGN: THE POLITICAL ORIGINS OF BANKING CRISES AND
SCARCE CREDIT BY CHARLES CALOMIRIS AND STEPHEN HABER, 2014.
PRINCETON, NJ: PRINCETON UNIVERSITY PRESS, 584 P
In Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, Charles Calomiris
and Stephen Haber hope to establish explanations for banking outcomes by researching
through the lens of not just economics, but political science and history. They use case
studies of five different countries to assist them in this task: Britain, the United States,
Canada, Mexico, and Brazil. Through an investigation of each country’s unique history and
governmental structure, Calomiris and Haber compare and contrast the development of
each country’s banking system. For example, the United States has experienced 12 banking
crises since 1840 but Canada has had zero. Through the case studies, Calomiris and Haber
attempt to find out why. The book suggests that a country’s financial sector is determined
by a process labeled the “Game of Bank Bargains” where politics and banking become intertwined,
and powerful coalitions and incentives become extremely important. Thus how
political institutions and coalitions differ explain the unique banking outcomes of different
countries.
Calomiris and Haber begin by discussing the origins of banking. They claim that states
and banks are dependent upon one another, for states made banks and banks made
states. Banks require the presence of government so as to enforce their contracts and
promote the rule of law. On the other hand, the state needed banks largely to finance wars
and create sufficient trade, which helped to ensure the survival and dominance of the
current regime. As evidence, consider that almost every country has undergone a period
of having a state-chartered bank. Calomiris and Haber state that the interdependence of
rulers, financiers, and merchants led to the need of banks and their growth. However,
the book importantly warns that government faces a conflict of interest with its role in
the financial sector. The government must regulate banks and determine the winners/
losers of bailouts, but the government both depends on the political support of those using
banks and is heavily financed by the banks themselves. This can lead to problematic
rent-seeking behavior.
The authors next turn to Great Britain where they find one of the oldest banking systems.
Once Britain’s political responsibilities were transferred from the monarch to parliament
in 1688, the country’s debt now became a national issue. In response, Britain created
and chartered the Bank of England in order to finance the government (mostly military
conflicts). During this time, the Bank of England had a monopoly over banking in the coun-
New Perspectives on Political Economy56
try as it was the only bank parliament would charter. A banking crisis in 1825, however,
served as a focusing event that demanded reform. Parliament reacted by ending the Bank of
England’s charter monopoly and allowing competition. After the 1850s, Britain’s banking
sector entered an era of “tough love” and its banking system was more stable until the 2007
financial crisis. This is not to say that during the World Wars government crowding out of
credit did not occur. The state took control of large portions of the economy in an attempt
to please the median voter, which lasted until Margaret Thatcher’s reforms. Thatcher’s
success, and Britain’s history, point out that democracy alone does lead to a certain type
of banking system that is immutable. Most importantly, Thatcher’s tenure illustrated that
democracy does not simply lead to a welfare state where rulers continue to make promises
for the population until the system collapses.
Calomiris and Haber next discuss the banking system of the United States. As aforementioned,
the financial system in the U.S. has been unstable having had 12 banking crises
since 1840. Remarkably, the U.S. underwent an era of unit banking from 1810 to 1980. This
meant that banks were not legally allowed to have branches, so each bank was more or less
a localized monopoly. Unit banking inherently meant instability for two reasons. First, risk
could not be spread out and diluted. Second, funds could not be allocated to banks that
were failing because banks did not have branches to aid them. One should wonder why such
a system was in place at all if it produced such poor results. Calomiris and Haber find that
the U.S. government’s heavy reliance on federalism, and thus local populism, promoted
unit banking. Ultimately, lack of economic growth and technological innovation, such as
the ATM, brought an end to unit banking.
Due to large-scale branch banking and increased competition, the banking system of the
U.S. improved but did not become stable. Why? Moral hazard and the abundance of easy
credit plagued the financial sector. Starting in the 1980s, banks already were considered
“too big to fail,” and failures were bailed out. This punished taxpayers for the banks’ shortcomings
and did not incentivize careful investing. Moreover, in the early 2000s, political
activists encouraged the government-sponsored enterprises Fannie Mae and Freddie Mac
to make home-owning more affordable for low income and urban individuals. This created
an era of easy credit that engulfed much more of the population than just those targeted
groups. The takeaway from the story of the U.S. is twofold. First, even well-intended policies
can be harmful. Second, how political coalitions are able to assert their influence has a
profound effect on the structure of the banking system.
The authors move on to Canada, which is important because their banking system has
been remarkably stable while their neighbor the U.S. has undergone multiple banking crises.
First, Calomiris and Haber clarify that Canada has had large business cycle fluctuations
but they did not carry over into the banking sector. Unsurprisingly, the banking outcomes
were not the only unique aspect of Canada, so too was the structure of its banking system.
Canada did not even have a central bank until 1935, and even then, it held little power.
Alternatively, Canada had a large system of nationwide branch banking where there were a
few large and competitive banks. The reason for this is that Canada has a stronger central
A bilingual interdisciplinary journal 57
government resulting from the British being fearful of the French population in Canada
during the colonial period. This history meant that Canada has not faced the strong regional
factions and banking coordination problems that the U.S. did, leading to a much
more stable system. Another essential feature of the Canadian banking system was focus on
avoiding moral hazard. Sometimes the government bailed out banks, but usually troubled
banks were allowed to fail or saved through voluntary agreements with other banks. This
led to a much more stable system. For example, not a single Canadian bank failed during
the Great Depression!
In the central part of Fragile by Design, Calomiris and Haber shift their attention to autocracies.
Through studies of Mexico and Brazil, they find that autocracies almost always
lead to worse banking outcomes than democracies. A banking system should be valued
based on two aspects—the availability of credit and the stability of the system. Autocracies
have a few, unsuccessful banks in large part because the government cannot help itself from
expropriating the banks. Banks then do not have the funds needed to finance the needs of
the general population so credit is scarce. Likewise, without economies of scale and the dispersion
of risk, these banks are unstable as well. Usually, government-run banks then result,
but they typically favor the political and social elite of society. These banks can sometimes
be stable, but credit is so rare that it hardly is conducive to economic growth.
As a result of their research, Calomiris and Haber come to several conclusions. First,
banking crises are not random events. If such crises were random, they would be evenly
distributed across the globe, but they certainly are not as is clear by the difference between
the U.S. and Canada. Second, banking outcomes stem from a process the authors
call the “Game of Bank Bargains” where the political structure and coalitions within a
given state combine to produce a system that serves the interests of those who are politically
powerful. Politicians utilize banking systems to pursue policies and agendas because
the alternative is doing so through taxation, and taxation is much more transparent and
unpopular. Third, Calomiris and Haber assert that readers should not expect politicians
or regulators to alleviate banking instability and prevent the next crisis without populist
pressure. They rarely feel the effects of such crises and are strongly motivated to pursue
their own interests unless pressured for reform, as was the case during the Thatcher era
in Great Britain.
Fragile by Design: The Political Origins of Banking Crises and Scarce Credit is a fascinating
read. While one may be familiar with the banking history of a specific country, this
text exposes readers to a comparison of various countries. The book does have a few
flaws, however. Calomiris and Haber spends a vast amount of time detailing the specific
history of each country discussed. While it is important to detail the history of each country,
the broad scope of detail covered in the book at times seems unnecessary and takes
away from the most crucial events. In addition, while Calomiris and Haber superbly deconstruct
the financial sector in these countries, they rarely reconstruct it and provide a
normative way forward. Readers of the book will likely come away with a very pessimistic
view of potential reform. Ultimately, however, Fragile by Design does a phenomenal job at
New Perspectives on Political Economy58
opening the readers’ eyes to the cause and effect nature of political institutions, banking
systems, and banking outcomes. After having read the book, a reader will have a much
better understanding of how interwoven politics and banking is, and perhaps that is the
important takeaway.
Derek Hunter
Penn State University Law School
and
Joshua Hall
Director, Center for Free Enterprise, West Virginia University
joshua.hall@mail.wvu.edu
LIST OF ARTICLES
Antón Chamberlin, Walter E. Block: The Illogical Fear of Automation,
Falling Wages, and Falling Prices.....................................................................5
Darcy W. E. Allen, Chris Berg: Subjective political economy.....................19
Youliy Ninov: National Defense as a Private Good: Freedom as a Positive
Externality......................................................................................................... 41
BOOK REVIEW
Derek Hunter, Joshua Hall: Fragile by Design: The Political
Origins of Banking Crises and Scarce Credit by Charles Calomiris
and Stephen Haber...........................................................................................55
www.cevroinstitut.cz