Constitutional Economics

In an article that reminds the profession of how far it has strayed from its original assumptions, James Buchanan conceptualizes the economy as "an emerging and complex dynamic order" and feels that the economic problem is far more complex than the simple "efficient allocation of scarce resources among alternative uses",

"The economy, in some inclusive definitional sense, is perhaps best described as an order that consists of an interlinked set of exchanges, simple and complex, from which outcomes emerge that may in some respects be meaningfully measured but that cannot be chosen, and thereby controlled, by concentrated decision takers."

Crucially, about interpreting Adam Smith, he writes,

"Adam Smith’s whole effort can be interpreted as an argument for getting the 'laws and institutions' reformed so as to allow individualized self-interest to generate emergent outcomes that would prove beneficial to all participants, especially to the members of the working classes."

He drives home the need for economists to go beyond observing and measuring aggregate parameters over which they have no control, and pay "attention to the constitutional structure within which economic actors play out the multitude of transactions that describe the market order". Instead of asking generic question about how markets work, economists should explore "how markets work under this or that set of constitutional and institutional constraints". Economists should enquire into the role of the existing constitution - sets of constraints or rules - and the actions required to overcome (or construct new rules) those that are likely to come into the way of achievement of the desired outcomes. He writes,

"The relevant question is not that of asking how this or that end-state or outcome may be put in place through possible collective or political action. The question becomes, instead, how can this or that set of constraints be predicted to operate so as to allow the generation of an order that meets certain criteria of desirability?"

He advocates a "constitutional revolution" (as opposed to mere tinkering with rules) where a genuinely alternative set of rules have to be, first, articulated and then put in place so as to generate desired outcomes. And his prescription,

"Some modern equivalent of one hundred percent, or full, reserve banking must finally be installed and enforced. The Glass-Stegall efforts to separate deposit and investment banking should presumably be updated and put in play. Some extension-application of the antitrust laws to the banking conglomerations seems to be in order here."

See also Amol Agarwal here.