"Governance" consists of the enforcement of rules. A
"government" is most generally an agency which enforces rules. We
normally think of a government as that of a state, which is a
government having ultimate authority over some geographic area and
over its subjects or citizens. But a voluntary association also
has governance, which we can call an "association" to distinguish
it from a state.
The state government can play two different economic roles.
The first role is that of marketization: the legal recognition of
the rules and rights of the market and their enforcement. The
fundamental ethical rules that markets adhere to were discussed in
Chapter 1. Marketization involves the implementation of the
1) All acts and only those acts which coercively harm others
are prohibited or penalized. Every individual has the natural and
legal right to life, liberty, and property. This includes the
right to create voluntary associations.
2) Contracts consist of voluntary agreements. If an agreement
is violated, the victim may sue for damages.
3) People and enterprises that are not able to pay obligations
may declare bankruptcy. This does not eliminate the debt, but
provides for an orderly priority of payment and the ability of the
debtor to preserve the minimal possessions required for life.
4) Property rights and boundaries are established and
recorded. These include air rights and the division of the
electro-magnetic spectrum into frequencies for radio, telephone,
and television transmissions.
5) The possession of natural resource properties, including
surface land, minerals, air rights, and pollution dumps, are
subject to the payment of the rents and social costs involved in
using these properties.
These fundamental market rules are best inscribed in a
constitution. A constitution consists of the supreme rules of a
community, such that all other laws and rules are based on the
constitutional rules. The constitution sets the organization of
the government, the rules that the members follow, and the rights
that the members and visitors have. There is a branch of economics
called "constitutional economics" which studies the different
effects of having various constitutional rules.
The second role that government plays is intervention. In
contrast to marketization, intervention is an interference into the
market process, making the economy less efficient and violating
rather than protecting rights. Whether policy is marketizing or
interventionist depends on the incentives of public choice.
2. Public Choice
A private choice is a decision that only affects the person
who does the choosing. When a decision affects others, the choice
becomes public. In particular, when people vote or when government
officials select policies, these are public choices. Political
scientists have studied these decisions, but economists also have
studied political choices. This has become a branch of economics
called "public choice."
Two of the key issues in public choice involves voting by the
citizens and the choices made by government officials. In the
democracies we have today, citizens are confronted by candidates
and parties seeking the votes of thousands and millions of people.
These candidates are total strangers to most voters. As noted by
Henry George (1883, p. 174), "a principle should always be kept in
mind which we have largely ignored, that the people cannot manage
details, nor intelligently choose more than a few officials." An
individual voter not only does not know the character of the
candidate, but also knows little about the candidate's past
political record, how he or she voted on various issues and what
kinds of interests have influenced the candidate. Most people are
busy with their private lives and don't find it a high priority to
invest much time in researching the background of a candidate,
since one vote will normally make very little difference in the
Hence, most voters have what economists call "rational
ignorance," a lack of knowledge about candidates and issues due to
the lack of power make a difference in the outcome. Also, many
people are swayed by emotional appeals and the image and appearance
of a candidate, how he or she appears on television.
As a result, candidates must project a positive image and
appeal to the voters' emotions and ideologies. They get the most
votes by appealing the majority views, not to fringe and minority
interests. Given a one-dimensional range of views on a particular
issues, such as spending a little, a moderate amount, or much on
the military, the voter in the middle of the distribution is called
the "median voter." Candidates will appeal to this voter, since
appealing to the right or left of the median will lose more votes
than it gains. Thus, in a two-party system, the parties will tend
to converge on the views of the median voters. Much of the
advertising will then be to project an image of good character and
to vilify the opponent. The two-party system in the United States
has become a duopoly, or dual monopoly, with laws in most states
imposing burdensome signatory requirement for minor parties. With
proportional representation, where people vote for parties and
minority interests can be represented, the candidates are selected
by the party leaders, leaving the voters to choose among parties
offering packages of policies which they may not like entirely.
To appeal to thousands and millions of voters, candidates and
parties need to spend great amounts of money, unless the law
restricts it and provides for media access. The funds for
campaigns comes from individuals, special interests, and the
In large campaigns, the bulk of the funds come from special
interests rather than individuals. Unless a voter has a good deal
of sympathy with a candidate, party, or issue, he will not tend to
pay much attention to politics. The reason is that the benefits to
an individual are small, compared to the cost in time and
resources, unless he is keenly interested. In contrast, special
interests, such as farmers, captains of industry, and religious
organizations, receive concentrated benefits from government
subsidies, protection, and privileges. They therefore have a strong
incentive both to contribute to campaigns to gain influence, and
then after the election to lobby for favorable legislation. The
public choices of legislators are therefore heavily influenced by
special interests. Since candidate need funds and votes, they
cater to special interests and the median voter. The interests of
minorities without financial or voting clout will usually be
Non-elected government officials also make public choices. As
James Buchanan has noted, their choices are "cost-influencing" but
not "cost influenced." This means that bureaucrats make rules that
impose costs on others, but the officials themselves do not have
any cost. The head of a government agency will normally seek to
increase his power and authority and spend as much as possible.
The result of these choices by government officials is that
much government spending is geared to the desires of special
interests and of officials rather than the goods that the public
desires. This is a main reason for government failure. The other
major reason is the knowledge problem - that even with good
intentions and incentives, a central government lacks the knowledge
needed to plan for large economic activities.
Henry George analyzed the impact on public choice of the
economic structure of society, of the effect of democracy when
there is a great inequality in wealth.
Political equality is not sufficient to promote prosperity and
avoid decline. "Equality of political rights will not compensate
for the denial of the equal right to the bounty of nature" (1879,
p. 545). If the equal right to vote co-exists with an increasing
economic inequality, a large class of poor and a small land-owning
elite, this "must ultimately beget either the despotism of
organized tyranny or the worse despotism" of chaotic revolt (p.
530). The slaughter and wars in Rwanda, Cambodia, El Salvador,
Bosnia, and elsewhere testify to the terrible consequences of the
failure to establish a just economic and political order.
George recognized the important distinction between form and
substance in government and economics: "forms are nothing when
substance has gone, and the forms of popular government are those
from which the substance of freedom may most easily go" (p. 530).
Citizens may still vote, yet the vote can be empty as power passes
"into the hands of jobbers who will buy and sell it" or "into the
hands of demagogues who will seize and wield it" (p. 531).
Democracy degenerates when there is a gross inequality of
wealth, poisoning the national character. "To give the suffrage to
tramps, to paupers, to men to whom the chance to labor is a boon,
to men who must beg, or steal, or starve, is to invoke
destruction... To put political power in the hands of men
embittered and degraded by poverty is ... to put out the eyes of
Solomon and to twine his arms around the pillars of national life."
Thus, "in a corrupt democracy the tendency is always to give power
to the worst... the worst float to the top, ... transmuting races
of freemen into races of slaves" (p. 532). "A corrupt government
must finally corrupt the people, and when the people become corrupt
there is no resurrection" (pp. 532-3).
George saw in his day what we recognize too well in ours, that
it is in our great cities that is found "the greatest wealth and
the deepest poverty. And it is here that popular government has
most clearly broken down..." Here "are men of power, whose favor
the ambitious must court and whose vengeance he must avoid" (p.
3. Government structure
The implications of public choice analysis are that 1) a
precondition for a sound government is a sound economy, in which
gross inequalities, due to the unequal ownership of land, are
avoided, 2) the efficient provision of collective services is best
left to the market process or, if that is not feasible, that
government be structured so that the incentive to confer privileges
is minimized, 3) governance and voting in small groups provides
less opportunity for special interests than large groups.
The structure of government needs to be inscribed in a
constitution, so that it is not easy to change by legislation.
These constitutional restraints are of two types: 1) restraints on
government activity; 2) the division of government power.
Restrains on government include a general rule that government
shall not restrict peaceful and honest action. Government must also
be prevented from imposing taxes and arbitrary costs. A further
restraint is that government be voluntary. Secession from a
government jurisdiction is allowed from services such as education
and local public works, and from the authority of the government
itself. People could then form alternative associations and deduct
the cost of substitute services from their taxes or assessments to
A division of government power includes horizontal and
vertical divisions. The horizontal division is the well-known
separation of powers at some level of government, such as a federal
government. The usual division is into a legislature (parliament
or congress), an executive (president, monarch, and/or prime
minister), and a judicial branch, each with partial independence
with an ability to affect the actions of the others. One possible
fourth branch is an agency responsible for elections.
A vertical division of government power consists of levels of
government, from local to federal. The United States has three
levels: federal, state, and tribal for Native American Indians and
aboriginal Alaskans. Cities and county governments are actually
agents of the states, and only have powers granted to them by the
states. Vertical division can be increased by allowing individuals
to secede from any jurisdiction and create alternative governance.
Many private communities are already providing services similar to
those of government (see Foldvary, 1994). A strong vertical
division can be created by basing power in neighborhood councils,
which then elect higher-level government levels up to the top level
in a bottom-up pyramid structure.
The benefit of vertical division is that governance becomes
more of a market. With decentralized governance, people can more
easily move and join communities with more efficient governance or
with specialized services. Bad government becomes less likely if
people can secede from it rather than have to engage in costly and
Another aspect of government structure is the method of public
choice by the voters. As described above, when candidates must
appeal to thousands of anonymous voters, there is a strong
incentive for special interests to be influential. An alternative
is bottom-up voting. A city or county is divided into townships
and then into districts of about 500 persons. Each district elects
a local council. Each council then elects a representative to the
township board, representing about a dozen districts. The
townships then elect delegates to a city or county council. These
elect the members of the state legislature, which in turn elects
members to the federal congress or parliament. At the bottom
level, the districts are small enough for the voters to know the
candidates personally, so there are no media campaigns and appeals
to image. Special interests would find it difficult to sway the
elections. Bottom-up democracy is an alternative to the top-down
systems that have been an improvement over dictatorships but have
let to the rule of special interests and a top-heavy government.
A free and prosperous economy requires governance with a marketizing rather than interventionist policy. The government needs to be carefully structured so that the incentive for government monopolies, privileges, and oppression is minimized. This is done with constitutional rules which restrain government intervention, provide for the collection of rents, and allow individuals to exit from jurisdictions when government becomes abusive.