Different institutional arrangements in the apparatus of government, and different configurations of constitutional rights, produce different rates of knowledge creation and knowledge diffusion. There is only one constitutional configuration that produces maximum economic growth, based upon maximum rates of knowledge creation and diffusion.
James Buchanan suggested that different constitutional rules produced different social welfare outcomes.
One of the unknown variables in Buchanan’s model is the loyalty and trust that citizens extend towards each other in financial and political transactions, not simply in the current unit of time, but in future units of time.
The issue of trust involves the reliance of a citizen that another party to a financial exchange will reciprocate in the future on keeping promises that involve a future payment.
In other words, for example, can a banker extend trust to a debtor to repay the loan?
Or, can a venture capitalist trust the entrepreneur to make good on the promise of a future capital gain?
Buchanan noted that allegiance to the rule of law, and obedience of citizens in following the constitutional rules, could vary among different cultural and institutional arrangements.
The differences in the level of citizen rule obedience between societies was explained by Buchanan in terms of the perceived “fairness” of the rules.When social and economic rules are perceived as unfair, citizens have no logical justification in voluntarily following the rule of law.
The issue of fairness can be resolved, according to Buchanan, when citizens are involved in the deliberations about creating the constitutional contract.
In Constitutional Economics, James Buchanan wrote that “Uncertainty about where one’s own interest will lie in a sequence of plays or rounds will lead a rational person, from his own self-interest, to prefer rules and arrangements, or constitutions, that will seem fair, no matter what final positions he might occupy.”
As noted by Buchanan, “Individuals are recognized to possess their own privately determined objectives, their own life plans, and these need not be common to all persons. In this setting, rules have the function of facilitating interactions among persons who may desire quite different things.”
The main point of the Buchanan constitutional economic model is that the level of rule obedience depends on how the rules are interpreted by an individual citizen in affecting that citizen’s life plans.
The economic term for “life plans” is individual utility function, also known as individual welfare function.
Conflicts between citizens over the “fairness” of constitutional rules, when individuals desire “quite different things,” must be resolved by reference to how the rules are made and enforced.
Only one configuration of constitutional rules, and only one method of citizen participation in the making of fair constitutional rules, creates maximum rates of economic growth, and maximum diffusion of welfare benefits.
That single constitutional configuration creates the maximum level of trust among citizens, so that citizens can trust each other to obey the rule of law.
It also creates the maximum rates of knowledge creation and diffusion among citizens.
Maximum rates of knowledge creation creates maximum rates of technology innovation.
Technological innovation, as suggested by Solow, accounts for most of the economic growth in a free market economy.
That single constitutional configuration is the Natural Rights Republic, which citizens in America created in 1776, when they left the state of nature to form their first constitutional contract, called the Articles of Confederation.
Buchanan’s Constitutional Economic Rules
Buchanan’s rules are aimed at overcoming part of the dilemma associated with the issue of individual choice in choosing the constitutional contract, when citizens leave the state of nature.
Individual choice, in the free market system, is essential to constitutional economics because economic individualism is linked to equal political natural rights.
Socialism, or collectivism, is not based upon individualism, and those constitutional values are not comparable to the welfare outcomes of the individual choice model because aggregating the welfare of groups is not the same logical process as aggregating individual welfare functions to determine the best social welfare outcome.
Buchanan’s rules aim at creating a society based upon mutual reciprocity of fairness and trust.
The issue raised by Buchanan is that it is impossible for citizens to rank the “best” set of rules if everyone’s preference rankings are not given the same weight.
In his book, The Theory of Public Choice, II, Buchanan defines an individual from the brain’s rational choice attribute. He states, that, “…we can simply define a person in terms of his set of preferences, his utility function. This function defines or describes a set of possible trade-offs among alternatives for potential choice.”
In other words, Buchanan’s constitutional economic model assumes, as its first principle, equality of individual preference rankings, that are subsequently aggregated into a social welfare ranking, in order to judge the “best” constitutional arrangement.
Buchanan noted Kenneth Arrow’s issue of irrational social welfare rankings in a socialist society, when some individual’s welfare is given more weight than other individuals in the social preference rankings.
Rational consistency in the ranking of end goals of a democratic society, Arrow concluded, in Social Choice and Individual Values, was impossible when individual preference rankings were not equal.
Given the unequal preference rankings in socialism, consistency in rational decision-making, according to Arrow, could only be achieved in a dictatorship.
What Arrow meant by the condition of dictatorship is the ability of one individual preference function to become the social preference ordering, regardless of the preference functions of the other individuals.
In creating the constitutional contract, citizens in a collectivist society, who desire different things, would attempt to skew the constitutional rules to meet their own individual preferences.
The constitutional public purpose in socialism would mean whatever the elite special interests in control of the government, say it means, at the time in history that they happen to be in control.
In Buchanan’s conception, when there is not equal weightings in individual preferences, there is no logical rule making mechanism to prohibit the elected socialist representatives from substituting the maximization of their own welfare function, as a part of them imagining that their own welfare improvement is the same thing as a social welfare improvement.
Once a centralized government bureaucracy is created that is removed from the consent of the governed, the bureaucracy develops its own interpretation of the social welfare function it presumes to maximize.
Compliance with the rule of law in socialism would become arbitrary because citizens would not have prior knowledge of what behavior served the public purpose, at any moment in time.
The logical conclusion of Buchanan and Arrow is the well-known warning about socialism that it requires an elite tyranny to impose rule adherence on citizens, who are viewed as components of social identity groups, not as sovereign individuals, with their own unique welfare function.
As a consequence of this dilemma in socialism, the constitutional public purpose of a socialist government cycles endlessly, over time, in a do-loop that changes whenever the elite dictators change.
The voluntary rule obedience in Buchanan’s individualism gives way to totalitarian dictatorship in socialism, using the police power of the state to impose rule adherence.
The great virtue of Buchanan’s competitive free market system is that voluntary, cooperative social behavior coordination can be achieved without tyranny and totalitarianism, when citizens have certainty about the fairness of the rules.
The common term to describe this outcome of fairness, in the natural rights republic is, “equal justice under the law.
In The Reason of Rules, Buchanan and Geoffrey Brennan, addressed how free markets and individual freedom were intertwined in a natural rights system of rules.
For Buchanan, the organizations within the institutional arrangement established the playing field upon which economic and political transactions took place.
Buchanan’s distinction between the institutional rules of the game, and the organizations in society, flows over to his distinction between policy choices made by elected representatives, and the rules of politics of electing representatives.
Both policy and politics, under the reason of Buchanan’s rules, requires a certain type of shared morality about the end goals of the rule of law. Buchanan advocated an allegiance to a moral law as a general rule of law, similar in concept to Locke’s emphasis on liberty.
While Buchanan’s initial definition of the individual identifies the brain’s rational choice function in terms of self-interest, he later ties individual self-interest back to socials rule obedience that results from an awareness of the welfare of another individual by suggesting the possibility of an interdependent utility functions.
Buchanan argues that the voluntary citizen compliance with the rule of law, based upon moral reciprocity in the constitution, leads to rule obedience because all citizens are subject to the uncertainty that they may, one day, find themselves at the bottom of the economic totem pole.
In other words, human rational choice leads to voluntary constitutional rule obedience, under Buchanan’s rules.
Rule obedience, in Buchanan’s free market system, leads to fair economic outcomes in the distribution of incomes.
Buchanan’s entire voluntary, cooperative system depends on a shared cultural belief and faith in an individual’s capacity to be the best judge, and the best guardian, of their own individual welfare.
Natural Rights Economic Growth Theory
Quantity and price adjustments in equilibrium theory, do not lead the society to any pre-determined optimal end point at all. Prices, in the market, are not independent variables that serve to guide society to some magical point of social optimality.
Prices are dependent variables that are caused both by the interaction of the set of rules and legal entitlements enacted through a constitutional convention, and by investments made in previous periods, under supply and demand conditions that existed in those prior time periods.
Price adjustments are a reflection of changing rules and laws, not simply the result of changes in supply and demand forces. Price adjustments lead to equilibrium not social welfare maximum.
Any point along the production possibility frontier will generate a non-unique set of prices, if the distribution of income between social classes is changed. The set of prices at that point of production possibilities reflects the existing distribution of income.
There is only one constitutional configuration of rules that produces maximum social income. That constitutional configuration is the natural rights republic because it starts out with the assumption that its function is to create “maximum” happiness.
No other constitutional configuration starts out with this social goal.
Change the constitutional rules on private property, for example, and the distribution of income between the classes is changed, and, voila, a new set of equilibrium prices occurs, at that point of consumption and production.
Prices are not freely and exclusively determined in the single present unit of time. Prices in the present time unit are partially determined by the level of investments made in prior units of time according to the rules established by the constitution.
Investment decisions about the future are made using discounted market prices that heavily bias the decision towards the present. With this bias in the investment decision process, justice, defined as a market exchange value, is always being discounted by its monetary value, just like incomes and jobs are discounted in the future units of time.
In other words, to return the conundrum known as “Arrow’s Paradox,” if the constitutional bedrock of laws does not contain the telos of upward occupational mobility, happiness, and fair rules for the competition of income, then the subordinate laws that are passed by Congress will not provide logically consistent outcomes.
The economic consequence of Arrow’s paradox of lack of fairness, is static income distribution for the majority, and unequal incomes for a tiny minority of elites.
Static income distribution means loss of technological diversity and, contingently, the elimination of the forces that contribute to economic growth.
Only one set of constitutional rules aims at increasing future incomes, which are obtained if new markets emerge, which have new products, that consumers favor over the old products.
New products and new markets may emerge, given a specific configuration of cultural values and laws that favor individual initiative and the appropriation of rewards based upon individual merit.
Under another set of constitutional rules, income distribution is static, and new markets, based upon the commercialization of new knowledge, do not emerge.
For example, under the 8 years of the Obama regime, incomes were static and economic growth did not occur.
The new future markets are contingently created as a result of knowledge creation and knowledge diffusion, which contingently, may lead to commercializing new product ideas.
At any moment in time, in Buchanan’s individualistic economy, technological conditions may be changing, and the main question of economic theory is to predict what type of economic environment is likely to emerge in future time periods, given the prior conditions.
The economic predictions would be based upon an investigation into the dynamics of feed back effects from the current final demand market based upon consumer preferences for new, technologically-advanced products, offered by new ventures, in comparison to the old existing products, offered by incumbent firms.
The most important social rules for explaining and predicting economic growth in the natural rights republic are the rules for individual initiative to create new ventures and appropriate profits.
Future economic growth (G), is dependent on the knowledge variable, K, which reflects the marginal contribution of a vintage sector, s, to the rate of innovations, which is the “…rate which an old idea becomes obsolete and the rate of diffusion of older ideas into current general knowledge.”
In other words, future economic growth depends on the consumer acceptance of a product innovation in the current period of time. When many new products find new future markets, new markets may emerge, creating entirely new flows of income, where none had previously existed.
Future economic growth, in an individualistic economy, is a Bayesian probability distribution function of the consumer acceptance of the new product compared to the old product.
Knowledge, as a social asset, is linked to an increase in future social incomes, as a result of new products and the emergence of new markets.
As William Baumol has noted, social rules and laws regarding appropriation of income set the economic reward structure of income for a national economy.
The behavior and adaptations of humans in markets change as a result of the introduction of novelty, which causes the “structure” of market relationships to change. Most of the novelty in markets, but not all of it, is related to the introduction of new technology in both products, and the way products are made.
The human response to novelty is contingent, and depends on the mental ability of humans to anticipate the future. What humans do in markets when new products are introduced depends on what humans anticipate other humans are going to do when they see the new product for the first time.
Most human economic activity is based on the biological ability of humans to anticipate what other humans are going to do, and imagine a course of action to take under different scenarios. The shared cultural value of trust, in the natural rights republic, allows individuals to imagine and visualize a common future with other citizens.
In other words, in a natural rights republic, the human response to novelty is “intentional.”
Whereas, in socialism, the response, by citizens, to novelty is fear and a preference for the status quo arrangement of power.
Generally, in the absence of a constitutional mandate that points to the goal of open competition for income, the reward structure associated collectivist rules about income distribution are manipulated to the benefit of the most powerful set of elites who obtain power over setting the rules and the laws.
Markets change when humans anticipate the behavior of other humans by imagining the future, and trying out, mentally, what may happen under different hypothetical scenarios. The behavior choices confronting humans are restricted and limited by laws and social customs, which vary by market and by geographical region.
The rational choice set of behavior in future markets being imagined in the brains of humans depends on the freedom to choose, and the freedom to pursue an individual course of destiny, once the choices and decisions about the future have been determined.
Individuals who happened to born and live in a natural rights republic have greater individual freedoms to create a different future market environment, for themselves, than individuals who happened to be born in a socialist society.
Markets characterized by property rights, and cultural values of trust and reciprocity would create a different set of imagined future choices in the brains of humans than markets that did not possess this resource set.
Freedom, in individualistic capitalist markets would generate different mental images than the absence of freedom, in socialistic, or collectivistic markets where the future choice sets are determined by self-appointed elites.
In the presence of novelty, changes in behavior of an individual are reflected in choices and decisions made by consumers. The change in behavior acts as a communication or signaling mechanism to other humans, in much the same role that neoclassical economists suppose that prices act as a signaling mechanism that equilibrates supply and demand.
Short term price-based decisions made by consumers depend on temporary, fleeting, relationships that occur, as the Walraisiain auctioneer instantaneously clears all markets, at all times, both now and in the future.
Longer-term strategies are time-based, not price-based, and depend on how permanent relationships are modified by constitutional rules. Most of the permanent relationships require the anticipation of who to trust in future exchanges based upon the cultural values of reciprocity and mutuality.
Given a certain set of civil rules and the rule of law, markets would evolve differently than under another set of civil rules or the absence of the rule of law.
Laws and customs determine prices in the market, and consequently, also determine income distribution, not the other way around.
When these consumer behaviors about novelty, in a natural rights republic, occur with some high frequency, the behaviors can be described as having law-like properties that have the logical pattern: “If such-and-such environmental conditions occur, then we would expect humans to exhibit such-and-such behaviors.”
Trust allows human imagination in the realm of economic behaviors to be fulfilled over a long period of time, which may eventually lead to the emergence of new markets, if the cultural value of trust is inherited over successive generations.
Trust is a moral and cultural value that is inherited when the social and legal structure is characterized by a certain configuration of civil rules of exchange and laws regarding property and appropriation of profit.
Current market selection leads to future market emergence very slowly because wants and preferences develop gradually, as consumers learn about product technology, and as they shift preferences from older product technology to newer product technology.
What happens in a natural rights republic when innovation occurs is that many different humans see the phenomena and use many different mental images to interpret the meaning of the innovation.
The slow emergence of a common social perception among different humans means that the market is providing the validation of the interpretation.
When many mental images reach the same conclusion and behavior is based upon the interpretation, the meaning of the innovation is validated across market environments.
Given a certain type of prior social and political conditions in political power and cultural values, the economy could be predicted to take a certain type of trajectory.
Given another constellation of political power, for example, socialism, the economy would maintain the status quo.
There is a Bayesian probability attached to each configuration of political power and cultural values, based upon the degree of belief about the future held in the mental images of humans in a natural rights republic.
As the conditions in the social environment change, new opportunities for technological combinations and mutations appear, which can be tried out, or “selected” by the consumers.
In other words, in constitutional economics, the basic theoretical premise is that some event or condition in a prior time period affects, or “maps on to” events in later time periods.
The Bayesian statistical analysis would be applied to beliefs and expectations in the current period that related to the appearance of entirely new technological coefficients in the national economic interindustry matrix.
The appearance of new interindustry coefficients serves as the evidence that new products are being selected by consumers.
The appearance of something new, in this case a new technological product, causes humans to imagine the future possibilities that the new thing creates.
The future that they are imagining creates the conditions of contingency that the Bayesian analysis can investigate.
Given a set of prior expectations about the future, the novelty may cause a new set of expectations, which can provide probability distributions or estimates of the most likely future market that may emerge.
Economic Growth In A Natural Rights Republic
The process of economic growth and the emergence of new markets in a natural rights republic can be described by a series of “then if” contingent logical statements:
• If exit events in the past create a pool of entrepreneurial profits, then if,
• The entrepreneurial profit is used to fund new ventures that create new products, then if,
• Technological genetic crossover occurs between two products, then if,
• Consumers and markets select new products, then if,
• Complementary markets are created, then if,
• New patterns of income distribution are created, then if,
• New technological knowledge is created, then if,
• New technological knowledge is diffused, then if,
• New production assets are “called forth” from the expanding production possibilities frontier, the assets have a greater probability of being “inherited” by subsequent generations of products, and the evolution of the market can continue through a future attractor macro bifurcation and the emergence of an entirely new market.
The claim made in this paper of a single “best” national social welfare function relies on a series of social political concepts that a society possesses, as initial factor endowments.
The function of the constitutional rules is to organize these concepts into a coherent set of rules that citizens voluntarily agree to follow, based upon their level of trust that other citizens will also follow the rules.
1. Institutional Social/Political Structure Concepts
• Degree of individual civil liberties and civil rights.
• Degree of property ownership rights and rights to transfer title of property.
• Number of voluntary membership civic clubs and civic/ professional organizations.
• Degree of population ethnic diversity.
• Degree of occupational diversity.
• Degree of interlocking networks in civic, social and professional organizations.
• Number and diversity of non-government media and communication channels.
2. Institutional Information Network Structural Concepts
• Infrastructure of telecommunications and mass media.
• Number of mobile communication devices in use.
• Number of journals, newspapers, websites.
3. Information Network Units of Analysis
• Rate of speed of information diffusion/contagion of new ideas.
• Rate of marketing or advertising expenditures on new products.
• Rate of political campaign contributions to incumbents.
Given a certain configuration of constitutional values, the rate of economic growth can be visualized as a point in the current period of economic equilibrium.
The economy is seen breaking away from equilibrium towards some future unknown attractor point, in time period 2.The oscillations around the growth trajectory become smaller, representing the concept that the future attractor point is a new future point of economic equilibrium.
At the point of equilibrium, in time period 1, vested financial and political interests have political allegiance to the status quo distribution of income, making it hard for the economy to break away from equilibrium.
In this case, Buchanan’s model suggests that the social welfare of the elite special interests have become the surrogate national social welfare function.
Official corruption, in this case, is the use of government resources to promote private financial enterprises and the personal financial interests of business and political elites in the economy.
One technique of political control of the elites is to limit economic growth is to control the creation and diffusion of knowledge. In socialist societies, there is only one official version of knowledge and all technological innovation is under the control of the elites.
In other words, from the perspective of existing equilibrium theory, the resource allocation for existing products may be efficient and in competitive price equilibrium over a period of time when prices are declining to the end point of zero market demand.
But, unless the constitution limits the corruption of the elites, in favor of future economic growth, the national economy will not grow. The economy will stagnate.
The act of “ knowledge creation,” is defined by the appearance of something new that did not exist before. If knowledge can be defined as a national economic asset, or a pool of knowledge, then that pool or asset must be measurable and additions to knowledge must be distinct.
The knowledge creation and diffusion are an essential precursor condition that allows entrepreneurs to take a risk on starting a new venture.
A nation that had once possessed this type of institutional structure, rules, laws and trust, could easily slip into the orbit of a Nash attractor point and experience the effects of Mueller’s Ratchet of economic decline.
In other words, knowledge, as a national social asset, cannot be subjected to political manipulation and political control and still create economic growth, and if control over knowledge creation is attempted, knowledge, as an asset, erodes.
Knowledge is a social asset, and is an essential precursor resource for product innovation. Product innovation and future growth depend on the ability of citizens to imagine new future markets, and commercialize those new product ideas.
Knowledge creation is not a price-based activity, but is dependent upon the economic structure of interindustry relationships that exist in the current time period of the economy at equilibrium.
To the extent that the temporary price-based relationships at time period 1 are characterized by forward linkages from intermediate demand to final demand, and backward linkages, from final demand to intermediate demand, the rate of technological knowledge creation will be greater.
To the extent that the national structure of interindustry relationships feature both vertical flows of production technology information, up and down column coefficients, and horizontal flows of information of demand information, along row coefficients, the rate of technological knowledge creation will be greater.
This constraint on information flows generates a recursive effect of knowledge transmission via players’ mobility across firms which affects simultaneously the players’ payoffs and the number of active players engaged in market competition.”
New mental images in the brains of individuals, in other words, imagination, which is the basis of knowledge, is not amenable to external political control, as a variable in an individual’s welfare function.
In other words, despite what the elites do to limit knowledge, human brains are always spinning out new alternatives and new ideas about how to make life better and have more control over individual destiny.
Only one constitutional configuration allows entrepreneurs the maximum liberty to actualize their new product ideas. All other constitutional configurations tend to inhibit and control knowledge creation, in order for the elites to direct social welfare benefits to themselves.
The knowledge creation and adaptive learning in the natural rights republic creates new markets when current expectations about the future, based upon individual guesses of entrepreneurs, are confirmed by collective expectations of other citizens and consumers.
The new products and new ventures that the venture capitalists create act as a market signaling device, in an information feedback system in the intermediate demand markets that function to coordinate mutually reinforcing expectations between the entrepreneurs and the consumers.
In a natural rights republic, a future market becomes the present market based upon product technological inheritance and technological variation in product improvements, linked by consumer selection of the newer, better products.
In a natural rights republic, product heuristics mutate, in a process of product innovation, and consumers and capitalists modify their behavior by improving strategies in a constrained maximization environment by buying the new and better goods that are produced at lower costs than existing goods and are sold at prices that yield a slightly higher (marginal) profit for a brief period of time.
That brief period of time is represented as time period 2, in the graph. It is the new equilibrium point, based upon the emergence of new markets.
The end goal of the natural rights republic is economic growth, based upon the maximum rates of new knowledge creation and diffusion.
Maximum rates of knowledge creation and diffusion depend on widely-shared values of trust that citizens will obey the rule of law.
Only the natural rights configuration of constitutional values, based upon equal individual preference rankings, can create the new future markets that create economic growth, and new flows of income, where none had existed before.
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