Buchanan’s works relate primarily to the area of Public Finance., specially to an area of collective decision making. According to Buchanan, Public finance as a field of study, is essentially a study of political economy. Economic and political analysis must join in studying the effects of political or collective decisions on the economy.
Buchanan has written an excellent introductory text book, The Public Finances. In it he discusses new topics not found in any conventional text book, such as political basis of decisions, simple and complex models of majority voting and fiscal Constitution. His most significant publications in the area of Public Finance include:
The demand and supply of Public Goods, Fiscal Theory and Political Economy and Public Finance in Democratic Process.
Buchanan has no faith on government’s actions which only sets limits on individual actions. So he wants Constitutional constraints on Government’s actions.
Buchanan’s methodology is individualism. Individuals are final decision makers and they need maximum freedom of choice. As individuals differ in tastes, capacities and their environmental setting their expectations of events and their knowledge of information is not uniform. Hence their decisions are subjective in nature.
Buchanan believes that individuals, through exchange can achieve improvements in their position. Exchange can only be effective, Buchanan argues, if individuals acknowledge the mutual existence of others and admit their property rights. Mutual agreement is fundamental in Buchanan’s analysis of collective action. His concept of State is purely individualist. Collective action is taken when individuals choose to use Government to achieve some purpose jointly rather then acting individually.
Buchanan is mainly concerned with how property rights arise (between individual sand between individuals and the State) and how they are modified. With in the realm of collective action, he focuses on individuals responses to different collective institutions. His subject mater is positive Public choice, among individuals, holding property rights and a propensity to trade; who enter into voluntary contracts to their mutual benefit.
How laws arise to uphold contracts between individuals and how they are modified and enforced are examined by Buchanan in his major works. The Limits of Liberty, and Freedom in constitutional contract. Following the calculus of consent individuals formulate a set of rules, a constitution. From the formation of a social Contract two distinct types of Government emerge. Self-interest leads an individual to default on contractual agreements when he believes that this can be achieved unilaterally. Consequently, at the Constitutional stage, an agency is created to perform the function of enforcing contractual agreements. Buchanan terms this agency the protective State. At the post-Constitutional stage, individuals may choose to provide a good collectively rather than through private or voluntary organizations. So a productive state is devised to provide public goods.
So long as the Governmental action is restricted to largely if not entirely, to protecting individual rights, persons and property and enforcing voluntarily negotiated private contracts, the Market process dominates economic behaviour, and ensures that any economic rents that appear will be dissipated by forces of competitive entry. If however, Governmental action moves significantly beyond the limits defined by the minimal or protective state, if the Government interferes on a large scale in the market adjustment process, the solution lies in constitution revolution.
Coase:
Coase too believes in the Market mechanism to resolve any divergence between Private costs and Social costs.The standard example for external economies is that of a factory, the smoke from which has harmful effect on those of neighbouring properties. There will be divergence between private costs and Social costs. In such cases, the suggestion often made by many is that it would be desirable, to make the owner of the factory liable for the damage caused, or alternatively, to place a tax on the factory owner or to exclude the factory from the Residential areas. It is Coase’s contention that the suggested courses of action are inappropriate in that they lead to results, which are not necessarily or even usually desirable.Coase argues that regardless of the specific initial assignment of property rights, the final outcome will be efficient provided that the initial legal assignment is well defined and that the parties can reach and enforce an agreement at zero cost. So long as the legal rights are marketable and well defined, the ‘Invisible-hand’ of market forces leads the parties to an efficient outcome. A Pareto optimal allocation can come about regardless of how property rights are initially assigned provided the negotiations required are feasible.
Welfare Economics originated with the ethical hedonism of Bentham, Sidgewick, Edgeworth and Marshall. The traditional Welfare economics is based on Utilitarianism. This tradition was criticized by Gunnar Myrdal and Lionel Robbins as involving inter-personal comparison of Utility. This has led to the modification of Utilitarian tradition. In fact an important part of the so called now Welfare-Economics had explicit use for only one criterion of social improvement Viz; the Parete criterion. The Parete criterion of social state ‘X’ is to be judged better then social state ‘Y’, if at least one person has more utility in ‘X’ then ‘Y’ and everyone has at least as much Utility in ’X’ as in ‘Y’. Kaldor, Hicks and Schitovsky have suggested Compensation criteria of Social choice. The Kaldor criterion states that a change is an improvement if those who gain evaluate their gains at a higher figure than the value which the losers set upon their losses. According to Hicks, state ‘A’ is socially preferable to ‘B’, if those who would lose from ‘A’ can not profitably bribe the gainers into not making the change from ‘B’ to ‘A’. Schitovsky suggested a criterion requiring a double test. State ’A’ is socially preferable to ‘B’ if the gainers can bribe the losers into accepting the change and simultaneously the losers cannot bribe the gainers into not making the change. In this criterion, if the change from one situation to another passes both parts of the double test, then only the move is an improvement. Bergson suggests a different approach. He suggests formulation of a set of explicit value judgments. His suggestion amounts to the construction of an indifference map, ranking different combinations of Utility which may accrue to member of a society. Such an indifference map is called a Social Welfare function. The modern theory of Welfare – Economics, founded by Bergson has been further developed by Samuelson and J de V. Graff.
Arrow
Kenneth Arrow won the Nobel Prize for his contributions to Welfare Economics specially to Social choice theory, a collective choice made by entire society. Arrow’s path - breaking article “social Choice and Individual Values” is well – known as ‘Impossibility Theorem’. Arrow did away with real valued welfare function and he said that ranking is enough. Arrow formulated his ‘Social – Choice Problem’ using individual preferences and call it as ‘General Possibility Theorem’. Arrow considered a set of conditions relating Social choices or social judgments to the set of individual preferences and showed that it is impossible to satisfy those conditions simultaneously. That is why Arrow’s theorem came to be known as ‘Impossibility Theorem’.
Arrow defines a Social Welfare function as a functionalrelation which specifies one Social ordering R, for any set of individual preference orderings. Arrow proposed the following conditions which social choices must meet in order to reflect individual’s preferences. 1) Unrestricted domain of the Social Welfare function .The domain should include every possible combination of individual orderings .The number of distinct Social orderings should be at least three. 2) Fulfillment of weak Pareto principle. If every one prefers any x to any y ,then that x is socially preferred to that y. 3) Social choice must be transitive in the sense that if X is preferred to Y and Y is preferred to Z, then X will be preferred to Z. 4) Another condition is that of non-dictatorship, which requires that the social ordering shall not coincide with the ordering of any particular individual regardless of the ordering of others.
Arrow’s ‘Impossibility theorem’ states that there does not exist any social welfare function that simultaneously fulfills the above conditions. The standard procedure for reaching group decisions is by voting and the criterion of choice is majority rule. Let us suppose three persons: Anu, Dhanesh & Santosh vote for three candidates, X, Y & Z. Their preferences indicated by Ranking among the candidates are
There is a two to one majority in favor of X over Y and Y over Z. Anu and Santosh preferred X over Y. Anu and Dhanesh preferred Y over Z. By transitivity rule X should be preferred to Z. But Dhanesh and Santosh preferred Z over X and it is intransitive. Thus it is impossible to make Social Choices on the basis of individual order of preferences alone.
A.K. Sen:
Now, coming back to general discussion of Arrow’s problem, exclusive reliance on Utility information and the Pareto criterion make the information base narrow. Non-Utility information on distributional inequality, or positive right and freedoms, for instance can enrich a modified Arrow framework. A.K. Sen suggested the use of non-utility information. .
With the distancing of Ethics from Economics, Welfare – Economics role became very restricted. The traditional Welfare Economics has Pareto optimality as the only criterion of judgment, and self – seeking behaviour as the only criterion. As such, Sen feels that the scope for saying something interesting and useful in Welfare Economics became exceedingly small.
According to Sen, persons may have reasons for pursuing goals other than personal well-being or individual self-interest. This is the agency aspect of the person. Further, well-being need not always be judged by Utility, It can be based on some objective circumstances such as a person’s functioning achievements. Finally a person’s freedom can be seen as being valuable in addition to his or her achievements. All these ethical issues must be borne in mind while taking individual and public decisions. Sen argues for closer contact between Ethics and Economics.
In his book, The Idea of Justice, Prof. Sen reiterated the need for social norms. Besides mutual benefit, social norms are especially relevant for cooperation among small homogenous groups.
Prof. Ostrom, another Nobel Laureate, observed many cases of collective cooperation. She describes in her book, Governing the Commons, the advantages of cooperative behaviour and the vindication of that behaviour through voluntary restraint of members of a group. Prof. Ostrom’s field observations corroborates Prof. Sen’s hypothesis of Social norms.