Living within Rules: A Theoretical and Empirical Exploration of Institutional Diversity and Optimal Federalism

Vlad Tarko

Advisor: Peter J Boettke, PhD, Department of Economics

Committee Members: Richard E. Wagner, Paul Dragos Aligica

Enterprise Hall, #318
April 22, 2015, 10:00 AM to 06:30 AM


Institutions can be understood as social technologies enabling communities to solve various problems, from the coordination of production and distribution activities to the resolution of conflicts. But why are certain issues addressed by markets, others by politics, and others by courts? Why are some issues addressed at federal level, while others at state or local levels, and others are left to private clubs and individuals? Why do hybrid institutions such as independent regulatory agencies or judicial review also exist? How efficient is the political process in correctly allocating the issues to the right administrative scales or to the proper regulatory agencies? In short, what factors explain the observed institutional diversity, and what are the normative criteria for evaluating institutions and proposing reforms? This dissertation expands Buchanan & Tullock’s calculus of consent model such that all the above questions can be answered from a unified, non-ad hoc theoretical perspective. Agent-based simulations and network theory are used to explore, numerically and analytically, the effects of having different collective choice institutions, and provide a better idea of the generality of the calculus of consent assumptions about the functional form of the cost functions.

1          An Institutional Theory of Public Economics

This chapter revisits the calculus of consent model, and proposes an institutional theory of public economies which replaces and generalizes the Samuelsonian classification of goods in terms of rivalry and excludability. Rather than referring to the nature of the goods, this theory looks at how different collective choice institutions and different ways to “compound the republic” lead to different capacities for facilitating consensus building. The calculus of consent is used as the underlining theory of collective choice and public economics guiding the analysis. Within this framework, marginal decision and external costs provide a non-ad hoc foundation for an institutional approach to public economics. These marginal costs are determined by the levels of preference heterogeneity (how controversial a solution is to a given problem) and the capacity to build consensus in expanding groups. It is these two variables that provide the alternative, institutional, perspective replacing the focus on supposedly inherent rivalry and excludability.

2          The Economic Theory of the Compound Republic

Standard accounts of federalism discuss the economies of scale for providing various public goods. Such an approach assumes, however, that the economies of scale can be assessed from an outsider expert perspective. By contrast, this chapter uses the calculus of consent to address, from a self-governance perspective, questions such as “How many people need to agree?” and “Who should be involved in the decision and who should be excluded?” across a variety of issues. The chapter, first, develops the analytical theory of self-governance, showing that under conditions of self-governance a particular collective choice pattern should be present. Second, it shows how to evaluate federal structures in light of this pattern, answering the question of whether an issue should optimally be more centralized or decentralized, and showing that the presence of exit costs leads to over-centralization. Third, it illustrates the theory by analyzing US House of Representatives decisions across a variety of types of issues over the 1953-2004 period.

3          Escape from Europe: A Calculus of Consent Model of the Origins of Liberal Institutions in British American Colonies (co-authored with Kyle O’Donnell)

The migration out of Europe and the establishment of North American colonies presents us with a great puzzle: Why did the colonists establish democratic forms of governance? Considering the nature of the colonists and that early democratic colonies appeared even before philosophical works such as those of Locke and Montesquieu were written, it is difficult to make the case that ideology was the driving factor. We show that the calculus of consent model, understood as a theory of collective action and public economies, explains this puzzle. Because migrants formed much more homogeneous communities, and because, thanks to the large geographical expanse, the inter-jurisdictional externalities were small, the efficient level of consensus within each colony was much greater than in Europe, and the scope of efficient centralized decision-making was much smaller. Hence, thanks to the change in the cost functions, a structure of highly decentralized democratic communities emerged as the efficient outcome.