Principles and politics: Like oil and water

In a democracy, public policies require majority support to be enacted, so politicians must enlist the support of others to further their political agendas. Successful politicians are those who can negotiate in the political marketplace to steer outcomes their way, and to succeed, politicians must be willing to set their principles aside and trade their votes away to get something better. In contrast with the principled politician whose support cannot be bought, the unprincipled politician’s support must be bought, so unprincipled politicians accumulate political IOUs that they cash in to advance their agendas. Democratic politics by design reinforces unprincipled behavior and punishes principled behavior.

Malinvestment

In the Austrian business cycle theory, monetary expansion lowers the interest rate and sends misleading relative price signals to investors, who then make investments that turn out to be unprofitable. One criticism of the theory is that if malinvestment is predictable, investors should understand their businesses well enough to see and avoid the temptation to be lured into unprofitable investments. A broader understanding of the Austrian school's framework explains why malinvestment takes place. The economy is a complex order, and while the theory explains that malinvestment will rise during the expansionary phase, it cannot identify which investment projects will eventually become unprofitable, nor can investors themselves tell ahead of time. Furthermore, applying the fallacy of composition, it may be that one investor could profitably invest based on those price signals, but all investors cannot. Monetary expansion lowers the informational content of prices, making it more likely that unprofitable investments will take place. Even if investors become more cautious, the percentage of investment projects that eventually will prove unprofitable will rise.     

Economic Institutions and the Durability of Democracy

Why do some democracies persist while others break down? Some studies have suggested that economic development decreases the likelihood of authoritarian reversal, which is consistent with Milton Friedman’s argument that economic freedom is necessary for political freedom. An empirical investigation of countries that have transitioned to democratic governments since World War II shows that higher quality economic institutions increase the durability of those democratic governments. This supports Friedman’s observation about the relationship between economic and political institutions.     

Politics as exchange: the classical liberal economics and politics of James M. Buchanan

James Buchanan advocated the market mechanism for allocating resources because it is based on voluntary exchange. People engage in market transactions only when they believe they benefit from doing so. Buchanan depicted the political process the same way. People engage in collective activities to accomplish together ends that they would be unable to accomplish individually, or through bilateral exchange. Buchanan’s vision of politics as exchange is a normative framework for evaluating the rules within which political activity takes place. Rules that meet the criterion of agreement are desirable constitutional rules, and Buchanan recognized that not all government activity satisfies that criterion. Buchanan is the father of the subdiscipline of constitutional political economy, and his “politics as exchange” approach provides the foundation for much work in that area. Buchanan has created a foundation that is rich in ideas, but leaves behind a number of unanswered questions that point the way toward a further development of the research program in constitutional political economy.     

The common pool of transitional profits

Transitional profits are above-normal profits that can be earned by firms as a result of changes in market conditions or entrepreneurial innovations of the firm. They are a common pool and are competed away by firms that enter profitable markets or imitate the innovations of profitable firms. The economics literature provides two conflicting views on transitional profits. One is that above-normal profit is a sign of economic inefficiency and is the result of either monopoly power or disequilibrium. The other is that economic profit is necessary for economic efficiency because profit is the lure that pushes entrepreneurs to allocate resources more efficiently. Both views are considered, along with an analysis of whether this common pool resource is competed away too rapidly, as the theory of common pool resources would suggest.     

The Origins of Entrepreneurial Opportunities

Kirzner's (1973) theory of entrepreneurship emphasizes the equilibrating role of entrepreneurship. When the market is not in equilibrium, profit opportunities exist, and entrepreneurs discover and act on these profit opportunities to equilibrate the market. Because Kirzner focuses on entrepreneurial actions when profit opportunities exist, and does not describe where they come from, one could imagine a fixed stock of profit opportunities that get used up as entrepreneurs discover them. But new profit opportunities are being created constantly. A taxonomy of the origins of entrepreneurial opportunities includes factors that disequilibrate the market, factors that enhance production possibilities, and most notably, opportunities created from previous acts of entrepreneurship. Entrepreneurial actions do not use up profit opportunities, but create them, and the critical role of entrepreneurship in the creation of new profit opportunities is emphasized. This line of reasoning leads directly to policy implications regarding the economic environment conducive to entrepreneurial discovery and the role of government in research and development. This paper enhances Kirzner's theory of entrepreneurship by illustrating how entrepreneurship enlarges the stock of future entrepreneurial opportunities, and points to entrepreneurship as the engine of economic progress.     

Pluralism and heterodoxy in economic methodology

Economists work within models that are simplified depictions of reality. An argument for a pluralistic understanding of economics is that different approaches lend insight by looking at different phenomena from different viewpoints. While all economists can benefit from taking a pluralistic approach to understanding economics, Austrian school economists must be more pluralistic in their understanding and presentation of ideas than mainstream economists if they want their ideas to have an impact on mainstream economics. Despite the argument for a pluralistic understanding of economics, in research, as in other activities, specialization increases productivity. While Austrian school economists can benefit from taking a pluralistic approach to understanding economics, they are likely to be most productive in their research by specializing in the development of Austrian school methods and ideas.     

Intra-industry adjustment and the correction of an externality

Conclusion The purpose of this paper is to apply some of the existing microeconomic theory literature on intra-industry adjustment resulting from factor price changes to the use of corrective taxes on externalities. The optimal tax to correct the effects of an externality is one placed directly on the external damage. Such a tax is sometimes not practically feasible, in which case either the inputs or output of firms in the externality-producing industry must be taxed as a proxy for the external damage.When the tax is placed on the input associated with the externality, the tax will only produce the optimal result if all firms produce an equal external damage which is proportional to the amount of the input which is used. If the amount of the externality produced by different firms is different, then an input tax will not satisfy the marginal conditions for optimality; and in some cases, the external damage may actually increase as a result of the input tax. An output tax, on the other hand, will never cause the external damage to increase, but will not in general satisfy the marginal conditions for optimality.When the amount of external damage caused by each firm in an industry is difficult to monitor, input or output taxes are two possible policy alternatives for controlling the externality. This paper has demonstrated that there are a number of problems associated with calculating the optimal input or output tax, and that a tax that is correct under restricted assumptions may actually aggravate the problem when examined in a more general environment. This analysis may explain why policy makers favor direct controls to reduce externalities, rather than taking the economist's frequent advice of using corrective taxes to price the externality.We are indebted to Charles Maurice for helpful comments on an earlier version of this paper.     

Taxation and the redistribution of income

Conclusion This paper has offered no empirical evidence, and is not trying to argue that after-tax relative wage rates will not change at all in response to a change in the progressivity of the tax structure.⁸ Rather, the point is that there is a market mechanism that causes changes in progressivity to be at least partially offset by changes in the pretax wage structure. This mechanism is not taken into account by any model of redistribution through taxation that treats labor output as a homogeneous factor of production. Treating labor output as homogeneous eliminates adjustments to relative wages that are certain to occur in response to a change in the progressivity of the tax structure. Thus, progressive taxation has less ability to redistribute income than is commonly realized. Any shortcomings in the paper remain the responsibility of the authors.