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This journal is for YOU! *Order today for more FREE book options Perfect for students or anyone on the go! The Independent Review is available on mobile devices or tablets: iOS devices, Amazon Kindle Fire, or Android through Magzter. INDEPENDENT INSTITUTE, 100 SWAN WAY, OAKLAND, CA 94621 • 800-927-8733 • [email protected] PROMO CODE IRA1703 Liberty and Democracy as Economic Systems —————— ✦ —————— RANDALL G. HOLCOMBE ntil the twentieth century, economics and politics were studied together under the heading of political economy. Two major nineteenth-century Utreatises on the subject, by David Ricardo (1817) and John Stuart Mill (1848), had the title Principles of Political Economy. Toward the end of that century, the subdisciplines separated; the turning point might be marked by the publication of Alfred Marshall’s Principles of Economics in 1890. With economics and political sci- ence going their separate ways, the implication, often explicitly stated, was that the economic systems of nations could be analyzed independently of their political sys- tems. Economists, increasingly preoccupied with the characteristics of economic equi- librium, developed theories devoid of political institutions, as if any set of political institutions could be compatible with any set of economic institutions. For purposes of recommending policy, economic theorists often assumed the existence of dictator- ship as a simplifying device, and with rare exceptions the assumed dictator was a benevolent one who always chose welfare-maximizing policies.1 In this article, I argue that economic models always imply an underlying set of political institutions and that economic institutions and political institutions cannot be properly analyzed if they are treated as separate and independent. I develop a Randall G. Holcombe is DeVoe Moore Professor of Economics at Florida State University. 1. In macroeconomics, the preoccupation with equilibrium began with Keynesian economics in the 1930s. The goal was to apply fiscal and monetary policies to maintain an equilibrium with low unemployment and low inflation. The benevolent dictator could manipulate aggregate demand to achieve this objective. In microeconomics, the preoccupation with equilibrium gave rise to modern theoretical welfare economics, in which anything that keeps an economy from fulfilling the conditions of a unique, stable Pareto-optimal equilibrium is deemed a market failure. In this context, the benevolent dictator carries out policies to cor- rect market failures by means of corrective taxes and subsidies, production of public goods, and so forth. The Independent Review, v.VI, n.3, Winter 2002, ISSN 1086-1653, Copyright © 2002, pp. 407–425. 407 408 ✦ R ANDALL G. HOLCOMBE framework for analyzing economic and political institutions, and, using this frame- work, I show that liberty and democracy are best conceived as economic rather than political systems. In the twentieth century, economic systems increasingly came to be viewed as located on a continuum, with pure capitalism at one extreme and pure socialism at the other. Capitalism meant private ownership of resources, whereas socialism meant col- lective ownership. Mixed economies lay somewhere between those extremes. Political systems were also viewed as located on a continuum, from democracy to dictatorship, again with intermediate systems in which the citizenry had only limited say over the decisions made by government. In these classifications, a fascist system was seen as combining a capitalist economy with a political dictatorship, whereas the Swedish model was seen as combining socialism with democracy. Within this framework, polit- ical systems and economic systems could be mixed and matched in any combination. Following this taxonomy, Francis Fukuyama has recently declared “the end of his- tory,” arguing that liberal democracy has established itself as the “final form of human government” and that the free market has established itself as the ultimate destination in the evolution of the economic system (1992, xi). The analysis of political and economic systems in this article raises questions about Fukuyama’s conclusions. First, I argue that political systems necessarily lay the foundation for economic systems, so both liberal democracy and the free market are simultaneously political and economic systems. Ultimately, the economic and political aspects of those systems cannot be separated. Second, I challenge the notion of an end of history, arguing that there are inherent tensions between democracy and a free- market economy that make it difficult to maintain a stable system. In particular, the ascendancy of democracy threatens the survival of the free-market economy, which was built on a foundation of liberty. Many have discussed the idea that the direction of an economic system is determined by its political institutions (see Friedman 1962; Friedman and Friedman 1980; Schumpeter 1950; Usher 1992), but the notion that liberty and democracy are as much economic as political systems has never been fully developed. Liberty and Democracy The inherent tension between liberty and democracy may not be immediately appar- ent—in a sense, they relate to different aspects of the political system—but the notion that they are in fundamental conflict was well expressed by José Ortega y Gasset. Using the term liberalism to refer to the ideas of liberty, Ortega declared: Liberalism and democracy happen to be two things which begin by having nothing to do with each other, and end by having, so far as tendencies are concerned, meanings that are mutually antagonistic. Democracy and liber- alism are two answers to two completely different questions. THE INDEPENDENT REVIEW L IBERTY AND D EMOCRACY AS E CONOMIC S YSTEMS ✦ 409 Democracy answers this question—“who ought to exercise the public power?” The answer it gives is—the exercise of public power belongs to the citizens as a body. Liberalism, on the other hand, answers this other question—“regard- less of who exercises the public power, what should its limits be?” The answer it gives is—“whether the public power is exercised by an autocrat or by the people, it cannot be absolute; the individual has rights which are over and above any interference by the state.” (1937, 135) Ortega also remarked, “The English revolution is a clear example of liberalism. The French, of democracy” (128). In contrast, the goal of the American Revolution was to create a government that was both liberal and democratic, in Ortega’s sense of those terms. The underlying philosophy of the American Revolution was liberty (Bai- lyn 1992), and the Founders explicitly sought to avoid creating a democracy in the sense of a government directed by the preferences of the general public (Dietze 1985, 225, 257–69). Once the new government had been created, however, somebody had to run it, and it was designed so that those in charge of its operations would be selected by a democratic process. This means of selection, the Founders believed, offered the best chance of keeping the nation from falling under the control of a rul- ing elite. Still, they wanted to insulate government leaders from the direct influence of the citizenry. Accordingly, the Constitution originally specified that only members of the House of Representatives would be elected directly by the people. Senators were to be chosen by the state legislatures, the president was to be chosen by electors sent to an electoral college by the state legislatures, and Supreme Court justices were to be appointed by the president. Being insulated from direct accountability to citi- zens, these government officials would be more likely to remain within their consti- tutionally mandated limits. Only the House of Representatives offered citizens a direct check on the activities of their government. Thus, the Constitution created a limited government designed to protect liberty, not to foster democracy. In the centuries since the Constitution was adopted, the federal government has become increasingly accountable to the pressures of citizens. The electoral college rapidly evolved into a system of popular voting for president. In the nation’s earliest presidential elections, a state’s legislature most commonly selected its electors (still a constitutionally allowed method), but by the 1820s most states had adopted the sys- tem of direct presidential voting.2 The Seventeenth Amendment, ratified in 1913, required direct election of senators, making the federal government much more sub- ject to democratic pressures than the Founders