Why Government Sets Rules

Why Governments Become Involved in Designing and Imposing Institutions

One may ask the question: What are the advantages of external authorities in rule setting and enforcement, as compared to an exclusive reliance on internal rules?

Collective, political rule setting and enforcement has often a number of comparative advantages:

1.   Popular customs and conventions may be ambiguous.

Popular customs may not be spelled out clearly enough and may not be widely known enough.

External institutions may often be more knowable, saving the people information costs.

If internal institutions are officially codified—written down formally and pronounced in edicts—they may become more effective, and more visible sanctions can be laid down.

This enhances the normative function of rules. Thus, law-givers such as Hammurabi (ca. 1728 – 1866BC in Mesopotamia), Moses (who probably lived ca. 1225BC in Palestine) Opens in new window, Solon (who codified laws in Athens, 630 – 560BC) Opens in new window, the decemviri of Rome Opens in new window (a committee of ten who were asked in 451BC to write down the existing laws), and Ashoka the Great Opens in new window (304-232BC in India) are celebrated for having codified existing internal institutions Opens in new window and decreeing them in the form of external laws.

Enhancing the institutions by formalizing them and attaching formal penalties for infringements has often been effective in improving the human condition. Such law-giving made it harder for people to be forgetful, slovenly, dishonest or negligent.

American statesman James Madison (1751 – 1836) Opens in new window comes to mind, as he said as far back as 1788: “If men were angels, no government would be necessary”.

2.   The Spontaneous Application of Internal Rules

The spontaneous application of internal rules by the members of the community may be haphazard, far from dispassionate and unbiased.

Enforcement of internal rules may for example favor (favour) the rich, the popular or the beautiful. To constrain such arbitrariness and bias, community leaders with a reputation for being ‘just’, may be elected to become judges.

Just here means that they are even-handed in protecting everybody from coercion by others and treat everyone as equal before the law.

Judges may then develop and make public the rules which they apply, including procedural rules of the sort that are now known as ‘due process’.

External rule making responds to the need that justice needs not only be done, but has to be seen to be done in order to have a normative influence on behavior (behaviour).

Such adjudication does not necessarily require a government, but financing the expenses of independent judges frequently makes government funding preferable.

There is ample historic evidence that informally emerging judges without financial independence may fall prey to temptations of bribery. On the other hand, the material independence of tax-funded judges has proven a weak bulwark against judicial corruption.

Therefore, there will be great advantage in external institutions that facilitate the supervision of judges in the administration of justice (Benson, 1995).

One external institutional device to achieve this is the existence of several layers of jurisdiction.

Since judges of lower courts do not like to see their rulings overturned on appeal to higher courts, they try to comply with top-down controls. Another mechanism for the control of judiciary decisions is critical public opinion and criticism of judgments by the wider legal profession (Cooter and Ulen, 1997).

3.   Enforcement of Judgments

When judgments have to be enforced, informal sanctions such as shaming or spontaneous community reactions may prove unsatisfactory—think only of effective, excessive anger, such as mob rule, lynching or spontaneous expulsions from the community.

Given the likelihood of thuggery on the part of some, there is advantage in appointing ‘violence professionals’ (police, jail warders, military and so on), who are licensed to inflict legitimate punishment through penalties that are accepted in the community as commensurate to the crime or misdemeanor.

There is of course always a certain danger that the ‘violence professionals’ will abuse their position for their own purposes (principal-agent problem Opens in new window). Therefore, the agents of law enforcement have to be controlled from acting on their own account.

These are arguments for government authorities having the monopoly over the legitimate use of force (except in rare situations of legitimate self-defense) and for subjecting the monopoly to non-violent, institutional means of control by those with political power.

Most communities have found that turning the violence professionals into government agents and inventing non-violent processes of supervising them is the best mechanism of control. As James Buchanan (the 1986 Nobel Prize winner in economics for his pioneering work in public choice and constitutional economics) argued, the task is to find a set of institutions of governance that can empower the protective and productive state, and yet restrain the redistributive state.

4.   Credible Contractual Commitments

An important aspect of institutions is that they allow people to make credible contractual commitments. In certain circumstances, third parties are needed to make contractual promise credible. Government agencies can wield the weapon of formal enforcement when they become such third parties.

5.   Prisoners’ Dilemma

A fifth arguments for collective, rather than private action derives from what is discussed in designated post under the heading of the prisoners’ dilemma Opens in new window. It has been said that cooperation, which is often advantageous, requires the back up of government institutions to be sufficiently credible (Buchanan, 1975; North, 1990, p. 13).

Clans and tribes, who rival with each other, suffer from being prisoners of eternal conflict. All would be better off by cooperating, subject to some external authority, such as a government. They reap, so to speak, a ‘disarmament dividend’ by ending conflicts (Buchanan, 1975).

Commitments to cooperate are frequently made more credible—and the peace is conserved better—if the deal which dissolves the prisoners’ dilemma is supported by an overarching third party, such as a ruler (Axelrod, 1984).

6.   Free-Riding

A closely related reason for governments setting and enforcing rules is what has been called ‘free-riding’ (Olson, 1965).

Free-riding refers to a situation where the costs of information or exclusion are such as to make it impossible to exclude others from benefitting from a good or service that someone in the community has provided.

Thus, it may not be possible to exclude youngsters from taking a free ride on a hay wagon, and it may be too costly to exclude people from accessing the radio waves once someone sets up a station.

However, technology Opens in new window may change and allow measurement of use and exclusion, so that the free-rider problem disappears and private production becomes feasible. This has, for example, been increasingly the case in television, where free to air services are supplemented by pay TV.

In the real world, certain assets have indivisible costs or benefits. Where others cannot be easily excluded from benefits, we speak of a ‘public (domain) good’. For example, if one citizen sets up a force of security guards who keep malfeasants away from the community, all neighbors (neighbours) benefit and no one can be excluded from the benefit.

The first citizen has to incur high fixed costs to maintain the security guards, but his neighbors (neighbours) enjoy a free ride without paying (for them, it is a free external benefit).

In these circumstances, insufficient provision is likely to be made for security service and fund its provision by coercive taxation.

This same argument applies to protecting the external peace and sovereignty of a nation by a military force. Here, too, nationalization, sharing the costs through the external organization of government and control by external institutions, prevents free riding and leads to a better provision of the public good, namely protection from external aggression.

7.   Tragedy of the Commons

A further, related reason given in the literature why governments become involved in designing and imposing institutions is the tragedy of the commons, a situation in which members of the community, if acting in isolation, find themselves in particular prisoners’ dilemma Opens in new window:

Members of the group exploit a common asset, for example when their cattle graze on community-owned land.

As long as resources are bountiful in relation to the demand, grazing land is not scarce. But as the number of users goes up—for example with population growth—grazing has to be rationed.

Internal, informal constraints tend to do the trick in small communities, where everyone knows everyone else and spontaneous castigation of those who overgraze work informally at the interpersonal level. It has been found that informal constraints tend to work satisfactorily within groups of up to 50 or 70 members (Hardin, 1968; Ostrom, 1990, 2005).

If the group is bigger, individuals become anonymous, information about individual behavior (behaviour) is insufficient and informal restraints on individuals (such as damage to their reputation) cannot control the excessive exploitation of the commons.

As a consequence, overgrazing occurs and the land deteriorates. Then, some authority administering external rules has an advantage; in our example a government authority could allot limited grazing rights to each member of the community. Another solution would of course be to divide the commons into private properties, which fences can protect.

8.   Collective Action May be Preferable in Certain Circumstances

A final reason why external institutions and collective action may be preferable in certain circumstances has to do with the fact that internal institutions often work by discrimination and exclusivity.

Internal institutions Opens in new window often have to discriminate between insiders and outsiders to function. Only then is sanction of exclusion feasible.

Networks of traders or financiers often build complex internal rule systems as a foundation for their business pursuits and enforce the rules by confining the network advantages to the members.

Examples for this are the medieval corporations of European traders and bankers who managed the trade between Venice, Florence, Nuremberg, Frankfurt and Amsterdam, the famous Champagne fairs Opens in new window, the Arab merchants Opens in new window who ran the caravan trade, the caravanserais Opens in new window and the Bazaars Opens in new window, and the contemporary Chinese family networks Opens in new window in East Asia.

These networks cover numerous participants and are based on internal institutions, which allow huge volumes of risky business to be conducted at low cost. But these networks can only function if the number of participants is limited and malfeasants can be excluded.

Exclusivity and small size are essential to the functioning of the internal institutions within such networks. This may pave the way for monopolization and eliminate beneficial outsider competition.

Experiences shows that the informal, internal institutions of personally networked trade and finance carry economic development up to a certain level, but not further. This is the reason that is often given to explain why the Mid-Eastern bazaar trade Opens in new window did not lead to industrialization. Small trader networks were able to raise the funds for a caravan, but not the capital to build factories. Beyond certain levels, external institutions and protective government enjoy economies of scale and ensure just, open market access to all comers (North, 1990, pp. 48 – 53).

The infrastructures for modern, open, extended markets often simply require sanctions other than private sanctions. Designed, formal laws and a formal judiciary then move more effective in bringing about an open order, enabling a wider, more dynamic division of labor (labour).

These arguments give rise to the external imposition and enforcement of institutions by government, to what James Buchanan called the ‘protective function of the state’ (Buchanan, 1975; 1991).

These arguments also hold true with regard to the advocacy of anarchy. Unfortunately, the human condition condemns us to accept some state power and to ceaselessly define and control government agents.

Simply advocating anarchy, the abolition of all collective action (all government), is a facile way to avoid the difficult issues of the limits and roles of government, which social scientists must address.