James Buchanan & Co.

How a self-described down-home country boy joined forces with a State Department bureaucrat, changed the face of economics, and even picked up a Nobel prize.

Last year, the Nobel Prize for economics was awarded to James M. Buchanan for his contributions to the theory of "public choice." The award touched off an unusual public discussion. Most economists usually agree that even if the winner was not their first choice, he was at least on their list of deserving recipients. And journalists who write about the issue either feel the same, disagree mildly, or simply admit that they don't know enough about the recipient's contributions to judge.

Not so with Buchanan. For the first time since 1969, when the prize in economics was first awarded, there has been serious dissent about whether the winner deserved it. The dissent has been expressed in public among journalists, and if Washington Post columnist Hobart Rowen is to be believed, in private among economists. Robert Lekachman, a socialist economist at the City University of New York, wrote in the New York Times that Buchanan's scholarly achievements are "rather modest." Rowen quoted an anonymous economist who was "shocked, surprised, and nonplussed" that Buchanan won the prize.

Rowen himself equated Buchanan's contributions to economics with those of—get this—columnists George Will and William Safire, and pollster Richard Wirthlin. Michael Kinsley, editor of The New Republic, called Buchanan "an obscure right-wing eccentric" and claimed Buchanan had said nothing that Kinsley hadn't said.

They are wrong. That these critics find Buchanan's insights obvious (Kinsley called them "trivial") shows just how profound an effect the public choice school has had: ideas about government that were once considered revolutionary are now common wisdom.

The Apples and the Bees

Public choice challenges the widespread belief that participants in the public sector pursue the public interest as diligently as people in the private sector pursue their own interests. Public choice economists assume that politicians, voters, bureaucrats, and lobbyists act in their self-interest—just like everybody else.

A personal story best illustrates how economists used to think about government. When I took an undergraduate economics course in 1971, before the public choice revolution had taken hold, the professor gave the typical treatment of government intervention in the economy. We learned that the free market is efficient if a number of very stringent conditions hold. But if these conditions don't hold, then all bets are off.

One possible cause of such "market failure" was "externalities." The usual example was of apples and bees. Apples provide nectar, which bees use to make honey. If unable to charge the beekeepers for use of their apples, the orchard owners, in deciding how many apples to grow, will not take account of the gains to beekeepers. Therefore they will produce too few apples. The positive effect of apple growing on honey production is called an externality.

Another case of market failure was "public goods." I already knew that the "free-rider problem" was a classic and widely accepted justification for government provision of national defense: there is no obvious way to charge people for the benefit they get from defense. If we tried to do so, everyone would have an incentive to free-ride on everyone else and we wouldn't get defended. Thus the justification for taxes to pay for defense.

But the professor who taught me, and the article he assigned by former JFK advisor Francis Bator, took the public goods rationale for intervention further. Even a radio signal is a public good, wrote Bator, because one person's tuning in does not prevent another person from doing so. How about allowing the radio station to scramble its signal and charge people for descramblers to exclude nonpayers? Bator objected that excluding nonpayers is economically inefficient, since the cost of servicing each additional person is zero.

Bator's analysis was not a foot in the door for government intervention—it removed the door completely. Our professor's explicit bottom line was that government intervention could be justified in virtually every area of people's economic lives. And the content of this course at a mainstream school was very similar to what hundreds of thousands of economics students had learned before and have learned since.

When we came to discuss the actual effects of existing government intervention—oil import quotas, agricultural subsidies, airline regulation—the tone changed. Our professor sounded like free-market exponent Milton Friedman. All these regulations and government programs had pernicious effects, he said, and ought to be abolished.

As he attacked program after program, I and a like-minded student could barely suppress a cheer. We egged him on, asking about this intervention and that one and not being disappointed by his answers. By the end of the hour, I felt exhilarated. Whatever this guy's views about the theoretical case for government interventions, he seemed to oppose every one we had.

The exhilaration was short-lived. The more I thought about what had gone on in those classes, the more profoundly dissatisfied I felt. Sure, the professor had analyzed particular government regulations and even called for their abolition. But it didn't lead him to challenge his theoretical case for intervention. We had seen the theoretical case for market failure. Where was the theoretical case for government failure?

Actually, there was such a case, and public choice economists had made it. Today, economics students are exposed to a very different view of government from the one we received.

Consider today's microeconomics textbooks. In one of the best-selling, Microeconomics: Private and Public Choice, authors James Gwartney and Richard Stroup take an unabashedly public choice approach. Even textbooks written by liberal economists bear the imprint of public choice. Listen to this quote from the latest edition of a textbook whose 12 editions have sold over 3 million copies: "Before we race off to our federal, state, or local legislature, we should pause to recognize that there are government failures as well as market failures'" (emphasis theirs).

The text? Economics, by liberals Paul Samuelson of MIT and William Nordhaus of Yale. Clearly, economists view government differently from the way they used to.

The Seeds of Revolution

Although most people today think of James Buchanan and his colleague Gordon Tullock as the originators of public choice, its first major contributor was Anthony Downs, now an economist at the Brookings Institution. In An Economic Theory of Democracy, published 30 years ago and based on his Ph.D. dissertation at the University of Chicago, Downs sowed the seeds of public choice.

Starting with the simple assumption that politicians' main motive is to get reelected, Downs derived some powerful conclusions. One is that rational voters will choose to be ignorant about government policies. Why? Because information is a lousy investment: the effect of one vote on an election's outcome is so small that it does not pay for a voter to become informed.

Downs also concluded that in a two-party system such as ours, once party A has taken a position on an issue, party B will position itself close to A so as to get as many votes as possible from opponents of A's position, while at the same time alienating as few voters as possible who favor A's position. For example, if the Democrats advocate spending $5 billion on some program, the Republicans would rationally advocate, say, $4 billion.

That way, they could establish themselves as a clearly preferable choice for those who want no spending and at the same time pick up votes from voters who want spending but want it to be below $4.5 billion.

Clearly, this Tweedledee-Tweedledum behavior of the two major parties is what we usually observe. Candidates out on the extreme—for example, Barry Goldwater in 1964 and George McGovern in 1972—lose.

Downs also argued that government programs that hurt the economy overall are viable if they impose small losses on large numbers of people to finance big gains to small numbers of people. A good example is the federal program introduced in 1983 to subsidize milk producers for not producing milk. These subsidies enrich about 100,000 dairy farmers by thousands of dollars per year, while costing taxpayers and milk drinkers less than $50 per year each. Economists have shown that the total cost of such programs exceed their benefits. For instance, taxes have disincentive effects; MIT economist Jerry Hausman estimates that these cost the economy about 29 cents for every $1.00 collected. Yet, in spite of greater costs than benefits, the milk subsidy program shows no sign of being repealed. Downs's model explains why.

The dairy farmers have a strong incentive to support the program. They are well informed about how members of Congress vote on it, and their payoffs to politicians who support the program are legendary—in just 1981 and 1982, the two years before the program was introduced, the dairy lobby contributed $2 million to congressional campaigns. On the other hand, taxpayers and milk drinkers have virtually no incentive to oppose it, because their individual gains from doing so would be so small.

Popularized in the 1970s by Milton Friedman and others, this analysis of special interests' advantages now seems like mere common sense. But do not underrate the value of common sense. Downs's analysis would be news to David Stockman. In his recent book, The Triumph of Politics, Stockman asserts that in the early 1980s the United States in effect had a national referendum on government spending and that the vote was overwhelmingly against cutting it. In fact, there never was such a referendum. Voters never had a direct say in spending. Rather, they had to choose among particular politicians, virtually all of whom understood that the way to assure reelection is to cater to special interests, not to the general voter. The failure of Stockman, a very bright man, to distinguish between votes for spending and votes for politicians who have an interest in spending shows that the public choice message is less obvious than its critics keep saying.

The War on Orthodoxy

Although Downs's book was the first major breakthrough, the impact of public choice ideas would have been much smaller had it not been for Buchanan and Tullock. They were the ones who institutionalized public choice. And the story of how they did so is fascinating.

It began in 1948. Buchanan, who had just completed his Ph.D. dissertation at the University of Chicago, was browsing in the "dusty stacks of Chicago's old Harper Library" when he discovered a little-known and untranslated 1896 essay that the Swedish economist Knut Wicksell had written early in his career. Its gist was that the only justifiable taxes and government expenditures are those the taxpayers approve unanimously. That way, explained Wicksell, proponents of programs have to devise taxes that actually take money from the beneficiaries of those programs.

Wicksell argued that such a system would be not only efficient but also morally sound: "It would seem to be a blatant injustice if someone should be forced to contribute toward the costs of some activity which does not further his interests or may even be diametrically opposed to them."

Reading that essay, says Buchanan, "was one of the most exciting intellectual moments of my career." Wicksell had stood orthodox public finance theory on its head in ways congenial to Buchanan's own way of thinking. The proposal and its justification were at odds with the mainstream view of the 1940s that there need be no connection between taxes paid and benefits received. That it came from Wicksell, a giant among early 20th-century economists, gave Buchanan "a tremendous surge of self-confidence." He vowed to spread Wicksell's message and immediately started translating the essay from German into English.

In the 1950s, there were few conservative or libertarian academics in the country, at most two or three per college. Most of them had developed a fortress mentality. The Volker Fund, a private philanthropic organization, was set up to remedy this. It worked.

The Fund held conferences to bring such academics together for moral and intellectual sustenance and nurture. At one of these, Buchanan and fellow Chicago graduate G. Warren Nutter, both of whom were teaching at the University of Virginia in Charlottesville, met the Fund's representative, Richard Cornuelle. Out of that came a five-year Volker grant to set up the Thomas Jefferson Center for Studies in Political Economy.

The grant authorized them to hire a postdoctoral fellow for a year. Nutter recommended his former debating partner at the University of Chicago. The candidate's credentials—a law degree, one course in economics, and nine years as a State Department employee specializing in Oriental communism—were not obvious qualifiers. But neither Buchanan nor Nutter was into credentialism.

Buchanan met this government bureaucrat at the American Economic Association meetings in Philadelphia and came away with a thick manuscript full of insights into how bureaucracies work. After reading it, he offered the fellowship. Gordon Tullock accepted. Thus was formed a close association that lasted for over 20 years. The manuscript turned into a book, The Politics of Bureaucracy, that should be thought of as a classic.

In 1959, Buchanan and Tullock decided to write The Calculus of Consent. This book is a classic. That it was published in 1962, the 175th anniversary of our Constitution, is appropriate. For in it, the authors defend a constitutional democracy with checks and balances, much like the one we started with in this country. Their book is really a modern-day version of James Madison's contributions to the Federalist Papers, informed by a much more sophisticated knowledge of economics.

In Calculus, Buchanan and Tullock analyze various possibilities for constitutional rules of governance. One they consider is a requirement that any government activity be approved unanimously. While such a rule assures that no government action will impose net costs on anybody, it is also unworkable in practice. So they consider various ways of modifying the rule to attain "workable" unanimity. But they do much more than this, and a few paragraphs cannot do justice to their accomplishments. This book alone should have won the Nobel for Buchanan and Tullock.

Compatriots in the Revolution

When I read books by people I've never seen, I form mental pictures of them. Reading Calculus in 1970, I pictured Buchanan and Tullock as urbane, pipe smoking, Ward Cleaver types in their mid-40s. I was roughly right about their ages, but dead wrong otherwise. Buchanan, who grew up in rural Tennessee, regards himself as a down-home country boy, or, in his words, "one of the great unwashed." He is also very shy. Tullock, who grew up in Chicago, has a cherubic face that makes him look like an overgrown kid. He is very abrasive. He loves to tangle people in knots when he disagrees with them and will push until they cry uncle. My guess it that his abrasiveness cost Tullock a Nobel. (The Nobel decision was apparently a cliff-hanger: Tullock claims he was told that the committee split at the last minute on whether to make a joint award.)

Had personalities counted as much to Buchanan and Tullock as they appeared to with the Nobel committee, their partnership would never have materialized. But what counted was their ideas. Although Tullock had entered the University of Chicago "as a moderate Republican who believed in high tariffs," and Buchanan as a self-described "libertarian socialist," within weeks both had become hard-core free-marketeers. Tullock attributes his conversion to a 10-week course in basic economics taught in the law school by Henry Simons. Buchanan was most influenced by the legendary Frank Knight.

(In 1986 Buchanan described himself to the Washington Post as a libertarian. But he holds some apparently unlibertarian ideas. In a 1971 article, Buchanan advocated equalizing people's economic opportunities with "confiscatory inheritance taxation," "massive public outlays on general education," and "selective programs to eliminate poverty." He still does. Explains Buchanan: "I don't think libertarianism makes much sense until you define who are the players in the game. People have to have the sense that it's a fair game. By evening up the starting point, we make it fairer.")

Together, Buchanan and Tullock nurtured the public choice school of thought. Tullock arrived permanently at the Thomas Jefferson Center in 1962. He left in 1967 over a conflict with the university administration—they had thrice denied him promotion from associate to full professor. Buchanan followed the next year: "I left because there had been repeated signs that the university's administration did not support us. They did nothing to keep Ronald Coase (who then went to the University of Chicago Law School) or Andy Whinston. Tullock was the last straw."

But during those years they had, according to Tullock, "an extraordinary collection of students." Among them were James C. Miller III, currently head of the Office of Management and Budget, and Robert Tollison, now a leading academic public choice economist. One of the students, J. Ronnie Davis, refers to those years as "Camelot."

A core group of these students made names for themselves even while in graduate school by publishing Why the Draft? in 1968, the height of the draft protests. Edited and entrepreneured by Miller, the book made a solid case—on grounds of economics, justice, and tradition—against the draft. With an introduction by Senator Edward Brooke of Massachusetts and glowing praise on the cover by both Milton Friedman and John Kenneth Galbraith, it sold about 35,000 copies.

A popular book by graduate students in economics is almost unheard of. One reason this one came to be is that Buchanan nurtures students. He has them write weekly papers, many of which later become scholarly articles. One of his favorite sayings is, "Don't get it right—get it written." Buchanan contrasts his approach with what he calls the "UCLA disease." When I first heard him use the term, I knew immediately what it meant, having earned my Ph.D. there. We UCLAers learned very quickly that if you made a mistake, the gods of economic wisdom—the professors—would jump all over you. That made most of us gun shy—and many ex-UCLAers have taken years to recover.

Precisely the opposite happens to Buchanan's students. Their first work as graduate students is usually not their best. But they grow quickly. This encouragement is a big factor in the spread of public choice.

Tullock also did his share to disseminate the new paradigm, both with his own prolific writing—he dictates articles quickly into a tape recorder and then edits the transcripts—and by beginning a journal. Started as Papers in Non-Market Decision-Making in 1966 and funded out of Tullock's own pocket, within a few years it became the Journal of Public Choice.

What's in a Name?

How did they come up with the phrase "public choice"? Says Tullock: "We started having annual meetings of people interested in the field. We considered calling ourselves the No-Name Society, then Polyconomics, then Synergetics. We didn't like any of them. We couldn't use the term 'Political Economy Society' because 'political economy' in those days meant Marxist. Bill Riker [a political scientist at the University of Rochester] suggested 'public choice.' No one liked it much, but it was neutral."

The first years as the Journal of Public Choice were at Virginia Polytechnic Institute (VPI), where Tullock went in 1968 after a year at Rice. Buchanan followed Tullock to VPI a year later, and together they set up the Center for Study of Public Choice, funded partly by private money and with salaries paid by the school's economics department. In 1982, Buchanan and Tullock—and the Center—moved to George Mason University in Fairfax, Virginia.

Throughout this time, their interests diverged. Buchanan has focused on what he calls "constitutional economics." He spends a lot of time thinking about what kinds of rules people would choose if they could revise the Constitution. (For example, he himself favors some kind of balanced budget amendment.) His interests in the area have become more philosophic and less economic, as he struggles with some of the same issues as philosophers Robert Nozick (Anarchy, State, and Utopia) and John Rawls (A Theory of Justice).

Tullock, on the other hand, is an "economic imperialist" who has applied the economic approach to understanding revolutions, dictatorships, and court trials. He also pioneered the theory of "rent seeking": the use of political activity to redistribute wealth from others to oneself. Most economists who write about redistribution think of wealth being channeled from the rich to the poor. But Tullock, especially in his 1983 book Economics of Income Redistribution, emphasizes the even more substantial transfers that have nothing to do with rich and poor.

A good example is farm programs. Many farmers are rich, many are middle-class, and many are poor. Exactly the same is true of the consumers and taxpayers who pay for these programs. Tullock was the first to note that the attempt to redistribute income to oneself is costly and that many of the gains from rent seeking are dissipated in the process. His work has generated a great deal of controversy about what fraction of the redistributed income gets lost in the process. Tullock is currently trying to figure it out himself.

He is doing so at a new location. Last summer, Tullock moved to the University of Arizona. He says the move was not triggered by bitterness at not sharing the Nobel. "I am irritated—not at Buchanan, because he had nothing to do with it, but at the Nobel committee. I was very upset when it first happened: I couldn't sleep the first two nights. I have quieted down." So why the move? Part of it is the divergence of Buchanan's and Tullock's interests. But also, Tullock turned 65 this year, qualifying him for the Virginia state retirement plan. By moving to Arizona, he will be able to "double dip."

Of course, much research on public choice has gone on at places other than the Center. For example, William Niskanen, now chairman of the Cato Institute, wrote one of the classics on bureaucracy while at the Institute for Defense Analysis. In Bureaucracy and Representative Government, published in 1971, Niskanen applies to heads of government bureaus the central assumption of public choice—that people in the public sector pursue their own interests. Figuring that these bureau heads have a monopoly on the goods and services they produce for "sale" to the legislature, Niskanen concludes that bureaucracies will produce approximately twice the optimal level of output.

Other economists have criticized this conclusion and the analysis leading to it. For example, Earl Thompson of UCLA showed in a journal review at the time that if Niskanen were right, half the voters would want to eliminate the bureau altogether—something we don't observe.

Niskanen admits the criticism but responds that his monopoly assumption is the culprit. In practice, he notes, bureaus often do compete. The Federal Trade Commission and the Justice Department both enforce antitrust laws, and such competition, he claims, makes a bureau's output closer to the optimal level.

Another strand of public choice research is that of economists at the California Institute of Technology who have focused on the political agenda. Their thesis: he who controls the agenda controls the outcome. That is, by specifying the options from which voters can choose, and even by specifying the order of options, a clever agenda-setter can get whatever outcome he wants. An important way to limit the power of legislatures, therefore, is to have an initiative process, such as California's. That way, voters who are unhappy with the alternatives they're given can, with enough votes, get their preferred option on the ballot.

The Pioneers Forge Ahead

Much is brewing in public choice research today. Robert Tollison, director of the Public Choice Center at George Mason, has consistently produced new ideas. He is not content with having demonstrated, with coauthors William F. Long and Richard Schramm, that antitrust authorities prosecute firm A and not firm B because firm A's sales are higher. Nor does he stop at showing, with coauthor Robert McCormick, that the pay of a state's legislators is directly related to the date of its constitution (the more recent the constitution, the more power it gives to legislators).

Now Tollison is taking on the view of Milton Friedman and Anna Schwartz that honest mistakes by the Federal Reserve Board caused the money supply to shrink in the 1920s, thus causing the Great Depression. Argues Tollison: "The Fed purposely engineered the Great Depression to hurt banks that were not members of the Federal Reserve System and to help banks that were members."

Friedman is not convinced. Yet he recently admitted that public choice has affected his view of the Federal Reserve. "I no longer give advice to the Fed. I instead try to figure out what kind of constitutional or institutional arrangements we could set up which would make it possible to abolish it."

Even outside the Center, a large research community works from the public choice framework. Gary Becker, a University of Chicago economist who pioneered the application of economic analysis to discrimination, "human capital," and the family, has recently weighed in on rent seeking. In a 1983 article, he reaches a controversial conclusion: that government programs to redistribute income will be the most efficient ones possible for achieving that redistribution.

Becker claims that the programs will not impose net losses. In fact, what he really demonstrates is that the losses will be as small as possible. Why? Because if the losses for a given amount of redistribution could have been smaller, then the gainers would have an incentive to substitute programs that give them the same benefits but cost the losers less: that way, less opposition would be generated among losers.

But Dwight Lee, a public choice economist at the University of Georgia, disagrees. Often, notes Lee, the most efficient way of redistributing is to tax everyone and give the proceeds directly to the politically powerful. "The problem is, this is also the most blatant. A blatant way of subsidizing the politically powerful will generate more opposition among the losers than an inefficient but subtle way that they are not even aware of."

Even with Lee's caveat, Becker's theory can explain why privatization of government assets has been much more extensive in Britain than in the United States. When the Thatcher government wanted to unload public housing on which it was taking a loss, it sold the housing to current tenants at below-market prices. This made the politically powerful tenants, who otherwise would have opposed privatization, into strong supporters. In the United States, on the other hand, when Reagan's Office of Management and Budget tried to privatize electric power in the West, it did not propose giving current beneficiaries of artificially low-priced power any share in the gains. Not surprisingly, OMB's initiative is going nowhere.

And not to be missed in a necessarily incomplete survey of the public choice landscape is a paper on gerrymandering being written by Ben Zycher. Gerrymandering—dividing states into election districts to give one political party an electoral majority in a large number of districts while concentrating the opposition's strengths in as few districts as possible—is often considered unsavory, even immoral. In recent years it has mainly helped Democrats who disproportionately control the state governments that do the redistricting.

But Zycher, a free-market economist at the Rand Corporation, defends gerrymandering. In its absence, he argues, many more elections would be close, thus increasing the power of concentrated groups and creating a bias toward bigger government. Furthermore, gerrymandering guarantees the minority party a minimum number of seats even in a landslide, thus preserving the political system's long-run competitiveness.

The Choice of a New Generation?

Of course, not all students of the political system have been persuaded by the public choice paradigm. Joseph Kalt of Harvard's Kennedy School of Government and Mark Zupan of the University of Southern California have given overwhelming evidence that narrow self interest alone cannot explain legislators' votes. In a 1984 article, they show that the ideology of U.S. senators was an important factor in their votes on a bill to regulate strip mining. In a recent book Making Public Policy: A Hopeful View of American Government, Kalt's colleague Steven Kelman raises many similar cases that cast doubt on the public choice view that only self-interest matters, not ideas—for example, about the proper role of government.

Buchanan himself agrees: "Public choice scholars who assume that voters and legislators care only about their narrow self-interest have gone too far." But he points out that the public choice approach is useful even though people have broader, more altruistic concerns. Just as the tax deductibility of charity increases the amount of charitable giving, he argues, so allowing government officials the power to distribute "rents" will lead people seeking those rents to invest more to influence the officials' decisions.

Has public choice had an important impact? Buchanan and Tullock student and OMB chief James C. Miller III answers that question with a resounding yes. Says Miller: "The public choice approach has caused people to focus on a question that virtually no one was asking or answering: how do you structure incentives in the political system so that politicians will make the 'right' choices?" He sees the seeds of public choice thinking in the Gramm-Rudman law and in proposals for a balanced budget amendment.

Milton Friedman, not himself a member of the public choice school, finds its work "tremendously important." What they did, he said recently, "was to bring out explicitly…and develop logically and systematically" what had been implicit in the writings of earlier economists: that government officials are as self-interested as businessmen.

Buchanan, Tullock & Co. have reinforced a skepticism of government native to Americans. On questions of government intervention, the burden of proof is now more than ever on the proponents. And that is all to the good.

David R. Henderson, a former member of President Reagan's Council of Economic Advisers, is currently a regular contributor to Fortune.