Neoclassical Theory of the State Summary (North)

CHAPTER 3: A NEOCLASSICAL THEORY OF THE STATE DOUGLASS C. NORTH, STRUCTURE AND CHANGE IN ECONOMIC HISTORY (1982)

DEFINTION OF STATE: State is an organization with a comparative advantage over violence, extending over a geographic area whose boundaries are determined its power to tax constituents. ARGUMENT PRESENTED: North presents a model of the state as both a contract and an exploitative regime. The contract: the state provides goods (security and justice) in exchange for taxes. To promote growth (and thus taxation), the state provides public goods (to lower transaction costs; e.g. creates standardized weights and measures). This theory may explain why the state potentially can provide a framework for economizing on the use of resources and therefore can promote wealth. The exploit: The state, in its fuction, to exctract income from the rest of the constituents in the interest of that group or class. To maximize tax receipts, the regime alters property rights to extract the highest rents possible. The predatory theory ignores the initial gains of contracting and focuses on the extraction of rents from constituents by those who gain control of the state. 

Role of the state is to maximise wealth for society and to function as the third-party to enforce contracts which can be done by written or unwritten constitution.

TWO ASPECTS FUNDAMENTAL TO ECONOMIC HISTORY: 1.

The widespread tendency of states to produce inefficient property rights and hence fail to achieve sustained growth.

2.

Inherent instability of all states which leads to economic change and ultimately to economic decline.

THREE ESSSENTIAL CHARACTERISTICS OF A STATE WITH WEALTH- OR UTILITY-MAXIMIZING TENDENCIES 1.

State trades services (protection & justice) for revenue Total income in the society is higher as a result of an organization specializing in these services that it would be if each individual in society protected his own property.

2.

State acts like a discriminate monopolist The state separates each group of constituents, further, devising property rights to maximize revenue

3.

State is constrained by opportunity cost of its constituents since there always exist rivals to service provision

Douglas North. STRUCTURE AND CHANGE IN ECONOMIC HISTORY | 1

STATE OBJECTIVES: The basic services that the state provides are the underlying rules of the game; whether evolving as a body of unwritten customs or as a written constitution, they have two objectives: 1.

To specify the fundamental rules of competition and cooperation which will provide a structure of property rights for maximizing the rents accruing to the ruler.

2.

Within the framework of the first objective, to reduce transaction costs in order to foster maximum output of the society and, therefore, increas tax revenues accruing to the state. The second objective will result in the provision of a set of public (or semi-public) goods and services designed to lower the cost of specifying, negotiating, and enforcing contracts which underlie economic exchange.

IMPLICATIONS FOR STATE OBJECTIVES: 1.

Put together, the two are not completely consistent. Inconsistency between objectives: cannot maximize both societal and ruler output.

2.

The creation of an infrastructure designed to specify and enforce a body of property rights entails the delegation of power to agents of the ruler. Have to delegate power to agents of ruler; however, the effect of such diffusion of the powers of ruler will also be a reduction in the monopoly rents of the ruler.

3.

The services provided by the ruler have differently shaped supply curves. Services provided by rulers have supply curves that may be costly to the ruler depending on the technology and need for protection The cost curve of protection would be relative of the military technology and would specify the size of the political-economic unit as “efficient”when the marginal cost of protection was equal to the incremental tax revenue.

4.

The ruler may have competition for other regimes. This depends on the structure of competitive political units (geographic proximity, number of neighbours, supply curve of protection) The closer the substitutes, the fewer degrees of freedom the ruler possesses, and the greater the percentage of incremental income that will be retained by the constituents. The ruler’s efforts to gain or keep constituents will be determined by the supply curve of protection and the marginal benefits to be derived from the additional constituents.

5.

Property rights will never be fully efficient because the ruler will agree to favourable property rights from some groups regardless of its effect on efficiency.

Douglas North. STRUCTURE AND CHANGE IN ECONOMIC HISTORY | 2

Efficient property rights may lead to higher income in the state but lower tax revenues for the ruler because of the transaction costs as compared to those of a more inefficient set of property rights. Technological change, the spread of more efficient markets, and so forth would alter relative prices and the opportunity cost of constituents and would lead eventually to conflicts with the fundamental ownership structure of property rights. 6.

Changes in information cost or technology can destabilise the state A change in relative prices that improves the bargaining power of a group of constituents can lead to alteration of the rules to give the group more income, or alternatively, the constituents can force the ruler to give up some of his rule-making powers. In Early modern Europe, Alterations in military technology led in some instances to the delegation of rule-making powers in return for the increased revenue needed for survival. With the second Economic Revolution, the decline in the relative importance of land rent, the growth of manufacturing and services, the growing share of income going to labor, and in particular the growing importance of human capital have transformed the structure of production and created new interest groups, further, they are the basis of the struggle to control the state that has been going on in the past century. The property rights and allocation implications of the rise of pluralism are explored everywhere.

Changes at the margin lead to instantaneous adjustment, adjustments occur only as long as the private returns exceed private costs; otherwise the free rider problem will prevent adjustment. Whenever the relative value of land/labour or anything else changes, the ruler would have to modify property rights and such in order to: (a) appease possible alternative rulers and (b) continue maximizing rents subject to the constraints of Problem of Free Ridership: 

States are more stable than predicted because of free-riders The costs to the individual of opposing the coercive forces of the state have traditionally resulted in apathy and acceptance of the state’s rules, no matter how oppressive.



Theories originating in social science & Marxist thoughts do not provide convincing theoretical understanding for how to overcome the free-rider problem.



The free rider problem has implications for the state: 1. Institutional innovation will come from above of the hierarchy (because of free riding, citizens won’t come up with new institutions) 2. Revolutions will usually be executed at the top (e.g. a coup) from ruler’s agents 3. Where the ruler is from a particular class, some rules for successions will be devised to minimize the opportunities for disruptive change or revolution upon the ruler’s death

Douglas North. STRUCTURE AND CHANGE IN ECONOMIC HISTORY | 3