James M. Buchanan- In Memoriam Scholar Part 8

James McGill Buchanan, Jr. was born on October 3, 1919 and died recently on January 9, 2013. He is this week’s In Memoriam scholar due to his revered work on public choice theory.

Like many top-scholars in our In Memoriam series, Buchanan received his doctorate from the University of Chicago in 1948. He was influenced by the great Frank Knight and Swedish economist Knut Wicksell who studied how government spent money relative to taxpayer wishes. Buchanan founded the Center for Study of Public Choice at the University of Virginia, where he was a long-time professor, before moving to George Mason University. Additionally, he won a Nobel laureate for economics in 1986 and published many books on liberty, democracy, public goods and public debt.


He is most known as the co-founder of public choice theory, alongside Gordon Tullock. Their co-authored book, The Calculus of Consent: Logical Foundations of Constitutional Democracy, explains individual decision-making in the context of the public sector. Some excerpts from Buchanan and Tullock’s book can best explain this constitutional calculus that an individual endures when considering public action:

“The collectivization of an activity will be supported by the utility-maximizing individual when he expects the interdependence costs of this collectively organized activity (interdependence benefits), as he perceives them, to lie below (to lie above) those involved in the private voluntary organization of the activity. Collective organization may, in certain cases, lower expected costs because it removes externalities; in other cases, collective organization may introduce externalities. The costs of interdependence include both external costs and decision-making costs, and it is the sum of these two elements that is decisive in the individual constitutional calculus.” (pg. 50)

The two costs that are explained in the book are:

  1. “Costs that you will endure as a result of the actions of others” (pg. 51)

“An external cost may be said to be imposed on an individual when his net worth is reduced by the behavior of another individual or group and when this reduction in net worth is not specifically recognized by the existing legal structure to be an expropriation of a defensible human or property right. The damaged individual has no recourse; he can neither prevent the action from occurring nor can he claim compensation after it has occurred.”

  1. Decision-making costs which are “the number of individuals who are required to agree before a final political decision is taken for the group” (pg. 51)

“If two or more persons are required to agree on a single decision, time and effort of another sort is introduced—that which is required to secure agreement. Moreover, these costs will increase as the size of the group required to agree increases.”


“The rational individual, at the stage of constitutional choice, confronts a calculus not unlike that which he must face in making his everyday economic choices. By agreeing to more inclusive rules, he is accepting the additional burden of decision-making in exchange for additional protection against adverse decisions. In moving in the opposing direction toward a less inclusive decision-making rule, the individual is trading some of his protection against external costs for a lowered cost of decision-making. “(pg. 57)

Buchanan and Tullock show that individuals face a trade-off when deciding upon collective action. Their book which is written in great detail further explains that not all collective activity should be organized the same way and expands on earlier discussion to include rules of when collective action should be taken. Lastly, half the book discusses welfare economics, voting and taxes in a context that incorporates individual rationality. This was unique at the time, because individual decision-making and individual actions were not explained as fundamental to the collective action problem. Buchanan and Tullock popularized this and essentially, became the “fathers” of public choice theory. Much of Buchanan’s work and Tullock’s work go hand-in-hand and Buchanan’s contributions to public choice and political theory are hard to discuss without mentioning his common co-author Tullock.

In this short video, Friedrich Hayek, a past In Memoriam scholar, and James Buchanan both discuss how economic patterns cannot distinctively be explained by mathematics. At 1:40, Buchanan explains that mathematics can fall short of explaining the entire economic problem and individuals neglect emergent choice. Hayek states we should accept “the impossible”—economists cannot make predictions about everything.

The Punch Bowl Stays: Fed Keeps Interest Rates Low

The Dow Jones closes at a market high today at 17,156.85 after the Federal Reserve met and announced that interest rates will be staying the same.  The reasons for keeping the federal funds target rate in the 0-0.25% range  based on the  FOMC press release are:

  1. The unemployment rate has barely changed and we are under-utilizing labor resources
  2. The housing sector is recovering slowly

While other reasons that they mention seem to support increasing the interest rate:

  1. Household spending and business investment is rising moderately
  2. Inflation is below the Federal Open Market Committee’s long-run goals

However, in the end the Committee felt that to attend maximum employment and price stability maintaining the current interest rate is best. Additionally, the FOMC will buy federal agency mortgage-backed securities at a pace of $5 billion per month (rather than the $10 billion they were buying) and Treasury securities at a pace of $10 billion per month (rather than the $15 billion they were buying). By holding a large amount of long-term securities, the hope is that long-term interest rates will make “financial conditions more accommodating” (i.e. to support mortgage markets). Lastly, the FOMC mentioned that the 0-0.25% federal funds rate will remain even after the asset-buying program dies down, which is set for October.

The video on the bottom of the USAToday article, here, explains why the stock market moves after a Federal Reserve announcement and what has happened over the past four announcements this year. It is a short one minute and thirteen second video, but it is a fantastic way to catch-up with what has been happening with Federal Reserve. Also, here is a neat response after the FOMC announcement from Brad McMillian, the Chief Investment Officer for Commonwealth Financial:


“The Fed is not going to take the punch bowl away. They didn’t want to spook the market.”


Elinor Ostrom: In Memoriam, Part 6

In this week’s edition of In Memoriam—our series in which we honor 10 noteworthy social scientists who have passed away in recent years—I bring you Elinor “Lin” Ostrom. Lin is the only woman on our list and the only woman thus far to win the Nobel Prize for Economics. Her work has also had a great impact on me personally.


Ostrom YoungOstrom Old

Lin received her PhD in Political Science from UCLA in the 1960’s and spent the bulk of her 40-plus year career at Indiana University Bloomington, where she and her husband Vincent Ostrom founded the Workshop in Political Theory and Policy Analysis. There Lin carried out a research program that was focused on addressing real-world problems—from how organizational theory could offer insight into public administration of local police services in the St. Louis metro area, to identifying the institutional requirements for sustainable local management of common pool resources in Indonesia, to the most effective use of development aid in Africa—and she did so not only through an impressive array of social science methodologies, e.g., econometrics, game theory, etc., but with an emphasis on field research which sought to take seriously the capacity of people in local communities to solve their own problems with appropriate help. In the video below, Ostrom summarizes the Tragedy of the Commons and how local communities can devise strategies to avoid depleting common pool resources:

In keeping with the pattern I established in my Amos Tversky and Herbert Simon posts, I will say a little about Lin’s contribution to the rationality debate.  In the development of theoretical models, Lin warned, researchers should remain well-grounded in the world of real humans:

An important challenge facing policy scientists is to develop theories of human organization based on realistic assessment of human capabilities and limitations in dealing with a variety of situations that initially share some or all aspects of a tragedy of the commons. Empirically validated theories of human organization will be essential ingredients of a policy science that can inform decisions about the likely consequences of a multitude of ways of organizing human activities. Theoretical inquiries involve a search for regularities. It involves abstraction from the complexity of field setting, followed by the positing of theoretical variables that underlie observed complexities. Specific models of a theory involve further abstraction and simplification for the purpose of still finer analysis of the logical relationships among variables in a closed system. As a theorist, and sometimes a modeler, I see these efforts at the core of a policy science. One can, however, get trapped in one’s own theoretical web…Confusing a model—such as that of a perfectly competitive market—with the theory of which it is one representation can limit applicability…

Governing the Commons

People are nested in cultural settings with indigenous norms. Any theoretical account which ignores such phenomena has abstracted away too much from how human decisions are made. When it comes to collective action problems, Lin reminded social scientists that top-down planning by elites is not the only way that collective action dilemmas can be resolved and often not the best way. She called on social scientists to look hard at actual communities and discovery how individuals can often voluntarily cooperate to solve their own problems in ways that make sense on the ground:

What is missing from the policy analyst’s toolkit—and from the set of accepted, well-developed theories of human organization—is an adequately specified theory of collective action whereby a group of principals can organize themselves voluntarily to retain the residuals of their own efforts.

Hat’s off to you, Lin Ostrom!