Constitutional Economics

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Recent documents concerning constitutional economics

The following article appeared on the Real Incomes site:

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The importance of constitutional economics


Constitutional Economics (CE) is a field of study concerned with the influence of constitutional provisions, institutional procedures & government decision-making on economics. The most important pioneering work in this field includes such developments as "public choice theory" (developed by the American economists James M. Buchanan and Gordon Tullock circa 1962 1 ). James M Buchanan, a Nobel Prize winner for his contribution to economics in this field, continues to develop the theory of Constitutional Economics to this day.

Constitutional Economics

Constitutional Economics takes into account the significant impacts of political economic decisions as opposed to limiting analysis to economic relationships as functions of the dynamics of distribution of "marketable" goods and services".

CE can often explain why policy outcomes are not what were intended from the standpoint of pure economic analysis. Similarly the expression of individual preferences through economic transactions can result in social legislation failing because of economic reasons. Asw a more comprehensive approach, Constitutional Economics provides a more rational forum for the evaluation of such failures as well as a basis for identifying better solutions.

Work in this field is gaining recognition as representing a framework through which political economic choice that navigate an appropriate pathway between depresssion and uncontrolled mnominal growth so as to avoid , providing solutions to the types of economic crises experienced in 1929, 1975 and again in 2007, the worst financial crisis in living memory. The issues of a democratic deficit, the identification of the free will of electorates, the processes of creating appropriate macro-economic policies corresponding to preferences, the distribution of income, arbitrariness of decisions by governments, the regulation of financial intermediaries, excessive financial debt and the accelerating use of finite natural resources are better accommodated and managed within the confines of Constitutional Economics than by the more stark perspectives of conventional schools of macroeconomics such as Keynesianism, Monetarism or, even Supply Side Economics.

The events of the 1930s and 1970s are past and our current challenge is to understand why, what were thought to be major beneficial policy shifts at the time, yet again failed in 2007.


The degree to which governments uphold freedom is dependent upon the basic constitution, existing laws and how laws are interpreted and applied.

Constitution2 is a set of fundamental principles according to which a community or country is managed, it defines how governance operates. It is largely concerned with describing the functions of government, explaining the political system for the selection of community representatives (MPs) to parliaments through elections, defining their responsibilities and scope of action in legislation, with the formation of the government executive and selection of the Prime Minister or head of state.

A constitution can be a single document to which amendments can be added over time or it can be a collection of separate documents, a body of law, consisting of documented principles, precedents and law.

In practice, limiting the consideration of constitution to general principles of governance does not protect individuals and economic units from undesirable events or direct attacks, less obvious discrimination or inappropriate policy decisions of those governing. Individual freedom can be suppressed by arbitrary political decisions which ignore the preferences of some or all. There is, therefore, a need to build into constitutions additional principles specifically designed to defend individual freedom.

Unfortunately, comprehensive constitutions covering both the principles of governance and including principles for the defence of individual freedom are also insufficient. Constitution cannot be set in stone in this way. How we elect MPs, how they legislate, or fail to legislate, on new as well as stealth legislation, constantly creates pressures eroding individual freedom. More significantly, political parties and politicians have gradually changed the practice of governance in terms of the exercise of their own powers. These subtle changes in practice have not involved the approval of the electorate. They have simply ended up as "normal practice" or as components of the British political tradition but which unfortunately have eroded the individual freedoms of the people of the country. There are also several instances of laws and regulations being ignored or pro-actively abused by governments. The principal institution established to defend individual freedom, the jury, has been subjected to a silent agenda consisting of a persistent pressure to reduce and eventually remove its role from legal provisions.

Constitutional Implications

The constitutional dimensions of this state of affairs are clear. Basically no one voted for economic and financial chaos caused by a small number of managers in private financial institutions taking very bad decisions. Also, no one voted for a government policy "solution" to create unemployment, higher taxes and or reduced government services. The unelected civil servants, lobbies and politicians simply decided to act the way they did with no reference to the electorates. This state of affairs and the current evolution in the economy does nor reflect the preferences of the majority of the social or economic constituencies. This alone is a serious constitutional issue in terms of the electorate and calls into question how we manage our affairs as a "democracy"

This web site

The outstanding contribution to constitutional economic theory in the form of public choice theory has been undertaken by James Buchanan and others. However, in practice, government policy making, including macroeconomics, and its implementation does not involve any significant "public choice" but often involves no "public" choice as a result of extra-constitutionl practices, circulation of biased information and, in general, an undermining of genuinely participatory political models by motivations arising from political party imperatives for survival. To establish a functioning constitutional economic framework it is necessary to identify the mechanisms that undermine transparent participatory democratic discourse, within a constitutional context, otherwise public choice theory remains a theory. As a result it becomes something of little practical significance as a mechanism to reflect the preferences of the economic and social constituencies. This is why this site attempts to identify the significant elements needed to establish an economic system that embodies the necessary mechanisms so as to bring about the benefits of constitutional economics based upon freedom of choice.

The range of factors that constrain the free functioning of the economy and whose removal can contribute to a shift towards constitutional economics is large but each has specific and easily understood effects. This web site provides discussion and insight into each of the main constraints on the effectiveness of conventional macroeconomic management and the regulation of sector activities. This discussion is developed under the following themes:
  • Culture
  • Diversity & Complexity
  • the Real Incomes Approach to economics
  • Truth as Public Interest
  • False logic
  • Facts
  • The Minority Principle
  • Ethical Decision Analysis
  • Extra-Constitutionalism
The current crisis was exacerbated by the excessive "financialization"3 of both economic policy and market transactions where debt and commoditization of finance through derivatives and physical asset risk hedging has created higher real prices in an economic regime of "low inflation" and "low interest rates". The use of derivatives can be traced to the early 1970s, just after the abandonment of the Gold Standard by the USA, and their significant growth coincided with the transition in policy emphasis from Keynesian to Monetarist principles. The actions of governments during the current financial crisis have increased public debt and passed on to future generations the onus of repaying the debt generated by poor policy decisions on the part of politicians.

Evidence of the wholly inadequate nature of such conventional macro-economic theories and derived policy decisions is that the purchasing power of the Pound Sterling falling to about 4% of its value in 1945.

Some Constitutional Implications

Governments consider financial intermediaries to be "vital" for economic growth, and such institutions have been selectively rewarded for their failure with a massive donation of public money. The private individuals who risked their own funds by investing in such intermediaries would, under normal circumstances, have lost their investment. The normal rules of the market, however, were prevented from applying because politicians panicked, goaded on by financial intermediation lobbies and because conventional economists were incapable of, or discouraged from, presenting more equitable solutions.

Again, no one voted for this decision and governments have acted arbitrarily basing their decisions solely on imperfect economic theory. In fact what we see today is a switch from Monetarism to Keynesianism whereas in the 1970s and 1980s the "solution" was to switch from Keynesianism to Monetarism. Governments persist in applying policies that have a 60 year track record of poor performance.

Therefore the constitutional dimensions of the current state of affairs are significant and a starting point is to consider how the constitutional arrangements might be improved to accommodate the means of ensuring that economies are managed so as to meet minimum standards of provision. One basic provision, is, for example, that of managing economic affairs so that the irresponsibe decisions of a small number of financial intermediaries does not put at risk segments of the population who have no connection with the activties and transactions concerned. For this to come about it is imperative that politicians recognise that macroeconomic theory and the policies spawned by this theory are highly flawed and high risk. In constitutional terms future activities need to enable the transparent detection as well as satisfaction of the preferences of the social and economic constituencies. These actions need to include policies that ensure that no constituent or economic unit constrains the freedom or ability of others to achieve their objectives.

Alternative policies?

Recently, the common sense question, "Are there alternative policies that can avoid the shortcoming of the conventional policies?" has been raised in political circles, by the Governor of the Bank of England, members of the "Occupy Movement" and, indeed, throughout the constituency of the United Kingdom, European Union and world in general. This fundamental issues is being raised, largely by non-economists while most economists struggle with trying to find practical solutions within the pre-determined terrain of their particular "school of macroeconomics". This was the situation at the beginning of the last Century when Keynes published his book, "The General Theory of Employment, Interest & Money" (1936), the same exchanges occurred during the late 1970s and they are repeating themselves now.

1 James Buchanan & Gordon Tullock, "The Calculus of Consent", Ann Arbor: Univesity of Michigan Press, 1962.
2 from: McNeill, H.W., "The Briton's Quest for Freedom Our unfinished journey ...", Chapter 1, The Issue, Signs & Approach, pp 10-11, HPC 2007, ISBN: 978-0-907833-01-7
3  In 1973, Fischer Black and Myron Scholes published a paper, "The Pricing of Options and Corporate Liabilities", which provided a method to help determine reasonable prices for options (derivatives).