Constitution, Government, Economy – Part 2

In part 1 of “Constitution, Government, Economy”, I had explored what a state is, what an economy is, the need for a constitution, the restrictions that must be imposed on a government, etc. This is a continuation of the same. In this, I go into some details on redistribution and why it must no be done by government.

Constitution, Government, Economy – Part 2

The government, or the state, does have a role in the Great Society (as Hayek called it) but it is not what is generally assumed to be. The popular conception of the state is that of a benevolent despot who tirelessly and selflessly promotes the welfare of the people. This welfare is obtained in part, the popular sentiment goes, by making welfare transfers to some individuals (based on some arbitrary criteria) by taking from some other individuals; and by involving itself in the financing and provisioning of what is labeled as “public goods”. These ostensible public goods rarely if ever have any correspondence with what are economic public goods.

Public and Private Goods

In passing, we note the economists’ definition of “private” and “public” goods rigorously distinguishes the two and have consequences in terms of their financing, production, distribution and consumption. Public goods often have to be financed publicly; and once produced, have to be distributed and consumed in ways that are different from that of private goods. Private goods and services are adequately and efficiently produced by any well-functioning market economy without the intervention of the state.

The bottom-line is that the state does not have any justification for getting into the business of producing goods and services. It has neither the expertise nor the motivation to produce them efficiently and in adequate quantities. In fact, the state when it gets into the production of goods and services, usually ends up as a monopolist in the market, and therefore behaves exactly as monopolists do: high prices, low quality, and insufficient quantities. So when the state does in fact get into the provision of private goods and services, it is usually so that those in government can benefit at the expense of the public. Therefore to ensure that those in government don’t get into business, the constitution has to prohibit the government from going into business.

But what if there are no private businesses that are willing to produce some something that clearly needs to be produced? In that unlikely case, the government should be allowed to enter that business, provided — and this is important — the government does not prohibit private sector providers from entering the market, and that the government compete on a level playing field in that market. A level playing field means that the government firm does not enjoy any advantage over the private players.

In the particular instance of India, the state must be prohibited from businesses that are adequately represented by private firms. Airlines, hotels, railways, steel production, electricity, telecommunications, energy, . . . , and so on do not have to have public sector firms. And as mentioned before, if the state does enter into business, then the state cannot prevent private sector firms entering in the same business, and if required, put the public sector firms out of the business.


One of the pernicious effects of the government controlled public sector monopoly firms is that it affords those in government the opportunity and the temptation to realize private gains from business — corruption, in other terms. Corruption is a consequence of arbitrary control. Removal of arbitrary control by the government is the only means to remove public corruption — that is corruption by government officials (politicians and bureaucrats.)

State control of the economy can be either direct — through ownership of monopoly businesses — or indirect — through the “license, permit, quota” requirements imposed on private businesses. State control of the economy leads to economic inefficiency and waste, aside from the opportunity for private gains that it provides to those in control, as mentioned before. The more pernicious side-effect is that it leads to the problem of “adverse selection” in terms of the political leadership.

Kleptocracy and Kakistocracy

If the state has the power to control the economy, it is privately profitable to have political and bureaucratic positions in the state. Suppose being the minister for industries affords one the opportunity to make a couple of billion dollars in bribes; then the criminally inclined would find it worthwhile to seek the office of minister of industries, and they would spend a great deal of money (perhaps supported by “friends” in industry) to win the elections. These people don’t have to be competent or be motivated by public interest; the primary motivation would be to mint massive private wealth. In competitions for public office, the truly honest and competent will lose out because they would not be able to match the funds that the corrupt can mobilize for elections.

To dramatically reduce, if not entirely eliminate, the need to spend massive amounts in elections, the state must be constitutionally prohibited from being in business. If the state is not barred from doing business, the dynamics of “democracy” progressively push the state into kleptocracy (defined as the rule by the greedy) and from there into a kakistocracy (the rule by the least principled and the most corrupt.)

The Minimal State

Every modern nation needs a state because there are certain necessary functions society needs have to be collectively funded, and for these collective decision-making has to be made. These functions are at a minimum, the protection of life, liberty, and property; the enforcement of contracts; the resolution of disputes; the punishment of unlawful activities, and the financing (though not necessarily the provisioning) of strictly defined public goods.

The people collectively and unanimously agree to constitute a government, enumerate its duties, and give it limited powers to discharge those duties, and grant it the necessary limited monopoly use of force or coercion. In other words a limited state. An all-powerful state, in contrast, is not only economically inefficient, it is morally unjustified. Only what Robert Nozick calls a “night-watchman” or minimal state is justified.

An article on Nozick’s work in the Internet Encyclopedia of Philosophy minimal state puts it thus:

. . . the only sort of state that can be morally justified is what Nozick calls a minimal state or “night-watchman” state, a government which protects individuals, via police and military forces, from force, fraud, and theft, and administers courts of law, but does nothing else. In particular, such a state cannot regulate what citizens eat, drink, or smoke (since this would interfere with their right to use their self-owned bodies as they see fit), cannot control what they publish or read (since this would interfere with their right to use the property they’ve acquired with their self-owned labor – e.g. printing presses and paper – as they wish), cannot administer mandatory social insurance schemes or public education (since this would interfere with citizens’ rights to use the fruits of their labor as they desire, in that some citizens might decide that they would rather put their money into private education and private retirement plans), and cannot regulate economic life in general via minimum wage and rent control laws and the like (since such actions are not only economically suspect – tending to produce bad unintended consequences like unemployment and housing shortages – but violate citizens’ rights to charge whatever they want to for the use of their own property).

Maximal State

Only a minimal state is consistent with maximum freedom of citizens, and therefore a minimal state is required for maximum prosperity of all individuals in society. A maximal state, a state that interferes in the private lives of citizens, that runs businesses, that redistributes wealth and income between individuals and groups, that restricts voluntary trade among consenting parties, that manages the channels of communications, that censors and dictates what information citizens have, that runs and controls banks, that runs and controls educational institutions, . . . , and involves itself in hundreds of other unnecessary activities, is a recipe for poverty and immiserization.

By attempting to do what it is not qualified or justified to do, a maximal state fails in the basic tasks that it is required to do. If the state cannot efficiently run a judicial system and provide law and order — legal cases take decades to sort out, criminals are not apprehended and punished — what justification can it have in running businesses, producing goods and services that the private sector can manage quite well?

Redistribution – Private

By involving itself in businesses that it has no business to be in, the state necessarily destroys economic wealth and the possibilities of the production of wealth. The other activity that non-minimal states engage in which distorts incentives for wealth creation is “redistribution.”

As noted before in this essay, charity redistributes wealth. Charity is a necessary activity and is morally justified. It is human nature to want to help, and indeed help, others. We don’t have to be coerced to help; the act of charity is a natural consequence of the innate human capacity of sympathy and compassion. But if charity is coerced in any sense, it is not only immoral, it stops being charity and people naturally rebel against it and stop being charitable. Coerced “charity” hurts society at large and most unfortunately impacts the needy.

When the government takes by force from some for the ostensible purpose of giving to some others that it chooses, it has two destructive effects. First, because the state chooses the givers and the receivers of “charity”, it gets to choose whom to favor and at whose cost. This leads to the “moral hazard” of the state officials engaging in redistribution for their own benefit. They handle the funds meant to help the needy with very sticky fingers.

Taking from one group to give to another group is a zero-sum game: one group’s gain is the other group’s loss. This creates rivalries and animosities among groups. Thus state-coerced charity leads to loss of social cohesion and the creation of divisions.

The second destructive effect is that state charity crowds out private giving. If a citizen is already paying for state-enforced charity, he will be that much reluctant to help the needy around him, and will necessarily have a lowered capacity to help. State controlled charity, which is necessarily centralized, cannot replicate the efficiency associated with decentralized private giving. People can monitor more efficiently and effectively if what they are giving is being used locally to help those in need. Charity has to be local because the informational requirements — the knowledge of who needs what — are severe.

The conclusion is that the state must be prohibited from involving itself in any charity, public or private. The citizens must have the freedom to choose how much to give to whom, and should have the freedom to collectively organize charities that they wish to have.

Center-States Relationship

What should be the relationship between the nation and its sub-units is a central question of great consequence. That is, how should be center treat the states that the nation consists of. The answer has to do with freedom, responsibility and accountability. If the center were to meddle in the affairs of the states, the result will be predictably negative.

States (here I use the term “state” to refer to the states the union of which form the nation) should be left to administer themselves with the most minimal of control by the central government. What this means at a minimum is that the central government must raise only those revenues from the states that are required to pay for the functions of the central government such as national defense, the central level provisioning of law and order, etc. Everything else should be the preserve of the states.

The states must raise their own revenues through state taxes to fund their own state purposes, make their own policies specific to the states such as industrial policies, make their own expenditure decisions within the constraints of their revenues, etc. In short, the states have to be independent in their fiscal decisions, and suffer or enjoy the consequences of that independence.

If the center were to collect revenues from the states, and then divvy out the revenues to various states according to their “needs”, then once again the problem of efficiency, moral hazard and adverse selection creep in. In that case, states that are relatively more prosperous will get penalized for their prudent policies, and states that mismanage their resources will get rewarded.

Taxes introduce distortions. They blunt the incentive to produce on both sides of the revenue and expenditure accounts. They also blunt the competition between states, and result in a race to the bottom to be the most backward so as to receive more central funding.

The constitution must prohibit the center from redistributing at the level of the states, just as it must prohibit redistribution at the individual and group levels.

The governments of the states, knowing that the center is prohibited from redistributing wealth from other states, will have an incentive to create conditions for economic activity within the state: peace, ease of doing business, and ease of living and working in the state. This would lead to healthy competition among the states to run an efficient government in terms of enforcement of the law, provisioning of public goods and infrastructure. Competition is the only mechanism known that promotes prosperity.

In part 3 of this essay, I will address why the Indian constitution must be replaced. The British-era constitution has failed spectacularly and created unimaginable misery for hundreds of millions of people.

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