Francesco Parisi * POLITICAL COASE THEOREM

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1 Francesco Parisi * POLITICAL COASE THEOREM ABSTRACT: This article considers the applicability of the Coase theorem (in both its positive and normative formulations) to the political market. The article analogizes the choice of decision rules in the political market to the choice of legal rules in the traditional Coase theorem and further analogizes alternative initial coalitions to the different initial allocations of entitlements considered by Coase (1960). On the basis of these analogies, the paper examines the relevance (or lack thereof) of alternative voting rules and initial coalitions on the final political outcome. The article further shows that, if all voters are allowed to enter into Coasian bargaining over the policy outcome to be adopted by the majority coalition (i.e., if political bargains are possible and are enforceable), uniqueness and stability are obtained. The analysis of the axiomatic Nash bargaining equilibrium yields an interesting geometric intuition. If voters have similar utility functions centered around different ideal policy points, the Coasian bargaining will be conducive to the center of mass of the policy space, which weighs the agents preferences as revealed in the bargaining process. Such ideal equilibrium satisfies most criteria of social welfare. The article concludes considering the various practical limits of this ideal political market, whenever collective action and agency problems affect the political bargaining in a representative or direct democracy. With all side payments prohibited, there is no assurance that collective action will be taken in the most productive way. James M. Buchanan & Gordon Tullock (1962) In most legal systems of the world, the wholesale market for votes is constitutionally protected. Interest groups are allowed to influence policy outcomes through campaign contributions which are in turn used to obtain larger political support through advertising (Levinson, 1999). Yet, vote buying is prohibited at the retail level. Anti-trafficking laws, in fact, generally prohibit offering, making, soliciting, or receiving payments in * I would like to thank Henry Hansmann, Dennis C. Mueller, Charles K. Rowley and Gordon Tullock for insightful comments and guidance in this research. Carlo Lancellotti, Dario Fusato and Richard Souther provided valuable research assistance. 1

2 return for voting or withholding a vote (Karlan, 1999). The different legal treatment of wholesale and retail vote trading has enjoyed occasional rationalizations in legal and economic theory. 2 On this point, the intellectual split between political scientists, political economists and public law scholars is most evident. For political scientists, vote trading is such a natural component of real life politics that they make no effort at rationalizing, justifying or challenging such reality. Common names, such as horse trading or deal making, are generally used by political scientists to describe the general phenomenon of vote trading. Political economists are equally at ease with the idea of an implicit market for political consensus and develop and actively utilize politics-like-market metaphors that unveil the implicit market mechanisms that drive political dynamics. 3 Public law scholars remain among the few who evaluate the normative implications of market for votes. These latter scholars occasionally object to the commodification of political consensus. It is argued, the commodification of the vote would undesirably encourage citizens to bring their own self-interest into the process, at the expense of the aspirational and expressive qualities of the political exchange and to the 2 It has been suggested that, in this respect, the American political system is flawed, since it invites wholesale vote buying, but prohibits vote buying at the retail level (Levinson 1999, p. 1749). The exchange of campaign contributions for favorable governmental policy outcomes from political office-holders, is an uncontested reality of the political market, yet there is a substantial intellectual hostility in the recognition, let alone the enforcement, of explicit transactions for political consensus. Most recently, Karlan (1999, p. 1711) explains the fact that legal systems prevent the buying of votes and, at the same time, they permit implicit votebuying through campaign promises with the argument that wholesale campaign promises differ from the purchase of votes because they serve informational role that enables voters generally to choose more intelligently among candidates. 3 The politics-like-markets analogues form an established foundation of much of the work in public choice and political economy. Stigler (1971); Becker (1983) and Peltzman (1990), among others, have provided seminal formulations of the efficiency hypothesis of politics. The trust of this foundational hypothesis is that political markets are generally clearing, at least in the sense that, in equilibrium, no individual can improve his wealth (or utility) without reducing the wealth (or utility) of at least one other individual. For an outsider s review essay on the Chicago perspective on political markets, see Rowley (1993, p ) 2

3 detriment of the community at large. 4 The objections and institutional analysis of vote trading usually focuses on vote trading in legislative settings, with little or no consideration of the buying of the votes of individual voters. While such lack of attention may be justified by pragmatical reasons (given the practical difficulties of monitoring and enforcing vote trading at the individual level), we should nevertheless consider that individuals and groups with strong preferences for particular policy outcomes may use alternative, in-kind means of vote buying. They donate money to the campaigns of favored candidates, finance the advertising of political messages, distribute cigarettes and other items to marginal voters on election day, offer to transport them to and from the pools, and so on. These practices and institutions, while in many ways falling short of the necessary attributes of the first-best exchange and enforcement mechanisms considered in this paper, nevertheless should not be ignored. Objections to institutionalized vote trading are also raised with respect to logrolling at the representatives level. Public law scholars suggest that such political exchanges should be discouraged because they undermine political accountability and because imperfections in the market for votes are likely to engender costs that outweigh the benefits of a free market in votes (Karlan, 1999). These arguments, while sensible in their own turf, seem to treat indistinctly the question of agency problems in political representation with the understanding of the effects of an explicit market for votes on the 4 According to Karlan (1999, p. 1711), there is a methodological tension in the current conceptualization of the right to vote: On the one hand, the right to vote serves a powerful expressive function.... On the other hand, the functional point of voting is to aggregate individuals preferences and to allocate political power (and ultimately the benefits and burdens the government confers) among groups. Karlan (1999, p. 1713) further notes that the presence of money could change voters preferences: If voters think of their votes as simply something to be auctioned to the highest bidder, they are likely to see the sole purpose of the political process as maximization of their own short-term self-interest. 3

4 resulting political outcome. This article wishes to shed some light on the issue of logrolling and political representation, giving separate attention to the two dimensions of the problem. Building on the results of my previous paper on the market for votes (Parisi, 1998), I will focus preliminarily on the properties of a market for votes in the absence of agency problems, e.g. in a direct democracy or in a world where the representatives preference profiles faithfully reflect the preferences of the people. In such ideal world of perfect representation, the incentives of the legislatures are perfectly aligned with those of the voters, so that we can interchangeably think of the aggregation of the politicians policy preferences as the aggregation of the preferences of society at large. These assumptions are later relaxed, considering the different impact of vote exchange mechanisms in the presence of agency and collective action problems. In particular, this Article examines the potential role of bargaining and side-payments among voters subject to a majoritarian decision-rule, in inducing stable and socially desirable policy outcomes. Revisiting the conclusions reached by Bernholz (1980), I show that, under fairly standard assumptions, majoritarian outcomes with bargaining are unique and stable as long as minority voters are allowed to influence the majority policy-making through side payments and as long as political bargains are enforceable. The results in turn provide an argument for enforcing political bargains. 5 In addition, this Article provides an alternative 5 The desirability of allowing enforceable political contracts in a direct democracy could also be examined through the following Rawls-type or Buchanan-type arguments. In the original position meta-bargain among the three agents, there are three reasonable 2 person solutions (1/2,1/2,0),(1/2,0,1/2),(0,1/2,1/2) given zero bargaining costs and the typical axiomatic bargaining specifications which leads to the fair split of the voter s surplus. In that setting if voters had an opportunity to agree ex ante on a procedure (this could be formulated as a Rawlsian original position choice or as contractarian choice of the rules of the game a-lá- Buchanan). However, given the voters concave utility functions, by Jenson's Inequality, each player prefers U(1/3) > 2/3U(1/2), therefore each is willing to bind himself to a system of enforceable political contracts as opposed to taking the chance that he will be the excluded party (each party has a 1/3 chance of this happening, under symmetric initial bargaining positions). 4

5 explanation for Tullock's (1981) puzzle as to why there is so much stability in the political process. By reconceptualizing Arrow's (1963) theorem using voters' utility functions rather than mere preference profiles (i.e., ordered preferences), the approach adopted in this Article allows voter preferences to be continuous and differentiable, without imposing any stringent condition relative to cardinality and interpersonal comparability of preferences. 6 Part I discusses the considerations that motivated this research and formulates claims on the properties of a market for votes. Part II presents a basic Pareto optimization model as a benchmark to evaluate a Coasian bargaining result. The model is used to explore the implications of Coasian assumptions for the bargaining outcome. If agency problems in representation are assumed away, bargaining and side payments among voters will yield Pareto-optimal outcomes, reaching results similar to those of an ideal unanimity rule, yet avoiding the hold-ups and transaction costs often occasioned by such rules. 7 Part III discusses the geometry of the market for votes, identifying the conditions under which bargaining and side-payments will yield a unique and stable majority outcome. Part IV explores the welfare implications of the market for votes. This analysis shows that if voters have utility functions with similar curvatures, centered around 6 The cardinality and interpersonal comparability of preferences is regarded as one of the main problems of social welfare analysis. Two individuals, A and B, can say if they prefer X to Y (ordinal preferences), but nobody can say if A likes X more than B likes Y (cardinal preferences with interpersonal comparability). The use of utility curves in this paper avoids the problems associated with straight cardinal comparisons. This approach appears to have become rather common in the social choice literature. See, e.g., Roemer (1996). 7 As indicated above, for the purpose of this exercise, I assume away agency problems in representation. This condition could materialize in the limit case of direct democracy, but would also be met if we imagine that reelection or reputational constraints of legislators guarantee that the trading process takes some account of the preferences of the platform-voters. 5

6 equidistant ideal points, the bargaining outcome will satisfy the Benthamite 8 and Nash 9 criteria of social welfare. Conversely, if voters' utility functions have different curvatures or are centered around ideal points that are not equidistant from one another, then the competing criteria of social welfare are likely to be satisfied at different points and the bargaining outcome will fulfill only the Benthamite criterion of social welfare. Part V discusses some implications of the market for votes in the real-world political marketplace. This Article concludes by considering possible extensions and welfare implications of the political bargaining model once the assumption of symmetric preferences is relaxed. I. MAJORITY VOTING AND INTER-COALITION BARGAINING One of the main insights of social choice theory is that the correlation between preference and choice is weaker for groups than for individuals. 10 According to Arrow's possibility theorem, it may indeed be too much to expect methods of collective decision making to be at the same time rational and egalitarian. (Arrow 1963, pp ) Arrow's (1963) theorem shows that any social decision that is adopted must violate at least one of six self-evident axioms of normative political theory, commonly described by the following terms: range, universal domain, unanimity, 8 According to the Benthamite criterion, the measure of social welfare is given by the sum of the utility of the various members of society. See Mueller (1989), attributing the additive form of the social welfare function to Jeremy Bentham. 9 According to the Nash criterion, social welfare is given by the product of the utility of the members of society. See Mueller (1989, pp ), attributing the multiplicative form of the social welfare function to John Nash. See also Nash (1950). 10 The insight in this formulation is attributable to a well-known game-theorist, Shubik (1982). 6

7 nondictatorship, independence of irrelevant alternatives, and rationality. 11 Arrow's (1963) conclusion and its various corollaries pose a dramatic threat to the legitimacy of political decisions given the absence of any guarantee that the optimal collective choice will be obtained through a stable political process. 12 The heart of Arrow's (1963) theorem states that there are no nondictatorial rules or procedures for collective decision-making that reflect the combined preferences of voters to a consistent collective outcome. 13 This Article considers the implications of Arrow's (1963) theorem where there are cyclical majorities which are capable of repealing any resolution that has been adopted previously. As this Article will demonstrate, if all voters are allowed to enter into Coasian bargaining over the policy outcome to be adopted by the majority coalition, and if political bargains are enforceable, collective preferences in a multi-dimensional policy space will be transitive as long as individual preferences are single-peaked. This result runs contrary to the common thought in public and social choice theory. Most of the literature on the stability implications of log-rolling 14 considers the context of bargaining for the formation of coalitions where side-payments are only instruments for entering the majority coalition, and no side-payments are 11 See, e.g. Mueller (1989, pp ); Stearns (1994, pp ); and Vikrey (1960). 12 The observation that the likelihood of cycling majorities decreases in situations where the number of decision-makers is much greater than the number of choices does not affect the practical relevance of Arrow's analysis applied to the political process, where the large number of decision-makers is actually concentrated into a restricted number of interest groups with group votes. 13 For the proof of these propositions, see Arrow (1963); see also Stearns (1994, p. 1249) and Stearns (1995). 14 See, e.g., Bernholz (1973); Miller (1977); Schwartz (1977). 7

8 made by those who are not part of the majority. 15 Furthermore, the conclusions that logrolling situations imply voting cycles assume that every voter at every step of the logrolling sequence can betray a previous coalition agreement to enter into a new coalition with other parties. This Article considers a broader role for bargaining and side-payments. Bargaining is permitted, with exchanges taking place among all voters and all coalitions. This assumption more accurately reflects the bargaining that takes place during the legislative process. 16 Additionally, voters agreements (whether under the form of explicit vote trades or implicit logrolling) are assumed to be enforceable. In such a scenario, where bargained-for exchanges take place among all voters and coalitions and where there are enforceable political agreements, the intransitive result of Arrow's (1963) paradox holds true only under implausible conditions. A. One Man, One Vote, and the Limits of Democracy In situations in which no strong political consensus is reached on a given issue, intransitivity may result. This intransitivity implies that a different order in the decision-making process may affect the outcome, and that any winning coalition may be undermined by the reintroduction of an alternative it previously defeated. The structure of the voting process does 15 Such bargaining does not require any relaxation of Arrow's axioms, although it may at times be perceived as interfering with the irrelevance axiom in that parties could attach value to otherwise irrelevant options. 16 Such cross-coalition exchanges are not uncommon and often occur in a flurry. For example, in anticipation of a congressional vote on fast-track trade authority in November 1997, President Bill Clinton and House Speaker Newt Gingrich (R-Ga.) engaged in a frenzied round of deal-making in an attempt to acquire enough votes to support the measure (Yang & Pianin 1997). The White House offered what the late Rep. Sonny Bono (R-Cal.) called a sale like I've never seen before, (Gugliotta 1997) and House Republican leaders similarly offered to support specific spending projects for Democratic lawmakers (Yang & Pianin 1997) who agreed to vote in favor of the legislation. 8

9 not allow the cycle to be broken by looking at the intensity of voters' preferences. The outcome is arbitrarily determined by the order of motions, with no guarantee that the ultimate result will yield a higher level of social welfare than that potentially afforded by any other defeated policy alternative. Democratic voting allows no expression of intensity of preferences, but only ordering among alternative outcomes. The inability of the democratic process to capture the intensity of the voters' preferences is a byproduct of the generally espoused principle that every individual is entitled to one and only one vote. This effect of the one man, one vote rule is exacerbated by the fact that individual voters do not face the opportunity cost of casting their vote. Whether their preference is strong or weak, voters will cast their vote in favor of their favored option. Even if specifically designed to allow voters to indicate the intensity of voters' preferences, the voting ballot could not possibly capture such intensity. Absent a mechanism to extract the true intensity of their preferences, individual voters would tend to overstate their cardinal preferences in order to maximize the impact of their votes. Democracy gives equal weight to all votes when they are counted, regardless of how strongly or weakly the voters feel about the issue. 17 In this way, numerically equal groups have equal political say in the process. However, if the distribution of sentiments on an issue is not symmetrical, and the minority holds strong preferences, the outcome would be inefficient. B. Introducing Vote Trading and the Opportunity Cost of Voting By introducing the possibility of bargaining and vote-trading in the 17 See Davis v. Bandemer (1986). 9

10 process, the intensity of preferences is reflected in the decision-making process. With bargaining and side-payments, the one man, one vote rule would provide the initial entitlement for each voter-trader. The exchange mechanism would then reveal the relative strength of individual preferences. 18 Once voters have an opportunity to trade their votes, they will face the opportunity cost of casting their vote. In the case of non-tradeable votes voters would cast their vote for their favored option regardless of the intensity of their preference. Once vote trading is permitted, however, voters may be inclined to utilize their vote only on issues for which they feel strongly about. They would, instead, prefer to transfer their vote in support of less preferred policies in exchange for payments or in-kind concessions. This sort of behavior, to some extent observable in real life legislative settings, creates an opportunity cost in casting a vote. Put it differently, the presence of exchange opportunities allows the voting system to capture intensity (as well as ordinal ranking) of voters preferences. In this way, political bargaining may provide a solution to the intensity problem, and at the same time correct for the cyclicality problem. Politicians know well that under certain conditions the outcome may depend on the sequence of decisions and therefore on agenda-setting. For example, in a situation with intransitive preferences, the agenda-setter may influence the process in favor of his preferred policy by determining the sequence of decisions. 19 Agenda-setting increases the internal predictability of the outcome for those who are involved in the process and have full information about it. Voters (or legislators) sharing similar information on their respective prospects will have an opportunity to bargain under condi- 18 From an efficiency perspective, in fact, weight should be given to intensive preferences. 19 Judge Easterbrook (1983) has noted that someone with control of the agenda can manipulate the choice so that the legislature adopts proposals that only a minority support. See also Levine & Plott (1977); Levmore (1989). 10

11 tions of symmetric information, trading votes for issues on which they hold weak preferences in exchange for votes on issues which have more value for them. Economic theory teaches that bargaining between politicians will continue until the marginal utility of gaining one vote on a certain issue equals the marginal cost of giving up one vote for another issue. Generalized bargaining yields a Pareto-optimal policy outcome. If cycling majorities still occur, it may be for either of two reasons. First, bargaining among politicians may not be perfect if strategic gate-keepers are still capable of influencing the outcome. 20 In such cases, a solution must be found in eliminating the barrier to Pareto-improving trades. Alternatively, the intensity of preferences may be identical across voters, so that there is no surplus to pursue through political bargaining and vote trading. In this latter case, cycling produces unpredictability but not inefficiency. The situations left to cycling would be those that leave deciding voters indifferent. In these rather marginal cases, there are no social welfare losses from the cyclicality of the outcome. One should further expect the competitive nature of the market for votes to cure some of the problems that have been identified in the social choice literature For example, in September 1997, Senator Jesse Helms (R-N.C.), as Chairman of the Senate Foreign Relations Committee, was able to block the committee from considering President Clinton's nomination of William F. Weld to be ambassador to Mexico. Although committee Democrats were able to garner the votes of two Republicans to establish a majority and force Helms to call a meeting, Senate rules enabled him to act as a strategic gate-keeper and leave consideration of Weld's nomination off of the agenda. See Dewar (1997). 21 For the reasons explained above, however, this expectation is at odds with the common thought in the public and social choice literature, specifically the results reached by Bernholz (1980). 11

12 II. COASIAN BARGAINING AND COLLECTIVE DECISION-MAKING This Part considers whether the outcome selected by majorities in a Coasian environment can be said to maximize the combined welfare of the platforms. The analysis suggests that both stability and efficiency are obtained through Coasian bargaining: a result which is partially at odds with some of the conclusions of the social choice and public choice literature. Previous attempts to study the stability and efficiency properties of logrolling include Buchanan and Tullock (1962), Coleman (1966), Mueller (1967), Park (1967), Mueller, Philpotts and Vanek (1972) and Koford (1982), among others. Buchanan and Tullock (1962) are generally recognized as the first public choice scholars expressly to discuss the issue of vote trading in a multi-dimensional policy space. The issue, treated in Chapter 10 of their Calculus of Consent, rests on the insightful and wellknown assertion of efficiency of vote trading, expressed in the following terms: Permitting those citizens who feel strongly about an issue to compensate in some way those whose opinion is only feebly held can result in a great increase in the well-being of both groups, and the prohibition of such transactions will serve to prevent movement toward the conceptual social optimality surface, under almost any definition of this term. (Buchanan and Tullock, 1962, p. 133). Buchanan and Tullock s contribution left its mark, not so much for the exposition of the efficiency or stability properties of the outcome (results that, in the context of their monographic treatment, were asserted more as intuitions than proofs), but rather for having postulated a framework of exchange in collective decisions that could operate just like an exchange of economic goods. In subsequent years, Coleman (1966) first tackled a formal analysis of a hypothetical vote trading in the context of Arrow s impossibility theorem in search for a method that would allow voters to express the 12

13 relative intensity of their preference and differences between utility levels associated with alternative policies. Coleman contemplates sequential decisions in a legislative body, where actors have an opportunity to express the intensity of their preference, even if imperfectly and incompletely. Through this hypothetical mechanism political behavior can be viewed as a generalization of market behavior and political institutions can be viewed as an extension of the market. Coleman (1966, p. 1122) interestingly points out that unlike the atomistic market of neoclassical economics, each political actor has only partial control over any given outcome, rather than complete control over a specific result. This requires the use of expected values in all political trades and the more complex consideration of rational behavior under uncertainty and possible risk aversion. Coleman s (1966) paper provided an important contribution to the conceptualization of vote trading, but triggered some debate and criticism. Among others, Mueller (1967) criticized Coleman s (1966) model for the lack of a mechanism for voters to actually exchange votes. The absence of an actual market mechanism with enforceable promises induced two major shortcomings. First, the hypothetical agreements failed to reveal the voter s true preferences because of the voters incentive to conceal their true preferences in order to increase their bargaining power. Second, because voting decisions are made sequentially, there is the temptation for the second voter to violate the agreement once the first voter has delivered his end of the bargain. By replacing the set of agreements with a systems which allows votes actually to be exchanged, both of these weaknesses could be eliminated, but Mueller (1967, p. 1310) concluded his critique of Coleman suggesting that the resulting set of policy decisions will fall far short of being in any sense socially optimal. A different attack to Coleman s results was moved by Park (1967) who disputes Coleman s (1966) apparent assertion that there is ordinarily a stable equilibrium outcome to a vote 13

14 trading situation with many decisions and many voters. Park (1967, p. 1301) argued, instead, that no such stable outcome would exist and if it did, it must be exactly the same as the outcome without vote trading. In later years, Mueller, Philpotts and Vanek (1972) revisited the issue of vote trading with a computer simulation. The simulation established a market for votes, allowing actual exchanges of votes and adjusting prices until markets cleared. Once equilibrium was established, the votes are cast in accordance with the preferences and number of votes held by each voter in the final equilibrium state. The results are then compared to the likely outcome of a simple majority rule without vote trading, revealing two substantial improvements of vote trading over simple majority rule: (a) the computer simulation generated results that indicated gains in efficiency, with higher aggregate social utility that simple-majority voting; and (b) vote trading improved the equity of the voting process by narrowing the dispersion of utility gains of the participants. Even though the interesting results of Mueller, Philpotts and Vanek (1972) are consistent with the general intuition of my paper, I shall resist the temptation to generalize the interpretation of their results, which necessarily rest on the specifications of their computer simulation. More recently, Koford (1982) presents a model of legislative votetrading contemplated to fit to American institutional realities. To keep number of traders low, the model assumes that legislators trade only with party leaders, who set prices for political support of proposed bills. Each legislator trades away votes on bills of little importance to his constituency and of high concern to others in exchange for promises to support (or oppose) particular bills of high concern to his constituency. This model is focused on replicating the features of actual logrolling and political exchange mechanisms rather than studying the general welfare attributes of a market for votes. 14

15 A. The Basic Model Consider the simplest case of a two-dimensional policy space (G 1, G 2 ) with three voters (1, 2, 3) who are allowed to bargain and offer sidepayments in a generic consumption good (Y) in exchange for policy concessions from the other voters. 22 The existence of concave and wellbehaved 23 utility functions for all voters guarantees the existence of a single policy outcome which satisfies the Pareto criterion of efficiency 24 and the Benthamite criterion of social welfare. 25 Consider three voters 1, 2 and 3, with utility functions U i = u (G 1, G 2, Y i0 -Y i ) for all i = , where G 1 and G 2 are publicly provided goods and Y i0 is the initial endowment of Y for voter i, and Y i is the individual contribution to the public good. Further consider a public sector production function F = f (G 1, G 2, Y) where G 1 and G 2 are the production outputs and Y is a generic input, equal to the sum of the individual contributions, such that Y = Y i. One can study the conditions for Pareto optimality for this problem by setting up a Lagrange equation 26 of the following fashion: 22 The existence of a numeraire different from the object of the bargaining is essential for any of the bargaining to take place. The Coasian bargaining for a change in the distribution of tax burdens, for example, will not be conceivable if money is the only thing that can be used as a numeraire for the exchange. It is, in fact, impossible to buy money with like money, since there would be no surplus from the trade. 23 The assumption of well-behaved utility obviously refers to the functions being smooth and continuous to allow for differentiability. In the context of this Article, they carry the additional implication of single-peakedness of the individual preferences. 24 In this setting, the Pareto criterion is satisfied because nobody can be made better off without someone else being made worse off. Any policy move from the central equilibrium will be prejudicial to the interest of at least one voter. 25 See Mueller (1989). 26 See Chiang (1984). 15

16 (1.1) = U 1 (G 1,G 2,Y 10 Y 1 ) + i [U i (G 1,G 2,Y i0 Y i ) U i0 ] + 1 (Y 1 +Y 2 +Y 3 Y) + 2 f (G 1,G 2,Y) One can then study the first order conditions by setting all partial derivatives equal to zero and solving the system of equations. (1.2) / G 1 U 1G1 + 2 U 2G1 + 3 U 3G1 + 2 F G1 = 0 (1.3) / G 2 U 1G2 + 2 U 2G2 + 3 U 3G2 + 2 F G2 = 0 (1.4) / Y 1 U 1Y1 + 1 = 0 (1.5) / Y 2 2 U 2Y2 + 1 = 0 (1.6) / Y 3 3 U 3Y3 + 1 = 0 (1.7) / Y 2 F Y 1 = 0 Further consider that all partial derivatives with respect to the Lagrangian multipliers are set equal to zero. From equation (1.4) one can find the value of 1 which can be substituted into equations (1.5), (1.6) and (1.7). This substitution allows one to solve for 2, 3 and 2. Substituting these values into equations (1.2) and (1.3), one finds (1.8): (1.8) U 1G1 /U 1Y1 + U 2G1 /U 2Y2 + U 3G1 /U 3Y3 + F G1 /F Y = U 1G2 /U 1Y1 + U 2G2 /U 2Y2 + U 3G2 /U 3Y3 + F G2 /F Y Assuming identical production functions for G 1 and G 2, and equal 16

17 marginal utility of wealth across voters (i.e., assuming away wealth effects), such that the following is true: (1.9) F G1 = F G2 (1.10) U 1Y1 = U 2Y2 = U 3Y3, equation (1.8) collapses to the following proposition, as characterizing the solution to our optimization problem: (1.11) U ig1 = U ig2 Equation (1.11) yields very interesting results. First, given strict concavity of all U i 's, in equation (1.1) the optimization point is unique. This uniqueness follows from a very simple geometrical intuition. 27 If all U i 's are concave, their sum must be concave, as the maximum of a concave function is unique. The countour of points that maximizes equation (1.1) will collapse into a single point given its nature as a maximum in a twodimensional plane. Second, if U i 's have equal curvatures around different ideal points, equation (1.11) implies that the bargaining outcome will be conducive to a policy outcome which is at the interior of the policy triangle shown in Figure 1 below. As shown in Part III, the optimization point will be equally distant from the voters' ideal points. Again one can invoke the geometrical intuition behind this proposition. Given the uniqueness result, symmetry requires that such point be equidistant from the voter's ideal 27 The mathematical proof of the uniqueness under strict concavity is omitted, given the geometrical intuitiveness of the proposition. 17

18 point, as shown in equations (2.8), (2.9), (3.8) and (3.9) derived below. This condition of equal distance will be met at the center of the policy space. This implies that the bargaining result will generate moderate and centrist policy determinations with outcomes that will approach the center of mass of the policy space. The greater the steepness of the utility hill for one voter, the closer the policy outcome comes to her ideal point. Thus, more politicallysensitive voters can be viewed as having a greater bargaining power in the political exchange process. 28 B. Toward a (Positive) Political Coase Theorem We can now articulate some implications of a Coasian result in the context of the political market. As for the general case, rights and initial entitlements need to be established, 29 and contracts or exchanges need to be costlessly enforceable. 30 The results are far-reaching and can be articulated in the following three propositions and corollaries. 28 This notion was probably reflected in the Fall 1997 fast-track trade authority vote-bargaining. The Senate overwhelmingly favor[ed] fast track, primarily because senators can balance adverse trade effects in one part of [their] state against boom times elsewhere, and catastrophe is easier to absorb. But in House districts, a member's political future may depend on the tariff structure of a single agricultural commodity. (Gugliotta 1997). Thus, it was in the House of Representatives where the bargaining frenzy took place, and the most politically sensitive representatives were able to bargain for the biggest payoffs (Gugliotta 1997). 29 As Cooter (1987) observes, one of the most relevant impediments to the working of the Coase theorem is the existence of uncertainties regarding the content and enforceability of the rights. An imprecise definition of which political bargains could enjoy legal protection and which other agreements would only be supported by the threat of informal political sanctions renders the actual working of a market for votes problematic. In order for the conditions for the free exchange to be verified in the Political Coase theorem, it is necessary to define ex ante the content of the rights without ambiguity, and to specify the legal or political means to enforce their transfer. 30 E.g., a side payment given in consideration for a policy amendment needs to grant an enforceable right to the amendment itself. 18

19 Proposition 1: If the conditions for the Coase theorem are present for all voters, different initial majority coalitions will lead to the same final policy outcome. Proposition 1 is the political analogue of a core result of the traditional Coase theorem according to which the efficient final allocation of resources is achieved independently of the initial assignment of rights. 31 The implicit premise of this proposition draws upon a fundamental postulate of microeconomic theory: the free exchange of goods in the market moves goods towards their optimal allocation, such that, only when every possibility of beneficial exchange is satisfied, resources will reach their stable final allocation. 32 The political system creates many entitlements that are also susceptible of implicit or explicit exchange. Applying by analogy the idea of the free exchange of goods in the market, this suggests that the transferability of votes in a free political market leads towards efficient final policy allocations. Any socially sub-optimal majoritarian policy would be cured by the voluntary bargaining between majority and minority parties in the political marketplace. Different initial coalitions like different initial assignment of rights in the traditional Coase theorem will obviously change the direction of 31 Stigler (1966, p. 113) was the first scholar to restate Coase's argument in the form of a theorem. Coase (1988) recognizes Stigler s merit in this respect. The following year, Demsetz (1967, p. 349) provided a more extensive formulation of the theorem: There are two striking implications of this process that are true in a world of zero transaction costs. The output mix that results when the exchange of property rights is allowed is efficient and the mix is independent of who is assigned ownership (except that different wealth distributions may result in different demands). Soon thereafter, Guido Calabresi (1968, p. 68) stated the same principle in the following terms: Thus, if one assumes rationality, no transaction costs, and no legal impediments to bargaining, all misallocations of resources would be fully cured in the market by bargains. 32 In his recent Notes on the Problem of Social Cost, Coase (1988) cites Edgeworth (1881) as the principal source of inspiration for the formulation of this important part of his theorem. 19

20 side payments. But such distributional effects will have no impact on the final policy outcome. This result should not be surprising. After all, Buchanan and Tullock (1962, p ) have shown that majoritarian decision-making can impose negative externalities on the outvoted minority. Like for its original case of externalities among farmers and ranchers, the Coasian bargaining solution fulfills its mission, correcting the externality problem of majoritarian democracy. The Coasian bargaining assumption 33 implies that all vote promises are enforceable. 34 The coexistence of zero-transaction cost and full enforceability assumptions may in some way be seen as contradictory: contract enforcement are a cost of transacting. But such costless enforcement also provides the basis for the traditional formulations of the Coase theorem, as it applies to the exchange of legal entitlements. The enforceability assumption further necessitates that, once entered into, contracts can be modified only with the consent of all the parties. Minority voters can join the coalition and have a marginal effect on the policy outcome by out-bidding or bribing 35 members of the pre-existing majority. 36 With enforceable contracts, majority members cannot cheat on each other. Collectively, they will entertain offers made by minority voters who will influence the status quo with their side payments. In the real-world 33 See generally Coase (1960). 34 Among the transaction costs that the Coase theorem assumes away are those associated with monitoring and enforcing any bargain struck. (Elhauge 1991, p. 96 n. 247). 35 [G]roups with lower costs of organizational and collective action are likely to be those which can mount the most effective bribe, as public choice theory presumes in the political context. (Kahn 1990). 36 Note that the Coasian result requires that contracts are binding. Thus, any change away from a policy supported by a majority coalition requires the agreement of all members of the coalition. If any bargaining or side-payment is made by a minority member, it should be directed to all members of the current coalition, not just to a subset of decisive voters. 20

21 market for votes, legislators sometimes have to be creative to make contracts enforceable. 37 Many real-life instruments often concur to induce such result. Reputation associated with seniority and past voting record, relational contracts, political hands-tying and bonding mechanisms, etc. often contribute to making the fulfilment of political promises more attractive than their breach. Some of these institutions are discussed in Crain et al. (1986). 38 Assuming continuous policy options which allow incremental moves, consider the following. If there is a socially superior option, parties left out from the initial majority will be able to bribe all majority voters and induce them to move closer to that point. The new bribers will now be part of the expanded majority coalition. If the new policy is not yet at the social maximum, there will still be an additional voter willing to bribe all contracting parties to move closer to their ideal point. As we learn from microeconomic theory, the potential for reciprocal benefit in the exchange will not be exhausted until the policy with the highest social value is implemented. In the political context, this predicts that, in a competitive market for votes without transactional impediments, the resulting policy outcome would be globally efficient. This intuition is verified in Part IV, where it is shown that the bargaining outcome will be obtained at the Benthamite social optimum point and, under conditions of initial symmetry, 37 In the Fall 1997 bargaining for fast-track trade authority votes, many representatives willing to trade votes to President Clinton and Speaker Gingrich still insisted on cementing Clinton's promises in print in an omnibus Ways and Means Committee amendment that [would have been] inserted into the fast-track bill when it came to the floor. (Gugliotta 1997). After support fell short and the vote was postponed, the White House attempted to signal the enforceability of its bargains (and ensure its influence against the status quo) in a future vote by publicly stating that it would not go back and undo the things that we pledged that we would do. (Gugliotta 1997) (quoting presidential spokesperson Michael McCurry). 38 Even though the legal system offers no enforcement mechanism for explicit political exchanges, there are may non-legal enforcement mechanisms, comparable to those examined by Kronman (1985) that are at work in the context of political exchange. Furthermore, there is an extensive literature on structure-induced equilibrium that in many ways may be relevant to the point. 21

22 it will at the same time satisfy the Nash criterion of social welfare. Once the contracting parties have reached the social optimum policy, there will be no occasion for further instability. No voter or group of voters will be able to bribe all others to alter the ultimate policy outcome. The key for this result is that contracts are enforceable (i.e., contracts can be revised only with the consent of the contracting parties). The zero transaction cost version of the Political Coase theorem is uninstructive with respect to the choice of optimal decision rules. As the following proposition and corollaries point out, if political bargaining is possible and costless, the same policy outcome is obtained regardless of the decision rule chosen for policy deliberations. Proposition 2: In a world of zero transaction costs, the choice of alternative decision rules has no effect on the policy outcome. The absence of transaction costs guarantees that the final policy outcome will not depend upon the choice of decision rules. As easily recognizable, Proposition 2 is the political analogue of another important result of the traditional Coase theorem, according to which, in a world of zero transaction costs, the choice of remedies is irrelevant for the efficient final allocation of resources. The logic of this result is relatively straightforward. Building upon the conclusions of Proposition 1, consider again that in the political context, an initial majority coalition with globally suboptimal policies has an incentive to shift the policy outcome away from the majority contract curve towards the minority ideal point, as long as political contracts with side payments between minority to majority voters are allowed and 22

23 enforceable. 39 Such an exchange will continue until there is no further room for reciprocal net benefits for majority and minority voters. The same bargaining will take place regardless of the initial size of the majority coalition and regardless of the voting majority requirements. Different decision rules like different remedies in the original context of the Coase theorem will have no effect on the final policy outcomes. In the political context, this proposition has two explanatory corollaries that can be formulated as follows. Corollary 2.1: At the limit, in a world with zero transaction costs, dictatorship and unanimity rules would be conducive to identical policy outcomes. Corollary 2.2: Likewise, the choice of different majority or super-majority decision rules would have no impact on the final outcome. In the absence of transaction costs, the same logic explains the irrelevance of alternative decision rules. If decisions are initially made by a single dictator, all individuals (except the dictator himself) can be thought as the minority group. In the absence of transactional impediments, any socially sub-optimal dictatorial policy would be cured by the voluntary bargaining between the dictator and his subjects, until the resulting policy outcome is globally efficient. The above irrelevance propositions, obviously, lose their grasp in a world of positive transaction costs. We could thus use some of the normative corollaries to the Coase theorem in order to obtain some insight 39 In this context, globally suboptimal policies would be those that fail to take into proper account the intensity of preferences (or willingness to pay) of minority voters. 23

24 for the choice of optimal decision rules. For example, if, in the absence of transaction costs, unanimity rules and dictatorship lead to identical policy outcomes, which should be the default decision rule in the presence of positive transaction costs? Should the decision rule be one of unanimity (putting the burden on the sponsors of a new policy to acquire the consent of all other voters) or should the decision power be granted to a single dictator (shifting the burden on the citizens to bribe their dictator for desirable policy outcomes)? One can realize that the above question is qualitatively similar to the question we are used to pose with respect to the allocation of rights and choice of remedies in the traditional context of the Coase theorem. In the presence of transaction costs, different decision rules not only have distributive effects (i.e., changing the direction of payments from one group to the other) but may also have significant allocative (i.e., efficiency) consequences. In the political context, the answer to this question should be found considering the tradeoff between direct and external decision making costs, along the lines of Buchanan and Tullock (1962). Furthermore, if transaction costs are high, the normative extension of the Coase theorem would suggest that rights should be allocated in such a way as to minimize the impact of such transactional impediments. In the political context, if there is a strong asymmetry between the intensity of preferences of the various members of society (e.g. a minority would suffer a great loss while a majority would receive only a small benefit as a result of a civil right violation) supermajority or unanimity requirements may be appropriate. This, indeed, is the logic that explains the constitutional protection of civil rights. 40 Likewise, in cases of unequal group size with a 40 Buchanan and Tullock (1962) utilize a dramatic example of logrolling to illustrate the potential benefits of a free market for political consensus. The example was narrated in a retrospective essay by Tullock (1998, p. 131) along the following lines: It is fairly clear logrolling can generate benefits.... Long ago when 24