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The Adam Smith lecture: on the structure of an economy: a re-emphasis of some classical foundations.

Economic choices are made by many buyers and sellers as they participate in many markets for many goods and services. "The Economy" is best described by the structure (the rules) within which these market choices take place. Efforts to reform the pattern of results observed in an economy should be directed exclusively at this structure; attempts to modify directly the outcomes or results of market process within structures are based on fundamental misunderstanding.

TO THOSE OF US who share the view expressed so well by Adam Smith in my frontispiece citation, there is both "good news" and "bad news" in the global political economy of 1988. The "good news" is reflected in the developing recognition that centrally planned economies everywhere remain glaringly inefficient, a recognition that has been accompanied by efforts to make major changes in internal incentive structures. More extensively, throughout the developed and the developing world of nations, the rhetoric of privatization in the 1980s has, occasionally, been translated into reality.

The "bad news" emerges from the United States, where in a single week in early May 1988 two separate stories in the media caught my attention. The first was a report that the Greenspan Federal Reserve Board had returned full circle to the once-abandoned effort at monetary fine turning. The second was a report that councils well placed in the Democratic Party are increasingly disposed to promote specific and directed governmental intervention into industrial operation. These two stories came on top of the protectionist-mercentilist absurdities abroad in the land, absurdities that seemed excessive, even by presidential election years standards.

These items, along with the formal title of this, The Adam Smith Lecture, prompt me to devote my attention exclusively to a restatement and re-emphasis of what I think was Adam Smith's own normative attitude on the structure of a national economy, and, by inference, on his attitude toward political-governmental directions for economic policy. Let me say at the outset, however, that I am not an exegetist, and that my concern is really not what Adam Smith may have said or failed to say. My concern is, instead, with articulating what I think would be a consistent position, for Adam Smith, in the context of the United States political economy in the late 1980s. And you will not, of course, be surprised that I shall exploit yet another opportunity to present my own perspective on political economy generally.

I propose, therefore, to defend the categorical distinction to be made between the structure of an economy and the operation of that economy within such structure. I shall argue that the appropriate domain for political economy, for politically directed reform as well as for discussion and analysis of that reform, is exclusively limited to structure. Efforts directed toward effectuating modifications of results that emerge only from complex interdependencies within structure are misguided, as are all canons of putative advice advanced by pundits who fail to understand the necessary distinction. +y argument may be properly interpreted as a restatement of the positive case for laissez-faire that Adam Smith might have made had he used this term. Above all else, Adam Smith was a man of prudence, who would never have countenanced those fools of right or left whose caricatures through the decades have reduced a potentially meaningful slogan to polemical absurdity.

I shall proceed as follows. In the next section, I shall offer a precautionary tale about the dangers of terms that seem semantically and didactically useful but that may have the effect of making enlightened understanding more difficult to achieve. Functionalism, the familiar scourge of explanatory analysis in the other social sciences, also works its spell among economists. The third section is devoted to a necessarily foreshortened discussion of the order of an economy, as it operates within its own constraining structure. The next section examines elements of structures and analyzes relationships between structure and operations within structure. In the following section, I argue that elements of structure offer the only appropriate targets for reform. In the final section, I demonstrate how confusion in understanding the distinction between structure and operation-within-structure, between rules of the game and play within the rules, between process and end states, produces misdirected, and ultimately self-defeating, ventures in economic policy. The lecture falls clearly within "constitutional political economy," although, by comparison with some of my other papers, discussion here is concentrated on the structure of the economy rather1 than on the structure of the polity. In other words, the analysis examines the impact of politics on the economy, both in its positive and normative variants. The analysis does not, at least directly, introduce constitutional politics.


An economist who was exposed directly to the teachings of Frank Knight at the University of Chicago or indirectly through access to one of the many elementary textbooks that incorporated elements of Knight's introductory monograph, "The Economic Organization" (1933), is familiar with the listing of the "functions" of an economic order. As initially presented by Knight, these are:

1. establishment of a scale of values;

2. organizing production;

3. distributing final product;

4. making provision for growth;

5. adjusting demand to supply over periods of

transition This listing is indeed useful, both semantically and didactically. It allows the student to focus on distinguishable categories of the economic interaction process, while continuing to recognize that the process, as it operates, carries out or performs the five functions simultaneously.

I want to suggest, however, that this Knightian introduction to our central subject matter may be misleading because it may be interpreted to imply that "the economy," the economic organization," or "the economic order," accomplishes the listed functions, whether efficaciously or not, is some purposefully directed sense. If the economy, as such, has an acknowledged function or functions such as the establishment of a value scale, does it not seem to follow that the economy, modelled perhaps as a corporate actor, or perhaps through its politically organized agents, acts in furtherance of the stipulated and functionally defined objective? Should we really be surprised when the state, in its perceived role as helmsman of the national economy, takes upon itself those tasks presumably assigned to it by the economists who purport to understand their own domain of scientific competence?

To interpret the listing in this way is, of course, a mark of misunderstanding and confusion, both of Knight's own purpose in setting it out, and of the whole interaction process that defines the central subject matter of our discipline. Indeed we look to Adam Smith for one of the first explanations of how the economy does "perform" the listed functions without such functions, as such, being within the consciously pursued purposes of anyone, whether the individual participant as buyer or seller in a market or the political agent for such a participant. It becomes functionalist fallacy to impute purpose to "the economy" from the observation that the listed functions are, somehow, carried out. The argument from result to conscious design has been, since the eighteenth century, the argument that the economist must counter. And it is but small exaggeration to say that the core of our discipline embodies the understanding that the observed results of economic process emerge without conscious design while at the same time they describe an order that is amenable to scientific analysis.


I apologize for re-emphasizing basic principles of economics that may seem both to insult your intelligence and to be remote from practical relevance. I submit, however, that these principles are ignored, forgotten, or deliberately violated in too much of what passes for learned wisdom in our profession. I submit that many modern economists do not know what they are talking about, or, more charitably, that they talk about a realm of discourse beyond that constrained by the origins and history of their scientific discipline.

Adam Smith laid out the boundaries. We take as our assigned task to understand and to explain how an economy generates patterns of order that incorporate achievement of our objectives without requiring either benevolence on the part of economic actors or explicit direction by political agents. The principle of spontaneous coordination of the market is the principle of our discipline. Perhaps the most widely cited statement in The Wealth of Nations is that which suggests that we get our supper's meat not from the benevolence of the butcher but from his regard to his own self interest.

The butcher has a private pecuniary interest in having inventories of meat that will meet the demands of buyers. The qualities of desireability and availability take precedence over those qualities that may seem aesthetically superior by the butcher's own standards for the simple reason that the butcher seeks a larger relative share in the overall surplus generated by the nexus of trade and exchange among specialized participants. As we add the baker, the candlestick maker, and all of the other producing specializations in the modern complex economy, we explain the emergence of the set of goods and services that we observe, along with quality and locational characteristics . The butcher, in trying to meet the demands of his buyers, who bring to the market their autonomous demands, along with all other potential and actual producers-suppliers and demanders, establishes the scale or standards of valuation, the first of the listed functions that we discussed earlier. This scale or standard emerges from the whole interaction process; it does not directly enter into the self-interest calculus of any participant. The butcher acts on the basis of strictly localized information concerning the demands of his clientele; the relative evaluation of beefsteak does not emerge as if from a poll of public opinion; it emerges from the set of interdependent choices made by sellers and buyers, each of whom responds directly to the incentives that he or she faces in a localized market setting.

The complex order of a market economy emerges from a large set of interlinked game-like cooperative interactions between individual sellers and buyers, each of whom maximizes his or her utility in the localized setting of choice. No "player" in any of these game-like interactions chooses on the basis of an ordinal ranking of "social states" that describe the possible economy-wide inclusive imputation of goods and services, post-exchange. A "social choice" among "social states" (allocations, distributions, value scales) is, therefore, conceptually as well as practicably impossible, so long as any person is allowed to adjust behavior independently in the localized choice setting that is confronted.(1)


I have re-emphasized the familiar proposition that, so long as individual buyers and sellers retain liberties to choose among the alternatives offered for sale and purchase in the separate markets, there can be no economy-wide "choice" of the particularized results of the economic interaction process, as these results might be described in terms of allocations, distributions, or evaluations. This conclusion holds independently of how any such attempted choice may be organized, whether under the auspices of an authoritarian regime or a democratically elected government. The results emerge from the whole set of interdependent choices made by individuals as these choices are constrained by the structure of the economy. In its inclusive definition, this structure must incorporate the resource and technology limits that describe the natural environment. These more or less immutable limits are not among my principal concerns here. My emphasis is placed instead on those elements of structure that are subject to purposeful modification and change.

The terminology of game theory is helpful. The structure of an economy describes what we may call the "rules" for the whole complex set of interdependent game-like interactions between and among many players, each of whom acts in pursuit of privately selected purpose. This interpretation of structure as a set of rules directly suggests that, as an individual chooses and acts within the structure, as he or she plays in the inclusively defined game, there is, and can be, no conscious or explicit consideration given to the possible choice among alternative sets of rules. For purposes of rational choice behavior in the economic process, the individual must accept the structure of the economy (the rules) as fixed, as a relatively absolute absolute that is not subject to his or her own privately orchestrated change. For example, the pre-exchange endowments that are within the recognized entitlements of any person are defined by and in the structure of the economy; such a person cannot, separately and independently, modify these endowments.

A distinction must be made between the individual's influence on the overall results of economy-wide interaction (on allocation, distribution, and evaluation) and the influence on the structure. As noted earlier, the results of economic interaction, within a structure, emerge from the localized private choices made by all participants. Each individual choice must, therefore, affect the aggregate result, even if no person, as chooser, has any conscious sense of his or her own influence on this result.

Again a game analogy will be useful. A player chooses among strategies available under the rules that define the game; any player's choice of all the solution that emerges from the choices will affect the players, but no player "chooses" the solution, as such. By contrast, the rules or structure do not emerge from the within-rules choices made by participants; the structure remains necessarily independent of these direct in-structure or within-rules choices.(2)

The pattern of outcomes or results of the economic interaction process (allocations, distributions, evaluations) depend both upon the individualized choices made in the whole set of interlinked exchanges and upon the structure of the economy. I have argued that there can be no effective choice among alternative aggregate results, whether the attempt is made individually or collectively. Only the pattern of results is subject to deliberative change and patterns can be changed only through effective changes in structure, i.e., in the set of rules that constrain the exercise of individual choices to be made within therules. I have noted also that the individual can exercise no influence on the structure of the economy as he chooses separately and independently among the options that he confronts. From this it becomes evident that any choice among alternative sets of rules must be, and can only be, collective. The structure of an economy, the set of constraints that limit the choice options of individuals, that define the feasibility spaces, is public in the classic sense. This structure is both nonpartitionable and nonexcludable. Any change in structure must, therefore, impact on all actors in the process, quite independently of how and by whom the collective action is motivated and carried out.


The analysis of the working properties of alternative structures of an economy, alternative sets of rules and institutions that serve to constrain the choice behavior of participants within that economy, defines the domain for constitutional political economy in its positive aspects. Until recently, neo-classical economists tended to neglect the necessary interdependence between structure and potentially observable patterns of outcomes of the economic process. This neglect has been largely corrected by the emergence of the set of interrelated research programs summarized under the rubric "the new political economy:" law and economics, property rights economics, the new institutional economics, public choice. In each of these research programs, the focus of analysis is the impact of differing structures of incentives on the choice behavior of economic actors and, through this impact, on the pattern a aggregative results in an economy.

The positive exercise must precede any normative judgment on structure, on any part thereof, whether directed at the status quo or at any proposed alternative. The only legitimate normative exercise involves institutional-structural comparison. Demonstration of "failure" against some idealized standard (efficiency, justice, liberty) that is not anchored in structural feasibility is irrelevant.

How are alternative structures to be arrayed in the normative exercise? What are the standards for ranking? Answers to these questions call for treatises, but I can by cryptic here, especially because I have written at near-disquisition length elsewhere. (1962, 1975, 1977, 1985, 1988)

There are two, quite separate, responses to these questions that must be countered and shown to be untenable. The first is that which proceeds from the presumption that there is a unique, and agreed-on, objective, or objective function, for an economy that allows the working properties of alternative structures to be readily assessed. This direction of response, which continues to dominate the thinking of economists, reflects a carryover from idealism in political philosophy. Politics, inclusively defined, is conceived as the search for the "true," the "good," and the "beautiful," some ideal state of bliss waiting "out there" to be discovered or revealed.

As Adam Smith recognized so clearly, however, there is no agreed-on objective for the participants in an economic nexus, each one of whom seeks only to pursue his or her own privately defined aims (which may or may not reflect narrowly-defined economic interest). Absent such agreement, there is simply no external standard by which alternative structures can be evaluated.

A second response commences from this very fact of individual differences. Each person, as participant in the political-economic nexus, can, presumably, array alternatives of structure as "better" or "worse" in terms of his own subjectively defined interest. From these observed differences among persons, the inference is then drawn that no normative judgment that transcends individual evaluation is possible. Hence, if we differ on the ranking of structural alternatives, we fight; that is, the setting is one of pure conflict, out of which a single structure will emerge that satisfies the winners and coerces the losers.

I suggested above that neither of these responses to the basic normative questions is acceptable. We must reject the presumed existence of an ideal standard, and we must also reject the nihilism implied by the absence of agreement. And at this point it is, I think, important to recognize, and to acknowledge quite explicitly, that in some fundamental sense many of us, as citizens, behave as if the structure of the economic-political order embodies legitimacy, which implies voluntary acquiescence in the coercion of the state without attribution of either omniscience or benevolence to political agents. That is to say, we live with each other neither as nihilists nor idealists. In an empirical, practical sense, we reconcile the absence of an ideal agreed-on standard of evaluation and the implied conflict among individual objectives.

In a more formal exercise, we achieve this constitutionalist stance by the introduction of some means of dampening the potential for disagreement among individuals. Such means is provided in the use of something like a veil of ignorance and/or uncertainty, either conceptually or practicably, in the evaluation of alternative structures or constitutional rules. This device is, of course, familiar, from the works of John Rawls (1971), John Harsanyi (1956), Buchanan and Tullock (1962), and others.

The task of normative evaluation of alternative structures for an economy to be carried out after the positive exercise of comparison is assigned to individuals who are ignorant or highly uncertain about how the alternatives for structural choice will impact on their own identifiable interest. Such individuals will be led to agree, in their own interest, on structural features that exhibit many of the characteristics of the classical liberal social order.(3) And, the empirically observed acquiescence in the operation of many of the rules that define the existing structure suggests that, for many participants there is implied agreement, even without the carrying through of the formal veil-of-ignorance evaluative exercise.

This contractarian-constitutionalist derivation of the elements of structure for an economy allows us to flesh out, in modern terms, much of Adam Smith's message that was left implicit in his own work. The construction here allows us to derive a regime of "laws and institutions" that offer protection to person and property on a nondiscriminatory basis, that enforce voluntary contracts among persons nondiscriminatorily , that protect the natural liberties of persons to enter into voluntary exchanges, that prohibit restriction on entry into trades, that prohibit agreement on restrictive terms of trade. This listing, which could be extended and elaborated, contains elements of the structure that has come down to us in classical liberalism. Adam Smith was straight-forward in suggesting that, within this broadly defined structure of an economy, there was no legitimate basis for directed interference by political agents.

The listing of constituent elements of structure that might be derived from the contractarian normative exercise can be extended to include, importantly, the political-legal guarantee of predictability in the value of the monetary standard or unit of account in the economy. Historically observed political orders have rarely, if ever, provided this guarantee. (And, indeed, I suspect that this failure in structure offers the basis for much of the discussion at this conference and others of your association.)

The contractarian construction remains necessarily incomplete at critical elements of economic structure. While laws and institutions that protect the liberties of persons to enter and consumate voluntary exchanges command legitimacy directly, what are the limits suggested when voluntary exchanges affect other parties outside the exchange itself? The whole domain of externality, inclusively defined, does not find structural resolution directly in the initial normative exercise. As modern research has indicated, however, structural change that moves toward incentive-compatible imputation of rights may eliminate much of the contractarian ambiguity.


As many subtitle indicates, this lecture re-emphasizes the classical foundations of political economy, and especially as there are reflected in the encompassing vision of Adam Smith. Even Smith, however, is subject to criticism in his selection of the title of his treatise. By calling attention to the wealth of nations, Smith may be interpreted as setting up a single-valued criterion by which the functioning of an economy might be measured. As I have noted, a much-preferred title would have been "The Simple System of Natural Liberty," because what Smith demonstrated was that there is no need for us to conceptualize a single overriding or even an agreed-on purpose, aim, or objective for an economy, or for those political agents who may presume to take on the charge of furthering such purpose.

Properly understood, the economy has neither purpose, function, or intent. The economy is defined by a structure, a set of rules and institutions, that constrain the choices of many persons in an interlinked chain of game-like interactions, one with another. For any individual, there are, of course, "better" and "worse" economies, but these evaluative terms translate directly into references to sets of rules of structures. Within any given structure, laissez faire becomes the indicated policy stance, and this principle holds quite independently of the normative content of structure itself.

In one sense, there is absolutely nothing new or novel in what I have said in this lecture. But in yet another sense, the implications are revolutionary. The shift of emphasis to structure as the exclusive and only appropriate object for reform, along with implied principle of laissez faire applied to operation within structure, relegates to absurdity all proposals for reform supported on arguments from "national purpose," as well as all claims that the economy functions more satisfactorily if it is explicitly guided by presumably omniscient and benevolent political agents.

There are two separate, but related, aspects of the normative argument that I advance. The very definition of the economy as a structure, a set of constraining rules within which individuals seek to achieve their separately determined purposes, makes teleological direction of policy normatively self-contradictory. But alternative structures may be compared, and evaluated, in terms of their abilities to facilitate the accomplishment of the separately determined individual objectives. Because only individuals themselves can know what goals they seek, any direct delegation of authority to choose among structures reduces the information content of the constitutional choice process. The implied policy stance involves laissez faire within constitutional structure and consensus in the ultimate choice of structure itself.

No claim is made here that adherence to the normative precepts outlined will resolve all issues. Even within the constitutionalist-contractarian paradigm, differences among individuals may arise both in scientific interpretation-explanation-prediction and in a choice of ultimate moral norms. As noted earlier, many features of the classical liberal position would be predicted to emerge from the contractarian procedural test. But the precise boundaries of the constitutionally chosen structural limits on individual voluntary association, as well as the constitutionally derived definitions of the protected spheres of individuals themselves, cannot be drawn from sources other than as revealed by those who count as members of the body politic.

Let us by all means continue to strive for, and to support, efforts to analyze the structure of the economy, and to seek consensus on means to make this structure more capable of allowing us, as individual participants, to further those separately defined objectives that we seek. Let us, however, guard against allowing intellectual confusion about what an economy is to offer, legitimatizing cover for the efforts of some persons and groups to impose their own purposes on others. Beware of those who pronounce on the economy's purpose.


(1) This point was central to may early (1954) criticism of Arrow's (1951) extension of his impossibility theorem to apply to the results of market process. Only in writing this lecture did I realize that, although stated quite differently and developed from a differing perspective, Amartya Sen's (1976) demonstration of the paradox of the Paretian liberal comes ultimately to the same conclusion.

(2) The categorical distinction made here would be modified somewhat if we treat elements of structure as products of an evolutionary process. In this case, choice behavior within a structure might itself modify the development of structure over a sufficiently long period of adjustment. For my purposes, however, the categorical distinction made here serves a didactic function. By separating, both conceptually and analytically, the choices made within rules and the choices made among sets of rules, the appropriate domain of normative political economy may be much more clearly set forth.

(3) For more extended discussion, see my paper, "The Contractarian Logic of Classical Liberalism" (1988).


Kenneth Arrow, Social Choice and Individual Values

(New York: Wiley, 1951). James M. Buchanan, "Social Choice, Democracy, and

Free Markets," Journal of Political Economy,

LXII (April 1954), 114-123. _________________, The Limits of Liberty (Chicago:

University of Chicago Press, 1975). _________________, Freedom in Constitutional Contract

(College Station: Texas A & M University

Press, 1978). _________________, Liberty, Market and State (New

York: New York University Press, 1985). _________________, Economics: Between Predictive Science

and Moral Philosophy (College Station:

Texas A & M University Press, 1988). _________________, "The contractarian Logic of Classical

Liberalism" (draft paper prepared for conference,

Social Philosophy and Policy Center,

Bowling Green University, 1988). James M. Buchanan and Gordon Tullock, The Calculus

of Consent (Ann Arbor: University of Michigan

Press, 1962). John Harsanyi, "Cardinal Welfare, Individualistic Ethics,

and Interpersonal Comparisons of Utility,"

Journal of Political Economy, 63 (August 1955),

309-321. Frank H. Knight, "The Economic Organization" (Chicago:

University of Chicago, 1933, mimeographed). John Rawls, A Theory of Justice (Cambridge: Harvard

University Press, 1971). A. K. Sen, "The Impossibility of a Pareto Liberal," Journal

of Political Economy, 79 (Nov.-Dec. 1976),

1406-14-7. Adam Smith, The Wealth of Nations (Oxford: Oxford

University Press, 1976).
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Author:Buchanan, James M.
Publication:Business Economics
Date:Jan 1, 1989
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