DPA 703 West Chester University Political Economy Discussion


ppmr / June 2009
Public Financial Engineering
and Its Discontents
Justin Marlowe
University of Washington
ABSTRACT: In this essay I argue that many of the technical and analytical
developments in public financial management—known broadly as public financial
engineering—have weakened rather than strengthened public budgeting. Our
central challenge going forward is to understand how these developments will
continue to reshape public management.
KEYWORDS: budgeting, financial management, resource allocation
ur field’s most substantial problems are the decline of allocative efficiency in
public budgeting and the fact that public administrators are contributing to that
decline. Here I attempt to explain the nature, causes, and implications for public
management of that decline.
Public management happens in a context of scarce resources, and the prevailing
theory of resource allocation suggests public organizations allocate those scarce
resources according to priorities. For most organizations, the budget process is the
principal mechanism for determining those priorities and matching resources as
such. Public budgeting scholarship tends to focus on situations where resources
and priorities are misaligned. It seeks to understand the underlying causes of that
misalignment and to determine whether changing the machinations of the resource
allocation process can mitigate that propensity for misalignment.
A corollary is that allocative efficiency, or an organization’s abiltiy to quickly
reset priorities and reallocate resources in response to those new priorities, is a
desirable characteristic of public budgeting. Organizations with a high degree
of allocative efficiency tend to behave in similar ways. They carry out timely,
forward-looking, and unbiased analysis of financial trends (Meyers 1996). They
engage relevant stakeholders in ways that promote consensus on broad goals
rather than parochial interests. They are able to shift resources quickly within
programs or agencies, across programs or agencies, and across goals and objectives as necessary. They are responsive but not hyper-responsive to pressures for
Public Performance & Management Review, Vol. 32, No. 4, June 2009, pp. 626–630.
© 2009 M.E. Sharpe, Inc. All rights reserved.
1530-9576/2009 $9.50 + 0.00.
DOI 10.2753/PMR1530-9576320413
Marlowe / Public Financial Engineering and Its Discontents 627
There is mounting evidence that allocative efficiency is rapidly eroding in public
organizations around the world. Consider, for instance, that the majority of annual
expenditures by both central and subnational governments are now for entitlementbased health and social welfare programs, expenditures for which are determined
by demographic trends, health-care-cost inflation, medical technology, and other
forces mostly beyond government control (Schick, 2002). Budgeting is also increasingly institution driven. Innumerable budget rules and constraints shape how
and when revenue is collected, how and when organizations can access the public
capital markets, how appropriations legislation is debated and amended, what
level of resources can be allocated to particular programs and services, and what
types of resources can be set aside to address unexpected developments (Primo,
2007; Schick, 2002). Add to this the difficult cross pressures exerted by the exponential growth in the problems that now demand a public policy response—what
Posner (2007) called the agenda explosion—on the one hand, and fierce anti-tax
sentiment among taxpayers all over the world on the other. The net effect is that
resource allocation outcomes are often determined long before the formal budget
process begins. Many years ago, V.O. Key (1940) articulated public budgeting’s
central question as one that asks “On what basis do we allocate $x to activity A
over activity B?” Today a more appropriate question might be whether that basis
is even discussed.
We need serious attention on the question of whether there is still a role for
priority setting in budgeting. If there is, then what role should public administrators
play in maintaining or re-establishing that priority-setting process? If they are to
play a role, how should they play it? What sorts of tools are available to re-engage
elected officials, citizens, and other stakeholders in that priority setting? What do
public policy analysis, organization development, strategic planning, and other
analytical tools offer that might assist in that process?
The irony, and a cause for serious concern, is that public administrators are
actually accelerating the pace at which priority setting is being taken out of budgeting. The catalyst for much of that decoupling is the advent of what we might
call public financial economics. Financial economics is a relatively new field that
integrates tools and concepts from mathematics, economics, physics, and the behavioral sciences in an effort to create and apply new knowledge about enduring
issues in corporate finance. It has brought new knowledge and strategies to bear
on classic questions like how to craft a portfolio of investments to maximize return
and minimize risk, how to construct an optimal mix of debt, equity, and current
revenues (i.e. the capital structure question), and others.
In a recent Public Administration Review article, Thompson and Gates (2007)
outlined several potential public sector applications for tools and concepts from
financial economics. They made clear how these tools can add value to public
sector risk management strategies, capital structure analyses, and other contem-
ppmr / June 2009
porary public management concerns. However, they overlooked (unintentionally,
I believe) that these tools can be misapplied, sometimes with disastrous consequences. In fact, some of the early assessments of the recent troubles in the financial
markets attribute those problems to financial engineering, and most directly to the
proliferation of complex financial instruments that allowed investors to take on
unprecedented levels of financial risk. We now know in the aftermath that many
investors did not realize their actual risk exposure until it was too late.
Aside from the potential for misapplication, public financial engineering
is dangerous because it can make public sector resources less scarce. Making
resources less scarce erodes budgeting’s role in priority setting; it dampens the
urgency of need to make tough decisions about competing claims for those same
scarce resources.
Consider the example of public sector capital leasing. Most of us are familiar
with the notion of a lease, an arrangement in which one party owns an asset and
another rents from or operates that asset for the owner. Public organizations use
lease arrangements to procure everything from vehicles to computer equipment;
most assets that require ongoing maintenance or regular replacement are good
candidates for leasing. These arrangements are attractive because in many cases
the money an organization borrows to finance a lease arrangement does not count
against statutory and other limits on the amount of money it can borrow. More
important, in many cases leasing allows the entity to circumvent voter approval
requirements on new borrowing. In short, this is possible because instead of pledging to repay a sum of borrowed money, the organization can instead pledge to
appropriate money each year to the party that owns the asset. The twist is that in
many cases the entity that borrows the money, constructs or acquires the asset, and
maintains the asset is a public authority created by the organization itself. Recent
figures indicate that more than $300 billion in public capital projects have been
financed through leasing, often for colossal public projects. The South Florida
Water Management District, for instance, recently sold $1.2 billion in lease-backed
bonds to rebuild the public infrastructure behind the Everglades.
This same dynamic also works in the opposite direction—it is now common
for public organizations to lease their own assets to private sector operators. The
City of Chicago began this trend in 2005 when it sold the rights to operate the
Chicago Skyway (a large downtown tollway) to a consortium of European investors. The City received $1.8 billion upfront for this transaction, and the private
sector investors get to keep all tolls collected on the Skyway for the next 99 years.
Since then governments have explored leasing other public assets ranging from
lotteries to ports to student loan holdings. A colorful example played out recently
in the city of Akron, Ohio, where the mayor proposed leasing the city sewer system
to finance college scholarships for Akron residents. Critics of this plan dubbed it
“stools for schools.”
Marlowe / Public Financial Engineering and Its Discontents 629
Accounting tricks and other tactics to achieve a phantom budget balance have
always been a part of the public resource allocation process. But the tools of financial engineering—sophisticated forecasting and actuarial analysis methods, lease
financing and sell-out–lease-in arrangements, financial options and derivatives, and
many others—are eroding allocative efficiency and changing public governance
in fundamental but not well-understood ways. Here I mention four.
First and foremost, as mentioned, they diminish the priority setting part of
budgeting. That the budget is often viewed as a permission process is a good thing.
The reality of scarce resources and competing demands forces us to constantly
reevaluate why and how goods and services are provided, even if that evaluation
does not change anything. It forces stakeholders to take a broad view of what an
organization does and how it does it and to determine whether resource allocations
really square with priorities. But competing demands do not matter if organizations can access new resources by simply restructuring their financial risk profile
or changing their key financial assumptions.
Second, these strategies introduce a new element of budget sclerosis. The notion
of raising several billion dollars by simply allowing the private sector to operate a
piece of public infrastructure was unimaginable even a few years ago. However,
all indications are that the popularity of these tools will expand, perhaps exponentially, in the next several years. Accounting tricks typically have implications
for the next two or three fiscal years. Many of the recent large-scale leases have
required decades-long commitments to private operators. One can persuasively
argue that it is always advantageous to transfer to the private sector the financial
risk of operating a large piece of infrastructure. But, by locking an organization
into such a long-term deal and then immediately spending the windfall realized
from that deal, organizations create additional barriers to future reprioritization.
In other words, even if an organization seeks to reprioritize, it may simply not
have the option. In effect, these strategies take future resource allocation options
off the table.
Third, these sorts of tactics expand the governance process to include new and
unknown stakeholders. The public sector has always relied on private capital.
However, the investors who animate many of public financial engineering’s main
tools bring to the table a unique and heretofore unknown set of expectations. Unlike the traditional capital markets, where investment banks—or at least what we
used to call investment banks—are principally interested in earning a commission
on the transaction, many of public financial engineering’s tools require that those
same financial experts become actively involved in managing the asset. How they
carry out that task, and whether they change the public sector’s expectations about
risk and return, are important questions going forward.
Fourth, these techniques expand, perhaps unfairly, stakeholders’ expectations
about public administrators capacity to solve problems through administrative
ppmr / June 2009
means. In my view, it is no exaggeration to say the pace of innovation in financial
engineering is such that at some point in the near future, public organizations will
have tools that will allow them to undertake any new program or infrastructure
project, regardless of underlying financial condition or political circumstances.
Public financial managers might be expected to troubleshoot any and all resource
allocation problems. Whether this is an appropriate development, and whether
public administrators are obliged to determine when and how not to employ these
tactics, are important emerging issues.
These developments may seem esoteric, but they have enormous implications.
My main concern is that they further erode allocative efficiency by delaying or
even obscuring difficult resource allocation questions. Students of public management need to better understand whether the decision to employ these sorts of
techniques follows from a deliberate resource allocation strategy, the desire to
shift tough choices onto future elected officials, both, or something else. If and
how these innovations will fundamentally alter resource allocation, the most
fundamental process of public organization life, demands more attention than it
has received thus far.
Key, V.O. (1940). The lack of a budgetary theory. American Political Science Review,
34(4), 1137–1140.
Meyers, R.T. (1996). Is there a key to the normative budgeting lock? Policy Sciences,
29(3), 171–188.
Posner, P. (2007, December 5). The agenda explosion and public management. Governing.
www.governing.com/mgmt_insight.aspx?id=4620, accessed March 12, 2009.
Primo, D.M. (2007) Rules and restraint: Government spending and the design of institutions. Chicago: University of Chicago Press.
Schick, A. (2002). Does budgeting have a future? OECD Journal on Budgeting, 2(2),
Thompson, F., & Gates, B.L. (2007). Betting on the future with a cloudy crystal ball? How
financial theory can improve revenue forecasting and budgets in the United States.
Public Administration Review, 67(5), 825–836.
Justin Marlowe is an assistant professor at the Daniel J. Evans School of Public
Affairs at the University of Washington. He specializes in public budgeting and
financial management and has particular interests in public capital markets, resource allocation and control, and governmental accounting.
Power and Political Institutions
Terry M. Moe
Rational choice theory tends to view political institutions as structures of voluntary cooperation that resolve collective action problems and benefit all concerned. Yet the political process often gives rise to institutions that are good for some people and bad for
others, depending on who has the power to impose their will. Political institutions may be structures of cooperation, but they may
also be structures of power—and the theory does not tell us much about this. As a result, it gives us a one-sided and overly benign
view of what political institutions are and do. This problem is not well understood, and indeed is not typically seen as a problem at
all. For there is a widespread sense in the rational choice literature that, because power is frequently discussed, it is an integral part
of the theory and just as fundamental as cooperation. Confusion on this score has undermined efforts to right the imbalance. My
purpose here is to clarify the analytic roles that power and cooperation actually play in this literature, and to argue that a more
balanced theory—one that brings power from its periphery to its very core—is both necessary and entirely possible.
ore than a decade ago, I attended a conference at
Yale on the rational choice theory of political institutions, where I presented a paper that took issue
with the way the theory was then developing.1 The problem, as I saw it, was that the theory tended to view political institutions as structures of voluntary cooperation that
resolve collective action problems and benefit all concerned, when in fact the political process often gives rise
to institutions that are good for some people and bad for
others depending on who has the power to impose their
will. Institutions may be structures of cooperation, I argued,
but they may also be structures of power. And the theory
should recognize as much.
I didn’t get a standing ovation at the conference. But
in the broader community of scholars I was hardly alone
in thinking that power is essential to an understanding
of political institutions. Jack Knight soon published a
book-length analysis arguing that institutions are mainly
explained by distributional conflicts—and power—
rather than collective benefits.2 Even by then, major studies relying on rational choice reasoning had already made
power central to their analyses of political institutions,3
and in the years since this kind of work has continued to
Terry M. Moe is the William Bennett Munro Professor of
Political Science at Stanford University and a senior fellow at
the Hoover Institution (moe@hoover.stanford.edu). An earlier version of this article was presented at the Yale Conference on Crafting and Operating Institutions, April 11–13,
2003. The author would like to thank Sven Feldmann,
Lloyd Gruber, James Fearon, Peter Hall, Jennifer Hochschild, Stephen Krasner, Chris Mantzavinos, Gary Miller, Paul
Pierson, Theda Skocpol, Barry Weingast, and anonymous
reviewers for their helpful comments.
grow and reach a broad audience.4 Indeed, power is so
commonly featured in this literature that it is now easy
to believe—as I suspect most scholars in the field do—that
power is an integral part of the theory, on a par with
cooperation in explaining political institutions.
But it really isn’t. However much power might be discussed, the fundamentals of the theory have not changed.
They take their orientation from the same framework that
guides all economic theory: voluntary exchange among
rational individuals. They identify the key challenge as
one of understanding whether rational individuals will
cooperate in the face of collective action problems. And
their explanations are built around mutual gains, credible
commitments, self-enforcing equilibria, and other concepts that flow from the logic of voluntary choice. This is
the analytic core of the theory, the root source of its logic,
language, and formalization.
There are two problems here. The first is that power is
a peripheral component of the theory. The rational choice
theory of political institutions is really a theory of cooperation that, with elaboration, can be used to say something about power. As Mancur Olson rightly notes, “We
need to understand the logic of power”—and the current
theory of voluntary exchange is not designed to do that.5
The second problem reinforces the first. It is that, because
power is so obviously important to politics and so commonly a part of institutional analysis, the literature gives
the sense that power is being given equal (or at least appropriate) weight in the overall theory. There is a good deal of
confusion about the relative analytic roles of power and
cooperation, and this confusion undermines efforts to right
the imbalance.
Of course, maybe there is just one problem here: that I
am confused. And I expect that more than one rational
choice theorist will tell me so. But I have participated in
June 2005 | Vol. 3/No. 2 215
Power and Political Institutions
this field for a long time now, and I think it’s fair to say
that, if I am confused, I’m not alone. There is much to be
gained, therefore, in clarifying how power and cooperation are dealt with in this literature, and in encouraging
an appropriate balance between the two.
Institutions as Structures of
Prior to the 1980s, social choice theory had shown that
collective decisions are prone to instabilities, and that voting can easily lead to chaos in which virtually any alternative can beat any other given the right manipulation of
the agenda.6 A puzzle remained, however, because voting
processes in the real world of government are usually quite
stable. Why so much stability? The answer, as Kenneth
Shepsle and Barry Weingast so elegantly showed, is that
voting typically occurs within a structure of rules that
limit the agenda and bring about stability.7
Thus began the positive theory of political institutions.
The early focus on agenda control was only natural given
the dilemmas of social choice. Yet agenda control was
regarded as important not simply because it brings stability to chaos, but also because of its clear connection to
political power: whoever controls the agenda can engineer
voting outcomes to his or her own advantage, and thus
gain power over policy. Indeed, the classic works on agenda
control by William Niskanen and by Thomas Romer and
Howard Rosenthal were not centrally about chaos and
stability.8 They were studies of institutionally based power
that showed how particular actors—bureaus in the former
case, school boards in the latter—used agenda control to
get their way in politics.
By the early 1980s the rudiments of a power-based
theory seemed to be in place. The public choice literature
was already well developed; and in addition to its work on
agenda control, its work on rent-seeking also put the spotlight on power. Rent-seeking focused on the power of
interest groups over public policy, and on the social inefficiencies that arise from lobbying and special-interest policies.9 While the subject of this work was policy rather
than institutions, the overlap was substantial and unavoidable. Policies that create tariffs and quotas in international
trade, for example, are essentially just creating institutions—
rules, agreements, organizations. Thus, while the rentseeking literature is often portrayed as an interest-group
theory of public policy, it also offers a (nascent) theory of
political institutions—arguing that they are beneficial to
some, harmful to others, and socially inefficient.
Prior to the new institutionalism, then, rational choice
theory was already providing power-based explanations
for governmental structure. Its analytic center of gravity,
however, was about to change. The stimulus was the rise
of a new body of theory within economics that sought to
explain the existence and properties of economic organi216
Perspectives on Politics
zation.10 Once economists trained their sights on issues of
organization, their new analytic tools—among them transaction cost economics, agency theory, and theories of
repeated games—transformed the intellectual terrain of
their discipline. Political scientists soon began applying
these tools to political institutions, and the new institutionalism was off and running.11
As in economics generally, the basic framework in this
literature is one of voluntary exchange among autonomous actors. But its distinctive focus is on cooperation.
How can individuals who are self-interested and opportunistic overcome their collective action problems to cooperate for mutual gain? The answers take the form of
institutions—usually involving rules and other formal structures, but sometimes consisting solely of informal arrangements (rooted in norms, for instance)—which allow
participants to mitigate obstacles to collective action, commit to cooperative agreements, and realize gains from trade.
As such, institutions emerge as good things, and it is their
goodness that ultimately explains them. They exist and
take the forms they do because they make people better
Consider the familiar principal-agent relationship
between an employer and a potential employee. The principal has limited time and knowledge, and he can gain
by hiring someone with expertise to do the work. The
agent can gain by getting paid. But despite the prospect of
mutual gain, it is not easy for them to cooperate. The agent
has interests of his own—for example, in leisure or
professionalism—that give him incentives not to do what
is best for the principal. He also has an informational advantage that makes such shirking possible: for he has expertise
the principal does not have, takes actions the principal cannot observe, and has personal qualities—his levels of honesty, diligence, and the like—that are largely hidden. A bad
worker has incentives to use the information asymmetry to
pass himself off as a good worker, while a good worker may
have a hard time convincing the principal of his true type.
As a result, the principal has reason to distrust his agent, to
pay him less than a good agent is worth, and perhaps not to
hire anyone at all.
These actors face a collective action problem. The principal and a good worker could both benefit from cooperation, but the information asymmetry prevents them from
fully realizing gains from trade. The way around the problem is for the principal to devise an efficient set of rules,
incentive structures, and monitoring mechanisms that—by
mitigating the information asymmetry and bringing the
agent’s interests into alignment with the principal’s—
represents a mutually beneficial arrangement to which both
parties can credibly commit, and is either self-enforcing
or enforceable by a third party such as the courts. This
arrangement is an institutional solution (a simplified version of the business firm) that makes cooperation possible. The actors choose it and stick with it because they
both benefit, and this is what explains the institution’s
emergence, its specific form, and its ultimate stability.13
I have used the principal-agent framework for illustration, but the logic is characteristic of the new economics
of organization more generally. Transaction cost economics, for example, leads to the same basic conclusions. Efforts
by both actors to strike a beneficial deal are confounded
by the same information asymmetry, creating high transaction costs. And efforts to minimize these costs lead to
the same sorts of institutional solutions that help them
cooperate for mutual gain. All roads lead to Rome.
Given this perspective on institutions, how does power
fit in? The literature offers no clear answer. In our principalagent example, it might seem obvious that the employer
exercises power over the employee. But the institutional
solution to their cooperation problem has to be mutually
beneficial, and could just as well be designed by the agent.
This is true even of whatever formal authority the employer
gains under the new institution; for authority is endogenous to their agreement and beneficial to the agent as
well as the principal. The principal, by this logic, has no
special power just because he is on top.
An alternative view is that the agent actually wields
power in this relationship, using his informational advantage to circumvent the principal’s control and pursue his
own ends. Such information-based power is well recognized in the study of bureaucracy, going back to Max
Weber.14 But if we turn to the basics of the theory, the real
import of asymmetric information is not that it somehow
empowers the agent, but that it creates problems for the
principal and the agent and is bad for both of them. Yes, the
agent’s expertise gives him leverage and allows him to shirk.
But this is why the principal distrusts him and may not
want to deal with him at all. The source of his power is the
source of his undoing. His challenge is to find a way—an
institutional solution—to overcome the handicap of his
power and get the principal to cooperate with him for
mutual gain. This is what the analysis is really about. Not
agent power, but cooperation for mutual gain.
In political science, the new economics of organization
has been applied to a broad range of political institutions,
from legislatures to bureaucracies to international organizations to the basic framework of democracy.15 Power is
often part of these analyses. But with a few exceptions,
which I discuss below, it is included because it is obviously
relevant to institutional politics and can’t be ignored, not
because the theories are designed to explore its exercise
and consequences. The most basic arguments are about
how self-interested actors can make voluntary choices to
overcome collective action problems and cooperate for
mutual gain. Often the focus is specifically on credible
commitments and self-enforcing agreements, two major
ingredients that can make cooperation possible.
A good example is Barry Weingast and William
Marshall’s analysis of the internal organization of Con-
gress.16 In effect, their logic begins with a stylized state of
nature in which legislators make decisions by majority
rule. These actors face a collective action problem. All
want policies beneficial to their own districts, but they
can’t get them without the support of colleagues whose
interests are often very different. Efforts to construct the
coalitions needed for countless bills over time are threatened by endless haggling, frequent reneging, complexity,
uncertainty, and other sources of heavy transaction costs.
Most coalitions never form, and the gains from trade are
foregone—to the disadvantage of all.
The solution, Weingast and Marshall argue, is to reduce transaction costs dramatically through a set of internal structures—committees with strict jurisdictions
and gate-keeping powers, for example—that facilitate credible commitments and promote regular cooperation. This
institutional solution, they claim, is the structure that
has emerged to govern the modern Congress, and it is
stable because it is self-enforcing—that is to say, because
legislators find it beneficial and have no incentive to defect.
The rational choice literature is more diverse than this
one illustration can suggest. But the theme is a general
one, and it has put its distinctive stamp on the way institutions are studied and understood. This is succinctly
revealed in the observations of scholars who have sought
to provide perspective on the literature as a whole. Consider, for example, Shepsle’s summary remarks in an influential early article on the nature of political institutions:
The argument developed only briefly here is that cooperation
that is chancy and costly to transact at the level of individual
agents is facilitated at the level of institutions. Practices, arrangements, and structures at the institutional level economize on
transaction costs, reduce opportunism and other forms of agency
“slippage,” and thereby enhance the prospects of gains through
cooperation, in a manner generally less available at the individual level. Institutions, then, look like ex ante agreements about
the structure of cooperation.17
Thematically, things have not changed over the years.
In a recent compendium on the discipline of political
science, Weingast offers the following overview of the literature on why institutions exist and take the forms they
In brief, the answer is [that individuals] often need institutions to help capture gains from cooperation. In the absence of
institutions, individuals often face a social dilemma, that is, a
situation where their behavior makes all worse off. . . .
Appropriately configured institutions restructure incentives
so that individuals have an incentive to cooperate. . . . The essence
of institutions is to enforce mutually beneficial exchange and
Power and Domestic Institutions
It might seem easiest to argue the importance of power
when political institutions are the creations of predatory
rulers or international hegemons. So let’s begin at the other
June 2005 | Vol. 3/No. 2 217
Power and Political Institutions
Alternative views
end of the spectrum, with political institutions that are
There are other ways of looking at institutional politics
created through democratic politics under constitutional
that put a more positive, cooperationist spin on these issues,
rules of the game. On the surface, these contexts would
and they are worth considering—in part because they repappear to give cooperationist theories the greatest possible
resent familiar lines of reasoning, and in part because they
advantage and a power critique its greatest challenge.
are sources of confusion that need to be clarified. Two
What kinds of institutions do democracies normally
stand out.
create? Political scientists tend to rivet their attention on
The first is rooted in Coasian models of economic
the key authoritative institutions—legislative, executive,
exchange, in which freely bargaining actors can arrive at a
and judicial—set up by the constitution, or on the framepoint on the Pareto frontier that is efficient and beneficial
work of democratic rules themselves. The great bulk of
to all concerned. In a political context, the idea is that,
government, however, is composed of bureaucratic
when public policies (and institutions) help some interagencies—unexciting as this may sound—and they are
ests and hurt others but expand the size of the pie, the
designed and adopted by public officials who make deciwinners can compensate the losers through some form of
sions under prevailing rules of the game. To simplify the
bargain and both can be better off. When policies are
discussion, these are the institutions I’ll be focusing on
inefficient and don’t expand the size of the pie, bargaining
It is easy to see that these most common of demowill lead to their rejection. The vision is one of cooperacratic institutions are often not cooperative or mutually
tion and mutual gain.
beneficial for many of the
This argument doesn’t
people affected by them.
wash, however. Consider
These most common of democratic
They involve the exercise
the best-case scenario in
of power. This is so even
which a policy (such as
institutions are often not cooperative or
if the democratic rules of
free trade) stands to make
the game are assiduously
both sides better off once
mutually beneficial for many of the people
followed in their creation
compensation payments
and design. A prime reaare made, and the supaffected by them. They involve the exercise
son is that the public
port of both sides is
authority employed to
needed for passage. The
of power. This is so even if the democratic
create and design them
problem is that such barcan be exercised by whatgains tend to involve enorrules of the game are assiduously followed
ever coalitions gain the
mous transaction costs
necessary support in the
and are difficult if not
in their creation and design.
legislature (often a majorimpossible to arrange. The
ity). Whoever wins has
transaction costs arise not
the right to make decisions on behalf of everyone, and
only from difficulties in identifying the relevant actors,
whoever loses is required by law—backed by the police
amounts, and conditions, but also from difficulties in arrivpowers of the state—to accept the winners’ decisions.
ing at agreements that are mutually credible and enforceThis means that any groups that prevail under the forable despite the uncertainties of democratic politics. As
mal rules can legitimately use public authority to impose
Thrainn Eggertsson notes, “[I]n the real world, high costs
bureaucratic institutions that are structurally stacked in
of negotiating and enforcing such agreements prohibit
their own favor, and that may make the losers worse off,
them: seldom do winners voluntarily compensate the losperhaps by a lot.20
ers.” 22 If the losers’ support is not necessary for passage of
In the voluntaristic framework of the new economics,
the policy, things are of course brighter for the winners,
which often makes good sense in competitive contexts of
who do not need to bargain at all. Society is allegedly
economic choice, people who expect to lose from any
better off with the new policy and the bigger pie. But the
proposed institutional arrangement can simply walk away.
winners now have no incentive to compensate the losers—
This is what guarantees (in theory) that such structures
who are worse off, and stay worse off.23
Now consider the flipside of the above scenario. Let’s
will be mutually beneficial. The losers don’t have to parassume that a powerful group is in a position to impose a
ticipate. But in democratic politics, they can’t leave, at least
special-interest policy that is inefficient for society, maknot unless they are prepared to leave the country, which is
ing the size of the pie smaller but the winning group
typically not a practical option. So when they lose under
itself better off. According to the Coasian argument, the
the democratic rules of the game, they have to suffer the
losers would prevent this inefficient policy from being
consequences—and the winners are well aware of this.
adopted by paying off the winners. But here too, for the
The latter can impose the institutions they want. There is
same reasons as in the first case, the transaction costs will
nothing to stop them. They don’t need to cooperate.21
Perspectives on Politics
typically be prohibitively high, and most bargains will
not actually happen. The inefficient policy will be enacted,
the winners will win, and society as a whole will be
worse off. (Even if the bargain does happen, the losers
still wind up worse off than under the original status
quo, and the winners get a bundle for simply threatening
to use the power of public authority.)
Note the logic at work here. The argument that bargaining will somehow save institutions from social inefficiency,
an argument that essentially defends the cooperationist
theme of the new economics, runs smack into the logic of
the new economics itself. A political bargain to produce an
efficient policy—or prevent an inefficient one—is only likely
to succeed in a Coasian world in which transaction costs
are small and unimportant. But the defining claim of the
new economics is that transaction costs tend to be large and
important.24 Indeed, this is the foundation of its analysis of
institutions. If transaction costs in politics are large and
important, however, then many political bargains are likely
to be untenable, compensations are likely to go unpaid, political outcomes are likely to be inefficient, and there are likely
to be losers as well as winners.
Now consider a second line of reasoning that also puts
a positive spin on democratically created institutions. This
one arises from the familiar notion that government is
based on a social contract. The idea here is that, while
certain groups may be losers when new institutions are
created within democratic politics, they are not really losers (or do not expect to be) in the grander scheme of
things. They accept the overarching framework of democratic rules; and although they know they may lose on
particular decisions, they expect to be better off than they
would be outside the framework—under some other constitution, say, or no constitution at all. Thus, particular
domestic institutions may not be to their liking, but this
is part of the larger deal, and the system as a whole is good
and beneficial.
This argument might carry some weight if a political
system were analogous to what Oliver Williamson calls a
“governance structure” in the economic realm.25 Governance structures are relational contracts in which actors
agree to procedures that allow them to adjudicate disputes, adjust to new developments, and otherwise ensure
that their original agreement is maintained over time in a
changing environment. The actors know that particular
decisions may not go their way, but they participate because
they see the entire arrangement and its stream of decisions
as beneficial.
What makes such stylized governance structures different from political systems, however, is that they are voluntary. People agree to participate, and they can walk away
if they believe they are not better off. Political systems are
different. Centuries of political philosophy notwithstanding, there is no social contract in any meaningful sense
that can account for the foundations of government.26 In
all modern societies, people are typically born into the
formal structure of their political systems, do not agree to
it from the outset, and cannot leave if they find it disadvantageous (unless they leave the country). This being so,
the fact that some groups lose in domestic politics—and
have new institutions thrust upon them that they do not
want—cannot be glossed over by saying that they have
agreed to the larger system. They haven’t.
Another problem with the social contract argument is
that it substitutes oranges for apples. A theory of institutions should be able to explain how bureaucratic agencies
emerge from the political process and why they take the
forms they do. If the theory implies that institutions are
cooperative and mutually beneficial, then surely this conclusion should apply to bureaucratic organizations (where
it fails). But the social contract argument shifts attention
to the democratic framework itself. While it recognizes
that bureaucratic organizations may not be cooperative
and mutually beneficial, it implicitly contends that the
framework is the institution we ought to be focusing on,
and that this institution is cooperative and mutually beneficial. Even if this claim were true (and it isn’t), it does
nothing to address the original challenge to the theory—
that bureaucracies often violate the theory’s expectations—
and nothing to move us toward a theory that accounts for
the kinds of institutions that arise out of democratic politics. Instead, it confuses the issue by creating ambiguity
around what we mean by “institution” and what we are
trying to explain.
Theories of bureaucracy
These sorts of ambiguities are not unique to the social
contract argument. They pervade virtually all aspects of
what the new economics has to say about political institutions. Consider the rational choice theory of public
bureaucracy, which attempts to explain precisely the kinds
of domestic institutions that we have been discussing thus
Here the seminal work is by Matthew McCubbins, Roger
Noll, and Barry Weingast, who use a principal-agent
approach to explain the structure of American bureaucracy.27 How, they ask, can an “enacting coalition” of legislators and interest groups ensure that its favored policies
are faithfully carried out by its bureaucratic agents? The
solution takes the form of structure: a rational coalition
will impose rules, decision procedures, and reporting
requirements that are strategically designed to constrain
the bureaucracy to do what it wants. Their explanation of
bureaucratic structure, then, arises from the efforts of legislators and their allies to control the bureaucracy.
In another major work, Murray Horn wants to explain
the same things that McCubbins, Noll, and Weingast do.28
But he focuses less on the principal-agent problem facing
the enacting coalition than on the exchange relationship
June 2005 | Vol. 3/No. 2 219
Power and Political Institutions
between legislators and interest groups, and thus on the
agreement that gives rise to the enacting coalition itself.
Actors on both sides of the exchange have something to trade.
Interest groups have campaign contributions and other
resources to offer legislators; legislators have the authority
to create policies and agencies beneficial to the groups.
Attempts to cooperate for mutual gain, however, are undermined by transaction costs. Most important, the legislators
have a hard time guaranteeing that any benefits provided
today will endure over time because they can’t commit future
legislatures (possibly controlled by opponents) to uphold
the deal. And the less credibly legislators can promise future
benefits, the less the groups will want to pay in the current
period. To overcome this commitment problem, legislators
create agencies that—by structural design—are not only constrained to pursue the groups’ interests, but also insulated
from unwanted future influences.
These two theories are self-conscious applications of
the new economics, but neither does much to clarify how
bureaucratic institutions are cooperative and mutually beneficial. There is much to be gained from exploring this, so
let me offer a reconstruction of their arguments that I
think is consistent with the logic of their work.
In both analyses there are inevitably losers in the politics by which bureaucratic agencies are created. The authors
make nothing of this. Nevertheless, the enacting coalition
is only one faction of legislators and interest groups. Other
factions are losers and may be worse off because of the
coalition’s choices. The same is true for portions of the
larger population, who must live with the institutions being
thrust upon them. In this fundamental sense, the bureaucracy can not be viewed as a structure of cooperation.
This is only half the story, however. Even if the bureaucracy is coercive, in the sense that it is imposed by winners
on losers, these analyses correctly point to two cooperative
elements that explain how structural choices emerge out
of politics. The first is that legislators and groups in the
enacting coalition must arrive at an agreement that overcomes their collective action problems. This agreement,
which is largely about the structural contours of the agency,
is cooperative and mutually beneficial. The second element is the principle-agent relationship between legislators and the bureaucratic agency. If the legislators are to
get the performance they want from the agency, they must
solve the “principal’s problem” by designing an efficient
structure that is acceptable to the bureaucrats. Because of
the acceptability criterion, which is fundamental to any
principal-agent relationship, this agreement too can be
viewed as cooperative and mutually beneficial.29 The
bureaucracy thus arises out of two founding agreements, a
coalitional agreement among legislators and interest groups
and a principal-agent agreement among legislators and
bureaucrats. These agreements are interrelated—each presupposes the other—and can jointly be viewed as a nexus
of contracts that create the new institution.
Perspectives on Politics
Both power and cooperation are essential, therefore, to
any effort to understand public agencies. Bureaucracies
are institutions that are imposed by winners on losers. But
they are also cooperative and mutually beneficial for the
subset of actors who agree to their creation. Each property, in fact, is fundamental to the other. It is precisely
because they cooperate that the winners are able to use
public authority to impose their will on the rest of society.
And it is the prospect of exercising this power that motivates the winners to cooperate.30
With this as background, let’s step back and consider
two basic ambiguities that plague the new economics, at
least as it applies to political institutions. First, what are
the institutions being explained? Second, who are the actors
for whom these institutions are cooperative and mutually
When attention is confined to private firms, the situation being analyzed is self-contained: all the action is “internal.” The firm is a nexus of contracts among owners,
managers, and workers, who enter into voluntary agreements about the organization and its structure that apply
to them and govern their own behavior. In effect, the institution is their agreement, and they are creating the institution for themselves. It only makes sense, then, that they—
the “insiders”—are the relevant population by which we
determine whether the institution is cooperative and mutually beneficial.
Suppose we apply this same line of reasoning to public
agencies. On the surface, what we are trying to explain is
exactly the same: the organization and its structure. But the
underlying agreement that creates an agency does not consist of the people we would at first blush think are its insiders, namely, the bureaucrats who make up the agency. The
agreement includes the bureaucrats plus all the legislators
and interest groups in the enacting coalition. It is this much
larger and very different “institution” that is the political
analogue to the business firm. And all these political
players—bureaucrats, winning legislators, winning interest groups—are its insiders. They are the ones who have
cooperated in creating an agency that is beneficial for them.
If we view them as the relevant population, then, the institution can be said to be cooperative and mutually beneficial.
This perspective identifies an important sense in which
bureaucracies are structures of cooperation. Yet it fails to
recognize what is truly fundamental about them: that they
are created through a process of collective choice in which
the victorious insiders get to impose their institutional
creations on society as a whole. The cooperative agreement that they reach among themselves is not just an
agreement that applies to them and governs their own
behavior. It is an agreement that applies to everyone and
governs everyone’s behavior. This being so, defining the
institution in terms of the agreement among insiders ignores
the fact that, once the agreement becomes law, everyone
must follow its rules. They can’t walk away.
There are other confusions as well. Consider what happens when we try to explain a public agency’s stability.
The new economics would have us focus on the overarching agreement among the firm’s insiders and on whether
they have incentives not to defect from the deal. But in
politics this doesn’t make much sense. Once an agency is
created, it becomes a legal entity in its own right, and its
survival and structure are protected by democratic rules of
the game. In the American system, for instance, the policymaking process is filled with veto points, making new
legislation difficult to achieve and blocking relatively easy.
The upshot is that, while a strong coalition may have been
necessary to create the agency, protecting it from formal
change is much easier—and can be carried out by a weaker
coalition, a different coalition, or by ad hoc voting partners who come to the agency’s aid in time of need. Thus
the stability of the agency itself is not contingent upon
maintaining the original agreement or preventing members from defecting from the enacting coalition. The only
part of the agreement that needs to live on is the agency,
which can live forever as long as no new legislation is
In the end, whether a political institution is considered
cooperative and mutually beneficial, as well as how we
want to think about its stability, depends on what we
mean by “institution” and which actors we count as the
relevant population. These are not matters of objective
truth, but matters of analytical choice. The argument I
presented earlier, that domestically created political institutions are inherently coercive, is also not a straightforward matter of truth. It was founded on a conceptual
choice, which I left ambiguous: I was looking at institutions and their relevant populations in the broader sense
just outlined, not in the narrower sense that a businessbased application of the new economics seems to imply.
The claims I made were correct, given my implicit definitions. But a new economics claim that political institutions are cooperative and mutually beneficial is also correct,
based on alternative interpretations of those same terms.
While there can be no right way to define our concepts,
we do need to be clear about them, and thus clear about
what we are saying. When we are, it turns out that both
power and cooperation play essential roles in explaining
how public agencies emerge from democratic politics, how
they get designed, and what their consequences are.
I want to close by returning to the ambiguity at the
heart of all principal-agent relationships: the question of
whether, in a relationship of cooperation and mutual benefit, principals and agents might still be thought of as
exercising power over one another. In the discussion above,
I ignored this ambiguity to avoid complicating a basic
point that needed to be clarified: that cooperation occurs
among insiders, who use their cooperation to exercise power
over others. This point is relatively easy to drive home,
because the kind of power involved makes someone worse
off. When we talk about power within a principal-agent
relationship, however, we no longer have this advantage,
because both the principal and the agent come out ahead.
If power is being exercised, it is more difficult to recognize
and more difficult to distinguish from cooperation.
The usual interpretation of the bureaucratic theories
we just considered is that they are theories of political
control—theories, that is, of how the legislature controls
the bureaucracy. Indeed, the McCubbins, Noll, and Weingast argument is a major component of what is often called
the congressional dominance theory.31 It would be easy to
infer, based on the language employed, that these must be
theories of power. Yet this is true only in a superficial
sense. For if we take their analytic frameworks seriously,
the power presumed to be exercised by the legislature over
the bureaucracy is embedded in relationships that are cooperative and mutually beneficial, and the explanation of
bureaucratic structure is rooted in cooperationist theory.
These are theories of cooperation that talk the language of
power, but without recognizing or dealing with the key
ambiguity involved.32
I will revisit this principal-agent ambiguity in a later
section. For now, I simply want to observe that if we can
find a way to think clearly about power within principalagent relationships, and if we decide that power is being
exercised, then cooperation among the insiders actually has
a power dimension to it. This being so, a theory of institutions would need to recognize a key role for power not
simply in the efforts of insiders to impose their institutional creations on everyone else, but also in their efforts
to arrive at agreements among themselves.
Power and Institutions in the
State of Nature
If power is essential to an understanding of institutions in
orderly, rule-governed contexts, what about contexts that
lack an overarching set of constitutional rules—because
the rules do not exist, say, or because they are vague or in
transition or the subject of struggle?
In these sorts of anarchic settings, public authority and
government do not exist, and they cannot be used by
some groups to impose their will on others. On the surface, this might seem to brighten the prospects for cooperation, and it is tempting to make parallels to the state of
nature that economists often assume: a marketplace in
which autonomous actors are free to make choices and
enter into agreements as they see fit. Given such a scenario, it might seem that any agreements would be cooperative and mutually beneficial
But the economists’ state of nature implicitly assumes
an overarching system of law that guarantees property rights
and enforces contracts. The existence of such a system
obviously reduces the likelihood of theft and violence,
promotes social order, and enhances cooperation and
June 2005 | Vol. 3/No. 2 221
Power and Political Institutions
exchange. It also violates what we mean by a state of nature,
for its actors are playing by rules imposed and enforced
from above.
What happens when there aren’t any rules? The answer
is that social actors are plunged into a Hobbesian world in
which people are nominally free to make their own decisions and enter into cooperative arrangements—but everyone is also vulnerable to predation by everyone else, and
the weak are particularly vulnerable to predation by the
powerful. They are free to be robbed, free to be murdered,
free to be enslaved
The absence of government cuts both ways, then. It
removes public authority from the political equation, and
thus eliminates the immediate means by which the winners impose new institutions on the losers in domestic
politics. Yet it also removes the framework of rules that
can guarantee order in society, protect property rights and
contracts, and promote trade and cooperation. And in
eliminating such rules, it creates opportunities for the exercise of other types of power that do not depend on public
authority for their force.
The rise and development of national institutions
In their attempts to explain the origin of political institutions, rational choice theorists often begin with a state of
nature—which is sometimes Hobbesian and sometimes
not—and ask about the prospects for cooperation. How
can self-interested individuals overcome their collective
action problems and all the dangers of the state of nature
to arrive at basic rules for the conduct of their affairs? 33
Until the new economics burst on the scene, the accepted
answers were essentially negative. Hobbes, of course, had
argued that the solution was an all-powerful Leviathan.
And Olson had argued that rational individuals would
usually not cooperate in pursuit of common interests, and
that selective incentives or coercion would typically be
required to get them to organize.34 (Even then, they would
not really be cooperating.)
With the new economics, the pendulum swung hard the
other way. Theories of repeated games, whose technology
was just becoming available, showed that the prospects for
cooperation are much brighter when people interact with
one another again and again over time, and pointed toward
a variety of factors—the strategies of the players, the “shadow
of the future,” reputations, the ability to commit, and so
on—that determined whether cooperation would occur.35
The rise of transaction cost economics and agency theory,
which linked cooperation to formal institutions, was an integral part of all this. Both took advantage of the same technology, and their cooperationist logic reinforced the same
themes. Before long, cooperation was the basis for a new
theory of political institutions.
As the theory has grown over the years and been applied
to a range of institutional topics, some of the most influ222
Perspectives on Politics
ential work has dealt with how the fundamentals of
democracy emerge out of state-of-nature-like contexts in
which rules of governance are absent, problematic, or in
flux. A notable example is a widely cited article by Douglass North and Barry Weingast on the rise of democracy
in seventeenth-century England.36
Their account takes the following form. The English
kings needed money for their military campaigns (and
other things) but had difficulty raising funds. The problem was that, however solemn their promises to repay
loans from financial elites, their own sovereignty allowed
them to renege on any deals—so their promises were not
credible, and fund-raising deals that could have been mutually beneficial often did not materialize. In effect, the
kings were too powerful for their own good, and they
were suffering the consequences. As were financial elites.
There was, however, an institutional solution to their
dilemma. The solution was to “tie the king’s hands” by
devising a new system of governance that transferred significant legal powers to parliament and an independent
judiciary. This dilution of monarchical power was good
for kings because they could now raise money by making
credible promises to repay loans. And it was good for the
moneyed interests (represented in parliament) because
they could now make loans, be repaid, and have their
property rights protected. The institutional solution—
the basic framework of democracy—was thus cooperative and mutually beneficial, and it was stable because
neither side had an incentive to defect.37
The notion that democratic institutions arise as cooperative solutions to collective action problems can be found
in other influential works as well. In his study of transitions to democracy in Eastern Europe and Latin America,
for example, Adam Przeworski argues that democracies
emerge when opposing groups see elections as giving them
a fair chance of competing for office, and when they believe
that—even if they stand to lose on occasion—they can
still advance their own interests over time.38 When these
conditions are met, the groups can agree to abide by a set
of democratic rules. Democracies are thus self-enforcing
structures of cooperation and mutual benefit.
But this begs an important question: who are the insiders for whom the agreement is cooperative and mutually
beneficial? In Przeworski’s case, the insiders are the two
opposing groups, and his analysis shows that, under certain circumstances, they can arrive at a solution that involves
elections. Yet in any real-world context, these two groups
would not represent the preferences of all citizens, and
there is no guarantee that the unrepresented would be
better off as a result of the deal. They never agreed to it.
What we do know is that two groups powerful enough to
be threats to one another, and probably to national peace
and stability, have forged an agreement that is imposed on
everyone else. It is cooperative and mutually beneficial for
them, but not necessarily for others.
In North and Weingast’s argument, the situation is more
involved. As I have told their story—consistent with the
theoretical lesson usually associated with it—the insiders
would appear to be a select group of elites, namely, the
king and the moneyed class. If so, it would be their agreement. The new democratic institutions would be cooperative and mutually beneficial for them, but not necessarily
for ordinary people, who were not part of the deal. But
the story that North and Weingast actually tell is more
complicated. For although tying the king’s hands proves
to be a good thing for monarchs over the long haul, the
monarchs themselves did not see it that way ex ante. They
fervently resisted having their hands tied, and only violence and revolution settled the issue. Democratic institutions had to be forced on the monarchy. The rise of British
democracy had at least as much to do with power as with
cooperation—but this is nowhere reflected in the theoretical lesson we are supposed to take away from the analysis.
This same literature on the rise of the state also advances
an important companion theme. The idea is that democratic institutions promote economic growth, that economic growth is good for everyone, and that this makes
democracy attractive to those who choose institutions.
The connection between institutions and economic
growth has been explored most influentially by North.39
In a series of publications that won him a Nobel Prize,
North’s institutional theory departs significantly from neoclassical economics in explaining why some economies
succeed and other do not. The argument is multifaceted,
but its main lesson is simply this: that political institutions have profound effects on economic growth, and if
rulers are able to adopt the right institutions—if they are
able to get property rights right—then the economy will
grow and everyone in society can benefit, including the
North recognizes that rulers usually do not choose this
productive path—in part because it can threaten their
hold on political power—and that they often create institutions that are predatory and socially inefficient instead.
The coercive power of the state, he says, is necessary in
order to impose a good framework of rules that encourage
productive cooperation, but the conundrum is that “if the
state has coercive force, then those who run the state will
use that force in their own interest at the expense of the
rest of the society.” 40 This problem might be mitigated
when the circumstances are right—for example, when leaders have long time horizons and expect to gain from economic growth. Yet history shows that circumstances are
often otherwise.
But while North is unflinching about the downside of
political institutions, this is not what his analysis is really
about. His aim is to understand the connection between
institutions and economic growth, and “the central focus
is on the problem of human cooperation—specifically
the cooperation that permits economies to capture the
gains from trade that were the key to Adam Smith’s Wealth
of Nations.” 41 The theory he seeks to displace is neoclassical economics, and “what has been missing is an
understanding of the nature of human coordination and
cooperation.” 42
Power and predation are not irrelevant to North’s way
of thinking, then, but they are not in the same league with
cooperation. They may not even be of secondary importance. For when arguing how neoclassical economics can
best be modified once cooperation is taken into account,
he points not to issues of power and predation but to
issues of incomplete information and subjective perceptions. “There is nothing the matter with the rational actor
paradigm,” he maintains, “that could not be cured by a
healthy awareness of the complexity of human motivation
and the problems that arise from information processing.
Social scientists would then understand not only why institutions exist, but also how they influence outcomes.” 43
Indeed, in later articles distilling his theoretical views on
the development of institutions, the arguments he lays
out—and the research agenda he goes on to develop—
have nothing to do (directly) with power and predation,
but a lot to do with perceptions, attitudes, culture, and
knowledge, and with bringing cognitive science to bear
on the study of institutions.44
Most of the rational choice literature shows a similar
ambivalence toward power, recognizing its relevance yet
pushing it to the analytic periphery. In particular, there
seems to be widespread agreement among rational choice
theorists that
• the coercive power of the state is often necessary for
enforcing cooperative agreements and creating institutions (contract law, property rights) that promote
• a state powerful enough to use coercion toward such
positive ends can also use it predatorily; and
• this dilemma of state power must somehow be
resolved—for example, by tying the king’s hands—if
cooperative, mutually beneficial outcomes for society
are to be realized.
The role of these insights, however, is typically to provide
a better understanding of cooperation and mutual gain
(and democracy and economic growth), not to shed light
on the pervasive and often troubling ways that power can
shape political institutions, and not to promote a broader
theory that brings cooperation and power into balance.45
A relatively small number of rational choice scholars
have given power much more serious attention, They
have done so in different ways, however, and their separate attempts—while often laudable in themselves—have
not produced much coherence in the aggregate. Some
have emphasized power in the context of empirical work,
where attention centers mainly on the details of particular cases.46 Others have offered theoretical arguments about
June 2005 | Vol. 3/No. 2 223
Power and Political Institutions
particular aspects of power, but without launching a more
generalized attack on mainstream theory.47
A few, however, have attempted to develop broader arguments about the need for integrating power into the theory
of institutions. I put myself in this category,48 but here I
want to focus on a small group of scholars—Robert Bates,
Margaret Levi, Jack Knight, and Mancur Olson—who
write about how the state and its institutions develop from
more primitive beginnings.49
Bates has the most in common with North. He devotes
considerable attention to power and its often destructive
effects, but his ultimate concern is with how power is used
to promote cooperation, mutual gain, and the institutions
that make them possible. This is the thrust of his seminal
work on Africa, in which he shows how Kenya’s leaders
used their power to get property rights right, with beneficial results.50 It is also the theme of his more recent Prosperity and Violence, which shows how “violence becomes
domesticated . . . and is used not to predate or to destroy
but rather to strengthen the productive forces of society.” 51 Even so, his larger theme is that power and cooperation are inextricably intertwined, and that institutions
can not be understood unless this is recognized.
Levi’s departure from North is more striking. Her focus
is not on the positive, but rather on the broader consequences that power can have for political institutions and
citizens. From the beginning of the new institutionalism,
she has been the strongest proponent of a power-based
theory, arguing that political institutions are shaped by
power asymmetries and that they protect and promote the
interests of the powerful.52 Cooperation is essential too,
she makes clear, but it is bound up with the exercise of
power. In Of Rule and Revenue, for example, a central
theme is that rulers are typically predatory but can extract
resources from their citizens most efficiently when the latter engage in “quasi-voluntary compliance,” which may
require rulers to adopt institutions with a degree of public
legitimacy.53 Another theme is that cooperation is a key
means by which rulers ally themselves with other elites so
that all can extract resources most efficiently from the
larger population. The insiders, in other words, cooperate
to plunder those who are not part of the deal.
Levi and Bates push the envelope by bringing power to
center stage. But neither takes on the more fundamental
task of challenging the analytics of rational choice. Knight
was the first to do this in a systematic way.54 Beginning
with the basics of individual choice and strategic interaction, he argues that institutions are “not best explained
as a Pareto-superior response to collective goals or benefits, but, rather, as a by-product of conflicts over distributional gains,” 55 and he aims to show how a theory of
institutions can be rooted in bargaining relationships and
the power asymmetries that shape their outcomes.
Knight’s analysis is admirably ambitious, and it succeeds in calling attention to fundamentals. But it does not
Perspectives on Politics
readily serve as a springboard for change. One reason is
that it focuses on informal social institutions and doesn’t
devote much attention to the formal political institutions
that make up the state. More important, its bargaining
analysis almost always turns out to be an analysis of how
rational individuals struggle to distribute gains—with no
one losing—rather than an analysis of redistribution (or
coercion or violence) in which some individuals gain and
others lose. Particularly for this latter reason, it remains
ambiguous what kinds of analytic changes Knight is really
proposing, and whether a bargaining framework—which
rational choice theorists use to understand the voluntary
division of gains, not the imposition of losses on involuntary victims—is appropriate for the job.
Knight, Levi, and Bates are all political scientists, and
this should come as little surprise. Power has long been
central to the way political scientists think about politics,
and it is only natural that, when rational choice rose to
prominence, some of them would try to fit power into a
rational choice framework. It is not at all natural for economists to do such a thing. Their theory and research are
tightly constrained by the analytics of voluntary exchange,
and even when they turn their attention toward politics
they tend to either avoid the subject of power entirely or
to explore it in a limited way that fits their framework of
This being so, it is significant that perhaps the most
provocative argument for a power-based theory of the
state—Olson’s Power and Prosperity—comes from one of
the world’s most prominent economists and is clearly
intended to influence the thinking of other economists.57
Published two years after Olson’s untimely death, this is a
work he had been developing for years and had yet to
perfect. Partly for this reason, I suspect, it is not as tightly
argued as it might have been.58 Even so, Olson was a
creative and iconoclastic thinker, and this work is a bold
attempt to make power a central concern of economic
For our purposes, Olson makes two noteworthy contributions here. The first is his power-based theory of the
state, which elaborates ideas developed in his earlier work.59
A major theme is that even autocratic leaders sometimes
have incentives to use their power for social good. But
Olson puts the spotlight on coercion, corruption, inefficiency, and predation—viewing them as the norm and
rightly at the center of theory. He stands out, moreover,
because he builds his theory on simple and insightful conceptual distinctions—between encompassing and special
interests, between roving and stationary bandits—that allow
for a logical analysis that is focused, simple, and potentially far-reaching. Unfortunately, he also stands out by
making little constructive use of the new economics, aside
from his own work on collective action; and as a result,
the concerns that play key roles in the rest of the literature—
about credible commitments, the tying of hands, and the
like—are not well integrated into his analysis, which is
almost purely his own. He compounds the problem by
ignoring Bates, Levi, Knight, and others, and indeed dismissing all work on power but his own as “only a jumble
of ad hoc arguments and some fancy jargon.” 60
His second contribution, at any rate, is potentially more
important than the theory he develops: he launches an
attack on voluntarism itself, arguing that an adequate theory
of the state must get beyond the usual bargaining framework and develop a logic of coercion and force. He devotes
an entire chapter—destined, he thinks, to be the “most
interesting part of the book” to economists 61 —to a critique of voluntarist theories of government. The content
of his critique leaves much to be desired, for it focuses on
the Coasian claims of the Chicago School,62 and it speaks
with confusion about—but mainly ignores—the new economics and its cooperationist theories of institutions, which
are his real competition here. So this part of his analysis
is an opportunity missed. Even so, what he tries to do is
exactly what the field needs.
The international system
The international system is the paradigmatic state of nature,
an anarchy in which there is no overarching authority,
property rights are ultimately unprotected, and every nation
is out for itself. While various schools of thought organize
debate within the field, there is widespread agreement on
the importance of power; and it is the realist school, which
portrays the international system in stark terms of power
and self-interest, that is the benchmark theory against which
all others try to establish their validity and earn attention
and support.
The rise of the new economics has presented realism with
a major challenge. The pioneering work comes from Robert Keohane, who argues that international institutions are
cooperative means by which nation-states can overcome their
collective action problems to realize gains from trade.63 He
agrees that powerful nations like the United States create
institutions to promote their own interests. But he also argues
that other nations only join these institutions because they
benefit from them, and he emphasizes that the structural
means by which institutions bring about cooperation—
chiefly by providing information, rules, and principles that
reduce transaction costs, enhance decentralized enforcement, and increase interaction—make it easier for members to pursue shared interests and reap mutual gains.
Keohane’s work has stimulated a flood of scholarship
on the prospects for international cooperation, and in
the process the new economics has profoundly shaped
the intellectual perspective of the field. Whether the subject is international trade or war and peace, and however
much power enters the equation, the language of institutional analysis is one of credible commitments, selfenforcing agreements, and cooperation for mutual benefit.
A mainstream example is Milner’s Interests, Institutions,
and Information, which explores the impacts of domestic
politics on international cooperation.64 A less obvious
(but more telling) example is Martin’s influential study
of economic sanctions, Coercive Cooperation. Martin clearly
acknowledges the coercive role of sanctions and threats,
but the purpose of her book is to “examine the conditions under which states cooperate to impose economic
sanctions,” 65 and its “major finding . . . is that considerations of credibility provide the most explanatory leverage.” 66 International institutions enter the picture as
“useful commitment mechanisms” and are “positively associated with the level of cooperation achieved.” 67
Even realists, who tend to discount institutions as epiphenomena of power, often find themselves speaking the
same language—and singing the same tune. In a widely
cited article, for instance, Stephen Krasner argues that the
institutional system is driven by power; and he points the
way toward a broader theory rooted in the new economics
that can explain how power is used to promote national
interests.68 His accompanying analysis, however, shows
how nations faced with coordination problems (in the
area of telecommunications policy) can move from inefficient outcomes to the Pareto frontier, and how the more
powerful nations have disproportionate influence over
which point on the frontier is chosen. The role of power,
then, simply determines how the gains from cooperation
are divided up. All of the cooperating nations are made
better off in the process. There are no losers.
Krasner is not alone in arguing the importance of power,
but then relying on a theory of cooperation that directs
attention away from all the bad things that power can do
(at least to the nations being victimized by it). For example, a recent consortium of researchers involved in what
they call the Rational Design Project is concerned with
mapping out and explaining the institutional structure of
the international system, and they explicitly acknowledge
the need for an expanded theoretical framework that takes
power into account. But even for them, power mainly has
to with distribution problems, coordination problems, and
choices among multiple equilibria, not with nations being
forced to do things that are against their interests. Indeed,
it is one of their premises that “over the long haul states
gain by participating in specific institutions—or else they
will abandon them.” 69
The logic of voluntarism is also central to the literature
on international bargaining. Even though this work is often
about war and about how aspects of power can affect bargaining outcomes, the basic framework is one of cooperation and mutual gain. In a prominent summary of the
bargaining literature, Robert Powell puts it this way:
Bargaining is about deciding how to divide the gains from joint
action. That is, coordinated action frequently increases the size
of the “pie”—for example, the exchange of goods often creates
gains from trade; revising the territorial status quo peacefully
June 2005 | Vol. 3/No. 2 225
Power and Political Institutions
rather than through the costly use of force means that the resources
that would have been destroyed by fighting can now be divided.
The existence of potential gains from acting jointly creates an
incentive to cooperate.70
A recent book by Lloyd Gruber stands apart from the
rest. Gruber takes the mainstream to task for building a
cooperationist theory of international institutions that
largely ignores power, and he launches a challenge that is
truly fundamental: arguing that nations sometimes join
international institutions even when they expect to be worse
off for doing so. What looks like cooperation often hides
the underlying exercise of power.71
Gruber’s argument is based on an insightful idea that is
both simple and correct. Some nations, he notes, are so
important in a given sphere of activity—as nations with
large economies are in international trade—that when one
or more of them decide to “go it alone” in creating a
multinational institution, other nations may eventually
choose to join even if they never wanted such an institution in the first place and expect to be worse off. This may
seem inconsistent with rational behavior, but it actually
isn’t. For the key issue is: worse off compared to what?
This is where the novel insight comes in. When the
prime movers band together to form an institution—say,
to promote free trade and the coordination of their economic policies—nations that oppose such a development
are faced with a fait accompli. The original status quo has
been taken away from them, and the new reality is that
this new institution does exist. They can either join or be
left out in the cold—but they can’t go back to the way
things were. If they now decide that joining makes them
better off than not joining, they will voluntarily become
members. But they expect to be worse off than if the
institution had never existed in the first place.
Gruber marshals evidence for his argument by studying
NAFTA and the European Monetary System. He shows
that in both cases there were prime movers (the United
States and Canada for NAFTA, Germany and France for
the EMS) that engineered a new status quo, as well as
nations that preferred not to have any institution at all
(Mexico for NAFTA, Italy and Britain for the EMS) but
joined nonetheless once the original status quo was taken
away from them. Other scholars may or may not agree
with Gruber’s empirical conclusions, as it is difficult to
calculate each nation’s expected benefits under alternative
scenarios. Even so, his argument is provocatively subversive. For it not only suggests how power can worm its way
into the very foundations of “voluntary” choice, but also
asserts that institutions may not be cooperative and mutually beneficial even for the insiders that willingly join them.
If power is fundamental to institutions, we need to think
about it as rigorously as we now think about cooperation,
and we need to integrate both into a common rational
Perspectives on Politics
choice framework. While it may sound naïve to say so, my
own view is that this is not exceedingly difficult to do, at
least from an analytical standpoint. The difficulty lies in
overcoming mind-sets that have prevailed among economists and political scientists for decades.
Economists aren’t very interested in studying power. It
is true that their theories of voluntary exchange point them
in other directions; but economists created these theories,
and they have always been free to modify, reinterpret, or
expand them to allow for a more far-reaching analysis of
power. They haven’t done so because they haven’t wanted
to, not because there is something inherent to economics
that prevents them.72 Political scientists are interested in
studying power, as it is central to much of what they want
to explain. But the community power debates of the 1960s,
combined with the large and contentious philosophical
literature on power, seem to have convinced much of the
discipline that power can not be defined or studied rigorously.73 And when rational choice took the field by storm,
its theories of voluntary choice and cooperation reinforced
these jaded notions.
So how can power be made more fundamental to rational choice? I don’t presume to have a perfect solution up
my sleeve. Nor do I mean to trivialize the complex issues
that the concept of power ultimately raises. But in the few
pages remaining, I do want to set out some simple ideas
about how we might proceed in putting power to more
productive use.
A good first step is to recognize that the definitional
problems surrounding the concept do not have to be
entirely resolved for theoretical progress to be made. After
all, there is still no agreement on what an institution is.
Some scholars see institutions as rules of the game, others
see them as formal organizations, others as patterned behavior, still others as “myths” and ideational structures.74 But
these differences haven’t prevented the theory of political
institutions from making tremendous progress over the
last twenty years. I suspect the same will prove true for
different notions of power. We simply need to move ahead.
We can do this most effectively by focusing first on
power’s most egregious expressions, coercion and force—
precisely as Olson has argued.75 It might seem that these
aspects of power are flatly inconsistent with voluntary
choice and thus outside the framework entirely. How, then,
can rational choice deal with them? The answer, perhaps
surprisingly, is that it already does—but in a confusing
way. If this confusion can be cleared up, there is no reason
that these aspects of power can not become an integral
part of rational choice theory. No technical innovations
are really required.76
To see why, consider a stylized situation in which a
criminal presents his victim with a classic choice: “your
money or your life.” An economist might say that this is
just another case of voluntary exchange. If the victim
chooses to hand over his wallet, he is simply acting on his
preferences and making a rational choice. He would rather
lose his money than his life. There is no need to introduce
power into the analysis, because voluntary exchange already
explains the outcome. The common sense response, however, is that the exchange between criminal and victim is
obviously not voluntary. The criminal is using threats of
violence, and he is coercing the victim to give up his money
against his will. The economist can rejoin, though, that it
actually is the victim’s will to give up the money, and
common sense is thus thrown into doubt by a semantic
dispute over what the victim’s “will” really is.
There is no right or wrong here. Whether the exchange
is voluntary or coercive depends on how you look at it.
There is, however, an analytical means of cutting through
the confusion. This is to recognize that the victim’s will is
being expressed relative to a specific agenda of alternatives. And the criminal is now controlling the agenda.
Before the criminal walks up, the victim lives peacefully
with his wallet in his own pocket and his life not subject
to threat. This is the original status quo. When the criminal arrives on the scene, however, the victim is presented
with two alternatives—give up his money or give up his
life—and they compose his entire choice set. He cannot
choose the original status quo, which requires that he be
left alone, because the criminal has taken this alternative
away from him. The victim “voluntarily” gives up his wallet when faced with the power-constrained choice set,
because he is better off giving up his money than getting
killed. But he is worse off than he would be under the
original status quo—which he can no longer have, thanks
to the criminal’s exercise of agenda power.
This is the kind of power Gruber is talking about.77 It
is a form of agenda control in which one actor denies the
status quo to others in order to steer them into accepting
alternatives more to his liking. Most instances of institutional power that we discussed earlier are of this type as
well. For when legislators and interest groups impose institutions on the broader population, or when rulers adopt
predatory institutions to extract resources from citizens,
these insiders are revoking the original status quo and
giving outsiders two choices: play by the new rules or be
punished by the police powers of the state. The outsiders
cannot go back to the way things were. They must now
choose from the power-constrained choice set and from
that alone. They may (and probably will) choose to “cooperate.” But they may also be worse off than before the
institutions were imposed.
A related type of agenda control operates to protect the
status quo rather than change it. This can occur, for example, when actor A uses his agenda power not to deny actor
B the original status quo, but rather to deny him other
alternatives that he would actually find preferable—
alternatives that A wants to prevent being adopted. This is
the kind of power that Peter Bachrach and Morton S.
Baratz highlight in their classic critique of pluralism, in
which they argue that political elites often maintain their
positions not by winning conflicts against opponents, but
by using agenda control to keep conflictual alternatives off
the table entirely.78
This kind of power has a lot to do with the stability of
political institutions. Recall, for example, that public
bureaucracies can usually survive (regardless of what happens to their enacting coalitions) as long as no legislation
is passed to kill them. Supporters who play pivotal roles in
the policy-making process, then, can use agenda control—
even if they are a distinct minority—to keep reform proposals off the table, and thus to prevent change from even
coming up for a vote.
Both types of agenda control help to clear up confusion
and make power more analytically tractable.79 In the first
case, A exercises power by denying B the original status
quo and constraining him to choose an alternative he otherwise would not prefer. In the second, A exercises power by
denying B attractive alternatives to the status quo and
preventing him from adopting changes he otherwise would
prefer. Note that in both cases B is making voluntary
choices within the power-constrained choice set—but at
the same time he may be a victim of coercion or force,
because A is setting limits on his options and engineering
his choices. B is better off by reference to the constrained
choice set—but at the same time he may be worse off by
reference to the alternatives denied him. He is cooperating and reaping gains from trade—but at the same time
he may be a victim of manipulation and even predation.
There is nothing contradictory about these apparently contradictory claims. They are all equally valid descriptions of
the same choice situation, and they can all be recognized
and explored using the logic of rational choice. We simply
need to be clear about our frames of reference.
Even if we are, semantic squabbles are inevitable. The
analytics may lead us to agree, for example, that B is worse
off relative to the original status quo denied him by A; yet
some might call this coercion and some might not, depending on the extent of B’s loss, whether A intended for it to
happen, and other considerations. Given the plasticity of
ordinary language, there is no avoiding these ambiguities.
But the important point is, they don’t matter much. What
matters is that we have an objective basis for saying that B
is worse off—and indeed for measuring the magnitude of
his loss—even in cases when the mainstream explanation
would point to cooperation and mutual gain.
Ironically, coercion and force are the easiest aspects of
power to deal with. This is because they are essentially negative (B is made worse off) and readily distinguished from
cooperation and mutual gain. Other aspects of power are
more challenging because the boundaries are less clear. Suppose we agree that much of what we mean by power has to
do with one actor intentionally shaping the choice-set of
another.80 Then what do we make of an apparently simple
case of positive inducements: a situation, for example, in
June 2005 | Vol. 3/No. 2 227
Power and Political Institutions
which rich nation A gets poor nation B to accept troops on
its territory by paying a large sum of money? The standard
explanation would see this as a voluntary exchange that
makes both nations better off. But is it also an exercise of
power? After all, A influences B’s choices by adding an attractive alternative to B’s choice set, and this allows A to get
what it wants. Other nations, moreover, may find their future
decisions heavily constrained by A’s success in stationing
troops on B’s soil: a spillover effect that is surely what A wants
as well.
Principal-agent relationships give rise to the same sorts
of questions—and it is in this context that the ambiguity
at the heart of these relationships needs to be understood.
As I discussed earlier, if we explain bureaucratic structure
as deriving from the efforts of a legislative principal to
control the behavior of its bureaucratic agent, then the
structure may be characterized as cooperative and mutually beneficial. Yet the legislature is clearly using structure
to constrain the agency from doing what it would otherwise want to do, such as pursuing policies more to its own
liking. And the agency is clearly using its informational
advantage to shape the beliefs and available choices of the
legislature. So while both benefit from the final outcome
relative to some baseline, both are also actively engaged in
controlling the other’s agenda—and they can be construed as making each other worse off relative to other
Generalizing the analysis of power to situations of mutual
gain raises subtle issues, and to address them fully would
require more extensive treatment than I can undertake
here. Fortunately, some of this ground has already been
covered, notably by Randall Bartlett, whose Economics and
Power is a comprehensive attempt to show how these and
other aspects of power can be integrated into economic
theory.81 Bartlett’s perspective—and mine—is that, given
the right frames of reference, there is no contradiction
between mutual gain and the exercise of power, and that
both are often going on at once. Indeed, it is in seeing
them as integral components of the same relationship that
we gain a better, more fully rounded understanding of it.
And a better theory.
I should add, finally, that whether we think of power in
general terms or focus more narrowly on coercion and
force, the exercise of power doesn’t just occur in political
institutions. It also occurs in business firms and throughout the private sector, and is relevant to how these institutions get structured, how they perform, and how people
are affected. Current theory largely ignores this, emphasizing voluntary agreement and implying that all actors
can easily walk away when dissatisfied—which provides a
stark contrast with the public sector. This is a contrast I
have used several times, for heuristic purposes, to drive
home basic theoretical points. But the fact is, severe constraints on choice and high costs of exit are often facts of
life in the private sector too—especially when competi228
Perspectives on Politics
tion is weak and monopoly strong—and the theory needs
to recognize as much. Were it to do so, its rosy view of
business firms would no longer be so rosy.82
The rational choice theory of political institutions has
been extraordinarily productive over the last few decades,
and much of what it reveals about political institutions is
valid and important—namely, that their creation, design,
and consequences have a lot do with the efforts of social
actors to find cooperative solutions to collective action
problems. Yet political institutions are more than just structures of cooperation. They are also structures of power,
and the theory does not tell us much about this. As a
result, we get a one-sided—and overly benign—view of
what political institutions are and what they do.
This problem is not well understood, and indeed is
typically not seen as a problem at all. For there is a widespread sense in the literature that, because power is so
frequently discussed, it is being taken into account and is
just as fundamental to the theory as cooperation. Confusion about these matters is a problem in itself, and is
actually the more serious one—because it not only prevents well conceived movements for change, but also undermines the motivation for any change at all. If a theory that
truly integrates power and cooperation is to be developed,
the key prerequisite is simple clarity.
It might seem that the cooperationist theory would be
at its clearest and most compelling in explaining institutions created under democratic rules of the game. But this
is not the case. As the new economics has been transported from business firms to democratic institutions, the
logic of the analysis has gotten muddled. Key concepts
and components—like what the relevant institutions are
and which actors count as the relevant population—do
not make the transition very well. They get used in different ways across the two sectors, and indeed in various
ways within the public sector itself, and this alters the
meaning of what is actually being argued. Even the most
basic of claims—about cooperation, mutual benefit,
stability—become unclear.
When these issues are untangled, and when familiar
but distracting arguments (about Coasian bargaining,
about the social contract) are dealt with and dismissed, it
turns out that the usual cooperationist explanations are
valid—but only for some of the players and part of the
overall story—and that power is essential to the story
too. In effect, the new economics focuses on the political
insiders: the legislators, interest groups, and bureaucrats
who are the winners of the democratic struggle, and who
use public authority to create and design the bureaucratic institutions that fill out democratic government.
Their relationships are indeed cooperative and mutually
beneficial—for them. But they use their cooperation to
impose institutions on the political losers, and indeed on
everyone else in society, and these outsiders are not part
of the deal. In democratic politics, cooperation and power
are two sides of the same coin: cooperation makes the
exercise of power possible, and the exercise of power often
motivates the cooperation.
To focus on cooperation alone, then, is to miss the
essence of what is going on as democratic institutions are
being created and designed. Much the same can be said
about their stability over time. Once they are set up, they
become legal entities in their own right, protected by the
rules of the game, and they can survive with only periodic
backstopping from much smaller and perhaps very different bands of supporters. The new economics’ focus on the
stability of the original cooperative agreement—and on
whether it is self-enforcing—misconstrues what often
accounts for the survival of political institutions. Usually,
they are stable because of the agenda power of current
supporters, not because the original agreement lives on.
When we turn our attention to the rise of state institutions from more primitive beginnings, or to the rise of
institutions in the international system, it might seem that
the cooperationist theory would be less dominant and
more accommodating to notions of power. And in some
sense it is. The literature is very much concerned with
predation, confiscation, war, and other aspects of power.
Yet all this attention to power has not paid off. Power is
typically just an add-on to the underlying cooperationist
theory, playing a peripheral role that leaves the fundamentals of voluntarism and mutual benefit unchanged. Predation and other downsides of power are acknowledged, but
the focus tends to be on cooperative solutions that l…
Purchase answer to see full

Order your essay today and save 15% with the discount code: VACCINE

Order a unique copy of this paper

550 words
We'll send you the first draft for approval by September 11, 2018 at 10:52 AM
Total price:
Top Academic Writers Ready to Help
with Your Research Proposal