The Inter-jurisdictional Spontaneous Order

In her recent Nobel lecture, Elinor Ostrom talked about the superiority of polycentric over hierarchical governance structures in managing common-pool resources. Among other things, she mentioned Charles Tiebout’s idea of “voting with the feet” and the ability to enter and exit jurisdictions as conducive to good governance of a variety of jointly consumed goods and services.

It is my purpose here to elaborate a little on the relevance of inter-jurisdictional competition, entry, and exit in theories dealing with democracies and markets as spontaneous orders. Consider first an imaginary world where there is only one unitary single-level democracy, and thus no opportunities for individuals to choose one jurisdiction rather than another one. What are the implications of such a world regarding the relationship between democracy and the market order?

If we assume normal procedural democratic rules such as recurring elections to a legislative assembly and majority decision-making within that assembly, we would then face a set of incentives that could be predicted to give rise to a “logic of collective action” that corresponds to Mancur Olson’s: small well-organized interest groups will tend to effect redistributive policies with concentrated benefits and dispersed costs. Over time, such interest groups will multiply at the expense of productive endeavors, representing a redirection of entrepreneurial activity toward the destruction of value and, ultimately, societal gridlock. The inevitable consequence would be a slippery slope toward the socialization of all economic activity. This view—which treats a single democracy as the inescapable reality for its citizens—is not all that different from theories by a substantial number of Public Choice economists. For optimists, the policy implication is to institute severe constitutional constraints that protect property rights against rent-seeking. For pessimists, nothing less than the dissolution of the state will do the trick.

The problem with this line of reasoning is that neither citizenship (de jure membership in a jurisdiction) nor residency (de facto membership) is an inalienable bundle of rights and liabilities. There are multiple jurisdictions. People vote with their feet. Firms vote with their capital goods. As long as there is no inter-jurisdictional organization that enforces the standardization of a specific public policy, individuals and firms retain an element of choice—although the feasibility of different choices can of course be smaller than necessary, since an increase in the spatial extent of a jurisdiction is associated with an increase in relocation costs (relocation costs include not only transportation costs but more importantly cultural transaction costs associated with informal institutions and social networks).

The important point is that the inter-jurisdictional spontaneous order guarantees that democracy can never become all-encompassing in an open system, since wealth-destroying policy excesses will tend to result in a net loss of productive individuals and firms to other jurisdictions, and thus to an erosion of the jurisdictional tax base. Some economic historians (for example Eric Jones) have argued that it was the fragmentation of medieval Europe that bestowed the key developmental advantage on that continent as compared with medieval—and centralized—China. The inter-jurisdictional order does thus not ultimately depend on a multiplicity of democracies, but on a multiplicity of states that may be authoritarian if they allow their citizens to leave (so Singapore is part of the contemporary inter-jurisdictional order but North Korea is not).

It is helpful in this context to think in terms of ideal types. The ideal inter-jurisdictional order would allow freedom of movement between jurisdictions for people, capital, goods, and services; there would be no top-down inter-governmental standardization of regulations, taxes, or government spending. It is the logic of the European Economic Area rather than that of the European Union (Norway, Iceland, and Liechtenstein are members of the EEA but not of the EU and are thus order-promoting jurisdictions). The systemic resource will ultimately be some measure of capital: a jurisdiction is successful if it attracts a net gain (inflow) of human and material capital. This would also imply that policies that restrict the information content of inter-jurisdictional capital flows are destructive of the order: an unrestricted flow of people and capital goods implies that jurisdictional decision-makers receive the best possible information about how attractive a bundle of institutions (the legal system, particular policies etc.) is to its consumers (individuals and firms). We should however note that the best possible information does not equal perfect information: formal institutions are always bundled together with apolitical location factors such as language, customs, and climate.