Scaling Up, International Trade, and Demand for Government

Leeson makes three points in response to my critique.

  1. In theory, self-enforcing agreements can indeed scale up, if they rely not on punishment in repeated play, but on signaling, whereby “honest” types separate themselves from “dishonest” types.
  2. The large volume of international trade is evidence that self-enforcement without government is in fact possible.
  3. The correlation between income per head and size of government arises from the fact that more prosperous countries can afford to pay the higher costs that larger governments impose.

Let me say a few words about each of these points.

1. Although I have not studied the papers that Leeson refers to, I think I understand the theory that Leeson has in mind. I do not agree that this line of reasoning evades the scaling up problem. Successful signaling relies on separating, rather than pooling, equilibria. In other words, “honest” traders have to incur costs that “dishonest” traders would find too onerous to bear in order to effectively signal their type. That means some participants have to be shut out of the benefit from trade in order for the remaining to benefit.

You might say that this is just as it should be: if there are honest and dishonest traders, it is only the former that deserve the benefits of economic exchange. But as soon as we put it this way, we understand what is wrong with the signaling argument in this context. People are not born honest or dishonest: enforcement problems arise in practice not because honesty is an attribute of some individuals and not of others, but because all individuals have the incentive to behave opportunistically when circumstances allow them to do so. Relying on signaling in these settings, even when it works, leaves many wasted opportunities for economic exchange.

2. On international trade, I had made the point that much of it still relied on the shadow of the state. What I meant by that is not the esoteric New York Convention at all. What I was thinking of is that traders can still sue each other in their respective legal jurisdictions, or in fact in third-country jurisdictions. Arbitration decisions too are typically enforceable in some legal jurisdiction. What keeps traders honest is not simply the fear that they will be excluded from future commerce, but also that their assets can be taken away through legal judgments.

The other point I had made is that because these legal and quasi-legal arrangements for contract enforcement work more poorly in the international arena than they do domestically, international exchanges are still subject to much higher transaction costs. Anderson and van Wincoop have estimated these transaction costs to be around 40 percent in ad valorem terms. And indeed there is a large literature on international trade that talks about “missing trade” and “border effects.” Trade volumes may be high, but not anywhere near as high as they would be without the transaction costs imposed by jurisdictional discontinuities at the national border.

3. On the correlation between size of government and level of incomes, I am happy to accept that there may be some reverse causation. But what exactly does that mean? It means that people in rich countries demand more government! Public services are a luxury good, to put it in economists’ language. Why would that be, if government came only with rent-seeking, corruption, and other costs?

I am also happy to accept that more government is not necessarily better government, although I would not rely on the Heritage Foundation index to make that point. There are some big governments that do a lot of bad things (North Korea) and some big governments that do mostly good things (Sweden). I just have a hard time with the doctrinaire view that identifies government with only the former model.

Also from This Issue

Lead Essay

  • Anarchy Unbound, or: Why Self-Governance Works Better than You Think by Peter T. Leeson

    Everybody seems to know we need government … But pirates didn’t! How did they manage without the state? In this issue’s thought-provoking lead essay, Peter T. Leeson, the BB&T Professor for the Study of Capitalism at George Mason University, explores what pirate “constitutions,” credit institutions among 19th century African bandit traders, and the well-being of Somalians after the collapse of the Somalian state have to tell us about the possibility of practical anarchy. It works better than you think, Leeson concludes. “As long as there are unrealized gains to realize, people will find ways to realize them” – state or no state.

Response Essays

  • Anarchy Bound: Why Self-Government Is Less Widespread than It Should Be by Bruce L. Benson

    Bruce L. Benson, author of The Enterprise of Law: Justice Without the State, argues Peter Leeson’s defense of anarchy is too moderate. Governments in developed nations, Benson maintains, are not better than ordered anarchy. Drawing on Franz Oppenheimer’s classic account of the state as a protection racket, Benson argues that the state only seems necessary because it offers “solutions” to problems the state itself creates. Benson claims that even well-constrained states are essentially parasitic, leading him to conclude that “even when a relatively ‘good’ government exists, there still is way too much government and not nearly enough anarchy.”

  • The Limits of Self-Enforcing Agreements by Dani Rodrik

    Harvard economist Dani Rodrik is willing to accept a number of steps in Peter Leeson’s argument for anarchy, “but [Leeson’s] bottom line … represents a huge leap of faith.” Citing the work of several important thinkers, Rodrik argues that “the problem with self-enforcing agreements is that they do not scale up.” Both theory and data show that complex, well-functioning social and economic systems require the enforcement of rules by government. “Those societies in which markets work best are the ones where the reach of the state is longer, not shorter.”

  • Anarchy From a Policy Perspective by Randall G. Holcombe

    Florida State University economist Randall Holcombe argues that even if Leeson is right about anarchy, it doesn’t much matter. “Regardless of its merits,” Holcombe writes, “anarchy has no prospect as an actual policy option.” The bottom line is that government is popular in developed nations. Furthermore, anarchy may not be a “stable equilibrium,” in which case it might “coalesce into governments … potentially more oppressive and more destructive than those we see in prosperous areas today.” According to Holcombe, if we’re going to get a government anyway, the best approach to policy is to “make it smaller, less intrusive, and more libertarian,” not to make it go away.

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