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[Elster, J. and Roemer J. (1993), A Third Way?, East European Constitutional Review 2 (1):38-75] [This text was found on the Internet. I do not hink it is the whole text and there are no page numbers] A Third Way? Constitutional issues in market socialism by John Roemer and Jon Elster The separation of powers is a central issue in constitutional thought. The separation of executive and legislative powers, discussed elsewhere in this issue, is a prominent case. An independent judiciary is another. In a broader sense, the independence of the central bank and of the state-owned media can also be seen in this perspective. The argument for separation of powers rests both on positive and negative considerations. On the one hand, the separation of powers is a form of division of labor that enhances the efficiency of the political system. On the other, it serves to prevent total usurpation of power by any one state agency. One special problem with separation of powers - or lack of separation - plagues a number of political systems. It may be briefly characterized as the need to separate the instruments of economic policy from the tools of social policy. In theory, and in the long run, both economy and society will benefit if policies are oriented towards economic efficiency, thus maximizing the revenues that can be used to alleviate problems of unemployment and poverty. In practice, because policy- makers are often influenced by short-term considerations, there is a temptation to make economic choices on the basis of their immediate social consequences. To maintain employment, governments all over the world support declining industries and inefficient firms, blunting the edge of competition. The bailout of Chrysler in United States and the subsidization of the mining industry in Britain are two prominent examples from the West. With regard to the planned Communist economies, Janos Kornai coined the phrase "soft budget constraint" to describe the position of managers who know that banks or local governments have a strong vested interest in keeping their firms afloat - and the political clout to do so. The results in Eastern Europe, as we know, were disastrous. To be more precise, the economic crisis of the Communist countries was due largely to their failure to solve various principal-agent problems. A principal-agent problem arises when one actor or group relies on another to carry out orders or provide information, but where the two have potentially conflicting interests. This sort of problem arose as the inevitable consequence of three characteristics of the Communist systems: the non-market, administrative allocation of resources, the non-competitive nature of politics, and direct control of firms by political authorities. In many parts of Eastern Europe, it is taken for granted that the only way to overcome these problems is to move towards a regime of private property and untrammeled market competition. A look around the world, however, suggests that other institutional arrangements might also be used to overcome principal-agent problems. In South Korea, for instance, the active industrial policy of the state succeeds without undermining the credibility of the bankruptcy threat. In this brief article we explore the idea that a revived form of market socialism with suitable constitutional (or quasi-constitutional) constraints might also overcome the incentive problems mentioned above. In market-socialist models of the 1990s labor and virtually all other private goods are allocated in competitive markets. Various mechanisms are proposed whereby profits of firms, whose managers are supposed to maximize profits, are distributed in a more or less equal fashion to the population. Yet if profits are equally distributed, no individual citizen will have sufficient incentive to expend the costs to monitor the management of a firm. A proposal made by Pranab Bardhan and John Roemer is that banks, themselves publicly owned, would monitor firms, much as they do in Japan and, to a lesser extent, in Germany. Each bank would be responsible for its group (in Japan, keiretsu) of firms. Financing of investment would come largely from bank loans; a bank would be responsible for putting together loan consortia for the firms in its group. According to the blueprint, banks would monitor firms carefully, because by doing so the bank would acquire the reputation that firms in its group pay back their loans, and this would facilitate its job as the organizer of loan consortia. In this scheme, banks are intended to constitute a hard layer between the state apparatus and firms, rendering firms economically accountable rather than accountable to politicians who, in general, would have an interest in promoting inefficient policies. The question that has to be answered is: What will guarantee that publicly owned banks will do their job, that is, monitor firm management and take actions to maximize the long-run expected profits of firms? Here are some possibilities. (1) The stock of the bank should be held not only by the government, but by pension funds and insurance companies, which have an interest in the bank's profits. (2) Representatives of the public (as distinct from representatives of pension funds and other institutional shareholders) should be appointed to the bank's board of directors to represent various interest groups - workers, citizens, and customers of firms in the bank's keiretsu. (3) The doors of international product competition should be kept open, putting pressure on firms to innovate and on bank management to encourage innovation by firms. (4) Bank managers should be hired on a competitive labor market by the board of directors, which would induce bank managers to build good reputations. (5) Loans for large investment projects should be accompanied by well-publicized precommitments from banks, in the form of schedules of expected progress on the project. Any renegotiation of the contract between a bank and a firm which softens the firm's budget constraint would thereby be open to public scrutiny. From a constitutional point of view, the third and the fifth of these measures are the most significant. The third could be enforced and made credible by free-trade agreements - similar to the abdication of national sovereignty to IMF or the World Bank. The fifth would be enforced by free and vigorous media that could expose underhanded subsidies to inefficient firms. In other words, to insulate economic policy from political pressures one would appeal on the one hand to the international community and, on the other, to the critical scrutiny of the press. [Elster, J. and Roemer J. (1993), A Third Way?, East European Constitutional Review 2 (1):38-75] |