Chapter 8: Order analysis part IV





1st Introduction to the difficulty

2nd Characteristics of the individual order types

3rd The distinction of different systems of order

4th The aim suitability of the individual order types

5th On the pathology of the order types




5th On the pathology of the order types


At our previous considerations, we have always proceeded from the tacit assumption that the individual systems of order do function. For example, the aim suitability of the market was derived on the assumption that functioning competitive markets are present. We now have to take into account that - and this applies to all systems of order - only under certain conditions an order type can fulfil the functions intended for it. If these conditions are not met, these tasks are either not fulfilled at all or at least only inadequately fulfilled. Here, we speak of pathological orders.


The fact that an order system does not fulfil its tasks satisfactorily has already been proved very early for market economy systems. It was spoken of an ideal-typical market order, which would provide the predicted results only in theory and distinguished this from the real, actual market economies. Of this arouse the criticism on the market economy system and the demand that certain tasks, which had originally been left to the market, shall be accomplished by other systems, especially by the state.


It was overlooked here that deviations from the ideal are to be expected in all real systems, that there are actually also pathological negotiation-, electoral- and bureaucratic systems. Therewith, however, change the conclusions that have to be drawn from these pathological order types. The existence of pathological processes alone does not reveal whether the existing market regulation should be replaced by another system. It must indeed be reckoned with the possibility that the alternative forms of order have even larger deficiencies, and that the market may, under certain circumstances, be an unsatisfactory, quite bad order, and nevertheless be the best among the possible orders.


It is unacceptable to compare an actual market with the results that can be expected under real conditions and then opt for a different system of order because this system can be expected to yield better results under ideal-typical conditions. This approach, which is stigmatised as Nirvana approach, leads to false results; the individual systems are to be tested always for their suitability in such a way that either ideal-typical or real systems are compared with each other.


Order systems are then unsatisfactory if there is either a lack of the prerequisites that supply and demand can be balanced at all; this is the question about the existence or the stability of a balance. Here, we are speaking about the failure of the order system.


Or they do not satisfy when the realised solutions are to be described as suboptimal. The determination of suboptimal results requires, though, that we have previously determined when it can be spoken of an optimal solution of a problem. This is the question which is examined within the framework of the traditional welfare theory, which stems from Vilfredo Pareto. Within this theory, it has been shown that the best of all factually possible solutions can only be expected if, on the one hand, we are able to impose a complete competition on all markets and on both sides of the market, thus all market partners refrain from applying monopolistic scarcity strategies to improve their results.


On the other hand, the best possible solution can only be expected if at both the production decisions as well as the consumption decisions all costs are included in the maximisation calculation (the same applies for the revenues) which arise in the total economy. If one of these two prerequisites is not present, no optimal solution can be expected, we are speaking about the deficiencies of a system of order.


Let us first turn to the question of the conditions under which a failure of an order is present. It is assumed that a solution is conceivable at all, at which supply and demand coincide, that is, a solution of equilibrium exists. On the markets, this is precisely the case when there is an intersection between the supply curve and the demand curve, in other words, if there is a price at which the suppliers offer exactly the quantity of goods that is demanded by the demanders at this price.


This problem can be further limited by the fact that such a point of intersection must be present at realistic prices and quantities. If, for example, the intersection point were reached at prices which could never be paid by the demanders, or if an equality of supply and demand would only appear with quantities of goods that could not be produced at all because of a lack of resources, then it has to be said also that no equilibrium is existent.


Much more important than the question of the existence of equilibrium is the question of the stability of the equilibrium, thus the question whether we can expect that the equilibrium point will be reached by itself from any initial position, hence whether there is a tendency to equilibrium. We therefore assume that for any reason - we are talking about changes in data - an imbalance arises, so that one of the two curves is shifted and a new point of intersection arises and we check whether the market itself finds the new equilibrium point.


For such an automatic tendency to equilibrium to be present, two prerequisites are necessary. On the one hand, the occurrence of an imbalance must lead to price changes, namely an excess supply must lead to price reductions, whereas an excess demand must lead to price increases. Only in this case we speak of normal price reactions.


Furthermore, these price variations must trigger very specific changes in supply and / or demand. A price increase must entail, for example, either to a reduction in demand and / or to an increase in the supply. Both effects reduce the imbalance and thus trigger a trend to reduce the imbalance. The same applies to price reductions. Only reactions in this direction are called normal.


It is now easy to see that the equilibrium trend is generally higher the more rapid the price changes and the quantity adjustments are, and the greater the changes in quantities are that are caused by a price variation of one percent. We measure the extent of a price reaction with the price responsiveness, and the quantity reduction by means of the price elasticity of supply and demand. A market system is only politically sustainable if this equilibrium trend occurs within reasonable periods of time.


Nevertheless, it must be warned against a misinterpretation of an equilibrium theory. The thesis that markets generally have an equilibrium trend does not mean that at any moment, or even as a rule, an equilibrium is actually present, nor that it would be desirable that equilibrium conditions are present whenever possible. Exactly the opposite is the case. We have to assume that data changes occur permanently which lead away from the equilibrium.


These data changes are also desired  in general, as data changes in technology lead to an improvement in the production, and thus to a welfare increase, as well as data changes in demand express that consumers are endeavouring to allocate their material resources better. These data changes are a result of free decisions of private households.


Positively worded, the equilibrium theory merely states that the market reduces imbalances by itself, so that it has not to be feared that the imbalances will accumulate. It has to be assumed that no economic unit - neither households nor enterprises - has an unlimited capacity to bear imbalances, so that, for example, an enterprise that only has losses will have to file for bankruptcy one day and collapse.


If there would occur an unlimited accumulation of imbalances, the individual economic units would have to reach this capacity limit sooner or later, and one day the market would necessarily collapse. In reality, this collapse would generally not happen at all. Politics would feel compelled to enter the market even before a final collapse.


Also in the context of a negotiated solution, it must be reckoned also with the possibility that in individual cases the conceptions of the collective bargaining parties are so far apart that the parties fail to reach an agreement. Then, there is no solution with which both partners can agree. One helps oneself out of this difficulty by the fact that a neutral third party is called in, which reveals new possibilities for solving the problem and therewith settles the labour disputes. Also the fact that the trade unions are calling for a strike, that is to realise the strike threats, can help under certain conditions to increase the pressure on employers and under such pressure they are willing to meet the ideas of trade unions more strongly than before.


Within an electoral system, several factors are known which can prevent the occurrence of a decision and thus equilibrium. Thus, in the case of a tie, no majority decision can occur for the alternative programs under discussion. However, this first difficulty can be solved relatively easy by institutional provisions. Thus, it can be provided that the number of voters (e.g. the number of deputies) is always an odd number and that for these reasons a stalemate situation can not arise at all. Or, it may be provided that in cases of stalemate, the chairman of the parliament gives the casting vote for the proportion of votes.


Larger difficulties are to be expected if the so-called Arrow’s paradox is present. Here, several alternative programs can achieve a majority depending on the order in which it is voted.


Let us make this theorem clear to us by means of a simple example. Three persons (or parties): P1, P2, P3 shall participate in a vote. There were three alternatives to the vote: A1, A2, A3. The following ranking scale would apply to the individual parties:


P1: A1 > A3 > A2

P2: A3 > A2 > A1

P3: A2 > A1 > A3


Initially, the question would come to the vote whether A1 or A2 should be chosen. According to the scales of preference, P1 decides for A1, P2 for A2 and P3 for A2. Thus, there results a majority for A2.


Secondly, the question would be under consideration whether A2 or A3 should be chosen. According to his preference scale decides P1 for A3, P2 for A3 and P3 for A2. The majority therefore speaks for A3. The collective ranking is valid: A3> A2> A1.


Now we assume that it would have been voted in a somewhat different order. The first question was whether it should be voted for A1 or A3. Then P1 would have decided for A1, P2 for A3 and P3 for A1. So the alternative A1 would have won.


Now, in a second step, it would have been decided whether the group preferred alternative A1 or A2. P1 would again opt for A1, P2 for A2, P3 finally for A2. Now the alternative A2 would be chosen. In this case, the collective ranking scale would apply: A2> A1> A3.


Depending on the random order of the votes, the result would be different - even at the rational behaviour of the individuals – which signifies a contradiction. It is not possible at the same time to apply the collective ranking: A3> A2> A1 and A2> A1> A3. In the first voting sequence, the alternative A3 would be ranked 1st, but in the second voting sequence, it would be ranked 3rd. That can not be. It is therefore impossible to constantly derive a consistent collective indifference curve from consistent individual indifference curves.


Such cyclic majorities can only be avoided if the number of alternatives is reduced to two or if the preferences of the voters broadly coincide. A de facto reduction to two alternatives usually takes place in majority voting systems, where only two big parties stand for election and one party emerges victorious from the elections. At the vote in the parliament, there are mainly two programs up for election: the programme of the government and the programme of the opposition.


A further precondition for absence of quorum is when qualified majorities or even unanimity is required for the conclusion of a decision. For example, until recently the European Union's statutes provided that all members of the EU Commission had to approve in order for the submission to be considered as adopted.


Finally, there is the possibility that at distribution policy issues a long-term balance is prevented in a proportional representation with several smaller parties, even if all parties behave rationally. Since just in the distribution policy the ideas of a fair distribution of the incomes are very different, the politicians are forced to rely on minimal majorities. Here, an opposition can bring about a change thereby that it produces a differently composed majority. In the long term results then a to and fro swinging between different majorities and thus an unstable situation. In particular, Friedrich von Hayek has pointed out this problem.


Finally, a bureaucratic system can also get incapable of acting for various reasons. This applies, for example, if individual departments of a government are not sufficiently coordinated with one another and block each other. Let us take the case that a question which is put to the vote touches the competence of two ministries, but that the ministry A is led by the party S, the ministry B by the party C, and that both parties have very different ideas about the solution to the question, then it may well be that in the run-up to the consultations both instances block each other.


It is also conceivable that there is a lack of a loyalty relationship between supervisors and subordinates, and that for these reasons the subordinate bureaucrats refuse to carry out correctly the decisions of the government.


Let us now turn to the problem of the system deficiencies, first of all to the question of the importance of external effects. As already briefly pointed out, we always speak of external effects when at the production or the consumption of individual goods of the national economy arise costs which are not attributed to the producer or the consumer. The same applies to national economic revenues which are not assigned to the producer.


Probably the most important example of external costs is the environmental pollution: exhaust emissions are discharged into the air or into the water at the production, resulting in impairments of the climate (ozone hole) or health hazards of the residents. The most important example of external revenues is the one of the collective goods according to Mancur Olson: individuals who are not willing to participate in the costs of the production of these goods can not be excluded from the consumption of these goods.


External costs arise in market economy systems in connection with free goods, for which there are no proprietary rights of neither private persons nor the state, which can therefore be freely disposed without incurring costs for the users of these goods. These goods are considered not to be scarce and therefore they neither obtain price at markets.


However, if there are external costs (and the same applies to external revenues), the market mechanism fails and therefore does no longer lead automatically to a welfare optimum. Without external costs, goods are produced only when the cost increases that arise during production are lower than the benefit increases generated by production.


Let us assume an arbitrary allocation of material resources onto the individual goods, and we ask ourselves whether a change in the allocation promises incremental benefits; we thus produce one unit less of the one type of good A, and use the thereby liberated production factors to produce another good B. The economic cost increases of such an allocation change are caused thereby that a loss of utility now takes place in the case of the reduced goods.


This utility loss is compared with the incremental benefit at the increasingly produced goods. As long as the incremental benefits are greater than the utility losses, the allocation change acts welfare increasing; the welfare optimum has not been reached yet. Conversely applies, when the utility losses correspond to the incremental benefits, the welfare optimum is achieved; no change in the allocation could result in an incremental benefit on balance.


However, if some of the costs of a national economy are not included in the profitability calculation of the operating person, if thus the actual costs are estimated too low, these goods achieve a too low price, hence too much is produced of these goods, there is produced too little of other goods and this means that the allocation of the resources onto the individual goods deviates more or less from the optimal allocation.


External effects also occur in connection with negotiated solutions. As an example, at labour disputes not only the directly concerned employees and employers are affected, but also third groups are affected, for instance the employees and employers in supplier companies or the population directly (labour disputes at the passenger transport or refuse collection). In all of these cases, the disputing parties are causing costs which are not paid directly by the disputing parties but by third parties.


A special kind of external effects has to be expected in electoral systems. Politicians can increase their chances of re-election by focusing their activities primarily on measures whose positively assessed effects are noticeable in the short term, or whose negatively assessed effects are only visible in the far future. The politicians can afford such behaviour because, according to the experience, the voters have a very short memory. They orient their vote decision on the measures of the politicians that are visible immediately before the elections, thereby forgetting the loss of benefits they had to experience immediately after the last election.


The probability of external effects is especially high in bureaucratic systems. Since at the decisions of bureaucrats their assets are not used, they can neither be prosecuted materially with the loss of assets for wrong decisions. Now, however, the responsibilities of the bureaucrats could also be maintained by the fact that bureaucrats would be dismissed or demoted in the case of wrong decisions, or an otherwise imminent promotion would be skipped.


However, in practice, these possibilities are often obstructed by the fact that non-promotion is excluded by means of a regular promotion (one is automatically promoted after a series of service years), or that dismissal of official bureaucrats is not possible since they have been employed for lifetime and a dismissal is only permitted at very extreme misconduct at all.


Then there remains only the possibility that the bureaucrats have to justify themselves for their actions publicly or in front of a parliamentary control committee. But these possibilities are also very limited in practice because the bureaucrats often have better information than the public or parliamentarians who are ought to control these bureaucrats.


In a similar way to the external effects, a one-sided monopolisation of markets leads to suboptimal results. The monopolist gains control over the entire supply (the total demand) of a market, and can therefore shorten his supply respectively demand and thus achieve a result that is more favourable for him. Only in the case of a bilateral monopoly, under certain ideal preconditions, the same allocation as in the case of full competition is realised. Thus the allocation of resources occurs in these cases also optimally. These preconditions include homothetic utility functions (the marginal utility of the income remains constant!), furthermore homogeneous linear production functions and a step-by-step negotiation strategy.


The negotiated solution corresponds to the market form of the bilateral monopoly. Therefore, an optimal allocation is theoretically conceivable here. In this connection, John Kenneth Galbraith speaks of countervailing powers which take on the functions of the competition.


Nevertheless, it is necessary to state restrictively that an optimal allocation can be reached only under limiting conditions, and that at least the assumption of a constant marginal utility of the income does not correspond to the reality in opinion of most economists. One assumes in general that a millionaire experiences a considerably lower incremental benefit if his income is increased by one unit as if the same income increase takes place at an individual with a very low income. Therefore, one will have to assume under realistic conditions that the negotiated solution leads to suboptimal negotiation results as a rule.


An electoral system can lead to optimal results only if the electors can choose between several parties. Nevertheless, it would be wrong if one would assume that the results of an electoral system turn out the better the larger the number of the parties is which stand for election. Within the scope of the economic theory of the democracy it could be shown that the majority voting system basing essentially on two competitive parties leads to better results than a proportional representation system at which generally a variety of little parties stands for election.


The reason for this lies particularly therein that in majority-voting systems the parties are much more under pressure to consider the interests of as many sections of the population as possible, while in proportional representation systems there is the danger that the individual parties try to represent to a stronger extent the interests of smaller groups. In a majority-voting system a party can only form the government when it succeeds to poll the majority of the votes. This is, though, in general only possible when no larger section of the population is put at a disadvantage.


In the framework of a proportional representation system no party can hope anyway to poll the majority of the votes. Therefore coalition governments must be formed with a majority of parties. In order to be involved in the government it depends not on representing as many voters as possible. Also a party which represents only a little section of the population has chances to be involved in the government.


In addition to this, experience has shown that majority election systems are much more stable than proportional representation systems. In a majority election system, it is generally sufficient that a slightly larger population group is dissatisfied with the present government in order to achieve a replacement of the government by the opposition in the next election. But precisely for this reason, the democratic system can be maintained even at greater dissatisfaction of the voters; only the party which represents the government has been replaced.


Whereas in proportional election systems there is a risk that the parties on the base of the democratic order already belong to the government. So that in the event of a great dissatisfaction with the present government there is the danger that radical parties will prevail and that these intend to break down the democratic order.


Thus, for effective competition in the electoral system it depends less on the fact that as many parties as possible are competing with each other. Nevertheless, there is also the danger of monopolisation in the political electoral system, e.g. when it is passed over to a one-party system, when an all-party government is formed or when the existing parties arrange that certain particularly critical problems are held off from the election campaign.


The bureaucratic system is characterised thereby that even in an ideal-typical case there is no competition present on the supply side. The function of competition provided in the other systems of order is realised here the way that the bureaucracy is subject to supervision of the parliament. But there is the risk that the bureaucrats will have so much information advantage towards the parliamentarians that the parliamentary control becomes ineffective.


Precisely this thesis is supported by William A. Niskanen within the scope of his theory of bureaucracy. Niskanen holds the view that the bureaucrats have the option fixation power towards the government, and have therefore the possibility to widen the government expenditures to a much greater extent than this meets the wishes of voters.