Edward Stringham on Private Governance

 

As the first generation of Cevro Institute’s PPE students are finishing up our studies, some of us have been fortunate to take advantage of Cevro’s international network and visit research institutions abroad. Sven Schütt and I are visiting the American Institute for Economic Research where we had the opportunity to meet and sit down for an interview with the institute’s president and director of research and education, Edward P. Stringham.

In addition to his work at AIER, Dr. Stringham is the Davis Professor of Economic Organizations and Innovation at Trinity College, editor of the Journal of Private Enterprise, and  author of several notable publications, including a book on the presence and merits of private governance, which served as a springboard for our discussion.

 

In your 2015 book Private Governance, you point out that systems of private ordering are much more prevalent than we commonly believe. In fact, in a series of case studies you show that private governance was historically present even in several areas, where most people generally believe that state intervention is crucial. You introduce a framework, which allows us to compare both types of governance, could you briefly summarize this approach for people who are less familiar with your work?

Most economists and legal scholars, most people in general, believe that order is created by government, and without government rules and regulations we will have disorder. What I found in my research, time and time again, is that even in places where government exists or is very prevalent there are tons and tons of examples of private rules and regulations, examples of private governance, which enable order in markets and make markets stronger. If we don’t examine things from an economic point of view, we can assume that all this order is created by the state, by the central government, and miss the fact that these sets of institutions that underpin markets are in reality private. So, I like to contrast government, the state, which – following Max Weber – I will define as the entity that arrogates a monopoly of the use of force in a given area, and contrast that with private governance, which I would refer to as voluntary, individualistic, or within a set of people in a community like clubs. So, you could have lots and lots of people in a club or very few amounts of people in a club, but the main difference is that people are voluntary opting into to the system of private governance in contrast to the state, the government, which is pushed on people whether they like it or not.

 

Why do you think that private governance is superior to government?

Because markets encourage and enable competition they reward success and they reward people coming up with better ways of solving problems. In contrast to monopolistic setups where the person, or entity in charge, such as government, the state, they don’t have to compete for the dollar of the customer or the investors. In monopolistic situations the government can provide bad services, or use their position to extract resources from the public.. In contrast, private governance where people have to compete for members if it is for a club, or for customers if we are talking about for-profit providers of private governance. You have an entirely different setup where the individual is king, under private governance, while under government the state is king.

 

The distinction between private and public governance at times seems quite vague. A lot of historical examples, which both you and your colleague Peter Leeson reference, seem very similar to the types of bottom-up collective institutions which Elinor Ostrom for example describes. On the other hand, some of the club arrangements that you point out in the financial sector, are in fact nested within a higher-level state order. These bottom-up institutions can also include territorial monopolies on the legitimate use of force. So, what are these, private or public?

A lot of what Ostrom studies is entirely consistent with and goes hand in hand with private governance. We can learn a lot from her work and think about the implications for private governance. In some of her studies of governing the commons she talks about how people will take what was formerly an open access resource to close it to make it more exclusive. In that sense we can think about that as changing what could have been a tragedy of the commence to a club good, there is a lot of overlaps to both fields. Her work in other areas is not entirely consistent in every respect so I don’t want to put too many words into her writing. But I did ask her once before a talk at the Association of Private Enterprise Education meeting how she viewed the idea that we could have complete markets in society, and subsequently her entire talk was how great and necessary government is. So, she is a fellow traveler in many respects and independent thinker in many other respects such that she independent, and slightly different from my perspective, her work is very complementary over all.

In terms of how we differentiate, a lot of time people like to think in numbers: if it’s big it must be government, if it’s small it must be private. I think a better approach is seeing if its contractually chosen or not. For example, Visa and Mastercard have hundreds of millions of people in their club, it does not include all people in society, it only includes people who voluntarily signed up for their club good, for their private governance that they provide within their network. In contrast to a government which could be local town or a state with over 300 million people. It is not the same thing when it is imposed on people whether they like it or not. The local town government might extract resources from the landowners or residents and act accordingly against the wishes of the property owners. I think the main difference, that I like to think about, between government and private or voluntary governance, is the idea that people voluntary opt in to market structures whereas the same is not the same with government structures.

 

In your book you reference the example of a private police force in San Francisco where you have private governance in a sense but nested within a higher order where the state also provides a license at the same time, to give the police force a monopoly. How do you reconcile that with the idea of private governance and is it really private governance if the state is the one basically enabling that private governance structure?

There are certain examples where it is much clearer, and certain examples where it is a little bit less clear. In the case of modern financial markets, which you asked about a minute ago, we have self-regulating organizations, but they have to have a stamp of approval on the government, for example the NASDAQ or the New York stock exchange. In a certain sense we don’t have a complete free market for self-regulatory organisations in the United States today. We could assume therefore they are nested in the government today that they necessarily depend on the government set-up. Historically these entities emerged at a time where they were operating outside the general set-up of the general government. That clearly was the case in London with the precursor of the London Stock Exchange, people were trading in coffee houses because stock brokers had been kicked out of the Royal Stock Exchange and they were explicitly not allowed to do their business and they figured out to create and enforce rules, independent of the government. Even though they existed in a society where government existed I don’t think we should say they were made possible by government officials.

Similarly with the case of the San Francisco private police right now, one does need permission from the government to be a San Francisco Special Patrol police officer. They are authorised by the government, but there were times in history where the private police was actually operating alongside,  independently of, and even in defiance of the government. There was a case in 1856 which some people refer to the business man’s revolution where the private police started putting constraints on the government and telling them they were not allowed to continue doing what they were doing, in one case a politician killed a prominent business man and the private police acted in open defiance of the government and enacted gun control against government police. And that’s the type of gun control that I think all of us can support.

 

Your former mentor professor Peter Boettke distinguishes your work and that of Leeson’s in terms of exclusion versus inclusion mechanisms. Could you tell us more about these mechanisms and why they are important?

Boettke ultimately argues that the two approaches are somewhat complementary and the big difference between the two is that my friend Peter Leeson, in many of his research examples, finds areas where people you might not think could find ways to cooperate, figure out how they could get together and make exchange work, even when we might assume that the cooperative outcome is not possible. My research, which has a slightly different approach, looks at cases where people are interacting in certain cases finding problems within their midst and then deciding if they can exclude certain unreliable people that will make the market more secure. In the case of the London Stock market they would prevent a defaulter or an unreliable person from continuing conduct business among their midst. They would put that person’s name on a blackboard and say: you are not allowed to come to this club anymore. What this does, is that it prevents what could be considered as a tragedy of the comens situation, where you got this valuable market and potential where lots and lots of people are coming in to undermine its success by acting opportunistically. By putting that blackboard at the entrance, or putting an entrance fee at the door, or putting a membership fee on the members, it includes the reliable and excludes the people who are potentially unreliable. Those people can still conduct business elsewhere, they can trade at their offices or at competing clubs. So, they are not being excluded from society, but they are being excluded from a particular private club, and system of competition allows competing private clubs to offer to the general public a system of rules and regulations and a set of members for the general public to evaluate which one is more reliable, where they want to do business. Do you want to do business with anyone on the street or do you want to do business with an entity like the London Stock Exchange, which eventually adopted as its motto “My word is my bond”.

 

If the final goal is for all governance to be provided privately what are the concrete steps towards reaching this goal, because today it seems that the size of government is increasing not decreasing in most of the developed countries?

Even with countries with lots and lots of government, or countries with intermediate amounts of government – private governance is in existence in every country to varying degrees. I can say that in modern US, we have had a huge increase in government regulation, especially over the past 8 years, nonetheless, we still see a lot of private governance. We still see the New York Mercantile Exchange, the Chicago Mercantile Exchange providing assurances for people who do business in those markets, to provide assurances for people who are making a futures contract are going to get what they are owed. So, even where the state is pervasive we still see a lot of private governance. What I view as particularly problematic is when the government interferes to outlaw, or to restrict the actions of providers of private governance. In certain cases they will make what had been private providers of governance act in the interest of the government. One example of this in recent years is when colleges were forced by the government to change their standards of evidence and of guilt to be a preponderance of evidence for certain accusations. So, not allowing the providers of private governance to have certain procedures of justice for their students. Here the government undermines private governance. In other cases the government crowds out private governance. So, when the Securities and Exchange Commision started imposing more and more rules that had been provided by groups like the New York Stock Exchange, the uniqueness of the New York Stock Exchange was diminished, the role of the exchange was diminished, and then the flexibility of trading and other exchanges were also eliminated.

Things are not always perfect, and I would say that the best we can hope for is for people to realize: hey, we have private solutions, and we don’t need all of these governmental mandates. We don’t need all of these governmental controls. With Dodd-Frank for example, they are micromanaging a huge percentage of the financial center, and I would argue  undermining American financial sector tremendously. That was a huge step in the wrong direction. That’s 25 thousand pages, it’s still not finished, and the more we go in that direction the worse it is. On the other hand, if people wake up and realize this is not why we have markets, this is not necessary for markets, we have order independent of Dodd-Frank, we have order through all types of private mechanism, then we can put the brakes on Dodd-Frank, or even see repeals of parts of it … We have seen a little bit of relaxation of some of the extremely burdensome regulations in the last few months. But there is still a lot more that we need to do.

 

Do I understand you correctly that you are saying we need a fundamental cultural/ideological shift?

Yes. If people believe that all order comes from government, then If there is ever a problem they are immediately going to turn to government, and under that mindset we are going to see more and more government rules and regulations. If people recognize that order can come from private sources then turning to more regulation might not be their first response or their only response. “There ought to be a law” is a mindset, which I think is tremendously harmful, and leads to the regulatory state, leads to the administrative state… As people see how that causes problems and restrictions on markets and as people see there are alternatives to that, then they can stop putting their blind faith in government regulatory agencies. As that happens then we aren’t going to see such increase in regulation and will potentially see a huge decrease in the amount of government control in the economy.

 

How could this shift in society take place?

I think we need economics to help educate people about the power of markets. A lot of people don’t understand basic economic principles about how simple goods show up on their dinner table every single night, or how prices are formed spontaneously through the interaction of supply and demand. Likewise, people don’t understand the private rules and regulations, private mechanisms associated with private governance that make markets possible. As people start understanding this, either just a little bit or, ideally, completely, the more people understand how markets work, the less likely they are going to be to turn to demagogues, who provide what I’ll call snake oil proposal, that the state control of our economy is going to be somehow useful and beneficial to all people.

 

Were we to reach the goal of a stateless society, how would that society defend itself against neighboring nation states? In historical terms Africa was home to many anarchic societies but colonial countries took over and enforced their jurisdiction. If private governance is truly the superior form of governance, why didn’t it prevail?

Any set of prefered policies requires a certain critical mass to support it. If one person is against murder in the world, and every single other person in the world is in favor of murder, then, unfortunately, I don’t think we are going to have a very good outcome. On the other hand, if the vast majority of people are against murder then at a certain point in time we might not eliminate all murder, but we can go in the direction that we have been going over the past few hundred years of dramatically decreasing homicide rates. Likewise, if a very small community is living next to the Soviet union than they might be the greatest entrepreneurs in the world and have worked out a perfect market set-up, but if the soviet army comes marching in, there is not going to be much hope for this society, this private community. The same is true even if it is a country, we can look at plenty of examples of nations that had been taken over by the Soviet armies. So this is a problem that will exist in all societies, with or without states.

Ultimately, we need to be thinking about enough people supporting markets, enough people supporting respect for others, respect for individual rights, respect for property. The more we go in that direction, the less likely we are going to see the Soviets taking over the world in Eastern Europe or in the United States for that matter. If more people in the United States believe in collectivism and the superiority of the government controlling the economy, then we will be in a situation similar to the one we are now. On the other hand, the more people see the importance of markets, the power of private property, then the more that we can go and assist them, the more individuals are free to see their lives as they see fit.

 

Thank you for taking the time to answer these questions and we would also like to use this opportunity to thank you for giving us the chance to visit the American Institute for Economic Research. Other students reading this will surely want to know if it’s possible for them to also participate in any future AIER programs. Which areas of research might have the most synergies with AIER mission. Any advice or suggestion for students who would like to apply?

Our institute is 85 years old and has had a long commitment to the importance of economics for advancing peace, prosperity, and human progress. People throughout the decades associated with the institute have researched and wrote about a broad range of topics including the importance of having sound money in society, topics like the perils of inflation, the importance sound banking, including hard backed currencies such as gold. We’ve also done a lot of research on the potential perils of regulation, and, for example, how the Securities and Exchange Commision might not actually be protecting investors, but harming people in the economy, including investors. So, one of our articles had a line in it: “who is to protect the consumer from the regulator.” So, there’s been a huge range of topics that we have been interested in, but generally our focus can be summed up as research into the importance of property rights, the importance of free markets, the importance of sound money, and individualism generally for creating good economic outcomes.

 

Professor Stringham, thank you for your thoughts and we look forward to seeing the student programs at AIER grow in the coming years and hope Cevro continues to be a part of that!

 

You can follow Professor Stringham on Twitter: @edstringham

 


 

You can also check out our other interviews with Peter Boettke, Andreas HoffmannDalibor RoháčJörg Guido Hülsmann, and Mateusz Machaj.

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