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The Role of Government in Business Environment Table of Contents Chapter Government and Business (Economic) Institutions. The New Constitutional Economics - 3 Buchanan's Constitutional Economics and the Institutional Foundation of Liberal Order - 6 Regulatory Function of Government in Business Environment Corporate Governance - 14 The Sarbanes-Oxley Act of 2002 - 15 The Implementation of Chief Risk Officers - 17 Case of Enron Corporation - 19 Government as Environmental Policy Formulator Green Lights Energy Efficiency Program - 23 Weatherization Program - 24 Green Government Procurement 25 Case of McDonalds Corporation - 26 4. Informational Function of Government in Business Environment Legislative - 28 Judicial - 29 Executive - 31 5. References CHAPTER 1 GOVERNMENT AND BUSINESS (ECONOMIC) INSTITUTIONS. INTERACTIVE MODEL: PHILOSOPHICAL AND THEORETICAL IMPLICATIONS Moral philosophy became thoroughly departmental when, as the social sciences, its dimensions were professionally divided and at most colleges and universities, departmentalized into the disciplines of sociology, political science, and economics. The effect of this has been to constrain the dimension of analysis in each domain of the social sciences.
The case I make here relates the interactive model of government and business organizations or institutions from the perspective of philosophy and economics. I begin with a brief account of Williamson's (2000) description of the deficiencies of the new institutional economics (NIE). Those deficiencies relate to a presumed but un excavated social foundation of the analysis. I then discuss the rich institutional analysis of James Buchanan (1991) who thoroughly developed the nexus between economic and political institutions. In the process, he excavated but did not explore the social foundation that Williamson presumes.
Buchanan's examination of the economic / political nexus is an extremely valuable to the issue of government involvement in business. THE NEW INSTITUTIONAL ECONOMICS Williamson began his Journal of Economic Literature article "The New Institutional Economics: Taking Stock, Looking Ahead, " with the following reflection: I open my discussion of the new institutional economics with a confession, an assertion, and a recommendation. The confession is that we are still very ignorant about institutions. The assertion is that the past quarter century has witnessed enormous progress in the study of institutions. The recommendation is that, awaiting a unified theory, we should be accepting of pluralism (Williamson 2000, 595). Williamson represented society's institutional structure as having four levels.
Level 1 encompasses the embedded "norms, customs, mores, [and traditions" of society (Williamson 2000, 596). Although these are institutionalized, they are not directly observable institutions. They are a "social stock of knowledge" (Berger and Luck mann 1966, 42) that each new generation inherits and takes as representing the natural order of things, as tacit knowledge. Unlike a court system, a legislative system, a body of common law, or a constitution, one cannot examine this social construct directly. It is a substructure, an invisible foundation upon which all other institutions are constructed. Although it is invisible, this schema (Hirsch 1987) or frame (Kahne man and Tver sky 1984) provides the base from which individuals then act, as the rational choice model of modern economic analysis describes.
Level 2 of Williamson's social construction encompasses what Douglas North referred to as the "formal rules" of social organization, rules that include "constitutions, laws, [and] property rights, " established, developed and monitored by the state (North 1991, 97). Unlike level 1, in which Williamson conjectured that the "informal institutions have mainly spontaneous origins-which is to say that deliberative choice of calculative kind is minimally implicated" (Williamson 2000, 597), the formality of level 2 institutions "opens up the opportunity for first-order economizing: getting] the formal rules of the game right" (pp. 597, 598). Similarly, level 3 -which Williamson referred to as the "play of the game" level (p. 597) -involves "second-order economizing, getting] the governance structures (e. g. , contract) right... " (p. 599).
Level 4 is that at which resource allocation and employment are determined-"getting the marginal condition right" (p. 597). The institutions at levels 2 and 3 of the social construct have a major impact on the cost of economic transactions because the conditions governing exchange are defined by the rules and structures embodied in those institutions. "Effective institutions... reduce transaction and production costs per exchange so that the potential gains from trade are realizable" (North 1991, 98). Thus, institutional analysis is central to "transaction cost economics [which] subscribe[s] to the idea that the transaction is the basic unit of analysis, ... [and that] governance is an effort to craft order, thereby to mitigate conflict and realize mutual gains" (Williamson 2000, 599, emphasis in original). To the degree that transaction cost analysis informs institution building at levels 2 and 3, it offers a valuable tool to help a society get its institutional structure "right, " as Williamson put it (p. 598). This promise of operationally practical benefits was for Williamson one of the great virtues of the NIE, and it is this promise that explains the NIE focus on levels 2 and 3.
Although the NIE analysis has been most richly developed at these levels, this focus comes with a caveat: "The institutions of embedded ness (level 1) are an important but underdeveloped part of the story" (p. 610). Understanding the social institutions of level 1 -norms, customs, mores, and traditions-is essential to a full model of social interaction including economic intercourse. As North put it, these social institutions exercise a "pervasive influence upon the long-run character of economics, " and, he wondered "What is it about informal constraints that gives them" such power (North 1991, 111). Williamson cited this quotation from North and wrote: "North does not have the answer to that perplexing question, nor do I" (Williamson 2000, 596). North took the question a step further.
Not only did he wonder at the power of these social institutions but also about their origin: "How does an economy develop the informal constraints that make individuals constrain their behavior so that they make political and judicial systems effective forces for third party enforcement?" (North 1991, 111). Williamson reflected on this question also; then he left it behind. Buchanan's (1991) constitutional economics enterprise laid bare the institutional foundation of Williamson's social construction. In doing so, it prepared the ground for an analysis of that social foundation and its relationship to the political and economic superstructure built upon it.
BUCHANAN'S CONSTITUTIONAL ECONOMICS AND THE INSTITUTIONAL FOUNDATION OF A LIBERAL ORDER Because institutions have power and because power can be used to generate rent (a return to control), ' institutions themselves can and do become a locus of competition-a rent-seeking competition that can drive institutional evolution in a counterproductive and even destructive direction. Rent-seeking theory has led some to the pessimistic conclusion that there is no way to get the institutional structure "right" because an institutional dilemma is built into liberal society. The individual freedom that is a prerequisite for free markets invites rent seeking because in such a free system countless opportunities exist for utility maximizing individuals to personally benefit from seeking institutional advantages. It seems, therefore, that liberal, free market societies are trapped between the devil and the deep blue sea: The oppressiveness of the tyrannical state that can suppress unbridled self-interest and the Hobbesian war of all against all if those central controls are removed. Buchanan (1991, 245) expressed distress about the state of the majoritarian democracies, but he rejected the pessimism. He believed it is possible to constrain rent seeking without infringing on the sovereignty of the individual by establishing constraints by consensus.
To represent this possibly, Buchanan expanded the dimensionality of modern analysis from the standard market question: What choices will be made given the extant set of constraints? to the more general question: What choices will be made, including what system of constraints (what contract) will be chosen? This latter question integrates levels 2, 3, and 4 of the NIE analysis. As with NIE, Buchanan's (1991) premises are the standard ones of methodological individualism, utility maximization, and rational choice.
he rejected the notion that society has an organic existence that transcends individuals (Buchanan 1991, 14 - 15, 29). Given this point of departure, Buchanan turned to an obvious question: Why would autonomous individuals "choose to impose constraints or limits on their own behavior?" (p. 5). Why would they be party to a process of social construction given that any social construct (e. g. , his constitutional order) implies some degree of constraint on individual choice? To explain why Buchanan cited Adam Smith: "Smith stressed [the]...
properties [of the market] that allow for self-interested behavior of persons and yet generate socially beneficial results, require an environmental setting of appropriate 'laws and institutions'" (Buchanan 1991, 208). Buchanan agreed. he rejected (1991, 35) the "romantic ideal of laissez-faire, the fictional image of anarcho-capitalists, in which there is no role for the state at all" for the same reason he rejected the socialist "romantic image of the state as an omniscient and benevolent entity. "ordinary humans" are not capable of either. Socialism is an invitation to the exploitation of centralized power, and anarchist laissez-faire is a path into the "Hobbesian jungle" (p. 35).
Any plausibly realistic analysis of social order, whether positive or normative, must be bounded by the limits set by these ideological extremes. The state is neither omniscient nor benevolent, but a political-legal framework is an essential element in any functioning order of human interaction (p. 35). According to Buchanan, we will agree to be a party to social construction because we need such constructs, constraints by consensus, if society is to cohere. How can we, mortal humans, create a state that constrains our humanness and its destructive predilection for rent seeking without tyrannizing us? '"How can the controllers be controlled?' Hobbes responded with despair" (Buchanan 1991, 235).
Buchanan turned to the contract arian tradition for an answer. The elements of Adam Smith's intellectual enterprise become directly precursory to the research program of constitutional economics only when those elements are imbedded within the tradition of contract arian political philosophy... In agreeing to be governed, explicitly or implicitly, the individual exchanges his or her own liberty with others who similarly give up liberties in exchange for the benefits offered by a regime characterized by behavioral limits. (Buchanan 1991, 12 - 13) To demonstrate why the constraints must be constitutional, Buchanan used the example of a poker game. Participants in a poker game face two choices: the rules of the game and, once those rules are determined, each player's strategy.
The rules of the game define the constitution of the game. The various strategies available within that constitutional order represent the post constitutional choice any participant in the game faces. For the game to be played in a constructive environment, it is crucial that there be an impenetrable wall of separation between the rule-setting stage, the constitutional construction, the in-rule play, and the post-constitutional strategic interactions. Any breech of that separation allows the strategic self-interested pursuits of individuals to be focused on rule manipulation. In a poker game, such manipulation would simply lead to a breakdown of the game: The "poker game is voluntary... [and] each player retains a low-cost exit option" (Buchanan 1991, 155). But "[t]he political game is compulsory, and we must all play" (p. 155) for the cost of not playing is the high probability of a significantly smaller distributive share as others manipulate rules to their advantage.
In the politicized market game micro motives drive rent seeking with its attendant negative sum implications (Schelling 1978). To avoid this dilemma, we must appreciate the lesson of the poker game. We must create that wall of separation between the rule-creation stage, during which individuals function as a cooperative group interested in designing the best standards for play-optimal rules for commutative justice-and the in-rule stage, during which individuals become players competing with one another within the context of the previously agreed-upon rules. Buchanan believed this was possible because he believed that two characteristics of the constitutional stage distinguish it from the post constitutional stage.
First, any agreement at the constitutional stage requires a greater threshold of social consensus than majoritarian democracy. "At the constitutional stage of choice among rules, our argument does, conceptually, require unanimous agreement among all parties" (Buchanan 1991, 47). Second, the perspective of the participants is fundamentally different when constitutional as opposed to post constitutional choices are involved. [A]gree ment on rules is much more likely to emerge than agreement on policy alternatives within rules because of the difficulties in precisely identifying the individual's economic interest in the first setting. The rule to be chosen is expected to remain in being over a whole sequence of time periods and possibly over a wide set of separate in-period choices during each period. How can the individual, at the stage of trying to select among rules, identify his or her own narrowly defined self-interest? ...
he or she is necessarily forced to choose from behind a dark "veil of uncertainty. " In such a situation, utility maximization dictates that generalized criteria, such as fairness, equity, or justice enter the calculus rather than more specific arguments like net income or wealth. (Buchanan 1991, 47 - 48, emphasis added) In effect, the veil masks what Buchanan referred to as the interest component in each individual's choice mechanism, obscuring questions like: What serves me"? What remains is the theory component, framing questions like: What kind of world would our choices create? With questions like this driving the discussion, a consensus is more possible because individuals are not engaged in conflict (what are my interests versus your), but they are engaged in cooperative discourse (what system seems most likely to serve us best? ). Buchanan argued that in such a discourse the paramount "concern for stability... will induce a concern for fairness" (Buchanan 1991, 57).
Very nice in theory, but is this feasible? The process is not costless; are the incentives sufficient to encourage a rational citizen to voluntarily participate in this conversation about the constitution? Buchanan's answer was, No. The constitution, "the set of constraints that limit the choice options of individuals, that define the feasibility spaces, is public in the classic sense. This structure is both nonpartitionable and nonexcludable" (Buchanan 1991, 24). Consequently, individuals...
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