Is the constitutionalisation of economic institutions and policies consistent with democracy ?

London School of Economics and Political Science

Lent Term

GV 4E2  

CAPITALISM AND DEMOCRACY

Formative Assignment

Subject: “Is the constitutionalisation of economic institutions and policies consistent with democracy?” (2014 paper)

Guilhem Chevallereau

Word count: 1636

“Money is much too serious a matter to be left to the Central Bankers”, wrote Milton Friedman in Capitalism and Democracy^[1]. Friedman’s wariness of central banks has often been associated with his economic arguments, but many forget the philosophical aspects of this rejection. Like many intellectuals, albeit for different reasons, Friedman saw a potential danger for democracy in the constitutionalisation of certain economic institutions and economic policies. The tension between democracy and economic constitutional commitments seems indeed plausible, given that it comes in the form of pre-commitments that constrain the future actions of democracies. It is undeniable that any economic policy implies trade-offs; for instance, making inflation reduction a priority almost certainly comes at the expense of unemployment rate^[2]. Yet there are many reasons to believe that such an opposition is highly contingent on the definition of democracy (I). Moreover, the constitutionalisation of economic institutions and policies can in reality be capacity-enhancing (II), comes under different forms and degrees (III), and remains democratic because of its changeable nature (IV).

At the heart of the constitutionalisation of any principle lies the idea that it creates a credible form of commitment, necessary to ensure stability, whether political or economic. Douglass North and Barry Weingast’s seminal work^[3] on the constitutionalisation of property rights in seventeenth-century England is a good example of how both aspects are related: establishing some economic security, namely that the guarantee that property was a right that could not be infringed upon, was achieved through the creation of political veto points not only consistent with, but necessary to democracy. There is a quite general consensus that guaranteeing some economic institutions, like property rights, is not incompatible with democracy. The debate remains, nonetheless, as to which ones, under what conditions, and whether economic policies should also be constitutionalised. And in this regard, it is important to agree on the definition of democracy since all different versions of it have normative consequences on what is acceptable to enshrine in constitutions and what is not. Following Jean-Jacques Rousseau’s direct democracy or Robert Dahl’s view of democracy as a system of pure representation of the people would lead us to deem as undermining democracy, not only the constitutionalisation of economic policies and institutions, but in fact of any type of policies or institutions. On the other end of the spectrum, Joseph Schumpeter’s view of democracy as a procedural system whereby enlightened elites compete for the votes of the people, the task of which is merely that of a choice between a few options^[4], opens more possibilities for such constitutionalisations to be regarded as compatible with democracy. This latter definition seems closer to reality than the more idealistic ones of Rousseau or Dahl, to name but a few; it will therefore serve as a basis for the rest of this essay.

With this important caveat settled, it is now possible to move on to qualify the widespread conception that constitutionalising an economic institution (e.g. an independent central bank) or an economic policy (e.g. setting a deficit limit) is necessarily constraining. On the contrary, pre-commitments can be capacity-enhancing. This true the same way that committing to saving money on a monthly basis through, let’s imagine, a standing order allows one to wilfully constrain his decision power so as to enhance his potential capacities in both the present and the future. Pre-commitments are in fact a way to make sure that ‘Peter drunk’s” potentially irrational and harmful decisions can be constrained by Peter sober’s” cool-headed judgement^[5]. Constitutionalising some economic institutions and policies can in fact increase the capacities for both the present and future generations. Sustainable development has been defined in the Brundtland Report as one that “meets the needs of the present without compromising the ability of future generations to meet their own needs”^[6]. Similarly, constitutionalisation of independent central banks can be seen as capacity-enhancing insofar as it provides the necessary stability without which no democracy can flourish. In a sense, this appeals to Amartya Sen’s notion of capabilities which differentiates real or substantial freedoms from formal ones: democracy needs some stability and prosperity for citizens to fully enjoy their rights. And, given that the mainstream opinion among economists is that independent central banks help achieve lower inflation and stability, the constitutionalisation of those economic institutions is not incompatible with democracy; on the contrary it enables it. Of course, some economists like Joseph Stiglitz^[7] argue that in a world of low-inflation, independent central banks have no raison d’être. What they fail to address, though, is that if inflation is low in the first place, it might very well be thanks to those central banks being independent; in which case their logic is equal to removing the training wheels off a bike based on the assumption that the bike is stable with the wheels. Identically, enshrining “golden rules” about public debt and deficits levels in the constitution is a way to increase the credibility of governments on financial markets, allowing them to borrow at lower interest rates which proves beneficial for both current and future generations. Once again, the constitutionalisation of some economic institutions and policies, far from being detrimental to democracy, is in fact, by virtue of its capacity-enhancing consequences, contributing to it.

        Furthermore, a key aspect to take into consideration when assessing the compatibility of democracy and the constitutionalisation of economic policies and institutions is the way in which such measures are implemented. Certain arrangements might be more in accordance with democracy while other can represent more of a challenge to it. In the case of central banks, for instance, a classic distinction is made between “goal independence” and “instrument independence”^[8]. While the former can reasonably be considered as a threat to democracy, the latter is, without a doubt, more consistent with it. Indeed, the ability to set objectives, goals, and broad policy directions is the very core of the democratic activity. The situation in which an institution would have the capacity to independently set such objectives, regardless of the opinion of the people, would imply a clear violation of the principles of democracy. Contrarily, that an institution can freely set the means by which it achieves democratically-set goals does not mean that it represents a menace for democratic principles. This distinction is essential to understanding why the European Central Bank (ECB), for instance, has not been “undemocratic” in the aftermath of the 2007-2008 crisis. The ECB was entrusted with the goal of maintaining inflation at level comprised between 0% and 2% from its creation. This goal, set by democratically elected and representative governments of the Eurozone, was to be achieved by any means appropriate by the ECB. At the apex of the debt crisis, nonetheless, the democratically elected governments of the Eurozone were able to change the goals of the ECB by adding to its list of objectives the duty not to allow a country to default. This change was implemented when Mario Draghi introduced his unlimited bond-buying policy. Another example in the European context demonstrates the importance of the arrangements and means by which constitutionalisations of economic policies and institutions matter in regard to their degree of democracy. Article 126 of the Treaty on the Functioning of the European Union sets limits for public debt and public deficits. Nevertheless, those limitations take into account the level of structural and cyclical spending. In other words, the limitations are only applicable to what can be considered “normal” economic situations. This flexibility in the application of the article 126 of the TFEU is very consistent with the potential change in fiscal policy that a democracy would require in a time of crisis. Both those examples illustrate the importance of taking into account the particular arrangements that apply to the constitutionalisation of economic institutions and policies; there is room for carrying those out without infringing upon the democratic nature of a regime.

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