The State and Commitments

A perspective on government

For a regime, as for a bank, mortality can be fatal.

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We might think of the state as a set of commitments and mutual obligations between the rulers and the ruled. One of the implications of this perspective is that government must have long-term credibility in order to function.

You might object to the phrase “mutual obligations.” To some libertarians, the obligation seems to go only in one direction. Citizens must obey the government, while the government is free to oppress the citizens. But the authors of the Declaration of Independence did not see it that way.

When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them. . .

The claim implicit in the Declaration is that people can and should rebel against unjust rulers. Political scientists would say that the state needs legitimacy, the belief by citizens that the regime should not be overthrown.

People expect the state to guard them from outside invaders. That means that the state must have military power that the public believes will be around indefinitely in order to provide protection.

People expect the state to provide law and order. That means that the state’s courts and police must be viewed as permanent institutions.

People expect to receive pensions and other benefits from government. That means that government must be expected to be able to raise the revenue needed to provide those benefits.

People who lend to the government expect to be paid back. That means that they believe that in the future the government is always going to have the will and the means to pay its debts.

For government regulation to work, citizens have to believe that regulations will remain in place and enforced for a long time.

A government cannot function if the regime is about to fall. Once the fall of the regime becomes imminent, civil servants can leave their desks, because they know they will not be paid. Soldiers do not know whether their generals are still with the regime or are joining a coup.

Democracy works better than autocracy because the transfer of power does not entail a crisis. In a democracy, the mechanism is in place for a peaceful transfer of power. Civil servants can keep working. Soldiers can remain at their posts. Citizens know that they ought to continue to pay taxes and obey the law. The regime persists.

When an autocrat dies or is overthrow, all of this is up in the air. Maybe he made a succession plan, but maybe he didn’t. If there was a succession plan, maybe it is implemented with no one contesting it, but maybe it isn’t. Once a new leader takes the reins, maybe there is continuity of institutions, or maybe there isn’t. Meanwhile, there is regime uncertainty, and regime uncertainty means that risk premiums are high, and nobody wants to sell insurance or make other long-term commitments.

Robert Higgs argued that the length and severity of the Great Depression in the United States was because we experienced regime uncertainty. Both revolutionaries out of power and radicals within the Roosevelt Administration created doubts in the minds of capitalists that long-term investments would be sufficiently protected to earn rewards.

Regime uncertainty undermines the banking system. If the government will not be there tomorrow to enforce contracts between banks and borrowers, then how can depositors be confident that their own contractual relationships with banks will be honored? When the fall of a government is imminent, worried depositors rush to transfer money overseas.

In fact, for banking to work, banks must convince their customers that the bank is a perpetually-lived institution. Back in the day, that is what those marble lobbies were all about. As soon as the public gets a whiff that the bank might fail, unless another bank or the government steps in with a guarantee, the people will run from the bank, and it will fail.

Banks and government operate on the basis of long-term commitments. They must make long-term commitments in order to function effectively. And people must believe in those long-term commitments in order for them to work.

My reading of Niall Ferguson’s The Cash Nexus is that it shows how banks can reinforce confidence in government (by supporting government debt) and governments can reinforce confidence in banks (with policies, including deposit insurance, that reassure bank customers). I expect that we will find confidence in banks where we find confidence in government, and vice-versa. When either experiences a sharp drop in confidence, a sharp drop in confidence in the other is likely to follow.

Banks and government succeed when people are convinced of their immortality. I like to say that for either institution, mortality can be fatal.

This essay is part of a series on human interdependence.