Liberal Democracies and Authoritarian Regimes: The Case for Law Enforcement. (Part 10 of 12)

However, theorizing about law enforcement takes on vital importance when it comes to considering whether a low level of law enforcement denatures the Rule of Law in such a way that it implies, de facto, a change of regime. That is, when it happens that, under the shell of a constitutional system, an increasingly authoritarian system begins to develop, which successively curtails freedoms and deteriorates the viability of individual life plans, denigrating the dignity of people, through the file to weaken the application of the legal norms destined to protect said rights, guarantees, and freedoms.

For this reason, a liberal political regime requires a substantive content that involves the express recognition of individual freedoms and rights, but also requires in a vital way the respect and enforcement of those procedures that make their effective exercise possible. This is, through a high degree of law enforcement, previously inspired by those political principles typical of liberal democracies.

When we are in the presence of a constitutional system that is designed to guarantee the existence of a government limited by the law itself and to protect the freedoms and rights of individuals, a low level of application of legal norms implies a true denaturalization of such a regime. political and a de facto transition to an authoritarian system of government. As has been pointed out, given that the low law enforcement imposes high opportunity costs on those who spontaneously choose to comply with the law and places them at a severe disadvantage compared to their competitors, the reduced law enforcement works as an incentive to generate low regulatory compliance by the population. In turn, assigning such low regulatory compliance by citizens to cultural or ethnic characteristics works as a pseudo-sociological foundation to increase punishments and continue the aforementioned de facto transition towards an authoritarian or totalitarian system.

A similar mechanism had been noted at the time by Friedrich Hayek in his well-known book The Road to Serfdom, although he did not focus so much on the low law enforcement as on the pretexts and excuses used to justify such a transition towards an authoritarian system. Generally, in a mistaken way, the “road to serfdom” is characterized as a process of increasing state interventions, but such assertion does not constitute the core of either the aforementioned book or about what should be understood by a road of servitude. As Hayek stated on that occasion, we are not faced with a political process of this type when governments intend to carry out a plan of social and economic transformation in accordance with a model of society whose characteristics are rarely stated expressly and which is placed above the procedures and constitutional safeguards designed to legally limit the power of governments and defend the rights and guarantees of individuals. Thus, the system of constitutional safeguards is seen as too onerous an obstacle for the transformation process set in motion and, consequently, it begins to be de facto repealed through a low level of regulatory application and the gradual replacement of a political decision-making system. based on rules by another of decisions taken based on the opportunity, merit and convenience related to the aforementioned model of society to which it is aspired to achieve.

Both in the case of the path of servitude, as of a smooth and flat deterioration of the levels of law enforcement, we find ourselves in the presence of a transition of political regime: from the Rule of Law towards an increasingly authoritarian system: the government of the pure will of men, free from legal and constitutional ties. In both cases, the validity of the notion of individual freedom as the absence of arbitrary coercion is under serious threat.

As it will have to be repeated every time it is necessary to do so, it does not depend on cultural, historical or ethnic traits. Such processes of political regime change respond to an incentive system that perverts the functional dynamics of the Rule of Law. In the case under study here, the low application of legal norms.

But to describe with a greater degree of precision what the aforementioned process of de facto change of the political regime, from liberal democracy and the Rule of Law to authoritarian or totalitarian systems consists of, it is necessary to delve into the distinction between decisions based on rules and those that are They are motivated by reasons of opportunity, merit or convenience, that is, in the exercise of discretionary power.

As previously admitted in this writing, every government official, whether he belongs to the administration or is a judicial magistrate, enjoys a certain margin of discretion in the exercise of his functions and within the framework of competences that the Constitution and the laws give him. grant. Thus, a judge can say the right for a specific case that is subject to his jurisdiction within a range of alternative solutions that the law and judicial precedents impose on him. Thus, we are not faced with a mechanical law enforcement -which is reminiscent of the modern aspiration of “mechanization of thought” – but rather in a judgment of the adequacy of the rules to the specific case that the courts carry out taking into account the special circumstances of people, time, and place that the law, being expressed in abstract and general terms, cannot foresee. However, such adaptation of the law to the specific case should not in any way distort the meaning, scope and purpose of the law. Something similar occurs with administration officials, who enjoy certain powers granted by law and who have a margin of discretion to operate within it, which is subject to control by other hierarchical state bodies, superior or judicial.

Likewise, there are situations in which both judges and public officials deviate exceptionally from the abstract and general guidelines of the laws without them configuring any illicit, that is, exceptions that are within the legal system itself. Thus, we find ourselves in the judicial sphere with judgments that are based on notions of justice and equity and in the administration sphere with discretionary powers expressly granted to officials by law.

[Editor’s note: this is Part 10 in a 12-part essay; you can read Part 9 here or read the essay in its entirety here.]

Liberal Democracies and Authoritarian Regimes: The Case for Law Enforcement. (Part 9 of 12)

If individual freedom is defined as the absence of arbitrary coercion – as F. A. Hayek did in his The Constitution of Liberty (1960) – it is clear that a government that bases most of its decisions on rules known to all will have to be less arbitrary than the one who makes decisions according to his own criteria of opportunity. Of course, this also requires an effective notion of the principle of equality before the law, since decisions based on norms that prescribe privileges according to definitions of races, estates or social classes will also be arbitrary. The same occurs with the other characteristics of what some authors have called a free government: division of powers, system of cross-checks between them, declarations of rights and guarantees, principles such as that of closure, the notion of representativeness of public offices and the requirement of their suitability to exercise them and other elements that make up the Rule of Law. The protection of individual liberty as the absence of arbitrary coercion comprises a whole set of political institutions and judicial procedures that make the limits to the free will of citizens and rulers legitimate. However, the level of law enforcement has generally been considered sidelong for both political and legal theory, relegating it to a purely sociological and even anthropological level. The law enforcement thus appears as a kind of “logical form” of law and politics, since it does not fully belong to either of the two territories, but rather delimits them.

This meant that the level of normative application has been seen as a social phenomenon, which in any case could be studied by an intersection between sociology and economics, as can be seen in the studies carried out by Gary Becker at the time; the same as the approach practiced centuries ago by Cesare Beccaría (who Joseph Schumpeter would label “the Italian Adam Smith”).

However, the high or low level of application of legal norms does not in itself constitute a sociological or anthropological phenomenon, since the commitment to the effective law enforcement depends directly on a political decision. This political decision activates a series of feedback mechanisms in society that allows it to be described as an autonomous and automatic system, as is any incentive system, but such uses and social practices are not the cause of regulatory compliance or non-compliance, but rather its adaptive response to the aforementioned political decision that underlies at all times.

Therefore, an approach that characterizes low regulatory compliance as the social response to the political decision to implement a low level of law enforcement requires a behavioral model consisting of individual utility-maximizing agents in their decisions, both at the level of citizens as well as government officials and magistrates. According to this behavioral model, it is government agents who seek to maximize their power by reducing the level of law enforcement, in order to gain discretion in its exercise; while ordinary citizens seek to minimize the costs of such discretion on the part of the rulers trying to evade compliance with a law that in a relatively low number of cases is actually applied.

Putting an end to such a state of affairs depends on a political decision: that of enforcing the law for the majority of cases and limiting exceptions to it to the minimum possible. However, since this will bind the rulers to the law and reduce their discretionary power, it should not be expected that such a decision will be taken spontaneously by the governing bodies, but under pressure from the branches of the state whose function consists of the control of government acts, such as the congress and the judicial system.

However, as already mentioned, the political system itself is in a trap, since raising the levels of law enforcement right off the bat would mean making effective punishments and sanctions pressed for a lower level of enforcement. For this reason, an improvement in the levels of law enforcement requires, previously or at least simultaneously, a reduction in the volumes of repressive sanctions, fines and compensation. A similar reasoning must be done for tax collection cases, since many times the tax levels discount a certain evasion rate. Reducing the tax evasion rate requires a prior or simultaneous tax reduction.

Law enforcement and political regime

As has been stated, the degree of compliance with legal norms by a population does not depend on cultural issues (far from it, ethnic), but is a variable on which governments can influence in a decisive way. The main instrument that governments have when it comes to encouraging (or discouraging) citizens’ compliance with the right is to regulate the degree of law enforcement. Once it has been decided what degree of regulatory compliance by the population the government intends to achieve, it remains to implement an efficient use of the budget item in order to achieve said objective while sacrificing the least amount of resources possible.

Thus, if a government decides that regulatory compliance should be close to 100%, then it will have to provide its supervisory system, security forces, and its judiciary with the necessary resources to obtain such a degree of law enforcement that show a clear signal to the population that the sanctions, repressive or pecuniary, that the law provides, will have to be applied. This will mean that whoever complies with the law will not incur any opportunity cost in terms of waiving possible advantages derived from its non-compliance, since such non-compliance by its competitors and other third parties is highly unlikely.

Of course these considerations belong to the field of “instrumental reason.” Before discussing the necessary mechanisms to achieve a high degree of compliance with the law by the population, it is imperative to discuss what type of law such a political regime will have. A democratic, modern, and liberal regime requires that the laws respect and ensure the validity of certain values, such as recognition and respect for human dignity, the right of each individual to have their own life plan, or as at the time It had been listed by the Scottish philosopher David Hume, ensuring stability in possession, his peaceful transfer of property, and the fulfillment of promises. It is useless to theorize about techniques to achieve a high degree of compliance with the law, if they are to be used by a regime that is dedicated to curtailing freedoms.

[Editor’s note: this is Part 9 in a 12-part essay; you can read Part 8 here or read the essay in its entirety here.]

Liberal Democracies and Authoritarian Regimes: The Case for Law Enforcement. (Part 3 of 12)

This reference to the distinction of values ​​between the short and the long term also refers to the theory of capital and interest that Eugen v. Böhm-Bawerk and Austrian and Swedish economists who followed him in such developments, such as Ludwig v. Mises, Knut Wicksell, the already named Friedrich Hayek, Ludwig Lachmann, or the British economist John Hicks. Current economic science recognizes the element of time preference in the interest rate, but emphasizes the predominance of the value of money as its main component. In contrast to this, the Austrian and Swedish economists referred to had emphasized a characteristic of homo economicus that brought them closer to the behavioral presuppositions of David Hume: agents prefer the same good in the present than in the future, or, expressed in other terms, for an individual to agree to defer the use of a present good towards a future time, such abstention from consumption must be compensated by an increase in the future value of such good. Thus, if a person lends a certain sum of money and therefore incurs an opportunity cost by abstaining from its consumption, it is because he expects to receive compensatory interest on his waiting in the future. Of course, Böhm-Bawerk’s theory of interest received its timely evaluation by numerous economists, pointing out its weaknesses and subsequent developments by his disciples met with mixed luck – to the point that, for example, Friedrich Hayek declared that he had never undertaken the task of writing the second part of his work The Pure Theory of Capital attentive to the extreme complexity of the theory of interest that inspired him. However, re-expressing David Hume’s legal-political theory in terms of the Austrian and Swedish theory of capital represents an intellectual exercise with a significant heuristic function.

In “natural” terms, an individual will “spontaneously” fulfill a promise if he calculates that the present value of breaching it is less than the future loss of credit with respect to his creditor or the community with which he habitually – a term proper to the Humean empiricism – it interacts. This is consistent with Hume’s own theory of empathy, according to which each individual can understand how his neighbor would feel and judge a certain situation, better if he is someone known than a complete stranger. Thus, the tendency to cheat is less corroborated with those who have the expectation of interacting more than those in whom the interaction will occur in a single play – as illustrated by the best known game theory.

We can thus see how, in the absence of the incentives provided by the coercive powers on the part of the state, the natural tendency to keep promises is better corroborated among acquaintances, with continuous interaction over time, than with strangers with what will have to be done. interact only once. This is what led David Hume, likewise, to reject any theory of the social contract – since, by definition, in the supposed state of nature there would be no one to guarantee its fulfillment – and to consider that, in a primitive stage of the individual and society, the primordial political unit would have to be the family – in fact, the very etymological meaning of this term conveys a “micro-political” connotation.

It will be later Adam Smith who will extend the foundation of a human interaction order beyond the nearby nuclei through his concept of “Great Society,” in which unknown subjects are capable of spontaneously coordinating their respective activities through the signals transmitted by the system. of prices, which indicates the relative modifications in the terms of exchange of complementary and substitute goods, contemporary or deferred in time. However, neither did Adam Smith deny a fundamental function that some mechanism must fulfill in order to emerge and sustain such an extended cooperation order: the application of the norms of peaceful coexistence, which guarantee stability in the possession of goods, the transfer by consent of said possession and the fulfillment of the contracts entered into for the purpose of perfecting said transfers.

Consequently, the problems of law enforcement, which concern the degree of effective compliance with the legal norms that condition human conduct, must represent a major chapter of the political philosophy and theory that characterizes legal institutions and policies as true incentive systems.

[Editor’s note: this is Part 3 in a 12-part essay; you can read Part 2 here or read the essay in its entirety here.]

Liberal Democracies and Authoritarian Regimes: The Case for Law Enforcement. (Part 2 of 12)

Obviously, there is a whole question of information and transaction costs surrounding the game between empirical social norms and positive legal norms. The former are more agile and immediate, better adapted to the circumstances, but at the same time they are not enough to guarantee peace when the interests at stake gain social relevance. There are cases in which the legal system takes advantage of the immediacy of the empirical norms to give dynamism to the daily traffic and at the same time reserves the last word for a case of serious controversy: it is the referral made by the positive right to the validity of uses and customs. A typical example of this is commercial law.

Although in another frame of reference, but in the same vision, we can find in David Hume an antecedent of this distinction between empirical and positive norms. The Scottish philosopher called the first “natural virtues” and the second “artificial virtues,” and it was precisely justice that was among the latter. In turn, in the 20th century, Friedrich Hayek expressly collected his political philosophy in order to enunciate his concept of “spontaneous order”, which, among other characteristics, consisted of that diffuse zone in which the norms have not yet bifurcated between empirical and positive – and for which reason it is so elusive to categorize the first volume of Law, Legislation and Freedom, entitled “Norms and order,” either within social theory or within the theory of law.

The truth is that – something that Hayek did not have the opportunity to address – in that diffuse area in which it is difficult to distinguish a social norm with empirical compliance from another with recognition by the legal system – to use H. L. A. Hart’s own concepts – a determining factor for both types of norms, in addition to the violence that its non-compliance or its subsequent retaliation may involve, is the opportunism that acts as an incentive for the acting agents -with which here we return to the Humean distinction between natural and artificial virtues: stability in possession, the peaceful transfer of it and the fulfillment of promises are three virtues that make up the idea of ​​justice but that, for its fulfillment, require from the agents a general vision of the social consequences compliance or non-compliance, or the incentive provided by government sanctions in anticipation of non-compliance.

Opportunism on the part of private agents consists in preferring a present good to deferring that good in order to obtain a greater good in the future. For example, breaking a promise in a pressing situation constitutes a present greater good for the defaulter. However, the generalization of such default by all debtors would destroy a credit system that would, in the future, go against the interests of the entire society as a whole, including the defaulter himself. However, for the debtor, the default means an obvious immediate advantage, which can only be counteracted by the threat of a social sanction – stop being seen and treated as a “good businessman” – and, if this does not reach to modify their behavior, due to the threat of a legal sanction, such as compensation for non-compliance or, if necessary and if this non-compliance had been deliberate and obtained through a ruse, imprisonment.

It is here where the superiority of representative democracy is manifested over direct democracy, and of mixed systems, which combine long-term and even life-long terms or “while their good conduct lasts.” In these cases, the rulers exercise the “opportunism” of enforcing the law, following the adage of Herman Melville regarding “private vices, public benefits” or Machiavellian realism: greater wealth and, consequently, higher taxes come from societies in those that are characterized by a high fulfillment of promises and contracts, since it goes without saying that, abstaining from a present good to achieve a greater good in the future, generates in the long term a greater volume of wealth than enjoying a good present at the cost of giving up future good. If a government had to be revalidated daily, its incentive to stay in office would be to make short-term benefits prevail. Likewise, it is not only enough with a political system with stability in office, but also with legal and political responsibilities around the demand to make the long term prevail over the short term.

In this distinction between legal responsibilities and political responsibilities of officials, the Humean distinction between artificial virtues (the legal responsibility for the poor performance of the position) and the natural virtues (the personal desire to continue in office, through re-election or by avoiding impeachment). The legal-political system is articulated through opposite incentives: individuals have a “natural” tendency to breach promises, which is counteracted by the incentive of the legal system that establishes forced fulfillment of contracts; while the political system is expected to align incentives in such a way that rulers have “the natural tendency” to enforce contracts. This natural tendency of the rulers does not come from any “natural” characteristic of the person of the ruler but from the incentives provided by the constitutional system.

[Editor’s note: this is Part 2 of a 12-part essay; you can read Part 1 here or the whole essay in its entirety here.]


  1. Frederick Douglass and a glorious liberty Tony Williams, Law & Liberty
  2. Dealing with terrorists Michael Koplow, Ottomans & Zionists
  3. An oral history of Texas punk Pat Blashill, Southwest Review
  4. Institutions, machines, and complex orders Federico Sosa Valle, NOL


  1. The highway to serfdom (pdf) Gus DiZerega, Cosmos + Taxis
  2. Russia’s greatest river Farah Abdessamad, ARB
  3. A marketplace and a temple (h/t Michalis) Michael Kulikowski, LRB
  4. politics are now entirely a consumer-branding exercise” Antonio Garcia-Martinez, TPR


  1. The anti-colonial revolution Adom Getachew (interview), Tribune
  2. Testing balance-of-power theory in world history (pdf) Deudney, et al, EJIR
  3. Hayekian balance-of-power theory (pdf) Edwin van de Haar, TIR
  4. Globalization and peace: A Hayekian perspective (pdf) Adrián Ravier, LP


  1. Hayek and Cassel on the Great Depression David Glasner, Uneasy Money
  2. Giving Trump the OJ treatment Thomas Knapp, WLGC
  3. Liberalism in Brazil Lucas Berlanza, Econ Journal Watch
  4. Brazil will not become Venezuela Bruno Rosi, NOL


  1. Hayek, spontaneous order (pdf) Scott Boykin, TIR
  2. Karl Marx Branko Milanovic, globalinequality
  3. United Arab Emirates Rafia Zakaria, Baffler
  4. American capitalism Edward Glaeser, City Journal


  1. Varieties of capitalism Milanovic & Ranaldi, VoxEU
  2. Shakespeare in the military Jacqueline Whitt, War on the Rocks
  3. Tyranny unmasked Don Boudreaux, Cafe Hayek
  4. Of Habsburgs and Hayek Robert Bellafiore, Modern Age


  1. The politics of self-esteem Mikko Tolonen, Liberty Matters
  2. Between Allah and America Farzana Shaikh, Literary Review
  3. A history of the Russian bathhouse Rachel Polonsky, NYRB
  4. But when will Conor Friedersdorf leave the Atlantic?

The Seldon Fallacy

Like some of my role models, I am inspired by Isaac Asimov’s vision. However, for years, the central ability at the heart of the Foundation series–‘psychohistory,’ which enables Hari Seldon, the protagonist, to predict broad social trends across thousands of galaxies over thousands of years–has bothered me. Not so much because of its impact in the fictional universe of Foundation, but for how closely it matches the real-life ideas of predictive modeling. I truly fear that the Seldon Fallacy is spreading, building up society’s exposure to negative, unpredictable shocks.

The Seldon Fallacy: 1) It is possible to model complex, chaotic systems with simplified, non-chaotic models; 2) Combining chaotic elements makes the whole more predictable.

The first part of the Seldon Fallacy is the mistake of assuming reducibility, or more poetically, of NNT’s Procustean Bed. As F.A. Hayek asserted, no predictive model can be less complex than the model it predicts, because of second-order effects and accumulation of errors of approximation. Isaac Asimov’s central character, Hari Seldon, fictionally ‘proves’ the ludicrous fallacy that chaotic systems can be reduced to ‘psychohistorical’ mathematics. I hope you, reader, don’t believe that…so you don’t blow up the economy by betting a fortune on an economic prediction. Two famous thought experiments disprove this: the three-body problem and the damped, driven oscillator. If we can’t even model a system with three ‘movers’, because of second-order effects, how can we model interactions between millions of people? Basically, with no way to know which reductions in complexity are meaningful, Seldon cannot know whether, in laying his living system into a Procustean bed, he has accidentally decapitated it. Using this special ability, while unable to predict individuals’ actions precisely, Seldon can map out social forces with such clarity that he correctly predicts the fall of a 10,000-year empire. Now, to turn to the ‘we can predict social, though not individual futures’ portion of the fallacy: that big things are predictable even if their consituent elements are not.

The second part of the Seldon Fallacy is the mistake of ‘the marble jar.’ Not all randomnesses are equal: drawing white and black marbles from a jar (with replacement) is fundamentally predictable, and the more marbles drawn, the more predictable the mix of marbles in the jar. Many models depend on this assumption or similar ones–that random events distribute normally (in the Gaussian sense) in a way that increases the certainty of the model as the number of samples increases. But what if we are not observing independent events? What if they are not Gaussian? What if someone tricked you, and tied some marbles together so you can’t take out only one? What if one of them is attached to the jar, and by picking it up, you inadvertently break the jar, spilling the marbles? Effectively, what if you are not working with a finite, reducible, Gaussian random system, but an infinite, Mandelbrotian, real-world random system? What if the jar contains not marbles, but living things?

I apologize if I lean too heavily on fiction to make my points, but another amazing author answers this question much more poetically than I could. Just in the ‘quotes’ from wise leaders in the introductions to his historical-fantasy series, Jim Butcher tells stories of the rise and fall of civilizations. First, on cumulative meaning:

“If the beginning of wisdom is in realizing that one knows nothing, then the beginning of understanding is in realizing that all things exist in accord with a single truth: Large things are made of smaller things.

Drops of ink are shaped into letters, letters form words, words form sentences, and sentences combine to express thought. So it is with the growth of plants that spring from seeds, as well as with walls built from many stones. So it is with mankind, as the customs and traditions of our progenitors blend together to form the foundation for our own cities, history, and way of life.

Be they dead stone, living flesh, or rolling sea; be they idle times or events of world-shattering proportion, market days or desperate battles, to this law, all things hold: Large things are made from small things. Significance is cumulative–but not always obvious.”

–Gaius Secundus, Academ’s Fury

Second, on the importance of individuals as causes:

“The course of history is determined not by battles, by sieges, or usurpations, but by the actions of the individual. The strongest city, the largest army is, at its most basic level, a collection of individuals. Their decisions, their passions, their foolishness, and their dreams shape the years to come. If there is any lesson to be learned from history, it is that all too often the fate of armies, of cities, of entire realms rests upon the actions of one person. In that dire moment of uncertainty, that person’s decision, good or bad, right or wrong, big or small, can unwittingly change the world.

But history can be quite the slattern. One never knows who that person is, where he might be, or what decision he might make.

It is almost enough to make me believe in Destiny.”

–Gaius Primus, Furies of Calderon

If you are not convinced by the wisdom of fiction, put down your marble jar, and do a real-world experiment. Take 100 people from your community, and measure their heights. Then, predict the mean and distribution of height. While doing so, ask each of the 100 people for their net worth. Predict a mean and distribution from that as well. Then, take a gun, and shoot the tallest person and the richest person. Run your model again. Before you look at the results, tell me: which one do you expect shifted more?

I seriously hope you bet on the wealth model. Height, like marble-jar samples, is normally distributed. Wealth follows a power law, meaning that individual datapoints at the extremes have outsized impact. If you happen to live in Seattle and shot a tech CEO, you may have lowered the mean income in the group by more than the average income of the other 99 people!

So, unlike the Procustean Bed (part 1 of the Seldon Fallacy), the Marble Jar (part 2 of the Seldon Fallacy) is not always a fallacy. There are systems that follow the Gaussian distribution, and thus the Marble Jar is not a fallacy. However, many consequential systems–including earnings, wars, governmental spending, economic crashes, bacterial resistance, inventions’ impacts, species survival, and climate shocks–are non-Gaussian, and thus the impact of a single individual action could blow up the model.

The crazy thing is, Asimov himself contradicts his own protagonist in his magnum opus (in my opinion). While the Foundation Series keeps alive the myth of the predictive simulation, my favorite of his books–The End of Eternity (spoilers)–is a magnificent destruction of the concept of a ‘controlled’ world. For large systems, this book is also a death knell even of predictability itself. The Seldon Fallacy–that a simplified, non-chaotic model can predict a complex, chaotic reality, and that size enhances predictability–is shown, through the adventures of Andrew Harlan, to be riddled with hubris and catastrophic risk. I cannot reduce his complex ideas into a simple summary, for I may decapitate his central model. Please read the book yourself. I will say, I hope that as part of your reading, I hope you take to heart the larger lesson of Asimov on predictability: it is not only impossible, but undesirable. And please, let’s avoid staking any of our futures on today’s false prophets of predictable randomness.

Efficient markets as normative systems

Recently, I came across this outstanding interview with Eugene Fama published by The Market / NZZ. Besides the main subject discussed -the inability of central banks to control inflation-, the interview is intertwined with gripping assertions about the limits of knowledge, such as the following ones:

Bubbles are things people see in hindsight. They don’t identify them in advance. Sure, you can look at the behavior of prices, and you may be able to identify cases where they are too high. But if you only look back and say: «Oh, stocks went down a lot, so that was a bubble», then that’s 20/20 hindsight. At the time, there was no evidence that there was a bubble.

I don’t say markets are completely efficient, but they’re efficient for most questions that I address. Models are never a 100 % true. If they were, we would call them reality, not models. But for almost all purposes, market efficiency is a very good approximation.

The real question is: How do you pick Warren Buffett? The way you pick him is after the fact, since he has done very well. Now, suppose I take 100,000 investors and say: Let’s let them run for 30 years and pick out the winner. Because you roll the dice so many times, even if none of them is a good or bad investor, many investors will do well and many will do poorly purely by chance. Statistically there is also going to be a big winner, but solely due to chance. In other words: There will be extremely good outcomes and extremely bad outcomes, but you just can’t tell who is successful because of luck and who because of skill.

This quotations resemble the distinction made by Friedrich Hayek between relative and absolute limits to explanation (The Sensory Order, 1952):

8.67. Apart from these practical limits to explanation, which we may hope continuously to push further back, there also exists, however, an absolute limit to what the human brain can ever accomplish by way of explanation -a limit which is determined by the nature of the instrument of explanation itself, and which is particularly relevant to any attempt  to explain particular mental processes.

8.68. If our account of the process of explanation is correct, it would appear that any apparatus or organism which is to perform such operations must possess certain properties determined by the properties of the events which it is to explain. If explanation involves that kind of joint classification of many elements which we have described as “model-building”, the relation between the explaining agent and the explained object must satisfy such formal relations as must exist between any apparatus of classification and the individual objects which it classifies (Cf. 5.77-5.91).

5.90. The model building by such an apparatus of classification simplifies the task and extends the scope of successful adaptation in two ways: it selects some elements from a complex environment as relevant for the prediction of events which are important for the persistence of the structure, and it treats them as instances of classes of events. But while in this way a model building apparatus  (and particularly one that can be constantly improved by learning) is of much greater efficiency than could be any more mechanical apparatus which contained, as it were, a few fixed models of typical situations, there will clearly still exist definite limits to the extent to which such a microcosm can contain an adequate reproduction of the significant factors of the macrocosm.

8.69. The proposition which we shall attempt to establish is that any apparatus of classification must possess a structure of a higher degree of complexity than is possessed by the objects which it classifies; and that, therefore, the capacity of any explaining agent must be limited to objects with a structure possessing a degree of complexity lower than its own. […]

Being confronted with an absolute limit to explanation does not mean that chaos lies outside those limits. Indeed, what we have beyond the scope of our models is a complex order -in this case, efficient markets. A kind of order whose “[…] existence need not manifest itself to our senses but may be based on purely abstract relations which we can only mentally reconstruct” (F. A. Hayek, “Law, Legislation, and Liberty”, Chapter II; 1973), and because of that its explanation finds not practical limits but absolute ones. For example, in this field, “passive investing” would be homologous to a law-abiding behaviour or to the moral saying “being honest is the best policy”. Of course, for such systems -economic, legal or moral- to evolve there have to be some “prices”, i.e.: people who trade in the short term or who perform innovative behaviours which establish a new legal precedent or a new habit.

But for this innovation to happen it is indispensable for the agents to count on a framework of stable regularities -usually called abstract or spontaneous orders- upon which they could draw their own “maps”, create new expectations, and coordinate their plans with other agents. That indicates that we have already spent enough ink writing about the economic way of looking at the law, and perhaps it is time to start pondering markets as complex normative systems.


  1. The Fatal Conceit of F. A. Hayek (pdf) Larry Sechrest, Reason Papers
  2. Democracies are spontaneous orders, not states (pdf) Gus DiZerega, Cosmos+Taxis
  3. Empire: public good and bads (pdf) Coyne & Davies, Econ Journal Watch
  4. Bangladeshi colonies in space Asif Saddiqi, Los Angeles Review of Books


  1. 9/11 + 19: Lessons Irfan Khawaja, Policy of Truth
  2. Misinformation and foreign policy Scott Sumner, EconLog
  3. The Hayek question Chris Dillow, Stumbling & Mumbling
  4. Why not anarchy? Daniel McCarthy, Modern Age