Byzantine political economy

With Sinclair Davidson and Jason Potts. Originally a Medium post

For more than three decades economists and cryptographers have been working on the same problem.

Neither species has recognised their own work in the other.

But it turns out that the question of how to coordinate a society and how to ensure communication can be trusted is the same question differently phrased.

Our argument in this essay is simple: What cryptographers call byzantine fault tolerance and economists call robust political economy is the same thing.

This observation turns out to have some significant consequences for understanding the history of economic thought and the directions of institutional cryptoeconomics.

But to explain why, let’s quickly revisit one of the most important debates in the history of economics.

The socialist calculation debate

Economists from Adam Smith on have sought to explain the wealth of nations — why some nations are prosperous and others are not. By the twentieth century this debate had coalesced into a debate about which of two economic systems (communist central planning or capitalist decentralised markets) were more likely to bring prosperity.

Smith argued that market societies were characterised by spontaneous orders. Social order came from market incentives.

Karl Marx objected that the state (or some central coordinating authority) could produce superior outcomes to the market through conscious, deliberate planning.

Before the socialist calculation debate the liberal critique of socialism focused on the problem of incentives — how could a socialist community convince people to work hard if the product from their labour was redistributed? (See, for example, the discussion of socialism in Bruce Smith’s 1887 book Liberty and Liberalism.)

In 1920 the Austrian economist Ludwig von Mises published Economic Calculation in the Socialist Commonwealth. In this essay, Mises made a new, fundamental critique of socialist planning — the problem of information.

In a market economy, Mises argued, prices constitute signals about the highest value use of a good or service, providing a guide for what goods were in demand, and which were in a glut.

But a socialist system has no prices. As one of us has described Mises’ argument,

How would [a socialist planner] decide whether to send rubber to Tyre Factory 12 or Hose Factory 7? In a market economy, the factory that needed the rubber most would be willing to pay the highest price. But there is no natural price system in socialism — consumer prices are decided by the planner, and rubber allocated according to their diktat.

Mises’ critique of socialism was extended and elaborated by Lionel Robbins and Friedrich Hayek. Hayek turned this argument into one of the greatest essays in economics: ‘The Use of Knowledge in Society’, where he described prices as a decentralised knowledge network.

Centralised computer socialism

The Mises and Hayek argument today is well known, particularly after they seemed to be proven right by the fall of the Berlin Wall. By contrast, their opponents in the debate are less read today.

Mises and Hayek’s criticism was answered by the Polish economist Oskar Lange and extended by Hayek’s Russian-born student Abba Lerner.
Lange and Lerner accepted the importance of the price system in organising economic activity. But they argued that this system could be simulated mathematically.

Working firmly in the equilibrium economics school Vilfredo Pareto and Léon Walras, they imagined the price system as computational machine. In On the Economic Theory of Socialism, published first in 1936 and 1937, Lange concluded that a socialist economy could simulate the effect of the price system by trial and error.

Lange revisited his argument 30 years later. “Were I to rewrite my essay today my task would be much simpler”, wrote Lange:

My answer to Hayek and Robbins would be: so what’s the trouble? Let us put the simultaneous equations on an electronic computer and we shall obtain the solution in less than a second. The market process with its cumbersome tâtonnements appears old-fashioned. Indeed, it may be considered as a computing device of the pre-electronic age.

Not only could computers simulate the market but the computer could conduct long range planning and implement that plan — “a function which the market never was able to perform”.

How decentralised is Hayek’s market, really?

It is typical to cast these two visions of the economy as Lange’s centralised planned economy and Hayek’s decentralised market.

But Hayekian decentralisation still has a lot of centralisation in it.

Here the Marxists are right. Free markets have an awful lot of state involvement in them. Property is private but its enforcement relies heavily on public authorities — the legal system courts, sheriffs, police.

But what both the Hayekians and the Marxists missed is that property rights are not only about enforcement. They’re about the identification and verification of property rights. And (right now) the state does most of that.

As we argued in our previous essay, so much of what the modern state does is endorse, manage, and verify ledgers of social relations. The state manages the property titles register. It manages ledgers of social security entitlements. It manages the ledgers of who is a citizen and who can therefore participate in political bargaining.

This is a very big, important, and largely unappreciated function that the state fulfills. The state does is in charge of these crucial ledgers because it is a large ‘trusted’ entity. But of course how much we can trust the state is questionable.

The invention of the blockchain presents us with new institutional choices.

A new typology of political economy

In our new typology of political economy, political ideas are arranged in a grid of centralised and decentralised economies, and decentralised and decentralised ledgers.

In Lange’s computer socialism, the economy is centralised and the ledger is centralised — the state is a planning machine, both managing the ledger and executing a global plan.

In pre-Marxist communalism, such as the scheme devised by the Welsh utopian socialist Robert Owen, economic planning is centralised but the relevant jurisdiction — that is, the ledger-providing authority — consists of subnational groups of voluntary, socialistic communities.

Hayekian distributed capitalism has a decentralised economy — planning is done by individuals rather than the state — yet the state still organises, records, verifies and updates the ledgers of identities, rights, obligations, and entitlements.

By contrast, in a cryptoeconomy both the economy and the ledgers are decentralised. Blockchains take the state out of both planning and verification.

Information and incentives

Markets work because they align incentives into productive work and they harness distributed information productively.

In the second half of the twentieth century the public choice school extended the incentives critique to encompass the incentives of the planners themselves. How could a socialist commonwealth ensure that planners worked in society’s interest, rather than their own personal interest?

Today, what scholars now call a ‘robust political economy’ (see Mark Pennington’s book and this paper by Peter T. Leeson and J. Robert Subrick) is an economic system structured to deal with the twin problems of information and incentives. How can we coordinate action — make exchanges, build relationships and communities — in a world of incomplete information and potential rentseeking?

Turns out, cryptographers and computer scientists have been working on these two problems as well.

The Byzantine Generals’ Problem

Distributed computing systems have to deal with what is known as the Byzantine Generals’ Problem.

This problem was first expressed in 1982. Imagine a Byzantine army surrounding an enemy city.

Illustration from the 12th century Madrid Skylitzes, a history of Byzantium between 811 and 1057

The army consists of divisions, each headed up by a general, and they need to establish a consensus about when exactly to launch their attack on the city.

Centralised command is out of the question. No individual general has line of sight to all the generals — or the authority to impose consensus on the whole army at once. They can only communicate by messenger.

So there’s an information problem. The generals need a system — an algorithm — that allows all generals to agree on a consensus.

The problem is made even harder because it’s not certain that all generals are loyal. Some have been paid off by the enemy, and are actively trying to disrupt the plan. The traitorous generals don’t want the loyal generals to come to a consensus.

Thus Byzantine Generals’ Problem describes the challenge of a) achieving consensus in distributed, decentralised systems b) when information flows imperfectly, and c) in the presence of adversaries.

Blockchains achieve Byzantine fault tolerance in part by treating it as an incentive problem. The Bitcoin proof-of-work mechanism incentivises good behaviour, makes it extremely expensive to attack the network, and reduces the payoffs for a successful attack.

The so-called ’51 per cent’ attack on Bitcoin — the possibility that a majority of hashing power could coordinate and then undermine the network — is what would happen if more than half the generals were traitors. (Of course, that itself would be hard to coordinate.)

Two fields together

A decision to attack a city simultaneously is just a narrow slice of the general economic problem: how to coordinate activity in when information is incomplete, communication is imperfect, and people can be lazy, opportunistic, and self-interested.

What computer scientists have been trying to solve algorithmically, economists have been trying to solve constitutionally.

Where cryptographers have found their solutions in public key cryptography and proof of work mechanisms, economists have found solutions in markets, regulation, and institutions.

Blockchains bring these two fields together. They turn constitutional questions into algorithmic questions, and algorithmic questions into constitutional ones.

Byzantine political economy

One way to see this is as a curious historical instance of two largely unrelated fields (computer science and economics) somewhat simultaneously working on a structurally similar problem (decentralised coordination) and arriving at the same type of solutions (consensus protocols and market institutions).

But a more interesting perspective is that blockchain technology actually joins these worlds together in reality. Blockchains can provide the secure fault tolerant decentralised layer for property rights information and its verification and updating whenever that information changes, which can support a decentralised economic layer of markets.

The socialists were wrong in their hopeful quest that (centralised) computers would replace markets. Actually, it is decentralised computers (blockchains) than can replace governments.

Markets always need governance, and the limits of a market society were always the ability of the state to provide those services of record keeping, validation and verification of transactions in property rights. In return, the state levied taxation to fund these services.

Blockchains are a new technology of fault tolerant governance that can furnish the governance to underpin a market economy and society.

We call this Byzantine Political Economy.

The problem with Nobel laureate Richard Thaler’s nudgonomics

With Sinclair Davidson

Economists have spent the last 240 years – ever since Adam Smith published The Wealth of Nations – trying to understand how decentralised economies work. In that time they have established that the price mechanism does a pretty good job of coordinating economic activity, and that profits provide excellent incentives to stimulate human action.

In the course of understanding how economies operate, economists have had to develop a working model of human behaviour, and various simplifying assumptions have been made. An example of such an assumption is that people are pretty smart, and best know their own self-interest. That is the so-called rationality assumption.

But, of course, there are many rationality assumptions. Standard economic theory maintains what can be described as ‘strong-form’ rationality. In this view of rationality, the human brain is an unlimited resource and can easily and quickly compute all outcomes and make choices that maximise satisfaction and well-being.

Then there is a ‘semi-strong form’ of rationality – bounded rationality – associated with 1978 economics laureate Herbert Simon. He suggested that people intend to be rational but that there are limits to rationality. Finally ‘weak-form’ rationality, associated with the Austrian school, suggests that people economise on their brain power as they would any other resource and make use of rules of thumb and heuristics to make choices and decisions.

So the notion that economists have a single dogmatic view of human behaviour and rationality is something of a straw man, if not actually a whipping boy when non-economists debate economists.

Enter into this milieu Richard Thaler of the University of Chicago, and the latest economics laureate awarded for his work in behavioural economics. Thaler is a worthy Nobel winner. He has successfully challenged the mainstream and standard assumption of strong-form rationality. He has brought respectability to what would have been heresy as recently as the 1970s. Many of the insights of his research agenda and his followers have been profound, others have been trivial. That is to be expected from any productive scholar and intellectual movement.

What is unexpected is how successful behavioural economics has been in a policy sense. Popularly and politically, Thaler is best known for his book Nudge, written with Cass Sunstein. This remarkable book both established a new theoretical framework for government intervention and successfully marketed it to the governing class.

Nudge was published in 2008. By 2010, the Conservative government in Britain had established a ‘nudge unit’ within the Cabinet Office. Many other governments have followed suit. The rapid leap that nudge theory made from seminar room to law-of-the-land has been unprecedented.

These days, lots of policies are routinely described as ‘nudges’, and the word is as much a political branding exercise as anything. But Thaler and Sunstein were very specific about what they meant by a nudge. As they describe it, we all have two ‘semiautonomous’ selves: the ‘doer’ and the ‘planner’. The doer is irrational – thinking only about the short term and gratuitous pleasures. The planner is rational – thinking about the future, focusing on getting healthy and saving money.

The planner makes the best choices; the planner makes the choices we don’t regret and would make again. In nudge theory, government should design systems that allow us to favour what our planner selves would rather do, rather than our reckless doer selves.

In this way, Thaler and Sunstein avoid one of the central critiques of the nanny state – the nanny state wants to impose its own preferences on others. Both the planner and doer’s preferences are our own. We still get to choose. Thaler and Sunstein describe nudge theory as ‘libertarian’ paternalism.

But it has some serious practical and conceptual problems.

Rather than just leaving choice to the market, nudge theory says the government should try to discern a set of best preferences from our worst ones – but not impose its own. Then it should regulate the economy so it favours the choices of our planner selves, but doesn’t force us into any specific choice. This sounds like hard work for a government.

More fundamentally, is it true that we have two separate, distinct selves? Nudge theory needs there to be two distinct systems so the government can choose between them. ‘Dual systems’ theory, as it was known in the psychological literature, has now been replaced by theories that describe our cognitive processes as a continuum or graphical space. The upshot is that it is not meaningful to say we have two sets of preferences – good ones and bad ones – but an infinite number of sets of preferences.

With this shift, psychologists seem to have coalesced around the weak-form Austrian view of rationality: that rationality itself is a matter of trade-offs and choices. One could even say this was Adam Smith’s view. People are a rich mix of passion, interest and sympathy – not all-knowing, rational calculators.

Thaler’s contribution has been to help return us to that understanding. But it’s a big leap from the observation that ‘people are not always perfectly rational’ to ‘bureaucrats can make us rational’.

The Blockchain Economy: A beginner’s guide to institutional cryptoeconomics

With Sinclair Davidson and Jason Potts. Originally a Medium post.

The blockchain is a digital, decentralised, distributed ledger.



Ledgers all the way down








Ownership, possession, and ledgers








The evolution of the ledger







Blockchain and the economic institutions of capitalism








Institutional cryptoeconomics







The economic consequences of the blockchain





Institutional creative destruction

We’ve been through revolutions like this before.





Complete and incomplete smart contracts









Whither government?












Whither Big Business?









Bitcoin investors should be taxed like any other investor

By Chris Berg, Sinclair Davidson and Jason Potts





Why cryptocurrency is a mix of money, debt and equity















How dequity should be regulated





Institutional Cryptoeconomics: A New Model for a New Century

With Sinclair Davidson and Jason Potts



















Government must leave encryption alone, or it will endanger blockchain

With Sinclair Davidson and Jason Potts












But the blockchain revolution is not inevitable.






Malcolm Turnbull’s Super Ministry












































Policy uncertainty is exactly what Koutsantonis has delivered.

The end of liberalism?

Nothing in the language of the 2017 Commonwealth budget was exceptional by Australian standards. Treasurer Scott Morrison stood in parliament and announced what he described as a ‘fair and responsible path back to a balanced budget’, followed by an optimistic account of global macroeconomic conditions, a happy assurance that surpluses would be achieved in years to come, a brief panegyric of the virtues of small business, followed by a list of infrastructure projects to be built near marginal electorates.

Nonetheless, the 2017 budget is likely to be seen as one of the most significant in Australian history. In a very real way, the budget bills that Morrison announced can be said to cap not the era of economic reform (Australian governments have long given up serious market driven reform and privatisation), but an era where at least one side of politics was offering any ideological or intellectual support for free market policies.

There have been disappointing budgets before, of course, and disappointing budgets from Liberal governments. But there are two features of the 2017 budget that make it significantly different from the disappointments that have gone before: the bank tax and the increase in the Medicare levy to fund the National Disability Insurance Scheme. The first is a punitive, distortionary, arbitrary, and incoherent fiscal attack on an unpopular but absolutely vital economic sector. The second is a broad based tax increase to finance a new social service that seems more like Whitlam-era public policy.

The bank tax is most striking because it is almost entirely disconnected from any explicit policy rationale. The complete argument for the bank tax Morrison presented on budget night was this: it ‘represents an additional and fair contribution from our major banks, is similar to measures imposed in other advanced countries, and will even up the playing field for smaller banks.’ In other words, it is ‘fair’, other countries have done it, and it will cut the big banks down to size.

Since budget night advocates of the tax have been trying to retrofit justifications to the proposal: arguing that it is a payment for deposit insurance or the government’s implicit too-big-to-fail protection. But the new bank tax does not even pretend to be pegged to the value of any implicit government guarantee. The government just wants money, and banks are where money is.

Of course, governments have always looked to the banks for money. Arbitrary, punitive taxation is hardly unprecedented. But we are not living in just any historical moment, in any country. Australia is one of the richest, freest and most open countries in the world, the beneficiary of three decades of economic reform — reform that sought to reduce the number of arbitrary, punitive and counterproductive taxes and regulations on the industries central to our wealth.

The budget in the sweep of Australian history

The era of economic reform is typically said to have begun in 1983 and ended in 1993 or 2000. It kicked off with Paul Keating’s floating of the dollar, from which so many other reforms had to flow. It ended either with the Fightback! election loss, or the introduction of the GST by the Howard government.

But of course no policy reform movement comes from nothing and disappears immediately without leaving a shadow. Political interest in market reform survived the reforms themselves. The Abbott government’s 2014 Commission of Audit remains an impressively radical and ambitious document.

Likewise, the ideas of market reform significantly predate the Hawke government. The floating of the dollar and the subsequent liberalisation of banking would not have been possible had the Fraser government not commissioned the Campbell inquiry into the Australian financial system in 1978, and directed it to develop recommendations consistent with ‘the Government’s free enterprise objectives’. And those objectives did not come from nowhere. Malcolm Fraser himself might have been a reluctant free marketeer but the Fraser government was starting to feel the ideological heat from the Dries within its ranks. The sense of a sharp division between the reform period and the 2017 budget is in part because Morrison and Malcolm Turnbull have chosen totarget, of all sectors, banks — the high ground of market reform for half a century.

Yet by the time of the Campbell committee, economic liberalisation had been a pitched battle in Australian politics for more than a decade. The truly pivotal ideological moment was the appointment of Alf Rattigan as chair of the Tariff Board in 1963. Rattigan, who had been assumed at that time to be a quiet, unassuming and pragmatic bureaucrat, waged a long running war against Australia’s high tariff regime from his Tariff Board post. Working with sympathetic and economic literate journalists like Maxwell Newton, Max Walsh, Alan Wood, P. P. McGuiness, Tony Thomas and Ken Davidson, as well as parliamentarians like the legendary maverick Bert Kelly, Rattigan made tariffs and trade a central political issue, redefining the terms of Australian policy debate, and, over time, creating the divide between those who wanted to reduce the government’s reach over the economy and those who wanted to maintain the status quo.

It is often forgotten how this division shaped the bitterly personal contests between John McEwen, John Gorton and William McMahon. This convoluted battle was focused as much on Australia’s tariff regime as anything else. In the 1966 election, a group of woolgrowers and graziers created the free trade lobby, the Basic Industries Group. Although it wished not to harm the Coalition and campaigned only in a few safe seats, it nearly tore the Coalition apart, creating a divide between Liberal free traders like McMahon and the protectionist McEwen. Maxwell Newton, who had been editor of The Australian Financial Review and founding editor of The Australian, used the small trade newsletters he ran in the late 1960s to conduct what the journalist Alan Reid described as a ‘free wheeling political vendetta’ against McEwen on the issue of the tariff.

The tariff contest burbled away in the background of the Liberal Party and the conservative movement more generally during the Whitlam years. Milton Friedman came to Australia in 1975, and Friedrich Hayek visited the year after that. By the time the Society of Modest Members — the group of current and former state and federal MPs dedicated to market reform — had its first meeting in 1981, the free market insurgency had been long established. The ideas on which the Modest Members pinned their hopes had been the source of bitter division in the Coalition for a decade and a half.

The origin of the victory of market economics over technocratic social democracy dates further than even the most senior of our press gallery journalists. Yet with Morrison’s budget, that victory seems to have expired.

Is market liberalism exhausted?

Market liberalism has gone through cycles of decline and resurgence before. Historical perspective helps because it is easy in the current political environment to personalise what is happening: to blame Tony Abbott or Malcolm Turnbull, or any other constellation of political leadership. It is certainly the case that Australia has been poorly served for the last decade. But the leadership comes from the political class itself; they provide the pool from which the leader is chosen and they have the votes. Every prime minister, even the most disappointing, had, at one stage, the endorsement of majority in their party room.

The Liberal Party has been severed from its base — the core voters which support it, raise money for it, man booths for it, and generally give it social force — and has not been rewarded with national popularity.

The Liberal government has tried to echo the Labor Party on notions of ‘fairness’, but why would you buy Liberal fairness when you can buy Labor’s real thing? If trying to reduce inequality by taxing the rich is desirable, why vote Coalition? If the banks need to be punished, why not support the parties that really believe it?

Opponents of reform to section 18C of the Racial Discrimination Act have repeatedly argued that the fight for freedom of speech is a ‘distraction’, and that the Coalition government should be allowed to concentrate on economic reform. But now it seems that the government has given up on both free speech and lower taxes — civil liberties and market economics go hand in hand, and the government seems uninterested in both.

The decline of the Liberal Party, and to a lesser extent the Liberal-National Coalition, into a shadow of its opponents is a sign of exhaustion in the centre-right political class. It also reflects a failure to revitalise free market ideas — and liberalism more generally — decades after the age of Margaret Thatcher and Ronald Reagan.

The window for ‘reasonable’ policy ideas in Australia is remarkably narrow and parochial. No government wants to be caught stepping even slightly outside the thin band of mainstream policy ideas. Canadian income tax rates are indexed to inflation, eliminating the problem of inflation-induced bracket creep. Yet it would be seen as radical and unrealistic in Australia to propose anything of the sort, even though tax rate indexation has successfully worked overseas and was trialled in Australia under the Fraser government.

The unwillingness to puncture some of these sureties, to develop, legitimate and push through policy in the face of opposition, and to seriously challenge the status quo has left Australia’s policy regime stagnant and fragile. Market liberalism arose in just this sort of historical moment, when the Keynesian policies of the mid-century exhausted themselves, unable to provide answers to the economic decline throughout the developed world. Is market liberalism now exhausted too? Certainly parties that profess market liberalism seem to be tired of pursuing free market policies.

The Coalition’s push to the left on economics has been paralleled in other developed countries. Theresa May’s 2017 manifesto declared that conservativism ‘is not and never has been the philosophy described by caricaturists’:


But far from rejecting the caricature, this seems to reinforce it. Who, after all, believes in ‘untrammelled free markets’? Even the most vigorous anarcho-capitalist believes that markets are ‘trammelled’ by the constraints of norms, values and human-made institutions. If there is a cult of selfish individualism, does it have any members? May claims to be distancing the Conservatives from some sort of spartan Thatcherism but the frivolous nature of this attempt only underpins the impression that ‘May-ism’ is just unmoored from any philosophical foundation.

Against this, the appeal of a Jeremy Corbyn — whose public persona is inseparable from his deeply held political views — is obvious.

Market liberalism looks slightly better across the Atlantic but even in the United States it is in a bad way. The Trump administration’s red tape reduction program, ambitious tax reform, and budget proposals look exciting — if they can be accomplished. Withdrawing from the Paris Agreement is deeply symbolic, but needs to be married with specific policies that roll back the renewable energy labyrinth put in place by the Obama administration.

Otherwise, Donald Trump’s explicitly anti-trade position undercuts one of the founding principles of market liberalism.

Seen in this context, the exhaustion of liberalism in Australia is hardly surprising — it’s exhausted everywhere.

Rebuilding liberalism

Yet we should not look to high politics for a guide to the vibrancy and potential of a set of ideas as rich as the philosophy of liberty. In 1929 a group of Australian economists wrote that in Australia:

practically all shades of thought are committed to some form of Government activity in the economic sphere, whether it be wage regulation or assistance to immigration, criticism of the policy of laissez faire is unnecessary.

The Institute of Public Affairs was founded fourteen years later, and half a century later the idea that we needed to introduce competition and markets into our stagnant economy was a bipartisan view. Long before this year’s budget it has been obvious that our politicians had declared free market ideas as empty platitudes; a period of time in the wilderness will allow for the intellectual rebuilding of centre-right politics.

In fact, the times suit the ideas of free markets and individual liberty more than our political parties realise or acknowledge. The IPA has spelt out at length the tax and red tape challenges holding back the Australian economy — nothing the Labor Party or the newly centrist Coalition are currently proposing have a hope of tackling those two fundamental economic problems.

If the retreat of market liberalism globally has the effect it had in earlier times — greater macroeconomic instability and uncertainty — Australia will need a resilient and adaptable economy to suit.

Other trends demand a revitalised liberalism: the spread of automation from the industrial sector to the high-end service sector, the increasing demand for personal control over healthcare, the move of global economic power from the West to Asia.

Malcolm Turnbull failed to turn his 2016 innovation agenda into anything more than slogans, but like it or not, this is where the big changes are going to come. Doubling down on the twentieth century welfare and planning economic model is not going to help the losers from those changes, nor will it ensure the benefits are distributed widely.

The task now is an intellectual one — to build a new liberalism, a neo-neoliberalism, out of the failures of centre-right politics.