The State

The new institutionalism in state theory has been embraced by some economists, such as Douglass C. North, who observes that "the whole development of the new institutional economics must be not only a theory of property rights and their evolution but a theory of the political process, a theory of the state, and of the way in which the institutional structure of the state and its individuals specify and enforce property rights" (p. 233). There have been few significant efforts to follow through on this observation. Joseph Stiglitz also suggests that because most state activities involve questions of resource allocation, state theory falls within the purview of the economics discipline, but economists have largely neglected the state despite their agreement that there are only two ways of coordinating the economic activities of large populations: (1) central direction involving the use of coercion (that is, the state) and (2) the voluntary cooperation of individuals (the market).

Economists have devoted little attention to the theory of the state because most assume that markets provide optimal resource allocations in contrast to the state's supposed inefficiency. From this perspective, state intervention in the economy is only justified in cases of market failure, but since market failures are considered exceptions to the rule that markets optimize resource allocations, the analysis of the state and its role in society is considered marginal to the main focus of neoclassical economics. At its most extreme, libertarian philosophers and economists not only accept this proposition, but draw on well-accepted definitions of the state as a coercive institution to argue that the state is inherently parasitic. Murray Rothbard claims that regardless of its form, the state is inherently illegitimate since it is dependent on "coerced levies" (i.e., taxes) that make it essentially no different from "a criminal band" beyond the fact that it is the "best organized aggressor against the persons and property of the mass of the public" (pp. 46–47). In contrast to Marxist theory, which views the state as a mechanism for subordinating subaltern classes by a dominant class, libertarian theory views the state itself as a political class that exploits the entire society of economic producers.

Stiglitz has proposed an economic model that reverses the main assumption of neoclassical economics with the argument that markets are always imperfect because information is imperfect and this makes all markets incomplete without state intervention. In Stiglitz's model, the issue for economists is not to identify market failures, since "these are pervasive in the economy, but of identifying large market failures where there is scope for welfare-enhancing government interventions" (pp. 38–39). This model incorporates the normative assumption that the state will (or should) pursue welfare-enhancing policies and, therefore, challenges the normative claims raised by most other theories of the state, which view it is an exploitative organization.