Fiat Money and the Natural Scale of Government

The competitive market structure of a decentralized economy is converted into a self-policing system treating the bureaucracy and enforcement of the legal system endogenously. In particular we consider money systems as constructs to make agents’ economic strategies predictable from knowledge of their preferences and endowments, and thus to support coordinated resource production and distribution from independent decision making. Diverse rule systems can accomplish this, and we construct minimal strategic market games representing government-issued fiat money and ideal commodity money as two cases. We endogenize the provision of money and rules for its use as productive activities within the society, and consider the problem of transition from generalist to specialist production of subsistence goods as one requiring economic coordination under the support of a money system to be solved. The scarce resource in a society is labor limited by its ability to coordinate (specifically, calling for the expenditure of time and effort on communication, computation, and control), which must be diverted from primary production either to maintain coordinated group activity, or to provide the institutional services supporting decentralized trade. Social optima are solutions in which the reduced costs of individual decision making against rules (relative to maintenance of coalitions) are larger than the costs of the institutions providing the rules, and in which the costs of the institutions are less than the gains from the trade they enable to take place.

Keywords: Bureaucracy, Contract enforcement, Taxes, Money

JEL Classification: C7, D5, H5, K42