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Marc F. PlattnerMancur Olson's book Power and Prosperity is an important book, written with clarity and verve.
— Wall Street Journal
Why do some economies do better than others? How does society encourage the kind of market economy that generates continually increasing incomes? How do particular styles of government affect economic performance? World-renowned economist Mancur Olson tackles these questions and others in what will surely be regarded as his magnum opus. Olson contends that governments can play an essential role in the development of markets. Reliable enforcement of private contracts and protection of individual rights to property...
Why do some economies do better than others? How does society encourage the kind of market economy that generates continually increasing incomes? How do particular styles of government affect economic performance? World-renowned economist Mancur Olson tackles these questions and others in what will surely be regarded as his magnum opus. Olson contends that governments can play an essential role in the development of markets. Reliable enforcement of private contracts and protection of individual rights to property depend on governments strong enough not to undermine them. His exploration of "market-augmenting governments" will stand as a cutting-edge work on economic growth and provide a useful framework in which to consider the Asian financial crisis and its aftermath. As Susan Lee noted in Forbes, "his pioneering insights might have won a Nobel Prize for Olson had he lived a bit longer."
THE LOGIC OF POWER
These days, virtually all economists (and I think also most people in other fields) would agree that societies are most likely to prosper when there are clear incentives to produce and to reap the gains from social cooperation through specialization and trade. If a society is to achieve its highest possible income, the incentives must not only be clear but must induce firms and individuals in the economy to interact in a socially efficient way. That is, they must be similar to the incentives in perfectly competitive industries: those where the market, in addition to having other virtues, is so large—or the firms in it are so small—that no single firm has a monopoly power or a perceptible effect on price.
When we shift from what is best for prosperity to what is worst, the consensus would probably be that when there is a stronger incentive to take than to make—more gain from predation than from productive and mutually advantageous activities-societies fall to the bottom. In a Hobbesian anarchy, where there is no restraint on individuals' incentives to take things from one another, or in a kleptocracy, where those in power seize most assets for themselves, there is not much production or many gains from social cooperation through specialization and trade.
What determines where a society falls between the one extreme, where each firm and individual has an incentive to do what would best serve the welfare of the population, and the other, where predation eliminates investment, specialization, and trade? What determines whether there is a pattern of incentives that generates efficient production and social cooperation, or one that yields nothing more than subsistence? We need to find out what those in power have an incentive to do and why they obtained power. When will those with power in a society have an incentive to use their power to promote production and social cooperation? When will they take much of the gains from production and trade? And why did those who have power obtain it? To begin to answer these questions, we need to understand the logic of power.
A theory of power has long been the Holy Grail for political science, but the Grail has not been found. Some economists have tried to deal with power by extending the market model: they begin with the voluntary transaction—the Coaseian bargain—and then use the transaction costs that limit trade and bargaining as the basis of a theory of government and politics. Some of these economists go on to extend the Coase theorem—the idea that, unless transaction costs are too great, individuals have an incentive to bargain until they have maximized their joint gains—to government and politics. This process leads these economists to believe that power tends to be used in socially efficient ways. I explain this intriguing belief—and show that it is vitiated by a logical error that has previously been overlooked—in Chapter 3. But it should be immediately evident that the logic of power cannot be adequately explained through voluntary transactions: power—and not least governmental power—is the capacity to bring about compulsory compliance, and thus it involves compelling authority and the capacity to coerce. As we shall see, it is not enough to understand the theory of voluntary exchange: we must also understand the logic of force.
The Criminal Metaphor
Power is exercised by human beings, who are, of course, extraordinarily complex. As I see it, human beings rarely act out of unmixed motives. There is not only self-interest but also a benevolent element—and even a malevolent streak—in human nature. Historical outcomes surely depend not only on the incentives and self-interest of those with power but also on their morals and temperaments. I will, before the end of this book, analyze some contexts where disinterested and principled choices are decisive for progress of societies, but I start with a focus on the incentives and inducements to rational and self-interested action that face those with power.
For our focus on coercive power and our analysis of self-interested behavior, I use a criminal metaphor. Clearly, we cannot understand robbery as either a voluntary trade or a moral act, and thus it helps us to focus only on the self-interested use of coercive power. With the aid of this metaphor, we will be able to see beneath the surface and then construct the needed theory. Since criminal behavior is the exception rather than the rule in a successful society, the criminal metaphor will also remind us of the extent to which we are abstracting from the complexity of human nature.
Consider the incentives facing the individual criminal in a populous society. Other things being equal, a criminal is better off in a rich society than in a poor society: there is more to steal. Theft also makes societies less prosperous than they would otherwise be—the time devoted to theft produces nothing, but it reduces the rewards from productive work and investment and induces a diversion of resources from production into guards, locks, police, prisons, inventory control systems, and the like. Therefore, the crime committed by each criminal reduces the wealth of society and thus also the amount that is available to steal. Does this make the individual criminal curtail his or her crime?
Everyone already knows that it does not, but we must understand why. The typical individual thief in a society of, say, a million people, bears about one-millionth of the loss to society that occurs because his crime makes society's output less than it would otherwise be. Yet he alone normally bears the whole loss of whatever opportunities for theft he passes up. Therefore, the gain to criminals from a wealthier society and the reduction in that society's wealth due to crime do not keep crime from paying. (The opposite would be true only in a bizarre case where the loss to society from a theft were about a million times or more as valuable as what was taken by theft.) It is only society's punishment of criminals that keeps crime from paying, and it is not always sufficient to inflict punishment. Though each criminal has a stake in the prosperity of society, that stake is so minuscule that the criminal ignores it: he normally takes everything there is in any purse or till. As we shall see, it makes a huge difference whether individuals with coercive capacities have a minuscule or narrow stake in the society, on the one hand, or an encompassing interest, on the other.
Before turning to encompassing interests, we must remind ourselves that the same self-interest that made the criminal steal leads to dramatically different results when there is voluntary exchange in the market. If, say, better deterrence of crime led our criminal to serve his interests through voluntary exchange in the labor market, he would typically take the job that offered the highest pay. No profit-maximizing employer employs a worker who does not add at least as much to the firm's revenues as that worker costs. In self-interestedly seeking the highest wage, our ex-criminal works at jobs where his marginal social productivity or contribution to output tends to be greatest.
Now let us contrast the individual criminal in a populous community with the head of a Mafia family or other criminal gang that can monopolize crime in a neighborhood. Suppose that in some well-defined turf, a criminal gang cannot only steal more or less as it pleases but can prevent anyone else from committing crime there. Obviously, the Mafia family has an incentive to keep other thieves out of its own domain. But will it gain from taking all that it can on its own ground? Definitely not.
If business in this domain is made unprofitable by theft, or migration away from the neighborhood is prompted by crime, then the neighborhood will not generate as much income and there will not be as much to steal. Indeed, the Mafia family with a true and continuing monopoly on crime in a neighborhood will not commit any robberies at all. If it monopolizes crime in the neighborhood, it will gain from promoting business profitability and safe residential life there. Thus, the secure Mafia family will maximize its take by selling protection—both against the crime it would commit itself (if not paid) as well as that which would be committed by others (if it did not keep out other criminals). Other things being equal, the better the community is as an environment for business and for living, the more the protection racket will bring in. Accordingly, if one Mafia family has the power to monopolize crime, there is little or no crime (apart from the protection racket). The considerable literature on monopolized crime makes it clear that secure monopolization of crime does, in fact, usually lead to protection rackets rather than ordinary crime. Outbreaks of theft and violence in Mafia-type environments are normally a sign that the controlling gang is losing its monopoly.
This criminal metaphor illustrates the theory of narrow and encompassing interests presented in my book The Rise and Decline of Nations. The individual robber in a populous society obtains such a narrow or minute share of any loss or gain to society that he ignores the damage his thievery does to society. By contrast, the Mafia family that monopolizes crime in a community has, because of this monopoly, a moderately encompassing interest or stake in the income of that community, so it takes the interest of the community into account in using its coercive power. Whereas the individual criminal in a populous society bears only a minuscule share of the social loss from his crime, the gang with a secure monopoly on crime in a neighborhood obtains a significant fraction of the total income of the community from its protection tax theft. Because of the encompassing interest in the income of society that this monopoly gives, it bears a significant fraction of social losses, including those from its own protection tax theft. Therefore, though the individual criminal normally takes all of the money in the wallet he steals, the secure and rational Mafia leader never sets a protection tax rate anywhere near 100 percent: this would reduce the neighborhood's income so much that the Mafia family itself would be a net loser.
The Stationary Bandit
A story about a Chinese warlord suggests that we need to take this logic further. In the 1920s, China was in large part under the control of various warlords. They were men who led armed bands with which they conquered a territory and then appointed themselves lords of the territories they had conquered. They taxed their subjects heavily and used the proceeds to serve their own interests. The warlord who I was reading about, Feng Yu-hsiang, was noted for the exceptional extent to which he used his army for suppressing thievery and for his defeat of the relatively substantial army of a notorious roving bandit called White Wolf. Apparently, most people in Feng's domain wanted him to stay as warlord and greatly preferred him to the roving bandits.
At first, this situation was puzzling: Why should warlords who were simply stationary bandits continuously stealing from a given group of victims be preferred, by those victims, to roving bandits who soon departed? The warlords had no claim to legitimacy and their thefts were distinguished from those of roving bandits only because they took the form of relentless tax theft rather than occasional plunder.
There is a good reason for this preference. As we have seen, there is little production in an anarchy and thus not much to steal. If the leader of a roving bandit gang who finds only slim pickings is strong enough to take hold of a given territory and to keep other bandits out, he can monopolize crime in that area—he becomes a stationary bandit. The advantage of this monopoly over crime is not mainly that he can take what others might have stolen: it is rather that it gives him an encompassing interest in the territory akin to that of the Mafia family considered in the previous section. He actually has a stronger encompassing interest than the Mafia family, since the bandit leader who takes over an anarchic area does not have competition from any government's tax collectors: he is the only one who is able to tax or steal in the domain in question.
This monopoly of theft changes incentives dramatically. We have seen that the individual criminal in a populous society has such a narrow or minuscule interest in the society that he rationally ignores the damage he does to it, which is obviously also true of a gang of bandits passing through. These socially perverse incentives make anarchies work badly. The encompassing interest of a stationary bandit leader who can continue to keep out not only other criminals but outside tax collectors as well gives him an incentive to behave very differently.
First, it leads him to reduce the percentage he takes from each victim of his theft. As we have seen, the criminal who is only one among many will take 100 percent of the money in any till he robs. By contrast, the stationary bandit with continuing control of an area wants to make sure that the victims have a motive to produce and to engage in mutually advantageous trade. The more income the victims of theft generate, the more there is to take. A secure stationary bandit, by making his theft a predictable tax that takes only a part of his victims' outputs, thereby leaves them with an incentive to generate income. If he cuts his rate of tax theft from 95 percent to 90 percent, he doubles his subjects' posttax reward for production and trade, which might well increase output and tax receipts by a large multiple.
The stationary bandit keeps on gaining from reducing his rate of tax theft down to the point where what he gains (from tax theft on a larger output) is just offset by what he loses (from taking a smaller share of that output). He is left at the revenue-maximizing rate of tax theft. If the stationary bandit cut his tax rate from 51 percent to 50 percent, thereby raising output of his domain from 98 percent to 100 percent, he would essentially maximize his tax collections: he would receive half of the increase in output, which would be approximately offset by the reduction in his share of total output. That is, the stationary bandit, because of his monopoly on crime and taxation, has an encompassing interest in his domain that makes him limit his predations because he bears a substantial share of the social losses resulting from these predations. If the stationary bandit in the example above increases his tax rate from 50 percent, he bears about half of the social or "deadweight" loss from the distortion of incentives that this higher rate of predation brings about, which is enough to keep him from taking more. Generally speaking, the greater the loss in production from taxation at any given rate of tax, the lower the rate of tax theft at which the stationary bandit's take is maximized. Though the deadweight losses and how they vary with tax rates—and thus a stationary bandit's rate of tax vary from case to case—every stationary bandit has a rate of tax theft that is always lower than 100 percent—and usually much lower—which maximizes his collections.
A Benefactor to Those He Robs
The second way in which the encompassing interest of the stationary bandit changes his incentives is that it gives him an incentive to provide public goods that benefit his domain and those from whom his tax theft is taken. Paradoxically, he provides these public goods with money that he fully controls and could spend entirely on himself. We know that a public good benefits everyone in some area or group and that many public goods, such as levees that protect against floods, police that deter crime, and quarantines that limit contagious diseases, make a society more productive.
Because the stationary bandit obtains a known share of any increase in the output of his domain, given by his optimal rate of tax theft, he has an incentive to spend his resources on all productivity-enhancing public goods up to the point where his last dollar spent on these goods equals his share of the resulting increase in output. Thus, if the stationary bandit's optimal rate of tax theft is 50 percent, he will spend on public goods up to the point where the last dollar spent on these goods adds $2 to the output of the domain, since he will then receive $1. More generally, if the stationary bandit's share of any increase in output is S, he will best serve his interests by spending the resources he controls on public goods up to the point where the output of the domain increases by 1/S. Readers who want formal proofs and a mathematical and geometric exposition of this argument should consult an article by Martin McGuire and myself on "The Economics of Autocracy and Majority Rule."
The Origin of Autocracy
In short, the bandit leader, if he is strong enough to hold a territory securely and monopolize theft there, has an encompassing interest in his domain. This encompassing interest leads him to limit and regularize the rate of his theft and to spend some of the resources that he controls on public goods that benefit his victims no less than himself. Since the settled bandit's victims are for him a source of tax payments, he prohibits the murder or maiming of his subjects. Because stealing by his subjects, and the theft-averting behavior that it generates, reduces total income, the bandit does not allow theft by anyone but himself. He serves his interests by spending some of the resources that he controls to deter crime among his subjects and to provide other public goods. A bandit leader with sufficient strength to control and hold a territory has an incentive to settle down, to wear a crown, and to become a public good-providing autocrat.
Thus, governments for large groups of people have normally arisen because of the rational self-interest of those who can organize the greatest capacity for violence. These violent entrepreneurs naturally do not call themselves bandits, but on the contrary give themselves and their descendants exalted titles. They sometimes even claim to rule by divine right. Since history is written by the winners, the origins of ruling dynasties are, of course, conventionally explained in terms of lofty motives rather than by self-interest. Autocrats of all kinds usually claim that their subjects want them to rule and thereby nourish the usually false assumption that their governments arose out of some kind of voluntary choice.
Once we understand how the incentives of a bandit gang change when it can settle down and securely hold a territory, we see why the warlord's subjects, even though he extracts tax theft from them year after year, prefer him to the roving bandits who rob only sporadically. Roving banditry means anarchy, and replacing anarchy with government brings about a considerable increase in output. The subjects of a stationary bandit obtain the proportion of the increase in income that is not taken in taxes. The logic of the matter—and historical information and recent observations—suggests that the continuing exactions of a stationary bandit are far better than anarchy.
It follows that the familiar metaphor of the predatory state is inadequate, even for autocracies with utterly selfish leaders. As we saw earlier, a stationary bandit has an encompassing interest in the territory he controls and accordingly provides domestic order and other public goods. Thus, he is not like the wolf that preys on the elk, but more like the rancher who makes sure that his cattle are protected and given water. No metaphor or model of even the autocratic state can therefore be correct unless it takes account of the stationary bandit's incentive to provide public goods while maximizing his rate of tax theft.
The Historical Record
From history, we know that the encompassing interest of self-interested autocrats can be consistent with economic growth and even the advance of civilization. Autocracy has been commonplace at least since King Sargon's conquests created the empire of Akkad in ancient Mesopotamia not long after the first development of settled agriculture. Most of humanity over most of history has been subjected to autocracy and exploited by tax theft. It is very difficult to find examples of benevolent despots. The stationary bandit model fits the facts far better than the hypothesis that autocrats are altruistic.
Yet, remarkably, there was considerable growth of total income, population, and civilization in the age before democracies came to be dominant. There has also been rapid economic growth in more recent times under several autocracies. Admittedly, I shall argue later that relatively democratic societies—or at least nonautocratic societies with representative governments—have played a disproportionate role in economic progress, which is no accident.
Excerpted from POWER AND PROSPERITY by Mancur Olson. Copyright © 2000 by Mancur Olson. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
|Foreword by Charles Cadwell||vii|
|Preface by Mancur Olson||xxi|
|1 THE LOGIC OF POWER||1|
|2 TIME, TAKINGS, AND INDIVIDUAL RIGHTS||25|
|3 COASEIAN BARGAINS, TRANSACTIONS COSTS, AND ANARCHY||45|
|4 RATIONAL INDIVIDUALS AND IRRATIONAL SOCIETIES||69|
|5 GOVERNANCE AND ECONOMIC GROWTH||89|
|6 THE SOURCES OF LAW ENFORCEMENT AND CORRUPTION||101|
|7 THE THEORY OF SOVIET-TYPE AUTOCRACIES||111|
|8 THE EVOLUTION OF COMMUNISM AND ITS LEGACY||135|
|9 IMPLICATIONS FOR THE TRANSITION||155|
|10 THE KINDS OF MARKETS NEEDED FOR PROSPERITY||173|
Posted July 20, 2011
No text was provided for this review.