Out of anarchy

JUST before Mancur Olson died in 1998, he finished work on a new book, “Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships”. Now published by Basic Books, it comes as a reminder of just how much the discipline of economics lost when Olson passed away.

As in his other well-known works, “The Logic of Collective Action” and “The Rise and Decline of Nations”, Olson grapples with a huge and, for most economists, intimidating question—why do some economies prosper while others fail? And in trying to answer it he has, just as before, relegated the arid technical discourse of most theoretical economics to separately published academic papers. The book contains just the essence of the argument, stated accessibly, elegantly and always with Olson's delicious wit.

The new book develops themes from earlier work and links them together in revealing ways. A central strand is the nature of political power, and how different kinds of power promote different kinds of economic behaviour—a subject which, surprisingly enough, mainstream economics rarely gives much thought to. The book accordingly begins with Olson's memorable metaphor of rulers as robbers.

Through history, Olson observes, it has been better to live under political tyranny than to be subject to the depredations of roving bands of warrior-thieves. Indeed, advancing from the second to the first generally marks the start of civilisation.

But this is a puzzle. Assuming that tyrants and thieves are alike, in that they are out for whatever they can extract from their subjects, why should one kind of predation be better than the other? The answer, Olson explains, is that the tyrant has a stake, an “encompassing interest”, in the domain he is exploiting: if it prospers, he can extract more for himself in taxes and other ways. A roving bandit merely destroys and moves on. A stationary bandit keeps taxes low in the short term in order to spur growth and gather more revenue later; in fact he goes further, and provides growth-promoting public goods, the better to improve his take.

Autocracy, then, is usually much better for the victims than anarchy. What about democracy? Suppose, just suppose, that democratic governments rule solely in the interests of the majority that keeps them in power; suppose, in other words, that they would exploit the minority with no more qualms than the tyrant has in exploiting all his subjects. Democracy would still have a great advantage over tyranny in purely economic terms. Even in a predatory democracy, the government has a greater encompassing interest than a tyranny.

Why? Because the majority in whose interests the government is ruling must pay a share of the taxes that finance redistribution in its direction; because the majority benefits directly from rising incomes (not merely indirectly, through redistribution of wealth); and because the majority likewise gains directly from new public goods.

The incentives that guide a tyrant to moderate his exactions therefore work far more powerfully in a democracy. The bigger the majority in whose interests the government is ruling, the larger the encompassing interest. Constitutions with checks and balances requiring supermajorities for certain actions may create what Olson calls “superencompassing” interests, leading as you might expect to even smaller growth-retarding exactions on the minority and greater attention to the supply of growth-promoting public goods. And this beneficial outcome follows, remember, on the extreme assumption that voters act not out of concern for the greater good, but out of pure self-interest.

This argument demolishes at a stroke the notion that democracy is a luxury only rich countries can afford. Historically, Olson argues, the dispersal of political power and the emergence of representative government have often been the trigger for faster economic growth. It is perfectly true that prosperity has been conducive to democracy, but the converse, improbable as it seems to many, is at least as true. The book explores at some length the implications of this claim for the transition economies of Eastern Europe and, especially, for the former Soviet Union.

In “Power and Prosperity” Olson also has much to say about markets—and again what he says is puzzling at first sight. Markets are pervasive in even the poorest countries, he points out. Excessive government intervention in those markets is no doubt damaging, but the most productive (and therefore most profitable) transactions are generally not thwarted: it is only at the margin, where transactions are less value-creating, that bad interventions do harm. Anyway, governments in rich countries also intervene a lot, and very often as clumsily. Misguided intervention cannot do enough harm to explain the chasm that separates Mozambique, say, from Sweden.

The crucial difference lies not in markets that exist, but in markets that are entirely missing. Markets in the poorest countries generally conduct “self-enforcing transactions”, with goods exchanged on the spot for money or other goods. Transactions involving distance or, especially, time are not self-enforcing: a promise to pay next week for goods received this week is a risky contract for the seller. If such contracts cannot be made with confidence, the corresponding market may not exist at all. A feature the poorest countries have in common is that contract rights and property rights are badly defined or weakly enforced. Such rights, necessary for advanced markets, which in turn are necessary for rapid growth, are themselves a kind of public good. Again, therefore, Olson sees the failure to provide these rights as springing from the ruler's lack of a sufficiently encompassing interest. Again, the absence of democracy, serving to narrow the ruler's interest, is at the root of the country's economic failure.

As Olson recognised, what he described is just a model, and models must simplify. But that was fine with Olson. His credo was: search for the “stark and simplifying proposition”. In his case, it was always a triumphantly successful strategy. The man is irreplaceable, but this marvellous book is a consolation.