In my previous posting, I described the book "Why Nations Fail" and some of my reactions to it. I ended with the promise of a discussion of the curious point that the book does not address, or appear to provide much in the way of analytical tools to explain, namely the current crisis in Europe or the probable coming one in the U.S.
I refer, of course, to the structural problem in much of Europe of chronic low growth of the private sector, high unemployment, high tax rates, widespread tax evasion, a very large public sector (as a percentage of GDP), large sovereign debt loads (again as a percentage of GDP) and a large portion of the societies who are beneficiaries of significant government entitlement programs.
Obviously, these conditions are closely inter-related.
In order to bring such a fact-pattern within the paradigm if the book, its central theory needs to be expanded.
The authors note that certain South American countries that had the appearance of democracies (i.e. appeared to be inclusive political structures) were, in fact, extractive political structures, where the elite continued to hold power through an informal scheme by which nominally opposing political parties "took turns" holding executive office. They cite Colombia and Venezuela as examples. I can certainly confirm this from personal knowledge as it applies to Venezuela up to Chavez. (With the coming of Chavez, the pluralistic formal institutions of society have been systematically dismantled, so that the clothing of democracy has become thinner than a belly dancers veil.)
However, the authors fail to generate a theoretical framework for this type of situation. I think it exemplifies the possibility of a formally inclusive political institution (i.e a real democracy) being subverted by a self-appointed elite, even without the elections themselves being rigged.
In the U.S. this group is sometimes referred to as the "political class". In truth, the members of the political class, regardless of differing political affiliation, share common interests in maintaining and expanding the proportion of national wealth under government control (and therefore their control) to a greater extent then they share common interests with their constituencies (except, of course, to the extent that their constituency are groups who significantly benefit from government funding). Even politicians who initially get elected by appealing to the interests of taxpayers, on whose backs the whole structure is supported, often switch, over time, as they become seduced by the power (and wealth) that comes to those who control the taking and redistribution of other people's money.
Anyone who is familiar with French society (to take an example in Europe), understands that there is a small political elite at the top of the major parties which is closely interconnected with the economic elite which run most of the economy (both public and privately controlled). In France, this group is self-perpetuating and extremely stable regardless of political winds, the collapse of Republics, wars won and wars lost etc. Since public office is determined by election, with broad universal suffrage, this elite must achieve its balancing act by buying large numbers of votes through the distribution of money in the form of government programmatic handouts. This is not dissimilar to the political elite in the Roman Empire buying peace and political loyalty from the Roman citizenry by means of daily provision of food and entertainment at government expense (bread and circus). In the Roman case, there was not universal suffrage, but the mob still held collective political power in its capacity to riot. French society is dirigiste. As a result, the history of French politics is like plate-tectonics, pressures building inexorable over time, and then a sudden catastrophic release of political energy which often results in barricades in the Paris streets and the collapse of the Republic.
So, I submit that the authors need to realize that an extractive political structure can be created in a real democracy, and one of its hallmarks will be a very significant proportion (ideally a majority) of the population receiving government handouts.
De Tocqueville warned of this possibility and its corrosive effects on what he identified as the societal strengths of America.
The authors note that extractive structures do not cavil at wasting national resources, or accepting sub-par growth, provided they get their skim. I submit, to the authors of "Why Nations Fail", that the European welfare state is (counter-intuitively) an extractive structure for the benefit of a small self-perpetuating elite even though a broad swath of society receives money (taken from a partially overlapping group known as tax-payers), thereby giving the structure the superficial appearance of an inclusive structure.
The problem with these structures is the risk that the perpetual need to buy voter loyalty leads to ever-increasing government largesse (as a percentage of GDP), and extraction to pay for it, which creates a disincentive to entrepreneurial wealth creation, which undermines the tax base, which requires borrowing to square the circle, which eventually leads to a debt crisis.
Wednesday, May 30, 2012
Wednesday, May 9, 2012
Why Nations Fail
I recently read "Why Nations Fail" by Daron Acemoglu and James A. Robinson. Through the first half of the book I kept trying to decide whether it was one of the most intelligent books I have read in the last thirty years or another example of the common academic conceit of claiming great insight when all that has been done is to invent new nomenclature. I finally decided it was the former, despite the latter.
The nomenclature in the book is "extractive" political and economic structures and institutions versus "inclusive" ones.
Extractive economy institutions are designed to reinforce the ability of a small self-perpetuating proportion of a society to benefit at the expense of the rest, and extractive political institutions concentrate political power in a small group and exclude from power the others. Some extreme examples of societies with extractive economic and political institutions are present-day North Korea, pre-revolutionary France and the US South during both the antebellum and "jim crow" periods.
Inclusive institutions create opportunity for economic and political participation of the great majority.
The book is a slog because it follows the standard advice to speakers, namely "tell them what you are going to tell them, then tell them what you are telling them and finally tell them what you have told them" nested in a fractal like structure of repetition.
None the less, it is an extremely important book. Aside from the central ideas, the great strength of the book is the authors' broad grasp of economic and political history, which allows them to mine it for numerous examples to illustrate their ideas.
Although never stated this way in the book, its essential syllogism is as follows:
1. National prosperity is a function of continuous wealth creation activity (the longer the better).
2. Wealth-creation activity is a function of risk-taking entrepreneurial activity and technological innovation.
3. A society's level of entrepreneurial activity and technological innovation is a function of:
a) the proportion of the population permitted to engage in such activity (e.g. slaves and serfs (and jews in many parts of Europe during different periods) were not),
b) the existence (and reliability of) essential supporting structures (e.g. private property and contract rights, a just rule of law, and a functioning capital market) and
c) the absence (or minimization of) impediments such as corrupt public officials, prohibitive regulations, confiscatory taxing policies and politically protected (or created) cartels or monopolies.
4. Entrepreneurial and innovative activity results in "creative destruction" which as economically and politically adverse to those who are currently at the top of the political and economic heap (elites).
5. Therefore, political and economic elites will tend to seek to shape political and economic institutions (if permitted) so as to discourage entrepreneurial activity and the introduction of technological innovations in order to avoid creative destruction.
6. Inclusive political and economic institutions are mutually and self- reinforcing (virtuous circle) as are extractive institutions (vicious circle).
7. Other than as a result of 6 above, there is no historical, cultural or geographic destiny or imperative or immutable law governing the economic trajectories of nations. (The book is a very effective refutation of Jared Diamond's theories).
8. Counter-intuitively (to the central idea), nations with extractive institutions can engineer bursts of strong economic activity by importing technology but they cannot sustain the high rates of growth when further advances require risking creative destruction of the economic base that sustains the extractive institutions.
Oddly enough, the book utterly fails to address the current crisis in Europe or the coming one in the US. More on that in the next posting.
The nomenclature in the book is "extractive" political and economic structures and institutions versus "inclusive" ones.
Extractive economy institutions are designed to reinforce the ability of a small self-perpetuating proportion of a society to benefit at the expense of the rest, and extractive political institutions concentrate political power in a small group and exclude from power the others. Some extreme examples of societies with extractive economic and political institutions are present-day North Korea, pre-revolutionary France and the US South during both the antebellum and "jim crow" periods.
Inclusive institutions create opportunity for economic and political participation of the great majority.
The book is a slog because it follows the standard advice to speakers, namely "tell them what you are going to tell them, then tell them what you are telling them and finally tell them what you have told them" nested in a fractal like structure of repetition.
None the less, it is an extremely important book. Aside from the central ideas, the great strength of the book is the authors' broad grasp of economic and political history, which allows them to mine it for numerous examples to illustrate their ideas.
Although never stated this way in the book, its essential syllogism is as follows:
1. National prosperity is a function of continuous wealth creation activity (the longer the better).
2. Wealth-creation activity is a function of risk-taking entrepreneurial activity and technological innovation.
3. A society's level of entrepreneurial activity and technological innovation is a function of:
a) the proportion of the population permitted to engage in such activity (e.g. slaves and serfs (and jews in many parts of Europe during different periods) were not),
b) the existence (and reliability of) essential supporting structures (e.g. private property and contract rights, a just rule of law, and a functioning capital market) and
c) the absence (or minimization of) impediments such as corrupt public officials, prohibitive regulations, confiscatory taxing policies and politically protected (or created) cartels or monopolies.
4. Entrepreneurial and innovative activity results in "creative destruction" which as economically and politically adverse to those who are currently at the top of the political and economic heap (elites).
5. Therefore, political and economic elites will tend to seek to shape political and economic institutions (if permitted) so as to discourage entrepreneurial activity and the introduction of technological innovations in order to avoid creative destruction.
6. Inclusive political and economic institutions are mutually and self- reinforcing (virtuous circle) as are extractive institutions (vicious circle).
7. Other than as a result of 6 above, there is no historical, cultural or geographic destiny or imperative or immutable law governing the economic trajectories of nations. (The book is a very effective refutation of Jared Diamond's theories).
8. Counter-intuitively (to the central idea), nations with extractive institutions can engineer bursts of strong economic activity by importing technology but they cannot sustain the high rates of growth when further advances require risking creative destruction of the economic base that sustains the extractive institutions.
Oddly enough, the book utterly fails to address the current crisis in Europe or the coming one in the US. More on that in the next posting.
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