Saturday, February 20, 2010

The Rise and Decline of Nations

By Mancur Olson

“The Rise and Decline of Nations” put forth Mancur Olson’s theory to explain macroeconomic growth. Why do some countries grow quickly and others slowly? Why do some countries grow quickly at some times and slow at others? Though he doesn’t claim that it is the only factor, he answers that a main reason for this effect is that over time, in stable countries with unchanged boundaries, distributional coalitions (interest groups, collusive organizations) start to form and grow. The longer the country is stable, the more distributional coalitions it will have. These groups influence politics to gain benefits for their group, thereby imposing economic inefficiencies on the country. Collusive groups of businesses may set prices higher than the market rate. These inefficiencies slow growth in these countries. In countries that undergo upheaval (Germany and Japan after WWII, for example), these coalitions are broken down, and once they are stable again, these countries will have a high growth rate for a period of time. He applies this theory to countries around the world, uses it to suggest an explanation for the caste system in India and apartheid in South Africa, and uses it to explain unemployment throughout time and stagflation in the 1970s.

1. The Questions, and the Standards a Satisfactory Answer Must Meet
A satisfactory theory about macroeconomic growth must be able to explain why there are different growth rates at different times and in different places – it can’t simply explain one issue. It should match up with microeconomic theory, so it is possible to understand why individuals are making particular decisions. In general, a good theory should be parsimonious (short) and explain a lot.

2. The Logic
In Olson’s previous book, “The Theory of Collective Action,” he explains how and why groups form. In general, it is difficult to form groups for collective action if there is no way to exclude people from the benefits. Any member could refuse to participate, and not make any contribution, but that member would still benefit from the work of the group. (For example, if you’re fixing up a neighborhood park, one person may not help fund or work on the park, but others won’t be able to keep that person from using the park when it’s finished.) This is called the ‘free rider’ problem. Furthermore, if the benefits to each group member don’t exceed the costs each pays, they will not take any action. From this understanding, Olson argues that smaller groups are easier to form than larger groups. He also suggests a number of ways that people can be influenced to join groups. One is social pressure – if there are small groups of people that know each other, there can be pressure on individuals not to be “free riders.” Another is selective incentives. Selective incentives are things that are provided to members, but not to non-members – it could be a magazine, special insurance rates, or any other item that can be provided only to group members.

3. The Implications
Building on the logic about groups presented in the second chapter, Olson lays out nine implications that form the basis of his theory, which is used to explain particular situations in the rest of the book.

1. There will be no countries that attain symmetrical organization of all groups with a common interest and thereby attain optimal outcomes through comprehensive bargaining. Essentially, through groups will continue to be created and grow over time, the power will never even out so that the groups perfectly represent society and don’t hurt efficiency – some, the poor, consumers, and other dispersed groups, will not be as well represented.

2. Stable societies with unchanged boundaries tent to accumulate more collusions and organizations for collective action over time. The longer the country is stable, the more distributional coalitions they’re going to have.

3. Members of “small” groups have disproportionate organizational power for collective action, and this disproportion diminishes but does not disappear over time in stable societies. It’s easier for small groups to form, and the benefits they can each get from redistributing wealth (through political action) to their own small group is greater than the benefit that each member of a larger group would get from redistributing the same amount of wealth. Basically, interest groups are more likely to represent a relatively small group of farmers, industries, etc., rather than large dispersed groups like consumers, the poor, etc.

4. On balance, special-interest organizations and collusions reduce efficiency and aggregate income in the societies in which they operate and make political life more divisive. It is more beneficial for the groups to spend money to redistribute wealth to themselves (through political lobbying or collusion), rather than increasing overall efficiency of the economy (investing in new technologies, etc.), since the redistributions go only to their small group while the overall efficiencies would benefit the economy as a whole. The involvement of many special interest groups in politics makes issues more divisive and complex.

5. Encompassing organizations have some incentive to make the society in which they operate more prosperous, and an incentive to redistribute income to their members with as little excess burden as possible, and to cease such redistribution unless the amount redistributed is substantial in relation to the social cost of the redistribution. If an organization represents a very large group of society, then the benefits of overall economic growth may be more beneficial than redistribution. An example is a national labor union, which may be more interested in economic growth and creating more jobs, rather than protecting one particular type of job.

6. Distributional coalitions make decisions more slowly than the individuals and firms of which they are comprised, tend to have crowded agendas and bargaining tables, and more often fix prices than quantities. Since there is so much bargaining, lobbying, and other interactions that need to occur among groups, the process moves more slowly in reaching a conclusion. In collusive groups, prices are easier to fix than quantities because it is easier to monitor whether other industries are selling at a different price, while it may be difficult to monitor the actual quantities they are producing.

7. Distributional coalitions slow down a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions, and thereby reduce the rate of economic growth. Since it is difficult to make decisions, and since many groups have an interest in the status quo, it will be more difficult to adopt new technologies, create new industries, and generally adapt to changing environments.

8. Distributional coalitions, once big enough to succeed, are exclusive, and seek to limit the diversity of incomes and values of their membership. Since any benefits that are gained through lobbying or collusion need to be shared among the members of the group, once the group is large enough to be successful, it will not want to admit more members. For example, if a small number of companies has a monopoly over a particular market, it will be in their interest to make it difficult or impossible for new-comers to enter their market, so they can maintain their monopoly benefits.

9. The accumulation of distributional coalitions increases the complexity of regulation, the role of government, and the complexity of understandings, and changes the direction of social evolution. As the number of distributional coalitions grows, it will make policy-making increasingly difficult, and social evolution will focus more on distributing wealth among groups than on economic efficiency and growth.

4. The Developed Democracies Since World War II
The implications discussed above suggest that a country that has just undergone major upheaval, once it is stable again, will experience increased economic growth. This is the case in the “miracle” economies in Germany and Japan after WWII. It is not surprising, under this theory, that countries such as Britain had relatively slow postwar growth, since they had been stable over a long period and had a large number of distributional coalitions. He also looks at the growth of various states within the U.S. over time, finding that in the 1960s and 70s, the states in the west and south had higher growth rates than those in the northeast. This agrees with the theory, since the northeastern states have existed and been stable for the longest period of time.

5. Jurisdictional Integration and Foreign Trade
Though the theory would make it seem that occasional upheaval or revolution would be beneficial to economic growth, that is not the policy implication that Olson aims to provide. He notes that similar benefits can be had by opening boarders – i.e. implementing free trade. He gives the example of France (and many other countries) which in medieval times was broken into largely autonomous towns and cities. There were often tariffs imposed by each city, and tolls imposed to pass through them. In each town, the people who practice a particular art could fairly easily collude – these were the medieval artisan’s guilds. Olson uses these guilds to illustrate implication 8 – that once groups are big enough to succeed, they aim to limit their membership. Therefore, once guilds were formed, increasingly strict rules were put into place to ensure it was difficult for outsiders to join the profession. People could only begin the profession if they first became an apprentice. In many cases, each professional was only allowed one apprentice. In this way, the guilds were able to maintain multi-generational monopolies in their occupation in each of the autonomous towns. When national monarchs began to take more control and removed the tariffs and tolls, it was difficult for the guilds to maintain their monopolies – people could buy in other towns for less, and even if sellers tried to keep the monopoly in their town, they’d have an incentive to sell in another town at a price under-cutting that town’s guild. This breakdown of barriers put distributional coalitions into disarray and allowed countries to have a period of more rapid growth. Similar effects are seen after the creation of the European Union and even after unilateral free trade decisions.

6. Inequality, Discrimination, and Development
Though it is more difficult to get historical data, Olson argues that the theory applies not only to Europe, but to all parts of the world. He gives the example of guilds that existed in ancient China and India. He even suggests the theory could help to explain why India’s caste system has seemed to grow more rigid. He argues that the castes were similar to occupational guilds, and that rules such as endogamy (only marrying within the group) were put into place to keep the power of the group over multiple generations (limiting the size of the group once it is successful – implication 8). Ensuring people only marry within their caste ensures that the group does not mix and become so large that the benefits to each member would be diminished. Encouraging prejudice among groups reinforces the rules for interacting and marrying only within the group. He gives a very similar explanation for apartheid in South Africa. He argues that when the Boers first came to South Africa, the separation between white and black was not as extreme, and there were a number of mixed-race relations. In the beginning, mining companies hired cheaper, black laborers for the unskilled labor and hired the more expensive, white workers for the semi-skilled and skilled positions. The mining companies, however, then believed that it would be in their interest to provide the black laborers with some training so that they could take over some of the semi-skilled and skilled jobs at lower wages, thus decreasing costs for the mining companies. However, the white laborers started lobbying the government to pass legislation setting wages for semi-skilled and skilled jobs. Legally imposed high wages meant there was no incentive for mining companies to train or hire black workers for semi-skilled or skilled jobs. Additional laws were passed, increasingly separating white and black, with the aim (implication 8 again) to keep the interest group from growing, now that it was successful. Political efforts were paired with other things, such as endogamy within groups and cultivating prejudice to keep the powerful group from expanding. Olson argues this evolved into the strict apartheid regime.

7. Stagflation, Unemployment, and Business Cycles: An Evolutionary Approach to Macroeconomics
When both high inflation and unemployment occurred in the 1970s, it went against many of the prevailing economic theories – Keynesian theory suggested inflation and unemployment could not happen simultaneously, and traditional monetary theory had no explanation for long periods of unemployment. Olson suggests this phenomenon can be explained using the theory presented in this book. He notes that the result and reaction to depressions had been changing over time. He compares the crisis in 1839-43 to the great depression in 1929-1933. In the earlier period, the contraction in money supply was greater and the fall in the price level was substantially greater, both of which would suggest the effects would be worse in the earlier period. However, in the earlier period, real consumption was positive, while in the second period, it was negative. Similarly, in 1839-43, the real GNP rose, while in 1929-33, the real GNP fell. Olson argues that the growth of collusive organizations and distributional coalitions was the cause of this difference. In a crisis, it is best if wages and prices are flexible, so that employers can offer lower wages and employees get jobs at lower wages, but still continue producing things and continue working. However, if there are labor unions that insist a wage stay set at a high level, then the wage is not flexible, and employers and employees can’t make mutually beneficial agreements to work together at lower wages – less people can be employed and the system is less efficient. This was the case in the great depression. In this situation, all of the people who can’t get jobs try to move to industries that do have flexible wages. In the great depression, many people tried to move to farming, for example, but since there were so many people moving into this area, it flooded the market, and the value of farm goods decreased significantly, so that people couldn’t make a good wage in this area either. Olson argues that this trend continues, so that unemployment and inefficiency become more and more of a problem during crisis over time in stable societies.

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