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A Not-So-Dismal Science: A Broader View of Economies and Societies

Author(s):Olson, Mancur
Satu Kähkönen, Satu
Reviewer(s):Adams, John

Published by EH.NET (March 2003)

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Mancur Olson and Satu K?hk?nen, editors, A Not-So-Dismal Science: A Broader View of Economies and Societies. Oxford, Oxford University Press, 2000. x + 274 pp. $75 (cloth), ISBN: 0-19-829369-0; $24.95 (paper), ISBN: 0-19-829490-5.

John Adams, Center for South Asian Studies, University of Virginia.

A dozen years after its founding, the IRIS Center at the University of Maryland, College Park, continues to flourish. IRIS is the acronym for Institutional Reform and the Informal Sector. IRIS began work in 1990 after representatives of USAID approached Mancur Olson about creating a research and policy institute that would actively apply his creative ideas about collective action, political economy, and economic growth to problems of Third World development. At that moment, the informal sector was briefly on the screen as a hot topic, but it was understood that IRIS had a wider ambit. On the immediate horizon, issues of economic reform were beginning to emerge as more East European and Central Asian economies confronted the task of making the transition from state-directed to market-based guidance. It appeared to some of the more alert minds at USAID that Olson’s The Rise and Decline of Nations (New Haven: Yale University Press, 1982), and his related papers, could bring fresh insights into the agency’s thinking. Not the least of the attractions was that institutional reforms could yield cheap, high-payoff effects on efficiency, productivity, and growth rates, when compared to the capital-intensive infrastructure or other investments favored by the donors.

The University of Maryland presented the advantage of its location in the Washington suburbs and, further, had a long tradition of institutional and policy-oriented faculty members in its Department of Economics, and the campus had strengths in related social sciences. The university administration, acting under the crusty directives of archaic state accounting and personnel practices, had no latitude to allow for the creation of a semi-autonomous unit that would enjoy flexibility in its financial management and personnel affairs. After tedious negotiations, Olson finally succeeded in establishing IRIS, thereby enabling his vision of a center devoted to rigorous, academically based economic policy advice, but with his own unmistakable twist. (The curious are directed to: http://www.iris.umd.edu/.) The irony escaped no one, certainly not Olson, that the first IRIS victory for institutional reform had to be won in College Park and Annapolis, before advancing on to the new fronts in Moscow and Lusaka.

Over the years, IRIS has turned out many publications in all forms. This book grew out of a long-term project centered in India. Olson and the other authors gave talks that were designed to cover general issues, rather than focus only on Indian topics. The intention was to provide Indian audiences with an introduction to the IRIS approach to policymaking and reform, and then engage in give-and-take discussions. The ten contributions to Not-So-Dismal certainly cover the range of ideas for which Olson and IRIS have become known, although the high stature and personal vantage points of the other authors bring additional cachet and riches to the table. As the editors tell us in the introduction, their principal ambition was to demonstrate the effectiveness of pushing new institutional economics out into the “suburbs” of the discipline, there to interact with historians, political scientists, and lawyers. One has to say that they succeeded very nicely.

Olson contributed two essays to the compilation. The volume opens with his “Big Bills Left on the Sidewalk: Why Some Nations Are Rich and Other Poor.” This is vintage Olson stuff. Take a couple of simple observations and then play with them like a kitten with a mouse. He starts by calling attention to the striking variations in levels of productivity and income marked out by national boundaries. When an immigrant from, say, Bangladesh lands in the U.K., his earnings rise by a factor of fifty or more. Because the immigrant did not miraculously acquire either more human capital, or assume radically different cultural or religious values, during an 11-hour airplane flight, then the determining factors must lie in the institutional and policy differences between the two countries.

The logic of Olson’s dissection of this conundrum is as entertaining as it is intuitively plausible. Economists generally believe that people are rational and will seize opportunities for gains from innovation, allocational efficiencies, and contractual adjustments. These are the “Big Bills” of the title, and we see in poor countries that these often remain on the sidewalk or cow path. Olson considers as possible explanations for the persistence of national poverty the usual neoclassical variables: technology, capital, the quantity and quality of labor, and land and natural resources. He rejects each in turn: knowledge is widely available at low costs; human capital differences are insufficient; land/labor ratios and diminishing returns do not appear explanatory. What’s left? Policies and institutions, of course. His advice to the less-developed world: “Wise up.”

Olson’s second chapter in the volume is, “Dictatorship, Democracy, and Development.” A monarchist once said that a king afforded the best kind of government, because he is the “owner of the country,” and like a householder, when something is wrong “he fixes it” (p. 119). Claiming to have worried about this apparent conflict with his democratic inclination since he was a student, Olson asserts that he has finally resolved it. Societies “work satisfactorily” when they have peaceful orders and produce decent quantities of public goods. The problem is that the usual collective action contradictions intervene so that it is very hard for large societies to govern themselves well: any individual bears the costs of public good production, but is unlikely to recoup sufficient benefit to warrant the loss. Small bands or villages do not have this problem in like measure. Olson proceeds to argue that a “roving bandit” has a motive to become a “stationary bandit,” that is, a warlord or king, with a monopoly on violence because he has an “encompassing interest” that yields tax revenues from the gains from order and any economic expansion. Even with a tax rate of one-third, he has an incentive to produce public goods until the return on a unit of spending falls below three units of gain. Not optimal, but some public goods are better than none.

When dictatorships falter, it is likely because a short-term survival crisis leads to a reversion to plunder that robs subjects of incentives to remain productive and reduces spending on public goods. The leadership of a democracy is interested in securing the majority votes needed to hold power through adequate provision of public goods, but its willingness to tax is constrained by the majority’s encompassing interest in the gains its members get from higher output. Higher taxes not only take a larger share of a person’s income, but to the extent they depress incentives and product, impose an added loss. Democracies can also take the long view, which dictatorships can rarely do, plagued as they are with often deadly contests for the rulership and with crises of succession. Olson teases out of this contrast between dictatorship and democracy the further implication that governments that protect property rights and human liberties are likely to be those that do the best job of setting policies favorable to economic development. These themes are more fully developed, and applied to the problems of regime transitions, in his posthumously published Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships (Basic Books, 2000)

The other eight chapters in the book rove around these classic Olson ideas, playing off them, augmenting them, or challenging them. As we all recognize, solid ideas are among the best of public goods. Joel Mokyr takes up the question, why technologies that are known to have economic and financial potential, are actively suppressed. Answering this poser should de-obfuscate the singular difficulty many poor nations have in absorbing new knowledge and techniques. Mokyr goes down a fairly well worn path in identifying winners and losers in the social balance, and pointing to the different outcomes of the market calculus versus the political geometry. Many innovations have religious and cultural facets, as well as technical and scientific ones, and this mixture frequently lends itself to a judicial or political sorting out, rather than a bare market test. Opposition to adoption can arise from those fearful of job loss, capital obsolescence, human capital erosion, or dreaded externalities, such as those from pesticides or nuclear disaster. Various political economy, Olson coalitional, and path dependence factors intrude. Summing up, no one does technological evolution better than Mokyr — but we knew that!

Oliver Williamson writes about economic institutions and development, with emphasis on the structure of corporate governance and the role of transaction costs in shaping that structure. The firm operates in a larger institutional framework but is inhabited by individuals who feature bounded rationality and opportunism in their contractual dealings. The main determinants of outcomes are the status of credible commitments, the nature of the operative bureaucratic organization, and remediableness, which is whether an admittedly deficient institution actually can be supplanted by a superior alternative, not including an idealized costless or frictionless arrangement. Political leadership and bureaucracies don’t have to be perfect, and generally successful societies can tolerate a fair number of institutional and policy stupidities.

Williamson makes an intriguing argument that in rich countries with more or less decent governance, it is hard to make a case against the odd examples of inefficiency or irrationality, such as the U.S. sugar policy, since they were derived in a system that most people support and over a long period of time their distributional quirks have been tolerated. When we have a developing country with governance above a threshold of adequacy, then reform and policy improvements can be nudged by external assistance conditionalities; in other words, remediableness is feasible when credible commitments are applied. Like Mokyr’s adroit essay on technology, Williamson’s is the gold standard on organizations. If there is a critique, one would have to say that in both cases it takes so much space to present their unique languages and grammars, there is very little room left over for applications to the developing world.

After bowing to the insights of the new institutional economics with respect to contracting, property rights, and the political economy of social choice, Pranab Bardhan reverts to a more traditional political economy approach, centered on distributional conflict. He opens by reassessing the relation-based kin and clan networks that have defined the channels of Asian commerce for many centuries down to the present. He emphasizes that the reduction in information, management, and contract-enforcement costs associated with these systems make them a clearly competitive alternative to Western business formations. The chief institutional lacunae are found in the absence of financial instruments and markets, which in turn is a consequence of the absence of governments, traditional or colonial, that could provide for “coordination in investment and risk-taking” (p. 253). Modern East Asian states nurtured economic success with managed capital markets, development banks, and infant-industry interventions. These governments could credibly commit, while many others in Asia, Africa, and Latin America have remained “soft” and are pretty much the captives of predatory special interests, as usually posited in the economists’ theories of the state.

Bardhan contrasts the close working relationships between state and private actors in East Asia with the disconnectedness of these players in South Asia. The diversity and inequalities of South Asian societies made it more difficult to build an encompassing coalition or to create a consensus in favor of a coherent, forward-looking economic strategy. Weak performance incentives for the bureaucracy in India, as one case, created a fertile ground for capture of key decision-makers by private interests, aka corruption. Bardhan offers the useful reminder that the neo-institutionalists are apt to overestimate the plasticity of institutions in adjusting to factor prices or market opportunities, in comparison to the neo-Marxists who continue to insist on the staying power of entrenched economic elites or broader class interests. In India, we see familiar failures of beneficent collective action in the villages, where social divisions bar cooperation in use of irrigation water or common property resources. What to say? Quite a lot of wisdom here and a reminder that theories require quite a lot of hammering and bending to be made to fit actual cases.

In “Overstrong Against Thyself,” J. Bradford De Long considers the difficulty states have balancing long-term prosperity goals against corrosive claims on the current product for such noble causes as conquest, spreading a religion, or exhibiting splendor. After the industrial revolution this conflict intensified because there was so much more to appropriate and states were much better organized to do it. How Great Britain resolved this dilemma is pretty much the story of this chapter. De Long observes that Europe’s cities and their mercantile leaders flourished in regions characterized by an absence of absolute rulers. He points out that “an oligarchy of merchant-burghers” had a “direct interest in economic prosperity” while the princes and kings were primarily interested in raising their military power (p. 146). A merchant-ruled city-state will tax at a lower rate than will an absolute prince, because of the burghers’ benefit in sustaining affluence. By 1600, new military organizations and technologies shifted the terms of armed conflict in favor of the princes and against the city-state militias.

First Spain and then other regimes, some autocratic and some not, became the great power(s) of an epoch, but then faltered when their military efforts, budgets, and manpower mobilization, sapped their economic capacities. Adam Smith and others were wise enough to see that Great Britain faced the identical dilemma. According to De Long, the Protestant character of the society raised the stakes for all its segments. A Catholic restoration would have been calamitous. Fear was ubiquitous: the king of losing his throne, the nobles of losing their estates, the people of losing “their souls.” Unlike their counterparts on the continent, all were happy to load themselves with taxes, with the result that the burdens of war were widely spread. Britain tended to win land engagements and naval battles, conquered new territories, and experienced rapid internal demographic expansion, all abetting wealth and military capacity. Meanings for today’s poor nations: be lucky; be realistic about growth expectations, remembering that for a long time Europe’s growth rates were well below those of today’s late starters; unite the nation, and have a fair tax code; try to elevate pro-growth, foresighted policies in the political pecking order.

I am going to shortchange the final four papers based on personal whim and a shortage of time and space. (If you think this is biased and iniquitous, go write your own review.)

Erik Moberg challenges Olson’s interpretation of Sweden’s economic slowdown after the halcyon 1960s, when a deft balancing act seemed to ensure long-term success based on heavy taxation, a plethora of social benefits, and comparatively rapid growth. Social homogeneity, economic equality, and the encompassing character of the major interest groups may have been facilitative, as Olson claimed. Moberg believes that Olson’s assertion, it can hardly be called an argument, that the retardation of growth stemmed from a fragmentation of the encompassing coalitions is not sustainable. Olson had stressed the benefits of free trade during the golden years, but Moberg observes that the oil shocks of the 1970s, high capital costs, and more rigid labor markets made it increasingly hard for Sweden to adapt to changed market conditions. This very conventional explanation may carry more water than coalitional rearrangements.

India and the United States have each put in place robust affirmative action programs, one based on caste and the other on color. Edward Montgomery undertakes a careful review of the political origins of affirmative action in these two democracies. He finds that theoretical and empirical work does not provide unambiguous answers to questions about the impact of quotas on the wages of covered or uncovered workers, or broader effects on their educational access and attainment. There is a tendency in both countries for coverage to expand over time. When adopted, India’s caste reservations of jobs and university seats, and the U.S.’s parallel doorways for minorities to enter workplaces and schools, were supposed to expire after a transition period. Although this end game had not materialized when Montgomery wrote a few years ago, it is interesting that strong moves are afoot in India and the United States to quash affirmative action, as a backlash from the upper castes and the white nobility cascades into a stream already swollen and muddied by religious, nationalistic, and militaristic currents.

Montgomery’s thematic is widened in the following chapter, by Russell Harding, who looks at the impact of India’s and the U.S.’s “socially autarkic groups” on economic policy and growth prospects. Harding distinguishes groups that define themselves socially, in terms of religion, practices, or origins, from economic groups, such as farmers. A problem arises when these groups seek state subventions to ensure their survival, predicated on some ethical or other normative principle. Linguistic diversity raises education costs and complicates government and business labor recruitment. This is all pretty much conventional sociology and has little to do, as far as I can see, with Olsonian issues. Robert Cooter contributes a chapter on law, written with an infusion of game theoretics, but the theory floats very airily above any Third World actuality. Nothing wrong with this, but one exits with a “so what” taste in one’s mouth.

What did Indian audiences make of all this? Hard to say without having been there. The theoretical contributions would be, by and large, novel in most Indian university or research circles. At the same time, I’d say that India’s policymakers are very much aware of most of the issues involved inside their own political economy mechanisms. Indian politicians are, I’ll just simply aver, the best in the world, qua politicians-committed-to-winning. If you want to triumph in an election, you’d better buy the votes of the landed castes with farm subsidies, free water, and free power. It’s pretty hard to miss hundreds of thousands of guys running around in orange gauzy pajamas waving tridents, or not be aware of festering tribal rebellions in much of the northeast, or not empathize with some 120,000,000 Muslims who find themselves being involuntarily detached from Nehru’s secularist social compact.

John Adams is an out-of-the-closet old, or original, institutional economist. To make a post-Enron disclosure, he reports that he was at the University of Maryland for 25 years, knew Mancur Olson well, and helped found IRIS.

(Dr. Adams graciously agreed to take on this review after the original reviewer proved unable to complete the assignment.)

Subject(s):Markets and Institutions
Geographic Area(s):General, International, or Comparative
Time Period(s):General or Comparative