This is a book report on The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities, by Mancur Olson. There isn’t a whole lot about how nations pulled themselves out of their medieval stagnation (see A Farewell to Alms for that), so a better title for this still-in-print book from 1982 would be “How Rich Countries Die.”
Table 1.1 shows annual rates of growth in per-capita GDP for each of three decades, the 1950s, 60s, and 70s, in a range of rich countries. Contrary to our perception of the U.S. as a growth dynamo and the Europeans as sclerotic, France and Germany tremendously outperformed the U.S., as did most of the other countries. If we have grown larger it is because our population has expanded much faster than the European countries.
Chapter 2 summarizes Olson’s groundbreaking work on how interest groups work to reduce a society’s efficiency and GDP. Some of this work seems obvious in retrospect and indeed Adam Smith noted that businessmen rarely met without conspiring against the public interest. There are a handful of automobile producers and millions of automobile consumers. It makes sense for an automobile company, acting individually, to lobby Congress for tariffs. The company will reap 20-40 percent of the benefits of the tariff. It doesn’t make sense for an individual consumer, however, to lobby Congress. It will cost him millions of dollars to lobby against Congress and preventing the tariff will save him only a few thousand dollars on his next car purchase. The economy suffers because some resources that would have been put to productive use are instead hanging around Washington and because cars are more expensive than they should be.
Labor unions are a drag on the economy, but a labor union that represents all of the workers in a company will be less of a drag than a union that represents only a small percentage of workers in each of hundreds of companies. The single-company labor union will have some interest in keeping its host company alive by not bleeding it too much. A union that represents only 10 percent of a company’s workers will recognize that it can drive up compensation to double or triple the market-clearing wage without, by itself, killing the host company.
Citizens won’t bother to inform themselves about public policy, especially the details. Given the lack of influence of a single vote, it doesn’t make sense for a non-specialist to invest the time. Olson says this is why we have a progressive income tax, obvious to all voters, and a lot of obscure loopholes that benefit the wealthy and influential. He notes that the benefits of Medicare and Medicaid to the old and the poor are publicized, not the fact that they are “implemented or administered in ways that resulted in large increases in income for prosperous physicians and other providers of medical care” because “the many smaller choices needed to implement these programs are influenced primarily by a minority of organized providers.”
Chapter 3:It takes a long time for special interest groups to form. Olson cites the fact that it was in 1851, a century after the start of the Industrial Revolution, that the first modern trade union formed in Britain. The longer that a society remains stable, the more freighted down with special interest groups it becomes.
The president of the U.S. would like to see greater economic efficiency in the U.S. as a whole. Individual congressmen, however, will push for pork-barrel legislation that benefits their district even if the cost to the overall economy is hundreds of times greater than the benefit (their constituents will pay 1/435th of the cost and receive 100 percent of the benefit). This leads to a perennial conflict between the president and Congress.
Unions or cartels of businesses slow an economy’s response to change because they require the assent of many members in order to effect a change. This makes wages and prices much stickier than in a classical free-market economy. Unions will negotiate agreements that favor senior workers at the expense of junior members and young people just entering the workforce.
Olson would not be surprised by the current auto industry bailout: “Special-interest groups also slow growth by reducing the rate at which resources are reallocated from one activity or industry to another in response to new technologies or conditions. One obvious way in which they do so is lobbying for bail-outs of failing firms, thereby delaying or preventing the shift of resources to areas where they would have a greater productivity.”
Special interest groups create complexity, by getting special rules established for their benefit, and thrive on complexity. If a tax or tariff code were only three pages long, an average citizen would be able to spot the sweetheart deals. If a code runs to 1000 pages, however, nobody will ever understand all of it.
Special interest groups may create government regulation. Prior to the Ford Administration’s mid-1970s push to deregulate railroads, trucking, and airlines, for example, the U.S. government was very effective at ensuring profits and excluding new entrants to the market.
Chapter 4 compares countries in the post-World War II period. Olson says that Germany and Japan did well because their special interest groups were shattered by military defeat. When new labor unions formed in Germany and Japan, they tended to be very broad-based and therefore had an incentive in the overall welfare of their societies.
“Great Britain, the major nation with the longest immunity from dictatorship, invasion, and revolution, has had in this century a lower rate of growth than other large, developed democracies. … Britain has [a] powerful network of special-interest organizations. The number and power of its trade unions need no description. [Olson wrote this book just as Margaret Thatcher was coming to power.] The venerability and power of its professional associations is also striking. … Britain also has a strong farmer’s organization and a great many trade associations.”
“[Britain's interest groups] are narrow rather than encompassing. For example, in a single factory there are often many different trade unions, each with a monopoly over a different craft or category of workers…”
Olson notes that slow growth can’t be due to something inherent in the British character, because the country was the world’s fastest growing from 1750 until 1850.
Olson cites a study by Murrell testing the hypothesis that Britain’s slow growth was due to special interest groups that took time to form. Murrell looked at new versus old industries in Germany and Britain. The disparity in growth rates was significantly larger in Britain than in Germany.
Britain during the time of the Industrial Revolution had more social mobility and less class consciousness than other European nations. Napoleon and totalitarianism destroyed the Continent’s nobility, reversing the relationship between Britain and the rest of Europe.
Olson preempts the question of “How come the Swiss aren’t poor given that they’ve had stability for so many centuries?” by looking at their constitution, which “makes it extremely difficult to pass new legislation. This makes it difficult for lobbies to get their way and thus greatly limits Switzerland’s losses from special interest legislation.”
Olson asks why the U.S., given its stable government and lack of invasions, hasn’t done very poorly. The first answer is that the U.S. has done poorly, growing slower than France, Germany, and Japan. The second answer is that the U.S. is not uniform. Some parts are relatively recently settled (the West) and/or relatively recently recovered from the Civil War (the South). It turns out that these are precisely the regions of the U.S. that have enjoyed the fastest rates of growth: “the longer a state has been settled and the longer the time it has had to accumulate special interest groups, the slower its rate of growth.”
Chapter 5 looks at medieval guilds and foreign trade. Olson finds that the countries with the lowest tariffs had the highest growth rates. The countries with the fewest restrictions on immigrant labor had the highest rates of growth in per-capita income.
Chapter 6 is titled “Inequality, Discrimination and Development.” Japan’s history is mined for evidence supporting Olson’s theory. The country was stable until the mid-1800s. This led to “tolls, tariffs, regulations, and legal monopolies”; the country was a basketcase economically. The nation was opened up via gunboat diplomacy, which shattered the feudal system and high tariffs. The country grew so quickly that it defeated Russia in 1905 and came close to humiliating the U.S. in 1941.
Olson quotes Nehru explaining that Muslims were able to conquer India because of the “growing rigidity and exclusiveness of the Indian social system as represented chiefly by the caste system.” Olson compares the caste system to the medieval guilds. The barring of marriage outside of one’s caste is explained by the desire of a caste to retain the fruits of its economic exclusivity.
South Africa is next. The mine owners wanted to hire mostly Africans because they could be paid less than whites. The trade unions were controlled by whites and wanted to force the mines to employ at least one white for every 3.5 black workers. Bitter strikes led ultimately to the rise of white supremacist political parties and legislation limiting employment opportunities for blacks. Restrictions on labor were naturally followed by restrictions on social interaction and marriage.
Olson notes that special-interest groups increase inequality in a society. A union prevents companies from hiring black workers at the same wages at whites. A caste system prevents someone from rising above the station to which he was born. Effective lobbying turns welfare or health care programs into cash cows for government workers or health care providers.
Chapter 7 is very timely, being about stagflation and business cycles. Olson points out that no standard economic theories explain how the U.S. and Britain could have suffered high unemployment rates for the full decade of the 1930s. Keynesian economics could not explain the simultaneous high unemployment and high inflation of the 1970s. Olson points out that no economic theory explains why “unemployment is more common among groups of lower skill and productivity, such as teenagers, disadvantaged racial minorities, and so on” (classical economics would have these folks working at the same rate as anyone else, but at lower wages).
Classical economics does not allow for involuntary unemployment. If the labor supply increases or the economy worsens, wages should fall until everyone is working for a wage that clears the market and that enables employers to make a profit despite lower prices for final products. “The main group that can have an interest in preventing the mutually profitable transactions between the involuntarily unemployed and employers is the workers with the same or competitive skills.” In other words, a company would prefer to replace a $60 per hour 50-year-old unskilled white worker with two $15 per hour black teenagers who would get a lot more done, but the old whites will form a union and prevent the company from hiring the young blacks. If the company does need to hire someone it will be stuck paying $60 per hour and it might as well hire someone with an advanced degree and a lot of skills, which explains why the unskilled are disproportionately unemployed.
How could the Great Depression have lasted so long? Olson suggests assuming that a lot of prices are fixed by colluding business cartels and/or by government regulation. The prices are fixed higher than they would be in a free market, which imposes costs on society and guarantees supranormal profits to cartel members. If there is inflation, the losses to the economy from the cartel are ameliorated. The fixed price is no longer than much higher than what would have been the market price. In the event of deflation, however, the fixed price is now ridiculously high, demand for such an overpriced product plummets, and production plummets. Investment in new factories will fall to zero almost immediately.
Olson divides the economy into a fixprice sector and a flexprice sector. The fixed price part of the economy includes government workers, union workers, products produced by cartels, agriculture supported by government, and imported raw materials whose price is set on world markets. The flexprice sector would include simple services such as cleaning houses and babysitting, In the event of deflation, the output in the fixed price sector will collapse, driving a flood of young and newly unemployed workers into the flexprice sector. The schoolteacher will continue to earn $100,000 per year and retire at 52. The laid-off manufacturing worker will find that the market-clearing wage for cleaning houses is one third of what it was before the economic downturn. This is in fact what happened during the Great Depression. Folks who kept their jobs sailed through; folks tried to make a living as street vendors could not earn enough to eat.
“The economy that has a dense network of narrow special-interest organizations will be susceptible during periods of deflation … to depression or stagflation.”
Olson looks at the tough times of 1975-76, with the world reeling from an oil price shock, and finds that the U.S. had an unemployment rate of 8 percent compared to Germany’s 4.5 percent and Japan’s 2 percent. Is that the only evidence that the U.S. is plagued with special interests? No. Phillip Cagan looked at U.S. price and output statistics since 1890 and “found that the tendency for prices to fall during recessions has declined over time. … an increasing proportion of the effect of any reduction in aggregate demand shows up as a reduction in real output.” [in other words, when times get tough in the modern U.S., we shut down our factories rather than running them with lower wages and lower prices for finished goods; in the event of deflation reducing collectible property taxes, a city will fire half of its schoolteachers rather than cut any teacher's wage]
Olson showed back in 1982 that modern macroeconomic theory was basically worthless in developed stable countries. Macroeconomics posits a free market in which wages and prices adjust dynamically. That applies to an ever-smaller sector of the U.S. economy. We have a rapidly growing governnment that directly or indirectly employs more than one third of our workers, many of whom are unionized. We have a health care system that consumes 16 percent of GDP and is staffed with doctors who restrict entry into the profession via their licensing cartel. The financial services sector is about 10 percent of the economy and they now tap into taxpayer money to keep their bonuses flowing in bad times. The automotive industry kept itself profitable over the years by successfully lobbying for import tariffs. When the profits turned to losses, they successfully lobbied to have taxpayers pick up those losses. A university-trained macroeconomist might be able to predict what will happen to babysitters in a depression, but not the price of cereal, the wage of a manufacturing worker, or the fate of those Americans who collect most of our national income (e.g., Wall Street, medical doctors, government workers).
A cashflow approach is much more effective for figuring out where we’re headed. Money flows out to the folks on Wall Street who bankrupted their firms, to schoolteachers who’ve failed to teach their students, to government workers who feel that simply showing up to work is a heroic achievement, to executives and union workers in America’s oldest and least competitive industries. If times are tough and money is tight, that means almost nothing is left over for productive investment. What would have been a short recession will turn into a long depression and decades of higher taxes and slow growth to pay for all of the cash ladled out. Special interest groups will continue to gain in power.
What practical advice can an individual citizen draw from this book? On the surface, it would seem to be a useful investment guide. Short New York and California; go long on Alaska and Hawaii. Invest in countries that have recently gone through a revolution or are recovering from an invasion (Cuba? Iraq?). One problem with the latter strategy is that instability itself makes it tough for an investor to make money. Only in hindsight do we know that World War II was the last war to rage through France and Germany during the 20th Century or that Red China’s conversion to running dog capitalism would last for decades.
How about as a guide for voting? Olson suggests that a rational voter should remain as ignorant as possible about politics and policies. Even if special interests manage to siphon off 80 percent of the voter’s income, the voter is better off devoting his or her energy to earning more rather than attempting to change the system (likely to require full-time effort, reducing income to $0, and be futile because the voter has no money compared to the special interests). If we ever had the opportunity to vote for something that would restrict the influence of lobbyists and special interests, we should do it, but Olson would predict that such an opportunity will never arise.
One thing an individual can do is choose where to live and in which industry to work. The logical conclusion from reading this book is to prefer a new state to an old state, a newly stable state to a long-stable state, and a new industry to an old one. The worst thing that a young person could do, for example, would be to move to Michigan to work for G.M.’s automobile division. The second best thing would be to move to Alaska or an up-and-coming foreign country and work to extract some new kind of energy. The very smartest choice would be to move to Washington, D.C. and work as a lobbyist for a decaying industry that is bleeding the U.S. economy and taxpayer…
More: Read the book