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Olson: Power and prosperity

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Olson. 2000. Power and prosperity. New York: Basic Books.

Y: Protection of contract and property rights (also tax levels, public goods provision)

X1: Regime's discount factor/probability of survival

X2: Regime's stake in the market (narrow, encompassing, superencompassing)

AN ABSTRACT BY WAY OF ANALOGY:

If a roving bandit robs a village, he takes everything. But if a stationary bandit (e.g. a king) robs a village, he will take as much as he can without killing his source of future revenue. This king will set tax rates at a level that maximizes his revenues; because GDP falls as taxes rise, the king maximizes his revenue at a tax rate far lower than 100%. Moreover, the king will find it in his interest to fund certain public goods to promote domestic growth, which further increases his revenues. This is the other invisible hand: autocrats have incentives to work toward the public good even when they have no real intention besides predation. (Tax rates and spending on public goods are defined by the "reciprocal rule.")

INDEPENDENT VARIABLES IN MORE DETAIL:

  • Discount factors: A government behaves like a stationary bandit only if it is confident of its continued reign. When citizens aren't sure of a government's stability, the government can't credibly commit to long-term protection of property and contract rights (which means less investment/growth); to overcome this problem, kings establish dynastic succession orders.
  • Discount factors in democracy: The checks and balances that preserve democracy have an excellent externality: they protect contracts and property rights. Olson stresses that if the checks and balances aren't set up in a way that will actually prevents the rise of an autocrat, then all bets are off. It is only "lasting democracy [that] implies lasting property and contract rights."
  • Encompassing interests: Whereas roving bandits have only a very narrow stake in the economy they plunder; they bear only a minimal share of the social costs that their plundering causes. Stationary bandits have an encompassing interest, however, in the overall success of the economy (which is why they provide public goods and charge less than 100% in taxes).
  • Encompassing interests in democracy: Democracies can be different than autocracies. Recall that an increase in taxes reduces GDP. Unlike the autocrat, members of a majority bear a direct portion of this reduction. Thus, a majority's optimal tax rate will generally be lower than an autocrat's. In fact, the super-majorities effectively empowered by democratic checks and balances will often have a superencompassing interest in the market, leading them to provide only public goods (without any redistributive extraction). In this case, members of the ruling majority gain more from economic growth (hence, public goods investment) than they could possibly gain through taxation.

IN THE CONTEXT OF THIS WEEK'S READINGS:

  • In the context of this week's readings, the main point is that an invisible hand makes governments benevolent, even if their interests are selfish. Our task is not so much to control politicians, but to seek to make this invisible hand function. As Olson points out, it functions most reliably within a democratic system of checks and balances.