BDM and Smith on Ukraine's Political Future

Bruce Bueno de Mesquita and Alastair Smith published a piece in Foreign Affairs, Ukraine's Last Best Hope: How Political Reform Can Defend Against Russian Intervention.

For my students that have had a belly-full of Selectorate Theory this past term, the argument will be a familiar one. In short, Ukraine's best hope is to reform its political system into one that requires a large coalition of essential supporters for leaders to stay in power. Such a system will provide leaders with the incentive to provide good public policy, as opposed to private benefits to essential supporters, and to try hard at it. Hard as in, as if their political survival depended on it because it would.

In Ukraine's case, establishing a government that requires a broad base of support will assure people in Eastern Ukraine that the government in Kiev will meet their needs. BDM and Smith argue that this is they way to deal with the demands of the Russian speaking population and to quell their desire for secession. As they put it:

Apart from all of these needed reforms, of course, there is the question of what to do about the Russian bear in the woods. Here, a few principles should govern the Ukrainian government’s response. Self-determination is a fundamental right advanced by coordination freedoms and competitive elections. The way to win the support of blocs of citizens is to provide them with effective public policies that advance their well-being. When governments fail to do that, then citizens naturally look for alternatives, either by selecting a new government or, in extremis, seeking to secede. Secession is the manifestation of failed government; precluding it by fiat is not the solution. Rather, providing incentives not to secede is the goal, attainable by structuring government so that leaders need the support of a broad base of society to stay in power and, consequently, must reward many people through effective policy.

 Democratic societies, in which leaders cater to as many people as possible, are virtually immune to coups, revolution, and civil war. The French political system withstood citizens taking to the barricades in the late 1960s, as did the U.S. political system during the Vietnam War. India, likewise, has withstood regular protests of government policies over the years because, in the end, most citizens recognize that they can redress grievances through normal political channels if enough of them express dissatisfaction with their government’s policies. To win over the hearts and minds of pro-Russian Ukrainians, the government in Kiev needs to make Ukrainian citizenship more valuable than defecting to Russia. But so far, the government’s responses to the unrest in eastern Ukraine have failed to do so. Kiev ought to balance resource allocations fairly, assure the freedoms and rule of law, and then gamble on a self-determination referendum later. Only then will the new government be able to convince many eastern Ukrainians that it is better to be Ukrainian than Russian.

During the Cold War, Western leaders seized any opportunity to score points against Russia. But today is not the Cold War, and a decade of U.S. involvement in Afghanistan and Iraq has tarnished the allure of military intervention. It is almost unthinkable today that the United States or NATO would intervene in Ukraine to thwart Russian ambitions. But given the ineffectiveness so far of sanctions, rather than confronting Russia, Western politicians today should focus on promoting a free and prosperous society in Ukraine. In the long run, such a transformation will prove to be a stalwart opponent to Russia’s expansion; democracies are hard to push around. The stars are aligned in Ukraine’s favor. Making real change toward democracy is the best weapon in the West’s arsenal.

The Green Nature of Markets or The Problem with Environmental Fads and Dogma

A couple of friends of mine were buying a futon when the saleswoman came up and said, "What you need to know about these is that they don't use any wood from the rain forest." One of my friends replied, "That doesn't matter. We're economists, all we care about is the price." My other friend said that the saleswoman just guppied for a minute before stammering, "Well...I guess that's a point of view."

Yes, it is a point of view and an extremely good one. This is because prices are the mechanism by which we get signals from the market about the relative costs and values of things. When one thing is cheaper than another, we know that either less resources were used to produce it or that it is less valued by other consumers. In the case of two identical products (say two futons), we can more or less ignore the second possibility and focus on the first. Therefore, when purchasing products, buying things that are lower priced will generally result in buying things that took less resources to produce.

In 2010, Stephen Budiansky offered what he called Math Lessons for Locavores.

But the local food movement now threatens to devolve into another one of those self-indulgent — and self-defeating — do-gooder dogmas. Arbitrary rules, without any real scientific basis, are repeated as gospel by “locavores,” celebrity chefs and mainstream environmental organizations. Words like “sustainability” and “food-miles” are thrown around without any clear understanding of the larger picture of energy and land use.

The result has been all kinds of absurdities. For instance, it is sinful in New York City to buy a tomato grown in a California field because of the energy spent to truck it across the country; it is virtuous to buy one grown in a lavishly heated greenhouse in, say, the Hudson Valley.

Budiansky goes on to look at the claims made by "locavores" about the energy that is wasted on shipping food over great distances and generally debunks them. Among other things he notes that it only takes one tablespoon of diesel fuel to move 1 pound of produce 3,000 miles by rail (which is totally credible since railroads get 476 ton/miles to the gallon). He also notes that transportation only accounts for 14% of the energy used in food production. In contrast, home preparation and storage account for 32%, so consumers are the real energy hogs.

As interesting as this all may be, focusing on energy alone ignores all the other resources that go into food production. As Budiansky puts it:

The best way to make the most of these truly precious resources of land, favorable climates and human labor is to grow lettuce, oranges, wheat, peppers, bananas, whatever, in the places where they grow best and with the most efficient technologies — and then pay the relatively tiny energy cost to get them to market, as we do with every other commodity in the economy. Sometimes that means growing vegetables in your backyard. Sometimes that means buying vegetables grown in California or Costa Rica.

Gee, wouldn't it be nice if we had some sort of system that made sure that things were produced in the most favorable locations, using the most efficient technologies and that took differing costs of transportation into account.

Excuse my sarcasm but this is exactly what markets do. If someone can find a way to make it cheaper enough somewhere else that it pays to ship the product of log distances, then they make a killing on it and consumers get lower priced produce.

In North Carolina, we have lots of hog and poultry farms be cause the climate here is very conducive to that type of operation (and not conducive to other things). These farms consume far more corn feed than North Carolina  produces. They only exist because the railroads found a way to inexpensively ship corn from the midwest. The key innovation there was the Big John covered hopper and the use of unit trains that carry only one commodity from point A to B. This allowed the growth of large meat packing firms like Smithfield which became the largest pork producer in the world. A lot of people in NC are totally ignorant of this railroad connection, even if they are aware if the size of the hog and poultry industry

But that's okay, we don't need to know all that because most of the relevant information is aggregated into the price. As Landsburg points out in reference to Budiansky's article: 

The key economic point is that in practice, there is one and only one way to account for all those costs (or at least most of them) and that is to look at the price of each tomato, which largely reflects the opportunity costs of the land, the workers, the farm equipment, the resources that produce that farm equipment, and much more that matters very much but that you and I probably won’t think of on our own. 

To be sure, markets aren't perfect, especially where externalities are concerned. But we need to realize that they are inherently "green" in the sense that they incentivize efficiency which is the essence of conservation. However, this efficiency only works when  people follow the incentives. Where consumers are concerned, this means buying things that are lower priced. If a locally grown tomato sell for less, by all means buy it. But if it costs more than one from California, it probably means that more resources were used to produce the local one, and you should buy the one from California if you care about conserving resources.

Of course, there is the possibility that the local farmer is just as efficient as the California one, but knows that a lot of people irrationally (as I have argued above) value local produce and will pay a higher price. Power to the farmer that can do this but his customers are playing the role of the Greater Fool in the farmer's plans.

On a personal note...

My wife and I have four chickens that I keep in my yard and this is supposedly sustainable agriculture. We get 3 eggs a day which are very tasty, so they are worth twice as much to me as the eggs I can buy in the supermarket. Therefore, I would put there value at $4/dozen which comes out to $30 of eggs per month.. Against that I have the cost of feed and other supplies which run about $20/month. This means I get $10 of value each month. However, I spent $1,500 building the coup and purchasing the chickens and other sundries. So I won't break even until 150 months or 12.5 years have passed. Of course, by then I will have needed to acquire several more generations of chickens and the coup will need maintenance, pushing the break even date farther into the future.

Of course, I haven't mentioned the labor involved in all this. My wife spends about 4 hours a month tending the chickens. Even at minimum wage (which dramatically undervalues her time), that's $29 of labor costs. So we are actually losing $19/month before I even begin to calculate my labor for building the coup (another $300 because that took me a while).

My point is that there is nothing sustainable about any of this. Our piddly little operation burns up far more resources than it produces. Sure the eggs taste better, but we end up giving half of them away because we just don't need 21 eggs a week.

In contrast, the professionals make a profit selling eggs for less than $2/dozen. They are the ones who are conserving resources and sustainably producing eggs and poultry, not us. We have some pet chickens we love and my wife especially enjoys tending them. Keeping chickens is entirely a leisure activity which puts it in the category of consumption not production. The eggs are simply a by product that lowers its overall cost (perhaps making it sustainable consumption). That's the only way our chicken endeavor makes any sense to me. (Actually, it is something my wife really likes and that's all I need to know.)

More on Externalities: Pigou and Coase

I found a very readable blog post by Stephen Landsburg on the contributions of Ronald Coase that also covers the basics of English economist Arthur Cecil Pigou's theory of externalities.

While I highly recommend reading Landsburg's post itself, the short versions is this. Pigou identified the problem of externalities (i.e., cost of transactions that were not born by the transacting parties) and proposed a straight-forward solution, internalize the cost by imposing a tax equal to the cost of the externality (what is known as a Pigovian tax). Pigou's primary argument wasn't that this was fair (though it certainly seems so) but that, by incorporating the costs into transactions,  the market would produce optimum levels of external costs. In terms of pollution, it would mean that we would get neither too little pollution (at the cost of more valuable economic activity) nor too much of it.

Coase proposes a wrinkle to this argument that made many people's head explode. He argued that it wasn't clear who was imposing costs on who. As Landburg sums it up:

If you breathe the pollution from my factory, I’m imposing a cost on you—but at the same time, you’re imposing a cost on me. After all, if you lived somewhere else, you wouldn’t be complaining about the smoke and I wouldn’t be getting punished for it.

While this example might seem a bit bizarre, consider the 19th century problem of railroads running through farms. If farmers plant their crops too close to the tracks, sparks from the old steam engines could (and did) set the fields on fire. Since the externality originates with the railroad, Pigou would argue that they should bear the costs of ant fire damage. But according to Coase, the farmer's choice of planting close to the tracks is as much of a factor as the railroad's choice to run trains down them. Furthermore, if the railroad is held accountable for the cost of fire, farmers have no incentive to avoid planting close to the tracks.

Here is where Coase's ideas become really interesting. Suppose that it would be cheaper for have farmers not plant within 50 feet of the tracks  than it would be to have the railroad compensate the farmers for fire losses. This might well be the case since fires destroy entire fields and not planting 50 feet of crops along the track would not reduce output by much. If this was the case, it would be more efficient to impose the cost of the externality on the farmer rather than on the railroad. Conversely, imposing the cost on the railroad would not be the optimum solution as farmers would have no incentive to keep their crops back and more fires would result.

Of course, in a perfect world where parties could costlessly negotiate with one another, it wouldn't matter what the rule was. If railroads were charged with paying damages for every crop fire and it was much cheaper to have farmers not plant near the tracks, the railroad could simply pay farmers to keep their crops back. The railroad would have to pay out less money and the farmers would be compensated for the loss in production. Such bargaining over externalities is known as Coasian Bargaining and the Coase Theorem argues that, if transaction costs for such bargaining are sufficiently low, then it will not matter what rules the government establishes. The parties involved will work out the most efficient solution among themselves.

Unfortunately, the real world is fraught with transaction costs that would make it hard for railroads to do this with large numbers of farmers. Therefore, the liability rules established by the government will matter and they can produce more or less efficient results depending on the specifics of the situation. Sometimes, indeed very often, a Pigovian tax or similar solution is the best way to go, other times not. In the example above, it would be more efficient to have the farmers not plant close to the tracks and the best rule may be that farmers are not allowed to plant with so many feet of the tracks.

As Landsburg points out, the real message Coase has for us is to move away from an obsession with identifying who is at fault and focus more on finding an efficient solution to the problem. Though the theory can not say what the best solution would be in any given situation, it does suggest that having the parties negotiate is a good approach in general. Landsburg notes that Coases's work led to the development of the field of law and economics.

On a tangential note, Abraham Lincoln gained prominence as a lawyer when he successfully argued a case for the Rock Island Railroad before the Supreme Court that dealt with externalities. The railroad had a bridge across the Mississippi that was struck by a riverboat. The boat owner sued for damages, claiming the bridge was a hazard to navigation. This was 1857, railroads were new and this bridge was the first one over the Mississippi. At stake was the right of railroads to build bridges over navigable rivers without being liable for every boat that bumped into them. Lincoln's victory established the liability rule (i..e, that the boat operator's are liable) that allowed railroads to span rivers (not a trivial matter for subsequent US economic development). [And, yes, Honest Abe was a corporate lawyer to the extent that he counted railroads like the Illinois Central among his biggest clients.]

Note: Lansburg also provides a link to Coases's 1960 paper "The Problem of Social Costs."

Matt Ridley on Differences between Economists and Ecologists

Matt Ridley, who bills himself as the Rational Optimist, has a post on his blog about "Why most resources don't run out" that looks at the different views that economists and ecologists have about natural resources.

He notes that ecologists frequently argue that natural resources are being exhausted at an unsustainable rate and are running out. Ridley 'had me at hello' here because I grew up during the first oil crunch in the 1970s and remember the dire warnings that we only had so many years (20 or 30) of oil left.Yet, here we are four decades later and we still have plenty of oil. Indeed according to BP's 2013 Statistical Review of World Energy, we had 52.9 years of oil at the end of 2012, up from 48.3 years a decade earlier.

Note that in the 10 years since 2002, when we supposedly had 48.3 years of oil left, we didn't go from 48.3 to 38.3 as you would expect, but we went from 48.3 to 52.9. This sort of reminds me of the line from "The Polar Express" in which the annoying kid says, "Come on, it's been 5 minutes to midnight for the last half hour."

Ridley comments on this foible among projected limits of resources:

But here's a peculiar feature of human history: We burst through such limits again and again. After all, as a Saudi oil minister once said, the Stone Age didn't end for lack of stone. Ecologists call this "niche construction"—that people (and indeed some other animals) can create new opportunities for themselves by making their habitats more productive in some way. Agriculture is the classic example of niche construction: We stopped relying on nature's bounty and substituted an artificial and much larger bounty.

Economists call the same phenomenon innovation. What frustrates them about ecologists is the latter's tendency to think in terms of static limits. Ecologists can't seem to see that when whale oil starts to run out, petroleum is discovered, or that when farm yields flatten, fertilizer comes along, or that when glass fiber is invented, demand for copper falls.

That frustration is heartily reciprocated. Ecologists think that economists espouse a sort of superstitious magic called "markets" or "prices" to avoid confronting the reality of limits to growth. The easiest way to raise a cheer in a conference of ecologists is to make a rude joke about economists.

The big point here is that ecologists often take static views of resource stocks and consumption rates when projecting trends forward. In contrast, economists see supplies and consumption rates as dynamic and changing in response to relative scarcities.

Take oil. When the supply of oil decreases, the price goes up. People respond by using less oil and trying harder to find more. If the price goes up enough supplies of oil that were previously economically nonviable will become viable. Also, higher prices give people an incentive to develop new technologies to extract oil, such as hydraulic fracking.

Mark Perry provided this graph showing the amount of energy the US uses per $1 of  Real GDP (i.e., adjusted for inflation). Note that from 1970 (when energy prices started rising significantly) to 2013, the amount of energy of all types used to produce $1 of GDP shrunk from 14.4 thousand BTUs to 6.2 thousands BTUs. This is a 57% reduction in 43 years.

Of course, the US is using more energy because our Real GDP grew 238% in the same period. But the point is that if, back in 1970, you had projected that the US economy would grow 238% and used 1970 energy intensities to calculate the amount of energy the US would be using, you would over estimate today's energy consumption by 142%. Put another way, we are only using 41% of the energy to produce our current level of GDP as we would have had to use to produce the same amount with 1970 technologies and usage rates.

This is not the result of "superstitious magic" but the working of the market and, to a debatable extent, the effects of government policies. There should not be anything mysterious about the fact that, when a resource becomes more scarce, its price rises. Nor should there be anything unfathomable about consumers responding to a rise in price by using less or producers responding by producing more. Indeed, it is more unfathomable to assume that consumers and producers will not change their behavior in the face of changing prices as ecologists do when they project current patterns of behavior forward.

Ridley gives an example of the difference between the way ecologists and economists look to the future with regard to food production:

In his recent book "The View from Lazy Point," the ecologist Carl Safina estimates that if everybody had the living standards of Americans, we would need 2.5 Earths because the world's agricultural land just couldn't grow enough food for more than 2.5 billion people at that level of consumption. Harvard emeritus professor E.O. Wilson, one of ecology's patriarchs, reckoned that only if we all turned vegetarian could the world's farms grow enough food to support 10 billion people.

Economists respond by saying that since large parts of the world, especially in Africa, have yet to gain access to fertilizer and modern farming techniques, there is no reason to think that the global land requirements for a given amount of food will cease shrinking any time soon. Indeed, Mr. Ausubel, together with his colleagues Iddo Wernick and Paul Waggoner, came to the startling conclusion that, even with generous assumptions about population growth and growing affluence leading to greater demand for meat and other luxuries, and with ungenerous assumptions about future global yield improvements, we will need less farmland in 2050 than we needed in 2000. (So long, that is, as we don't grow more biofuels on land that could be growing food.)

If the economists seem to be overoptimistic, consider this chart from the USDA showing the corn yield per acre in the US from 1983 to 2013. While there have been yearly fluctuations due to weather, the trend line shows that there has been over a 50% increase in the amount of corn produced on one acre of land in 30 years.

Keep in mind that the US agricultural industry was already one of the most technologically advanced in the world in 1983. Brad Plumer at WaPo's Wonkblog notes that US corn yields have increased dramatically since the 1940's. Prior to then, the average yield was between 20-30 bushels per acre. The recent yield of 158.8 bushels per acres is about a 600% increase over that level.  In the same period, the US population has only somewhat more than doubled.

If you look at the chart of US corn production per acre that Plumer provides (shown below) you get a sense of the expansion of production that is possible once an nation industrializes its agricultural sector. You also start to understand why Ridley has adopted the moniker of rational optimist.

The Three Faces of the Resource Curse

The Resource Curse hinges on the argument that a nation with large natural resources, such as oil, will perform more poorly than nations that do not possess such resources. This was originally an economic concept and the performance in question was the economic growth of the economy. As Jeffrey Frankel described it in a 2010 NBER working paper:

It has been observed for some decades that the possession of oil, natural gas, or other valuable mineral deposits or natural resources does not necessarily confer economic success. Many African countries such as Angola, Nigeria, Sudan, and the Congo are rich in oil, diamonds, or other minerals, and yet their peoples continue to experience low per capita income and low quality of life. Meanwhile, the East Asian economies Japan, Korea, Taiwan, Singapore and Hong Kong have achieved western-level standards of living despite being rocky islands (or peninsulas) with virtually no exportable natural resources. Auty (1993, 2001) is apparently the one who coined the phrase “natural resource curse” to describe this puzzling phenomenon. Its use spread rapidly.

Therefore, we can look at slower economic growth and development as the first face of the Resource Curse.

In The Dictators Handbook, Bueno de Mesquita and Smith argue that having valuable natural resources can promote the development and survival of autocratic governments, thus putting a second or political face on the Resource Curse.  The argument here is that natural resources provide an income stream for political leaders that is largely independent of the government's economic policies. Resources such as oil, lumber, and minerals can be extracted without having a well functioning economy and a productive workforce (beyond those involved in the resource industries). Income from the resources provides a steady and easily controlled stream of income from which autocratic leaders can pay off their essential supporters and, thus, remain in power.

Because, such leaders are not primarily dependent on tax revenue from the domestic economy, they have little incentive to invest in public goods such as infrastructure and education that would promote economic growth (and greater tax revenue). Indeed, they face incentives to do the opposite in order to prevent the larger population from organizing a revolution to change the system. After all, the freedoms and resources that people need to conduct economic activities can also be used to carry out political activities that might threaten the regime. Being independent of tax revenue allows autocrats resource rich to deny these public goods to the population, and thus stay in power in addition to keeping the bulk of the nation poor.

In a recent post on the Monkey Cage, Ross and Voeten argue that resource wealth, specifically oil wealth has a third, global face to it. As they put it:

If a government anticipates that it can sell its main export irrespective of its foreign policy behavior, then abiding by bothersome international norms and institutions becomes less of a priority. A large fraction of the world’s rogue regimes – Iran, Venezuela, Sudan, Libya (under Qaddafi) and Iraq (under Saddam) – are financed by oil wealth.

They note that as most nations become economically and socially globalized,  they face incentives to become politically globalized by joining intergovernmental organizations and agreements. They also have incentives to international political norms to assure economic partners that they will also adhere to economic institutional norms. However, Ross and Voeten find that this is not the case for oil-rich nations. In their words:

We find that beyond a certain level of oil income (around $100 per capita) more oil wealth is correlated with sharply lower levels of political globalization.  Strikingly, this pattern shows up when we compare oil-rich states to oil-poor states, and when we look at individual states over time, as their oil production rises and falls. The findings also hold when we control for possibly confounding factors, such as democracy, economic development, and regional effects. We find very similar effects when we use other indicators to measure the degree to which states are integrated into and cooperate with international institutions.

This leads to what Ross and Voeten call "unbalanced globalization" and they argue it produces a set of nations upon which we are economically dependent but which are not "well integrated into the world’s political and legal institutional infrastructure".

What To Do About Development In Poor Nations

Dani Rodrik writes that he like to ask his economic development students whether they would rather be rich in a poor country or poor and rich country? He clarifies the question by defining a rich nation as being in the top 10% of all nations ranked by average per capita income and a poor nation as being in the bottom 10%. He defines being rich as being someone in the top 10% of the country’s income distribution, while being poor means being in the bottom 10%. He notes that most of his students respond by saying they would rather be rich in a poor country, but argues that the data shows that his students are way off.
According to Rodrick’s calculations, the average poor person in a rich country earns three times more than the average rich person in a poor country. Adjusted for differences in purchasing power parity, the median income of the bottom 10% in rich nations is $9,400, while the median income of the richest 10% in poor nations is only $3,000. He goes on to note that other indicators of well-being, such as infant mortality, also support the argument that it is better to be poor in a rich nation, then rich and poor nation (Rodrik, 2011, p 135-136) [All references listed here]

What this strongly suggests is that, somehow or other, the richer nations in the world have developed a political economic system that is unarguably superior to those of poor nations. Underlying this conclusion is, of course, the view that wealth is created, not expropriated and, therefore, the rich nations have not got rich by exploiting the poor nations. However, even if we make this intellectual leap over the theories of Marx, Lenin, and Wallersteen, we are left with the question of what it is about the political economies of rich nations that make them rich, and how can poor nations can improve their own systems?

In answering these questions, it may be helpful to categorize the obstacles to development as being in political, economic, or social realms. In the political realm, the more prosperous nations have created a powerful central government that has, in Bates’s (2001) terms, domesticated violence in the society and have resolved what Weingast (1995) calls the fundamental political dilemma of the state by restraining state power so that its policies are not predatory. According to Selectorate Theory (Bueno de Mesquita et. al. 2003), this latter condition will only be met if the nation’s political leader depends on a large coalition of supporters so that the leader must provide public rather than private goods to supporters. In the economic realm, rich nations have established what Acemoglu and Robinson (2012) describe as inclusive economic institutions that provide the freedom and incentives necessary for the larger part of the population to actively participate in economic production and wealth generation. In the social realm, the rich nations have both provided their citizens with adequate education and information to exploit the economic opportunities available to them as well as providing the mental space needed to do so as described by Banerjee and Duflo.

These categories or realms are far from distinct.  They overlap in many places as well as have causal effects on one another. For instance, a small coalition political regime will not only be predatory but will tend to set up extractive economic institutions (Acemoglu and Robinsons, 2012) and provide limited education to the population (Bueno de Mesquita and Smith, 2011). At the same time, as poor and uneducated population will lack the information and mental space either to fully exploit the economic opportunities available to them (Banerjee and Duflo, 2011) or challenge the political system (Bueno de Mesquita and Smith, 2011).

Therefore, the question of how to spur the development of poorer nations does not admit to simple answers. Focusing on changes in one category runs the risk of overlooking needed changes in the others or, worse, failing to foresee how aspects of the other categories might confound the desired effects of changes in the first.

Economic theories of development are arguably prone to making this mistake to a greater or lesser extent. Neoclassical growth theory is perhaps most open to this criticism as it assumes that property rights are established and enforced in the political realm and that individuals are fully informed and rational in the social realm. Even when economic theories of development, such as North’s theory of institutions, recognize the inadequacy of institutions and the limits of the assumption of economic rationality, they still tend to assume that the government has an interest in improving the economic performance of the economy at large.  This assumes away the political problems that must be solved in order for their policy prescriptions to be effective.

This is not to say that economists are unaware or willfully ignorant of these political problems.  They are very aware of them and some, like Acemoglu and Robinson (2012), try to incorporate political factors into their theories and analysis. However, everybody has an area of expertise within which they focus and a set of analytic tools which give them more leverage on one set of issues than on another.  Therefore, each researcher gives answers to a subset of the questions involved in economic development.
It is all too natural to suggest that researchers should expand their scope and bridge gaps between different approaches. Better yet, one might seek a unifying theory to simultaneously consider political, economic and social issues at the same time.  However, bridges take a long time to build, unifying theories tend to be elusive, and, in the meantime, policy makers must act. (Not to mention that students must answer essay questions about what advice to give them.).

So what can we glean from the partial answers of extant research with regard to the political, economic and social realms?

Political: It is tempting to give the political realm pride of place in fostering development over the economic and social realms for two reasons.  First, establishing a central political power that can domesticate violence seems to be prerequisite for any meaningful economic growth. Second, once a hegemonic state is established, reining it in becomes the primary concern, which is itself a political problem.  This suggests that Bate’s (2001) domestication of violence and resolution of Weingast’s (1995) fundamental political dilemma must historically precede other changes needed to spur long term economic growth.  Selectorate Theory and Acemoglu & Robinson (2012) would both argue that the fundamental political dilemma would only be solved by having a political system that required leaders to have large coalition of support. In theoretical terms, these political developments are necessary conditions for growth and prosperity.

It is important to note that a necessary condition is, by definition, one that must be met for something to occur, but is not sufficient to produce the occurrence of that thing.  Therefore, the argument is not that the establishment of a strong central government that requires a broad coalition of support will produce long term economic growth but that a lack of such a government will prevent it.

Acemoglu and Robinson (2012) would also provide an important caveat that short to medium term growth, perhaps lasting as long as several decades, is possible under extractive political institutions (what Selectorate Theory would call a small coalition regime)  if the ruling elites are confident in their power and can control the flow of resources.  However, this growth will fizzle out once all the opportunities for growth through investing and adopting existing technologies are exploited. At that point, further growth would require domestic innovation and significant creative destruction which the elites will not allow to occur.

Economic: In this realm in particular, Acemoglu and Robinson argue that prosperity depends on having inclusive economic institutions, which they define as follows:

those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills that enable individuals to make the choices they wish. To be inclusive economic institutions must feature secure property rights, an unbiased system of law, and provision of public services that provides a level playing field in which people can exchange and contract; it must also permit the entry of new businesses and allow people to choose their careers. (Acemoglu and Robinson, 2012, p 74-75)

Of course, this definition is very broad and focuses on what the institutions do more than on the particular form they take. This means that the problem of designing the right institutions to “encourage participation by the great mass of people in economic activities” is far from trivial.  Once fairly inclusive institutions are established (though their development and refinement will be ongoing), the majority of the economic theories of development also come into play.

Social: This is the realm in which people actually live and make the choices that the incentive structures of the economy and polity are intended to influence. As Banerjee and Duflo point out repeatedly, efforts to help the poor often fail for five reasons

1. The poor often lack critical pieces of information or believe things that are not true.
2. The poor bear too much responsibility for making decisions about too many aspects of their life.
3. Markets may not be viable for things the poor need or they may face unreasonable prices for goods and services where markets are viable.
4. Program failures in poor countries often have more to do with ignorance, ideology and inertia (the three I’s) than with poor governance and institutions.
5. Expectations about what poor people are able and unable to do often turn into self-fulfilling prophesies. (Banerjee and Duflo, 2011, p 268-272)

It should be pointed out that Banerjee and Duflo (2011) argue against the notion that efforts to help the poor are doomed if the political and economic institutions are inadequate. They point to research that shows that much can be done within bad institutions and that these efforts may produce incremental changes in the institutions themselves.  For their part, Acemoglu and Robinson (2012), though arguing that such humanitarian efforts will not bring about prosperity, argue that, even if 90% of aid is siphoned off by elites, the 10% that gets to the poor may be very important for relieving their suffering. Indeed, Acemoglu and Robinson suggest that if aid is structured in a way that empowers people who are excluded by the political institutions, it may lead to future changes in the institutions.

So what do we do to promote development?

One approach, suggested primarily by Selectorate Theory, would be to distinguish between countries with small and large coalition regimes. Large coalition regimes would be expected to be motivated to improve the well-being of the larger society as the cheapest way to provide benefits to their supporting coalition. While they will still be biased towards policies that favor the segments of society that are in the supporting coalition and will be far from corruption free, the leaders of these governments will be held accountable for their nation’s economic performance. Therefore, they will be somewhat reliable partners in international efforts to promote development.

In contrast, leaders of small coalition regimes face incentives that require them to provide private benefits to a small group of supporters. Therefore, they can be expected to make every attempt to twist aid to that purpose.  Foreign aid is, therefore, likely to fail in its intended purpose and have the unintended consequence of bolstering the leader’s hold on power. This is particularly true of aid during an economic crisis when the leader is in danger of not being able to pay off his/her essential supporters and, thus, losing power.
Selectorate Theory suggests that the best approach is one of tough love and suspicious vigilance towards small coalition regimes. Aid should either be withheld to hasten the regime’s demise or tied to political reforms that will have the same effect. Humanitarian aid must be closely monitored and, if possible, given directly to its recipients.

Another, more incremental approach to political change is suggested by Acemoglu and Robinson (2012). As noted above, they argue that aid which empowers people excluded from political decision making may contribute to institutional drift towards more inclusiveness.

Of course, it could be argued that any international efforts at fostering political change in small coalition regimes will be resisted by the government if those efforts actually threaten (or appear to threaten) its hold on power.  Russia’s current crack down on NGOs seems to be a case of this.

Banerjee and Duflo (2011) seem to favor dealing directly with the dire needs of the impoverished and focusing on testing the effectiveness of programs to determine what works and what does not. Though their approach does not directly address the broader political questions, their focus on measuring effectiveness and only doing what is demonstrated to work implicitly takes government interference into account. That is to say if the government thwarts the program’s intended purpose, the data will show it. Thus, their emphasis on accountability based on scientific research methods provides an inherent and political neutral check on government interference.

Democracy and Economic Growth

In their book, Why Nations Fail, Daron Acemoglu and James Robinson argue that poverty is produced by extractive political and economic institutions and that prosperity results from having inclusive institutions. Their book is replete with examples of autocratic governments pursuing policies that impoverish large parts of the population to benefit small elites. While far from being the worst case (and, believe me, there is some stiff competition for that distinction), Uzbekistan is a clear-cut example of what they are talking about.

Indeed, the authors featured Uzbekistan in their first blog post, perhaps because the nation offered the spectacle of a modern government forcing millions of school children into the fields to pick cotton (which is what the Uzbek child in the photo to the left is doing).

In a subsequent blog post, Acemoglu and Robinson give a thumbnail sketch of the situation that produced this forced labor:

Uzbekistan gained its independence when the Soviet Union collapsed in 1991. Islam Karimov, previously first secretary for Uzbekistan of the Soviet Communist Party, declared himself an Uzbek nationalist and became, and since then has remained, president through fraudulent elections and repression.

After independence, farmland that was previously under the control of state-owned firms was distributed to farmers. But they weren’t suddenly free to plant and sell what they wished. The government introduced regulations that determined what they should plant and how much they should sell it for. For cotton, that meant they would receive a tiny fraction of the world market price. For many, it wouldn’t make sense to grow cotton at these prices. But the government dictated that they had to. Before independence, much of the cotton was picked by combine harvesters. Yet given these rewards, farmers stopped investing in or maintaining farm machinery. So coerced child labor was Karimov’s cost-effective method of picking cotton.

Naturally, child labor on this scale could not go unnoticed and an international effort known as the Cotton Campaign was launched after the scope of the problem was documented by a London University School of Oriental and African Studies 2008 report. However, NYT reported that Uzbekistan now drafts people from the public sector to pick the cotton. So, instead of school children picking the cotton, over a million doctors, nurses, school teachers, bureaucrats and small business employees "volunteer" to pick the cotton in order to avoid being arrested or fired.

While it is morally satisfying that younger children are now exempt, the move to using otherwise skilled labor to do unskilled work (which should be mechanized in the first place) is even more economically inefficient than using school children. After all, the school kids weren't producing much in class, so the opportunity costs of sending them to the fields was low (which, of course, is why the government choose them in the first place). Now they are taking some of the more productive workers in their economy away from their jobs to do the work while receiving their normal wages. While more palatable from a PR point of view, this is more economically absurd while remaining almost as morally objectionable.

Though Acemoglu and Robinson haven't addressed this recent change, it is a good example of an argument they make in their book. Namely that when poor or undesirable performance results from extractive political and economic institutions, one cannot engineer a fix without reforming the underlying institutions. That is to say that if the system is set up to transfer wealth and income from one part of the population to another, the system will only find another way to do this when pressured to change a particular policy.

In Uzbekistan, international pressure to stop using child labor forced Karimov's regime to adopt a more costly means of enriching itself. However, that cost almost entirely falls on the population in the form of the shortage of public services resulting from having healthcare workers, teachers and government employees out in the field (not to mention the cost to the people being forced to pick the cotton). If further international pressure is applied to end the forced labor of adults, without any changes in the underlying political and economic institutions, the government will undoubtedly channel its efforts into finding a way to continue its extraction in a manner that evades criticism. Because disregard to the costs to the general economy and the populace is inherent in the institutions, whatever response the government devises will probably just make a different set of powerless people worse off.

However, if examples like Uzbekistan make the case for the link between poor economic performance and extractive institutions, is it true that more inclusive institutions necessarily produce better growth and prosperity. China would appear to be a case of an authoritarian system that has produced both remarkable growth and reductions in poverty growth, and there are certainly many cases of new democracies having economic troubles.

In a recent scholarly paper, Acemoglu, Naidu, Restrepo, and Robinson look at the data on the economic performance of democracies versus non-democracies. Acemoglu and Robinson summarize their findings in a blog post entitled Democracy, What is it good for? They chose this question for the title because much of the previous empirical research has questioned the value of democracy in producing economic growth (and they wanted to riff off the old Edwin Starr song, you know "War, what is it good for?").

Acemoglu and Robinson argue that previous negative findings reflect the complicated relationship between transitions to democracy and economic performance that is revealed when one looks at GDP growth in the years preceding and following a nation's democratization . They find that authoritarian regimes usually democratize as the result of a economic crisis and, therefore, newly democratized nations tend to be dealing with unusually unfavorable economic conditions. This may explain why new democracies have lower GDP growth in comparison to non-democracies  in the first 5 years following democratization.   In the next 5 years (5-10 years after democratization), the performance of newly democratized economies tends to improve, but even then only matches the growth of non-democracies. However, after the 10 year mark, the democratized economies clearly outperform the economies of non-democracies. They use the graph below to illustrate their findings:

As to why democracies are able to achieve these results, though there are many theoretical arguments as to why this would be the case, the authors do not have conclusive empirical evidence to answer this question. They do note that democracies appear to be better at implementing economic reforms, providing education, and providing other public goods.

It should be noted, that while Acemoglu, Naidu, Restrepo, and Robinson find that democracy is good for economic growth, in other research they have found that  it is not so good at reducing income inequality. While it does shift resources away from elites, democracy does not have as much impact on the societies overall income equality as one might expect. However, they admit that the data here is somewhat problematic and they can't determine whether the inequality they observe is the result of market induced inequality (such as one would expect if technological change was increasing the difference in wages between skilled and unskilled workers) or politically induced (such as one would expect if middle classes where capturing the system and directing income towards themselves).

Venezuela Continues to Pursue its Socialism Fail

Reuters has a report about the shortages of food in Venezuela. The people that run soup kitchens and food banks are having trouble getting the food they need to feed the hungry.

Note that the problem isn't that they do not have enough money to buy the food. They just can't find it for sale at the government mandated prices. People are having to queue up for food everyday as the items are in short supply and shoppers can only get one thing one day and another thing on another.

As mentioned in the article, this is very reminiscent of the old Soviet Union where people had plenty of money but stores were constantly short of goods. In his book, The Russians, Hedrick Smith noted that Moscovites in the 1970s typically went about their day with a mesh shopping bag and up to a month's wages in their pocket. Whenever they saw people lining up to buy something, they would join the queue, often without any idea what they were lining up for. They then bought the maximum amount of the product allowed, whether they needed it or not, since they could always trade the items with someone who did need them. Part of this confidence was driven by the fact that almost everyone they knew was doing the same thing and usually had something to trade.

I had a friend in college who emigrated from Russia at about that time and he described his first experience in a western supermarket in Vienna. He and his mother walked the aisles bewildered by all the merchandise on the shelves where you could just reach out and touch it. They had never seen anything like it.

Of course, it's simple economics 101. In a market system, consumers pay for the cost of producing and distributing everything they buy. This is known as the scarcity value of the good. In a commercial for Doritos, Jay Leno used to quip, "Crunch all you like, we'll make more." That pretty much sums up the dynamic, if one keeps in mind that to crunch the Doritos, one must pay the cost of making them plus a little extra to give people an incentive to do so. Because the price covers the cost of putting the products on the shelf, producers and retailers put as much of the stuff on the shelf as they think consumers will buy. An empty shelf is a lost opportunity to make a profit.

One of the big problems with Socialism (the real kind, not what right wingers accuse Obama of being) is that it denies that prices work this way. Socialists argue that the profits producers make inflate the price above its true scarcity value. They frequently, as in the case of Venezuela, place limits on the prices producers can charge in the belief that this will force producers to accept a lower "fair" rate of profit.

The result is entirely predictable given the economic laws of supply and demand. The law of supply says that at lower prices, producers will offer less of a good for sale and the law of demand says that consumers will demand more of a good at a lower price. Less supplied plus more demanded equals shortage.

When you have consumers demanding more of a good than producers are willing to supply, the problem becomes one of determining which particular consumers will be allowed to buy the available goods. Waiting in line to purchase the limited supply of goods becomes a way to bid on the good and people who are willing to stand in line longer are essentially outbidding other consumers. Thus, the price of the good becomes the cash paid for it plus the time spent waiting in line.

Unfortunately, the time waiting in line is a complete loss to the economy. The people standing in line are neither producing anything (resulting in a tangible loss of productivity) nor enjoying themselves (resulting in an intangible loss of well being). More importantly, the producer derives no benefit from people bidding on the product with time spent standing in line.

In contrast, when consumers bid on products with money, the higher cost to the consumer is balanced by the higher profit to the producer. This provides two benefits. The producer can spend that money and stimulate demand in the economy. More importantly, the higher profit will encourage more production of the good. If profits are particularly high, they will encourage other would-be producers to enter the market, which will drive prices down while supplying more of the good.

Sadly, Socialists deny that this is how things work. Profit is bad and profit seeking is a behavior that must be engineered out of producers (or, alternatively, is an artificial motivation produced by the Capitalist system). While Neo-Socialists have largely come to the conclusion that market pricing is in fact the only efficient way to distribute goods (and have directed their attention to the ownership of capital as the problem to be fixed), Venezuela (and to a lesser extent Argentina) haven't gotten the word.