Coordination Problem

Democracy and Development

A recent NBER paper by Torsten Persson and Guido Tabellini (Democracy and Development: The Devil is in the Details) looks at how democracy promotes development. As one would expect, it depends on the way democracy is being implemented. The abstract explains the three main points of the paper:

First, democratizations and economic liberalizations in isolation each induce growth accelerations, but countries liberalizing their economy before extending political rights do better than those carrying out the opposite sequence. Second, different forms of democratic government and different electoral systems lead to different fiscal trade policies: this might explain why new presidential democracies grow faster than new parliamentary democracies. Third, it is important to distinguish between expected and actual political reforms: expectations of regime change have an independent effect on growth, and taking expectations into account helps identify a stronger growth effect of democracy.

The paper seems to address two important issues in political economy.

First that democracy generally leads to plunder if it is implemented before a country has secured a minimum income per capita based on the recognition of property rights and trade. Paradoxically, in order for democracy to exist, a period of illiberal democracy (i.e. enlightened autocracy) may be necessary to maintain freedom. This is the argument developed by Fareed Zakaria in The Future of Freedom: Illiberal Democracy at Home and Abroad.

This reminds me of the work of 19th century political philosopher William Lecky on democracy and freedom. As he put it, “a tendency to democracy does not mean a tendency to parliamentary government, or even a tendency towards greater liberty. On the contrary, […] democracy may often prove the direct opposite of liberty” (see his Democracy and Liberty, vol. I pp. 256-61).

Second, all forms of democracies are not equal. Many parameters will influence the outcome: the type of representation system, the existence of universal suffrage, the definition of electoral districts, etc. New Zealand and the MMP system, which replaced the FPP ten years ago, is a case in point (see here). In the 18th century, Condorcet showed how voting could lead to different results with the same voters’ preferences depending on the procedure chosen for casting and counting ballots.

Time and again, we find the same general principle emphasized by many, including most American Founding Fathers, Ludwig von Mises, and James Buchanan: societies don’t work because of democracy but in spite of it. The main role of democracy is to implement peaceful social change—it doesn’t guarantee the selection of good ideas, just that it will be done without bloodshed. For Mises, democracy “is the very means of preventing revolutions and civil wars. It provides a method for the peaceful adjustment of government to the will of the majority.” It is the idea that “a man’s ability to rule proves itself better by convincing his fellow-citizens than by using force upon them” (Human Action p. 150). In the end, however, what “determines the course of a nation’s economic policies is always the economic ideas held by public opinion. No government, whether democratic or dictatorial, can free itself from the sway of generally accepted ideology” (p. 850).

The ultimate question is: do we need the state to have democracy? Strange question you might say. It’s becoming clearer that a new generation of economists disagrees with the notion of state democracy as an enabler of peaceful social change (contra Mises). Murray Rothbard was one the few to voice this opinion a few decades ago. As my co-blogger Peter Leeson explains in his work (e.g. see here), new evidence tends to show that (some) stateless societies are more viable and more “democratic,” in some ways, than we once believed.

Wonders of the Wolani

Last night I watched a documentary on the Wolani of western New Guinea. Although New Guinea has a government, the political economies of people like the Wolani are essentially stateless. Government does not enforce agreements, resolve disputes, or even punish violence.

A clan chief was murdered by his wife's lover--a member of a competing clan. The documentary followed the reconciliation/negotiation process of the two groups.

Contra what I regard as popular perception about violence and warfare in such environments, the inter-clan conflict resolution process was remarkably peaceful, orderly, and deliberate. When the chief was killed, the clan to which he belonged did not deny the wrong doing. Nor did the victimized clan respond rashly with by attacking the wrongful clan.

Instead, the two groups met over a number of days and civilly hashed out the terms of compensation for the murder. Long-established, informal institutions of inter-clan conflict resolution were in place and followed. The negotiation process was broadly democratic and took place in literally an open field in which all could be heard. Clan elders led the process.

Some obstacles were of course confronted (on their source, see below). The victimized clan demanded compensation in cowrie shells. The wrongful clan wanted to pay in money. For a few days the clans could not reach agreement. The victimized clan threatened war and both sides began preparing for its eventuality in the coming days. Ultimately, however, a compromise was struck in which payment would be made in half shells and half money. Violence was averted and peaceable relations recommenced.

Interestingly, the New Guinea government recently mandated the prohibition of payment between clans in cowrie shells in an effort to "modernize" the population. A local agent of the government insisted that inter-clan compensation in this case be made in money, even though both clans preferred to use shells. It was his insistence that almost led the two clans to violently clash. The clans avoided war by violating the state’s legal prohibition.

This microcosm of statelessness in Africa delivers some of the most basic and important lessons of political economy:

1. The power of informal institutions in converting situations of potential conflict into situations of cooperation.

2. The inability of state-made institutions that conflict with informal institutions to bring about their desired results.

3. The damage that can be inflicted (in this case, nearly war) when government imposes institutions at odds with the private practices of individuals.

Lets Put the Free Back Into Free Markets

In a recent interview in National Perspectives Quarterly (Spring 2006), the 93 year old Milton Friedman addresses the questions of economic freedom and globalization.

NPQ | With globalization, are we seeing the freest world economy we’ve ever seen?

Friedman | Oh no. We had much freer trade in the 19th century. We have much less globalization now than we did then.

Will we go ahead back to this freedom of the 19th century? I don’t know. We have a freer world because of the collapse of the Soviet Union and the changes in China. Those two have been the main contributors to freedom in our time. The countries that have risen and separated out as a result of the collapse of the Soviet Union are, on the whole, following freer economic policies. Most of these states have freer government and less restrictions on trade.

This free-market base will likely expand from there by example to others not so free. Everyone, everywhere, now understands that the road to success for underdeveloped countries is freer markets and globalization.

Read the full interview.

Burn the Mathematics

I am teaching history of economic thought this semester (a joint undergraduate/graduate course) and at the moment we are discussing the contributions of Marshall. Marshall has this great advise about burning the mathematics. (1) Use mathematics as a shorthand language rather than as an engine of inquiry; (2) Keep to them till you have done; (3) Translate into English; (4) Then illustrate by examples that are important in real life; (5) Burn the mathematics; (6) If you cannot succeed in (4) then burn (3).

In thinking through this warning that we make sure that math is a servant to economic reasoning rather than the master of it, it is striking how resistant the scientistic impulse is to such practical advise.  As we will discuss later in the class, Samuelson promoted mathematical economics with the argument that confusion results in economics when we use the same words to mean different things or different words to mean the same thing.  He further argued that mathematical reasoning forces one to make explicit the assumptions underlying the analysis that remain hidden or implicit in literary analysis.

But Kenneth Boulding wrote an absolutely brilliant review essay of Samuelson's Foundations in the JPE and concluded that the flawless precision of mathematical economics may prove less productive in understanding the processes of human interaction than the literary vagueness of economic sociology and political economy.  Much of the history of modern economics has proved Boulding right and Samuelson wrong.  One of the main reasons for this is that mathematical reasoning can only ensure syntactic clarity and not semantic clarity, but economic reasoning requires both form of clarity to advance our understanding of the world.

Thinking About Spontaneous Order

For the New Palgrave Dictionary of Economics, Jennifer Dirmeyer and I have prepared the essay on Spontaneous Order.  It is going through some final edits, but when completed we will make it available to all.  There are obvious citations in the paper to Adam Smith, F. A. Hayek, Robert Nozick, and James Buchanan.  Buchanan in fact has argued that the primary role of economics conceived of as a public science is to teach citizens about the principle of spontaneous order so they may become informed participants in the democratic process.  We concur with Buchanan on this.  We also try to use examples to illustrate the prevalence of spontaneous order in modern civilization. And that brings me to the point of this entry ... what are your favorite examples of spontaneous order, and what are your favorite writings on the subject?

Still Have Love for the Mises -- It's the PJB

I never met Ludwig von Mises, though I did correspond with his widow once to express my deep appreciation for the work of her husband.  Ludwig von Mises is the single most important thinker in my life.  I've written a lot on Hayek, read almost everything ever written by Hayek or about him.   But it is Mises who inspires me and directs my research questions --- even when they are about Hayek or other thinkers in and out of the Austrian school of economics.  In short, Mises sets the standard against which I try to make sense of contributions in economics --- either ancient or modern.  Though I doubt whether most people associated with the Austrian school would recognize this in my work, or acknowledge it even if they did.  This has always put me in a rather weird position in the contemporary Austrian school --- neither recognized as a Misesian nor a Hayekian nor a Lachmannian, yet clearly an Austrian.  It is a weird position, but one that I gladly occupy with Israel Kirzner --- a man who has devoted his intellectual career to pursuing the Misesian research program in economics only to be labeled by many modern day "Misesians" as a "Hayekian".  I don't quite run into that problem, instead I have been labeled eclectic and self-indulgent.  Perhaps so, but  I do think it should be hard to deny my "love for the Mises".

Each spring I teach my graduate seminar in Austrian Theory of the Market Process II. The core books for the class are: Mises, Human Action; Hayek, Individualism and Economic Order; Kirzner, Competition and Entrepreneurship; and Rothbard, Man, Economy and State. Sections of readings from these books are required, and then other readings from the economics literature are suggested as supplements.  And it is my opinion that all of the work is derivative of Mises's work, including Hayek's outstanding contributions.  A close reading of Mises reveals that on matters of substantive economics he got there first.  Of course, Hayek already pointed this out to careful readers in a footnote in The Counter-Revolution of Science.

To give one example of how Mises's work is still relevant to the contemporary debates consider the discussion surrounding modern economic growth and development and the emergence of civilization.  Works by diverse scholars such as Jared Diamond, Guns, Germs and Steel, and Collapse; David Landes, The Wealth and Poverty of Nations; Kwame Appiah, Cosmopolitanism: Ethics in a World of Strangers; Paul Seabrights, The Company of Strangers; and Daron Acemoglu and James Robinson, Economic Origins of Dictatorship and Democracy.  The various hypotheses and propositions put forth in these works were addressed by Mises in his discussion of contractual bonds and hegemonic bonds (pp. 195-198); his critique of the fable of mystic communion (pp. 166-169); and his discussion of social cooperation and Ricardo's Law of Association in general (pp. 143-176).  Not only does Mises get there well before these modern authors, but his analysis is far superior because Mises's critique of socialism and its implications for modern political economy is still not fully recognized (pp. 689-715).

So as I dig into this material for presentation in my class again this spring, I am struck again at how foundational the work of Mises is to our ongoing project to understanding peace and prosperity.  Of course other writers --- namely Smith, Hume, Friedman, Hayek and Buchanan all are economic voices that made fundamental contributions to human understanding.  But I honestly believe that modern readers --- if they don't let Mises's language derail their reading by recognizing his unique intellectual struggle in his lifetime and thus contextualize the way he expressed himself and his ideas --- will benefit greatly from his towering achievement.

Where Economics and Philosophy Meet

In 2004 the Elgar Companion to Economics & Philosophy was published.  The book is self-described as follows:

The Elgar Companion to Economics and Philosophy aims to demonstrate exactly how these two important areas have always been linked, and to illustrate the key areas of overlap. The Companion is divided into distinct parts, each of which highlights a leading area of scholarly concern: political economy conceived as social philosophy; the methodology and epistemology of economics; and social ontology and the ontology of economics. The contributors are well-known and distinguished authors from a variety of disciplines, who have been invited both to survey and to provide a personal assessment of current and prospective future states of their respective areas of philosophical interest. Academics and students who have an interest in economics and philosophy, political philosophy and the history of ideas will find this book of great appeal, as will researchers working in the field and readers interested in the nature of the discipline of economics.

A symposium/article taking off from the book is being published in the Economic Journal and Chris Coyne and I are part of that ---- the full article is "Where Economics and Philosophy Meet" and our contribution is focused on moral philosophy and political economy.  Obviously we are thrilled to raise our hand in the classroom of economic opinion on this subject and to be able to do so in a journal of the prestige and quality of the Economic Journal.

Trading with Bandits

One of the oldest and most common justifications for government is protection against violence. According to this view, without government, the strong plunder the weak. This reasoning can be found in writings from Thomas Hobbes to Adam Smith. Most modern economists also believe this is true. Although a growing body of work shows how self-enforcing arrangements can overcome commitment problems that could lead to "peaceful theft" (e.g. fraud), the literature also contends that these arrangements are of no help in preventing the physically strong from attacking the physically weak.

In a recent paper entitled, "Trading with Bandits," forthcoming in the Journal of Law and Economics, I argue that this conventional wisdom is wrong. Individuals can and have used self-enforcing arrangements to prevent physical violence and facilitate trade under anarchy. Using pre-colonial Africa, I show how weak and immoble producers used self-enforcing mechanisms to convert the incentive of strong and mobile middlemen from banditry to exchange.

Is Europe Ready for Reform?

This week, Charlemagne’s column in The Economist deals with policy reforms in Europe (Reform or Die). The author argues that there is growing momentum for reform in Europe because the situation has become so bad that Europeans are now more ready for reform than ever in the hope that the “bad-times-can-be-good-times”.

Indeed, reforms do not take place because a country’s whole population has suddenly become libertarian or most people have become acquainted with Austrian economics. The idea that people’s mental models and views of the world have to change in order for policy reforms to take place is misleading. Surely, it would be great if public opinion could suddenly change in the right direction, but it doesn’t happen.

As the experiences of New Zealand, Ireland, and Britain show, policy reforms happen because a country’s economy slides towards the abyss. Then and only then, the political “courage” for reform can be found and new policies can be carried out in spite of what people believe. This is only because the choice is either to fall in the abyss or to reform. In essence, once the opportunity costs (political and otherwise) of reforms have plummeted, they become acceptable (see also here).

Years after the reforms started, people come to like what they see and realize that the reforms were necessary. They are still not libertarians, but they come to accept that a bloated and heavily regulated economy was probably not a good idea (until they forget). This is why public opinions and governments in New Zealand, Ireland, and Britain are now much more to the right (in the sense of pro-market) than they were 30 years ago (compare PM Helen Clark and Sir Robert Muldoon in New Zealand, and PM Tony Blair and Sir Edward Heath in the UK).

Has Europe come close to the abyss yet? Perhaps. Germany is now taking the lead in reforming, although they just started to sort out their public finances (see here). Spain also started a few years ago and is now ahead of the pack. On the other hand, the situation in Belgium, France, Portugal (see this other article in The Economist), and Italy is deteriorating but is not yet where New Zealand was in 1984.

It is hard to say when serious policy reform in Europe will happen. In the mean time, economists need to continue reflect on the mechanisms for social change and the policies to implement. As the great Milton Friedman said in his 1982 preface of Capitalism and Freedom: “That, I believe, is our [economists] basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable”.