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May 2000

Power and Prosperity By Mancur Olson Basic Books Click on the title to buy the book

The quality of this posthumous volume only makes those of us who respect and are indebted to the late Mancur Olson regret his untimely death even more.

Power and Prosperity is the last in Olson's series of works analyzing the effects of government and social interactions on economic growth. Hismethod has been the construction of relatively simple models of rational choice based on selfish motives to explain the course of economic growth. Even relatively elementary reasoning can give raise to surprising results. Olson does not consider that free markets are the entire solution to the problems of growth, though of course their vitality is a necessary condition. Collective action is also needed, though in his earliest work, Olson argued that collective action is unlikely to occur if there are many participants in the economy; each individual will have an incentive not to participate but to benefit from the collective actions of others (what economists call the "free-rider" problem). For example, if fires are handled by a volunteer fire department, it will pay any specific individual not to volunteer. Only if there are relatively few participants (or few organized groups of participants) will it be easy to recognize the gains from collective action.

This issue leads to a broader view. Suppose a nation is controlled by some autocrat acting entirely in his or her own interest. The autocrat may still have an interest in increasing the growth of the country, instead of simply stealing everyone's wealth, because over a period of time the autocrat will have more income to tax. Olson very neatly works out the implications of this remark. In particular, he shows that there will be an optimal tax by the autocrat which balances his or her desire for immediate consumption against future better prospects. The assumption is that the lower the tax the higher the rate of growth, since growth is fueled by private incentives. Of course, as Olson emphasizes, a good deal depends on the time horizon of the autocrat and thus the prospects of growth are greatest when the autocrat has a long horizon, as in the case of a royal dynasty.

In a democracy, the majority will generally have a stronger focus on overall growth than in particular interests, though this can be offset if some particular interests can express themselves more easily. In his classic The Rise and Decline of Nations Olson argues that democracies tend to decline in efficiency over time because special interests have more time to organize themselves.

Olson's latest (unfortunately, last) book concentrates on the disappointing transition of the formerly communist countries which were parts of the Soviet Union or satellites in Eastern Europe. Given the gross inefficiencies of the communist system, one would have expected the transition to a privatized market economy to yield a large increase in output. In fact, the Russian Federation, Belarus, and Ukraine, which together include the great bulk of the population of the former Soviet Union, have national incomes equal to about half of what they were before the fall of the communist system. Even the more successful Eastern European states, such as Poland, the Czech Republic, and Hungary, are only marginally better off than they were. The contrast with the recovery of the former fascist countries, such as (West) Germany and Italy after World War II, when there was also a great deal of war destruction, is very striking. Olson attributes the rapid postwar growth of the last two states to the fact that markets of all kinds could operate freely and reliably and that the institutions representing old special interests had been destroyed by the defeat.

Olson's argument for the failure of growth of the ex-communist countries has several strands. On the one hand, direct state ownership and control meant a more efficient extraction of income by the dictatorship. But this implies the non-existence of the kinds of markets that are needed for growth. Olson several times pointed out that markets involving time and uncertainty are especially important for growth, e.g., a commitment that the proceeds of an investment in fixed capital would remain in the hands of the investor. Since investment under communism was undertaken by the state, these markets did not exist. Further, special interests had had a considerable time to organize, and they remained powerful after liberalization began. As a result, the large industries in Russia are run on subsidies from the government and non-payment of bills, so that efficiency pressures are weak.

Olson argues that the different experience of China can be explained by the Cultural Revolution, which had the effect of destroying vested interests. Hence, once privatization was allowed, a more genuine market system, including markets for capital, could emerge.

There is far more to Olson's analysis than I have given here. He emphasizes the role of force and its disruptive power in preventing efficient use of resources. His stress is everywhere on the importance of good government, by which is meant freedom of property (within ascertainable and impartial limits) and the rule of law in the enforcement of contracts. He regards democracy as one of the guarantees of good government and, at the same time, an insurance that general interests will usually (but not always) prevail. Though the reasoning is strict, it is easy to follow, and the two hundred pages of this volume will make an attractive read.

One can ask whether the simple models that Olson prefers are sufficient to explain the complexity of human governments. As Olson argues, a richer description does not really provide an explanation and I found Olson's explanations for the most part very illuminating. While historical and cultural analyses provide additional background, they do not necessarily serve as useful ways of understanding and prediction.

But I am not entirely convinced by all his arguments. In particular, his explanation why democracy has sometimes emerged is not particularly compelling; it is that the overthrow of an autocracy may require a number of factions or leaders, none of whom wants to be subordinated to others. But time after time, and especially with regard to the transition economies, his arguments shed new light on a complex subject.