Government by Goldilocks

Read Acemoglu too quickly, and it sounds like a libertarian rant. State bad, let property rip. They don’t help matters by embracing the moniker “libertarian.”

But one of the major rhetorical shifts one notes in Why Nations Fail is his how AceRob put the need for strong states at the center of their analysis. Check out their definition of “inclusive states”:

We will refer to political institutions that are sufficiently centralized and pluralistic as inclusive political institutions. When either of these conditions fails, we will refer to the institutions as extractive political institutions. (p. 85)

As far as I can tell, the book’s major innovation relative to their past work (besides its non-mathematical style) is that they substitute the word “inclusion” for what they used to call “institutions of private property.” This definitely changes the ideological resonance of the book, for the better.

Of course, a close read of their past work shows that they have long been concerned for state capacity. As Daron put it in a 2005 paper,

when both the state and the citizens make productive investments, it is no longer true that limiting the rents that accrue to the state is always good for economic performance. Instead, there needs to be a certain degree of balance of powers between the state and the citizens. When self-interested rulers expect too few rents in the future, they have no incentive to invest in public goods. Consequently, excessively weak states are likely to be as disastrous for economic development as the unchecked power and expropriation by excessively strong states…

there is [also] an optimal level of the political power of the state. Intuitively, when… the state is excessively powerful, citizens expect high taxes and choose very low levels of investment (effort). [When] the state is excessively weak and there is the reverse holdup problem; high taxes will encourage citizens to replace the ruler, and anticipating this, the ruler has little incentive to invest in public goods, because he will not be able to recoup the costs with future revenues…

[A] ‘‘consensually strong state’’ equilibrium… can emerge when citizens accept high taxes as long as there is a credible promise that a sufficient fraction of these will be invested in public goods. This equilibrium is made possible by the fact that the state is politically weak, so the elites can be replaced easily if the ruler deviates from the prescribed behavior.

This is Government by Goldilocks: not too big, not too small…. just right.

Having recognized that the state is important, though, what should it do? This is where matters simply aren’t that different from the standard prescriptions of neoliberal institutional economics. AceRob write that states should enforce property rights, plus offer some public services (roads, anti-fraud regulations, education) that also promote market exchanges (79-80). Elsewhere, they are deeply skeptical of industrial policy and planning (see here, here and especially here) , i.e. more active roles for the state.

Much in the way that previous NIE authors idealize the “market” as a decentralized field with so many buyers and sellers that none can influence prices, AceRob say that power needs to be diffused so broadly in political institutions that no single entity can alone influence outcomes (because this would supposedly interfere with the types of creative destruction and accountability that creates a fertile ground for technological innovation). They deem such political institutions as “pluralistic.” (412) I

Of course, deep skepticism of government has a long intellectual lineage. Hayek saw it is an encroachment on liberty, and unable to do much of anything (because of the complex informational environment).

Acemoglu takes up this thread from from two angles. Firstly, he worries that rulers will run the state as an instrument of rent extraction. Essentially, this is Ralph Miliband’s instrumental Marxism, where the capitalists run the government for their own benefit. But Acemoglu subtracts classes and capitalism, and instead looks at classless cohorts running the government as their own slush fund. (Why bother using the state to prop up capitalism when you can use it to get some sweet shoes??)

Secondly, while the state can help private parties enforce their own contracts, Acemoglu worries that the state can’t enforce commitments to which it is party. This idea has a long lineage in neoliberal institutional economics. As Douglass North wrote:

impersonal exchange with third-party enforcement.. has been the critical underpinning of successful modern economies involved in the complex contracting necessary for modern economic growth. … the returns on opportunism, cheating, and shirking rise in complex societies. A coercive third party is essential. One cannot have the productivity of a modern high income society with political anarchy.

But North worried that we couldn’t trust the state to perform this role. While North’s worry seems to be mostly ideological and based on his own crude concerns about rent seeking, Acemoglu goes a step further to posit formally the problem. Ronald Coase suggested that efficient institutions would always emerge because parties could transact and trade for the winners to compensate losers. A modified version of this is that, if inefficient institutions exist, it is because society wanted them and transacted to make it so.

Acemoglu argues against this on several fronts. First, he does not believe that countries choose bad institutions, but that they inherit them. When they realize that institutions are not working (as North Korea would have by the 1980s), the political Coase theorem suggests that they would simply upgrade. However, they don’t – not only because of the simple rent problem noted above – but also because efficiency in institutional change requires the ability to negotiate transfers between the winners and losers (which won’t happen unless there is enforcement by a state). No transfers are theoretically possible when they come from the state to citizens. The incentives in such a case will almost always be wrong: a leader can’t promise not to expropriate in the future without stepping down, and they won’t step down because their successors won’t have incentives to make life nice for them.

This is where it would be useful for economists to be more aware of the work done in other disciplines. There has been decades of work in international affairs examining how states are constrained in political anarchy.The problem is that one has to abandon formalism (and probably incentives based frameworks) and instead look at norms and culture – things that are difficult to mathematically represent. I will return to this thread in future posts.