From Infancy to Senility and Back

I would prefer to construct a tower, an arch, or even a gargoyle on a great cathedral that will last for ages than to take credit for single-handedly constructing a shack that will be blown away by the next change in the winds of intellectual fashion.

Despite a sprinkling of such disclaimers, Mancur Olson, an economist at the University of Maryland, wants to build a cathedral of universal ideas that will explain why countries decline economically. His problem is simple. None of the countries that have been world economic leaders has managed to stay ahead forever. Why?

The problem differs dramatically if you believe that economic growth is the natural state of mankind and something has to occur to prevent it, or if you believe that economic stagnation is the natural state of mankind and positive forces have to arise to break that stagnation. From Olson’s perspective, growth is the natural outcome of a competitive economy and something has to happen to screw it up, whether it takes the form of unions, cartels, tariffs, or selfish pressure groups, to name only a few. Economies that really are competitive cannot “not grow.” The natural tendency would be for a nation once ahead, for whatever reason, to stay ahead forever. Since nations don’t stay ahead forever, the cathedral builder must then look for the systematic forces “silting up the channels of economic progress.”

From the contrasting point of view one would try to explain why the social and technological forces that once led to economic growth no longer do so. The railroads, for example, created a great improvement in transportation and a host of new opportunities for growth, but these opportunities were eventually exhausted.

This is not Olson’s approach. For him, the proposition that competitive markets always produce economic growth is evidently central, and he keeps his attention fixed on competition; but he leaves the proposition itself unexamined, assuming that it has been demostrated by the discipline of economics. Yet I know of no such demonstration.

Market economies can be mathematically shown to be efficient in distributing goods and services—“Pareto optimal” in the jargon. In a free market no trades could be made that would make someone better off without making someone else worse off. Competitive free-market economies systematically exhaust the economic possibilities of the current known technologies, but they do not guarantee the perpetual growth of new technologies and hence permanent economic growth. In all standard economic models, including the competitive one, technology is determined by outside factors and not explained by the model itself. Market economies are naturally “efficient” but they do not naturally “grow.”

If technology quits growing, for whatever reason, all competitive free-market economies would grind to a halt regardless of whether their channels of economic progress had, or had not, silted up. To adapt Olson’s metaphor, the river of economic progress itself would have stopped and the channels would have become irrelevant. The major problem with Olson’s analysis is that he has not taken a trip up the economic Nile to find its source.

Even if we accept Olson’s basic premise that economic growth is the natural state of competitive economies, he makes the problem too simple. Since he is sure that economic growth should be perpetually occurring, he need merely look to see whether the forces retarding growth from country to country are random or systematic. They are not, of course, necessarily incompatible. A variety of both random and systematic forces may be at play. For there is another major problem left unexamined in Olson’s book. No country has been the world’s economic leader forever, but different leaders have certainly lasted for very different periods.

How does one explain that the Egyptians were probably the world economic leaders for three thousand or four thousand years, the Romans for a thousand years, the British for three hundred years and the Americans for fifty years? Why did America go from infancy to senility with only a brief encounter with economic maturity while these other societies had long fruitful periods of maturity? And what does one say about such a country as Kuwait, which passed us in per capita GNP during the early 1950s?

To raise the question is to answer it. Even if there are systematic factors bringing economic progress to a halt, they certainly seem to work at different speeds. Which factors, random or systematic, affect the speed of “silting up” is the real question, but it is a question Olson does not examine. And as the history of Kuwait would indicate, random good or bad luck certainly has an important effect on economic success or failure.

At the same time there is merit in Olson’s argument even if it is not the ultimate argument he is looking for. Growth is a process of creative destruction. Every new product adversely affects some old product. Video games are killing the market for records. The robot is going to make some human skills redundant. The electronic watch severely damaged a mechanical Swiss watch industry with a thousand-year history. The new product or process never has a constituency to defend it as large as that of the old. The old, who are to be hurt, know who they are while the new do not yet know who they will be. In this situation of specific concrete losses and general amorphous gains, Olson argues, the losers organize to stop the new, even though the aggregate gains from the new for society as a whole may far outweigh the aggregate losses.

So Olson often sees self-interest pitted against the general good. Coalitions arise in every society to defend the status quo and to raise the income of specific groups at the expense of the majority. The longer a society has existed, the more such groups there are apt to be. But with the new in retreat or under attack, societies cannot take advantage of new opportunities, and growth stops. Decline sets in.

According to Olson, Germany and Japan became world economic leaders after World War II because their defeats destroyed the vested interests of the status quo. Their leadership came not from the factories that were blown up and replaced but from the social institutions and attitudes that replaced those that were blown up. I also believe this to be so, but the story is more complicated than Olson would make it.

Is it really true that defeat leads to economic success and that countries not before they are conquered? In per capita GNP the world’s industrial leaders are not Germany or Japan, but Switzerland and Sweden—two countries with a very long history of not having been defeated or socially upset. And what of World War II? Is it not impossible to imagine a Nazi victory? They came very close. If the Nazis had won, would Olson say that America, Britain, and Russia were rotting societies? If not, what about the conclusion that large countries are never conquered but only rot? If so, hasn’t the proposition become a tautology? Every society that is defeated militarily is labeled a rotting society. In reality every society is a mixture of new growth and rot. Which predominates is not obvious, and it is too easy to take an event, a military defeat or victory, and make a restrospective argument that would be precisely reversed if the event had turned out otherwise.

While there certainly are systematic tendencies for channels to silt up, there are also dredging mechanisms. Tariffs may stultify competition and growth; but they are sometimes removed (as in the “Kennedy round” of trade negotiations between 1964 and 1967 and in the Common Market) as well as put on. New industries emerge—the auto replaces the buggy. It is the balance between silting and dredging that produces thousands of years of economic supremacy or only a few. Leadership and the way that societies are organized to promote dredging and retard silting make a difference. Because of the way that American and British elections are financed, lobbying groups have more political influence in the United States than they do in Great Britain. If we could mount the necessary political effort, we could alter our election system to reduce the influence of narrow economic self-interest.

The random good luck of technology makes a difference. Better methods of transportation, the railroads in particular, made possible great continental economies such as those of the United States and Russia. Conversely the success of such technology was in the long run going to weaken the relative position of great island economies such as Great Britain’s. During the late nineteenth century, when the American economy overcame the lead of the British economy, the US was not more open to international trade than Great Britain—although, according to Olson, openness to international trade is one source of success or failure. Rather, the US had important technological force moving in its favor while the same force was moving against the British. It was this and not, as Olson argues, the worries of eastern American manufacturers about potential competition from entrepreneurs in newly settled regions of the American West that kept America unsilted.

While it is a mistake to think that there is one and only one culture that leads to economic growth, there are just as certainly cultures that inhibit it. These cultures throw up barriers to economic change that can be described as if they were identical to the narrow economic self-interest of American special-interest groups, but they aren’t. To think of the Indian caste system as if it were merely comparable to a system in which steel workers set out to protect themselves from Japanese steel, as Olson does, is to miss the essence of a caste system. One can describe the elements of similarity but they are over-whelmed by the differences that Olson does not consider. No American steel worker ever has, or ever would, throw the baby of a Japanese steel worker into the village fire—the fate of more than a few Indian “untouchables.”

The question also arises, as in most historical analysis, whether too much is being concluded from limited data. Consider the contortions that Olson has to go through to be able to explain why New Zealand, Australia, Great Britain, and the United States (including Canada) have all had a relatively poor economic performance since World War II. New Zealand and Australia have silted up their economic channels with tariffs that are too high. But since Great Britain had the lowest tariffs in the world and joined the Common Market to further international competition, its decline must be traced to domestic cartels—presumably the unions. Since the United States has fewer workers in unions than any other industrial country, its decline must be traced not to unions but to highly organized, narrow economic interests. All might be described as “silting up” but the process is very different from country to country.

Perhaps it would be simpler to say that there is something wrong with the culture or institutions that English-speaking countries inherited from Great Britain. Institutions and a culture that once worked to produce economic growth don’t in a different world. Perhaps with today’s technology a more highly disciplined group ethic, such as that always possessed by the Japanese, pays off in economic growth while earlier an individualistic ethic produced better results. The 8K RAM semiconductor chip could be designed by a single genius; but the 246k RAM semiconductor chip can only be designed by a large and highly integrated team of engineers. Japanese culture succeeds in one situation; American culture in another.

In science one contrary piece of evidence disproves a theory. More is required in history but let no one think that the counterexamples to Olson’s thesis do not exist. For example, consider Massachusetts, America’s industrial leader for most of the nineteenth century. Yet when I first went to work as a professional economist in 1964, seven out of the ten most depressed areas in America were in Massachusetts. Its channels of economic progress had silted up. By 1982 Massachusetts again had the lowest rate of unemployment of all industrial states, including those in the Sun Belt, and was a world leader in high technology—including computers and aerospace. Its channels had unsilted. How? No change in tariffs had taken place, no rolling back of the unions, no reduction in the size or scope of local government. The market worked as it always had. But where it had once been driving shoes and textiles out of business, it now induced high technology to come into business.

The answer to this puzzle is relatively simple even if it is not Olson’s answer. Massachusetts became an industrial leader in the nineteenth century because it had plentiful water power. But conversely it had no comparative advantage in the heavy industries of steel and coal. There were no reserves of either coal or iron ore. When heavy industries were the growing part of the economy, Massachusetts was not going to grow. At the same time it lost its comparative advantage in shoes and textiles—not because it did something stupid but because the development of alternatives to water power made it more efficient to put textile plants in the South close to where the cotton was grown. And, of course, good conditions for farming were determined largely by climate and not by silting up.

When basic scientific progress made it possible to produce high-technology products, Massachusetts had the skilled labor and great scientific institutions that made such production possible, and it quickly became economically successful. It should be noted, however, that the great scientific universities of Massachusetts, Harvard and MIT, were world leaders in science both when Massachusetts was a depressed region and when it had the country’s lowest unemployment rate. There was no one-to-one relationship between universities prominent in hard science and firms producing high technology. Any economic history of Massachusetts must be more concerned with technological change than with social silting. Yet what happened to Massachusetts could easily happen to a whole country.

At the end of his book Olson leaves the issue of “decline and fall” and moves on to stagflation. Here again the argument is that good market economies should not produce unemployment and inflation and, again, only do so because of “silting up.” In the market economy Olson favors, wages should fall to prevent both unemployment (with lower wages employers would hire more workers) and inflation (with lower wages other prices could fall to offset price shocks such as OPEC-oil price hikes). This does not happen because employed workers organize a cartel—unions—to prevent the market solution. The majority, those employed, organize to throw all of the costs of economic adjustment upon a minority, the unemployed. Note, however, that Olson now has a majority coercing a minority whereas in his theory of “decline and fall” he had a minority coercing the majority.

The problem of why wages do not fall in the face of unemployment is central to economics, but I do not think that Olson has discovered the key to the puzzle. As a percentage of the work force, the number of unionized workers has been falling rapidly in the United States and the United States has far fewer workers in unions than any other industrial country. Why then has our record of stagflation been getting worse relative to our own history and worse relative to the performance of those that are more highly unionized than the US? If unions are the key, the fact remains that of all prices in the US, the proportion that is flexible—i.e., sensitive to supply and demand—is very large (85 percent of the economy is not unionized) relative to the fixed-price sector. The proportion is not a small one, as Olson maintains. If unions are not the key, what is the mechanism whereby unorganized workers keep unemployed workers from bidding for their jobs at lower wages? Olson has no answer.

I am skeptical whether Olson has constructed even a gargoyle on a cathedral of universal ideas. He forgets that progress is made by building shacks that eventually get blown away. The epicycle theory of heavenly motion was an improvement on what came before and prepared the ground for Newton. It was blown away but it (or something like it) had to exist for progress to be made. Quantum mechanics and subparticle physics may blow away much of what we previously believed about physics, but they do not blow away the giants of physics who built such shacks.

History will tell us whether Olson has built a cathedral of ideas or a shack in the intellectual winds, but either way he provides an interesting starting point for our speculations. One doesn’t need a cathedral to get religion.