Readings #4 (part 1)

Economics the old-fashioned way (ugh)!!

3

The Implications


I


Although some of the implications of the logic in the preceding chapter were set out in that chapter, they were only the immediate implications of that logic alone. When we combine the argument in chapter 2 with some other logic and facts, and in particular with some standard findings from economics, we obtain a further set of implications. These second-level implications tell us what we should expect in certain types of societies and historical conditions if the theory we are now constructing is correct.

The validity or invalidity of our argument depends not only on the correctness of the preceding chapter, but also on what will be added. Fortunately, most of the economics we shall use is well-established; it is mainly the widely tested “microeconomic theory” of individual firms, consumers, and industries. Many laymen suppose that economists disagree about everything, but in fact this part of economics is mainly acceptable to almost all skilled economists, be they left-wing or right-wing, Keynesian or monetarist. To this we must add the less formal but invaluable “Schumpeterian” insight into innovation and entrepreneurship, which is also rather widely accepted, and a brief extension I have to the economist’s usual analysis of the role of entry of outside firms into unusually profitable industries.

Unfortunately, it will not be possible to see how the further implications or theory we shall develop here relate to concrete problems in particular countries until we have first gone through the mildly abstract argument in this chapter—the rest of the book is not comprehensible by itself. Logical arguments that are not immediately related to practical experience do not seem important to some people, so there may understandably be readers who will wonder whether the abstract arguments of this chapter and the last one are of much practical significance. I can, without any fear of ultimate disagreement, promise the reader that, if the argument in this chapter and the preceding one is largely correct, it is indisputably of great practical importance.

Our initial second-level implication has to do with whether a society could achieve a rational or efficient economy through bargaining among organized groups. The last chapter pointed out that a small group of individuals or firms interested in a public good would have an incentive to continue bargaining with one another until they had maximized aggregate gains. There can be no confidence that bargaining even in a small group will work, much less have the complete success that is needed for group-optimality. But such an outcome is clearly a prominent possibility, and if everyone has participated in the bargaining the result might even be deemed fair to some degree. This reminds us to ask whether whole societies could achieve efficient results through comprehensive bargaining by leaders of all the groups in the society.

If the logic set out in the previous chapter is correct, a society that would achieve either efficiency or equity through comprehensive bargaining is out of the question. Some groups such as consumers, taxpayers, the unemployed, and the poor do not have either the selective incentives or the small numbers needed to organize, so they would be left out of the bargaining. It would be in the interest of those groups that are organized to increase their own gains by whatever means possible. This would include choosing policies that, though inefficient for the society as a whole, were advantageous for the organized groups because the costs of the policies fell disproportionately on the unorganized. (In the language of the game theorist, the society would not achieve a core or Pareto-efficient allocation because some of the groups were by virtue of their lack of organization unable to block changes detrimental to them or to work out mutually advantageous bargains with others.) With some groups left out of the bargaining, there is also no reason to suppose that the results have any appeal on grounds of fairness. On top of this there is the likelihood that the costs of bargaining and slow decision-making would make a society that made decisions by group bargaining inefficient in any case. Thus our first implication on this level is:

There will be no countries that attain symmetrical organization of all groups with a common interest and thereby attain optimal outcomes through comprehensive bargaining.

If such countries should emerge, that would mean that the argument in this book is probably wrong.


II

Our second implication relates to the emergence of organizations for collective action over time. The last chapter argued that collective action is difficult and problematical. In addition, there are normally some special start-up costs in creating any organization or new pattern of cooperation, including the fear of and resistance to the unfamiliar; as Machiavelli pointed out in another context, ‘There is nothing more difficult to arrange, more doubtful of success, and more dangerous to carry through, than to initiate a new order of things. Men are generally incredulous, never really trusting new things unless they have tested them by experience.” Thus even those groups that are in situations in which they may be able to organize or collude, because their members are small or because some selective incentive could in principle be worked out, may not be able to organize until favorable circumstances emerge. Even in small groups there will often be difficulties in working out bargains for collective action; each party wants to bear the lowest possible share of the costs and in bargaining has an incentive to hold out, sometimes for an indefinitely long time. Thus some of the collective action that is attainable through bargaining in small groups will not be attained until some time has passed.

In larger groups, where collective action is attainable only through selective incentives, even greater difficulties must be overcome. If coercion is the selective incentive, the coercive force has to be arranged, and since people do not like to be coerced there is difficulty and even danger in this. Strong leadership and favorable circumstances will usually be required. The beginning of the union career of Jimmy Hoffa illustrates this. The young Hoffa was one of the workers in an unorganized warehouse in Detroit. On a hot summer day a large shipment of strawberries that would soon spoil arrived, and Hoffa then persuaded his coworkers to strike. The employer found it better to accept Hoffa’s demands than to lose his perishable cargo. Usually the circumstances are not so favorable, and leaders with the cunning, courage, and lack of inhibition that characterized Jimmy Hoffa are not often on the scene.

When social pressure and social rewards are the selective incentives, there are also difficulties and delays. When a group that is already socially interactive needs a collective good, the problem may not be so difficult, although even here the social interaction must generate a sufficient surplus for the participants that they are willing to maintain it even after they are taxed for the cost of the collective good. Creating new patterns of social interaction is more difficult and surely time-consuming as well. Some late nineteenth-century American farm organizations, such as the Grange, managed to do this particularly well with relatively isolated farm families in recently settled areas, but attracting members away from previously established social networks, when possible at all, is likely to take exceptional leadership and even then to evolve only over a considerable amount of time.

Positive selective incentives of a more tangible and material kind can also be found, if at all, only after a great deal of effort. Generating a surplus that can finance provision of a collective good or induce others to provide it is inherently chancy—there are failures as well as successes among those who attempt to create new businesses. And entrepreneurs who make money naturally often keep it for themselves. Thus usually some complementarity between the activity that can provide a collective good and that which produces income must be found or exploited; any lobbying power must be used in part to get favorable governmental treatment of the business activity, for example, or the reputation and trust of the lobbying organization among its beneficiaries must be exploited by the associated business activity. Even when such complementarities can be exploited, they may be discovered or worked out only after some time, and then only if there are imaginative leaders.

Scattered observation, at least, supports the hypothesis that organization for collective action takes a good deal of time to emerge. Though there was some earlier collective action by workers, it was not until 1851, or nearly a century after the start of the Industrial Revolution, that the first sustainable modern trade union emerged, the Amalgamated Society of Engineers in Great Britain. Though there was legal repression of combinations of workers at times during the Industrial Revolution, this cannot explain why unions did not become the norm in Britain until the decades just before World War I. Elsewhere unionization took place even later. In the United States a number of unions were established in the last half of the nineteenth century. but the fastest growth of union membership was in the period from 1937 to 1945, long after the country achieved the industrialized condition most favorable to unions. A study of unionization, industry by industry, in France similarly reveals “a lag between the initial appearance of an industry and the time its workers acquire an organizational capacity for collective action.” Farm organizations have taken even longer to develop. In the United States there was some farm organization in the second half of the nineteenth century, but it was not until the organization of the Farm Bureau (by the government-funded Agricultural Extension Service) after World War I that there was any really large or stable farm organization. Yet American farmers had significant common interests from the founding of the American republic. Many similar examples could be cited for other countries and other types of organizations.

The other side of the matter is that those organizations that have secured selective incentives to maintain themselves will often survive as organizations even if the collective good they once provided is no longer needed. As the sociologist Max Weber pointed out long ago, the leader who is making a living out of an organization may keep it alive even after its original purpose has disappeared; an organization set up to represent the drivers of teams of horses, for example, will take on the task of representing drivers of trucks, and an organization set up to help the veterans of one war will outlive these veterans by representing veterans of subsequent wars. Selective incentives make indefinite survival feasible. Thus those organizations for collective action, at least for large groups, that can emerge often take a long time to emerge, but once established they usually survive until there is a social upheaval or some other form of violence or instability.

If organizations and collusions for collective action usually emerge only in favorable circumstances and develop strength over time, a stable society will see more organization for collective action as time passes (unless, of course, constitutional and legal constraints on collective action, or on the changes in public policies lobbying is permitted to bring about, should leave little scope for such organizations). The more time that passes, the larger the number of those groups that are in situations in which collective action is a possibility will have enjoyed the favorable circumstances and innovative political leadership that they need to organize, and the greater the likelihood that the organizations that have been created will have achieved their potential. This, in combination with the fact that organizations with selective incentives in stable societies normally survive indefinitely, leads to our second implication:

2. Stable societies with unchanged boundaries tend to accumulate more collusions and organizations for collective action over time.


III

The third implication is perhaps the hardest to relate to casual observation, so its meaning may not be clear until later. The source of this implication is, however, obvious: it is the finding in the last chapter that oligopolists and other small groups have a greater likelihood of being able to organize for collective action, and can usually organize with less delay, than large groups. It follows that the small groups in a society will usually have more lobbying and cartelistic power per capita (or even per dollar of aggregate income) than the large groups. The fact that small groups can usually organize with less delay than large ones implies that this disproportion will tend to be greatest in the societies that have enjoyed only a brief period of stability and least great in those societies that have been stable for a long time. Accordingly, our third implication is:

3. Members of “small” groups have disproportionate organizational power for collective action, and this disproportion diminishes but does not disappear over time in stable societies.
The reader may find it helpful to give this implication a skeptical examination after it has been put to practical use later in the book.


IV

If the extent and type of organization for collective action varies across societies and historical periods, then it is important to determine what impact such organization has on the efficiency and rate of economic growth of a society. Normally all such organizations, whatever their scale or form, have reason to want economic efficiency and growth, and good fortune generally for the society in which they operate. Whatever type of goods or labor the members of an organization sell, normally the demand for it will be greater the more prosperous the society (there are “inferior” goods on which more is spent if income falls, but they are exceptional). Similarly, the available technology will generally be better and the goods (though not the labor) that the members of the organization buy will generally be cheaper if they live in a more productive society. It might seem that one logical possibility, then, is that such organizations could in some circumstances serve their members’ interests by helping to make the society in which they operate more productive.

Except for a special case we shall deal with later, the only other way in which such an organization could serve its members’ interests is by obtaining a larger share of the society’s production for the organization’s members. In other words, the organization can in principle serve its members either by making the pie the society produces larger, so that its members would get larger slices even with the same shares as before or alternatively by obtaining larger shares or slices of the social pie for its members. Our intuition tells us that the first method will rarely be chosen, but it is important to figure out exactly why this is so.

It will normally cost an organization something to make the society of which it is a part more efficient. Suppose a lobbying organization were to strive to eliminate the losses in economic efficiency that arise because of differential rates of tax on income from different sources (tax loopholes), or to attempt to reduce the losses from monopoly in the society. An effective campaign to achieve such goals would have significant costs that the organization sponsoring the campaign would have to bear. But the members of the organization would get only a part of the benefits that would result if they made the society as a whole more efficient; they would share in the lower prices or lower taxes or other gains from greater efficiency in the society, but so would most of the rest of society. This is important because in most cases each organization of the kind we are considering represents only a minute percentage of the population or other resources of a society. The typical trade association for an industry represents a small number of firms which, even though they may be large, own only a tiny share of the productive assets in a country; the typical labor union, even if it has tens or hundreds of thousands of members, includes only a minute percentage of the labor force of a country, and so forth. (There are exceptionally encompassing organizations for collective action in a few countries, and these are considered separately below.)

Suppose, for the sake of illustration, that an organization represents workers or firms that have 1 percent of the income-earning capacity in the country. This organization will have to bear the cost of whatever campaign it mounts to make the society more efficient, but its members will tend, on average, to get only about 1 percent of the resulting gain to the society. The organization’s members would, on average, profit from devoting their resources to making the society more efficient only if those resources produced social gains one hundred times or more larger than the cost of obtaining those gains. (More generally, in the symbolic language of the footnote on page 31 in chapter 2, the benefit-cost ratio of the activity to make the society more efficient must equal or exceed 1/Fi, or the reciprocal of the fraction of the income-earning capacity of the society that the organization represents.)

Thus there is a parallel between the individual in a group that would gain from provision of a collective good and the organization for collective action within the society. The organization that acts to provide some benefit for the society as a whole is, in effect, providing a public good for the whole society, and it is accordingly in the same position as an individual who contributes to the provision of a collective good for a group of which he or she is a part. In each case the actor gets only a part (and often only a tiny part) of the benefits of its action, yet bears the whole cost of that action.

Now suppose that our illustrative organization that represents 1 percent of the income-earning capacity in the country attempts to serve its members by getting a larger slice of the social pie. The resources that are diverted to seizing a larger share of the society’s output will not, of course, produce the social output they produced in their previous employments, so this will reduce social output to some extent. More important, the pattern of incentives in the society will be changed by the redistribution, and (as we shall see) in ways that can vastly reduce the level of production. On the other hand, the members of the organization are part of the society, so they will also share in the loss of social output that results from the redistribution toward themselves. Self-interest alone will make them take these losses into account along with the gains from the redistribution to themselves. But it will pay to go ahead with the redistribution, unless the reduction in the value of the society’s output is a hundred or more times larger than the amount won by the organization’s clients in the distributional struggle. Exactly the same logic we have used all along suggests that the typical organization for collective action will do nothing to eliminate the social loss or “public bad” its effort to get a larger share of the social output brings about. The familiar image of the slicing of the social pie does not really capture the essence of the situation; it is perhaps better to think of wrestlers struggling over the contents of a china shop.

In short, the typical organization for collective action within a society will, at least if it represents only a narrow segment of the society, have little or no incentive to make any significant sacrifices in the interest of the society; it can best serve its members’ interests by striving to seize a larger share of a society’s production for them. This will be expedient, moreover, even if the social costs of the change in the distribution exceed the amount redistributed by a huge multiple; there is for practical purposes no constraint on the social cost such an organization will find it expedient to impose on the society in the course of obtaining a larger share of the social output for itself. (The ratio of the social cost or excess burden to the amount redistributed must equal or exceed 1/Fi before it will constrain the organization.) The organizations for collective action within societies that we are considering are therefore overwhelmingly oriented to struggles over the distribution of income and wealth rather than to the production of additional output—they are “distributional coalitions” (or organizations that engage in what, in one valuable line of literature, is called “rent seeking”).

There has long been some intuitive apprehension of this, if not of the extent of social losses that it would pay such organizations to impose on society in efforts to get a larger share of social output. This intuitive apprehension is perhaps suggested by the special-interest group label sometimes used for such organizations. Now that the incentives such organizations face have been set out starkly, I shall sometimes use the expression special-interest group as a synonym for distributional coalition, even though that expression has, as we shall see later, a somewhat narrower connotation in everyday language than is appropriate here. These coalitions may be cartels as well as lobbies and are often both. Any combination of individuals or firms for collusive action in the marketplace, whether a professional association, a labor union, a trade association, or an oligopolistic collusive group, will here be called a cartel, whatever term may be used to describe it in everyday language.

One of the obvious ways in which a special-interest group can increase the income of its members while reducing the efficiency and output of the society is by lobbying for legislation to raise some price or wage or to tax some types of income at lower rates than other income.

Although the effects may be different under certain initial conditions (because of “second-best” problems), in general measures of this sort will not only increase the income of those favored by the legislation but also reduce efficiency. There will be an incentive for additional resources to move into the industry or activity that is favored by the higher price or lower tax, and this shift of resources will continue until the private post-tax returns are the same in the favored area as in the rest of the economy. But if the price is higher or the tax lower in the favored area simply because of special-interest legislation, then the extra resources that have been diverted into the favored area will be adding less to the value of society’s output than they did in their previous employments. Whenever resources are free to move into the favored area, the private returns will eventually be the same in the favored area as in the rest of the economy, and this tends to make the gain to the special-interest group very small in relation to the cost to society. In this type of case the only gain to the clients of the distributional coalition is the capital gain on those assets that are specialized to the favored industry plus transitional profits during the time it takes other resources to move into the area. The situation is different if entry is not allowed into the favored area, but as I shall later show, barriers to entry usually impose substantial social costs of other kinds. The argument we have just used is extremely simple and leaves aside many fascinating questions, both technical and social. The argument also has only a lesser applicability to any country in which constitutional and structural factors constrain the number and power of lobbying organizations, as appears to be the case in Switzerland. Nonetheless, as later parts of this book should show, the basic point that it makes is widely applicable and enormously important.

Another way in which a special-interest organization can increase the income of its members while reducing society’s output is through cartelization—the members can agree to reduce output as a single monopolist would have done and thereby enjoy a higher price. The gains from cartelization and monopoly arise because less is sold to obtain a higher price, so naturally there is (in the absence of other distortions) a reduction in social output; in general, the society will get a mix of goods that contains an inefficiently small proportion of those goods sold at a monopoly price and an inefficiently large proportion of those goods sold at a competitive price. Effective cartels must always block entry into the line of business in which they have raised the price, so the process described in the preceding paragraph, which made the coalition’s gain small in relation to the cost to society, does not work in the same way. But the ubiquitous barriers to entry will make certain other social costs (which we shall examine later) even greater.

There is an interesting literature in economics, stemming mainly from a seminal article by Arnold Harberger, suggesting that the social losses from monopoly and (as others have argued) from tariffs and certain other distortions of the price system are relatively small in relation to the national income. Later I will endeavor to show that these losses can sometimes be colossal, but for the moment it may be sufficient to point out that the foregoing analysis of the incentives faced by special-interest groups could make them impose very large costs indeed on the society as a whole. And, as the international trade theorist Jag-dish Bhagwati has pointed out, there is, alas, nothing in the laws of economics that requires that, if a society is inefficient, it must be inefficient in a small way.

One consideration that does limit the losses from distributional coalitions to some extent, however, is that occasionally some of them will nullify or offset the effects of others. A farmers’ lobby may win the repeal of a tariff on farm machinery or automobile manufacturers may limit the protection given the steel industry. Note that, in cases such as these, the effort of the special-interest group can lead to an increase in the efficiency and income of the society, but that the gains are not diffused through the society so that the special-interest group gets a share approximated by the proportion of the income-earning capacity of the society it represents—instead, those in the special-interest group get a substantial share of the total social gain from their activity. Occasionally there are other types of situations in which the constituents of special-interest organizations seek to increase social efficiency because they would get a lion’s share of the gain in output; this occurs when the special-interest organization provides a collective good to its members that increases their productive efficiency and also when it gets the government to provide some public good that generates more income than costs, yet mainly benefits those in the special-interest group. It certainly is not easy to find any significant percentage of special-interest organizations whose principal objective is some policy that has the special property that it will mainly benefit the clients of the organization and at the same time increase the efficiency and aggregate income of the society. Yet multiple causation and mixed motivation are usually evident in any area, including that of special-interest groups, so it is important not to lose sight of organizations or situations of this type. The
largest proportion of the cases that this researcher has been able to find appear to consist of organizations whose clients suffer disproportionately from inefficiencies obtained by other distributional coalitions and who therefore oppose those inefficiencies. If the first of the implications in this chapter—that there is not and will not be a symmetrically organized society—is wrong, this situation is not or will no longer be a special case. But if, as the findings in later parts of this book and elsewhere suggest, that implication is true, then the great majority of special-interest organizations redistribute income rather than create it, and in ways that reduce social efficiency and output.

In addition, this focus on distribution makes the significance of distributional issues in political life relatively greater and the significance of widespread common interests in political life relatively smaller. The common interests that all or most of the people in a nation or other jurisdiction share can draw them together, as they are drawn together when they perceive a common interest in repelling aggression. In distributional struggles, by contrast, none can gain without others losing as much or (normally) more, and this can generate resentment. Thus when special-interest groups become more important and distributional issues accordingly more significant, political life tends to be more divisive. Moreover, as Dennis Mueller, building on the work of Kenneth Arrow, has shown, the increased emphasis on distributional issues due to accumulations of special-interest groups can also increase the likelihood that a democratic political system can repudiate its prior choices, even if all the individuals in the electorate have the same preferences as before—it can (for some reasons that cannot be explained briefly or without technical language) encourage intransitive or irrational and cyclical political choices. The divisiveness of distributional issues, and the fact that they may make relatively lasting or stable political choices less likely, can even make societies ungovernable.

Thus we have our fourth implication:

4. On balance, special-interest organizations and collusions reduce efficiency and aggregate income in the societies in which they operate and make political life more divisive.



Mancur Olson, The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities, (1982) Yale.