There Really Is a Solid Reason for Optimism

Things seem grim. But there is cause for optimism, perhaps even enthusiasm, for the adjustment process that we face “after the virus.” The source of that optimism, surprisingly, is a very pessimistic book, The Rise and Decline of Nations by Mancur Olson (Yale, 1982).

Olson argued that there is a strange dynamism in societal success, but an unavoidable accretion of forces that leech away the ability to sustain success. Eventually, great civilizations fail. Over the time of quarantine here in North Carolina, I read Edward Gibbon’s famous Decline and Fall of the Roman Empire. It was better than I expected, full of examples of the problems of public choice and matching private incentives and public disaster.

Olson extends the logic decline to other nations, noting that there appears to be what we might now call a “common pool resource” problem in budgets and the energy of the public sector. Over time, more and more latent groups become organized interests, and they use the political power of organization to secure rents from the public purse. The problem is that once rents are secured, it is essentially impossible to take them back. Large latent groups may be difficult to organize to eliminate rents, because the individual benefits are negligible.

But the real problem is that organized groups will fight to the death to preserve their ill-gotten portion. The reason is Gordon Tullock’s simple but powerful insight about the “transitional gains trap.” Once a rent or entitlement is secured by an organized interest, there is a one-time wealth increase. But the expectation of the rent is capitalized in asset prices immediately: land prices, or the price of a taxi medallion or occupational license, increases to the point where the owner makes only a normal return. But the activity is expensive, and sucks out some of the life juices of the economy.

Individually, this leech-like rent-seeking has only limited impact; that’s why each separate act of thievery can succeed: the tiny marginal impact has costs that are so widely dispersed as to appear invisible. But in the aggregate, as with any common pool resource, the effect of each separate taking adds up to collapse the society. Interest groups “overfish” the budget, and there is nothing left. California cities have no effective budget remaining, after they pay the inflated pension obligations snatched by public unions. Overall, the “ratchet” of government growth, which once expanded in an area cannot be cut, is constantly forcing nondiscretionary spending upward, leaving less and less ability to respond to needs of infrastructure and normal services. 

The Upside: Saltation

The reader may be wondering, “Jeez, where’s the optimism? This sounds terrible.” And that’s right, it is terrible. My optimism is more of the “silver lining” than the “what good luck!” sort. There has always been a tendency among the economically illiterate (and I have to include Paul Krugman among those) to see destruction as an economic stimulus. Frederic Bastiat long ago identified this as the “broken window” fallacy, but it won’t disappear: every time there’s a catastrophe, someone says, “Well, actually….” No. NO, NO, NO. Destruction does not create wealth.

Except that sometimes, destruction may create an opportunity for future growth, if the destruction includes the piled-up layers of interest group guano that coats the gears of the system. We sometimes talk about technology as having this function; in my book (Platforms: Perils and Promise, IEA 2020) I give the example of how GPS has made a huge amount of human capital nearly worthless. 

For decades, an entry license to drive a black cab in London required the ability to recite from memory the street location of and directions to any address in the city. And the driver needed to know at least a snippet about every tourist stop in the city. As a result, the salaries of black cab drivers were high, and it was difficult to increase the number of drivers in response to changes in demand.

But the value of what drivers called “The Knowledge” was destroyed in less than a decade. A smart phone with GPS, combined with increasingly accurate apps such as WAZE that give constantly updated information about construction and accidents en route, means that rides can be provided at a 50% discount compared to black cabs, with little difference in arrival times. I have called this kind of change “saltation,” meaning a re-sorting or leapfrogging transformation. 

Which brings us back to Mancur Olson. He noticed that catastrophes caused saltation in institutions, because all the layers of interest group rent commitments were breached. Either the group did not exist in the same form, or political change was so dramatic that their implicit and morally illicit commitments to a share of taxpayers’ efforts were no longer enforceable. The most obvious way of breaking the stranglehold of organized interests was war, according to Olson. And not winning a war; that likely makes things worse. The “solution” is to lose a war, catastrophically, so that the society gets to start over free of the accretion of parasites and second-handers that had thrived on the work and thrift of others.

On p. 76 of Rise and Decline, Olson argues that the reason that Germany and Japan did so well after World War II is that they lost completely and abjectly, and had new institutions imposed from outside in ways that abrogated the commitments that would have been honored if choices had been made internally. Olson points out that the other major Axis power, Italy, managed a negotiated peace that preserved its institutions, and the result was a crippled and anemic postwar recovery compared to Germany and Japan.

Olson is quite careful to avoid the “broken window fallacy,” I should note. He does not conclude, “And therefore complete destruction following a lost war is what we want!” His point is that there is little hope for normal political processes to break up the interest group rent carnival short of losing a war, which means that the decline of nations is inevitable: either their dynamic energies are slowly choked off by institutional sclerosis (bad), or they lose a war (very bad now, later good, but overall more bad than good).

But there it is. That is the optimistic part. I would never have advocated for the intentional destruction of many of the supply chains, cronyist partnerships, and cozy iron triangles that the state has nurtured in the past 50 years. Right or wrong, though, we did that. Our economy in the fall of 2020 will look more like an economy emerging from a bitter war than any time since the fall of 1945. All those interest group commitments that normally would be sapping our national vitality will be up for grabs.

Our systems of occupational licensing—always a mook’s game, but now clearly preventing rapid response to emergencies in other states—drug and medical equipment certification, and regulating employment in the “gig” economy, have all been shown to be catastrophic. The economic justification for these grants and set-asides was never persuasive. Let’s get rid of them! Olson’s argument is that “a fresh start” on regulation is actually a great tonic for economic anemia.

The point is clear: the economy lost the war. Many of our industries and normal ways of doing business got blown up. That’s done; we lost a war we did not even want to fight. But it happened, and now we have an opportunity for saltation. We can make the rebuilt political economy better than the bloated, creaky rent-selling machine that we had at the start of 2020.

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