Monday, November 24, 2014

Why Are Rich Countries Democratic?

CAMBRIDGE – When Adam Smith was 22, he famously proclaimed that, “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.” Today, almost 260 years later, we know that nothing could be further from the truth.

The disappearance of Malaysia Airlines Flight 370 shows how wrong Smith was, for it highlights the intricate interaction between modern production and the state. To make air travel feasible and safe, states ensure that pilots know how to fly and that aircraft pass stringent tests. They build airports and provide radar and satellites that can track planes, air traffic controllers to keep them apart, and security services to keep terrorists on the ground. And, when something goes wrong, it is not peace, easy taxes, and justice that are called in to assist; it is professional, well-resourced government agencies.

All advanced economies today seem to need much more than the young Smith assumed. And their governments are not only large and complex, comprising thousands of agencies that administer millions of pages of rules and regulations; they are also democratic – and not just because they hold elections every so often. Why?

By the time he published The Wealth of Nations, at age 43, Smith had become the first complexity scientist. He understood that the economy was a complex system that needed to coordinate the work of thousands of people just to make things as simple as a meal or a suit.

But Smith also understood that while the economy was too intricate to be organized by anybody, it has the capacity to self-organize. It possesses an “invisible hand,” which operates through market prices to provide an information system that can be used to calculate whether using resources for a given purpose is worthwhile – that is, profitable.

Profit is an incentive system that leads firms and individuals to respond to the information provided by prices. And capital markets are a resource-mobilization system that provides money to those companies and projects that are expected to be profitable – that is, the ones that respond adequately to market prices.

But modern production requires many inputs that markets do not provide. And, as in the case of airlines, these inputs – rules, standards, certifications, infrastructure, schools and training centers, scientific labs, security services, among others – are deeply complementary to the ones that can be procured in markets. They interact in the most intricate ways with the activities that markets organize.

So here’s the question: Who controls the provision of the publicly provided inputs? The prime minister? The legislature? Which country’s top judges have read the millions of pages of legislation or considered how they complement or contradict each other, much less applied them to the myriad different activities that comprise the economy? Even a presidential executive cannot be fully aware of the things that are done or not done by the thousands of government agencies and how they affect each part of society.

This is an information-rich problem, and, like the social-coordination challenge that the market addresses, it does not allow for centralized control. What is needed is something like the invisible hand of the market: a mechanism for self-organization. Elections clearly are not enough, because they typically occur at two- or four-year intervals and collect very little information per voter.

Instead, successful political systems have had to create an alternative invisible hand – a system that decentralizes the power to identify problems, propose solutions, and monitor performance, such that decisions are made with much more information.

To take just one example, the United States’ federal government accounts for just 537 of the country’s roughly 500,000 elected positions. Clearly, there is much more going on elsewhere.

The US Congress has 100 senators with 40 aides each, and 435 representatives with 25 aides each. They are organized into 42 committees and 182 subcommittees, meaning that there are 224 parallel conversations going on. And this group of more than 15,000 people is not alone. Facing them are some 22,000 registered lobbyists, whose mission is (among other goals) to sit down with legislators and draft legislation.

This, together with a free press, is part of the structure that reads the millions of pages of legislation and monitors what government agencies do and do not do. It generates the information and the incentives to respond to it. It affects the allocation of budgetary resources. It is an open system in which anybody can create news or find a lobbyist to make his case, whether it is to save the whales or to eat them.

Without such a mechanism, the political system cannot provide the kind of environment that modern economies need. That is why all rich countries are democracies, and it is why some countries, like my own (Venezuela), are becoming poorer. Although some of these countries do hold elections, they tend to stumble at even the simplest of coordination problems. Lining up to vote is no guarantee that citizens will not also have to line up for toilet paper.

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    1. CommentedOta Nik

      Nice PR article, except that few (so max. 2) of the richest countries in the world are democracies.
      1. Quatar
      2. Luxembourgh
      3. Singapore
      4. Norway
      5. Honk Kong
      6. Brunei Darussalam
      7. USA
      8. United Arab Emirates
      9. Switzerland
      10. Kuwait
      OK, some are oil powers and not too big. So let's talk about the USA, as an example, when it was used in the article. A recent study have shown that the USA are not ruled by democracy but an oligarchy. It firstly. And secondly, the point is that the rich countries (governments), or that the people in those countries had well?

      And what more:

    2. CommentedSrki Ledeni

      There is no democracy as they imagine by ordinary people. There are only ideas of the elite, implementing them through "democracy" and "freedom of the press." After losing some ideas winner assuming the right to determine what is right and what is not.

    3. Commentedlt lee

      A country of X people theoretically can have X! parallel conversations at any one time. But these conversations won't accomplish anything unless the people are talking to each other and not talking pass each other with the same language. Democracy is not only people rule. It is also people rule as one. They talk with one language and toward the same goal.
      Why are rich countries democratic? Simple, all other things being equal, wealthy citizens of rich countries could afford to think for the common good more.

    4. CommentedPrasanna Srinivasan

      Given the subject you've written about there will always be several opinions that contradict! But a nicely presented viewpoint. A big glitch is when markets are colonized by players - for example, financial markets - where a few super large players affect many fundamentals though the decisions of a few. This newsletter includes an article by Mr Roubini on markets reacting to "risks" deemed superbig or disastrous a year ago. Some of these aren't really in such serious play now. These include US fiscal criris/debt default, break up of the EU, Iran and Israel at war etc. The huge fluctations in markets during these 12 months have reflected pure speculation and divorced from fundamentals. The mere existence of democracy or even laws does not imply market efficiencies or even public good. Should a central govt decide? no. Neither should a "central" financial system. The latter isn't run by governments, making them unaccountable.

    5. CommentedJuan Gabriel Gómez Albarello

      disappointing - that's how i would describe your piece. You could quote Amartya Sen and Jean Drèze's work on why democracies prevent the occurrence of famines (they did compare authoritarian China with democratic India) as part of the overall argument concerning the cognitive superiority of democracies. Yet, the way you describe how the system works in the United States makes abstraction of the way in which the communication process is systematically skewed by the interference of the industrial-military complex. What would you say in regards to how the democratic system dramatically fail to prevent such a terrible political "mistake" such as the war on Iraq? What about the Vietnam war?
      Your piece also makes abstraction of the fact that the international system is also skewed and, because of that, powerful "democratic" countries interfere in the domestic affairs of small ones. Actually, small is a poorly chosen word. Peripheral is much more precise. Brazil in 1964 was not a small country, yet a peripheral one. Do you know what happened that year? If you knew it well, perhaps you had written another kind of article.

    6. CommentedWayne Davidson

      The justification of any political system cannot be measured by it's economic success. Western representative, eastern authoritarian and your own latin american democracies are administered by a cabal of elitist minorities. The institutionalised politically corrupted economics of wealth transfer has defined these political systems. The ultimate value of any political system is the unqualified right to self determination by all citizens.

      "The Great Depression in the United States, far from being a sign of the inherent instability of the private enterprise system, is a testament to how much harm can be done by mistakes on the part of a few men when they wield vast power over the monetary system of a country."
      Capitalism and Freedom.
      Milton Friedman.

    7. CommentedEdward Ponderer

      Professor Hausmann's article is quite insightful, and the argument that is powerful. But there are two important corollaries to it.

      Firstly, it is the very correlation between national wealth and democracy, that implies that a barbell curve where the national wealth increases but that of the average citizen decreases, is moving from democracy into oligarchy--de facto if not de jure.

      Secondly, indeed since self-organization is the key to true democracy, then the formation of natural systems from bacteria megacolonies up should naturally be the role model. In all these cases, the behavior of all members is mutual responsible -- altruistic in appearance. This is the exact opposite of barbell formation just mentioned.

      In short, both true democracy and universal prosperity depend upon solid, mutually responsible interrelationship. This is, really, what defines the ultimate of the democratic ideal--a society of universal mutual guarantee and trusting collaboration with fractal organization towards ideal sense, communication, and control. That is precisely how natural systems, such as the fractal beat pattern of the heart. Self-organization is a reaction to an ensuing crisis of a community, where there is a phase change to the chaotic. One of the major breakthroughs of late 20th century nonlinear science was the realization that the map of deterministic chaos in phase space (roughly the space of position and its variation) is a "fractal orbit." It is precisely a mutually responsible, fractal interrelationship network that forms the self-organization success story of nature.

      And we best follow it, lest in the course of globalization, the complexities come to the point where sense, communication, and control slip through the hands of governing power as dissolving sand between the fingers--and we head off without wheel or compass into the ominous fog ahead...

    8. CommentedProcyon Mukherjee

      The conduct of democracy, is different from the simplistic traditions that allow universal suffrage and that is itself not a sufficient condition for an end that we are looking for, equality of opportunity and peaceful coexistence of peoples.

      Democracy, if it is vacuously represented by those ills that we want the society to be devoid of, like the preponderance of intrigue to stall lawful processes and a banal invitation concurrently to usher the unlawful to act in concert with certain constituencies for the ends that make a minuscule minority get all the dividends at the cost of the majority losing the faint hope of coming out of depravity and destitution, better be eschewed as a transgression than a formality of social cohesion for equanimity and justice.

      Democracy has a meaning only in the results, not merely in the processes.

    9. Commentedhari naidu

      If you’re proposing some sort of a hypothesis on comparative government and popular democracy, as an economist, I’d say your yardstick is rather similar to macroeconomists and their obtuse modeling system which got us into the (2008) financial meltdown and the prolonged recession world-wide.

      If rich countries are based on the function of a market economy, it appears (WTO) globalization is putting a dent into your political assumptions.

      The last thing I wish to know from economic profession is the meaning of democracy. Do you consider mainland China a (centralized) democratic social system? And, if not, why? Do you consider Indian subcontinent a democratic social system? If yes, why?

      American plutocracy is on the rise and economic inequality is becoming rampant; centerpiece of American democracy can be defined by its lack of democratic coherence and accountability.

      Rich for you in per capita terms defines a democracy. Is that a valid assumption? Or is democracy an evolutionary social process in the march of society since ancient Greece? And, btw, we really don’t know how it’s all going to end…

    10. CommentedBoon Tee

      Commendable analysis.
      Somehow one gets the impression that the content does not reflect the superfluous title "Why are rich countries democratic?".

    11. Portrait of Michael Heller

      CommentedMichael Heller

      Ricardo, thank you, this a stimulating article. It’s very welcome to see an economist starting to think about how to apply economic theory to understanding institutional or government complexity. Leaving aside the small point that the literature on the causal relationships between democracy and wealth is enormous and complex (even in a short popular oped you might have hinted to readers that drawing easy conclusions about it is risky) there are a couple of substantive problems with your analysis worth mentioning here.

      1. You are conveniently ignoring distinctions between essential natural monopoly state services and services that can and have been devolved to markets. In other words one cannot draw this simple distinction between absolutely indispensable state inputs and the inputs markets are able to provide. They lie at a constantly shifting frontier. Or rather it would be constantly shifting in evolutionary terms (that’s how society survives complexity) were it not for activist economists always trying to shift the frontier backwards in order to aggrandise the state. Adam Smith would have favoured emphasis on keeping that public-private frontier really flexible, because he understood the imperatives of adapting to complexity!

      2. You misleadingly imply Adam Smith became more leftwing as he grew older and wiser. The contrast between book 1 and book 2 is not nearly as sharp as you claim (in fact many people read the two books as complementary from different disciplinary perspectives). It is certainly true he changed his mind about which taxes were most effective (do we tax the beer, the brewing, or the malt? do we reduce tax on sugar to increase consumption and revenue?). But there’s plenty of evidence in book 2 indicating that despite the penchant of the period -- it was a long time ago! -- for tinkering at the margins in response to changing national security priorities Smith retained classical liberal laissez faire minimal state views, typically including toleration for some public works but dislike of redistributive activism.

      3. None of the above is as important as the intriguing way you treat the Smithian invisible hand, equating it simply with democracy rather than with the more integrated vision of spontaneous coordination in modern government familiar in other social sciences. The issue is too long for me to comment on here, so yesterday I wrote a piece discussing your (stimulating!) approach. My critical response can be read at Heller Economic History Entertainments.

      Best wishes,
      Heller Economic History Entertainments

    12. CommentedRamin Amini

      this is a very interesting and broad topic, no doubt political scene of countries have a highly correlated relationship with their economies. although we see examples such as Saudi Arabia, Malaysia, etc.
      the more important question to ask is how a liberal state could be reached in the first place; i.e what does guarantee an election to be democratic and not just an act of queuing for toilet papers?

    13. CommentedJohn Nick

      Air travel companies need to ensure that pilots do not endanger their market position. They could do it by financial loss through plane loss (and related). And through client loss, as fear from one company's accident records makes clients choose some alternative. The state has no need to act on this. Flight coordination (radar, satellite) is also a solution that would arise fast from transporter's needs. Security managed by private owners would be much more effective. It would be a subject of state's supervision, eventually, to avoid arbitrary action. And so on. Much of this argument is ideological at least. In fact it is more, much more. It's the state acting on resources centralization in order to make those resources available for redistribution. Redistribution from all of us to the few beneficiaries. Legitimate redistribution but also very fraudulent redistribution.

    14. CommentedVal Samonis

      I sounded alarm when former communist nations started returning to power "experienced" former communist nomenklatura in 1992. And my argument was precisely based on the need for the new roles of government in the economy; old apparatchiks only had the worst kind of "experience". Unfortunately or fortunately, people are free to vote but they are not free from the consequences of their voting.

      Val Samonis
      Vilnius University, Lithuania

    15. CommentedJose araujo

      A simple definition of economy would say that, economy is the science that studies the satisfaction of endless need through the use of limited resources. Now it’s clear for all that efficient markets are the fundamental instrument for this distribution and resource allocation what is not clear for all is what follows next.

      First, the markets need to be efficient/perfect competition, hence Smiths lowest barbarism, peace, easy taxes and justice among others, if markets are not working they may or may not be the most efficient way of resource allocation (second best principle).

      The second is that Markets are not alone in the allocation function, namely two other, at least of similar importance institutions exist on our societies - firms and bureaucracy

      Now laissez faire would be a sensible theory if markets were in perfect competition, but even then firms would have to exist, and resource allocation in firms is not efficient using markets mechanisms. So we always need some degree of centralized planning, centralized decision, hierarchies, etc, etc. Firms to be efficient cannot be chaotic and self-regulated, norms and rules must be implemented.

      On beurocracy we have the same problem. We cannot rage war under markets mechanisms, administer health, education, security, roads, etc . We can do it through firms, but if we take profit out of the equation then beurocracy is very similar to firms.

      In conclusion, not only democracies facilitate the emergence of perfect markets, but they are fundamental for firms and beurocracy to work efficiently. Check and balances mechanisms, performance appraisal, incentives, de-centralization, empowerment, participation, etc etc are most developed in democratic institutions

    16. CommentedVelko Simeonov

      This is not always the case, Singapore is no democracy if we apply our western standatrs. The most impressive exmaple for growth and wealth creation (both in individual, corporate, government terms) in the past couple of decades is China., which does not even pretend to be a democracy. Do not confuse cause with effect.

    17. CommentedGerry Hofman

      Ricardo Hausman puts an interesting case forward here, that undoubtedly has many angles. And while there are many things that can make a country rich or poor, what he seems to be mainly discussing here is the absence of presence of a smoothly functioning economy. This however, would not so much depend on the particular political organisation in a country as on the level of participation, dedication and contentment of the people in that economy. So you can have a centrally administered economy which, if it scored highly on those factors, would still have an effective economy, while a democracy that scored low would still face many challenges, and basically be a mess.
      In Europe there have been very heated discussions over why the northern countries tend to score higher on economic efficiency and the southern ones score lower. One explanation could be that in the Calvinistic north, being frugal, dependent and reliable have been considered highly virtuous qualities which are introduced to children at an early age, while in the south living abundantly and a greater life satisfaction are more highly valued. On the scale of national economies these things make a difference.
      So the functioning of a countries' economy depends on the personal application of its individual citizens, as well as their general philosophy. But when it's not in the nature of a people to be that particular, perhaps technology can provide a solution. We are now in an age where the mass collection of information about citizens movements has become routine, and we may soon reach a state where breaking this information down into comprehensive structural hierarchies will become possible. In that case some company could sell or lease your country a system that monitors the many different pathways that people are connected, to correct, by automatically contacting people directly, any obstacles or mismatches that would cause the flow of goods and services to falter. There might be a price to pay for this but it would guarantee a better quality of living, if we ever wanted to take things that far.

    18. CommentedKeshav Prasad Bhattarai

      What Hausmann said is a traditional narrative on democracy –while Mr. Hermann has noted some formidable challenges that democracies are living with. Therefore, besides what Hermann has said I would like to some more points to support the issues raised by Mr. Hermann and request Mr. Hausmann take note of the following and produce another provocative article on democracy - that tops all human achievements-

      1. According to Ian Bremmer, “United States now borrows about $4 billion per day, nearly half of that from China”.

      2. In 2007, the United States’ economy was four times bigger than that of China, but in 2013, the gap is less than double. Today China is the world’s largest lender and the US - the largest borrower. The US debt has reached to the size of its economy.

      When President Obama resumed office in 2009, its debt was some $9 trillion, but by the end of his first term, it had reached $15 trillion. By now, it is more than $ 17 trillion. A Federal Reserve data has admitted that the current economic recovery is the slowest since World War II.

      China ‘s foreign exchange reserve is amounting some $3.8 trillion – bigger than the economy of Europe’s first and the world’s fourth largest economy – Germany.

      3. China Development Bank and China Export-Import Bank offered loans of at least $110 billion to other developing country governments and companies in 2009 and 2010, while during the same period the loan commitments made by the World Bank was just some $100.3 billion.
      4. Democracy to the size of a country like India and its complexities - is not more than a political miracle. The impressive economic achievement in its account is similarly astounding and exciting. However, when compared to China it has fared worst, although India’s geo-political location gives it far more strategic and economic advantage than China.
      In economic and quality of life indicators, there is no match between India and China. By 2015, for example, China is going to eradicate extreme poverty from its territory, while India may take at least another 15 years for this.
      5. Humphrey Hawksley – a leading BBC foreign policy correspondent and author, states that the development achievement of India “is at least a generation behind that of non democratic China, a neighboring country of comparable size and population.” Hawksley also reminds us that China began its modern journey two years later than India. The size of Chinese economy is nearly five times bigger than that of India.
      6. In 2004, while one in five members of Indian parliament had criminal cases pending in the courts, but in 2009, about one third of them had such charges. If put into number 128 of the 545 members of India’s 14th parliament ,but in an election held five years later it reached 162. The greatest irony of Indian democracy in the words of former Chief Election Commissioner of India S.Y Quraishi, as quoted in the Washington Post is that – Those with criminal charges “are popular with voters”. Quraishi added, “I call it the Robin Hood syndrome. They take care to use their corrupt money, money that they get through illegal means, to give to the poor.”
      7. Surprisingly, corruption is not limited to developing countries; On the beginning of last month, while introducing the – EU anti Corruption Report, Cecilia Malmstrom, the European commissioner for the home affairs admitted that corruption has hurt the European economy, “undermines citizens’ confidence in democratic institutions and the rule of law”.
      Malmstrom further presenting the most conservative estimate claimed that the corruption annually costs Europe roughly some $162 billion. The majority of European believes that corruption has increased in their countries, Malmstrom admitted.
      Lastly, as Mr. Hermann has also admitted powerful interest groups prevail in World’s most powerful country – and the most powerful democracy at the cost of common people.

        CommentedJan Smith

        Some excellent points here.

        Smith was a simpleton, and so was Hobbes. (Which is to say, the American libertarians are simpletons and so were the Soviet communists.) The question is not centralization vs decentralization but which decisions should be centralized and which ones decentralized, in which circumstances.

        To all appearances, given the USA's exploding private and public debt, and of course its current-account deficits, one must conclude that the USA is no longer asking these very difficult questions or seeking answers in an empirical, critical, and trial-and-error way. In this critically important respect, as far as I can see, China already is way ahead of the USA.

        Libertarian ideologues insist that China's centralized vested interests will never allow enough decentralization. But one might argue that the USA's decentralized vested interests will never allow enough centralization. The proof is in the results. Which economy is thriving and which one stumbling, according to the historical record of the past thirty years?

    19. CommentedZsolt Hermann

      I was a bit surprised by the title.
      It raised the questions of how can we define "rich" and "democratic"?
      In terms of "rich" I think we could assess many Middle Eastern countries as rich, wealthy without any classical democratic systems, in terms of national debt, natural resource availability, even military power we could name China, Russia "rich", even "richer" than the US for example, not to mention in terms of the fast changing global influence.
      In terms of democracy I am not sure I would call the US or even most of Europe democratic in "classical" terms, at the last US elections we could follow day to day how much the American Presidency cost, how much the President and his administration has absolutely no freedom to act, but are pulled on strings by influential lobby groups constantly. The character of Brad Pitt put it interestingly at the end of the film "Killing Them Softly", describing the US not as a country, but as a business.
      In Europe after "democratic" national elections the countries are mainly controlled these days by EU technocrats, dictated by a few more powerful countries. Even in the UK the elections are only a showcase for the self-serving political parties, and in between elections they primarily prepare for the next election campaign.
      Most importantly especially since the 2008 crash it has become very obvious both in the US and in Europe that governance, leadership is only concerned about the markets and its serving financial system, all the "solutions", "bailouts" were solely to allow continuing liquidity without any consideration to the public, whose life is steadily worsening.
      And it has become clear all this has no direct relation to the actual governing structure, the riots, uprising happening in Venezuela right now, or what happened in the Ukraine, might be springing up in Spain or Italy very soon, or even in the "richer" and "more democratic" so called developed countries.
      We entered into a dark and dangerous vacuum, where all our previous achievements, including freedom and democracy are only spoken but not practiced.
      And we have no choice in bringing those ideas back into practice until we correct the root cause for the failure: our inherently self-serving and egoistic human nature.
      We need first of all a brand new and appropriate education system for all, to provide a positive motivation without coercion and trickery, explaining to each and every one of us that in a global and fully interdependent human system we can only survive by mutual responsibility, mutually complementing cooperation instead of competition and exploitation.
      Venezuela is not alone. We are all sitting on the same boat.

    20. Portrait of Ricardo Hausmann

      CommentedRicardo Hausmann

      Hi Heiner: It is true that China is not a formal democracy and people's rights get often trampled. However, it would be important to describe what are the channels through which information about the the public policy needs of a highly diversified economy are channeled and addressed by the state. That is a description I wish I had.

    21. CommentedHeiner Hartmann

      "Lining up to vote is no guarantee that citizens will not also have to line up for toilet paper." A free press and organization at the local level are important for bottom-up feedback. Very well put, though i miss the press reports about "Hola presidente" with Hugo Chavez, for people not living in Venezuela that was entertainment.

      Altough there is one counter narrative on which the "vote" is still out: China.