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Monday, February 28, 2011

Kaddafi and His Ilk Are Not Crazy: Are Dictators Predictable?

As Kaddafi machine guns demonstrators, we are told these are acts of an insane man. We must be careful what we say or do because the criminally insane are erratic and unpredictable. Using such logic, the U.S. was among the last to call for his ouster. Examples of insanity are his public rants, the ordering of the bombing of Pan Am 103 (for which he thought he would never be caught), the ludicrous philosophizing in his Green book, the pitching of his tent in New Jersey, and his refusal to ride elevators. Other dictators are pictured in the same way: Iran’s ruling mullahs are religious fanatics; Stalin was a psychotic paranoid.

Insanity is the easiest explanation of dictatorial atrocities for Western minds to fathom. That “criminally insane” dictators follow a common pattern, transcending time and place, argues however that they share a common goal and use the same instruments and practices to achieve it. Just as we can explain business behavior through the profit motive, so can we understand and even predict dictatorial behavior by analyzing how they generate and use political power. If their actions consistently promote the paramount goal of power, their actions are completely “rational,” no matter how morally repugnant or obscene. Rational behavior can be analyzed; insane behavior cannot.

None of these dictators was offered power on a silver platter. They “had to earn it” as a famous brokerage house commercial used to say. Kaddafi gained power as a young military officer by skillfully outmaneuvering rivals and manipulating one tribe against another. Iran’s ruling mullahs won a fierce and bloody power struggle in which a large number of the ruling elite were assassinated. Stalin was the victor in one of the bloodiest succession struggles in history against better know and seemingly superior rivals. Kaddafi, Iran’s ruling mullahs, and Stalin won because they were better at accumulating and using power than their rivals. These were not accidental victories. They held on to power by skillfully playing one rival against the other and using ideology, propaganda, patronage, and religion to their advantage.

There is a growing theoretical literature that provides systematic insights into the behavior of dictators. It assumes, quite unobjectionably, that dictators aim to accumulate sufficient political power to hold on to power. They “produce” power by combining loyalty and repression (the carrot and the stick). They keep the secret police or army in check by appointing relatives or incriminated associates as its head and by removing intermediate links between operatives and the dictator. Some results are non-intuitive, such as the greater stability of dictatorships (due to the incumbent’s immense advantages) and the fact that a rational dictator will kill innocent people (a practice often used as proof of insanity).

Democratic rulers must offer platforms that please the median voter, thus the scramble to the middle in elections. Dictators can offer their platform and then “eliminate” (by jail, execution, disenfranchisement, or exile) those who disagree with it.

Public demonstrations reflect general disaffection with the dictator’s “platform.” The dictator can respond by “reforms” that move his platform closer to the public’s, by ramping up repression, or by a combination of the two. In general, public demonstrations threaten to weaken the dictator’s power below the threshold necessary to stay in power. The dictator must do something to prevent this from happening.

The response of “constrained” (Mubarak) and “unconstrained” (Iran and Kaddafi) rulers has been strikingly different in the Middle East. The former have unsuccessfully used limited repression, concessions and material rewards in a vain effort to boost their political power. The morally-unconstrained have used as much repression as necessary while offering targeted material incentives (such as increased army pay and according to recent reports handing out cash). This strategy will likely work in Iran but fail in Libya.

For unconstrained dictators such as Kaddafi, there are eventually diminishing returns to repression. At some point, more and more segments of the population understand that they themselves are at risk and withdraw their loyalty. As the loyalty of the neutral or even loyal population collapses, the regime falls below the threshold necessary to stay in power and the dictator is overthrown. This is Kaddafi’s likely impending fate.

Notes: Research conducted in the Hoover Institution Soviet State and Party Archives over the past decade has aimed at applying the theory of dictatorship to the Stalin period. For those interested in our results, see: Paul Gregory, Terror by Quota (Yale –Hoover, 2009), Paul Gregory and Norman Naimark (eds.), The Lost Politburo Transcripts (Yale-Hoover, 2008), Paul Gregory and Valery Lazarev eds., The Economics of Forced Labor: The Soviet Gulag (Hoover, 2003); and Eugenia Belova and Valery Lazarev, Funding Loyalty (Yale-Hoover, forthcoming). The theory of dictatorship has been developed, among others, by Ronald Wintrobe, Bruce Bueno de la Mesquita, James Robinson and Daron Ademoglu.

Saturday, February 26, 2011

Can We Stop the March To Fifty Percent? Facts on Why the Tea Party Is Right to be Alarmed

The European welfare state is a boogeyman for conservatives and a panacea for the left. It is defined differently by different people, but it has distinctive features on which most agree:

1) The state’s share of the economy (as captured by spending) is fifty percent or above,
2) The major portion of this spending is for welfare programs,
3) Regulation of the labor market is pervasive, and
4) The welfare state is largely paid for by taxes on labor.

Public spending in France, Italy and Sweden is in the mid fifties and half or more of that spending is for social welfare. The traditionally frugal Germany is currently at a “modest” 48 percent of GDP. Payroll taxes as a percent of labor costs are 39 percent in France, 33 percent in Germany and 31 percent in Italy. In these countries, unemployment benefits are an entitlement for the long-term unemployed, health care is paid for out of payroll taxes but is an entitlement for those not working, and there are extensive protections against firings and layoffs.

The European welfare states rank among the world’s richest. They are rich because of past economic growth. For the past three decades, they have been among the slowest growing nations of the world, and their populations are shrinking.

Using these measures, how far away is the United States from the European welfare state?

Our government share of spending (federal, state and local) last year was above 41 percent. Of this 40 percent was for social welfare spending. Payroll taxes were 14 percent of labor costs. Most health care costs are paid for by insurance at the place of work, but the non employed are not covered by insurance unless they are retired or poor. President Obama’s health care reform is supposed to change this latter feature. The unemployed are offered unemployment insurance whose duration is limited but which tends to be extended during periods of high unemployment.

The U.S. would therefore share the characteristics of the European welfare states if the current government share of GDP were to rise another ten points, if the share of social welfare spending of total spending would also rise another ten points, if social security taxes were to more than double, if our labor market were as strictly regulated as Europe's, and if unemployment insurance became an entitlement.

What are the chances of these things happening?

Of this list, the doubling of social security taxes appears the most unlikely given our political aversion to social security reform. However, credible economists have warned for more than two decades that substantial increases in payroll taxes must inevitably come about given the Ponzi-scheme nature of our social security system. If and when this happens, U.S. workers will suffer along with their European counterparts the competitive disadvantages of bloated labor costs in a world of cut throat competition.

The conversion of the U.S. into a European-style labor market with highly-restrictive firing restrictions, shop-floor worker rights, month-long mandated vacations, and short work weeks is also unlikely. In Europe, such labor market protections have a long history, going back to Bismarck’s Germany, to Europe’s codetermination laws, and to organized labor as a quasi political party. Another peculiarly U.S. factor that makes the Europeanization of our labor market unlikely is the declining labor-market share of labor unions, which are now largely restricted to public employees.

The conversion of unemployment insurance into an entitlement is more likely, especially as long-term unemployment rises to European rates. The entitlement nature of unemployment insurance may never be recognized in legislation, but legislators will lack the political will to cut off benefits for the chronically unemployed. By lowering the personal cost of long term unemployment, the U.S. unemployment rate will rise, hopefully not to European levels.

If we look at the history of government spending as a share of the economy over the past forty years, we see an increase from one third or below in the 1970s to the mid to upper 30s after 1980. We had only one noticeable decline in the government’s share (during Clinton’s second term with a Republican congress). Public social spending rose between 1980 and the present at a similar rate (from 13 to 16 percent).

The government share of spending is a race between the growth of government spending and of nominal GDP. Just to keep the government share from rising, nominal GDP must rise at the same rate as government spending. The growth of nominal GDP equals the inflation rate plus real GDP growth.

In this race, it is difficult to stay even. Over the past half century, government spending has risen, on average, 7.5 percent per year. Were it not for the incredibly slow government growth of the period 1990-2000, the growth of government would have been more than eight percent per annum. Political economists have devoted considerable research to explaining this inexorable growth of government spending, and past history says it can be reduced only during exceptional circumstances. Just to keep the government share constant with such growth of government (assuming a two percent inflation rate), the real growth of the economy has to be a remarkable five and a half percent per year! Such growth is highly unlikely to say the least. Even with a three percent inflation, we would still have to have a sensational 4.5 percent real GDP growth!

Thus, we either have to reduce the growth of government spending or face continuing increases in the share of government.

The Congressional Budget Office’s projections do not inspire confidence. They project a miserly three percent growth of nominal federal government spending over the next five years, with a projected decline (!) in 2012. Under this rosy scenario, the federal government’s share of GDP will decline from 24.2 to 22.3 percent between today and 2015.

In government spending, the past is usually a better guide than rosy projections of austerity, especially during a period when a vast new entitlement program is being put in place.

If we replace the CBO’s unrealistic projections with the rates of past history (and use their own projections for nominal GDP), we get the alarming result that the federal government expenditure share of GDP alone will rise by 2020 from the current 24.5 to 32 percent – an almost eight point increase. With this accomplishment, the US by 2020 would almost reach the spending levels of the European welfare states, even if state and local level spending does not increase its share of GDP.

As measured by spending, the United States will be a European-style welfare state without a historic permanent shift against spending growth. We will be a European welfare state, however, without its funding base of payroll taxes more than double our current levels. The only option will be to seek new funding sources, such as a national value added tax.

These figures sound the alarm for those who do not want the United States to become a European welfare state. They explain why we have a Tea Party movement, whose motto is “it’s the spending stupid” and the vociferous opposition to the new health-care entitlement. It also shows the crucial role of the Republican house freshmen in holding the line on spending. These figures show that we are at a turning point at which those who wish for a European welfare state for the United States see it in sight within a relatively few years.

Most of our attention has been focused on the deficit, and rightly so. However, it would be a mistake to overlook the effects of the spending component of the deficit on the way our economy is organized and functions.

Data sources: The data used in this report are from the OECD Factbook 2010, The Economic Report of the President, and the CBO’s Baseline Budget Outlook.

Tuesday, February 22, 2011

The Good News That No One Is Telling About Iraq

A map of the Middle East shows two countries untouched by uprisings against the established regime: Israel and Iraq. (another exception is Turkey, an Islamic country but not in the Middle East). Israel is no surprise. It is a democracy. If its citizens are upset with the government, they devote their energy to the political process. The fact that Iraq has been spared a general popular uprising is proof that it has arrived as a democracy. I have heard no reports of Iraqi authorities mustering troops and riot police to quell a general uprising.

Despite the huge imperfections of Iraqi democracy, Iraqis understand that they must channel their discontent into supporting political figures and parties that they feel represent their interests. They understand that they must resolve their grievances through the political process, not through revolution.

There is another untold story about Iraq. Studies of newly formed democracies (primarily in areas that were once part of the Soviet empire) reveal that true democracies have been created only in those nations that did not allow the former bureaucracy and party elite to continue their jobs. Only after a lustrification (Latin originally meaning religious purification) were they allowed to reenter the mainstream and hold public office. In countries where lustrification did not occur, the old elite became the new elite and prevented a democracy from being created.

In the light of this history, the much-criticized decision to cleanse the state and military of Baath party elite was correct.

Quite often obvious things like this escape notice. I think that silence on this story goes beyond the practice of not reporting what is going right. In the case of Iraq, there has been a great reluctance on the part of the democratic party and the press to accept positive news about Iraq. We must also accept the fact that democracies, both old and new, are messy and often chaotic. It is only in times like these, when we clearly see the consequences of authoritarianism and dictatorship and the peoples’ hatred of them, that we can see democracy’s advantages in proper perspective.

Sunday, February 20, 2011

Hayek’s Gloomy Prognosis for Egypt

F.A. Hayek’s most important insight is that we cannot have political freedom without economic freedom. Hayek’s inexorable Road to Serfdom, from which it is difficult if not impossible to return, describes a number of today’s troubled countries, and it likely portends the future of post-Mubarak Egypt. Those caught up in the euphoria of democratic street demonstrations must confront the reality that the long-run outcome is likely to be bad.

Take Russia and Iran as possible role models for Egypt. Despite their huge differences (a KGB state versus an Islamic theocracy), they share a common and sinister pattern: A revolution occurs (the collapse of the Soviet Union, the Iranian revolution); a nominal democracy is established; the democracy is hijacked by the ruling elite; the ruling elite (Kremlin-favored oligarchs, the Revolutionary Guard) gains control of the commanding heights of the economy; the ruling elite viciously blocks democracy and liberalization as mortal threats to their vested interests. Anyone who stands in their way is dealt with harshly as corrupt or traitorous.

Egypt is poised to follow this same path. Its private economy is weak. Some thirty five percent of Egyptians work for the state. Ninety percent of cotton spinning and sixty percent of fabric manufacture is in the hands of the state. The poor Egyptian public receives its food through state ration coupons as it did 3,000 years ago. Only ten percent of property rights are secure.

Egypt is currently a democracy in name only; the goal of its idealistic young “tweeter-generation” demonstrators is to make it a real democracy with real elections. Egypt has thrown out Mubarak and will surely punish the corruption of Mubarak, his family, and associates. The country is ruled by the military, who will oversee the transition to something that will be called “democracy” no matter what the outcome.

Herein lies the rub: Egypt’s commanding heights were under the shared control of Mubarak and associates and the military. His removal places a vast amount of Egyptian wealth up for grabs. Mubarak’s share may go to “society” or it may be gobbled up by the military, giving the military even more incentive to avoid the voter scrutiny and transparency of true democracy.

The truth of Egypt’s military’s economic clout is just coming out: The ruling military council is a strong advocate of state controls and a staunch opponent of economic liberalization. The military owns day care centers and beach resorts, makes television sets, jeeps, washing machines, furniture, olive oil and bottled water. Estimates of the military’s share of economic output range from ten to thirty percent. It enjoys huge advantages over private enterprises. Military enterprises pay no taxes, use conscripted soldiers, buy public land on favorable terms and have no obligation to disclose their activities to the Parliament or the public.

As in Putin’s Russia and the Mullah’s Iran, the Egyptian military can eliminate opponents through charges of corruption, collaboration, or other misdeeds. Threat alone will be enough to silence most advocates of reform and change. As in Russia, liberalization can be discredited by associating marketization and privatization with chaos and corruption.

Real revolutions always redistribute society’s wealth. This is why entrenched elites resist change and protect their vested interests. The Bolshevik revolution redistributed wealth from the nobility and landlords to what Lenin and Stalin called “the worker state.” The Putin revolution redistributed Russian wealth from one group of oligarchs to another. The Iranian revolution redistributed wealth from the Shah and associated businesses to the Mullahs and Revolutionary Guard. In a real Egyptian democratic revolution, the military would lose its wealth – either to a true democracy or to a triumphant Muslim Brotherhood, and it understands this fact clearly.

Among the first moves of the military government was to charge with corruption or force from their jobs businessmen and public officials favoring opening the economy and liberalization. The military is satisfied with the status quo of its monopolies, economic privilege, and insecure private property rights.

The Hayek model points to the incredible obstacles facing the true Egyptian democrats. The military “fox” is “guarding the hen house.” The young democrats must somehow figure a way to persuade the military to sacrifice its own economic interests and to do the “right thing” for the country. Judging from past history, their chances of doing so are remote.

Friday, February 18, 2011

Truths of Putin’s Justice: A Courageous Women, the Internet, and More on Khodorkovsky

A bare conference room in a Moscow office building. A strikingly beautiful woman in her early 30s, dressed immaculately in black and white, is interviewed by a young man and woman clad in jeans and pullover sweaters. She is nervous but composed and answers their questions in a subdued but steady voice.

This is the world of Russian internet TV. As in many other places, internet TV is a last outlet where the networks are controlled by “higher authorities.” Such an interview would be too hot to handle elsewhere.

The interviewee, Natalya Vasilyeva, knows the personal consequences of this interview: firing or worse and a tough life to follow. As the press secretary for the Khamovnichesky district court of Moscow, she is an insider witness to the months’ long trial of Mikhail Khodorkovsky, whom her boss, Judge Viktor Danilkin, sentenced on December 27 to an additional seven years in jail.

Vasilyeva puts a face on a distorted justice system, which “all participants understand but no one is willing to say anything.” In political cases, such as Khodorkovsky’s, the verdicts are “ordered” from above. If any cog in this “justice” machine refuses to play their role, the best that can happen to them is that they lose their jobs. They are warned “to think about their careers and children.” When prodded to explain what is meant by “consider their children,” Vasilyeva answers that “it is up to the individual to interpret what that means.”

As the person responsible for briefing the press on the Khodorkovsky case, Vasilyeva is a frequent visitor in the judge’s chambers. She paints a sympathetic picture of Danilkin: “I must say that the whole judicial community knows that this is an ‘ordered’ case. They all sympathize and understand him, but no one can say how he can emerge from this situation as an honorable man.”

Throughout the trial, Danilkin reports regularly to his superiors in the Moscow central office. If the matter cannot be clarified by phone, he is called in. As the case proceeds, he is increasingly agitated, nervous, and depressed. In his office for instructions, the exasperated Danilkin tells her: “I can’t answer your questions. I don’t know where I’ll be tomorrow or what will happen to me.” Danilkin’s agitation rises as the sentencing approaches: “Do what you want. I don’t care anymore.” She enters his office on the third day of the reading of the sentence to find an ill Danilkin taking medicine for his heart. He assures the alarmed Vasilyeva: “I am Ok now.”

The heart of Vasilyeva’s testimony is that the sentence was not the judge’s: “Danilkin had no relationship to the verdict.” In fact, her boss’s superiors get upset that he begins writing the verdict on his own. On Saturday December 25, Danilkin is called to the Moscow central office to meet with “an important person.” Shortly thereafter “Danilkin’s” verdict is sent over. Parts of it arrive only during the actual reading of the verdict. Normal practice for the Khamovnichesky court is for the judge to write the verdict; formatting and spelling are then checked in house by court secretaries. In this case, the secretaries make the technical corrections on electronic files received from the central office.

The young interviewers close by asking Vasilyeva whether she understands the consequences. Answer: “I will be fired.” They warn that she will be accused of lying for sinister reasons. Her answer: “I am speaking out because I am disappointed. I wanted to become a judge, but, when I saw the internal working of the law, I understood it is a fairy tale that the judge carries out the law independently. The law itself has been transformed into a fairy tale. It is a fairy tale that the judge is subordinated to the law. Instead, the judge is subordinated to higher authorities.”

Natalya Vasilyeva’s brave actions will likely not change anything. She has been fired. Her former boss, Danilkin, has threatened her with a lawsuit for defamation. But sometimes courageous actions by one small person can have unanticipated consequences. People become fed up and speak out. Other regular people – all women -- are following her lead. One Svetlana Dobronravova reported to the limited-circulation “Metro Gazette” that, on the trial’s last day, she heard the following telephone conversation of the female prosecutor: “The lawyers are getting their honorariums, we have done in Khodorkovsky, but the verdict is not ready. They have not sent it over from the Moscow office.” She says she is ready to testify in court. Journalist, Vera Chelishcheva, wrote on a blog: “I can confirm what Natalya Vasilyeva has said. We all heard Danilkin shouting in his chambers at the prosecutors so loud that it could be heard at times in the courtroom.”

At a much higher level, the Khodorkovsky verdict is having uncomfortable ramifications. President Medvedev’s entourage to Davos admitted that the Khodorkovsky verdict discourages foreign investment, but Medvedev has taken no action even though he has the power to pardon Khodorkovsky. We can understand Medvedev’s reluctance to tangle with his “boss” Vladimir Putin. Putin’s answer to queries about Khodorkovsky leaves no doubt where he stands: “Thieves should sit in jail.”

For those wishing to see the Vasilyev interview, see: http://www.newsru.com/russia/14feb2011/hodorkovsky.html

Wednesday, February 16, 2011

The Khodorkovsky Trial, a Courageous Woman, and the Smoking Gun

Every now and then, acts of courage by ordinary citizens have big consequences. I still recall vividly (after twenty five years), the courageous women who demonstratively refused to count ballots stuffed for Fernando Marcos. The Marcos regime fell shortly thereafter.

A similar act of courage by Natalya Vasilyeva, the assistant to the presiding judge in the Khodorkovsky case, confirms that the verdict was dictated by higher ups in the Kremlin. Outside observers understood that the trumped up charges against Khodorkovsky were part and parcel of Putin’s vendetta against a potential political rival. We also knew this was a case of “telephone justice” where the presiding judge was given his verdict by superiors. But rarely do we have confirmation of such goings on from actual participants. To reveal such things is dangerous to say the least.

According to Vasilyeva’s understated statement to the online newspaper Gazaeta.ru, the judge “had to communicate with the Moscow City Court on all sorts of controversial issues that came up during the trial…. He had to provide information to the Moscow City Court and…. received from there instructions about how to behave.” Further, she stated that the judge “began to write the sentence…. I suspect that the higher authorities did not like something in it. And in connection with this, he received a new sentence, which he had to hand down.”

The judge denied Vasilyeva’s comments and threatened her with a lawsuit. The same day, a court spokesperson reported that the Ms. Vasilyeva had resigned.

I doubt that Ms. Vasilyeva’s courageous act will have the same consequences as the Philippine ballot counters, but we should give her the attention, coverage, and respect that she is due.

The New York Times is to be commended for its excellent coverage.

Tuesday, February 15, 2011

Straight Talk: Why Would a Dictator “Reform?”

Dictators in the Middle East are advised by Western politicians that they should introduce democratic reforms if they want to stay in office. This might work for the most moderate of rulers, such as in Jordan. It worked in Spain and Portugal, but only after the death or incapacitation of the dictator made a smooth transition possible. For other dictators, there is no way to split the difference between a dictatorship and a democracy. No brutal dictator can navigate the fine line between meaningful reform and remaining in office. True reform requires transferring or sharing power with others. Once your democratic partners have some degree of power, they will make sure that you will be out of office. Pinochet tried to protect himself by parliamentary immunity and spent the final years of his life fighting off criminal charges. The “power sharing arrangements” in Iran and Zimbabwe have been shams in which the democratically elected partner (Khatami and Tsvangirai) is rendered powerless by the Mullahs or Mugabe.

Any brutal dictator who allows a meaningful reform is, in effect, committing political suicide. There was no chance for a Mubarak to continue in office in a “reformed” Egypt. Under the best of circumstances, he could have been a transitory figure head. At the worst, he would have been put before a firing squad like Ceausescu. Mubarak had no way of winning once the democratic genie was let out of the bottle. It was in his interest to keep the genie firmly locked in the bottle.

The current reform advice to dictators reminds me of earlier advice to Soviet rulers to allow meaningful reform of their political-economic system. The aging Soviet leaders after Stalin were not particularly bright, but they understood one basic fact: Real reform meant the end of the system as they knew it. It was not until Gorbachev – the first Soviet leader too young to be part of Stalin’s coterie – that the USSR was led by a communist party leader who did not understand that real reform would destroy the pillars of the entire system, which it did.

I presume that brutal dictators throughout the Mid East -- Kaddafi, Assad, the Iranian mullahs -- understand better than Gorbachev that meaningful reform means the end of their careers. Our pleas for them to become “democrats” will go unheeded. From their perspective, this is very bad advice.

Sunday, February 13, 2011

Kleptocrats, Oligarchs, and Billionaire Entrepreneurs (In this Game Mubarak Is a Piker)

Kleptocrats, Oligarchs, and Billionaire Entrepreneurs (In this Game Mubarak Is a Piker)

Personal wealth is created in one of two ways. On the positive side, it arises as a result of innovation, hard work, brilliant insights, or even luck. Entrepreneurs create enormous wealth when they have a better idea (Henry Ford’s assembly line), discover and develop new products (Microsoft Windows or Google’s search engine), see a new business model (Sam Walton), or are simply at the right place at the right time. Often, it is a combination of innovation and timing, something economists call network externalities.

A second and negative route to personal wealth is through political connections, lobbying to obtain benefits from the state, violence to remove competitors, or outright theft of public resources. Those who earn their fortunes the first way create jobs, raise productivity, and contribute to economic welfare. Those who use the second route are “rent seekers” who subtract from growth and welfare for their own benefit.

Bill Gates, Sam Walton, and Sergei Brin represent wealth earned through entrepreneurship. Their Microsoft, Walmart, and Google made them not only among the richest persons in the world. They have created new technologies, hundreds of thousands of jobs, new business models, and have revolutionized they way we gather and process information. Carlos Slim, the world’s wealthiest man, made his fortune by monopolizing Mexico’s telecommunications market (presumably with help from government regulators). Poor Mexicans have been denied the wide range of choice of telephone services that others have and pay for his wealth in the form of the highest telephone rates on the continent.

The most egregious rent seeking occurs in autocratic and dictatorial regimes in which wealth accumulation is not constrained by an electorate, corporate transparency, or a free press. Such authoritarian regimes breed kleptocrats –those who accumulate wealth for themselves through their official positions. Oligarchs are those who use their access to those in power to accumulate wealth. Both kleptocrats and oligarchs transfer assets from society or from others to themselves; they do not create new products or additional jobs. They reduce economic welfare by crowding out real entrepreneurs, who refrain from economic activity knowing the fruits of their labor will be stolen. Kleptocracy and oligarchy are determined by the quality of society’s institutions and rule of law. The better the institutions, the more limited kleptocracy and oligarchy.

I present here some data on the world’s kleptocrats, oligarchs, and top entrepreneurs. The wealth of kleptocrats cannot be measured with any degree of precision because, as heads of state or government officials, they wish to conceal it. However, the figures capture rough orders of magnitude. Oligarchs, not being government heads or officials, are less prone to conceal their wealth. They may even feel a sense of pride when they see their names listed in Forbes.

I begin with a ranking of kleptocrat heads of state by absolute wealth. (I convert the wealth of past kleptocrats into current dollars). Four of the top six rule (or ruled) countries with rich natural resources (Putin, Nazarbaev, Aliev, Mobutu), such as energy or diamonds. The real “oil curse” is therefore the tendency of the rulers of mineral-rich countries to steal the national wealth. Other kleptocrats controlled poor countries lacking access to rich natural resources. The recently deposed Mubarak (whose personal wealth is listed at the maximum estimate) is in the middle range of notable kleptocrats. Of the eleven countries represented, four (Philippines, Indonesia, Nicaragua, and Peru) have subsequently democratized, although Nicaragua’s democracy may be shaky. Democracy strikes at the root causes of kleptocracy by making the rulers accountable to an electorate and investigative journalists.

Ruler(ranked top to bottom)Year  Wealth (bl. 2010 $)
Putin (Russia)2011  40
Suharto (Indonesia)1998   25
Nazarbaev Kazakhstan)2011  20
Marcos (Philippines)1986  7.5
Aliev (Azerbaijan)2011  10
Mobutu (Congo, Zaire)1997  5
Mubarak (Egypt)2011  5
Abacha (Nigeria)1998  3.5
Milosevich (Serbia)2000  1
Duvalier (Haiti)1986  0.55
Fujimori (Peru)2000  0.6
Alemain (Nicaragua)2002  0.1
Estrada (Philippines)2001  0.08

Heads of state who steal from less populous countries (Serbia, Haiti, and Nicaragua) accumulate less wealth ceteris paribus than those in populous economies (Russia, Indonesia and Nigeria). The grazing ground for kleptocrats is less spacious in poor countries than in rich countries. The percentage of the kleptocrat’s wealth to GDP is a measure of the kleptocrat-head-of-state’s s burden on society. This table shows that Mobutu, at the end of his reign in Congo, had accumulated wealth equal to more than forty percent of the nation’s meager output. Duvalier had accumulated an estimated ten percent – a figure comparable to the Central Asian oil magnates of Kazakhstan and Azerbaijan. Marcos and Suharto are in the three to four percent range, whereas Putin and Milosevic are in the one to two percent range.

Ranked top to bottomYear  Percent of GDP
Mobutu (Congo, Zaire)1997  0.4202
Aliev (Azerbaijan)2011  0.1111
Nazarbaev (Kazakhstan)2011  0.1036
Duvalier (Haiti)1986  0.1000
Marcos (Philippines)1986  0.0429
Suharto (Indonesia)1998  0.0331
Putin (Russia)2011  0.0180
Milosevich (Serbia)2000  0.0165
Abacha (Nigeria)1998  0.0127
Mubarak (Egypt)2011  0.0100
Alemain (Nicaragua)2002   0.0073
Fujimori (Peru)2000  0.0029
Estrada (Philippines)2001  0.0003

It should be noted that these figures show the economic burden imposed only by the head of state. Heads of state have their courts, which share in the plunder of resources. The court’s assets are not calculable, but we imagine that, if they could be included as well, the kleptocratic burden would be multiplied many times over.

The next table shows the cumulated wealth of the ten wealthiest persons in industrialized democracies (the United States, the European Union, and South Korea), in two former Soviet states (Russia and Ukraine), Mexico and in China. These figures omit the wealth of the head of state.

The table shows that the top ten have more wealth in the large and wealthy United States and European Union (between 170 and 270 billion). Relatively poor Mexico and Russia both have nearly one hundred billion. (There are as many billionaires listed for “poor” Russia as for the “rich” United States – a remarkable testimony to rent seeking in Putin’s Russia.) The top ten in South Korea and Ukraine have the same amount of wealth even though South Korea is five times richer. China lies between Mexico and Ukraine although it has the world’s second largest economy.

Ranked top to bottom  Wealth of Top 10 (bln $)
US  264.8
EU (without UK)  171.5
Russia  97.0
Mexico  90.3
China  42.3
South Korea  21.4
Ukraine  17.7

The US top 10 list is comprised largely of entrepreneurs whose ideas and business methods changed whole industries (Gates, Buffet, Walton, and Brin). The Russian top 10 list is made up of Kremlin-favored oligarchs who were awarded extremely valuable assets that had previously belonged to the state. The South Korean list is populated by industrialists who formed conglomerate businesses that compete in world markets, while the Ukrainian list is made up of those who received valuable state assets during privatization. China’s list is of industrialist owners of successful Chinese companies (most partially owned with the state), who could not have been successful without the support of the Chinese state.

The next table shows the wealth of the top ten as a percent of GDP. In those countries (US, EU, South Korea) where the top wealth holders play primarily entrepreneurial roles, their share is between one and two percent. Viewed in the light of their contribution to the economy, their wealth reward seems rather modest. In Ukraine and Russia, the share of GDP of the top ten is between four and six percent – a rather substantial return to those making a negative or questionable contributions to output and welfare. The high Mexican share is due to the “Carlos Slim Effect.” He alone accounts for most of the high Mexican figure.

Top 10 Persons  Wealth of top 10 as percent of GDP
Ukraine  0.0586
Mexico  0.0583
Russia  0.0437
US  0.0184
South Korea  0.0147
EU (without UK)  0.0113
China  0.0042

China is an outlier. The wealth of its richest persons is small relative to the size of the Chinese economy. What this suggests is that there are forces at play, other than the usual constraints imposed by democracy and a free press, that have limited rapacious rent seeking on the part of connected Chinese businessmen . At this juncture, we do not know enough about the internal workings of large Chinese businesses to define the entrepreneurial roles played by their chief executives. These constraints on rent seeking in China may be one of the many (still unexplored) reasons for China’s rapid growth.

The basic message of this analysis is that, in countries with good institutions, generous wealth accumulation is a reward for positive contributions to the economy. These are rewards for innovation, radically new ideas, persistence, and risk taking. In societies with good institutions, the rewards are relatively modest as a percent of total economic activity. These rewards are constrained by competition, social morays, and the rule of law. In countries with poor institution, wealth is accumulated either by the head of state or by oligarch cronies by transferring assets from others or from society itself. Such transfers not only do not increase national wealth; they reduce it insofar as real entrepreneurs cannot prosper in such an environment.

We are often reminded of the greed of those at the top. Little attention is devoted to the contributions of those entrepreneurs whose ideas and methods have contributed to economic growth. Walmart, Microsoft and Google currently employ 2.1 million, 93,000, and 22,000 respectively. The indirect employment they create through suppliers, vendors and other stakeholders is a multiple of these figures. Their annual payrolls equal a large fraction of the accumulated wealth of their founders.

Warnings about the growing concentration of wealth at the very top must be considered in proportion to the size of economic activity, whose increase is in fact positively affected by those at the top. Today, the top ten account for less than two percent of GDP in the United States. At the turn of the twentieth century, the top ten accounted for more than five percent! In a ranking of the 100 top wealth holders from the founding of the United States to the present (as a percent of GDP), only five living persons are listed, and Gates and Buffet are ranked only numbers 31 and 39 respectively.

Data sources: This data is drawn from Forbes rankings of the world’s richest people, from estimates of Transparency International, and independent estimates of the wealth of Vladimir Putin and informal estimates of the wealth of Nazarbaev of Kazakhstan and the Aliev family of Azerbaijan. The wealth of other kleptocrats is given as of the date of their removal from power converted into 2010 US dollars. The top five Ukrainian oligarchs are taken from http://ukrainianguide.com/5-wealthiest-ukrainian-oligarchs/2/ Only five Ukrainian oligarchs made the billionaire list; so I assume there are five more slightly below one billion. Mubarak’s wealth is taken from an ABC News report of February 11, 2011 citing U.S. intelligence sources. These sources dismiss the high figures cited in the press and place Mubarak’s wealth between $1 and $5 billion. I take the upper figure to avoid underestimation. The wealthiest 100 Americans throughout history is taken from http://www.getrichslowly.org/blog/2006/07/29/the-wealthy-100-a-ranking-of-the-richest-americans-past-and-present/

Sunday, February 6, 2011

Obama Does Not Understand Business

As a teacher of comparative economics and textbook author on the subject, I cannot refrain from commenting on President Obama’s unfortunate lack of understanding of business.

Obama’s last weekly address to the nation shows his profound misunderstanding, despite an international consensus as to what determines a good business climate. The various indexes that purport to measure it have one thing in common: A good business climate is one where the government gets out of the way of business. Overregulation, inconsistent application of the rule of law, a heavy tax burden, and insecure property rights reduce business formation, investment, and economic growth. The strong positive correlations between such measures of business climate and economic performance prove this basic fact.

Obama’s pronouncements suggest a quite different understanding: In his mind, a good business climate emanates from public and private alliances, subsidies of progressive business activity, industrial policy, state-directed investment, the “saintly” non-profit sector, and massive infrastructure campaigns. It should be noted that none of President Obama’s “good business climate” measures are included in the existing business climate indexes.

Obama’s stated goal is as American as apple pie: to “make America the best place to do business” In return, businesses should “set up shop here, and hire our workers, and pay decent wages, and invest in the future of this nation. That's their obligation." Contrary to Obama’s assertion, the real obligation of businesses is to make profits for their owners. In pursuing this goal, far sighted businesses will hire, invest and pay decent wages.

Three examples, among many, illustrate the President’s thinking:
The most recent is his vaunted “move to the center” in appointing the “pro business” Jeffrey Immult, the CEO of General Electric, as his chief economic advisor. Immelt and GE exemplify a business whose fortunes hinge on a cozy relationship with government -- aan American version of Crony Capitalism. Notably, he did not appoint a true self-made entrepreneur, who made it on his own without the government.

The second example was the notorious bullying of secured Chrysler creditors – an outright attack on contracts and property rights. The shoving of Chrysler’s creditors to the back of the line helps explain much of the current reluctance to lend.

The third example has been the Obama administration’s conclusion that it was the government’s responsibility to deal with “excessive” executive pay rather than leaving the matter up to shareholder owners, as has always been the case.

It will not be possible to make America the best place to do business in the world with such thinking, but there are few signs, other than some PR forays, that this message has been heard. If such misconceptions continue to shape government policy, the result will be a continued deterioration in the U.S. business climate.