Puzzle of Economic Growth in Developed Democracies

1. Alexander Tabarrok The Rise and Decline of NationsCh. 4: The Developed Democracies Since World War II

2. A puzzle! • Consider the economic growth rates of the major democracies post World War II, say 1945-1980. Which countries had the best growth rates and most robust economies? • Germany and Japan! i.e. the losers of WW II! France and Italy did well also. Clear slow growers were United States and Great Britain! Great Britain called the old man of Europe. • Why? • Catch up? • British Disease? • Japanese industriousness and willingness to sacrifice? Graph from David Kern

3. Olson’s Solution • Olson draws on implications 2, 4, 7, • Stable societies with unchanged boundaries tend to accumulate more collusions and organizations for collective action over time. • 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. • Distributional coalitions slow down a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions, thereby reducing the rate of economic growth. • To arrive at a further implication: • Countries where distributional coalitions have been “emasculated or abolished by totalitarian government or foreign occupation should grow relatively quickly after a free and stable legal order is established.”

4. One Interest to Rule Them All • After assuming dictatorial powers in 1933 Hitler moved to eliminate all competing sources of power. Thus, he abolished the labor unions (and made strikes illegal), he abolished all political parties other than the Nazis, he suppressed churches, clubs (other than those he controlled such as the Hitler Youth), state governments and any independent sources of power. • When the war was over the allies destroyed the industrial cartels that had supported Hitler and they took control of the military. i.e. they dismantled the military-industrial complex. • Thus Germany after WWII had very few organized special interest groups.

5. Germany • The administration of affairs in Germany shall be directed towards the decentralization of the political and administrative structure and the development of local responsibility. To this end you will encourage autonomy in regional, local and municipal agencies of German administration. The German economic structure shall also be decentralized. • …You will prohibit all cartels or other private business arrangements and cartel-like organizations, including those of a public or quasi-public character… • …It is the policy of your government to effect a dispersion of the ownership and control of German industry Directive to Commander in Chief of United States Forces of Occupation Regarding the Military Government of Germany IPCOG 1 April 26, 1945.

6. Japan • Under MacArthur the Americans rewrote the Japanese constitution. • Goal: Break up the military-industrial complex and establish democracy and free enterprise. • Truman to MacArthur: • “Encouragement shall be given and favor shown to the development of organizations in labor, industry, and agriculture, organized on a democratic basis. Policies shall be favored which permit a wide distribution of income and of the ownership of the means of production and trade. • …[I]t shall be the policy of the Supreme Commander…to favor a program for the dissolution of the large industrial and banking combinations which have exercised control of a great part of Japan's trade and industry. • SWNCC 150/4 General Douglas MacArthur rewrote the Japanese constitution after WWII.

7. Great Britain v. West Germany • Great Britain had a long history of stability and thus a long time for special interest groups to arise. In Great Britain every trade had its own union, the doctors were organized, the lawyers were organized, the trades were organized, land holders were organized, there was an extensive class system (note on classes and cartels, French Revolution, and Napoleon) etc. etc. • A survey of associations in 1971 showed that: • 51% of associations in Great Britain were formed prior to 1939 but only • 37% in France, • 24% in West Germany and • 19% in Japan.

8. Encompassing Unions • West Germany had another advantage relative to Great Britain. In the post WW II era the Germans, with allied encouragement, set up a new structure for unions. • In Great Britain unions were (and are) organized along trade lines so there is a metal worker’s union, a carpenter’s union, an electrician’s union and so forth. This means that every union is a special interest group with respect to any particular firm. i.e. if the carpenter’s union goes on strike it bears only a fraction of the cost of shutting the firm down. • In Germany unions were set up so that all the workers of a given firm belonged to the same union. Moreover, the unions were federalized so that the same union represented firms at many companies and in total the Federation of German Trade Unions (Deutscher Gewerkschaftsbund or DGB) represents in one way or another most workers.

9. Great Britain v. West Germany • Murrell compared the growth rate of young, y, and old, o, industries in Great Britain and West Germany (correcting for differences in average growth rates) he reasoned that if Olson were correct the growth rate of young industries should be relatively higher. Why? • New industries in both countries have few interest groups gumming things up and therefore should grow quickly in both countries but old industries in GB should have lots of interest groups but not in WG therefore the new should grow relatively faster than old in GB not WG. • i.ie Murrell tested whether • Answer: Yes.

10. Encompassing Unions • Sweden and Norway two other countries that have a long history of stability but that have grown well post WWII also have encompassing unions, practically all union members belong to labor organizations. • One can see the difference this makes. In Sweden the unions oppose tariffs! Why? • Encompassing organizations take into account the interests of the winners as well as the losers. • Hence in Sweden the unions prefer • Prefer broad subsidies (to tariffs) to increase labor mobility • Prefer retraining to firm-specific subsidies • Are highly tolerant of market forces.

11. The United States • What states have been the fastest growing since the mid 1960s? The South. • The South was destroyed in the Civil War was taken over during Reconstruction and then again to a less degree by the Federal government in the 1960s. Since that time the growth rate has been higher in the South than in the rest of the country. • More generally, Olson shows that older states have grown more slowly. Older states also have more special interest groups, as measured by union organization per capita. • Older cities have also grown more slowly – also consistent with the rise of the industrial revolution – a topic for next class.

12. Chapter 5: Free Trade • Free Trade whether between countries or when created by the creation of a county often leads to large increases in income. • Comparative advantage! • Careful measures of the potential efficiency gains from comparative advantage, however, suggest that the gains from comparative advantage can only explain part of the increases in income with free trade. • Olson argues that with a large free trade area the old special interest coalitions fell apart and had to be reestablished.

13. Rationally ignorant majorities vs Concentrated minorites • The Income distribution looks like this • If we posit that most people would prefer that other people pay taxes, who will pay? • Everyone? The poorest 51% ? The richest 51% ? • The poorest 10% The richest 10% • Majoritarian Discrimination versus the Motivated, Organized Minority Groups Tax Policy Center, 2015

14. De Toqueville Versus Olson • The Tyranny of the Majority? • The Exploitation of the Masses? • Meh. • Rather, it is the shifting of the burden upwards by the masses, mixed with the lobbying and rational investment of the wealthiest to shift the burden downward • Leaving taxes to be paid by those with enough money that its worth taking, but not so much that its worth investing in lobbyists, lawyers, and accounts to protect.