Category Archives: Economics

Governments and the Quick-and-Dirty Triangle of Public Policy

09 Monday Oct 2023

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In the previous post, I discussed several basic functions of government—while inserting snide remarks about whether governments actually carry out these functions. Anyone who pays even the slightest attention to the news will understand why; governments often claim to pursue a given goal, but then enact policies that seem designed to a) be ineffective at achieving that goal or actually make the problem worse, and b) happen to benefit the ruling faction politically or monetarily.

Why? In the basic model of public-choice economics, it is because all government officials act in their own personal best interest, at all times, even if that involves neglecting or victimizing the populace. If there is any hope of good policy, says this model, it can only be when it is in the personal interest of the officials to deliver good policy. (This is why democracies tend to have better policies than autocracies, at least on average: politicians need to at least look like they are furthering the interests, or perceived interests, of at least half the voters.)

We needn’t accept the strong form of this model, at least not all the time. We can still recognize that some political figures and bureaucrats genuinely want to do a good job. But good policy is hard to pull off, even with the best of intentions, because governments don’t always have enough information to make good judgments about complex policy choices, and often don’t even understand the information they do have. This is related to the “knowledge problem” of Hayek—people are better at accurately perceiving their own personal surroundings and experiences than they are at interpreting imprecise representations of the wide world that have gone through several rounds of abstraction and reification.

In an environment of insufficient information, it is very easy for even a small faction of self-interested actors to put their thumb on the policy scale, so to speak, so that policies end up favoring them. It is also easy for well-intentioned ideologues to push policies that seem nice in the abstract, but prove hideously inappropriate for the real world.

For worldbuilding purposes, we can boil down the messy workings of policy formation into a triangle with three points. One point represents the “best” policy that could be arrived at, assuming that governments were perfectly benevolent and omniscient. (This assumes, of course, that you know what the “best” policy would be for your invented society; but hey, it’s your story.)

A second point represents the most likely policy to be arrived at assuming benevolent intentions but imperfect decisionmaking, given the limitations of available knowledge and skill among policymakers, their mental models, and the capabilities of existing government structures, among other bits of administrative friction. (You can throw in the workings of the political system as a further obstacle, if you want to be ambitious!)

A third point represents what policy would be set if government officials were strictly maximizing their own personal interests (or alternatively, the interests of the state as against the populace or rival states—or a combination of both!). This is trickier than it seems; as we discussed with regard to taxation, an actor’s evaluation of its best interest will depend on its values and time horizon, among other things. But as a rule of thumb, it still gives you something to hang your hat on.

This is not meant to be a rigorous exercise, but a quick and dirty way to think about policy choices in your invented setting. For any given society, or even for specific policy areas in the society, you can arbitrarily decide at what point (within the triangle) public policy is going to land—and then you get to imagine how it ended up that way!

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)

Government’s Role in the Economy

09 Monday Oct 2023

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We’ve repeatedly alluded to the role of governments in structuring the economy. The full role of government goes well beyond a single blog post, or even a single book, but we can still lay out a few basic ideas to structure how we think of governments’ role in the economy in our worldbuilding settings. We’ll begin by talking about what ideal governments do, and in a later post we will discuss reasons why the real world often falls short of the ideal.

Let’s begin with a simple inventory:

Providing and enforcing laws. We’ve discussed how commerce thrives in stable societies where the threat of violence and banditry is low, and we can rely on enjoying the fruits of our labors even far in the future. The more secure that property rights are, the more complex commerce tends to become.

Notably, you don’t need a formal government to have and enforce laws. Several societies achieved a degree of social and commercial stability without a formal government, because a customary or religious set of laws was widely agreed upon and followed. Examples were/are the Nuer, Somali tribes following customary law, and the Jewish diaspora. Some societies in a border region even maintained a shared legal code even while at war with each other, such as the Law of the Marches between England and Scotland.

Similarly, it’s not necessary that a territory follow a single law code. In medieval England, the law merchant would compete with royal courts, which in turn competed with the courts of local lords. Today in America, the states often compete to provide laws that are favorable to particular industries, and companies also can use private arbitration to settle disputes.

Still, it seems that formal governments tend to be more effective at maintaining a stable legal system, on average. Or at any rate, the provision of law and order is one of the most compelling justifications that governments can give for their existence.

Providing public goods. How one defines “public goods” strongly depends on one’s level of cynicism, but in general we can say that there are certain kinds of things that governments have historically paid for that often do not get paid for in their absence. Militaries, road networks, and massive irrigation projects and drinking water are typical examples. One of the classic justifications of government is that by levying mandatory taxes and directing unified projects, it can overcome the collective-action problem and ensure that everyone benefits from public goods that everyone wants, but no one is able to fund on their own.

Again, many are quick to label something a “public good” when in fact it could be provided privately, as long as the necessary incentives are created and methods exist to coordinate people and resources. Mercenary units have existed since the dawn of time, and private companies often build roads and water projects if they are able to charge for them. Robert Nozick imagined a contractual mechanism in his Anarchy, State, and Utopia for people to commit money to a project and only be charged if enough other people join, and today we actually do this on crowdfunding sites such as Kickstarter. I myself have hoped for a long time that we could replace much of our tax code with crowdfunded public works (and published a rather amateurish short story on that theme—but we all have our old shames!).

Nevertheless, there is a sense felt by many that certain goods and services ought to be provided collectively, and not through market mechanisms. National defense and crime prevention are prime examples.

Redistribution of incomes. The oldest governments known, in ancient Egypt and Mesopotamia, spent the bulk of their efforts on gathering food and then distributing it to their populaces. Ever since, some level of social support has been practiced by nearly all governments. The scale of such redistribution varied widely between, say, the Soviet Union and Victorian England. But in general, governments usually recognize that their power comes from their (control over the) populace, and that allowing large numbers of people to starve to death does not serve their interests (if it can be prevented cheaply enough, anyway).

Redistribution is expensive, and often bitterly resisted by those who are forced to pay for it. And it is also quite common for redistribution to be manipulated to produce, ahem, unexpected beneficiaries.

Aside from the three roles above, economists typically point to three other roles that seem, to me, rather less universal:

Stabilizing the economy. Economic fluctuations and crises are of concern to states, for several reasons. (But not all states are able to respond usefully; and not all states’ responses are effective.)

In one interesting example, he Babylonian Talmud records that the Temple in Jerusalem would use a portion of its treasury to buy food products if market prices were unusually low, and then sell them to the market once prices rose. [Find the cite.] The text is silent on whether such market activity was meant to be stabilizing; but the profits from such trading were spent on “extra” sacrificial offerings, rather than being retained, suggesting that profit was not the motivating factor.

Maintaining competition (or the reverse!). Often, governments use regulations to prevent markets from being dominated by particular actors. For example, governments might impose a fixed rate on rail freight so that farmers are not squeezed by the rail companies. A city might require that marketplace stalls have a maximum size, so that many sellers can fit in the town square. 

Conventional economists aside, often governments do the opposite: reserve an entire market sector for a designated monopoly. This can be done for purely self-interested reasons (such as to enrich a government minister or an ally), but governments often justify monopolies in situations with high barriers to entry, such as the need to outfit a private navy to deepen trade links with the East Indies, or building fantastically expensive semiconductor plants. Creating a monopoly, it is sometimes believed, can prevent “wasteful” competition in situations where it would yield little benefit.

Similarly, state monopolies are often advocated for in situations prone to “natural” monopolies, such as a water utility that needs to build pipes to every building.

Finally, and most speculatively, we have:

Correcting externalities. Often, commercial activity creates costs that the participants can shift to others, such as pollution or the depletion of natural resources. Since the participants don’t bear the whole costs, they have incentives to act in ways that are, globally speaking, not optimal. Governments often (claim to) act to control such misaligned incentives. For example, the U.S. government has a cap-and-trade system to limit harmful emissions from power plants, and many have advocated for a carbon tax to discourage energy-intensive behavior.

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Now, merely listing the potential activities of governments does not tell you what governments actually do, or why. As we know, governments often have different motivations than the welfare of their peoples. But this post is already going long, so we will discuss a three-part model for government motivations in a future post.

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)

Building an Economy: Entrepreneurship

26 Tuesday Sep 2023

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In the economics literature, there is a heated debate over whether entrepreneurship should properly be considered a factor of production, or whether it is better thought of as a special mode of using the three main factors of production. For the present purposes I don’t really care; the main thing is that entrepreneurship is sufficiently different from land, labor, and capital that it merits discussion by itself.

What is entrepreneurship? Depending on who you read, it can consist of either or both of willingness to bear risk, or skill at coordinating and directing the other three factors of production. In either case, unlike land and capital (both passive resources) and labor (the physical work of masses of people), entrepreneurship is a mental and social activity of individuals (though groups of skilled entrepreneurs can be quite effective, for example the “PayPal Mafia”)

Willingness to bear risk (or uncertainty, not the same thing) means to accept the possibility of failure when trying something that could work better (or be more profitable) than the status quo. The entrepreneur has a certain amount of resources, and is willing to devote them to some business pursuit even though they could be lost if things go bad. This is distinct from “normal” work or investing, where a given amount of labor or capital yields a more or less predictable output (wages or interest payments). (You might argue that many workers face risks as well; according to this framework, they would therefore be acting in part as entrepreneurs.) This was the standard 18th- and 19th-century formulation, pioneered by Cantillon.

The newer understanding of entrepreneurship is skill at coordinating the three factors of production in new and more productive ways. This aspect is somewhat broad; it could encompass inventiveness, creativity, strategic vision, skill at managing employees and vendors and getting them to play nice with each other, skill at negotiating deals, or a deep desire for technical or organizational optimization. Note also that this aspect of “entrepreneurship” doesn’t require that the entrepreneur be using her own capital; the entrepreneur could be an employee of the firm specifically for her entrepreneurial talents, rather than being the boss and risking her own money. This vision of entrepreneurship was pioneered by Joseph Schumpeter and Israel Kirzner.

A word on organizational skill. Anyone who has ever run a business, or been a supervisor or manager, knows just how hard it is to get a group of people pointed in the same direction and keep them from dissolving into acrimony or full-throated mutual combat. The ability to manage people, and to cultivate a strong organizational culture, is what often separates successful companies (and countries) from backward ones. And the prevailing culture of a society can make building strong organizations easier or harder. Willingness to work hard and work as a team, balanced by the confidence to take individual initiative, can lead to tremendous results. Conversely, a society that fosters narrow selfishness, does not encourage individual drive, and punishes nonconformity or excellence, will tend to produce organizations that are lackluster at best.

Additionally, while entrepreneurs are risk-tolerant, they still want to find good opportunities that are worth the risk. So they thrive in a society that is relatively stable (but not stagnant!), has predictable laws, and low levels of violence. Societies with high corruption and banditry, on the other hand, make entrepreneurialism a difficult sell—because businessmen are much less likely to enjoy the fruits of their labors.

As a result, you can fairly characterize whole societies as being more or less hospitable to entrepreneurialism. America is famously entrepreneurial (or more properly, certain parts of America); Israel has been called the “Startup Nation,” punching well above its weight in terms of new businesses. By contrast, countries with high levels of social stratification and economic corporatism, such as France or Germany, will tend to discourage entrepreneurs because it is hard for them to challenge the status quo with something new. And countries that have high corruption or social unrest (or even civil wars) will have little entrepreneurialism beyond the informal “hustles” of people trying to keep themselves alive by any possible means.

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)

Building an Economy: Social Capital

25 Monday Sep 2023

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We previously discussed how the main factors of production are land, labor, capital, and entrepreneurship. I might have to amend that list, however, to include social capital—that is, the set of beliefs and attitudes about the world that influence how people living together cooperate to form a society, or not. (I might also end up squeezing it into an existing category such as the “culture” component of human capital; but the categorization is artificial anyway.)

The study of social capital was largely kicked off by Robert Putnam, famous most recently (I think) for Bowling Alone, his argument that the American social fabric was fraying. But the basic theory was based on over a decade of research prior to that, focused on Italy. By comparing the northern cities of Italy (which had a heritage of having become free cities some 500 years ago) with cities in the Italian south (which did not), Putnam showed not only that people in the northern cities were much more prone to social and civic involvement, were less tolerant of corruption, and had more generalized trust—he showed that these characteristics had measurable impacts on economic growth. The more social capital a society had, the more economic growth.

Luigi Zingales (in A Capitalism for the People) discusses why this is so, specifically with regard to generalized trust—that is, the predisposition to trust other people even before you know them. Generalized trust is the reason that we hand packages off to the postal worker, that we deposit money in the bank, and that we buy things from the supermarket while they are still in the package. A general belief that most people are trustworthy, absent concrete evidence otherwise, makes possible a tremendous amount of trade and exchange.

Contrast the above picture with the situation in backward villages of Sicily. Zingales describes a social milieu where no one trusts anyone else outside of his family (and even within the family, not much!), and people are chiefly concerned with not being a sucker. Moreover, that expectation is justified by experience, as government officials are corrupt, businessmen are shady, and people from other families will cheerfully exploit any momentary advantage offered by some poor sap. As one result, farmers do not cooperate with each other and end up with perennially bad yields, remaining mired in poverty.

Zingales also notes that it takes a very long time for people to develop generalized trust. Immigrant communities in the United States from low-trust countries take several generations for their level of generalized trust to rise to the level prevailing in American society. By contrast, it is very easy to lose such trust. If a government victimizes the people, or businesses do the same (for example, by the growth of crony capitalism or by violating laws with impunity), generalized trust suffers immediately and the legacy of such abused trust can echo for hundreds of years.

Depressing, certainly (especially given how cavalier our political class is acting right now in squandering the trust of the public; but I digress). But extremely useful for worldbuilders. If you characterize an invented society as having high or low levels of social capital, that has a whole host of implications for its history, its future development, the basic attitudes of the people, and its level of economic dynamism.

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)

A Few More Comments on Cities

20 Wednesday Sep 2023

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Rereading Fernand Braudel recently, I came across two critical points he makes during his discussion of cities. We’ve previously discussed how cities show up where they are most convenient for commerce, production, or government control (and sometimes all three at once). But Braudel adds some lovely texture to that discussion.

First, he notes that in Europe, cities were often placed by rivers in order to take advantage of watermill power for production. Every inch of suitable riverbank was harnessed by mills, where possible (and where the riverbank was not already devoted to docks for the vast array of shipping needed to supply the city). If the site was not conducive to the growth of a city, the mill complex would become a standalone production site, such as ironworks or mines. But cities had several advantages as centers of production even before the Industrial Revolution, namely that they had lots of workers nearby and potentially had lots of customers, and easy access to the transportation networks for raw materials and the export of finished goods.

In a more abstract sense, you could say that cities grow where they can access enough power (plus food, another frequent topic of Braudel’s). If new ways to produce (and transport!) power emerge, expect to see new cities grow up that can make use of the new power availability to exploit opportunities that previously were out of reach.

Second, we noted that “administrative” cities often have little production of their own, and rely on constant government funding. Braudel (starting around pg. 530 of Structures of Everyday Life) gives us hard numbers of major European capitals, which were particularly prone to such tendencies, and they are quite astonishing.

Lavoisier, writing in the mid-1700s, estimated that the city of Paris spent some 260 million livres per year to support its populace—of which only 20 million came from commercial profits, while 140 million came from government salaries and bonds, and 100 million came from ground rents or from business activities conducted outside of the city.

Some 141,000 people lived in Berlin in 1783, of which some 33,000 were soldiers and their families, 13,000 bureaucrats-and-families, and 10,000 servants—in other words, over a third of the city was economically unproductive, spending salaries that came from tax revenue. Many of the remainder made their living solely by catering to the needs and tastes of the salaried class.

St. Petersburg, capital of imperial Russia, was even more lopsided. In 1789, it had about 220,000 inhabitants, more than two-thirds of whom were male. Soldiers, (military) sailors, and cadets (and their families) comprised some 55,000 people, over a quarter of the city. Large numbers of others were servants. And let us not forget the bureaucracy. The city itself was placed in a bad location for practical purposes, constantly dealing with bitter cold and floods that killed many every year, far away from its sources of food and even building material; but that was where Peter the Great wanted his court, due to the spectacular vistas it afforded. Consequently, vast sums of money were spent to build the city and keep it working.

None of this is bad, per se. If a country has the money and wants to spend it in a major city, good for it. But it does illustrate that the fortunes of such cities are inextricably tied to those of the government. Braudel notes that when the Mughals of India moved their capital city, practically the entire population of the old capital would move with them; they had no way to support themselves otherwise.

Braudel also points out, in an argument later echoed by Jane Jacobs, that when a capital city grows too large and lacks an independent commercial base, its elites end up bending government policy to favor the capital city at the expense of the rest of the country. Jacobs noted in particular that London favored policies that benefited its international banking business and impoverished the rest of Britain. Paris likewise became a massive megalopolis that drained wealth from the countryside.

(I note in passing that until recently, Washington DC and its environs were not a major urban powerhouse—that role was played by New York, Los Angeles, and other major cities able to counterbalance the centralizing tendencies of the capital. By 2011, however, that had changed. The region has become overrun by well-paid lobbyists, and to a lesser degree by financial and healthcare firms that benefit from easy access to regulators. This was probably a symptom, not a cause, of the growth of centralized policy; but once such people are ensconced, they continue to drum up business at the expense of the common citizen. See Luigi Zingales, A Capitalism for the People [2012]. Matters have only become more exacerbated since he wrote.)

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)

Collective Action Problems

27 Thursday Jul 2023

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Why is it so hard to organize people behind a project that benefits everyone?

Economist Mancur Olson won a Nobel Prize for his answer (which he laid out in his book The Logic of Collective Action), which in a nutshell is this: when multiple people work on some task that benefits all of them, each of them faces an incentive to shirk—meaning to work less hard on the task and wait for all the other people to pick up the slack. If the group succeeds even when an individual member shirks, then that member gets all the benefit for none of the cost (that is, the member is a “free rider”). Conversely, if the member puts forward full effort but not enough others do and the project fails, then the working member is a sucker (so to speak) and has suffered high costs for no benefit.

But if all the people have that incentive to shirk, then everyone will shirk and the project itself will not be accomplished. As a result, says Olson, only certain types of groups will successfully accomplish their goals.

The first type is a group working toward a goal that is so valuable, each of its members would do all the work necessary by itself if it had to.

The second is a group that is small enough that each of the members can monitor the others, to make sure that they all are pulling their weight.

The third type of group is one that manages to create “selective benefits” to reward its members for their participation, even where direct monitoring is infeasible. For example, the AARP is an advocacy group that also provides benefits like insurance or travel perks to its millions of members. That encourages people to pay the membership fees, which are then used to fund the AARP’s advocacy.

(A selective benefit can also be social, or even metaphorical. For example, most religious groups consider charity to be spiritually beneficial for the giver. Someone who holds this belief will tend to give charity even in the absence of a material incentive to do so.)

By contrast, large groups of people who cannot monitor each other, and who lack a selective benefit to encourage participation, will have a very hard time sustaining cooperation between their members to achieve their goals.

Olson notes that lobby groups are often small groups of actors seeking especially valuable payoffs. Citizens’ groups, by contrast, are relatively large, and often have a hard time providing selective benefits. As a result, narrow lobbies (which Olson later names “distributional coalitions”) routinely have a leg up in advocating their goals (in a democracy but also in other systems, such as autocracies where access to the ruler is restrictive), compared to the citizens’ groups who are often unable to stop them. Over time, therefore, public policy is likely to be more responsive to narrow lobbies than to the interests of the majority, or the populace as a whole.

Olson continued exploring this insight in a follow-on book, The Rise and Decline of Nations. As the title indicates, Olson is pessimistic about the implications of his theory. If society remains stable over time, the number and power of distributional coalitions will grow as time passes; and “there is for practical purposes no constraint on the social cost such an organization will find it expedient to impose on the society in the course of obtaining a larger share of the social output for itself.” (As Adam Smith noted in an earlier century, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”)

Distributional coalitions generally obtain “shares[s] of the social output” by securing special privileges for their members, such as by excluding competitors from their industries, or by getting a direct government subsidy paid for by general taxes. Typically, such privileges end up burdening the rest of society, and as such burdens accumulate, it becomes relatively less attractive for individuals to engage in productive activity—and more productive to devote your energies into fighting for a larger slice of the pie. Political life consequently becomes more and more acrimonious, a constant brawl of distributional groups against each other to see who can best expropriate the public.

As distributional coalitions proliferate and grow in power, society will reach a tipping point where its most talented people take up lobbying and rent-seeking rather than productive activity. At this point, the calcification of the economy accelerates. Worse, because much of the economy is now subject to the demands of distributional coalitions, and such coalitions make decisions slowly in a process of internal bargaining and consensus-building and lobbying the government, the economy as a whole grows less responsive to changing conditions. New technologies are adopted more slowly, resources are not reallocated to meet new crises and opportunities, and economic growth stagnates.

Importantly, the power of distributional coalitions depends on their relationships with the government and their dominance of their industries. Free politics and freedom of trade are therefore a threat to such coalitions; electoral turnover can bring less friendly politicians to power, and the rise of economic competition can disrupt the existing industry structure and dethrone those at the top. (Olson was writing before the rise of today’s powerful identity-based interest groups, or he would have said something similar about the power to define your own identity, rather than having it imposed on you by powerful interest groups that want to yoke you to their plow.) Therefore, distributional coalitions hate and fear freedom and seek to curtail it wherever possible. They much prefer stability, since that freezes their own advantageous position.

As a result, Olson concludes, long-lived societies tend to become shot through with durable class divides that harden over time, between those who amass special privileges for themselves and those who do not. (He discusses apartheid South Africa, Britain, the Indian caste system, and the pre-Communist Chinese guilds, among several other cases.) Those social groups with effective distributional coalitions tend to cement their power over time. As Olson notes, “There is greater inequality, I hypothesize, in the opportunity to create distributional coalitions than there is in the inherent productive abilities of people.”

The only way out, according to Olson, is to periodically disrupt society and shake up the cozy power arrangements that accumulate. The most common way in history that this came about was through conquest by a foreign power, unfortunately. But gentler means are also available, such as free economic and electoral competition.

******

In your own worldbuilding, Olson’s theory can be a powerful tool in creating settings simmering with latent conflict. The old and decadent society that is ripe for revolution is a mainstay of fiction for a reason. As a first pass, think about who the most powerful groups in your invented society are, and ask how they got there. Then ask, what would they want to do next, and at whose expense?

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post will show up in the planned second and third books in this series, working titles Wealth for Worldbuilders and Tyranny for Worldbuilders respectively. No idea when they will be finished, but they should be fun!)

Beliefs About Economic Growth

10 Monday Jul 2023

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There have been many, many books written about culture (and you should definitely read a few!), and some of them discuss the effect of culture on politics, or the economy, or both. (We already discussed Ronald Inglehart in an earlier post.) Going too far into the weeds on this topic will take us very far afield, but I did want to point out one key bit of cultural variation that has massive political significance: Do people believe that the economic pie is fixed, or that it can be grown?

If you believe that economic wealth has a fixed quantity, then you believe that no one can gain wealth unless someone else is losing it. (This basic attitude was a staple of Continental socialism. Proudhon’s “Property is theft” and Balzac’s “Behind every great fortune lies a crime” come to mind.) If so, then the key ground of economic conflict becomes “Who gets what?” The characteristic emotion toward the rich will be jealousy. All else equal, more effort will be spent in redistributive activities such as government lobbying, speculation, and sheer banditry.

If you believe that economic wealth can grow in the aggregate, then your attention will be drawn towards ways that wealth can grow. An attitude of optimism may, or may not, coincide with a certain disdain for those who could be accumulating wealth but instead allow themselves the luxury of idleness (though this disdain tends to be characteristic of societies influenced by Calvinism in particular, per Max Weber). The key economic conflict becomes “What is standing in the way of greater wealth?” The characteristic emotion toward the rich will be admiration. All else equal, more effort will be spent building businesses, engaging in commerce, and building infrastructure.

Of course, in the real world we tend to believe in a complex, contradictory mix of both. Partly this is due to our evolutionary history. Prehistoric times were typically a rough approximation of the “fixed pie” condition, because people had few possessions—and what they had often needed to be shared, for the sake of mutual survival. And during long stretches of written history, economic conditions were persistently bad as societies were ravaged by war and famine. The last two or three hundred years featured an explosive growth of affluence beyond anything in our prior experience.

Additionally, it is clear that some people become wealthy by creating wealth, and others become wealthy by taking the wealth of others. Steve Jobs, for example, became fantastically wealthy by creating whole new categories of tools for the betterment of humanity (ideally!). By contrast, Trevor Milton bilked investors seeking to participate in the electric-car boom and sold them a bill of goods. (He may not remain wealthy for long, however, depending on his sentencing in September!)

Still, those two opposed attitudes towards wealth can motivate a whole range of beliefs and behaviors—excellent grist for the fictional mill!

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders, along with some overlap with the planned third book, working title Tyranny for Worldbuilders. No idea when they will be finished, but it should be fun!)

Banking and Economic Development

09 Sunday Jul 2023

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If you think about the differences between a poor peasant society, a relatively affluent society such as an 18th-century English city, and a 21st-century technological society as we experience in much of the West, one of the big differences is the sheer amount of infrastructure that we have. If you think about roads, power plants and power lines, sewers, networks of schools and hospitals, and on and on, it’s a little bit staggering to think about how sheer stuff had to be built to enable our modern lives—and how much money had to be spent in order to build it all.

In poor societies of yesteryear, roads are typically mud tracks. Electricity does not exist, and people often had to cut their own firewood. What “public” facilities there were, such as single-doctor clinics, are small scale. This is not merely a question of technology. The Roman roads were tremendously useful tools of power projection (and consequently, tools of commerce), yet they remained the gold standard for perhaps fifteen hundred years in Europe because few people wanted to pay the huge amount of money it would take to extend, or even maintain, the road network. Even in major post-Roman European cities, there were no paved roads until the 13th century. (Baghdad had streets paved with tar beginning in the 8th century.)

What this means is that to take a society from abject “backwardness” to a high level of “development” (in the sense of Alexander Gerschenkron) takes not merely technology, or manufacturing ability, but the money and other resources to build the massive amount of stuff necessary.

Some types of development can be done gradually, in a decentralized manner. For example, local communities can each build a school, without necessarily needing to coordinate with other communities or a national authority. However, other types of development functioned more effectively if they were coordinated at the national level. (Or at any rate, that’s how it tended to work in our actual history, with the types of technology that we had to work with and the kinds of conceptual models that our national planners used, given the role of massive scale in the 19th and 20th centuries.) For example, the electrical grids in 19th- and early 20th-century Western European countries tended to be much more stable than those of America at the time (and even today), because the American grid was a patchwork of local grids built by local power companies, whereas the European grids were built according to a national plan, with money and resources mobilized from the entire country.

One key element in this was the role of massive banks. America had an early lead in its financial development, due to the proliferation of local state-chartered banks that soon blanketed American society. These banks were a tremendous stimulus to local and regional commerce and the development of new settlements. (The English experience was broadly similar, although it was still relatively difficult to start a bank in England.) European powers were slow to catch up, but in the 19th century settled on a strategy of having centralized national banks that would finance not merely local businessmen, but the vast infrastructure projects of modernization. America was hobbled by the system of unit banking, which tended to keep banks relatively small, and by the lack of a muscular national bank. (Such a lack was not necessarily bad, as the conflicts over the Banks of the United States indicate!)

In an era before banks, much wealth is economically sterile—golden and silver goblets sitting in some nobleman’s vaults (for example), where they do not contribute to ongoing commerce. But when such wealth is deposited in a bank, it can serve as the basis for lending and new capital investment. (It can also promote new kinds of systemic risks, but that’s a different discussion.) Banks thus can mobilize formerly unproductive resources and put them to good use. And when the bank is national in scale, it can attract the money of the vast middle and even lower classes (in the case of the postal banks of e.g. Germany and Japan) and pool the money into a vast fund, which can then be used by the state in its development plans.

Banks are not the only way to do this, of course. But in our history at least, the alternative was coercive taxation or sheer plunder by the state (as in the case of Tsarist Russia, and later the Soviet Union).

At any rate, the key point here is that to build up a society takes a lot of money, and often that money has to be pooled somehow and deployed in coordinated projects. How that process works in your invented setting is, of course, entirely up to you.

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders, along with some overlap with the planned third book, working title Tyranny for Worldbuilders. No idea when they will be finished, but it should be fun!)

Building an Economy: Human Capital

06 Thursday Jul 2023

Posted by in Economics, Education, Politics for Worldbuilders, Writing

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Returning to the Labor component of the four factors of production in our quest to build a worldbuilding model of the economy, we will now discuss human capital.

Human capital, unlike other characteristics of one’s labor such as your health or general attitudes toward work, is often domain-specific. You may be a highly trained surgeon, but that would do you little good if you have to plant crops. You might be an expert at negotiating trade deals, but that doesn’t help you if you are trying to program your thermostat. In general, the value of your human capital depends on, and interacts with, the available opportunities you have to apply that human capital.

There are many kinds of human capital. In our model, we’ll focus on three:

  • Training,
  • Experience, and
  • Interpersonal skills.

Obviously, this categorization is artificial. Distinguishing between training and experience is not always easy or useful. And the development of interpersonal skills is influenced by training, but also by cultural context—both in terms of what is considered proper etiquette in that culture, and in terms of whether the culture encourages values like teamwork, taking responsibility, giving proper credit, and politeness or other values such as saving face, kiss-up-kick-down, dominance, and rigid separation of roles. So interpersonal skills should strictly speaking interact with the “Culture” factor of labor in our model. Nevertheless, as a scaffold for our thinking, we’re still going to use this three-part division.

Experience and interpersonal skills are fairly self-explanatory. (Some people develop particular skill in working with others, in a way that measurably shows up in company performance, and these skills can be learned; see Crucial Conversations: Tools for Talking When Stakes Are High.) In the rest of this post, we will be discussing training in particular, and focusing on a key question that has wide-reaching implications: who bears the costs of a worker’s training?

(Note: “costs” include actual money, but also instruction time and effort, the frictions involved in assigning real work to a trainee, and the like.)

Following Kathleen Thelen’s book How Institutions Evolve, we can talk about three kinds of vocational skills: general, industry-specific, and company-specific. General skills are widely applicable, such as literacy or basic computer skills. Company-specific skills, on the other hand, are only useful within a particular company—how to use a custom inventory system, for example. Finally, domain-specific skills are useful within a specific industry.

Because general skills make a worker more valuable across industries, a worker who gains general skills is more likely (all else equal) to leave her current employment and find a better offer. As a result, employers will generally not want to pay for their employees to gain general skills (all else equal), because even though they would benefit from having skilled employees, those employees are likely to be poached away and the current employers are less likely to keep the benefits of such skills. The employees, on the other hand, will want to pay for general skills because the risk is low: even if their current job goes away, the skills will be useful to many other employers. Employees thus get the benefits of having general skills, and are willing to pay for them (if they can afford it!).

For company-specific skills, companies have a much easier time paying for workers to develop them; the skills only have value within that company, so training your workers makes them relatively less likely to leave. As long as the employer is confident that a worker will remain, and as long as company-specific skills would actually be useful, the employer is likely to pay for such training. The employee himself is relatively less likely to pay for company-specific skills, for that reason.

But when we consider domain-specific training, we have a problem. If the worker bears the cost of his own training, he also runs a relatively high risk that no one will hire him for that job even after he is trained (since it only applies to one industry). If so, the cost of the training will be wasted, since he would not be able to apply the specialized training in a different domain. As a result, the worker will be less willing to bear the cost of his own training unless he had some sort of assurance that the investment would pay off.

Conversely, if the employer bears the cost of training a new employee with domain-specific skills, she runs the risk that the employee will receive all the expensive training and then happily jump ship to a different employer, or strike out on his own, or simply underperform at his new job. The employer will be unwilling to spend lots of resources training employees unless she had some sort of assurance that they would remain with her, and perform up to par.

This is probably why medieval Europe featured long apprenticeships and state-sanctioned professional guilds—apprentices could devote years of their life (but did not have to pay money) to learning a trade secure in the knowledge that their master would employ them (albeit under bad conditions), and the master could invest the considerable effort needed to train an apprentice secure in the knowledge that the apprentice could not run off early and ply his trade elsewhere, because the apprentice could be imprisoned or even executed. The apprentice was locked into his contract for several years, long enough for his master to reap the benefits of his growing skill.

On the other hand, there are significant drawbacks to the apprenticeship system. First of all, the master is taking a big risk—what if you turn out to be really bad even with training, or dishonest, or just unpleasant to be around? Second, the apprentice has to sacrifice many years of his life toiling for someone else—and what if the master is cruel, or incompetent, or just bad at business or teaching? Why not take opportunities to abandon your master and improve your life?

Most of all, an apprenticeship system requires overpowering coercion to work—either from a powerful state that enforces contracts between master and apprentice, if you’re lucky enough to live under one, or else a social milieu that tolerates private violence by masters and guild enforcers against the hapless apprentices. Or perhaps both.

In modern times, we typically use other means, which have varying levels of success and different outcomes. Here, we’ll talk about two models, and call these a “liberal” labor system and an “organized” labor system.

In a stylized “liberal” labor system where workers can move between companies and industries without restrictions, companies have less assurance that they will be able to keep workers around after they have been trained; as a result, companies tend to invest relatively little in workforce training (except for company-specific skills), and workers themselves are encouraged to finance their own training.

Workers, for their part, will therefore tend to invest in general skills that do not depend on a particular employer or industry, as they have a higher likelihood of benefiting from such investment wherever they end up. They will also invest (where possible) in especially valuable skills that are industry-specific (such as computer programming), because the expected return from such investment is still positive even with the uncertainty of the payoff.

But less valuable industry-specific skills (such as trades) will tend to be neglected. Moreover, the skill development of the workforce as a whole will largely depend on the workers’ ability to invest in their own skills. If they lack the funds, the time, or the access to credit, workers will not be able to get all the skills they want. (This is a particular problem at the beginning of your career, when you have no money!) As a result, a “liberal” system will tend to produce a workforce with reasonably levels of general skills and highly valuable industry-specific skills, and a large gap of skills in the middle.

One way to address this gap is for the state to provide free or subsidized education to younger people, especially to fund the development of general skills. Unsurprisingly, in the United States over half of the workforce has college degrees, while only perhaps 35% of German workers do (and many of these are professional degrees, rather than what Americans would recognize as a liberal-arts degree).

Another way is for companies to offer strong incentives for employee loyalty, partly mitigating the poaching problem. Examples include the Japanese system of worker seniority, or the common practice among American startups to offer restricted stock compensation that vests over several years.

By contrast, in a regimented system of long-term employment with few opportunities to switch jobs (what Thelen calls an “organized” system, as one finds in Germany), companies will be assured that they can capture the benefits of training investments; each company will therefore train its employees to the level that the company needs (or thinks it needs). However, workers themselves will tend to underinvest in their own skills; because of the limits on job choice, they will not reap all the benefits of such investment.

As a result, an organized system tends to produce a workforce that has good basic and “middle” domain-specific skills, but lacks skill on the high end. (In Germany, for instance, nearly half of workers have attended vocational schools, often funded by their future employers. Germany also features industry groups that collectively manage worker training, and agreements between companies to manage worker poaching.)

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The upshot is that a skilled workforce doesn’t spring from the ground fully formed. Someone has to bear the costs of training, and that someone has to be confident that she will reap the benefits of that investment. There are several ways to resolve the resulting problems, but each of them will result in a characteristic pattern of skill development—and such patterns can add texture to your invented societies.

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders, along with some overlap with the planned third book, working title Tyranny for Worldbuilders. No idea when they will be finished, but it should be fun!)

Factor Mobility and Political Conflict

25 Sunday Jun 2023

Posted by in Economics, Politics for Worldbuilders, Writing

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In an earlier post, I mentioned the argument of Michael Hiscox that whether investment capital is mobile or immobile will play a big role in the way that political conflict over the economy plays out. The truth is, Hiscox argued that the same basic principle applies to all the factors of production.

Human capital too can be of general usefulness, like being able to read, or it can be highly specialized, like knowing how to audit the internal reports of a McDonald’s franchise. Empty land near a city could be used to grow crops or graze cattle, or it could be repurposed for housing or a factory; but land in the middle of a swamp can’t be used for much except fishing or peat harvesting. Even people themselves might be mobile or immobile, depending on how easy transportation is between where they are and where they might want to be. (Hiscox references the Law of One Price in describing this tendency.)

We noted in the earlier post that if capital is inflexible, then it cannot easily shift between industries and people will fight hard to defend their own industry against competitors; politics thus features intense lobbying and narrow sectoral factions, with the bosses and workers largely allied to defend their own niche. By contrast, if capital is flexible, then if one industry is having trouble, investors will simply shift their capital to a more profitable industry with a minimum of fuss. Thus, politics shifts its focus to broad, class-based coalitions (workers versus owners, haves versus have-nots). (Additionally, flexible capital is better able to serve as collateral for lending, while in its absence entrepreneurs are forced to rely on equity finance, which is more difficult to get.)

Essentially the same is true for the other factors of production. Labor and land, too, have different political effects based on how easily they can be repurposed. Ease of transportation plays a particular role in allowing resources to equalize between different regions or different industries. So does the state of technology; if workers can easily adapt to the machinery in different industries, it is much easier to shift people around than if machinery is highly specialized and takes a long time to master.

Hiscox notes that political conflicts over the economy thus follow some consistent patterns based on the level of technological development of a society. In a preindustrial society, the factors of production are relatively immobile: knowledge of a trade doesn’t transfer well, most industrial capital is immobile and difficult to repurpose, and transportation is slow and risky. In particular, money itself (e.g. gold and silver bullion) is tricky to move around, which limits the ability of investment capital to flow into poorer regions where there might have been good uses for it.

As a result, capital and labor do not readily shift between industries or regions, with the result that you often see guild rivalries and conflicts breaking along professional lines, with class conflict as such usually taking second place. (This does not mean that it never happens; for example, the Bauerenkrieg or Peasants’ War of c. 1524 was largely kicked off when German nobility put in place new laws on land ownership to force the free peasants into serfdom.)

Early industrialization, by contrast, makes factors of production much more mobile. Transportation gets much easier, reducing frictions in shifting factors of production between regions or from one use to another. Unskilled people can more easily move between industries, since basic factory work is similar across industries in this stage of industrialization. Similarly, advanced education becomes useful in a wide range of industries, and someone initially educated to be a priest could readily become an engineer, scientist, diplomat, and statesman. Capital likewise becomes much more mobile, as much industrial equipment is relatively multipurpose.

It is no accident, says Hiscox, that mass politics based on class divides becomes much more salient in the period of early industrialization. (For example, Marx’s argument about the role of unemployed workers as the “industrial reserve army” of capital would make no sense in a preindustrial economy; unemployed weavers could not magically become potters or shipbuilders.)

Later industrialization causes factor mobility to decline again in relative terms. Human capital becomes much more specialized (for example, a growing number of Americans today are seeking master’s degrees, professional degrees, and PhDs, finding that a “mere” bachelor’s degree is not enough for their needs). So does productive capital (for example, the cost of building a single semiconductor plant can be as high as $10 billion!). Also, specific forms of human and technological capital can only be used with each other—a computer programmer is useless without a computer, and an astronomer cannot function as such without massive telescopes. So, says Hiscox, class-based political struggles tend to decline, and industry lobbying rears its head again.

(Hiscox notes that government policy can improve factor mobility, as in Sweden, and allow class coalitions to persist—and at the time of his writing, Sweden was able to respond to economic shocks much more rapidly as a result, particularly through wage equalization between industries.)

Since Hiscox wrote, I would argue that we have seen a relatively unbalanced situation develop where parts of the economy are getting more flexible, and other parts of the economy are getting more inflexible. It is far easier today to invest in, say, a broad-based ETF of Chinese companies than it was thirty years ago, and just as easy to yank your money out with a few mouse clicks. But building a factory now requires highly specialized robotic equipment, some of which is impossible to use in any other industry. A general grounding in basic computer use or marketing skill can be applied in many different industries; and at the same time, to be a physicist or biomedical researcher now virtually requires getting a PhD first, where in earlier times you could get started with a bachelor’s degree or even be entirely self-taught.

No surprise that our modern politics feature a weird mixture of class-based politics and sectoral-lobbying politics, in a volatile and high-temperature mix that makes it much harder for any political conflicts to be resolved.

*****

At any rate, Hiscox’s model gives you a handy lens to think about how factor mobility can affect the politics of your own invented worlds. In particular, if you want to have class conflict in your story, make sure that the economic environment is conducive to such conflict, as opposed to conflict between competing guilds, for example.

*****

(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)