Category Archives: Economics

Inflation and Deflation, a Quick Primer

02 Sunday Apr 2023

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

≈ Leave a comment

Tags

, , , , ,

I can’t remember off the top of my head reading much fiction that used conflicts arising from inflation or deflation, but as Neal Stephenson demonstrated in his System of the World books, you can actually generate some pretty cool plot conflicts that way. But many people lack a good understanding of what inflation or deflation really is and how it comes about, and I suspect authors are similar. So let’s dive in.

(We’re going to focus on the political/inequality effects of inflation and deflation, rather than purely economic. So I’ll be skipping discussion of inflationary spirals, for instance.)

One tricky bit is that when we speak of “inflation,” we might be talking about at least three separate phenomena:

  • Price levels are rising because people are actually getting richer and are spending more money on things, somewhat faster than production can increase in response (which we will call “wealth-driven inflation”).
  • Price levels are rising because real wealth is staying the same, but a bunch of new money is sloshing around the economy due to borrowing or other forms of money creation, leading to artificial demand not backed by real increases in wealth and consequent distortions in wealth distribution (“monetary inflation” or “bubbles”).
  • Price levels are rising because it is literally getting more expensive to make anything, so price increases coincide with destruction of wealth and real increases in poverty (“stagflation”).

Similarly, “deflation” could mean a few different things:

  • Gentle price declines due to increasing technological or organizational efficiency over time.
  • Sudden price crashes due to the collapse of a speculative or demand bubble.
  • Ruinous price declines because nobody has any money left to buy things with (i.e. persistent economic depression).

Generally, a healthy economy ought to see alternations of wealth-driven inflation and gentle efficiency-led deflation, so that new production and innovation are encouraged and then make people’s lives better. Unfortunately, “prodigals and projectors” (as Adam Smith referred to reckless overborrowers) tend to leverage themselves to the hilt whenever possible; and at the same time, governments often try to magic money out of thin air in order to pay for their programs, without paying as much attention to creating real wealth.

On the flip side, even mild deflation becomes terrifying to the Powers That Be as more and more of the economy depends on free-flowing debt on the one hand, and massive investments in fixed capital that need to be repaid over long periods of time on the other. Both debtors and owners of fixed capital would be crippled by price declines that lead to declining profits, since they would no longer be able to pay their debts or obligations generally. (The same applies to the government itself, which relies on tax revenue funded by economic activity and generally has rigid obligations.) Thus, governments have tended to favor mild inflation instead of allowing gentle oscillations between inflation and deflation; the Federal Reserve, for example, has an explicit target of 2% inflation.

As a result, governments often promote increases in the money supply, promising that it would be a cure for all that ails us. Instead, it tends to fuel violent booms and busts, of the type that we are well familiar with today.

Monetary Inflation

Note that an increase in the money supply doesn’t magically spread across the entire population instantly. It starts when one corner of the economy suddenly earns a lot of new money—perhaps from striking gold in the hills, perhaps from exporting oil and sowing the seeds of Dutch Disease, perhaps by selling bonds to the Federal Reserve (paid for with dollars hot from the metaphorical printing press). That first sector then spends the money in other sectors, like luxury cars and real estate for example, and bids up the prices there; and eventually the tide of new money washes across the economy in general. But the initial “nouveau riche” sector was able to spend money at almost the original prices, while successive groups had to pay higher and higher prices for goods, while the very last people to be “enriched” by the new money end up suffering from inflation well before they actually “benefit” from it.

(The foregoing was a very brief summary of a point made by the brilliant Henry Hazlitt in his 1946 book Economics in One Lesson, in Chapter 22—starting at page 148 in this free edition in the paragraph beginning “[a]n increased quantity of money comes into existence,” though properly the discussion begins on page 145. Every person who has any opinions at all about economics ought to read this book, more than once.)

Note also that if prices increase in this way (due to increased buying pressure), by definition this will hurt the poorer segments more, simply because they don’t have the purchasing power to keep up. This is especially true with food. If luxury autos double in price, a poor family won’t care; but if eggs and milk double in price, suddenly the poor face a serious threat to their well-being. The net effect is that high inflation harms the poor more than those better off, tilting the relative balance towards the rich (though even the rich might not actually be better off, in real terms).

Some people say that inflation is good for the poor, because it would tend to increase their wages; but that’s rarely correct. First off, if the poor are net borrowers, they simply pay higher interest rates on new borrowing. Even existing debt, if it is variable-rate, becomes more expensive. People with a lot of existing fixed-rate debt do benefit, but such people are rarely poor. Second, even if nominal business profits are rising from higher prices, that doesn’t automatically translate into higher wages. If there is a lot of competition for jobs, from other workers or from technological improvements, then employers need not pay any extra or could even reduce wages. (Arguably, this has been the story of the last forty years.) Only if the labor market is tight, and employers desperately need to keep their employees happy, will wages tend to rise along with revenues.

Stagflation

Prices could also increase due to real increases in the cost of production or sale. This is easiest to see when fuel and electricity prices go up. Energy is an input into almost everything in the economy, so even if total wealth stays the same, producers will have to raise their prices or go bankrupt. This means that fewer people will afford to buy what they used to; most people will have to cut back. In other words, the rise in prices simply means that society has gotten poorer, because it is harder to make things.

Energy is not the only input that could cause this effect. Increased regulation, difficulties in transportation or supply-chain management, higher wages, higher salaries for executives, or increases in crime and property destruction can also impose costs on companies, often forcing prices higher. (Some of these costs might come with benefits, while others might be pure waste, but that is a different discussion.)

Deflation

As we noted, mild deflation is usually healthy—if prices are declining because the economy is getting more efficient at making things, that’s another way of saying that people are getting richer because they can buy more things. However, prices can also decline as part of the hangover from a speculative bubble. We can see this in the stock market when prices suddenly collapse after a long bull market. But it happens in the real economy, too. For example, one major cause of the Great Depression was that lots of manufacturers built new factories in the middle and late 1920s, each of them overestimating the total market demand for their goods and underestimating the amount of competition that would be online by the time their own factories were finished. As a result, the market was soon flooded with manufactured goods, and most of the manufacturers went bankrupt.

(A famously influential book on booms and busts was written by eminent economist Irving Fisher during the depths of the Great Depression. He also summarized the book in this article, which is quite a useful read. Fisher’s book was a major inspiration to John Maynard Keynes in the development of Keynes’s general economic theory.)

In a deflation due to a shortage of money, and a consequent excess of production, people sometimes rediscover that money is only one way to pay for things. People might resort to barter. Communities might create alternate payment methods such as local currencies or scrip. If you are lucky enough to find a supplier willing to extend credit, you can receive inputs now and pay for them once you have sold your goods. These means are usually inefficient compared to money, however, which is why they tend to disappear when the economy recovers.

If a deflationary episode persists for too long, it might lead to a deflationary spiral—people fear that prices will continue to drop, and therefore buying anything today is a surefire way to lose money. So people hoard their money instead, causing producers to lose their buyers and go bankrupt (especially if they have to meet payroll or mortgage payments). If it goes for too long, a deflationary spiral can permanently cripple the economy and reduce economic output.

Not everyone suffers in a deflationary spiral, however. Prices for everything become cheap—especially investment assets such as troubled businesses, stocks and bonds, or land, as their owners face financial ruin and need to sell quickly at any terms available. And if you have money in the bank, a deflationary spiral can be a fantastic opportunity to buy up assets and make a massive profit once prices normalize (assuming that they do!). (For example, if you had perfectly timed the stock market bottom midway through 1933 during the Great Depression and bought into the S&P 500, you would have nearly tripled your money by 1936.) As the saying goes, during deflation, “cash is king.”

A Takeaway?

All of the above being so, it would be easy to imagine that evil oligarchs might deliberately engineer a sequence of booms and busts in the economy, so they could buy assets cheaply during crises and then sell them to overexcited investors during the good times, gradually concentrating much of the world’s wealth into their desiccated, claw-like hands. The extent to which this happens in real life is, shall we say, unclear. But it would be a fantastic fictional plot, wouldn’t it?

And in any case, you can use the concepts here to impel several kinds of plots. For example, the biblical Book of Ruth is kicked off when Naomi’s family leaves Israel to escape an economic depression.

*****

(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!)

Advertisement

Building an Economy: Natural Resources

28 Tuesday Feb 2023

Posted by in Economics, Politics, Politics for Worldbuilders, State Formation, Writing

≈ 1 Comment

Having discussed population density and ease of transport, it’s time to finish off our discussion of land by talking about natural resources—and some surprising implications that natural resources can have for economic development, and politics.

(And in retrospect, this one really should have been the first subtopic in land that we discussed, since it really conditions all the others. I’ll correct that in the book to come!)

“Natural resources” can mean many things. One of the most fundamental will be the presence of available food production, from fertile soils and rain or rivers for agriculture, wild plants and herbs for gathering, animals to be hunted, or fish to be—err, fished. If a region does not have enough food production to feed its populace, it will have to depend on imports, which means that it will have to have something to sell to the outside world in order to pay for those imports.

Other things might or might not be a natural resource, depending on the details of your setting. For example, deposits of aluminum will only be valuable if the society has figured out how to smelt aluminum, a surprisingly difficult process. Small streams might be good places to fish, but if the society has developed the technology of the gear (meaning the round turny thing with teeth), streams can also drive watermills to provide kinetic energy for machines in a workshop.

(This also means that advances in technology, or other changes that turn something that was previously useless into something valuable, could bring new prosperity to formerly backward regions—or make them tempting targets for invasion!)

For each region you would need to decide what the key natural resources are for your story, and how abundant they are. The details of them obviously matter; but for our model, we will abstract away from the details (for the moment) and characterize each natural resource (in relative terms) as

  • rich or poor, and
  • concentrated or widely available.

Resource-Poor

If a region is poor in necessary resources, the people will have to either trade for them, substitute some other inferior resource, or do without.

If the people are wealthy—perhaps they are skilled businessmen or traders, or perhaps they are successful pirates—they can sustain a society even in a place with few resources; but they would be dependent on the outside world for most of their essentials, like food, fuel, raw materials, and the like. Essentially, a region with few natural resources stands in a similar relationship to the outside world as a city does with its surroundings: it must produce a lot of economic value to pay for its imports, and it lives and dies with the ability to transport the needed goods.

If the people don’t want to trade for the good they are missing, or the good is simply not available, they may try to use substitutes. For example, the Scottish Highlands had few trees for firewood; instead, the Scots burned peat (something halfway between coal and mud). Few people would prefer burning peat to wood; but it did the job. Similarly, early iron weapons were actually inferior to bronze in most respects, contrary to the common assumption; but bronze is made from both copper and tin in a specialized process, and when the tin trading network across Eurasia was disrupted for unknown reasons, local communities fell back on iron, which was readily available and easy for blacksmiths to forge. (That was a gross simplification of a complex process with many causes, but for our purposes it makes the point.)

If no substitute is available, then the populace will do without. The typical result is widespread poverty (at least in “objective” terms; a people that has never known the telephone will not mourn its lack, and will find plenty of other prestige goods to compete over). If the missing resource was critical to sustaining life, its lack may put a hard cap on how many people can live in the region. In the worst case, the region may simply be empty of people.

(The concentration of the resource matters, but only on the micro-scale; if you have a small amount of wood and no one else has any, you will be prosperous personally, but it won’t affect the rest of the region much.)

Resource-Rich

If a region is rich in natural resources, on the other hand, it could have wildly varying effects depending on whether the resource is mainly used by the region itself, or mainly exported. If the resource is mainly used by the region—either directly, such as foodstuffs, or as an input into some other production, such as timber into shipbuilding or iron into machine production—it will contribute directly to the region’s prosperity. Not only will the region use the resource, the availability of rich resources will tend to encourage the growth of new industries that require that resource (though not automatically; see our later discussion of entrepreneurship). In ideal circumstances, the natural resource serves as fuel for the larger economic engine, being transformed into ever more valuable uses as products move up the chain of production, and the economy will develop in healthy directions.

Problems emerge if the resource is produced mainly for export, however. The economy will tend to develop mainly to facilitate the export of resources, and other industries will be relatively less developed. An economy that is heavily unbalanced in the direction of exporting natural resources (or really, by any other single desirable export) is prone to Dutch Disease. For our purposes, Dutch Disease happens when a particular economic sector generates massive amounts of money from external sources; this could be oil, or timber, a wildly successful service sector such as London banking, or even foreign aid or foreign direct investment. People end up using that money to import new luxuries or to enjoy more local services, diverting revenue and labor away from local productive industries to a degree. (It gets worse if countries have independent currencies with fluctuating values; the vast exports of oil or whatever will cause your country’s currency to strengthen, making imports relatively cheaper, but also kneecapping your other industries such as manufacturing or tourism.)

The result is that even as the growing sector prospers, the other parts of a region’s manufacturing economy will tend to stagnate. If allowed to continue unchecked, the end result of Dutch Disease is to turn the region into a supply region with a hypertrophied primary export sector and a bloated service sector, and relatively little industry otherwise. The region will be excessively dependent on its main export industry and suffer booms and busts along with that industry. (This often happens on a smaller scale with oil towns, mining towns, and the like.)

The Resource Curse

We must also ask if the rich resources are concentrated or widely available. A large timber forest is relatively hard to monopolize, though kings certainly try; and as a result, it would allow a relatively large number of people to support themselves from the resource. But a much more concentrated resource is easier to monopolize, either by the state (a common occurrence) or by a private actor (which might accumulate much of the effective power of a state, as with the “Shell police” in Nigeria). Often, this actually leads to worse outcomes for the region—the so-called “paradox of plenty” or “resource curse.”

Investigating the paradox of plenty, Terry Lynn Karl in her book identified a common pattern in modern oil-dependent states. When oil is first discovered in a previously poor state, the state has a sudden budget surplus—either because it takes control of the oil directly, or heavily taxes the oil companies. With the sudden influx, the state massively raises its spending, usually first on social services, then on subsidies for new heavy-industry as the state tries to translate its new wealth into durable prosperity. Often, taxes on the broad populace are reduced, sometimes to zero. (This is not an unmitigated good; often, regimes reduced taxes and increased subsidies in order to demobilize their populaces and render them indifferent to national politics, the better to rule tyrannically in the absence of popular opposition.)

However, state spending often grew much faster than oil revenues, as new interest groups form to feast on the new state largesse. Moreover, efforts to nurture new industries often failed, overcome by the mismatch between the planned new industries and the existing technological competence of the society, the resulting inability of the economy to support the planned new industries (as Jane Jacobs discusses), the eventual growth of political patronage in subsidized or state-owned industries, and their resulting implosion from ineptitude. Factor in the effects of the Dutch Disease and consequent inflation, and the economy as a whole actually suffers from the new oil wealth. Many petro-states found that they could no longer feed themselves without imports, as local food production was crowded out by inflation and the lack of farm labor.

The ultimate beneficiaries, however, are the state itself (which grows massively from the new revenue) and the new stratum of state functionaries that fills all the new state jobs. But such prosperity is brittle, depending as it does on the revenue from oil. When oil prices suddenly fell in the mid-1980s, these states faced crippling crises that lasted decades.

Matters are less bad in states that already have strong state institutions, even if their economies are heavily dependent on the resource in question. Alaska, for example, managed to avoid the worst ravages of the resource curse by distributing much of its oil wealth directly to its citizens each year. The temptations of rentier-state gluttony are certainly present, but mitigated by the preexisting power of the citizenry and the strong tradition of limited government.

*****

This post has already gone on too long, but you can already see that the effects of a region’s natural-resource endowment can provide great fodder for plot conflict. And once you add in a few elements from the other building blocks of an economy? Yowza.

*****

(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: Ease of Transport

22 Wednesday Feb 2023

Posted by in Economics, Politics, Politics for Worldbuilders, State Formation, Writing

≈ 1 Comment

Tags

, , , , ,

In our last post, we started building a model for how to think of a region’s geography with three major factors: population density, ease of transport, and natural resources. Here, we will discuss the second factor, ease of transport.

We’ve referenced the importance of transport several times before, including with regard to cities and touching on it briefly in Book 1 of my “Politics for Worldbuilders” series during the discussion of the Nobility. Now we’re going to discuss transport squarely. It plays vital roles for economic activity, the placement of cities, and politics.

Let’s begin by assuming that a given territory can be easy to cross, difficult to cross, or have particular constrained routes such as rivers or valleys that allow for easy transport but can also be easily controlled. Each of these options generates its own set of possibilities.

Trade

The easier it is to transport goods and people, the easier it is to trade—you have to be able to get your goods to buyers without too much cost, and on the flip side you have to be able to access raw materials. If transport is cheap and easy, a lot of trade becomes feasible and economic activity will tend to flourish. Cities will be supported by food transports and shipments of raw materials such as iron ore or coal, paid for by the goods and services they generate, and they can also trade finished goods with each other and with their surrounding rural areas.

Similarly, the easier that transport is, the easier it is to stay current on news from distant places. This is somewhat less of a factor in our modern era of instant communication, rather than having to wait for the latest ship from far-off shores; but even today, there needs to be people on site to report what is going on, who want to report it to you or to an audience that includes you. This is more likely when transportation is easy and cheap.

If transport is difficult—the territory is a rugged mountain range, for instance—trade becomes difficult as well. People will have to depend more on their own production, rather than producing for trade with distant buyers. Villages will be inward-focused, struggling to produce their own food, clothes, tools, and other goods. Traveling peddlers might come along every month or three, or not at all. Cities will be rare, placed in the few places where transport is relatively easier, and more likely to be administrative/garrison cities supported by the government than commercial or industrial cities, simply because it is so hard to produce anything and transport it out to buyers. Economic activity as a whole will be stunted as a result.

(Many scholars believe that this is one of the reasons for the relatively low economic growth of the inland part of the African continent and Eurasia. In contrast to Europe, which features long coastlines and many rivers that penetrate into the hinterlands, Africa and Eurasia are mostly landlocked and have few rivers. As a result, areas along the coast and next to rivers will tend to flourish more than inland areas that have a relatively difficult time getting goods to market.)

Trade and production in places with difficult travel will tend to focus on valuable and rare goods if they are present, such as gold, spices, uranium, and the like. If there is enough money to be made, governments or merchants will invest in roads or other transport at fantastical expense that go directly to the production site and nowhere else, in order to make extraction easier. This will create path-dependency effects that favor continued focus on the extractive industry, rather than allowing the economy to broaden and deepen in healthier ways. The region will likely become a supply region. If no such valuables are present, economic activity will simply stagnate. People will focus on producing their own needs, or else migrate to greener pastures if available.

If transport is possible through otherwise rough terrain down particular pathways such as rivers or valleys, we can expect these roads to become the focus of military conflict or economic competition. Whoever controls them will be able to profit from the trade that goes through them, and if the pathways are the key enablers of trade between vast regions then the rewards might be great indeed.

Note that if the transport situation changes—new roads are built, or somebody invents magical zeppelins, or the mountain pass suffers an avalanche and is blocked until spring—the effects on the society might be profoundly good or bad. There is certainly a story to be written here, about who would benefit from such changes, who would be threatened, and what they would do about it.

Politics

Just as trade is easier if travel is easier, so is power projection. It is no accident that the Roman Empire spent incredible effort on building its famed roads.

Political boundaries often map onto geographic boundaries such as rivers or mountain ranges, simply because it is hard to transport armies across, or to enforce laws or collect taxes on the other side. The more rugged the terrain, the more likely that an area will feature a patchwork of smaller domains rather than a unified government. (This is part of why Afghanistan continues to be the graveyard of empires.) As with trade, nominal distances as the crow flies matter less than travel time. This is particularly true with the transmission of information; the less information that can get through, the less likely that an empire or other political unit can maintain its control and the more likely that control will devolve to a more local level.

And naturally, the political situation will have effects on the economic one as well, good or bad. A vast regime might enable more internal trade, as Rome did, or it might ruthlessly squeeze its subjects, as Rome also did at various times. A patchwork of small principalities might be littered with obstacles to trade and feature frequent conflicts, or it might become a fecund region promoting creativity and economic development.

You can see how these factors interrelate. A government might build roads for military purposes, which then have the side effect of stimulating new economic activity. The interstate highway system in the United States, and the Autobahn in Germany, are good examples. So is the rail system in much of Europe. Or a transportation system built for commercial purposes might be adopted for military ones, such as airplanes.

*****

All in all, the ease of transport across a territory will dramatically condition what happens there and how people live. For worldbuilders, we can readily exploit some of the challenges that this presents in our stories.

*****

(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: Population Density

20 Monday Feb 2023

Posted by in Economics, Politics, Politics for Worldbuilders, State Formation, War, Writing

≈ 1 Comment

Tags

, , , , ,

After a great deal of procrastination, it’s time to revisit the Land/Labor/Capital triad, identified by the classical economists like Adam Smith and the like as the key factors of production.

(Side note: modern economists consider entrepreneurship to be a fourth factor of production. I’m still trying to figure out whether there is a nice way to characterize entrepreneurship in our model, as it would obviously lend itself to strong stories.)

Remember, we’re not trying to explain everything about an economy from the ground up. We’re trying to build a relatively simple, yet powerful and flexible framework that worldbuilders can use to quickly mock up the contours of their invented societies. Once the bones are in place, you are then in a position to dive into all the cool little details, confident that they will be consistent with the structuring logic.

So when we talk about land, we’re going to focus on three broad variables—each of which can have surprisingly powerful implications:

  • Population density
  • Ease of transport
  • Natural resources

Really, these are interrelated. For example, you can’t have a dense population without lots of food, and and an easy way to get the food to people. Still, it’s useful to consider them separately to keep everything straight in our heads. Let’s begin with population density.

*******

If you want to have a country or region with a high population density, that implies several things. We already noted the need for lots of food and efficient transportation of it. On the other hand, you don’t necessarily need to have urban cities, if people are living in densely placed villages and growing their own food with intensive agricultural methods. (It will mean that animal husbandry will likely use methods that require little land, rather than pasture-grazing.) And the material standard of living might still be low if most people are producing food, rather than more specialized goods. Still, the more people there are living close together, the more opportunities for specialization and exchange, and the more likely that the economy will develop more complexity.

Conversely, if the population is thinly spread, the people might still be relatively prosperous. They could have large herds of livestock that move from place to place, or practice a carefree foraging lifestyle where they only spend a few hours a day gathering food and use the rest of their time making luxuries, playing games, fighting with neighbors (!), or relaxing. Or they might be desperately poor, if the land is not very productive and they all have to work hard to feed themselves, since there are few opportunities for trade. With a thinly spread populace that cannot sustain specialization and exchange, chances are that the energy surplus of the society will be small, which limits the development of their society and culture. (And you can see how the productivity of the land interacts with population density.)

So whether you choose to have a dense population or not, you can play around with what that looks like for you and your story.

But what about the political effects of a dense population, or its opposite?

Note that the more thinly spread the population, the harder it is to control the territory. If you are being oppressed by a ruler, or landlord, or moneylender, or cruel family members or whatever, you always have the option to pull up stakes and run; and all else equal, it is more difficult for a ruler to stop you if the population is thin. This is because fortifying the border to keep people in would be too expensive, compared to the number of people being contained. By contrast, if the society has a dense population, it is relatively more efficient to fortify the border even at great expense, because of the large number of people you will be able to contain and control.

Jeffrey Herbst argues that this is one of the key differences between the experience of Western Europe and of precolonial Africa; Western Europe, being densely populated and urbanized, made it worthwhile for rulers to fortify their borders, the better to control the moments of their people (as well as to defend against invasion!). In Africa, however, the landscape was so vast compared to the populace that there was little practical way to control the territory as such. Instead, African rulers focused on strategies to control people directly—ties of loyalty or marriage for some, enslavement and physical domination for others.

Let’s see why. When seeking wealth or other resources, a ruler must ask a key question: is it easier to exploit one’s own people, or someone else? If your people are easily controlled and restrained, it will be relatively easier to tax them. If your people can move around easily, however, then they will not tolerate heavy taxation. On the other hand, if your army can also move around easily, it becomes more attractive to invade your neighbors and cart away plunder, in goods or people.

So as a broad pattern, we see regions of high population density focus on fortification of borders and relatively high reliance on taxation or other means to generate resources from their own people (which does not exclude invading and pillaging neighbors, of course!); and regions of low population density feature relatively higher mobility, societies that feature relatively less political coercion and taxation, and lots of raiding of neighbors for treasure and slaves.

Of course, rulers can also change the population density of their territory. A very common pattern, as James C. Scott tells us, was for city rulers to concentrate the surrounding populations by force within the city walls, and have them cultivate fields that were within easy reach of the city (and the city’s military). This allowed them to tax their peasantry’s output more easily than if farmers were living in distant villages.

So when you’re creating a new territory, think about the population density of the land, and then consider what consequences flow from that. The implications for your story might be surprising.

*******

(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!)

Uncertainty and Value

29 Sunday Jan 2023

Posted by in Economics, Politics for Worldbuilders

≈ Leave a comment

Tags

, , , ,

In the middle of a discussion about the laws of damages, the Babylonian Talmud (Bava Kamma 7b) comments in passing that during that period (roughly 200-500 C.E.), the sale price of land in Israel varied considerably by time of year—by as much as half. This is a startling passage, and for our purposes it helps illuminate some key concepts in economics.

What could be the explanation for such dramatic differences in price? The rabbinic commentator Rashi understands this to mean that between planting and harvest, the expected value of the anticipated harvest was baked into the land’s sale price. By contrast, once the crop had been harvested, the land was reduced to itself, so to speak. So the sale price of the land would rise as we got closer to the harvest, and fall dramatically once the harvest was over.

This explanation has some difficulties. First of all, that would mean that the land itself was only valued at roughly its yield for a single year’s harvest—or even less, if there were multiple harvest seasons over the course of the year. Why would land be so cheap?

The later Tosafists also note that the talmudic passage doesn’t distinguish between farmland and housing. It’s possible that the passage assumed that we would know that it was discussing farmland; but if not, similar price dynamics would be at work in housing as in farmland, even though there is no crop to plant or harvest. So then what would cause the variation? The Tosafists tentatively suggest that demand for housing followed cyclical patterns, rising during the fall and falling at other times of the year. But that is just a way of restating the original question. What drove these patterns? And whatever the cause, why would the price swings be so dramatic?

I have no insight into why housing might exhibit seasonal patterns; but I think I can add a suggestion for why the price variation was so large. If we assume that the “intrinsic” value of the land was not small—and the Talmud makes clear in many places that land ownership was valued and valuable—there must be something at work that changed the expected value of land, meaning the expectation that the land’s owner would be able to benefit from owning the land.

“Expected value” is basically the value of a good, times the chance that you will gain the value. For example, if I say that I will give you a dollar, the expected value of the dollar is $1. But if I give you a dollar only if you win a coin flip, then the expected value of the dollar is only fifty cents. It’s the same dollar; but because you’re less likely to get it, it is worth less to you in advance, while you are still uncertain of the outcome. If Bob wanted to buy from you the chance to do the coin flip, he would only be willing to pay fifty cents, not a dollar. The uncertainty of the asset depresses its price.

And in fact, at the time of the Talmud, land ownership was very insecure. There are many references in the Talmud (for example, Gittin 58b) to people having their land stripped from them by “extortionists,” who apparently took advantage of the weak governmental authority of the occupying power to take people’s lands by force. This would have the effect of depressing land values, because the expected value of the land would be less than if landownership were secure. However, as you got closer to harvest, the likelihood that an extortionist would suddenly take your land before harvest became vanishingly small, increasing the expected value of the land and the harvest, for the moment.

This is related to the argument of Peruvian economist (and sometime politician) Hernando de Soto that informal communities without legal land tenure were poorer as a result (partly because their land or houses could not serve as collateral for secured loans). While that says nothing about whether poor people would actually benefit from getting legal title, instead of whatever informal arrangements they themselves developed in the meantime (in Peru, formalization of title did not lead to significant decreases in poverty, though it was useful in kneecapping the violent insurgency of the Sendero Luminoso), it does highlight the role of certainty and uncertainty in economic value.

So what can worldbuilders get out of this? Most importantly, the insight that changes in likelihood lead to changes in price. Uncertainty causes loss. Certainty is valuable, and people are willing to pay for it. (Which is why the insurance industry exists.) And with some thought, you can use this concept to drive some pretty interesting plot conflicts.

*****

(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!)

Taxation and Conflict

17 Saturday Dec 2022

Posted by in Economics, Politics, Politics for Worldbuilders, State Formation, Writing

≈ 1 Comment

Tags

, , , , ,

Worldbuilders often have settings in which tax policies are key drivers of conflict. This is as it should be, given that taxes often drive conflict in the real world, for very good reasons. But typically, the decisions that a fictional ruler face are boiled down to “Do I want money? If so, tax everything that moves.” In the real world, things are more complex. And introducing a bit of carefully chosen complexity into your stories can make the conflicts a lot more interesting.

Our current discussion is based on the seminal model of Margaret Levi. Based on a deep review of the history of governments, Levi starts from the assumption that in general, sovereigns want to maximize their tax revenue. But this does not simply mean jacking taxes up as high as they can go.

First of all, the more you tax, the more opposition you get from those being taxed. This is obvious, but it has some notable consequences. A weaker regime will be able to tax less, because serious opposition could bring it down. Additionally, taxes will tend to fall more heavily on social groups that are less able to resist the government (often because they are poor!), or who depend on the government more, or who would benefit directly from the additional government projects that the tax revenues would fund and are thus more willing to bear the burden. In any event, the rulers will have to limit their taxation if they don’t want to antagonize the people.

Second, the higher the tax rate, the more that economic activity becomes depressed as many businesses simply become unprofitable. Moreover, it becomes worth it for people to rearrange their businesses to pay less tax, or even cheat on their taxes altogether. As a result, if you increase taxes by ten percent, say, your tax revenue will rise by somewhat less than ten percent. And at a certain point, tax collection actually goes down with higher taxes. (This concept is popularly known as the Laffer Curve.)

So a ruler will have to figure out the optimal tax policy for generating revenue. This is a difficult problem, especially if you don’t have a lot of data about the economy. Often, rulers get it wrong and set the tax rate too high for the amount of revenue they want to collect. (It is much less common to set the tax rate too low!)

This basic issue also functions across time periods; collecting lots of taxes this year will often mean that the economy’s growth will slow down in the future, reducing tax collection later. As a result, Levi notes that a major factor in the taxation decisions of sovereigns was their discount rate—that is, how willing they are to forego money today in exchange for more money tomorrow. 

(A quick example: suppose you have an opportunity to invest $100 today, and in a month you’ll get back $110 guaranteed. If you have money in the bank and won’t miss $100, you’ll happily invest the money for a good return. If you only have $100, on the other hand, and you need to spend it on food, it’s another matter entirely. Still, you might be willing to invest the hundred dollars if you would get back a thousand; for that much money, you’ll find some way to last the month. In the first case, you have a relatively low discount rate; you can afford to be patient. In the second case, you have a relatively high discount rate; you need money today, and it would take a massive amount of money in the future to get you to give up what you have.)

Levi notes that sovereigns facing a crisis—particularly a war—needed lots of money today, and were more willing to raise taxes for current revenue even if it harmed future growth, and even if it provoked domestic opposition (to a point). In other words, these rulers had a very high discount rate.

Next, certain types of taxes take different types of bureaucratic infrastructure; if you don’t have the infrastructure, you can’t levy the tax. For example, to tax incomes, you need a way to monitor how much money people make. This is tremendously hard, which is why direct income taxes across all of society were nearly unknown until the early 1900s. And some kinds of taxes would cost more to administer than you would actually raise!

A sovereign will then want to invest in new bureaucracy, to be able to collect more taxes in the future. But such investment takes money and time, and it usually provokes opposition from society—people resent intrusions into their privacy, and know that higher taxes are going to result in the future.

Levi’s model thus has a number of moving parts, including:

  • the discount rate of the sovereign;
  • the capability of the tax-collection apparatus;
  • transaction costs for commerce, and for tax collection (which include information/monitoring costs, and fees, operating expenses, and other forms of friction); and
  • the relative bargaining power of the state versus different classes in society.

Levi’s entire discussion includes many other complex facets, including the concept of quasi-voluntary compliance which I already touched upon in Beyond Kings and Princesses in the discussion of bureaucracy; I hope to write about more from Levi in future posts. But even this starting overview provides some useful tools for worldbuilders looking to juice up their political conflicts.

*****

(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!)

Pirate Ships

20 Sunday Nov 2022

Posted by in Economics, Politics for Worldbuilders, State Formation, Writing

≈ Leave a comment

Tags

, , , ,

We briefly mentioned Peter Leeson’s work on the economics of pirate ships already; now, let’s take a closer look. (Because honestly, who doesn’t like pirate ships?)

In his study of pirate ships between 1682 and 1726, Leeson identified several remarkable features of how pirate ships were run, especially when compared to civilian merchant ships or naval vessels. While the latter vessels were run autocratically, with an all-powerful captain who could not be gainsaid, pirate ships were typically run along democratic lines:

  • they were governed by written articles of association, which had to be adopted unanimously;
  • they featured separation of powers between the captain, who controlled duty assignments and tactical authority, and a popularly elected quartermaster, who controlled the money and administered discipline—and the crews could replace either of these figures if they were abusing their power; and
  • crew members were typically paid in equal shares of the plunder (the captain and quartermaster typically got two shares), net of costs for repairing the ship or medical care and bonuses for the wounded.

Why? Leeson argues that pirate crews had to solve several problems in order to function well. First and most pressing was the risk that the captain could abuse his position. A frequent scourge of civilian ships was that the captain, nominally the omnipotent representative of the ship’s investor-owners back on shore, would exploit his power to harm the crew members, or enrich himself at the owners’ expense. This is an example of a principal-agent problem. (Indeed, many sailors turned to piracy in order to escape such exploitative captains.) But on a pirate ship, usually the sailors were the “owners” of the ship; and they would not tolerate a captain who would abuse them or divert “their” plunder.

Second, pirate crews were fairly large—the average pirate ship had some 80 crewmen (and some had many more, or even fleets of ships such as the expedition of Captain Morgan), as opposed to merchant ships which carried 13-17 men. (By contrast, naval ships often carried hundreds of sailors.)  With such large crews, it became harder to monitor individual sailors’ behavior. Yet harmony aboard ship needed to be maintained if the crews were to fight well. Disputes needed to be prevented, or resolved peacefully.

In response, pirate crews (which often shared ideas between them) soon developed a system of formal governance, with strong democratic features, well before any national governments adopted separation of powers or democratic voting. Ships’ crews drew up written articles of association (and so did pirate fleets, when several ships joined together for particular expeditions), which had to be approved unanimously. These articles laid down rules for the ship, and assigned different authorities to the captain, the quartermaster, and the other officers. They also specified how officers could be removed by popular vote.

The captain had total control over decisions during battle, and the assignment of ship’s duties. But he had no control over discipline, or over the plunder. That was the job of the quartermaster. Yet the quartermaster too was constrained; he was typically not allowed to store the plunder under lock and key, and many crews had a system of random searches to detect if a quartermaster (or any other crewman) was stealing plunder. Theft was punished severely, usually with marooning or execution.

Interestingly, Leeson finds that privateers—“legal” pirates whose activities were sanctioned by their governments—shared some of these features. They too paid out plunder in equal or nearly equal shares, and also used written constitutions. Leeson concludes that profit sharing and written constitutions must have been an efficient solution to the problem of keeping order among large crews, far from home.

But few privateers had the checks-and-balances system of captain and quartermaster, or democratic governance. (At least, not officially; Leeson doesn’t discuss how many privateers would engage in unsanctioned piracy on the side.) This was likely due to the need to enforce the authority of the ship’s government, just as merchant ships needed to enforce the authority of the absent owners. Pirates, lacking fealty to a distant authority, didn’t have this problem.

Leeson and other academics such as David Skarbek look at several other forms of organization, such as stateless societies in Africa, or prison gangs; and I hope to write more about these. But the basic takeaway for worldbuilders is that certain kinds of settings, like a pirate ship, present certain kinds of problems that the people have to solve. And the way that they solve those problems can make for fascinating stories.

*******

(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 for Worldbuilders. No idea when it will be finished, but it should be fun!)

Trading with Bandits

13 Sunday Nov 2022

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

≈ 1 Comment

Tags

, , , , ,

Suppose you were a merchant going into the mountains, seeking to trade for rare spices. The local clans know where the spices are; but they would much rather kill you and take all of your trade goods than part with their own valuable spices, even in a profitable exchange. You know this, and they know you know this. Is there any way that you can trade with the locals anyway, and escape with your life and a good profit?

There are a few ways to entice the locals to trade peacefully. One is to invest in military strength to deter attack—hiring bodyguards or improving your own martial skill. Another is to offer the possibility of repeated interactions, meaning that you will keep coming back with more trade goods if each trip goes well. Therefore, if the locals behave peacefully they will end up making far more profit over time than if they simply plunder your caravan. (This strategy only works if the locals trust you to come back, and if their time preference isn’t heavily weighted to short-term gains rather than long-term gains. If they need lots of money today, they might be willing to plunder you and sacrifice the long-term profit.)

Another method was to threaten the bandits with retribution from your allies, even if they are not present at the time. Your own weakness could be counterbalanced by the strength of your allies. This was one of the perks of being a Roman citizen, for example—everyone knew that a Roman was inviolate. If you harmed a Roman, you could expect legionnaires to be knocking on your door in short order. This did not prevent banditry entirely, but it certainly kept it to a much lower level.

All well and good; but let’s spice things up a bit. What if the merchant were the bandit, and the local clan were too weak to resist? And what if the clan had a permanent village, so they couldn’t simply escape from the traveling merchants until they had passed by? The merchants have powerful weapons, and while they wouldn’t mind striking a fair bargain if they needed to, they would cheerfully sack the village and take all of its valuables and people as booty if they thought it worthwhile.

If the weaker party is immobile and cannot escape, the above methods to induce peaceful trade no longer work. By assumption, the village is unable to invest in greater strength. And since the merchants are mobile, the village cannot easily threaten it with retribution from its allies. Repeated interactions are trickier too; merchant expeditions are expensive, and the merchants would want a high enough profit margin to be worth the bother.

So what is there to do?

I shamelessly stole the title of this post from the journal article it is based on, by Peter Leeson. Leeson, who would later enjoy some fame for his work on the economics of pirate ships, investigated our second case with the dangerous merchants and weak village, and gained some insights by looking at trading patterns in Central Africa. There, trade networks would connect producer villages deep in the interior with the European trade outposts on the coasts. The producer villages were at constant risk of being attacked by the merchant caravans, so they developed two major strategies to protect themselves.

The first strategy, paradoxically enough, was to demand that the merchants paid their side of the bargain upfront, and extend credit to the village. The village would then provide its own goods to the merchants the next time they came by. This allowed the village to reduce its stores of plunderable goods during the merchants’ first visit, since they wouldn’t need to pay right away. That way, the merchants would have less reason to plunder the village, since there would be little booty to plunder. And when the merchants came back, they had already paid for their goods and would have little incentive to use violence—unless the village tried to cheat them and withhold payment.

Since the merchants were stronger than the village, they could safely extend credit and know that they could punish the village for cheating if they needed to. (The reverse would not have been true; the village could not dare pay goods up front—that is, lend money—to the merchants, because they could not possibly enforce the bargain.) And the merchants had an incentive to play along: if the village didn’t think it was safe to stockpile its trade goods, it would simply produce no goods for trade and only enough to subsist on. That would make it unprofitable for traveling merchants to come all the way out and plunder them, discouraging violence.

But there was still a problem: what if the village makes a bargain with one set of merchants, then produces the trade goods that it owes, only to be attacked by another set of merchants?

To mitigate this risk, the village would expect the merchants that it bargained with to protect the village from other merchants. That is, part of what the village was trading for was protection. It was worth it for the merchants; they would lose out if their precious trade goods were stolen by some other group of merchants.

Still, the whole business was touch and go. For the system to work as described, the merchants had to be sufficiently patient to prefer long-term riches to short-term plunder, and be able to protect the village and enforce exclusivity against other merchants—and the village had to be able to reduce its stock of trade goods to unprofitable levels for the merchant, to make plundering a poor proposition and induce the merchant to offer credit. If the village’s trade goods were of the sort that was difficult to deplete or hide (such as livestock, or slaves or people who might be enslaved), then the village would have a difficult time indeed avoiding attack.

****

In your own worldbuilding, you might not necessarily have these specific situations. But the concepts involved are delicious for generating story conflict. Stakes are high, incentives can balance on the edge of a knife, and much will depend on the characters involved. A good deal can be messed up by an impatient character, or implacable enemies might recognize an alignment of interests that can encourage the first tentative steps toward peace.

*****

(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 for Worldbuilders. No idea when it will be finished, but it should be fun!)

Different Kinds of Finance

01 Tuesday Nov 2022

Posted by in Credit, Finance, Politics for Worldbuilders

≈ Leave a comment

Tags

, , ,

Some fictional stories involve finance, of the high or low varieties. Other stories really ought to mention finance of some kind, due to the way that the setting is constructed, but the author never does—perhaps because the author is not comfortable with the subject. Finance is something that everyone is affected by, but few people understand deeply. Fortunately, the basic concepts are not difficult; and you might find them useful in your writing.

It often happens that someone wants to launch a business venture or some other project needing a lot of money; and other people who have money want to put it to work profitably, but have other people handle the details of executing. When the person with the money (“the investor,” let’s say) funds the person with the venture (“the founder”), hoping to earn a profit, that is what we call “finance.”

The two basic types of investment finance are debt and equity. (There are a few more exotic varieties, but they are fairly marginal and we can safely skip them.) Equity can take a few forms, but essentially, the investor and the founder are joint partners, and the investor is entitled to some fraction of the profits from the business. Exactly how much profit will depend on many factors—not least of which, how easy is it for the founder to find investment capital, and how much risk does either party want to take?

In a pure equity investment, the fortunes of the investor rise and fall with those of the venture. The investor can lose the entire investment if the venture fails, or make incredible amounts of money if the venture takes off. The investor’s interests are therefore closely aligned with those of the founder (at least in broad terms).

Debt, on the other hand, is more adversarial. If the founder borrows money from the investor, he is promising to return the money and the finance charge whether or not the business is profitable. And the investor maximum return is limited by the agreed-upon finance charge; the investor will make the same amount of money if the business is a modest success, spectacularly profitable, or even mildly unprofitable (as long as there is enough to cover the loan payments). Obviously, the investor would prefer that the business succeed, so that the founder has enough money to repay the loan. But a lender’s main interest will be safety, and he will not necessarily pursue the chance of high returns if it means taking high risks. He will also try to get his money back even if it means sucking the venture dry.

Lenders are happier when they can lend against some kind of collateral—some valuable good which can be seized if the loan is not repaid. This could be many things: a house, a car, a horse, family jewelry, or the rights to future royalties from sales of Harry Potter. The better the collateral, the less risk the lender is taking. In a well-functioning society, the lender will therefore charge less interest on a secured loan than an unsecured loan, because the chance of losses is smaller. (That is why you can still get a mortgage in America for less than 10% interest, while credit cards typically charge 15% and up.)

This also means that if you don’t have collateral—for example, if you are starting some sort of business venture and have nothing to show for it yet—it is very hard to get debt financing. Equity finance is better at handling business ventures without tangible assets.

But equity finance poses special problems: how do you keep track of how much money the business made, and the investors are entitled to? It is very easy for the management of a venture to hide profits from the investors, without a very complex infrastructure of laws, public data, and accountants to try and keep people honest. It took centuries of slow accumulated experience and trial-and-error before we arrived at the system for securities markets that we have today, and it is by no means perfect. But in previous times, equity investment was typically limited to partners who knew, and trusted, each other. Equity was thus on a relatively small scale, businesses were very hard to start, economies were relatively stagnant, and economic growth was slow.

Debt, on the other hand, is fairly easy to deal with. How much you owe is fixed by agreement; and the lender doesn’t need to know anything about how you made the money, only that you are able to repay on time. Debt was therefore the most common form of finance by far throughout history; and it is only recently that equity investments have been possible on a large scale.

However, even in ancient times it was possible to combine the two methods of investing. For example, the Babylonian Talmud records a common form of partnership in which half of an investment was considered equity, and half was debt. The founder thus had to repay half (but only half) of the investment regardless of the venture’s success or failure, along with a portion of the profits if there were any. Interests were better aligned between the partners, and the investor still had some degree of safety.

To summarize, when thinking about some sort of business venture that needs investor capital, like a caravan to the Far East, or a merchant ship, or a band of mercenaries sent to plunder the fabled City of Gems, you can think about useful investment structures with the following questions:

  • Who is taking the risk of irregular profits, and how much risk?
  • How well can the investor monitor the founder?
  • What kind of collateral is there?
  • Does the legal system or other external structures provide protections for either side, or make one kind of investing more attractive than the other?

*****

(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 for Worldbuilders. No idea when it will be finished, but it should be fun!)

Economies Dependent on Outside Investment

26 Wednesday Oct 2022

Posted by in Economics, Finance, Politics, Politics for Worldbuilders, State Formation

≈ Leave a comment

Tags

, , , ,

One of the most trafficked posts on this blog is a brief discussion of “Varieties of Capitalism” theory, pointing out how some capitalist economies feature a set of institutions that foster a more dynamic economy and radical innovation, and others have institutions that foster a more sedate, “managed” economy featuring more incremental innovation. (As far as I can surmise from web traffic stats, some comparative-politics professor at San Francisco State University must have noticed the post and included it in a course syllabus. I’m flattered!)

But in the years since I left grad school, the field has marched on. Apparently, scholars have identified at least one other “variety” of capitalism that fills in a bunch of empirical gaps of prior theory. This is the dependent market economy (DME), whose distinguishing feature is that it relies heavily on the foreign investment of outsiders for capital—typically transnational corporations. In this post, I’ll briefly discuss the key features of the DME that would be useful for worldbuilders.

The first economies to be designated as DMEs were found in Eastern and Central Europe, countries that had formerly been dominated by the Soviet Union. They featured an unusual combination of factors: a populace that was reasonably well educated and technically skilled, yet still had low wages, and where the countries’ economic institutions had been totally wiped away and could be built afresh according to the preferences of anyone with enough clout. These were the transnational corporations, who are always on the lookout for skilled, cheap labor. They used the lure of their massive investment to induce the former Warsaw Pact countries to establish institutions that were favorable to company interests—and turned these countries into favored sites for the assembly of “semistandardized industrial goods.”

What are the features of the DME, and the institutions that develop there?

  • A population that had reasonable technical skill—but not too much, or they could develop their own indigenous industries and not be dependent on outside investment.
  • Low wages.
  • A massively disproportionate level of foreign direct investment that dominates the economy, usually because of the lack of domestic capital. (For example, in 2007 Hungary and the Czech Republic both had FDI equal roughly half of their entire gross domestic product.)
  • Governance that is largely controlled by transnational corporate hierarchies, so local company subsidiaries take orders from the parent companies back home. (They also receive funding from back home, rather than relying on local banks or the stock market.)
  • Weak labor laws and no national labor unions.
  • On the other hand, individual companies typically treat their workers well in relative terms, because they don’t want their supply chains disrupted; so management and labor tend to work closely together, company by company. (But companies try to avoid simply paying higher wages, which defeats the point of the exercise!)
  • Little investment in worker training or a public education system, and the education system’s reorientation to the specific skill needs of the transnational companies, because companies don’t want to spend a lot of money or make it easy for their workers to leave, and because the DME is not meant to develop new technology—only to implement the technologies developed elsewhere.
  • Sectors of the economy where the country has a clear comparative advantage, such as the assembly of automobiles or electronics, are dominated by foreign ownership. The same is often true of the banking system, which needs a lot of capital. Meanwhile, less competitive segments of the economy remain in domestic hands, but languish. If left unchecked, this division could lead to tensions between wealthier and poorer worker groups in society.

We thus have another model for what an economy could look like, and why it would look that way. True, few worldbuilders will be working with a direct analogue to something like the collapse of the Iron Curtain; but if you’re thoughtful, you can extract useful principles from the foregoing for use in your work.

There are additional types of economies—chiefly the typical “dependency” economy (or supply region) that is exploited for basic commodities; the “patrimonialist” society with high corruption, patron-client networks, informal arrangements, and pervasive insecurity; and the incoherent mishmash that borrows features from several other economies which don’t necessarily work well in combination. I hope to explore some of these more in later writing.

******

(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 for Worldbuilders. No idea when it will be finished, but it should be fun!)