I had the pleasure of attending a conference at the University of Michigan on “Conflict, Legitimacy and Authoritarian Rule” last week (April 26th 2013).

The conference was sponsored by the University of Michigan’s Department of Afroamerican and African Studies (DAAS) and the African Studies Center and organized by Didier Péclard and Anne Pitcher, who were terrific hosts. Here is the description:

This one-day workshop proposes to look comparatively at the social and historical construction of political legitimacy in contexts of civil war, political instability, and authoritarian rule. What makes institutions and/or regimes legitimate in the midst of violent conflict and apparent disorder? How does institutional order emerge out of instability or conflict? How do authoritarian regimes build their legitimacy, in particular in post-civil war transition periods? What influence do resources (natural, material but also symbolic) have on the development and social perception of legitimate rule?

I presented a paper on monarchical exceptionalism in the Middle East and North Africa (MENA) both during the Arab Spring and historically. This paper complements an earlier paper that uncovered statistical evidence for the fact that MENA monarchies are far less likely to experience political instability than non-monarchies, a paper that caught the eye of Marc Lynch at Foreign Policy. Here is the slideshow of the presentation.

For folks interested in the other papers presented at last week’s conference (see poster, above), which were all quite stellar, here are the abstracts.

By Susan Whiting

Agreeing that fiscal capacity is only one part of state capacity, I’ll still focus on fiscal capacity and ask whether China’s fiscal capacity is actually low (and whether it’s low in light of China’s history).

Should we expect China’s antiquity to affect its tax ratio? No, for the following two reasons. First, there have been sharp historical discontinuities in China, especially during the 1900-1950 period. These included devastating rebellions from the mid-19^th Century on, warlordism, and a civil war in the 1^st half of the 20^th Century. Second, it is not just the existence of institutions that matters, but the nature of the institutions that matters. One can note the debates over the nature of the tax burden during the Qing dynasty. And taxes played a very small role in the planned economy. Instead, revenue was extracted through state monopoly ownership, “profit’ remission, and state-set prices.

Taking these factors into account, is Chinese extractive capacity low? No, because formal taxes are only part of the systematic extractive capacity of the state used for infrastructure development, administration, and other public goods. While the tax ratio in the post-planning period went from low of ~11% to ~18%, this ignores fiscal off-budget revenue, which rivals the size of the formal budget (based on formal taxes) and is used in significant part for public goods provision, especially infrastructure.  So, the effective budget of the Chinese state is systematically under-estimated.  Today, much land revenue is off-budgetary in China, although land is only the latest big source of extra-budgetary revenue.  The bottom line is that extractive capacity is systematically undercounted if one looks only at formal taxes.

Formal taxation targets firms (more generally than just SOEs as Xiao argues) more than individuals—so the relationship between legitimacy and revenue extraction may be different in this case. Therefore, I agree with the essence of Xiao’s point.

In my 2001 book I show with comprehensive small-n data that the jurisdictions with successful public/collective firms that have low tax ratios have high levels of off-budget funds used in large part for infrastructure development and administration. I conducted a separate survey focusing on extra-budgetary burdens conducted in 1997 in 127 industrial enterprises selected through a random, stratified sampling procedure in Xingtai City and Qinghe County of Hebei Province.[1]  It includes public, private, and foreign firms, including state-owned enterprises, urban collectives, township- and village-run enterprises, shareholding companies, private enterprises, and foreign-invested enterprises selected through a random, stratified sampling procedure.  This survey highlights the challenges in trying to gather comparable statistical data across a large number of firms; it proved very difficult to get complete and comparable accounting data on both sanctioned and unsanctioned extra-budgetary levies.  The most complete data was from attitudinal and experiential data collected from firm managers:

Firm Managers Who Agree that “Unsanctioned levies are a considerable burden on this firm.”

Firms Subject to Unsanctioned Levies During the Past Year

Firms Subject to Unsanctioned Exactions In-Kind During the Past Year

Firm Managers Who Are Indifferent Between Continued Unsanctioned Fees and a Formal Tax Increase Accompanied by the Abolition of Fees

This is from my more recent chapter “Fiscal Reform and Land Public Finance”:

Off budget funds exist outside effective MOF oversight. There exist no comprehensive data for those funds, but they are reported to rival or even exceed the size of the formal bud get for many local governments. The sources of off budget funds reflect both available revenue “handles”— places where revenue opportunities exist to exploit— and gaps in effective MOF oversight. These sources have shifted over time from enterprise fees to highway fees to land transfer fees and sale of government assets.

According to one study of land fees conducted in 2004, Guangdong, Shandong, Hunan, Zhejiang, and Jiangsu provinces generated the most off – budget funds from land transfers (Ping 2007, 9). Nationwide, these funds were estimated to total 615 billion Yuan in 2004, equivalent to roughly 3– 4 percent of GDP; they have become a primary source of income for many local governments (p. 9). An MOF study of local land revenues (including primarily land transfer fees) shows that they increased at nearly 70 percent per year on average nationwide between 2000 and 2004 (Zhang 2007). …

According to Li (2006, 42), for example, in Hubei Province the funds derived from land transfer fees are “almost without exception” dedicated to basic infrastructure development. Ping Xinqiao (2006) finds that, compared with budgetary funds, off – budget funds tend to have positive effects on spending for infrastructure and administration.

[1] The survey was conducted under the auspices of the Asian Development Bank Technical Assistance No. 2743-PRC and implemented by the Research Center for Contemporary China at Peking University.

I agree with Dick’s argument that a state’s legitimacy is closely associated with its capacity to extract revenue. A state’s perceived legitimacy determines people’s expectations about the state, and subsequently the degree to which they acquiesce to the state’s policies (including taxation). By this definition, the poorer the legitimacy of a state, the weaker the state’s capacity, and the more likely the state would adopt coercive means to induce compliance. For most of the twentieth century, as Dick illustrates, China was indeed ruled under brutality, a manifestation of the state’s “legitimacy deficit” and its relatively weak capacity.

Dick also argues that the Qing government’s failure to provide a key public good—transportation—resulted in its retarded urbanization, which eventually led China to a path of economic development that was quite different from its European counterpart. This very insight is actually consistent with Kenneth Pomeranz’s (2001) influential (yet controversial) work on the divergent development trajectories between the West and the East. He recognizes, as Dick does, that on the eve of the industrial revolution, Britain and China had achieved similar levels of development.

So why did the industrial revolution occur only in Britain? Pomeranz argues that the key difference lies in the distance between the two countries’ traditional economic centers and their major coal mines. Britain’s traditional economic center and coal mines overlapped. In contrast, China did not enjoy such a correspondence, resulting in a prohibitive cost of transporting coal to its economic center. While Britain was able to use more energy efficient coal to engage in large scale production, the Chinese got stuck with traditional production modes; they were unable to undertake the type of large scale production that requires huge inputs of energy and, of course, unable to generate a powerful new merchant class who could eventually make a difference to their country’s political institutions as was the case in Britain. In short, transportation does matter!

Getting back to the topic of state capacity: While I do agree that direct taxation is a good measure of state capacity in general, it may not speak to the particulars of specific countries. In the case of China, my feeling is that the ruling Communist Party is very aware of its relatively weak legitimacy, therefore it strategically chooses much less salient (or indirect) ways of extraction to avoid a potential demand for “more representation (i.e., democracy)” associated with direct taxation. A very large portion of China’s revenue comes from the state-owned enterprises (SOEs), which enjoy monopoly status in key sectors such as energy, electricity, transportation, telecommunication, and banking. The government “taxes” the population indirectly by first letting its agent—SOEs collect their monopoly rents, and then transferring these rents to the state. This “disguise” certainly works.

In China’s online discourse, we can find many people expressing their grievances over the prohibitive gasoline price (China’s gasoline price is now more expensive than that of U.S. even by nominal currency), or banks’ unreasonably high service charges, but we can hardly find anyone who complains about how much tax s/he pays (as we would often find in US). By the way, the consumption tax in China is baked into the sticker price (in contrast to the US), which is another manifestation that taxation is concealed by the government.

In addition to SOEs, land is also an important source of government revenue. Land is owned, and can only be owned by the state in China. When a person purchases a home, s/he makes an ostensible purchase payment to the real estate developer. In reality, s/he makes a payment to the state, because the developer has to pay the state a lump sum to acquire the right to use the land for 70 years (This means the state still keeps the title, and people basically lease their home or 70 years; for business property, the period is 40 years). The amount of money the state collects from selling the land-use right (also popularly called “land revenue”) is astronomic. In 2010, alone, local governments in China collected 441 billion dollars in land revenue. As a comparison, local governments’ revenue through taxation was about 600 billion dollars in the same year (calculated by myself based on official statistics and adjusted for non-tax revenue). In conclusion, China’s low share of direct taxation might be a strategic response by the Chinese government to its “legitimacy deficit”; and it does not mean the government lacks other, less salient (or indirect) ways to extract enough revenue from the population and then use it to act like a strong state.

The China case shows how complicated it is to measure state capacity. One big problem is that there is no clear-cut definition of state capacity. People often lump state capacity together with countries’ other characteristics, including their regime type. I still remember that in one of the compulsory “brain washing” classes I took during middle school in China, my teacher taught us that the former Soviet Union descended into chaos, and its people suffered a steep decline in their quality of life, as a result of them “choosing western style democracy”. I now realize that the teacher (or the Propaganda Department that formulated her lesson plans) lumped democracy together with the state weakness that followed the Soviet collapse to better impugn democracy.

On February 21st 2013 I gave a talk entitled Latin American Exceptionalism: the Politics & Economics of Unfulfilled Promise to the World Affairs Council of Olympia.

I was kindly received by John Hamilton, who was U.S. Ambassador to Peru from 1999 to 2002 and to Guatemala from 2002 to 2005, along with a group of other wonderful folks who have either lived in Latin America or traveled widely throughout the region.

Here is the slideshow that went along with my talk.

Here is a summary of my talk:

At the World Affairs Council I addressed the puzzle of why there has been such a sharp divergence in political, economic and social outcomes between the Latin American countries and former settler colonies such as the United States, Canada, and Australia. These differences exist despite the fact that the countries in both regions are about the same age, and despite important similarities. They bespeak a widely documented reversal of fortune in which the Spanish colonies were once significantly wealthier and more sophisticated than the North American ones. This was true both before and during colonialism, until the latter overtook the former on their way towards joining the world’s most developed countries.

To help explain this puzzle I illustrated the importance of a few crucial and interrelated factors. These factors partially account for both these countries’ divergent historical trajectories and contemporary differences. I began by outlining the differences between Latin American countries and former settler colonies in terms of their colonial and post-colonial histories and political economies. I drew on Engerman and Sokoloff (2002), Easterly (2007), Haber (2010), Haber and Menaldo (2011), and Haber (2012), and outlined differences in factor endowments, including climate, soils, and the presence and density of native populations. I also discussed differences in the colonial strategy pursued by Britain versus Spain and Portugal, as well as differences in the distribution of income, assets and human capital among the colonies’ respective populations.

The crux of my talk was to link these underlying differences to differences in colonial and postcolonial institutions. A legacy of oligarchy and centralization connected to relative structural inequality in Latin America versus democracy, civil rights, and federalism connected to relative structural equality in North America. I argued that these institutional differences have mapped onto very different economic policies – fiscal, monetary, regulatory, land, and immigration policies, among others. In turn, these policy differences explain both historical and contemporary differences between Latin America and the settler colonies in terms of modernization, economic development, the progressivity of the tax structure, the provision of public goods—most importantly education and infrastructure—and social insurance.

Whereas public investments and egalitarianism have been more common in North America, they have been relatively rare, and have only arrived quite recently, in Latin America. For obvious reasons, I argue that these policy differences therefore culminated in palpable differences in inequality and poverty rates between Latin American countries and their North American cousins. These persist today.

In what follows I outline some puzzles about China’s state development and capabilities and Dick Wesley then addresses them.

China’s contemporaneous level of state capacity is much lower than would be predicted by its age. While China is the world’s oldest continuously existing state, on some dimensions it is quite a weak one. The figure, below, evidences this fact by depicting the relationship between the State Antiquity Index (plotted on the X axis) and direct taxes (plotted on the Y axis) for a cross- section of countries in 2006. Collecting income taxes requires major investments in enforcement and compliance structures across the economy. Assessing and collecting direct taxes depends upon a well-functioning legal system and a competent, professional, and honest bureaucracy that can enforce compliance. Meanwhile, State Antiquity is a measure of the longevity of a state’s infrastructure and bureaucracy. Countries with longer political legacies have had a greater chance to develop state capacity tied to the development of agriculture, urbanization, and the use of money.

Direct Taxation is taxes on income, profits & capital % GDP. It is from Albertus and Menaldo (2013). State History is the State Antiquity Index. I follow the authors and use the normalized version (0 to 1) of this index while discounting the influence of the past for each half-century by 5%. I also follow Putterman and Weil (2010) and adjust the index by migration because, during the colonization of America, Sub-Saharan Africa, and Asia, European settlers, non-European servants and slaves migrated and imported their home institutions.

That China lies considerably below the regression line, in the lower right hand corner, is very puzzling. Although a state’s age is certainly not the only factor that explains its ability to collect direct taxes (the r-squared of the regression represented by the figure is only .05), China’s surprisingly low fiscal capacity differs notably from countries that are similar. Take Japan, which is also a very old state and, as expected, collects a relatively high level of direct taxes (its observed value for this variable lies on the regression line). China’s low fiscal capacity is also surprising from the vantage of its own history, in that China has been home to various administrative innovations over millennia. Indeed, it was two centuries before Christ that the Ch’in dynasty, from whom China got its name, introduced a centralized bureaucracy, a census, and a standardized system of weights and measures.

Why does China have such low fiscal capacity today? Does it also have low levels of state capacity on other important dimensions? What role, if any, does the Chinese state’s legitimacy (or lack of it) play in explaining its contemporary patterns of state capacity?

Dick Wesley helps address these questions in the following essay.

State capacity may be defined by many elements. I will focus upon 3 major elements: (1) societal acquiescence or approval by either coercion or persuasion (2) fiscal capacity-the ability of the state to obtain financial resources from its population in order to efficiently provide public goods (3) steering or regulatory capacity-the ability to encourage economic development.(Sharpe 1995). All 3 elements are crucial and interdependent. If a government has limited ability to maintain societal acquiescence or societal approval, its ability to provide adequate fiscal capacity or to steer the society through laws will likewise be limited. State legitimacy is closely related to state capacity and is the crucial element required for societal approval through persuasion. The excessive use of coercion by a state to maintain societal acquiescence results in reduced durability of the state, and greater difficulty in performing both its fiscal and steering/regulatory functions.

China at the beginning of the 20th century was governed by the late Qing Dynasty which exhibited extremely weak state capacity as manifested by its inability to control its population. The central government had originally considered the Boxer Rebellion to be an internal threat to its existence and engaged in attempted suppression of the boxers. When the 8 powers invaded China in an attempt to protect their citizens, missionaries, and legations from the boxers, the Chinese central government reversed course and declared war against the invading 8 powers. The weakness of the Chinese government is clearly shown by division within the central government and lack of support for the war exhibited by many of its officials. The failure of the southern warlords to support this declaration of war further illustrates the state’s weakness. One southern warlord ordered mass decapitation of men, women and children accused of being a part of the boxer movement. The heads were hung from trees within an orchard within his province. Aside from violence and brutality, what can we understand from this event? I argue that these actions are a sign of weak governing capacity of the local warlord. The action was designed to warn local residents that support of the boxers would be suppressed brutally. Control of society was managed by coercion rather than persuasion. The latter approach would have been far more costly for the local government. An alternative measure to execution would have been imprisonment but this, too, would have been more costly. The method of execution, decapitation, was shockingly symbolic. While this event was carried out by a provincial warlord, under other circumstances, the central government and provincial warlords/local elites worked together for management of government – societal control, taxation, and institutions regulating commerce, and social interactions. Thus, weak local societal control becomes a manifestation of weak state capacity.

The concept of societal acquiescence or approval by government through coercion and persuasion has been long understood in China. Records from the Han Dynasty (200 BCE) confirm the understanding that social control through persuasion is preferable when possible, but that state coercion is often required (Turner 1993). Much attention was paid to construction of laws to provide consistent punishments and rewards. The efficacy of harsh punishments by government was questioned. The Confucian principle advocating education and moral leadership was recognized as the preferred approach. The preceding Qin Dynasty had used excessive force and capricious application of law which was felt to have been a major causal factor for its short duration. This evidence suggests that cultural knowledge supported brutal government coercion as a last resort. Only a weak state would indiscriminately utilize excessive coercion as the primary means of societal control(Gilley 2006).

The capacity of the state to extract revenue from its population efficiently and in adequate quantity is crucial to support government functions(Collins and Chan 2009). Both the size of China in terms of territory and the low density of its predominantly rural population made this process difficult. Because of the nature of its agricultural economy, taxation of land and salt were primary sources of government revenue. The high cost to the central government to adequately monitor apportionment of taxes and their collection led to delegation of this activity to local landowning elites. Efficient tax collection suffered from tax evasion by local elites and diversion of tax revenue by local elites. It is estimated that as much as one third of all tax revenue was diverted through corruption in 1753(Kiser and Tong 1992). It is estimated that in 1840, total tax revenue represented only 2% of Chinese GDP(K. Deng 2003). However, others suggest that tax revenue was as high as 5% of GDP in both China and Europe by 1900 (Feuerwerker 1984). In the 20th century, tax revenue as a percent of GDP grew rapidly in Europe reaching 20% or more while tax revenues in China were unchanged.

Efficient government provision of public goods (such as internal and external security, roads, dams, irrigation projects, economic institutions, education, judicial system, and social welfare) represents a 2nd element of fiscal policy. How well was the Chinese government of the 20th century able to perform these functions? Given the collapse of the Qing Dynasty in 1911, continuous civil war between 1927 and 1949, and the 2nd Sino Japanese war (1931-1945), it takes little imagination to recognize that provision of public goods was both inefficient and insufficient. Following the conclusion of the Civil War and the establishment of the People’s Republic of China, conditions did not improve. The Great Leap Forward and the Cultural Revolution produced government made/man-made disasters between 1949 and 1978. Only in 1978 did the Chinese government begin to improve the provision of public goods.

One of the most important elements of public goods provided by governments are the economic institutions which allow efficient economic function, gains in productivity, and thus gains in prosperity. Economic prosperity and fiscal capacity of the state are intimately linked. All things being equal, revenue extraction from the population by the state increases as prosperity increases. As the state is then able to provide a greater quantity of public goods, economic productivity improves and prosperity increases. Thus, a positive feedback mechanism exists. Unfortunately, the reverse is also true. As the state provides less public goods (economic institutions, judicial systems, roads, etc.) productivity in the real economy decreases and prosperity also decreases. This may well have been the case in 20th century China for the reasons stated above. Public goods are accumulated over centuries(Bockstette, Chanda, and Putterman 2002). Economic institutions, judicial systems, educational systems, roads, and dams are examples of public goods developed are accumulated over time. China entered the 20th century with a deficit of public goods relative to Japan and Europe.

In 1800, scholars are in agreement that China and Europe had essentially equal economic prosperity(K. G. Deng 2000)(Feuerwerker 1984). During the 19 century Europe experienced dramatic increases in economic productivity (Industrial Revolution) which were not matched in China(K. Deng 2003). Scholars are divided over the cause of this economic divergence. The most convincing evidence suggests that China did not develop the economic institutions required for rapid growth of economic productivity(Acemoglu, Johnson, and Robinson 2005). These institutions include protection of property rights, contract enforcement, financial markets, banking systems(Greif and Tabellini 2010), labor mobility, and trade markets. Most scholars agree that China had developed adequate property rights and labor mobility but had failed to develop financial markets and banking systems(K. G. Deng 2000)(Greif and Tabellini 2010). Financial markets and banking systems allowed accumulation of capital for investment in Europe but not in China(Feuerwerker 1984). Further, China had limited trade relative to Europe, which did not allow China to benefit from gains provided by comparative advantage. Limited access to shipping lanes hindered trade for most of China. Concentrated capital allowed the development of large firms in Europe but not in China. All else being equal, large firms demonstrate greater economic productivity than smaller firms.

Development of manufacturing firms requires that several conditions are met. A country’s agricultural sector must be able to produce sufficient food to support the non-agricultural sector. Further, food must be transported from the point of supply to the point of demand. The cost of transportation is an important consideration. Evidence suggests that Europe was able to supply food to towns and cities less expensively than was a case in China. By 1900, 10% of Europeans lived in cities with populations greater than 100,000. At the same time in China, 5% of Chinese people lived in towns with populations greater than 4000(Feuerwerker 1984). It is known that 20% of the rural population of China was engaged in non-agricultural activity which suggests that China had adequate food production to support larger urban populations(Feuerwerker 1984). I conclude that transportation cost of food in China, relative to Europe, was the limiting factor for urbanization. Because China could not support efficient urbanization, large manufacturing enterprises did not emerge as they did in Europe.

State legitimacy may be defined as societal acceptance or approval. Crucial to this definition is the understanding that legitimacy is determined by consensus of the society. Multiple scholars have described the origin of societal consensus differently. Lipset (1981) suggests the concept that legitimacy is obtained when the society accepts existing political institutions as appropriate. Linz (1988) suggests that legitimacy is achieved when society accepts existing political institutions as better than or at least as good as any possible alternatives. Zhao suggests 3 potential sources of legitimacy which appear to cover all of the alternatives: (1) ideological legitimacy, (2) legal-electoral legitimacy, and (3) performance-based legitimacy(Zhao 2009). Chinese state legitimacy during the Empire phase (221 BCE-1911 ACE) was based upon ideology, according to the work of Yuri Pines. During the 20th century, Chinese state legitimacy, if present at all, was highly unstable and transitory. Zhao argues that Chinese state legitimacy after 1978 has been increasingly based upon performance. As performance-based legitimacy has grown, the Chinese state has relied increasingly less upon coercion(Gilley 2006). Future control of state power by the Chinese Communist Party will depend upon both performance-based legitimacy and coercion in varying amounts. Should economic progress falter, one might expect the CCP to rely more heavily upon coercion. Other scholars argue that economic progress may reduce CCP/state legitimacy in China (Perry 1994). As the CCP relaxes control of social organizations, coercion will become more difficult due to reduced ability to monitor these organizations(Saich 2000). Legal-electoral legitimacy does not appear likely as a basis of state power in the near future.

Bibliography:

Acemoglu, Daron, Simon Johnson, and James Robinson. 2005. “Institutions as the Fundamental Cause of Long-Run Growth.” In Handbook of Economic Growth, the role. North Holland Press.

Bockstette, Valerie, Areendam Chanda, and Louis Putterman. 2002. “States and Markets: The Advantage of an Early Start.” Journal of Economic Growth 7 (4) (December 1): 347–369. doi:10.1023/A:1020827801137.

Collins, Paul, and Hon S. Chan. 2009. “State Capacity Building in China: An Introduction.” Public Administration & Development 29 (1) (February): 1–8.

Cumming-bruce, Nick. 2013. “U.N. Calls on Papua New Guinea to Curb Violence After Burning Death of Woman.” The New York Times, February 8, sec. World / Asia Pacific. http://www.nytimes.com/2013/02/09/world/asia/un-calls-on-papua-new-guinea-to-curb-violence-after-burning-death-of-woman.html.

Deng, Kent. 2003. “State Transformation, Reforms and Economic Performance in China, 1840–1910.” http://www.cambridge.org.offcampus.lib.washington.edu.

Deng, Kent G. 2000. “A Critical Survey of Recent Research in Chinese Economic History.” The Economic History Review 53 (1): 1–28. doi:10.1111/1468-0289.00150.

Feuerwerker, Albert. 1984. “The State and the Economy in Late Imperial China.” Theory and Society 13 (3) (May 1): 297–326. doi:10.1007/BF00213228.

Gilley, Bruce. 2006. “The Meaning and Measure of State Legitimacy: Results for 72 Countries.” European Journal of Political Research 45 (3): 499–525. doi:10.1111/j.1475-6765.2006.00307.x.

Greif, Avner, and Guido Tabellini. 2010. “Development, Culture, and Institutions – Cultural and Institutional Bifurcation: China and Europe Compared.” The American economic review. 100 (2): 135.

Kiser, Edgar, and Xiaoxi Tong. 1992. “Determinants of the Amount and Type of Corruption in State Fiscal Bureaucracies An Analysis of Late Imperial China.” Comparative Political Studies 25 (3) (October 1): 300–331. doi:10.1177/0010414092025003002.

Perry, Elizabeth J. 1994. “Trends in the Study of Chinese Politics: State-Society Relations.” The China Quarterly (139) (September 1): 704–713. doi:10.2307/655137.

Saich, Tony. 2000. “Negotiating the State: The Development of Social Organizations in China.” The China Quarterly (161) (March 1): 124–141. doi:10.2307/655983.

Sharpe, M. E. 1995. “State Capacity.” Chinese Economy 28 (3) (May 1): 27–43. doi:10.2753/CES1097-1475280327.

Turner, Karen. 1993. “War, Punishment, and The Law of Nature in Early Chinese Concepts of The State.” Harvard Journal of Asiatic Studies 53 (2) (December 1): 285–324. doi:10.2307/2719452.

Zhao, Dingxin. 2009. “The Mandate of Heaven and Performance Legitimation in Historical and Contemporary China.” American Behavioral Scientist 53 (3) (November 1): 416–433. doi:10.1177/0002764209338800.

Is there a resource curse? For decades, parallel literatures in political science and economics have argued that oil and minerals are correlated with a lack of economic diversification, slow growth, corruption, and authoritarian government. These findings have had an impact well beyond the academy. The resource curse is taken as a self-evident truth at multilateral aid organizations, presented as a robust fact in popular books on world poverty, and is disseminated widely in the media. Indeed, New York Times columnist Thomas Friedman has gone so far as to decree a “first law of petro-politics”: the price of oil and the spread of political freedom are inversely correlated. The policy implications are non-trivial. Some researchers have even suggested that developing countries should consider leaving their resources in the ground, in order to avoid their pernicious effects.

Just yesterday, Tina Rosenberg posted a Fixes entry in the Times about how to mitigate the so-called resource curse. This follows countless other opinion pieces that assume there is such a thing and/or prescribe solutions for it, as well as normal reporting about the developing world that warns readers–and by extension, policymakers and concerned citizens–about the dangers of the resource curse. A quick search of the term revealed 6,890 results! I urge folks to do this search to get a sense of how deep-seated this belief is.

Tina Rosenberg writes:

Every nation wants to strike oil, and after it happens, nearly every nation is worse off for it. It may seem paradoxical, but finding a hole in the ground that spouts money can be one of the worst things that can happen to a country.

Oil-dependent countries, writes the Stanford professor Terry Karl, “eventually become among the most economically troubled, the most authoritarian, and the most conflict-ridden in the world.” This phenomenon is called the resource curse.

Oil is the world’s most capital-intensive industry, so it creates few jobs. Worse, it obliterates jobs all across the economy. The export of oil inflates the exchange rate, so whatever else a country manufactures is less competitive abroad.

Oil concentrates a nation’s economy around the state. Instead of putting resources into making things and selling them, ambitious people spend their time currying favor or simply bribing the politicians and government officials who control oil money. That concentration of wealth, along with the opacity with which oil can be managed, creates corruption.

Petro-dependence also leads to conflict. The conventional wisdom used to be that grievances were the cause of conflict, but that ended after the economists Paul Collier and Anke Hoeffler found in a series of ground-breaking studies that more important was the opportunity to grab oil or other commodity resources. They showed that if a third or more of a country’s G.D.P. came from the export of primary commodities, the likelihood of conflict was 22 percent. Similar countries that did not export commodities had a 1 percent chance.

If a government can finance itself through the profits on oil, it needn’t collect taxes. Let me suggest that this is not a good thing. Taxes create accountability — citizens want to know how the government is spending their money. Substituting oil revenues decouples government from the people. The list of the world’s worst-governed countries today features many that are dependent on the production of oil: Nigeria, Angola, Chad, Venezuela, Libya, Equatorial Guinea.

Simply put, none of this is true! It does not hold up to empirical scrutiny.

What accounts for the fact that several resource rich countries—e.g., the United States, Canada, Chile, Mexico, Trinidad and Tobago, Botswana, Ghana, South Africa, Malaysia, Indonesia and Australia—have modernized and become democratic? Why is reliance on resources in developing countries such as Ecuador, Bolivia, Nigeria, Angola, and Iran higher than it ever has been in the United States, Canada, Norway, and Australia, even though the latter’s geological endowments are larger and their resource extraction more efficient (David and Wright 1997: 236)?

Rooted in these questions, the view that there is a causal relationship running from oil to the pathologies enumerated above has been increasingly challenged by research that prioritizes sound causal inference. Bruckner et al. (2012), Haber and Menaldo (2011), Wacziarg (2013), and Wright et al. (2012) exploit time-series variation and instrumental variables and conclude that oil may actually bolster democracy, not undermine it. Haber (forthcoming) argues that Latin America’s industrialization was catalyzed by resource booms. Other skeptical research finds that oil boosts public goods (Stijns 2006), and economic growth (Alexeev and Conrad 2009; Brunnschweiler and Bulte 2008; Lederman and Maloney 2008), and does not cause civil wars (Brunnschweiler and Bulte 2009; Cotet and Tsui 2010).

Might it be the case that the causal arrow runs from weak institutions to resource flows, or even stocks?  Or might resources and the pathologies attributed to them be jointly determined by a third, yet unidentified, factor?

In recent work I identify what determines oil exploration and oil extraction rates in the first place. I argue and show that revenue-strapped states with low capacity are more likely than stronger states to launch oil exploration efforts and extract it at a high rate. I introduce a theory that argues that weak states fail to provide the political, legal, and infrastructural context that fosters broad-based economic development and, concomitantly, cannot generate a revenue base that can be easily taxed. States with low state capacity have large informal sectors and a dearth of modern firms with readily taxable assets and revenue flows. They do not possess the administrative infrastructure required to levy regular income and domestic consumption taxes. Moreover, weak states suffer from a scarcity of foreign exchange needed to pay for vital imports. These challenges motivate revenue hungry, weak states to explore for oil and fastidiously extract the associated rents once resource discoveries are brought online.

I also identify several strategies that have evolved to selectively protect property rights in the oil sector despite insecure property rights generally. Older methods were colonialism, Gunboat Diplomacy, and the oligopolistic structure of the market. Contemporary methods are centered on vast asymmetries in information and power between foreign investors and host governments. They include oil exporters partnering with investors through production sharing agreements and abiding by Bilateral Investment Treaties.

I surmise that the resource curse might be more fiction than fact. Causality may run from state weakness to both oil and several development pathologies that, rightly, produce consternation among well-intentioned researchers and policymakers. On the one hand, many oil-rich countries have always been cursed by state weakness. Conversely, state weakness is also responsible for the high inflation and inefficient, oligopolistic industrialization that has bedeviled much of the developing world. Therefore, it is institutions—not resources—that are the real curse.

Further reading:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1545103

The above linked paper, co-authored with Steve Haber, who has also published other work on the myth of the resource curse (check out “The Politics of Property Rights”) was the lead article in the flagship journal in political science (The American Political Science Review) two years ago. It shows that oil is positively associated with democracy: a resource blessing!

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2008889

The above linked paper demonstrates that it is weak institutions that induce oil exploration and greater reliance on oil, not the other way around. In other words, countries cursed with weak institutions are the ones that end up being oil reliant so that there is an institutions curse, not an oil curse.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2028270

The above linked paper shows that oil wealth actually boosts non-oil taxation in many cases. I am revising this paper with better measures of oil stocks and now find that there is no evidence for a negative relationship between oil wealth and direct taxation.

I wish I could say this was the last post I will write on this topic. But I sincerely doubt it, because the resource curse is worse than a zombie. It simply refuses to die!

By Victor Menaldo

Below is an excerpt from a new paper I’m working on:

Do guns prevent tyranny? Do they help make democracy self-enforcing? The hypothesis that the right to bear arms, and the ubiquity of weapons in the general population, prevents tyranny has a long pedigree. It was articulated by the United States’ Founding Fathers, arguably inspired and continues to justify the Second Amendment to the US Constitution, and has become an increasingly popular adage. Meanwhile, the tenet that democracy is sustained when elites and citizens grow to have a self-enforcing stake in its continued survival has recently become a central idea in political science (Przeworski 1991; Weingast 1997; Acemoglu and Robinson 2006; Fearon 2007), emerging in the 1990s to grapple with an important puzzle. Only some democracies survived the wave of democratizations that began in the Iberian Peninsula in the late 1970s—with the death of Franco in Spain and the ouster of Salazar in Portugal—and were followed by political liberalization in several Latin American nations and the fall of the Berlin Wall and eventual collapse of the Iron Curtain. Many instead lapsed back into dictatorship, including Russia, Ukraine, Ecuador, Peru, Pakistan, Thailand, Madagascar, Mali, and Niger.

Uses of the term “Second Amendment Protects” in books published in English according to Google Ngram

At the heart of theories of self-enforcing democracy is the notion that citizens have a vital, active role to play in enforcing democratic practice and electoral results. This implies two things. The first is that citizens can solve their collective action problem (Olson 1965) and coordinate to advance their interests. The second is that citizens can credibly threaten political elites; that they can use the threat of punishment to ensure elites acquiesce to the demand for democracy in the first place (Acemoglu and Robinson 2006), or do not overstep their bounds after they are elected to office (Weingast 1997). This begs the question, however. If by controlling the government elites have or approach a monopoly on the use of force (Weber 1967), and this entails the ability to threaten, harm or kill citizens, then how do citizens make their threat to punish or even overthrow the government credible?

One obvious answer is that this threat is made credible by citizens’ easy access to weapons and their ability to organize as a militia to protect their rights. In other words, it is guns that might make democracy self-enforcing and thus prevent tyranny. Indeed, the desire to prevent tyranny continues to be summoned as a key reason to vouchsafe the integrity of the Second Amendment to the United States’ Constitution, which gives citizens the right to own and carry arms, as well as organize as militias. The United States’ Founding Fathers themselves are often recruited to make this point. For example, George Mason, brainchild of the Bill of Rights, is quoted as saying, “To disarm the people is the best and most effectual way to enslave them.” James Madison, one of the key authors of the Constitution, remarked that tyrants “(are) afraid to trust the people with arms.” And although the history of Second Amendment jurisprudence once evinced a preoccupation with the connection between the right to bear arms and the existence of, or participation in, a well-organized militia, this has recently given way to an interpretation of the amendment as an individual right explicitly tied to the framers’ concern that the confiscation of weapons could lead to oppression (see Scalia 2008).

It is unsurprising, therefore, that the hypothesis that the right to bear arms prevents tyranny has been politicized in the United States. It is frequently used by the National Rifle Association and gun enthusiasts as a rallying cry against gun control; moderate politicians and everyday citizens are also wont to voice this apothegm. Indeed, the shibboleth that the Second Amendment prevents tyranny has gained in popularity in light of the fear that tougher gun restrictions are on the horizon after a deadly spate of mass killings in 2012 that culminated with the Sandy Hook Elementary School Massacre in Newtown Connecticut. The murder of 20 schoolchildren and six adults seems to have galvanized greater support for gun control.[1]

Beyond politics and polemics, the popularity of this hypothesis is puzzling. Even if citizens were armed to the teeth with powerful and technologically advanced weapons, how could they ever stand a chance against the better armed and organized United States’ military? Provided that citizens could somehow solve their collective action problem and coordinate to defend their rights via armed rebellion, would they really be able to challenge history’s most awesome professional military: thousands of highly skilled officers and soldiers equipped with tanks, rocket launchers, Humvees, minesweepers, radar, jet aircraft, and infrared goggles? Indeed, is it not these individuals, not a ragtag militia of civilians with a hotchpotch of weapons and disparate levels of training to use them, which the United States’ government should fear?

In this vein, this paper takes the tenet that guns prevent tyranny to task—at least as it is conventionally understood. Indeed, I turn this notion on its head.  This paper introduces and empirically tests a theory in which democracy becomes self-enforcing when the personnel that compose a nation’s military develop a stake in the regime’s survival. Although this can occur for a variety of reasons, the primary manner in which it has happened in the modern era is through the development of advanced weapons systems centered on sophisticated technology. The adoption and institutionalization of these weapons calls on the creation of an equally sophisticated military. Building such a military requires identifying and training highly skilled and professional officers and soldiers who develop valuable human capital in areas such as engineering, mechanics and processing. Because the market for these skills is highly regulated by governments, however, in that militaries do not usually acquire their labor on open markets, these officers and soldiers earn rents from their employment in the armed forces vis-à-vis their outside options. They therefore develop a stake in the maintenance of democracy, lest the political instability that is endemic to authoritarian governments interrupt or endanger these rents. Therefore, guns do prevent tyranny indeed—but only when they lie at the technological frontier and are in the hands of professional soldiers.

By Dick Wesley

Puzzle: What has Greece gained and what has Greece lost as a result of participation in the Economic and Monetary Union (Eurozone)?

Argument: Greece has gained a little and lost much as a result of its participation in the Eurozone.

The Facts: Since economic statistics have been maintained for the Eurozone beginning in 1992, growth in the Eurozone has underperformed relative to the European Union.

Real GDP growth in Greece has outperformed the Eurozone average since Greece’s entry in 2001. This growth does not indicate benefit from entry into the Eurozone, but is explained by 3 additional factors. Greece began from a very low GDP per capita (see below) relative to the Eurozone. Greece benefited from a huge inflow of capital. This capital inflow resulted from massive national budget deficits, as well as large amounts of portfolio inflow from foreign investors (see below). The result was unsustainable growth with high inflation.

 The purpose of Greek entry into the Eurozone was to promote greater trade within the Eurozone area, the European Union, and the world. As is shown in the next graph, there has been imperceptible increase in world trade as a percentage of GDP for him Greece since entry into the Eurozone. The graph does indicate that Ireland has benefited from increased exports as a percentage of GDP.
Greece has shown virtually no change in percentage of exports to Eurozone countries since entry into the Eurozone in 2001. At the same time, Greece has shown significant increase in exports to the European Union. Membership in the European Union seems to have benefited Greece, but adoption of the euro has not.

Examination of Greece’s 10 largest trading partners shows that only 4 are part of the Eurozone while 7 are members of the European Union. Membership within the European Union appears to be more beneficial than membership within the Eurozone. Only 2 of Greece’s 5 largest trading partners are members of the Eurozone.

OECD-Monthly Statistics of International Trade.

Examination of foreign direct investment and foreign inflow of portfolio capital reveals that Greece had large amounts of the latter but small amounts of the former. Assuming rational investors, Greece was not viewed as an economy with long-term potential for economic growth and thus foreign direct investment was small. Other rational investors assumed that Greece would benefit in the short term from convergence to the Eurozone average GDP.

 When Greece’s economic problems became visible in 2008, both foreign direct investment and foreign portfolio investment immediately stopped. The graph above demonstrates an outflow of portfolio capital in 2008 and dramatic flight in 2010.

 The graph below documents Greece’s laws of international trade competitiveness resulting from relatively high inflation and fixed exchange rate (euro area) since entry into the Eurozone. The dramatic rise in the current account deficit of Greece began in 2004 and continued until 2008. Since 2008, there has been a reduction in Greece’s current account deficit. It is instructive to compare the years 2008-2011 with the years of 1989-1991. Greece experienced an increasing current accounts deficit in 1989 and 1990. Because Greece had a sovereign currency and flexible exchange rate, the current account deficit in this early period resolved rapidly. Note that Ireland, Italy, Spain, and Portugal were all part of the European Monetary System and Exchange-Rate Mechanism between 1979 and 1999. In 1990, fully flexible capital flows were instituted in countries utilizing the Exchange-Rate Mechanism. Between 1992 and 1994, all of these countries experienced relatively high inflation in comparison with Germany and rising current account deficits. As a result, all 4 countries devalued their currency against the European Currency Unit and rapidly improved their capital and current account deficits. The option of currency devaluation did not exist between 2008 and 2011. As a result, these countries have experienced prolonged capital flight and current account deficits.

Conclusion: The evidence that Greece has benefited from adoption of the euro is difficult to find. The evidence that Greece has experienced prolonged economic depression beginning in 2008 and continuing through the present is clear. There is evidence that membership in the European Union has resulted in trade growth within the European Union. Many of Greece’s most important trade partners are neither in the Eurozone nor within the European Union.

 The future benefit to Greece of remaining within the Eurozone is unclear at this time. A departure of Greece from the Eurozone would be devastating for its economy in the short term. If Greece is able to restructure its economy to become competitive on the world market and is able to restrain the national deficit, it has much to gain from remaining within the Eurozone. If Greece fails to restructure its economy, then Greece’s future in the Eurozone is certain to be plagued by cycles of relatively high inflation, followed by cycles of severe depression and deflation.

Nate Jensen at Washington University asked for my thoughts on the role of legislatures in autocracies. His intent is to post these and other observations from political scientists and economists on his blog. I’ve decided to share these thoughts, with a few amendments, on my blog as well, since I’ve written about this issue elsewhere (here, here, and here).

Mexican President Miguel Alemán Valdés, of the PRI, delivering his second "state of the union address" to the Mexican Congress on September 1st 1948.

Myanmar’s recent political reforms speak to the importance of legislatures in authoritarian regimes. In April 2012, the opposition leader Aung San Suu Kyi assumed a seat in Burma’s parliament when she and her National League for Democracy (NLD) won 43 of 45 open seats in a parliamentary by-election. The arrival of the NLD members in parliament marked the first time in many decades that pro-democracy activists have had a chance to participate in government. Yet the current constitution, engineered by the generals who have ruled Myanmar for the past half-century, stipulates that one-quarter of parliamentary seats must be reserved for the military. Much of the remainder is held by members of the pro-government party. This has allowed the generals do dominate the legislative process to continue to cut favorable economic deals for themselves and consolidate their hold on power. The constitution is likely to remain in effect for the foreseeable future given that three-quarters of the parliament must vote in favor of any constitutional amendment for it to pass.

Across dictatorships legislatures have served a similar function. I will flesh these out below. These observations are informed by the Myanmar example outlined above, as well as by a few examples from the heyday of Latin American authoritarianism in the Cold War period. Specifically, what I have in mind is Mexico under single party rule (1929-2000), Brazil under military tutelage (1964-1988), as well as scattered episodes during the post-World War II history of Peru, Ecuador, Bolivia, and Panama.

Dictators turn to legislatures, among other tools, to consolidate their political authority once the regime has stabilized somewhat and reach a more mature stage. This is because legislatures, along with other seemingly “democratic” institutions, take a considerable amount of time to bear fruit. Parties and legislatures that are established at the outset of a regime remain unproven in their capacity to forward the interests of the political elites until they are tested, which requires considerable time. Regime insiders will therefore try to rely, first and foremost, on a constitution and most often take a big and direct role in crafting it; indeed, it is quite normal for political elites to push for a new constitution soon after a new dictator comes to power in order to codify their rights and interests and have at their disposal a focal point that they can use to coordinate against a dictator if need be. This pattern is now being repeated in Egypt by the Muslim Brotherhood to the considerable chagrin of opposition, liberal forces that have been excluded from the political game after Mubarak’s fall. In this sense, the power of legislatures is derivative: they are designed by constitutions and implemented according to a timetable outlined by the constitution.

Once established, however, legislatures, along with political parties and courts, allow a dictatorship to formally institutionalize their political power by defining who qualifies as a regime insider and who does not, what political insiders’ rights are, and what tools they can avail to defend their rights and pursue their interests. Along these lines, legislatures allow a dictator to do two important things. First, usher in a stable distributional arrangement, in terms of who will benefit from rents produced by the coercive power of the state and its politicized regulation of the economy. Second, help a dictator credibly commit to protecting the property rights and vital interests of regime insiders—not only in the immediate present but in the uncertain future, and even when the identity of key individuals who helped launched the regime into existence has changed.

A legislature helps achieve these functions because it provides a concrete and transparent set of rules and a predictable structure of political authority beyond the raw power possessed by regime insiders. A legislature provides a forum for political elites to come together and coordinate. This disciplines the dictator and deters opportunism against regime insiders. A legislature also allows for information to flow from the dictator to political elites and for feedback from the latter to the dictator.

Indeed, it may be the case that the law and who crafts the law matters as much or more in a dictatorship than a democracy. Membership in the legislature and its committees, or the ability to lobby legislators, allows political elites to have an opportunity to craft or at least modify the bills that define their rents. By having a direct input into the laws that are crafted, regime insiders have a say over monetary and financial policy, fiscal policy, trade policy and regulatory policy. It is through protectionist measures that create barriers to entry, and attendant monopoly rights, as well as tax breaks and subsidies. In many ways, therefore, autocratic legislatures might not be too different from legislatures in democracies if these are captured by special interests and end up doing the bidding of the politically powerful in ways that damage the interests of the median voter.

In the case of Mexico under the PRI dictatorship, for example, it was the legislature where the following economic pathologies were either created or refined: a highly regressive tax structure, transparent limits to competition in the banking system that led to severe credit rationing, and protectionist tariffs that propped up woefully inefficient industrial conglomerates that imposed very high prices on shoddy products–and many of which were eventually nationalized either de jure or de facto (through backdoor subsidies or forbearance on stranded balance sheets). Although these policies surely stimulated investment and rapid growth over decades, the so-called Mexican Miracle eventually came to a crashing end in 1982 when Mexico defaulted on its debt and devalued. That is to say, autocratic legislatures foster growth — until they don’t.

Finally, dictators can rely upon legislative institutions under autocracy to impose constitutions that will stick after democratic transition if their legislatures are relatively strong and autonomous. The reason for this is that new constitutions most often call upon elections for a constituent assembly, and dictators are able to more smoothly call, operate, and control such an assembly when it is rooted in an existing and well-functioning legislature. When constituent assemblies are called for in the absence of an effective legislature, it is more difficult for dictators to impose resilient constitutions. Consider Venezuela’s 1952 constituent assembly elections. That year a military junta that had been in power for three years held elections for a constituent assembly that was charged with drafting a new constitution and choosing a provisional president. Lacking the ability to identify and co-opt the opposition via a legislature, the military assassinated dissident army officers and others opposed to military rule. It also jailed approximately 4,000 citizens. Two million votes were cast in the presidential election that followed and it was won by the leader of an opposition party, Jovita Villalba of the Union Republicana Democrática (URD). The result was unexpected—and proved intolerable to the regime. The head of the junta, Pérez Jiménez, ignored the results of the election and proclaimed himself president. He then banned opposition parties. Although the constituent assembly finally met in 1953 and ultimately ratified Jiménez’s presidency, it was unable to agree upon a stable succession mechanism that could protect the military elite beyond the medium term. Jiménez remained in power another six turbulent years before being ousted in a coup.

By Dick Wesley
Has China been able to effectively deflate a property bubble? Will it be able to avoid a politically dangerous economic contraction? A review of the IMF July 2012 Article IV Consultation suggests this might be the case: China is orchestrating a relatively soft landing, although there are serious headwinds that may steer China off course and land it in a deeper downturn.
The highlights:

1) Growth: IMF staff project growth to moderate to 8 percent in 2012.
2) Inflation: IMF staff note that Chinese government policy has effectively reduced inflation from 6.5% in July 2011 to 3% in May 2012. Policy efforts to reduce inflation in the housing market appear to have been successful.
3) The eurozone crisis has resulted in a substantial reduction of Chinese exports.
4) Chinese fiscal reforms are needed in order to redirect the Chinese economy from export oriented growth to a consumer-based economy by boosting household purchasing power and improving living standards.
5) Monetary policy: IMF staff recommend reduction of foreign exchange accumulation in order to allow the artificially low Chinese exchange rate to rise to a market determined level.
It is crucial to understand that private consumption in China is extremely low at 35% of GDP – for comparison, private consumption in the US is 70%. A rise in consumer credit is unlikely to boost China’s growth rate significantly. (I am unaware that credit cards are used to any degree in China.) Net exports are growing very slowly, primarily due to the decrease in exports to the eurozone.

China has been working vigorously to reduce its inflation rate, which peaked at 9% in 2010. A real estate bubble present in China’s largest cities in 2010 appears to be headed for a soft landing with falling prices.

As we can see from the above graph, the official Chinese policy has been to reduce lending to reduce inflation. Local governments have been deeply involved in the real estate expansion, and therefore have huge debts. In 2010, the central Chinese government allowed local governments to sell bonds for the first time since 1994. This indicates the unwillingness of the central government to bail out local governments who made unwise real estate investments.

Major interest rate reform occurred in July 2012.

A cooling off of the real estate market.

Machinery and textiles remain major export products for China and the eurozone is a major importer of these 2 products.

Profits continue to grow in both textiles and machinery which are major exports to the eurozone. Exports to eurozone are no longer growing as rapidly as previously and have now grown only 5% in the last year.

China continues excessive capital investment, although growth of investment is slowing.