Monday, 21 January 2013


I love Google Scholar.

Like all things hyperlinked, Google Scholar's number one unintended attribute is that it makes serendipity not just possible, but inevitable. You look for X, you find Y along the way.

Tonight I found myself looking, for the umpteenth time, for and at papers explaining Greece's record of Total Factor Productivity Growth after the 50s, as part of my efforts to expand this article. If you'd like to follow that thread, the best I found for you tonight was this paper on the incomplete convergence of Total Factor Productivity between Greece and other European countries.

Anyway, as I was leaping, monkey-like, from citation to citation with about 30 tabs open, I stumbled onto this paper, a review of about 60 years of productivity growth in Europe. In itself, it seemed to me like  the EU-KLEMS stuff I've read so much of, only a little out-of-date. I know I'm doing some solid researchers a great disservice in saying this but hey, it's my evening, I demand something slightly more interesting.
Then suddenly I stumbled on this phrase, which sounded eerily familiar:
"Harrison (2002) considers a game between the Dictator (D) and the Producer (P) to investigate when it will pay both parties to maintain a high coercion, high effort with monitoring equilibrium."
I love that phrase: 'high coercion, high effort with monitoring equilibrium' - it implies there's an opposite equilibrium involving low coercion (well, by the standards of an abstract Dictator), low effort and monitoring. And that, my friends, sounds a little like Greece.

You see, Greece is a paradox of both over- and under-regulation, where an overbearing, omnipresent state coexists with a truckload of employer misconduct, poverty, rent-seeking, anticompetitive practices and cronyism. You can't call it socialism because profits (often in fact rents) are widely tolerated and the state's safety net was full of holes in the best of times. You can't call it capitalism, because price signals are either supressed or hopelessly distorted by state intervention. So here's my hunch: the low-coercion, low effort and monitoring equilibrium that Harrison blames for the collapse of the Soviet Union is in fact also responsible for the failure of the Greek State, which, despite undisputedly democratic elections, remained unreconstructedly authoritarian in its function except where it was forced by outside stakeholders (usually the EU) and the threat of a popular backlash to act otherwise.
Harrison (2002) is in fact this paper and I urge you to read it. Some of it is game theory; most is in fact economic history illustrated by facts, figures and equations. Harrison, as we've seen, set up a game with two agents: the producer and the dictator.
"The dictator maximises a payoff made up by the value of rents less his costs and losses, while producers maximise their income received in wages and bonuses and appropriated through theft, less the costs of effort and punishments."  
In the Greek case, for 'producers' read 'businesses and the self-employed' - the mix of 'wages' and 'bonuses' would be different to what Harrison expected under this reading but I doubt this changes much. For 'Dictator' read, of course, the State, but in a broader sense, reflecting the particular social classes and interests that hold the State captive for a particular period of time. Output theft relates to entrepreneurs' failure to render the tax and social contributions and regulatory compliance expected by the State, whether through avoidance (legal) or evasion (illegal). Of course calling these things 'output theft' is not the libertarian view of tax, but it definitely fits the authoritarian view quite well. For a quick analysis of how regulation is a tax, I would refer you to pg 14 here. You might argue that Harrison doesn't have regulation in mind when speaking of Dictator's rents, but actually he does - just check out page 21 here.
"The dictator sets coercion high or low by deciding whether or not to monitor. Without monitoring the dictator cannot stop producers stealing output. The dictator raises coercion by monitoring output, which efficiently eliminates stealing, but monitoring is costly and is a deduction from their rents. When output is monitored, high output can be rewarded and low output punished."
"Output depends on both effort and the scale of punishments. Producers decide whether effort is to be high or low. When effort is low, the value of output is positive and the producer cost of effort is zero. When effort is high and has a positive cost, the value of output is raised by the value of effort. Output depends also on the scale of punishments, because firing and forced labour reallocate workers towards employments of lower intrinsic productivity. Output is high when effort is high, low when effort is low and low output is unpunished, and lower still when low output is punished. (Because planners know who is being punished, the dictator can discriminate between the output loss arising from low effort and that arising as an indirect cost of the punishments he has imposed, so he does not try to punish the latter twice." 
In the long run the scope for high coercion depends positively on the dictator’s return from high effort, the cost to the dictator of not monitoring, and maximum feasible or credible punishments, and negatively on the costs of effort and monitoring. It also depends positively on the excess of the dictator’s discount factor over that of producers. The more the dictator is orientated towards the long run, the more he will pay to sustain coercion in the present; the more producers are orientated towards the short run, the less they will sacrifice to persuade the dictator to abandon coercion. 
So how does the system collapse? For Harrison the two key variables are the cost of monitoring the economy and the Dictator's reputation. He argues that post-industrial economies are much harder to monitor than agrarian or industrial ones, making it unsustainable for the command economy to maintain a high-monitoring equilibrium. Some reforms can, of course put things back on track rather than undermine the Dictator - but in Greece's case the reforms would have had to increase tax administrative capacity - which never worked. In fact, even to this date the reaction to every effort at increasing the State's capacity to monitor is staggering, as the IMF's most recent review of the Greek bailout reveals:

To cut a long story short, here is a summary of Harrison's findings:

  • The system remains stable right up to the point of collapse.
  • Command economies can secure stable high output through artificial incentives, under given historical circumstances.
  • Coercion can be legitimate socially but not legally. Authority that rests on coercion cannot make binding commitments. Rather, the credibility of commitments rests on the Dictator’s reputation, which is fragile and may be lost if coercion is relaxed once. The absence of binding commitments results in a time-consistency problem for central planners.
  • In exercising coercion the dictator is rationally secretive. Both the dictator and producers may exploit information asymmetries to shift payoffs in their favour. Specifically, the dictator will conceal monitoring and punishment costs, and producers will exploit the difficulty of observing effort to overstate its subjective costs and secure improved rewards.
  • Command economies may be undermined by adverse trends in monitoring costs. Changes in the means and complexity of production can raise the costs of monitoring producers. When monitoring becomes unprofitable, the dictator will abandon high coercion.
  • Command economies may also be undermined by bad policy. Too much and too little coercion are both destructive. Too much means overreliance on penalties. Too little means tolerating rent–seeking and erosion of the dictator’s reputation. Both can undermine the profitability of monitoring.
  • Command economies can be undermined by economic reforms. Moreover, the cycle of reforms and counterreforms can harm the dictator’s reputation.
  • The dictator’s surrender, not workers’ resistance, triggers the system’s collapse.

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