Just about every economics student learns Adam Smith’s famous metaphor of the invisible hand, which in a free-enterprise system guides producers and workers, acting in their own self-interest, to accomplish the common good.
In Power and Prosperity, written before his death in 1998, political economist Mancur Olson argues that prosperous societies benefit from a second invisible hand, one that leads governments to act in the best interests of society.
“There can be no satisfactory theory of power, of government and politics, or of the good and the harm done by governments to economies, that leaves out the second invisible hand,” Olson writes.
He’s onto something here. It’s the working of this second invisible hand that holds the key to great questions of our times:
Why most Western, liberal democracies are rich;
Why some societies stay mired in poverty in a world where capital and technology move freely; and
Why defeated Japan and Germany prospered in the decades after World War II, but Russia and large parts of the former Soviet empire suffered economic collapse after the end of the Cold War.
Olson, who taught at the University of Maryland, travels beyond the realm of traditional free-enterprise economists. They celebrate the efficiency of markets, disdaining government as, at best, a necessary evil that often mucks up the sublime perfection of unfettered capitalism.
Olson will have none of it. Anarchy, with no government authority to curb predators, is the worst of all possible worlds. Economic incentives evaporate because anything that’s produced will be stolen by bandits. Time horizons shrink to finding the next meal, destroying any motivation to invest for the future. Olson reaches a conclusion sure to irk those who denigrate government as an economic deadweight: a purely private world is condemned to poverty, not plenty.
Indeed, economies fare better under the most ruthless warlords than in anarchy. At least despots, if they’re secure in their power, have an incentive to allow some economic progress. A rational tyrant, for example, won’t steal everything from his subjects because it would destroy the tax base. The same interest in increasing tax revenue gives the ruler a reason to provide law and order, roads, and other public goods that enhance the potential for economic growth.
“A surprising portion of the progress of humanity is due to the incentive for roving bandit leaders to settle down and become rulers,” Olson contends.
In Olson’s conception, liberal democracies foster the greatest economic progress—a conclusion that certainly jibes with the world around us. But why? “It makes a huge difference whether individuals with coercive capacity have a minuscule or narrow stake in the society, on the one hand, or an encompassing interest, on the other,” Olson writes.
In defining encompassing interest, Olson focuses on who reaps the rewards from broad-based economic growth. When the majority in power grabs the lion’s share of the benefits, it will redistribute less of society’s wealth to itself, provide more productivity-enhancing public goods, and take better care of the rights and interests of minorities. The broader the majority, the more encompassing the interest, the better.
Olson assumes that the best societies maximize income. To that end, governments work best when they pursue policies that spur investment—for example, protecting property from capricious appropriation, enforcing contracts fairly, and providing a stable currency. It’s best when these rights are secure for the long-term, as they are in democracies where power is dispersed and legal systems are independent. Autocrats, no matter how enlightened, bring with them the danger of shortened time horizons, with the temptation to repudiate debts, seize property, or debase the currency.
Olson’s freshness comes in a theory of political economy free of personality. His public-sector corollary to Smith’s invisible hand doesn’t produce better or worse outcomes because rulers are kinder or crueler, wiser, or duller. All of Olson’s conclusions flow from rulers or, in the case of democracies, majorities following their narrow self-interest.
But Olson is no Dr. Pangloss either. He knows that the real world rarely produces perfect economic policies, even in the United States and other advanced Western countries. In resurrecting a theme he pursued in The Rise and Decline of Nations, he reminds us that some powerful forces in society don’t possess encompassing interests. Those forces in turn finagle redistribution schemes that sap vitality from the economy. Special interests, moreover, don’t always have a clear idea of their stake in overall economic growth—or the impact of specific government actions on their well-being.
It’s the notion that agents of collective action often work against the public good that provide Olson with the analytical tool for post-communist economic failure.
Olson wrote Power and Prosperity out of a nagging curiosity about why the former Soviet bloc did not blossom into thriving capitalist systems. Markets did quickly develop on a small scale, but the communist system left behind petty dictatorships, all with perverse incentives that hinder economic progress.
Entrenched power, some of it inside newly privatized enterprises, some of it inside the government, pursued narrow interests, as it always does. Most importantly, the former state-run companies, still run by the old elite and workers, wanted to retain their subsidies and privileges, no matter how uneconomic. The results have been inflation, inefficiency, and irrational investment—a sure recipe for economic disaster.
“True market-oriented economic reforms will not, in fact, make those associated with large state-owned enterprises better off, at least not over any time span short enough for them to have any confidence,” Olson says.
Power and Prosperity presents largely theoretical arguments, so the book might not appeal to readers who prefer their history and economics in narrative form. And Olson’s logic, while impeccable, doesn’t provide much of a guide for the nitty-gritty of policymaking, especially in the United States and other successful economies.
Even so, Olson’s work helps explain the world we live in. Most powerfully, he reminds capitalism’s adherents that prosperity isn’t simply a matter of markets and their work. Olson’s book offers a solid understanding of how a second invisible hand shaped the most important transition of our times—the rise of the liberal democracies and the fall of communism.
Richard Alm is a business reporter at the Dallas Morning News and co-author of Myths of Rich and Poor: Why We’re Better Off Than We Think.