As can be seen in posts pondering the past, present and or future nature of the Chinese, Brazilian or Ancient Roman political economy, capture is inevitably a recurring theme in my analyses. More specifically, I have recently found myself leaning towards reviewing income inequality as an intermediary step between macroeconomic and institutional variables. However I’ve long struggled to explain the logical steps behind this otherwise instinctively true fact. This post hopes to address that shortcoming.
Rent Seeking, State Capture and Collective Action
A state that is captured will endow the winning interests groups, at the detriment of the rest, with extraordinary rents above and beyond what is warranted by their effort or what their resources, in a perfect or imperfect market, would otherwise facilitate as profits.
One of the distortions that captured states will often provide their supporting interest groups from is protection from competition. This can be done by limiting access and entry to the market directly through permits, by setting a minimum price that deters competition because it is in line with the inefficient price provided by incumbent producers, or by any other forms of regulatory capture.
While the above insight holds true for labour unions, employers, landowners or asset managers, Mancur Olson’s insights hold that capture is most likely to succeed if the interest group is small and better organised, as is often (but not always) the case with the latter three groups. Very often, as a result of the difficulty of setting up a new market (think Colonists, Capitalists (in developing economies), and investment banks) with all the sunk fixed cost associated with it, any market may of necessity start out with few players. They may then acquire political clout and seek to extract rents from the state in the manner described above. The logic behind this fact has been described and is now taken as given. What interests me is its continuity and permeability to reform. In other words, ‘Why is it that such systems tend to be persistent?’ or to put it differently ‘Why do the rich stay richer?’ and ‘How does income inequality affect the likelihood of political capture?’
How does income inequality affect the likelihood of political capture?
The answer is relatively simple, to the point of self evidence, perhaps, but still worth spelling out.
Olson showed that capture will tend to happen if the fraction benefitting an individual providing a club good, say lobbying for his interest group, is superior to the cost of that good divided by the value of the good to the group.
Without further detail, it is clear that if the fraction to be gained by any politically entrepreneurial individual “i”, ‘Fi’ is distributed in a skewed manner then the condition for successful lobby will be verified more easily (the LHS>RHS). This shows that the more unequally income is distributed in a society, the more likely it is that those at the top will capture the state, in accordance with Olson. Income inequality increases the likelihood of political capture.
Caveats, Implications and Extensions
By this, I do not mean to attack inequality as a concept. Clearly a degree of inequality is desirable for wholly different reasons. It creates increased agency at the top, which if well targeted can be extremely positive. It creates competition and innovation at the bottom, pushing society to explore new grounds, if the top allows it. And that is where the clear formulation of the insight above has interesting implications. Inequality is a trade-off: What you gain in agency at the top you may just loose in competition from the bottom. Inevitably if this hypothesis is true, income inequality should provide us with a number of insights about an economy, first among which, that the more unequal an economy, the more it’s markets are likely to be inefficient, in one manner or another. Extending capture to a more generous and difficult to quantify dimension, this insight also helps understand the pervasiveness of corruption in very unequal countries.
Now consider money as portable power. Any system without checks and balances and political competition whether it is of the monetised capitalist form, of the politicised communist manner or of the barter feudalist taste will always suffer from these problems.
This may seem basic but seeing it thus helps clarifying the mechanism beyond instinct quite a bit.
Now, how does this reality interact with the conclusive observation that inequality leads to authoritarianism?…