Streetwise Professor

Recently it was disclosed that Gazprom and Rosneft were given permission to form their own armed security forces. Does this mean that the companies believe that the state is unable to protect them from security threats? Or is it perhaps that they are most worried about threats from within the state? In a country where the state is the biggest threat to property rights, and many disputes are settled with violence or threats of violence, vertical integration into security (and the potential for violence) is individually rational. That is, for a company like Gazprom it makes sense to provide its own “roof.”

Although this is rational for a company in Russia, this decentralization of violence potential is symptomatic of an unhealthy state. In a state where the capacity for violence is subject to the rule of law, and those who control this capacity are constrained from using it for economic or political advantage, large and profitable companies have no need for their own paramilitaries. Such forces are much more valuable when those conditions are not met. The creation of Gazprom and Rosneft militias speaks volumes about the security of property rights and the reliability/trustworthiness of state security forces in Russia.

I have mentioned the North-Wallis-Weingast “Natural States” analysis in several posts. It is sufficiently interesting and important, however, to deserve a stand-alone analysis. In a nutshell, I find many things about their analysis quite persuasive, but in the end, I believe that it exaggerates the stability of natural states, and fails to analyze adequately the factors that determine the stability (or instability) of natural states.

Overall, I am quite sympathetic to the NWW view that those with a comparative advantage in violence will utilize their power to extract rents. I also agree that rival violence specialists have incentives to cooperate, agreeing to divide rents among themselves and avoid conflict that would dissipate these rents. That is, there is some truth to their contention that the natural state “uses limited economic entry to generate economic rents which are used to create credible commitments among elites to support the current regime and provide order.” However, economic logic and history both demonstrate that these agreements among violence specialists–either within a natural state or between natural states–are often not self-enforcing. Put differently, cooperative arrangements among violence specialists often break down, leading to violence within states or between states. Moreover, NWW pay insufficient attention to the costs of “negotiating” the cooperative arrangements among violence specialists. Due to these costs, they may fail to arrive at stable agreements. Furthermore, the costs incurred to arrive at cooperative arrangements can waste substantial economic resources.

In some ways, NWW are applying efficiency wage theory, or the Stigler-Becker theory of honest enforcers, to the study of political organization. Rents are costly (there are distortions at the margin relative to the first best), but they can support second best arrangements. The question arises, however, whether there is an “invisible hand” operating in the “market among violence specialists” that will result in such a second best outcome. Although NWW acknowledge that natural states are prone to violence and civil wars, overall they convey the impression that the natural outcome in natural states is for the “efficiency wage” for violence specialists to induce them to eschew violence, and to encourage stability and enough economic specialization and trade to enhance their rents. I think this is overly optimistic.

In essence, NWW posit that violence specialists will form a cartel. Indeed, firms in an industry always have an incentive to collude to restrict output and raise prices, and share in market power rents. The “folk theorem” of game theory states that if cartel members discount the future sufficiently lightly, the collusive outcome is self-enforcing; the threat of a rent-dissipating price war in response to a defection from the cartel agreement induces the cartel members to adhere to the agreement. NWW essentially argue that the threat of a real civil war that would dissipate rents induces the members of a violence cartel from seizing the rents of others.

But the experience with cartels–even when they were legal, and even when they were legally enforceable (as in pre-WWI Germany)–is that they are seldom stable, folk theorem or no folk theorem. Cooperation tends to come undone, leading to episodes of “price wars,” and often the complete collapse of the collusive agreements.

Similar considerations raise doubts about the stability of violence specialist cartels. Violence specialist cartels are not stable under all parameterizations. In particular, if violence cartel members discount the future too heavily, collusion cannot be supported. A breakdown of collusion within a state leads to civil war. A breakdown of collusion between natural states leads to a war between them.

The dreary litany of civil and international wars in Europe, for instance, suggests that stability is the exception, rather than the rule. This is not surprising, given: the short lifespans of monarchs and the aristocracy (which means that they likely discounted the future quite heavily), the incompleteness and imperfection of information about past actions and violence capacity of cartel members, and the possible entry of new violence specialists not part of the original agreement.

The interaction between violence specialists/elites within a state and inter-state rivalries also plays an important role. Members of a state largely secure from the threat of foreign conquest are likely to have a lower discount rate than those of a state under threat of invasion. A stable cooperative arrangement among the violence specialists is more likely than the secure state than the insecure one. This conjecture has empirical content. Specifically, the creation of an international order that raises the costs of inter-state aggression should lead to greater internal stability in natural states.

Thus, if you believe as I do that self-enforcing cartels are the exception, rather than the rule, you will recognize that NWW’s characterization of natural states is unduly optimistic. I also have some difficulty with their suggestion that the development of rent-creating institutions is intended to achieve stability. They say that the “natural state solve[s] these problems [of political instability] by creating and maintaining privileged rights to valuable resources.” This implies that the conscious purpose of the privileges is to create stability. I rather think that the violence specialists use force to seize the privileges, and that under nearly ideal conditions a balance of terror among the violence specialists results in a stable outcome, whereas under less ideal conditions the outcome is violence and strife. That is, the natural state and its elaborate array of privileges is not the (second best) solution to a mechanism design problem intended to maximize some objective function. Instead, the stable natural state is an almost accidental equilibrium that only occurs under an unusual confluence of circumstances.

NWW also pay little attention to the process of negotiating an agreement among violence specialists. When there is heterogeneity among bargainers, and/or information is imperfect and incomplete, it is often very costly to reach agreements. In the context of violence specialists, uncertainty about the capacities of competing specialists and heterogeneity in the distribution of rents among them can impede the consummation of agreements. The process of “negotiation”–if it can be called that, even as a metaphor–in this context is likely to entail considerable exercise of violence, perhaps lasting over long periods. A considerable fraction of the rents can be dissipated during the process of “negotiations” among violence specialists, as the chronic financial difficulties of monarchs and aristocrats throughout European history attests.

Libecap’s interesting work about the unitization of oil fields illustrates the difficulties of negotiating arrangements to split rents. Libecap shows that although there are clear gains to owners of property with access to a common pool of oil to operate that pool cooperatively, such agreements are typically reached only after a substantial fraction of the rents accruing to the pool are wasted through excessively rapid, non-cooperative extraction. Analogously, although as NWW suggest it would be jointly rational for violence specialists to reach an agreement to secure their rents, it is often individually rational for them to expend considerable resources in an attempt to gain a larger share of the total rents. Again, a reading of European history suggests that this is practically important.

NWW raise the interesting question of the transition from natural states to “open access” states that create far fewer rent-generating privileges for elites. As they note, there are relatively few examples of this transition, and there may be different mechanisms leading to the transition. The destruction of the natural state by an external invader who does not impose a new natural state in its place–as occurred in German and Japan post-WWII–is one mechanism. The history of England suggests another. Specifically, the financial distress of a monarch involved in rent seeking foreign conflicts with other natural states weakens the monarch’s bargaining position relative to non-elites, who agree to finance the monarch in return for a reduction in elite privileges.

In sum, NWW’s concept of a “natural state” is a useful way of understanding the operation of most states throughout history. Its emphasis on the use of violence, or the threat of violence, to secure privileges that produce economic rents for the violence specialists is appropriate and illuminating. Where they go astray, in my opinion, are their suggestions that (a) the elaborate structures of preferences in natural states are designed to secure stability, and (b) that stable, self-enforcing “cartels” among violence specialists are the rule, rather than the exception. The violence specialist cartel analogy, which is implicit in the NWW natural state concept, suggests that instability may indeed be the rule. That is, although sometimes rents can support self-enforcing agreements, they often cannot. In my view, exploration in a political economy context of the conditions that support cooperation, and a study of these conditions historically, will advance our understanding of political and economic evolution, and particularly of the transition from natural states to open access orders.

I find this WSJ article (subscription required) disturbing. It says that General Casey, who ran operations in Iraq in 2005-2006 when things spun out of control, and who was kicked upstairs to the Joint Chiefs and replaced in Iraq by General Petraeus, is still pressing on with his plan to reduce the US troop presence. He is also continuing to advocate a change in the mission of US troops. Under Casey’s plan, the US troops would withdraw to bases, and focus on counterterrorism and training Iraqi troops. According to the article, Casey has the ear of SecDef Gates.

I understand that the Surge is stressing the Army and Marine Corps, and that the current troop level and aggressive posture cannon continue indefinitely. But the objective evidence suggests that it is putting much more stress on the enemy. Casey’s preferred strategy of a return to a more passive, hunkered down, less aggressive, and less persistent mode of operations–the very strategy that created the openings that Al Qaeda and Iran-allied Shiite groups (notably the Sadrists)–threatens to undo all that has been accomplished since the Surge began. We have a good chance to snatch victory from defeat’s jaws. Let’s not throw it away. Premature relaxation of the Surge’s pressure would allow Al Qaeda and the Iranians and their Iraqi clients to regroup and roll back the progress we’ve made.

The most recent declassified National Intelligence Estimate (for whatever it’s worth) argues that changing our mission from Counterinsurgency to Counterterrorism threatens to undo the recent progress we’ve achieved in the past 7 months. I would state things somewhat differently; classic counterinsurgency methods are the best way to combat the type of terrorism that has plagued Iraq. The CI focus has seized initiative from the terrorists, and made them devote more resources to self-preservation and fewer to terrorist offensives. Moreover, by improving security, the Surge has improved intelligence, and allowed us to target the terrorists more effectively. Counterinsurgency and counterterrorism are not antithetical. Counterinsurgency is the best way to combat insurgents who rely almost exclusively on terror tactics.

We don’t want to be in the position of Sisyphus, having to roll the rock up the hill again and again. We need to suck it up and keep pushing. Even if we reduce troop levels, we must continue to use those that remain aggressively in order to maintain the initiative. Casey’s plan threatens to surrender the initiative that we have fought hard and well to win. I hope Secretary Gates and President Bush recognize this, and tell Casey that his approach had its day–and failed. Now is time for a different approach, one that puts higher stress upon the armed forces, but which holds out the prospect of success.

No, the title of this post is not a reference to Putin’s recent Village People audition pix. Instead, it is a reference to some other Macho-Macho Man performances, namely the resumption of Soviet–sorry–Russian strategic bomber sorties, overflights of Georgia, military exercises with China, boasts about new strategic weaponry, and announcements of dramatic increases in purchases of armaments for the Russian military.

My first reaction to these events is to recall Marx’s remark that history repeats itself, first as tragedy, then as farce. This analysis by Alexander Goltz, an independent military expert, hits very close to the mark:

“Now our military leaders have enough money to create a kind of caricature of the Soviet armed forces, and they want to do a lot of the same old things,” says Alexander Goltz, military expert with the independent online magazine Yezhednevny Zhurnal. “But their plans are a confused mixture of realistic goals and unworkable Soviet-style symbolism,” says Mr. Goltz.

Indeed, Mr. Goltz is too kind: there are many more parts Soviet-style symbolism in the mixture than realistic goals. What Talleyrand said of the Bourbons seems to fit the Russian military-industrial complex: they have learned nothing, and they have forgotten nothing. The world has moved very far since 1991, and few things have moved farther than military technology and doctrine. But Putin and his military coterie seem locked in the Disco Days of the 1970s.

There are many reasons to believe that there is much more Pose than Power in Putin’s recent moves. Although Putin is spending a good deal of the energy price windfall on the military, there is serious reason to doubt he is getting much bang for his buck–or should it be rumble for his ruble?

Take, for instance, the much touted Bulava SLBM program–the cornerstone of the revitalization of Russia’s strategic forces. This program has been plagued by test failures, which have been widely publicized despite concerted efforts to conceal them. The missile’s designer attributed these failures to “the progressive degradation of the Russian defense industry.”

Nor are the Bulava’s problems the only symptoms of this degradation. Russia has failed in its contract to refurbish one of the Soviet’s old aircraft carriers sold to India. The head of arms export monopolist Rosoboronexport concedes that the company “encountering colossal problems fulfilling existing export contracts and are withholding from signing some new ones, because we cannot figure how they may be fulfilled.” I have also read [desperately searching the link–will provide when I find it] that throwing money at the Russian defense establishment has not succeeded in leading to increases in output–just increases in prices. [This may well be the idea–more on this below.] That is, due to the decay in Russia’s capacity to produce advanced weapons (which is due, in part, to the fact that the Soviet defense establishment had pieces spread throughout the republics, and no single republic had a self-sufficient defense production establishment), massive investment is needed to make it possible to ramp up the output of new weapons. It should also be noted that even if Russia succeeds in cranking up output, it will be producing weapons that are at least a generation behind American ones. The MIG-29 and SU-30 are good aircraft–comparable to the F-15–but a generation behind the F-22 and F-35.

And to put things in perspective, only recently did Russian GDP return to 1991 levels. Moreover, in the 1980s the USSR spent a far larger fraction of its GDP on the military than Russia does now. (Just how much is a mystery. Guesses range from between 20 percent and 40 percent–or more.) In that time, US GDP has grown by over 60 percent. The burden of competing with the United States destroyed the Soviet economy, and Putin (and his would-be successors) have to know that an attempt to devote Soviet level fractions of the economy to the military would be similarly disastrous. So, no matter how much oil money Russia has, it cannot devote a similar fraction of GDP to the military as the Soviets did, and what’s more, Russia’s economy is much smaller relative to the US than it was in 1991. Thus, Russia’s fundamental situation with regards to military competition is substantially weaker than the Soviet situation was in the 1980s. And we know how well that worked out, don’t we Vlad? Any attempt to compete seriously is seriously deranged–which is another reason why I believe that a lot of the recent events are more bravado and posin’ than a serious attempt to close the military gap.

But wait. It gets better! (Or worse, depending on your perspective.) Russia’s main problem is not hardware–it is software. That is, as debilitating as Russia’s defense industry’s shortcomings are, its main military weakness is the quality of its people. As dazzling as American military technology is, it is widely understood that the quality and training of American soldiers, Marines, sailors, and airmen is what makes the US armed forces far and away the best in the world. It is also widely understood that the quality of Russian conscript soldiers is very poor, and that they are poorly trained and suffer from poor morale (except in some special units). The conditions that Russian conscripts face are truly horrific. Hazing by “grandfathers”–that is, by last years recruits, who were brutalized by the previous year’s recruits, who were brutalized . . .–is institutionalized. Any young Russian male who can escape conscription does so, by hook, or by crook. As a result, the Russian Army is disproportionately manned by misfits. Moreover, brutal treatment is hardly conducive to high morale, and a desire to stay in the service. Short term conscripts have little time, and less incentive, to master the demands of the modern battlefield. (This problem may become even worse, as Russia plans to reduce conscript terms from two years to one–or just enough time for unmotivated soldiers to learn how to put on their uniforms and point their weapons in the right direction.) The Russian Army is a conscript force rather than a professional one like the current US military. And professionalism matters. It matters a lot.

There have been numerous announcements of plans to replace the Russian conscript army with a professional, volunteer force, but these calls to improve the software have recently been drowned out by the chest-thumping announcements of purchases of new hardware. As an illustration, plans to create a professional cadre of non-commissioned officers along the lines of those in the US or British militaries have been pushed further and further into the future. Moreover, a volunteer military faces much opposition from within the Russian military establishment. And perhaps most importantly, the rapid rise in wages in Russia in recent years–a major reason for Putin’s popularity–has made an all volunteer force much more expensive. This increased cost makes it less likely that the transformation to a professional, volunteer force will occur any time soon. It took more than a decade for the US to build a volunteer military. It will take longer for Russia to do that–if it ever starts, which looks increasingly doubtful.

The preference for hardware over software is not uncommon in military establishments. Given the traditional Russian/Soviet officer corps’ view of its soldiery (which makes Wellington’s view of his troops as “the scum of the earth” look benign by comparison), this bias is likely even stronger in Moscow. Moreover, spending money on a volunteer military offers very few opportunities to direct large quantities of money to siloviki, but I imagine many of the rubles raining on Russian defense manufacturers magically make their way into well-connected pockets. (Hence my earlier suggestion that the inflation of prices for hardware is a feature, not a bug.)

In sum, I strongly suspect that the ramp-up of Russian military spending and the Russia’s increasingly aggressive military posture is more for show–a pose. If they are not, they are symptomatic of serious collective delusions in Russia’s military and foreign policy establishments. Objectively, even with the oil and gas windfall, Russia is in no position to compete seriously in the military sphere. Anyone who believes otherwise is deluded. And given Russia’s serious problems–notably in public health, health care, and demography–it is very sad that so many resources are being wasted on military baubles. Oh, the price that some will pay for appearances.

I got a chuckle reading this quote from a Moscow Times article on the growth of the Russian bureaucracy:

From inside the Kremlin’s walls to everyday lives with endless paperwork, bureaucracy rules. Like the nation’s economy, bureaucracy seems to be booming. Determining its exact size is difficult, much like navigating the mire of it. But by all accounts, the number of public servants today likely exceeds Soviet levels. And they are making substantially more money than their average compatriots. Sociologists have detected a growing inclination among young people toward jobs like customs officers or tax inspectors, despite widespread allegations of corruption and inefficiency. [Emphasis mine.]

Er, despite isn’t the right word. Because is more apt. Resources flow to their most highly remunerated use (not necessarily their most efficient one.) In societies where rent seeking is highly rewarded, resources will flow to activities conducive to rent seeking. Just as Willie Sutton said he robbed banks because that’s where the money is, young Russians are evidently seeking glorious careers in the customs or tax services for exactly the same reason.

This does not bode well for the future of the Russian economy. As Tullock, Anne Kreuger, Vishny & Shleifer, and others have noted, the flow of real resources into rent seeking activities creates a drag on growth. Vishny & Shleifer note that there are sources of increasing returns in rent seeking. Their basic mechanism is that rent seeking depresses the returns to private economic activity, which makes it more attractive to go into rent seeking governmental positions, which results in further depression of the returns to productive work, etc. There are other mechanisms at work too. North, Wallis, & Weingast note that “natural states” built on rent seeking need to suppress private economic activity in order to prevent the rise of political interests that would challenge the rent seekers. Mancur Olson argued that rent seekers come to dominate politics, and introduce rules and regulations that increase their opportunities to extract rents while throttling private economic activity.

Vishny & Shleifer also derived a model in which high rewards to rent seeking activity impede growth by inducing the most talented to go into non-productive activities. In this model, in the productive sector the rate of productivity growth depends on the skill of the most talented individual in that sector (because of spillovers/learning by doing–the less talented learn from the most talented.) High rewards to rent seeking induce the most talented to go into unproductive redistributive activities, thereby reducing growth in the productive sector. (The V-S model presumes free entry into rent seeking activities. Presumably the rent seekers will attempt to protect their turf and erect entry barriers that will mitigate this problem of dynamic inefficiency, but which will create other static deadweight losses as people expend real resources to attempt to get into the cartellized rent seeking sector.)

If the sociologists’ observations are accurate, this is an indication that rent seeking in Russia is not limited to expropriating foreign energy companies, but is instead a more pervasive phenomenon. This would represent a throwback to Tsarist times, and to traditional Russian patramonialism. Sigh.

One other thought comes to mind in this regard. The increasing centralization of power in the Putin years–the re-establishment of the “vertical power”–could actually make things less bad–not good, just less bad. Centralized, “cartellized”, coordinated rent seeking is typically less inefficient than the de-centralized, uncoordinated rent seeking that apparently characterized the Yeltsin years. Vishny-Shleifer analogized the cost of uncoordinated rent seeking to the losses that arise from multiple marginalization that occurs when complementary goods are sold by separate monopolists; integration into a single monopoly can improve efficiency in this case. With corruption, numerous independent bureaucrats each extracting a bribe will collectively charge a bribe that exceeds the monopoly bribe, creates more deadweight loss than the monopoly bribe, and actually results in lower bribery collections. Coordinating the activities of corrupt officials makes everybody better off–though not as well off as they would be if corruption were stamped out. Think of the “anti-corruption” campaigns in Russia as being aimed at making corruption more efficient, not as an attempt to stamp it out altogether. Where’s the fun (and profit) in that?

Similarly, Olson argued that a “stationary bandit” with monopoly control over a territory has an “encompassing interest” in encouraging some economic growth to permit him to extract greater revenues. In contrast, “roving bandits” view the populace as a commons, and have an incentive to steal as much as they can as soon as they can lest somebody else steal first. They have no incentive to encourage any economic growth as unlike the stationary bandit, they can’t get their hands on the fruits of this growth.

This is not to say that I advocate strong power verticals that coordinate theft. It is just to say that as bad as this is, things can be worse. This can also help explain Putin’s popularity. Compared to a normal civil society in which rent seeking and corruption are highly circumscribed, Putin’s Russia appears dreadful. But that’s not a comparison that most Russians can make, never having lived in such a normal civil society. Compared to the era of roving bandits and uncoordinated corruption that preceded Putin, ordered corruption by the vertical power looks pretty good. The tragedy is that many Russian minds identify chaotic corruption with freedom, economic liberty, and democracy, as that is how the transition was described to them. And Putin is not about to disabuse them of that notion. Indeed, he is doing everything to reinforce it, as AEI’s Leon Aron discusses in this article.

One last thing on the Russian economy. I am reviewing some data on recent Russian economic performance, and will soon post an extended entry analyzing that performance, and making some observations on what the future is likely to hold.