Olson, Mancur (2000).

Power and Prosperity: Outgrowing Communist and Capitalist Dictatorship

New York: Basic Books
Mancur Olson's writings are original and unique in their theoretical apparatus. One reason
could be his effort to "reestablish political economy as a central intellectual concern for the
social scientists" (Cadwell in foreword, Olson 2000, page xv), which also led him to take up
the challenge and provide his own answers to problems of post-socialist transition.
Unfortunately, his untimely death five years ago prevented him to finish the book so we can
now read only posthumously published draft.
The original title Capitalism, Socialism and Dictatorship, a variation on the Schumpeter's
famous book, suggested major ambition to develop one of the "grand theories" of the state
and human development. Olson aimed to formulate appropriate intellectual framework,
which would allow for a systematic understanding of dictatorship, democracy and markets
and thus enabled us to provide meaningful answers on transition and development. It should
address questions such as "What is it that makes some market economies rich whereas
others are poor?" or put differently "Why there are innumerable markets in almost every
society, yet riches only in a few?" (Olson 2000, page xxiii).
Those knowledgeable of Olson's previous works will most likely find the Power and
Prosperity coming short of the ambition 1 . The book summarizes the key arguments of
Olson's previous seminal works - The Logic of Collective Action (1971) and The Rise and
Decline of Nations (1982), brings an interesting interpretation of the Stalinist economy and
contributes towards the "institutions matter" consensus, which was just about to establish
itself during the time of writing (in 1997). At the same time, one should admit, that it
provides the kind of intellectual framework Olson was calling for. But let us start from the
basics.
The logic of power
Olson builds on a consensus that "societies are most likely to prosper when there are clear
incentives to produce and to reap the gains from the social cooperation through
specialization and trade" (Olson 2000, page 1). The next step is to understand incentives of
rulers to promote an environment conductive to productive incentives. Olson finds the logic
in the self-interest of the ruler/bandit who gains power and wants to maximize her tax
revenue. Assuming that the bandit is stationery and has a long term perspective to remain so,
she makes the rational choice to provide those she robs with the two public goods essential
for development - secure property rights and protection from other internal and external
bandits.
The stationary bandit has a monopoly of coercion and can expropriate whatever she wants.
However, it is not in her rational interest to put the tax rate anywhere close to 100 percent,
because it would reduce the income generated in her domain and consequently made her a
net loser. If she is rational enough, she will not kill the goose laying golden eggs. Instead,
she will spend on public goods until the point where marginal expenditure equals to extra
marginal revenue. The logic of power rests in the encompassing interest of rulers and it
benefits both population and bandit herself. Moreover, benefits are not brought about by any
social contract or voluntary transaction but simply by the stationary bandit following her
self-interest.

However, one should always bear in mind the reviewed book reached only the stage of "polished draft".
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When comparing the behavior of an autocrat to that of majority or supermajority, Olson

concludes that the taxation under the rule of majorities will be lower, as their encompassing
interest in the well-being of their society is higher. Majority's incentive to redistribute from
minorities is constrained, because excessive taxation creates social deadweight loss, largest
share of which would be born by the majority itself. Inversely, high encompassing interest
will also induce majority to provide an efficient amount of public goods, as their members
benefit most.
The time dimension is of profound importance. Rulers, who do not have long time horizon,
face the incentive to expropriate all wealth to maximize their one-off income. Autocratic
regimes, even if instituted in the form of dynasty, always face the thread of succession crisis,
thus it is difficult to make its long term horizon credible beyond the life span of the autocrat.
However, fortunate outcome of succession crisis may be an introduction of democratic
representative government. Olson defines four preconditions: (i) number of competing
leaders small enough to allow for collective voluntary agreement on representative
government (point of Niscanen 2000, page 138); (ii) broadly equal dispersion of power that
makes it imprudent for any leader to attempt to overpower others; (iii) such separation of
potential rulers that split to miniautocracies is not possible; and finally (iv) sparing the area,
where the democratic rule is emerging, of external conquest.
As being an autocrat is far more profitable job than being an elected leader, the leader
always has an incentive to reap the power for herself. Leaders of other groups thus have an
incentive to watch her and prevent her to become an autocrat so they could have their go
when the balance of power leans towards their interests. The potential for disputes between
the leaders and their respective groups creates the need for an independent judiciary, i.e. a
dispute resolution system that protects property and contractual rights from expropriation by
the leader. At the end, it is the rule of law that gives democracies the advantage of a long
term horizon without severe succession crises.
Olson finds it important to repeat the argument of The Logic to explain why alternative
theories of power, such as Chicago School of Political Economy and the social contracts, do
not hold. They assume that rational individuals would arrive to Pareto-efficient outcome
through voluntary bargaining. Olson explains that the result will always depend on the size
of the group in question and he also adds some insights to concepts of Coase theorem and
the Prisoners' dilemma on which alternative theories rely.
The Coase theorem may not work even if all transaction costs are fully covered by some
external party. If the group sharing the common interest is small, then the combination of
selective incentives and strategic interaction is likely to be sufficient to arrive to and enforce
the mutually advantageous bargain. However,
"if a group is sufficiently large, its members will not have any incentive to engage in the costly
bargaining and strategic interaction that would work out Coaseian bargain. [A]ny
expectation that the Coaseian bargain would be made would generate a game without a core a
continuing effort of all rational individuals to be in a subgroup that obtained the largest gains,
the coalition of free riders" (Olson 2000, page 87).

The Prisoners' Dilemma suggests that there may be no agreement even if only two parties
are involved in a transaction of their common interest. Olson points out that this holds only
if they can not communicate and thus agree on a common strategy. This is highly superficial
assumption; usually the two parties can even sign an enforceable contract.
Olson's logic of power can be summarized as follows: under reasonable assumptions
rational autocrats with largely encompassing long term interest will reach an equilibrium
extortion rate, which will maximize their fiscal revenue over the long term. This
equilibrium will not only be beneficial to leaders but also to the population in their domain,
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which will benefit from public goods. Notably, leaders will provide public goods not for
any noble intentions, but out of pure maximizing self-interest.
Law Enforcement and Corruption
The chapter on law enforcement and corruption bridges the debate on the logic of power
and the analysis of the communist system. Olson deals with a question why the tax revenue
may not be sufficient to cover the cost of law and order. Under normal circumstances such
costs should not be more than a fraction of revenue but he finds two reasons why it might be
much more expensive.
Firstly, there may be a fight for the dominance among several groups of similar strength.
This is, however, unlikely if the state already established itself, either by credible rules of
succession or as a democratic regime. Then its policing power should grow sufficiently to
avoid internal challenge. Secondly, cost reducing element of maintaining order comes from
the "powerful private-sector incentives to greatly reinforce the government's efforts at law
enforcement and bear much of the costs of maintaining law and order in the private sector"
(Olson 2000, page 103). Private sector has an incentive to invest in the property right
protection, be it a lock or well written contract, which complements the ruler's effort.
However, if the ruler insists on policies, which are contrary to the market logic, then the
private sector invests in avoiding consequences of market-contrary policies and thus costs
of policing skyrocket as ruler has to spend more to police normally compliant private sector.
Stalin's tax innovations
To address the issues of transition, Olson turns his attention from the general theoretical
framework to the specifics of the Soviet system, which framed the initial conditions of
transition countries. Olson's view is a synthesis of his rather original description of the
Stalinist system, with the theory presented in The Rise and Decline of Nations.
Brutal innovations enabled Stalin's dictatorship to make more resources available for the
purposes of its leadership than any other society in history. Stalin was a dictator with
encompassing, long term interest, who managed to extract much more than what could be
perceived as a maximum tax. The key features of Stalinist implicit tax extraction system
were: (i) expropriation of all natural resources and capital, thus adding all non-labor
income to its receipts; (ii) circumvention of investment implosion, which would normally
follow such an expropriation, by squeezing the consumption to, or even below, subsistence
level, which in turn created artificially high savings used for investments in
industrialization; and (iii) imposition of implicit taxes on labor income that reached
unprecedented levels and introduction of tax-price discrimination capturing higher
proportion of the economic rent created by more productive individuals. Moreover,
implicit taxes on extra hours of work were low, as opposed to high taxes on standard hours,
thus giving the incentive to increase labor participation and hours worked. These were
elevated further by the fact that wage rates for standard hours were set below subsistence
levels.
To make the implicit tax system stabile, i.e. to ensure survival of exploited population, a
supply of cheap foodstuffs and strict monitoring was needed. The former was achieved by
nearly perfect expropriation of the farmers and peasants through collectivization and the
later by monitoring through various mechanisms, ranging from bank controlled payment
system to centralized provision of mechanization in agriculture. Moreover, Stalinist terror
played its role, but Olson does not mention it explicitly.
Soviet regime managed to mobilize "a fantastic amount of resources, but did not use them
well" (Olson 2000, page 132). As it reached stabilized phase the forces of social
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ossification started to work, reducing the efficiency further until the complete paralysis and
subsequent implosion.
Inevitable ossification
Collective action of various actors within the Soviet bureaucratic hierarchy had to start
very tacitly as covert collusion. Actors had incentives to collude in order to reduce quotas
subscribed to them by central plan and to skim off some resources for themselves.
Moreover, as brutal monitoring mechanisms of Stalin era continued to weaken the
collusion was proliferating from the top to the bottom. As collusion became less dangerous
and more widespread the power devolved from the centre to the colluding interest groups.
They had monopoly of information and the autocrat Politburo could no longer enforce
its will without their consent.
Having described the functioning of the hierarchy, Olson returns to the issue of law
enforcement and corruption. Soviet economy was a market contrary system, creating
incentives to collude against the prevailing law to mutual advantage of parties involved.
There was no private property and thus no incentive to complement state efforts by private
investments in protection of any property except personal one. Politburo, an effective
owner of all non-labor rents, needed an army of watchers and watchers of watchers. Those,
however, had incentive to collude with already colluding parties and share the gains from
illegal trades. Inevitably, as time passed the whole pyramid became corrupt and inversely,
the plan became a virtual reality - without engaging in informal or black market it was
nearly impossible to produce or buy anything.
Effectively, people were stealing from the bandit what he has stolen from them and the
motto of the system became "who refrains from taking state property is robbing his family"
(Olson 2000, page 152). The encompassing interest of the stationary bandit was substituted
with partial interests of colluding groups. That is in Olson's eyes one of the crucial legacies
from the final years of communism in Central and Eastern Europe.
Ossified legacies in transition
Olson contended that the Stalinism was not about the ideology but about implicit taxation.
In the same logic he claims that transition is not about replacing one ideology governing
the system by another one. To Olson the key question is what to do with the sclerotic status
of societies dominated by the powerful entrenched interest groups. He drew on his
knowledge of Russian transition and explained several adverse and unexpected outcomes
of early transition period by reference to the theory of collective action.
The high inflation is usually explained by observation that the government prints money to
finance the budget deficit. However, it does not explain why rational government with
encompassing interest would pursue such a distorting policy. Olson points out that Stalin
was able to extract an unprecedented proportion of GDP, whereas Gorbachev was not. His
tax revenue could have been negative, as enterprises, which in 1950s produced large
surpluses, in 1980s required large subsidies. Due to devolved power the bandit was neither
able to resist demands for subsidies nor collect revenue. The end of one party rule
weakened the centre even further, thus the governments in transition were in even weaker
position then Gorbachev.
Privatization to insiders can also be explained by powerful interest groups. These were
concerned with staying in control of economically non-viable enterprises in order to keep
access to soft credits (hidden subsidies). As they were not threatened by liquidation, they
certainly did not mind exchanging their informal entitlements for property right.
Negative growth. The initial intuition was that after abolishing irrationalities of the Soviet
economic system, transition economies would swiftly get on the growth path. This seemed
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to be supported by the post-fascist as well as by Chinese transition experience. Contrary to

expectations a steep decline was the reality. Olson finds again an explanation in the initial
conditions. Whereas, fascists interest groups were virtually wiped out by the end of the war,
and so were the corrupt pre-cultural revolution elites in China, the peaceful transition in
Central and Eastern Europe left the interest groups in place and in power; able to block
meaningful reforms that would start growth.
Order of the day
Olson distinguishes between two types of markets. The self-enforcing spot markets, which
emerge spontaneously, exist everywhere and are virtually indispensable. These, however,
allow only for limited gains from trade and thus are not the source of wealth of nations. On
the contrary, socially contrived markets emerge only if a society maintains supportive
institutions over the long term. These markets allow for multiparty, multi-period trades,
which are so crucial for prosperity.
Olson provides the following answer to the logical question what institutions are needed to
support socially contrived markets.
"To realize all the gains from trade, then, there has to be a legal system and political order that
enforces contracts, protects property rights, carries out mortgage agreements, provides for limited
liability corporations, and facilitates a lasting and widely used capital market that makes
investments and loans more liquid than they would otherwise be. These arrangements must also be
expected to last for some time" (Olson 2000, page 185).

The listed institutions are a prerequisite but not sufficient for emergence of sophisticated
markets. Olson joins ranks of development economists who claim that individual rights are
not a luxury developing countries can not afford. Olson's reasoning is based on the
existence of uncertainty, which can be effectively dealt with only if entrepreneurs are able
to try and fail many things, until they find the most profitable business for themselves.
Such a search is impossible without individual rights.
However, uncertainty also causes winners and losers being picked by pure luck. Therefore,
Olson calls for some redistribution in the form of social insurance. It improves incentives
to take entrepreneurial risk and at the same time it also helps to overcome the opposition of
potential losers towards meaningful reforms. Social insurance thus facilitates the
reallocation of resources to the more beneficial uses.
Recapitulation
In a nutshell Olson laid down the following conditions for successful transition.
1. Well defined individual, property and contract rights rights, of people and
corporations, both local and foreign, enforced by the independent judiciary;
2. Absence of predation of any kind. If the individual rights hold there is no predation
from the government or other private party. But in a stable democracy there can still
be predation arising from lobbying, accommodation of special interest demands or
cartelization of groups which lack encompassing interest and thus bear only
miniscule proportion of consequent social losses.
The most likely environment where the two conditions are satisfied are "secure, right
respecting democracies where institutions are structured in a way that gives authoritative
decision making as much as possible to encompassing interests" (Olson 2000, page 198).
Over time such democracies are prone to sclerosis, which is by no means inevitable,
especially if we are aware of the problem and academicians and other professionals face
strong selective incentives to analyze these affairs and to contribute towards a collective
action needed to remedy sclerosis.
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Conclusion
The Power and Prosperity composes of an array of hypotheses accompanied with scattered
historical anecdotes and no empirical support. One can only say that it appears to be
logically consistent, as long as one swallows somewhat overstretched generalizations,
which are due to the broad topic. One way to look at the book is to note that it only
vaguely applies to transition notions already established in the two famous Olson's books.
This may be true, but it overlooks the fact that the role of interest groups in transition is
one of the most neglected topics in the field and yet one of the most important as any
explanations of non-trivial transition outcomes avoiding the role of interest groups merely
scratch surface.
Olson is right when pointing out that there is no systematic framework for analysis of
special interests under different political and economic regimes and thus no framework to
analyze the transition from one regime to the other. The book can be regarded as a step in
this direction. However, to make the much needed breakthrough it would need to have
three times as many pages packed with more details and empirical evidence. Then there
would even be a chance for a new "grand" economic theory of the state based on the
encompassing self-interest.
Olson left us with a theory and research agenda, which has yet to prove its viability. There
is plenty to be added and explained. For example, Olson warns against sclerosis, but says
little on how to preventing, except suggesting that because we study it we will be aware of
it. The reliance on the rational response of autocrats and ruling majorities to productive
incentives seems also somewhat a jugular, especially in transition context when uncertainty
is overwhelming and time horizon short. Can we do something to improve the likelihood
that those in power will deliver institutions needed for sophisticated markets to develop
and contribute towards growth and development? This book just formulated the question.
Olson in preface and Cadwell in a foreword create somewhat higher expectations then
could be fully satisfied on the last page. One can only hope that others will take the
challenge and build on this book, which could possibly become a corner stone of deeper
understanding of political economy of both transition and development.
References
Niscanen, W.A. (2000). Power and Prosperity: Outgrowing Communist and Capitalist
Dictatorship. Cato Journal: Book review.
Olson, M. (1971). The logic of collective action; Public good and the theory of groups.
Harvard University Press.
Olson, M. (1982). The rise and decline of nations: economic growth, stagflation, and
social rigidities. New Haven: Yale university press.
Olson, M. (2000). Power and Prosperity: Outgrowing Communist and Capitalist
Dictatorship. New York: Basic Books