The Rise and Decline of Oligarchic Regimes
Zeuthen Lectures
Daron Acemoglu
MIT
May 23, 2012.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
1 / 61
Rise and Decline of Oligarchic Regimes
Rise and Decline of Nations
Introduction
Many scholars have noted a pattern of “rise and decline”; previously
advanced civilizations collapse, while others prosper.
Prominent examples include:
The declines of the Roman Empire, the Egyptian empire, the Chinese
Empire in the ancient times.
The decline of Venice and Genoa and the rise of England and the
Dutch Republic (and then the decline of the Dutch Republic).
The decline of Inca and Aztec empires and the rise of the civilizations
in North America in the New World.
Existing theories:
Building up of social rigidities (Olson).
Military over-expansion (Kennedy).
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
2 / 61
Rise and Decline of Oligarchic Regimes
Rise and Decline of Nations
This Lecture
A di¤erent perspective on the rise and decline.
Main idea: institutions appropriate (or only marginally costly) under
certain circumstances become more costly later.
Most important example: oligarchic institutions
Thus a theory of interactions between institutions and economic
opportunities.
Indirectly about:
the costs and bene…ts of the di¤erent economic (political) systems?
the potential for change and ‡exibility within given institutional
environments.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
3 / 61
Rise and Decline of Oligarchic Regimes
Rise and Decline of Nations
Plan of Talk
Examples of “rise and decline” and path dependent change.
Caribbean versus Northeast America (within a broader “reversal of
fortune” among former European colonies).
Venice and Spain versus England and the Dutch Republic.
A model of oligarchy versus democracy.
Key trade-o¤ between protecting the property rights of incumbents
versus creating a level playing …eld for non-incumbents.
Dynamic distortion of “oligarchy”.
Implications for recent developments in the United States
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
4 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
The Reversal of Fortune
Use of urbanization and density of population before European
colonization as a proxy for income per capita and how advanced
pre-colonial civilizations are.
Robust negative relationship between income today and urbanization
in 1500 among the former colonies.
Robust negative relationship between income today and log
population density in 1500.
Not due to any geographic variable, or identity of colonial power.
When urbanization and population density both included, population
density is the main determinant.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
5 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
Measuring Prosperity Before National Accounts
.
USA
CAN
GDP per capita, PPP, in 1995
10
BRB
MUS
9
GABMYS
ZAF
PAN BWA
CRI
KNA
LCA
NAM
GRD
FJI
GTM
ECUTUN
DZA DOM
BLZ
VCT
PRY
JAM
PHL
MAR
EGY
SLV SUR CPV BOL
SWZ IDN
GUY
AGO
LKA
ZWE
HND
CMR
GIN
CIV
SEN
COM PAK
SDN GHA
VNM LSOIND
GMB
TGO
CAF
HTI
LAO
BEN
KEN
UGA
NPL
BGD TCD MDG
ZAR
BFA
NGAZMB
NER
ERI
MLI
BDI
RWA
MOZ
MWI
SLE
TZA
8
7
MRT
COG
MEX
COL
TTO
BRA
HKG
SGP
AUS
NZL
CHLBHS
ARG
VEN
URY
PER
DMA
NIC
6
0
Acemoglu (MIT)
50
Urbanization in 1995
Success and Failure of Nations
100
May 23, 2012.
6 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
The Reversal of Fortune
.
USA
10
CAN
AUS
SGP
HKG
GDP per capita, PPP, in 1995
NZL
CHL
9
ARG
VEN
URY
MYS
COL
BRA
BLZ
GTM
DOM
PRY
8
MEX
PAN
CRI
JAM
PHL
ECU
PER
TUN
DZA
IDN
SLV
GUY
BOL
EGY
MAR
LKAHND
NIC
VNM
HTI
PAK
IND
LAO
7
BGD
0
Acemoglu (MIT)
5
10
Urbanization in 1500
Success and Failure of Nations
15
20
May 23, 2012.
7 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
The Reversal of Fortune
.
CAN
AUS
10
USA
SGP
HKG
GDP per capita, PPP, in 1995
NZL
CHL
ARG
URY
BWA
BRA
9
VEN
ZAF
NAM
SUR
GUY
8
7
BHS
BRB
MEX
GAB
MYS
KNA
PAN
COL TTO
CRI
LCA
TUN
ECU
GRD
PER
DZA
BLZ
DOM
DMA
VCT
GTM
JAM
PHL
IDN
MAR
SLV
AGO
LKA
ZWE HND
NIC
CMR
GIN
CIV
COG
MRTGHA
SEN
COM
SDN
LSO
GMB
TGOVNM
CAF
HTI
LAO KEN BEN
UGA NPL
ZAR
BFA
TCD
MDG
NGA
ZMB
NER
ERI
MLI
MWI MOZ
PRY
SWZ
CPV BOL
TZA
EGY
PAK
IND
BGD
BDI
RWA
SLE
6
-5
Acemoglu (MIT)
0
Log Population Density in 1500
Success and Failure of Nations
5
May 23, 2012.
8 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
The Timing and Nature of the Reversal
When did the reversal take place?
Not when the Europeans plundered the previously rich societies or
killed of their populations.
In the 19th century, and intimately related to industrialization.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
9 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
The Timing and Nature of the Reversal
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
10 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
The Timing and Nature of the Reversal
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
11 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
Plantation Versus Industrialization
Speci…c example of the nature ande timing of the reversal:
The Caribbean Plantation societies in the 17th and 18th centuries
initially prosperous, but then falling behind Northeastern United
States.
Caribbean plantation societies rich from sugar. Highly oligarchic
societies, dominated by the richest plantation owners. Supported by
repressive political institutions.
Relatively e¢ cient for production and processing of sugar for the
plantation owners. But no room for change.
In contrast, the more “democratic” Northeast United States, more
‡exible to take advantage of new economic opportunities.
In fact, 19th century growth in the U.S., fueled by industry and
entrepreneurs not previously part of the ruling elite.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
12 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
Institutions and Industrialization
Whether a society has institutions of private property or extractive
institutions may matter much more when new technologies require
broad-based economic participation.
Industrialization is such a process, requiring investments from a large
number of agents who were not previously part of the ruling elite.
Therefore, there are natural reasons to expect that institutional
di¤erences will matter much more during the age of industry.
We …nd that there is a strong interaction between institutions and
industrialization: institutions start mattering much more in the age of
industry.
This explains why the reversal took place during the 19th century.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
13 / 61
Rise and Decline of Oligarchic Regimes
Reversal of Fortune
Path Dependence and Industrialization in the Former
Colonies
Dependent variable:
industrial
OLS
0.132
(0.026)
production p.c.1750-1950
OLS
OLS
IV
0.145
0.202
(0.168)
(0.035) (0.022) (0.030)
Institutions
8.97
(2.30)
10.51
(3.50)
Year e¤ects
Country e¤ects
Additional controls
Yes
No
No
Yes
No
Yes
UK industrialization Institutions
Acemoglu (MIT)
Success and Failure of Nations
Yes
Yes
No
Yes
Yes
No
May 23, 2012.
14 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Rise of Europe
Western Europe grows faster than Eastern Europe and Asia after
1500 using either urbanization rates as proxy for income or
Maddison’s estimates for GDP.
When we break things out into Atlantic vs. non-Atlantic Western
Europe, almost all of the faster growth is driven by growth in Atlantic
nations (Belgium, Britain, Denmark, France, Ireland, the Netherlands,
Portugal and Spain).
Same pattern when we look at city growth.
The timing of takeo¤ of various Atlantic ports consistent with timing
of involvement in Atlantic trade by individual countries.
Asmong Atlantic countries, early growth in Spain and Portugal, but
short lived. Major growth in Britain and Dutch Rep.
Related to institutional change in Britain and Dutch Rep.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
15 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Rise of Europe
Voyages per year: Atlantic Trade (to Americas, African coast and Asia via Cape), and Mediterranean
(W.Europe, excluding Britain and Netherlands, to Levant)
800
700
600
500
Atlantic voyages per year
400
Mediterranean voyages per year
300
200
100
0
1300
Acemoglu (MIT)
1400
1500
1600
1700
1750
Success and Failure of Nations
1800
May 23, 2012.
16 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Rise of Europe (continued)
120.00
Average population in Atlantic ports, Mediterranean ports, and West European
cities not ports (balanced panel)
100.00
80.00
60.00
40.00
20.00
0.00
1300
1400
1500
1600
1700
1750
1800
1850
Inland West European cities
Atlantic ports
Mediterranean ports
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
17 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Rise of Europe: Where Did Happen? Interpretation
Caribbean plantation economies did well initially because they
provided the right incentives to the major asset holders in society.
Similar to Venice in the 15th century or even to Spain after the
discovery of the New World.
But long-run growth requires a process of “creative destruction” with
new entrance and new blood coming in.
Di¢ cult when the regime dominated by incumbents.
Thus industrialization more likely in Northeast United States.
Also, institutional change supporting sustained economic growth more
likely in places where incumbents weaker; institutional change in
England and the Dutch Republic but not in Spain.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
18 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Path Dependence in the Rise of Europe
Dependent variable:
Atlantic trader Volume of Atlantic trade
urbanization rate,
OLS
OLS
0.011
0.011
(0.002) (0.002)
Atlantic trader Volume of Atlantic trade
Institutions
Full set of institutions year interactions
Acemoglu (MIT)
1300-1850
OLS
0.001
(0.001)
0.021
(0.004)
No
Success and Failure of Nations
Yes
Yes
May 23, 2012.
19 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Oligarchy, Growth and Stagnation in the Dutch Republic
The Dutch Republic, one of the main bene…ciaries of Atlantic trade,
became perhaps the most developed part of the world in 1647-72
under somewhat inclusive, but oligarchic institutions.
Thereafter, stagnation and decline.
Jonathan Israel (1995, p. 1016-17)
“Dutch society in the eighteenth was a society dominated by the
rentier. ... Living o¤ the legacy of the past, the Republic was still an
a- uent society compared with neighboring countries. But it was a
society in which the middle strata were being squeezed and wealth
becoming more polarized than had been the case in the Golden Age.”
De-urbanization and increasing rural property.
Root cause: the same elites in power even though not as economically
active and productive, and the urban elite and guilds blocking
economic change.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
20 / 61
Rise and Decline of Oligarchic Regimes
Rise of Europe
Oligarchy More Generally
David Stasavage (2012) provides evidence that the Dutch experience
is not atypical.
Autonomous cities in Europe, which were dominated by urban
oligarchies, initially grew more rapidly than non-autonomous cities
(starting from about 1000), but then stagnated and in fact grew more
slowly than non-autonomous cities.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
21 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Ingredients of Model
Construct a simple theoretical model to emphasize and clarify the
trade-o¤s.
Consider an economy where agents enter entrepreneurship or
production work.
Heterogeneity in entrepreneurship.
Entrepreneurial talent imperfectly correlated over time.
Two types of policy distortion:
Redistributive taxation with incentive costs.
Entry barriers protecting incumbents.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
22 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Trade-o¤ Between Oligarchy and Democracy
Entry in democracy, sclerosis in oligarchy.
Lower investment in democracy.
Worse allocation of talent in oligarchy.
Democracy more equal, oligarchy more unequal (lower wages higher
pro…ts).
Oligarchy gets worse over time as the comparative advantage of
incumbents gets worse.
Oligarchy and democracy creating di¤erent types of distortions.
But long-run growth likely to be slower in oligarchy because of
dynamic costs of entry barriers— sclerosis..
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
23 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Understanding Rise and Decline of Nations
oligarchy less harmful initially, even encouraging investment because
less redistribution away from major producers.
but harmful as comparative advantage of oligarchs disappears.
oligarchy particularly harmful when new technologies shift investment
opportunities from insiders to newcomers.
oligarchy less ‡exible than democracy
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
24 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Regime Dynamics
When does oligarchy transition to democracy?
Two possibilities:
1
2
Smooth transition to democracy because of within-elite con‡ict (small
producers disbanding oligarchy).
Con‡ict over regimes.
Incumbents richer, can maintain the system that serve their interests.
Path dependence in equilibrium regimes possible.
Caribbean vs. United States in the 18th and 19th centuries.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
25 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Model
In…nite horizon economy, with the unique non-storable good, y .
Preferences
U0j = E0
∞
∑ βt ctj ,
(1)
t =0
Assume each agent dies with a small probability ε, consider the limit
of this economy with ε ! 0.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
26 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Model (continued)
Choice between entrepreneurship and production work.
Entrepreneurial talent atj 2 fAL , AH g with AL < AH .
Either already own an active …rm, or set it up (costly when there are
entry barriers).
Each agent starts period t with entrepreneurial talent atj 2 fAH , AL g,
and stj 2 f0, 1g which denotes the individual possesses an active …rm.
Agent with stj = 1 member of the elite.
Each agent takes the following decisions: ctj , etj 2 f0, 1g.
If etj = 1, then he also makes investment, employment, and hiding
decisions, ktj , ltj and htj , where htj denotes whether he decides to hide
his output in order to avoid taxation.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
27 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Model (continued)
Three policy choices: a tax rate τ t on …rms, lump-sum transfer, Tt ,
and a cost Bt to set up a new …rm (pure waste).
Production function for talent atj :
1
1
α
(atj )α (ktj )1
α
(ltj )α ,
To simplify assume that ltj = λ, and that entrepreneur himself can
work in his …rm as one of the workers.
Denote: bt
Acemoglu (MIT)
Bt /λ.
Success and Failure of Nations
May 23, 2012.
28 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Model (continued)
Denote the wage rate by wt
0.
Pro…t function (without hiding):
π τ t , ktj , atj , wt
=
1
1
τt j α j 1
(a ) (kt )
α t
α
(ltj )α
wt ltj
ktj ,
(ltj )α
wt ltj
ktj λ.
(2)
With hiding:
π̃ τ t , ktj , atj , wt
=
1
1
δ j α j 1
(a ) (kt )
α t
α
Thus
R1
τt
R
δ,
Labor market clearing: 0 etj λdj = j 2S E λdj 1, where StE is the
t
set of entrepreneurs at time t.
For agents with stj = 0, setting up a new …rm may entail an
additional cost Bt because of entry barriers.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
29 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Model (continued)
Law of motion of individual states:
stj +1 = itj ,
atj +1
8
>
AH
>
>
< H
A
=
>
AL
>
>
: L
A
with probability σH
with probability σL
with probability 1 σH
with probability 1 σL
(3)
if atj
if atj
if atj
if atj
= AH
= AL
,
= AH
= AL
(4)
Stationary distribution fraction of high-productivity agents:
M
1
σL
.
σH + σL
Assume
Mλ > 1,
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
30 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Model (continued)
Timing of events:
1
2
3
4
5
6
7
h i
Entrepreneurial talents, atj , are realized.
The entry barrier for new entrepreneurs
h i Bt is set.
Agents make occupational choices, etj .
Entrepreneurs make investment decisions ktj .
The labor market clearing wage rate, wt , is determined.
The tax rate on entrepreneurs, τ t , is set.
h i
Entrepreneurs make hiding decisions, htj .
h i
where atj shorthand for the mapping at : [0, 1] ! AL , AH , etc.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
31 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Analysis
Economic equilibrium: subgame perfect equilibrium given a policy
sequence fbt , τ t gt =0,1,... .
Equilibrium investments:
ktj = (1
Π τ t , wt j stj , atj
=
τ t )1/α atj λ.
α
1
α
Tax revenues:
(1 τ t )
Tt = τ t
1 α
Acemoglu (MIT)
(5)
τ t )1/α atj λ
(1
1 α
α
λ
Success and Failure of Nations
∑
wt λ.
atj ,
(6)
(7)
j 2S tE
May 23, 2012.
32 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Analysis (continued)
Who will become an entrepreneur?
1
2
Entry equilibrium where all entrepreneurs have atj = AH .
Sclerotic equilibrium where agents with stj = 1 become entrepreneurs
irrespective of their productivity.
An entry equilibrium will emerge only if the net gain to a high-skill
non-entrepreneur of incurring the entry cost and setting up a …rm (at
a given wage) is positive.
This net gain takes into account the future bene…t of becoming an
elite protected from competition (as a function of future entry
barriers etc.).
Determined by simple dynamic programming taking equilibrium
policies as given.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
33 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Analysis (continued)
Let the value function of a worker of type z as a function of the
sequence of future policies and equilibrium wages, (pt ,wt ):
W z pt ,wt = wt + Tt + βCW z pt +1 ,wt +1 ,
(8)
where the continuation values from time t + 1 onwards are:
CW z pt +1 ,wt +1 =
n
o
λbt +1
(9)
σz max W H pt +1 ,wt +1 , V H pt +1 ,wt +1
n
o
+ (1 σz ) max W L pt +1 ,wt +1 , V L pt +1 ,wt +1
λbt +1 .
These incorporate optimal occupational choice from time t +1
onwards.
Similarly, for a current entrepreneur
V z pt ,wt = wt + Tt + Πz (τ t , wt ) + βCV z pt +1 ,wt +1 ,
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
(10)
34 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Analysis (continued)
De…ne the net value of entrepreneurship as a function of an
individual’s skill a and ownership status, s,
NV pt , wt j Az , s = V z pt ,wt
W z pt ,wt
(1
s ) λbt ,
where the last term is the entry cost for agents with s =0.
NV pt , wt j AH , stj = 1
NV pt , wt j atj , s
and
NV pt , wt j atj , s
NV pt , wt j AL , stj = 0 .
Therefore, high-skill incumbents remain entrepreneurs and
low-productivity workers never become entrepreneurs.
Whether low-productivity incumbents remain entrepreneurs depends
on taxes, wages and entry barriers.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
35 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Analysis (continued)
De…ne entry equilibrium wage such that
NV pt , wtH , wt +1 j atj = AH , stj = 0
So
α
(1 τ t )1/α AH
wtH
1 α
β CV H pt +1 ,wt +1
+
λ
Similarly, sclerotic wage is
α
wtL
(1 τ t )1/α AL
1 α
β CV L pt +1 ,wt +1
+
λ
An entry equilibrium only when
wtH
Acemoglu (MIT)
= 0.
bt
CW H pt +1 ,wt +1
CW L pt +1 ,wt +1
,
.
wtL .
Success and Failure of Nations
(11)
May 23, 2012.
36 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Labor Supply on Labor Demand in the Entry Equilibrium
wt
LS
wtH+bt
wtH
wtL
LD
wtL-bt
0
1
λM
λ
Labor Supply/Demand
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
37 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Labor Supply on Labor Demand in the Sclerosis
Equilibrium
wt
LS
wtH+bt
wtL
wtH
LD
wtL-bt
1-ε 1
Acemoglu (MIT)
Success and Failure of Nations
λ
May 23,
2012.
38 / 61
Labor
Supply/Demand
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Analysis (continued)
Therefore, in equilibrium wte = wtH .
De…ne fraction of high-productivity entrepreneurs:
µt = Pr atj = AH j etj = 1 = Pr atj = AH jj 2 StE
Since no entry barriers initially, µ0 = 1.
Law of motion of µt :
µt =
Acemoglu (MIT)
σ H µt
1
+ σ L (1
1
µt
1)
if (11) does not hold
.
if (11) holds
Success and Failure of Nations
May 23, 2012.
(12)
39 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Political Equilibrium
Consider two simple extreme political regimes:
1
2
Democracy: the policies bt and τ t are determined by majoritarian
voting, with each agent having one vote.
Oligarchy (elite control): the policies bt and τ t are determined by
majoritarian voting among the elite at time t.
Focus on Markov perfect equilibria.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
40 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Democracy
Non-elites in the majority.
Majoritarian voting: taxes will be chosen to maximize per capita
transfers,
(
1 α
(1 τ̂ t ) α
τ
λ ∑j 2StE atj if τ t
δ ,
t 1 α
(13)
Tt (bt , τ t ) =
0
if τ t > δ
where τ̂ t is the tax rate expected by the entrepreneurs and τ t is the
actual tax rate set by voters.
Since 0 pro…ts, entry barriers will be chosen to maximize equilibrium
wages, thus bt = 0.
Intuitively, entry barriers reduce labor demand and depress wages.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
41 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Democracy (continued)
Proposition
A democratic equilibrium always features τ t = δ and bt = 0, and etj = 1 if
and only if atj = AH , and µt = 1. The equilibrium wage rate is given by
wtD =
α
1
α
(1
δ)1/α AH ,
and the aggregate output is
YtD = Y D
1
1
α
(1
δ)
1 α
α
AH .
(14)
Perfect equality.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
42 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Oligarchy
Policies determined by majoritarian voting among the elite.
To simplify this talk, assume
1
1 AH
+ ,
2 AL
2
which ensures that low and high-skill elites prefer low taxes.
λ
(15)
Otherwise, low-skill elites side with the workers to tax the high-skilled
elites.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
43 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Oligarchy (continued)
Then entry barriers will be set
bt
CV H pt +1 ,wt +1
αAH
+β
1 α
btE
CW H pt +1 ,wt +1
λ
!
.
(16)
so as to prevent entry.
Imposing wte+n = 0 for all n 0,
"
#
1
αλ 1 βσH AL + βσL AH
L
Ṽ =
,
1 β 1 α (1 β (σH σL ))
and
Ṽ H =
1
1
Acemoglu (MIT)
β
"
1
αλ
1
α
σL
β 1
(1
AH + β 1
β (σH σL ))
Success and Failure of Nations
σ H AL
(17)
#
. (18)
May 23, 2012.
44 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Oligarchy (continued)
Using these equilibrium relationships,
"
1
αλ 1 β 1 σL AH + β 1
E
bt = b
1 β 1 α
(1 β (σH σL ))
σ H AL
#
.
(19)
Wages are zero and aggregate output is
YtE = µt
1
1
α
AH + ( 1
µt )
1
1
α
AL
(20)
where
µt = σ H µt
with
lim YtE = Y∞E
t !∞
Acemoglu (MIT)
1
+ σ L (1
1
1
α
µt
1)
AL + M ( AH
Success and Failure of Nations
AL ) .
May 23, 2012.
(21)
45 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Oligarchy (continued)
Proposition
Suppose that condition (15) holds. Then an oligarchic equilibrium features
τ t = 0 and bt = b E as given by (19), and the equilibrium is sclerotic, with
equilibrium wages wte = 0, and fraction of high-skill entrepreneurs
µt = σH µt 1 + σL (1 µt 1 ) starting with µ0 = 1. Aggregate output is
given by (20) and decreases over time starting at Y0E = 1 1 α AH with
limt !∞ YtE = Y∞E as given by (21).
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
46 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Comparison of Oligarchy and Democracy
We always have that initially:
1
1
α
(1
δ)
1 α
α
AH < Y0E =
1
1
α
AH .
Will oligarchy fall behind democracy?
If (1) democratic taxes are low and not very distortionary; (2) selection
of entrepreneurs is di¢ cult, and (3) comparative advantage in
entrepreneurship is important, then oligarchy ultimately worse than
democracy:
Condition for this:
!
1 α
AL
AL
(1 δ ) α > H + M 1
.
(22)
A
AH
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
47 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Comparison of Oligarchy and Democracy (continued)
Yt
YE 0
Y’E∞
Output in oligarchy
YD
Output in democracy
YE∞
Output in oligarchy
t'
Acemoglu (MIT)
t
Success and Failure of Nations
May 23, 2012.
48 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Comparison of Oligarchy and Democracy (continued)
Workers always worse o¤ in oligarchy than in democracy.
What about entrepreneurs?
High-skill entrepreneurs always better o¤. But
Proposition
If
1
αλ
βσH AL /AH + βσL
< ( α + (1
(1 β (σH σL ))
δ ) δ ) (1
δ ) (1
α)/α
, (23)
then low-skill elites would be better o¤ in democracy.
Low-skill entrepreneurs still willing to remain in entrepreneurship,
however, taking equilibrium prices and future policies as given.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
49 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
New Technologies and In‡exibility of Oligarchies
At t 0 > 0 a new technology arrives.
Productivity with new technology:
1
1
α
(ψâtj )α (ktj )1
α
(ltj )α ,
where ψ > 1
Law of motion of âtj orthogonal to atj , and given by
8
>
AH
with probability σH
if âtj = AH
>
> H
<
A
with probability σL
if âtj = AL
âtj +1 =
,
>
AL with probability 1 σH if âtj = AH
>
>
: L
A
with probability 1 σL if âtj = AL
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
(24)
50 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
New Technologies (continued)
In democracy, aggregate output jumps from Y D to
1
Ŷ D
1
α
(1
δ)
1 α
α
ψAH .
In oligarchy, elites will stay in entrepreneurship despite their worse
comparative advantage
For example, if ψAL > AH , then aggregate output jumps to and
remains at
Ŷ E
1
1
α
ψAL + M (ψAH
ψAL ) ,
Potential explanation for why oligarchic societies don’t adjust well to
new opportunities/technologies.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
51 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Regime Dynamics
Two cases to consider:
1
2
Con‡ict within the elite— when low-skill elites worse o¤ in oligarchy
than in democracy (when condition (23) holds), they disband oligarchy
when they become the majority within the elite.
Con‡ict between classes over regimes— the elite prefer oligarchy and
the citizens democracy; income distribution matters for regime
dynamics; possibility of path dependence.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
52 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Regime Dynamics (continued)
Suppose that, in oligarchy, current elite can legislate a permanent
transition to democracy. Then
Proposition
Suppose (15) holds and the society starts oligarchic.
If (23) does not hold, then for all t the society remains oligarchic.
If (23) holds, then the society remains oligarchic until date t = t̃ where
t̃ = min t 0 2 N such that µt 0 1/2 (whereby
µt = σH µt 1 + σL (1 µt 1 ) for t < t̃ starting with µ0 = 1). At t̃, the
society transitions to democracy.
The low-skill elites disband the oligarchy when they become the
majority.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
53 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Con‡ict over Regimes
Di¤erent set of issues arise when no smooth transition to democracy.
Under many plausible scenarios, wealth in‡uences political power.
Consider a reduced-form model of this.
Suppose that the probability that an oligarchy switches to democracy
is qtD = q D (∆Wt 1 ), where ∆Wt 1 = WtE 1 WtW 1 is the
di¤erence between the levels of wealth of the elite and the citizens at
time t 1.
Assume q D ( ) decreasing.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
54 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Con‡ict over Regimes
Similarly, when democratic, a society becomes oligarchic with
probability
qtO = q O (∆Wt 1 )
where now q O ( ) is a non-decreasing function, with q O (0) = 0, so
that with perfect equality, there is no danger of switching back to
oligarchy.
Here ∆Wt refers to the income gap between the initial elite (those
with with s1j = 1) and the citizens.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
55 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Con‡ict over Regimes (continued)
Then regime
8
0
>
>
<
1
Dt =
0
>
>
:
1
dynamics are:
with probability 1
with probability
with probability
with probability 1
q D ( ∆ Wt 1 )
q D ( ∆ Wt 1 )
q O ( ∆ Wt 1 )
q O ( ∆ Wt 1 )
if
if
if
if
Dt
Dt
Dt
Dt
1
1
1
1
=0
=0
, (25)
=1
=1
Suppose that each agent saves out of current income at a constant
(exogenous) rate ν < 1.
Therefore
∆ Wt = ν ∆ Wt
Acemoglu (MIT)
1
+ λYtE
Success and Failure of Nations
1
.
May 23, 2012.
56 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Con‡ict over Regimes (continued)
This implies that in oligarchy
∆ Wt = λ
t
∑ νn YtE n
(26)
n =1
and
lim ∆Wt = ∆W∞
t !∞
λY∞E
,
1 ν
(27)
where Y∞E is given by (21).
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
57 / 61
Rise and Decline of Oligarchic Regimes
Modeling Oligarchy
Con‡ict over Regimes (continued)
This implies that starting from low wealth levels, wealth inequality
will increase in oligarchy.
Therefore, transition from oligarchy to democracy may become harder
as oligarchy persists.
In particular, if there exists ∆W < ∆W∞ such that q D ∆W = 0,
then after a certain number of periods, the society will be stuck in
oligarchy.
In contrast, in democracy, all agents earn the same amount, so when
Dt +k = 1 for all k 0,
∆Wt +1 = ν∆Wt and lim ∆Wt = 0.
(28)
t !∞
The implication is that a switch back to oligarchy is most likely soon
after a switch from oligarchy to democracy.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
58 / 61
Rise and Decline of Oligarchic Regimes
Oligarchies in the United States?
Lessons for the United States
Dangers of oligarchies.
Nature of oligarchies in the United States di¤erent.
Based on information and expertise.
But whether this has di¤erent implications is unclear.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
59 / 61
Rise and Decline of Oligarchic Regimes
Oligarchies in the United States?
Value of Political Connections
Value of political connections in an “emerging market” (e.g.,
Indonesia, Malaysia): ~20% of …rm value.
Estimated by “shock” disappearance of patron.
In the United States, connections typically worth little: <1% of …rm
value (Je¤ords) or 0 (Cheney, Paulson).
Reason: strength of US institutions.
But such strength cannot be taken for granted, particularly during
times of crisis.
New research: …nancial …rms “connected” to Tim Geithner had
cumulative abnormal return around 15% after his nomination as
Treasury Secretary in November 2008.
Negative e¤ect when his “tax issues” threatened to derail his
appointment in January 2009.
Why? Tentative answer: Perceived value of connections increases in a
crisis, even in the U.S.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
60 / 61
Rise and Decline of Oligarchic Regimes
Oligarchies in the United States?
Interpretation
Perception of the markets during times of crisis.
No evidence of explicit corruption or even favoritism, but markets
seem to think that connections to matter.
New patterns for the United States.
Why? Institutions are still strong (but perhaps weaker during crisis).
But strong institutions essentially reduce political discretion. Much
greater discretion during crisis.
Consistent with new research by Pablo Querubín and Jim Snyder on
politician rents during the US Civil War.
Increasing importance of expertise: markets might think that we listen
to has become more important.
Acemoglu (MIT)
Success and Failure of Nations
May 23, 2012.
61 / 61