Model uncertainty, political learning, and institutions: a broader view on Mancur Olson's theory of institutional sclerosis.

• Author: Bischoff, Ivo
• Position: Symposium

1. Introduction

   Twenty-five years ago, Mancur Olson published his monograph on the Rise and Decline of Nations. Therein he argues that countries that have been politically stable for a long time suffer from institutional sclerosis. This sclerosis is caused by the growing political influence of so-called distributional coalitions. Their search for rents leads to increasing complexity in regulation and larger governments and reduces society's ability to adjust to changes in technologies and the economic environment. In the long run, declining rates of economic growth are the result. Olson's Rise and Decline of Nations marked a milestone in the research on the political economy of growth and inspired a large body of literature. In particular, the fact that he provided a number of testable hypotheses invited many scientists for empirical testing (among others, Choi 1983; Murrell 1984; McCallum and Blais 1987; Gray and Lowery 1988; Tang and Hedley 1998; Bischoff 2003) and still invites more testing (Mueller 2003). The existing empirical evidence is mixed and provides only limited support for Olson's theory.

   This paper takes this mixed empirical evidence as its starting point. Section 2 briefly reviews the basic chain of cause and effect underlying Olson's theory and categorizes the related empirical literature with respect to the different elements of this chain. Section 3 sketches a simple model of party competition in a complex environment, and section 4 shows how this model can be used to provide an alternative explanation for low growth rates in politically stable democracies. In the light of these considerations, section 5 reassesses some of the anecdotal evidence Olson provided to motivate his theory and the mixed empirical support for his theory. It also draws on new empirical evidence on the relationship between institutions and economic growth and shows how this literature relates to Olson's theory, to the theoretical model sketched in section 3, and to the empirical literature reviewed in section 2. It will provide additional reasons why the support for Olson's theory is likely to be mixed and points out directions for future research. Section 6 concludes.

2. Olson's Rise and Decline of Nations--A Brief Outline

   The Rise and Decline of Nations does not provide a full-fledged formal model to back its central theme. Instead, it relies on economic intuition, a rich body of case-based evidence, and a number of regressions on the role of unions and the relationship between years of statehood and growth in the United States. Following Gray and Lowery (1988), Unger and van Waarden (1999), and Paque (1996), the basic chain of cause and effect underlying Olson's theory consists of three hypotheses (see Table 1). If all three of these are valid, the chain holds, and thus Olson's theory provides a valid explanation for declining growth rates in politically stable countries. If one element within the chain does not hold, it does not necessarily mean that politically stable countries are not suffering from institutional sclerosis and declining growth rates. In this case, however, Olson's theory does not provide the correct explanation, but other explanations must be found.

   When analyzing and/or testing Olson's theory, it is possible to take steps of different scope. The right-hand side of Table 1 shows that, depending on the scope of the analysis, five different types of studies can be identified. First, it is possible to take on a single hypothesis and assess its tenability individually (see studies of type I, II, and Ill in Table 1). The literature contains a number of empirical studies of type I, testing the relationship between the number of interest groups within a country and its history of political stability. The evidence is mixed and proves very sensitive to the definition of political stability (Murrell 1984; Bischoff 2003: Coates, Heckelman, and Wilson 2006). Second, one can take two hypotheses of Olson's chain of reasoning and test them jointly. A number of studies performed a joint test of hypotheses 2 and 3 to see whether the number of interest groups has a negative effect on economic growth (Gray and Lowery 1988; Knack 2003). The number of these type IV studies is limited because of restrictions in data on the number of interest groups. The majority of studies compiled by Heckelman (2007) found weak or no support for a negative relationship between the number of interest groups and economic growth. Third, by far the largest part of the literature tested all three hypotheses jointly by analyzing the direct relationship between a country's years under political stability and its economic growth rates (Choi 1983; McCallum and Blais 1987: Tang and Hedley 1998). The majority of studies find a negative relationship, but other results are also reported. Mueller (2003) and Heckelman (2007) conclude that the existing evidence generally confirms Olson's central conclusion. It is important to note that most empirical studies are based on cross-sectional data. They show that countries with a long history of political stability have lower growth rates than countries with a shorter history. This result suggests that the economic growth rates of a single country decline with the duration of its political stability. Nevertheless, when referring to the empirical evidence, I will hereafter speak of low growth rates in politically stable countries (rather than declining growth rates).

   Olson's theory was discussed among economists, political scientists, and historians (Heckelman and Coates 2003). In many cases, they challenged not his central conclusion but rather the underlying chain of reasoning (Maddison 1988). Some authors, particularly historians, argued that Olson does not account for the many country-specific factors that determine differences in economic performance (Paque 1996: Whaples 2003). Among economists, the neoclassical catching-up hypothesis is considered an important alternative explanation for the empirical observation that politically stable countries grow at a slower pace than countries that recently endured politically unstable times. Especially after World War II, countries such as Germany and France, whose physical capital stock had been largely destroyed by the war, naturally experienced high rates of capital accumulation and thus growth. They were catching up with Great Britain and other countries that were less heavily destroyed after the war. If duration of political stability is generally positively correlated to GDP per capita, catching up provides an alternative explanation for low economic growth rates in politically stable countries (Abramovitz 1983; Nardinelli, Wallace, and Warner 1987; Maddison 1988). Accordingly, Olson's empirical observation may be caused not by the negative impact of political stability on growth but rather by political instability frequently coinciding with a destruction of capital stock. Other authors point at an argument that has already been made by Olson (1982), but that is very difficult to account for in empirical studies. Accordingly, the third hypothesis of Olson's reasoning holds only for special interest groups but not for encompassing groups. Societies with strong encompassing groups are less likely to witness declining growth rates than countries that are populated primarily by special interest groups (Maitland 1985; Gray and Lowery 1988; Lindbeck 1997). This may explain why the evidence of type V and especially type IV studies is mixed.

   Sections 3 and 4 provide an explanation for this empirical picture, which applies especially to democracies and that has so far been neglected. The starting point is a simple model of party competition in a complex environment where voters and politicians do not perfectly understand the functioning of the economy and of economic policy. I will argue that party competition is a path-dependent process and that politically stable countries will find themselves in a poorer starting position when having to adjust to changes in the economic environment. Other things equal, they will fail to adjust more frequently and thus witness periods of low economic growth due to inadequate policies. The model does not require an active part of distributional coalitions and thus may explain why the evidence for type IV studies is mixed. Section 5 leaves the narrow focus of the model. It draws on more recent literature on institutions, political stability, and economic growth. I will argue that some institutions are able to increase the probability of successful adjustment in politically stable countries. Similarly, institutional settings codetermine the political influence of distributional coalitions. In both cases, the degree of institutional sclerosis depends on the political institutions. The fact that this has rarely been accounted for in the empirical studies of type IV and V may explain their mixed results.

3. Political Decision Making and Party Competition under Model Uncertainty

   The section starts by assuming that the economy is a complex system. Its macroeconomic performance is determined by a large number of different factors, some of which are unobservable, and the relationship between these different factors is nontrivial (von Hayek 1972; Rosser 1999). Because of cognitive limitations, neither voters nor politicians are able to gain a full understanding of the economy and the impact of different economic policy measures. In other words, they act under model uncertainty. Under model uncertainty, adequate policies cannot be identified ex ante in thought experiments but must be discovered in real experiments (von Hayek 1972; Wohlgemuth 2002). In parliamentary democracies, the process of choosing the experiments to be conducted consists of two steps. First, the political parties suggest certain experiments (by proposing policy platforms). Second, the voters choose between proposed experiments (by voting for a particular...