0:33 Intro. [Recording date: August 2, 2013.] Russ: We're going to talk again about violence and growth and political economy, as we did before. And you've written a paper with Gary Cox and Doug North called "The Violence Trap," and another paper on Adam Smith, and we're going to use those to get us started. We'll start with the "Violence Trap" and then I hope we'll get to Adam Smith. Now you start with a very old and interesting puzzle. We have a good idea of the policies and institutions that weaken prosperity. Why don't the leaders of poor nations adopt those policies and try to create those institutions? So let's start by looking at what policies, institutions are, we think, the keys to prosperity? Guest: Well, I think economists have long understood this, and that is that it involves the deepening of markets, the rule of law, open access, and competition. And so the puzzle is, if this is reasonably well understood, that countries that adopt these policies do well, then the puzzle is: Why don't they do that? Russ: By open access you mean--that's a term you used in your book and that we talked about before. What do you mean by 'open access.' Guest: By 'open access' we mean that a large number of citizens have rights, as opposed to a more narrow elite; and second that citizens have the ability to form organizations. In particular, to compete with existing organizations. And without their ability to form organizations then competition is limited and often we see the creation of rents and rent seeking. Russ: Exploitation, attraction of--predation. Yeah. So, what are some of the arguments that academics and scholars have put forward to explain why this seemingly free lunch isn't eaten. There's this opportunity to make the pile a lot bigger, and yet leaders often persist in following unproductive, inefficient, impoverishing policies. Guest: Well, the literature provides several different ideas about this. And let me mention three. So, one is Bestly[?] and Pierson[?], who have written that politicians have a shorter time horizon because they only stay in office for so long, and so as a consequence they are much less likely to impose policies that have benefits in the long-term future because that won't do them any good. Especially if they have short-term costs. Another set of arguments-- Russ: Can I just step in for a sec? So, if you are a dictator, it still could be the case the reforms might take longer than your lifespan to come into play. So it's not just that you are in the Congress for 2 years. Right, go ahead. Guest: And with dictators, there's the problem of coups. Russ: Yes, there is. Guest: That reduces their time horizon. We'll talk about violence in a minute, and I'll give you some statistics about turnover, especially in poor countries, that relates to dictators. Russ: So, go ahead. That's one argument, the short time-horizon for decision makers. Guest: And then we come to an argument advanced by Doug North in his 1981 book, Structure and Change, and Acemoglu and Robinson in a 2006 paper, and that is that many of these changes reduce the probability that the incumbents will stay in office, in part because reform creates powerful alternative actors who want control of the state and want to kick out the current people. And so as a consequence, this is a barrier to reform. Russ: It's a risk aversion argument. Guest: It's a risk aversion--and a future. Russ: A bird in the hand is worth 7 in the bush. It's true you can be richer but you might not be in power to be able to grab some of it. Guest: That's right. Russ: Any other literature you want to mention? Guest: Well, I want to mention the Fernandez and Rodrik paper. So one of the things they observe is often the beneficiaries of reform don't know who they are. So if you create competitive markets that will create a whole bunch of wealth for a large number of people, those people tend to not know who they are prior to reform, and as a consequence there's less pressure for reform, while the current incumbents, who are advantaged by the existing scheme, are there to lobby against. And so the politics weighs against, in their argument. And I think these are three different, interesting arguments, all of which point to political mechanisms against reform.

5:40 Russ: But you have a different explanation. So, what are you proposing? Guest: In our view--and this gets to the paper that Gary Cox, Doug North, and I have recently written--the problem is really the violence trap. And I want to begin by pointing out that I think that economists have missed the margin of violence in a developing world. And as a consequence they miss how developing countries organize themselves in a way that at once reduce the probability of violence but also create problems for economic growth. And there's a tendency, as in Collier's book on the Bottom Billion, for example, to think about violence as something that happens in failed states: that there's a small number of states like Rwanda or Yugoslavia or Somalia that go through these periods of violence, but they are isolated. Whereas our view: this is much more systematic. So, shall I give you some data? Russ: Yeah, yeah, let's hear. So, by the way, when you talk about violence and economic development I always think of an example I learned from Walter Williams: most of human history, the way you got richer was to bang your neighbor over the head and take his stuff. Guest: Right. Russ: And the insecurity of property rights is obviously a deterrent to innovation, accumulation, etc. But you are talking about a different level of violence. You are talking about violence at the national level--civil war, revolution. Right? Guest: Well, I think that they are related. But yes, I am talking about civil war, revolution; and I will mention, coups. Especially coups, because coups are a very important form of violence, very prevalent relative to the others as far as leadership turnover goes. And so all those are very important. And when new leaders come in they tend to have new factions, and they tend to expropriate or predate on the property of the existing people. So that means that investments ex ante are insecure, in just the way you said. And so the violence trap does imply insecure property rights and hence problems with investment. In particular, a lot of people will forgo otherwise profitable investments because they are concerned that if there is violence that those investments are worth nothing. Russ: So it's not just the mob in the street or the caveman next door taking your saber-tooth tiger skin rug. It's also the new guy in office has a different set--you might have been on the good side of the current leader so your house is secure, but the new guy likes your villa and his friends come take it. Guest: Yes. Or your business. Russ: Correct. Guest: Or your land. In a previous era where land was so much the major asset. So, let me give you some data on this. We are concerned here about violent leadership turnover. So we are going to discuss a regime--a regime is a country, and we are going to find a regime and a country as lasting as long as there is peaceful turnover in leadership. So that means if there is a coup, a regime ends. It also means that this is a very narrow definition of regime change, because if we allow for constitutional change as regime change, that's not included here. So, we are only looking at violent leadership turnover. Russ: So, in this world the United States has one regime since 1789. Guest: Correct. Russ: Because we've never had a violent turnover, as far as I know. Guest: Correct. We've had violence--the Civil War. But the Civil War did not result in a takeover of the government. The South failed. Russ: Okay. Guest: So as a consequence we've had one regime, and of course the United States is of course the longest-lasting regime. It's the order-statistic. Russ: Is it? I didn't know that. Is that true? Guest: I think so. So, if we look at the prevalence of violence in terms of regime change, leadership turnover, what we see if we look at the poorest half of the distribution since WWII, the median poor country has violence-- Russ: Poor defined as? Guest: The bottom half of the distribution of countries. Russ: The median within that half. Guest: The median within that half experiences violence every 7 years. Russ: A regime change. Not just some fighting outside the palace. That's shocking. Guest: Right. Presumably there's some of that, too. Russ: How many countries are we talking about here roughly? I guess 100. It changes over time. But it's a lot of countries. Which means that, you take that number, divide it in half; that means that at least half of that, roughly half, have had violence every 7 years or more frequently. Guest: That's right. Russ: Which is very frequent. Guest: Yeah. A good 10% I think last only 1 year. That is, poor countries in the bottom half of the distribution. Now the next category to look for is the richest, developing countries. So, these are the so-called 'middle income' countries, like Mexico, Argentina, India. And if we look at this category, the median regime lasts 12.5 years. So, a little more than 50% larger. Russ: Still not so long. Guest: Not so long at all. Russ: If we look at the lifetime of a house or land-- Guest: Less than a generation. So this means that most people in the world--so we are talking about 90% of the countries here--experience violent regime change in their lifetime. Ninety percent of the world, in fact. Russ: Well, 90% of the world's countries. But if you start with China--China has had one regime change since WWII, correct? Guest: I think so. Russ: Mao's Revolution. So a billion people have lived in a very stable system by this definition. Again, as you point out, it's an extreme definition. A lot of change in China; but not 'regime change.' Not violence. Guest: Not violent turnovers. The agricultural--this again gets to how it's underestimating violence. The Cultural Revolution--you can kill off 10 million people and that's not counted here. Russ: Correct. Although that was certainly a deterrent toward long-term planning for many people. Guest: That's right. That has the same effect, time horizons and reducing the incentives to investment. So, the final piece of data is looking at the median of the rich countries--that is, the top 10% of the income distribution. And here the median is just dramatically different. The median country-- Russ: And these are the United States, England, France, Japan-- Guest: Netherlands, Denmark, Austria, Sweden, the Nordic countries of course. The median here is 60 years. So just dramatically different. So this is not a continuous distribution in income. Russ: Three generations. Guest: It's positive--you have more income, it goes up for most countries in the developing world. But very flat. And then it jumps. So in other words, there's some missing middle in a sense. There's some very big difference. There's a big dividing line between developed countries on the one hand and developing on the other.

12:40 Russ: I have to say, Barry--we're 12 minutes into this podcast; we could probably go home. I know you have a lot more to say. But that's an extraordinary thing I've never thought of, heard. One way to think about it is: Stability is fabulous. Unless it goes the other way. Unless causation runs the other way. Right? It could be that rich countries are stable, not just: Stable countries are rich. But it's a fascinating empirical regularity there. Guest: Yeah. Dani Rodrik actually has, in a 1999 paper called, I believe, "Where Did All the Growth Go?" actually has quite a bit of empirical work on this, and he suggests that poor countries do grow, and they actually grow quite fast when they grow. But then they get various kinds of shocks, and they contract, often very quickly. In 2000 or 2001, Argentina you may recall had experienced a fair period of economic growth, and then overnight devalued--they had pegged their economy to the dollar, so they devalued. They suddenly, unexpectedly, devalued by a half, and the value of the wealth of Argentina fell, by a half. So that's quite common that there are these various kinds of growth shocks. Russ: So, what's the implication of this level of violence among poor countries? Guest: Well, I'm glad you asked. That's the key question I think. And that's where we get to the question, again, of economists missing the margin of violence. Because violence is so prevalent. It means that countries have to organize themselves to reduce the probability of violence. Because it's so awful. And so these figures that I've given you are in a sense better than they actually look because these countries are organized to reduce the probability of violence. So the key implication is that all states have to reduce the probability of violence. And one of the problems with that is that there tends to be in these countries dispersed sources of violence. That means multiple people have access to violence. And so there is no state that has the monopoly on violence that we tend to think about in our developed world. That's a characteristic of the developed world, not the developing one. Russ: That the state is the one that gets to put people in jail, shoot them, legally, etc. Guest: Yeah. And that there's very little organized violence that can fight the sovereign commands, for example. So, if we think about Mexico: So, Mexico is a relatively rich developing country. It's more sophisticated, more organized, to reduce violence. And yet there are multiple sources of violence in Mexico. So, besides the government, we have PEMEX, the oil company, the state-run oil company. And it has so many workers, more than they need, largely because it's a private army. And so if Mexico wanted to reform PEMEX into a more efficient organization and one that captured fewer rents and provided more benefits for Mexicans, in various forms, they'd have to fight this army. Similarly, there are teachers. Teachers' unions, for example, have shut down states when they don't get what they want. And of course then there are the drug lords and also the fighting in Chiapas and the indigenous population. So there's four alternative sources of violence in Mexico. And it's one of the rich and better-organized states. In fact it's had very few coups since 1930.

16:38 Russ: I have to say something about emergence and coordination. You spoke somewhat casually when you said 'states have to find a way to reduce violence' or 'states look to find ways to reduce violence.' Obviously, the people in power don't want to be overthrown. They are not trying to create institutions that reduce violence in some general sense. They are trying to keep people who don't like them from overthrowing them. There's nothing--that's a very natural, organic force; and it's, as you point out, maybe surprising how bad they are at it. Given their very natural incentive. So how does this tie in back to development? I've gotten a little off the track in my own head. You made the observation that violence is endemic in the developing world, in this definition you have of regime change. Why is that significant? Is it simply that that reduces the incentive to invest? Is it the violence itself is destructive? Where's the trap? What's the trap here that we're trying to explain or put in question. Guest: The trap is several fold. So, first of all there's the actual direct incentives that the threat of violence has. So that reduces the returns from investments, especially investments of economic integration across lines that are likely to fight. And so as a consequence there's much less of that integration of the economy, less specialization of exchange, less investment, the classic sources of economic growth. But there's more to it than that, and that is: So, we have these multiple sources of dispersed violence. How does the state mitigate the fighting? How does it prevent them from fighting? And the way that it does that, I argue, is that it creates rents. So this is rent creation. Russ: What creates rents? Guest: Oh, the state creates rents. Those in power. As you said, those in power want to remain in power. How do they do it? And in the face of multiple sources of violence? Russ: And by 'rents' you mean goodies. You don't mean landlords. You mean they create profits and profit opportunities that are excessive relative to what they otherwise would be. Guest: Exactly. They create monopolies, for example. They allow certain groups to have complete control and in fact run certain regions for example, as they see fit. And they run it in an extortionary way. There's a prevalence of monopolies. There's limits on the degrees of competition. There are tariffs. All kinds of different instruments that countries use to manipulate the market for political ends. And in this case to push rents to people who are powerful in a way that those who are powerful are better off cooperating with the regime. And consuming the rents instead of fighting. Russ: So it's a payoff. Essentially a payoff. Guest: Yes. Russ: It's a bribe to keep certain groups incentivized to keep the status quo. Guest: Yeah. And one of the key results in the paper--we have a bargaining framework that I won't get into--but the key result, I think, we call the 'proportionality principle', or principle of proportionality. That is, it's the idea that rents have to be in proportion to the power of the different groups. And the reason is, the more powerful you are, the greater the returns from fighting. And so if we need to give you incentives not to fight, if you are more powerful, we need to give you more rent. So this also means that if you have little power, very little access to organization and violence, you get cut out. So Bates's[?] story, for example, about the African peasants--the peasants are in the countryside, they are not organized, they've got to tend their crops, and so they are the ones in the regime that are exploited by the rest.

20:37 Russ: So in this story, the problem of violence, it's not so much the direct effects that violence destroys resources. Which it does--it's purely wasteful in some dimension. And it's not the incentive. It's that the way you best cope with violence is you mess up your economic system. That's what you are saying. Guest: Exactly. Economists have a tendency to look at this and see, without recognizing the margin of violence--they look at this and they see what they call 'market intervention.' And the observation is clearly correct--that is, that the politics is manipulating the economy for political reasons, and so they are preventing the economy from being this great engine of growth. And economists in the standard kind of recommendation for reform, they say: Well, undo those constraints. And they think: This will make everybody better off. Russ: Because the pie is going to get bigger, you'll have all this expansion of trade, investment. Guest: The problem is, again, as I've mentioned: They've missed the margin of violence. And so if rents are the glue that's keeping the peace, then undoing these rents undoes the glue. Russ: It's inanity. Guest: Yes. And so even people that are exploited are willing to support the status quo. Because being exploited under peace is better than being in the middle of a great disorder. Russ: So, I don't know this literature very well, but the standard way I used to think about this, and it's probably--we probably talked about it in a conversation with Bruce Bueno de Mesquita a long time ago--but I tend to think of, if you just follow better economic policies, the pie would get bigger but it's hard to redistribute that larger pie in proportion to what people are currently getting. So even though the average person is going to be better off, you can't necessarily compensate. As economists often like to pretend they can. When they talk about efficiency, they say: Oh, we're going to make everybody better off. No one will be worse off. We could after this change. But there's no cheap, transaction-free, cost-free mechanism for a redistribution. And so that's what keeps things from happening, it would be enlarging the pie. But you are making a more dramatic argument. You are suggesting that it's not just, well, it's hard to redistribute the goodies; it's that if make the pie larger that way, some people are going to get really mad and they are going to kill you. And you are going to get no goodies. Guest: That's exactly right. Existential threat here. Which again economists tend to ignore, that people might come kill you. Because you are the masters of the status quo; it's been an oppressive system. And so, that is a really important block to the whole problem of reform. So, this in essence is the Violence Trap. The idea that the way out of the violence trap is through economic integration and reform, but you can't reform if there's a threat of violence. And so you are in something of a trap. Adam Smith said something like this, not referring to violence, but he said: Till some stock is produced, there is no division of labor. But without the division of labor, there can be no stock. So stock is his notion for capital. And so he's clearly seeing a threat there, the kind of trap we are talking about. Russ: Can we talk about that for a sec? Say that again. Read that--if you don't know that stock is capital, the first time you hear it you are confused, because you are going to think about the stock market. So, read the quote again. It's a great quote about the challenge of igniting prosperity. Right? It's [?] stock. Guest: So remember, Adam Smith opens the Wealth of Nations with the idea of division of labor. Division of labor is the source of specialization exchange and how people get rich. And so that's one of his key features about economic growth. He has others, but that's a key. So that's one. And the other one is that stock is, as you mention, is work[?] for capital. And so here's the quote, or the essence of his idea: Till some stock is produced, there can be no division of labor; but without the division of labor, there can be no stock that gets produced. And so you are in a trap. And that's the essence of these kind of-- Russ: Any surplus. To put something aside for the future, which is what a machine or an investment is, essentially. It's a sacrificing of consumption today for consumption tomorrow. But if you don't have division of labor, there a subsistence level, so you can't get started. Guest: And Thucydides actually put this a little differently. And I'm summarizing here; one of my colleagues, Josh Ober, who is one of the experts on Thucydides-- Russ: who we interviewed last summer-- Guest: And he summarizes Thucydides this way: To survive, a community needs a wall. This is in the ancient times, a lot of violence. But walls require money. Capital. How do you get it? And in his view there's two ways of getting it. You go somewhere and either you trade or plunder. But to trade or plunder you need ships. How do you get ships? Well, you need to build them. And in order to build them you need security and a wall. So without walls-- Russ: it sucks-- Guest: This is the essence of the violence trap. You are stuck.

26:18 Russ: Now, why is it that some nations have escaped it? Guest: Well, that is a really important question, and I think that the key takes, this is what we call the 'escaping the violence trap.' And part of this I think has to do with greater economic integration. So, if you have greater economic integration, you are raising the cost of fighting. But of course violence, the threat of violence, is what prevents that. And so, what are the circumstances? So, one of the things I want to point out is that economic development is relatively rare. Countries can get rich within being a developing country. So, Rwanda is much worse off than is Mexico, India, Venezuela, for example. But still, as we suggested, there is this big gulf between the developing countries and the rich countries. So, how does this happen? Something in the environment has to change in a way, otherwise you are just in this equilibrium. And that's where this role of shocks come in, various kinds. The world changes. So, let me give you an example. So, France, between the Revolution and the 1870s had something like 11 or 12 Constitutions. So, it was constantly in turmoil. They were fighting; there were 2 factions in the post-Napoleonic world, and each trying to get an advantage. They were nominally thought of as the republicans as one and the monarchists as another. And they are fighting each other; and it is not a stable place. And then something happens in 1870 and 1871. The Germans. The Germans were not thought of as the great threat in this world; but France and Germany get into a war, the Franco-Prussian War, and the Prussians just beat them handily. And moreover, at the same time, Germany unites. So Prussia becomes much more powerful. They institute universal male enfranchisement for the lower house as part of their deal. Russ: Germany? Guest: Yes. And they begin conscripting mass armies. So the threat starts getting much bigger. Russ: So they lost a war and the future doesn't look good, either. Guest: Right. And so the only hope is to cooperate. So survival requires that the two factions stop fighting each other. And of course the stakes at which they are fighting are small relative to the existential threat of Germany. And of course, we know, Germany invades two more times. And creates problems for France. Russ: But there's no regime change for France for a long time. Guest: No. In fact, the longest-lived--so France has had many Constitutions since then. And to this day the longest-lived Constitution is the one they created in 1871, through the middle of '70s, the Third Republic. And it lasted all the way to the Nazi capture, takeover, in 1940. Russ: Yeah. Guest: And so this regime, was the most stable of the all the French. Russ: So that's the violence we've only been discussing implicitly, which is external violence. Right? To quell internal violence. So you are giving an example of how a country that faces the tension of internal violence could give that up, could escape that trap because of the threat of external violence. Guest: Well, I think part of the idea is that the external threat serves as a commitment device. So one of the problems with the two different sides--I didn't mention this in the theoretical discussion--but one of the problems is that shocks regularly change the relative capabilities of the, say, of the bargaining parties. And remember we have the proportionality principle, the idea that people with stronger violence potential have to receive greater rents. So if there are shocks that occur that change their relative capabilities, then you need to adjust the flow of rents. Now if you and I are potential groups that might fight, and I know that your capabilities have risen and mine have diminished, then we can bargain. I might not do it happily, but I know I have to because if I don't, you are going to find me. Russ: Crush you. Guest: Now there are two problems with that, with those kind of bargains. One is the idea of asymmetric information. That is, you may become stronger in ways you know much more about than I do. Correct? Russ: Right. Guest: But I know you become stronger, but I don't know you become that strong. Russ: And you might not know that my particular strengths are ones that are particularly dangerous to you, or are relatively unknown to you. Guest: Right. And as a consequence, if you think you are much stronger than I think you are, then the highest bargain I am willing to give you is lower than the lowest bargain you are willing to accept. In which case we have to fight. Russ: Right. Guest: So that's a standard model Jim [?] and others have had about fighting, international fighting. Russ: Because on the surface fighting is stupid. Guest: Yes. Excuse me. Those models are in the world of international fighting and I'm using it here within factions within the country. Same principle. And so the way that the international threat--so now we add to this mix, international violence. And so the way the international violence works is it changes the incentives of the parties. Because the amount I want to take from you is small relative to the amount that the outsider is going to take from both of us. And so as a consequence we start to cooperate. We see this quite regularly in the world. Russ: Which is fabulous. Intellectually fabulous. Because it's hard to understand why people suddenly can get along. But you are saying there's an incentive offered. Guest: Yes. An incentive. So, former enemies become fast friends. And I think this is an example. And the number of countries that have a kind of existential threat in the modern world are relatively small. So, Korea and Taiwan. But so many other countries don't have this kind of existential threat. This gets us to the work of Bob Bates, moving far afield, but one of the things Bates argues, in his 2001 book on Violence and Prosperity is that the developed world polices the borders of the developing countries. And as a consequence it's very hard for them to face these existential threats. And so as a consequence this mechanism of the outside threat is not very prevalent in the modern world.

33:08 Russ: I want to go back to Korea and Taiwan. You are suggesting that the threat of Chinese aggression-- Guest: North Korean and Chinese aggression-- Russ: makes South Korea and Taiwan more prone to cooperate--internally; the factions are less prone to violence. And then you can get good economic policies. You are suggesting that the growth rates of the rather extraordinary performance of South Korea and Taiwan are politically possible because they are worried about an external threat. How do you then explain China's growth rate, and China's liberalization? How do they? Guest: I'm not saying this is a necessary condition. China, I think, is extraordinary. I think they did perceive an existential threat, given that they were an aggressive communist nation in the mid-1970s, the death of Mao. And that they did worry about how they would survive. And so if you look at the initial history of reform, Deng Xiao Ping is the master of reform, but he is not the initial leader. Instead there is a more modestly led, more liberal leader, than Mao. And every knows after the cultural revolution that it just ended. That you needed more economic growth in order to get back on the road toward prosperity and survival. And the modestly liberal leader was unable to create this, and so Deng Xiao Ping came to power. And remember, Deng Xiao Ping didn't set out for gross reform. He did it very incrementally. And he really believed in the Pareto principle. In the literal Pareto Principle. Russ: Which is? Guest: Which is the idea it is not that in principle we can make everybody better off. Russ: And no one worse off. Guest: But every step has to make people better off without creating big losers. So the first thing that he did was reform agriculture from the collectivization, and that very failed model in the countryside. Russ: Which led to famine and millions of deaths. Guest: Yes. He created reform so that people had long-term leases and along with privatization, and agriculture, production of grain, doubled in two or three years. Russ: Yeah. Guest: And for the first time the countryside was able to feed itself. Because under the Mao regime, as you said, there were famines. The Mao system was exploiting them; they were unable to organize. So the Mao system exploited them by underfeeding them. Russ: Expropriating their grain. Guest: Right. And so this system provided much more grain for everybody, including the farmers. So right away you've got 400 million people who are supporting the next step. And so the next step was GuangDong[?]. And it was done in a way that if it failed it wouldn't have been Deng Xiao Ping's problem. Russ: Why? Guest: Because they are letting--what they did, it was called 'One Step Ahead,' the reform process. And they let Guang Dong[?] reform as an experiment, and if it failed, Guang Dong[?] would have been a failure. I mean, it would have had some negative implications for Deng, but it wouldn't have been like he created national reform that failed on a national level. And he didn't choose a random place. He chose the place that was most likely to succeed, GuangDong being the old Shanghai, being one of the trading entrepots of China in the years before Mao. And so they had the most ties to capital, Chinese capital, from around the world; people had fled. And as we know, the rest is history. The experiment succeeded and was imitated. Russ: Yeah. Internally. Yeah.

37:01 Russ: What about the peace trap? The good kind of trap. One has the impression, which I think is overrated, but most Americans I think believe that there is no chance of anything changing in the United States. Of almost any kind. They can't imagine--well, lately they are starting to imagine it--but in general, that something would fundamentally change in the United States--it seems extremely stable. The odds of a violent coup; the odds of the military, say, overthrowing the government; the odds of the Mafia overthrowing the government: minimal. Not just minimal. Unimaginable in the literal sense of the world. People can't imagine it. I can. I can imagine it. As you've pointed out, in world history, these things happen. But they happen infrequently, as you point out, in the wealthy countries. Are we all set? Can we fall back into a violence trap? Or are we going to cruise along? Guest: No, I agree with you. I think there is some possibility of falling back. I don't think it's very likely. But it's not zero. One example, for example, is: Suppose 9-11 had been the first of many. So one of the things we know, you look at opinion polls after 9/11 is that a majority in the country favored trading off rights for security. So suppose there had been one every six months, you know, just on average, for 10 years. The world would have been so much different--our world would have been so much different. There would have been a significant reaction on the part of government to create more security. A significant demand from the people to create more security. Even at the expense of rights. And we can see a very different United States because the margin of violence had suddenly changed. Russ: But let's keep on that story, for a minute. I qualify what I said a minute ago. People, we're at a time now, they are concerned about the National Security Agency (NSA), surveillance; they are concerned about political use of the Internal Revenue Service (IRS)--we don't really know what the full story is there. So there is, I think, a slightly heightened awareness of the potential for the abuse of power at the national level. Especially when it's classified. We can imagine the worst. If there had been a series of violent acts, from the outside--so there might have been some removal of individual rights. There might have been more surveillance, more camera monitoring, more preventive arrests even, than we have now under our current system. I don't know if you saw yesterday, I think it's a true story: somebody had been googling backpacks and googling crockpots. And that reminded the employer of this person of the Boston marathon bombing, and so a team of scary people showed up at this guy's house wanting to know why he'd been googling backpacks and crockpots. Pressure cookers, not crockpots. I think you are safe with crockpots--listeners. It's 'pressure cookers'--that's what the dangerous search term is. But anyway, let's say that happened. I'd have been upset, disappointed, perhaps. I hope I'd have been one of the people who had said this is a bad tradeoff, but maybe I'd have gone along and said it's necessary to preserve our security, reduce the odds of these horrific attacks, as we were imagining--that they were frequent. Would that change the odds of a regime change? If we lost some more rights, First Amendment rights, Search-and-Seizure rights, as citizens, are you suggesting that we could move to a world where we wouldn't have civil, peaceful elections and transfer of power between Republicans and Democrats? What story do you have in mind there? It's fascinating to think about. Guest: I don't think that's very likely, but I think it's possible. And I think the reason is that, in the drive to create more security, people would willingly support not only compromises in, not only rights, but the rules of the game. And so Congress, for example, could be seen as a problem by the Executive Branch because there are so links[?]. And it's in the way; they have all kinds of special interests they are trying to protect, in the ways that security goes. I can talk at great length about the Homeland Security Act and all the politics there and the way in which security, the provision of homeland security, was greatly compromised by the nature of the political exchanges. And I think we'd see a lot more of that if there was more legislation needed. And as a consequence, you could imagine that the Executive Branch reacts to this, trying to say: They are an impediment to solving our problem. And remember, if there is lots of violence that is going on from these terrorists, a large number of people, I think would support this. As I mentioned, with the opinion polls after just one event that a majority of the country I think then felt that it was okay, that these compromises were okay. I don't think a majority now feels; but we've had 12 years of relative peace, relative absence of these terrorists. Whereas if we had one every 6 months I think people would feel much more insecure. Russ: And I guess to play along with your unpleasant thought experiment: In many ways I think there a lot of people who are violently opinionated about either of these very discrete, binary choices. You either think we need a lot more security or a lot less. And I could see violence erupting between those two groups. I could see--if it gets serious enough, and people felt the country was losing its character either because it was insecure or too secure. Guest: Another form of our polarized society. Russ: Yeah. A very different one than we usually talk about or worry about. If you follow Twitter. Guest: Polarize along those same lines. The polarization could be along very similar lines. Not exactly the same, Democrats versus Republicans. Russ: No, but it's hard to remember, but in 1776 there were a lot of people who didn't want to go to war, and a lot of people who did. And that can lead to internal violence. I'm sure there was some. Guest: Well, one thing to remember there, and an ugly episode in our history, is we actually kicked out the loyalists after the war. Russ: We kicked them out? What did we do to them? Literally exported them? Guest: We confiscated properties and various kinds of things. And that's where English Canada comes from. Russ: They left. Guest: They left from the United States, because, as you recall, Canada was French. Russ: Correct. I do recall that. That's good. I didn't know we kicked the loyalists out, though. People who were loyal to the British crown. The last thing I'll say about this, and then we are going to turn to Smith, is that I do find it interesting in the aftermath of 9/11, in some dimension, how little we moved toward security. If we think about past episodes of U.S. history, the most obvious being the treatment of the Japanese during WWII or the Germans, German-Americans or particularly Japanese-Americans, that is unimaginable today. We reacted to the 9/11--I really don't like that we make people take their shoes off and x-ray them, but in the grand scheme of things it's strikingly small. And I think your point is correct, that if it were every 6 months it wouldn't be so small; it would be on a different path. Guest: Yep.

45:16 Russ: Let's turn to Adam Smith. What does Smith have to say about this that might be relevant? Guest: Well, Smith--one of the exciting things I find in reading Adam Smith's Wealth of Nations, his Book III. And Book III I think has historically been the least interesting book for economists. In part because--let me put it this way. You could read Adam Smith's Wealth of Nations, and Mark Blaug says this explicitly, that the Wealth of Nations is a treatise on economic development. And one of the confusing things I think about Smith is that he offers three different ideas about economic development. So, I mentioned one: the division of labor. If you want greater development, you've got create the conditions that foster economic development. Russ: Specialization. Guest: Specialization, exchange, division of labor. Second, he emphasized--and that's Books I and II. Russ: And I should say, he explicitly laid out the most important one, which is the size of the market. You've got to have trade over large groups. Guest: Yep. The larger the market, the greater the division of labor. Famous phrase. In book IV, he's very explicit about the nature of policies. If you have bad economic policies you lead to bad growth. And here's where he talks about all kinds of the guild regulation and monopolies and of course constraints on international trade and hence international specialization and exchange. So economists--both those speak very clearly to modern economics. The problem is that in Book III, he has another set of ideas about the political foundations about economic growth. And the problem for economists in seeing it is that it's written differently. This is an odd part of the book in a way. It's the shortest piece of the book. It's only 50 pages. The Wealth of Nations is 1000 pages. So this is 5%. All the other books are hundreds of pages. And one of the problems is, it's a narrative. So it's hard to pick out what are the key underlying abstract points. The rest of the book, Books I and II, is abstract theory-- Russ: And very analytical. Guest: And Books IV and V are applications. Just the way economists do that now. Book V is a narrative. So, what does Book III say? Well, first of all, he begins with a story about why feudalism wasn't equilibrium. Russ: Why it was. Guest: Yes. Why feudalism was stable for so long. Russ: And by the way--I didn't remember reading Book III. Or maybe I hadn't, before this podcast, at your urging, encouragement I read it. And it's a very brief history of the world. He starts, I think, with primitive ancient times. The building of cities; then he goes to Rome; then he goes the Middle Ages; and then he gets to the present. But it's a very quick overview. Guest: Sweeping. Russ: 'Sweeping' is the right word. And you're right--it's very different. Guest: So, what he does--he does two things, really big things, I think, in this. He concentrates on feudalism as an equilibrium, and then what are the processes by which that changed. How did we get the transition to what he called the 'commercial economy', what we think of as the process of development, a much richer world where there was rule of law; there are investment contracts, competition markets, and of course political and civil rights as well. And so he explains this. And I think the violence trap is very useful in understanding what Smith says. Because I think Smith's argument about the stability of the Middle Ages is very much a violence-trap argument. And so one of the things he's saying is that there is fighting among the local lords, all the time. That the king is a little bit stronger than the local lords but not strong enough to impose security. So there is no law in this system. Russ: There are islands of security but that threaten to fight among themselves. Guest: Yes. And because they are fighting each other all the time there is what he calls this 'constant predation.' One of the things he says is that "men in this defenseless state naturally content themselves with their necessary subsistence, because to acquire more might only tempt the injustice of their oppressors." So, in other words, there is very little investment in this, very little specialization and exchange. The vast majority of the population, probably on the order of 99%, is living at subsistence. And then there is a small military elite that lives on top of this that extracts from the peasants. And they fight each other all the time. And this reflects the whole idea of the violence trap. So, you and I are neighbors, neighboring lords, and we have an accommodation. And I've been a little stronger than you are and so I've been able to take some things from you or force you to give me things--that is, land and peasants. Russ: And the threat of violence. Because they are more powerful. Kind of in your example to let me be the more powerful one. [?] Go ahead. Instead of you, you could have let-- Guest: Well, I actually was going to do it the other way. So, okay, so you're the more powerful one. But what happens? You don't have a son and I have a son. And so while you are more powerful now, 20 years from now you don't have a son. And you don't have a way of organizing; you are too old to do this. And as a consequence I come back and we fight again. And you've got to give up things for me. And this is happening constantly. Russ: So we've got these 'shocks', essentially. Guest: Yes. Shocks are prevalent all the time, in various kinds of forms. So one way to think about this is that this is a world in which there are three players. So, I mentioned the king. The king is not particularly more powerful than a lord--a little bit. And there are many other lords so in aggregate they are much stronger than he is. But there are also a third group, and that's the towns. And the towns are traders. And they are located on the coast. And one of the things that occurs around the 9th and the 10th century is an expansion of trade. So there are greater possibilities of economic expansion, but the problem is that the elite, the lords, are predating on the towns. And so as a consequence, they are unable to take advantage of this.

52:09 Russ: Now, when you say they are predated, they are being predatory, what's the--is this 250 guys on horseback burning down parts of the town and going to the corn silo? What are they doing there, do we know? And how do we know, by the way? They didn't have YouTube back in the 9th, 10th century. So we don't have any videos of this. So how do we know anything about it. Guest: There are books. There are people that have written about this. So there's plenty of work, both of archeologists and anthropologists as well as historians. There's plenty of records. Russ: But not a lot of primary sources. Guest: No. There's not data. We don't see that kind of thing. But nonetheless what we do see are these records of this violence, these predations on the part of local lords who hate these guys because they are trying to amass an alternative source of wealth and power, and possibly fight them. And so as a consequence they are constantly predating and fighting these guys. And so in this world--so a political exchange emerges in this world between the kings and the town against the middle. So, both have problems with the lords. And as a consequence they form this alliance, which you can think of as a tax-limitation agreement. So, what the towns do is they agree to a fixed payment every year of taxes to the king, and also are willing to give some military service to the king. Russ: Which helps him tremendously because he is outnumbered by the lords' effective armies. He's got nothing to really--he has no leverage, little leverage. Now he has more. Guest: Now he has more leverage. In exchange the towns get the ability to build walls, to self-govern, and also to trade, as well as defend themselves. So they create local armies, and they have a military advantage locally over the local lords. This is key. And the reason they do that is they are more organized. They are right together and they say, Okay, I'll go. So if they start moving into the countryside, the problem is the way the military organizations of each of the lords work is very dispersed. Each of the underlords-- Russ: They don't have a barracks. Guest: They don't have a barracks, right. Russ: They are scattered around. Guest: They are all separate. So when the threat comes like this, they have to get organized. That takes time and that doesn't happen overnight. And so the town is able to subdue the local lords. And this has a very important economic consequence-- Russ: This is Barry Weingast talking, not Adam Smith. You are using this Smithian insight that there was tension and threat of violence; but this 9th, 10th century history and the organization of the lords and the king--that's not in Book III, is it? Guest: Well, some of this is. You are right that I'm mixing my own interpretation of this. Russ: Carry on. Guest: But Smith does explain how the local lords are subdued. Russ: Okay, go ahead. Guest: He doesn't explicitly talk about the military advantage. That was the piece I added. But he does talk about them subduing and about the consequence is that they bring their rules into the countryside that they've subdued. And that transforms what had been very poor, self-sufficient agriculture, very little division of labor, into an exchange economy. So they start producing food and other kinds of primary products that can be exported. And so they become market participants, specialists and market participants, that are often international markets. And so we're getting the advantages of the expansion of the market and the division of labor. And it's because the towns are able to impose their system of rules and liberty, and rule of law, on the countryside. And another thing that Smith explains happens is that very rich merchants start to move into the countryside. And organize. They start to experiment with agriculture, and invest and innovate and bring their capital. And so we see growth in the countryside that feeds this. But that makes the town even stronger and so it expands its international trade, gets more profits from there; it expands the size of the market locally; it becomes more powerful and it expands locally. And it does it again. So, part of what they are doing is subduing the local lords. And one of the things he mentions, that Smith emphasizes, is that there is a dramatic sociological change in the countryside. Because these local lords who used to be military leaders now have been subdued. They no longer have military organizations. They no longer need to spend their rents on supporting all these retainers that were part of the military organization. They get rid of those guys. Russ: So they are doing something productive instead of merely beating people up or fighting off the other lords. Guest: And part of what happens is the middle ranks start to become investors in agriculture. And we see their property rights go up, their rights go up; and they become greater producers. And they become, in some places, the gentry. Over a century or so we see a dramatic change in the countryside. And so what we see here is the escape from the violence trap. There is something that's very novel that comes along. Russ: So the forcing variable, the exogenous change there, is this increase in trade that allows the seaside port city to get a little richer. And if it can do that before it gets expropriated, they have a chance to use that incentive to organize and then keep the lords at bay. Guest: Yeah. And so we can sort of look at a history of Europe this way, in the following sense. Let's do some comparative statics. So, one of the things that's occurring is the king is getting stronger as a consequence of this alliance. The lords are getting weaker. And so there is something of a clash between the kings and the towns, eventually. And it goes different ways. So, let's start with France. So, France is predominantly interior countries. Russ: Interior? Guest: Interior meaning most people live away from the coast. Russ: Okay. Guest: And so the reach of the coastal towns is relatively small into the interior of France. And so as a consequence, the towns don't become particularly powerful in France. And so the effect of the towns on the countryside is small. Nonetheless because France is so big, it's nonetheless powerful as a nation against the world. The Dutch Republic is just the opposite. It starts almost exclusively with towns. And the local population, agricultural population, is easily taken over by the towns. And it becomes almost 100% market. And so it is dominated by the towns and has rule of law. It's a republic, the Dutch Republic. Russ: And it grows tremendously. Guest: It grows tremendously. And this tiny little place becomes one of the richest places in the world in the 17th century. And in fact, in the Dutch revolt against the Spanish--the Hapsburgs had nominal control over the Dutch in the 16th century, and the Hapsburgs try and extract too much taxes and the Dutch revolt. And nobody expects this tiny little province, set of provinces, to beat the most powerful organization in the world. But they do. And part of the reason they do is they have a market economy. They have rules and there is so much capital there that they are able to use debt financing to finance a much larger war than the Spanish expect. Russ: Cool. Guest: So that's the difference. Now let's look at England. England is roughly divided, in the 17th century, half and half. So there are a lot of coastal towns; London is one of the great trading places in the world. And London as a town needs two things: food and firewood. And as it grows, it needs more food and firewood. So what happens? So, all up and down the Thames River and the coastal towns up and down, around the mouth of the Thames become transformed from this poor, self-sufficient agriculture into markets producing in this specialized international economy supporting London as the trading entrepot. Russ: So producing one crop instead of trying to feed yourself. Guest: And they become rich. And they are supporters of the commercial economy, of course. Because their fate is tied up with the commercial economy. Whereas the interior of England still remains this traditional subsistence economy. And these are the two groups that fight the civil war in the 1640s. And of course what's happening is that the commercial economy is growing, getting more powerful, and ultimately comes, after the Glorious Revolution in 1689, to take over and dominate in the 18th century and creates a really successful commercial economy that then Smith starts writing about in the mid- and late 18th century.