Secession Week 2010: The Size of Nations

Welcome to day two of our second annual Secession Week! Today, we’re talking the size of nations.

An Intro to the Size of Nations

As you might have guessed from the name of this blog, we want to see more nations. There are serious benefits to having more and smaller states: the efficiency coming from jurisdictional competition, the robustness coming from decentralization, and the satisfaction coming from choice are all, frankly, awesome.

In his keynote at the 2009 Seasteading conference, video below, Peter Thiel asks how many countries there will be in the year 2050. There are just under 200 independent states now; significantly more than at the end of the second world war. It would be a strange coincidence indeed if that number happened to remain roughly the same. We therefore need to think about two possible futures: a world with many more nations (let’s say a thousand), or many fewer (let’s say one). We want the first outcome; others want the second.

While the size of nations is normally taken as an uninteresting brute fact by political economists, there have been some notable attempts to explain what causes a country to be a particular size and what size a country should be.

In his 1977 paper A Theory of the Size and Shape of Nations, David Friedman uses the tools of economic theory to lay out the conditions which determine the size of nations. He is concerned purely with how big nations will be, not how big they should be. He models states as profit-maximizing leviathans in military competition with one another for territory.

A government aims as maximizing its tax yield net of collection costs.  Generally speaking, states will want to take over as much land as possible in order to achieve this goal. They are, however, constrained by other states seeking to do likewise. What happens when two government want the same piece of land? One answer is that the state with the most military power always prevails. That’s not a good answer, however. Rather, we need to think about the price each country is willing to pay for the territory in terms of military and/or diplomatic effort. Just as markets provide goods to those with the willingness, not simply the ability, to pay, disputes over land are decided primarily by who wants it the most.

Given the assumption that each state aims to maximize its total net tax yield, it’s the complementarities among regions in terms of tax collection we need to consider: the state whose other land will best combine with a disputed territory in order to increase total tax take will be willing to pay the most and will prevail. This means that national borders will be arranged in a way which maximizes taxes minus collection costs.

What factors maximize the total net tax yield? If a state can tax trade, it will be in its interest to encompass an entire trading area. If a state can tax labor, it will be in its interest to increase the barriers to exit. Large and culturally homogeneous countries increase exit costs by increasing the physical and cultural distance of neighboring jurisdictions. Friedman shows that the size and shape of past and existing nations tends to support his theory.

If you think that sounds like a bad thing from an individual welfare point of view, you’d probably be right.

In their book The Size of Nations, Alberto Alesina and Enrico Spolaore take a different approach to thinking about how big countries will be, and also consider how big they should be.

When considering how big countries ought to be, they compare the costs of large countries with those of small countries; the country size which minimizes the sum of these costs is considered optimal.

The main cost of big countries comes from preference heterogeneity. As a single state encompasses a larger population, we’re likely to see more diversity in what people want government to do. Since government imposes one solution upon everyone, a larger country is going to make its citizens less happy with government on average. If this were the only issue, we’d want roughly six billion countries each having one citizen (which sounds alright to me). That way, we’d have no preference heterogeneity within countries.

A central simplifying assumption of the model is that physical distance from the center of a country matches up with ideological distance: geographically peripheral regions diverge most strongly in terms of their preferences over government policy.

There are, of course, costs of small countries too. First, Alesina and Spolaore suggest, there are economies of scale in the production of government services. As the size of a country increases, the fixed costs of government are shared among more people and the cost per head decreases.

Secondly, a bigger country implies a bigger market. Wealth is generated by specialization and the division of labor which, as Adam Smith pointed out, is limited by the extent of the market. This means that being able to trade over a larger area makes people better off. Of course, living under different governments shouldn’t stop two people from making a voluntary trade, but borders do increase costs. Most obviously and annoyingly, governments like to restrict trade across borders by means of tariffs, subsidies, and quotas. They best idea is to get rid of protectionist policies, but given they exist there’s a second-best case for having geographically larger states.

There is also a more inevitable cost of transacting across borders. Since different jurisdictions have different rules (a wonderful thing in general!), striking a deal across a border is more complicated. There are many mundane examples: certification or labelling requirements for products frequently vary by country, meaning that a product sold in one country will often be illegal in another. Getting the right certification and including the right information on the label is costly, and will tend to reduce cross-border trade. Another issue is the settling of disputes. Living in different jurisdictions under different rules increases transaction costs.  With negotiation, they can agree to rules which suit the situation, but the fact that businesses within a country are generally optimized to local law makes cross-border trade costly.

When it comes to how big countries will be, Alesina and Spolaore’s argument depends on the system of government in question. In a dictatorship, their way of modelling the problem is similar to David Friedman’s. In a democracy, they assume that majorities can vote to split up an existing country. When the costs of preference heterogeneity exceed the benefits of economies of scale for a majority of voters, a country will fracture. Alesina and Spolaore see the incentives of democracy leading to countries which are too small. In his review of the book, though, David Friedman shows that this result is entirely dependent on arbitrary assumptions: we could get the opposite result with equally reasonable assumptions.

The work of these economists provide a useful framework in thinking about the size of nations. We’ll attempt to move beyond this static approach, though, and consider what happens when we consider a dynamic market for governance.