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Kicking the Backside of the State with an Invisible Foot

August 31, 2010

It may disenchant some that we consistently compare governments to firms competing in a market. As firms compete for customers, ideally nations should compete for citizens.

To say the same dynamic at play between Coke and Pepsi also occurs between the U.S. and Canada appears to the patriotic as heresy. But what we lose in forgoing the emotional charge of God and Country, we gain in understanding. Let me rephrase Edward Gibbon’s thoughts on Christianity and Roman history to suit my point: the political philosopher may indulge the pleasing task of describing Justice as it has descended from Reason or Heaven, arrayed in its purity. But a more melancholy duty is imposed on the Thousand Nations blogger. He must discover the inevitable mixture of error and corruption which Justice has contracted in its long residence upon the earth, among a weak and degenerate race of beings.

One key claim we make is that the goods of civilization (human flourishing and prosperity, respect for basic rights) are not founded on the long term resilience of particular governments. In fact, and perhaps more controversially, we hold the opposite to be true–long term resilience at the level of the state dampens the rate of improvement in the quality of governance and, ultimately, economic growth as well. One driver of this stagnation is the Olsonian story about accumulating special interests sapping the dynamism of an economy until it petrifies. Another is how democracy skews toward short term thinking. Policy makers generally aim to craft policy that will help them win the next election, a goal often but not always at odds with long term wealth creation and the preservation of human rights.

The main mistake most political theorists make is to assume that the macro-resilience of worldwide prosperity arises from the micro-resilience of a particular state and its national rule set. In other words, subsystem stability–preserving particular national rule sets–is taken to bolster the larger system of global governance.

But that claim is mistaken. The truth is that a certain kind of micro-fragility leads to macro-resilience in a complex adaptive system.

Over at the Macroeconomic Resilience blog, Ashwin Parameswaran has been pursing this line of inquiry with respect to the global economy. But I can’t help but draw analogies to the market in governance. Parameswaran writes:

Although it is typical to equate resilience with robustness, resilient complex adaptive systems also need to possess the ability to innovate and generate novelty. As Allen and Holling put it “Novelty and innovation are required to keep existing complex systems resilient and to create new structures and dynamics following system crashes”. Evolvability also enables the system to undergo fundamental transformational change – it could be argued that such innovations are even more important in a modern capitalist economic system than they are in the biological or ecological arena. The rest of this post will focus on elaborating upon how macro-economic systems can be both robust and evolvable at the same time – the apparent conflict between evolvability and robustness arises from a fallacy of composition where macro-resilience is assumed to arise from micro-resilience, when in fact it arises from the very absence of micro-resilience.

The point is that the overall health of an economy is determined by the underlying chaotic churn, the creative destruction that occurs at the level of the firm. And while the invisible hand of the price system guides producers and consumers to the most efficient allocation of goods, it is the invisible foot that kicks firms into a race to produce disruptive technologies. (And remember, national rule sets are a kind of technology.) So what is the invisible foot?

The concept of the “Invisible Foot” was introduced by Joseph Berliner as a counterpoint to Adam Smith’s “Invisible Hand” to explain why innovation was so hard in the centrally planned Soviet economy: “Adam Smith taught us to think of competition as an “invisible hand” that guides production into the socially desirable channels….But if Adam Smith had taken as his point of departure not the coordinating mechanism but the innovation mechanism of capitalism, he may well have designated competition not as an invisible hand but as an invisible foot. For the effect of competition is not only to motivate profit-seeking entrepreneurs to seek yet more profit but to jolt conservative enterprises into the adoption of new technology and the search for improved processes and products. From the point of view of the static efficiency of resource allocation, the evil of monopoly is that it prevents resources from flowing into those lines of production in which their social value would be greatest. But from the point of view of innovation, the evil of monopoly is that it enables producers to enjoy high rates of profit without having to undertake the exacting and risky activities associated with technological change. A world of monopolies, socialist or capitalist, would be a world with very little technological change.” To maintain an evolvable macro-economy, the invisible foot needs to be“applied vigorously to the backsides of enterprises that would otherwise have been quite content to go on producing the same products in the same ways, and at a reasonable profit, if they could only be protected from the intrusion of competition.”

The same result obtains with provision of government services. Not only does government monopoly block a more efficient allocation of resources, but it also stifles innovation in the creation of new rules. A world of monopoly in governance is a world with little beneficial political change. For just as it is necessary to apply the invisible foot to the backsides of firms, so too must we find a way to apply a commensurate pressure on the backsides of sluggish governments. We need the intrusion of competition. And the force of the invisible foot is directly related to the number of new firms who can freely enter a market. Parameswaran writes:

Burton Klein’s great contribution along with other dynamic economists of the time (notably Gunnar Eliasson) was to highlight the critical importance of entry of new firms in maintaining the efficacy of the invisible foot. Klein believed that “the degree of risk taking is determined by the robustness of dynamic competition, which mainly depends on the rate of entry of new firms. If entry into an industry is fairly steady, the game is likely to have the flavour of a highly competitive sport. When some firms in an industry concentrate on making significant advances that will bear fruit within several years, others must be concerned with making their long-run profits as large as possible, if they hope to survive. But after entry has been closed for a number of years, a tightly organised oligopoly will probably emerge in which firms will endeavour to make their environments highly predictable in order to make their short-run profits as large as possible….Because of new entries, a relatively concentrated industry can remain highly dynamic. But, when entry is absent for some years, and expectations are premised on the future absence of entry, a relatively concentrated industry is likely to evolve into a tight oligopoly. In particular, when entry is long absent, managers are likely to be more and more narrowly selected; and they will probably engage in such parallel behaviour with respect to products and prices that it might seem that the entire industry is commanded by a single general!”

Entry into the market as a government service provider is extremely rare. Creative destruction at the level of the state is non-existent. Charter Cities and Seasteading are efforts to eliminate or lower the cost of that barrier. But without any other solutions on the horizon, are we surprised that it appears as though the entire government industry has evolved into a tight oligopoly?

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6 Comments
  1. September 1, 2010 3:28 pm

    Fabulous analogy between Parameswaran’s “Macroeconomic Resilience” analysis and competitive government. Parameswaran is brilliant, and it is very much worth exploring the application of his analysis to the issue of competitive governance.

  2. Jeff Gibson permalink
    September 1, 2010 6:10 pm

    Great post – Savvy analysis of how governments are largely a cabal shielded from proper evolutionary forces.

    It is worth emphasizing that governments must provide a baseline of stability for economic systems to flourish at current, as well as in the past. In the future, we can contemplate anarcho-capitalistic schemes and their viability.

    “Barbarians at the gate” – metaphorically and tangibly so, are historically proven to devalue property, currency, luxury, specialization – leading to manorial or tribalism system a-la medieval period.

    Thus borders need to be secure, stores of value trusted, and laws at least tractable allowing an extent to freedom of commerce. If the above are violated, then the system fails.

    For now, the conditions above remain true. And, thus, any government entity must be able to do all of the above. The borders and sovereignty control issue is the toughest task for the future of a proposed alternate state, because success begets aggression from the old players.

    • Mike Gibson permalink*
      September 4, 2010 12:52 am

      Stability and trust are important goods. No one will invest in or move to a state that doesn’t supply them. But the point is to let unstable corrupt states die off or hollow out. (Peacefully)

      And as technology improves, public good problems, such as defense against the barbaric hordes, become easier to solve with private solutions. I’m not saying we’re there yet. Perhaps nukes are currently an underpriced existential threat. But hopefully (a big hope) things move in that direction.

  3. September 2, 2010 8:56 pm

    For what it’s worth, Berliner saw the key prerequisite for the “invisible foot” as the option to exit. Soviet planners had instituted many positive incentive programs (carrots) to create a sort of “socialist competition” system where firms would get bonuses for hitting targets. But to Berliner, this system could not provide the negative incentive (the stick) essential to capitalist innovation – firms could still not decide to change their supplier for example so the supplier was still incentivised to stick to his tried and tested routines.

    • Mike Gibson permalink*
      September 4, 2010 12:56 am

      Very good. I should delve deeper into Berliner!

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