The State as “Extorter of Last Resort”

To develop economically a territory needs an “extorter of last resort.”

The phrase is adapted from the idea of a lender of last resort. A lender of last resort lends when no one else will. The idea is, during a crisis, to extend money to those who are solvent but who may become bankrupt due to circumstance. The idea has been central to banking policy since 1873.

Traditionally the state has been viewed as an agent of development for a couple of reasons.

First of all is its role in enforcing property rights. The state ensures that you alone control the use of your goods. This gives you an incentive to invest in new productive technologies to make yourself richer, knowing nobody will steal that wealth from you. In making yourself richer you generate positive outcomes for everyone and so the state’s protection of your rights helps everyone.

Secondly the state plays a role in resolving market failures. It is difficult to profit from roads and infrastructure and the state can have a role in providing these. A market failure occurs when social gains from an activity are smaller than its private gains so it is under-provided. A state can force many people to pay towards the upkeep of roads etc. when they wouldn’t on their own.

Integral to the above ideas on the roles of the state is the idea that a state can be forced to fulfil those roles. Key to forcing a state to do this are veto points where a parliament, a senate, a court can stop arbitrary extortion, or unfair imprisonment, of a citizen. In addition a state must be strong enough to overpower its domestic rivals and force all under its control to pay the taxes set (c.f. Patrick O’Brien).

My theory is that the state plays a slightly different role, the state coordinates threats of extortion. Rather than act in a way which minimises extortion or threats to private property, the state focuses these threats in a single agent. This makes bargaining over how to share an economic surplus more straightforward. It makes investment decisions less risky as it is not only easier to secure a share of the profits for yourself, but is easier to argue that it is in your extorter’s interest to let you keep a large share to incentivise you into investing more.

In a crisis a central bank can credibly commit to lend to a troubled institution when nobody else will. A developmental state needs to credibly commit to be the only institution to steal from a individual or corporation if it wants to forment economic development. By coordinating this threat a state can simplify negotiations to avoid or mitigate extortion. This minimises uncertainty and makes investing more likely.

Knowing what to expect, and who to expect it from, is more conducive to economic growth than a credible commitment to not extort. A credible commitment to not extort isn’t worth much through a period in which the state is building a mountain of debt (see below graph). However a commitment to be the sole power with which those with an actor must negotiate how to split an economic pie can be credible, especially when the state has crushed all opposition (as Tilly argued European states had).

North and Weingast famously argued that the English state, from the C17th onwards, was able to credible commit to not steal from its citizens and helped enable the Industrial Revolution. The English monarch was neutered, after the Glorious Revolution Kings had to report to Parliament and had to respect the property of the wealthy. In the following two centuries England became the most powerful nation in the world.

However, although Britain could borrow somewhat more cheaply than absolutist countries like France, England’s economic development was only a little in advance of France, the Low Countries or Switzerland. A credible commitment to not extort does not seem to unite countries which successfully developed.

In support of this argument a comparison between European states and Asian states is required. From the C16th onwards Europe had a system of small competing states which needed to raise large amonts of money to defend themselves. This led to Europeans states becoming efficient at taxing their subjects.

Contrary to popular misconceptions, Empires like the Ottoman, Mughal or Qing taxed their subjects much more lightly than the Europeans, and especially the English. Qing China, contemporary with Glorious Revolution England, averaged a 6% of GDP tax take, England averaged a tax take of around 12% of GDP. Qing’s lower taxes financed a weak, but geographically vast, bureaucratic state but it did not provide the funds to maintain a state which could credibly commit to be the final extorter.

The taxes paid in C17th (and onward) England were the last likely threat of extortion. In Qing China or Mughal India your taxes were just one element of the expropriation risk you faced, corrupt officials could treat the territory you lived in as a little fiefdom or your landlord could charge an extortionate rent. The English state was able to commit to being the biggest, or only, thieving bastard you would face.

This helps to explain the success of France vis a vis England in the C18th and C19th despite its absolutist, unchecked power structures. Although the French state contracted out some of its extortions to tax farmers (hated local bastards who bought tax revenue at a discount from the state), the French state was the sole predictable source of extortion. Having your income extorted from you is not pleasant. This is why North and Weingast argued the English state benefited from promising to do as little of it as possible. I would argue that having your income extorted is somewhat inevitable and that knowing who is responsible is far more important than thinking it is less likely to happen than before.

I have chosen the phrase “extorter of last resort” because in Mughal India or the Ottoman Empire those that extort from the populace are  also able to extort from the state. The purchase, or forced awarding, of privileged positions to minor stationary bandits means that the state is merely primus inter pares of extorters. Successful European industrialisers (and other more recent industrialisers) have succeeded in becoming the sole extorter, and this makes life much more predictable.

Considering the above I would argue that the states role in coercing its citizens is not just useful because it allows for the enforcement of property rights, it is useful because it lends a predictability to who is going to be stealing from you. This predictability reduces uncertainty and makes investing more valuable than waiting to invest, at the margin.

I stress that this is a new theory which is only partially theoretically developed and which is as yet only partially supported by the evidence. However, I think it offers an important new way of looking at the state’s role in economic development. Coordinating threats of extortion simplifies decision making. The threat of extortion remains across early European and Asian States, but European states are better able to centralise this tendency and reduce the transaction costs of negotiating with the extorter.

This post has set out the theory and I hope to publish more posts on this theme trying to confirm, or falsify, it over the next few weeks. Although I’m off to Glastonbury on Wednesday so there may be a little delay. All feedback is welcome, of course. Luis, Chris, Paul, Paul, Carl, Tim, Duncan; thoughts? 

This is a postscript, describing how I came to my theory, skip if you’re uninterested in arguments on the internet.

Tim has drawn my attention to a man who thinks one of the options for libertarians is to secede from the UK and set up a nice libertarian paradise. Patri Friedman – for it is he, the spawn of the spawn of Milton – has had a similar idea and is setting up a libertarian utopia out to sea somewhere. Of course our author is a bit of a SWIP: Selfish White Identity Politico. Moaning about the Guardian and how immigrants are forcing people to be illiberal and allowing foreigners into England is what’s truly ‘abhorrent and utterly illiberal.’ Forcing people at gunpoint onto planes is of course fine… Swippies are like that.

So that combined with a conversation in Tim’s comment section with Kay Tie and blindcyclist and I more or less finally gave up on Libertarianism as anything other than identity politics for selfish white people. Devil’s Kitchen I like, Old Holborn and people like our secessionist seem more typical, no historic understanding of where the state came from or what it has done and an awful lot of incoherent nonsense which just so happens to perfectly justify the lifestyle of a western, relatively well off, white person.

I am interested in the where the state came from, because it is an institution which took centuries to form, and which developed in very different ways in very different societies. For example, the pop culture history theory of the British state runs that William the Conqueror invaded and stopped all the various English Fiefs fighting. The Magna Carter secured the wealthy some basic rights. The Glorious Revolution protected the property rights of capitalists to encourage them to invest. The Great Reform Act and Factory Acts helped legitimate the state. This is rubbish, but seems to be what SWIP/libertarians take as gospel, and that is what I want to study.

So during the conversation I began to develop a new theory of the state and its role in economic development. I even have a handy phrase. Right, that’s the postscript over with.

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4 thoughts on “The State as “Extorter of Last Resort”

  1. hi L.O.

    Sounds sensible to me. of course in addition to eliminating other risks of extortion, the state can deliver useful stuff in return. Theres a good deal of economic research on taxation and state building, this being a nice short read:

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1621374

    That paper prob cites work by Mick Moore and someone called Mahon, which you may like too

  2. Hi Left Outside,

    Really fascinating article.

    I agree that the standard approach to history outlined in your postscript is pretty inaccurate.

    Another example you may want to use is that of the Enclosure Acts, which were for a long time seen as being a perfect example of Ronald Coase’s idea that the problem of the tragedy of the commons was reduced by allocating property rights. The reality of course is that enclosure had already been happening without state means for over a century before, and that ‘the commons’ had actually evolved their own type of property rights – they weren’t generally held in common at all. In fact, their smaller plots of land sometimes allowed for greater experimentation and innovation than the much larger, more homogenous grand estates.

    However, I would contest your assumption that the British state became an effective extorter of last resort before the Industrial Revolution. The British state was highly inefficient at securing or upholding property rights, and most policing was still done privately. For a long time, the British state continued to be biased towards vested interests, and there was a further conflict between common law and statutory law.

    For example, even after the Combination Acts were revoked by Parliament, the ban on “conspiracy” that prevented the existence of unions continued to be upheld by some common law courts. (Again, there’s an element of mythology here in that common law judges are assumed to have been almost universally classically liberal, often leading the way on some reforms before Parliament – while this was sometimes the case, the truth is much murkier, and some common law judges acted as vested interests seeking to use the law to further their own ends).
    Another example here is to do with the ban on joint-stock companies without an Act of Parliament. Even after the ban was lifted, some companies were dissolved by common law courts as the judges simply (and illegally) used the revoked statutory law as their basis for common law precedent.

    This sort of inconsistency means there was not always an ‘extorter of last resort’ in Britain. While property rights may be an important part of what a state provides, the historical evidence of this in Britain isn’t quite as straightforward as both libertarians and statists like to believe.

    Having said all that, your theory is interesting. You might want to check out some of the anarchist literature on the subject too. For example, “The Not So Wild Wild West” and Pete Leeson’s work on pirates. Hayek has some good stuff on the evolution of common law too.
    I haven’t read it, but I know Francis Fukuyama has just published a book on the evolution of the state too (even if he managed to discredit himself recently by totally misrepresenting and misunderstanding Hayek and his ideas)

    It seems to me though that if your theory is correct, it’s an argument for greater decentralisation, with smaller ‘extorters of last resort’ to make the investment environment as predictable as possible. It may explain the success of so many city states at enriching themselves so rapidly.

    P.S. I’m a libertarian, so I’d appreciate it if we avoided the name-calling. You’ll find that real libertarians are actually those who see themselves as combating *all* vested interests that seek to use the state to further their ends at the expense of all others; not just the ones that use the state to harm the ‘rich, white male’.

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