The Dictator's Handbook

by Bruce Bueno de Mesquita

  Privatized Tax Collection

  When even indirect taxation proves to be too much trouble, autocrats sometimes turn to outsiders for help extracting funds from their people. For autocrats and for their tax collectors this has a virtue and a liability. People hired to extract money for the government, keeping a portion of what they collect for themselves, have a strong incentive to take in lots of tax revenue. That’s good for them and good for the leader who receives the substantial remainder not kept by prudent tax collectors. But people hired to extract money can also use the power of that money to become a threat to a leader, and that, of course, is dangerous for them and for the incumbent.

  The Caliphate was the Muslim empire created by military conquest following the death of the Prophet Muhammad in 632. It ruled much of the Middle East, North Africa, and parts of Europe until 1258. In the tradition of the Romans before them, the caliphs avoided the technical difficulties of tax collection by outsourcing the task altogether. A tax farmer would pay the treasury for the right to collect taxes from a particular territory. Obviously, once they had paid for the privilege, tax farmers extracted everything they could. They were notoriously brutal and always looking for ingenious ways to take more. For instance, they would demand payment in silver coins rather than crops, and then collude with merchants to fix prices. Those who could not pay were punished or even killed.

  Naturally, the people resisted. Tax farmers contended with a persistent problem of people fleeing the land rather than paying their property taxes. To prevent this, tax farmers set up patrols to check identities. Non-Muslims were often tattooed or forced to wear “dog tags” with their name and address to prevent them from fleeing.14 Initially some of the tax collected by the tax farmers was only applicable to non-Muslims. This proved to be a very successful, if not wholly intended, means of encouraging religious conversion. It seems that many non-Muslims, realizing that they could reduce the tax collectors’ reach by becoming Muslim, put their religious beliefs aside and converted. As long as these conversions did not assume massive proportions, the tax farmers made themselves incredibly rich at the expense of the average citizen. When conversion became commonplace, tax farmers adjusted, no longer excluding Muslims from some of the taxes they levied. And from the perspective of the Caliph, they ensured reliable revenue. That they terrorized the people was of no political importance: impoverished and persecuted farmers were not part of the winning coalition.

  Autocrats can avoid the technical difficulties of gathering and redistributing wealth by authorizing their supporters to reward themselves directly. For many leaders, corruption is not something bad that needs to be eliminated. Rather it is an essential political tool. Leaders implicitly or sometimes even explicitly condone corruption. Effectively they license the right to extract bribes from the citizens. This avoids the administrative headache of organizing taxation and transferring the funds to supporters. Saddam Hussein’s sons were notorious for smuggling during the 1990s when Iraq was subject to sanctions. They made a fortune from the sanctions that were supposed to harm the regime.

  Extraction

  “Oil is the Devil’s excrement,” at least according to Juan Pablo Perez Alfonzo, a Venezuelan who founded the Organization of Petroleum Exporting Countries (OPEC), the cartel of oil-producing nations. “Ten years from now, twenty years from now, you will see: oil will bring us ruin.” And he was right.

  As many leaders have learned, the problem with raising revenue through taxation is that it requires people to work. Tax too aggressively or fail to provide an environment conducive to economic activity and people simply don’t produce. Actually extracting revenue from the land itself provides a convenient alternative, cutting the people out of the equation altogether.

  Take oil, for example. It flows out of the ground whether it is taxed at 0 percent or 100 percent. Labor represents but a small part of the value of oil extraction. This makes it a leader’s dream and the people’s nightmare. In a phenomenon often called the resource curse, nations with readily extractable natural resources systematically underperform nations without such resources.15 Resource-rich nations have worse economic growth, are more prone to civil wars, and become more autocratic than their resource-poor counterparts.

  Nigeria, the most populous nation in Africa, achieved independence from Britain in 1960. At the time of independence it was a poor nation, but expectations were high. These expectations grew with the discovery of oil. Nigeria is believed to have the world’s tenth largest reserves. With the rise in oil prices during the oil crises in the early and late 1970s, Nigeria found itself awash with funds. And yet, by the early 1980s the country was swamped by debt and poverty. From 1970 to 2000, Nigeria had accumulated $350 billion in oil revenue.16 It has not helped the people. Over the same years, average annual income per capita went from US$1,113 in 1970 to US$1,084 in 2000, making Nigeria one of the poorest nations in the world, in spite of its vast oil wealth. Poverty has risen too. One dollar per day is a common standard used for assessing poverty: in 1970, 36 percent of Nigerians lived on less; by 2000 this figure had jumped to nearly 70 percent. The situation can hardly be said to have improved since then. Even with today’s inflated dollars, a majority of Nigerians earn less than a dollar a day and per capita income has continued to fall. Adjusted for inflation, income is below what it was when Nigeria became independent.

  Nigeria is not exceptional. Figure 4.2 shows exactly that. The horizontal axis shows natural resource exports as a percentage of GDP in 1970. The vertical axis shows the average level of economic growth between 1970 and 1990. The trend is clear. Nations flush with oil, copper, gold, diamond, or other minerals grow more slowly.

  Nevertheless, natural resources are wonderful for leaders. Unlike getting their subjects to work, leaders don’t have to encourage natural resources to work. Admittedly the minerals need to be extracted, but by and large autocrats can achieve this without the participation of the local population. In Nigeria, for instance, the oil is concentrated in the Niger Delta region. Foreign firms with foreign workers do most of the extraction. Few Nigerians participate. The oil companies run security firms, effectively small private armies, to keep the locals from obstructing the business or complaining about the environmental degradation that results. BP and other foreign firms are free to act with impunity, provided they deliver royalty checks to the government. This is not so much a failing of these companies as the way business must be conducted in countries whose leaders rely on a few cronies to back them up. A company that acts responsibly will necessarily have less money to deliver to the government and that will be enough for them to be replaced by another company that is willing to be more “cooperative.”

  FIGURE 4.2 Growth and Natural Resource Abundance, 1970–1990

  One interesting manifestation of the differences between wealth and poverty in resource-rich lands is the cost of living for expatriates living in these countries. While it is tempting to think that cities like Oslo, Tokyo, or London would top the list as the most expensive places, they don’t. Instead it is Luanda, the capital of the southwestern African state of Angola. It can cost upwards of $10,000 per month for housing in a reasonable neighborhood, and even then water and electricity are intermittent. What makes this so shocking is the surrounding poverty. According to the United Nations Development Program, 68 percent of Angola’s population lives below the poverty line, more than a quarter of children die before their fifth birthday, and male life expectancy is below forty-five years. The most recent year for which income inequality data are available is 2000. These data suggest that the poorest 20 percent of the population have only 2 percent of the wealth. Angola is ranked 143 out of 182 nations in terms of overall human development. Prices in Angola, as in many other West African states, are fueled by oil.

  The resource curse enables autocrats to massively reward their supporters and accumulate enormous wealth. This drives prices to the stratospheric heights seen in Luanda, where wealthy expatriates and lucky coalition mem
bers can have foie gras flown in from France every day. Yet to make sure the people cannot coordinate, rebel, and take control of the state, leaders endeavor to keep those outside the coalition poor, ignorant, and unorganized. It is ironic that while oil revenues provide the resources to fix societal problems, it creates political incentives to make them far worse.

  This effect is much less pernicious in democracies. The trouble is that once a state profits from mineral wealth, it is unlikely to democratize. The easiest way to incentivize the leader to liberalize policy is to force him to rely on tax revenue to generate funds. Once this happens, the incumbent can no longer suppress the population because the people won’t work if he does.

  The upshot is that the resource curse can be lifted. If aid organizations want to help the peoples of oil-rich nations, then the logic of our survival-based argument suggests they would achieve more by spending their donations lobbying the governments in the developed world to increase the tax on petroleum than by providing assistance overseas. By raising the price of oil and gas, such taxes would reduce worldwide demand for oil. This in turn would reduce oil revenues and make leaders more reliant on taxation.

  Effective taxation requires that the people are motivated to work, but people cannot produce as effectively if they are forbidden such freedoms as freedom to assemble with their fellow workers and free speech—with which to think about, among other things, how to make the workplace perform more effectively, and how to make government regulations less of a burden on the workers.

  Borrowing

  Borrowing is a wonderful thing for leaders. They get to spend the money to make their supporters happy today, and, if they are sensible, set some aside for themselves. Unless they are fortunate enough to survive in office for a really long time, repaying today’s loan will be another leader’s problem. Autocratic leaders borrow as much as they can, and democratic leaders are enthusiastic borrowers as well.

  We are all at least a little bit impatient. It’s in our nature to buy things today when better financial acumen might suggest saving our money. Politics makes financial decision making even more suspect. To understand the logic and see why politicians are profligate borrowers, suppose everyone in a country earns $100 per year and is expected to do so in the future too. The more we spend today, the more we must pay in interest and debt repayment tomorrow. Suppose, for instance, that to spend an extra $100 today we have to give up $10 per year as interest payments in the future. It is reasonable to see that people could differ on whether this is a good idea or not, but politics certainly makes it more attractive. To simplify the issue vastly, suppose leaders simply divide the money they borrow among the members of their coalition. This encourages leaders to borrow more. If a leader has a coalition of half the people and he borrows an amount equivalent to $100 per person, then everyone has to give up $10 in each future year (as taxes to pay the interest). However, since the coalition is only half the population, each coalition member’s immediate benefit from the borrowing is $200. While to some this might still not seem like an attractive deal, it is certainly better than incurring the same debt obligation for $100. Governments of all flavors are more profligate spenders and borrowers than the citizens they rule. And that profligacy is greatly multiplied when we look at small coalition regimes.

  As the size of the coalition shrinks, the benefits that the coalition gains from indebtedness go up. If, for instance, the coalition includes one person per hundred then, in exchange for the debt obligation, each coalition member receives $10,000 today instead of the mere $200 in the 50 percent coalition example. This is surely a deal that most of us would jump at. As the coalition size becomes smaller, the incentive to borrow increases.

  Of course, borrowing more today means higher indebtedness and a smaller ability to borrow tomorrow. But such arguments are rarely persuasive to a leader. If he takes a financially reasonable position by refusing to incur debt, then he has less to spend on rewards. No such problem will arise for a challenger who offers to take on such debt in exchange for support from members of the current incumbent’s coalition. This makes the current leader vulnerable. Incurring debt today is attractive because, after all, the debt will be inherited by the next administration. That way, it also ties the hands of any future challenger.

  A leader should borrow as much as the coalition will endorse and markets will provide. There is surely a challenger out there who will borrow this much and, in doing so, use the money to grab power away from the incumbent. So not borrowing jeopardizes a leader’s hold on power. Heavy borrowing is a feature of small coalition settings. It is not the result, as some economists argue, of ignorance of basic economics by third-world leaders.

  In an autocracy, the small size of the coalition means that leaders are virtually always willing to take on more debt. The only effective limit on how much autocrats borrow is how much people are willing to lend them. Earlier we saw the paradoxical result that as Nigeria’s oil revenues grew so did its debt. It wasn’t that the oil itself encouraged borrowing—autocrats always want to borrow more. Rather revenues from oil meant that Nigeria could service a larger debt and so people were more willing to lend.

  Although the large coalition size in a democracy places some restrictions on the level of borrowing, democratic leaders are still inclined to be financially irresponsible. Remember, while the debt is paid by all, the benefits disproportionately flow to coalition members. Over the last ten years the economies of many Western nations boomed. This would have been a perfect time to reduce debt. Yet in many cases this did not happen. In 1990, US debt was $2.41 trillion, which was equivalent to 42 percent of GDP. By 2000 this debt had grown in nominal terms to $3.41 trillion, although in relative terms this was a decline to 35.1 percent of GDP. However, as the economy prospered during the 2000s, debt continued to slowly accumulate instead of shrink. In 2007, before the financial crisis, US debt stood at $5.04 trillion or 36.9 percent of GDP. A bigger economy means a greater ability to service debt and a capacity to borrow more.

  We may be inclined to explain the expansion of the debt by citing the party politics of the leader in charge. However, ideology offers a poor account of these trends. The major accumulations of US debt in the postwar period both began under Republican administrations: Ronald Reagan (1981–1989) and George W. Bush (2001–2009). This debt grew at a staggering pace during the 2007–2010 recession as the United States underwrote troubled banks and embarked on Keynesian policies of fiscal stimulus. By the third quarter of 2010, debt was $9.13 trillion or 62 percent of GDP. British debt follows a similar pattern. In 2002 debt stood at 29 percent of GDP, but by 2007 it was 37 percent and this has exploded in the wake of the 2008 financial crisis to 71 percent of GDP.

  From a Keynesian perspective, many governments are taking the perverse steps of trying to cut spending during a recession instead of stimulating demand. This does not reflect a desire by politicians to borrow less. Rather debt crises in Iceland, Greece, and Ireland have led many investors to doubt the ability of nations to repay. This has pushed up the cost of borrowing and made it much harder to secure new loans. It is supply, not demand, that has shrunk.

  Markets limit how much a nation can borrow. If individuals borrow too much and either cannot or will not repay it, then banks and other creditors can seize assets to recover the debt. With sovereign lending to countries, however, creditors cannot repossess property. On a few occasions creditors have tried. For instance, France invaded Mexico in 1862 in an attempt to get Mexico to repay loans. France also invaded the Ruhr, an industrial area of Germany, in 1923 to collect reparation payments due from World War I that Germany had not paid. Both attempts failed. In practice, the only leverage lenders have over nations is to cut them off from future credit. Nevertheless, this has a profound effect, as the ability to engage in borrowing in financial markets is valuable. For this reason nations generally pay their debt.

  However, once the value of access to credit is worth less than the cost of servicing the debt then
leaders should default. If they don’t then surely a challenger will come along who will offer to do so. This was one of the appeals of Adolf Hitler to the German people in the 1930s. Germany faced a huge debt, in part to pay reparations from World War I. Hitler defaulted on this debt. It was a popular policy with the German people since the cost of servicing the debt was so high.

  As debt approaches the balance point where the value of access to credit equals the cost of debt service, lenders refuse to increase the overall size of debt. At this point, if leaders want to borrow more, then they need to increase revenues such that they could service this additional debt. As in the Nigerian case, the discovery of exploitable natural resources provides one means to increase debt service and hence more borrowing. However, without such discoveries, the only way to increase borrowing is to increase tax revenue. For autocratic leaders this means liberalizing their policies to encourage people to work harder because they already tax at a high (implicit) rate. Only when facing financial problems are leaders willing to even consider undertaking such politically risky liberalization. They don’t do it frequently or happily. They liberalize, opening the door to a more democratic, representative and accountable government only when they have no other path to save themselves from being deposed today.

  Debt Forgiveness

  Debt forgiveness is a popular policy, but one that is generally misguided. Those in favor of forgiving the debt of highly indebted poor countries argue that the debt burden falls on the poor people of the nation who did not benefit in a consequential way from the borrowed funds. This is certainly true. As we have explained, the benefits go to the leader and the coalition while the debt obligation falls on everyone. But people who argue for debt forgiveness construct their arguments in terms of how they think the world should operate, rather than how it actually works.