Why does capitalism work only in capitalist societies,Hernando de Soto asked many years ago,and the answer he gave was in terms of how societies were organised. Capitalist economies like the US,for instance,allow firms easy entry and exit,so we can actually get closer to the assumptions of perfect competition in these countries in comparison,with both entry and exit difficult in countries like India,were that much further from having full-blown competition.
The governments chief economic advisor,Kaushik Basu,takes this one further. Given the high levels of inequality,and thats just one example,he points out that Adam Smiths invisible hand which allows us to get our dinner,not from the benevolence of the butcher,the brewer or baker but from their regard to their own interest is clearly not working. Smiths invisible hand requires all companies,and consumers,to be price-takers,to not have the ability to influence prices through their participation or withdrawal from the market. While that doesnt obtain in real life,what we have are large players,both sellers and buyers,who play strategically,to influence markets.
That said,Basu does what he does best,he plays the games economists do he uses all manner of permutations and combinations with game theory,the basic prisoners dilemma being the most basic,to explain how individuals and societies behave. Why do Indians tend to zigzag across lanes while driving,while Americans dont. Most would tell you its about the rule of law in the US,people are afraid of getting caught,and so obey the rules. That would then require strict enforcement of the law,and would also mean the policeman /judges incentives have to be worked in such a way that they earn more out of enforcing the law than by looking the other way. But that doesnt always happen and if thats the case,why do you still drive on the left side of the road (if youre an American) in the desert,at night,in the middle of a dust-storm?
This is where Basu brings in the role of convention and morality that neither economists nor economic theories ever take into account,and are that much the poorer for it. Indeed,he argues,even Kafkas Trial or the caste system in India,or McCarthyism in the US,are an example of the invisible hand and their results are pretty oppressive since few of them use overt force,it is really societal pressure that is important here (so theres hope India will clean up its act!).
Basu doesnt just postulate this,he demonstrates this with various game situations. In a typical economy,it is obvious,one way to get more equality is to tax the rich and distribute this to the poor. But take the tax too high,and if the rich think its better not to work (think India in the Indira period where marginal taxes could be as high as 97 per cent),theres that much less wealth to even distribute. Now bring in the possibility of migration,of both capital and people. If the tax in India on the rich is too high,they will migrate to the US along with their capital so,he says,globalisation makes it difficult for nations to control their inequality (NAC,please note).
So far,its not too difficult to follow Basus permutations and combinations,but after this it gets a bit tricky though,for someone who claims not to set store by complex maths and stuff like that,Basus games get tougher to understand as he brings in more players than those in the standard two-player game he still thinks its easy,so thats probably something he inherited from his father who,Basu says,looked at his textbook briefly and began teaching him Euclidean geometry,and was disappointed he never got full marks in this since it was really just logic!
To go back to the traffic violations and the cops and judges,at a very basic level,it would be in the own interest of the cops and judges to accept a certain gratuity to look the other way. And yet they dont. Why? So,in the standard game theory,you have two equilibrium points one where it is in everyones interests (including the rash driver) to abide by the law; and another where it is in everyones interests to junk the law.
This is where Basu brings in whats called a focal point. Take a standard two-player game where two people agree to meet at the airport. How do they meet if there is no pre-arranged spot? They can just wander around,waiting for fate to join them,or they can decide the AH Wheeler shop is the central point and go there,and find each other there. Thats the focal point theory. Now lets say that the airport authorities wise up to the problem and formally designate a place meeting point. You now have a problem. Do you go by the new point selected by the authorities or do you continue to meet at Wheeler? The way Basu designs the incentives in his game,people will continue to flock to Wheeler and ignore meeting point. Moral of the story: you can bring in as many laws as you want,if society believes they wont be implemented,they wont make an iota of a difference (thats a caution sign for the Lokpal Bill).
If convention is everything,are we doomed to be who we are? Youll just have to read the book to figure out Basus solutions. One controversial suggestion is changing the incentive patterns across bribe-givers and bribe-takers give an amnesty to the former,and they have an incentive to rat on the latter. While this sounds logical,critics have pointed out itll never work since both bribe-giver and bribe-takers have to constantly deal with one another,it is in their own interest not to squeal on one another.
Basus other book that has just been released,An Economists Miscellany (OUP,Rs 395),is the one to read for various other solutions/ perspectives to give you a sense of how different Basu is from your textbook economist: he paints saris,writes plays and has even created two games (duidoku and ultimate duidoku) purely as a diversion from everyday work.