Summer School 1: A government's role in the economy is to make us all richer

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0:35That ring can only bring one thing. It's the Planet Money Summer School. Your easy listening, hard thinking, audio economics degree. And the only education you can get these days without putting on pants or taking on debt. I'm your host, Robert Smith. This is the sixth year we've done summer school. six years of taking the biggest ideas in economics and packing them up like a beach reed for your ears. If you've been enrolled with us since the very start, your parents might be wondering if you're finally a doctor yet. Soon. Soon. Of course, you may be asking, Robert, we have already done whole summers on micro and macro economics.

1:15We've learned about investing, entrepreneurship, and the economic history of the world. What else is there? Well, this summer, we will tackle the biggest economic player of them all, the government. As you might have noticed, the biggest debates in our country right now are about how much government should be up in our business in trade, taxes, immigration, healthcare, regulations, you name it. Every day, it feels hard to make any personal or economic decision until we can figure out what the government is going to do. So every Wednesday this summer, we will hear stories of how politicians sometimes make all of us richer.

1:53And yeah, sometimes screw it all up. And we'll talk about the big economic question. What is the right amount of government in our lives? As always, we will have a final exam at the end of the season and a souvenir diploma plus, and this is big, a live graduation ceremony in New York City in late August. Details in the show notes and at the end of this episode.

2:26So, government, the big G. I know we like to imagine the free market, the invisible hand, as being independent from political influence. But our guest professor today, Simon Johnson from MIT Sloan School of Management, says that influence has been there since the birth of economics. So Adam Smith and other early writers on economics did not see any separation between economics, how the economy functions, and politics, meaning who makes the decisions around the rule of law and markets and all the things that make the economy function. I mean, where do you think these decisions came from? They didn't descend from the heavens unassisted.

3:01Somebody wanted something to happen, right? Who was that person? What did they want to happen? What was the process there? Simon Johnson was one of those somebodies, well, at least advising the big decisions. He was the chief economist of the International Monetary Fund and one of our first regular guests back when Planet Money started. Oh, he also won the Nobel Prize after those interviews. So, I don't know, causation, correlation? Well, I was disappointed the prize committee didn't cite those specific interviews, Robert, actually. I bet that may have probably just an oversight on their part.

3:31Just an oversight. What we're trying to do this summer has a big fancy name, a degree in political economy. Simon, why don't you help us define that? I think what political economy is, at its best, is an attempt to reintegrate economic elements with political decisions. And the political decisions, of course, take into account who's got power, who's got money, who wants what kind of outcomes. So politics and economics, which are taught separately, they shouldn't be separated at all, I think, Robert. You have to understand one to really appreciate the other. Who's got the power? Who's got the money?

4:04That's what we'll be talking about over the next eight weeks.

4:10In a few weeks, we'll talk about taxes, for instance. Not as this annoying thing we always have to pay, but as a magic wand the government can use to change our collective behavior. If you want the biggest bang for the buck, you send everybody a check in terms of political bang, right? There's nothing like a good check in your hands. Also, this season, we'll have a whole class on how the government regulates every little part of our lives, sometimes for good and sometimes for reasons that no one can figure out. American regulations require that the windshield wipers capture a larger part of the windshield versus European ones.

4:44But I mean, what is the even logic behind that? You know, I guess Americans might be taller on average, therefore they would be looking at a different part. I mean, I'm struggling here. I agree with you to come up with a rationalization. We'll also have a lesson on how the government encourages innovation by protecting our property and our inventions, even when those inventions don't seem all that innovative. There's patents for people for walking dogs while holding onto a leash on a bicycle. There's patents for dumping the remains of a cremated body from an aircraft. But all this is just the syllabus.

5:18After the break, we will pick up our first lesson with Simon Johnson. And it's one of the biggest questions of all. Why are some countries rich and some countries poor?

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6:22Luckily, the Dell PC helps you get it all done. Get yours at dell.com slash holiday. Okay, class. I know you're excited. first day and all, but it's time to sit down. Summer school is in session. And we are lucky to have Professor Simon Johnson with us for our first lesson. What can governments do to make a country rich or poor? Simon, you won the Nobel Prize last year, along with Daron Asamoglu and James Robinson, for work that looked at the role of institutions in countries around the world. When we think of institutions, we might think of, oh, I don't know, the Supreme Court or Congress. But what are some of the institutions we might not think of?

6:58Yeah. So when you make comparisons across countries, Robert, you look at things like rule of law, you know, can contracts be enforced? If you go to court as a regular person, do you get a fair hearing? Or, you know, are there issues of bribery, corruption? Is all the power in the hands of a few families, for example? Is this country a place where most people have equal protection before the law? Or is it a place in which a few people, whatever their job titles or family ancestry, a few people have all the power? Yeah, and that has a big effect on economics. If I wanted to start a business, say, I need to know that the rules are fair, that I'm competing on the value of my intellect and my products, and I need to know that if my business is successful, it's not going to be suddenly taken away from me.

7:43Well, we don't think enough about expropriation and extraction, which means somebody can steal your stuff. And the way that happens in many places is that some powerful person says, look, you're in violation of this rule, or I've just decided my son-in-law wants to live in this house, or something like that. And then you could go to court, but you would lose because the court system is massively biased against ordinary people. We just assume in the United States that powerful people can't come and take our stuff away. We tend to assume it's a level playing field for most people, which it is a lot of the time.

8:12And that's a perfect lead in to our first case study of the season. We're going to look at a place without a level playing field and see how it affects a particular business on the island of Jamaica. In 2010, Alex Bloomberg and Hannah Jaffe-Walt brought us this story that starts with three women selling fruit alongside a road outside of Kingston, Jamaica.

8:36You know, Alex, normally when reporters go abroad, they hire translators. Right, well, she's speaking Jamaican patois, but she also speaks a little English. And so here's the scene. This woman, I never got her name, she's one of three women, and they're all selling fruit out of boxes on the side of the road. right outside this mall. So you're selling these things right here? Yeah, right here. Tell me what you're selling. It's a ackee, breadfruit, plantain, gunga peas, plantain. Plantains, gunga peas. And now it's nice. And no buyer, feed all of it there. So how long have you been out here selling this?

9:11How long? 20 years. 20 years. No, can't make it. 20 years? Yes. So this is your business, right? All of you? Yeah, all of them share their business. So this is like on the side of the road somewhere, three women sitting on the side of the road with fruit? Right, and just in cardboard boxes. They don't even have chairs for themselves. There's no stand or anything, but they're just like, they've got these boxes, they're selling this fruit. But it is their workplace. I mean, you heard she's been doing this for 20 years, the three of them. Every day they go to this big market in the center of town, they buy their produce, then they set up here, and they sell it.

9:45So here's the thing, though. Even though they do this every single day, and they've been doing it for 20 years, it is totally informal. Their business does not have a name, they have never filed any paperwork with the government, and they definitely do not pay taxes. The government isn't collecting tax from you. No, but we pay the taxes on the food that we buy in the supermarket. Right, right. Yeah. You hear what she's saying. This is something that people say a lot in Jamaica. She's saying, I don't pay taxes on the income I get from my business, but you know, I do pay taxes when I buy the stuff that I'm selling in my business.

10:16Everything I have here, I pay taxes. It would not be a very persuasive argument here with the IRS. No, it would not. Okay. Ready? Let's go somewhere else. How many? One. One? One. I sell grapes, apple, orange, banana, etc. So where are we now, Alex? Now we're in New York. We're right outside our office, actually. This, you know, that guy who sells fruit right down the street on 40th Street? Oh, right downstairs. Yeah, I buy fruit from that guy. Right. His name is Mehdi. He's originally from Bangladesh, and he's been here in this country for just six months. But he's working at this fruit stand, which has been there for a long time.

10:54And this fruit stand, you'll be happy to know, totally legal. Do you have to have a permit to sell here? Oh, yeah. I have permit. Oh, you have the permit? Yeah. Oh, can I see it? Oh, yeah. And you're showing it to me right now. This is my permit. This is the honor permit. and there's the push-cart permit. And the push-cart permit. Yeah. So there's all these permits that you have here. Yeah, yeah. And the guy who owns the business, he pays taxes on his business, right? Yeah, yeah, yeah. So he has three permits? Right, he has three permits to sell fruit on the side of the road in New York versus zero permits to sell fruit on the side of the road in Kingston.

11:39And this tale of two sidewalk fruit vendors is the tale of two very different economies. In the United States, most people are like this fruit seller that you just heard from. They work in the formal sector. The businesses have been registered, they have a legal status, and the owners pay taxes. In the Jamaican economy, it's largely informal. But if you think about those three ladies selling fruit on the side of the street, I'm not sure that it really makes sense for them. Right. I mean, we were joking that they're tax cheats, but their lives are really hard. They're just barely scraping by as it is right now.

12:12And how would paying taxes help them? And, you know, well, obviously, first of all, they're probably not making enough money to actually pay taxes in the first place. But the second thing is just because you're in the informal sector does not mean that you're not paying taxes. You're just not paying taxes to the government. You are paying taxes to criminals like these ladies do. Corrupt cops come by. They call them the Metro man. They come around and steal their fruit and lock them up. And they told me about it. Sometimes when the metruman come, we have to run with the things. Take away our stuff and lock me up.

12:47Yes, I carry down a jail. I have to go to court and pay. Wait, the police come and take away your stuff? Yes. We pay tax. Them charge. Them come on a way and collect money for themselves. So you pay taxes. You pay taxes, they call it. Yeah, protection racket. Yeah. Yeah. And when did that happen? Up to last month. Last month? Yeah. Last month the police came, they beat you, took your food. Yeah, and they bring the van, two van. And then you had to go back and buy your food back from them? We have to beg and go back and buy. We don't pay them and we don't, when they pay, you don't, you don't get it back.

13:24Them carry out the children's homes and take it for themselves. Sometimes we cry. Yeah. Hungry, you know? Yeah. God, that's horrible. So there's like police walking around that they're afraid are going to come and steal their fruit and beat them up while they're selling? Yeah. Or sometimes it's somebody else. I mean, I got the sense that it happened fairly regularly from various different people. Like they're sort of defenseless, you know, on the side of the road there. So we're talking about taxes. Like that is a barrier to economic growth. Yeah, absolutely. And that's a big problem in Jamaica.

13:56I mean, there's like, you know, those criminal gangs that, you know, extort, you know, protection money from people. And so you're in the informal sector. You're still paying taxes. Alex Bloomberg and Hannah Jaffe-Walt from 2010. We're listening along with our professor, Simon Johnson, who has done a lot of research on the ways basic rules like paying taxes, private property can make the difference between rich and poor nations. Simon, this was about Jamaica, but we could have told this story anywhere in the world, including the United States of America, where oftentimes there are businesses who operate off the books.

14:31I live in Brooklyn, I know. There's arbitrary enforcement of rules all the time. You found a helpful way of looking at this across countries by asking what kind of institutions do they have in their economy? Yeah, so the terminology that we settled on and a lot of people have started using is extractive versus inclusive institutions. So the inclusive one, I think, is what I would start with because it's the easy place to understand this, which is, do these institutions allow you to build a company? Do they allow you to own a house? Do they allow you to drive your car around without being hit by extra fees or demands for bribes or outright confiscation, honestly?

15:12So all of these different kinds of rights that you have as a person, as an economic actor, if they're inclusive, it means you have the same rights as everybody else. So in the case of the Jamaican women, if there were inclusive institutions, should have had the right to their products, not to be hassled by the police and that sort of thing. That's right. I mean, there would be rules. You might need to have a permit, but the permit would cost you five cents and you'd get it automatically. You know, when you register a car in the United States or get a driver's license, you do have to go to the DMV.

15:39Nobody loves that experience. But it's relatively straightforward. And hopefully in the modern United States, you don't have to pay bribes to anybody to get your license or get your car registered and so on. So that's inclusive institutions. The other thing you said was extractive institutions, which is sort of the opposite. What does that mean? so extractive institutions means that a few people have established the means to take anything and everything that they want so think for example about north korea which is a very extreme case it's run by a dictatorial family and and some allies they actually by all accounts live reasonably well most people in that country are immensely poor and sometimes actually starving and so the the ruling elite in in a place like north korea extract all the value from people anytime somebody something good happens to an entrepreneur or somebody tries to build something, if the ruling elite wants it, they just take it.

16:31And there's no recourse. There's no court system you can go to. In fact, I'm pretty sure that if you appealed against the actions of anybody in that ruling elite in North Korea, you would never be heard from again by anyone. And what are the results of having inclusive rather than extractive institutions? I mean, does this result in a richer country or more social mobility or less inequality? What will we look for? So I think the case study is very good on this. So think about Jamaica and the women who are selling the fruit. So they can make a living on a good day, but they have no way to invest, no way to build a business, no way to borrow money, no way to get a return on capital because they could get wiped out at any moment.

17:12In fact, if they are successful and do build something that catches the attention of anybody powerful, they will get expropriated, right? That's exactly how it works. So then you think about it from the view of those women, and they're saying, you know what, I just need to make enough money today. I'm not going to invest. If I make an investment, I'm creating a vulnerability for myself. If I make any extra money today, I'll hide that. So in the worst case, Robert, you don't make investments, the private sector doesn't grow. So why do some countries end up with inclusive institutions and others have these extractive institutions.

17:43I know in your work, you've talked about the historical context, how colonialism in some places was very extractive. They would steal gold and send it to Europe. They would kidnap indigenous people for slavery. But then in other places, they would create these inclusive institutions because they were going to settle there, right? They were focused on keeping some of the riches in their colonies. So what lesson can we learn from that different history? I do love history. And I think in a nutshell, the answer is that you have to build up a sufficiently strong group of people. Some people would call it middle class that really wants that stable property rights and rule of law.

18:29So if you get a middle class that says, hey, let's have stronger, better rule of law, less extraction, that's not necessarily good for the elite. So I think that actually a lot of places, Robert, don't grow as fast as they could because the elite likes the current arrangements just fine. And that's a major impediment to shared prosperity around the world. If the rich, powerful people don't want it, you're not going to get it. But one of the nice things about your work, Professor, is that you've shown that countries can change and that institutions can actually get better. We'll have a story about that from the country of Peru after the break.

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20:14Okay, students. Eyes forward, or I guess I should say ears forward in this case. Listen carefully now to our second case study. This one was done by David Kestenbaum and Jacob Goldstein in 2015 as a profile of Hernando de Soto. De Soto is a businessman in Peru who saw these extractive institutions we've been talking about and decided to do something about it. The story starts right around 1980. Right around then is when Hernando de Soto moved back to Peru. And de Soto, he's a businessman. He's not an academic. But he keeps chewing over this really abstract question. What is holding Peru back? And at first, he's kind of working over this question on the weekends.

20:56He's actually walking around, talking about guys selling stuff on the street. After a while, I found out that they were in the street, but they didn't like being in the street because he needs running water. He doesn't have running water. He wants to be away from thieves. And he wants to have stocks and refrigeration, which he can't have in the street. I always figured they didn't have more space. They didn't have refrigeration because they didn't have the money because they just couldn't afford to pay for those things. Here I am stalled with the same question you are, right? The same question.

21:28Now they don't have the money. They don't have this. But at the same time, since I'm befriending them, I'm walking them through their homes, right? I'm going to see where they live and what they do. Then I look at the roof because it's flat. Okay. So I look on top and I see, my God, you got cement backs up there and you've got bricks and you got pieces of iron. These vendors do have at least some money. They've saved enough to build a solid house. They're saving more so they can put another floor on that house. So money is not the thing keeping the vendors out of the markets. And DeSoto sees those bricks on the roof and realizes something else.

22:02People in Peru aren't saving the way people in wealthier countries save. Instead of saving money in the bank, what you're doing is you're saving in bricks and in cement bags. These street vendors don't have bank accounts. And DeSoto discovers poor people in Peru are missing out on all kinds of basic things we take for granted. They're basically living outside the system. They don't have a deed that says they own their house. They don't have a permit that says they can run their business. DeSoto realizes he has to do more than just wander around and chat with people to really understand what's going on.

22:34So the next thing he does, the thing that makes him famous, is he does an experiment. He runs an actual experiment. He wants to see what it would take to actually live inside the legal system instead of outside of it. So he decides to set up a shirt factory to get all the proper paperwork, all the permits. He rents space in a warehouse. He buys a few sewing machines and a knitting machine. But he has no plan to ever make a single shirt. He just wants to see what it would take. So he hires a lawyer and a few students and he tells them, go out and do everything you have to do to make this a fully legal shirt factory.