With the Velvet Revolution in Czechoslovakia, the world awoke in November 1989 to a monumental economic experiment – once never dreamed possible – involving the engineering of a transformation from a command economy to a market-based one. An entire economic system of coordination needed to be replaced by a vastly different system based on the pursuit of profits, price signals, and independent actions. A socialist economy is characterized by state ownership of enterprises, central control of production, and trade by state agreements, while a market economy is characterized by private ownership of enterprises, decentralized market coordination of production, and international trade by private agents. If Czechoslovakia had been the only economy confronting such a transition, the problem might have been less poignant, but other countries quickly rejected socialism, including East Germany, Romania, Yugoslavia, Poland, Hungary, Bulgaria, and the fifteen former Soviet republics. In 1996, there were twenty-nine transition countries attempting to transform their Soviet-based planned economic systems to a market economy. Still other communist regimes (for example, China, Cuba, and Vietnam) are currently experimenting with market reforms.

Peter Murrell (1996, p. 31) aptly describes the transition attempted from 1990 to 1996 as “the most dramatic episode of economic liberalization in economic history.” The transition involved freely fluctuating prices, trade liberalization, enterprise reform (including privatization), the creation of a social safety net, and the construction of the legal and institutional framework of a market economy.

Open any modern-day textbook in economics and you will see game boxes and game trees used to explain the strategic interaction among diverse economic agents. It matters not whether it is a macroeconomics text addressing policy making, or a public finance text analyzing how people voluntarily contribute to a public good. This methodological revolution has swept economics during the last two decades. When I completed my doctorate in 1971, game theory had barely been mentioned, and when it had been discussed, the reference had usually been disparaging. My first exposure to this tool came in the early seventies when, as an assistant professor at Arizona State University, I took mathematics classes from Albert Tucker and Evar Nering. These great mathematicians had been at Princeton University during the days when game theory was being developed as a mathematical tool for the social sciences. There had been high hopes during the 1940s and early 1950s that this development would provide all of the social sciences with a unifying theoretical base, from which great insights would spring. A driving force behind this development was a brilliant mathematician – perhaps the brightest of the twentieth century – named John von Neumann. This self-absorbed, totally focused individual first developed his game-theoretic ideas in papers published in 1928 and 1937. His quickness and brilliance were legendary, but then so was his single-minded dedication to his work. Albert Tucker, his ex-colleague at Princeton, once illustrated von Neumann's consuming and humorless focus with the following story. Von Neumann had come to Tucker for a name for John's latest monograph on an esoteric geometry that contained no points.

I once had a friend who owned a house beside a stream. Unlike his neighbors' houses, plagued by mice and rats, his house had been rodent-free during his ten-year occupancy. His neighbors thought him dishonest when he would reply to their incessant complaints about rats that he had never seen a single rodent in his house. On the day before he was to sell his house, he was awakened in the middle of the night by a weird sound coming from the attic. Thinking that he would come face to face with his first rat, he went with a flashlight to inspect the attic. When he opened the trap door and stuck in his head, he let out a scream and dropped the light. The ten-year-old mystery had been solved – a large beady-eyed snake stared at him with a rat in its coils. My friend faced a real dilemma: should he tell the prospective buyer about the snake, or try to rid the house of the reptile, or just be quiet about it? He chose silence, as the other options could either jinx the sale or be very costly. He reasoned that the snake was harmless and served a very useful purpose. So he said nothing, and the house and the snake were sold together. This rather bizarre, but true, story represents an instance of asymmetric information, where one party to a transaction is more informed than the other party.

Have you ever wondered why discount stores all locate in the same parts of the city, and are typically right next to one another? This is also true of car dealers, bookshops, furniture stores, antique dealers, and fast-food restaurants. Travel to other countries and you observe the same phenomenon. What does this clustering of similar stores have to do with candidates in two-party elections espousing almost identical positions? Among the major candidates who ran for US president in the 2000 primary campaign, it was virtually impossible from listening to their positions – if they bothered to reveal one – to know their party affiliations. Is John McCain a Republican or a Democrat? The same question could be asked about Bill Bradley. Party labels have become less descriptive of candidates' positions. This is not only true in the United States; for example, is Britain's Tony Blair a Tory or a Labour Party member? The field of public choice, which applies economic methods to the study of political science, addresses the convergence of candidates' platforms as well as myriad other questions. These questions include the following. Does a multiparty system provide more choice than its two-party counterpart? Does logrolling serve a useful purpose, or does it lead inevitably to too much government as vote trading allows for the passage of more spending programs? Can majority rule lead to the efficient provision of public goods?

Suppose that the bodies of three great political economists – Adam Smith, Thomas Robert Malthus, and David Ricardo – had not decayed into dust, but had instead been frozen and preserved through the ages. How would these three philosophers view economic thought and methods today if they were reincarnated? It would be an amusing sight to see Adam Smith wandering a modern campus muttering to himself, clad in Reeboks, blue jeans, and a baseball cap, rather than his usual buckle shoes, knee breeches, and beaver hat. Ricardo and Malthus would delight in seeing one another and renewing their lifelong debate over the principles of political economy, now by e-mail. As a gifted businessman and stock trader, a reincarnated Ricardo would be apt to exercise his astute business acumen and amass a fortune as an entrepreneur of space technology or as a day trader. Malthus would look at the growth of population in the less-developed countries (LDCs) and feel partly vindicated. For advanced industrial countries, he would point to the second edition of his Essay on the Principle of Population as It Affects the Future Improvement of Society, in which he recognized the exercise of moral restraint from marriage and childbearing. Nevertheless, he would marvel at the Earth's ability to support six billion people, about six times the world population at the time of the first edition of Malthus's essay in 1798.

Each of these great economists would have to reassess some of his key predictions and policy prescriptions.

One morning I awoke to find that I had changed. Although I had not grown a shell and turned into a beetle, as in Kafka's story, I had experienced a fundamental metamorphosis in my views of economics and my role as an economist. I could no longer fathom why I had followed my fellow economists in making my writing accessible to so few. I realized that economics had taken root because the writings of Adam Smith and David Ricardo could be read by any educated person, including policy makers. So I decided then and there to write more general-interest pieces and to communicate more widely. If I succeeded, then maybe even my brothers and sisters would finally understand what I study and do. I began this task with Global Challenges: An Approach to Environmental, Political, and Economic Problems, which showed how basic game theory could enlighten us on a host of exigencies confronting humankind. This book opened doors previously shut to me, thus reinforcing my revelation that being understood by people in international organizations, students in universities, and others among the general population had its rewards. But Global Challenges was only a halfway house, because many of the game concepts remained abstruse.

The success of Global Challenges emboldened me to go further with my venture. Thus, I coauthored The Political Economy of NATO with Keith Hartley. This book was written for an interdisciplinary audience that included political scientists.

In this chapter, we examine the comovement of macroeconomic variables, similarities, and dissimilarities of industrial structure, as well as patterns of similarity and dissimilarity in the movement of inequality in manufacturing earnings. This information can illuminate the degree of economic integration across countries in a region, and it can highlight important differences between Europe and Asia. We then examine the relationship between financial crisis and the movement of inequality. We show that crises typically generate increases in inequality, but more so in less developed countries and more so in regions that are more liberal in their policy regimes.

Introduction

In this short chapter, we examine the comovement of macroeconomic variables, similarities and dissimilarities in industrial structure, and the movement of inequality in manufacturing earnings, on which we have annual information for much of the global economy over the past thirty years. We argue that this information can illuminate the degree of economic integration across countries in a region and that it can highlight important differences between Europe and Asia. We then examine the relationship between financial crisis and the movement of inequality.

Macroeconomic Comovement and Regionalization

Was there an Asian crisis? Or again, was there an Asian crisis? Was the financial crisis that swept across the Pacific Rim in the summer of 1997, with a cascade of stock market crashes, currency devaluations, and regime changes, notably in Indonesia, specifically Asian, reflecting distinctive characteristics of the Asian region?

This chapter introduces in nontechnical terms the principal techniques used in this book: Theil's T statistic, cluster analysis, and discriminant function analysis.

Introduction

How does one measure whether one society is more equal than another? Or whether an economy is more equal than it had been in the past? Equality is a broad concept with many layers of meaning: There is equality and inequality in legal rights, in social and political standing, and in many matters of culture. And even within the economic dimension, one may focus on inequalities of wealth, of family income, of individual earnings, and of wage rates. Each of these has its own importance, and each is measured from different sources of data and in slightly different ways.

Most of the theoretical literature on economic inequality is concerned with the determinants of pay: with wage rates and employment prospects, which together determine earnings in particular industries and occupations. Pay rates and job openings are a characteristic of the employer and the workplace. Yet most of the empirical work on inequality derives from surveys whose focus is on employees and their households, which are aimed mainly at assessing the distribution of family or household income. This is an important, even vital, issue, obviously: The distribution of household income is a key social fact. Yet data sources based on household surveys of income only indirectly provide information about the distribution of wage rates.

For most of Latin America, the 1970s were a decade of growth, though with political upheaval in Argentina and Chile. The 1980s were a disaster. The 1990s saw economic reform, liberalization, a return to democracy, and financial turmoil. This chapter reviews the three decades as one piece through an analysis of the evolution of earnings inequality from year to year in eight major Latin American countries and one Caribbean nation. We find that changes in earnings inequality are a sensitive indicator of slump, repression, political turmoil, civil war, natural disaster, and – on the positive side – occasional periods of growth and stability in Latin America. Indeed, almost the whole recent history of Latin America can be summarized in the movement of industrial inequality statistics.

Introduction

This chapter focuses on the relationship between industrial earnings inequality and the political history of Latin America. First, we offer a word on the data and the method used to construct a measure of the movement of industrial earnings inequality for each of the countries under study. Second, we investigate the relationship between political regimes and changes in earnings inequality for each of the countries, including orthodox and heterodox stabilizations and the transition from closed to open trading systems. Third, we examine the relationship between economic growth and our measurement of inequality and present the report card for each of the regimes of the countries studied. Conclusions stressing policy implications complete the chapter.

In this chapter, we use industrial data to derive estimates of the pattern of change in wage inequality in Mexico and Brazil. Using the group decomposition of Theil's T statistic, we present monthly changes in the dispersion of industrial wages for Brazil (1976 through 1995) and for Mexico (1968 through 1998). Both countries show increases in wage dispersion over time, and we find a strong negative correlation with the rate of real economic growth. Other things being equal, the later Brazilian heterodox stabilization plans seem to have reduced inequality in the short run.

Introduction

A great many things have been written about inequality on the basis of evidence that may charitably be described as thin. As the recent work of Deininger and Squire (1996a) makes clear, the measurement of household and personal income inequality for most countries has been sporadic and of uneven quality. Even where these authors judge the data to be of acceptable quality, the number of observations is generally too few to permit useful time-series analysis. Over the quarter century from 1970 to 1995, Deininger and Squire find only fourteen acceptable estimates for Brazil and only five for Mexico.

This chapter presents measurements of change in the dispersion of industrial wages for Brazil from 1976 through 1995 and for Mexico from 1968 through 1998.

This chapter presents a brief review of the relationship between various forms of state violence–including war, revolution, civil violence, and coups d'état–and a measure of inequality of manufacturing earnings in countries around the world over the period 1960 to 1995. We find evidence of several systematic relationships, of which the strongest and most striking is that coups precede a long period of rising inequality with a very high probability.

Introduction

This chapter asks whether there exist systematic relationships between levels of state violence and changes in economic inequality in countries around the world. The question is, of course, quite natural. Entire lexicons exist that describe economic relationships in terms that evoke violence; exploitation, dependency, unequal exchange, and class struggle are but prominent examples. And the case histories of war, revolution, repression, and coups d'état are loaded with what seem – transparently – to be efforts either to rectify gross inequalities or to impose them.

Yet from the standpoint of an empiricist interested mainly in the search for patterns in data, substantial obstacles stand in the way of definite observations. First of all, there is the difficulty that reliable measures of short-term change in economic inequality, measures that are both consistent and consistently available, particularly in countries that have been wracked by violence, have not existed. Second, there is the problem of arriving at a consistent categorization of types of violence, so that one may define the predicted effect of each type on economic inequality and vice versa.