Efficient Methods Of Reducing Crime

My previous post may have left some wondering, "If spending more of public funds to catch criminals cannot reduce crime, what will?" To answer this question, we will have to understand why organized crime exists in Kyrgyz Republic, the relevant dimensions of this enterprise, and the organizational structure of the criminal enterprise.

The economic theory of crime suggests that organized crime arises when (1) government fails to provide basic protection and enforcement of law, (2) government exercises excessive bureaucracy, (3) government makes certain goods and services illegal. Generally, it is perceived that organized crime impoverishes the areas that it controls. A careful investigation of the causal link indicates that organized crime does not cause poverty but rather fills the vacuum that the state created by failing to protect citizens and enforce laws. In those conditions, organized crime acts as a de-facto  government by introducing set of rules, enforcing these rules, and collecting fees for their services. Sicilian mafia (for that matter Neapolitan and Calabrian organizations), which was glorified by Hollywood movies and Mario Puzo's Godfather books, had much less romantic upbringing than one may think. According to Professor Anderson, a prominent scholar in the economics of organized crime and mafias, before the Italian unification of 1870, inhabitants of the island of Sicily used private protection services. After the unification, the state's unwillingness or inability to fund centralized enforcement of law led to outsourcing the law enforcement and governance to the private entrepreneurs known as gabelloti. The subsequent mergers of gabelloti under a more efficient organizational structure became what we now refer to as mafia. Mafia or organized crime in Italy in those impoverished areas took on the role of the government, because government had failed to provide social assistance, protection of property rights, and enforcement of legal agreements. They had the local support and improved the living conditions of peasants.

Italy sounds like a distant and irrelevant comparison. A remote mountainous area known as upper Kodori in the border of Georgia and Abkhazia was populated primarily by an ethnic group called Svans. The recent Georgian and Russian/Abkhazian war left that area impoverished, deserted, and effectively worse than it had been before Saakashvilli's attempt to remove Kodori warlord Emzar Kvitsiani. During Shevarnadze's reign over Georgia, the state decided not to meddle in Kodori business as long as Kodori Svan sided with the Georgian government. Effectively, Kvitsiani was the boss of an organized crime group that had the overwhelming local support. According to some estimates about 1/3 of the "Vory V Zakone" in the early 1990s were from that Abkhazia/Georgian overlap regions. One of the reasons for such a high representation of these people in the criminal world has been the fact that Soviet government was unwilling to enforce state laws and prosecute criminals in that area. People in that region had very minimal protection, hence the rise of criminal organizations in that area was inevitable.

Another big reason for the rise of criminal organizations is changing the legal status of certain goods and services. For example, by making alcohol illegal, the US experienced one of the highest crime rates and the rapid growth of criminal organizations during the prohibition period. Professor Jeffrey Miron has the most convincing data and discussion on this matter. Here is the graph of Homicide Rates in the US and the Federal Expenditure to 'fight' the Crime:

 

The graph above shows that the unusual jump in homicide rates came about the same time when the Fed outlawed alcohol and again around 1980's Reagan's war on drugs. I will not elaborate on the mechanisms how these laws led to more crime, but if you are interested you can read Jeffrey Miron's books and articles. Soviet experience around the alcohol prohibition years 1985 to 1987 is another clear examples to this end. I remember as a child that some of our neighbors became active in this business. Brutal fights, knife stabbings, and incidence of alcohol poisoning became quite frequent in my neighborhood (yes, I lived in a poor neighborhood). When the state refuses to extend the law and justice, the private sector steps in to fill that gap. Unfortunately, the only credible way to enforce contracts under these circumstances is the use of brutal force.

So far I have addressed the causes and consequences of criminal enterprise in other parts of the world. What about Kyrgyz Republic? Well, first and foremost, citizens are concerned about the homicide rates. What does the homicide rate look for KG? Here is the graph that I constructed using UN data:

As you can see, the homicide rates are highly correlated with the economic uncertainty and political change. In 1990s, there was a sharp increase in the murder rate as the assets were being divvied up among various criminal groups. In 2005, there was another round of asset redistribution activities with deadly consequences. And of course, though it is not shown in the graph, the recent political turbulence led to massive death toll.

The data suggest that the homicide rate is counter-cyclical, when times are tough the murder rate is higher.

What lessons can we learn from it all? The most efficient way to reduce crime in Kyrgyz Republic is not hunting (scape goat) public enemies but making sure that


TRUST IN LAW ENFORCEMENT AGENCIES
1. Our law enforcement agencies carry out very basic duties such as following their code of conduct, arresting anyone who infringes upon private property, and punishing anyone who commits grave crimes to the full extent of the law. (Here I would advocate that we institute death penalty, but my feeling is that many will not support it. I will address this issue of death penalty in my next entry)
2. Releasing 80% of the law enforcement agents from their duty and start a new hiring process by an independent agency.
3. Reducing the number of militsia but increasing the salary for those who are selected for the job.
4. Creating clear Performance Indicators and rewarding officers for superior jobs.

LEGALIZATION OF PROSTITUTION and DRUGS
5. Legalizing prostitution in order to reduce criminal enterprise's revenue source, and most importantly to provide a better legal protection for young women and men in this sector.
6. Legalizing drugs by following Swedish model. In other words, legalize the sale of drugs but make buyers subject to criminal offense. It will reduce the drug related crimes, reduce drug impurity, bring the industry under public watch and away from criminal underground.

CREDIBLE PUNISHMENT
7. Publicizing the funds allocated to prison system and conditions in the prisons.
8. Address the issue of overcrowding in prisons that tends to further improve the criminal network and skills.
9. Publicly discuss various punishment terms, including the death penalty, for various crimes.

EDUCATION
10. Addressing the retention and improving quality of education for youth in elementary and secondary schools, since these are the ones who are easily recruited by criminal organizations.

Why War On Crime Is Not A Good Idea

Last week, Madam President announced the government's intent to start a war on crime, specifically organized crime. Just as milking a bull will not get you any milk, the government's effort to 'fight' the organized crime by spending more of public resources will not get any results either. And here are the reasons why.

First, the government's approach to fight crime primarily relies on hunting bad guys. For example, a well-known criminal by the name of Kolbaev Kamchy has become a new poster boy. Will catching Kolbaev reduce activities of the criminal enterprise? As you all know, it will do no such thing. Should we let criminals like him roam freely in the country? Of course, the answer is no. The real issue is will this policy that will require more of the very limited public funds get the promised results. The implicit assumption in the government's plan is if you catch a bad guy, there will be a reduction in criminal activities. Or, in technical terms the elasticity of supply of criminal activities with respect to its one particular input is extremely high. Evidence at home and abroad suggests that there is a high degree of substitution. Put it differently, for every Kamchy there are 100s of other talented criminals waiting to replace him.

Second, since corruption is deeply rooted in our country, there is a good reason to believe that some of the key law enforcement agents are in bed with the criminal organization bosses. Even if the policy is implemented with good intentions, the actual consequences are more likely to serve some criminals to eliminate their competition by using public funds.

Third, there is an extensive evidence suggesting that regional crime bosses have a strong local support. Going after crime bosses will further destabilize the fragile political and social equilibrium that we have finally achieved.

In short, this policy is bad because it does not address the underlying problem but rather attempts to cure a particular symptom. Furthermore, the treatment generates more harmful side effects.

Are Fears of Runaway Inflation Justified?

Ultimately, deep and unsustainable imbalance between the productive capabilities of the country and the government's expenditures will result in uncontrollable debasement of the currency. This is not the case in Kyrgyz Republic. What is different about 2010-2011 in contrast to 2009-2010? In terms of physical/human capital and unskilled labor, nothing has really changed. The real source of turbulence comes from the unstable institutional fabric of the country.

The following graph shows the historical debt/gdp, debt service/gdp, and inflation trends in Kyrgyz Republic.

Clearly, increase in the supply of money, backed by foreign borrowing, following the 1998 Russian financial crisis led to a higher rate of inflation, the first spike in the graph above. One of the largest banks went bankrupt, many more firms became insolvent, and the fact that most of the banking system's loan portfolios was made up of irrecoverable loans became public knowledge. The revenues declined as a result of deteriorating tax base, but the expenditure on social services and other government activities did not decrease much. Total foreign trade decreased, though disproportionately greater decline in imports (about 30% drop) than exports (i believe it was about 15% drop). Bottom line, 1999 was not a good year for Kyrgyz Republic. But the country survived, though it accumulated a good chunk of foreign debt.

What is the problem today? Following the second revolt, the economy experienced a slowdown: the trade volume decreased, investment in construction (a good indicator of the health of the economy) fell well below the last year's level, people are hoarding cash (velocity of money decreased and deposits in the banking system is showing a clear sign of slow down), the republican budget is bloated, the revenue numbers are highly questionable, and the rate of emigration is growing, especially from Osh and Chuy oblasts.
Have we seen these problems before in similar magnitudes? The answer is yes. Kyrgyz economy underwent even greater turbulent times and managed to rebound in a relatively short period.

One of the greatest source of annoyance for scholars in economic science is a systematic abuse of the term inflation. Inflation is a sustained growth of the general price level. The empirical investigation of this phenomenon suggests (Milton Friedman and Anna Schwartz's seminal work on monetary history provides the single most convincing evidence) that inflation as defined by economists is a result of the growth of money supply in excess of the amount that people wish to hold in cash and readily available deposits. A sudden rise in prices of some commodities increase the measure of the general price level, but they are never the source of sustained growth of the general prices! Their effect is transitory, and quite often the prices stabilize within a year. Higher prices for imported wheat and vegetable oil will undoubtedly increase the average price level, but these will not lead to uncontrollable hyperinflation. In 2008, prices for food items around the globe rose well over 50% and Kyrgyz Republic was not insulated from that effect either. For certain food items prices jumped over 50%. Did we have a sudden increase in starvation or extreme poverty then? Did we have mass protests? The government was too busy stealing, which worked out to be the lesser of two evils-- intervention that would lead to economy wide shortages and abstinence from price control on the part of the government but greater redistribution of wealth from hard working citizens to Bakiev and his gang. The economy rebounded, prices converged quickly to stable levels, and people did not have to experience shortages.

The lesson is quite simple. The government has never been the source of wealth creation, not during Roman times, not in modern US of A, and certainly not in Kyrgyz Republic. The government's relationship with its citizens is similar to the relationship between husbands and wives. If the objective is to have sex, equivalent to the government's objective to maximize social welfare, the best thing for husbands to do is to create the best possible environment that will encourage friskiness in their wives. By actively forcing themselves on their wives or telling them how to behave, they are sure to end up sleeping in the living room, alone and in front of a tv set.

The Kyrgyz government's rhetoric on the 'necessity' to intervene in price regulations not only will not work but will make the already fragile economic conditions worse. Here is the graph of the real GDP per capita in US dollars.

The latest number is about 1,000 US dollars per person. This number is about 6.5 times lower than that of Kazakhstan and about 8 times lower than that of Russian Federation. One might say, "well, they have oil and gas." My response to that is having oil and gas can be a curse, which we do not have. The standard of living depends not on transitory increases in wealth but on the long-term productivity of labor. The fastest growing economies are the dictatorships, but the slowest growing economies are also dictatorships. The ultimate benefit of a democratic society, which Kyrgyz people seem to demand more than any of their immediate and far neighbors, is ensuring a fertile ground for stable growth of wealth for its members. Kyrgyz Republic's problems lie in failure of the state to provide basic security against physical aggression and protect property rights, even if the government officials do not believe the owners are nice people. The real wealth of our country is its people--not gold, not uranium, and certainly not a 'self-sustaining' agriculture. Kyrgyz labor's comparative advantage lies in the service sector, light manufacturing, and knowledge sector. If our citizens engage in the activities that they have comparative advantage, their productivity will be higher, and subsequently their real standards of living will be higher. The only way the government can ensure such a progress is by creating the most accommodating liberal rules and punishing anyone, including its members, who infringes upon citizens' right to life and private property. As for happiness, I am sure, if the government acts in the least intrusive way, it will be invited to the bedroom at some point down the road.

Social Myopia and Wolves

Kyrgyz government recently announced its intentions to intervene if prices of 'important' commodities rise above the acceptable threshold. This policy will not only fail to achieve its stated objectives but also further exacerbate the shortages of vital commodities. The economists do not agree on many issues, but they all agree that price controls are ineffective, to say the least.

A simple theoretical economic reasoning suggests that price controls will create a wedge between the amount of good supplied and the amount that will be demanded. At lower prices, suppliers have incentives to reduce the amount of goods they will bring to the market and consumers will want to buy more than before. Effectively, the total amount of goods exchanged in the market place will be less than it had been before the price control. This reasoning seems pretty simple to understand, yet governments around the world still attempt to keep the prices artificially low. The real question is who gains from these policies?

Price control is not a novel concept. Historical records indicate that Roman Empire around the time of Emperor Claudius II engaged in massive debasement of the currency to finance large subsidies to welfare recipients that exceeded the productive capabilities of the empire. According to the Professor Prodromidis, the price of Egyptian wheat rose from 19 drachmas to 982 drachmas by the end of the third century. In 301 AD, Emperor Diocletian, who believed that higher prices were primarily caused by price speculations and conspiracy among suppliers to benefit at the expense of the 'good' citizens of Rome, imposed massive price controls on over 900 commodities. The results were less than encouraging: the markets were empty and many violators, often small time tradesmen with little political influence, were punished by horrific executions.

We do not need to delve into far past to understand the real consequences of price controls. Recently, Ethiopian government imposed price caps on primary food items in an attempt to bring the prices down to affordable levels and to fight the inflationary pressures. The results were repetition of Roman experience: empty shelves and more people joining the ranks of starving citizens.

Clearly, these policies do more harm than good. Then why do we see governments systematically employing price controls? Economists Pierre-Richard Agenor and Carlos M. Asilis investigated the historical episodes of price controls in Brazil, Argentina, Uruguay, and Israel and concluded that the immediate political gains to governments were overwhelming, even after controlling for the disastrous economic consequences of these policies.

Kyrgyz government is at the brink of another political reshuffling. Any means to 'buy' the constituents' support, especially if they are relatively easy to implement and their success is hard to assess, will be attractive policy options. These options may be politically feasible but they often have large and permanent economic costs. Mr. Bekov's recent bold claims that the government stands ready to intervene are nothing but a terrifying echoes from the past, Diocletian past of brutal persecution and empty shelves.

On Inflationary Concerns in Kyrgyz Republic

Here is an interesting graph that I made using EBRD data:

The question is why was the velocity of money so out of whack from 2002 to 2006? It is understandable why people decided to hoard cash in 2005 and 2006 (after the first revolt), but I am not sure about 2002 to 2004.

I've included Kazakh inflation rate to illustrate how closely Kyrgyz inflation rate tracks it (1999 and 2010 spikes are due to unusual M2 increases in KG relative to KZ money supply).