Davies’ “Extreme Economies” – Part 2: Failure

In the previous part of this three-part review, I looked at Davies’ first subsection (“Survival”) where he ventured to some of the most secluded and extreme places of the world – a maximum security prison, a refugee camp, a tsunami disaster – and found thriving markets. Not in that pejorative and predatory way markets are usually denounced by their opponents, but in a cooperative, resilient and fascinating way.

In this second part, subtitled “The Economics of Lost Potential”, Davies brings us on a journey of extreme places where markets did not deliver this desirable escape from exceptionally restrictive circumstances.

There might be many reasons for why Extreme Economies has become a widely read and praised book. Beyond the vivid characters and fascinating environments described by Davies, this swinging between opposing perspectives is certainly one. Whether your priors are to oppose markets or to favour them, there is something here for you. Davies isn’t “judgy” or “preachy” and the story comes off as more balanced because of it.

If the previous section showed how markets flourish and solve problems even under the most strained conditions, this section shows how they don’t.

Darien, Panama

We first venture to the Darien Gap, the 160-kilometre dense rainforest that separates the northern and southern sections of the Pan-American Highway – an otherwise unbroken road from Alaska to the southern tip of Argentina.

To a student of financial history, “Darien” brings up William Paterson’s miserable Company of Scotland scheme in the 1690s; trying to make Scotland great (again?), the scheme raised a large share of scarce Scottish capital and spectacularly squandered it on trying to build a colony halfway around the world. In the first chapter of subsection ‘Failure’, Davies skilfully recounts the Darien Disaster, “Scotland’s greatest economic catastrophe” (p. 114).

Judging from Davies’ ventures into the jungle bordering Panama and Colombia, it wouldn’t be a far cry to call the present state of affairs a similar economic catastrophe. Rather than failed colonies, the failed potential of Darien lies elsewhere: its environmental challenges coupled with the trade and markets that failed to emerge despite readily available mutual gains for trade.

A stunning landscape of mile after mile filled with rainforests and rivers and the occasional lush farmland, the people of the Gap make a living through extracting what the land provides. If you’re deep into environmentalism, you might even say unsustainably so. Davies’ point is to illustrate a more well-known economic problem: when unowned or communally owned resources suffer from the tragedy of the commons – the tendency is for such resources to be overexploited and ultimately destroyed.

Whether through logging companies exceeding their quotas or locals chopping trees out of desperation to survive, the story in Darien is altogether conventional. At the edge of the Gap, “the people of Yaviza do what they can. [T]he environment is an asset, and for many people living in Yaviza getting by is only possible by chipping a bit off a selling it” (p. 120).

What’s striking here is that in times of need (as Davies himself showed in the chapter on Aceh) that’s exactly what we want assets to do! We can show this in down-to-earth, real-world examples like Acehnese women drawing on their jewellery as emergency savings, or in formal economic models such as the C-CAPM, the Consumption Capital Asset Pricing Model, familiar to every business and finance student.

On a much cruder level: if the mere survival of some of the poorest people on earth depend on chopping down precious trees – well, precious to far-away Westerners, anyway – accusing those people of destroying our shared environment is mind-blowingly daft. To rationalise that equation, you have to put a very large value on turtles and trees, and a very small value on human life.

Elinor Ostrom, whose Nobel Prize in economics was awarded to her work on common pool resources, emphasised three ways to solve tragedies of the commons: clear boundaries (i.e. individual property rights); regular communal meetings such that members can voice opinions and amicably resolve conflicts; a stable population so that reputation matters and we can socially police deviant behaviour (p. 125).

The Darien Gap has none of those. Property rights are routinely ignored; the forest includes many different populations (indigenous tribes, farmers, ex-FARC fugitives, illegal immigrants); and those populations fluctuate a lot, meaning that most interactions are one-shot games where reputation becomes useless. End result: extensive, illegal, unsustainable logging mixed with armed strangers.

What I can’t quite wrap my head around is that almost all (market and non-market) interactions that all of us have daily are with strangers: the barista, the people we walk past on the street, the new client you just met or the customer support agent you just talked to. All of them are strangers. A large share of interactions with other humans in the last few centuries of human societies have been one-offs, yet very few of them have spiral into the lawlessness that Davies describes in Darien. Be it the Leviathan, secure property rights, the doux commerce thesis or some wider institutional or cultural reason, but the failure of Darien to establish well-functioning formal and informal markets of the kind we saw in the book’s first part are intriguing.

While a fascinating chapter, it might also be Davies’ worst chapter, factually speaking. He claims, mistakenly, that “globally, deforestation continues apace with 2016 the worst year on record for tree loss”. On the contrary, we’re approaching global zero net deforestation. More specifically, Davies claims that Colombia and Panama are particularly at risk here, with rates deforestation “increased sharply”. A quick look through UN’s Global Forest Resource Assessment report (latest figures from 2015), these two countries are indeed chopping down their forests – but by less than any other time period on record.  Moreover, the Colombian net deforestation rate of 0.05% per year is easily exceeded by a number of countries; not even Panama’s dismal 0.3%/year (worse than the Brazilian Amazon) is particularly high in a global or historical perspective.

To make matters worse, the figure on p. 158 titled “The World’s Disappearing Tropics” might win an award for the most misleading graph of the year: by making the bars cumulative and downplaying the annual deforestation, it suggests that the forests are rapidly disappearing. The only comparison to relevant numbers (remember, Rosling teaches us to Always Be Comparing Our Numbers) is the tired “football pitches”. That’s hugely misleading. A vast amount of football pitches cleared in the Amazon this year still only amounted to 0.2% of the Brazilian Amazon; in other words, Brazilians could keep chopping down trees for a few good decades without making much of a dent to that vast rainforest.

davies

Moreover, the only reference point we’re given is that over a period of almost twenty years, an area the size of France has been deforested – but that’s equivalent to no more than one-tenth of only the Amazon forest, and the tropics have many more forested areas than that. The graph aims to intimidate us with ever-rising bars signalling the loss of forests; with some proper numbers and further examination it doesn’t seem very bad at all. On the contrary, locals (and yes, international logging companies) use the assets that nature has endowed them with – what’s so wrong with that?

Finally, the “missing market” that Davies observes in the Gap involves countless of illegal immigrants from around the world that trek through the jungles in search of a better life in the U.S. We have cash-rich Indians, willing to pay people to guide them through unknown and dangerous terrain, and local tribes and farmers and ex-FARC members with such knowledge looking for income; setting up a trade between them ought to be elementary.

Instead, it’s not: “in this place of flux,” writes Davies, “reputation does not matter, interactions are one-offs” (p. 137). Overturning the market quip that “trading is cheaper than raiding”, in the Darien Gap raiding is cheaper than trading. One might of course object that the failures of rich countries to offer more liberal immigration rules for people willing to go this far to get there illegally is hardly a market failure – but a failure of government regulation and incompetent bureaucracies.

Kinshasa, Democratic Republic of the Congo (DRC)

A 12-million people city sprawled on the banks of the Congo river, so unknown to Westerners that most of us couldn’t place it on a map. Democratic Republic of the Congo, the country with more people in extreme poverty than any other, is frequently described as “rich”. Or, with Davies’ euphemism “unrivalled potential” (p. 143).

Congo, the argument goes, has “diamonds, tin and other rare metals, the world’s second-largest rainforest and a river whose flow is second only to the Amazon. [it] shares a time zone with Paris [and the] population is young and growing”. It is one of the poorest countries but “should be one of the richest” (p. 143).

No, no and no. Before any other consideration of the remarkable day-to-day trading and corruption that Davies’ interview subjects describe, this mistaken idea about wealth must be straightened out. Wealth isn’t what could be if this or that major obstacle wasn’t in the way (Am I secretly a great singer, if I could only overcome the pesky fact that I have a voice unsuited for singing and lack practice?). This is almost tautological; what we mean by a country being poor is that it cannot overcome obstacles to wealth.

All wealth has to be created; humanity’s default position is extreme poverty.

And natural resources do not equate to wealth – there is even more support suggesting the opposite – in which case Japan and Singapore ought to be poor and Venezuela and DRC rich. My own sassy musings are still largely correct:

As Mises taught us half a century ago – and Julian Simon more recently – wealth (or even ‘goods’ or ‘commodities’ or ‘services’) are not the physical existence of those objects somewhere in the ground, but the satisfaction and valuation derived by the human mind. The object itself is only a means to whatever end the actor has in mind. Therefore, a “resource” is not the physical oil in the ground or the tons of iron ore in the Australian outback, but the ability of Human Imagination and Ingenuity to use those for his or her goals. After all, before humans learned to harnish the beautiful power of oil into heat, combustion engines and industrial production, it was nothing but a slimy, goe-y liquid in the ground, annoying our farmers. Nothing about its physical appearance changed over the centuries, but the mental abilities and industrial knowledge of human beings to use it for our purposes did.

Still, “modern Kinshasa is a disaster everyone should know about” (p. 172). No country has done worse in terms of GDP/capita since the 1960s. And we don’t have to go far to figure out at least part of the reason: the first rule of Kinshasa, says one of Davies’ interviewees, is corruption (p. 145). Everyone “steals a little for themselves as the funds pass through their hands, and if you pay in at the bottom of the pyramid there are hundreds of low-level tax officials competing to claim your cash.” (p. 185). Mobutu, the country’s long-time dictator, apparently said “if you want to steal, steal a little in a nice way” (p. 159).

Whether small stallholders at gigantic market or supermarket-owning tycoons, workers or university professors, pop-up sellers or police officers, everyone in Kinshasa uses every opportunity they can to extract a little rent for themselves – out of desperation more than malice. And everyone hates it: “The Kinoise”, writes Davies, “understand that these things should not happen, but recognize that their city’s economy demands a more flexible moral code.” (p. 168).

Interestingly enough, DMC is not a country whose state capacity is insufficient; it’s not a “failed state”, an “absent or passive” government whose cities are filled with “decaying official buildings and unfilled civil-service positions.” (p. 148). On the contrary:

The government thrives, with boulevards lined with the offices of countless ministries thronged by thousands of functionaries at knocking-off time. The Congolese state is active but parasitic, a corruption superstructure that often works directly against the interests of its people.

Poorly-paid police officers set up arbitrary roadblocks and extract bribes. Teachers demand a little something before allowing their pupils to pass. Restaurant owners serve their best food to their civil service regulators, free of charge, to even stay in business. Consequently, despite an incredibly resilient and innovative populace, “these innovative strategies are ultimately economic distortion reflecting time spent inventing ways to avoid tax collectors, rather than driving passengers or selling to customers” (p. 162).

But, like the ingenious monetary system of Louisiana prisons, the most fascinating aspect of Kinshasa’s economy is its use of money. Arbitrage traders head across the river to Brazaville in neighbouring Republic of the Congo equipped with dollars which they swap for CFAthe currency of six central African countries, successfully pegged to the euro. With ‘cefa’ they buy goods at Brazaville prices, goods they bring back over the river and undercut exorbitant Kinshasa prices. Selling in volatile and unstable Congolese francs carries risk, so Kinshasa’s streets are littered with currency traders offering dollars – at bid-ask spreads of less than 2%, comparing favourably with well-established Western currency markets. Before most transactions, Kinoise stop by an exchange trader sitting outside restaurants or malls, to acquire some Congolese francs with which to pay. Almost, almost dollarisation.

In Kinshasa, people rely on illegal trading as a safety net when personal disaster strikes or the state’s required bribes become too extortionary. Davies’ point is a convincing one, that “a town, city or country can get stuck in a rut and stay there” (p. 174).

Judging from his venture into Kinshasa, it’s difficult to blame markets for that. I don’t believe I’m invoking a No True Scotsman fallacies by saying that a market whose participants spent half their time avoiding public officials and the other half bribing them to avoid arbitrarily made-up rules, is pretty far from a free market.

Believing the opposite is also silly – that markets and mutual gains from trade can overcome any obstacles placed before them. Governments, culture or institutions have power to completely eradicate the beneficial outcomes of markets – Kinshasa’s extreme poverty attests to that.

Glasgow, the last part of ‘Failure’, is discussed in a separate post.

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