Paul Collier’s “The Bottom Billion” – Synopsis and Review

In Paul Collier’s “The Bottom Billion” (2008) Collier advertises the text as a guide on how to design the most effective G8 agenda in terms of reducing global poverty. To do this, he splits the world’s economies into three categories. Developed, Developing, and the Bottom Billion. The book is unsurprisingly aimed predominantly at helping the latter category. The Bottom Billion refers to the combined population of the worlds so called “failing states”, that are caught in a cycle of political unrest, economic stagnation, and falling levels of prosperity. From this point, the Oxford University professor highlights the causation for economic failure, the potential for globalisation as a saviour for these states, and an evaluation of the effectiveness of potential instruments that may be able to alleviate the level of poverty within these nations.

The first half of the book focuses on the reasons for why the poorest countries are failing. These reasons are split into four categories : Conflict traps, natural resource traps, landlocked with bad neighbours, and poor governance. To me, this section of the book was the least personal. Collier laid out the statistics of how much a typical civil war costs a country ($64), as well as describing the economic phenomenon of “Dutch Disease” (the negative impact of an inflow of foreign currency into a domestic market), and the importance of protecting economic reformers within failing states. However, at this point the chapters seemed more like a text book, rather than the personal plea that was so passionately argued in the preface.

Bottom_Billion_book_cover

The latter half of the book focuses on the plausibility of developed countries using instruments that may be able to create an economic climate more suited to growth within failing states. Unlike various other texts such as Jeffrey Sachs’ “The End of Poverty”, Collier does not take a clear political agenda that overshadows the book. He neither takes the left’s perspective of blindly throwing international aid at failing nations as a means of increasing social welfare regardless of its hinderance towards economic growth, nor the right’s perspective of aid being part of the problem of poverty as vehicle for “welfare payments to scroungers and crooks”.  Instead of choosing sides, Collier focuses on case studies of prior uses of instruments to reduce poverty, then evaluates their successes and relates these to their situation. For instance, the controversial instrument of military intervention within a failing state was analysed through two different case studies : the failure of Iraq, and the success of Sierra Leone, ultimately arguing that military intervention is an invaluable tool to maintaining post-conflict peace and therefore encouraging the economic security that is necessary to attracting private investment.

To me, the final chapter of the book was the most compelling. Here, Collier links the policy instruments described in the second half of the book, with their potential for effectiveness in alleviating the traps laid out in the first half of the book. The bringing together of the first and second halves of the book, culminated in the ultimate argument of the book – currently, governments are not fully utilising their whole arsenal of instruments that would be beneficial to encouraging development within the bottom billion. In other words, the over reliance on aid is a dangerous pit to fall into, as often blindly giving aid without conditions or targets does nothing to encourage domestic industry, as the injection is leaked out of the economy through imports. For the nations most in need of assistance such as Somalia, increased aid conditions, military and international organisation presence, and mutually beneficial trade deals will provide the ideal climate to encourage growth that will work to lift the nation out of disorder and into self-sufficiency. If governments want to see the level of change expected from the UN Millennium Development Goals, they should not measure the extent of their altruism by the GDP percentage dedicated to foreign aid, but rather measure their success by the actual progress that these countries are making. It is only then that these failing nations will begin to see true development.

Do Politicians Learn Anything From History?- 3/3 : “The Danger of “Learning” Lessons” – ECONOMICS HISTORY

After analysing both crises individually, it is now important to compare their similarities in terms of causation, effects and response, and therefore conclude whether or not the crises are comparable. This will allow us to hence understand to what extent policy makers were justified in their response to 2007/8, and whether or not they actually learnt from the failures and successes of the response to the Great Depression.  

1929 car

The causation for both crises shares many similarities. For instance, the policy climate created in the 1920s were meant to encourage people to take out loans to fund stock investment, through maintaining low interest rates, and providing the ability to ‘Buy on the Margin’, which allowed the general public to access the overvalued blue chip stocks. This is similar to the situation in 2008. Throughout the 1990s, the Bush administration had been pushing home ownership through ‘help to buy’ schemes. The combination of this as well as cheap mortgages meant that people were easily able to gain credit to buy homes and fuel the bubble.

Both crises are also similar in terms of the overconfidence and over speculation placed in asset values. Namely, the 1920s Stock Market, and the 2000’s housing market. Both markets had been growing in value exponentially over the prior decade, and market speculation from investors suggested that the rise would not stop. Consequently, both the housing market and the stock market became overvalued, which contributed to the extent of effect for the crash.

The economics responses to the crash also share similarities. Namely, both Presidents initiated expansionary fiscal policy to boost growth. Hoover commenced the “Hoover Reconstruction Finance Corp” which allowed him to bail out the stock brokers and collapsing banks, so that they were able to provide necessary credit to cater for loans to encourage growth. This led to an increase in national debt, but an expansion in AD. Obama similarly initiated his “Jobs Bill”, which was intended to alleviate unemployment and therefore encourage consumption to kickstart short term economic growth.Obama and a table

Indeed, both responses were similar also in their shortcomings. Unemployment under Roosevelt rose to 21%, which lead Henry Morgentyav to argue “we are spending more than we have ever spent before, and it does not work.” This is simultaneous to Obama’s policies, which saw unemployment rise from 8%-10%, despite his stimulus packages.

What is also clear is that increasing taxation paid for both eras’ stimulus packages. To pay for Roosevelt “New Deal”, the top marginal income tax rate reached 94% for those earning over $200,000 a year, which leads to large disincentives for companies to expand, and workers to earn more. Obama similarly raised taxes, but he instead levied the taxes on demerit goods, for instance increasing taxes on cigarettes and liquor, in order to reduce over consumption, and raise necessary revenue for his Jobs Bills.

In essence, it becomes clear that both economic situations leading up to the 1929 crash and 2008 crash were similar. They were both consequences of overconfidence and speculation in an accessible market, which resulted in said market becoming overvalued, and prior investments being lost as soon as the market turned. This in turn led to the collapse of banks, a reduction in economic growth, and subsequent derived unemployment. Both era’s responses were equally similar, in their initiation of Keynesian policies to increase government intervention and boost growth through injections. However, the extent to which an economist would judge that policy makers learnt the lessons of the past depends on whether or not you believe Roosevelt and Hoover’s policies were successful. William Hazlitt criticised Roosevelt by saying that for each dollar of tax spent, it must first be raised, and increasing taxes contributes towards worsening Keynesian “animal spirits” through dis-incentivising the labour force, which can be more harmful towards economic growth.

In my judgement, 2008 policy makers did learn the lessons of the past, through their effective implementation of expansionary fiscal policy, which ultimately reduced unemployment and boosted growth. However, this is not to say that policy makers should always fall back on preconceived methods of escaping economic crises. One crash in one époque will never be a carbon copy of a previous crisis, as there will always exist some kind of individuality about every crash, either in terms of causation or effect. Hence, policy makers should not become complacent and presume that just because expansionary fiscal policy helped to resolve the 1929 crash, it will do the same in 2008. To this extent, policy makers must always develop and evolve their theories to fit with that period’s idiosyncrasies, as over-reliance on previously successful policies and falling back on the notion of “learning from history” to then apply history step by step in an incompatible era, is a sure recipe for disaster.

Do Politicians Learn Anything From History?- 2 : “The 2007/8 Crash- A Case of Déjà-Vu?” – ECONOMICS HISTORY

The causation of the 2007 recession is well documented by academics. However, in order to discuss whether or not politicians did in fact learn the lessons of history from the 1929 Crash, it is important to analyse to what extent the two crashes were similar. Therefore, without going into too much detail, I shall quickly evaluate the causation, effects, and response to the 2007 Financial Crash.

Throughout the late 90s and early 2000s, the American housing market has been booming, exponentially growing in value from year to year, fuelled by cheap mortgages and help to buy schemes. As we have discussed before, this unsustainable growth creates a climate of overvaluation, resulting in the creation of a housing bubble. Therefore, as soon as the housing market crashed and subprime loans expired; households were unable to pay back expensive mortgages, meaning that huge established banks (such as Leheman Brothers) went bust. Consumer and investor confidence evaporated, which combined with the bank’s lack of credit, resulted in a credit crunch. The consequent contraction of the US economy had economic repercussions across the world, which stimulated the “global financial crisis.”

Wall Street

The initial impact of the crash first hit America. Stock wealth in the U.S fell by $7.4 trillion from July 2008 to March 2009. Within 18 months, unemployment grew by 4.5% (5.5 million), as labour demand is derived from RNO. American households lost an average of $5800 in 2008 as a result of the crash and loss of income.

In terms of response, Obama initiated expansionary fiscal policy. Namely his controversial “Jobs Bill”, which included a $62 billion injection for a Pathways Back to Work Program for expanding opportunities for low-income youth and adults, in order to reduce the recessive nature of increased unemployment. The Federal Reserve were able to counteract the issue of major financial institutions collapsing with the assistance of bailouts (preventing a complete liquidity crisis), but were unable to prevent the stock market from plummeting.

From this analysis, we can begin to identify similarities between both crises in terms of their causation, effects, and response, which I will do in my next article on economics history.  This will ultimately allow us to the question as to whether or not the two crises are comparable, and therefore to what extent politicians were able to learn from the past to avoid / reduce the effects of economic crashes.

Do Politicians Learn Anything From History?- 1 : “The Great Depression vs 2008 Crash” – ECONOMICS HISTORY

Could politicians have looked to the past to predict the 2008 Financial Crash?

Philosopher George Santayana famously quipped that “Those who cannot learn from history are doomed to repeat it.” In many ways, this is a motto adopted by politicians and investors alike world wide. If an institution is about to invest in capital or start a new scheme, surely it makes sense to look to the past and gain foresight through reflection.  Often, politicians can learn a great deal from the mistakes made by their predecessors, and act to not repeat them. Here, I will try to draw parallels between the causes of the Great Depression of 1929, and the causes of the Financial Crash of 2008, and therefore answer the question as to whether or not politicians did indeed learn from the past.

The Great Depression of the 1930s began on the 24th October 1929, when the American Stock Market crashed. However, this collapse did not come from nowhere; rather it was the inevitable consequence of decreased market regulation, investor over speculation, and overconfidence within the stock market. During the 1920s, wartime technologies (such as the radio and hoover) were seen as necessities rather than luxuries, hence increased output resulted in short run economic growth within America. This translated to the increase in value of share prices, averaging an increase of 20% per year in the 1920s. Banks were eager to lend out credit to potential investors because as long as the money was invested in the Dow Jones, investors would see their asset prices rocket, and therefore encourage investors and consumers alike to borrow even more credit from banks (40% of bank loans during the 20s were used to fund investment). This level of borrowing to fund investment meant that stock prices soon became overvalued, as investors would pump money into shares, which would in turn increase their value, and therefore encourage even more people to invest in these blue-chip stocks (ie General Motors). As credit was near limitless due to the lax monetary policy of the Federal Reserve, this process was able to repeat, leading to the creation of a stock market “bubble”.

Indeed, this bubble was able to develop due to the “Buy on the margin” scheme, which meant that that investors would only have to pay upfront 10-20% of a transaction in order to buy the shares, as the rest could be borrowed from a broker. This meant that only a small amount of “real” credit was used in stock transactions, meaning that for the first time the stock markets became accessible to the general public, rather than just the extremely wealthy. This in turn made the effects of the crash more widely encompassing.

Indeed, the growing bubble was further fuelled by a lack of government regulation within stock markets. Republican Presidents Warren Harding, Calvin Coolidge, and Herbert Hoover were great believers in Laissez-Faire economics, (the belief the Adam Smith’s invisible hand behind market forces will ultimately result in the optimum allocation of resources, and any government interference prevents this action). However, this interpretation of the Austrian School of Economics allowed for the forming of monopolies, as wealth inequality reached record levels. The reduced levels of regulation allowed for the stock markets to go unmonitored, allowing small elite firms such as JP Morgan to control vast amounts of the stock exchange, and manipulate share prices.

However by October 1929, investors began to realise the expanding difference between share price and actual share value. It became clear that stocks had become overvalued, hence, on October 24th 1929, share prices began to fall. Immediately, investors and the general public alike rushed to sell their stocks, resulting in 16,410,310 shares being sold on Black Thursday, to the tune of $40 billion, a fall of 12%.

The Dow Jones continued to decrease in value for another 3 years. Labour demand is derived from RNO, hence as output shrunk unemployment grew to 25%. The decrease in demand for labour meant that workers lost their bargaining power, so wages fell by 42%, which lead to a regressive decrease in living standards, hence inequality grew (show in the creation of “Hooverville” slums for the unemployed).

Black Thursday Newspaper
London Herald Friday 25th October – The effects of the Crash were felt worldwide.

Therefore, the Great Depression came from a culmination of overconfidence, the public’s newly found hobby of investment in shares, and a seemingly endless supply of credit from banks and brokers alike. These ultimately fuelled the bubble that would eventually collapse to cripple the worldwide economy (international trade fell by 65%). In my next blog on ECONOMIC HISTORY, I will analyse the causation of the 2008 Financial Crisis, and then draw parallels between the two events, to conclusively decide whether or not the politicians of 2008 did learn the lessons of history.