What Makes an Economy Fragile

By Paul Sullivan,
Georgetown University

I have been thinking a lot about what makes people, organizations and countries fragile. This is a tough, competitive world with little leeway for fragility. Understanding when something or someone is fragile is often clear. How to toughen them up, make them more resilient and even anti-fragile is something else. I am using the term anti-fragile as it is used by Nicholas Nassim Taleb. Sometimes organizations, people, and even countries get anti-fragile when they are exposed to volatility, stresses and strains and the vagaries of the complexities that are existence, survival and thriving. Anti-fragile is more than resilience. Being anti-fragile means an organization or person gets better, smarter, more creative, etc. with more challenges and shocks.
Overprotecting children, artists, scientists, potential future leaders and more can lead to them being less than they could be. Of course, there are the complex tradeoffs involved in deciding when to protect and when to not, when to buffer and when to not, when to direct, advise or even order and when to not. Nothing in the realm of thriving as anti-fragile entities or people is easy.
Let us focus on economies for now. Economies are very complex organisms even when they are in small countries of few people. Economies have lots of moving parts. They are essentially quite human considering that humans make most of the decisions in economies. Computer models for finance and computer aided manufacturing are also human inventions. Economies are not to be simply analogized into equations that can show how easily they can be fixed, helped to develop and so forth.
Those who think changing one variable or another is sufficient to make an economy zoom ahead without much trouble should read deep into the economic history and history of economic thought with regard to policymaking. More often than not things do not work out as expected. Also, most economic policy is conditional. That is, the effectiveness of economic policy is determined by the complex situations in which it is applied. For example, if a country has little debt, its interest rates are fairly low, but not near to zero, its banking system and central bank are sound and well run, and its legislative branch and policymakers are functioning properly and effectively, then there is a much better chance for monetary and fiscal policy to work than if these conditions were not there. The present situations in the US and much of the EU are good examples of the combination of very high debt, very low interest rates, and dysfunction amongst the fiscal policy “elite” – even if the monetary policy elite and the central bankers are doing as well as they likely could ever within the circumstances that they face.
It is almost as if when the top universities started to see monetary policy as the solution to everything and fiscal policy as something to be scoffed at (and this has actually happened in many universities) then the abilities of those needed to explain and advise of fiscal policy weakened or were pretty much neglected in favor of anti-intellectual dribble that passes off as policymaking amongst some of the economic policy elite.
I got my training in macroeconomics and economic policy making from people like the Nobel Laureate James Tobin. I also read voraciously about monetary policy and what happens when you combine both policies. However, I will not forget what Professor Tobin told me so long ago about how even the best economic theories and best economic advice turn to mush and uselessness (or worse) when the wrong politicians get a hold of them.
Indeed, economics is complex, but as some of you have noticed I try to explain it in in everyday terms. One of my other mentors, the great economic historian William Nelson Parker IV, advised me once with this wisdom: “If you want people to understand you then tell a story.”
One of the most important things that can make an economy fragile, and hence more vulnerable and brittle when facing external and internal shocks is debt. Stating the amounts of a country’s debt is not enough. This debt has to be relative to how the country can pay for it. So some of the more effective numbers are debt service (usually per year and this is how much is needed to be paid in principle and interest on the debt) as a percentage of the GDP of the country, as a percentage of total government revenues or even as a percentage of export revenues for those countries that rely a lot for the government revenues and GDP from exports. In other words: unless you are pretty sure you can pay for it with little chance for going into difficult times do not borrow a lot of money.
Government debt can be important at the national, state or provincial as well as the town and local levels. Business and personal household debts compared to their incomes are also important indicators of the fragility of an economy. If business debts are massive percentages of business revenues and profits then there is trouble ahead, especially if no real growth is expected in these businesses. If household and personal debts are many times the income of those persons or entities then one would expect that they would be less likely to be able to survive big shocks. These debts still need to be paid whether there are shocks or not.
Borrowing is a risky activity if the reasons and returns to that borrowing are not clearly understood. Using a loan to start a business that has a very good chance of success makes a lot more sense than taking out the same loan to go on vacation in Hawaii or Thailand, no matter how nice such a vacation might be. This is especially so for a younger person just starting out and not particularly well off. There are benefits to thrift and economic conservatism in one’s younger years. Investing savings in something that will give a 5 percent return over the next 50 years is a lot better than paying off a loan at 5 percent for the next 50 years. However, if you can borrow at 5 percent and get a return of 10 percent by using that borrowed money wisely then you are ahead.
Corruption is another source of fragility in a country. The more corruption there is the less likely it is that most people in the society can contribute to the development of the country. Also, a lot is lost in unproductive activities like paying off the police, politicians and others rather than investing that money and getting people job. Highly corrupt places also have a serious problem with trust across contracting parties. This makes most economic activities far more expensive than they might be. Corruption can also literally kill an economy by squeezing out entrepreneurs.
Many entrepreneurs may just leave the country and make their money and create their jobs elsewhere. For some countries corruption is so endemic that trying to control it could take the economy down, but those countries were held back for years from their potential. Corruption can also keep information about what is really going on in the economy. The 2008 world financial crash is a prime example of this corruption requires opacity in exchanges and economic activities. This keeps important data away from those who are making some very important decisions, like buying a house or investing in a company. Corruption goes hand in hand with secrecy and opacity. When this happens there is trouble ahead and the economy and the country are really far more fragile than they could ever have guessed.
Running along with corruption and opacity are the weak and unequal applications of the rule of law. If only a select few can gain the benefits of a rule of law then most of the gains to economic development go to the select few. Uneven and unequal economies and societies are inherently fragile, whether they know it or not. If inequality of the application of the rule of law, and the inequalities of wealth and income, persist and get worse revolutions and civil strife can follow. Looking at the history of revolutions, civil conflict and even crime one can see strong economic explanations. Many of those economic explanations are based on inequality, corruption, and, frankly, most of people getting fed up with the sense of entitlement of the minority as most of the people suffered. This is not a class-based theory. This is common sense and human nature.
Inequality in opportunities, education, training and more can magnify the overall sense and actuality of inequality in a society. These sorts of human capital inequalities can also lead to fragilities to economic and political shocks.
Some countries suffer from the “fat cat syndrome”, where the fat cats who have fed off the economy seem to think all is going well until the hungry skinny street cats surprise them by eating them. The “fat boy syndrome” can also be problematic. The children of the elite strut around thinking they run the country as the resentment builds in the streets and the shanty towns of the country. The fat boys eat and drink as the hungry boys get angrier. This is a universal issue. No country will survive peacefully for long with it.
A country also retains and builds fragility when it relies for too long and too much on imported experts, imported capital, and imported ideas and technology. Until the country develops its expertise, investment markets, and technologies it will always be a follower. Hence, it will always be dependent. Hence, it will be fragile to the high winds of outside shocks when the world economy changes and they need to change quickly along with it — or else.
A more diversified economy is always a more anti-fragile one. An economy that relies on one of a very few commodities to be exported to grow is simply growing in GDP terms, not growing in strength. The more reliant a country is on a very few industries and a very few exports the more fragile it will be. This is especially so if the commodities relied upon have volatile prices and very finicky markets – or if the markets are dominated by few buyers. The fact that Mongolia relies so much on China for its exports of coal makes it fragile indeed.
There is lot more to the story of what makes a fragile economy. Next week I will look into how bail-outs, fine tuning, subsidies, overly complex and distorted tax systems and more can add fragility to an economy.
A fragile economy can affect everyone involved from the big businessmen to the poor people in the slums, from the grandfather hoping to save for his family to the newborn child looking to maybe a more hopeful future. We all need to understand this better. There will be shocks. There will be financial crises. There will be possibly even more than that.

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Posted by on Dec 27 2012. Filed under Opinion. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

2 Comments for “What Makes an Economy Fragile”

  1. You can censor me here if you like, but the truth about the propaganda is going viral, and you now seem to be officially on the wrong side of history.

  2. What causes “shocks” and “crises” in economies are the banksters that are given control of the money supply and they purposely rock the economy back and forth in order to harvest the profits from the hard work of the people, to put it simply. America’s problems now are a direct result of this. The central bank, the Federal Reserve, is not a government agency but a private corporation which in only it’s first 100 years has managed to cause a great depression in the 1930′s (cite Milton Friedman) and now drive it to the fiscal cliff it now stands at. Beware of those who hide these facts about so called “fragile economies”!

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