Lessons in resilience from extreme economies

Banner image: a pedal powered 'car' made from pieces of old bicycles used to help carry disabled people around the camp (credits: Richard Davies)

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This article is part of a series in which OECD experts and thought leaders  from around the world and all parts of society  address the COVID-19 crisis, discussing and developing solutions now and for the future. Aiming to foster the fruitful exchange of expertise and perspectives across fields to help us rise to this critical challenge, opinions expressed do not necessarily represent the views of the OECD.

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Economics when the lights go out

Pandemic economics is unlike regular economics. To see why, consider a dimmer switch. Regular economics studies what happens when the dial is turned: as quarterly output and employment figures ebb and flow, the light of the economy brightens and dims. Some years, like 2008, are darker than others and some are brighter—but the bulbs are always on. Pandemic economics is different: in early 2020 policymakers had to hit the switch, so the lights went out completely. The COVID-19 pandemic, an extreme event, has shifted attention away from day-to-day matters to a question that is more fundamental, yet economists rarely ask: how can we ensure resilience in the most pressurised and testing times imaginable?

The study of extremes—catastrophic tail events, surprising one-offs—is commonplace outside economics. In medicine the tradition goes back to the early 1600s and Londoner William Harvey, an anatomist whose investigations of extreme patients—their bodies damaged yet surviving—revealed how the heart worked and blood circulated.[1] Our understanding of the gastric system and brain rely on similarly gruesome outlier cases. In engineering the master of analysing extremes was David Kirkaldy, a Scot who collected fragments of warped rail track and bent bridges following disasters to understand the weaknesses in materials and how to eliminate them. As economists we tend to avoid analysing economic life in marginal and extreme places. The hard sciences would view this as a mistake.

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Seeking a fresh perspective, I set out to find nine of the world’s toughest economies. I travelled the world and collected personal accounts of people going through incredible economic stress and strain: from refugees fleeing the Syrian civil war to people made homeless by the 2004 tsunami, I met prisoners in maximum security jails and recovering addicts in cities wracked by post-industrial decline. What I found convinced me that the study of extreme cases is important in economics, too. Tough times provide a new lens on the way capital—physical, financial, human, and social—works, forcing us to re-think the production process and the way value is created. As in medicine and engineering, this rarer type of study—economics when the lights go out—may help us understand our economies in more normal times too.

Tough times provide a new lens on the way capital—physical, financial, human, and social—works, forcing us to re-think the production process and the way value is created.

Capital in a volatile world

Introductory textbooks, papers and models give primacy to physical capital: plant and machines are the foundation of production. Yet from tsunami-ravaged Aceh, Indonesia, to the Zaatari refugee camp in northern Jordan, I met people who showed that damage to physical capital is a problem that can be solved relatively quickly. This controversial idea was well understood by classical economists. In 1848 John Stuart Mill puzzled over rapid recoveries following disaster writing that “An enemy lays waste a country by fire and sword … all the inhabitants are ruined, and yet in a few years after, everything is much as it was before."[2] The ‘enemy’ was an extreme event (for Mill, an earthquake, flood or war) and his observation was the surprising pace with which damaged physical capital was put back together.

When physical capital is eradicated, resilience seems to be a fundamental human skill—adapting and rebuilding comes quickly and naturally.

The reason for the innate human ability to deal with damage to physical capital, Mill thought, is depreciation. Things decay—machines rust, buildings crumble—so people are constantly adapting to varying levels of physical capital and working to offset its decline. Extreme economies show that he was right. Acehnese entrepreneurs described how they quickly built a pop-up version of former businesses following the tsunami, cobbling together a self-built oven, smaller boat, or makeshift store. The entire Zaatari refugee camp is a lesson in capital re-deployment and repurposing: any waste wood or metal quickly used as extensions to homes or to crate storefronts, steel frames of bicycles cut up and welded back together to create wheelchairs for those with war injuries. The damage in these places is devastating but when physical capital is eradicated, resilience seems to be a fundamental human skill—adapting and rebuilding comes quickly and naturally.

One of the many informal, pop up stalls selling goods in the Zaatari refugee camp (credits: Richard Davies).

Financial capital operates in fascinating ways in extreme environments. I was surprised to find that my travels to marginal and stressed places were, in a way, a tour of informal monetary and financial systems. Everywhere I went, some form of money, lending or insurance had sprung up. I heard how currencies had formed overnight with the conversion of some durable good—powdered milk, coffee, tobacco—into an underground money. An extreme event often shifts resources between groups so that wants, needs and the resulting trades that markets facilitate will change. When financial systems are damaged, inaccessible, or seen as unfair, a new type of money often arises.

This organic financial rebound goes much further than currency—it includes informal versions of complex products and arrangements. In Aceh, chunky bangles made of solid gold, owned and worn by women, served as a form of self-insurance: selling or pledging the jewellery a way to access cash fast. In Glasgow, tight-knit tenement communities hit by industrial decline would loan goods for pawning when work at the shipyard dried up. In Louisiana, prison inmates described a new ‘dot’ payment system, a traceless way to trade contraband using pre-paid debit cards. Economists tend to think of finance as the most formal part of the economy, one where particular expertise or training is needed. Yet this self-built, outsider financial system exists everywhere: measuring and engaging with it is vital to understand how economies really function.

In extreme times it becomes clear that human capital, not physical or financial, is the foundation of resilience. It is an amorphous asset, existing in minds and ideas rather than in factories or bank accounts. Precisely because it is intangible, human capital is durable—impossible for a natural disaster or pandemic to destroy. In Aceh I met people who fished, cooked, cut hair and traded coffee beans as a way to rebuild their lives following the tsunami, using prior knowledge as a safety net. Human capital is also flexible: in Zaatari I met refugees who had re-deployed their skills: car mechanics who became bicycle repairers, logistics experts who worked as fashion buyers. The flip side of these stories of survival were places, like Glasgow, where the damage done by the extreme event—in this case a sudden loss of industry which made shipbuilding skills obsolete—had been primarily to human capital.

Of course, skill and knowledge are goods in themselves, but they are also latent assets - an option on the future and insurance against hard times ahead.

Regular economics gets into a pickle when it comes to human capital. Studies often find it hard to justify skills boosting policies, since estimating the impact of an extra year’s schooling, a vocational or technical training course is fiendishly difficult, as OECD research has shown. Yet extreme economies make the case clearly. Even if training is never used so that skill and abilities lie dormant, they make up a pool of potential that can be called on if needed. Attempting to link human capital to output, value-added or other productivity measures of productivity will miss this. Of course, skill and knowledge are goods in themselves, but they are also latent assets - an option on the future and insurance against hard times ahead.

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Finally, social capital, which extreme environments clarify the primacy of. Economists tend to avoid studying, analysing, or even talking much about social capital. There are a host of reasons why. The most ethereal of assets, it is hard even to define—existing as norms, traditions, reciprocal favours, and cooperation—let alone measure accurately. Anyone wanting to do empirical work is wise to give it a miss. Others take the understandable view that social capital is inherently political—those on the left regard reliance on it as an excuse of austerity, while those on the right think supporting it is government overreach. This means anyone seeking a workable centrist policy should duck discussing social capital too. The result is the near expulsion of social capital from mainstream economics.

On the ground, in the most extreme places, one can see why this is a mistake. Where social capital was high, I witnessed informal economic arrangements relying on trust—from unmanned vegetable markets in northern Japan where elderly gardeners would leave excess produce for sale, to the ‘menage’ credit unions that helped Glaswegians finance the purchase of tools. Often the benefit of this reciprocity can be seen in capacity utilisation: any given level of tools, money or skill will go further where social capital is high. By contrast the places I visited where economic stress had eroded trust and made cooperation harder—including the lawless Darien Gap and inequality riven Santiago—showed a concerning lack of resilience.

Renewing economics for extreme times

The COVID-19 pandemic is a reminder that economics is a discipline that we must constantly renew and improve. At present, the way we think about, discuss and model factors of production means we have an inaccurate picture of how economies work. This miscasting and miss-measuring leads to analysis that is incomplete, and often wrong, eroding the positive or descriptive mission of economics. More deeply still, economists must embrace the fact that making discoveries is not just a matter of better models or larger data sets (though these are great). Understanding the economy also means talking to people at length, engaging with their lives, stories, and challenges. In other words, adopting a more qualitative and human approach to gathering information is key. This material is harder to quantify but to ignore it makes economists seem out of touch with reality, and erodes the normative or moral mission of economics, which is to design better policies. As Alfred Marshall put it in the first line of his landmark textbook: “economics is a study of mankind in the ordinary business of life”[3]. To ignore this day-to-day, informal, and organic economics—which comes to the fore clearly in extreme times—is a great mistake.

Learn more about Richard Davies' new book: "Extreme Economies".

References

[1] Wright, Thomas (2013), Circulation: William Harvey’s Revolutionary Idea, Vintage.
[2] John Stuart Mill, Principles of Political Economy, Book I, Chap. 5, par. I.5.19.
[3] Alfred Marshall (1890), Principles of Economics, Book 1, Chapter 1, Paragraph 1.

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Richard Davies

Economist, Author, Bristol University, London School of Economics

Richard Davies is an economist and author based at Bristol University and the London School of Economics. Previously he was Chair of the Council of Economic Advisors at HM Treasury and Economics Editor of The Economist. His book, Extreme Economies, is published in paperback this September.

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