The World is Too Big to Fail But…

Who is Going to Bail it Out?

By Anjum Altaf

We have all read the stories about very big entities failing and being bailed out – these include cities like New York, countries like Mexico and Pakistan, and corporations like General Motors and Bank of America whose businesses were bigger than the economies of many countries. All of them defaulted on their debts – went bankrupt – and were bailed out by an entity that was bigger than them, the US Government alone or in concert with other developed countries.

The combination of size and of the existence of a savior, the protector of last resort, gives rise to a dilemma that is known as ‘moral hazard.’ When an entity believes its failure would damage the rest of the system and that there is someone who will not allow that to happen, then it loses the incentive to manage its risks prudently.

This is quite easy to imagine. If the corner bakery fails no one would bother about it – this is considered the strength of the free market which promotes efficient competition by weeding out incompetent firms. But when General Motors fails, this logic is suspended because GM’s failures could trigger cascading failures throughout the auto industry and its service economy. Because the managers of General Motors believe this, the incentives that guide their behavior and that of the owner of the corner bakery are quite different. For example, GM managers can take outsized risks and give themselves big bonuses even when the company is making huge losses. Similarly, Pakistan’s leaders can mismanage and pillage the economy knowing American policymakers have determined that Pakistan cannot be allowed to fail – which is great for the leaders but terrible for the citizens.

This brings us to a consideration of the world in the context of the global climate crisis. What can be bigger than the world? But, if the world fails, who will bail it out? Allah maalik hai is all and well but even if we fall back on that divine cushion we should remember the corollary that God helps those who help themselves. So, how exactly are we going to help ourselves in this crisis?

Let us leave aside for the moment two contentious issues: Is this crisis for real and, if so, is it the doing of human beings? My interest is more in figuring out how one goes about thinking of such an issue – so let us assume that it is real for the sake of argument. (The Government of Maldives already does and is looking to buy land in anticipation of a rise in sea level that would submerge the islands. South Asia is projected to be amongst the most affected regions by global warming.)

I find useful an analogy similar to the comparison between General Motors and the corner bakery in the context of moral hazard. Think of two households; however, instead of size, now focus attention on the differences in the nature of household budgets. Suppose the monthly household budget is Rs. 20,000 that you get in cash at the beginning of the month. In one case, you know that if in a particular month you break the budget (expenditures exceed allocations), you can borrow the balance from a bank or be subsidized by your father. In the other case, if you go over budget, your house is repossessed – it’s the end of the game. The first is known as the ‘soft’ budget constraint; the second as the ‘hard’ budget constraint. As you can imagine, the softness or hardness of the household (or business) budget constraint has a great impact on individual behavior.

Now apply this analogy to the environment. Clearly, our behavior reveals that we have been living in a world where we feel we are governed by a soft environmental constraint – we believe we can borrow against the future, i.e., we can have economic growth now and have the luxury of cleaning up its environmental consequences later. At the present time, the starkest example of this is China which is fueling its rapid economic growth by building more than one coal-fired energy plant a week. As a result, seven or eight of the ten most polluted large cities in the world are in China with some known and many unknown health impacts on the residents.

Presumably, China believes that it can follow the path trod by the West. Western cities were environmental hell-holes well past the Industrial Revolution but most were successfully cleaned up later – the London and LA smog are still remembered by many people (the former so well described by Eliot in The Love Song of J. Alfred Prufrock). The scenario in India is very similar to that in China, only less intense, which is not for any lack of trying by the Indians – inefficiency can at times be good for you.

But what if the environmental constraint is no longer soft? What if the decades of abuse of the environment (at least since the discovery of oil-based energy) have now turned it into a hard constraint? What, if that last unit of carbon dioxide emission that would trigger an unstoppable runaway process is close at hand? What if we have arrived at the tipping point beyond which all the king’s horses and all the king’s men would not be able to put Humpty Dumpty together again?

This is what an increasing number of scientists are warning – we are close to such a tipping point. And this opens up a host of interesting issues. Climate change does not know any borders – in the end it will not matter whether the bulk of the damage was done in the past by the now developed countries.  The innocence of the developing countries will not save them – as mentioned before South Asia would be one of the most affected regions from sea rise at one end to glacier melt at the other.

So, how are developed and developing countries going to find a mutually acceptable agreement that is both fair and goes far enough to make a difference? What kind of rules and morality applies in situations like these where the whole system is at risk and there is no one to bail it out. I can’t help my mind going back to the partition of the Indian subcontinent – its leaders kept bickering and were unable to find an acceptable agreement leading to a million deaths and ten million homeless. Is human shortsightedness, false pride, sheer stupidity, and lack of feeling for ordinary people going to make us witness a replay only now on a global scale? This time there might be no one left to gloat over the superiority of one side over the other.

It is useful to end with what has been termed the ‘boiling frog’ analogy: if a frog is placed in boiling water, it will jump out, but if it is placed in cold water that is slowly heated, it will not perceive the danger and will be cooked to death.

Will we allow ourselves to be cooked to death? Is it hubris to think humans are any wiser than frogs?

For the implications of climate change in South Asia see the special Autumn (October-November 2009) issue of Himal Magazine. For an argument that we have left it too late see this interview. For an essay competition on the tipping point, that fateful last tonne of carbon dioxide, see The Ecologist.

 

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11 Responses to “The World is Too Big to Fail But…”

  1. Vinod Says:

    In line with the theme of this post, I recommend the book that I am currently reading from my favourite author – Jared Diamond: ‘Collape – How Societies choose to fail or succeed’

    • SouthAsian Says:

      Vinod: I had bought Collapse after finishing Guns, Germs, and Steel but found the former less absorbing. GGS was hard to put down; I have to remind myself that I still have to finish C. Do you share that opinion?

    • Vinod Says:

      Yes, I do. GGS is my top favourite. C does not measure upto that.

  2. Vinod Says:

    SA, if you do not have the enthusiasm for the reading Collapse fully, do read the chapter on the Rwandan genocide. There are many lessons in there that explain a lot of situations in South Asian societies.

    • SouthAsian Says:

      Vinod: The section on modern societies in the book has four chapters – on Rwanda, Haiti, China, and Australia. I had read the latter two perhaps because I was shying away from the gruesome accounts that I expected in the others. I have now read the chapter on Rwanda. What I found most striking was the fact that in the 1930s, the Belgians required everybody to start carrying an identity card classifying themselves as Hutu or Tutsi. Why was this necessary? Why was their need to create these differentiated identities?

      This is the most striking parallel I see with the British in India. The seeds of conflict are sown in this one act. Once the colonialists begin to withdraw and an electoral system is instituted to determine the distribution of power, there is little that can prevent conflict. In some places it was simpler – for example, in East Africa the Indians could all be sent out of the country as was done by Idi Amin but this could not have been possible in Rwanda.

      I am less convinced by the environmental argument made by Diamond – at best it can be a contributing factor to something that had already been set in motion by colonial policies. We know from South Asia where population densities are also very high that the communal conflicts were purely political.

      • Vinod Says:

        SA, I think Diamond himself makes the case that environment problems perhaps underpinned the hostilities behind the communities to an extent that is often neglected. He admits that the environment problems may be a contributory cause only.

        Have you read the chapter on ‘Big Businesses and the Environment’? It is a very informative chapter on the economics behind environmentally sustainable businesses?

  3. Vinod Says:

    It is useful to end with what has been termed the ‘boiling frog’ analogy: if a frog is placed in boiling water, it will jump out, but if it is placed in cold water that is slowly heated, it will not perceive the danger and will be cooked to death.

    Is this the same as the problem of ‘creeping normalcy’ that Diamond talks about?

    • SouthAsian Says:

      Vinod: I don’t recall exactly where Diamond talked about it but it would be a logical fit in his description of situations where societies keep adjusting to environmental threats and never confront them squarely till it is too late. The two ideas seem to be addressing the same phenomenon. There are so many things in South Asia we have adjusted to that an outsider would find completely unacceptable. Yesterday there was a new report on poverty in India – I keep wondering how we can see a situation like this in front of our eyes and continue with our daily routines without registering some kind of protest.

  4. Vinod Says:

    Do you need to be given permission in order to live virtuously? That may sound like a silly question, but consider the implications. In order to do and be good, do you need to be given the go ahead by some authority? Most of you I’m sure, like me, would vigorously shake your head, and respond with an emphatic “No”. We don’t need permission to seek the good, to try and do right by one another. In fact, most of us try hard to do and be good, not because we have been told to be and do so, but because we earnestly desire to live the good life. And yet! And yet, you and I know that so much of the world’s ills are caused because we ignore the good, we deny goodness and often concoct “rationalizations” to explain our intentional ignorance.

    For decades, thousands, even millions of Americans ignored the obvious truth about smoking, that it was unhealthy and in fact deadly, because officially the science and the politics hadn’t declared it to be such. For centuries in the Americas slavery was seen as a “necessary evil” by a majority of the population. We knew it to be wrong, but perpetuated it because our economic survival, our comfort and happiness depended on ignoring the evil in our midst.

    You may have heard, but in the lead up to the UN Climate Change Conference in Copenhagen, personal emails by several leading climate change scientists were released showing, to put it kindly, an intentional suppression of evidence, raw data, and findings by scientists with contrary positions in order to promote the agenda that climate change is a serious and threatening issue to the survivability of our planet. While the debate will certainly rage on, whether or not this undermines in part or in large part the work of climate change scientists in proving their point that global warming is accelerating and needs to be checked remains to be seen. I’d be very surprised if it does. However, the fact remains that there are those, a very significant cross section of people in our country and around the world for whom the science needs to prove its case irrefutably before we should change our laws and our habits with regard to the consumption of fossil fuels. They would argue that until
    proven otherwise, we can continue believing (or pretending) that the planet is just fine, and that our consumer habits are perfectly healthy.

    It is at moments like this when a word of wisdom is so helpful. I heard just that last week when Diane Rehm interviewed Wendell Berry. Berry writes about farming, and politics, and cultural values in essays and novels and poems. He is not a climate scientist. But, responding to the above conversation, which had occurred in the first half of the show, Berry was asked by a listener what he thought of climate change. Berry’s response is, I think, quite powerful. He argued that even if the current science on climate change is all wrong, it doesn’t take a scientist to see “we would still be wasting too much, spoiling too much, and polluting too much” and that this reality should serve as a warning he said, “to revert to our longest and most honored understanding of ourselves as human beings – to thrift, and generosity, and temperance, and compassion, and forgiveness … And, if we try to revive in ourselves an understanding and appreciation of that old honored definition, then
    we will understand [what] we must do in our practical life and how we must carry it out without respect for official instructions and without waiting for official permissions.”

    To that I can only say, Amen.

    The Reverend Jered Weber-Johnson
    Assistant Rector
    St. Alban’s Episcopal Church, Washington, DC

    (This comment initially appeared as “A Daily Cup of Good News from the St. Alban’s Café”)

  5. SouthAsian Says:

    FYI: An interview that argues we have left it too late to stop climate change and delineates what we need to do to cope with the ‘new’ future – how the balance will need to shift from consumerism to citizenship. As in many other areas “Individuals as citizens – that is political actors – can be very effective because it is only through far-reaching mandated policy change that we will get anything like the response we need.”

    http://www.theecologist.org/Interviews/485059/clive_hamilton_solving_climate_change_is_out_of_the_question.html

  6. SouthAsian Says:

    This is an interesting interview in which it is suggested that humans may have only 200-300 more years left on earth. The characterization that I found thought provoking was of climate change as the earth fighting back against a virus – the virus happens to be human beings.

    And there was also something relevant with reference to the ongoing discussion on music (can knowledge increase enjoyment and the relationship between appreciation and enjoyment) but in a different context:

    I don’t believe science has invalidated religion and it can’t because they are two utterly different paradigms of existence. Science has enormously increased the wonder of the religious message. It doesn’t force us to believe in it but it is compatible with it.

    http://www.theecologist.org/Interviews/545088/michael_meacher_mp_humans_only_have_200300_years_left_on_earth.html

    This could be worth a discussion.

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