Why Some Countries are Poor

“Why do some places prosper and thrive while others just suck?”, asks P.J. O’Rourke at the start of Eat the Rich, “It’s not a matter of brains.  No part of the earth (with the possible exception of Brentwood) is dumber than Beverly Hills, and the residents are wading in gravy.  In Russia, meanwhile, where chess is a spectator sport, they’re boiling stones for soup.”

By the end of his book you’ll be laughing a lot, but his conclusions are somewhat vague.  Although he identifies the mechanisms by which some countries are either doing pretty well or doing very badly, he doesn’t ever quite manage to answer his own question.  Which is fine, because the book is a hoot.  But here’s my take on things.

Having done a lot of observing people, lots of people, in different countries on three continents all going about their daily lives, I reckon the success or otherwise of a country depends pretty much entirely on the ability of any two people of that country picked an random to trust one each other.

When I have seen populations being an awful lot poorer than they should be, which adequately describes most of the places in which I have worked except for Kuwait where people were an awful lot wealthier than they should be, the lack of trust is evident.  Here’s an example.

When I was living on Sakhalin, my wife was working in a brand new hotel located bang in the middle of Yuzhno-Sakhalinsk, the regional capital.  The hotel was owned by three local gentlemen who had made their fortunes, using fair means or foul, in Sakhalin’s lucrative fishing industry.  Attempting to diversify their portfolio, they decided to go into the hotel business.  The diversity idea was sound enough, but they didn’t know much about hotels.  The top floor, which offered lovely views of the mountains behind the town and a terrace to boot, was earmarked to be used for storage.  The bar was going to be in the basement.  Somebody talked some sense into them and the bar ended up being located on the top floor, but if anyone wonders why the windows are so small given there is so much worth seeing from them, that’s why.  The hotel was built by a Chinese outfit to a pretty decent standard, and it’s fair to say the initial phase of the project looked to have gone all right.  Some ripples were felt when the hotel management company hired to run and staff the place went bankrupt, and shortly afterwards franchise talks with the Ramada chain fell through (I suspect when it dawned on the Russians that franchise agreements don’t involve parent groups doing something for nothing and presenting your books for frequent inspection is part of the deal), but generally things got off to a good start.

Unsurprisingly, things were not to last.  Had the Russians been sensible they’d have stuck a management company in charge, given them an expected rate of return, and turned their attentions to other ventures.  Instead, typically, they decided that heading a fish mafia had given them all the experience needed to run a supposedly international standard hotel and started getting involved in the day-to-day activities.  First they decided they didn’t need so many western managers, so they were shuffled off, and one of the Russian’s daughters installed as General Director.  Any management decision, such as whether to pay the waitress three kopeks an hour more, had to be approved by them, and it usually wasn’t.  The General Manager’s job, which after a couple of years was handed to somebody more local, maleable, and cheap consisted of running about doing whatever the owners’ wanted him to do that particular morning.  They sacked the head chef, replacing him with a Russian who had little experience and even less interest.  And so on.  After two years the hotel had failed to maintain the standards reached when it was launched with such fanfare.

But that’s not the point of the story, as the owners would have made buckets of money from a hotel in Yuzhno-Sakhalinsk in the middle of an oil boom.  However, the hotel was only part of the project.  The owners had in their minds an entire complex built in three or four phases, which would eventually comprise the hotel, offices, and a leisure centre complete with swimming pool.  Phase 2 of the project was the construction of an office block adjoining the hotel, and it was well under way when the hotel opened.  Built by the same Chinese company which did the hotel, the office block was nearing completion in late 2007 at a time when office space was at a premium and there were still plenty of western and Russian companies coming into town looking to set up.  My wife, who was in charge of sales, had numerous enquiries as to when the building would be finished and discussions even took place regarding floor space, layouts, etc.  Connected by a corridor to the hotel, this would have been the premium office location in town, and by extension the whole island.  But it was never finished.  Work stopped in late 2007, and when I last went there in October 2011 it was still in exactly the same state – about 95% complete – although starting to deteriorate.  The scaffolding, the shipping containers in the yard around the back, the windows with the polythene protection still on, were all exactly as it had been when work stopped.

What had happened was one of the fishing bosses had decided to bail on the project, for reasons unknown.  What followed were months of squabbling about how much his share was worth, coupled with petty tit-for-tats which did little to improve the experience of the hotel’s customers and staff.  No agreement was reached, and nobody was prepared to put any more money in to finish the building, so it just stood there, uncomplete, deteriorating, and earning nobody anything, for years.

It doesn’t take much to realise that this inability to reach an agreement was monumentally stupid on the parts of all involved.  Now this wouldn’t happen in the US or UK, for two reasons.  Firstly, a Brit or American would compromise.  Despite the reputation Americans have for cut-throat business practices, they will take a hit if it means the overall business venture will progress.  There is no ego, pride, or loss of face at stake if the bigger picture shows everybody winning.  This is not the case in most of the world, where “face” matters.  Anyone who has attempted contract negotiations with a Korean engineering company, for example, will know that for a Korean to concede anything in such a situation is akin to admitting his dick is small and his wife deserves somebody more manly.

But the Russian society which often rewards strong-armed machoism over quiet compromise is not the main reason why Russian business is in such poor shape.  The reason is nobody trusts one another.  In the US or UK, the conundrum with the office block would be solved by the party who wants to leave finding an outside buyer for his share.  With little more than a few pieces of paper and a lawyer or two, his ownership of the project could pass to a complete stranger who would be confident that if the venture made money, he would be rewarded.  Not so in Russia.  No outsider would buy into a project with people who he didn’t know personally, as he would assume – correctly – that as soon as the money was invested he would either be strong-armed out or the others would disappear, never to be seen again.

And this reluctance to trust others in Russia is why the place never develops to its potential.  In the US or UK, if you have a business idea, you can issue bits of paper in return for which random strangers will hand over money to get your idea off the ground.  If you make money, so do they.  This means the income expected in the start-up period is limited only by how many people you can persuade to invest, and this can be up to any number you can think of.  In Russia, who do you get to invest in your new business venture?  Nobody is going to invest in a stranger’s business, as contracts in Russia are meaningless and the courts as bent as the Moskva river south of the Kremlin.  If three people do get together and pool their money, usually each one is looking to rip off the other two out of fear that they will be looking to rip him off.  And most of the time this is not paranoia but an accurate assessment of the true intentions of his new partners.

As a result, the income which can be expected during the start-up of a Russian business is limited to the savings of the sole proprietor, whatever his wife brings in from her day job, and whatever else he can scrape together from deals on the side.  Russians don’t even trust their own families, too many of them including a wayward brother or uncle who is likely to make off with the contents of the safe to fund a weekend of casinos and vodka in Vladivostok.  This is why the Korean Sakhaliners do so much better in business than the ethnic Russians in Yuzhno-Sakhalinsk, much to the disgust of the latter who thought the whole thing was unfair.  The Koreans trust each other within the family, and given their families were large and inter-marriage common, a new business can pull in the efforts and cash of four or five adults rather than some poor sod on his own.  How can a country expect to develop its medium-sized businesses – the backbone of any nation’s economic development – when nobody can be anything other than a sole proprietor?

The same is true of Nigeria.  They trust each other even less than the Russians, which is why any business you see is either owned by a government official or well-connected foreigner, or it’s a bloke in flip-flops walking the streets with a sewing machine on his back.  Or a woman with a baby strapped to her back and 10kgs of bread balanced on her head.  If any Nigerian asked another to invest in his business venture in return for the promise of future dividends, everyone would think he’d gone mental.  Or if the proposed investor actually ponied up the cash, they’d think he was mental.  This utter lack of trust between Nigerians is ever-present in the lives of expats.  Everything must be paid for right now, in person, and in cash.  I’m sure Lagos’ traffic problems would halve overnight if Nigerians didn’t insist on seeing somebody in person at the time of a business transaction.  Even my own employer prefers to have expats sat in traffic for an hour carrying hardcopies of forms between offices rather than trust its employees to send a faithful scan.

Many workers here have an accommodation problem, including all the drivers.  The reason for this is all landlords insist on having one or sometimes two years’ rent paid up front in cash.  Few drivers can afford this, so they ask their employers (i.e. the expats) to loan them the money.  Nobody in their right mind would loan them the money as there is a very high risk – and this has happened – that you’d never see your driver again.  But they do have a problem, because they cannot raise enough for the rent, leaving them with nowhere to live which isn’t three hours from where we all stay.  But I started to wonder why, given that there are dozens and dozens of them in this position, why they didn’t form groups and get somewhere together.  Each one of them seemed only to consider getting a place all on their own, which when you think about it is nuts.  No British student would live on their own, and most people in the UK continue to houseshare for the first 2-3 years after they get their first proper job.  Getting your own place is simply not affordable on a low salary, so you jump in with some others.  I asked my driver why he didn’t gather up a few others, pool their cash, and pay down the first year’s rent.  “I want to live by myself,” he said.  By the tone of his voice he seemed gobsmacked by my suggestion.  I didn’t pursue it, because pointing out that he couldn’t afford to live by himself would have been stating the bleedin’ obvious (they currently all sort of shack up in a day-room on the first floor of the residences).

But I don’t think it’s an aversion to sharing per se which stops them doing the obvious, it is simply that they do not trust each other one iota.  Probably if they gave all their money to one person to pay the landlord, they would never see him again.  Or he would do a deal with the landlord to allow only him to stay there and not the others.  Or he would not tell the landlord about the arrangement at all, and would just move in on his own and lock the door.  Or the landlord would not be comfortable with 3-4 men in his apartment as he could easily be out-muscled, so sharing is probably forbidden anyway.  Or each would worry that one day they’d come home from work and find one of the others has cleared out everyone’s possessions and skidaddled.  Or a combination of all of the above.

Whatever it is, this lack of trust keeps people poor and miserable.  Be it supposedly wealthy hotel owners in Russia or lowly drivers in Nigeria, if people in a country cannot, will not, or do not trust each other whatsoever, that country will not be going very far.  And trust being mainly a cultural thing, changing a country’s fortunes in this respect is going to be near impossible.  I don’t hold out much hope of the office block in Yuzhno-Sakhalinsk being occupied or Lagos’ drivers finding somewhere comfortable to sleep any time soon.

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15 Responses to Why Some Countries are Poor

  1. Westerlyman says:

    A very good point this trust thing. My son shared a house while at university with 6 people all of different nationalities. My son took charge of arranging all the utilities etc as no one else seemed inclined to do it. He only ever managed to get money out of the Irish and Botswanan student. The other students were Asians or Africans, all far wealthier than us, but none would ever pay their share. After subsidising them the first year I refused to let my son be the signatory in the following years. This caused tremendous problems as the letting agents held all students jointly accountable for the bills. They were nice kids but the cultural thing made it impossible to trust them because they would not ever give trust themselves.

  2. Alisa says:

    Tim, what about Asia (as in Asian Tigers)- what are their cultures like when it comes to trust among individuals? I agree that trust is a big part of the equation, but I suspect that it is more complex than that, your mention of Korea being one hint. Still, a totalitarian regime, such as the Soviet one, can only sustain itself in a culture where people do not tend to trust each other – but then it is a chicken-and-egg question: was this lack of trust created by the regime or did it exist prior to it?

  3. dearieme says:

    A million years ago an Iranian explained to me why only a fool would appoint another Iranian to run an oil refinery: a Westerner should always be appointed.

    Because the other Iranian would fill all jobs with his kin and never sack them however incompetent they proved to be. They would all then run the refinery for themselves and ignore the owner.

  4. Tim Worstall says:

    Much of economics can indeed be worked out from first principles, just as you have done. The art is in finding out what has already been worked out and then applying first principles to the things which have not.

    http://www.res.org.uk/society/mediabriefings/pdfs/2001/April/zak.pdf

    http://tqe.quaker.org/2006/TQE151-EN-Trust.html

    http://voxeu.org/index.php?q=node/590

  5. dearieme says:

    My apologies, Mr Newman, I’d forgotten to give you your Christmas present.
    http://www.kings.cam.ac.uk/chapel/virtual-tour/index.html

  6. Tim Newman says:

    Tim, what about Asia (as in Asian Tigers)- what are their cultures like when it comes to trust among individuals?

    I don’t have a lot of experience in this area, but from what I can gather amongst each other, especially the families, the trust is quite strong. When it comes to dealing with foreigners at a lower rung on the contract ladder however, there is no trust at all.

    Still, a totalitarian regime, such as the Soviet one, can only sustain itself in a culture where people do not tend to trust each other – but then it is a chicken-and-egg question: was this lack of trust created by the regime or did it exist prior to it?

    Personally, I reckon the USSR was a product of its people and not something imposed on its people. So probably the lack of trust was something which, if not present already, was easily formented.

  7. Mark says:

    “It doesn’t take much to realise that this inability to reach an agreement was monumentally stupid on the parts of all involved. Now this wouldn’t happen in the US or UK, for two reasons. Firstly, a Brit or American would compromise.”

    Never say never.

    http://news.yahoo.com/unfinished-construction-projects-litter-las-vegas-valley-153900263.html

    http://news.bbc.co.uk/2/hi/uk_news/england/gloucestershire/7905122.stm

    Naturally, the circumstances in these cases are somewhat different. However, the identical situations prevail; uncomplete, deteriorating, and earning nobody anything, for years.

    The very best of the holiday season to you and your family, and best wishes for a safe, prosperous New Year which is the occasion of many reunions. If you’re ever going to be in the area, don’t forget to call; we’d love to have you visit, and we almost always have a reliable ski season.

  8. Nickq says:

    Very interesting. I read a book a while ago about doing business in China. Western investors assumed that if they invested money in a business, that it would be legitimately spent developing the business they had discussed whereas what actually happened was their money was often taken and used to create a directly competing business whilst the investor was strung along with excuses about why his business investment was failing. Duping people you were supposedly in business with was a perfectly acceptable practice – it was a mark of a good businessman if you could get away with it.

  9. Tatyana says:

    You are in stellar form, Tim. Great read, and absolutely true.

    Hope you had a very merry Christmas, and wish you a marvelously adventurous New Year (in a good way!)

  10. There is what might be called the “Italian model” which has corrupt and relatively unaccountable government and strong family relationships. This allows businesses based on trust between family members to grow larger than the actual families, but possibly with certain enforcement mechanisms ensuring trust withing the businesses. (I am trying not to say “mafia” here). Under such a model a country can get fairly rich, but there are still problems of trust between businesses and resultant problems of capital raising.

    Some of the Asian countries are like this. I think China is like this a lot of the time, certainly Thailand, probably (in a very different part of Asia) Turkey, and a few more.

    The interesting one might be South Korea, which I think had roughly this pattern until about 1987. At that point, the political establishment changed, opposition politicians took power, and some of the most corrupt of the large family enterprises (Daewoo, most famously) lost political support and were allowed to fail. The remainder evolved into being less family run companies and less reliant on political support. I think it is a fairly positive example. It may be that the level of trust in the economy in general increased considerably.

    You can see some similarities in Japan, too, although the second world war and the amount of active intervention in the economy by the US afterwards makes it very hard to say what caused anything, I fear.

  11. Pingback: Streetwise Professor » Whither Kudrin? Roadkill, probably

  12. Tatyana says:

    OffTop:
    what do you think of this?

  13. Rog says:

    Good post, I actually believe that it is self interest which limits the potential of a community. The more self interest the bigger the problems in the society, lack of trust is a symptom of the lack of self interest.
    I’ve worked for 6years in the former USSR and the majority of stupid situations I’ve encountered have been due to an individuals (or groups) selfishness, putting themselves before others or their responsibilities. For example the bus driver who goes fishing rather than take a busload of passengers to the airport, The business partner who pulls out the deal at the drop of a hat is thinking purely of himself and not the project. All the scamming, cheating etc is down to self interest, the lack of trust stems from this in my opinion.
    Anyway a great post well done

  14. sconzey says:

    I did my CS masters thesis on this subject*.

    What you’ve stumbled upon is the very foundation of human civilisation: pacta sunt servanda “promises must be kept,” or what we more commonly refer to in English as the Rule of Law.

    No, more than that, the doctrine of pacta sunt servanda is civilisation.

    It goes far further than just trust between strangers; the whole fabric of society is woven with implicit interlocking networks of trust. When someone proves untrustworthy, and one finds oneself deceived, the reaction is shock, surprise at this abnormality, “people just don’t do that in this day and age.” Indeed.

    In this enlightened age, we dance around the issue of civilisation. In your post, you use the euphemism of “wealth.” You don’t really mean wealth. You mean civilisation. If you gave every man and woman in Lagos a million dollars (ignorning inflation ;)), the first thing that would happen is that everyone would leave. The second thing that would happen is that Lagos would still be a shithole. “I don’t mean money, I mean *real* wealth.” Quite.

    Your description of the problem is perceptive, vivid, well leavened by your first-hand experience. “One is always conservative on the issues one knows most about”

    And yet — what is the solution?

    “If you want spontaneous order, first, impose ordinary non-spontaneous order. Then relax.”

    * Actually my masters thesis looked at how trust works on the Web, and how it might change under the impetus of just-around-the-corner technology like the semantic web. Specifically, on the web ex-post enforcement of contracts using things like courts and the threat of imprisonment is incredibly difficult, and the challenge faced by online business owners is similar in some important ways to the challenge faced by business owners in developing countries.

    If you’re interested and you ask me nicely and I’ll send you a copy :P

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