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The DOG Paradox

Countries don't get rich by extracting and selling basic commodities, they progress only when they make and sell stuff freely

So if I were to ask you, dear reader, have you ever heard of the DOG paradox, what would you say? Chances are you would flip out your smartphone and go on to Google and try finding the answer. Google, because it throws up results for almost everything, will throw up results for this as well. But you won't get any relevant results for this.

You may want to ask why? Actually, there is nothing like the DOG paradox. I just made it up. The letters, D, O and G in this paradox stand for diamonds, oil and gold. And what does my DOG paradox actually mean?

Many countries which have reserves of gold and oil or where diamonds are found, find themselves in an economic mess. As Alan Beattie writes in False Economy--A Surprising History of the World "Oil and diamonds have indeed often proved to be worth less than nothing for most of the inhabitants of the countries in which they are mined." This is true in some cases about countries where gold is or was mined as well.

In order to understand this point let us go back in history.

Christopher Columbus wanted to discover the sea route to India. But he ended up somewhere else. An island he named San Salvador, which the locals called Guanahani. Columbus made three more journeys in search of a sea route to India, but never found it. His mission was financed by the King Ferdinand and Queen Isbella of Spain. And what he had discovered would come to be known as South America in the years to come.

In the end Columbus not finding a sea route to India did not really matter, because the Spaniards found what they were looking for: gold and silver, in ample amounts. Within half a century of Columbus' first expedition, the Spaniards had found most of the treasure that was to be found in the New World (or what is now known as South America).

Inspired by the wealth that the Spaniards discovered, the English wanted their own share of wealth as well. As Daron Acemoglue and James A Robinson write in Why Nations Fail--The Origins of Power, Prosperity and Poverty "It is thus no coincidence that English began their colonization of North America at exactly the same time. But they were already late comers. They chose North America not because it was attractive but because it was all that was available."

Trouble soon began when the Virginia company which had financed the mission to North America realized that even after two years, no profit had been made. There was no gold and silver to be mined as had been the case with the Spaniards.

In fact, soon, even food became a problem for the first English settlers who had landed on the land that would later come to be known as the United States of America. In the winter of 1609/1610, of the 500 hundred people who entered winter, only 60 were alive by March. "The situation was so desperate that they resorted to cannibalism," write Acemoglue and Robinson.

This led to the realization that what had worked for the Spaniards in what is now Mexico and South and Central America would not work for the English in North America, simply because there was no gold and silver to mine.

Hence, the English settlers were given incentives. As Acemlogue and Robinson point out "In 1618, the company began the "headright system," which gave each male settler fifty acres of land and fifty more acres for each member of his family and for all servants that the family could bring to Virginia...In 1619, a General Assembly was introduced that effectively gave all adult men a say in the laws and institutions governing the colony. It was the start of the democracy in United States." Over the next few centuries these democratic institutions in the United States kept evolving. The Virginia Company realized over the seventeenth century that the "only option for an economically viable colony was to create institutions that gave the colonists incentives to invest and to work hard."

In contrast, the Spaniards were just interested in mining the gold and silver, and not building institutions. By early nineteenth century Spain's hold over South America started to collapse. But this did not lead to any change. The new countries that emerged like was the case earlier continued to "be ruled by a narrow elite" that "organized society for their own benefit". This trend continued in South America well into the twentieth century where countries were ruled by a series of dictators. The United States on the other hand went from strength to strength.

"The economic institutions in the United States enabled..men to start companies with ease...Those institutions also made the financing of their projects feasible," write Acemoglue and Robinson. And it all started because the United States had no gold and silver. Hence, a geographical accident ensured that the United States emerged the way it did, and South America was left behind.

Beattie explains this phenomenon in False Economy. As he writes "Finding natural resources is rather like winning a big cash prize on a lottery. Thereafter it hardly seems worth working, given how much you have earned by sitting there. But in the longer run, you may in fact be better off by continuing to work, particularly if it means that income and skills continue to rise."

In fact, finding oil and diamonds also brings out the worse in human beings. One look at commodity rich central Africa proves it. Countries which have large reserves of oils and diamonds in some cases are also in the midst of a civil war. As Beattie writes "the discovery of oil or diamonds induces envy and greed, turns traders into thieves and business people into bounty hunters...oil companies - including those of Western democracies - have, over the decades, done some pretty repellent things to keep the stuff flowing, and to the lasting shame of their governments they have often had official backing."

One exception to this that people like to point out are the oil exporting countries of the Middle East which have reasonable per capita incomes. But there is a lot happening in these countries which does not come out.

As Beattie points out "The oil-rich Middle East...is full of young men living in economies that appear fairly successful. Saudi Arabia, for example, has a per capita income of $15,000 [the number maybe a tad outdated given that the book was published in 2009], in the top third of global rankings. Yet its true unemployment rate is estimated at up to 25 per cent and is concentrated among the young." In fact, even by 2000, after more than 50 years of selling oil, the per capita income of Saudi Arabia was lower than the communist countries of Europe.

To conclude, countries don't get rich by extracting and selling basic commodities. They progress only when they make and sell stuff freely.

Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]

This column appeared in the December 2014 Issue of Wealth Insight.