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THE SCHUMPETER
The Economics Society Magazine
Issue 5
THE SCHUMPETER CONTENTS

Economics Society News Upcoming Events:

Please make note of the following dates:

 Banks of England Tour;

Meaningless Numbers
Wednesday, 10 March 2010.
Anna Reitman
 Talk on Fiscal Monetary Policy;
Wednesday, 17 March 2010.
Happiness and Money: A Social Science Experiment

Fahad Memon For more information, please contact the

following Economics Society members:
Minsky’s Instability Theory and the Financial Crisis
President, Sammy Sung:
Miles Hamilton sienhangsung@googlemail.com

The End of a Dream, Time to Wake Up Vice President, Scott Doughty:

scott.doughty.1@city.ac.uk
Bhavina Bharkhada

Alternatively, contact the Economics So-

What Happened to Haiti? ciety via Facebook.
David Osborne

Who Says Crime Doesn’t Pay?

Folarin Araromi

The Economics of Prohibibion

Adrian Booth

From The Department

News & Extra

The Economics Society Magazine is funded by

member contributions, and relies on the contri-
bution of students and lecturers for articles. If
you would like to get involved writing for us
please email:
david.osborne.1@city.ac.uk
fahadmemon_73@hotmail.com
THE SCHUMPETER
ECONOMICS SOCIETY NEWS

Dear Readers,

Apologies to those of you who haven't heard from the Society for a long time. We have
had some difficulties processing e-mails. Many of the e-mail addresses we have did not
seem to work, some of your handwriting was quite interesting to read. Anyhow for
those of you that want to be added to the e-mail list, send us your addresses and I will
add you.

The Society Council is now actively seeking new members to fulfill a variety of roles
within the team. If anyone is interested in joining the Economics Society Council or get-
ting more involved, feel free to contact me. It is probably best to speak with me
on Facebook (Scott Doughty). Alternatively, we will have regular council meetings,
which will be announced via email or via the Facebook group.

Throughout the year the Society holds various academic and social events, such as
Bank of England Tours, Talks from authors (Tim Harford visited us recently) and other
guest lecturers.

We will be having a trip to the Bank of England very shortly; the planning of which
will be discussed at the next meeting.

So why join the Society?

 It’s a great opportunity to interact with your peers in economics.

 Current members have found the contacts they have made invaluable; it provides an
example of commitment that will set you apart from some of your peers.

The experience / example of teamwork can be helpful to use in interviews (as being
proactive / involved in extra curricular activities is something employers look for).

If you’re interested or have any queries, don't hesitate to get in touch with me at
scott_david_doughty@hotmail.co.uk

Kind Regards ,

Scott Doughty
Vice President of the Economics Society
Meaningless Numbers
M illions, billions and trillions have
been around for a while, but at the
beginning of the new millennium, quad-
rillions have made an appearance. The
Bank of International Settlements 2009
figures for total notional amounts of de-
rivatives are at just over one quadrillion
USD.
Andy Denis, senior lecturer in political
economy at City University London, calls
it “a meaningless number.” He said:
“Astronomers joke that they are going to
stop talking in astronomical numbers and
start talking about economics ones be-
cause the economics
ones are bigger now.”
At the risk of oversim-
plifying, here is what
one quadrillion repre-
sents.
You buy a house and get
fire insurance on it for
protection. There is
never any intention to
collect on it because
that would mean your house and every-
thing you love has burned down. In 2005,
a new law allows other people to insure
your house and nine people do, some us-
ing a very small amount of borrowed
money. All ten people will receive the
value of your house if it burns down.
S o m e o f t h o s e p eo p l e ar e yo u r
neighbours who are concerned about the
risk to their own property if your house is
burning, but two of those people are ar-
sonists.
Translating into the language of finance,
the amount of money you are protected
for but are not supposed to plan on col-
Anna Reitman
lecting is the notional amount and the
two arsonists out of the ten insurance
policy holders are the approximate pro-
portion of derivatives that are credit de-
fault swaps. Spreading a rumour that a
company is about to default would have
the same effect as burning down your
house and triggering an insurance payout
to all ten policy holders.
It is important to realise that derivatives
do not create wealth. For every winner on
these contracts, there is a loser. Those
losers are insurance companies that have
to pay out on the contracts and, by exten-
sion, present and future
citizens who are saddled
with enormous debt when
governments bail out in-
surance companies that
run out of money and
creditors.
An estimate of the value of
our collective house, the
earth and its resources, is
100 trillion dollars, so one
quadrillion is the sum to-
tal of ten contracts that stand to be paid
out if the earth burns down. At the mo-
ment, every citizen on earth owes a little
over 150,000 dollars. The potential wins
and losses for derivatives are infinite.
At this point you’re thinking, yeah, but
those same arsonists can’t burn the earth
down, can they? Well, not really, but evi-
dence is all around us that the earth is
burning up and being destroyed for profit
motives; global warming, polar ice caps
melting, water and soil contamination,
deforestation, species extinction, eight
major wars, the list of infinite losses con-
tinues on and on.
THE SCHUMPETER
The financial crisis revealed the giant
magnitude of money that has been cre-
ated out of nothing and how quickly it can
disappear back into nothing. One of the
consequences of these revelations is an
acknowledgement that something is not
working.
Dr. Denis thinks the failure is not in eco-
nomics, but in a dominant trend within
the discipline that assumes ideal condi-
tions. He adds that some new theories,
such as those discussed in Wilkinson and
Pickett’s book, “The Spirit Level,” argue
powerfully that we have reached the
point at which further economic growth
isn't producing any additional benefits
and that we would all, including the rich-
est, be better off if resources were shared.
He said: “sacrificing their material bene-
fits is not going to impact very highly on
satisfaction but what is gained is living in
a society which is more secure, more sta-
ble, less violent, one which enjoys better
health, a higher cultural level.”
A wider range of economic theories is
MEANINGLESS NUMBERS
likely to get a more receptive hearing, but
they have yet to be meaningfully imple-
mented. Top bankers are hanging onto
their bonuses with a vengeance and the
establishment is fighting regulations that
attempt to protect against risk while in-
vestment banks largely regarded as the
cause of the crisis are making record
profits. Climate change deals that focus
on limiting industry are failures, but
promises from heavily indebted countries
are made to spur economic growth for
‘green’ industry using giant piles of
money. The earth’s resources are due for
a massive re-evaluation, making any pre-
dictions of future production costs uncer-
tain.
Often, names for large numbers enter
common language use because of exces-
sive inflation. I don’t know whether quad-
rillions is a common term yet, but maybe
when we get to quintillions; it will be
more widely used. As the kids say, quad-
rillion is the new trillion.
Happiness and Money: A Social Science Experiment
Fahad Memon

D efinition: economics is a social sci-

ence that studies man as he seeks to
satisfy unlimited wants with resources
overall utility (a term interchangeable
with well-being, welfare or life satisfac-
tion).” Utility, in itself, is determined by
that are not only finite but have alterna- the consideration of factors that Easterlin
tive users. Four years ago, the subject of (2001) identifies primarily as “making a
economics was introduced to me in this living, family life, and health.” Thus ac-
manner. As a matter of fact, rather than cordingly, it may suffice to pronounce
introducing himself; my high school eco- that so long as all these facets are well
nomics teacher went with a more dra- catered to, one shall effectively realise
matic approach by first asserting said optimum life satisfaction.
statement. Subsequently, he picked apart
the phrase and stressed the fact that: In conjoining the concepts of economics
‘economics is a social science.’ and welfare, I seek to observe how one’s
happiness is affected by the controversial
All social scientists are aware (or at least factor of money (ceteris paribus). For
they should be) of this
specification as it pertains
to any other form of science.
Their knowledge is not con-
crete; it is a constant accu-
mulation of information
based upon observation.
This final word, due to its
variability, proposes a po-
tential threat to the integ-
rity of the data. Hence, to
accept economic facts,
economists are required to
comprehend relevant the-
ory, challenge presumptions
and test this via empirical
study again and again (and
again).

One such intriguing social

topic is that of the
‘economics of happiness.’ Though ques-
tions the likes of “what is happiness?”
may sound familiar to everyone, not all
arrive at the same conclusion (assuming
at least some are prohibited the aid of a
dictionary). Opting to answer the query
as an economist (via glossary), I define:
“happiness [as] the measure of one’s
clarification purposes (and to avoid the
debate over stocks and flows) it must be
stated that the specific factor in question
precisely represents one’s level of in-
come.
Within the context of the model for con-
sumer theory, basic undergraduate learn-
THE SCHUMPETER HAPPINESS AND MONEY : A SOCIAL SCIENCE EXPERIMENT
ing tells us that a rise in income emulates
a north-eastern shift mechanism on a
person’s budget constraint. Combining
this knowledge with the fact that an indi-
vidual’s utility increases as he or she
moves further north-east from their ex-
isting equilibrium position in the model,
we can firmly declare that as income
rises, overall well-being should inevitably
rise as well. An application of the model,
as illustrated, confirms that as income
rises from M to M’; real income also ex-
pands as we consume more of both X and
Y normal goods. Taking into account the
corresponding model assumption of
“more is better,” consumers will be hap-
pier with their new state of equilibrium.
By examining data reported in the 1994
United States’ General Social Survey,
Easterlin (2001) finds that just 16% of
individuals from the lowest income band
stated they were very happy. Conversely,
those of the highest income band whom
stated they were very happy account for a
greater 44%. While this only reveals in-
formation with regards to the extreme
‘very happy’ category, Richard Easterlin’s
facilitation of a happiness rating system
(where a score of 4=‘very happy’,
2=‘pretty happy’ and 0=‘not too happy’)
shows that on average the lowest income
earners report a rating of 1.8 while the
highest income earners disclosed a score
of 2.8. In terms of real income, Frijters et
al. (2004), utilizing the case of East Ger-
many’s reunification with West Germany,
finds that overall well-being increased by
20% between 1991 and 2001 where 35-
40% of the effect was accounted for by
rises in real household incomes. Funda-
mentally, both results verify what has al-
ready been stated in theory—money
brings people happiness.
The nature of a social science, however,
leaves plenty of room for further analysis.
As per varying income characteristics
THE SCHUMPETER HAPPINESS AND MONEY : A SOCIAL SCIENCE EXPERIMENT
over time, a number of paradoxes contest
the theoretical relationship found be-
tween earnings and welfare. For one, as
retirement age draws nearer—and thus,
as income tends to level off or decline—
the correlation between one’s income and
respective well-being weakens considera-
bly. According to the findings of Easterlin
and Schaeffer (1999) happiness tends to-
wards a constant value (i.e. becomes in-
dependent of income level) over the span
of a life cycle. Nevertheless, people
seemed to believe that they are better off
now than they were in the past and will
be more so in the future. Why would this
be the case if happiness converged to-
wards a fixed value?
In order to understand this, Richard East-
erlin assumed the following: the general
population’s preferences are more or less
parallel in the early part of the life cycle,
but as time elapses, preferences tend to-
ward more luxurious goods as income
raises are achieved. In assuming so, East-
erlin cites that persons make critical
measurement errors that alter their per-
ceptions. When making comparisons to
their past, they maintain current
(increased) preferences but evaluate
these in terms of the lower income they
earned at the time. The problem with this
is that the material aspirations in the pre-
sent were only made feasible because of
the fact that earnings increased. Though
one can understand that once grander
preferences are met, it is hard to revert
back to the preferences one had before-
hand; from an economics perspective, it
is unpardonable. In the same sense,
higher income expectations in the fu-
ture—taking material preferences to be
the same as today—provide fulfilment in
an unjustifiable manner, since anticipated
preferences growth is unaccounted for.
What the individual does not grasp is:
THE SCHUMPETER HAPPINESS AND MONEY : A SOCIAL SCIENCE EXPERIMENT

once the future date does finally arrive, chasing opportunities; fail to identify the
they conform to the same situation they coinciding adverse ramifications. Evi-
are at present; faced with the same in- dence presented in the 2006 paper pro-
come-to-preferences issue and a re- poses that high-income earners are on
cording of happiness that follows con- average not happier but instead more
stantly. stressed than low-income earners. Since
raised income levels are
achieved by occupying more
demanding positions, it leaves
one with less time to engage
in leisure. The “focusing illu-
sion,” in essence, misdirects
one’s thinking by disregarding
the additional hours spent
working, commuting and sac-
rificing for the sake of acquir-
ing more pay. This concept,
thus, suggests reasons for
why utility approaches a con-
stant rate in the long term,
despite changes in income:
“because attention eventually
Austrian businessman, Karl Rabeder, relinquished a $5 million
fortune because it made him miserable.
shifts to less novel aspects of
daily life [Kahneman et al.
Kahneman et al. (2006) further objects to (2006), p. 1910].”
the simple basics of consumer theory by
presenting an unsettling concept. The While conventional wisdom would de-
fundamental idea behind the article— note that more money would translate to
that of “focusing illusion”—finds that greater well-being, an in-depth look into
people tend to overestimate the impact of the ‘economics of happiness’ insists that
a particular force on welfare, in the spur this hypothesis is both controversial and
of the moment, because they’ve had their false. Money, as medium of exchange,
attention drawn specifically towards it. may indeed be needed for carrying out
Correspondingly, Schkade and Kahneman one’s life, but it is most certainly not the
(1998) cite that, “nothing in life is quite key to life satisfaction. Nonetheless, con-
as important as you think it is while you sidering that the area of study remains a
are thinking about it.” In light of previous highly debated matter among scholars, it
discussions on money as a factor of well- may be impulsive on my part to declare
being, Kahneman et al. (2006) essentially the study’s final conclusions. The exercise
dismisses its perceived immense signifi- showcases, however, why the subject of
cance. Considering that money adheres to economics is so fascinating. While a natu-
a derived demand function, people are ral science teaches one irrefutable facts, a
mostly interested in what they can buy social science develops knowledge by in-
with it (i.e. real income) rather than the creasing one’s exposure to ideas and sub-
money itself. When foreseeing income sequently, prompting one to venture into
promotions however, people, while in- comprehensive study—thus accordingly,
clined to think in terms of greater pur- it has produced this article.
Minsky’s Instability Theory and the Financial Crisis
Miles Hamilton

T he late Harvard trained Hyman P.

Minsky (1919–1996) was considered
somewhat of a maverick on account of the
and serve the debt. This leads to a finan-
cial structure in which there is large
weight to units engaged in speculative
extreme pessimism he reserved for the and Ponzi finance. Speculative borrowers
capitalist system. But with the world can meet interest payments but must
winded by the worst financial crisis ever constantly roll over their debt to be able
seen, one cannot help but hear ‘I told you to repay the original loan. Ponzi borrow-
so’ in the wind. In this article, I will en- ers can repay neither the interest nor the
deavour to briefly explain Minsky’s Fi- original loan. In the most recent euphoria,
nancial Instability Hypothesis and how it banks lent to ‘sub-prime’ individuals and
links to the current financial crisis. allowed highly leveraged positions to de-
velop.
The financial turmoil has recently
brought to prominence the ideas of Min- The essence of the Hypothesis is that the
sky and his Financial Instability Hypothe- longer people make money by taking risk,
sis (FIH), a theory rooted in the belief that
the more imprudent they become in risk-
all capitalist economies are perpetually taking. They make the psychological mis-
poised on a precipice, plunging into the take of mentally protracting the position
great abyss of financial crises at the of stability they are in into the future. Es-
slightest touch. sentially, Minsky shows that stability is
destabilising. Rosenberg (2009) sums this
Fundamentally, this instability stems point up brilliantly in the following ex-
from individuals’ behaviour during differ- tract:
ent stages of the business cycle. The pros-
perous upstage of the business cycle is “To a certain extent, this is an inevitable
characterised as a period of intense activ- outcome of human reason-we understand
ity typified by rapid output and invest- the unfamiliar, the distant, the uncertain,
ment growth. Underlying all this is a tre- the abstract, in terms of the familiar, the
mendous amount of credit creation as near, the certain, the concrete. But this
banks try to quench the insatiable thirst also means that we tend to ignore what
for euphoria. Profit seeking firms push for we know exists, but what we can't fully
maximum gains and borrow to provide grasp, control, or use to our advan-
funds, in the process increasing the pace tage. And so it is that even though we
of debt accumulation. know there are cycles of boom and bust,
we tend to ignore them, and somehow
In short lived euphoric states, the major- convince ourselves that ‘this time it's dif-
ity of firms operate in a position of good ferent’…”
financial health in which units are domi-
nated by hedge finance, meaning that The thrust of Minsky’s argument is that
borrowers can meet all debt payments credit creation is not a dangerous phe-
from their outflows. However, over a pro- nomenon in itself—as he did recognise
tracted period of euphoria, the pace of that credit creation leads to economic
debt accumulation starts to rise much growth—but it is dangerous when it is
faster than borrowers' ability to repay not backed up by real savings. This essen-
THE SCHUMPETER MINSKY ’S INSTABILITY THEORY AND THE FINANCIAL CRISIS
tially criticises the ‘fractional reserve’
banking structure which en-
ables the accruing of illiquid as-
sets (loans) and liquid liabilities
(deposits). This system works as
not all depositors require funds
at the same time and they in
turn obligingly trust the bank to
honour deposits made. Subse-
quently, the borrower who
holds the empty money takes
from the pool of real savings
without any additional real sav-
ings having taken place. As the
pace of un-backed credit ex-
pands, relative to the supply of
real savings, less becomes avail-
able to genuine wealth genera-
tors. Consequently, with less real savings,
less real wealth can now be generated.
Should any doubts about the validity of
this ‘contract’ arise then the tightly-knit
financial system quickly unravels – as
seen briefly in Britain in September 2007.
Another aspect of the FIH is that financial
cri ses can som et im es ari se from
‘financialization bubbles.’ This essentially
entails that during the euphoria, financial
intermediaries—who Minsky labelled as
‘merchants of debts’—try to lure inves-
tors to buy the debts by means of sophis-
ticated innovations. This is what McCulley
(2009) called ‘shadow banking’ and the
result is that there was an “explosive
growth in leverage and liquidity risk out-
side the purview of the Fed.” Ratings
agencies fuelled the problem by provid-
ing ratings on some overly complex struc-
tures when they did not understand the
underlying risks. Lured by high rates of
return, investors put their money in prod-
ucts that were very opaque and when
they became more transparent the sys-
tem unravelled.
This has been observed in both 1929 and
1990 but the extent of the present finan-
cial speculation
has not been
paralleled. Gov-
ernment regula-
tory mecha-
nisms had apti-
tude limitations
that could not
handle the ra-
pidity and ex-
tent of complex
credit products
and other illiq-
uid assets of un-
cer t ain valu e
bei ng push ed
through the sys-
tem. As Pandit (2009) noted “we have
been riding on a high-speed train… but on
rails laid more than sixty years ago for a
simpler, slower-paced world.”
Ultimately, many suggest that Minsky’s
FIH has value as it suggests that capital-
ism does not work, as suggested by
Shostak (2007); “doesn't this prove that
capitalism might indeed have inherent
tendencies of self-destruction.” I, how-
ever, disagree that this is the reason that
the theory has value because many peo-
ple can and do invalidate Adam Smith’s
theory of the invisible hand. Thus, I be-
lieve that the financial instability hy-
pothesis has value on the basis that it suc-
ceeds in fulfilling a much harder task, of
providing a framework for how and when
the invisible hand would break.
In the end, as we slowly emerge out of the
recession, many people have been ques-
tioning how to prevent recessions from
reoccurring in the future by use of policy
measures. If Minsky’s Financial Instability
Hypothesis is believed, then financial cri-
ses will inevitably strike again and there
is nothing we can do about it.
The End of a Dream, Time to Wake Up
Bhavina Bharkhada

city (without questioning what

exactly this exponential growth
was built on). In attracting all
this attention, Dubai has be-
come a leader in the Middle
East; a global city, and a hub for
service industries such as IT and
Finance.

In 2003, the government de-

cided to diversify from a trade
based, oil-reliant economy to
one that is based on services
and tourism. It meant property

D ubai, the glittering city in the desert become more valuable, resulting in the
has gone from being the pinnacle of property appreciation from 2004 to 2006.
the world’s economic boom to the brink The opening of the Atlantis hotel was ru-
of bankruptcy. So where, why and how moured to have cost a staggering $20 mil-
did it all go wrong? lion but alas, it would soon come to light
that this was to be the last party.
Situated on the Persian Gulf coast of the
United Arab Emirates, Dubai is neighbour The property bubble was certainly going
to the oil and gas giant Abu Dhabi. The to pop one day with rising property
City of Gold’s main revenue is generated prices daily fuelled by speculation. So
through tourism and real estate develop- where did the problems start? Dubai
ment, contributing 22.6% to the econ- World is a renowned investment com-
omy’s GDP (before the construction pany that manages a portfolio of projects
boom). Large increases in oil prices after and businesses for the Dubai govern-
the Persian Gulf War encouraged Dubai to ment; its property arm developed The
continue to focus on free trade and tour- Palm Islands and The World. Caught up in
ism, and the success of this led to the
constructions of Burj Al Arab, the
world’s tallest free standing hotel and
The Palm Islands. Since 2002 private
property development has recreated
Dubai’s skyline and robust economic
growth and high inflation (11.2% in
2007) has highlighted Dubai as an
emerging financial city. Ambitious
projects such as The Dynamic Tower,
The World, Burj Dubai and aforemen-
tioned Palm Islands brought busi-
nesses and consumers from all over
the world to invest in the promising
Dubai World chairperson, Sultan Ahmed bin Sulayem.
THE SCHUMPETER THE END OF A DREAM , TIME TO WAKE UP

the euphoria surrounding this emerging

city, nobody questioned the money used
to fund these developments as credit
checks and lending companies could not
wait to join the bandwagon. “Dubai was
immune” — maybe not quite. After a six
year boom the real estate market began
to descend, and fast. Revelations that the
company could not pay back its loans,
asking for an extension to at least May
2010 and laying off 10,500 employees
most from Asia (India in particular), sent
shockwaves through the financial mar-
kets.

One of Dubai’s biggest problems is the

small number of official statistics avail-
able to reassure investors that it is not on
a downward spiral. It was simply a case
of investments built on borrowed and
bought money. Now, Dubai World’s debt
stands at approximately $59 billion,
something not to take lightly. The oil rich
emirate Abu Dhabi has already bailed out
Dubai almost $10billion, something it was
forced to carry out again. Its international
reputation has been damaged by this out-
come; four banks have had their credit
ratings cut due to exposure to Dubai
World debt and fears among investors
are growing. The financial crisis has hit
Dubai hard; empty beaches, hotels and
shopping malls are a result of heavily in-
vesting into real estate and construction.
The stock market dropped a record 7.3%
in a single year and investors have left,
the real question is will they come back?

However, it is not all bleak; many inves-
tors believe that Dubai or the Federal
Government of Abu Dhabi will step in to
pay off Dubai World’s debt. Despite the
falls in the stock market they were not as
severe; some analysts believed the 10%
fall was predicted. There is a lesson to be
learnt in all this chaos, the same one
which has been echoed across the world.
Reckless lending, exponential growth
based on borrowed and bought money
and assumptions of an ever expanding
economy, sound familiar?
The sandy foundations of Dubai’s growth
have crumbled; let’s hope the over ambi-
tious projects such as Burj Khalifa and the
Meydan racecourse do not follow.
What Happened to Haiti?
T here are some similarities between
the United States and Haiti. They
were the first two countries in the west-
ern hemisphere to gain independence,
and there was widespread carnage and
civil war during the struggle for inde-
pendence of both countries. What is in-
teresting, however is that the United
States is the world’s richest country,
whereas Haiti ranks among the poorest.
Why, despite in the colonial era, being the
world’s richest colony, does the average
Haitian now earn less than $790 per
year? Why does almost 40% of govern-
ment spending depend on foreign aid?
“Chicago school” economists have gone to
great lengths to point out that free trade
is a primary aspect of economic growth
and development. However, Haiti’s inde-
pendence in 1804, and the fact that slav-
ery no longer existed in Haiti, was a dan-
gerous precedent to the slave-driven
economies of France, England as well as
the newly-independent United States.
These countries, consequently blocked
trade with Haiti and decided they would
show Haiti no favour, boycotting Haitian
goods and services – a severe blow to the
country’s economic development. Fur-
thermore, Haiti was not recognised as a
nation by its former colonial power, or
for that matter, by any of the European
powers, and as a result had to pay an in-
demnity to France for recognition. This
resulted in a gargantuan debt hovering
over Haiti for two decades short of a cen-
tury. Of course, due to the long term na-
ture of its debt to France, the interest on
the debt built up to become more than
the debt itself, plunging the nation fur-
ther and further into poverty.
David Osborne
Economists study education as a benefit
in kind and positively correlate it to eco-
nomic growth, because of its impact on
productivity, as an internal effect, as well
as an externality. According to UNESCO,
Haiti’s literacy rate hovers around 54.8%,
considerably less than it’s than its
neighbour, the Dominican Republic
(89.1%), and well below the average lit-
eracy rate for the Caribbean and Latin
America (90%). Scrutinising statistics
even further, we observe that only 67%
of children start primary school, and only
a third of this number finish. Further-
more, only 20% of eligible students at-
tend secondary school, and even fewer
finish.
The Haitian education system is based on
the French system, and is taught exclu-
sively in French. However, the mother
tongue of the Haitian masses is Creole,
which can explain the high drop out rate
of Haitian students. The average poor
Haitian feels out-of-place in a French-
speaking institution, and as a result, their
education is more or less characteristic of
the middle classes and the elite, who tend
to keep French as their comfort zone. For
the poor Haitians who do manage to com-
plete their education, they tend to emi-
grate, and use their skills in a place and a
way that will benefit them and their fami-
lies many times more than if they were to
stay in Haiti – a phenomenon known as
the Brain Drain. In fact, a report by the
World Bank, states that approximately
90% of college-educated Haitians live
abroad, making it the country with the
highest percentage of citizens living
abroad. Haiti’s percentage doubles that of
Ghana, which ranks second on the list.
THE SCHUMPETER
Inequality in education, also leads to ine-
quality in wealth, and this can be traced
back to the colonial days. In fact, the ma-
jority of the present Haitian elite are di-
rect descendants of the Haitian elite at
the time of independence two centuries
ago. According to the United Nations, the
Gini coefficient for Haiti is 59.2. This
ranks it as the most unequal country in
the Latin America. In an interview in
April 2009, the Prime Minister of Haiti
Michèle Pierre-Luis stated that: “All the
Elites – the mulatto elites, the university
elites, the peasant elites – are like a huge
elephant sitting on this country and you
cannot move it, because there is no politi-
cal class, because there are no political
parties, and everything becomes cor-
rupted and perverted. If you can’t go into
that system, the system rejects you. And
so far we have not found the wrench that
will move this thing.”
Her statement gives clear evidence to the
scale of corruption and the influence that
the wealthy Haitians hold, and the fact
that they stagnate the economy.
Corruption has plagued Haiti since its in-
dependence, and has continued to play a
major part in its poverty. Just the mention
of the Duvalier dynasty—“Papa Doc and
W HAT H APPENED TO H AITI ?
Baby Doc”—should give a vivid picture of
the scale of corruption that Haiti has gone
through. There is also the peculiar case of
Jean-Bertrand Aristide, who came into his
first term in office with the resolve to
purge the nation of corruption. After a
coup d’état in 1991, Aristide was power-
less until 1996, when he was re-elected.
However, in his second presidency, he
had changed, and appeared to be more
money-driven than he was prior. In his
second presidency, millions of dollars of
Haitian government money were “lost in
sophisticated financial transactions.” In-
vestigators have claimed that this money
was either laundered or embezzled. In
any case, this money could have been bet-
ter used for the greater benefit of the Hai-
tian people.
Haiti’s economic misfortune is a combina-
tion of the factors mentioned and many
other socio-political issues. Many people
also claim that the use of voodoo in Haiti
adds a reason for its poverty, being a
maverick in the Western world: the only
country to practise voodoo in the West,
and the poorest – this is a matter of opin-
ion. The fact of the matter is that Haiti is
in need of economic reform. The nation
needs a strategy to combat organised
crime, and also one that has the support
of the country’s peo-
ple and the interna-
tional community.
They say that ‘it’s
hard to teach an old
dog new tricks,’ but
the unfortunate
earthquake in Haiti
may just be the cata-
lyst to its economic
reform. Only time
will tell.
Who Says Crime Doesn’t Pay?
T he last few decades have marked the
creation of an increasingly global
economy. This globalisation has been fa-
cilitated by the removal of regulatory bar-
riers to international trade. Technological
advances have connected buyers and sell-
ers across the world, through transac-
tions that were not even possible twenty
years ago. At the helm of economic liber-
alisation came the creation of the World
Trade Organisation in 1995, extending
trading beyond just goods to the transna-
tional provision of services. With the pro-
duction and distribution of goods and
services now internationalised, economic
activity was able to move to locations in
which it incurred lower costs and reaped
higher profits. These movements were
the manifestation of Smith’s ‘invisible
hand’, and Ricardo’s principle of com-
parative advantage. However, lurking in
the shadows were criminal organisations
that leapt at the chance to attack as the
world let down its guard.
Folarin Araromi
Drug smuggling, arms trading, and hu-
man trafficking are just a few of the illicit
activities that have flourished due to the
advances of technology, and the free
movement of goods and services that
characterises the modern world. In 1980-
90, following a series of free trade agree-
ments, U.S. federal spending on drug con-
trol quadrupled from $1.5 billion to $6.7
billion, and the number of drug related
arrests rose from about 103,000 to more
than 404,000. Thus it came as no surprise
when international policy of the 1990s
was largely dominated by the USA, and its
efforts to exert its influence in the domes-
tic affairs of other nations.
Contemporary transnational crime is
largely a continuation of historical prac-
tices, such as piracy and slavery, albeit
now with far more sophisticated means
of organisation. Like other forms of eco-
nomic activity, organised crime conforms
to the profit maximising model, and in-
creasingly this has meant ‘outsourcing’
crime to countries with loose leg-
islation. This migration is espe-
cially evident from countries in
the West, where cost-imposing
regulation and en forcement
makes crime considerably less lu-
crative. Just like Microsoft and
Nike, profit-driven crime relocates
to poorer countries to capitalise
upon cheaper labour and produc-
tion costs, achieving greater
economies of scale. The organised
crime industry is a curious form of
oligopolistic competition, con-
forming to some of its characteris-
tics, whilst completely defying
others. For example, like legiti-
mate firms criminal organisations
engage in non-price competition.
THE SCHUMPETER WHO SAYS CRIME DOESN ’ T PAY ?

the organisation to use its powers of en-

forcement to charge prices that far sur-
pass the norm, becoming purely extor-
tionist.

The criminal industry, however, is also a

contestable one; that is, open to threat of
new entrants in the market. With free en-
try, we would expect an organisation’s
profits to be reduced in the long run,
however unlike legitimate markets, crimi-
nal organisations typically employ vio-
lence to quell competition. The implica-
tion of this is that devoting resources to
deterring competition results in fewer
resources for production. This means
even greater prices for consumers and
reduced efficiency. Hence, contrary to
economic theory, greater competition in
the criminal industry actually reduces
In legitimate markets this usually takes production and efficiency.
the form of brand wars and advertising
campaigns. However, in the criminal in- However, the influx of crime has not been
dustry it takes the form of turf wars be- as detrimental to some countries as ex-
tween private militias, sometimes even pected. There are instances where crime
fighting against governments for control might be considered desirable from the
over territories. view point of local jurisdictions. These
are crimes whose production process
In a similar fashion, the criminal industry might carry economic benefits, so that
echoes some of the economic conse-
quences of the market mechanism; how-
ever the causes of these effects differ
substantially. This is specifically evident
in the case of the ‘kinked demand curve’
of oligopoly. If one organisation in-
creases its prices its competitors will not
react and the firm subsequently loses
market share, however if it reduces its
prices, competing organisations will not
follow suit. Instead, they will threaten
their customers to prevent them from
switching to the cheaper cartel, thus the
firm that reduces it prices gains little ex-
tra demand. In some cases, certain or-
ganisations enjoy monopoly within cer-
tain countries. In these countries, the ab-
sence of significant competitors allows
THE SCHUMPETER
some jurisdictions have an incentive to
adopt lenient policies, thus “insourcing”
crime. This is especially the case where
the costs of crime are separate from its
benefits. For example, most of the world’s
cocaine is produced in Colombia (GDP
per capita, $4400), where it yields bene-
fits, such as the creation of jobs for the
locals, stimulating the economy. How-
ever, the majority of the cocaine is
shipped abroad to wealthier countries
like the USA (GDP per capita, $47400),
Mexican drug lord, Joaquín "El Chapo" Guzmán Loera, ranks among the
world’s richest at an estimated net worth of $1 billion.
where it is sold for as much as up to 40
times what it costs to produce. In some
countries, what sometimes occurs is a
complex pattern of regulatory competi-
tion. For instance, in less developed coun-
tries, certain relatively prosperous dis-
tricts might escalate their sanctions to-
wards crimes to deter it, whereas rela-
tively poor districts might lower the
criminality of certain ‘victimless’ activi-
ties to attract them.
Organised crime typically flourishes
when a central government is disorgan-
ised or absent, and this occurs most com-
monly in the developing world. Under
WHO SAYS CRIME DOESN ’ T PAY ?
these circumstances, criminal organisa-
tions can operate with less fear of inter-
ference from law enforcement, and may
actually serve to provide their localities
with a semblance of order and structure
that would otherwise be unavailable. For
similar reasons, organised crime also of-
ten takes root in countries with many so-
cially marginalised groups, whose mem-
bers do not trust local governments or
their agents. This lack of trust serves both
to insulate the criminal organisation from
the risk that law en-
forcement will find co-
operative witnesses, as
well as to encourage
community members to
entrust the criminal or-
ganisation to handle dis-
putes and protect the
community, rather than
the police. In effect,
these organisations be-
come the judge and pa-
tron of the people, and
this sometimes leads to
situations where law-
abiding citizens may ac-
tually act to defend the
organisation from the
law.
Evidently there are still many cracks in
law enforcement that are created not just
by the prohibition of certain activities,
but also by cleavages of ethnicity, race,
and class that modern societies still have.
As long as these cracks exist, organised
crime will continue to emerge to fill them.
Any attempt to eliminate organised crime
is not likely to be successful unless it ad-
dresses the forces that create these fis-
sures. At the least what can be said is that
without active legislation and enforce-
ment, the boundary between following
and breaking the law and could be com-
pletely eroded.
The Economics of Prohibition
“I contend that, strange as it may sound,
we have lost our most important right:
the right to our bodies” - Thomas Szasz —
Our Right to Drugs: The Case for a Free
Market
W hy do we want drugs? For the
same reasons we want other
goods. To change our moods, to enhance
our endurance or simply to make us feel
better. We want drugs the same way we
want cars, or go horse riding or skiing; to
make our lives more enjoyable and pleas-
ant. Just like alcohol, cars, and skis, we
use drugs to enjoy ourselves. Yet with the
amount of people who die skiing or horse
riding each year we don’t hear people
talking of ‘skiing abuse’. We hear of teen-
agers ‘abusing’ cannabis despite the near
zero death rate from the drug.
A free market system is based on individ-
ual property rights and the right of each
person to their own lives. A system which
punishes people for experimenting with
their own bodies, without harming others
around them, does not deserve the same
Adrian Booth
title. Thomas Szasz writes about this in
his excellent book, Our Right to Drugs:
The Case for a Free Market. The beginning
focuses on the assault on liberty the drug
war has resulted in. “How can a person
lose the right to his body? By being de-
prived of the freedom to care for it and to
control it as he sees fit”(i). Szasz finds it
absurd that laws should be introduced
telling people what they can and cannot
do with their own bodies. The War on
Drugs is a war on liberty that refuses to
acknowledge economic logic. Milton
Friedman provided the case against the
War on Drugs by attacking government’s
attempts to destroy supply. One argu-
ment he presented was that by destroy-
ing supply, thereby shifting the supply
curve to the left, the authorities were do-
ing more harm than good. By shifting the
supply curve from S2 to S1 (see chart),
when there is fixed inelastic demand, the
government simply entices suppliers to
supply more drugs over the long run. The
other unintended consequence of ma-
nipulating supply is the crime it causes.
With a higher price, addicts commit more
crimes and steal from more peo-
ple to feed their habit. In conclu-
sion, government policy to re-
strict the supply of illicit drugs
does not work in the long run
and ends up making the situa-
tion worse. A recent paper
showed that cannabis use in the
US has remained constant for
decades; despite the federal gov-
ernment spending hundreds of
billions attempting to eradicate
the drug and its consumption.
The inconsistency of drug laws
makes their very existence hard
to justify when 20% of deaths in
America each year are directly
THE SCHUMPETER
attributed to tobacco and alcohol. The re-
cent news story about a 49 year old Scot-
t i sh l ad y w h o d i ed aft er t aki n g
mephedrone(ii), a legal drug that’s used as
a substitute to MDMA, has led to calls for
the drug to be prohibited. The fact that
policymakers are calling for mephedrone
to be outlawed after a few deaths shows
the inconsistency of their thinking. Fig-
ures from January show that 9,031 peo-
ple died from alcohol consumption in
2008 in the UK alone. The table below
proves the bias towards illegal drugs such
as cannabis, cocaine and ecstasy and the
distortion the media presents when it
comes to illicit drugs and their dangers.
Over reporting deaths from illicit drugs
THE ECONOMICS OF PROHIBITION
and under reporting deaths
from legal drugs such as al-
cohol and paracetamol.
The economic and social
costs of drug prohibition
make it hard to justify the
existence of these laws. In
2008 Jeffrey Miron produced
a study estimating that legal-
ising drugs would inject
$76.8 billion in to the US
economy. By taking drugs
such as cocaine and canna-
bis, $32.7 billion would be
raised and $44.1 billion
would be saved from law en-
forcement. The use of canna-
bis in the US, despite the bil-
lions spent attempting to re-
duce consumption, has had
minimal impact. According
to the US government, nearly
15 million Americans use
cannabis at least once a
month. That's equal to every
man, woman and child in the
states of Oregon, Nebraska,
Indiana and Oklahoma com-
bined. It's nearly as many
Americans as those who will buy a new
car or truck in a year. The fact remains
that demand will always be there no mat-
ter how much money is spent trying to
curb it. As governments place strict pen-
alties on consumption and the sale of
drugs, the price rises to reflect the in-
creased risk of punishment. As price
rises, more suppliers come onto the mar-
ket and provide more drugs. From an eco-
nomic point of view the war is completely
unwinnable. It is a dire mistake to catego-
rise certain drugs as a ‘dangerous enemy’
we must ‘attack’ and ‘eliminate’ instead of
accepting them as potentially helpful as
well as harmful substances, and learning
to cope with them competently.
THE SCHUMPETER
FROM THE DEPARTMENT

On Monday March 22nd, the Economics Department will host a public lecture:

This Time is Different: Eight Centuries of Financial Folly

Series: The 23rd Sir Robert Birley Memorial Lecture.
Speaker: Kenneth S Rogoff, Harvard University.
Date: Monday 22 March 2010.
Time: 18:30.
Location: Oliver Thompson Lecture Theatre, City University London, Northampton
Square, London, EC1V 0HB
Note: Registration and refreshments 18:30, Lecture 19:00, Networking and re-
freshments 20:00

This Time is Different: Eight Centuries of Financial Folly

The lecture will discuss how quantitative analysis of financial history can provide
valuable benchmarks for assessing crisis vulnerability and for projecting the course
of a financial crisis as it unfolds. One key lesson from history is that public debt typi-
cally explodes in the aftermath of financial crisis. Thus it should be little surprise that
waves of international banking crises are often followed by waves of sovereign debt
crises. The lecture will also discuss some features of the novel data base on which the
analysis is based, together with some background on the challenges of constructing
it. The lecture will draw heavily on the author’s joint work with Carmen Reinhart,
including both their recent book (This Time is Different) as well as some related aca-
demic papers.

Kenneth Rogoff is Thomas D. Cabot Professor of Public Policy and Professor of Eco-
nomics at Harvard University. From 2001-2003, Rogoff served as Chief Economist
and Director of Research at the International Monetary Fund. He is also a former Di-
rector of the Center for International Development at Harvard. Rogoff’s treatise Foun-
dations of International Macroeconomics (joint with Maurice Obstfeld) is the stan-
dard graduate text in the field worldwide, and his monthly syndicated column on
global economic issues is published regularly in over 50 countries. He is on the Eco-
nomic Advisory Panel of the Federal Reserve Bank of New York and the Central Bank
of Sweden. His recent book with Carmen Reinhart, This Time is Different: Eight Cen-
turies of Financial Folly (Princeton University Press), builds on a massive new data
set covering 66 countries and 800 years.

Sir Robert Birley

Sir Robert Birley, the first head of Social Sciences at City University London, had a
passion for education and its practical significance for society and the individual.
THE SCHUMPETER
Cover
Polina Sheverdyakova
Picture References
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ConveraNet. [Online]. <http://www.converanet.co
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of West Georgia. [Online]. <http://www.westga.edu/
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“Happiness and Money: A Social Science Experi-
ment.”
(i) 1st pg., top — Pashley-Corbis, G. (n.d.).
“Money Happiness.” Newsweek. [Online]. <http://w
ww.newsweek.com/id/43884>. [Accessed: February
27 2010].
(i) 1st pg., right — Memon, F. (2010). “Model of
Consumer Theory.”
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Daily News. [Online]. <http://www.nydailynew
s.com/news/2010/02/10/2010-02-10_karl_rabeder
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“Minsky’s Instability Theory and the Financial Cri-
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sky.” Minn Post. [Online]. <http://www.minnpost.co
m/stories/2008/09/17/3542/financial_meltdown_
hyman_minsky_warned_us_this_would_happen>. [A-
ccessed: February 27 2010].
ACKNOWLEDGEMENTS
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r.com/talk/comment/2008/02/04/080204taco_talk
_cassidy>. [Accessed: February 27 2010].
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9/12/02/the-dubai-crisis-por-patrick-seale-the-new
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land-dubai/>. [Accessed: February 27 2010].
(iii) 1st pg., bottom — Jebreili, K. (2008). ”Sultan
Ahmed bin Sulayem, Chairman of Dubai World, talks
to the audience about the Nakheel Harbour & Tower
project, a more than 1 kilometer high tower of 270
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“What Happened to Haiti?”
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“Who Says Crime Doesn’t Pay?”
(i) 1st pg., top — “White Collar Crime.” (n.d.).
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r-crimes/>. [Accessed: February 27 2010].
THE SCHUMPETER
(ii) 1st pg., bottom — Rockstar Games (2008).
“Grand Theft Auto screenshot.” IGN. [Online].
<http://uk.retro.ign.com/articles/863/863037p
1.html>. [Accessed: February 27 2010].
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chapo.html>.[Accessed: February 27 2010].
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M.A. (2004). “Money Does Matter! Evidence from In-
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ACKNOWLEDGEMENTS
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(v) Schkade, D.A. and Kahneman, D. (1998). ”Does
Living in California Make People Happy? A Focusing
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(i) Rosenberg, P. (2009). “Understanding the Fi-
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openleft.com/diary/15283/unders
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[Accessed: February 22 2010].
“The Economics of Prohibition.”
(i) Szasz, T.S. (1992). “Our Right to Drugs: The
Case for a Free Market.” New York: Praeger.
(ii) BBC News (2010). “Legal high warning after
'bubbles' drug death.” [Online]. <http://
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ruary 20 2010].
THE SCHUMPETER
News Summary
The Department of Economics at City University
London hosted the 5th PhD Meeting of the Royal
Economic Society on January 16th &17th 2010.
The conference attracted more than 150 scholars
nearing completion of their PhDs in Europe, the
UK and the USA.
—————————————————————
The UK inflation rate rose to 3.5% in January
2010. This is the fastest annual pace annual rise
for 14 months. In December 2009, inflation was
2.9 %.
Words from the Editors
“Working on this edition of The Schumpeter from
sunny Barcelona has been challenging as well as fun.
The fun part, as always is reading the remarkable
submissions. Every new edition of The Schumpeter,
brings new talent, and builds on our old talent. I
hope that we can keep this momentum and see The
Schumpeter grow, for the next edition, which will be
the ultimate publication for this academic year. I
would like to thank everyone who has submitted arti-
cles, and my co-Editor, Fahad, without whom this edi-
tion would not have been possible. I also must com-
mend our cover artist, Polina for her amazing work.”
David Osborne, co-Editor of The Schumpeter
“Truth be told, whilst editing this issue’s submissions,
I declared to my co-Editor, David, “I'm thinking we
should all get together in a few years and start a na-
tionally-distributed Schumpeter of our own!” Though
I may come across as a ‘broken record,’ I truly believe
that I am surrounded with immensely talented and
passionate individuals, here at City. It has been my
honour to know the likes of Adrian, Anna, Bhavina,
Folarin and Miles as well as previous contributors like
Anaam, Balraj, Francesca and Habeeba. David’s idea
of integrating a cover image for the magazine has also
brought forth the likes of Cora and Polina; both of
whom I would like to thank for producing such splen-
did works for The Schumpeter. Finally, I would like to
thank David for being such a pleasure to work with.
We hope those reading this edition of The Schum-
peter realize what I have: City University’s student
body is a force to be reckoned with.”
Fahad Memon, co-Editor of The Schumpeter
Any comments / contributions, contact: david.osborne.1@city.ac.uk or fahadmemon_73@hotmail.com
NEWS & EXTRA
Quotes
"Quadrillion? That is a number only super comput-
ing engineers and astronomers used to use, not
economists and bankers!" —Tom Foremski (of
Silicon Valley Watcher).
"Money is counterproductive – it prevents happi-
ness to come." —Karl Rabeder, Austrian million-
aire who gave up his $4.8 million fortune to the
less fortunate.
"Stability is unstable" —Hyman Philip Minsky.
"What began as a pharaonic construction site is
suddenly sinking in economic quicksand, its future
as an archeological attraction possibly more prom-
ising than its pretensions as a global financial cen-
ter." —Amotz Asa-El (of MarketWatch) on Dubai.
"The Chinese use two brush strokes to write the
word 'crisis.' One brush stroke stands for danger;
the other for opportunity. In a crisis, be aware of
the danger – but recognize the opportunity." —
John Fitzgerald Kennedy.
"We have to decentralize... this catastrophe is an
opportunity to create the new Haiti Inc. where
every single Haitian is a shareholder." —Jim Wyss
(of Miami Herald).
"Obviously crime pays, or there'd be no crime." —
George Gordon Liddy.
"Marijuana never kicks down your door in the mid-
dle of the night. Marijuana never locks up sick and
dying people, does not suppress medical research,
does not peek in bedroom windows. Even if one
takes every reefer madness allegation of the pro-
hibitionists at face value, marijuana prohibition has
done far more harm to far more people than mari-
juana ever could." —William Frank Buckley Jr.
"I'm in favor of legalizing drugs. According to my
value system, if people want to kill themselves, they
have every right to do so. Most of the harm that
comes from drugs is because they are illegal." —
Milton Friedman.