Paul Collier’s The Bottom Billion is the best economics book not written by a dear friend that I have read this year, it’s full of serious, important ideas and the writing sparkles.
You won’t find a better explanation of the time consistency problem, for example, than this brief bit on the Chad-Cameron pipeline. As you may recall, the World Bank lent Chad money for the pipeline on condition that the money would be controlled not by the government but by an independent panel, the "College," with members drawn from civil society.
The deal was that the government of Chad would pass a law establishing the College, and in return the oil companies would sink $4.2 billion of investment into oil extraction. Now ask yourself which of these is easier to reverse, the law or the investment. Once you have answered that, you have understood the time consistency problem…
Brilliant. Collier then goes on to make the important point that the idea of giving control of resources to independent service organizations rather than to governments is in many cases a good one but the idea applies better to aid than to oil because…
With aid you do not have to sink $4.2 billion in order to get started. It is just a flow of money that can be switched off, unlike the flow of oil. Knowing this, the government has no incentive to tear up the deal.
Here is Tyler on the Bottom Billion.
Great writing == “you have understand the time consistency problem”?
Actually, it doesn’t make the time consistency problem clear. Because it doesn’t make clear what’s being reversed. I’ve known investors to pull out in many occassions, IF THE MONEY HAS YET TO BE SPENT. What he really wants to ask is: “which if these is easier to reverse, an act of legislation on a piece of paper, or the pipeline facilities already laid down at a cost of over $4 billion?”
That would make the matter clear.
What I first read it, I was thinking of how that would have worked in, say, the US, where the law is almost IMPOSSIBLE to reverse, and any investor would have set up a line-of-credit to fund the project which could be easily discontinued with a phone call.
The Economist also reviews it very fondly in its latest edition:
http://www.economist.com/printedition/displayStory.cfm?story_id=9581576&fsrc=RSS
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