The Limits of Policy and Politics: I. The Economic Crisis

05/30/2010 05:12 am ET | Updated May 25, 2011

It is an unfortunate fact that "necessary" and "impossible" are not antonyms. When both adjectives apply to the same requirement, the result is disaster. This is embodied in a joke I have told before.

Interviewer: What would you do if you saw two trains three miles apart headed toward
each other at 60 miles an hour?
Applicant: I'd call my little brother.
Interviewer: Your little brother? Why?
Applicant: He ain't never seen a train wreck.

It happens. Applied to public policy, however, that is a very conservative formulation--policy can do nothing. As a liberal, I prefer an amended formulation, in which the applicant's response is "I'd call 9-1-1 to send lots of ambulances", (A tea party conservative would have saved money by cutting out the emergency response number and public ambulances.)

Liberal or conservative, however, the degree of realism the joke represents is lacking in most policy and political discourse. Government is exhorted to "Do something!"--exhorted by conservatives as well as liberals: Defeat terrorism! as well as
Reduce unemployment!

And when "something" does not prevent disaster, the politicians in power are blamed. Which in a democracy is the way it is and probably should be.

The disastrous "stagflation" of the 1970s was caused by the OPEC-induced petroleum boycotts which forced oil-consuming countries into the impossible choice between stimulating growth and employment at the cost of rapid inflation, or constraining inflation by slowing growth and increasing unemployment.

The choice was impossible but politicians in power had to choose. Over a few years, liberals in power like Jimmy Carter in the United States, Jim Callaghan in Britain, Helmut Schmidt in Germany, and PierreTrudeau in Canada were replaced. It was not simply a left-to-right movement, however: France was led by conservative Valery Giscard d'Estaing, and he was tossed out too. Politicians are there to provide solutions, and even if no solution is possible, goodbye to them.

Whoever is in power, however, public policy can be improved by recognizing its frequent impotence. If disaster cannot be avoided, perhaps it can be slowed, its severity can be muted, or its effects meliorated. Bring in the ambulances!

Examples of the unlikelihood of policy "solutions", particularly short term solutions, and the need for realist focus on melioration in the meantime abound--in climate change, in international problems from nuclear proliferation to peace in the Middle East.

This one is about the global economic crisis.

Nearly all the discussion of its causes has concerned the housing bubble and its exaggeration by the arcane devices of Wall Street and the banks. Suggested remedies to avoid recurrence have focused on better regulation to avoid future bubbles. But bubbles have been with us for three centuries of amazing economic growth. Do we really want to prevent them, or might that prevent growth? Indeed, can we prevent them?

Beyond regulation and reform, ongoing economic controversies focus on the causes of business cycles and the cures for the current one. Economists generally agree on he central problem (although they disagree on the language and metaphor they use to describe it.) For a variety of reasons, more goods and services come up for sale than buyers want to buy; therefore producers cut production and jobs and many other things spiral downward.

But economists then divide roughly into two schools on the causes for the gap and particularly on possible remedies. Neo-classicists recommend letting the free market work things out, aided by monetary policy to put money on the table for private investors and consumers to pick up and spend, but they do so with a great deal of caution about planting the seeds of future inflation. Neo-Keynesians emphasize deficit-financed fiscal stimulus to fill in the gap before private spending revives; they worry less about long-run inflation but focus on immediate needs and remedies. The controversy is waged with competing models.

A much smaller group (including me),while not dismissing that controversy, suggests that the basic causes of economic fluctuations lie outside the neo models, classical or Keynesian. As put by Narayana Kocherlakota in a blog exchange:

Why do we have business cycles? ... At this stage, macroeconomics has little to offer by way of answer to these questions. The difficulty in macroeconomics is that virtually every variable is endogenous [within the models]--but the macroeconomy has to be hit by some kind of exogenous [outside the models] specified shocks if the endogenous variables are to move.

Recent examples (mine, not hers) of such exogenous shocks, well outside of either classical or Keynesian models, are the oil crisis of the 1970s (negative), which caused a decade of stagflation and the Information Technology revolution (positive), that, brought about the increasing productivity and accelerating prosperity at the end of the last century. The trigger for the current crisis was the housing/financial bubble, but the underlying causes are much deeper.

If such powerful changes lie below the current crisis, however, then proposed fiscal and monetary policies cannot provide any long-run remedy; we must await the next shock and hope that it is positive. That was the case with the Great Depression, which was ended only by the positive (from an economic viewpoint) shock of World War II. This time, one shock to the world economy, already taking place is the rapidly growing economic power of the developing economies, led by China, India, and Brazil. It remains to be seen whether that shock will be positive or negative for the rest of the world.

In the meantime, the current malaise continues: bring on the competing ambulances; The differences between the neos are important for melioration, particularly of unemployment, if not for long-run solution. I am on the Keynesian side. What current policy can and should do is to cushion the effects by using fiscal policy backed by monetary and regulation instruments, even at the cost of deficits continuing over many years, and, yes, real risks of inflation and possibly stagflation sometime in the future. The future is likely to be governed by technology, war, changing global economic structure, or other factors outside the models, anyhow.

But voters vote in the short run, which is a major reason why current political leaders may fall off the same cliff as those of the 1970s. Barack Obama's health-care victory may have started him backup politically, but unemployment rates near two digits at the end of this year and in perhaps in four years will not lead to a continuing stream of electoral victories. The fact that Gordon Brown in Britain, Nicolas Sarkozy in France, even the newly elected governments of Germany and Japan, and perhaps even Vladimir Putin in Russia face similar difficulties suggests that the faults are not national.

Policy can't solve the problems, but in politics that is no answer.