Wednesday, November 26, 2014

The Tyranny of Political Economy

CAMBRIDGE – There was a time when we economists steered clear of politics. We viewed our job as describing how market economies work, when they fail, and how well-designed policies can enhance efficiency. We analyzed trade-offs between competing objectives (say, equity versus efficiency), and prescribed policies to meet desired economic outcomes, including redistribution. It was up to politicians to take our advice (or not), and to bureaucrats to implement it.

Then some of us became more ambitious. Frustrated by the reality that much of our advice went unheeded (so many free-market solutions still waiting to be taken up!), we turned our analytical toolkit on the behavior of politicians and bureaucrats themselves. We began to examine political behavior using the same conceptual framework that we use for consumer and producer decisions in a market economy. Politicians became income-maximizing suppliers of policy favors; citizens became rent-seeking lobbies and special interests; and political systems became marketplaces in which votes and political influence are traded for economic benefits.

Thus was born the field of rational-choice political economy, and a style of theorizing that many political scientists readily emulated. The apparent payoff was that we could now explain why politicians did so many things that violated economic rationality. Indeed, there was no economic malfunction that the two words “vested interests” could not account for.

Why are so many industries closed off to real competition? Because politicians are in the pockets of the incumbents who reap the rents. Why do governments erect barriers to international trade? Because the beneficiaries of trade protection are concentrated and politically influential, while consumers are diffuse and disorganized. Why do political elites block reforms that would spur economic growth and development?  Because growth and development would undermine their hold on political power. Why are there financial crises? Because banks capture the policymaking process so that they can take excessive risks at the expense of the general public.

In order to change the world, we need to understand it. And this mode of analysis seemed to transport us to a higher level of understanding of economic and political outcomes.

But there was a deep paradox in all of this. The more we claimed to be explaining, the less room was left for improving matters. If politicians’ behavior is determined by the vested interests to which they are beholden, economists’ advocacy of policy reforms is bound to fall on deaf ears. The more complete our social science, the more irrelevant our policy analysis.

This is where the analogy between human sciences and natural sciences breaks down. Consider the relationship between science and engineering. As scientists’ understanding of the physical laws of nature grows more sophisticated, engineers can build better bridges and buildings. Improvements in natural science enhance, rather than impede, our ability to shape our physical environment.

The relationship between political economy and policy analysis is not at all like this. By endogenizing politicians’ behavior, political economy disempowers policy analysts. It is as if physicists came up with theories that explained not only natural phenomena, but also determined which bridges and buildings engineers would build. There would then scarcely be any need for engineering schools.

If it seems to you that something is wrong with this, you are on to something. In reality, our contemporary frameworks for political economy are replete with unstated assumptions about the system of ideas underlying the operation of political systems. Make those assumptions explicit, and the decisive role of vested interests evaporates. Policy design, political leadership, and human agency come back to life.

There are three ways in which ideas shape interests. First, ideas determine how political elites define themselves and the objectives they pursue – money, honor, status, longevity in power, or simply a place in history. These questions of identity are central to how they choose to act.

Second, ideas determine political actors’ views about how the world works. Powerful business interests will lobby for different policies when they believe that fiscal stimulus yields only inflation than when they believe that it generates higher aggregate demand. Revenue hungry governments will impose a lower tax when they think that it can be evaded than when they think that it cannot.

Most important from the perspective of policy analysis, ideas determine the strategies that political actors believe they can pursue. For example, one way for elites to remain in power is to suppress all economic activity. But another is to encourage economic development while diversifying their own economic base, establishing coalitions, fostering state-directed industrialization, or pursuing a variety of other strategies limited only by the elites’ imagination. Expand the range of feasible strategies (which is what good policy design and leadership do), and you radically change behavior and outcomes.

Indeed, this is what explains some of the most astounding turnarounds in economic performance in recent decades, such as South Korea’s and China’s breakout growth (in the 1960’s and the late 1970’s, respectively). In both cases, the biggest winners were “vested interests” (Korea’s business establishment and the Chinese Communist Party). What enabled reform was not a reconfiguration of political power, but the emergence of new strategies. Economic change often happens not when vested interests are defeated, but when different strategies are used to pursue those interests.

Political economy undoubtedly remains important. Without a clear understanding of who gains and who loses from the status quo, it is difficult to make sense of our existing policies. But an excessive focus on vested interests can easily divert us from the critical contribution that policy analysis and political entrepreneurship can make. The possibilities of economic change are limited not just by the realities of political power, but also by the poverty of our ideas.

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    1. CommentedKeshav Prasad Bhattarai

      Truly revealing story on our state of political economy. Thanks and please invest more of your intellect and energy with ideas that can fight the tyranny of those vested interests in the area of political economy with broader policy solutions to fight them.

    2. CommentedSergio Reuben Soto

      The question is if the economic relationships (the individuals property of mean of production) can to make possible the rule of the vested interest in politics. If you arrive to a kind of conclusion, then you can think how to impede the concentration of wealth and means of production in a few hands. And you are now talking about of distribution and talking about economic theory.

    3. CommentedJoshua Ioji Konov

      Well mr. Rodic, the tragedy is not that the economists could not oversee the 2007-9 Recession, neither give appropreate guidelines in the early post-rcession, but it is that they through the IMF and the most powerful governments continue advising and pressing countries to take austerity and other action based purely on ideology and perception...

    4. CommentedRhonda Collier

      What about James Buchanan's revelation about the importance of constitutional constraints on economic policy making given the effect of vested interests of both politicians and businessmen? Isn't this an example of policy action/recommendation to come from this analysis. It doesn't seem fair to say rational-choice political economy is a dead end for improving institutions. Couldn't we then ask which sorts of constitutional constraints are best?

    5. CommentedDevi Natasia

      This is indeed true, that different strategies are needed to make a significant change in economic. Yet how if the government in some countries are consisted with majority of conservatives? Isn't it will be harder to come up with a strategy, good enough and creative enough to pursue those interest that could enhance economic sector?

    6. CommentedCamden Cornwell

      You claim that "endogenizing" political behavior excuses political malfeasance. I am not sure that it does. I think it exposes politicians and teaches us what rules or constraints contribute to a continuing problem of the political economy. Ignoring it, as you seem to suggest, is just as bad, if not worse, and certainly would not lead to the "policy design, political leadership, and human agency" that has been lacking. The fact that these things are lacking in the political sphere is reason this discipline was conceived of in the first place. Moreover, not all theories of the political economy neglect the power of ideas. But it is true that for the vast majority of political actors that private interests and re-election are paramount.

    7. CommentedEdward Ponderer

      A particularly important point here is the realization that steering the economy in a positive direction is most realistically accomplished not by a "99%" threatening to send the "1%" to the guillotine. This especially when those most competent at successful organization and management are among these 1%.

      Rather, synthesizing political with behavioral economics, the direction exists to offer a new scenario of deeper benefit and security -- propose a reasoned sales pitch for paradigm shift -- to "the powers that be" to peacefully and to their benefit more than any others, make them into the "power that could be."

      In particular per the very recent book, The Benefits of the New Economy (Michael Laitman, ARI Publishers, January 2013, "Tycoons in the New Economy -- from predators to prosocial...," p. 133 ff), more than ever before, there may well be an undercurrent of longing to transform a shaky base of overindulgent wealth for its own sake, into a more stable lower monetary base in exchange for tremendous levels of social acclaim. That is, without changing the magnitude of the psychological reward (read "happiness"), the dial could be turned from taker to giver in exchange for the respect and actual love by society.

    8. CommentedJoan C F

      I agree 100%. Perhaps a hybrid discipline that combines political economy and a renewed (behavioral and institutional) welfare economics would make the work of economists ever more policy relevant.

    9. CommentedZsolt Hermann

      The most important line in the article:
      "...In order to change the world, we need to understand it..."
      And the article also gives us the most important understanding about our world today: the single most important factor determining everything in our world today is "vested interest".
      And because of this all our sciences, structures, solutions break down at a certain point.
      We always set out to study and understand the "world as it is" in an objective fashion.
      But when all our moves, motives are determined by "vested interest" it is impossible to see, research objectively, we will always see and create a distorted world.
      And this comes from our inherent human nature, there exists no human being that is capable of viewing the world in an objective fashion, we will always perceive the world subjectively, basing all decisions and actions on self calculations, thus if we truly want to view and change the world we have to start by changing our inherent human nature. We need to exit our selfish boxes, "meet each other in between" in a mutual space and start examining the reality there.
      And although it sounds impossible at first sight, humans are the only creatures that can develop a truly objective self-analysis and based on that we are also capable of changing ourselves.
      It is not easy, and it is a gradual process, and first of all we need a desire to do so by recognizing our failures, looking honestly at the world and the crisis around us that originates purely from this selfish, self centered human nature.
      Increasing suffering, hardship has the power to force us to this self analysis and self-change, but we could speed up the process, going a step ahead of the blows, if we are wise and start acknowledging and examining the signs around us properly and honestly from now on.

    10. CommentedYK Chang

      Very sightful notion! However, I wonder what do you mean by the 'emergence of new strategy'? Now, Korea and China are both suffering so called 'vested interests' very badly. Without correcting the problem, those countries will not be able to move forward. For example, widening gap of wealth is now preventing korean people from cooperation which was one of the most valuable virtue that have enabled the country to develop very fast. Now, politicians are attacking big company group (so called Chabol) in order to buy votes. What could be new strategy for them?

    11. CommentedReinaldo Domingues

      This line of argumentation sounds a lot like R. Keohane and J. Goldstein’s work on “Ideas and Foreign Policy”. Even the categorizations mentioned by Rodrik are similar. Nevertheless, it remains an interesting analysis. It might be interesting to add a “reflectivist” point of view to a field so deeply characterized by rationalist approaches.

    12. CommentedShane N

      The source of poverty in the field of economics is due to viewing your "job as describing how market economies work". Political economy (economics) isn't and shouldn't be only about studying capitalism.

    13. CommentedMareike Kleine

      A bit harsh. Political economy also helped us understand the crucial role of well-designed institutions. That's a hugely important contribution.

    14. CommentedProcyon Mukherjee

      The power struggle has assumed a different form as holders of capital have found it increasingly difficult to negotiate their path without alliances. These alliances, sometimes with the polity, have transformed the way capital has been used to generate further wealth, but in recent times it is becoming difficult with so much surplus capital chasing too few ideas. The power is slowly shifting as the Bain report says, from the holders of capital to the holders of ideas. The economists have to adjust themselves to this new reality in days of ‘super-abundance’ of capital.

    15. CommentedNick Bormann

      Dr. Rodrik,

      Vested interests alone may not be a satisfying basis for political economy models, but focusing on ideas is unsatisfactory as well. Politicians respond to voters who are typically ignorant of economic arguments, so even if decision-makers are enlightened they cannot act on that superior knowledge. Primacy of vested interests may result in more optimistic conclusions than focusing on ideas.

      I wrote a blog post fleshing out this argument in more detail:

      -Nick Bormann

    16. CommentedKoldo Casla

      A nearly perfect spaceship wouldn´t take you to the Moon either