Wednesday, November 26, 2014

Politics-Proof Economies?

MILAN – Governments’ inability to act decisively to address their economies’ growth, employment, and distributional challenges has emerged as a major source of concern almost everywhere. In the United States, in particular, political polarization, congressional gridlock, and irresponsible grandstanding have garnered much attention, with many worried about the economic consequences.

But, as a recent analysis has shown, there is little correlation between a country’s relative economic performance in several dimensions and how “functional” its government is. In fact, in the six years since the global financial crisis erupted, the US has outperformed advanced countries in terms of growth, unemployment, productivity, and unit labor costs, despite a record-high level of political polarization at the national level.

Of course, one should not paint with too broad a brush. Unemployment is lower in Germany, Canada, and Japan. And America’s income distribution is more unequal than most advanced countries’ – and is trending the wrong way. Still, in terms of overall relative economic performance, the US clearly is not paying a high price for political dysfunction.

Without dismissing the potential value of more decisive policymaking, it seems clear that other factors must be at work. Examining them holds important lessons for a wide range of countries.

Our premise is that the global integration and economic growth of a wide range of developing countries has triggered a multi-decade process of profound change. These countries’ presence in the tradable sector of the global economy is affecting relative prices of goods and factors of production, including both labor and capital. At the same time, declining semi-conductor costs have encouraged the proliferation of information and communication technologies that are replacing labor, dis-intermediating supply chains, and reducing routine jobs and lower-value-added jobs on the tradable side in advanced economies.

These are secular trends that call for forward-looking assessments and long-term responses. Relatively myopic policy frameworks may have worked reasonably well in the early postwar period, when the US was dominant, and when a group of structurally similar advanced countries accounted for the vast majority of global output. But they cease working well when sustaining growth requires behavioral and structural adaptation to rapid changes in comparative advantage and the value of various types of human capital.

What, then, accounts for the US economy’s relatively good performance in the post-crisis period?

The main factor is the American economy’s underlying structural flexibility. Deleveraging has occurred faster than in other countries and, more important, resources and output have quickly shifted to the tradable sector to fill the gap created by persistently weak domestic demand.

This suggests that, whatever the merit of government action, what governments do not do is also important. Many countries have policies that protect sectors or jobs, thereby introducing structural rigidities. The cost of such policies rises with the need for structural change to sustain growth and employment (and to recover from unbalanced growth patterns and shocks).

No country is frictionless in this regard, but there are substantial differences. Relatively speaking, Germany, northern Europe, the United Kingdom, Canada, Australian, New Zealand, and the US are relatively free of structural rigidities. Japan intends to get there. Southern Europe has a substantial agenda of flexibility-enhancing reform ahead of it.

Removing structural rigidities is easier said than done. Some stem from social-protection mechanisms, focused on jobs and sectors rather than individuals and families. Others reflect policies that simply protect sectors from competition and generate rents and vested interests. In short, resistance to reform can be substantial precisely because the results have distributional effects.

Such reform is not market fundamentalism. The goal is not to privatize everything or to uphold the mistaken belief that unregulated markets are self-regulating. On the contrary, government has a significant role in structural transitions. But it must also get out of the way.

Relative to the US, Europe has two sets of problems. One is the need, especially in several southern European countries, to enhance structural flexibility and boost productivity. In the euro’s first decade, the southern economies’ unit labor costs diverged from those in Germany and the north, with growth sustained either by excess public debt and the government component of domestic aggregate demand, or, in the case of Spain, by a leveraged housing bubble. In the absence of the exchange-rate mechanism, resetting the system to allow the tradable sectors to generate growth involves painful relative deflation, a process that takes longer in a low-inflation environment.

Second, the eurozone permits these divergences because policies that affect growth are decentralized. The common currency and monetary policy are in constant tension with decentralized policymaking on taxation, public-sector investment, and social policies – all of which affect countries’ structural flexibility. Moreover, the single market is relatively complete in goods but not in services.

This is not a stable situation. Europe eventually must gravitate either toward deeper political, fiscal, and policy integration, or toward a structure that includes adjustment mechanisms – for example, greater labor mobility – to accommodate divergences in productivity.

Many countries, not only in Europe, must undergo structural adjustment in order to achieve sustainable growth patterns. All advanced economies’ structures and portfolios of employment opportunities are facing similar competitive and technological forces, and all are tending to shift income toward the upper end of the distribution and toward owners of capital.

The cross-country differences in performance partly reflect past policy choices affecting the speed of adjustment. Initial conditions matter, and in this respect America’s policy framework seems to have ensured the US economy’s relatively higher resilience not only to the global crisis, but also to domestic political volatility.

Structural flexibility is not the whole answer; higher levels of public-sector investment would also help to generate sustainable recovery, especially in the advanced countries. But, with severe fiscal constraints in many countries likely to delay that element of the policy response, flexibility-enhancing reforms are the right place to start.

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    1. CommentedJose araujo

      In a time that most of the countries were making bad decisions, not having a functional government can be a good thing. Just look at the example of Belgium vs Holland.

      Any theory must have explanatory power, and the link between functional governments, curruption and growth isn't one that olds particularly well.

      Not comparing countries, there are better run governments then other that cannot achieve the same growth rates.

      And not within countries. Portugal had a massive decrease on corruption level and increased institutional transparency, yet the growth levels have decreased.

    2. CommentedTim Chambers

      I just finished reading Karl Polanyi's The Great Transformation, and one of the things that he points out is that Fascism resulted from the inability, née intransigence of the elites to deal with the underlying problems that caused the Great Depression, namely the distortions economic distortions caused by "free markets."

      It would seem that we have the same problem today and that Fascism is once again on the rise.

    3. CommentedJoshua Lee

      Those on the fringes of the political spectrum feel that Government is dysfunctional. This includes many in the media and academia who sit to the left of many Americans who are doing just fine. The American political system has led to fast economic growth and amazing innovation. So I posit that the system is perfectly functional. It finds the true median. It is a large diverse country and change happens slowly but it can happen.

      Some might not like competition but America is very competitive. Economic and labor flexibility is just a small part of a superior ethos and culture. States with bad policies suffer consequences and they often benefit when they adjust. Americans love of sports is a reflection of their admiration for striving and winning. We are lovers of wealth and celebrity. We also prize technology and dream of a better future. Education.

      Also, being the best is self sustaining. The best and brightest in the whole world come here to learn, to teach, to work in hollywood or sillicon valley or in finance.

      We have the worlds reserve currency.

      We have a huge military industrial complex which actually distributes wealth to contractor companies soldiers scientists and spies.

      And dare I say good demographics and good work ethic due to high levels of - religion! Contentious point I know but especially vs europe I would take a herd of good little christian sheep to work in my shops over a mob of unruly nhilistic depressed socialists any day. Europeans actually have too much education for their own good. Its inefficent and frankly causes friction.

      Just my 2 cents.

    4. Commentedde Lafayette

      {At the same time, declining semi-conductor costs have encouraged the proliferation of information and communication technologies that are replacing labor, dis-intermediating supply chains, and reducing routine jobs and lower-value-added jobs on the tradable side in advanced economies.}

      Whoa! It's not that simple.

      That semiconductor price should drop is NOT the main reason that Amazon is a money-spinner. There were/are a great many other engineering developments behind that phenomenon, namely the internet itself.

      This word "productivity", which seems to have become the Golden Ring on our GDP merry-go-round, is worth serious debate. Typically, it supposedly (I repeat supposedly) measures the value of output as a fraction of the value of input. Therein lies the problem. For purposes of said calculation, are we not mixing apples with oranges just because they are fruit? And what about the kiwis?

      The present calculations are just rough-estimates of productivity trends, because the very measurement employed are inexact. The value of GDP in any given sector is easy to estimate, but the value of sectoral inputs in terms of manpower, kinds of manpower, and their respective values in terms compensation (and therefore input costs) are also highly variable.

      I have seen some strange happenings in the usage of sectoral productivity measurements, particularly in Europe. It is difficult for me to understand why France and Germany, that work far fewer hours than the US, should have manpower productivity levels that are greater (if GDP is corrected for PP). So, productivity based upon the cost of manpower input and that based upon the number of hours worked come out with different sets of numbers. What’s going on?

      That is the real question, I submit. (And if I had an answer, I’d certainly be writing it here …)

    5. Commentedjames durante

      I agree with Robert Snashall. I think what the authors mean is "Politics-Proof EconomICS"-- the fundamental assumptions of capitalism should never be challenged. The problem is that economics is a sub-set of politics. What should an economy be designed to do is a basic political question. If everyone agrees at the outset that an economy should, first and foremost, maximize returns to those who own the means of production--the unexamined political assumption of these and all other orthodox capitalist economists-- then all of their verbiage about structural rigidities and adjustment, labor mobility and lower unit labor costs makes perfect sense.

      If we assume instead that economics should provide a high standard of living and considerable leisure time for all while having minimal ecological impact we would probably come up with a very different set of recommendations. These would include, at a minimum, a living wage, low max work hours per week, the immediate transition to green energy and transportation, and a steady state economics and would require greater reliance on IGO's (assuming much more democratic participation and transparency) than corporate boardrooms, investment banks, and national political parties.

      Or if we stay more with traditional national politics and economics then Snashall' recommendations are a starting point.

        CommentedRobert Snashall

        Thanks mate.. I agree with you completely. We need to look at what makes us happy and pursuing those goals might be a lot different from just simple wealth maximization. There's a reason why the Nordic countries are the happiest whilst also the most socialist and full of "rigidities".

    6. CommentedProcyon Mukherjee

      Government actions, either fiscal in nature or policy stances that create the shift towards development and growth, should not be measured in the immediate lagging indicators we see, but rather in the direction of the leading indicators.

      One such indicator is the direction of the median income (which is moving down) and if one compares that trajectory with the productivity growth (which is still going up) one would notice that these two have diverged decades back. This divergence is not so acute in the case of Nations like Germany, Japan or even smaller nations like Switzerland.

    7. CommentedRobert Snashall

      This is the kind of economics that I find particularly depressing.

      This rigid and uncompromising belief that overall GDP growth is the sole indicator that one seeks to maximize is ridiculous.
      Yes, I agree with many of the points about Southern Europe, but at the same time holding up the US as an economic role model is something only an academic aristocrat would do.
      A country that has allowed real incomes to decline for the majority of it's citizens, with inequality not just high, but increasing. And that is the country you wish the world to emulate? The fact that this article treats inequality as a side note says it all.
      It is market fundamentalism and a lack of understanding of how societies work and what economics should aim to achieve.
      I believe there has to be one of two things;
      1. Increase trade restrictions and unionization to reduce the effects of deindustrialisation and lessen the impact of social dislocations, whilst simultaneously reducing the political incentive for international tax competition, thus allowing funding for better government services. I am not talking about crazy protectionism, just a pragmatic approach to massive problems.
      2. Or, redesign the economic system so that we can accommodate the huge unemployment that is going to ensue over the next few decades. When your country has 20% unemployment persistently with the only way for the poor to be employed is to be paid third-world wages, what do you do? I don't know and neither does economics.

    8. CommentedZsolt Hermann

      They say "economics is the external representation of the inter-relationships in between people".
      So we can imagine a multi-layered structure where people and the relationships in between them are the foundations, these inter-relationships determine the trade and economic system in between them, and then there are certain governing institutions trying to regulate, harmonize the structure.
      The regional, national differences reflect the cultural, national characteristics of the actual regions, but the baseline operating software is the same: we all operate based on self-centered calculations, engaging in ruthless, exclusive competitions with each other, and especially since we are interconnected in a global system by default we have to succeed at the expense of the others.
      The governments have lost almost any influence on this structure since now the markets, corporations, human interconnections are supra-national, a national, even regional governing body has no influence.
      But even if they had, even if we formed a truly functioning supra-national governing body it would not be able to guide the global economy towards prosperity until the fundamental layer, human inter-relationships are not changed.
      In a global, integral world ruthless competition, succeeding, prospering at the expense of others is a "cancer-like" self-destructive behaviour.
      Through a new type of global, integral education program first of all we have to help people of all backgrounds social, educational layers understand that in today's, interconnected and interdependent world system only mutually complementing cooperation, mutual responsibility can guarantee success at any part of life.
      When we adjust our inter-relationships accordingly all the other layers, trade, economy, finances, and the governing structure above will form optimally, automatically.

        CommentedEdward Ponderer

        It looks to me that you are talking about a behavioral economics approach to this, and I fully agree with that perspective Mr. Hermann. The fundamental problem with the approach of the article, is simply that neither a top-down approach (nor a bottom-up approach for that matter) to economic solution will work any longer. Global interdependence seeps down through all levels, and the politics--read in behavioral terms as an external attitude of naturally resulting from human ego--follows suite.

        It must be understood that what Peter Drucker already foresaw as a global layer of nonlinear equations was added to the lower tiers of economic realities, is coming at us with a vengeance--mathematical chaos. In our linkages with politics, the social and cultural, the family "unit," and even nature--biochemical, trans-species, general ecology, and climate--this complex has led to vast cross-components coming out of the woodwork, in addition to the direct second-order, tertiary, and higher-order attrition.

        When any communal system of independent members in nature reaches the crises of run-away chaos, success is achieved only by an altruistic re-ordering of the system and this new mutual responsible entity grabbing the Murphy's Law bull by the horns and taming it. Our own coronary system and general body homeostasis is such a success story of worst nightmare chaos becoming our best friend in mathematical control. The key is not vertical or lateral management, but fractal entity control -- from the international governmental and corporate entity, down to the local community and business, and the individual entrepreneur, worker, and family member. In short, we will require a true "Family of Humanity."

        But it won't work through a chain of managers as "Who guards the guardians" will rapidly decay a chain of command per what works best for the individual in the mind and heart of the individual--rats fleeing a sinking ship and all. The information of the necessary mutualism is stored in the system, not in an individual manager nor the chain of command. Approaching chaos, everybody, is a lynch-pin, and the overwhelming entropy make any classic management a hopeless juggling of evermore water balloons until catastrophic failure.

        As to the matter that you can't change human nature--of course you can't, but you can use it. However, only now is it possible to do so in the correct way. Only through an integral education will the egoism of individual, and net-egoism of groups, be directed to see that in the present world--it is mutual responsibility that is its best interest, "its" true power. Communism, and now capitalism, are both failing in essence because the former ignored the dominant reality of human egoism--imagined that it only lay with some special capitalist class that could be eliminated--and the latter though it could be put in a black box and controlled for everyone's benefit.

        Tragically, the present debate among economists--including that presented in this article--continues to ignore the underlying psychological reality here.

        Behavioral economics is the key, but most specifically, a fractal one--to all levels, beginning with an education toward integration supported by societal values of mutual responsibility. The power mass media bred to sell us so successfully on non-existence "needs" and desires in the name of consumerism, can surely be redirected in the cause of establishing a sable global society and economy--if we can muster the will to do so.