In Search of Dynamism
Three Paths for Indebted Democracies
Raghuram Rajan
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CHICAGO – Democratic governments are not incentivized to take decisions that have short-term costs but produce long-term gains, the typical pattern for any investment. Indeed, in order to make such investments, democracies require either brave leadership or an electorate that understands the costs of postponing hard choices.
Brave leadership is rare. So, too, is an informed and engaged electorate, because the expert advice offered to voters is itself so confusing. Economists of different persuasions find it difficult to reach a consensus about the necessity of any policy. Consider, for example, the cacophony of arguments about government spending: is it the only thing keeping depression at bay, or is it moving us steadily down the road to perdition? The debate does not lead to agreement, moderate voters do not know what to believe, and policy choices ultimately follow the path of least resistance – until they run into a brick wall.
The build-up of public debt in industrial countries (which was rising briskly well before the Great Recession pushed it to near-unsustainable levels) reflects this kind of calculus. The public rewards democratic governments for dealing with the downside risk caused by competitive markets – whether by spending to create jobs or by rescuing banks that have dodgy securities on their balance sheets.
Even if inaction (or action oriented towards the longer term) is the best policy, it is not an option for democratically elected politicians, whom voters expect to govern, which inevitably means action with the potential for quick results. A sympathetic press amplifies heart-rending stories of lost jobs and homes, making those counseling against intervention or advocating longer-term fixes appear callous. Democracies are necessarily softhearted, whereas markets are not; government action has expanded to fill the gap.
With governments in many developed countries now reaching the limits of their gap-filling capacity, three undesirable possibilities loom large (in addition to the desirable possibility that they will have no choice but to undertake long-postponed reforms that will create sustainable growth with less need for government buffers). One is that they intervene directly in markets, both domestic and across borders, to reduce competition and volatility while they rebuild their buffering capacity. Another is that they muzzle democracy to suppress public anger. A third is that they find scapegoats.
All three were tried during the Great Depression of the 1930’s. The results were not encouraging.
One factor diminishing the likelihood of governments intervening more directly in markets is that the recent crisis seems to have discredited government as much as it discredited the financial sector. During the Great Depression, matters were different. As economic collapse caused the public to lose faith in the private sector and markets, faith in government grew. For example, in the United States, public support for President Franklin Roosevelt’s New Deal was broad-based throughout the 1930’s.
One possible reason for the difference in attitudes today is that bankers were visibly punished in the 1930’s. Legislation such as the US Glass-Steagall Act clipped their wings. Many bankers also suffered direct losses as their banks collapsed, or as investigations exposed them to public ridicule, and even jail.
Today, by contrast, broad segments of the public see the big banks and big government as being run by the same elites who created the crisis, and then spent public money under one guise or another bailing the banks out. Even as bankers are back to reaping enormous bonuses, taxpayers have been left to foot the bill for the economic collapse. Many workers are unemployed and in danger of being evicted from their homes, while no important banker has been put in jail.
The biggest banks now account for an even larger share of the financial sector after benefiting from a government rescue, while efforts like the Dodd-Frank Act to legislate more constraints on banks have been lobbied into shadows of their original selves. The elite, whether in government or big business, seems to look after itself and no one else.
In the US, this sentiment has fueled the Tea Party, which coalesces around opposition to government expansion (and to elites more generally), even if that expansion is aimed at regulating big banks (presumably because government regulations tend to be shaped by the powerful among the regulated). Movements like the Tea Party have thus tended keep in check those who, after a crisis of the sort that America has had, typically want more government action, including curbing markets and competition.
The US is not alone in having a discredited government. In the eurozone, in addition to the perceived nexus between banks and governments, the governing elite’s willingness to embrace European integration, and taxpayer-financed cross-border financial support, without broad public consultation has generated a similar sentiment. In Japan, two decades of relentless economic malaise has decimated the public’s faith in politicians and the government bureaucracy.
The second undesirable possibility – that governments with little spending capacity to assuage public anger turn against democracy and free expression – is also remote for now. Democratic institutions in industrial countries are stronger, and have deeper roots, than was the case in the 1930s.
That leaves the third undesirable possibility, the search for unprotected scapegoats upon whom public anger can be dissipated. Unfortunately, several countries are taking this path, with undocumented immigrants and Muslims being the first targets.
Politicians who seek scapegoats might argue that they mean no harm to their targets, and that they are helping their societies to avoid worse possibilities. But, as the 1930’s showed, it is hard to imagine any possibility worse than where this type of behavior can lead.
Raghuram Rajan, a former chief economist of the IMF, is a professor of finance at the University of Chicago's Booth School of Business and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy. His blog is at http://blogs.chicagobooth.edu/faultlines.
Copyright: Project Syndicate, 2011.
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reinventlatvia 09:52 10 Apr 11
RTFL.lv sent Rajan’s blog to Jeffrey Sommers and asked for comment, for those interested, he responded with:
Rajan has a book, Fault Lines, that has received much attention. His chief argument is “let’s not look for scapegoats.” Terribly convenient in Latvia’s case, given there were those warning the crisis was looming, and what the role of bankers and a government that failed to regulate finance and tax real estate played. For those who do not remember, and/or choose not to remember, see Sommers & Hudson in Diena, June 2008 (warnings they had been issuing in the press since February, 2005).
For full response visit http://www.rtfl.lv/
Blankfiend 10:07 11 Apr 11
As usual, an excellent perspective. Another way to view the cause of mounting debts within "representative" forms of government may be a desire to maximize system benefits for business and elites with miminal costs (ie taxes too low for services provided), while simultaneously needing to appease the masses with programs that can only be funded with deficit spending given the unrealistic revenue collections. As you have said, "let them eat credit."
RalphMus 05:28 12 Apr 11
The root of the problem is that while we have barred politicians from direct access to the money printing press (that is the main reason for independent central banks), we have not barred them from the debt printing press. And national debt and money are very similar in nature.
It would be perfectly logical to have central banks (or any committee of independent economists) responsible for the technical question as to whether inflationary pressures warranted money or debt creation. While politicians were responsible for strictly political matters, like what proportion of GDP is taken by public spending, and what the make-up of that spending should be.
For more on this, see: http://ralphanomics.blogspot.com/2011/03/why-separate-monetary-and-fiscal-policy.html
mmeister 02:28 13 Apr 11
This article is right wing nonense at worst. Typical Chicago. It
(a) Dismisses regulation attempts to curb the markets based on the dodgy argument that all modern regulation (and therefore regulators) is inherently corrupt (which makes me wonder why Glass Stegall worked if this was so)
(b) Tries to pass the tea party as a grassroots intellectual movement against government corruption. In reality it is a largely funded astroturf libertarian movement who's supporters average IQ level is cringeworthy.
(c)Doesn't actually propose any solution to government indebtedness other than to suggest government should just cease doing anything.
(d) Equates any government action with 'curbing markets and competition'. In fact, government action is required for competition and markets existence in most scenarios (anti-trust laws, copyright enforcement, consumer protection).
You'd think after 2008, these people would crawl back into their test tubes.
wilze1 06:02 15 Apr 11
Thank you for your article clarifying what the world's major economies [indebted democracies] will do [and are doing] given the cirsis we find ourselves in.
Now I know that their solution/reaction to the problem is scapegoating. So they are now directing public anger toward --what groups was it again---oh yes-- Muslims and undocumented [thank you for not saying illegal] immigrants.
And I thought the world's major governments plan for pulling us out of the crisis was to stimulate economic growth through a number of fiscal and monetary policies etc. Where did I get that Idea?
The only criticism I have of the article is that you failed to mention that during this economic crisis there are a number of other individuals and groups that are also being scapegoated --right here in the US!. For example, Wall Street money managers -Bernie Madoff and other hedge fund managers [too many to name here] celebrities like Lindsey Lohan, politicians like Blogojevich-- embezzlers,tax cheats. I could go on and on. The scapegoating is rampant!
Why is it in times of crisis we have to victimize those who break the laws of this country? What kind of people are we?
Thank you for trying to bring us to our senses and also showing us the way out of this terrible world-wide economic crises.
glossolalique 09:00 10 Apr 11
glib and factually wrong. Illegal border crossings are a law enforcement failure, predate this recession by at least twenty-five years, and so far, the US government has taken the side of the undocumented against states who have attempted to deal with the flood of economic refugees from Canada. I say "Canada" because if I said "Mexico" I'd be excoriated as racist, and I just couldn't endure that.