PRINCETON – James Carville, Bill Clinton’s chief campaign strategist in 1992, famously expressed a bit of established insider wisdom about winning elections: “It’s the economy, stupid.” Incumbents win if the economic outlook is rosy, and are vulnerable – as George H. W. Bush was – when times are hard. Indeed, throughout Europe – in France, Greece, Ireland, Portugal, Spain, and the United Kingdom – governments have been turned out of office in the face of a crisis that they have seemed unable to address.
By this standard, President Barack Obama should now be in a hopeless situation. According to United States Census data, household income fell in 2011 for the fourth consecutive year. Unemployment remains persistently high, despite the $787 billion stimulus package in 2009, and house prices, though recovering slowly, remain far below their pre-2008 peak.
And yet Obama seems likely to be reelected in November. One reason is that there is no reliable way to render an instant judgment about economic effectiveness, and the legacy that Obama inherited – coming to office in the middle of a major economic and financial catastrophe – clearly matters. President George W. Bush and Prime Minister Gordon Brown are obviously more responsible for the financial crisis than are their successors, who have to clean up the mess.
Moreover, as Zhou Enlai memorably responded when Henry Kissinger asked him about the effects of the French Revolution, “It is too early to tell” (though Zhou apparently thought he was being asked about the consequences of the 1968 Paris student uprising). Tracing the precise consequences of policy measures or institutional reforms – and estimating when they might “pay off” – is hopelessly complex. Much else is happening. Obama could not have known that a European crisis would have a big impact on US banks, and he could not have done much more to get European leaders to solve their problems.
The long-term success of the economy, and its capacity to build wealth and jobs, depends on productivity gains, which in turn depend on technical and organizational innovation. Governments cannot just conjure that up by waving a magic wand.
But governments can influence the development of productivity. And this is where legitimate debate begins, because immediate action to save jobs does not necessarily help.
The wrong kind of stimulus may get in the way of future productivity growth by channeling workers into the wrong kind of employment (or keeping them there). Large-scale public projects, particularly when they are aimed simply at putting as many people as possible quickly back to work, will lead to a shortage of labor available for more productive jobs.
In the 1930’s, some governments tried to make themselves popular with large-scale public work programs. John Maynard Keynes and his disciples pushed the idea that even apparently useless projects, such as pyramid construction in ancient Egypt, made sense. Keynes’s Cambridge disciple, Joan Robinson, was particularly worried because Hitler seemed to have grasped this point more quickly than democratic governments had. Hitler, she noted sarcastically, had solved Germany’s problem by “painting the Black Forest white and putting down linoleum in the Polish Corridor.”
In fact, increased spending, which the Keynesians saw simply as boosting aggregate demand, produced distortions. Under Hitler, the German economy in the 1930’s shifted to a lower-productivity mechanism in order to churn out armaments and shoddy manufactured goods, neither of which would have any use in a market economy.
Such misallocation of resources was not just a menace of the interwar period. The big pre-2008 construction boom in Spain did as much harm as subsequent high unemployment, because it encouraged a generation of young people to take high-paying, low-skill jobs in the building industry.
But simply permitting the crisis to continue is a terrible option. A severe and long-lasting episode of large-scale unemployment is devastating, because it erodes an economy’s skill base, undermines human potential, and affronts human dignity.
Government policy should thus be subject to a longer-term test: How effectively is initiative being enabled and skills developed? But the answer to that question is not why the pundits are cheering Obama. They are cheering because financial markets are cheering, following the Federal Reserve’s recent announcement of further stimulus.
Though the evidence that monetary stimulus produces increased investment and a business upturn is patchy, its effects on financial markets and asset prices are very easy to document quickly. Asset prices create a large “wealth effect” that determines how financially well off people feel. With many Americans anxiously monitoring the monthly performance of their private pension plans, the only economic statistic that matters is that the S&P 500 has returned to its pre-2008 level.
As a result, the lesson about the economy’s electoral salience is being subtly reformulated. It is no longer the real state of the economy, but rather the perception of asset markets, that is crucial. And the perception can be far removed from reality, which means that the more the prevailing political wisdom assigns decisive electoral importance to the economy, the greater the temptation to view monetary policy’s impact on asset prices, and not on long-term growth, as crucial.
In America, the Federal Reserve is bound to become much more politicized as a result. Republicans will blame their defeat in November on the Fed’s monetary stimulus (if not on the ineffectiveness of Mitt Romney’s blunder-filled campaign).
Meanwhile, in Europe, many national leaders, looking at Obama and the Fed, may conclude that they would do better with more direct control over the central bank. Given the difficulty of establishing such control over the European Central Bank, the euro’s next great challenge may be growing sentiment in favor of a return to national currencies.