The last decade hasn’t been kind to economists’ egos. Almost no-one saw the 2008 crisis coming. The subsequent recovery has been ‘too slow for too long’. And, at a deeper level, there is widespread discontent with the way the middle class has been left behind while a tiny fraction is enjoying a repeat of the ‘gilded age’.
Thus economics seems to be in need of root-and-branch rethinking. The tried-and-true macro-economic policies that should have ensured a rapid recovery after 2008 are inadequate, with monetary policy resorting to distortionary settings of interest rates and exploring policies (‘helicopter money’) that speak more of desperation than rational analysis. Fiscal policy has been left on the sidelines by a combination of fixation with debt and far-fetched academic theories designed to support doctrine rather than recovery.
This reappraisal has been underway for some time. On macro-policy, the International Monetary Fund has shifted a long way from its initial support for austerity, although it hasn’t much to offer other than the general mantra of ‘structural reform’. This falls on deaf political ears (‘We all know what to do: we just don’t know how to get re-elected after we have done it’).
Meanwhile there is the rise of structural explanations, each with its recommendations for change. Thomas Piketty’s analysis of the return to Downton Abbey has been overwhelmingly supported, but his solution of higher taxes has not. Larry Summers sees partial salvation in more infrastructure spending, but at the same time worries that entrepreneurial dynamism is dead. Robert Gordon’s view is similarly dismal: the dynamics of the 1870-1970 century were driven by life-altering innovation, which has petered out.
Stephen Cohen and Brad De Long add to this structural-focused analysis with Concrete Economics. They draw their lessons largely from the history of the US, described as ‘the place where economic policy has been, without a doubt, the most successful over the last couple of centuries’.
This book tries to remind us, in simple concrete terms, of how the American economy, again and again, was reshaped and reinvigorated by a loveless interplay of government making broad economic policy and entrepreneurs seeking business opportunities.
In recounting the history of America’s economic success, they show that in each phase of development the government played a central role in giving broad direction, leaving it to private-sector entrepreneurs to innovate and experiment within the environment of incentives and constraints set down by the government. Each new phase had broad public support, with trade-offs, compromises, subsidies and division of the benefits determined by the political process.
Some of the early history will be of more interest to Americans than to others, but the post-WWII period from Eisenhower to Kennedy had such international influence that the narrative is broadly familiar to all. The progressive elements that Cohen and De Long advocate were all present. Administrations were prepared to take a major role in the economy. Defence expenditure, running at 10% of GDP (twice the current level), was a major instrument in guiding private industry into areas that were seen as the most promising. Government-funded infrastructure (such as the national highways in the 1950s) opened up scale opportunities by reducing transport costs. Suburban housing proliferated, epitomising the ‘good life’ and providing strong demand for home-improvement. Education expanded rapidly, and with it high-level university research.
There was very little doctrine driving these decisions. Pragmatism and experimentation prevailed rather than dogma. The whole spectrum of policy tools was used: infrastructure development, tariff protection, direct picking and promoting of winners, exchange rate devaluation, and selective protectionism through import quotas and ‘voluntary’ export restraints by trading partners. The aim was not simply to direct resources according to comparative advantage, but rather to change America’s comparative advantage. This environment produced a flood of high-technology productivity-enhancing inventions.
The authors see the last redesign of the American economy, beginning in the 1980s, as quite different; and inferior. America allowed its manufacturing to be eroded by competition from East Asia, believing that the way ahead lay in a post-industrial world — the higher-value industries of the future. The government had no concrete practical plans for this new era: just a doctrinal faith that deregulation and free markets would deliver the right answer.
The pervasive doctrine of ‘the magic of the market’ was sometimes beneficial (deregulation of airlines), but more often encouraged resources to flow into areas of doubtful benefit for productivity and living standards. [fold] The prime example is the financial sector, which doubled its share of GDP and put the best-and-brightest into innumerable variations of re-packaging finance and trading, with no more benefit to society than a casino. The additional resources in finance didn't improve price discovery and investment allocation. And it all unraveled in the 2008 crisis.
Finance is not the only example. America’s litigious society means its best brains arm-wrestle each other. A market-based health system accounts for 17% of US GDP (compared with 11-12% in most advanced economies), weighed down by top-heavy, paper-shuffling administration. The pre-2008 real estate boom was a bonanza for those who organised the transactions, the real estate agents and lawyers.
Certainly, there are winners: there is no denying the success of Silicon Valley and Hollywood. But these industries are too small and too specialised to provide jobs for the blue-collar and clerical middle class, displaced by imports and technology.
Where do the strongly-dirigist policies of the East Asian successes (Japan, Taiwan, South Korea, Singapore and now China) fit into this narrative? Cohen and De Long seem to see these as having many of the desirable attributes the authors advocate, although a key ingredient of these countries' success — a ready global market for exports — is not an option for all. But aren’t these successes counterbalanced by the failures of similarly-dirigist policies in Latin America, starting with Argentina, once counted among the richest countries in the world? It’s hard to identify generalities which explain the diversity of the successes and failures.
Of course it is easy to find fault in this latest effort to pick apart what has gone wrong with economic policy-making. But each successive contributor to the debate — whether Piketty, Gordon, Summers or Cohen and DeLong — identifies three common themes. The pernicious influence of doctrine (and specifically the free-market ideologues); the insidious undermining of political consensus through income mal-distribution and the rise of politically-powerful vested interests; and the misallocation of our best talent into finance, with so little apparent benefit to society.
Photo courtesy of Flickr user Chris Devers