Making sense of economic policy
The past week has seen a marked deterioration in economic sentiment. Job creation numbers in the US were lousy. More evidence of a growth slowdown in China was made public. India’s political paralysis continues. And, in Europe at present, the focus of so many fears, the Spanish government bond spreads reached levels that in the past have triggered bailouts in Ireland, Greece, and Portugal.
Grim world economy prospects challenged participants at the annual Transatlantic Economic Dialogue that just took place in Washington, DC. The question on everyone’s mind was: What is to be done? The Germans, who sponsor the meet, were out in force and a number of the hardliners — all former central bankers — read the ‘riot act’ and rejected all criticism.
As we listened, we got the sense that the hardliners were addressing not just the foreign audience, but also, the German foreign policy experts present, some of whom are concerned that Germany’s high standing in Europe is being undermined by the hardliners’ criticism of the bailout countries. Germany may soon have to choose between economic purity and good relations with much of southern Europe. My money is on the foreign policy imperative trumping others in Berlin and the hardliners being marginalised in the months to come.
Speculation aside, we begun to think about why the hardliners’ arguments weren’t convincing. Why weren’t they making sense? Four tests came to mind, which might help assess policy advice now that the storm clouds are gathering again over the global economy.
To avoid accusations of putting forward unproven recommendations, policy advocates frequently cite evidence from this country or that, which has successfully followed similar advice. The problem is that, often, the evidence doesn’t quite match contemporary circumstances. Nowadays, the hardliners recipe involves simultaneously implementing fiscal austerity, bank deleveraging and writing off bad debts and structural reforms (such as labour market reforms). However, all too often, the evidence they offer concerns countries that have successfully implemented one of these reforms. That’s not enough. We deserve to be told if all three sets of reforms can be successfully pulled off at the same time. The first test then is whether the evidence really supports every recommendation made.
Questions-and-answer sessions provide the fodder for the second test. Most difficult economic policy choices involve assessing and balancing competing factors. Little is clear-cut — if it was, such policy proposals would command wide-ranging support and there wouldn’t be much debate in the first place. So, be concerned if a policy advocate’s reaction to tough questions concedes absolutely no ground. Watch for attempts to change the subject or to denigrate alternative proposals through insinuations about their proponents’ track record or integrity.
A third test is whether principles — in the worst cases, morality masquerading as principles, rather than desirable results in some realistic timeframe, are used to justify an economic policy proposal. Ask yourself if you are listening or reading a proposal that will sacrifice living standards now for an unspecified period of time to reach the ‘promised land’. How long will the pain last? How confident can we be that the implied adjustments in the economy will work out as advertised?
Such purists often sweep other values under the carpet. At the moment, it is very fashionable to condemn the debtors in Greece and Spain, while overlooking the fact that someone, or, rather some foreign bank — decided to lend them the money in the first place. The lender freely entered into economic transactions involving more than one party; so, why does it make sense to blame borrowers but not creditors? Principle-based arguments have a tendency to frame policy choices in a one-sided manner.
The fourth test takes into account the fact that most countries, where there are real problems today, are democracies. All policy proposals must pass through a political filter. The fourth test then is whether a policy proposal can develop enough support across the political spectrum to ensure its faithful implementation. Policy proposals that target one group in society, often demonised by hardliners for being lazy, inefficient or corrupt, are not likely to pass this test, unless, much of the rest of society is united against the group in question. Many policy proposals on employment protection, welfare state, and privatisation reforms fail tests of political viability.
If the world economy is slowing down, and if, Europe is on the brink of another round of bailouts and instability, then, quality policy proposals would come at a premium. At the moment, creditors are in the driving seat, offering policy proposals that quite frankly, don’t meet the four tests mentioned here. For the sake of living standards everywhere, we must do better.
Also published in the Financial Chronicle, 6th June 2012