All 14 entries tagged Politics

Rationalising the Macroeconomy

Writing about web page http://www.ft.com/cms/s/0/478de136-762b-11de-9e59-00144feabdc0.html

In The Financial Times on July 21, Paul de Grauwe published the best comment I have read so far about the crisis in macroeconomic policy. If your time is scarce, don't read on; click the link and read him.

De Grauwe makes a fundamental argument, which I will summarize in four steps.

• Today, macroeconomists are distributed along a spectrum from "Keynesian" at one end and "Classical" at the other. They tend to clump at the extremes so there are many passionate Keynesians and passionate Classicals, as well as less passionate scholars in between.
• The Classical macroeconomists expect the macroeconomy to bounce back quickly from a major disturbance (for example, a credit crunch) on its own accord; government intervention is more likely to hinder than help. The Keynesians believe the opposite.
• For practical purposes, both schools model the behaviour of the people in the macroeconomy as follows: their behaviour is based on expectations of the future that are guided by the model, whether Keynesian or Classical. Classical macroeconomists assume that people's behaviour is based on the expectation that the outcome of the Classical model will be fulfilled, and Keynesian macroeconomists similarly.
• In both models, these expectations are self-fulfilling.

De Grauwe's punch line:

So what? Does it matter that economists disagree so much? It does. Take the issue of government deficits. If you want to forecast the long-term interest rate, it matters a great deal which of the two camps you believe. If you believe the first [Classical] one, you will fear future inflation and you will sell long-term government bonds. As a result, bond prices will drop and rates will rise. You will have made a reality of the fears of the first camp. But if you believe the story told by the second [Keynesian] camp, you will happily buy long-term government bonds, allowing the government to spend without a surge in rates, thereby contributing to a recovery that the second camp predicts will follow from high budget deficits.

In short, in a Keynesian model, the agents are assumed to expect that a credit crunch will have lasting adverse consequences. As a result they will rein in consumption (because households expect lower incomes) and investent (because firms expect depressed markets). The economy will stay depressed until government action flips the economy back to normal. But in a Classical model, the agents are assumed to expect that a credit crunch will soon be overcome, provided markets are allowed to work normally. Do nothing, and any damage to confidence will soon be restored. Unnecessary government action, however, by enlarging public spending and debt, will depress long term expectations and so inhibit the restoration of confidence.

This point is not new. I'm not sure who made it originally. It has been around a long time. I checked my notes from 1998/99, the first year I lectured to first year undergraduates at Warwick on this particular topic. I found the following passage:

We’re trying to explain a state of the world in which at least some unemployment is involuntary, money isn’t instantly neutralised by price change, and business cycles last anywhere between 5 and 9 years. The fundamental problem of the RE [rational expectations] approach is that it proves this state of the world can’t exist. Underlying this are some basic conceptual faultlines.  Learning from experience may be more difficult than RE theory assumes. Large experiments are rarely if ever repeated under controlled conditions (e.g. joining, then leaving the ERM). Large shocks (e.g. oil shocks, monetary shocks) make it hard to discern the underlying things which remain the same.  What is the true model of the macroeconomy? RE theorists tend to assume that most people adhere to a Classical philosophy. But since economists have such difficulty decided how best to model the economy, it’s not clear why rational non-economists should be different. Policy demonstrably does affect the real economy, so why should rational people believe it won’t?  This is particularly important since the outcomes of actions based on RE tend to force the world to conform to the model, not the other way round. What is created here is a "guessing the winner" problem: what’s important in forming rational expectations is not "how does the economy work?"; nor even "how does the economy work in my opinion?"; but "how does the economy work in most people’s opinion", bearing in mind that in forming their opinions they are all asking themselves the same question.

I claim absolutely no credit for this; I was not saying anything original. I got the argument from somewhere or someone else. My point is that the basic paradox in rational expectations has been understood for a long time, but the horrendous policy implications are perhaps only now fully apparent.

How bad does that make economists? Ten years ago I told my students that the idea of rational expectations, although not wrong, contained a paradox. I had no idea how to resolve it, however. One route the profession has taken has been to consider that, just as economists learn, so do non-economists. As a result, macroeconomic models have been developed that incorporate heterogeneous expectations -- when different people in the macroeconomy start out with different models of how the economy works and so different forecasts of the future -- and model how they might then learn from experience. A recent review by George W. Evans and Seppo Honkapohja is here.

This takes me well outside my comfort zone. I thought about it, however, when a friend forwarded some lines from an internet discussion including the suggestion:

Until the "science" of economics detaches itself from econometrics and unilateral modelling and realises that humans are "rationalising beings", not "rational beings", then the predictions and opinions stemming from its adherents should be treated with caution.

In the context I took the gap between "rationality" and "rationality" to reflect some falling short of cognition or computation. It wasn't that I disagreed; the suggestion seemed almost trivially true (apart from the reference to econometrics, which seemed silly). What it made me think is this: If humans are "rationalising beings," then so too, being human, are economists. All economic models have cognitive and computational limits. They model reality; they don't and can't reproduce it. 

In the often misquoted words of George Box and Norman Draper (from Empirical Model-Building and Response Surfaces, New York: John Wiley 1987, p. 63):

All models are wrong; the question is how wrong do they have to be to not be useful.

Mark Harrison : 27 Jul 2009 09:15 |  Tags: Economics Keynes Politics Recession |  Comments (3) |  Close comments |  Report a problem

Afghanistan's Future Lies in the Past

Writing about web page http://www.guardian.co.uk/world/2009/jul/12/paddy-ashdown-afghanistan-policy

A few days ago Nicholas Watt, chief political correspondent of The Guardian, reported Lord Ashdown in the following terms:

In remarks likely to fuel the debate about the future of the war, Ashdown accused Britain and other European countries of setting "ludicrously ambitious targets" of attempting to turn Afghanistan into a fully democratic and progressive nation.

I thought to myself: Of course, Ashdown's right. Then, I recalled a short paper that I wrote and circulated more than 7 years ago (my first draft was dated 4 December 2001), when blogs were in their infancy (and years before I started one). Anyway, no one noticed what I had to say at the time, that's for sure.

My argument was simple: For Afghanistan, real democracy (and real capitalism) was going to be a step too far. If not democratic capitalism, what should we aim for? My answer was: For a country like Afghanistan, even feudalism would be a step forward -- as long as it was of the right kind.

This is a very general argument. It is about our goals, more than the strategy or tactics required to achieve them, or the value and costs of doing so. I don't have a clue about important details like whether we should have fortified bases in Helmand or even whether we are currently winning or losing.

Still, I believe the merit of my general argument has, if anything, been strengthened in the years since 2001. If nothing else, Paddy Ashdown agrees! So, I decided to reprint it. Starting here is the full text, exactly as I revised it on 9 January 2002.

What Afghanistan Needs is the Right Kind of Feudalism

Afghan warlords have been meeting in Germany to try to agree their country’s future. This future looks bleak. Afghanistan lies ruined by decades of foreign intervention and civil war. Its territory is being redivided among heavily armed rival warlords with dreadful records of human rights abuses based on ethnic and religious factions that hate and mistrust each other. How, under these conditions, can Afghanistan’s economy be rebuilt? How can purpose and prosperity be returned to its people?

It might be thought that what Afghanistan needs is a powerful dose of democracy and liberal capitalism. This isn’t going to happen, at least not for a century or so. For a start, take democracy. We think of democracy as “majority rule”. But majority rule by itself is not enough. It’s also important that the majority doesn’t rule by exterminating minorities. In a democracy, minorities have rights that cannot be overriden: rights of free speech, criticism, and opposition. In Afghanistan there are many minorities, but there is also too much hatred and there are too many guns for any minority to be sure of these protections.

Then take capitalism. For a capitalist market economy to work ownership rights must be taken for granted most of the time. Business grinds to a halt if you have to spend all your time guarding your property with guns, or paying lawyers or bribing officials to get what you’re due. If warlords, thieves, or bureaucrats take a cut too frequently, economic life will slow down or come to a near stop. Too much of a cut and the only activity that’s left is when people grow their own food and then hide it until they can eat it. Afghanistan has already come to this.

Feudalism is the best that Afghans can hope for right now. Feudalism emerged in Europe from the Dark Ages, when the costs of fighting became so heavy that warlords got together and chose rulers to keep order among them. The result was a more stable form of society in which everyone had prescribed rights and responsibilities and everyone knew their place. In fact, everyone was fixed in place: peasants in their villages, squires in their manors, monks in their monasteries, kings in their courts. The farmer served the noble by providing him with food and labour. The noble served the king by providing him with taxes and men. Kings and nobles provided justice and protected those under them. As a result, economic progress became possible. Feudalism of the right kind proved prosperous and stable, and left monuments of art and culture that are still admired and loved after many centuries.

It’s true that feudalism was an unfree society. People could not choose where to live, what to believe in, whom to serve, or with whom to trade. Peasant revolutionaries saw it as organised robbery. Women and children were subjected to domestic tyranny. Yet it was not the worst of all possible worlds. For what feudalism restricted first of all was the universal freedom of each to rob and kill all others.

The late American historian Mancur Olson put it like this: such rulers are thieves, but a thief who stays in one place and settles down is better than one who plunders and moves on. The reason is that the thief who settles and rules the territory around him has an interest in its prosperity. He protects the people under him in his own self– interest, because they are his assets. To enlarge his own revenues he gives them legal rights and provides them with services to encourage the economic activity that he can tax. Thus as European society was stabilised on feudal lines, dukes and kings built roads and towns, provided schools, and organised trade. They taxed the trade, which was bad, but they prevented others from taxing or robbing it and this at least was good. They spent heavily on armies and navies; they also patronised the arts and sciences. They provided law: the laws were biased in their favour, but at least there were laws, not just the law of the jungle. Even the hereditary character of the lords and monarchy, which now seems laughably antique, had an important function. By agreeing to the hereditary principle, the nobles gave incentives even to a dying ruler to care about the stability and prosperity of the kingdom he would bequeath to his children, and ensured that the ruler’s death would be followed by an orderly succession, not civil war.

It will be a step forward if the Afghan leaders meeting in Bonn can agree upon this kind of society. But they will only do so if their self–interest lies there, so that they recognise the alternatives of unbridled rivalry and civil war without end as worse. The thief who controls a province promotes its prosperity only while he can be sure some other thief will not invade it and drive him out. The Afghan warlords need to agree some rules of mutual self-restraint. Everything must start from this. Otherwise there will be no rules at all and Afghanistan will return to civil war; or a dictator will emerge to restrain the warlords by force, and Afghanistan will have to undergo a new tyranny.

What kind of feudalism? It was important for European countries that their feudalism was of the right kind. The ruler had to accept limits on his power in relation to both the nobility and all citizens. In England the king’s responsibilities were agreed among the nobles and written down in the Magna Charta of 1215 which also set out principles of justice, ownership, and trade. The Magna Charta stopped the king from robbing, imprisoning, and killing without lawful reason. The result was that the English monarchy became more pluralistic than tyrannical. The state and religion, although not fully separate, at least retained separate powers. Women had some rights, although fewer than men. There was a Parliament, although at first it was only for the nobles.

For England the next few centuries included a necessary civil war to cut down the ambitions of the Tudors and Stewarts, and a period in which burgeoning democracy nearly descended into wholesale corruption. There were many colonial wars in which Englishmen behaved badly to the Scots, Irish, Africans, Indians, and others. At the same time they continued to mistreat large numbers of English women and children and also each other. British history has not been a Sunday School picnic. Still today there is enough poverty and discrimination at home that we cannot afford to be complacent. But by global standards Britain has become a relatively prosperous and stable society. If you were born here or can get in, it is a freer place to live than most. Is feudalism really the best that Afghans can hope for? I do not mean that we should silence Afghan democrats when they ask for elections or Afghan women when they demand education and a visible role in society. Part of the deal should be their right to speak and be heard. But we should not blame Afghan rulers who do not deliver this immediately and in full. There are worse things they can do, such as return Afghanistan to a perpetual state of internal warfare.

There are implications for the west. The decisive step in reconstituting Afghanistan is to establish the rights of the rulers, not of the ordinary people. If ordinary Afghans are to gather more rights than they have at present, they will flow at first from the self–interest of the rulers, not from ideals of citizenship and democracy or conventions on human rights. Only a stable division of rights of the rulers will provide this. We shouldn’t expect too much from Afghanistan’s new rulers. The big rewards that the west can offer, such as dollars for reconstruction and development, should be delivered to those that show commitments to peace, to rule that is governed by law, and to separating religion gradually from the state.

As for democracy and a market economy in Afghanistan, these lie in the future. Mancur Olson also wrote that democracy had the best chance to evolve when it was hard for one ruler or group to impose their will on all the others, leading to an absolutist dictatorship. To encourage power-sharing, and make it difficult for new big or little tyrants to emerge, we should distribute aid to projects and communities that cross the boundaries of each warlord’s domain, valley by valley. Perhaps a period of enlightened, pluralistic feudalism may then permit Afghanistan to evolve over the next few centuries into a more decent place for its citizens to live.

This version:  9 January 2002. First draft: 4 December 2001

Mark Harrison : 18 Jul 2009 15:33 |  Tags: Afghanistan Politics |  Comments (1) |  Close comments |  Report a problem

Moats, Mole Catchers, Munchies, and Mortgages

Writing about web page http://www.guardian.co.uk/news/datablog/2009/jun/19/mps-expenses-houseofcommons

What on earth were they thinking of, as they filed their claims for moat cleaning, mole catchers, munchies, and non-existent mortgages? Where was their sense of decency? Of reality?

The answer is most likely that members of Parliament are just ordinary people, doing what ordinary people do. Sometimes, ordinary people that join together in a crowd do things together that they would not do individually. Their sense of normality comes to differ from that of others, precisely because it comes from the crowd they belong to, not from outside; because of this they come to behave in ways that other ordinary people not in the group find ridiculous or abhorrent. The "in" crowd are not bad people, at least to start with, but they may end up doing bad things.

This is part of a growing field at the interface of economics and psychology -- the psychology of crowds, and the economics of herd behaviour. A recent article by Andrew Oswald on Herds, Housing, and the Crisis provides an application to the housing market bubble. It can also apply elsewhere. Recently, MPs have had a bubble of expense claims -- or is it that the public has overinvested in the trust we place in our representatives? Either way, the bubble has been well and truly pricked.

Yet the truth is that our MPs do represent us. We are, most of us, capable of being like most of them.

The best recent evidence of this comes from a recent study of MBA students carried out by Scott A. Snook, an associate professor at Harvard Business School. (His study will be published soon by Harvard University Press as Becoming a Harvard MBA: Confirmation as Transformation). Looking at their ethical maturity, Snook found that his students fell into three roughly equal groups.

One group of students had reached the fully-developed, self-authored adult perspective that we would like to think we all have. Deciding to undertake some action or other, they would judge: It’s okay because, having fully weighed the costs and benefits to others, I have decided that it is. At the other extreme, there was a group that operated from a largely "transactional" view of the world. They would act, having judged: It's okay if it benefits me. Of greatest interest to me was the intermediate group, described as predominantly other-directed. These would act on the basis: It's okay if others do it too.

It's really not difficult to construct the dialogue that most new MPs must have been through. "Can I really claim that?" "So, do the others claim it?" "Oh. Okay."

It doesn't make it right. It just makes it understandable. To me that's a good thing; I'm a social scientist, not a judge. Have we put too much trust in our elected representatives? Of course. Do we expect too much of them? For sure. Do they need new rules? Absolutely. But we need to remember they are just like us, even in ways that we might find uncomfortable; for one thing, they are no more (and no less) moral than we are.

In fact, they are just like us in every way -- but two: First, they are more ambitious than the average, and that is how they get to be where we put them. Second, we put them in a special club, the Houses of Parliament, a club where they learn from each other and learn to follow each other.

We need to get used to it.

Mark Harrison : 22 Jun 2009 20:18 |  Tags: Politics |  Comments (1) |  Close comments |  Report a problem

Saintly Inquisitors

Writing about web page http://www.nytimes.com/2009/04/18/world/middleeast/18zubaydah.html

On April 18, the New York Times reported:

Abu Zubaydah had provided much valuable information under less severe treatment, and the harsher handling produced no breakthroughs, according to one former intelligence official with direct knowledge of the case. Instead, watching his torment caused great distress to his captors, the official said.

By implication, the CIA operatives who first did this were good people who implemented a bad policy reluctantly and against their own better judgement.

That's something I can credit. I don't have a problem with believing it.

But there must be more. I explained why, in a short article I wrote more than seven years ago, back in November 2001 when the policy of torture was still a twinkle in Dick Cheney's eye. I wrote:

The practice of torture also attracts those who find it enjoyable and use it as an instrument of self-gratification rather than investigation.

How else could you explain the fact that, as the New York Times reported on April 19:

The C.I.A. officers used waterboarding at least 83 times in August 2002 against Abu Zubaydah, according to a 2005 Justice Department legal memorandum ... The 2005 memo also says that the C.I.A. used waterboarding 183 times in March 2003 against Khalid Shaikh Mohammed, the self-described planner of the Sept. 11, 2001, terrorist attacks.

It defies belief that the same inquisitors continued to experience the same distress throughout these 83 episodes, let alone the 183 times (six times on an average day!) that they or others waterboarded Khalid Shaikh Mohamed in the month of March 2003. Either they changed their feelings, or they changed places with others. The CIA officers that initially found the practice of torture "distressing" must either have overcome their scruples and learned to find satisfaction in it, or they would inevitably have given up their place to others that enjoyed it without forcing themselves.

The outcome, I concluded back in 2001, is that:

The process of torture is corrupting ... It gives rise to vested interests in its continuation that do not wish to be held accountable for their actions. These interests are helped by secrecy. Torture takes place in secret. Most people find the subject distasteful and do not wish to know about it, and this further strengthens the wall of secrecy. The result is a part of the state that exercises a cruel and tyrannical power over society, one that grows inevitably with the extension of torture and has the power to resist subsequent attempts to curb it.

It is something of a miracle that today, this cruelest form of corruption has not only been curbed but is being brought to light.

Mark Harrison : 21 Apr 2009 06:01 |  Tags: Politics Torture |  Comments (0) |  Close comments |  Report a problem

The Other Enemy

Writing about web page http://blogs.ft.com/maverecon/2009/04/the-green-shoots-are-weeds-growing-through-the-rubble-in-the-ruins-of-the-global-economy/

Looking back on the G20, there seems little to say that has not been said better by Willem Buiter in his recent blog. I'm going to address a related question: Are our leaders now doing too much, or too little?

Here are some people who think president Obama and prime minister Brown are doing too much: The British (Conservative) and United States (Republican) oppositions, and the governments of France, Germany, Ireland, and the Czech Republic. In varying terms, they fear the same enemy. Fiscal action to combat the Great Recession will cause very large increases in the public debt. In the medium term there will have to be a heavy settling of fiscal accounts. One risk is that governments that have started to enjoy their wider powers will try to pass the burden onto others through inflation or default. Even if they deny themselves this pleasure, they will have to enact tax increases that risk causing large market distortions. Persistent damage to market institutions could ensue, justifying further expansion of the role of government. This is what people mean when they refer to creeping collectivism or socialism.

As I have said before (but Buiter says it better), there is genuine reason here for concern. But those of our leaders that have lined up in the "too much" camp are facing the wrong way. In doing as much as Obama and Brown have been prepared to do, we risk creating one enemy. But the other enemy is the one we will cede power to by doing too little. And this enemy is the more dangerous of the two.

By doing too little, we will give up the political middle ground to populists and pressure groups of left, right, and middle England: protectionists, advocates of self-sufficiency and economic isolation, nationalists, xenophobes, and proponents of extra-parliamentary politics and direct action. I do not meant that such people are all the same; they are not. But whether they fight side by side or against each other, they are capable of destroying confidence in representative democracy. This would give away far more power to arbitrary government than a little gentle Keynesianism.

No one can be 100% sure, but I don't believe our leaders have done too much. They may have done too little. By doing too little, we risk a future governed by those that want to weaken the market economy permanently, or even destroy it, not fix it.

To try to do nothing in the face of the Great Recession is not even desirable. The unnecessary ruin of hundreds of thousands of businesses and households, and the consignment of a similar number of young people to unemployment, would be a great social crime. Bad as it will be to burden our children with a larger public debt in the future, it would be worse to burden them with a Great Depression in the present. The current wave of layoffs and bankruptcies is already under way, and nothing can now stop that, but we can and should do all we can to mitigate its extent and duration.

To try to do nothing will eventually fail, because our society will not tolerate complete inaction on the part of its leaders. Remedial intervention in the economy is inevitable. This means that, in the next few years, there will inevitably be more public spending, debt, and regulation. Just as most medications have harmful side effects, remedial intervention that is guided by the best intentions and the best judgements will have harmful spillovers and unintended consequences.

I would like to see remedial intervention carried out by politicians who do not relish it, but understand it as a necessary but temporary expedient, to be reversed in the medium term. I would apply this even to banking regulation: clearly, the regulatory framework must change, but it should not leave a permanently greater role for political action.

Maybe that's too much to ask. But it is what our future demands.

The alternative is to give up the keys of the city to the other enemy: to allow the remedial instruments to fall into the hands of state-building entrepreneurs who will use them enthusiastically to accumulate power, build persistent economic and political monopolies, and gradually acquire the means and motives to suppress criticism and opposition.

Mark Harrison : 14 Apr 2009 05:51 |  Tags: G20 Globalization Politics Recession |  Comments (2) |  Close comments |  Report a problem

War and the Great Recession: Some Thoughts

A while back, an American journalist wrote to me:

We ... are trying to determine how big of a war we would need to have in order to drive the US out of this recession.  It is common belief that WWII was a major factor in invigorating US economy which had been decimated during the Great Depression.  I was wondering if it would be possible to make a projected estimate for our current situation using that era as a model. 

This question got me thinking and I put quite a lot of effort into some answers, which they did not use. So, I thought I would update them and share them here.

Basically, the question sees the problem back to front and upside down. The problem we should be thinking about today is not how to start a war that can help pull us out of recession. The real problem is that, if we don't pull ourselves and others out of recession fairly rapidly by peaceful means, we will face growing risks of war -- and that could end in a catastrophe for everyone.

So, it is a trick question. Sometimes, however, it is interesting to take trick questions at face value and work out what is wrong with them by seeing where they lead. This is what I did.

• Is the situation of the U.S. economy today comparable with the Great Depression?

At the moment, the situation of the U.S. economy over the next year or two looks bad compared with the recent past, but it is still way better than it was in the 1930s. Economists often work in terms of what is called the "output gap," the proportion of potential output that is unrealized because there is not enough demand in the economy. The Congressional Budget Office currently expects the output gap over the next two years to average almost 7 percent.

There are various ways of calculating the output gap of the U.S. economy before World War II, and it varied a lot from year to year, but any reasonable estimate would be far above 7 percent. At the bottom of the depression, in 1932, the gap was probably around one third. At the end of the first recovery, in 1937, around one fifth of potential output was still not being realized, and in 1938 and 1939 the output gap widened again. It had got back to relatively normal levels by 1941.

So the good news is that, on present forecasts, the fiscal stimulus that is required to fix the U.S. economy is much less than was called for in the 1930s. What everyone should worry about, though, is that if things play out badly in the world as a whole there is plenty of scope for present forecasts to prove optimistic.

• What size of war would be required to provide an equivalent fiscal stimulus?

U.S. GDP is currently around $15 trillion a year, and so an output gap of 7 percent means about $1 trillion a year of lost production. Since, in the U.S. economy, an extra dollar of public spending should give rise to about an extra $1.50 of total (public plus private) spending, a stimulus of around $700 billion a year would be needed to stimulate $1 trillion a year of extra output.

As far as I am aware from press reports and so on, the total U.S. budgetary appropriation for the global war on terror (Afghanistan, Iraq, and the protection of U.S. embassies abroad) has reached around $1 trillion in total, spread over the entire period from 9/11 to the present. I am not certain what the annual cost is currently, and I believe that not all of it is explicitly funded (i.e., the GWOT has been partly funded by the Defense Department taking resources from elsewhere.) For the sake of argument, suppose the net budgetary cost of the GWOT has recently been of the order of $200 to 250 billion a year. To provide a stimulus of $700 billion a year, therefore, the required war would have to be the equivalent of three additional global wars on terror, waged on the scale of the recent past.

How does that compare with the fiscal stimulus package that went through Congress recently? The package is $700 billion spread over two years, and much of it is tax cuts rather than public spending, which will have a lesser impact because tax cuts can be saved rather than spent privately. It is one half or one third of the stimulus that would halt the slide, so it runs the risk of being too little, too late.

One reason for the modest size of the package is that President Obama is restrained by conservative opponents of big government in Congress. I suppose someone could argue that a war might help to overcome such constraints. I think that would be a bad argument. It amounts to saying that we should whip up nationalism in order to stigmatize the people we disagree with as unpatriotic and crush them. That is not unheard of, but it does not appeal to me.

• How good for the U.S. economy would it be to have another war?

History should make us very skeptical. Here are five reasons. First, it is true only in small part that World War II pulled the U.S. out of the depression. In fact, 1940 was the first year after 1919 when U.S. military spending rose above 2 percent of the national income. The fiscal stimulus from New Deal spending was also modest. The main driver of the U.S. recovery up to 1940 was private investment. If World War II had not broken out, this natural recovery process would have continued.

Second, it is true that the wartime period saw a huge further increase in the total output of the U.S. economy. In the three years from 1941 to 1944 the GDP rose by about two thirds. The main element in this was Federal outlays on national defense that brought about a vast increase in the mass production of standardized machinery and equipment for combat and transportation. Because of mobilization and wartime controls, patriotic national feeling, and mass production and the associated efficiency gains, the U.S. economy could temporarily produce far above peacetime norms -- effectively, there was a negative output gap. But the extra output did not make anyone better off; it was mainly in the form of ships, planes, and guns that achieved victory, not higher living standards.

After the war, most of the extra output disappeared and the economy fell back, not towards depression, just towards normal peacetime operation. So the wartime "production miracle" did not bring about lasting gains. The U.S. economy was much more prosperous after 1945 than before 1941, but this was not because of the war. It was because of the return to normal working combined with underlying productivity advances that had continued through the Great Depression, but were temporarily overwhelmed by the lack of demand.

Third, it is true that millions of U.S. citizens had a good war, economically speaking. Many people would previously have expected to live out their lives in poverty in the South and Mid-West. They moved to the industrialized, urbanized North and found new lives there. Many young men gained new skills and experiences by joining the military and fighting or supporting the war effort overseas. You might ask whether there were cheaper ways of achieving the same goals without having to fight a war. I don't mean that American involvement in that particular war was wrong; it was clearly in America's own national interest. But if you want to achieve a more mobile, equal society, and war is not forced upon you, there are cheaper ways.

Fourth, it needs to be said out loud that war is costly to society in terms of death and disability. I looked up what Michael Edelstein has to say in his chapter on “War and the American Economy in the Twentieth Century,” in The Cambridge Economic History of the United States, vol. 3 (published in 2000), on pages 342 and 349. He measures the budgetary cost of war as the cost of defense above normal peacetime operations, and the social cost is the capitalized value of lost earnings of the killed and injured. Everything is in constant 1982 prices. Edelstein’s estimates are: WW1, budgetary cost $378 billion and social cost $25 billion, WW2 $2,460 billion and $202 billion, Korea $206 billion and $27 billion, and Vietnam $313 billion and $46 billion.

You can see a couple of things. One is that, on this measure, the social costs were relatively small. Why? Mainly because the United States could fight all these wars at a distance against much less well equipped enemies. In World War II, U.S. battle deaths in Europe and the Pacific were around 350,000. In contrast, Red Army battle deaths on the Eastern Front were around 8.7 million.

Another thing is that, on the same figures, the ratio of social to budgetary costs rose continually from war to war. As a share of the combined total, the human costs were around 6% in WW1 rising to 12% for Vietnam. Why? I think, mainly because there was rising productivity, so human life got relatively more expensive. In their book on the costs of the Iraq and Afghanistan conflicts, Joseph E. Stiglitz and Linda J. Bilmes come up with various figures but their “realistic moderate” scenario (The Three Trillion Dollar War, published in 2007, page 112) suggests about 12% for social costs as a share of the total of budgetary plus social costs combined. (Stiglitz and Bilmes include items of veterans’ welfare costs that Edelstein I think does not, but these appear on both the budgetary and social sides of the balance.)

What does this mean? Well, if you want $700 billion a year of fiscal stimulus through going to war, you’d better factor in that, for every year at war, the U.S. economy will also lose a future income stream with a capitalized value of $100 billion, because of troops killed and injured. That does not seem like a good idea.

Fifth, a war today would bring huge costs in further disruption of the international economy. In 1941 international trade was a small fraction of its pre-1913 volume, so there was little to lose. The world today is much more interdependent than it was in the 1930s. Stiglitz has pointed up the billions of dollars lost to the U.S. economy because the war in Iraq triggered higher oil prices. You need to factor that in too.

Maybe I should finish this bit by quoting Edelstein again (on page 349):

It is absurd to think that the methods and perspectives of economic history come anywhere near to comprehending the meaning of human losses from war. We are far better served by the speeches and letters of Lincoln or the poetry of Sassoon, Brooke, Owen, Graves, and Seager.

OK, but where does this leave us?

I have two conclusions. One is that the only good reason to have a war would be to defeat an enemy. If our leaders want to make our economy work better in everyone's interests, and if they have legitimate instruments to achieve this, and if such improvements would also be an accidental by-product of a war, then that is not an argument for a war. It is an argument for adopting peaceful ways to achieve these things that carry democratic consent and do not also involve the irreversible losses and persistent collateral damage that a war would bring.

My other conclusion is that the original question ("how big of a war we would need to have in order to drive the US out of this recession?") confuses the problem for the solution. It's true that the Great Depression ended in the most terrible war the world has seen. But it did not end because of the war; the depression would have come to an end anyway. In fact, the war curtailed the natural recovery process.

But why did the war come about? World War II happened for a number of reasons, but one of them was the great powers' failure to avert the Great Depression in the first place, and rapidly to mitigate it once it came along. Many of the ingredients for violent conflict were there, but until the Great Depression they lacked a spark. Before 1929, was Germany evolving gradually towards a normal parliamentary democracy? Yes. Would Hitler have come to power without 30% unemployment in Germany in 1932? Probably not.

Eurasia today, from the Baltic to the China Sea, has many of the ingredients for violent nationalism. Scattered around that vast landmass, there is more than enough petrol and a good supply of oil-soaked rags. Meeting in London today, the G20 has the power to coordinate an effective international response to the global economic calamity that threatens us. If they fail, it is not just an economic calamity that we should fear; the world's leaders are playing with matches.

Mark Harrison : 02 Apr 2009 13:08 |  Tags: G20 Globalization Politics Recession War |  Comments (5) |  Close comments |  Report a problem

Naomi Klein, Milton Friedman and Me

Writing about web page http://www.warwick.ac.uk/go/markharrison/comment/shockdoctrine.pdf

On February 24, 2009, by Naomi Klein was awarded the first Warwick International Prize for Writing, for her book The Shock Doctrine. On behalf of the panel of judges, the novelist China Miéville described The Shock Doctrine as "a brilliant, provocative, outstandingly written investigation into some of the great outrages of our time."

That got my attention. Here's why. On August 26, 2008, Kurt Jacobsen reported in The Guardian about opposition to plans to set up a Milton Friedman Institute at the University of Chicago. The report included some claims that I thought were wrong. So, I replied. Here's my letter, published on August 28:

Your feature on Chicago's proposal to establish a Milton Friedman Institute of economic research (Milton Friedman gives Chicago a headache, August 26) is misinformed in some important respects.

You state: "In postwar America, Friedman's market fundamentalism was regarded as lunatic-fringe stuff." This was never the case. I learned economics in Cambridge in the late 1960s. My professors followed Keynes and Marx, but they rightly made Friedman's work part of my undergraduate syllabus. Friedman's scholarship, not his opinions, made him one of the most influential economists of the 20th century.

You state that Friedman "worked for General Pinochet". While Friedman visited Chile, he did not work for the dictator. His advice was that Chile should turn back from state control of economic life; in the long run, he argued, free markets and political freedoms go hand in hand.

Finally, you give the impression that the mission of the proposed Friedman Institute is tendentious: "The design and evaluation of economic policy requires analyses that respect the incentives of individuals and the essential role of markets in allocating goods and services ... design of public policy without regard to market alternatives has adverse social consequences." While such a statement may be infinitely qualified, few economists today would dispute the principle.

I didn't expect to get away scot-free. On August 30, The Guardian published a letter from David Waddilove of Teignmouth, Devon:

Mark Harrison (Letters, August 28) is disingenuous about the relationship of Milton Friedman to Pinochet's Chile. Neither does he mention the havoc, bloodshed and mass starvation wrought on the people and economies of, among others, Uruguay, Argentina, Russia and Iraq by the Chicago School's symbiotic relationship with sundry dictators and their personal financial gain from those relationships. Nor, of course, does he mention the benefits to US corporate power wrought by the destruction of the public sector in each country the Chicago School meddles with. It is sad to see Warwick University, once the harbinger of some radical thought, now accommodating such "free" market orthodoxies without reference to their real-life testing grounds. Naomi Klein's The Shock Doctrine should be required reading for anyone interested in what actually happened.

I didn't think of replying, but I didn't like the tone. It seemed to be all guilt by association: Chicago-Pinochet. Chicago-Harrison. Harrison-Pinochet. Harrison-Warwick. Warwick-Pinochet. It looked like I must have blood on my hands. If that was the spirit of The Shock Doctrine, I wasn't sure I wanted to read it. Still, it stuck in my mind.

Months went passed. Then, the prize went to ... Naomi Klein for The Shock Doctrine. Not just any prize, but the first biennial Warwick Prize for Writing, a major literary award endowed by a great university, one that I love and have worked and lived for over thirty years.

Maybe I had missed something.

I got hold of the book and read it. It had a big, important message that I wrestled with. I asked my colleagues what they thought about it. It turned out none of them had read it. I think that is a mistake: the book has already had a significant influence on how people see economics and economists, David Waddilove of Teignmouth being one.

After some reflection, I wrote down what I think about the book in a paper called Credibility Crunch: A Comment on The Shock Doctrine. This is how it begins:

If you think that free markets haven’t worked that well recently, it is perhaps not surprising. If you think that free markets are spread only when business executives, politicians, soldiers, technocrats, and economists join to overwhelm popular resistance by force and violence, then you may have read it first in Naomi Klein’s The Shock Doctrine.

It concludes:

For the [Warwick Prize] panel, China Miéville described The Shock Doctrine as "a brilliant, provocative, outstandingly written investigation into some of the great outrages of our time." The Shock Doctrine merits this praise, but it does not merit belief.

If you are still interested, I hope you'll look at my paper and see the reasoning that fills the gap between my opening and my conclusion.

Mark Harrison : 25 Mar 2009 09:12 |  Tags: Globalization Naomi-Klein Politics Using-Data |  Comments (9) |  Close comments |  Report a problem

G20: Gordon Brown's Got It … Anyone Else?

Writing about web page http://www.guardian.co.uk/politics/2009/mar/13/g20-obama-brown

On March 4, the Prime Minister told the United States Congress:

... never before have the benefits of cooperation been so far-reaching.

On jobs, you the American people through your stimulus proposals could create or save at least 3 million jobs. We in Britain are acting with similar determination. How much nearer an end to this downturn would we be if the whole of the world resolved to do the same?

... Just think how each of our actions, if combined, could mean a whole, much greater than the sum of the parts ... the impact multiplied because everybody does it - rising demand in all our countries creating jobs in each of our countries - and trade once again the engine of prosperity, the wealth of nations restored.

I guess the President was listening. But did he really get it? My point is this. Brown was not just indulging in the easy rhetoric of let's-all-pull-together and unity-makes-us-strong. What he said is literally, word-for-word true. But you have to get the economics to really get it.

Why? A fiscal stimulus by one country acting alone creates a spillover benefit (economists call this an "externality") for other countries. There is an increase in our national debt, which is a cost to us, but part of the benefit, the global increase in demand, is received beyond our borders through our demand for imports. Because it is costly to us, and others reap part of the benefit of what we do, the incentive is for us to do less than we should.

This barrier to action can be overcome by everyone agreeing to help themselves and each other at the same time. We can pull each other out of the hole. Through international coordination, each country can reap the benefit at a lower cost measured by the increase in the national debt.

Without coordination, in contrast, each country gains privately from protectionism, which internalizes the benefit of a national stimulus package at the expense of other countries; hence, beggar-thy-neighbour. The resulting losses from despecialization will be long-term and the damage to the international economy will take decades to undo. Sounds familiar? Yes, it happened before. That, with a few twists, is the story of the 1930s.

When I heard Gordon Brown's speech I thought to myself: "Yes! He's got it!" Did Barack Obama get it? I hoped he did. According to this morning's papers, maybe not. Maybe Obama thought Gordon's words were just special-relationship type rhetoric. Or maybe he figured: the United States economy is so big that the Americans can go it alone more easily than any other country. A  huge loss for the world, but only a small loss for America. (Hmm. I hope that's not what he figured. I'd prefer to think he just didn't get it.)

Much harder for us to understand is the cowardice of France's Nicolas Sarkozy and Germany's Angela Merkel. France and Germany are not giant economies that can go it alone. Yet this morning's papers report Merkel, following joint discussion, sending "a common signal" to the G20 summit that France and Germany will stand aside from any further fiscal coordination (unless you call it coordination when everybody does nothing at once). Merkel said:

The issue is not spending even more but to put in place a regulatory system to prevent the economic catastrophe that the world is experiencing from being repeated.

I see ... We're sliding towards disaster, but the right thing to do is not avert it, just hold a seminar about not doing it again. If we're still there at the end of it, that is.

The denial that is currently at the heart of Europe extends to the fate of Europe's East. I know Merkel and Sarkozy don't want this, but almost certainly we will have to bail out others as well as ourselves. There will be no choice over this; it's just another thing that Merkel and Sarkozy don't get yet.

One thing we will be able to choose: Eastwards, how far will the European bail-out extend? Can the EU risk letting longstanding members like Greece (and Ireland in the West) go to the wall? Surely not. New arrivals like Poland, Hungary, the Czech Republic, the Baltic? Hmm. And beyond EU borders, there lie Ukraine and Turkey. Somewhere, either within or beyond current EU borders, a line will be drawn. Inside the line, we will prop up what we can. The countries beyond it will go to the wall.

Don't underestimate the importance of that line. The countries that lie beyond it will be greatly impoverished compared with their position a year ago. They will have been impoverished by Europe's indifference, our lack of coordination, our failure to lead.

The Great Depression was followed by a recovery, it's true. But by the end of the Great Depression every poor country in Europe was ruled by a dictator.

Mark Harrison : 13 Mar 2009 11:19 |  Tags: G20 Globalization Obama Politics Recession |  Comments (0) |  Close comments |  Report a problem

New Romantics

Writing about web page http://www.guardian.co.uk/commentisfree/2009/feb/20/economics-emotions-human-values

There is a strong case for thinking about how emotion and mood affect economic decisions.

Does my own mood affect my decisions? I discussed this with my wife, and she agreed I'm a model of level headed rationality. But she knows lots of people for whom that wouldn't be true. She's not saying who (but I bet they're not economists).

If mood can affect decisions, does it affect the decisions that really matter? Not all decisions are important. But isn't it at least possible that powerful emotions like joy, fear, sadness, or enthusiasm interfere with our ability to calculate an optimum? Suppose that emotions frame our vision of the future; suppose they are capable of boosting our willingness to provide for the future or winding it down; suppose they make us more or less willing to shoulder risks. In that case, important economic decisions will indeed swing with our moods.

Again the net effect, averaged across millions people, might not add up to much. If one person's mood cancels out another's, the total effect should be zero. But if the moods of millions swing together, in a concerted way, billiions of pounds could swing with them into -- or out of --  particular markets.

And it is intuitively plausible, to say the least, that the mood of millions of people is taking a hit at the moment, as homes and jobs are lost and the fear of loss infects our nation.

As Jon Elster pointed out some years ago in The Journal of Economic Literature (1998), economists have given much closer attention to cognitive limits on rationality than to emotional limits.

Which brings us to the critics of orthodox economics. There are so many at the moment ... it seems invidious to pick and choose. But choose we must, so we'll pick from my daily newspaper which, despite the fact that it is written mainly by and for lunatics, remains The Guardian. On February 16, 2009, Larry Elliott wrote:

There have been many economists down the years who have expressed scepticism about reducing their discipline to a mechanistic subject. Malthus told Ricardo to be wary of becoming too attached to abstract hypotheses; Schumpeter talked of creative destruction; Hayek saw the market as a voyage of discovery; Keynes stressed the importance of "animal spirits."

And:

Mervyn King says Britain is in a deep recession ... Interestingly, the governor cited Keynes at the Bank's inflation report press conference, noting that animal spirits were currently depressed. With confidence so weak, it is hard to envisage an early or a robust recovery.

Two days later, Sam Whimster (Professor of Sociology at London Metropolitan), commented: 

We should also consider the place of emotions in economic life. The share price of UK banks fluctuates wildly as traders attempt to calculate their capital value from future estimated losses and profits. Keynes, in 1933 in his lectures on his General Theory, said that current yields of firms exercise an "irrational" influence on estimating future worth.

In the boom years that have ended so abruptly, Whimster continues:

Infectious greed and optimism was the mindset of economists, bankers, politicians and regulators - leading to behaviour that no regulatory mechanism could have controlled. But the extent of the greed and adventurism, and the flouting of standard banking precautions which had been stress-tested by decades of history, raises the question of what determines which emotions come to the fore.

The question of whether economists should take emotions into account is a good one. But where are the answers? Not as easily to hand as one might hope. Let me mention some issues that everyone should think about at this point.

To begin with, emotions are just one more variable. There is a lot going on in the world economy that we understand all too imperfectly. But it doesn't help our understanding to say, after the event: Oh -- people have been behaving irrationally, it must be because of their emotions. Change the context a little and you'll see how fainthearted and pathetic this is. Imagine me telling my wife: You've been behaving irrationally, it must be because of your emotions. (I can't imagine saying it, but you can try.) She'd kill me, and rightly so. The reason is not just that it's insufferably patronising, but that it also devalues emotions into something irrational, flighty, whimsical, and beyond understanding.

In different words, adding another variable, the variable of emotions, to a model does not add to its predictive power unless the added variable is itself predictable. Are emotions predictably variable?  It is entirely possible that aggregate moods are predictable -- in fact, I made a prediction above when I suggested that "that the mood of millions is taking a hit at the moment, as homes and jobs are lost and the fear of loss infects our nation." If so, perhaps we should be working towards a model of emotions. But be aware that it may not be worthwhile. If the aggregate mood just goes up and down with the rate of unemployment, for example, then modelling emotions may add complexity without increasing the predictive power that is already taken there in conventional models.

A deeper question is whether emotions truly vary in ways that are beyond our individual control. Consider hatred. Two sorts of people can kill without hating. Some are trained and paid to do so to defend us against our enemies, and these are our soldiers. The rest are few in number and we call them psychopaths. The majority of people kill only those whom they hate. So, hate first, then kill. But here there is a problem: the idea that killing, or any kind of premeditated violence, is the deterministic result of uncontrollable feelings, flies in the face of our traditions of personal moral and legal responsiblity. In fact, it is possible that we must first allow ourselves to hate those whom we have a prior intention to kill. Decide to kill, then hate, then kill. If so, emotions as such do not decide what we do; we decide what to do, and then select the emotions that validate our decisions. This is a difficulty that must be resolved before we can understand whether emotions add anything to economics.

Clearly, we must learn more about the psychological laws underlying emotions. I am open minded as to whether we will ultimately need more complex economic models. Whatever we decide, I am in favour of economic models -- maybe not more complex ones, but just better ones.

If so, I am going to disappoint Elliott, in whose view:

The mechanistic approach to economics has failed.

"Mechanistic" is a prejudicial term in this context, however. Economic models are just thought experiments. They are mechanical in the sense that they are formal (as opposed to purely literary and intuitive) and logical (as opposed to internally inconsistent). They still seem like useful things to me. For argument, I will quote briefly from the best essay written on this subject in the last 30 years: Paul Krugman's "Two Cheers for Formalism," published in The Economic Journal (1998); I also strongly urge you to read the original in full:

First, much of the criticism of formalism in economics is an attack on a straw man: the reality of what good economists do is a lot less formalistic than the popular image. Bad economists, of course, do bad economics; but one should not confuse a complaint about quality with a complaint about methodology. Second, when outsiders criticize formalism in economics, their real complaint is often not about method but about content - in particular, they dislike "formalistic" arguments not because they are formalistic, but because they refute their pet doctrines. Finally, as a practical matter formalism is crucial to progress in economic thought - even when it turns out that the ideas initially developed with the help of formal analysis can in the end, with some work, be expressed in plain English. Moreover, this is especially true precisely in the sorts of areas that economists are often accused of neglecting, such as those that involve imperfect competition, incomplete rationality, and so on.

I'm not sure where I should leave Whimster, who starts his comment by asking to bring in emotions and ends up bringing in values; the problem, he concludes, has been that:

Anglo-Saxon attitudes have been dominated by what Weber would have called the values of adventurer capitalism, and the economist and sociologist Werner Sombart would have called the lust for wealth ... Aesthetics, harmony with nature, the ethics and politics of community - these need to be reasserted as values independent of and superior to market values, which as the Romantics pointed out should be merely means to other ends. It is time for what Nietzsche termed the revaluation of values.

Don't you love the wedge that's driven between "market values" and higher things? We're losing a hundred thousand jobs a month, but it's okay because we should refocus on "aesthetics, harmony with nature, the ethics and politics of community."

Markets that work well have allowed millions of people to live and work as they choose, enjoy the freedoms of the press and media, travel the world, and address the world from their own homes. Markets that work well have another virtue, as Hayek understood so clearly: they allow one person's end to be another person's means, without anyone having to rule on or even consider the difference. Millions of people aspire to what well-functioning markets can offer: opportunity, mobility, prosperity, stability, insurance, the backdrop to the everyday joys of friendship, love, sex, children, and families -- or not, if you don't want them. I don't know what's higher than that.

That's why, when markets don't work well, it's so important to fix them.

Mark Harrison : 23 Feb 2009 22:56 |  Tags: Keynes Politics Recession |  Comments (0) |  Close comments |  Report a problem

Automatic Destabilizers

Writing about web page http://www.coventry.gov.uk/ccm/content/chief-executives-directorate/corporate-policy/communications-team/news-releases-2009/coventry-residents-set-for-44p-a-week-rise-in-council-tax.en

The day after Leeds City Council announced the loss of 650 local authority jobs because of "lower government grants and the economic downturn," it's Coventry's turn. According to a news release on Coventry City Council's website, our city faces a "budget gap" of £13.5 million. More than £9 million of savings have been identified. These include, in addition to "efficiency reviews of services," "a £469,000 reduction in publicity and advertising budgets, 3% cuts in grants to voluntary organisations and £530,000 through increasing charges in some social care services." It is expected that 190 posts could disappear. Councillor Kevin Foster, Deputy Leader of Coventry City Council, is quoted:

The Council, like all councils, is facing a number of challenges over the coming year. Clearly the recession is having a major impact on our finances ...

Oddly enough, this is not what is supposed to happen in a recession.

As I wrote here, faced with the current collapse of aggregate demand, "the government faces a bitter choice. It can stabilize its budget, or it can stabilize the economy, but it cannot do both." The recession is plunging the budgets of central and local government alike into deficit. Stabilizing the budget means cutting government spending and jobs as revenue falls. Stabilizing the economy, in contrast, means maintaining spending and jobs, borrowing to cover the widening budget gap. In the interests of us all, including the interests of tomorrow, the government should choose the latter course.

In theory, some stabilization of the economy should happen automatically. In our economy, taxation is progressive; this means that, when personal incomes fall, the government's tax take should fall more than proportion. As a result, personal incomes should fall by less than the country's national income, and this should to maintain spending and employment. Part of what the government spends is also progressive: as jobs and family incomes fall away, the government should automatically replace part of what is lost by meeting entitlements to unemployment benefits and other income support. These "automatic stabilizers" don't make things better. They just make things a little less bad than they would be otherwise.

Think about that word, "otherwise." It means: in the absence of the automatic stabilizers. If, say, the government always spent every penny it received, but never more, the government would continually add to the natural volatility in the economy. Every time there was a boom, the government would experience a rise in its revenues and, by rushing out to spend them, heighten the boom. Every time there was a slump, the government would respond to its lost revenues by spending less and so deepening the recession. It doesn't just sound like a bad idea: it is an absolutely terrible idea.

Yet this idea is currently being put into effect by local authorities up and down the country. As property values and business and personal incomes fall, city councils are losing revenue from council taxes and charges. At the same time, for exactly the same reason, local claims on services and benefits are growing. But our cash strapped cities not only cannot meet these rising demands; they must cut back provision.

Rather than mitigating the jobs crisis, they are adding to it and deepening it.

This is the result of a policy failure on the part of central government -- a failure of scandalous proportions. While Westminster plays the blame game -- who should be punished for the failures of our banking system? -- the real economy is sliding down into depression. The solution is well known: a strong fiscal stimulus. But, while Westminster talks, what our country is actually experiencing is the exact opposite: a powerful fiscal brake that is spread by the collapse of local government finance and adds to the burden on us all.

The failure is scandalous because the solution could be put into effect overnight. The Treasury must promise now to stabilize local government funding at its pre-recession level. Local authorities should be enabled to plan for the future without adding to the pool of the unemployed. When the economy recovers, the additional subsidy from the centre can be gradually withdrawn.

I can see two obstacles to this simple course of action.

First problem: Purists may object that our cities are subsidy junkies already; if the subsidy from central government is temporarily increased, it may be politically difficult to withdraw it later when conditions improve. I acknowledge this danger. It is an example of what, on January 20, Bank of England governor Mervyn King described as

the paradox of policy at present – almost any policy measure that is desirable now appears diametrically opposite to the direction in which we need to go in the long term. Spending now supports the economy, but in the long run we need to save more and borrow less. Public borrowing sustains spending, but in the long run needs to fall. Banks are encouraged to run down their capital to enable them to absorb losses while continuing to lend, but in the long run they will need more capital. Interest rates have fallen to unprecedented levels, but in the long run will need to rise to more normal levels.

In the same way local government in the UK must be allowed to spend its way through this crisis, yet in the long term become fiscally more self-reliant. But there are ways to achieve this; for example, local authorities could take out loans from the Treasury with repayment contingent on local incomes or employment rates returning to their pre-crisis levels. But the time for complicated solutions may be already past; this is, after all, a crisis.

Second problem: The Westminster government may positively not want to do this. Whitehall is full of spending ministers. If there is to be a stimulus package, they will want to monopolize it and claim the credit for it. Scattering central funding across many local authorities, many (like Coventry) managed by parties that are in opposition in Westminster, may not look like the best way for Labour to prepare for the next general election. I suspect this is the most important obstacle to the action that our country needs. If so, it makes the failure to act even more scandalous.

Let me repeat: allowing local authorities to keep up their spending during the current recession is not a solution to the crisis. It is just a way to neutralize a mechanism for destabilization, one that is currently making the crisis worse than it needs to be.

Mark Harrison : 17 Feb 2009 11:02 |  Tags: Coventry Keynes Politics Recession |  Comments (0) |  Close comments |  Report a problem