Monday, May 7, 2012

Rajan on the world's troubles

My colleague Raghu Rajan wrote a very thoughtful essay in Foreign Affairs. Though titled "The True Lessons of the Recession" it's really more a grand view of the last 50 years and prospects for growth ahead. The subtitle "The West Can’t Borrow and Spend Its Way to Recovery" is worth repeating.

Raghu reminds us that growth, in the end, comes from productivity. Keynesians have stolen the term to mean a few years of caffeinated stimulus, but to everyone else, growth means better living standards for decades. And the lesson of modern growth theory is that such growth comes only from greater from productivity -- people able to produce more valuable goods and services per hour that they work.

Raghu reminds us that growth is not a given. There is no stone tablet saying GDP per capita will rise 2% per year forever. Every drop of growth is hard-won. It comes from people investing in ideas, in the human capital that produces ideas, in better skills, and able to start businesses, displace ossified incumbents, make new and better products and services.

He offers a thoughtful capsule view of the last 50 years; the strong postwar growth, how it petered out, and how the US responded with deregulation. Now it's petering out again, and the question for us is whether we will be able to remove the sand in the gears. 

Raghu reminds us what economists know but seems forgotten in policy circles: The global rise in inequality over the last 30 years comes from the rising returns to skill, not from lower taxes, "greed" or malfaisance. The rich didn't get richer; new people came in and got rich. As he put it, starting in the 1980s, 
It was no longer as important to belong to the right country club to reach the top; what mattered was having a good education and the right skills.
Raghu goes on to a long list of disastrous policies our government has followed which are greatly to blame for the current mess.  

While I agree these policies are disastrous, I'm less convinced of Raghu's political narrative: that our government subsidized houses and credit as a benevolent but ham-handed attempt to address rising inequality.  There is more to an overarching theory of the political determinants of US economic policy than this. 

In part, I think Raghu's own analysis proves the point,
Outside the United States, other governments responded differently to slowing growth in the 1990s. Some countries focused on making themselves more competitive.
OK, so if other governments such as Germany chose different policies, then our particularly damaging policies were not simply an inevitable reaction to the skill premium.

I part company even more as Raghu describes what to do about it. Raghu's analysis emphasizes  America's disastrous inability to provide its middle-class citizens with decent education. You would think a stunning denunciation of teacher's unions and associated public-school bureaucracy would follow, but it doesn't.

Raghu offers instead:     
The United States must improve the capabilities of its work force, preserve an environment for innovation, and regulate finance better so as to prevent excess.
This kind of sentence drives me a bit batty. Who is the subject of this sentence, really? You smell a new set of programs, but to be put in place by the same government that Raghu so skewers for the last 20 years?

Admittedly, Raghu adds, 
None of this will be easy,... Government programs aimed at skill building have a checkered history. Even government attempts to help students finance their educations have not always worked; some predatory private colleges have lured students with access to government financing into expensive degrees that have little value in the job market. 
OK, but he's still apologizing for not layering new programs on top of the old failed programs. And with this little caveat the start-new-programs instinct takes over full-force,
That is not to say that Washington should be passive. Although educational reform and universal health care are long overdue, ...
Wait a minute, Raghu! You just diagnosed the disasters of America's public education system, and how desire to subsidize the middle class led to policy disasters. You want the same genius system to run health care too?
[Washington] can do more on other fronts. More information on job prospects in various career tracks, along with better counseling about educational and training programs, can help people make better decisions before they enroll in expensive but useless programs. 
Again, that indefinite tense. Who is going to provide this "more information?" and "counseling?" What about that "checkered history" of such efforts in the past?   
...subsidies for firms to hire first-time young workers may get youth into the labor force and help them understand what it takes to hold a job. 
Rajan offers brillant analysis of the global skill premium, and we're back to tinkering with the tax code to overcome the disincentives offered by the minimum wage?

As finance professors, both Raghu and I pay extra attention to financial regulation.
Finally, even though the country should never forget that financial excess tipped the world over into crisis, politicians must not lobotomize banking through regulation to make it boring again. 
Amen, brother Rajan. But continuing,
At the same time, legislation such as the Dodd-Frank act, which overhauled financial regulation, although much derided for the burdens it imposes, needs to be given the chance to do its job of channeling the private sector’s energies away from excess risk taking. As the experience with these new regulations builds, they can be altered if they are too onerous.
What? The Dodd-Frank act is a monster compared to Fannie and Freddie, which Raghu just skwered. He surely would not write
At the same time, agencies such as Fannie and Freddie, although much derided for the subsidies and distortions they impose, need to be given the chance to do their job of channeling funds to housing, small business and student loans. As the experience with these agencies builds, they can be altered if their side-effects are too onerous.
 He does write
Americans should remain alert to the reality that regulations are shaped by incumbents to benefit themselves. They should also remember the role political mandates and Federal Reserve policies played in the crisis and watch out for a repeat.
Yes. Exactly why hoping that a complex monster like Dodd-Frank can work is sure to lead to more trouble.  Dodd Frank is designed and destined to lobotomize, monopolize and politicize the financial system. 

In sum, I think Raghu's soft tinker-at-the-edges solutions just don't match the eloquence of his diagnosis. We have a disastrous public education system that is leaving the middle class and poor behind, and a shattered middle-class family structure that renders education even more difficult. Accept his diagnosis that our political system drove us to financial disaster by patching up the resulting inequality.  Is not the answer much more far reaching, and much more of the stop-banging-our-head-against the wall variety?

One sentence on "educational reform" isn't enough, let's talk about the deep reforms that need to be taken, now. How can he  hope that the same political system will act more wisely, though it has much greater arbitrary power with the health law and Dodd-Frank?  Take his reading of the 1980s deregulation and how it solved the stagnation of the 1970s and gave us a new round of growth. Is the answer not the same sort, get out of the way rather than a spate of new Federal "competitiveness" programs?

Raghu regains his eloquence on the idea that a touch more stimulus is all we need, that growth is just a short-run "demand" problems not deep "supply" problems. 
Countries that don’t have the option of running higher deficits, such as Greece, Italy, and Spain, should shrink the size of their governments and improve their tax collection. They must allow freer entry into such professions as accounting, law, and pharmaceuticals, while exposing sectors such as transportation to more competition, and they should reduce employment protections...
Yes, but why does the same advice not hold for the US as well? Certainly not because we have the option (for a while) of running higher deficits.

But he really comes in to focus with this gorgeous paragraph: 
The industrial countries have a choice. They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities. For better or worse, the narrative that persuades these countries’ governments and publics will determine their futures— and that of the global economy


Anyway, go read the original -- provocative, thoughtful, and refreshingly well-written.