The General Theory
If I were a public intellectual, I would have a written a big fat book about the current global economic problems with a title that included ‘general theory’. As it is, I am just a blogger. But as a character in some Humayun Ahmed play might say, ব্লগারদের কি আর সাধ আহ্লাদ নাই (don’t the bloggers have any fond wish?)…
So, over the fold is my ramblings about what’s going on. Unlike most my economy-related posts, there won’t be any data or charts here. This is really a blog post in the original, weblog, style. It’s not an attempt to persuade. Rather, it is really an old fashioned diary entry. The interested reader can look up various econoblogs listed on the right panel, and look up the dead and alive scribblers whose mugs are posted.
Over the past five years, two recessions have hit, in some places simultaneously. And they have happened against the backdrop of two supply side developments of immense magnitude. And the political economy of most major economies are proving incapable of dealing with the economic shocks.
Each of these five things are different in their scope and impacts. None of them are good news. Policy options for each of them are different. And none of them will provide a solution to our problems in the near term.
First, there are full-blown financial meltdowns, the most dramatic of which happened in September 2008. When Lehman collapsed, no one knew which bank (and other institutions) had what skeleton in their accounts. No one wanted to even talk to anyone else. As a result, money stopped flowing, and then goods stopped flowing, and then production stopped, and job losses started. The sharpest drop in output actually took place not in the United States, but in trade-reliant economies of East Asia.
Policy responses came in two fronts. First there was the financial / banking policy. Here, nationalisation was never a serious option in any major economy — American authorities simply didn’t have the bodies needed to manage nationalisation, and it was no different elsewhere. Muddling through was the only course, which Team Geithner did, and they got lucky. A sense of normalcy returned to the financial market by mid-2009, and this was a success.
Then there were the macro stimuli (fiscal and monetary) that put a floor under the economy. The idea was to try to do as much as possible as quickly as possible to stop job losses and stabilise the labour market — prevent depression and double digit unemployment. Again, this was a success.
The mission was to prevent another Great Depression, and that mission was achieved.
However, if another Lehman moment were to occur, we might not be so lucky. There doesn’t seem to be any European Geithner. And there will be no fiscal stimulus.
It’s hard to remember now, but back in late 2007 / early 2008, the consensus view was that the US might get a very shallow recession, or avoid one altogether, but suffer from a prolonged period of sluggish growth. This ‘nasty recovery from the non-recession’ was the result of deleveraging that followed the housing bust, not just in the US but in many parts of the world. The heavily indebted households were expected to put a brake on consumption, pay down their debt, and build up savings. This balance sheet adjustment was expected to would take years. This means, consumption and housing, and in turn business profits and employent were to grow at a sluggish pace for years. With steadily rising population, and thus jobseekers, this would have meant unemployment slowly edging upwards, putting wages under pressure and squeezing the households even more.
External shocks could have helped or hurt the households. Perhaps President McCain and a Democratic Congress would have passed a climate change bill initiating a green boom. Or perhaps McCain would have started a war with China. Who knows. What we know is, until the panic of late 2008, the central projection of most forecasters was one of a slow grind well into the 2010s.
And this was considered, on balance, a welcome development. American (and other western) households had been living beyond their means for decades. It was time for the baby boomers to finally grow up. US was running large twin deficits. It was time to unwind these imbalances. At most, if there were to be a recession, interest rates could be cut, and households could be given a cheque to smooth things for a few months, before the necessary adjustments could run their course.
Abstracting from the panic and the political economy problems, what’s happening now is simply this deleveraging recession playing itself out. Of course, it’s a lot nastier when the starting point of the deleveraging process is 10% unemployment instead of 5% unemployment. And we know that financial meltdowns coupled with deleveraging means very protracted recovery.
The thing about deleveraging is that any policy (and do-nothing is a policy) is necessarily redistributive, and thus inevitably political. There are plenty of historical examples of debt hangovers leading to political upheavals or jubilees. Even supposedly technocratic solutions like NGDP targeting would imply redistribution in favour of the debtors. And it’s hard to see how that can be left to technocrats. It has to be the stuff of politics.
And that takes us to the world of political economy.
Meanwhile, political economy comes to the centre of analysis for a different reason. The incorporation of China, India, former Soviet bloc, and other economies of the erstwhile third world into the global market has led to a massive expansion in the supply of labour and capital. This has tremendous distributional consequences. While this has led to welfare gains for the average person, as well as for large number of persons at both ends of the distribution — the so-called 1% as well as hundreds of millions of people escaping abject poverty — for a large number of people in the upper middle end of the global distribution — the so called middle America and such like — this hasn’t been easy.
This creates political problem which threaten either open markets or open democracy or both.
Things are further complicated by the fact that there is a general slowdown in the leading economies’ capacity to grow. Over time, economies grow through either more inputs, or more productive inputs. Demography is hurting the first channel in not just the west, but also China and other East Asian economies. Further, prolonged slack in the labour market may cause hysteresis in the US. But most damagingly, there is a general slowdown in the rate of technological progress in the frontier economies. Not only does this make it difficult to assess the potential output the economy could reach in equilibrium, but also that the pie is far smaller to redistribute and buy off discontentment.
And it appears that the political institutions of major economies are not capable of handling these momentous shocks.
In Europe, a monetary union created in an suboptimal currency area for political reasons makes for at best an excruciatingly grinding deleveraging process, and at worst another panic. But at least Europeans once every generation or so usher in major political changes. So they may end up with a sharp break, one way or other. Contrary to the conventional view, Europeans are really from Mars. So are the Chinese, whose system is coming up against some sharp constraints.
Not so for America and India, who are from Venus, and whose muddle through approach may well prevail in the long run, when we are all dead.
Whatever happens, don’t expect any radical improvement anywhere anytime soon.