Day By Day

Monday, February 23, 2009

The Failure of Economic Policy

There are two fatal flaws in our national management of the economy.

First, there is no agreement among economists as to what is the best policy to follow. Ultimately, the "dismal science", despite all its pretensions, is not all that scientific. Expert opinion is to a great extent shaped by ideology and political utility. This means that expert opinion is unreliable as a guide to policy formulation.

This brings us to the second flaw. Policy making is ultimately a political act, and that means politicians will be deeply involved in the process. This is really a good thing, since expert opinion alone is not to be trusted [I would never, ever advocate technocracy], but it does insure that action, good or bad, right or wrong, will be taken, whether it is necessary or not. Politicians cannot afford to be perceived to be uninvolved in a time of crisis [remember how Bush was bashed over Katrina]. What is more, political pressure insures that whatever action is taken it will be extreme, over-hyped, and to some extent misdirected and that is a bad thing.

Jeffrey Sachs, writing in Scientific American, explains what is wrong with the current set of economic policies:

The U.S. political-economic system gives evidence of a phenomenon known as “instrument instability.” Policy makers at the Federal Reserve and the White House are attempting to use highly imperfect monetary and fiscal policies to stabilize the national economy. The result, however, has been ever-more desperate swings in economic policies in the attempt to prevent recessions that cannot be fully eliminated.

President Barack Obama’s economic team is now calling for an unprecedented stimulus of large budget deficits and zero interest rates to counteract the recession. These policies may work in the short term but they threaten to produce still greater crises within a few years. Our recovery will be faster if short-term policies are put within a medium-term framework in which the budget credibly comes back to balance and interest rates come back to moderate sustainable levels.

Read it here.

But a reasonable and moderate response to the current crisis is not politically feasible. Moreover, as the article shows, policymakers over the course of the past two decades have been strongly influenced by calculations of the political impact of their decisions. The result has been to introduce distortions into the markets that have contributed to the severity of the present crisis.


Robert Samuelson argues that the interference of politics has severely limited the effectiveness of the stimulus plan. Much of the money will be spent on non-stimulus, but politically attractive, applications, and much more will not be spent until [hopefully] the worst of the crisis has passed. And that's not counting the long-term drag on the economy imposed by "temporary" measures included in the bill.

He writes:

Politics cannot be removed from the political process. But here, partisan politics ran roughshod over pragmatic economic policy.

Read it here.