Why are economists so bad at politics? A good post over at Rortybomb reminded us of this question. The post included links to Ken Rogoff and Carmen Reinhart, authors of This Time is Different, who have been reminding us that this is not just a recession, it is a financial contraction, maybe even the ‘Great Contraction’ (Rogoff and Reinhart). The financial dimension is important because it changes the dynamics of a ‘normal’ recession. Here’s Rogoff:
“In a conventional recession, the resumption of growth implies a reasonably brisk return to normalcy. The economy not only regains its lost ground, but, within a year, it typically catches up to its rising long-run trend. The aftermath of a typical deep financial crisis is something completely different. As Reinhart and I demonstrated, it typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak.”
As 2012 looms, it appears even that goal might not be reached, especially if a double-dip is on the way. What is one to do in such a situation? Rogoff again puts it most starkly:
“But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.”
Before the reader gets excited and thinks that a former Chief Economist of the IMF is proposing a pseudo-socialist scheme of wealth redistribution, let’s consider the argument in more detail. Rogoff and Reinhart propose to transfer wealth from creditors to debtors mainly by inflating away debt. Reinhart, for instance, thinks zero interest rates are “very appropriate” and Rogoff has called for some fiscal stimulus plus, mainly, lower interest rates. Now we’ve discussed the limits of monetary policy on this blog as have a number of others (recall recent Henwood and Robin posts).
But the problem is not just that loose monetary policy has failed to get investors to invest, only produced mild inflation, and left the debt overhang unresolved, (on national, corporate and household debt, see this fantastic graphic from The Economist). It is also that Rogoff and Reinhart seem to think that some expert managers can simply decide to engage in a “scheme to transfer wealth from creditors to debtors,” wave their magic interest rate wand, and we’ll have the right solution. Despite their very appropriate warning that we should not forget we’ve lived through a Financial Crisis, they have a limited view of what this period of high finance was about.
Besides producing overleveraging, the last twenty to thirty years have also seen a dramatic restructuring of class power. Financialization coincided with a dramatic decline in working class power. This chart on strikes from LBO kind of says it all on the worker side:
Cheap borrowing, amidst stagnation of real wages, is what allowed living standards, for a time, to be maintained, even while the ability of workers to defend earning power – say through strikes – declined. Though this is for another post, finance also facilitated deindustrialization (or shift to less unionized states) in the United States. Moreover, it helped create a class at the top that, on the whole, has been very effective at protecting its gains.
Why does this matter? Because a significant transfer of wealth from creditors to debtors is something creditors won’t like. And they will do everything they can to stop it, and that means economic policy immediately becomes a matter of social and political power. Moreover, there is more than one way to reconstruct balance sheets. At the household level, for instance, falling house prices is a serious problem as it increases debt-to-income ratios – the one underlying asset keeps falling. But the longer-term cause of increasing household debt is the decline in average earnings. Why not reconstruct balance sheets not, or at least not just, by inflating away debt, but by actually undertaking measures that strengthen the earning power of the struggling majority? Why, furthermore, not simply use the coercive power of the state much more aggressively to modify mortgages, progressively tax high earners, provide employment, even take over banks (as was briefly considered during the bailout)? These are, of course, just those things the Obama administration has avoided doing in any serious way. The DOJ doesn’t even seem to be all that interested in prosecuting white collar crime.
A number of the aforementioned measures would a) transfer wealth but b) in a way more favorable to the long-term earning potential of many households, and might even c) increase their social and political power. These are by no means panaceas for deep, structural problems in the economy. But the point is that economic policy is not just about knowledge and expert maneuvers. Each policy is a product of and continues to produce social power. That is doubly so for a policy whose basic premise is a massive wealth transfer.
The other (and final) way of putting our point is the following. If Rogoff and Reinhart really do want such a significant wealth transfer via inflation, why stop there? Why not substantially strengthen the ability of ‘debtors’, but mostly workers, to maintain their wealth once they have it?