Saturday, March 31, 2012

Crisis Management without Political Economists

The Greek crisis has underscored something I have known for a long time: that there are very few serious political economists out there. And this dearth has serious consequences in terms of how we think about the current economic crisis.

Of course, political economy is an old subject and one that is flourishing in academia: there are journals, professors and students specializing on the topic. But political economy means something very specific in academia: for economists, it usually means using economic tools to explain political phenomena; and for political scientists, it usually means using political tools to explain economic phenomena. Thus, in a department of politics, a political economist will study bureaucracies and power structures to explain monetary or trade policy; in an economics department, the political economist will use game theory to explain voting patterns or democratization or war.

As a result, we rarely get true political economy. Instead, we get economic interpretations of politics or political interpretations of economics. We no longer have people who write in the tradition of Frederick Hayek or Joseph Schumpeter or Adam Smith. (The one exception I would gladly grant is Benjamin Friedman, whose book “The Moral Consequences of Economic Growth” is the kind of political economy I have in mind; the book connects broad trends in a country’s economy with broad trends in the country’s politics – it is, thus, a true book of political economy because it links economics and politics thematically rather than methodologically.)

How does this relate to the Greek crisis?

Mainly this is a question of diagnosis. A purely economic interpretation of the Greek crisis that focuses on current account deficits and on public debt is incomplete without the political context that helps us understand why those numbers played out as they did. Such a diagnosis tells us “what” happened but not “why.” To do that, one needs to veer into political economy and the interaction between political participation, electoral politics, and economic decision-making. Without a proper diagnosis, it is hard to offer proper solutions. Thinking about this crisis in a political economy context yields a different view on the crisis.

Think about the most basic question: what is the purpose of bailing out Greece? In May 2010, the IMF report that authorized money to Greece noted in its first page that: “Greece is adopting an ambitious comprehensive multi-year adjustment program to lower the fiscal deficit and the debt ratio, reduce domestic demand in line with capacity, and increase supply and competitiveness so that the economy can step onto a higher growth path led by investments and exports.” Later in the same page it noted offhand that, “Risks to the program are high. The adjustment needs are unprecedented and will take time, so fatigue could set in.” In essence, this is an economic reading of the crisis, which, as a result, lays out concrete economic targets regarding the deficit and the debt, coupled with political and economic policies to achieve those targets.

A political economy reading would say: “Greece faces a legitimacy crisis. Politicians spend too much state money to buy votes. The state is thus weak and has little capacity to perform basic functions such as law enforcement or tax collection; it is also caters to special interests who demand protections of their economic privileges. The problem is that the state is both too big and too inefficient, while much of the private sector is insulated from paying taxes or from competition. An uncompetitive economy, high debt, and runway public finances are the result.”

Of course, both diagnoses may lead to similar prescriptions: reform the public sector, control public spending, promote competition in the private sector, etc. But their different point of departure would yield different metrics for success. The economist will ask: how can Greece pay down debt and reduce its deficits? The political economist, by contrast, will ask: how can Greece create a political momentum favoring a smaller but more effective state and a more competitive private sector?

These readings produce a different answer to the question: “what is success?” As I wrote in my review of the first bailout, we ought to judge success on three levels: economics, political economy and political philosophy. It is also the reason I have been against an outright default and exit from the Eurozone – because I believe that such a path does not create good conditions for reform. I don’t expect the IMF to produce a set of political economy or political philosophy benchmarks and to judge Greece on those measures. Nor can the IMF write in a report the things that I wrote above.

But conceptualizing the crisis as a political economy crisis can allow us to ask more relevant questions and allow the IMF and Europe to track progress in Greece along broader criteria. Instead of asking, “is this policy going to reduce the deficit” we can ask, “is this policy likely to help or hurt the momentum for reform?” The IMF is always keen to talk about “program ownership” where the host government is the chief architect of the program; a political economy reading would take that idea to the next level and ask, what kind of program would best appeal not just to the political class but to the Greek public; what reforms will bolster support for further measures; can we make economic concessions that may hurt specific fiscal targets in order to create a bigger coalition that favors change?

Without such re-think, we end up with the kind of program that Greece has just signed up for (see here). It is a program that defies politics and economics, and which is engineered to inflict so much targeted pain that is unlikely to succeed, much less survive. The IMF and Europe, of course, are constrained by national politics – they have to design a program that parliament will pass. But this constraint is exacerbated by a narrow read of the crisis, which prevents them from focusing attention on creating the conditions for change. It also creates enormous frustration and a sense of lack of progress when progress, is in fact, taking place. We would all be better served by asking the right questions when it comes to Greece – and that requires moving beyond “how to bring down Greece’s debt” to “how can Greece’s economy change?”

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