Sunday, August 28, 2005

Another list.

Note: one can seemingly replace "economic" with any one of several other descriptors and still have the expressed truisms hold.


Ten useful lessons for a sexagenarian
John Llewellyn
Sunday August 7, 2005

Turning 60 can be salutary. Certainly, it has led me to ask myself what, over the past 35 years as a professional economist, I have learnt that is of real use. In a way, it has been downhill from the beginning. After just one year of undergraduate economics, I knew how to solve every economic problem known to man: three and a half decades later, most problems appear less tractable. On reflection, I would suggest 10 lessons.

1) Economic events - what economists call 'shocks' - seldom produce just one consequence. Usually the effects ripple on for years. A tax cut or an increase in government spending usually does indeed have the sought-after effect of increasing total spending, output, and employment. But later it may result also in higher inflation, balance of payments problems, currency depreciation, higher interest rates and misallocated resources. Maybe, in the end, all the expansionary policy achieves is the bringing forward of some demand and output - followed by an unavoidable 'payback' period of below-trend output and above-trend inflation. Maybe, maybe not. That debate rumbles on. But the point that policy proposals should be evaluated over their full lifetime, and not just an electoral lifetime, is well made.

2) Good economic policies do not guarantee good economic performance; but bad economic policies inevitably result in bad performance. No economist finds it easy to say what policies would guarantee a better performance in France or Germany. But virtually no economist doubts that Zimbabwe's disastrous performance is mainly the result of its economic policies.

3) It is structural, not demand-side, policies that most influence economic performance over the long term. The experience of reforming economies as diverse as Australia, New Zealand, the Netherlands, and Poland is testimony to that. But structural policies take ages to produce effects. The initial consequence is usually a reduction in expenditure, which slows economic activity. It typically takes five years or more for positive effects to start to outweigh the negative. No surprise that politicians so seldom undertake reform. They know that the negative consequences will occur on their watch, while the benefits will accrue to their successors. Look at how Labour has benefited from the policies of Mrs Thatcher.

4) People respond powerfully to economic incentives. They may not analyse the situations they face in the framework, or use the terminology of the professional economist. But discussion in the cafe or pub, plus trial and error, results in a solid practical understanding of what it is optimal to do, given the rules of the game. Look at the way unemployed people in Britain, in contrast to those in Belgium and France, now go in search of a job - the rational consequence of the incentives in the UK's new unemployment benefit regulations.

5) Economic and social policies have to be considered as a whole. It is no good, as the Dutch found, setting unemployment benefit at a level that gives incentives to unemployed people to seek work if, meanwhile, the social benefit system encourages them to register as disabled. In the Netherlands in the 1990s, disability benefit was equivalent to at least 70 per cent of the recipient's wage, and often matched it. No wonder that 13 per cent of the Dutch workforce was on disability pension.

6) Competition is one of the most powerful of forces that motivate the perpetual quest for more efficient ways of doing things. It also makes companies' lives more demanding, one of the reasons that they so often seek to curb competition, not least that which comes from abroad via international trade. However, when such competition causes major layoffs and plant closures, such that workers who lose their jobs cannot find another for which they are qualified, the costs - economic and social - can outweigh the benefits. It is therefore sensible, fair, and efficient that society finds ways for the winners to compensate the losers: but without reverting to protectionism. The way in which Scandinavian countries retrain workers whose skills have become obsolete is the classic example of such thinking.

7) History seldom, if ever, repeats itself precisely. Economies have the habit of producing new mixtures of circumstances that require new approaches. The Korean War commodity price shock of the 1950s produced scarcely a ripple in overall inflation: but the similar-sized oil shock of 1973-74, which happened in an environment of strong unionisation and widespread wage-price indexation, zoomed inflation in many countries up to 20 per cent or more. And who would have thought that, a little over 20 years after tackling 20 per cent-plus inflation, Japan would be grappling with the problems of deflation.

8) Complicated economic policies whose rationale is hard to explain usually fail. J K Galbraith gives a great example. During the Second World War he was in charge of price control in the United States. A crusty, 71-year-old adviser, Bernard Baruch,said: 'just put a ceiling over the whole price structure'. Galbraith, young, enthusiastic, and a trained economist, knew better. He devised a system that allowed price increases where warranted, disallowed them where not. It failed. He improved - complicated - the system further. Again, failure. In the end his agency effectively froze all prices for the duration of the war. And it worked.

9) Some of the biggest, and most important, economic issues remain unresolved. One current example: A major experiment in macroeconomic management is under way, with the US on the one hand and the continent of Europe on the other, following quite different philosophies. In the US the biggest fiscal and monetary boost to spending in the past 50 years has produced a strong economic recovery, but also two asset price booms/bubbles - first the stock market; now housing. Steadier polices in the euro area, by contrast, have largely avoided this. But economic growth has been slow, and risks becoming self-perpetuating. Whether activist US policy, or the steady-as-she goes European approach will produce the better outcome over the economic cycle as a whole is not yet clear: this is a two-act play, and so far we have seen only the first.

10) Last lesson, and perhaps the most important. Just because professional economists don't always have a confident answer, it does not follow that all proffered solutions have equal validity. Folksy, common sense-sounding, policies can often be demonstrated by the economist as simplistic at best, dangerous at worst. Hence, often the biggest contribution that the professional economist can make is to demonstrate why the current fad or nostrum is wrong and will fail. Examples of policies that policy makers thought would work, but whose economic illogic was demonstrable from the outset, are legion. Go no further than Zimbabwe's seeking to reduce inflation by printing smaller-denomination bank notes, or France's seeking to reduce unemployment by making it illegal to work for more than 35 hours a week.

John Llewellyn is chief economist at Lehman Brothers.

Guardian Unlimited (c) Guardian Newspapers Limited 2005


Post a Comment

<< Home