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One of the most striking structural weaknesses uncovered by the euro crisis is the lack of consistent banking regulation and supervision in Europe. Although the European Banking Authority has existed since 2011, its influence is often trumped by national authorities. And many national governments within the European Union do not seem anxious to submit their financial institutions to European-wide regulation and supervision.

The post The limits of regulatory cooperation appeared first on OUPblog.

There’s a puzzle around economics. On the one hand, economists have the most policy influence of any group of social scientists. In the United States, for example, economics is the only social science that controls a major branch of government policy (through the Federal Reserve), or has an office in the White House (the Council of Economic Advisers). And though they don’t rank up there with lawyers, economists make a fairly strong showing among prime ministers and presidents, as well.

But as any economist will tell you, that doesn’t mean that policymakers commonly take their advice. There are lots of areas where economists broadly agree, but policymakers don’t seem to care. Economists have wide consensus on the need for carbon taxes, but that doesn’t make them an easier political sell. And on topics where there’s a wider range of economic opinions, like over minimum wages, it seems that every politician can find an economist to tell her exactly what she wants to hear.

So if policymakers don’t take economists’ advice, do they actually matter in public policy? Here, it’s useful to distinguish between two different types of influence: direct and indirect.

Direct influence is what we usually think of when we consider how experts might affect policy. A political leader turns to a prominent academic to help him craft new legislation. A president asks economic advisers which of two policy options is preferable. Or, in the case where the expert is herself the decisionmaker, she draws on her own deep knowledge to inform political choices.

This happens, but to a limited extent. Though politicians may listen to economists’ recommendations, their decisions are dominated by political concerns. They pay particular attention to advice that agrees with what they already want to do, and the rise of think tanks has made it even easier to find experts who support a preexisting position.

Research on experts suggests that direct advisory effects are more likely to occur under two conditions. The first is when a policy decision has already been defined as more technical than political—that experts are the appropriate group to be deciding. So we leave it to specialists to determine what inventions can be patented, or which drugs are safe for consumers, or (with occasional exceptions) how best to count the population. In countries with independent central banks, economists often control monetary policy in this way.

Experts can also have direct effects when possible solutions to a problem have not yet been defined. This can happen in crisis situations: think of policymakers desperately casting about for answers during the peak of the financial crisis. Or it can take place early in the policy process: consider economists being brought in at the beginning of an administration to inject new ideas into health care reform.

But though economists have some direct influence, their greatest policy effects may take place through less direct routes—by helping policymakers to think about the world in new ways.

For example, economists help create new forms of measurement and decision-making tools that change public debate. GDP is perhaps the most obvious of these. A hundred years ago, while politicians talked about economic issues, they did not talk about “the economy.” “The economy,” that focal point of so much of today’s chatter, only emerged when national income and product accounts were created in the mid-20th century. GDP changes have political, as well as economic, effects. There were military implications when China’s GDP overtook Japan’s; no doubt the political environment will change more when it surpasses the United States.

Less visible economic tools also shape political debate. When policymakers require cost-benefit analysis of new regulation, conversations change because the costs of regulation become much more visible, while unquantifiable effects may get lost in the debate. Indicators like GDP and methods like cost-benefit analysis are not solely the product of economists, but economists have been central in developing them and encouraging their use.

The spread of technical devices, though, is not the only way economics changes how we think about policy. The spread of an economic style of reasoning has been equally important.

Philosopher Ian Hacking has argued that the emergence of a statistical style of reasoning first made it possible to say that the population of New York on 1 January 1820 was 100,000. Similarly, an economic style of reasoning—a sort of Econ 101-thinking organized around basic concepts like incentives, efficiency, and opportunity costs—has changed the way policymakers think.

While economists might wish economic reasoning were more visible in government, over the past fifty years it has in fact become much more widespread. Organizations like the US Congressional Budget Office (and its equivalents elsewhere) are now formally responsible for quantifying policy tradeoffs. Less formally, other disciplines that train policymakers now include some element of economics. This includes master’s programs in public policy, organized loosely around microeconomics, and law, in which law and economics is an important subfield. These curricular developments have exposed more policymakers to basic economic reasoning.

The policy effects of an economic style of reasoning are harder to pinpoint than, for example, whether policymakers adopted an economist’s tax policy recommendation. But in the last few decades, new policy areas have been reconceptualized in economic terms. As a result, we now see education as an investment in human capital, science as a source of productivity-increasing technological innovations, and the environment as a collection of ecosystem services. This subtle shift in orientation has implications for what policies we consider, as well as our perception of their ultimate goals.

In the end, then, there is no puzzle. Economists do matter in public policy, even though policymakers, in fact, often ignore their advice. If we are interested in understanding how, though, we should pay attention to more than whether politicians take economists’ recommendations—we must also consider how their intellectual tools shape the very ways that policymakers, and all of us, think.

The post The influence of economists on public policy appeared first on OUPblog.

        

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Bliss was it in that dawn to be alive
But to be young was very heaven!
– William Wordsworth on the French Revolution

I was not that young when New Europe’s transition began in 1989, but I was there: in Poland at the start of the 1990s and in Russia during its 1998 crisis and after, in both cases as the resident economist for the World Bank. This year is the 25th anniversary of New Europe’s transition and the sixth year of Old Europe’s growth-cum-sovereign debt crisis. Old Europe can learn from New Europe: first, about getting government debt dynamics under control if you want growth. Second, about implementing the policy trio of hard budgets, competition and competitive real exchange rates to keep debt dynamics under control and get growth. The contrasting experiences of Poland and Russia underline these lessons (Andrei Shleifer’s take on the transition lessons can be found here).

Poland started with a big bang in 1990, but ran into political roadblocks on the privatization of large state enterprises. It achieved single-digit inflation only in 1998. Between 1995 and 1998, Russia did the opposite. By early 1998, privatization was done and single-digit inflation achieved. But while Poland started growing in 1992 and has one of the most enviable growth records in Europe, Russia suffered a huge crisis in August 1998 after which it was forced to adopt the same policy agenda as Poland.

The first difference is that Poland quickly established fiscal discipline and capitalized on the debt reduction it received from the Paris and London Clubs to get government debt dynamics under control. Russia lost control over its government debt dynamics even as the central bank obsessively squeezed inflation out.

The second difference is that Poland instantly hardened budgets by slashing subsidies to state-owned enterprises (SOEs) and subsequently restricting bank lending to loss-making SOEs. It summarily increased competition by liberalizing imports, but was careful to avoid a large real appreciation by devaluing the zloty 17 months after the big bang, and then moving to a flexible exchange rate. The first two elements of this micropolicy trio, hard budgets and competition, forced SOEs to raise efficiency even before privatization. The third, competitive real exchange rates, gave them breathing space. Indeed, SOEs were in the forefront of the economic recovery which began in late 1992, ensuring that debt dynamics would remain sustainable. This does not mean privatization was irrelevant: SOE managers were anticipating it and expecting to benefit from it; but the immediate spur was definitely the micropolicy trio.

In contrast, Russia’s privatized manufacturing companies were coddled by budgetary subsidies and large subsidies implicit in the noncash settlements for taxes and energy payments that sprouted as real interest rates rose to astronomical levels. Persistent fiscal deficits and low credibility pushed nominal interest rates sky high even as the exchange rate was fixed in 1995 to bring inflation down. The resulting soft budgets, high real interest rates and real appreciation made asset stripping easier than restructuring enterprises, killing growth. Tax shortfalls became endemic, forcing increasingly expensive borrowing that placed government debt on an explosive trajectory and made the August 1998 devaluation, default and debt restructuring inevitable. But this shut the country out of the capital markets, at last hardening budgets. The real exchange rate depreciated massively, leading to a 5% rebound in real GDP in 1999 (against initial expectations of a huge contraction) as moribund firms became competitive and domestic demand switched from imports to domestic products. This policy mix was maintained after oil prices recovered in 2000, ensuring sustainable debt dynamics.

Old Europe, especially the periphery, can learn a lot from the above. Take Italy. By 2013, its real exchange rate had appreciated over 3% relative to 2007, while real GDP had contracted over 8%. The government’s debt-to-GDP ratio increased by 30 percentage points (and is projected to climb to 135% by the end of this year), while youth unemployment went from 20% to 40% over the same period! Italy has no control over the nominal exchange rate and lowering indebtedness through fiscal austerity will worsen already weak growth prospects. Indeed, Italy has slipped back into recession in spite of interest rates at multi-century lows and forbearance on fiscal austerity.

The counter argument is that indebtedness and competitiveness don’t look that bad for the Eurozone as a whole. However, this argument is vacuous without debt mutualisation, a fiscal union and a banking union with a common fiscal backstop, the latter to prevent individual sovereigns, such as Ireland and Spain, from having to shoulder the costs of fixing their troubled banks; the recent costly bailout of Banco Espirito Santo by Portugal is a timely reminder. Besides, Germany has to be willing to cross-subsidize the periphery. Even then, this would only be a start. As a recent IMF report warns, the Eurozone is at risk of stagnation from insufficient demand (linked to excessive debt), a weak and fragmented banking system and stalled structural reform required for increasing competition and raising productivity. Debtor countries are hamstrung by insufficient relative price adjustment (read “insufficient real depreciation”).

The corrective agenda for the Eurozone has much in common with the “debt restructuring-cum-micro policy trio” agenda emerging from the Polish and Russian transition experience. The question is whether the Eurozone can have meaningful growth prospects based on banking and structural reform without an upfront debt restructuring. The answer from New Europe’s experience is “No.” Debt restructuring will result in a temporary loss of confidence and possibly even a recession; but it will also lead to a large real depreciation and harden budgets, spurring governments to complete structural reform, thereby laying the foundation for a brighter future. The key is not the debt restructuring, but whether government behaviour changes credibly for the better following it. As the IMF report observes, progress “may be prone to reform fatigue” with the rally in financial markets. In other words, the all-time lows in interest rates set in train by ECB President Draghi’s July 2012 pledge to do whatever it takes to save the euro is fuelling procrastination even as indebtedness grows and growth prospects dim. Rising US interest rates as the recovery there takes hold and the growing geopolitical risk over Ukraine, which will hurt the Eurozone more than the US, only worsen the picture. The Eurozone has a stark choice: take the pain now or live with a stagnant future, meaning its youth have fewer jobs today and more debt to pay off tomorrow.

The post What can old Europe learn from new Europe’s transition? appeared first on OUPblog.

        

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By George DeMartino

At the annual meetings of the American Economic Association (AEA), held the first weekend of January in Denver, the association’s leadership established a committee to explore whether there is a need for rules in the profession to govern disclosure of apparent or real conflicts of interest. The issue arose in reaction to Charles Ferguson’s new documentary Inside Job, which exposes what appear to be stunning failures of leading academic economists to reveal the large incomes they received from business interests when writing reports and taking positions on policy matters of direct concern to those interests. The film, and a series of reports by journalists and economists that further documented failure to disclose, led the AEA leadership to break with a century-long habit of side-stepping ethical issues that arise in economic practice. It’s far too early to know what will come of this initiative, it just might mark the first step toward the emergence of a new field of inquiry in economics: the field of professional economic ethics.

This development is long overdue. The economics profession exerts enormous influence over the life chances of others — not a few others, but all those who populate the economy. This influence necessarily implies that economic practice, from teaching and research to advising, forecasting, forensic work and the like, is ethically fraught. There is no adequate way to paper over this ethical fact, though the profession has done its best to do so. When a profession enjoys substantial influence over others but fails to examine and raise the awareness of its members and the public regarding the responsibilities that this influence entails, it is falling far short of its deepest professional responsibilities. It is a rogue profession.  If Ferguson’s film ultimately has the effect of inducing the profession to mend its ways, he will have made a much greater contribution to economic welfare than have many recent Nobel Laureates.

But there is a danger here as well. All of the recent attention has been focused on just one professional ethical issue: disclosure of conflicts of interest. Though hardly unimportant, this is a very narrow issue that is perhaps most easily addressed, as I’ve outlined here. The danger is that the AEA and other economic associations will fix this one problem, and believe themselves to be done with professional ethics altogether. But economists face much more important and difficult ethical challenges and professional responsibilities.

In my research for The Economist’s Oath, I interviewed 40 applied and academic economists about the nature of their work, and the challenge they routinely face as they try to do their work with integrity. Turns out that these arise all the time.  A simple example includes time and resource constraints: applied economists in particular are asked to do the impossible, generating reports in hours or days that would take weeks or months