Rethinking the State and the Economy

On December 16, 2011, in economic theory, tax policy, by Jon Lewis

Government versus Markets: The Changing Economic Role of the State. Vito Tanzi. Cambridge University Press, 2011, pp. 376, $35.00 If the past is any guide to the present, many voters in the 2012 presidential primaries, as well as in the general election, will make their choices based upon the personalities of the candidates. While unfortunate, [...]

Government versus Markets: The Changing Economic Role of the State. Vito Tanzi. Cambridge University Press, 2011, pp. 376, $35.00

If the past is any guide to the present, many voters in the 2012 presidential primaries, as well as in the general election, will make their choices based upon the personalities of the candidates. While unfortunate, this is not entirely without good reason. It would be preferable, however, if the majority of the voting public were able focus less on the quixotic personalities in the race, and more on the most pressing, and interrelated, issues of our time; namely, the size and scope of the federal government and the national debt. Whatever one might think of their methods or their ideology, the American public has the Tea Party largely to thank for bringing attention to the debt crisis and the unsustainability of the current entitlement system.

In Government versus Markets, Vito Tanzi (formerly the director of the Fiscal Affairs Department of the International Monetary Fund) opens with the premise that, “[t]here is no more fundamental question in economics than what role the state or the government should play in a country’s economy.” Although some might dispute this characterization as demonstrating a bias toward macroeconomics, it is inarguable that the relationship between the state and the private sector is likely to be significantly redefined in the next decade. The question, of course, is in what direction. Will the next decade witness a move toward greater federal government involvement in education, energy, and health care or toward a smaller government that does less, but with greater fairness and efficiency? Or something in between?

In what can best be described as a sweeping intellectual history of the role of the state in modern industrial economies, Tanzi demonstrates how, from the late nineteenth century onward, the state has taken on an increasingly greater role in the economy. With references to economists Adam Smith, Karl Marx, and John Maynard Keynes, as well as to Bismarck’s social insurance legislation in Germany, which the author rightly notes “had a major impact on the world and must be seen as a major and perhaps the most important landmark in social legislation,” the author successfully integrates economic history with political philosophy. In Chapter 8, for instance, the author devotes his attention to both the voluntary exchange theory and public choice, citing the work of James Buchanan.

In Tanzi’s assessment, in the first half of the twentieth-century in industrialized countries, “the government became a huge insurance company and intermediary for the citizens.” This, of course, did not come without a cost; namely, increased taxation and spending. In a passage particularly relevant to the fiscal morass in which we currently find ourselves, Tanzi, in the book’s introduction, reminds the reader that there is a direct correlation between current fiscal policy and the future role of the state in the economy. “When governmental intervention comes through higher spending and higher taxes, as it often does, it can change for future years the economic role of the state and the status of a country’s public finances.” It would seem that, at times, large segments of the American public have forgotten Milton Friedman’s pithy observation that there is indeed no such thing as a free lunch.

In light of the ongoing public debate over income inequality, Tanzi’s discussion of the subject matter, albeit not the central focus of Government versus Markets, is worth consideration. He contends that, “in a competitive and globalizing world, reduction in income inequality, although important, cannot be the sole of the main objective of economic policy. If that were the case, the policies pursued by the planned economies in the past, and by Cuba and North Korea today, would be praised and imitated.” Indeed, if twentieth-century has taught us anything, it is that well-intentioned social engineering projects aimed at reducing income inequality have, unless constrained by an open, pluralistic political system and a commitment to the rule of law, will often backfire, which lead to greater misery for a larger number of people.

If the state’s power in the economy has increased throughout the past century, what is the likely role of the state in the future? It is here that Tanzi makes his most provocative contentions. Regulations, rather than the government’s taxing and spending powers, will become more influential. He suggests that governments have focused too much on replacing the private market with the public sector and too little on preventing market failure. A fundamental principle to guide the state’s economic role, Tanzi posits is an “ambitious normative option,” wherein governments should focus on the prevention of market failure, more than on remedying failure after the fact. Of course, regulatory policy is hardly an uncontested terrain. For this reason, it is likely that Tanzi suggests that, “a clear, binding, legal guideline may be necessary” to deal with the myriad political problems associated with regulatory policy, such as regulatory capture. This is perhaps much easier said than done.

In terms of fiscal policy, Tanzi enumerates four possible developments that, either by themselves or in combination, can contribute to large reductions in debts and fiscal deficits: substantial drops in interest rates for government debt; high economic growth; unanticipated inflation; “and reforms in taxes and in public spending associated with a major change in the role of the state in the economy that lead to large reductions in public spending and/or significant increases in tax levels.” It is the last approach – one, it should be noted, that is not altogether different from the path suggested by Congressman Paul Ryan – that Tanzi suggests is the better option.

Tanzi appears to call for a form of “libertarian paternalism,” a term that he uses in quotes. In this approach, the government’s focus would be on reducing risks, rather than correcting ex post preventable outcomes. Under this approach, the government would have a direct role in assisting the deserving poor. With lower taxes and less spending, the middle class would use its larger share of post-tax disposable income to buy protection from the market place and some social services formerly provided for by the government. “This,” opines Tanzi, “is not an easy way out from the current fiscal mess, but it may be the only realistic one for many countries over the long run.” Policymakers supportive of expanding the federal government’s role in health insurance would be well advised to take Tanzi’s arguments seriously.

In conclusion, Government versus Markets is an excellent and highly thoughtful book that deserves a wide audience. It is no longer possible to believe that the current fiscal trajectory in the United States is sustainable over the long term. Although reduced taxation and spending will come at a significant cost, it is likewise true that continuing business as usual will come at an even greater cost, particularly for the recent college graduates who are inheriting a future with limited opportunity.

Jon Lewis (c) 2011

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How Capitalism Survived The Crisis

On December 7, 2011, in banking, Federal Reserve, monetary policy, by Jon Lewis

The Legacy of the Crash: How the Financial Crisis Changed America and Britain. Edited by Terrence Casey. Palgrave Macmillan, 2011, pp. 291, $32.00 Historians, when studying economic or political events, often focus on whether a particular historical occurrence represents a break from, or continuity with, the past. There is, for instance, a general consensus that [...]

The Legacy of the Crash: How the Financial Crisis Changed America and Britain. Edited by Terrence Casey. Palgrave Macmillan, 2011, pp. 291, $32.00

Historians, when studying economic or political events, often focus on whether a particular historical occurrence represents a break from, or continuity with, the past. There is, for instance, a general consensus that the Great Depression, and both FDR’s and the Supreme Court’s response, represented a departure from American legal and political history, when the federal government intervened far less in economic affairs. But what of the responses to the financial crisis of 2008, when a Republican administration pursued a deeply interventionist strategy in the hopes of preventing a worldwide economic collapse, and the British government effectively nationalized a major bank? Did that represent the beginning of the end for Anglo-American capitalism or a temporary departure from business as usual?

The Legacy of the Crash, edited by Terrence Casey (Rose-Hulman Institute of Technology), attempts to shed light on how the crisis and its aftershocks may have transformed American and British political culture. Given that the chapters were originally academic papers presented at a September 2010 conference, it is unsurprising that the prose is largely scholarly, with numerous citations. The book is divided into three sections: the causes and consequences of the financial meltdown; political trends after the crash; and how public policy changed after it. While The Legacy of the Crash would be most valuable to scholars, readers interested in learning more about how the financial crisis affected the United States and the United Kingdom can nevertheless benefit somewhat from a perusal of the book.

Casey, in the book’s introduction, contends that the origins of the financial crisis had multiple causes. He argues against simplistic explanations of what went wrong. “It may provide moral or political comfort to identify a sole culprit, be it greedy bankers, economic theorists, short-sighted politicians, misguided regulators, or irresponsible homeowners. Reality though is closer to the plot of Agatha Christie’s Murder on the Orient Express, where everyone was guilty.” This passage, while pithy, might have been better written to acknowledge that, whereas everyone was guilty, not everyone was equally guilty. After all, it would be difficult to imagine that the crisis would have occurred but for the Federal Reserve’s easy money policies enacted after the dot-com bust in the early 2000s.

Are the American and British versions of capitalism similar? In “Was there Ever an Anglo-American Model of Capitalism?” (Chapter 2), Wyn Grant (University of Warwick/International Political Science Association) puts forth the argument “that the UK does conform to a liberal model of capitalism, not least in terms of the centrality and mode of organization of the financial services sector, but that the terrain is more contested than in the US.”

If there was indeed a crisis of capitalism, as Casey suggests in his essay, “Capitalism, Crisis, and a Zombie Named TINA” (Chapter 3), does that logically infer that capitalism is doomed to the dustbin of history? Quite the opposite, according to the author, who cites Margaret Thatcher’s acronym, TINA — There is no Alternative (to Anglo-American capitalism). “This crisis of capitalism, in short has yet to produce a counter-liberal coalition in either Britain or America, let alone that has maneuvered to a position of electoral success. Mrs. Thatcher’s axiom still rings true, at least for now.” When the two aforementioned authors write of liberalism, it should be emphasized, they are speaking of classical liberalism and free market capitalism, rather than of the American liberal-left political tradition. The Occupy Wall Street movement may, however, be the beginning of an anti-TINA coalition. Indeed, it would appear that at least one Republican pollster is concerned about the impact of OWS on Americans’ perceptions of capitalism.

While the Anglo-American model may arguably remain intact, the United States and the United Kingdom have their differences. In “Fiscal Policy Responses to the Economic Crisis in the UK and the US” (Chapter 5), Edward Ashbee (Copenhagen Business School) argues that despite the notion of an Anglo-American model of capitalism, “there were, as the financial crisis unfolded, important economic policy differences between the US and the UK. In particular, discretionary fiscal policies took very different forms.” Tom Bale (University of Sussex) and Robin Kolodny (Temple University) cite the work of other writers and remind us that that, while both are center-right parties, the Conservatives and the Republicans have both their similarities and their differences.

In the book’s conclusion, Casey posits that there was a crisis of capitalism. It was expected that the political economies of both countries would take a new path. “And yet, as chronicled by this volume,” he writes, “so much of what has occurred since then belies this prediction. In terms of public policy, economic governance, and political trends, there has been far more consistency than change.” Whether one accepts Casey’s argument, of course, is a matter of perspective. A Tea Party activist, for instance, might posit that the Obama Administration’s interventionist policies, if not combated, will fundamentally alter the relationship between the federal government and the private sector.

Casey, however, is spot on in arguing that, “one would hope that the primary legacy of the crash is to demolish the sense that ‘it cannot happen here’ and that politicians, financiers, and even individual consumers will adjust their behavior accordingly.” This assessment is even more pertinent in light of the failure of the congressional super-committee and the yet uncertain effects that the European debt crisis will have on the American and British economies.

In conclusion, The Legacy of the Crash will be more useful to the scholarly community, rather than to policymakers. While the chapters on the causes and consequences of the crash (Part I) have some useful insights, they do not substantially break new ground. The comparative approach between the United States and the United Kingdom, however, is a useful one. It would certainly be beneficial if more scholarly analyses of the financial crisis acknowledged how the Bush Administration’s policies in late 2008 were similar to, or different from, policies enacted by other western governments. Today, it is the Continent, rather than the United States or the United Kingdom, which faces an immediate financial crisis. One could imagine that in a couple of years hence, scholars will gather to assess how various European governments either succeeded or failed to respond to events that may or may not end the Euro.

Jon Lewis (c) 2011

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