Nowhere man (homo economicus)

Like all career generals, top economists prepare themselves for the day when their theories can be put to the test of reality (or is it the other way around?).  Certainly, the so-called Great Recession that has hit the US since 2008, then morphed into an existentialist crisis for Europe, and now challenges China’s investment driven growth is such a opportunity.  And indeed, we have seen a wide array of economists make the case for their deeply felt diagnoses and attending cures.  Yet they have little to show so far.

He’s a nowhere Man,

Sitting in his Nowhere Land
Making all his nowhere plans
For nobody.

Traditionalists have thundered against the wasteful ways of the consumer society and its propensity to spend itself to exhaustion, mostly with money borrowed from any willing lender, investor or speculator.  The cure is simple: let them fail, lance the boil and wait for nature to heal itself.  Unfortunately, and as we have seen when applied in some places, this triggers economic collapse, societal tensions and political instability.  But not recovery.

Doesn’t have a point of view,

Knows not where he’s going to,
Isn’t he a bit like you and me?

Others, who quote Keynes, have argued that the state should step up to make up for the reduced demand from the private sector and thus avoid an economic depression.  Some have also argued that such boost would also result in some degree of inflation which would help reduce the excessive indebtedness of both private and public borrowers.  We haven’t seen much inflation in the US where this approach was tried; on the contrary, prices have been stable but public debt has surged and little of that fiscal stimulus has found its way into worthy investment projects for a variety of reasons.

Nowhere Man, please listen,

You don’t know what you’re missing,
Nowhere man the world is at your command.

A variant of the Keynesian school of thought is epitomized by the Japanese economist Richard Koo who has made the persuasive argument that the current crisis of excessive private sector indebtedness doesn’t respond to traditional monetary policy as debtors focus on reducing their debt outstanding, even if interest rates are at rock-bottom.  In his view, the state had to crank up spending and go on as long as necessary;  in most wealthy countries, funding this fiscal effort should be doable as private sector savings would generally equal public sector borrowings.  While his reasoning is powerful, the example of Japan, which, by and large, has followed his prescription, is not: twenty years after its real estate bubble burst, Japan is still doing poorly while its public debt is soaring.

He’s as blind as he can be,

Just sees what he wants to see,
Nowhere Man can you see me at all?

Yet another group put its hopes on reforms, sometimes stated vaguely, or extravagantly.  By definition, reforms will change the way people work and live, will produce some winners and losers and can cast a pall of uncertainty that will last for several years, for reforms take years to be debated, agreed and implemented.  Successful reformers have been able to fine-tune the process so that change took place while stability was preserved and expectations were not let to run wild, with fear or overexcitement.  But reforms alone didn’t work. 

Doesn’t have a point of view,

Knows not where he’s going to,
Isn’t he a bit like you and me?

There is no lack of example of countries overcoming deep financial or economic crisis; there were no magical wands, excessive debts were not transmuted into savings, orthodox measures such as public spending cuts were combined with currency devaluation and strong foreign direct investments; and yes, there also were some policies that were “unorthodox” in their days such as privatizations, tax cuts and private pension reforms.  But what these countries also had was strong political leadership, capable and willing to carry out painful recoveries and to rally their nations behind the effort.

Nowhere Man, don’t worry,

Take your time, don’t hurry,
Leave it all ‘till somebody else
Lends you a hand.

Chile was engulfed in 1982 by the Latin American debt crisis despite having carried out wider economic reforms than the rest of the region.  Its downfall however was precipitated by an overvalued peso and excessive US dollar borrowings.  Because it was governed by the Pinochet-led military junta, Chile, unlike its neighbors, received no international financial help and was left to solve its problems on its own.  It did so by first nationalizing the banks (closing a few unviable ones), devaluing the peso, controlling public spending and restructuring its private and public debt in a way that was both fair and conducive to stabilizing and even raising foreign productive investments.  It has often been argued that having an authoritarian government helped Chile carry out unpopular policies.  This is true to some extent only; there were times in 1984 and 1985 when the position of the government was precarious; besides there have been many examples of authoritarian governments that were miserable economic failures. 

But Chile’s success in handling its crisis can be attributed to other important factors as well: unlike other countries, Chile cleaned up the financials of public companies before it privatized them; it insured that many ordinary Chileans could benefit from large privatizations thanks to its so called capitalism popular; from the beginning, it promoted free markets and private investments.  Finally, Chile offered a number of intangibles which are generally overlooked yet were of critical importance, such as a fair and predictable legal system, a very competent core administration where corruption was absent.  To this day, this remains one of the best turn-around stories.

He’s a nowhere Man,

Sitting in his Nowhere Land
Making all his nowhere plans
For nobody.

Brazil had been an intractable basket case for two decades, with endemic hyperinflation and spiraling public debt when F. H. Cardoso, then minister of Finance, launched the Plano Real in 1994.  The plan’s insight was to break the vicious cycle of expected inflation and general indexation without imposing price controls.  It did so by creating a money of reference (the Unidade Real de Valor- URV which was in effect indexed to the US dollar, not to domestic inflation) alongside the money of exchange (the cruzeiro), and setting it initially at a high level.  After confidence in the URV was won, the URV became the new money of exchange, the Real.  The strength of the Real was preserved by setting positive interest rates, by controlling public sector spending at times via financial negotiations with Brazilian states and by large scale privatizations.  FHC’s credibility helped him carry out his key policies, although former allies reproached him his free market initiatives which he nevertheless had the courage to see through.

Some elements are common to these turnaround examples: currency devaluation (delayed in the case of Brazil as the key problem was internal debt and lack of faith in the currency), public spending cuts, free market emphasis for greater efficiency and accountability, generally, policies that are consistent and understandable for the public, and leaders who are competent, honest and unafraid.

Homo economicus has a lot of ideas, and while there is always room for new policies, abolishing "no pain no gain" is not one of them.  In the end, he is only as good as the homo politicus to whom he reports and from whom he should get support.