The War

There is a war going on in our society. It can be bowdlerized as a war between those who think that government can do no wrong and those who think that the government can’t do anything right. Fronts in the war include the halls of Congress, the town square, the editorial pages of the country’s newspapers, the trench warfare of the blogosphere, and the sniping of social media. This morning I found several new skirmishes.

In an editorial in the Wall Street Journal the recession of the early 1980s and the Great Recession, now declared at an end, are contrasted:

As the nearby chart shows, in 1983 the recovery surpassed its previous peak in gross domestic product very rapidly from the recession’s trough. Growth rose by 4.5% in 1983, 7.2% in 1984 and 4.1% in 1985, and it kept climbing through the rest of the 1980s. This is the kind of recovery you would expect coming out of a severe recession, since the deeper the trough the steeper the rebound.

This time, even after a year of recovery through June 2010, real GDP remained 1.3% below its previous peak in the fourth quarter of 2007, according to the NBER sages. The current recovery peaked with 5% growth in the last quarter of 2009 but has decelerated in 2010—to 1.6% in the second quarter. This tepid growth, in turn, has contributed to the sorry state of job creation, slow business investment and the overall sense of malaise.

Our readers know the competing explanations for this undeniably disappointing performance. White House economists and liberals say the financial roots of this recession have made the recovery unusually difficult, the fiscal stimulus saved the day, and thus we need more of it. Our view is that hyperkinetic government policies have done more harm than good, leading to uncertainty and higher costs that have undermined business and consumer confidence and slowed the economy’s otherwise natural recuperative powers.

That can be contrasted neatly with President Obama’s statements in practically any of his appearances:

Obama took head-on the criticism that his policies have been anti-business, and argued his administration has done much to stabilize the economy.
“Look, let’s look at the track record here,” Obama said.

“When I came into office, businesses — some of the same commentators who are on CNBC — were crying, ‘Do something!’ because as a consequence of reckless decisions that had been made, the economy was on the verge of collapse. Those same businesses now are profitable; the financial markets are stabilized.”

Obama has come under criticism from business groups for some of his policies, notably the Wall Street reform bill and proposals to raise certain business taxes, as well as for rhetoric that has sometimes bashed corporate America.

Another skirmish is taking place between Paul Krugman and Raghuram Rajan. Dr. Krugman, writing the New York Review of Books, mounts a defense of Fannie Mae and Freddie Mac, the Federal Reserve, the Congress, and the White House:

The idea that the government did it—that government-sponsored loans, government mandates, and explicit or implicit government guarantees led to irresponsible home purchases—is an article of faith on the political right. It’s also a central theme, though not the only one, of Raghuram Rajan’s Fault Lines.

In the world according to Rajan, a professor of finance at the University of Chicago business school, the roots of the financial crisis lie in rising income inequality in the United States, and the political reaction to that inequality: lawmakers, wanting to curry favor with voters and mitigate the consequences of rising inequality, funneled funds to low-income families who wanted to buy homes. Fannie Mae and Freddie Mac, the two government-sponsored lending facilities, made mortgage credit easy; the Community Reinvestment Act, which encouraged banks to meet the credit needs of the communities in which they operated, forced them to lend to low-income borrowers regardless of risk; and anyway, banks didn’t worry much about risk because they believed that the government would back them up if anything went wrong.

Rajan claims that the Troubled Asset Relief Program (TARP), signed into law by President Bush on October 3, 2008, validated the belief of banks that they wouldn’t have to pay any price for going wild. Although Rajan is careful not to name names and attributes the blame to generic “politicians,” it is clear that Democrats are largely to blame in his worldview. By and large, those claiming that the government has been responsible tend to focus their ire on Bill Clinton and Barney Frank, who were allegedly behind the big push to make loans to the poor.

While it’s a story that ties everything up in one neat package, however, it’s strongly at odds with the evidence. And it’s disappointing to see Rajan, a widely respected economist who was among the first to warn about a runaway Wall Street, buy into what is mainly a politically motivated myth.

Dr. Rajan responds:

My book suggests that many—bankers, regulators, governments, households, and economists, among others—share the blame for the crisis. Because there are so many, the blame game is not useful. Let us try and understand what happened in order to avoid repeating it. I detail the hard choices we face in the book. While it is important to alleviate the miserable conditions of the long-term unemployed today, we also need to offer them incentives and a pathway to building the skills required by the jobs being created. Simplistic mantras like “more stimulus” are the surest way to detract us from policies that generate sustainable growth.

Finally, a note on method. Perhaps Krugman believes that by labeling other economists as politically extreme, he can undercut their credibility. In criticizing my argument that politicians pushed easy housing credit in the years leading up to the crisis, he writes, “Although Rajan is careful not to name names and attributes the blame to generic “politicians,” it is clear that Democrats are largely to blame in his worldview.” Yet if he read the book carefully, he would have seen that I do name names, arguing that both President Clinton with his “Affordable Housing Mandate” (see Fault Lines, page 35) as well as President Bush with his attempt to foster an “Ownership Society” (see Fault Lines, page 37) pushed very hard to expand housing credit to the less well-off. Indeed, I do not fault the intent of that policy, only the unintended consequences of its execution. My criticism is bipartisan throughout the book, including on the fiscal policies followed by successive administrations. Errors of this kind by an economist of Krugman’s stature are disappointing.

I don’t know the truth of the matter, I don’t know what needs to be done, and, worse, I honestly don’t believe that anyone else does, either. I don’t know whether I’d consider myself a non-combatant in the war, a conscientious objector, or a freebooter.

You see, I think that government is capable of either success or failure but I’d rather think of things in terms of what government can do effectively and what it can’t do effectively. The terrible conundrum in which I believe that we find ourselves is that the government is doing too much of something it can do effectively (e.g. wage war), too much of things that it can’t do effectively (e.g. manage the economy), and not enough of things that it can’t do effectively but noone else is willing to do at all (e.g.. mass engineering projects like the Apollo Program, viz. re-vamping the power grid).

The challenge, as I have said before, is on a completely different plane than the one on which the war is being fought. It’s not so much whether the government can do no right or do no wrong. We need for the government to do things differently and the combatants are so committed to the status quo that they’re overly concerned with reaching the correct answer and not nearly concerned enough with whether there’s a path to that correct answer. More about that later.