Never let a good economic crisis go to waste

We wish it hadn’t come to this, but the next boom will be built on a stronger foundation


Never let a good economic crisis go to waste

Mon centre cède, ma droite recule. Situation excellente, j’attaque!—Marshal Foch

Coverage of the economy is shrouded in gloom at the best of times, on the principle described by the American journalist Gregg Easterbrook: All Economic News is Bad. News is change; change helps some, hurts others; the ones it hurts are the ones we hear from; ergo, AENIB.

But if the present crisis offers more than the usual opportunities to wallow in despair, it should also be a reminder of the corollary to Easterbrook’s law: All Economic News is Also Good. Though each day’s newspaper seems to bring worse reports than the last, it is nevertheless true that it brings reasons to hope as well. One boom may be ending. But the seeds are already being planted for the next.

As the economist Herb Stein was fond of saying, if something “cannot go on forever,” it will eventually stop. Throughout the boom, the louder it got and the longer it went on, the clang of doom was sounding—that sense that we were storing up trouble, that the imbalances and excesses in the system would eventually have to be corrected. It haunted us, whether we admitted it or not. Even as we were indulging ourselves, living beyond our means, racking up debt, borrowing against assets we knew to be overpriced, we all knew that it would have to end badly—that this time there would be no soft landing.

But we couldn’t stop, and neither could the policy-makers. The party had gone on much too long to take away the punch bowl. Everyone was paralyzed by the fear of what was to come, of the carnage that would follow if—when—the boom ever ended. And so no one did anything, or nothing that would really get at the problem at its roots.

But now the worst has happened, the crisis is really upon us, and there is no avoiding it any longer. Which ought to be . . . liberating. We do not have to govern out of fear any longer. There is nothing to be lost, and everything to be gained, from tackling policy changes that previously we would have avoided. We might wish it hadn’t come to this, but now that it has, well, to have no choice is a kind of freedom. The way is open to us to build the next boom on a more durable foundation.

An example. One of the contributing factors to the U.S. housing bubble that underlay and eventually precipitated the crisis was the perverse American policy of allowing home-owners to deduct the interest payments on their mortgage from their income taxes. It is one of the two or three worst policies since the building of the pyramids, a direct subsidy to indebtedness (without making housing more affordable: all that subsidized borrowing only served to drive up house prices, in effect capitalizing the value of the subsidy).

Everyone who knew anything about policy knew it was madness. But it could never be changed, since, as everyone knew, that would cause the housing market to collapse, and no politician dared risk the wrath of home-owners that would ensue. Well, now it’s collapsed anyway. So the opportunity presents itself at last to be rid of mortgage interest deductibility.

As the example suggests, policy paralysis of the type I have described is not only a matter of timid politicians. It is also arises from the accumulation over time of politically powerful interest groups in and around government, each with a deep stake in the status quo. In his 1965 book The Logic of Collective Action, and with greater historic sweep in 1982’s The Rise and Decline of Nations, the economist Mancur Olson analyzed how societies that enjoy long periods of peace and prosperity inevitably become encrusted with interest-group privileges, leading to stagnation and decline. The reverse is also true, Olson argued: it was no accident that postwar Germany grew faster than any other European country, and it had nothing to do with the Marshall Plan. Rather, having been laid flat, literally and figuratively, by the war, Germany had a free hand to remake its economy, unconstrained by the sort of entrenched interests that proved so intractable in, say, postwar Britain. One needn’t wish for crises to acknowledge they can have beneficial effects.

This has nothing to do with paranoid theories of “disaster capitalism,” as in Naomi Klein’s lefty fantasy: the notion that free-market economists are a breed of geopolitical ambulance chasers, exploiting catastrophes, natural or economic, to foist unpopular policies on unwilling populaces. In the face of a calamity, it is hardly dishonourable to suggest policies you sincerely believe will help—indeed, it would seem obligatory—nor, as we have seen, is the practice confined to the right: Rahm Emanuel, Barack Obama’s chief of staff, has been much quoted to the effect that no good crisis should be allowed to go to waste.

No decent person would deliberately impose measures that were harmful to the public interest, just as no democrat would persist on a course that the majority, given a vote, rejected. But there is a difference between the public interest and the special interest, and majority rule is not simply the sum of interest-group demands. If the present crisis liberates politicians to do things in the public interest they would previously have feared to do, that is all to the good.

Or as it has been said: what do you do when you have painted yourself into a corner? You walk out onto the paint.

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