A Best Case Scenario

Lately my posts on the economy have been full of gloom and doom, so as a change, why not look at it from the other side — what is a best case scenario?  To be sure, it has to be a realistic best case scenario, simply fantasizing that suddenly all the fundamental problems will go away makes no sense.  It also has to take into account that this is no ordinary recession; not since the 1930s has there been such a global rebalancing of an out of whack economy.  But it need not be like the 1930s.   What can turn things around?

First, it did not have to get this bad.  If the economic fundamentals were dealt with earlier, either after the 1992 recession or more likely after the 2001 recession, we could have rebalanced in an easier manner.  It would have been painful, much like 1979 – 82, but it could have been done.  Instead the bubble economy, built on a stock bubble followed by a property bubble, created a false sense of prosperity alongside a belief that all was well.  Speculative bubbles create their own imbalances which, alongside the current accounts deficit and increasing public and private debt make this a very difficult economic crisis to bounce back from.  What must be done?

Few emphasize that back in the 1930s there was an answer.  If the world had embraced the kind of increased free trade and stable currency markets that were ultimately created after the war in the Bretton Woods system, we might have pulled out of the depression early and avoided World War II.  If Briand and Streseman’s ideas of a kind of European economic bloc had been tried in 1929 instead of 1958, perhaps fascism could have been avoided.  Some say the war ended the depression, but that’s baloney.   If not for the dramatic shift in economic thinking heralded by the Bretton Woods system (fixed exchange rates based on the gold standard — which lasted in some form until 1971 — and a free trade regime, which persists today), the war could have fostered either a return to depression or, more likely, socialist revolutions in the West.

So let’s assume that there is an answer.  The answer is not within our current realm of conventional wisdom, and may not be seen as feasible; a call for a Bretton Woods like system would have been laughed at by most in the 30s as a political pipe dream — we needed a war to get people to move beyond their own thinking.  But it’s a different era than the 30s, the information and technology revolution is real, and globalization is much farther along.  The kind of nationalist wars of conquest promoted by Japan and Germany are obsolete.  Only the US has remotely tried such a thing, and it has proven to be a costly failure.

So maybe we can be forward thinking now.  One thing a solution would have to be is global, and inclusive.  In other words, we would need the kind of shift away from parochial nationalist economic thinking that we had with Bretton Woods.  This means an even more intense embrace of multilaterialist ideas, and a recognition that success has to be more than just success of the West — only an economic system that truly gives hope and prosperity to those in the third world who currently suffer poverty and malnutrition can work.

That means two shifts: go into negotiations without national interests (and interest groups) in mind, and see third world development as necessary for renewed first world growth.    Moreover, the US would have to recognize the unviability of the old “leaving beyond our means.”  Increasing debt and trade deficits made us seem much better off than we were.  We have to accept that the public and government will have to make major concessions in terms of expectations.

Luckily, we have the capacity to do that.  The fake economy of the last 26 years has created pockets of fat that can be trimmed in order to transition to a sustainable system.  That fat is in corporate and financial sectors, and the wealthy need to be taxed far more than they have been, with loop holes cut.  In the past, tax increases on the wealthy have been rejected because that will decrease investment, and we need investment to grow.  But that investment turned out in recent years to be mostly illusary paper gains based on financial speculation, and NOT efforts to build economic capacity and production.  Government will have to take a more active role in making sure investment is directed into productive sectors.  Those sectors should not be government run, but the market left to its own devices ends up serving those few who are able to manipulate information and regulation.

The latter means that Washington will have to do business differently.  Transparency rather than inside deals with lobbyists needs to become the stanard operating procedure.    The budget must be cut even as we try to increase production.  That means redoing the budget from the ground up, completely restructuring the United States governmental bureaucracy to be more efficient and less encompassing.   Most importantly military spending, mislabeled defense spending (we don’t need much to defend ourselves from invasion), needs to be slashed.  This will be politically difficult, but in times of economic crisis things can be done that otherwise would not have been politically possible.  Someone like Obama could pull it off.

So Internationally: a major international agreement designed to increase supranational regulation of credit markets, hold global financial and corporate actors accountable, create rules that transcend borders (to end a race to the bottom and companies shopping for governments who will deregulate and reduce taxes), and emphasize pathways for third world development.  That will require a political aspect to induce effective governance in corrupt third world states.  It won’t be easy, but third world development is a long term project, it only has to begin for the economy to start forward.   This absolutely necessitates the US being willing to compromise on previously unacceptable matters, embracing a level of internationalism that had been anathema to most Americans in the past.

Domestically, a reorganization of government, with a focus of government resources on developing productive capacity, taxing wealtheir folk and ending a regulatory set up based on powerful and wealthy lobbyists is necessary.   At the same time the American people will need to accept a decreased standard of living (since the old standard was built on debt and foreign labor/trade deficits), but one that can be made acceptable by undoing the massive increase in the maldistribution of wealth over the last quarter century.  The recession need not be as painful overall if the cost is paid fairly.  Technology to deal with global climate change and long term energy concerns could be key to helping reshape the American economy.

All that together sounds politically impossible.  Our thinking would have to change dramatically, the break from the past would have to be profound.  But who would have thought that a black man who had a Kenyan father and grew up in Hawaii and Indonesia, with the name Barack Hussein Obama, could be President?   Unlike past politicians, Obama has the capacity to make a major break with the past, and do so in a way that doesn’t lead the old elite to torpedo his changes.  Hence its important to have the Clintons, Jimmy Buffet and other current elites on board.   And the recession and war in Iraq have caused Americans already to question the conventional wisdom of the last 25 years.  I’ve heard many times in conversation and the media that “this is a different world than the one we’re used to.”  That recognition that this is a new world is the first step to embracing a new kind of thinking.

And, if done well, we could find that by the end of Obama’s first administration the global economy could be showing signs of promise few could have imagined in the dark days of late 2008.   And you know, it is possible.  Not just because of Barack Obama, but because of what his election represents: an American public ready for real change.  Remember, things are always darkest before the dawn.

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  1. #1 by Patrice on December 22, 2008 - 9:10 pm

    Did you really mean Jimmy Buffet? Or Warren Buffet? I mean, Mr. Margaritaville supposedly gives a great concert (I’ve never been), but I’ve never really thought of him as central to our political system.

    I liked this post, but all through it, I was thinking…it just seems impossible. But then, maybe Obama really can pull it off. I really like the guy, but I’m not sure even he could change the country’s mindset SO radically (he’s already come some of the way, but how much more does he have in him as far as that goes).

    The other night on the Colbert Report, Colbert was joking about the Blogojevich scandal, about how he tried to sell Obama’s seat. Colbert said “I’m surprised Obama even needs a seat. I thought he just levitated”. Heh heh. I hope you’re right and that he can do it!

  2. #2 by Mike Lovell on December 23, 2008 - 1:37 am

    “I mean, Mr. Margaritaville supposedly gives a great concert (I’ve never been), but I’ve never really thought of him as central to our political system.”


  3. #3 by Scott Erb on December 23, 2008 - 1:45 am

    Hey, I said it was a “BEST CASE scenario.” Who would you rather have in your cabinet, Jimmy or Warren ;-) Yeah, I meant Warren, but I guess you can see where my mind was really at.

  4. #4 by Mike Lovell on December 23, 2008 - 3:53 pm

    I’m going to guess, buried squarely in the liqour cabinet trying to find that damn shaker of salt?

  5. #5 by Darrell on December 24, 2008 - 6:44 pm

    “Government will have to take a more active role in making sure investment is directed into productive sectors”

    I take it you see no inconsistency with that statement.


  6. #6 by Scott Erb on December 24, 2008 - 7:04 pm

    I don’t see an inconsistency, Darrell. Some people have a faith in the market operating all by itself and giving the best result. Others put faith in government planning. Both extreme views are, I believe, shown false by historical data. Government action can help facilitate better market performance, but too much involvement or efforts to control become counter productive. Investment in recenate. The t years has shifted from going to improve production towards get rich quick speculative schemes with little or no regulation. That helped create a fake ‘bubble’ economy. To shift towards production I think government and businesses need to cooperate. Markets aren’t magic. That said, government planning doesn’t work either, so if it goes too far it’ll fail as well. The rise of Asian economies like Japan, China, Taiwan, S. Korea, etc., had a lot of government involvement in investment planning and R&D — it’s unlikely the market alone would have done as well. That said, many of the problems they face came from too much government, which leads to corruption. I don’t think there is an ideological ‘right answer,’ just tough, pragmatic balancing acts.

  7. #7 by Darrell on December 25, 2008 - 12:05 am

    Scott, you are attributing government success directing Asian economies with no evidence to support your assertion. I think the record is clear that those economies thrived once govt got out of the way, not because of govt. The Japanese government’s attempt with MITI to direct the economy (a prime example of the pragmatic balancing act between govt and free market?) was a disaster resulting in an economic collapse in Japan.

    Remember when the politicians were all worried about the Japanese taking the high definition tv market because of Japanese govt funding of analog? Those silly private companies in the US who didn’t know better were instead putting their R & D dollars into digital. How’d that one turn out?

    Similarly, China’s growth didn’t occur until they allowed workers and companies to begin to keep their own profits. Hong Kong, with almost zero natural resources other than their own people, drug themselves up from poverty to wealth in a generation because the govt let the free market run with minimal intervention

    The free market is millions and billions of consumers and businesses making choices with their own money. Government “investments” and decisions are made by a relative handful of politicians who think they know better, spending other people’s money. Which system do you think comes up with the most efficient choices more often?

    Other than prevention of fraud and other crime, govt “partnerships” directing the economy do more harm than good. Doesn’t mean that the govt, after spending billions and trillions to fund dead-end projects, might create a few things of value. But at what cost?


  8. #8 by Scott Erb on December 25, 2008 - 12:39 am

    Most of the CPE (Comparative Political Economy) literature I’ve read calls the Asian stories “State capitalism,” and note that Japan’s economic crisis came after a major rebirth of the economy after WWII, with MITI credited with a lot of that success. That fits my point: government can do good if it doesn’t go too far or get too entrenched.

    I think markets can work, but due to imperfect information, the ability to “winners” in one round to restructure future rounds to their advantage, and human irrationality and poor decision making, markets on their own are unlikely to render a result good for society, and could in fact lead to mafia like rule as powerful actors work to circumvent the market. Governments exist in part because without them markets couldn’t function, they’d be taken over by organized criminal units. So we need a balance — rule of law, limited government, accountability, and markets generally functioning as much as possible, with government needing to get involved to solve problems that can’t be dealt with by market forces alone. I believe the current crisis is one of them. That said, I dislike government power (and frankly would prefer most governance be at the state and local level rather than national). and the government-business nexus is one reason the current crisis has emerged. But practically, I think at this point in our economy there is no pure free market solution.

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