Monday, April 13, 2009

Glaeser on Precedent

Glaeser on the importance of a stable US policy:

IN THE 1990s, American economists roamed the world preaching the virtues of fiscal restraint, the rule of law, free trade, and privatization. Today, those four policy pillars, once known as the Washington Consensus, are abandoned in the city that gave that consensus its name. These policies were never commandments from Mount Sinai, but they are important ingredients of long-run economic success. In a recession, putting today's needs ahead of tomorrow's prosperity is understandable, but even in bleak times, doing too much can be worse than doing too little.

This year's deficit is projected to be $1.7 trillion, and this may be appropriate. But given the vast scale of this debt, the nation must husband the rest of its resources, to permit some chance of meeting our obligations. Protectionism, public ownership, and a breakdown in property rights will make it far harder for the future entrepreneurship of ordinary people to pay for today's deficits.

Clement Attlee wanted to nationalize British industry after World War II; Barack Obama certainly wants to avoid nationalization of either banks or car companies. Indeed, the sorry history of Attlee's experiment illustrates just how costly it is to put private enterprise in public hands. Run by Washington, General Motors could turn out just like the Rover Group, if we're lucky.

The government is trying desperately to find a middle ground between bankruptcy and nationalization, but I fear that middle does not exist. Little good comes from allowing private entrepreneurs to bet with public funds, so public funding leads inexorably to public control. The problem with large subsidized, nationalized companies isn't just that those entities will be run inefficiently. If GM is split up in a bankruptcy court, this will provide an opening for competitors, many of whom will buy up pieces of the company. If GM is kept whole and public, then taxpayers will pay heavily to crowd out entrepreneurship.

Worse, public enterprises will engender new policies, such as trade barriers, aimed at protecting those enterprises. The experience of the 1930s reminds us that protectionism leads to global conflict, not economic comeback. Today, the "Buy American" clause in the Recovery Act takes its cue from the Smoot-Hawley Tariff Act, and it has already been matched by protectionism elsewhere.

America's future prosperity depends on engagement with the world that is now lending us so much. American entrepreneurs have and will make fortunes by finding opportunities in the dynamic, developing economies. Indian software makes American companies more efficient. Chinese clothing makes American lifestyles more affordable. Tariffs are meant to protect workers in America's declining industries, but it would be far better for those workers to move from the industries of the past to the businesses of the future.

The most disturbing trend may be an increased taste for arbitrary expropriation. People don't invest if the government rewrites the rules to take their earnings. When the House of Representatives voted a 90 percent tax on bonuses, economic populism trumped responsibility. Allowing bankruptcy judges to cram down mortgages expropriates lenders and creates more uncertainty and lawyers' fees. Giving aid to people who lose their homes is a better way to help those in pain.

Few variables are as reliably correlated with economic growth as respect for private property. America's economic strength reflects, in part, the fact that investors have historically found this a legally reliable place. That reputation is a golden goose, and destroying it would be like adding trillions to the debt.

In a better world, the new administration would have started with healthy budget surpluses saved up from the fat years, but it started behind. The nation's debt-to-income ratio is projected to rise from 40 to 70 percent in four years. The government could reduce that debt by cutting spending more sharply after the recession and by scaling back other ambitious programs. Still, no matter what, the debt will be huge.

For our children to face this debt, they will need free trade, private ownership, and respect for private property. Eliminating fiscal restraint during a recession is understandable. Eliminating all four pillars of sound economic policy imposes too much of a cost on tomorrow for too little benefit today.


  1. On cramdown--
    Correct-- aiding homeowners with a government funded program "a bailout for the consumer" based on need and merit is the only appropraite approach, NOT expropriating funds from creditrors just because they happen to be there.

    Cramdown aritrarilly punishes creditors with even greater losses than they are already facing. Its one thing to let creditors foreclose on their collteral nd take their losses -- it's much worse for creditors to have to be stuck with the defaulting borrower and take on even more losses crammed down going forward. This expropriation from creditors is arbitrarilly imposed on all creditors and all loans based on which borrowers opt for bankruptcy rther than based on which lenders or loans used a bad or "unfair" structure at the time of the loan.

    Instead of falsely painting cramdown as good for creditors, recognize it as a penalty against creditors, and apply these retroactive involunatary cramdowns at most only to subprime loans or other offensive loans that "should never have been made". And to reduce the expropriation from lenders, give crammed down lenders sufficient rights to any future profits if the collateral regains its value.

    Other borrowers who need aid can get their bailout (to match the "banks' bailout") from goverment funds invested in the borrowers (with a government right of repayment from future sale if possible. Making the lenders pay this with cramdown is no more justified than going back to the original seller of the home and real estate agent and making them fund the needy home borrower.

  2. You'll find no disagreement from me. Then again, I tend to view the role of the homeowner as more culpable in this than most other people do - there were a lot of people out there who took out mortgages they could not afford, and the fact that banks let them doesn't absolve them of making that decision. Say what you like about banks misleading homeowners, but holding people responsible for the fiscal decisions they sign their name to isn't ridiculous to me.

    I also tend to think that while a lot of the people making the loans may have known that they shouldn't be, a lot also just did so because they had incompetent personnel. I had a post a while back about the Gaussian Copula and how it was incorrectly used by a number of managers. Banks shouldn't walk away unscathed, but neither should homeowners...