Simon Johnson in his Baseline Scenario Blog pointed a new paper from Daron Acemoglu. (ME is a big fan of Acemoglu but this crisis has shifted focus quite a bit; his papers and very extensive & require a lot of time).
In this paper he says crisis policies should be framed keeping long-term growth in mind.
I would like to argue that several economic principles related to the most important aspect of economic performance, the long-run growth potential of nations, are still valid and hold important lessons in our intellectual and practical deliberations on policy. But, curiously, these principles have played little role in recent academic debates and have been entirely absent in policy debates. As academic economists, it is these principles and the implications of current policies for the growth potential of the global economy that we should be reminding policymakers of.
He points to 3 reasons for this crisis – 1) great moderation, 2) capitalist economy can function with markets and doesn’t need institutions, 3) we can trust the large firms to monitor themselves because of reputational capital.
On his 2nd reason he takes a dig at Greenspan:
In our obliviousness to the importance of market-supporting institutions we were in sync with policymakers. They were lured by ideological notions derived from Ayn Rand novels rather than economic theory. And we let their policies and rhetoric set the agenda for our thinking about the world and worse, perhaps,even for our policy advice. In hindsight, we should not be surprised that unregulated profit-seeking individuals have taken risks from which they benefit and others lose.
:-) Most would have got the connection. Those who haven’t, Alan Greenspan is a well- known member of Ayn Rand Club that believes in free-markets. He says:
Forgetting the institutional foundations of markets, we mistakenly equated free markets with unregulated markets. Although we understand that even unfettered competitive markets are based on a set of laws and institutions that secure property rights, ensure enforcement of contracts, and regulate firm behavior and product and service quality, we increasingly abstracted from the role of institutions and regulations supporting market transactions in our conceptualization of markets.
I have said numeorus times that financial regulation is not really understood. We just don’t understand that we live in a highly regulated world. Same can be applied to financial sector as well but we just don’t progress enough on this issue.
Acemoglu also points to the narrowness of the institutions approach:
Sure enough institutions have received more attention over the past 15 years or so than before, but the thinking was that we had to study the role of institutions to understand why poor nations were poor, not to probe the nature of the institutions that ensured continued prosperity in the advanced nations and how they should change in the face of ever evolving economic relations.
This deserves a smile as well :-) After years of lecturing emerging markets on generating and sustaining growth, the advanced ecnomies need a lesson on sustainance too.
The paper then talks about how policy responses should not be that they lead to increasing protection in world trade and backlash against free markets. It is still our best hope with proper institutions in place.
Excellent as usual.