Friday, 20 August 2010

A Tragedy Of The Global Policy Commons

Two global economics observations about the ineptitude of economic policy.

First, we knew about the credit crunch for at least a 15-18 months before the September 2008 meltdown. Yet, the crisis was not only not averted, but perhaps not even slowed down. The months after the collapse of Lehman were spent in a frantic search for new policy solutions. Nothing seemed to have worked. The nature of the crisis eliminated the most powerful tool of the central bank: the financial transmission channel. And thus a surprising policy void followed. The extent we did not know what was going on is illustrated well by the widening of economic forecast range at the time (and the collapsing predictive power of the mean), as well as the jitters that followed the drastic fiscal expansion everywhere. Arguably, it was not the lack of data, but more our lack of knowing what to do with it that caused the problem. Even when the packages started to work in the summer of 2009 (or at least something caused the numbers turn better), it came as a surprise.

Second, there is an eerie ‘dunno what’s going on’ in the air again. The ‘good’ data tends to signal export led growth (Germany, China). The countries that keep importing are still and again showing signs of the malaise (US, much of rest of Western Europe, Japan). Nobody can come up with even a half credible forecast for for any period beyond the next few months. The lesson we seem to have learned from the 2007-8-9 forecast fiascos is not even try that hard…

Why is this? Why are we unable to provide even the basic level of forecasts? And in any case, if there is a double dip, why is it here? If the ‘global policy maker’ has been dealing with this crisis for three years straight, why has it not been sorted?

Well, one possible answer is that the global economy behaves very differently to how the national level economies do. This blog has argued in the past that the future of economics will certainly have to deal with the fact that the global macroeconomy cannot take for granted a series of assumptions that the national level ones could. Ecological buffers, and socio-cultural homogeneity can be assumed only if they tend to be there. Global economics, will have to come up with some very different notions.

Yet, the need for a new organisational level in our models is perhaps a problem for later years. For it is not hitting the ecological carrying capacity, or having dysfunctional societies that seem to be the reason for the lack of efficient management of the global economy.

It is the lack of global policy institutions.

Imagine that you take any well functioning national economy: the US or Sweden, New Zealand or Thailand. Eliminate the national government, leave the local municipalities in place. Then boost the locals’ finances, give them local currencies, and strong local economic policy institutions: a taxation, budget, central bank, regulators. What would that world be like? Would this world be just as good as the current one? Or would these local institutions start altering their policies to take the maximum benefit from what had been the ‘national economy’? Would this inevitably lead to meltdown? A macroeconomic tragedy of commons.

And what would happen to economic forecast? In good times, the self movement of the system would give you a good basis for efficient prediction. But in bad times, you would need to know the reaction of the economy to the net effect of the multitudes of those municipality-level policies. You would need to assume some form of quasi-national-level policy, and build the model on that. But how could you derive that from the local ones, especially if those were playing against each other?

The global economy is not as integrated as most national economies. But, it is on the way. Today's version is not unlike an emerging economy, going through rapid structural change, within an environment characterised by weak and mostly brand new policy institutions. The funny thing is that if you were to put it that way, we would know immediately what to do.

The ineptitude of policy and forecasting professions points to the same direction. The direction of global economic policy institutions.