Our System is broken

Some rather depressing, but I'm afraid accurate blogging at [Noahpinion]

Now, I acknowledge that it seems unlikely that the U.S. will make policy mistakes significant enough to tumble us out of the ranks of the rich countries. But there's no rule that the principles of development economics don’t apply to us! In particular, much of the development literature emphasizes the importance of institutions for living standards; there seems to me no reason to assume that once a country reaches the highest levels of per-capita income, its institutions are forever guaranteed to be top-notch.

This is my big worry about the current crisis. When I think of what might hold down our long-term growth, I think about political-economic equilibria and the quality of our institutions. What if an economic shock is severe enough to knock a country out of a good (but fragile) political-economic equilibrium - where factions basically agree on the need for public good provision and sound macro policy - and into a bad one, where no one can agree on anything?

Casual observation says that this may be what happened to Japan. A prolonged slump (compounded by macro policy mistakes) was followed by decades of political chaos that have seen prime ministers come and go like fashion trends. Gridlock has led to too-low taxes and massive debt, while trade and immigration policies remain stuck in the past. Now, personally, I think Japan's political institutions were never particularly good, but I also think that what virtue they had proved to be fragile to external events.

Looking at our current crisis over the debt ceiling, I can't help but worry that something similar is happening to us. Our nation needs to raise taxes, but we can't. Our infrastructure is falling apart, but we can't fix it. We seem to have reached a political-economic equilibrium in which the Republican Party, either by filibusters or by cyclical election victories, will always have the clout to throttle spending on public goods and prevent the taxes and health-care reform that are needed to close our own unsustainable deficits – and because Republicans are ruled by primary elections in the South and by Grover Norquist, their incentives will not soon align with the nation’s. As our roads and our health care system deteriorate, I am comforted neither by a long-term log-log plot of U.S. GDP nor by the limited usefulness of New Growth Theory.

Mark Thoma argues that long-term-ism is a basically conservative policy stance, since the RBC people and the "structural unemployment" people urge us to ignore stabilization policy and focus on things like lowering taxes. I don't think that's necessarily true, for two reasons. First, just because the long-term is important does not mean that conservative policy ideas are right. Conservatives' main mistake is to ignore market failures; yes, this leads them to ignore stabilization policy, but it also makes them ignore public goods. Second, just because the short-term is important does not mean that the long-term is not. The same political-economic dysfunction that stops us from implementing timely and appropriate stabilization policy also stops us from rebuilding our roads.

All that being said, here's the upshot of my post: I certainly am NOT saying we should ignore stabilization policy. If short-term policy and long-term policy were really in conflict right now, I would say we should carefully balance the two. But I don't think they are in conflict! We shouldn’t be afraid that raising taxes will harm the macro situation, because (as John Taylor and Paul Krugman both point out) tax cuts make poor stimulus. And spending more on infrastructure would be good for both short-term employment and long-term efficiency. So I really think there is no tradeoff right now.