A new Washington Consensus? POLICY RULES
‘Bad’ policy ideas long considered dead are again being taken seriously by economists
Academic economics is not the most swift-moving of disciplines. It does not respond as swiftly as it could to real-world events. It is not that it is disconnected from the real world. It is unfair to call economists, of all people, detached ivory-tower sorts; they, after all, have to work with actual realworld data most of the time. But it is true that research projects take time to respond to the headlines. Changing an entire discipline’s research agenda and priorities is like turning around a supertanker — you need a lot of space and time.
The financial crash of 2008 — and the slow growth of anti-globalisation, anti-openness populism since then — seems to have finally begun to show up in the words and papers of academic economists. In the process, ideas that have long been dead and buried are being resurrected.
Indeed, as I have argued on these pages before, it might be we are being too harsh on Prime Minister Narendra Modi for his weakness for 1970s-style statism. His backward-looking policies are very much part of the global zeitgeist right now. And, unsurprisingly, the world’s economists seem to wind up finding evidence to support the policy choices being made by the world’s politicians.
Consider, for example, some of the papers presented at a recent conference at the Peterson Institute for International Economics in Washington, DC. Coinciding with the fall meetings of the World Bank and the International Monetary Fund, the conference was titled, immodestly enough, ‘Rethinking Macroeconomic Policy’; luminaries from across the world of economics, including Larry Summers, Olivier Blanchard, Raghuram Rajan, Ben Bernanke, Mario Draghi, and Robert Rubin, presented papers and comments.
This column can’t summarise everything that was discussed — if you have a few hours to spare, most of the conference presentations are available on YouTube — but one thing certainly did come through: Ideas once considered old are back. Or, at any rate, ideas that were considered the state of the art are now being considered, by many, as no longer being so.
Two such ideas that came under attack at the conference were growthfocused policy and flexible exchange rates. Yes, really: The luminaries of international economics sat in a room and debated whether it is worthwhile to consider the effects of an economic policy on growth, and whether allowing your currency to float is really all that beneficial.
The questions about the benefits of flexible exchange rates came up in a discussion of the work of Harvard economist Gita Gopinath, who argued that classical trade theory failed to predict what was actually happening in the data. In particular, she said, countries that saw their currencies depreciate didn’t see an exports boom — something that theory predicted should happen. This is puzzling on one level; because if you have a cheaper currency, then your export goods should be cheaper, and thus your exports should increase. But, that mechanism is broken, argued Prof. Gopinath; she said the data showed that a one per cent depreciation in the exchange rate is associated with only a 0.1 per cent depreciation in the bilateral terms of trade (the price of your exports relative to that of your imports). In other words, the actual price of exports isn’t falling when the currency is. Why? Prof. Gopinath said that exports are no longer denominated in local currencies, but in dollars — and so their prices stayed relatively constant regardless of what happened to the value of the local currency.
A major benefit of flexible exchange rates, the ability to gain competitiveness in the world economy, is therefore being questioned. It is true that we should not jump straight to export pessimism; discussing Prof. Gopinath’s work, Raghuram Rajan said that perhaps we needed to look at a longer time period to be certain that there was, in fact, no adjustment to the relative price of exports after a depreciation. Yet the very fact that this is being debated seems significant.
Then there was the presentation by another Harvard economist, Jason Furman of the Kennedy School of Government. Prof. Furman is no stranger to real-world policy work; he was chairman of Barack Obama’s Council of Economic Advisors. Yet he argued that policymakers should recognise that they have very little ability to control growth. In fact, he said, the effects of any economic policy on distribution, especially in developed economies, far outweigh their effects on the level of output. Tax reform in the United States, for example, would raise long-run output by only two per cent. But past tax changes had had massive distribution effects, raising and lowering the income of high and low income percentiles by between seven and 12 per cent.
Thus he argued that policies in developed countries should be evaluated by looking at their effect on distribution first, and a growth focus should be, if not abandoned, at least relegated to an afterthought. This is quite an extraordinary claim to make. Some of the discussion of Prof. Furman’s paper, in particular a presentation by Dani Rodrik — also at the Kennedy School — focused on how this analysis could perhaps be extended to other areas, such as trade policy. Prof. Rodrik suggested that the benefits to trade were small in comparison to the distribution effects, and that trade policy should be re-evaluated in that light. In other words, the leaders of the global policy economics profession are discussing whether world trade should be held hostage to the US’s Rust Belt.
These are, of course, open research questions. Yet it is worth noting that a large number of ideas such as exchange rate management, growth-agnostic policy, and industrial policy that have long been considered bad are again being seriously evaluated. That, at least, seemed to be the zeitgeist at the Peterson conference in Washington, and at the fall meetings in general. Perhaps what we are seeing is the emergence of a new Washington Consensus.