There’s been a lot of talk about “peak trade” and the collapse in cross-border capital flows in recent years. I seriously doubt that Donald Trump or any of the other recently elected populists are going to do anything to expand economic openness. For all the gnashing of teeth about what this means, however, Sebastian Mallaby has an essay that is well worth reading on the state of the globalized economy in 2016. As Mallaby notes, globalization has, so far, demonstrated surprising resiliency:
Do these developments portend the start of a new era — perhaps one of deglobalization? Such a reversal is possible: the rapid globalization of the late 19th century gave way to the deglobalization of the early 20th. And yet, in the absence of a shock comparable to World War I or the Great Depression of the 1930s, history seems unlikely to repeat itself. A look beyond the headlines suggests that globalization is changing rather than stagnating or reversing.
Read the whole thing. He makes arguments very similar to those I made in my 2014 book “The System Worked,” which argued that despite the 2008 financial crisis, the rules of the global game maintained a fair degree of openness while adjusting to the financial crisis itself.
Which brings me to the Wall Street Journal’s Bret Stephens and the question of the system has actually worked.
Earlier this week Stephens’s column used my book as his centerpiece to explain the wave of populist nationalism sweeping the world’s democracies. Here’s some snippets:
What happened? In 2014, Daniel Drezner, a professor at Tufts, published a book extolling the International Monetary Fund and other institutions of “economic global governance” for putting out the fires of the 2008 financial crisis. The global economy had been teetering on the brink of another Great Depression, but it didn’t fall in. Ergo, success.
The book was called “The System Worked.” Except it didn’t. The system did more to mask problems than it did to solve them.
Government statistics can show a drop in the unemployment rate, but they give scant indication of whether the jobs available now have the status or pay of the jobs available previously. Giving unlimited credit to a panicked patient will always have a narcotic effect; it can also have an addictive one. Near-zero (or subzero) interest rates will goose stock markets to the delight of sophisticated investors — and the dismay of savers. Bank bailouts may make “systemic” sense. But they divorce behavior from consequence. Pushing economic management from elected officials into the hands of unelected central bankers and regulators flatters the vanity of the intelligentsia while offending the normal person’s sense that his vote should count toward his own livelihood.
Stephens’s broader themes of whether unelected officials have too much power, or whether justice was done in the wake of 2008, are questions worth considering. But I really wish he had actually read my book before considering them.
“The System Worked” was not a story of international bureaucrats seizing control from elected officials. Rather, it was a story of how both national and international officials provided the public goods that are necessary in a crisis (keeping markets open, injecting liquidity into the system), and reformed the existing rules of the game (shifting from Basel II to Basel III on banking standards, from the Group of 7 to the Group of 20 as a focal point for summits). To the degree that elected officials delegated any power to unelected officials or international agreements during the crisis, it was because they wanted their own hands tied to pursue policies that they knew were correct but would also be potentially unpopular.
Stephens has a case to make that, looking through the justice lens, the post-2008 response rubs many the wrong way. But there are three responses to that.
First, as Stephens himself grudgingly acknowledges, there were very good reasons for why there was a deficit of official vengeance after 2008. BloombergView’s Megan McArdle explained it well in her response to Stephens’ column:
The banks got bailed out because no one wanted a repeat of the “let them fail” experiment of 1929, which was devastating to ordinary folks, not just the bankers. And once we’d bailed them out, it was hard to punish them beyond replacing the CEOs of the failed institutions. There simply wasn’t good evidence that top executives had committed jail-worthy financial fraud. (A lot of ambitious prosecutors spent years trying to find some.)
Over the years, people have called for a lot of actions to make all this fairer, from “jail the banksters” to “force banks to write down mortgage principle to the current value of the house.” Unfortunately, doing any of these things would have required either expending vast and politically unpopular sums, or simply suspending the law of the land and giving the federal government substantial new powers to jail people and seize property by fiat.
Second, if Stephens had actually read “The System Worked” he would have known that there was a moral response to the 2008 financial crisis. That response, however, proved to be disastrous. The post-2009 shift toward fiscal and (in the euro zone) monetary austerity was grounded in the notion — held by analysts across the political spectrum — that the 2008 financial crisis was caused by an orgy of debt that needed to be curtailed. Unelected observers — including Stephens’s own editorial page — certainly pushed this argument. Nonetheless, it was elected officials, from German Chancellor Angela Merkel to then-British Prime Minister David Cameron to Rep. Paul D. Ryan (R-Wis.), who implemented the shift toward austerity. As I wrote on page 171 of “The System Worked”:
The desire for austerity had a moral resonance as well. For example, Krugman notes, “When applied to macroeconomics, this urge to find moral meaning creates in all of us a predisposition toward believing stories that attribute the pain of a slump to the excesses of the boom that precedes it — and, perhaps, also makes it natural to see the pain as necessary, part of an inevitable cleansing process.” Advocates for austerity repeatedly compared public finances to personal finances, arguing that governments should balance their budgets just like households. This gave their ideas a moral and personal dimension that was intuitively plausible to citizens, even if the comparison of households to governments was fatally flawed.
Let me suggest that it was the premature push toward austerity, grounded in warped notions of justice and morality, that deepened the Great Recession.
Finally, if voters behaved as Stephens suggests, then I’m super-curious about how they’re going to respond to the Trump administration’s proposed financial reforms. Stock markets have surged since Trump’s victory primarily because there’s an expectation that there will be a wave of massive deregulation. Some of these ideas might have merit, but they are certain to widen the gap between the financial haves and have-nots going forward.
Unfortunately, the political reaction to the 2008 financial crisis appears pretty consistent with the political reaction to past crises. A September 2016 European Economic Review paper looked at how polities react to economic crises. Their findings:
Our key finding is that policy uncertainty rises strongly after financial crises as government majorities shrink and polarization rises. After a crisis, voters seem to be particularly attracted to the political rhetoric of the extreme right, which often attributes blame to minorities or foreigners. On average, far-right parties increase their vote share by 30% after a financial crisis. Importantly, we do not observe similar political dynamics in normal recessions or after severe macroeconomic shocks that are not financial in nature.
This is, in my view, among the more tragic implications of this research.
Voters seek out law-and-order politicians precisely because the world has seemingly become so lawless and disorderly; yet those politicians are likely to produce even more chaos, uncertainty and instability.
Looking back on ‘The System Worked,” my biggest mistake was hoping that the damage from 2008 would be contained enough to forestall the populist political reaction. Unfortunately, I underestimated the damage the austerity movement would wreak on the politics of the developed world.
I don’t think Stephens characterizes my arguments terribly well, and he badly whiffs on the policy outcomes of the policies I discussed in the book. But credit where it’s due: Stephens nails the outrage that leads to the populist revolt we’re all about to endure for the next four years.