[Viewpoint] Three undesirable outcomes ...

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[Viewpoint] Three undesirable outcomes ...

Democratic governments are not encouraged to take decisions that have short-term costs but produce long-term gains, the typical pattern for any investment. Indeed, in order to make such investments, democracies require either brave leadership or an electorate that understands the costs of postponing hard choices.

Brave leadership is rare. So, too, is an informed and engaged electorate, because the expert advice offered to voters is itself so confusing. Economists of different persuasions find it difficult to reach a consensus about the necessity of any policy. Consider, for example, the cacophony of arguments about government spending: is it the only thing keeping depression at bay or is it moving us steadily down the road to perdition? The debate does not lead to agreement as moderate voters do not know what to believe and policy choices ultimately follow the path of least resistance - until they run into a brick wall.

The build-up of public debt in industrial countries (which was rising briskly well before the Great Recession pushed it to near-unsustainable levels) reflects this kind of calculus. The public rewards democratic governments for dealing with the downside risk caused by competitive markets - whether by spending to create jobs or by rescuing banks that have dodgy securities on their balance sheets.

Even if inaction (or action with a view toward the longer term) is the best policy, it is not an option for democratically elected politicians, which inevitably means action with the potential for quick results. A sympathetic press amplifies heart-rending stories of lost jobs and homes, making those advising against intervention or advocating longer-term fixes appear callous. Democracies are necessarily softhearted, whereas markets are not; government action has expanded to fill the gap.

With governments in many developed countries now reaching the limits of their gap-filling capacity, three undesirable possibilities loom large. One is that they intervene directly in markets to reduce competition and volatility while they rebuild their buffering capacity. Another is that they muzzle democracy to suppress public anger. A third is that they find scapegoats.

All three were tried during the Great Depression of the 1930s. The results were not encouraging.

One factor diminishing the likelihood of governments intervening more directly in markets is that the recent crisis seems to have discredited government as much as it discredited the financial sector. During the Great Depression, matters were different. As economic collapse caused the public to lose faith in the private sector and markets, faith in government grew. For example, in the United States, public support for President Franklin Roosevelt’s New Deal was broad-based throughout the 1930’s.

One possible reason for the difference in attitudes today is that bankers were visibly punished in the 1930s. Legislation such as the Glass-Steagall Act clipped their wings. Many bankers also suffered direct losses as their banks collapsed, or as investigations exposed them to public ridicule and even jail.

Today, by contrast, broad segments of the public see the big banks and big government as being run by the same elites who created the crisis, and then spent public money under one guise or another bailing out the banks. Even as bankers are again reaping enormous bonuses, taxpayers have been left to foot the bill for the economic collapse. Many workers are unemployed and in danger of being evicted from their homes, while no important banker has been put in jail.

The biggest banks now account for an even larger share of the financial sector after benefiting from a government rescue, while efforts like the Dodd-Frank Act to legislate more constraints on banks have been lobbied into shadows of their original selves. The elite, whether in government or big business, seems to look after itself and no one else.

In the U.S., this sentiment has fueled the Tea Party, which coalesces around opposition to government expansion (and to elites more generally), even if that expansion is aimed at regulating big banks (presumably because government regulations tend to be shaped by the powerful among the regulated.) Movements like the Tea Party have thus tended keep in check those who, after a crisis of the sort that America has had, typically want more government action, including curbing markets and competition.

The U.S. isn’t alone in having a discredited government. In the eurozone, in addition to the perceived nexus between banks and governments, the governing elite’s willingness to embrace European integration, and taxpayer-financed cross-border financial support, without broad public consultation has generated similar sentiment. In Japan, two decades of relentless economic malaise has decimated the public’s faith in politicians and the government bureaucracy.

The second undesirable possibility, that governments with little spending capacity to assuage public anger turn against democracy and free expression, is remote for now. Democratic institutions in industrial countries are stronger, and have deeper roots, than was the case in the 1930s.

That leaves the third undesirable possibility, the search for unprotected scapegoats upon whom public anger can be dissipated. Unfortunately, several countries are taking this path, with undocumented immigrants and Muslims being the first targets. Politicians who seek scapegoats might argue that they mean no harm and helping their societies to avoid worse possibilities. As the 1930s showed, it is hard to imagine any possibility worse than where this type of behavior can lead.

*The writer is a professor of finance at the University of Chicago’s Booth School of Business.

By Raghuram Rajan
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