8 Aug 2011

Panic in the markets

MD writes:
As an economist, you’ve got to be watching yesterday’s markets with fascination. From where I sit, it’s looking more and more like the collapse of the Washington Consensus, this just 20 years after the USSR kicked the bucket. Now no one seems to know what the dominant philosophy will be in this new global/technological world. I’m no economist; that’s my read as a layperson.
The market panic is the exact OPPOSITE of the collapse of the WC, which (1) hasn't really collapsed (look at Chile, Brazil, Estonia and other countries with low debt, small deficits, openness to trade, etc.) and (2) describes the kind of prudent macroeconomic policies that the US/EU are NOT pursuing.

Let's just list WC policies here:
  1. Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP;
  2. Redirection of public spending from subsidies ("especially indiscriminate subsidies") toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment;
  3. Tax reform – broadening the tax base and adopting moderate marginal tax rates;
  4. Interest rates that are market determined and positive (but moderate) in real terms;
  5. Competitive exchange rates;
  6. Trade liberalization – liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs;
  7. Liberalization of inward foreign direct investment;
  8. Privatization of state enterprises;
  9. Deregulation – abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions;
  10. Legal security for property rights.
I'd say that the US and the EU have failed (zero for ten) in terms of policy DIRECTION -- even assuming good policies in the past, e.g., Kelo weakened property rights in the US; the Italians and Greeks are opposing deregulation and privatization to protect special interests.

The "markets" panicked because people started to understand that political "solutions" like raising the debt ceiling, promising to print more money (QE3), or bail out Greece from wasteful loans do NOTHING to make the economy strong. At best, they transfer money to incompetent losers; at worst, they waste time and resources (shuffling deck chairs while the Titanic sinks).

Note that the Tea Partiers are not exactly paragons of macroeconomic wisdom. Their obsession with lowering taxes -- to zero percent, it appears -- is just as stupid as an obsession with the President's birth certificate.

Bottom Line: Political shenanigans [e.g, The Economist] will not strengthen the economy, and a weak economy will not support social programs that protect the weak.