What both parties are searching for, of course, isn’t necessarily the optimal economic policy or philosophy: They want the policy, consistent with their political-belief system, that plays best with voters. That’s a double challenge for economists to solve. It’s not enough to build a new and better understanding of the economy and its trapdoors. We need a simple narrative to explain it, too. The one that took root under Reagan and Clinton—that deregulating markets and expanding global trade would benefit everyone—worked for 30 years. Now, opinion polls suggest, that narrative doesn’t play. Americans don’t trust the government or the markets.
In an optimal world—a paradigm that economists are familiar with—both economists and lawmakers would acknowledge public frustration with government and markets and step up to the titanic challenge ahead. It’s impossible to say right now what policies would result from such a rethink. They could be small and surgical tweaks, such as increasing capital requirements for banks, rethinking government backstops for the mortgage market, or overhauling labor laws to slot more people into more-satisfying work. Frydman, the NYU economist who was so critical of Summers at Bretton Woods, suggests limiting government intervention in certain markets—say, housing—until such time as asset prices swing outside of traditional boundaries, and then ramping up regulation to dampen those prices.
It could be that in regulating extraordinarily complex operations with huge sums of money attached—such as deep-sea drilling and derivatives trading—governments will need to keep industry on what might appear to be a short leash, and regulators will need to work far more closely across international lines than they’re used to, knowing that a breakdown in the system anywhere is a worldwide threat. (Witness the global slowdown in nuclear-plant construction, not to mention the public-health panic, from the Fukushima Daiichi reactor disaster in Japan.)
Or, lawmakers might end up making radical changes in how they judge economic progress—perhaps adopting Turner’s suggested shift away from favoring GDP growth toward a more explicit effort to achieve full employment. Those changes, as Turner proposes them, would require lawmakers to invert some of the basic cost-benefit calculations they rely on to guide economic policy. If stability is more important to the U.S. economy than growth, Turner says, then lawmakers should stop worrying about the costs, in lost growth, of stabilizing the global banking system or counteracting greenhouse gases in the atmosphere. Banks should hold whatever level of capital is necessary to forestall runs on the system and a potential repeat financial crisis—even if that means slowing down lending and curbing the economic activity that grows from it. Countries should pay whatever it takes to dramatically improve energy efficiency and transition from fossil fuels to low-carbon ones, even if the increased price of energy stunts growth by far more than the 1 percent of global GDP that a British blue-ribbon panel estimates is the price of climate stability.
This is a quest that the U.S. can and should lead. Other nations are increasingly skeptical that Washington can balance its budget, reduce its debt, or bridge partisan divides. But in the realm of global economic thinking, the U.S. still stands alone. “The power of American economics is preeminent at this stage,” says Andrew Sheng, the chief adviser to the China Banking Regulatory Commission. At the Bretton Woods gathering, participants agreed that no strand of economics—not European, not Chinese—comes close to challenging that dominance.
But the question remains: Who will fill the vacuum? Who will follow the path of Friedman and Keynes and shake up economic policy-making for a generation? The joke in economics, as in many other scientific disciplines, is that the field advances one dead researcher at a time. Old ideas die; new ones grow. American economists and politicians would be wise to start thinking of the financial crisis as a collective funeral for old thinking—and as an opportunity to rise from the ashes.
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This article appears in the May 21, 2011, edition of National Journal.