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September 8, 2010

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What is the Role of the State?

Posted: 08 Sep 2010 12:42 AM PDT

When I teach the History of Economic Thought, one thing we focus on is how views on the role of the state have changed over time. It has a natural cycle to it, with eras such as the highly interventionist Mercantilist years followed by Physiocratic and Classical views stressing minimal government intervention. This is followed by a rebound in the other direction, and so it goes with a Keynes followed by a Friedman in the 50s, a rebound back to Keynes in the 60s, to classical ideas following the experience of the 70s, and so on, and so on. We are involved in the same debate, and a smaller version of the grand historical lurches in each direction, yet again today:

What is the role of the state?, by Martin Wolf: It is ... a good time to ask ... the biggest question in political economy: what is the role of the state? This question has concerned western thinkers at least since Plato (5th-4th century BCE). It has also concerned thinkers in other cultural traditions... The perspective here is that of the contemporary democratic west.
The core purpose of the state is protection. This view would be shared by everybody, except anarchists... Contemporary Somalia shows the horrors that can befall a stateless society. Yet horrors can also befall a society with an over-mighty state. ...
Mancur Olson argued that the state was a "stationary bandit". A stationary bandit is better than a "roving bandit", because the latter has no interest in developing the economy, while the former does. But it may not be much better, because those who control the state will seek to extract the surplus over subsistence generated by those under their control.
In the contemporary west, there are three protections against undue exploitation by the stationary bandit: exit, voice ... and restraint. By "exit", I mean the possibility of escaping from the control of a given jurisdiction, by emigration, capital flight or some form of market exchange. By "voice", I mean a degree of control over, the state, most obviously by voting. By "restraint", I mean independent courts, division of powers, federalism and entrenched rights.
This, then, is a brief background to ... the problem, which is defining what a democratic state ... is entitled to do. ...
There exists a strand in classical liberal or, in contemporary US parlance, libertarian thought which believes the answer is to define the role of the state so narrowly and the rights of individuals so broadly that many political choices (the income tax or universal health care, for example) would be ruled out a priori. ... I view this as a hopeless strategy...
So what ought the protective role of the state to include? Again, in such a discussion, classical liberals would argue for the "night-watchman" role. The government's responsibilities are limited to protecting individuals from coercion, fraud and theft and to defending the country from foreign aggression.
Yet once one has accepted the legitimacy of using coercion (taxation) to provide the goods listed above, there is no reason in principle why one should not accept it for the provision of other goods that cannot be provided as well, or at all, by non-political means.
Those other measures would include addressing a range of externalities (e.g. pollution), providing information and supplying insurance against otherwise uninsurable risks, such as unemployment, spousal abandonment and so forth. The subsidization or public provision of childcare and education is a way to promote equality of opportunity. The subsidization or public provision of health insurance is a way to preserve life, unquestionably one of the purposes of the state. Safety standards are a way to protect people against the carelessness or malevolence of others or (more controversially) themselves. All these, then, are legitimate protective measures. The more complex the society and economy, the greater the range of the protections that will be sought.
What, then, are the objections to such actions? The answers might be: the proposed measures are ineffective..; the measures are unaffordable...; the measures encourage irresponsible behavior; and, at the limit, the measures restrict individual autonomy to an unacceptable degree. These are all, we should note, questions of consequences.
The vote is more evenly distributed than wealth and income. Thus, one would expect the tenor of democratic policymaking to be redistributive and so, indeed, it is. Those with wealth and income to protect will then make political power expensive to acquire and encourage potential supporters to focus on common enemies (inside and outside the country) and on cultural values. The more unequal are incomes and wealth and the more determined are the "haves" to avoid being compelled to support the "have-nots", the more politics will take on such characteristics.
What are my personal views on how far the protective role of the state should go? In the 1970s, the view that democracy would collapse under the weight of its excessive promises seemed to me disturbingly true. I am no longer convinced of this... Moreover, the capacity for learning by democracies is greater than I had realized. The conservative movements of the 1980s were part of that learning. But they went too far in their confidence in market arrangements and their indifference to the social and political consequences of inequality. I would support state pensions, state-funded health insurance and state regulation of environmental and other externalities. I am happy to debate details.
The ancient Athenians called someone who had a purely private life "idiotes". This is, of course, the origin of our word "idiot". Individual liberty does indeed matter. But it is not the only thing that matters. The market is a remarkable social institution. But it is far from perfect. Democratic politics can be destructive. But it is much better than the alternatives. Each of us has an obligation, as a citizen, to make politics work as well as he (or she) can and to embrace the debate over a wide range of difficult choices that this entails.
Update: Read Martin Wolf's response to readers' comments

Protection, justice, correction of externalities, social insurance, and the provision of public goods (which I would like to have seen emphasized more above) are, in my view, legitimate roles of the state. I have more trouble when it comes to redistribution, I prefer that everyone have an equal chance in life with the chips falling where they may (with insurance against outcomes where individuals end up with too few chips). But redistribution to correct problems associated with, say, uncorrected market failures that redistribute income unfairly, or to compensate for an unequal playing field more generally, is another matter.

links for 2010-09-07

Posted: 07 Sep 2010 11:02 PM PDT

"He is One of the Best Fed Watchers Out There"

Posted: 07 Sep 2010 04:09 PM PDT

I figured Tim Duy would be too shy to post this, so I posted it for him.

Krugman and Wells: The Slump Goes On: Why?

Posted: 07 Sep 2010 09:45 AM PDT

Having just said that "the idea of 'public goods' and the need for government to provide them has been lost in discussions over stimulus spending," I'm glad to see this:

Infrastructure, by Paul Krugman: Some bleary-eyed thoughts from Japan on the reported administration proposal for $50 billion in new spending:
1. It's a good idea
2. It's much too small
3. It won't pass anyway — which makes you wonder why the administration didn't propose a bigger plan, so as to at least make the point that the other party is standing in the way of much needed repair to our roads, ports, sewers, and more– not to mention creating jobs. Once again, they're striking right at the capillaries.
Beyond all that, the new initiative is a chance for me to air one of my pet peeves: the stupidity of the claim, which you hear all the time — and you'll hear again now — that it's always better to provide stimulus in the form of tax cuts, because individuals know better than the government what to do with their money.
Why is this claim stupid? Because Econ 101 tells us that there are some things the government must provide, namely public goods whose benefits can't be internalized by the market.
So suppose we're going to put $50 billion of resources that would otherwise be idle to work. Is it better to use them to produce public goods like improved roads, or private goods like more consumer durables? That's not at all obvious — and anyone who tells you that basic economics settles the question, that is says that devoting more resources to production of private goods is better, doesn't understand Econ 101.
And there's a pretty good argument to be made that we are, in fact, starved for public goods in this country, so that it would actually be a good idea to shift some resources to public goods production even if we were at full employment; in that case, we should definitely give priority to public goods when trying to put unemployed resources to work.
Anyway, it's all academic right now. My response to the administration plan, at least as best as I can respond given a massive case of jet lag, is a big eh.

Looks like we agree on all three points, it's a good idea, but there's too little of it, and it's unlikely to pass. I would also add "much too late" to the "much too little" charge, but "too late" assumes the point of the proposal is to help people rather than play political games designed to influence the upcoming midterm elections.

But I've said all that before, many times, so let's move on to the actual reason for this post. In the NYRB, Paul Krugman and Robin Wells review Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram G. Rajan, Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini and Stephen Mihm, and The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession by Richard C. Koo:

The Slump Goes On: Why?, by Paul Krugman and Robin Wells, NYRB: In the winter of 2008–2009, the world economy was on the brink. Stock markets plunged, credit markets froze, and banks failed in a mass contagion that spread from the US to Europe and threatened to engulf the rest of the world. During the darkest days of crisis, the United States was losing 700,000 jobs a month, and world trade was shrinking faster than it did during the first year of the Great Depression.
By the summer of 2009, however, as the world economy stabilized, it became clear that there would not be a full replay of the Great Depression. Since around June 2009 many indicators have been pointing up: GDP has been rising in all major economies, world industrial production has been rising, and US corporate profits have recovered to pre-crisis levels.
Yet unemployment has hardly fallen in either the United States or Europe—which means that the plight of the unemployed, especially in America with its minimal safety net, has grown steadily worse as benefits run out and savings are exhausted. And little relief is in sight: unemployment is still rising in the hardest-hit European economies, US economic growth is clearly slowing, and many economic forecasters expect America's unemployment rate to remain high or even to rise over the course of the next year.
Given this bleak prospect, shouldn't we expect urgency on the part of policymakers and economists, a scramble to put forward plans for promoting growth and restoring jobs? Apparently not: a casual survey of recent books and articles shows nothing of the kind. Books on the Great Recession are still pouring off the presses—but for the most part they are backward-looking, asking how we got into this mess rather than telling us how to get out. To be fair, many recent books do offer prescriptions about how to avoid the next bubble; but they don't offer much guidance on the most pressing problem at hand, which is how to deal with the continuing consequences of the last one.
Nor can this odd neglect be entirely explained by the mechanics of the book trade. It's true that economics books appearing now for the most part went to press before the disappointing nature of our so-called recovery was fully apparent. Even a survey of recent articles, however, shows a notable unwillingness on the part of the dismal science to offer solutions to the problem of persistently high unemployment and a sluggish economy. There has been a furious debate about the effectiveness of the monetary and fiscal measures undertaken at the depths of the crisis; there have also been loud declarations about what we must not do—warnings about the alleged danger of budget deficits or expansionary monetary policy are legion. But proposals for positive action to dig us out of the hole we're in are few and far between.
In what follows, we'll provide a relatively brief discussion of a much-belabored but still controversial subject: the origins of the 2008 crisis. We'll then turn to the ongoing policy debates about the response to the crisis and its aftermath. Not to keep readers in suspense: we believe that the relative absence of proposals to deal with mass unemployment is a case of "self-induced paralysis"—a phrase that Federal Reserve Chairman Ben Bernanke used a decade ago, when he was a researcher criticizing policymakers from the outside. There is room for action, both monetary and fiscal. But politicians, government officials, and economists alike have suffered a failure of nerve—a failure for which millions of workers will pay a heavy price. ...[...continue reading...] ...
There's a lot in the article, but I do want to point to this section in particular:

The idea that the government did it—that government-sponsored loans, government mandates, and explicit or implicit government guarantees led to irresponsible home purchases—is an article of faith on the political right. It's also a central theme, though not the only one, of Raghuram Rajan's Fault Lines.
In the world according to Rajan, a professor of finance at the University of Chicago business school, the roots of the financial crisis lie in rising income inequality in the United States, and the political reaction to that inequality: lawmakers, wanting to curry favor with voters and mitigate the consequences of rising inequality, funneled funds to low-income families who wanted to buy homes. Fannie Mae and Freddie Mac, the two government-sponsored lending facilities, made mortgage credit easy; the Community Reinvestment Act, which encouraged banks to meet the credit needs of the communities in which they operated, forced them to lend to low-income borrowers regardless of risk; and anyway, banks didn't worry much about risk because they believed that the government would back them up if anything went wrong.
Rajan claims that the Troubled Asset Relief Program (TARP), signed into law by President Bush on October 3, 2008, validated the belief of banks that they wouldn't have to pay any price for going wild. Although Rajan is careful not to name names and attributes the blame to generic "politicians," it is clear that Democrats are largely to blame in his worldview. By and large, those claiming that the government has been responsible tend to focus their ire on Bill Clinton and Barney Frank, who were allegedly behind the big push to make loans to the poor.
While it's a story that ties everything up in one neat package, however, it's strongly at odds with the evidence. And it's disappointing to see Rajan, a widely respected economist who was among the first to warn about a runaway Wall Street, buy into what is mainly a politically motivated myth. Rajan's book relies heavily on studies from the American Enterprise Institute, a right-wing think tank; he doesn't mention any of the many studies and commentaries debunking the government-did-it thesis.5 Roubini and Mihm, by contrast, get it right:

They go on to detail some of the evidence against the Rajan view of the crisis.

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