Larry Summers spoke on Friday afternoon at the InterAmerican Development Bank in Washington DC. As he was addressing a group with much experience living through and dealing professionally as economists with major crises, he spoke the “language of economics” (as he called it) and largely cut to the analytical chase.
Summers made five points that reveal a great deal about his personal thinking – and the structure of thought that lies behind most of what the Administration is doing vis-a-vis the crisis. Some of this we knew or guessed at before, but it was still the clearest articulation I have seen.
- All crises must end. The “self-equilibrating” nature of the economy will ultimately prevail, although that may take massive one-off government actions. Such a crisis happens only “three or four times” per century, so taking on huge amounts of government debt is fine; implicitly, we will grow out of that debt burden.
- We will get out of the crisis by encouraging exactly the kind of behaviors that “previously we wanted to discourage” two years ago. It is “this insight, this view” particularly with regard to leverage (overborrowing, to you and me) that “undergirds the policy program in the United States.”
- There is a critical need to support financial intermediation and to ensure it is adequately capitalized, with a view to the risks inherent in the current situation. He then said, with a straight face, that the current bank stress tests are designed with this in mind.
- Growth in the 1990s and more recently was based too much on finance (this appears to be a relatively new thought for Summers). The high and rising share of finance in corporate profits “should have been a warning”. The next expansion should be based less on asset bubbles and more on investment in key public services.
- The financial regulatory system “in fundamental respects has been a failure”. There have been too many serious crises in the past 20 years (yes, this statement was somewhat at odds with the low frequency of major crises statement in point 1).
Crises definitely end. But do they end with rapid recovery or with stagnation? There was nothing in Summers speech that addressed how we avoid – at the US or global level – becoming more like Japan in the 1990s, given the state of consumers’ and firms’ balance sheets around the world. There is no issue with debt levels; apparently, we can turn everything around with fiscal expansion and support for banks.
The essence of the government’s short-term strategy is obviously to prop up the financial sector, in order to sustain something close to the current levels of debt in the economy. But there was no hint in his remarks that this creates tension with point #4 – growth needs to be less finance-oriented in the future, i.e., talent has to be allocated elsewhere. If the rents are now government-generated but still in the financial sector, why would people or capital move?
And if enormous effort goes into sustaining the prosperity (and apparently the bonuses, according to first quarter set-asides) of Big Finance, how will that help with serious regulatory reform – which presumably will be opposed by the banks that are now regaining their fortunes? This thinking, put next to the NYT article this morning on Tim Geithner’s work at the NY Fed, is not encouraging.
More generally, there was not even an indirect mention of political economy. Summers’ public narrative for the crisis is essentially that there was an accident: stuff happens. This narrative matters. Irrespective of what he thinks privately, unless he and other senior Admininistration officials can start to use the language (even of economics) regarding regulatory capture, political connections, and the way in which economic booms can create disproportionate political influence for the finance sector, we are unlikely to change the structure of power and the risk of crisis in our economy.
You may not care too much about this – “let’s first turn the corner and then worry about other things”, is a standard refrain. And for a recovery, obviously, much depends on actions that Summers and the White House can only indirectly influence – including the Federal Reserve’s push towards inflation and the actions of European governments.
But defering to big banks and prefering fiscal expansion is very much a decision in the hands of Treasury and the White House. They may feel this is essential to restoring confidence, but that is not the general experience of countries facing major crises. The usual advice – given by the IMF, often at the behest of the US Treasury – is: manage an insolvency process for failed banks, precisely to reduce fiscal costs now and in the future, and to help restore confidence in the economy. Come to think of it, wasn’t this exact point made – forcefully and publicly – by Summers to the Japanese government during the 1990s?
Forbearance on banks may work, but at great cost to the taxpayer. And how is that helpful to either to Summers’ stated strategy of growth led by further public investment, or – given the existing state of our public finances – to a more plausible strategy of (nonfinancial) technological innovation?
By Simon Johnson