Sunday, August 23, 2009

3 MDs, 3 different diagnoses

You’re sick with a bad sore throat. You go to three different doctors. You get three different diagnoses of your illness.

That personalized analogy, as fleshed out in a Salon article, is a good way to understand the different basic approaches that today’s economists take in diagnosing the current economic sickness.

Michael Lind, director of the New America Foundation’s economic growth program, analyzes the parallel diagnoses in his April 7 Salon article titled “Rx for the Economy: Which Doctor Should We Believe?" Here’s my somewhat oversimplified summary of his enlightening MD/PhDecon analysis.

-- The first doctor says you have a sore throat and prescribes an aspirin.
-- The second says your sore throat is a symptom of pneumonia and prescribes antibiotics.
--The third doctor sees your condition as more complex. He prescribes aspirin for the sore throat and antibiotics for your pneumonia, but also a 12-step program for overcoming alcoholism, an addiction that has weakened your immune system and renders it vulnerable to infections like pneumonia.
Those three different diagnoses have their parallels in three different ways that economists see what went wrong to cause the greatest global economic collapse since the Depression of the 1930s.

-- Economic doctor No. 1 blames lax financial regulation for turning the U.S. housing bubble into the current crisis. So the cure is some new financial regulation and tougher enforcement, national and international.

-- That cure is fine, says Economic doctor No.2, but it does not go far enough. It fails to deal with a larger cause – global trade imbalances, created by American (household, corporate, and governmental) overspending and oversaving by China and several other Asian governments to steer more investment into export manufacturing. The cure is not only tougher regulation but also a global economic rebalancing that includes a curb on currency manipulation.

-- Enter Doctor No. 3, whose diagnosis includes but is not limited to the diagnoses of the other two physicians. The bubble-blowing system of unbalanced trade never would have arisen in the first place, had employers on both sides of the Pacific shared more of the gains from productivity growth with their workers.

So the present crisis is caused indirectly by poor regulation, proximately by global trade imbalances, and ultimately by the maldistribution of the gains from economic growth among employers and workers in major industrial countries. The basic idea, as explained in Lind’s own words:
“Rich people have a lower propensity to consume (the term was coined by Keynes) than middle-class and low-income people. It follows that if the gains from productivity growth go to workers, they are more likely to spend the money, stimulating further investment and further growth. But if the gains from productivity growth disproportionately go to the rich, they are less likely to spend the money on mass-produced goods and services than they are to save the money or use it to speculate in assets. The result? Either the economy chokes (too much savings) or explodes (asset bubbles).“

The cure? Lind ends his article without specifying one. No wonder. Even the economists who agree on the overall diagnosis – Robert Reich, James K. Galbraith, and Thomas Palley, among others -- have not reached a consensus on anything like a 12-point recovery program.

Lind’s closing sentences: “We had better hope that the first physician is right: the world economy’s sore throat is nothing more than a sore throat, and an aspirin in the form of more financial regulation will be sufficient as a cure. Otherwise, the patient is a serious trouble.”

(For my analysis of Thomas Palley’s ideas, keep tuned.)

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