The Leaderless Economy

Peter Temin, of the Massachusetts Institute of Technology, was left stranded in the UK when Eyjafjallajökull erupted in Iceland in April 2010. He and David Vines, a fellow economist based at the University of Oxford, spent four days sharing “distress at the lack of understanding [of the financial crisis] in the popular press”. They could have done the obvious thing and penned an “outraged of North Oxford” letter to the Daily Telegraph. Instead, three years later, they have produced a monograph explaining why policymakers have been doing so badly, and how they could improve.

Have they found the answer others have failed to see, or did Eyjafjallajökull erupt in vain?

Their argument is drawn from a reading of the economic history of the past 200 years. They characterise the period from Waterloo to the Wall Street Crash as one of British financial hegemony. This halcyon age ended when, after the First World War, Britain no longer had the financial resources to sustain its position. The reparations imposed on Germany, and the US failure to show a lead, brought about the Great Depression of the 1930s, the rise of the Nazis and the Second World War.

So far, so conventional. There follows a lengthy diversion that tracks the evolution of John Maynard Keynes’ thinking, from The Economic Consequences of the Peace (1919) through the post-Wall Street Crash Macmillan Committee report to which he contributed, his 1936 General Theory of Employment, Interest and Money, and the 1944 Bretton Woods agreement on monetary management. The authors are unashamed pro-Keynesians; they worship the curves he drew.

In their reading, Bretton Woods led to the American “century”, give or take a decade or three, which they believe ended with the recent financial crisis. They regard it as an “end of regime” event, just like the Great Depression. After decades of enlightened policies from the Marshall Plan onwards, the US economy moved into chronic external imbalance, with catastrophic consequences. Successive administrations “encouraged [unsustainable] expenditure through financial deregulation and a low level of interest rates. This unhappy combination caused the financial bubble, which led in turn to the crash.” Instead, they should have “promoted a tighter fiscal policy and a devalued exchange rate”.

We leave the US hoist with its own petard, while Temin and Vines explore the problems of the eurozone. Their analysis is quite familiar, at least on the UK side of the Channel. They focus on the imbalances that built up within the eurozone in its first decade, as German competitiveness grew and that of the southern European states deteriorated. They are sceptical of the South’s ability to achieve the necessary adjustment unaided. Large internal devaluations are hard to engineer, and highly deflationary. So while they accept the case for austerity in Greece, Spain and elsewhere, this must be matched by expansionary fiscal policies in the North.

Germany will need to increase demand, and accept somewhat higher inflation. It will also have to bear much of the cost of adjustment. The European Central Bank must be the lender of last resort to banks and sovereigns. That is likely to result in losses, and “Germany will need to bear a large proportion of the tax burden needed to support this activity by the ECB”. I doubt that the German edition of The Leaderless Economy will rush off the shelves in Berlin and Frankfurt.

Our volcanic exiles finally turn to the global solution. After a few pages of game theory 101 (I wonder if there is something in the water coolers of economics departments that creates this compulsion) they argue for a prisoner’s dilemma-style “cooperative outcome”. The elements are a “sufficient increase in spending in surplus countries”, a “sufficient cut in spending in deficit countries” and a material “adjustment of real exchange rates”, especially a rise in the renminbi and other East Asian currencies.

How can this be made to come about in our leaderless economy? The US is weakening and disinclined, the European Union is preoccupied with its internal problems, and China is not yet ready to take on the hegemonic mantle. The answer, they think, might be the G20 Mutual Assessment Process (G20MAP), set up at the 2009 Pittsburgh summit under the Framework for Strong Sustainable and Balanced Growth. In its analysis of the policies being pursued by the main economies, it “pointed out policies that would move the world toward cooperative outcome, policies precisely of the kind we identified”.

I searched for G20MAP on the Financial Times website - it’s the only “popular press” I read. “Sorry”, it said, “no results were found for your search”, which I guess proves the authors’ point.