Date created:23 November 2001 Last modified: 23 November 2001 Maintained by: John Quiggin John Quiggin
4 October 2001
As the public service has been contracted and politicised in Australia over recent decades, the task of developing policy ideas has increasingly been left to private institutes or 'thinktanks'. To understand the debate on any policy issue today, the first requirement is to identify the key thinktanks.
Many historical parallels have been drawn in relation to the terrorist attacks on the United States three weeks ago. In economic terms, however, the only parallel that matters is that of the Kobe earthquake in Japan in 1995. The economic situation in the United States before the attack was almost unique, paralleled only by the slowly deflating bubble economy of Japan in the early 1990s.
Like the Japanese central bank a decade earlier, the US Federal Reserve took belated action during 1999 and 2000 to prick a bubble which had long since driven asset prices out of any relationship to reality. Again, as in the Japanese case, the illusion of economic invulnerability remained strong, and was still a crucial force in the US economy before September 11. In both cases, disaster spelt the end of such illusions.
Forward extrapolation is not encouraging. Nearly seven years after the Kobe earthquake, Japan remains mired in economic stagnation, and faces the prospect of yet another recession. Massive use of stimulatory fiscal policy has staved off total disaster, but expenditure on capital-intensive infrastructure projects has mostly been wasted, and the breathing space gained by fiscal policy has not been used to address the underlying problems. Thus far, the supposedly radical Koizumi government has been most notable for backward-looking moves like the sanctification of war criminals.
There are, however, reasons for guarded optimism in the US case. The Kobe disaster exposed the incompetence of the Japanese state, regarded until then as both omniscient and omnipotent. By contrast, the Bush administration has, so far, responded to the terrorist attacks in a thoroughly capable fashion, to the surprise of many observers, including myself. Other levels of government, and especially the New York city government, have excelled themselves. Moreover, the spirit of bipartisanship has survived the immediate aftermath of the attack and now seems to have some chance of enduring.
Leaving aside the diplomatic and military aspects of the problem, the attacks seem to have changed the economic policy landscape. Before the attacks, US fiscal policy represented the worst of all possible worlds. The federal government had mortgaged its future with legislative commitments to tax cuts a decade hence, but had given only trivial short-term fiscal stimulus to the economy. Meanwhile, budget projections were based on assumptions that implied huge cuts in basic governmental functions.
Many state governments, including that of New York, had dissipated their unemployment insurance funds on the assumption that good times would last forever. Looming unnoticed in the backgroundwas the approach of the five-year cutoff rule, legislated as part of the Welfare Reform Act, which threatened to throw hundreds of thousands of poor families into total destitution when it came into force at the beginning of 2002.
After the crisis, the spirit of government activism has suddenly revived. The government has announced plans to resume control of basic functions like public safety in airports. State unemployment insurance schemes have been bailed out. The need for large-scale fiscal stimulus has been generally accepted.
Ultimately, the acceptance of public responsibility will necessitate the repeal of the massive tax cuts enacted early this year, when economic policy was still based on illusion rather than reality. Moreover, it remains to be seen whether the new spirit of community extends to single mothers and the children of broken families. Nevertheless, the short-sighted selfishness which has been the driving force in US economic and social policy for many years seems suddenly to have vanished.
Of course, share prices have fallen sharply, along with consumer confidence and consumer spending. But this is a move towards equilibrium. Even after the recent declines, equity in US companies is overvalued and consumer spending is unsustainabily high.
It was never going to be possible to rectify the imbalances of the 1990s bubble without a recession. All that has changed after September 11 is that this fact is now generally recognised. The implicit assumption that nothing really bad can happen to America has been shown to be about as wrong as an assumption can be. In the long run, however, the US economy will be better served by sober realism than by the irrational exuberance of the 1990s.
Greg Lindsey (AFR 2/10) suggests that I have misrepresented the views of Hayek, Kasper and Schwartz. Those who would like to ensure that my quotes were accurate and in context should check Hayek, The Constitution of Liberty (Uni of Chicago Press 1960, p 105), Kasper, Building Prosperity, pp 99-100 and 'Schwartz 'Laissez faire not fair for all', Australian, 27 June 2001 p. 31.Professor John Quiggin is a Senior Research Fellow of the Australian Research Council, based at the Australian National University and Queensland University of Technology.
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