THE METHOD TO THE DEMOCRATS' MADNESS:

Seeing Crises Clearly: Prakash Loungani profiles economist Nouriel Roubini (Prakash Loungani, March 2009, Finance and Development)

[Nouriel ] Roubini picked Cambridge, Mass., but went to Harvard rather than MIT. Why? “I didn’t get into MIT,” he says. “But please make it clear that I take no offense. These things happen.” In fact, he got the benefits of interactions with both Harvard’s superstars—“Jeff Sachs, Larry Summers, Robert Barro, and Greg Mankiw were around”—and MIT’s. “I would attend classes [at MIT] by Rudi Dornbusch, Stan Fischer, and Olivier Blanchard,” he says. His first job after graduating from Harvard in 1988 was at Yale.

Influenced by the saga of Italy’s struggle with large and persistent budget deficits, Roubini was drawn to the study of fiscal policy—how governments decide how much to spend and how to pay for it. It was a time when governments were spending and not paying for it, at least not right away.

“It was quite striking,” says Roubini. “In the 1970s and early 1980s, many countries in Europe had deficits of about 4 percent of GDP, and in some, such as Belgium, Greece, and Italy, deficits were as high as 10 percent of GDP.” As a consequence, government debt increased significantly: the debt of the countries that would later make up the euro area “nearly doubled, from something like 30 percent to 60 percent” of their combined incomes. The United States and Japan also ran persistent deficits.

Two views prevailed in the academic arena of what gave rise to these government deficits and how much to worry about them. One view, put forward by Nobel Prize winner James Buchanan, was that there was a chronic tendency toward budget deficits because warring politicians competed for the votes of special interest groups by promising them a continuous IV drip of government spending.

The other view, whose main proponent was Robert Barro, was that on deficit spending governments tended to do the right thing over the long run: they ran up deficits in times of need, such as during wars and recessions, and paid back the debt—albeit fairly slowly—in tranquil times. This view was supported by the behavior of the U.S. and U.K. governments, which had behaved in roughly this fashion over the long sweep of history.

Roubini’s contribution, in work done in the mid-1980s with Alberto Alesina and Jeffrey Sachs, was to carve a middle passage between these two views. he looked carefully at the political situation in countries to understand when it was more likely that governments would be captured by special interests, but did not downplay the economic factors that also contributed to deficits.

In a series of papers, Roubini demonstrated that when power is dispersed, say across many political partners in a coalition government, there was a greater tendency toward out-of-control budget deficits; the shorter the expected tenure of the coalition government, the greater this tendency. Adverse economic conditions raised the odds that fights would break out among coalition partners, further exacerbating the loss of fiscal control.

This marriage of politics and economics made it possible to explain better the behavior of government deficits across the range of industrial democracies. It explained why Italy, which had decades of short-lived coalition governments, found it difficult to control budget deficits. But it also explained why Japan was able to sustain its plan to reduce budget deficits in the 1980s—the unbroken majority control of the ruling party there, and its expected longevity in office, gave it the political space to pursue such a policy.

Apply the analysis to our current regime and the massive spending can be seen as a function of the Left's recognition that it holds power only temporarily, because of a peculiar set of circumstances. Pretty insightful.

Posted by Orrin Judd at March 16, 2009 7:08 PM