Why Does the Worldwide Financial Crisis Fester So?

In today’s Journal, David Wessel nails it. (If you ask me, Wessel nails it consistently.) First, he asks the question that needs to be asked:

It has been two years since the flames were first spotted in Greece, yet the blaze still hasn’t been put out. Now it has spread to Italy.

It’s been five years since the U.S. housing bubble burst. Housing remains among the biggest reasons the U.S. economy is doing so poorly.

On both continents, there is no longer any doubt about the severity of the threat or the urgent need for better policies. Yet the players seem spectacularly unable to act.

What’s taking so long?

And then he offers a compelling answer:

Deciding who will get stuck with the tab.

“In every crisis, you have to allocate the losses between debtors, creditors and taxpayers,” says Anna Gelpern, an American University law professor and former Treasury official. “It’s a shockingly simple concept, and completely intractable.”

“By definition, it’s a political problem,” she adds. “Even if you came up with an optimal allocation, if it’s not politically salable, it can’t happen.”

Most people agree by now that our political structures are too incapable and/or impotent to a) responsibly address a crisis of this nature; and b) help create a framework that would prevent future crises.

To my mind, much of the trouble lies in how politicians’ incentives are badly misaligned: they are rewarded for short-term, self-interested activities (raising money, getting re-elected, coming down on the right side of short-term public opinion) while the goals the public really wants accomplished are long-term, public-interest works (which have almost nothing to do with raising money, electing politicians, or getting a good headline).

I have some inchoate ideas for how to address this incentive gap — to be framed out and written about here someday, hopefully — but I’m wondering what you all think of this politician-incentive problem and possible solutions to it?


Al

I have been saying this for more than 5 years. Politicians are in politics for themselves and the people who give them money. Short term fixes to get re-elected.

It is all a shame, however, if you read Howard Zinn's 'A Peoples History' you will see the system is actually working pretty much how the forefathers wanted it to be.

Mike B

You forget that voters by and large WANT easy answers. It's been mocked and satirized for decades. Europe has dealt with some of this by having a political class that is less accountable to voters, but that tends to only work when it comes to paying for long term investments. Also, back when media was more monolithic it was possible for the leadership class to sell sacrifice as an easy answer...but today there are a hundred pundits ready to jump on board with an even easier answer. This will only end once the public is ready to acknowledge reality.

John King

It is only part of the problem, albeit a large part. The “intractable” factor is that losses are necessary and we are watching politicians who absolutely refuse to consider alternatives to the current Keynesian scheme. They do it because it offers what they believe will mete out the least pain as well as save their own hides. They lack the courage to attempt alternative solutions - tax cuts and government austerity - even though history shows these have worked. The current policy only prolongs the pain over protracted periods and will end in tears anyway while risking hyperinflation, war or both.

Owen

What historical examples are you referring to?

Douglas Turner

Learn to read, and you will not need to be told. As history unfolds we tend to repeat ourselves since the incessant problem of bread and circuses seems to be the end game of both autocracies and republics. It is sustainable in neither.
"Tax the rich" is merely a mantra of those who want to provide bread and circuses today.

Michael

Maybe not everyone is as well read as you. Can you condescend to supply some examples? It is the internet so a copy-pasting should be all you need to do. Thanks, looking forward to it.

Leo Godin

Since most in Congress are career politicians, they are always in campaign mode. That mode may ramp up or down depending on how close elections are, but they are always campaigning. I'd like to see eight year terms for the Senate, House, and Presidency, but limit eligibility to one term. I would also prevent anyone currently in Congress from running for President. This would have two main benefits.
1) Once in office, they'd have eight years without campaigning. They could focus more on their legacy--which is more likely to result in public good--than their campaigns.
2) With eight years in office, they'd be able to look at a 3-5 year plan and not be so concerned with public and donors opinions today.

KL

I like that idea and believe that the underlining principle, the fact that politicians campaign frequently, contributes to the short-sighted nature, especially in the House. However, by lengthening the time of service, you could also be decreasing the functionality of politicians, which is to represent their constituents. In an 8-year term, there is less incentive for politicians to stick to campaign promises during the first few years of the terms since voter memories are also short-sighted. This leaves only the latter part of the term as effective governing.

I believe the solution may be capping number of terms in office at 2 (as we have with the presidency). This should place more incentive for politicians to focus on their legacy (which tends to have more of a long-term outlook on their performance) then their re-election.

KL

Alternatively, the government could issue financial options to politicians, similar to the stock options offered by companies. If a politician choose to partake in this program, he/she could purchase an option for a fixed price and the option would have an exercisable date years in the future. The value of the option would be determined by the sum total of GDP increase/decrease from the time the option is granted to the time the option is exercised. This would tie in the politicians' financial objectives with that of the country's.

David Collins

While the political will to effect such a change is missing, the first two problems could be fixed (at least significantly reduced) by public campaign financing (with spending limits) and term limits for all political offices.

164

My answer is that markets are out of equilibrium because prices freely move up, but are "sticky" on the way down. In other words property prices have come down a little, but not enough; wages have fallen a little but not enough to reflect market forces.

Wake Up

It is funny (and sad) how we can consistently identify symptoms of the problem, such as this, and yet never question the underlying system.

Does government do anything efficiently (other than taking our money)?

So why is the solution always more government, more regulations, more more more? The laws and regulations we come up with sound great on paper but they consistently benefit the lobbyists/incumbents... the cronies.

Isn't the definition of insanity doing the same thing over and over and expecting different results?

Research Ron Paul for an hour and THINK about what he is saying, before blowing him off as crazy. I don't know if his ideas will work, but I'm certain I like them a whole lot better then more of the same.

Joshua Northey

I like Ron Paul, spoken to him once or twice, and he makes a lot of good points. But a limited government isn't the solution to all these problems. A better government is. I agree under the current system simply reducing the size of the government may be the best course of action, but there are a lot of important roles for the government in a well functioning society. I think fundamentalist libertarians tend to be a little naive about that.

Government should absolutely be regulating pollution, enforcing robust zoning codes, making edicts about what people can and cannot eat. That is how you solve a lot of important collective action problems. But right now the government is a such a slave to two completely ineffectual parties that it is probably better to just reduce its power as much as possible.

John B

Did any of the people voting positive read what this person wrote? Government should absolutely be:

" enforcing robust zoning codes, making edicts about what people can and cannot eat. "

1. Robust zoning codes have caused much of the real estate problem, prevented buidling reasonably priced housing, racial segregation and created suburban sprawl. And helped NIMBY's become NIMBY's.

2. The government should make edicts telling us what we can and cannot eat? To put it mildly, one of the least intelligent posts ever put on Freakonomics.

Joe in Jersey

Like many other things the solution lies in aligning the incentives of the politicians with what is good for the country. However is that really possible in that politicians have such short term concerns. Would the solution be to increase term length, but stagger the elections so that they still occur at the current pace. Still creating the proper incentives isn't easy even when you thought it would be, look at CEO incentives and what a disaster that has been.

Jack

Agree with the comments on term limits, and extending the length of terms -- though disagree on how many terms and overall length. The downside of a single 8 year term is how to fire those doing a poor job, and how to "reward" those doing a good job.

Additionally, a balanced budget amendment and a cap on federal budget growth (except in times of war/emergency) indexed to inflation (or something else meaningful) would force politicians to make hard decisions of allocation rather than just borrow more money or kick the can down the road.

Nate

Perhaps with a long length of term to kick out the those doing a poor job have a yes/no vote after four years on whether to continue or face a reelection but with a necessary yes vote at say 40%, obviously there is some incentive to cater to short term goals but it is reduced compared to the current system. The good guys should be able to get on with their jobs while only the atrociously bad should face the risk of being kicked out.

Tim

Leo Godin for President. That's a fantastic proposal and eliminates the infernal struggle we witness so often between being effective and being re-elected.

Greg

I have been saying for many years that the way around the short term, get re-elected focus to adopt a single term limit for all political offices, with terms extended somewhat from what they are today. The prohibition would be absolute - serve one term for any single level. After the term is over the individual could run for a different office. That means no campaigning while in office. Serve, go back to work, run again if you wish for a different office. An individual, at the Federal level, could potentially serve one term as a Representative, one term as a Senator, and one term as President. In between they would have to do something productive. Prohibit bouncing back and forth between elected, appointed and lobbying positions.

Joshua Northey

I think you might even want a 10 year enforced cooling off period before being able to run again.

Neill Pieterse

I fully agree. Without a long-term plan that is above politics, like the constitution is, there will be no solution. Politicians will continue to be in it for quick gains!

Joshua Northey

This is a very complicated issue touching on a lot of things.

Obsolete political technology:
Our political technology is badly lagging behind our other technology. It is clear we could design more effective means of governance, but what interest is it of those who currently sit on top to shake things up?

The political structures in the US are badly broken. You have two parties who pretty much dominate everything regarding the political process, neither of which is remotely interested in good governance. As organizations they want more power and the ability to service the interests of their donors, personally they chase re-election and post-political employment. That is it. No where on that list does what is good for the country appear expect as a tertiary concern.

When was the last time any decision was made by congress or the top levels of the executive branch that had a time horizon over 2 years? Heck over 6 months is pretty rare. Meanwhile with life expectancy continuously rising and generational diversity we should be making almost all decision with a 25 or 50 year time horizon, if not longer.

I always think it is laughable when people try to invoke "the founders" on issues, but in this case I think we can know one thing about what "the founders" would think.

"The founders" would think it was absolutely insane that we were trying to run the country under a set of rules written when it had 1/200th the population, 1/20th? the area, a completely different economic system, a tiny pittance of its current GDP, a military that would today lose to police force of a small city, little to no real foreign policy entanglements. On top of that our means of sharing and disseminating information has completely changed, the power an availability of travel has completely changed, the destructive capacity of weapons is orders of magnitude different. You could go on and on.

It is just a joke. We are long long long overdue for a new constitutional convention. We are running "US government version 2.223" instead of "US government 10.20" and frankly the hacks and workarounds are not cutting it anymore. Unfortunately who knows how much a constitutional convention would even fix anymore, because you would almost certainly just have the current politicians running it...so the result would be more of the same but worse.

Institutional Sclerosis:
Other than the civil war the US hasn't really had anything bad happen to it (on historical scales 9/11 is a freaking mosquito bite). It hasn't been forced to improve. When the system is more or less the same for so long you end up having those institutions which are most able to gobble up power and favors benefiting disproportionately. This leads to further entrenchment and growth until eventually they are impossible to dislodge and you have this kind of institutional sclerosis. Look at the complete disconnect between our military needs after 1944 and our military spending. The beast simply has a life of its own completely separate from what is best for the nation as a whole.

So now we have a system where the strongest institutions always make sure none of their oxes are ever gored and thus you never have effective solutions (e.g. the healthcare debate).

This is why the Democrats failed so badly. They said "lets reform healthcare but not ask any of the current players to make any real sacrifices". No sacrifices for the big insurers, no sacrifices for patients, no sacrifices for doctors, no sacrifices for pharma. Well when that is your plan of course it is going to fail. It is impossible to have true reform without goring some oxes.

This political stagnation is only going to increase in an era where war is decreasingly prevalent. 500 years ago a country as dysfunctional as Greece would simply be overtaken by a neighbor, and the Greek populace forced to face economic reality that way. These days it can just limp along off borrowing. Postponing the day of reckoning.

Obviously wars are not a good solution with modern weapons technology, but we do need a way for dysfunctional ruling classes/populaces to be forced to face reality...

Radical ideas:
Governing the a country the size of the US is a really really important job. In fact probably the most important set of jobs ever. Yet we don't take selection for the positions seriously at all. Even on a local level the quality of people in political positions is pretty laughable compared to the importance of the decisions they will be making. On the national level it is absurd.

1) US Department of HR:
Lets say that being President was just a position in a company and everyone in the US had to fill out an application, would George Bush II have been among the top 100,000 candidates? Top million? Nothing about the man or his past would lead one to think he was remotely qualified, yet he got it. Talk about a broken process.

Maybe there should be some sort of government HR branch, you could still have elections, but they could be elections among approved candidates? Sort of like the Supreme Court except for recruitment.

2) Branch of facts/honesty
Science has come along way since the 1770s. It is passed time we have a branch of government that is responsible for making sure that the government is run sensibly. You could make it a requirement that legislation had to make specific claims about impacts and goals. The in addition to a law being struck down for being unconstitutional, it could be struck down for being factually incorrect. Obviously such rulings would be controversial, but so is the SC.

3) Being a congress person is really important, act like it
Here is a starter, congress is a little like serving on a nuclear submarine, or on a jury. If you are elected you are put in a secluded location and sequestered for your term. No meetings with constituents, no meetings with lobbyists. You sit in a isolated location and work out problems. Perhaps even have it so communication can come in, but communication cannot go out. Then when the term is up (say a couple months), you have a slate of legislation. Then the next group of people gets sequestered.

Anyway just some crazy ideas. Of course none of them will happen. We will continue on our slow slide toward complete dysfunction.

Read more...

Quentin

Regarding an organization with the power to approve candidates for office, it sounds nice until you look at where it has been tried before. In Iran, they have a constitutional republic, but a committee gets to determine the suitability of candidates, which has the effect of creating a one party system.

Noah

An amusing solution: Remove most of the short-term incentives by choosing political candidates randomly via a lottery, rather like we recruit jurors. Then in the popular election each candidate is individually subject to an approval vote.

Kim

Create truly competitive election districts, rather than allow parties to gerrymander the process every 10 years. When you have a district that is even just slightly (more than a 48-52 split) weighted in one direction, it's too easy to get the dominant party elected. If you have truly competitive districts, you have to have higher-quality candidates, because they have an actual fight on their hands. My brother is a political consultant, and as he says, there are districts where they are so heavily in favor of his party that he could get a cat elected over anyone else.

vinita

Read Hind Swaraj for what Mahatma Gandhi had to say on this.

Shane

Yet we are seeing some pretty severe austerity budgets in various countries. So this suggests that an alarmed electorate can be persuaded to make sacrifices if they feel it is in the country's interest.

Here in Ireland the main party who was in power before and during the crisis began austerity budgets and was destroyed in the general election, but the parties who replaced them were also promising severe budget cuts and tax hikes. There have been no riots and only a few minor protests, because most people think that this is necessary. So long as the governing parties can convince people that sacrifices are necessary, people will give them a mandate to make risky but necessary cuts.

So I wouldn't give up on the political system just yet! Estonia is another interesting example, pushing through an austerity budget of 9% in 2009. They seem to have bounced back well, growing 8.4% in the second quarter of 2011.

(I'm not saying that austerity budgets are necessarily the smartest way to deal with things. But perhaps it shows that governments can take unpopular measures, and have widespread support, if they convince the public that it is necessary.)

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Oleg

What we need is a different way to rank politicians. There is a software tool for fighting vandalism on Wikipedia, where anyone can come in and make any edit to pretty much any article. The tool works by assigning reputations to editors, and the reputation is based on how long their edit survives. Edits that add value tend to remain, while bad ones get replaced quickly.

We should do the same for politicians: rate them on how long the measures that they propose and vote for survive. If this rating gets widely accepted, politicians would carefully consider their actions and aim for long-term effects.

This is a purely tongue-in-cheek suggestion, but they say in every joke there is a grain of truth.

J

I think you have to admit part of the reason why political incentives are focused on the short term results is because the people that elect them also have a short term focus. Most of the anger people are venting about is how to fix these problems, and fix them now. If we put a politician in office for the next 10 years and he/she made a plan to work out the situation in that time frame, and things were worse five years out... it wouldn't matter what the laws was; that person would be dragged out into the streets.

The problem is everyone has a different threshold for "the short-term", and it's incredibly difficult to have people determine, even for themselves, the difference between what they want and what they need.

Gary

I can solve two of the three incentives (money, reelection, ego):

1. Stop funding individual politicians and fund the election process. This separates the lobbyists from those whose votes they buy. When donor/lobbyists fund the process, all certified candidates are financed equally (certification needs to be figured out, but it's not unresolvable) . The best at managing their allotment and message probably will win and what we need are good managers. Donor/lobbyists get some influence but it's diluted. This idea doesn't require public funding, either.

2. Term limits. Plain and simple - you can't make politics a career because your interests are narrow while the public's are broad.

3. As for ego. Well, just maybe if the first two ideas work, politics won't attract so many narcisistic jerks.

David Leppik

I don't think it's a matter of having a better political system. The fundamental question is who gets the short end of the stick. At some point, certain voters will be winners and certain voters will be losers. The only thing an ideal democratic process could accomplish is to provide that there will be more winners than losers...

...and that's assuming that the winners get to vote. In both Greece and the US, the crisis was caused when voters were getting huge value by borrowing unsustainably, and the winners were "us, then" and the losers are "us, now."

That said, we're far from a perfect democratic process, given that the main winners have been the 1%, and continue to be.