Saturday, January 31, 2009

Institutional changes in transforming US economy

David Leonhardt has an interesting article on what has to be done to transform and even reconstruct the US economy. He draws attention to the fact that two of the primary engines of recent American growth - the explosion in consumer debt and spending, which lifted short-term growth at the expense of future growth, and the great Wall Street boom, which depended partly on activities that had very little real value - are no longer active, thereby casting serious doubts about the economic growth prospects of the US.

His prescriptions for the transformation of the American economy include - greater government investments in infrastructure and research; cleaner energies and fuel consumption technologies; health care reforms; reforming education, especially high schools and upwards ( educating more people and educating them better) etc.

But he draws attention to one of the more important, but less focussed, requirements for any long-term and sustainable transformation - institutional changes in the socio-economic balance of power. Mancur Olson's seminal work on the decline and rise of nations had spotlighted attention on the role of interest groups in deciding the fate of nations. Olson had claimed that as economies grow, interest groups that accumulate more and more influence over time, at the expense of others and even stifling long term economic growth propsects.

Taking cue, Leonhardt writes, "This country’s long period of economic pre-eminence has produced a set of interest groups that, in Olson’s words, 'reduce efficiency and aggregate income'. Home builders and real estate agents pushed for housing subsidies, which made many of them rich but made the real estate bubble possible. Doctors, drug makers and other medical companies persuaded the federal government to pay for expensive treatments that have scant evidence of being effective. Those treatments are the primary reason this country spends so much more than any other on medicine. In these cases, and in others, interest groups successfully lobbied for actions that benefited them and hurt the larger economy." The biggest, most powerful and most debilitating was Wall Street."

Even as the Obama administration starts work on an agenda to end the economic crisis and reconstruct America, it will have to face "opposition from a murderers’ row of interest groups: Wall Street, Big Oil, Big Coal, the American Medical Association and teachers’ unions".

In this context, of equal relevance is the work of people like Frank Levy (and Peter Temin, and Robert Reich), who argues how the traditional institutions – unions, the minimum wage, the tax system, accounting conventions and ultimately the tone set by the government – have the power to either moderate or reinforce the underlying vagaries of the market. And how "U.S. institutions abandoned a moderating role sometime after 1975, when market forces were already tending toward greater inequality."

Leonhardt also points attention to the fact that governments have always had the most critical role to play in genrating the momentum for rapid economic growth - the GI Bill created a generation of college graduates; the Interstate System of highways made the entire economy more productive; and the Defense Department developed the Internet, which spawned AOL, Google and the rest.

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