Dysfunctional Politics – Time for a Reboot?

The failings of democracy have become more obvious and need more than just a tweak

Some things get better over time but politics seems to be getting worse.  Like a clunky computer that takes ages to get anything done, our political system has outdated hardware and buggy software which means that programs often don’t proceed as planned.  In computing terms, our governments’ failure to deal with the aftermath of the global financial crash is the equivalent of a number of flashing warnings and error messages.  With the faults more obvious than ever, perhaps it is time to look into rebooting the system.

Viruses in the system

Politics needs a remake as it has moved away from the ideals of democracy.  Our leaders have gradually become more and more separated from the world of the voters.  Direct contact has been replaced with communication through the media.  Policies espoused by the different parties take the form of grandstanding statements that fit into a newspaper headline.  The message contained in anything more complicated is often lost on voters with short attention spans. 

The result of this is that politics has become just another form of marketing vying for our attention.  We, in return, now also struggle to relate to political parties.  The number of those among us who are affiliated with a political party has been falling for decades.  Politicians instead work with pollsters and media firms to guess at what voters might want and how to package their policies. 

At the same time, politicians can only offer voters less bang for their buck.  In an increasingly globalized world, many choices that had previously been available to governments have been taken out of their hands.  No country can make decisions in isolation and this limits what politicians can offer voters.  Not that they will ever admit as much.  Yet this unspoken reality further separates voters from politicians who offer too much and can seldom deliver on their policies. 

Some rewiring needed

A good place to start in terms of rebooting politics would be to re-establish links with voters.  As with all forms of communication, this needs to be two-way street.  Politicians need to not only listen to the concerns of voters before forming policy, but more importantly to explain their actions.  Too often politicians sound as if they are talking in code with formulaic messages devoid of content or meaning.  More direct contact with normal people might help politicians to rediscover the benefits of speaking frankly and honestly.

The best politics these days seem to be happening at the city level.  Mayors are closer to the people they govern, even in the larger cities of London and New York, and they are better at solving problems with regard to things that matter in peoples’ lives such as transport, schools, and crime.  From personal experience, the mayor of my city is having a positive effect on the world around me even though I did not vote for him.  I cannot say the same for my representative in parliament (who only turns up once every four years at election time) - let alone our Prime Minister in the UK. 

Politicians serve many roles in their jobs.  At a time when politicians are offering less in terms of leadership, the least they could do instead would be to spend more time among those who elected them.  Something needs to be done to fix the systems that will only become more of a problem (see here for one idea).  A malfunctioning computer is a hassle but a broken-down political system is far more dangerous.  

Your Neighbourhood Economist turns 100

Not much cheer considering how little progress in dealing with economic stagnation has been made since the blog began

There has not been much to celebrate of late but Your Neighbourhood Economist is happy to have reached a satisfying milestone – 100 blogs (not years).  This blog started by asking “so what is going on?” back in November 2011, lamenting weak growth in the global economy.  Little did Your Neighbourhood Economist (or many others) know that there would still be few signs of improvement over two years later.

Perhaps the only consolation is that things could be worse.  At least the Eurozone has not self destructed (yet) thanks to the European Central Bank stepping in.  US politicians also showed some surprising good sense despite all expectations to the contrary.  But the positives are few and far between.

Governments in many countries have too much debt to be able to boost spending which is leaving monetary policy as the main route out of the current weak economic growth.  However, expansive monetary policy has not been enough to generate much economic stimulus despite record low interest rates and loads of newly printed cash in the global financial system.  In fact, monetary policy may be doing more harm than good.  

Movements of surplus funds are creating havoc in emerging markets.  Uncertainty over the direction of monetary policy is a major obstacle in the way of a return to economic growth.  The costs of such policies are becoming more evident as the benefits are increasingly being called into question.

Central banks have struggled as the traditional tools of monetary policy have failed to have much of an effect.  New ideas have been tried (such as forward guidance) but the desired results have proved elusive.  Policy makers are getting side-tracked as new problems, such as concerns about deflation in Europe, draw their attention away from more pressing issues such as reforms.

Chances to celebrate may be a long way off so Your Neighbourhood Economist is glad for reasons to be cheerful (such as reaching 100 blogs) whenever possible.

Debt Ceiling: Once more unto the breach

Politics in the United States is starting to cause more problems than it solves as compromise still seems far off.

Politicians are not usually seen in the best light.  Even in that context, the partial shutdown of the federal government in the United States is exasperating, so much so that Your Neighbourhood Economist was not even going to bother to comment.  The situation leading to the shutdown brings to mind kids in a playground fighting over a toy with everyone losing out after all of the toys are put away.  However, behind all the antics and posturing, there are bigger themes at play which is even more depressing.

October is marked with a number of dates which gradually ramp up the economic stakes.  The month began with the US government having failed to pass legislation for its spending budget for the 2014 fiscal year which starts on 1^st October.  While the bulk of spending by the government, such as benefits for the elderly or unemployed, is not affected, a significant portion of money doled out by the government must first be ratified by Congress before being spent.  As a result, not passing the budget resulted in a partial shutdown of the federal government with around 800,000 out of 2.8 million public employees being sent home without pay.  The parts of government affected include bodies such as the Environmental Protection Agency and the Food and Drug Administration, meaning that many procedures such as permits for certain business activities will not be processed.  NASA will also mostly shutdown as will many of the tourist sites overseen by Federal government employees.

But the partial government shutdown is just a precursor to something more threatening – the government running out of money to pay its bills.  While such an outcome may sound preposterous, it stems from the current budget deficit (with the government spending more than it receives) and the need to borrow to make up the shortfall.  The total amount of debt that the US government can take on is also something that requires approval from Congress.  With the government having racked up a string of budget deficits in the aftermath of the global financial crisis, the amount of borrowing has been steadily rising.  More debt is needed but the government has reached the debt ceiling which was raised in 2011 and is expected to run out of money by around 17^th October.

The stakes are higher if no deal can be done with regard to the debt ceiling.  While the partial shutdown of government can be seen as a bit of a nuisance, a government cash shortage could have global ramifications if it means that the government misses an interest payment on its bonds and thereby triggers a default.  Given that US government bonds are akin to another form of currency in the financial system, a default has the potential to bring the global financial system to its knees. 

In spite of this, the financial markets, while on edge, have not panicked - negotiations regarding the raising of the debt ceiling are still on-going, and even if a deal cannot be brokered, the effects are still unclear.  There are other sources of income such as money from taxes so the government will be able to keep up with some outgoing payments.  But that in itself creates another dilemma – which, if any, payments to forgo.  Investors would hope that debt payment would take priority over, for example, the payment of pensions.  Despite the potential consequences to the international financial system, it would take a brave politician to cut off pensions for old people.

Considering what is at stake, the consensus view is that the politicians will sort themselves out before the government is forced into making such choices.  Your Neighbourhood Economist would like to assume that this will be the case.  But the two main political parties have been squabbling for number of years with the situation getting worse rather than showing any signs of improvement.  Over the past few years, there have been skirmishes over a previous increase of the debt ceiling in 2011 as well as the negotiations regarding the fiscal cliff less than 12 months ago (for more on this, see Winning the election was the easy part) and one of the key obstacles to compromise is growing in strength – that being the so-called Tea Party portion of the Republican Party.

The Tea Party is the radical anti-government element of the Republican Party which is not afraid to be aggressive in pushing for a reduction in the size of government among other policies.  Its members in Congress are targeting large concessions from Obama to raise the debt ceiling – a position which is further fortified by Obama having conceded little in previous showdowns.  Perhaps the biggest concern is that the anti-government fervour of the Tea Party will translate into a view that the debt ceiling is an effective way of slashing government spending irrespective of the costs involved.

The Tea Party has found growing support among Americans disillusioned with the role of the government.  It is part of the rise of populist movements that can also be seen in Europe which rail against mainstream policies, such as an opposition to immigration.  The multi-party political systems in Europe can include such movements as separate parties which often struggle to get the necessary level of support to make it into government.  The political system in the United States only has two political parties and the Tea Party essentially controls a large portion of the Republican Party.  With voting districts in the United States having been shaped over the years to produce safe seats for either the Republicans or the Democrats, Tea Party candidates in Republican seats are typically better at whipping up support enabling them to win out over more moderate candidates. 

The Republican Party as a whole has increasingly felt the need to pander to this radical fringe which has brought a heightened level of conflict to US politics, within the Republican Party itself as well as between the two major parties.  Its unique system of democracy has been a key element behind the successful rise of the United States to global dominance.  But with the country’s place at the top of the global pecking order no longer assured (as described in A New Inconvenient Truth), it would be ironic if its political system was central to its downfall.

Detroit – Just the beginning?

A city is driven into bankruptcy by the same problems that plague the United States as a whole but will the outcome be any different?

We have become all too accustomed to firms going bust recently amid the economic doom and gloom but a city going bankrupt seems a little strange.  But that is what happened to Detroit last month as years of decline culminated in the city admitting that it was no longer able to pay its bills.  Having thrived along with the auto industry, Detroit was always doomed to struggle as American car makers lost out to foreign rivals but its problems are not that different from those facing the country as a whole – overgenerous spending commitments from politicians focusing on the short term.  Can the politicians in Washington do any better in dodging a budgeting accident?

Detroit’s demise has come after it lost the industrial base that was the foundation of the city – the manufacturing industry around Detroit was decimated as overseas firms took a large chunk of the US auto market.  The population of Detroit was close to two million in 1950 but has since plunged to around a third of its peak as the deteriorating job market prompted people to move elsewhere to find work.  The exodus created a downward spiral with a growing number of boarded up houses and deteriorating public services as tax payers fled to more prosperous locations. 

The sharp decline still left Detroit with a large number of bills to pay, and along with having to maintain the infrastructure of a shrinking city, there was also the pensions for its public sector workers.  Its debts are estimated at $18.2 billion but around half of this money is owed to its present and past workers in the form of promises of retirement pay-outs.  It is common for government workers to be paid pensions which are a percentage of their salary (referred to as defined benefit plans) which is different to the private sector where workers must pay into their own pension pot from which pensions are paid out (referred to as defined contribution plans). 

Promises made by politicians have come back to haunt their successors – offering up bigger pensions rather than higher wages as a means to placate government workers with lower pay rates.  Pledges made when times are good are difficult to uphold when things turn bad especially since officials fail to put away sufficient funds to cover future pension payments.  The fixed sums offered to public sector employees after retirement have become more of a burden with people living longer and investments yielding a lower return after the global financial crisis (which means that the initial level of funding of pension pots is higher).  It is like a massive scheme of offering up IOUs with big pay-outs in a few decades but not bothering to put away much money to settle up in the future.

Detroit was not the first city to go bankrupt (Stockton, Mammoth Lakes and San Bernardino in California did in 2012) and it will not be the last (even some of the largest firms in the United States such as General Motors and most of the airline companies have been laid low by lavish pension schemes), but more crucial are the similar problems faced by the federal government in the United States.  The US government has committed to paying pensions and medical bills for the old and poor which will gradually ramp up the pressure on the government budget as the baby boomer generation heads into retirement and the number of workers per pensioner falls (i.e. costs will rise as revenues fall but more slowly than in the case of Detroit).  Social spending on these and other entitlements accounted for 56% of government spending or almost 14% of GDP in 2012 and increasing spending is threating to overwhelm the government spending plans.

The approach of a fiscal disaster comes at a bad time - the US government is already struggling to sort out a considerable budget deficit equal to 7.0% of GDP in 2012.  The timing is made even worse when considering that the dominant global position of the United States is under fire due to the rise of new powers such as China (for more on this, see A New Inconvenient Truth).  Instead, politicians would rather squabble than deal with the raft of problems facing the country with numerous other areas such as taxation and immigration also crying out for reform.  Even sensible adjustments to policy, such as increasing the retirement age to account for people living longer, get vilified with both the Democratic and Republican parties at each other’s throats.  Elections do little to resolve the issues with politicians happy to just target their own supporters (refer to Election with no winners for more detail).  The country as a whole is being driven toward the same destination as Detroit and politicians would rather play a game of chicken amongst themselves than steer clear of trouble – watch out for accidents in the road ahead.

The perils of doing too much

Central banks have been recruited to stave off economic disaster but they may have been forced into overplaying their hand.

The global financial crisis has propelled central banks into prominent roles in fighting off recession while politicians have been slow to act.  Being the last remaining stalwart against economic disaster, central banks had to go further and do more than would have ever been previously conceivable due to their limited range of policies.  Even though the efforts of central banks have some effect in keeping the global economy afloat, the jury is still out with regard to the distortions left behind by the actions of central banks as well as their new roles as backstops for the global economy.

Most central banks have been given independence over the past few decades due to the notion that this will aid them in their central goal of reigning in inflation.  The theory behind this is that politicians would be tempted to use the tools of monetary policy – setting interest rates and the level of money supply – to boost economic growth and their re-election chances to the long term detriment of the economy.  So independent economists at central banks were given the reigns of monetary policy and a target for inflation of typically around 2% to ensure that a safe pair of hands would be in charge.  The typical cycle of monetary policy involved interest rates rising during periods of strong economic expansion to keep lending in check while a weaker economy prompted cuts to interest rates in order to make borrowing easier. 

The global financial crisis that struck in 2008 involved what could be deemed to be a perfect storm.  Politicians had got caught up in the bubbly state of the economy and government spending got out of hand backed by tax revenues that were later found to be just a temporary fill-up.  This was not just confined to a few countries but the Bush administration in the US, the Labour government in Britain, and many countries in Europe were running large budget deficits at a time when common sense would have suggested putting money away during the good times.  So when the banks got themselves into trouble and required help from tax payers, government finances were already stretched and there was nothing left in the coffers to bail out the economy. 

A crisis of confidence hit the global economy with spending by consumers and investment by companies being cut back due to the chronic uncertainty of whether the banking sector was going to collapse.  Your Neighbourhood Economist would argue, with a good dose of hindsight, that the typical Keynesian policies of an increase in government spending would have been the best response to the global slowdown with government making up for the shortfall in demand from elsewhere.  Government spending could have made up for the shortfall in demand, but the mismanagement of government finances meant that this option was not available.

Monetary policy was always going to be a struggle (a bit of hindsight coming in useful here too) as the activities of the central banks during recessions, such as boosting lending, are generally transmitted through the financial system.  Yet, banks everywhere were fighting for their own survival instead of being concerned about the tinkering of central banks in the background.  The weak translation of monetary policy into positive effects on the actual economy has resulted in the extent of the actions of the central banks having to be ramped up to have an effect.  The most obvious example of this is the recent announcement by the Japanese central bank that it plans to double the money supply in Japan which would be beyond belief even just a few years ago (for more, see All bets are ON). 

Even though the worst seems to be over, central banks are still in a difficult situation in terms of getting out of the role of being the guarantors of the economy.  The massive scale of their involvement in the economy will make an orderly retreat fiendishly difficult due to possible economic hiccups in the future and uncertainty over how the economy will respond.  Even if this Herculean task is pulled off with minimal problems, a new precedent has been set where central banks will now ride to the rescue if the economy goes bad. 

This situation is made worse by politicians who have shown themselves to only look short-term in their focus when dealing with such problems as the Eurozone crisis in Europe or the fiscal cliff in the US.  The expanding responsibilities of central banks may find them overextending themselves to the detriment of the good work they have achieved so far such as keeping a lid on inflation.  Central banks have overachieved during the global financial crisis considering their initial remit but should not have to be relied on to save the day.  Economists are not meant to be super heroes.

Winning the election was the easy part…

In a presidential election which was more notably for the money spent (an estimated US$6 billion) than any notion of what each candidate would do in power, Barack Obama managed to pull off a relatively easy (but not emphatic) victory.  But now Obama faces a bigger challenge - the fiscal cliff.  The fiscal cliff refers to painful measures which will be implemented if Democrats and Republicans are unable to come up with a solution on how to deal with high government spending and low taxes.  But the political stalemate looks set to continue in the United States following an election which was supposed to help provide impetus for new policies but may instead result in further gridlock.

Improving the government finances was increasingly becoming a concern in the United States due to a large budget deficit of 7.8% of GDP in 2011 and rising government debt topping 100% of GDP in the same year.  Investors are still happy to buy government bonds as the United States is seen to have a more viable economy whereas similar levels of debt would cause panic among investors in Europe.  Yet, it is unclear how much longer investors will tolerate rising debt.  Politicians realise the necessity for action but are ideologically opposed to how to go about it – the Democrats want to see spending cuts accompanied with higher taxes on the wealthy whereas Republicans flatly refuse to even consider higher taxes. 

The origin of the fiscal cliff is an attempt by the two parties to force themselves into a compromise by upping the stakes.   Politicians passed the Budget Control Act of 2011 whereby, if an agreement on how to cut the deficit was not reached by the end of 2012, a range of deficit-reducing policies which are painful for both Democrats and Republicans (and the economy) would automatically kick in from the start of 2013.  Politicians have been too consumed with electioneering up until now for a deal to be struck and only have a short time left to figure out a compromise before US$600 billion of spending cuts and tax rises come into effect - the consequences of which is expected to push the United States economy into recession in 2013.

Just the possibility of recession as a result of these measures is already having an adverse effect on the economy.  The uncertainty created by the lack of a deal means that businesses are holding off from making new investments and hiring extra workers at a time when the economy should be on a path to recovery.  The election should have been a great chance for each party to convince the voters that they had a plausible solution but the outcome has only seen minor changes to the political landscape and the status quo has been maintained so that continued gridlock is a real possibility. 

Life would have been difficult for whoever won the election.  With the Republicans controlling the House of Representatives and the Democrats holding sway over the Senate, agreement between both parties is needed to pass any new laws.  But neither Obama nor Romney put themselves in a strong position due to the bulk of the campaigning being negative rather than providing any ideas on new policy direction (see An election with no winners).  As such, despite winning, Obama does not have much of a mandate - an entitlement to implement policies due to the perceived backing of a substantive majority of voters following an election.  The going will be made tougher with Obama having failed to exhibit much leadership in his first term as president.  Yet, Obama has come out of the blocks strongly with a bold statement that any new measures must include higher taxes for the rich.  On the other hand, Republicans are still not convinced that Obama has much support from voters and are likely to stand firm for now with regard to their demands for no tax hikes.

This sets the scene for last minute dramas and for uncertainty to continue to plague the economy.  The extent to which politicians can be trusted to make pragmatic decisions is unclear and Your Neighbourhood Economist is unsure of what will ensue.  Even Greek voters showed a considerable degree of pragmatism in backing pro-bailout parties in elections in June 2012 (Back from vacation in Greece).  Yet, like the situation in Greece, any possible solutions regarding the fiscal cliff are likely to be drawn out with stopgap measures likely before the end of the year (if at all) and more long-term policies discussed in 2013.  The prolonged uncertainty and political sideshows could have not come at a worse time but it is even more frightening to think that the worst may not be over.