Three Ways Of Framing The Global Economic Crisis

This article, (via Mark Thoma) suggests that there are three perspectives that are being used to define the economic crisis and to direct public policy.  Two of the hypothesis are based upon neoliberal economic theory. The third hypothesis offers a more radical explanation, which places both versions of neoliberal economics at the center of the problem.  It also proposes stronger policy responses.  I found this to be an useful way to organize the frames that dominate the current debate.

The hard neoliberal hypothesis is advocated by republicans, and freshwater economists, who identify with University of Chicago neoliberalism.  They view the crisis as government failure.  The government made us do it!!  The government pushed banks into making bad real estate loans to encourage poor people to become homeowners.  The Fed facilitated this by cutting interest rates. Consequently, we have a structural problem in the economy that requires supply side solutions.  Fiscal policy is bad medicine. The article in Foreign Policy that I posted, and the op-ed by David Brooks that I critiqued, are partial to this viewpoint.  Since government is the problem, this is primarily a US problem.

The soft neoliberal hypothesis is favored by about half of the Democratic Party, and it includes the Obama Administration, and many saltwater economists from places like MIT.  They believe that is an example of market failure.  This is an orthodox perspective in the sense that market failure and government failure are accepted within neoliberalism.  The market failures came from inadequate regulation of the financial market, and an incentive system that encouraged the financial industry to take excessive risks. Moral hazard was also a problem since the risks were pushed upward from the bottom of the chain to investors in mortgage backed securities. The collapse of the financial industry led to the recession which is viewed as a collapse in aggregate demand.  The Fed should cut interest rates to encourage investment and fiscal policy is an appropriate response since interest rates have reached the zero bound.  This hypothesis is also supported by those who favor a third view of the economy in Europe.

The heterodox position accepts the explanation for the financial crisis, but it holds that the financial crisis is only part of the problem.  Neoliberal economic theory provides the ideology that supports deeper problems in the economy. It argues that we should return to the shared prosperity model that was severed by policies that were introduced beginning in the 1980's.  The link between productivity growth and wage growth was broken, and corporate directed globalization weakened labor's influence in collective bargaining.  The policy response should be focused on managing globalization. Policies should restore the balance between capital and labor and lead to the development of global labor standards.  There should also be more coordination on exchange rates and the management of capital flows. These policies are counter to one of the most revered tenets in both hard and soft neoliberalism.  That is, the ideology of free markets and the doctrine of comparative advantage.

Although I find myself more sympathetic to the heterodox hypothesis, I would agree with the author who argued that it would be suppressed by those who advocate both hard and soft neoliberalism. Paradigms do not change easily in response to evidence that challenges the paradigm.  A new paradigm must emerge over time to replace it. That is becoming more apparent, especially among younger economists.