Friday, November 7, 2008

Smart Intervention

With the conclusion of the American electoral cycle conducted amidst one of the most severe economic storms the globe has seen since the Great Depression, many are suggesting that the repudiation of the GOP at the polls in both the presidential and congressional races means that the era of bigger government intervention is back.

It was a combination of imprudent deregulation of financial markets on the one hand coupled with unwarranted government intervention in the housing market on the other that led to the collapse of such Wall Street icons as Lehman Brothers placing great clouds of uncertainty over the major economies of the world.

The most tired bit of analysis floating around with the ascension of the Democrats in Washington is that a new dawn has come heralding the end of economic fundamentalism (a term used by Warren Buffet), the neoliberal agenda with the ‘magic of the markets’ at its core. The economic philosophy espoused by Reagan and Thatcher has been the cornerstone of fiscal and economic policies of both Conservative and New Democrat/New Labor governments over the last thirty odd years. It is time to dust up John Maynard Keynes and consign Milton Friedman back into storage, so they say.

Joseph Stiglitz, a Nobel Prize recipient in economics for his work on the 'economics of information', former Chief Economist of the World Bank and former Chairman of the Council of Economic Advisors under Pres. Bill Clinton, has rightly pointed to the laxity of financial regulation in credit and derivatives markets under the Bush White House, coupled with monetary easing by the Federal Reserve in response to the post-911 and dot com collapse in the early part of the decade as foundations for the present sub-prime mortgage crisis.

This is only half the picture, which deflects a fair share of the blame that should be laid at the feet of the Democrats. The other half comes from the unintended consequences of well-meaning government policies in the housing market ratcheted up significantly by the Clinton administration but initiated as far back in Carter’s to promote greater home ownership by mandating the Federally-supported Fannie Mae and Freddie Mac to allocate a greater share of their lending to lower income groups, the so-called ninjas (no income, no job, and no assets).

The home mortgage meltdown was made up of two failures: a false-negative on the one hand (government failing to act when it should have) and a false-positive on the other (government acting when it should not have). This was a calamity caused not for a lack of public intervention, but by the inappropriate (non-)use of it.

Of course, in the heat of the campaign, a smart candidate like Barack Obama who has reportedly read his fellow University of Chicago professors’, Thaler and Sunstein’s book, Nudge (Yale, April 2008- see left) on this very issue (just as British Opposition Leader, David Cameron has) probably believes that government’s role is not necessarily to mandate things to individuals, but to ensure that they are primed to make intelligent choices, knew that to pose such a nuanced stance would only be self-defeating.

Yet, in his advocacy of tort reform as well as in his healthcare policy which had been opposed by constituents of his own party, trial lawyers in the case of the former, and rival Hillary Clinton in the case of the latter (for being too libertarian) he demonstrated the essence of what is being termed the ‘real third way’, paternal libertarianism: not quite the Keynesian model; one might think of it as the Chicago School of Law and Economics. This new school of thought is in essence a heterodox economic paradigm sprouting from the discoveries made in the budding fields of behavioral and neural economics.

By conducting experiments and studying the mental processes involved in decision-making, this new branch of economics has demonstrated how even highly rational individuals make foolish moves when facing complex, unfamiliar terrain. It demonstrates how our minds often get tricked by the manner in which problems are presented to us.

In order to optimize social benefits in these circumstances, it is not sufficient for policies to merely maximize choice by increasing competition through deregulation. Governments also need to ensure that choices made by consumers are more likely to serve their interests by creating regular feedback mechanisms with which they can evaluate their choices vis-à-vis other options in a timely fashion. This would counteract the inertia of sticking to a current yet less beneficial position or being swayed unnecessarily by the mentality of the herd into making a foolish one.

When laid out in plain English, as Obama did by calling it a policy based on common sense, he contrasted it with the prevailing dogma of neoliberalism. This presented a perfect counterfoil to the seeming blind adherence of the incumbent party to unbridled free markets as a way to allocate resources optimally in society. This soothed the wounded psyche suffered by the American electorate under the current adverse economic climate and appealed to their characteristic sense of pragmatism.

In contrast to the prognostics of most analysts appearing in the news media, the new dispensation is not necessarily going to mean greater intervention by the collective in the sphere of the individual, but smarter intervention. These sorts of intervention do not set out to limit choice, but are designed with better “choice architecture” in which options can be posed in a manner that intelligently spots and corrects for natural, irrational biases present in most humans (read: homo sapiens, not homo economicus).

Of course it remains to be seen whether this new principle can be put into practice by the incoming administration amid the euphoria and stratospheric expectations raised by ambivalent promises made during the campaign, but the kernel of a new idea has been planted, and given time its diffusion is going to be inevitable.

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