Is there a special hell for economists purveying bad policy?

Last month, this column had ventured the view that we were mid-way through the global economic difficulties attendant on the sub-prime credit difficulties in the US. It was a bit adventurous, for what can an inhabitant of the boondocks hope to know about the ways of high finance as practised by those who transport their biological selves in Lamborghinis and executive jets?

I was reading Nassim Taleb (Fooled by Randomness, Black Swan and other must-reads of the times) and he had this chapter titled “If you're so rich why aren't you so smart?” – about how luck (or randomness) plays an inordinate role in the enrichment of people, the statistical restatement of the old saying about “being in the right place at the right time”. But that is Taleb’s oddly structured question. Conventional wisdom puts this in a more straightforward fashion, namely “If you are rich, you must be smart”. I was surprised that Taleb had not dwelt on the difference between how he saw the issue, and how the rest of society did, and then on the corollary, “If you ain’t rich, you can’t be smart”.

But then, earlier this week, John Mack boss of Morgan Stanley actually said something of what I had written in my last column. The Financial Times reported that Mr. Mack “on Tuesday sounded a rare note of optimism on the credit crunch, predicting a near-term end to the troubles in the US subprime and leveraged loans markets and saying the crisis could be over within six months”. Now John Mack is smart by all the definitions, and I was relieved to learn that may be one had it right, however lacking in the manifold qualities of smartness.

But then John Mack sounded a “rare” note. The IMF has just come out with its Global Financial Stability Report where it has put the losses due to the credit crisis at nearly $1 trillion dollars – that’s $1,000 billion dollars. It is two-and-a-half times the upper limit of what anyone else had sought to venture previously. John Lipsky the No.2 in the IMF, who could be presumed to reflect views of US Treasury, in mid-March, proceeded to try and scare the daylights of the world’s leaders, speaking of how asset prices could spiral down further, taking the world’s economy down with it and how the world’s leaders must be able to "think the unthinkable". According to the official summary of his speech, Lipsky went on to “underscore the role of the IMF in the current global environment, noting that the Fund has the expertise to help countries”.

One cannot but help wonder what expertise he was referring to? That in evidence in the Asian Currency Crisis, as a result of which, emerging countries stocked up on hundreds of billions of dollars of reserves and effectively put the IMF out of a job? Or was it the billions of dollars of loans so expertly lent to the corrupt Yeltsin regime? Or is it the proposed sale of 400 tonnes of its gold reserves to pay for operating expenses and the laying off of hundreds of staff – of those that are still left at the Fund.

The late Senator Daniel P. Moynihan and one-time US Ambassador to India is reported to have told a senatorial colleague that “You are entitled to your opinions. But you are not entitled to your own facts, sir”. Surely the Fund is entitled to seek a new mandate, but not to exaggerating the dangers in the current context. The cynical may suggest that the credibility of the Fund has sunk so low that it does not matter.

In fact it is rather strange that the IMF has not thought about taking credit for all the good work that is has done in past decades, preaching good macro-economics – fiscal soundness, monetary responsibility, free markets and open trade, to feckless governments of the erstwhile Third World. So much so, that today we all appreciate the value of sound macro-economics – from previously hyper-inflating Brazil to sub-Saharan African countries to South Asia. And the attendant benefits are so widely in evidence.

All across what used to be once termed the “South”, economies are growing and people are getting less poor. With an acute sense of the irony of history I heard, a month back, senior economic policy makers from sub-Saharan Africa speak with amazement that the sound macro-economic principles which they had pursued so hard to achieve and which were now yielding them the expected beneficial results, seem to have been so uncaringly abandoned by their authors in Washington and New York.

The IMF should perhaps declare “Mission Accomplished” and find a new mandate – with greater and more representative global participation – and get on with the new job, instead of flogging a dead horse which it too had ridden. For, the uncharitable may well ask, when sub-prime lending was growing helter-skelter between 2002 and 2005, pray what was it doing, but dwell on the global imbalances arising from the US trade deficit and need for an “orderly” adjustment of the value of currencies – while carefully avoiding discussion on the one currency that was the largest contributor to the US trade deficit?

March was the third successive month that there was a decline in non-farm jobs in the US. Somewhat like the story about “crying wolf”, those who needed the excuse of a possible recession to cut interest rates in the face of high and rising inflation, have by undermining business and consumer confidence, now got the wolf at the door. Perhaps US policy-makers share Schumpeter’s belief that recession is a great curative, “like a cold douche” and have assiduously worked on an ice-cold shower.

Many people have forgotten that the US entered an extended period of inflation and growth stagnation after 1972 (one year before the first Oil Shock) under the stewardship of one Arthur Burns appointed Chairman of the US Federal Reserve by Nixon in 1970 – with it is believed instructions to keep credit conditions easy so that Nixon could be re-elected in 1972 (that was apart from the plumbers in the Watergate Hotel). The US too had many price controls in those days. Everything failed and by 1974 inflation crossed 12% and averaged 9% till the end of Burn’s term in 1978. After the brief interregnum of G.W. Miller who continued with Burn’s lack of success, he was, perhaps as an exemplar of the Peter Principle (it was President Jimmy Carter remember) appointed Treasury Secretary and the legendary Paul Volcker took over the reins at the US Fed.

It took Paul Volcker eight long years of monetary tightening to bring inflation to heel and the economy to an even keel. Needless to say fiscal and other reforms of the Reagan era helped in the process. A hellish fate always awaits the monetarily irresponsible and like everything else about history it is the guiltless citizen who must pay the heavy price for the incompetence and wilfulness of bad policy. One only hopes that there is a special hell for the economists who purvey bad policy advice. But unfortunately such hopes are ever so evanescent, Providence mostly ignores these pleas, much as might happen with Bernanke’s prayer that high oil and other commodity prices will be soon coming down.

(The author is Economic Advisor, ICRA)

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Published in Mail Today, Friday, 11 Apr. 2008