Accountability, Canada, Inequality, Political economy

Scrooge in Paradise: Why Private Wealth is a Public Issue

Scrooge

As global inequality grows to “extreme levels” — as revealed in the just-released World Inequality Report — it is hard not to wonder what it bodes for the health of liberal democracy — around the world and here in Canada.

Even though our growing levels of inequality may not come close to those in the United States, recent conflict-of-interest stories about both Liberal and Conservative MPs, a growing reliance on tax havens, and cash for access scandals all raise serious concerns about the influence of the wealthy in Canadian politics.

If money talks, then the rich are now deafening the democratic system. As economist Branko Milanovic explains, “the higher the inequality, the more likely we are to move away from democracy toward plutocracy.”

One of my favourite recent New Yorker cartoons shows two men in business suits looking out from a lavish corner office, as one says to the other, “Part of me is going to miss liberal democracy.”

Although we’re not quite there yet, the dark tone of the cartoon reminds us that the economic “haves” can be just as likely to become disaffected with democratic politics as the “have-nots” often singled out as the source of populist pressures (in fact, elites have historically been the most important factor behind de-democratization, as Charles Tilly notes in a recent book).

Reading that New Yorker cartoon, it is hard not to imagine that at least one of those businessmen is likely to be a good friend of President Trump’s. He’s turning conflict of interest into performance art, talking up his daughter’s clothing line and getting national park gift shops to sell Trump branded wine.

Yet, while Trump and entourage demonstrate a particularly brazen willingness to blur the line between public office and private gain, the problem is a much wider one — with echoes here in Canada.

The Paradise papers revelations, the cash for access scandals, and the use of “loopholes” in ethics screens are all legal strategies for giving the wealthy an unfair advantage in a system where we are all supposed to be equal as citizens. Each of these strategies works in a different way to undermine the democratic culture that makes our political system work. In the process, they further blur the line between public good and private gain, eroding the trust that makes democratic politics viable.

Cash for access is the most straightforward. It takes the existing informal advantage that the wealthy have to ensure that their voice is heard politically and weaponizes it. Why bother voting as an ordinary Canadian when politicians will spend their time listening to someone paying $10,000 for a rubber chicken dinner?

The “loopholes” in ethics screens that various Liberal cabinet ministers have admitted to using, as well as the failure of certain Conservative MPs to disclose business ties to China, work more subtly. They create the possibility that public office holders will be swayed by their private assets as they make decisions designed to serve the public good. Why bother being an engaged citizen when you don’t know whether those making the decisions are pursuing their own interests or ours?

The Paradise papers tell us that many of the public figures who speak and act in the name of the public good use tax havens to avoid paying their fair share. Why bother buying into a democratic system requiring that we all do our part by paying taxes when those with the most power are actively avoiding doing so?

Of course, the line that we draw between public and private in a liberal democracy is always something of a fiction. Liberal political thought tells us that everyone is an equal citizen in the public domain, with an equal right to participate politically. Liberalism is also based on the premise that we should be free to pursue wealth accumulation in our private lives, meaning that we will often be quite unequal in economic terms.

In theory, this private inequality should not affect our formal public equality as voting citizens. In practice, things are rather different, as wealth often translates into a greater political voice — as any government that has tried to put a halfway house into an affluent neighbourhood or to reduce tax advantages for doctors incorporated as small businesses will tell you.

To keep a democracy alive, and to ensure that everyone has a meaningful voice and stake in the political system, we must do two things. We must work to keep those private inequalities from getting too large (via public education, social programs, a progressive tax system, etc.). And we must work to minimize the ways in which private inequalities translate into unequal influence (via election financing laws, conflict of interest provisions, etc.).

In Canada, we have made progress on some of these measures, but we have also fallen behind in many respects. As recent census data shows, earnings inequality has continued to grow in Canada over the last decade, while the top 1% increased their share of total income in 2015.

When trying to figure out how we got here, there is blame enough to go around. The Chrétien Liberals began the trend towards growing inequality when they gutted transfer payments for social programs in the 1990s. Inequality grew under the Harper Conservatives, who also eroded some of the other bulwarks against buying political influence, notably through reversing changes to election financing laws, making parties more reliant on private donors once again.

Although the Trudeau Liberals have clearly stated their desire to reduce inequality, and have begun to tackle some of these problems, their own recent conflict of interest scandals suggest a very long way to go before the political culture in Ottawa starts to change.

As that New Yorker cartoon reminds us, unless we start taking the problem of inequality much more seriously now, we may soon find ourselves thinking nostalgically of the “good old days” of liberal democracy.

This blog post originally appeared on the CIPS Blog on December 19, 2017.

Accountability, Banking, Economics, Measurement, Political economy, Uncategorized, Uncertainty

Why we need better central bank accountability

As pundits debate whether the US Federal Reserve will raise interest rates again this summer or fall, we are reminded of just how much of the economy’s direction hinges on central bankers’ decisions.

Since the 2008 financial crisis, the power of central banks has grown, as they have used unorthodox tools to stimulate the economy, taken a greater role in financial regulation, and put themselves in more politically sensitive positions, including the tough debt negotiations with Greece.

In spite of this powerful role, central bankers are remarkably insulated from democratic oversight. As a recent “Buttonwood” column notes in The Economist, “Janet Yellen and Mario Draghi are very important players in the world economy, arguably more important than the US President or the German chancellor. And yet they are not elected; if voters do not like the job they are doing, they cannot get rid of them.”

There is a great deal at stake in decisions about monetary policy, as I suggest in a recently published article in Ethics & International Affairs. Central banks not only define the broad direction of the economy but also create winners and losers. Consider, for instance, the disparate reactions of a prospective first-time home buyer and a retired couple living on their savings to the prospect of yet another drop (or increase) in the interest rate.

Central bank independence in its current form is relatively recent. Elected leaders exercised considerable influence over monetary policy in the post-war era, seeking to achieve the right “trade-off” between full employment and inflation. It was only in the 1980s that policymakers moved away from this kind of Keynesianism and embraced the ideas of Milton Friedman, who advocated the creation of an independent monetary authority.

Friedman and other economists believed that if governments were given any discretion over monetary policy they would adopt inflationary policies because these were more likely to be popular with the electorate. They argued that the only way to ensure price stability was to radically limit the government’s influence over monetary policy by making central banks autonomous and requiring them to stick to a simple rule, such as an inflation target. By the late 1990s, central banks in over thirty countries had gone down this path and were using some form of inflation targeting.

The current model of central bank governance does provide for a certain kind of accountability—but only a very narrow one. Ensuring accountability generally involves three elements: broadly-agreed upon standards, information on whether they are met, and sanctions if they are not. Because the principle of central bank independence involves a very limited set of standards—specifically, the achievement of an inflation target—and very few opportunities for sanction, the main mechanism for accountability is provided by publishing information about the bank’s activities. Hence we have seen the rapid expansion of central banks’ commitment to providing more and better information about their models and decisions in recent years.

Unfortunately, while this informational form of accountability may have worked during the stable years of the “Great Moderation” (from the mid-1980s to the 2008 crisis), it is no longer up to the task in the volatile post-crisis era.

Bank of Canada Governor Stephen Poloz and US Federal Reserve Chair Janet Yellen have both suggested that growing economic uncertainty has reduced the effectiveness of simple models and rules. What these bank governors have not acknowledged (unsurprisingly) is the challenges that this growing uncertainty poses for existing forms of accountability.

If uncertainty limits the effectiveness of rule-based policy, then it ultimately requires greater discretion on the part of policymakers. This is not a problem in itself (here I would disagree with those Republican lawmakers who would bind the Fed even further with more stringent rules). More discretion does, however, require a more robust form of accountability.

There are three basic principles that should underpin any such reforms.

1) Fostering more deliberation and dissent

While the informational model of accountability obligates decision-makers to explain their actions, it reduces this process to a simple publication of data. What is missing is the back and forth of question and answer—the process of genuine debate and deliberation. By the mid-2000s, central bankers were being treated like oracles, with Alan Greenspan as the most revered among them. There must be more room for dissent—both among those with the power to set monetary policy and in the wider society that is affected by those policies.

2) Ensuring that central banks are answerable to the wider public

Because financial issues are complex and their impacts are often diffuse, monetary policy questions rarely become salient enough to mobilize public action. In this context, the power of sanction actually shifts away from the two groups to whom central bankers should be accountable—the government and the public—and toward financial actors, who can impose very serious sanctions on central banks if they disagree with their policies. Without overly politicizing monetary policy, we need to find creative ways of ensuring that central banks are more accountable to the wider public.

3) Broadening the objectives against which their actions are judged

One way of ensuring that monetary policymakers are accountable to the public is to ensure that the issues that affect citizens are reflected in the standards that guide bank policy. At present, most of these issues are not officially on the agenda, which is constrained by the goal of achieving a very low level of inflation.

A number of commentators have recognized this dilemma and have suggested that today’s inflation targets may no longer be appropriate. A recent Federal Reserve working paper suggests that increasing the current inflation target and supplementing it with a nominal GDP target makes economic sense. Such moves to broaden the objectives used to guide central bank decisions would also go some way toward increasing their accountability.

As central banks take on an increasingly powerful role in our political and economic lives, it is time to find new ways of ensuring that they are more fully accountable.

This blog first appeared on the Carnegie Council’s Ethics & International Affairs website.

Banking, Economics, Exception, Finance, Political economy, Risk, Uncertainty

Central banks are facing a credibility trap

Quite a few commentators have noted that central bankers have become rather less boring of late. Since the 2008 financial crisis, central banks have taken on new roles and responsibilities. They have experimented with a whole range of unconventional monetary policies. And, in the process, they have gained considerably in power and influence.

There has been less attention to a key paradox underlying central bankers’ new roles on the world stage: they are being forced to govern through exceptions in an era in which rule-following (particularly the holy grail of the 2% inflation target) has become the ultimate source of policy credibility. Where central bankers are supposed to stick to the rules, they have found themselves endlessly making exceptions, promising that one day things will return to normal.

This paradox poses real challenges for efforts to foster a sustained global economic recovery. Governing through exceptional policies is always a politically-fraught undertaking, particularly over the long-term, but it is even more difficult in a context in which the dominant convention is one of strict rule-following.

Since the early experiments with monetarism in the late 1970s and early 1980s, most central banks have moved towards an increasingly rule-based approach to monetary policy, with inflation targeting becoming the norm in many countries in recent years.

Yet today we are faced with a situation in which the rules no longer apply but are still being invoked as if they did.

A recent Buttonwood column notes that the Bank of England has missed its inflation target “almost exactly half the time” since 2008. The European Central Bank (ECB) has effectively expanded its narrow mandate, which formally requires it to make price stability its top priority, by arguing that employment and other issues are crucial to achieving it. Yet the ECB and the Bank of England continue to act as if the old rules still apply.

If we look beyond the narrow rules that are supposed to be governing central bank actions and examine the wider changes in their recent policies, we find similar patterns. Scratch an unconventional monetary policy and you will find a kind of economic exceptionalism: an argument that the crisis that we face is extreme enough that it requires a radical but temporary suspension of economic rules and norms.

Most of the unconventional monetary policies that have been tried to date, and just about all of those that have been proposed as future possibilities if we face a renewed global recession, break quite radically with existing norms. Negative interest rates weren’t even supposed to be economically possible (until they were tried), while quantitative easing (a central bank’s buying up bonds by massively increasing the size of its balance sheet) still carries a whiff of irresponsibility linked to its past as a way for governments to avoid fiscal retrenchment by “printing money.”

More recent proposals include helicoptering money into the government’s or the public’s accounts, abolishing cash to make low interest rates effective, and even introducing a reverse incomes policy—a government-enforced increase in wages (as opposed to the wage controls of the 1970s) to try to get inflation going.

All of these existing and potential policies break with current economic norms, and all are being pitched as temporary, exceptional measures that are (or may be) necessary in the face of an extreme crisis.

Ironically, rule-following was designed precisely to avoid this problem. It came into its own as an influential approach to monetary policy in the wake of the destabilizing 1970s, with their stop-go economic policies and rampant inflation. Mainstream economists came to love rule-based monetary policy as did politicians—not just neoconservatives like Margaret Thatcher and Ronald Reagan who first championed the approach, but eventually the more centrist politicians who followed like Tony Blair and Bill Clinton, as well as today’s mixed lot.

A rule-governed approach to policy was designed to be both politically and economically stabilizing—to do away with the problem and even the possibility of exceptions by removing not only governments’ but even central bankers’ discretion: just stick to the rule, and everything will work out. A tidy, efficient, depoliticized (although certainly not apolitical) approach to monetary policy.

Yet rules only seem great until they don’t apply anymore. A rule that pretends it can always apply (or at least, as Colin Hay puts it in his introductory blog, in the 99.9% of times that seem relevant) inevitably runs serious problems when an exception becomes necessary.

Of course, as Alan Greenspan has noted, the victory of rules over discretion was never entirely true in practice. But it was an extremely powerful narrative—one that promised that central banks’ (and governments’) commitments to low inflation and economic stability was credible because they were constrained to follow the rules.

It was also a very effective narrative that has convinced markets that anything other that rule-following is likely to be destabilizing. As central banks begin to face the limits of those rules, their earlier persuasiveness has come back to haunt them: a recent paper from some Federal Reserve staff notes that although a higher inflation target would make sense in the United States, increasing it could well backfire if market actors believed that it would be too inflationary.

This fixation on rule-following has thus put central bankers into a credibility trap. If bankers admit that the rules no longer apply, then they risk losing their credibility as market actors have come to believe the mantra that rules—particularly low inflation targets—are the only way to ensure sound monetary policy. On the other hand if they don’t admit the limits of the rules, and continue lurching from exception to exception, they will eventually lose credibility as the gap between rhetoric and reality widens.

Central banks are damned if they do admit the limits of rules and damned if they don’t.

Of course, the most viable solution to this trap is for governments to stop relying so heavily on central banks in the first place and start taking some responsibility for economic recovery through concerted fiscal action (something that the Canadian government has at least started to do). Yet for that kind of fiscal action to work, governments have to convince the markets that they believe in it enough to stick to their guns and follow through—a rather unlikely scenario in today’s austerity-driven times.

As the potential for renewed economic crisis continues to grow, this credibility gap will only widen—as central bankers and governments find themselves lurching from exception to exception, refusing to question the neoliberal rules that no longer seem to apply.

This blog was first posted on the Sheffield Political Economy Research Institute’s website.

Canada, Economics, Inequality, Political economy, Theory

Rebuilding the middle class: The Liberals have a chance to rectify their past economic mistakes

As the new Liberal government starts to put its economic plan into action, its commitment to paying attention to the evidence (unlike its Conservative predecessors) should provide them with both comforting and cautionary tales.

On the one hand, there is ample evidence to support the Trudeau government’s plan to allow for short-term deficits in order to reinvest in infrastructure and rebuild the middle class. On the other, the data also points to a rather more inconvenient truth: the trend towards growing inequality actually started on the Chrétien Liberal government’s watch.

A recent report by TD Economics notes that while the top 20% of income earners have gained 30% since 1976 (most of that since 1994), the middle 20% have only seen an increase of about 5% in that time. More tellingly, the report suggests that it was only in the mid-to-late 1990s that the level of inequality in Canada began to take off “when governments stopped leaning against income inequality.”

During the campaign, Justin Trudeau demonstrated his willingness to take on board new economic thinking and break with the old Liberal Party’s obsession with paying down the debt at any cost. Although the Trudeau Liberals’ willingness to run a small fiscal deficit in the short-term was ridiculed by the Conservatives and challenged by the NDP during the election campaign, it is actually entirely consistent with much mainstream economic policy thinking today.

A recent discussion note by economists at the International Monetary Fund (not exactly known as a bastion of left-wing thinking) warned governments like Canada against imposing austerity measures in order to pay down their debts more quickly. The authors note: “While debt may be bad for growth, it does not follow that it should be paid down as quickly as possible.” In fact, “If fiscal space remains ample, policies to deliberately pay down debt are normally undesirable.”

Or, to borrow former NDP leader, Jack Layton’s, well-known phrase (as noted in a column by Andrew Coyne last March) there is little point in paying down your mortgage faster when your house is falling down from badly-needed repairs.

This reminder of Layton’s common-sense wisdom should tell us two things. First, and most obviously, the NDP lost its way in its efforts to seem economically credible enough to govern. While there is no question that the party had far less political leeway than the Liberals to challenge what has become a Canadian obsession with balanced budgets and debt-reduction, by setting aside the more hopeful ambitions of Layton’s NDP, Mulcair and his advisors ended up in the odd position of being more conservative than the IMF (not to mention Andrew Coyne).

Second, we need to remember that it was the Chrétien and Martin Liberals, not the Conservatives, who made debt reduction a centrepiece of their economic policy in the 1990s and early 2000s.

The first cuts made in the 1990s were designed to reduce what had become a genuinely unsustainable deficit. Back then, Canada faced a milder version of Greece’s recent dilemma, with bond markets increasingly suspicious of the government’s credit-worthiness.

Yet what started as a strategic response to external pressures soon became an end in itself: the running of surpluses to pay down the debt became a mantra—part of the brand of the Liberal Party itself.

As we now know, that policy had its own very serious human costs.

I remember well the moment when the Liberal government stopped leaning against inequality and started to dismantle the same social policies that Pierre Trudeau’s government had built. I was a parliamentary intern in the House of Commons from the Fall of 1994 to the Spring of 1995 (in fact, one of my fellow interns was Arif Virani, who has just been elected as a Liberal MP for Parkdale-High Park). I watched a Liberal party that had campaigned on the left move sharply right. I watched smart, progressive politicians like Lloyd Axworthy overseeing the erosion of our social infrastructure, and I tried to understand why.

That experience shaped the rest of my career. I decided to go back to university and become a professor of international political economy in order to try to understand why countries like Canada could believe that they had to destroy their social fabric in order to survive economically—and how we could prevent this happening again.

In the twenty-plus years since I first sought to understand how Canadians can foster a caring and just society in a competitive and often unstable global economy, I have not come up with any easy answers.

But I do know that a Liberal government that is genuinely open to learning from the evidence, and committed to paying attention to inconvenient truths, will not reproduce the same mistakes that it once made.

Rising inequality hurts all of us. Recent research has shown that more unequal societies don’t grow as quickly, as many members of society find themselves unable to invest in their education and training, decreasingly overall productivity.

As the TD Economics report notes, the factors that allowed us to avoid the more radical hollowing out of the middle class seen the United States in recent years can no longer be counted on, as the commodity boom comes to an end and the hot housing market starts looking increasingly like a bubble about to burst (or at best deflate). Without creative government action, we are at risk of falling into a vicious cycle of lower growth, cuts to programs, further inequality and even lower growth.

While some might argue that the Bank of Canada’s recent downgrades to the economic outlook should push the Liberals back into their old austerity mode, that zero-sum game no longer holds water. As middle-class jobs come under even more pressure, leaning against inequality can help us all.

This was originally posted on the CIPS Blog.

Canada, Finance, Measurement, Political economy, Results, Risk, Uncertainty

Why we need to take economic uncertainty seriously

If you have been reading the financial press over the past week, you know that the global economy’s chances are looking a lot more uncertain these days. What you may not know, however, is that this more recent upswing in uncertainty and volatility is part of a much broader pattern in the global economy—one that poses some real challenges for how policymakers do their job.

Stephen Poloz, the Governor of the Bank of Canada, just released a working paper in which he suggests that the economic climate has become so profoundly uncertain since the global financial crisis of 2007-2008 that it resists formal modeling.

Because of this, the Bank will no longer engage in the policy of ‘forward guidance’, in which it provides markets with a clear long-term commitment to its current very low interest rate policy. The Bank is changing this policy not because it is any less committed to low interest rates in the medium term, but because it does not want to give the markets a false sense of security about the predictability of the future. Instead, Poloz suggests that policymakers should do a better job of communicating the uncertainties facing the economy and the Bank itself as it formulates its policies.

Why should we care about this seemingly minor change in the Bank of Canada’s policy? Because it underlines just how much our governance practices are going to have to change in order to cope with the increasing uncertainty of the current economic and political dynamics.

It’s ironic that this warning is coming from the Bank of Canada. Central banks do not like change. They are just about the most conservative government institutions around.

Since the late 1970s, central bankers have been wedded to the idea that the most straightforward monetary policies are the best—ideally taking the form of a simple rule that can be expressed as a quantitative target, like the Bank of Canada’s inflation target. Economists argue that such policy rules are stabilizing because they avoid giving too much discretion to central bankers, thus reducing uncertainty about the Bank’s plans and increasing the credibility of their commitment to low inflation.

Yet these simple rules are effective only as long as the models that they are based on can accurately capture an economy’s dynamics and needs. If the economy is too complex and uncertain for such straightforward forms of quantification, then simple rules are at best misleading, and at worst destabilizing.

Poloz’s recent paper suggests that he recognizes some of these dilemmas—and the importance of coming to terms with them quickly in the current period of economic volatility.

The Bank of Canada’s Governor is not alone in recognizing these uncertainties. Janet Yellen, the current Chair of the United States Federal Reserve Board, has also pointed to the limits of simple rules in guiding central bank policy in the current context. Her predecessor, Ben Bernanke, referenced Donald Rumsfeld’s concept of ‘unknown unknowns’ to describe the extreme uncertainty that faced market participants during the recent financial crisis.

Yet, with this paper, Poloz seems to go further than his American counterparts in recognizing the implications of these unknown unknowns. In the same speech cited above, Bernanke argued that the failures of the global financial crisis were failures of engineering and management, and not of the underlying science of economics.

Poloz, by contrast, describes the work of monetary policymaking as a “craft” (not a science), and suggests that it is too complex to be treated as a form of engineering. The uncertainty that we are dealing with today, he suggests, “simply does not lend itself as easily to either mathematical or empirical analysis, or any real sort of formalization.”

This is a remarkable departure from the kind of numbers-driven rhetoric that we have heard from the Harper government in recent years.

The Canadian government has been increasingly preoccupied with measuring results, in health careinternational development, and across government-funded programs. Last May, when announcing additional funds for the health of mothers and children in developing countries, Stephen Harper argued, “You can’t manage what you can’t measure.

Poloz’s paper suggests that, on the contrary, because of the sheer complexity and uncertainty of the current global order, we have no alternative but to find ways of managing what we can’t measure. As I argue in my recent book, rather than using ever-more dubious indicators and targets to drive policy on everything from health to the economy, we need to find better ways of assessing, communicating and managing the true complexity of the policy challenges that we face.

This will not be an easy task, either technically or politically. It will take time to educate a public—not to mention a market—that has become used to simplified pronouncements.

The less we can rely on objective measurements and simple rules, the more careful we have to be about ensuring democratic accountability for policy decisions—through the political process and through an informed and active media.

And perhaps the biggest challenge that this new reality presents is the need for our politicians to heed Poloz’s suggestion that they not only recognize the inescapability of “uncertainty, and the policy errors it can foster,” but that they wear them “like an ill-fitting suit . . . that is, with humility.”

Humility tends to be in scarce supply in political circles these days. That too will need to change if we’re going to develop the kinds of creative policy tools that we need to manage the uncertain times to come.

First posted on the CIPS Blog.

Failure, Global governance, International development, Measurement, Political economy, Results, Risk, Theory

Hedging bets: our new preoccupation with failure

Nobody likes to admit failure—least of all government-funded development organizations in hard economic times. Yet recent years have seen a number of prominent development agencies confess to failure. The International Monetary Fund (IMF) admitted its failure to recognize the damage that its overzealous approach to austerity would cause in Greece. The World Bank President, Jim Yong Kim, has adopted the idea of Fail Faires from the information technology industry, where policymakers share their biggest failures with one another. The United States Agency for International Development’s (USAID) Chief Innovation Officer also expressed some interest in organizing a Fail Faire, and the agency eventually did hold an “Experience Summit” in 2012.

This interest in failure is central to a broader shift in how development organizations—and other national and international agencies—have begun to work. As I argue in my new book, Governing Failure, these organizations are increasingly aware of the possibility of failure and are seeking to manage that risk in new ways.

This preoccupation with failure is relatively new. The 1980s and early 1990s—the era of ‘structural adjustment’ lending—was a time of confidence and certainty. Policymakers believed that they had found the universal economic recipe for development success.

The 1990s marked a turning point for confidence in the development success ‘recipe’. Success rates for programs at the World Bank began to decline dramatically’ critics started to label the 1980s a ‘decade of despair’ for sub-Saharan Africa; and both the AIDS pandemic and the Asian financial crisis reversed many gains in poverty reduction. These events made policymakers more aware of the uncertainty of the global environment and of the very real possibility of failure—lessons only reinforced by the recent financial crisis.

What happens to policymakers when they are more aware of the possibility of failure? On one hand, they can accept the fact of uncertainty and the limits of their control, becoming creative—even experimental—in their approach to solving problems. Or they can become hyper-cautious and risk-averse, doing what they can to avoid failure at all costs. We can see both reactions in international development circles.

A major shift in development practice over the past two decades has been the recognition that political ‘buy-in’ matters for policy success. As development organizations tried to foster greater country ownership of economic programs, they became quite creative. By reducing conditionality and delivering more non-earmarked aid to countries’ general budgets, development organizations shifted more decision-making responsibility to borrowing governments in an effort to create an open-ended and participatory process more conducive to policy success.

But development organizations also took a more cautious turn in their response to the problem of failure. The social theorist Niklas Luhmann first introduced the idea of ‘provisional expertise’ to describe this cautious trend in modern society. He pointed to the increase in risk-based knowledge that could always be revised in the face of changing conditions.

Risk management has become omnipresent in development circles, as it has elsewhere. No shovel turns to build a school without a multitude of assessments of possible risks to the project’s success, allowing the organizations involved to hedge against possible failures.

An even more prominent trend in development policy is the current focus on results, which is particularly popular in the Canadian government. Few organizations these days do not justify actions in terms of the results that they deliver: roads built, immunizations given, rates of infant mortality reduced.

At first glance, this focus appears to be anything but cautious: what greater risk than publishing the true results of your actions? Yet it is not always possible to know the results of a given policy. The problem of causal attribution is a thorny one in development practice, particularly when any number of different variables could have led to the results an organization claim as its own.

Some agencies such as the U.S. Millennium Challenge Corporation (MCC) have tried to get around this problem through sophisticated counterfactual analysis and the use of control groups in their aid programs. Yet even MCC staff members recognize that designing programs in order to gain the best knowledge about results can come at the expense of other priorities.

If donors can count as successes only those results that can be counted, they may well find themselves redefining their priorities to suit their evaluation methodology—and their political needs. In most cases, results are donor-driven: they are not calculated and published for the benefit of the recipient country but for the donor’s citizens back home, who want to know that their taxes are being spent wisely. So building roads and providing immunizations suddenly becomes more attractive than undertaking the long, slow, and complex work of transforming legal and political institutions. Caution wins out in the end.

Which kind of approach to failure is winning out today: experimentalist or cautious? Sadly it seems that the earlier experiment with country ownership has lost momentum, in part because the forms of participation involved were so much less meaningful than had been hoped. At the same time, the results agenda has only become more numbers-driven in the last few years. As agencies have grown more risk-averse after the global financial crisis, they have sought to make results-evaluation more standardized—and ultimately less responsive to the particular needs of local communities.

There is still hope, as the recent admissions of failure by major development organizations suggest. Yet the very fact that that the USAID event was ultimately named an ‘Experience Summit’ rather than a ‘Fail Faire’ is telling: even when leaders admit to failure, it appears that they can’t resist hedging their bets.

This blog post draws from my recent book, Governing Failure: Provisional Expertise and the Transformation of Global Development Finance, published by Cambridge University Press.

Earlier versions of this essay appeared on RegBlog.org and the CIPS blog.

Canada, Political economy

The austerity trap

As the prognosis for the global economy gets darker by the day, we are hearing one word over and over: austerity.  The British government has announced that it will extend its austerity measures past the next election in 2015. In Canada, Finance Minister Jim Flaherty has reiterated that the solution to the current economic crisis, both here and in Europe, is more “belt-tightening.”

But not everyone agrees about the virtues of austerity. Labour finance spokesperson Ed Balls called the British Government’s economic plans a “catastrophic error of judgment.” Two million British public sector workers are on strike over the effects of those austerity measures on their pensions. Closer to home, the former World Bank Chief Economist and Nobel-laureate, Joseph Stiglitz, recently told a Toronto audience, “Austerity is a suicide path.”

These critics are a diverse lot, including people affected by the cuts, Occupy activists, politicians of various stripes, and the leader of the International Monetary Fund. In different ways, they all point to some serious flaws in the current rush to austerity.  It’s worth looking at three of them:

1) The fallacy of composition (or: why Canadian debt isn’t just a bigger version of your family’s debt).

In a recent speech in Toronto, Flaherty noted that he’s applying to the federal government the same advice that he’s offering to Canadians: to tighten their belts and reduce debt. This sounds like it makes perfect sense. Except that it’s a classic error of logic that philosophers call the fallacy of composition: what is true of the parts is not necessarily also true of the whole.

Of course it makes sense for a Canadian family that has taken on too much debt to reduce it. But if all Canadian families at the same time reduce spending in order to pay off debt, then suddenly demand for goods drops, firms reduce production, and jobs are cut. As people lose jobs, it becomes much harder for households to reduce debt; in fact, they may have to take on more to pay the bills. And the risk to the economy is even greater if the federal government doesn’t step in to support demand but actually undermines it further by cutting back on vital services.

This same dilemma applies at the international level. Sure, Canada was able to get its act in order in the 1990’s through austerity measures (at great cost to our health system and infrastructure). But this was at a time when the Canadian economy and the global economy were in good shape.  And while we were cutting back, other countries were doing the opposite, taking up the slack. If everyone cuts back at the same time, there is no one left to keep the global economy going—making it likely that the outcome will be a deeper global recession and more, rather than less, debt in the long run.

2) The costs of austerity (or: why even the IMF thinks it’s a bad idea just now)

In a recent paper, IMF staff concluded that austerity measures do considerable damage in the short and longer term: “This conclusion reverses earlier suggestions in the literature that cutting the budget deficit can spur growth in the short term.” In other words, when someone tells you that austerity will stimulate short-term growth, they’re lying (or as Mark Blyth puts it in a brilliant short video on austerity, this is just about as believable as “a unicorn with a magic bag of salt.”)

What are the costs of austerity?  The IMF paper suggests that they include lower incomes in the short term and higher unemployment in the longer term. As more people become unemployed for longer, there is a real danger that unemployment will become entrenched. The costs of austerity are even higher in cases where a government can’t compensate by significantly lowering interest rates—as is the case today here and in Europe. Because of these very real costs, the IMF head, Christine Lagarde, is suggesting that countries like Canada and the UK not impose any immediate austerity programs while growth is fragile; instead they should be delayed until the economy is healthier. When even the IMF tells us not to impose austerity, and still the Conservative government insists on it, you have to wonder.

3) Inequality (or: whose belt are you tightening anyway?)

Not surprisingly, the IMF study also found that the costs of austerity are not equally borne by everyone. Reductions in wage income caused by austerity are three times larger than those from other kinds of income. It also notes that austerity will “add to the pain of those who are likely to be already suffering—the long term unemployed.” This means that working class people have to tighten their belts much more than others do, through job loss, reduced income and pensions, and the loss of services they rely on. As Blyth puts it: “This ‘common sense’ of austerity—of reducing public debt all at once through slashing services—involves a question of equity—who pays and who doesn’t. Those who made this mess won’t, while those who have paid for it already through the bailouts will pay again through austerity.”

Politicians proposing unpopular and foolhardy policies like to claim that ‘there is no alternative’. But there are alternatives, at least for those in Canada, the UK and other countries not struggling under the kind of crushing debt burden facing Greece. In his recent speech, Stiglitz proposed several suggestions, including investing in infrastructure and education (which would earn returns of 20-30%). The goal is not to reduce the amount that the government spends but rather to reduce government debt, which depends on the overall health of the economy. As Stiglitz notes, “Putting more people to work today means that over the next five to ten years the debt would be lower, GDP higher, the debt to GDP ratio immeasurably improved.”

Remember the unicorn next time you hear someone talk about austerity and growth in the same sentence.

First posted on the CIPS Blog on December 4, 2011.