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The angels in the detail

14 November 2012 By Edward Hadas

Barack Obama will not solve America’s most profound economic problems. That is not a partisan political statement about the newly re-elected president. Had Mitt Romney won last week’s contest, he also would not have been able to reduce unemployment, improve the trade balance, rebuild U.S. manufacturing excellence and strengthen the middle class. The fixing of the American economy is just not a one-man or one-woman job.

The Federal Reserve is trying to help with one of those problems, unemployment, but the central bank does not possess the refined tools needed to address this complex issue. Indeed, bold decisions made by the highest authorities cannot resolve any of the developed world’s greatest economic problems. The devil – and the angel – is in the innumerable details.

Of course, there are times when big policy decisions change the course of economic history, as when the new governments of formerly communist countries abandoned central planning, or when the U.S. government rescued its banking system during the last financial crisis. Less dramatically, changes in government deficits and central bank policies on interest rates can moderate fluctuations in the economy by compensating, to some extent, for hyperactivity or sluggishness.

Many economists want some grand gesture right now. Some call on the president to push for a big move towards fiscal austerity, others want massive stimulus, and still others want a big change from the Fed. Such calls are excessive. The economy is not robust, but it is not in crisis. Dramatic moves are far more likely to wreak havoc than to do good.

This is the time to address long-standing and deeply embedded problems. These issues can sometimes be summarised in a single statistic such as the unemployment rate or the share of GDP dedicated to infrastructure investment, but the causes are hugely complex and the cure requires thousands of detailed, dull and often difficult changes.

Take healthcare. While the United States delivers excellent medical care by any historical standard, in comparison to other developed nations its system is expensive and ineffective. However, there is no single clear weakness, just thousands of deeply embedded medical and financial practices which need revision. Hospitals, doctors, patients and insurers all have to change their habits and probably lower some of their expectations. Federal law and regulations can do only a small part of the work, presidential rhetoric can do even less.

The unemployment problem is similarly complex. The rate is not unacceptably high because of any crude error in monetary or fiscal policy. On the contrary, if economists Kerwin Kofi Charles, Erik Hurst and Matthew J. Notowidigdo are right, the big decisions which were supposed to reduce unemployment ultimately made the problem worse. The Fed’s relaxed monetary policy supported a job-creating boom in construction in the 2000s, but the researchers show that this good news masked an unusually rapid decline of low-skilled manufacturing labour. By the time the loss was fully recognised, after the housing bust, it was harder to start the long and detailed work of improving workers’ skills and creating less skilled jobs.

Of course, the government can help address such complex problems. Taxes, regulations, the legal system and educational practices can all be changed. The authorities can fund more helpful research and promote more effective economic coordination. Most of the detailed work, though, has to be done at lower levels of the economy. The secret of economic success is not the brilliance of leaders but the ability to create and sustain organisations which can take full advantage of individuals’ abilities.

Pre-industrial economies had guilds and close-knit trading networks. The corporation is now the predominant form of economic organisation, but institutions such as banks, industry groups, regulators and research consortia are also important. They can help spread good practices and ideas, and restrain bad ones. Even more significant are the informal economic ties created by family, education and location.

The economy flourishes when these many organisations and relationships work well, both separately and together. Conversely, when there are serious problems, the weaknesses are spread widely: a bad practice here, rewards for failure there, and the wrong people in control in some other place. Simple ideas and single decisions can rarely do much to improve complicated enterprises, let alone the complex networks that guide the whole economy.

The president and his fervent supporters may be frustrated by the limits to his economic power. Believers in the omniscience of government or the omnipotence of chief executives may be disappointed to learn that central authorities cannot simply order improvements. But such expectations are little more than magical thinking. In reality, a healthy economy is built by innumerable individuals who work together, strive for excellence and try to avoid bad practices. Problems are caused by excessive self-interest and destructive conflict. Problems are solved by economic angels, individual effort and fruitful collaboration, not by a wave of the presidential wand.

 

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