The Unlikely Revolutionary

The global economic crisis has produced far more villains than heroes among the economic experts in academia, journalism and business. Nonetheless, a few outspoken economists have become central to the national conversation, including Paul Krugman, who has actively critiqued the current administration from the left, Mark Zandi, whose research drove the stimulus debate, and Nouriel Roubini, who faced derision as "Dr. Doom" for his pessimistic but accurate pre-crash forecasts. None though, have created such a stir as Simon Johnson, the British-born economist and emerging markets expert who took a look at the United States and didn't see an economic powerhouse, but a banana republic.

"In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets)," Johnson writes in a piece published this month in The Atlantic.

Long-held assumptions about the efficacy of markets and the role of government in economic life have been under intense scrutiny since the September failure of the nation's financial system, perhaps most famously in ur-free market guru and former Chair of the Federal Reserve Alan Greenspan's congressional mea culpa last fall. But no other economist of Johnson's credentials has stepped forward to call the United States a financier-run oligarchy. It's a charge that's attracted a lot of attention coming from an MIT professor and former chief economist at the International Monetary Fund, an institution that is normally a bête noire of the left.

"I'm not a populist, OK. I'm very concerned about fiscal responsibility, I'm very concerned about runaway inflation," Johnson told me last week. "I'm interesting to people on the left in part because I really am a very centrist-type character who is completely agreeing with, and in fact going further than, many left-type people."

But there is more to his argument than mere controversy. His bleak picture of U.S. political economy hints at the future of a profession in crisis.

"In essence, everything is up for grabs," Martin Wolf, a former World Bank economist who is now the chief economics commentator at the Financial Times, says. "It's like asking, in a way, in 1932, two years after the crisis really hit, what was the Great Depression going to mean?' The answer, we now know, is that the Great Depression changed everything, it ended us up in a completely different intellectual world, political world, social world."

Johnson underwent this shift. He recalls, early in his time at the IMF, signing off on a report about liberalization in developing countries. "I didn't disagree with this at the time: If you have strong institutions and a well-run regulatory structure, you can and should move towards capital market liberalization," he says. But after an "oh-my-goodness" moment one evening last September, as the full impact of the Lehman failure and the U.S. takeover of AIG became clear, he changed his mind. "Now," he says, "that's not my view. We should go back and look at everything, and wonder about if anybody has the regulatory structures able to withstand what happens when you liberalize."

His argument, in a nutshell, is that the last 25 years have seen deregulatory policies driven by the banking interests, leading to an over-large financial sector that has captured the political process. Financiers promoted free-market ideals, served in government, and funneled millions into the political process. Now, the risky behavior of major financial institutions, combined with the public policy they promoted, has created a major crisis. But the bankers' political power hasn't waned, and they are preventing the government from acting aggressively to start recovery.

Johnson and other economists across the ideological spectrum have fashioned a rough consensus that the government needs to take insolvent banks into receivership and use anti-trust tactics to break them apart, producing a financial sector that is small, simple and heavily regulated. But Johnson doesn't believe this will happen unless the financial crisis becomes even more severe; otherwise, the political incentives standing in the way will be insurmountable even if the price paid by the economy is, in the long-term, devastating.

On the other hand, the results of the recent G-20 economic summit offer a glimpse of the current political response to the economic crisis: return to the status quo. Leaders blame the crisis on technical decisions made by regulators and the central banks that set monetary policy; they hope to prop up the existing system, and, with slightly more regulation, continue on with essentially the same game.

Many economists see in this approach as complacent, and indicative of a fundamental misunderstanding of the financial sector's structural problems. Johnson's contribution is identifying the political factors that contribute to the rosy-eyed government consensus in the face of many academics' hard-edged analysis.

"Economists don't usually talk like that about policy making unless they're in political economy departments," Wolf says. "That might change the way the debate goes and might delegitimize, if [Johnson] is successful, some of the policies promoted by the banking system and indeed the current administration."

Despite Johnson's comparison of the United States to an emerging market, a key difference is that the United States isn't broke and desperate for the aid of the IMF. Our ability to borrow cheaply gives us flexibility those countries don't have. Johnson worries that flexibility leads to indecision; others observe that the stakes are much higher for U.S. policymakers. While another country might suffer an internal financial crisis, U.S. failure risks a global depression. The American government worries that a massive bank receivership could create panic, and administrative challenges could lead to an even worse functioning financial system.

Wolf, a friend of Johnson's, agrees with much of the MIT professor's assessment -- up to a point. He differs not on the right solution but on the role of ideas, not just interests, in creating the crisis and the motivating the government's response. "It's not enough to tell people, as it were, they're venal, it's not enough to tell people they're wrong," Wolf says. "You have to tell them that the alternative that you want them to pursue is actually one that you can manage within the U.S. political context."

Like another Johnson critic, Harvard's Dani Rodrik, has argued, Wolf believes that free-market ideology, rather than the power of moneyed interests, plays a major role in the problem. While conceding that interest group politics is important, both Rodrik and Wolf cite John Maynard Keynes, who famously said that "practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist," to argue that the aggressively laissez-faire policies of the last three decades were driven not just by profit, but by an honestly acquired, if damaging, worldview.

"It really isn't true that Chicago economists and Alan Greenspan and all of these people had the ideas they had about the world because they were venal," Rodrik says. "They didn't do it because they were bought by anybody. They made these policy choices … because they had certain ideas about the way the world works."

Johnson, on the other hand, believes his argument "subsumes" the ideas critique, that the damaging world-view promoted by the Greenspans and Robert Rubins of the world is one of the ways oligarchy maintains its power.

Whether through corruption or an honest belief in the magic of derivatives, the same damaging decisions were made. But the distinction between ideas and interests is important if changing the current response matters. While defending his economic plan, President Barack Obama said that Sweden, an oft-cited example of a decisive response to a financial crisis, "has a different set of cultures in terms of how the government relates to markets, and America’s different." Obama's political instincts -- and constituency -- would normally put him opposite the bankers, but a major constraint is his, and his administration's, ideas about what is and is not acceptable. The battle to fix the financial crisis must include political organizing and efforts to limit the influence of money in politics, but we also have to change the way we think about economic policy.

Unfortunately, Johnson posits, the economic specialty that deals with business cycles and recessions -- short-run macroeconomics -- hasn't yet acquired the tools to assess the influence of political interests on their policy proposals. Perhaps unsurprisingly, finance specialists have.

'"If you walk into a finance seminar with data pertaining to power and influence, the kind of things we're talking about, they will take you very seriously," Johnson says. "The short-run macro people, not so much."

A fluid speaker who peppers his conversations with interruptions of "and another thing," Johnson recalls that when he was appointed to his IMF position, The Economist wrote a snarky piece criticizing his approach to economics. The magazine suggested his consideration of political issues was unsuited to the IMF's needs at a time when the institution was focused on macroeconomic liberalization and the World Bank was better known for its political focus on development and poverty. Now he feels vindicated.

"Short-term macro should be more about oligarchs, and power structures, and what goes on in countries," he says. "That turned out to be right. I didn't think it would be quite as right as it really is. On the other hand, you can say, look, that Simon has a hammer and everything's a nail. Maybe I'm wrong; maybe the banking system isn't too big, too powerful, or fundamentally bad for us."

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