We won’t know for some time yet whether we are living through a game-changing period in which a dominant economic paradigm is replaced by something else. We don’t yet know what the catchy label will be for it.
Yet some of our conventional notions about how states manage market expectations have already been upended in recent times. One of these concerns the politics of credible commitment, which doesn’t always work the way we think it should.
The phrase, perhaps most commonly associated with Douglass North, refers to government commitment to constrain its discretionary policy capabilities, often through some form of delegated governance, the better to reassure powerful and potentially hostile policy actors about what they will and will not do. Thus independent central banks, beyond democratic control and populist influences, are expected to be more credible in their commitment to securing low inflation rates. This will send signals to the markets, that is, to investors seeking signals about risk evaluation, that government is committed to orthodox monetary policy. This in turn is assumed to encourage investment and facilitate growth.
But even before the current crisis, something funny was going on. In a fascinating new research paper, my colleague Sebastian Dellepiane has thrown new light on the underlying logic of the British Labour Party’s surprise decision, as soon as they took power in 1997, after 18 years in the political wilderness, to make the Bank of England independent. It was widely interpreted at the time as the price Labour had to pay to gain the confidence of the City, and indeed it succeeded in this. For several years, it seemed that British economic policy was even more firmly in thrall to Conservative priorities than the Conservatives themselves had been. Chancellor Gordon Brown’s mantra of ‘prudence’ in tax and spending policy merely underscored the point.
But Dellepiane argues that Brown and his colleagues always intended this to be a transitional phase. Drawing on Elster’s work on constraint theory, he claims that they were not so much binding themselves as binding their political opponents and their market critics. Once they had changed the game-plan in everyone’s minds, once they had secured their credible commitment to low inflation, they were paradoxically freer than ever to engage in active tax and spending activity. Brown’s fiscal measures were always part of his political programme, but could not be openly avowed. But ‘redistribution by stealth’ resulted in a rising volume of public sector deficit during most of the 2000s. The politics of credible commitment, played out in the context of two-party politics, had facilitated exactly what it was meant to prevent.
An analogous observation may be made about European Monetary Union and the Stability and Growth Pact. Governments’ self-binding disciplines in the run-up to the Euro resulted in reasonably convincing convergence during the 1990s on inflation, interest rates, and debt. Governments sought to establish their credibility and win the benefits of currency stability, low interest rates, and frictionless trade. But the design of the SGP proved to have asymmetrical incentives to continue with self-binding. As Hallerberg and Bridwell have argued[i], the SGP rules interacted with domestic political institutions to produce asymmetrical outcomes. In countries which already possessed ‘fiscal contract’ decision-making systems, the SGP reinforced their practices, but in countries with strong delegated powers available to finance ministers, it had little effect. And large states were more likely to breach the rules than small ones.
So the politics of gaining credibility through self-binding turns out to have paradoxical outcomes. Gordon Brown deliberately used a self-binding monetary policy to enable activist fiscal policy. Governments’ self-binding adoption of the Euro had the unintended consequence of enabling asset price inflation in the peripheral countries and financial sector indiscipline in many other countries. The strong implication is that the consequences of self-binding depend on how the strategy interacts with domestic institutions and the configuration of domestic political interests. Neat economic theory trips over messy political reality once again.
[i] Hallerberg, Mark, and Joshua Bridwell. 2008. ‘Fiscal Policy Co-ordination and Discipline: The Crisis of the Stability and Growth Pact and Domestic Fiscal Regimes’, in The Euro at Ten: Europeanization, Power and Convergence, edited by Kenneth Dyson, 69-86. Oxford: Oxford University Press.
{ 5 comments }
chris 02.15.11 at 7:32 pm
Thus independent central banks, beyond democratic control and populist influences, are expected to be more credible in their commitment to securing low inflation rates. . . . This in turn is assumed to encourage investment and facilitate growth.
Since the former is code for “Damn the people and their desire for jobs, let alone decent-paying jobs”, I find it hard to believe that anyone could believe that would actually facilitate growth.
Maybe they’ve been staring at the Third World too long, but undercapitalization isn’t the only possible source of poor economic performance. Redistributing the fruits of production away from the work force and concentrating wealth in the hands of people with no incentive to spend it can wreck your aggregate demand just fine, and no amount of investment will help with that problem.
If you’re committing yourself to ruinously bad policy, securing more credibility regarding the commitment is the least of your problems.
Mark Healey 02.15.11 at 9:22 pm
This paper is very well observed and astutely argued, as in the earlier collaborative work on the Irish crisis. And I can’t help but wonder if Dellepiane’s insights into the paradoxes of credible commitment might not be distantly shaped by the experiences of his own native Argentina, specifically of the 1991 dollar peg (convertibility). The government essentially gave up the right to issue money, unless it was backed by new greenbacks from abroad. The idea was that this would put a permanent end to inflation, sharply constrain government spending, and prevent any expansion of the foreign debt. In practice, of course, it was so successful at stopping inflation that it eventually yielded deflation, and skyrocketing unemployment, while the illusion of virtue enabled its promoters to dramatically increase government spending and foreign debt (public and especially private). But while convertibility failed to achieve its goals, it did credibly prevent anyone from breaking with it, up until the spectacular flameout of 2000-1.
Niamh 02.16.11 at 3:15 pm
Mark, you are quite right. Sebastian has written elsewhere about Argentina’s convertibility law. He also has a book under review at the moment, Institutions Matter: The Politics of Credible Commitment.
I think the politics of pre-commitment analysed in the paper on Gordon Brown is quite fascinating, where self-binding in one area actually has enabling consequence in another that had been assumed to be jointly bound. This work is an absolute model of theoretically informed empirical study, where process-tracing in a detailed historical case study illuminates a larger puzzle.
erichwwk 02.16.11 at 5:29 pm
Well said, Chris.
Much of this wealth is being accumulated by folks that did nothing to produce it; also, what is being spent is primarily on assets already in existence, merely bidding up those prices rather than creating new value.
Tim Wilkinson 02.21.11 at 3:00 pm
The Brown paper is quite a compelling narrative (given the subject matter), and interesting for the concepts involved – I hadn’t come across the term ‘heresthetic’ before, though it names one configuration of the ways in which institutional and intentional-strategic (sometimes aka, usually illicitly, ‘conspiracist’) explanations can be combined – the intentional design of institutions.
(The other configuration, if we limit ourselves to looking at two levels anyway, is institutional determination, via incentive structures etc., of strategic intentional action, e.g., of course, corrupt and coordinated – ‘conspiratiorial’ – behaviour.)
But by the time I got to the end I wasn’t quite so sure it had anything new to say about the facts on the ground, though –
* the binding was already well-understood to be of the party as a whole, rather than of GB alone
* the paper admits that there was an element of intentional self-binding at the party level, constraining the tendency to submit to external manipulation and internal ‘weakness’ of political will
On the other hand, I suppose the role of that constraint in nullifying external coercive threats is at least hinted in there somewhere and for all I know not a widely recognised phenomenon. Though it’s not clear what kind of threat that would be – presumably a threat to act in such a way as to force interest rate changes would actually work better if those changes were controlled by as relatively predictable 3rd party: threats aimed directly at securing interest rate changes would be ineffective, I suppose, though.
As for the enabling role of binding,
*the idea that gaining the confidence of/placating the markets was thought important for the usual Thatcherite reasons is obvious enough, and not really enabling
*whereas how exactly CBI enabled what is bizarrely described as Brown being a “real socialist”* is not clearly explained, except:
*the getting a second term side of things is suggested, via the two parties’ (also many others’) understanding that public binding to gain market actors’ trust in monetary ‘responsibility’ was in Labour’s interests, but is correctly considered a standard analysis
*while the other facilitating aspect mentioned, the fact that effort and compromise involved in maintaining supposedly optimal interests rates was avoided comes under the also standardly recognised heading of hiving off responsibility
It seems a good enough overview, and it’s an interesting conceptualisation of the considerations involved. But unless I’ve missed something, the only puzzle that is solved is a self-generated one, viz. why it is incorrect to assume that this was all about personal self-binding per se?
The puzzle of why not announce it before the 97 election would seem to be resoluble by ref to the acknowledged fact that the plan was a secret from the party at large, along with the unacknowledged facts that it was obviously going to be a landslide anyway, and, perhaps, that swing voters were not guaranteed to be in favour of the move
* which suggests a degree of right-wing bias, though perhaps this is now regarded as ‘post-ideological’ in that nugatory sense of ‘post’ that means ‘we’ve got used to it’, as in ‘post-modernist’, ‘post-capitalist’?
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