The global financial crises of the 1990s suggest that the Bush administration should look beyond traditional remedies to pull the United States out of its economic doldrums.
There is little difference between the economist who concludes that a country suffers from low confidence and the doctor who explains that an illness results from an unknown virus. As correct as both may be in their diagnoses, they have little to offer by way of a remedy; their treatments will likely rely on trial and error rather than on a proven cure with well-understood consequences. "It is difficult for economic policy to deal with the the abruptness of a break in confidence," admitted Federal Reserve Chairman Alan Greenspan in February. That is because, as Nobel laureate Robert Solow has written, "Confidence obviously matters, and it is just as obviously unmeasurable. So it can explain anything."
In the United States and other industrialized countries, policymakers traditionally respond to economic slumps and feeble consumer confidence by lowering interest rates and sometimes taxes. The extra cash stimulates consumer spending and eventually spurs investment as businesses respond to increased sales. While lower interest rates will surely help revive the slowing U.S. economy, no one knows how long it will take for them to work or what side effects they might produce.
Over the last decade, the realities, habits, and expectations of American consumers and businesses have changed drastically, as have those of the rest of the world, further clouding the impact of changes in U.S. monetary and fiscal policy. Such uncertainty amplifies the importance of other, non-economic signals — inconsistent remarks by the U.S. president, disagreements between cabinet members, political scandals, and events overseas — that also shape the expectations of consumers and investors. This new vulnerability was one of the lessons of the 1990s, when mere technical fixes often failed to restore confidence in emerging countries reeling from an economic downturn.
Certainly, the United States is not Mexico, South Korea, or Poland. Yet, the experiences of these countries offer insights into what it may take to restore Americans’ confidence in U.S. economic prospects. Beyond tinkering with monetary or fiscal policy, confidence also rests on at least five other factors:
Sustainability: Haste, political compromises, bureaucratic infighting, inadequate information, and bad advice often have led governments to respond to economic distress with isolated, uneven measures that undermine the sense of continuity needed to restore confidence. For example, if American consumers perceive that the tax relief proposed by the Bush administration will have to be revised in a couple of years as fiscal pressures mount, then the tax break will fail to stimulate spending and will instead erode confidence even further. A good, long-lasting economic policy always beats one that is seemingly better but widely perceived to be short-lived.
The team: Top economic policymakers must learn to double as excellent politicians. Indeed, recent history is replete with brainy economic czars betrayed by their tin ear for politics. Last March, Argentina’s Ricardo López Murphy lasted only 15 days as minister of the economy because he grossly underestimated the political backlash against his proposals. Conversely, finance ministers with a flair for wooing financial markets and television audiences — such as Mexico’s Pedro Aspe or Vaclav Klaus in the Czech Republic — can deploy charisma, passion, and credibility to compensate for some of the weaknesses in their economic programs.
The politics: Unanimous political support for economic reforms is rare; most substantial reforms face stiff opposition and skepticism. Yet, no country can restore macroeconomic balance without a modicum of political accord. Many sound economic programs of the 1990s failed because of the fractious politics surrounding their adoption and execution. Governments that forced policies through deeply divided legislatures paid dearly afterwards, as bitter politicians blocked the implementation of key additional measures needed to consolidate business confidence. Financial markets in particular have become adept at detecting the foul political moods that threaten even the soundest economic reform programs.
The world: These days, economic confidence at home usually begins abroad. As the reformers of the 1990s discovered, the confidence of foreign investors and governments determines an economic program’s success as much as the support of domestic constituencies. Foreign influences may not be as meaningful to the United States, given its size and international dominance. Nonetheless, many an international monkey wrench can be thrown deliberately or inadvertently into the wheels of the U.S. economy, wreaking havoc on the best-laid plans to lift confidence. A crashing Japan, a sputtering Europe, or a stream of economic crises in emerging markets can surely hamper a U.S. recovery.
The leader: Leadership is the mother of all signals. People trust people, not programs, so good leadership at the highest level is essential to bolster economic confidence. Is the head of state perceived to have what it takes to get the economy out of its rut?
The ability to lead the United States out of a precipitous downturn was not a major consideration in the minds of voters in 2000. Yet as the U.S. economy continues to struggle, President Bush’s leadership abilities will become a crucial factor in bolstering or hampering confidence. Unfortunately, if he proves inadequate, there will not be much to do, as "leadership problems" are to politics what an "unknown virus" is to medicine. Both are much easier to diagnose than to cure.