ECONOMICS:Getting fiscal policy right is central to maintaining economy-wide stability, but some governments still haven't got the hang of it

‘WHEN YOU get right down to business, there aren’t too many policies that we can say with certainty deeply and positively affect growth.”

These depressing words were written by Arnold Harberger, an American economist (those who have spent time poring over economics textbooks may recall his name – he gave it to the triangle that graphically illustrates the dead-weight losses arising from monopoly).

Last week's Irish Timesopinion poll brought the quote to mind. An unprecedented 4 per cent of voters said they were satisfied with the current Government, yet 48 per cent of those surveyed said changing the Government would have no positive economic impact.

Are politicians and policy-makers really so at sea when it comes to formulating and implementing policies that could boost economic growth, as many Irish voters and some dismal scientists believe?

Although economists have huge gaps in their understanding of economic growth, one of the few things that can be said with certainty is that the role of government in influencing economies is asymmetric in nature. Any government can, in short order, collapse an economy but no government can click its finger and generate a sustainable boom.

Robert Mugabe is one in a long line of wealth-destroying political leaders. Until the mid-1990s, Zimbabwe was one of Africa’s most prosperous economies. However, in order to cling to power, he implemented policies that were guaranteed to bring failure, including politically motivated mass expropriations and unrelenting debasement of the currency.

In a matter of years, famine and hyperinflation, among other things, had visited the now benighted country.

No government at any time over such a period, regardless of its policies or commitment, has been able to do economic good on a scale to match the ill Mugabe has done. It is easier to tear down than to build.

Unified Germany over the past 21 years is an example of the limits of well-resourced good government. In 1990, the relatively impoverished communist east of the country was absorbed into the much larger and richer west. Almost overnight, the east got rule of law, enforceable property rights and a strong, fully convertible currency – some of the institutional underpinnings of wealth creation that most economists believe to be indispensable.

Eastern Germany also got lots of money. Capital became available to eastern companies, much of it heavily subsidised. Infrastructure investment poured in. Direct investment by west German companies brought the kind of benefits that FDI has bestowed on Ireland.

A range of other direct transfers boosted consumption, including the one-to-one conversion of savings from the worthless ostmark into the mighty deutschmark (up to a limit) which allowed easterners to buy real goods with real money for the first time in decades.

Despite the focus of such vast resources by a generally effective government over two decades, not even half of the gap that existed between east and west in 1990 in per capita incomes has been closed. The record on joblessness is worse still. The east’s rate of unemployment, which never dipped below double figures, remains almost twice that of the west.

This asymmetry in what government can achieve is one reason why free-marketeers of all hues – from 19th-century advocates of the “night watchman” state to today’s anarcho-capitalists – think it best to limit the size and scope of government wherever possible.

A hands-off approach, though, simply doesn’t work in practice. Bad things can happen to economies not only when politicians do bad things. They can also happen when those in charge don’t do enough.

Ireland’s current plight is a prime example. The reason this economy has suffered so severe a crisis is not because Brian Cowen behaved as a European Mugabe, actively wreaking havoc on the economy, but because he was negligently inactive. He slept at the wheel when in charge of the public finances and never dreamt of even inquiring as to the risks associated with property and credit booms.

Leaving well enough alone is not an option for governments in modern economies that are not the self-regulating, self-correcting machines a dwindling band of theorists believe them to be.

In an economic environment that has never been as complex or as rapidly changing, risks need to be actively managed and the horizon scanned constantly for threats. Focused, alert and proactive government can prevent bad things happening, or at least mitigate their effects if they cannot be avoided.

Doing even this is not easy, though. Providing stability, particularly macroeconomic stability, in a world that is probably more inherently unstable than most observers believed before the financial crisis, is an enormous challenge.

In retrospect, central banks bear a considerable responsibility for the financial crisis. Their monomania with consumer price inflation blinded them to the asset price bubbles that their low interest rates helped inflate.

If central bankers are rethinking monetary policy, regulators of financial systems are back at the drawing board. They grossly underestimated the nature and size of the risks posed by the financial services industry to the rest of the economy. It will be a long time before any can claim with confidence to have got regulation right.

Getting fiscal policy right is also central to maintaining economy-wide stability. Despite the more straightforward nature of public finances management, some governments still haven’t got the hang of it. Blowing the public finances is hugely destabilising, as the Irish know only too well as they suffer its consequences for the second time in three decades.

Harberger made the above comment in 2003. Since then economists’ understanding of how growth can be accelerated has advanced little, if at all. Even more depressing is the post-crisis realisation that policy makers capacity to maintain stability – a foundation for economic growth – is less than it was thought to be a decade ago.

No steps forwards, one step back.