Finding Our Way Out of a Nobel-Caliber Economic Mess

"Regular people" still struggle even as economists interpret their behavior for policymakers.
by , | October 11, 2011

The Royal Swedish Academy of Sciences announced Monday that two Americans, Thomas Sargent of NYU and Christopher Sims of Princeton, would share this year's Nobel Prize for economics. The academy said the two men had independently developed complementary methods that answer questions regarding the causal relationship between economic policy and different macroeconomic variables such as GDP, inflation, employment and investments and that their work has been adopted by both researchers and policymakers throughout the world.

The news seemed so promising at first blush. The dismal science had come to the rescue of the desperate straits in which many governments find themselves. And the architects of the solution were being recognized for their work with one of the world's most prestigious prizes. Good for them. But what good is it for the rest of us?

They see that we are in a mess but they don't see a way out yet. An Associated Press article in the Boston Globe on the announcement says that their work "is highly relevant today as world governments and central banks seek ways to steer their economies away from another recession." The article quotes Sims as saying, "I don't have any simple answer, but I think the methods I have used and Tom has developed are central to finding our way out of this mess."

And we're in this situation despite the fact that top policy makers pay attention to their work. The New York Times reports that the methods developed by Sargent and Sims "help decipher how regular people's expectations for government policies can affect their behavior." The Times also notes that "Dr. Sims's work has been the basis of important papers by Ben Bernanke, the Federal Reserve Chairman, and Olivier Blanchard, the chief economist at the International Monetary Fund."

So now what? I have to confess that my first thought on reading the press coverage of the award was 'If these two guys are so smart, why are we in such a mess?' I mean, it's not as if their work has been ignored -- the heads of the Federal Reserve and the International Monetary Fund have paid close attention to their research after all. And if these two Nobel Laureates don't see a way out, what are the rest of us mere mortals to think?

Here are some thoughts:

The central problem is lack of jobs, and while more sophisticated analysis can be done, let's start with a single dependent variable -- the unemployment rate. The deep global economic downturn has clearly hurt the world's economies. From 2007 to 2010, unemployment grew in virtually every Organization for Economic Co-operation and Development (OECD) country. The OECD average unemployment rate jumped by nearly 50 percent during that period.

There are, however, huge differences among countries in the impact on jobs. In the United States, the unemployment rate more than doubled. Some other countries are clearly much worse off than us - Spain's unemployment is over 20 percent - and other countries are better off - Norway's unemployment rate is only 3.6 percent. Seven of 36 OECD countries, including Mexico, have unemployment rates under the 6 percent level sometimes referred to as "full employment."

These smart guys ought to tell us what's driving the differences among the unemployment rates in these countries. I offer the following three independent variables as a place to start the analysis: investment in education; investment in infrastructure; and the size of the differences in income among the citizens of a country.

In an increasingly global marketplace, a well-educated workforce is essential to competitiveness. As governments struggle with economic priorities in the face of budget shortfalls, those that manage to preserve a strong system of public education from preschool through post-doctoral study are going to have more citizens who find employment.

Productivity is the result of capital applied to labor. For governments, the major infrastructure systems, from transit and transportation to water and sewer, constitute the capital investments needed to maximize the productivity of their citizens and the companies those citizens own and work for. Countries that adequately invest in state of the art and well-maintained public infrastructure are going to have more economic growth than those that do not.

And finally there is the wealth gap. There is some limit at which citizens who see the growing disparities between the rewards they can earn and the rewards heaped upon the people at the pinnacle of the economic pyramid begin to understand that the game is so rigged that it makes little sense for them to try to compete. We are a self-governing people. Economic prosperity depends upon civil order and stability. Civil order and stability depend upon educated, motivated citizens who have the resources to compete and who see a better life for them and their children as the reward for competing well.

Part of Sims' and Sargent's claim to fame is the recognition in their research that "regular people's expectations for government policies can affect their behavior." Both men are frequently in New York. Maybe they'll go down to what is now known as Liberty Park and talk to some of the Occupy Wall Street folks -- themselves only slice of regular people but whose angst-ridden protests have spread virally all over the country. I suspect Sims and Sargent would get some powerful insights that might enable them to tell the world's leaders how to get us out of the mess they've gotten us into.


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