seojiwo January 5, 2022 0 Comments

The Political Economy of Economic Policy

The COVID-19 pandemic strikingly illustrates the intersection of politics, economics, and other considerations. Public health experts have long warned that the world was likely to face a major pandemic and called for greater preparedness. Yet policymakers who have to focus on the next election find it difficult to invest the time, money, and political capital to address the abstract possibility of a future crisis. And so most of the world was unprepared for a global public health threat of the magnitude posed by the novel coronavirus.

As the pandemic has raced across the world, the policy response has continued to be tempered by political realities. Some members of the public, and some policymakers, have resisted the recommendations of public health experts, hoping for relaxed restrictions and a return to normalcy before the dangers have passed. At the same time, business interests have pressed for exceptions to benefit themselves, and for substantial subsidies—bailouts—to help them through difficult times.

At the international level, government responses to the pandemic illustrate the difficult politics of worldwide cooperation. A global pandemic requires a global response: microbes do not respect borders. A coordinated international response is clearly the best way to confront an international public health emergency. Yet policymakers under pressure from their constituents have diverted resources away from other countries, banned the export of food and drugs, and hoarded essential supplies. Each of these measures—popular as they may be to national publics—imposes costs on other countries. In the final analysis, the lack of cooperation makes everyone worse off. Such international institutions as the World Health Organization attempt to coordinate a cooperative global response to the global crisis—but they can be powerless in the face of potent nationalist political pressures (see, for example, Goodman and others 2010).

Every government faces tough decisions about the appropriate measures: what restrictions to impose and when to loosen them, where money will be spent and how it will be raised, and what national concerns can be limited to favor international cooperation. These decisions have to take into account public health recommendations, economic considerations, and political constraints. Just as the policy response to the 2007–08 financial crisis varied from country to country in line with local political economy conditions, so national policy responses to the COVID-19 pandemic vary for health, economic, and political reasons.

Politics at play

This hotly contested policy response to a universal threat is no surprise to political economists. It happens all the time. For example, just about every economist believes that small countries would be better off if they removed all barriers to trade. Yet unilateral free trade is practically unheard of, and no country in the world today pursues it. Why not? More generally, why do governments have so much trouble getting economic policies right? Why does the advice of independent observers, analysts, and scholars go so often unheeded?

Politics is the usual answer, and the answer is usually right. But that is too vague—like saying that some countries are rich and others poor due to economics. Exactly how does politics keep governments from making better policy, even in the face of imminent crises? What does that tell us about how economic policy can and should be made?

Political economy is about how politics affects the economy and the economy affects politics (see box). Governments try to pump up the economy before elections, so that so-called political business cycles create ebbs and flows of economic activity around elections. By the same token, economic conditions have a powerful impact on elections. Political economists have uncovered the simple (perhaps disturbing) fact that the rates of economic growth and inflation are all the information we need to predict quite accurately the results of the past 100 years of US presidential elections (see, for example, Fair 2018). So why don’t elections work to push politicians to choose the best policies?

What Is Political Economy?

Adam Smith, David Ricardo, and John Stuart Mill are widely regarded as the originators of modern economics. But they called themselves political economists, and Mill’s Principles of Political Economy was the fundamental text of the discipline from its publication in 1848 until the end of the century. These early theorists could not conceive of the economic and political worlds as separate.

Two trends divided the political from the economic analysis. First, governments began to reduce their direct control over the economy. Second, different political forms emerged: Europe went from almost exclusively monarchical to increasingly representative, and highly varied, forms of government. By the early 20th century economics and political science were established as separate disciplines.

For much of the 20th century this division reigned. With the Great Depression and problems of development, the purely economic issues were daunting enough to occupy economists. By the same token, the political problems of the era—two world wars, the rise of fascism and communism—were so serious as to require separate attention.

By the 1970s, however, it was clear that the separation between the economic and political spheres was misleading. That decade saw the collapse of the Bretton Woods monetary order, two oil price shocks, and stagflation—all highlighting the fact that economic and political matters are intertwined. The economy was now high politics, and much of politics was about the economy.

Over the past 50 years, political economy has become increasingly prominent in both economics and political science, in three ways:

It analyzes how political forces affect the economy. Voters and interest groups have a powerful impact on virtually every possible economic policy. Political economists strive to identify the relevant groups and their interests, and how political institutions affect their impact on policy.

It assesses how the economy affects politics. Macroeconomic trends can boost or ruin an incumbent’s chances. At the more microeconomic level, features of the economic organization or activities of particular firms or industries can have an impact on the nature and direction of their political activity.

It uses the tools of economics to study politics. Politicians can be thought of as analogous to firms, with voters as consumers, or governments as monopoly providers of goods and services to constituent customers. Scholars model political-economic interactions in order to develop a more theoretically rigorous understanding of the underlying features driving politics.

All three methods have profoundly affected both scholars and policymakers. And political economy has a lot to offer both to analysts of how societies work and to those who would like to change society.

Where you stand depends on where you sit

A basic economic principle is that any policy that is good for society as a whole can be made to be good for everyone in society, even if the policy creates winners and losers. It requires only that the winners be taxed just a bit to compensate the losers—and everyone is better off. Economists use powerful tools to clarify which economic policies are best for society. So why should economic policy be controversial?

A basic political economy principle is that the winners don’t like being taxed to compensate losers. And the battle is joined, not over what is best for society but rather over who will be the winners and losers. What is best for the country may not be best for my region, or group, or industry, or class—and so I will fight it.

Even in democracies, plenty of citizens might agree that politics obeys the golden rule: those with the gold make the rules. Special-interest groups do seem to play an outsize role around the world, democratic or not. These include wealthy individuals, powerful industries, big banks and corporations, and formidable labor unions.

How else to explain why Americans pay two or three times the world price for sugar? There are a handful of sugarcane plantations and a few thousand sugar beet farmers in the United States—and 330 million sugar consumers. You’d think that the 330 million would count for a lot more in politics than the several thousand, but you’d be wrong. For decades, subsidies and trade barriers have raised the price of sugar to the benefit of the sugar planters and farmers and to the detriment of everyone else.

Why does a tiny group of sugar producers matter more than the rest of the country? A commonplace of political economy is that concentrated interests usually win over diffuse interests. The sugar producers are well organized and work hard to influence politicians. If they didn’t get favorable government treatment they’d go out of business, so it’s important for them to organize to lobby and fund politicians. The cost to consumers is estimated at $2 billion to $3 billion a year. That’s a lot of money—but it comes to a couple of cents a day for the average American. No consumer is going to talk to an elected representative or threaten to vote for an opponent over a couple of cents a day.

The fact that producers are concentrated while consumers are diffuse helps explain trade protection. A few automobile manufacturers can organize themselves; tens of millions of car buyers can’t. That’s not all. Management and labor in the auto industry may not agree on much, but automakers and autoworkers agree that they want to be protected from foreign competition. Politicians—especially politicians from areas where automobile manufacturing is important—have a hard time denying a common demand of workers and owners in a powerful industry.

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