The Costs of “Good” Economics

If there is a central argument to 13 Bankers, it is that politics matters. The financial crisis was the result of a long-term transformation of the financial sector and its place in the overall economy, and that transformation occurred because of—and contributed to—a shift in the political balance of power.

Daron Acemoglu and James Robinson, authors of Why Nations Fail, take up this theme on a much broader scale in their recent article in the Journal of Economic Perspectives, “Economics Versus Politics: Pitfalls of Policy Advice,” burnishing their reputations as two of the most subversive thinkers around. People have always known that economics and politics are related: that economic power produces political power and that political institutions constrain economic policy choices. Still, however, at least for the past several decades, the universal assumption has been that good economic policy is always good policy, full stop: for example, that it is always good to eliminate market failures.

This is what Acemoglu and Robinson contest. For example, assuming for the sake of argument that unions create economic distortions, unions also engage in politics on behalf of workers and, in some cases, lower-class people more generally. Policies that weaken unions not only reduce this economic distortion, but weaken the political power of the working class—which was already outgunned by capital to begin with. Given the role of unions in supporting participatory political institutions, this can be bad for democracy and for economic growth in the long run.

One specific consequence of weaker unions is that “income will typically be redistributed from workers to the managers and owners of firms.” This is often rationalized on the grounds that the “owners” of firms include, to some measure, workers themselves (primarily through their retirement account investments). But small investors have nowhere near the political organization and impact of unions (especially since their investments are largely funneled through mutual funds, whose executives do not share their political preferences).

Acemoglu and Robinson back up this conceptual insight with their usual impressive array of historical examples from around the globe. For example, the more economically efficient organization of mining contributed to autocracy in Sierra Leone, while the less efficient organization contributed to democracy in Australia. Privatization of state firms in Russia—which virtually every economist at the time supported—resulted in a concentration of wealth that was widely perceived as illegitimate and helped make possible the Putin regime. Financial deregulation in the United States is another of their examples. Some of the constraints on banks established in the 1930s and 1950s probably made little economic sense, such as restrictions on interstate banking. But the elimination of those constraints helped create larger, more politically powerful banks, which contributed to the deregulatory wave whose consequences we know all too well.

This all seems obvious. So why is it subversive? For some time now, progressives have been arguing that “free market” economic policies are bad because they ignore market failures, and therefore government policy should eliminate focus on eliminating market failures—it’s just good economics. That’s all well and good. But Acemoglu and Robinson make a significantly stronger case against pure economism. Even “good” economics can be bad for society, when the political dimension is taken into consideration.

One implication is that traditional cost-benefit analysis is incomplete: it’s not just economic costs and benefits that matter, but political ones as well. More broadly, it means that progressives—or anyone who opposes the tendency to reduce all public policy to economic factors—shouldn’t fight every battle on the terrain of economic efficiency. Of course, evaluating the impact of policy on the political landscape is both difficult and contentious. But that doesn’t make it any less relevant.