Wednesday, April 28, 2010

Political Failure and Finance Reform

Matthew Yglesias’s depressing account of the state of play on the financial regulation bill sounds about right:
“On many aspects of financial regulatory reform, there’s no real consensus among reputable analysts about what should be done. Is the existence of big banks a problem, or does Canada’s stable and highly concentrated banking system prove that it’s a red herring? Should we fix the ratings agencies by regulating them more stringently, or do we need to deregulate and increase competition? What should happen to Fannie Mae and Freddie Mac? Given that we need to limit leverage, how much should we limit it before we start adversely impacting growth?

"The bill substantially punts on these questions, either not addressing them at all or else merely instructing regulators to come up with an answer. In part, that’s what speed required. And in part it’s the inevitable result of a process driven by technocrats rather than lengthy congressional deliberation. Which means that we’re looking at a bill that basically gives regulators the tools they say, in retrospect, they would have needed to prevent the crisis. That’s a pretty good idea, but it naturally raises the question of why they didn’t ask for these tools at the time. Instead of having a far-reaching debate that touches on the fundamental role of finance in our society and the relationship of banking to government, we’re updating the regulatory toolkit.”
We all know why Harry Reid has his foot to the floor anyway; the window for reforming the finance system in a progressive way is rapidly closing with the approach of the mid-term elections and a possible Republican takeover of the House. But it’s hard even for conscientious progressives like Yglesias to believe that we’re heading toward a good public policy decision. All the options laid out so far have too many moving parts, and therefore promise to generate too many unintended consequences, to inspire much confidence. Yglesias is right that, in a perfect world, we’d be able to slow down and scan the options more carefully. But in this world, progressives would be shooting themselves in the foot if they tried that. They have a compelling political reason to push a bill through, then, even if they lack confidence that it’s a good enough bill to take the the political issue of financial reform off the table.

A functioning system of public decision-making is supposed to get an ideologically divided public to a political equilibrium. When a major public decision generates political disequilibrium, it makes sense to speak of “political failure” in a sense that’s roughly analogous to the way economists speak of “market failure.” If Yglesias is right, we’re probably headed for a political failure with respect to financial reform.

Achieving a political equilibrium is partly a matter of public morality and partly a matter of distributing benefits and burdens efficiently. A public decision is morally stable by virtue of its legitimacy, that is, by its having been enacted through an authoritative decision-making process that generates an overriding obligation on the part of all citizens to abide by the final decision even if they think it’s unjust or unwise. A public decision is politically stable mostly by virtue of its efficiency, that is, by its distributing benefits and burdens among the population such that no significant constituency can be made better off without at least one other significant constituency being made worse off.  Efficient policies tend to be politically sustainable because powerful constituencies can be expected effectively to resist changes that make them worse off. That’s why a polity can usually move on to other things after it reaches an equilibrium on a matter of public policy, even though different constituencies prefer different equilibria.

Whatever you think of ObamaCare as public policy, it’s hard to deny that its enactment is an example of political failure. On the one hand, its supporters needed to resort to enough procedural innovations (e.g., circumventing the customary House-Senate Conference Committee and using reconciliation in the Senate to negate features of the bill on which conservative Democratic Senators had conditioned their earlier closure votes) to impugn its legitimacy among significant political constituencies. On the other hand, there’s ample reason to doubt ObamaCare’s efficiency owing to its unfathomable complexity and the imperfect metrics we've used to measure its effects (e.g., CBO accounting conventions). There’s no better evidence of political failure than the fact that, after a year-long process of public deliberation, a substantial majority of likely voters favor repealing a bill that was just enacted into law.

We can argue endlessly about who’s to blame. Democrats think that Republicans engineered a political failure by using the Senate filibuster irresponsibly. Republicans think that Democrats' specious pitches for ObamaCare (e.g., "if you like your health insurance you can keep it," or "ObamaCare won’t add a dime to the deficit") amount to political fraud. But there’s no denying that there’s been a political failure to blame someone for.

All other things being equal, that’s worse news for liberals than it is for conservatives. We're the ones committed to using the political process to do distributive work that conservatives would leave to markets. It’s up to us, then, to explain how the political process can operate with tolerable efficiency, and do our best to see that it does. The state of play with respect to financial reform illustrates how hard that is to do.

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