The Locomotive in the Rain Forest

(From Newsweek Japan)

Note: Newsweek Japan asked me (and others) to answer a series of questions on economics. Here is one on general economic policy.

Q10: In this age of uncertainty, what is the most credible and appropriate economic theory for governments to follow when making policy? Do you think Greenspan’s monetary policies have been right?

We often talk about the economy as if it were an engine or locomotive that needs to be “stimulated” or “sped up” or “kept on track.”

An engineer drives a locomotive and controls its speed. But the leader of a country doesn’t steer the economy. Even a skilled central banker, an Alan Greenspan, doesn’t run the economy. In the short-run, the Fed affects short-term interest rates. That’s a pretty small lever for moving the world in a hurry. Parents have trouble getting their children to behave in desirable ways–how could it even be remotely possible for a politician or even a legislative body to steer the behavior of millions of consumers, investors, workers and entrepreneurs? Most of the time, the politicians are merely along for the ride.

Talking about stimulating the economy implies there’s a gas pedal that just needs to be pressed down a little more forcefully. But most policies designed to stimulate the economy quickly take fuel from one part of the system in hopes of speeding up another part. It’s like trying to raise the level of the water in a bathtub by filling a bucket from the back of the tub and pouring it into the front. In the short-run there is very little that can be done with fiscal or monetary policy to speed up an economy.

The long run is very different. In the long-run, we’re not all dead. Our children and grandchildren are still around. What policies best serve them? The source of long-run growth is innovation. It’s impossible to anticipate which areas are the best bets for improving the human condition. Better to let a thousand flowers bloom and let us choose among them as consumers and workers. In this view, the key to growth is whatever increases the number of flowers.

That’s why I prefer a wilder metaphor for the economy–that of a rainforest. A rainforest is an incredibly complex place. Adding a species has unpredictable effects because the interactions between the plants, animals, soil and weather are too complex to understand with any precision. A person in charge of an ecosystem is at best a steward with no illusions about having an ability to “run” the rainforest. In the rainforest, you respect diversity as the way of the world. No one gardens an ecosystem. You keep the environment clean so that the natural competition and cooperation between species can work. You don’t pretend to know how it will look in a year. And you’re patient because you know that growth takes time.

The best stewards of the economy help create an environment for innovation. That means following policies that promote risk-taking and the accumulation of capital–policies that create stable prices, stable interest rates and the rule of law. Alan Greenspan is one of the most respected central bankers in history because of his ability–up until now at least–to contribute to that environment through stable prices.

Politicians are notoriously short-sighted. But that short-sightedness is a function of political institutions. In the democracies, we would be best served by asking less of our politicians in the short-run and more in the long-run. A little patience on the part of voters would lead to policies that let us plan for the future, save, innovate and flourish.