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Lost “Model Setting” Leadership

by Adam Posen
October 7, 2008

I side with those (from Nye to Setser) who say this is not the end of US relative power, and that fiscal constraints will not be hugely binding.

Regarding the latter, what Japan’s actions in the 1990s show us is that fiscal policy when properly used can be effective, that running up debt in what is clearly a temporary situation is not automatically inflationary (note that yen also had a sustained major depreciation and Japan had neither rising interest rate nor inflation), and that it is net debt, not gross public debt that matters (see the work of Broda and Weinstein).

What I am much more concerned about is the US having lost the intellectual or “model setting” leadership in the global economic community. This is in large part deserved because we did get sloppy with our regulation and supervision, we were too arrogant to others, and we did too little to submit our own policies to international institutions (even under Clinton, though obviously much worse under Bush).

The negative result for US policymaking is threefold: 1) less ability to set agenda in international negotiations over financial and investment matters, which will have to take place; 2) more propaganda points for those who wish to take an alternative economic path, or who can be swayed by a PRC or Venezuelan example (I know, very different from each other); 3) reduced ability to get agreement on standards or on openness amongst national economies.

As with the US from the mid-70’s to the early-90’s, the ultimate result of this will be the rest of the world falling further behind the US in relative economic terms. We can afford our mistakes better than our allies can; our lack of intellectual and institutional leadership hurts the weakest countries; those economies that go down excessively non-market or illiberal policy paths will end up harming their own economies more than our laissez-faire excess did.

So a slightly different spin on the matter than Sebastian had in his starting point.


  • Posted by Sebastian Mallaby, Director, Center for Geoeconomic Studies

    I find Adam’s smart post half comforting.

    Yes, if other countries choose to learn an anti-market lesson from this crisis, that will be mostly their own loss and US power will be paradoxically consolidated.

    But I still think there are other dimensions in play–not just the role model/soft power dimension that Adam is emphasizing.

    The world is deleveraging; isn’t that going to hurt the most indebted economy more than it hurts big savers such as China?

    Fancy securitized assets are in disrepute–doesn’t that hurt the financial center that created them (New York)? And doesn’t it raise questions about an economic model (the US one) that depended on foreign purchases of such instruments to finance a big current account deficit?

  • Posted by Adam Posen

    I appreciate Sebastian saying half-comforting rather than half-smart. Of course, I agree with him this is not the only dimension.

    More importantly, I want to be clear that a less stable, less prosperous, more ideologically contentious, world is not in the US long-term self-interest – even if it accompanies a relative improvement in US power/economic standing.

    I am however less concerned about the other two points here:

    1) Deleveraging helps those who previously borrowed by reducing the burden of their debt. It only hurts those who need to roll over credit in the short-term, or those who depend on lending for income. Savings is good for long-run growth, but that is independent of debt level.

    2)I cannot worry too much about the financial center if the profits and employment there were not sustainable, and if the spillovers from production of its products were toxic.

    I’m not sure about the latter part – the explosion in issuance of fancy securitized instruments only came in recent years, after the current account deficit was in relative decline; the major financiers of the US CA deficit, China, Japan, Mideast, et al, bought Treasuries and Agencies. The US has run CA deficits for decades, and not required these instruments to finance them.

    If the sale of these instruments then limits our future ability to sell US government debt, either through what it did to increase our debt level (certain, but of indeterminate magnitude) or perceived creditworthiness (uncertain, with conflicting signals), then I’m worried. But then the best thing is to shed those activities that impair our creditworthiness, real or perceived.