Does Government Matter?

As Americans celebrate the 235th anniversary of their independence, the country is embroiled in a typically noisy debate. This time, the argument centers around whether Congress should raise the ceiling on national debt in the interest of preventing a potential government default. The issue has proved to be partisan catnip. The GOP opposes any new taxes to pay down the U.S. debt, which is close to 95 percent of the country’s gross domestic product, on the basis that government has created this problem and that more government cannot be the answer. The U.S. debt burden, House Speaker John Boehner says, “can be traced to a misguided belief by politicians that the American economy is something that can be … influenced positively by government intervention and borrowing.”

Republicans want deep cuts in government spending to be part of any deal to raise the debt ceiling. Democrats counter that such measures would imperil the recovery. And they insist that robust government remains a key element of future growth. “We can’t cut our way to prosperity,” President Barack Obama recently said.

Government as the problem, government as a solution: The impasse over the debt is new, but the debate is old. From the Progressive Era of the late 19th century through the laissez-faire of the 1920s, from the New Deal and the Great Society to Ronald Reagan’s declaration that “government is the problem,” perhaps the only thing the left and the right have agreed on is that government matters. Liberals believe that if government does its job well, prosperity will follow. Conservatives argue that good government is less government, but they are no less obsessed with the role that Washington plays. Our entire political and economic debate takes place in the context of a shared assumption that government determines the nation’s collective economic success or failure, either because of the harm it does or because of the good.

But what if this assumption is wrong? What if government is neither a solution nor a problem? What if, when it comes to dealing with the economic challenges facing the U.S. today, government actually doesn’t matter?

When Herbert Hoover refused to intervene in the wake of the financial crisis in 1929, he was adhering to a 19th century worldview: Government’s role in the life of society was less important than the natural ebbs and flows of the market. The Great Depression and New Deal banished that philosophy to the extreme periphery. In the decades since, the consensus among policy makers pretty much everywhere—from Washington to Brussels, from the former Soviet Union to present-day China—is that government pulls the levers that determine economic health.

That’s no longer true. Today, the ability of any state to govern and control its own domestic economy is severely constrained. One key area is interest rates. In 2005, Alan Greenspan, then chairman of the Federal Reserve, confessed that he was stumped. Under his direction, the Fed had been steadily raising short-term interest rates, with the expectation that long-term rates would rise in response, thereby moderating economic activity, reducing the risk of inflation, and cooling off the steady rise in home prices in the U.S. Yet, long-term rates refused to budge much, staying stubbornly in the range of 4 percent. Greenspan dubbed this anomaly a “conundrum.”

Actually, the conundrum was the product of static models trampled by a changing world. When the U.S. economy was a closed system, as it was for the bulk of the 20th century, the decisions of the central bank shaped the cost of capital and interest rates along the entire curve. Now, however, a global market of buyers and sellers sets interest rates, and short-term rates (which are all the Fed can directly control) are only one factor. This became even more evident after the 2008 financial crisis, when the Fed slashed short-term rates to zero. Again, long-term rates remained in the range of 4 percent. Although they have since declined to around 3 percent, they have done so because that is the level at which capital is priced by a global market of institutions and not because any single government has pegged them there.

The American government’s struggle to reduce unemployment has further exposed its waning influence. Washington is divided between those who say the Obama Administration’s $800 billion stimulus of February 2009 was excessive and those who say the U.S. did not spend enough. Either way, the unemployment rate remains stuck above 9 percent, with underemployment and part-time employment rates significantly worse. Supporters of the stimulus package assert that without it, unemployment would have been even more dire, and they may be right. The fact remains, however, that over the past two and a half years, government efforts to move employment trends have come to naught.

Indeed, the only thing government has been able to do about the jobless problem is to hire people. Without government hiring in the past two decades (which accounted for about a quarter of all new jobs between 1990 and 2008), the unemployment rate in the U.S. would have been considerably higher. But direct government hiring is hardly an indication of government’s ability to affect market employment trends.

So what’s going on? Why is it that even aggressive government action has such little effect on the country’s economic fortunes, in either a positive or negative direction? In recent decades, the demise of capital controls has accelerated the rise of global bond markets and eroded the ability of governments to determine the value of their own currencies. That, in turn, has undermined their capacity to steer their economies. Meanwhile, global employment trends, such as the relocation of low-cost manufacturing to the developing world and the wide dispersal of supply chains, has meant that there’s vanishingly little that policy makers can do to create jobs for their citizens.

These dilemmas aren’t confined to Washington. The European Union is the world’s largest example of states’ voluntarily renouncing sovereignty over their economies. But that has tied the hands of the Greek government in addressing the structural defects that contributed to its current debt crisis. The Greeks can’t control their currency or their domestic cost of capital. They can slash spending, but it’s a blunt instrument that does nothing to make their economy more productive and functional. Even in China, whose growth has been driven by massive state intervention, the eclipse of government is inevitable. With every further move to loosen capital controls and promote private entrepreneurship, Beijing moves down a path that gives global markets more sway.

What, then, can nations and their officials actually do? The ecosystem of global capital, in which trillions of dollars, goods, and services are traded daily, transcends the reach of any one government. That doesn’t mean the U.S. can or should walk away from its obligations to pay off creditors. It does suggest, however, that even if Washington finds some elusive formula on debt and spending that all parties can agree on, the structural challenges standing in the way of economic growth—from unemployment to foreign competition—will remain. Governments are essential in moments of crisis, and they retain the unique capacity to channel collective resources, promote research and development, set social priorities, and create incentives for the private sector. But they are no longer the principal actor in the drama.

For this July 4th, we could do with a new credo: Government is neither the solution to our problems nor the cause of our ills. It is as much a mistake to blame Washington for the current U.S. economic malaise as it is to expect Washington to relieve it. The government is one vital element among many, and society will thrive only when neither too much nor too little is expected of it. This may not be as stirring as revolutions and crusades, but it’s better to accept limitations and work constructively within them than pin our hopes on policies—such as the massive attempts to juice consumption that the U.S. government has repeatedly tried—that are bound to disappoint. Bold plans with no chance of success won’t change employment patterns or make a nation competitive and compelling in a global system that is increasingly complex and dynamic. Today’s leaders need the humility to recognize what they can’t change so that they can meaningfully change what they can.

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