Power, intellect and the management of markets
THE MONDAY INTERVIEW; Lawrence Summers; Fresh from organising the 'orderly revival' of the battered dollar, the US deputy treasury secretary is ready for the bigger questions
Monday 16 October 1995
In the spring, after the dollar had lost around a fifth of its value against the yen, Mr Summers convinced the Clinton administration that a stronger currency would be in the national interest. He was the architect of the statement by the seven leading industrial countries in April that they sought an "orderly reversal" of the dollar's fall. It worked.
"People have counted the dollar out many times before and been proven wrong," says Mr Summers. The 40-year-old deputy secretary has become one of the most influential figures in world economic policy-making. He brings to this practical role one of the finest economic minds of his generation.
The combination of power and intellect is almost guaranteed to make him unpopular in some cricles. Mr Summers' rapid upward flight has run into several patches of turbulence, which critics say have been exacerbated by his arrogance.
At least he has good grounds for such confidence. Mr Summers became, at 28, the youngest tenured professor inHarvard University's history. The child of two economists, two of his uncles - Paul Samuelson and Kenneth Arrow - won Nobel prizes in economics.
For Britons, he has become a key figure because of his indirect influence on Labour Party policy. Ed Balls, adviser to the shadow chancellor, Gordon Brown, was a student of Mr Summers and has imported wholesale his approach to economics. It is not too fanciful to see Mr Summers as the unlikely apostle of New Labour's conversion to markets.
Drinking his signature can of Diet Coke in a grand office in the imposing US Treasury Department, he accepts that the power of financial markets causes some uneasiness. "In democracies, too often fear does the work of reason," he says. But he adds: "Capital markets punish but they also reward. It is Luddite to suggest that by slowing flows of capital you would let governments re-exert their influence."
Like most other policymakers at the recent meetings of the International Monetary Fund in Washington, Mr Summers argues that there is more popular support for cuts in government budget deficits than anybody expected. The demands of the financial markets for sound fiscal policy do not run counter to the will of the people.
Besides, flush with the success of the G7 accord to turn around the dollar, he believes markets can be monitored and managed. "Those who were sceptical about whether G7 pronouncements meant anything have learnt to respect them a bit more," he says.
"The benefits of greater flows of capital far outweigh any side-effects, but clearly the system needs to be managed."
The more liquid the capital markets, the less pronounced the side-effects will be. These lessons he applies to Mexico, where Mr Summers' certainty that he is right is reported to have rubbed both US and Mexican politicians up the wrong way. Mexico has just pre-paid some of its emergency US loans, and has also borrowed - in yen - on the international capital markets again.
According to Mr Summers: "With Mexico, we're out of intensive care and in the recovery stage." Although Mexican output has fallen and unemployment risen as a result of the crisis, it would have been worse if the country had not followed the advice to adjust its policies dramatically. As well as cutting the government deficit and raising interest rates, it has begun a programme of deregulation and privatisation.
"This demonstrates the importance of following a market-oriented policy," Mr Summers says. The bolder the adjustment, the better. "It is no less painful to pull a tooth out slowly."
The broad outlines of his economic policy views are orthodox: lower deficits, market liberalisation if necessary, and a credible anti-inflationary interest rate policy. This is the international policy consensus he has helped to reinforce in this year of turbulence in the financial markets.
He has two concerns about the outlook for growth and inflation. One is that complacency will put steady growth and low inflation at risk. The other is that the isolationist spirit will increase, both in the US and elsewhere. Mr Summers wrote a lengthy defence of America's need to stay involved in international financial institutions like the IMF and World Bank in the Wall Street Journal last week. Addressing those who would cut US funding for such institutions, he wrote: "Economic disengagement from the world could lead, as it did earlier in the century, to a spiral of protectionism and isolation that would be financially catastrophic for our own economy." However, the real economic policy challenge, he says, is not what level to set government spending or interest rates but what to do about the half of the population that is losing ground. How do we equip this half to participate in rising productivity and wages? The focus has to be on investment in human capital," he says. This is pure New Labour.
Mr Summers suggests, too, that the causes of business cycle fluctuations are so little understood that this would be a tempting area for research if he were back in the academic world. "The Keynesian paradigm has been shattered. Nothing satisfactory has been put in its place," he says. Economists need to try to understand speculative financial markets and how policy needs to respond.
"Adam Smith's world was one of widgets and corn, not McDonalds and Microsoft. We don't have ways of thinking about the profound changes in economic life caused by information technology and the development of the service industries."
This research agenda highlights an interest in the big questions in economics - the drive that took him into public policy in the first place. In 1993 he was awarded the American Economics Association's biennial John Bates Clark medal for the outstanding economist under 40. An appreciation of his work published to mark the award identified the essence of his approach as the identification of a key question in economics, and empirical testing of competing theoretical explanations. The citation continued: "His work has inspired a new generation of economists, many of them his students and collaborators, who are now reconstructing the empirical foundations of the discipline."
Mr Summers left academia temporarily in 1981-82, to work on the staff of the President's (then Ronald Reagan) Council of Economic Advisers in Washington. In 1989 he became chief economist at the World Bank, leaving after a storm created by the leak of a memo in which he argued that it could make economic sense for industrial countries to ship their waste to developing countries.
He refuses to be drawn now on whether he will return to academic life. "We'll have to see what happens down the road. But I would be a very happy professor of economics." Meanwhile, he believes it useful to bring an academic background to the inner circles of policymaking. "Economic reality is an important constraint on policy-making," he concludes.
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