Difference in perspective

As I listened to the debate on the stimulus and the different sides of the story, it struck me as surprisingly reminiscent, in an interesting way, to the debate before the Iraq war. Let me explain.

During the run up to the Iraq war many had felt the war was justified and others had felt it was not. If one looks dispassionately at their debate, it becomes clear that their difference arose not so much because of differences in information or facts, but in differences in their perspective and assumptions about the nature of the underlying problem of terrorism, which consequently affected their subsequent evaluation of all data.

Those for the war genuinely believed that 9/11 was a game changing event. That an evil group of highly organized people had declared war on them, a group they called "terrorists" and consequently it justified a counter "war on terrorism." Moreover, this war was different and the old rules no longer applied. Driven by a fear of imminent attack, the people who subscribe to this view advocated and still advocate no rules, no surrender, and a relentless fight against the enemy. Consequently, the suspension of compliance with rules of engagement and treaties such as the Geneva convention, rules that had been inviolable against foes as formidable as the USSR, seem to be justified. Is the cost of a few civil liberties really worth a collossal loss of life?

On the other side were people who believed that 9/11 represent the act of a bunch of criminals who had taken advantage of some laxities in the system to conduct a spectacular but ultimately futile attack. These people look at 9/11 as the same as the attacks in UK, Spain, India, Indonesia, Egypt, Yemen, etc. To these people, terrorism is a law and order problem, not a military problem. The fight is against a relatively sparse minority of disenchanted and highly dangerous mercenaries, not governments. They saw and still see no threat to the American way of life, no need for rethinking the structures of government or treaties. The solution they advocate is coordinated police action, removing safe havens, and beefing security. Ultimately though, these people see terrorists as being in the same category as drug czars and not USSR.

Note, those in favor of the war believed the rules had changed and it was war, those on the other side believed nothing substantive had changed and that it was a law and order problem. This difference in perspective has defined the debate ever since.

I remember listening to a commentator on TV who talked about the merits of competition of ideas, about how this really is the strength of democracy. The assumption was that there was an objective way of evaluating the data and rationally resolving the dispute. Yet, when one has such different perspectives, it isn't a data problem, it is a measurement or scale problem. The two sides value the benfits and costs in fundamentally different ways. So, it is nearly impossible to reconcile the problem with data alone.

There is a similar dissonance today in the economic debate. One group genuinely believes that this recession is like most others, just a bit deeper. That nothing really has changed. On the other side is a group that believes that there are fundamental structural issues that make this recession unlike any other since the Great Depression. What your view of the problem is colors the view of the solution.

Now, the bad news is that there are historical precedents to back both sides.

Backing the "everything is normal" camp is a bunch of historical data that essentially suggests that whether you do Keynisian intervention or monetary intervention, ultimately the market will find its own order, and that most recesssions are technical corrections that would probably revert to mean no matter what steps you take.

On the "the sky is falling" side, there are dramatic historical precedents of economies like Japan, where things were eerily similar to the conditions in the US today, and whose ravages are still being felt 15+ years after the fact. Add to that the fact that we have unprecedented monetary intervention, with interest rates no longer working and the Fed resorting to quantitative easing. We have massive fiscal deficits as far as the eye can see adding to the already burgeoning national debt. All of which calls into question how much wiggle room the government will have after the current suite of programs.

At the end of the day though, no one can truly claim to "know" with any degree of certainty which view is correct.

However, we can consider the pay-offs of different courses of action.

• If the government intervenes massively, and the "everything is normal" camp is right, then we will, at the the end, land up with an overheated economy and sharply rising taxes and interest rates at the other end which could stunt the pace of growth for over a decade. On the other hand, it would expedite recovery in the short run and potentially improve infrastructure in a way which wouldn't have happened without the intervention.
  
• If the government intervenes massively, and the "the sky is falling" camp is right, then we avoid a acalamity and recover from this recession in a way that makes it look like a just a slightly deeper version of a normal recession.


• If the government doesn't intervene, and the "everything is normal" camp is right, then we just have a slightly deeper recession but we come out of it structurally more sound and we would see slightly higher long term growth due to lower long term taxes and interest rates.


• If the government does nothing, and the "the sky is falling" is right, then the US and the world could experience a long depression, unemployment could rise to 20%+, and we would almost undoubtedly see massive wars and widespread famines. The end result could be a severe dent to the US domination of the world. Even otherwise, deep recessions have often been followed by periods of war, and we may yet see another one.

The GOP, it would appear believes "everything is normal". But here's the thing, the downside of going along with the "sky is falling" bunch isn't quite as bad as the downside of being wrong in your convictions. So, the GOP is taking a calculated gamble, assuming that Obama will win this round so they won't be held accountable for their convictions, but ensuring they have ammunition to attack Obama at the other end.

The more interesting thing is that Obama has opted for a middle road. As Paul Krugman (who is firmly in the "sky is falling" camp) explains, the current stimulus doesn't do much to plug the $2.9 trillion gap in the GDP projected by the CBO. For the roughly $600BN that will actually injected into the economy as part of the current stimulus package to actually be effective in plugging this gap, you need to assume that the velocity of money will be retained at current levels, i.e. it assumes that savings rates won't rise by too much. If you look at depressions, then that seems like a ridiculously optimistic presumption.

So, Obama is hedging his bets. This seems like a lose-lose proposition to me. If the "sky is falling" camp is right, then this won't be enough. If the "everything is normal" camp is right, it'll be too much. Net net, this will neither guarantee a rescue nor guarantee that we avoid the ills of overspending. Now, Obama may believe that the truth lies in the center and that a cautious incremental approach is better. And he may well be right. But he is banking on being able to get more legislation through Congress if and when the need arises. Let's hope he is right!