Do nations follow sounder economic policies if their citizens understand basic economic principles?
Minneapolis Federal Reserve Bank President Gary Stern raised that question in a brief radio interview a few days ago. The occasion was the release of a new study by the National Council on Economic Education that evaluated economic education standards in 50 states. Stern serves as president of the board of directors of that national organization.
Evidence on this question is spotty, however. Common sense and history tell us that when society has some understanding of cause and effect it is easier to solve problems. For example, yellow fever had scourged people in the tropics for eons, but the discovery that a specific species of mosquito transmitted the disease led to rapid declines in mortality.
Unfortunately, cause and effect in economic policies is not always as clear-cut as in medicine.
Economists had identified excessive growth of the money supply as the cause of inflation decades before the 1970s, but Richard Nixon introduced wage and price controls, Gerald Ford passed out buttons urging Americans to “Whip Inflation Now” and Jimmy Carter talked about reducing inflation through “the moral equivalent of war” — all to little effect.
To his credit, Carter did appoint Paul Volcker to head the Fed, and slower money growth under Volcker choked inflation out of the economy in a few years. However, the whole process would have been much less painful had it started in 1969 rather than 1979. And we would be richer as a nation.
Might the United States have adopted effective anti-inflation policies earlier if the public had been better educated? Perhaps, but other political factors intervene even when relevant knowledge is well diffused.
Nearly a quarter century has passed since Volcker and British Prime Minister Margaret Thatcher demonstrated how to whip inflation. But those lessons have not been absorbed in Brazil where the government headed by Luis Ignacio da Silva is rent by differences on monetary policy.
Brazilian interest rates are high. The basic benchmark interest rate of that country’s Central Bank remains at 26.5 percent and has not been below 15 percent in five years. Such high interest rates are hard on businesses and households. But lowering rates means increasing the money supply. Increasing the money supply can mean inflation.
Inflation is not an abstract worry in a country that experienced such rapid price changes that it had to adopt a new currency five times in the eight years from 1986 to 1994. Each new currency unit meant lopping three zeros off the old one because prices had effectively risen 1,000 percent in as little as 10 months.
Despite this history, citizens, businesses and politicians — including Brazil’s vice president — assail their central bank daily for not lowering interest rates.
In France, it is clear that existing pension systems are financially unsustainable. However, tens of thousands of French citizens are on the streets nearly every day demonstrating against even modest tightening of benefits.
In Germany, thousands of factory workers in the ex-communist east threaten strikes to achieve pay parity with workers in the west. Productivity per worker at auto plants in the east remains 30 percent lower than in the west, but eastern workers argue that equal pay for less output is a matter of “justice.”
One might argue that these examples merely show the need for greater economic education. If they understood the issues more clearly, Brazilian, French and German citizens might not demand the economically suicidal measures they seek.
But even informed citizens may use the political process to get what they can for their own benefit even when the outcome is detrimental for their societies as a whole. The arguments of populist demagogues may fly in the face of history and of well-known economic principles, but if demagoguery wins elections, it will continue in any political system.
Someone once argued that economic literacy is like knowledge of human reproduction. Knowing what acts lead to conception is essential if unwanted teenage pregnancies are to be reduced. But even teenagers who are well educated about sex still will engage in risky sexual behaviors in certain circumstances or when faced with certain social pressures.
In the same way, citizens who are well informed about economics may still throw their political support behind self-destructive policies. Economic education may be a necessary condition for sound policies in a democracy, but unfortunately, it is not a sufficient one.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.