Cracks in democracy's economic foundation

Project Syndicate (PS): Last July, you wrote that economists and investors were right to be apprehensive about deficit spending, public debt, and the risk of sustained price growth, but “it would be a mistake to respond to these concerns by pumping the brakes on the economy.” US inflation has now reached its highest level in decades, and the US Federal Reserve (Fed) is taking increasingly aggressive action to rein it in. Is the Fed doing enough? How concerned are you that sharp tightening will stifle the economic recovery, especially given the additional inflationary pressures stemming from the war in Ukraine?

Daron Acemoglu (DA): Well, I am concerned. It is hard not to be. What I emphasised last July was that high inflation and deficit spending carry significant risks, but not trying to save US democracy carries even larger ones. We have gotten the worst of both worlds: Inflation rates are very high, and democracy is in even more trouble now than it was then.

Six months before the US midterm elections, it seems incontrovertible that the Republican Party has become the party of Donald Trump, whose explicit support has practically become a prerequisite for GOP candidacy. To many well-educated, left-leaning Americans, this is still incomprehensible, and that, I suspect, is an important part of the problem. To safeguard US democracy from Trumpism, we must first understand why people are drawn to it.

Rather than label Trump supporters misguided or even “deplorable”, an approach that merely deepens the schism in American society, we must recognise that a very large share of the Americans who have not benefitted from economic growth and who have felt cast aside, both economically and socially, support Trump. We must acknowledge their suffering, and work to ease it. Economic growth that brings some degree of shared prosperity is the surest way to help this group, as well as many others, in the United States. This is why delivering job and wage growth, and thus showing that US democracy works, is so important.

In the meantime, however, it is clear that Trump is a hugely flawed, indeed, truly awful, emissary for discontented, economically disadvantaged Americans. He is a corrupt, mendacious, and unstable would-be authoritarian. So, the defining question of US politics becomes: Can anybody wrest these discontented voters from Trump’s grip? Worryingly, the answer may well be no, at least in the near future.

High inflation is also an important problem. The expectation that prices will rise and wages will keep increasing removes firms’ price-raising inhibitions. With that, inflation becomes self-sustaining.

To be sure, there’s nothing magic about the Fed’s longstanding 2 per cent inflation target. If everybody agreed that a 3 per cent target was acceptable or even superior, inflation could run at that level without destabilising the economy. The problem is the sense that we are facing runaway inflation, which fuels discontent and creates instability.

Of course, the war in Ukraine is not helping, and not just because it is placing upward pressure on energy and food prices. The conflict also generates a huge amount of uncertainty. The danger that we could sleepwalk into a much bigger conflict remains very real.

Yes, indeed, these are worrying times.

PS: In March, you argued that the war should spur action to close tax havens, arguing that Russian oligarchs and others elites had no incentive to rein in authoritarian leaders because Western countries’ policies and financial systems provided an attractive haven to stash their ill-gotten gains. Today, Western leaders seem convinced that sanctions against oligarchs can affect Russian President Vladimir Putin’s calculations in Ukraine. Can they, or are oligarchs’ holdings already too integrated into Western economies? What steps would increase the pressure on Russia’s economic elites in the short term?

DA: The system of tax evasion and money laundering we have for the world’s ultra-rich is truly shameful, doubly so, because this is not a sin of omission, but commission. The United Kingdom, for example, has purposely positioned itself as the banker and the butler to the crooked. The international financial system more broadly has been fueled by ill-gotten money from Russia, Ukraine, China and the Middle East. Ending these flows of illicit money is essential to build better institutions, and it is a moral imperative.

I also genuinely believe that Putin would not be where he is today, having turned Russia into a mafia state controlled by former KGB lackeys, had it not been for the largesse that the West has shown to current and past Russian oligarchs. That is why I was heartened that the West took meaningful action against Russia and its oligarchs.

Will the sanctions topple Putin? I’m not sure. He has such a strong grip on Russian institutions, and his security services are so powerful and ruthless, that there is very little room for maneuver. But his regime will get weaker, not least because its ideological basis is being challenged. Russians might be facing Soviet-style repression, but these are not Soviet times. With only a VPN  —  and, to some extent, even without one  —  they can access information from all over the world. Many have personal contacts in Ukraine and even in the West. Opinions will shift over time.

For now, the West should do more to support Ukraine, beginning with ending all energy imports from Russia. There is also space to increase pressure on Russian oligarchs. Even if some of their yachts and mansions have been confiscated, many of their families continue to live lives of luxury in Western countries, funded by assets that were stolen from the Russian people. While it is true that some of those assets are too integrated into the Western financial system to be confiscated, much more can and should be seized. And, of course, the West must announce a credible plan to prevent the future laundering of ill-gotten wealth.

PS: US President Joe Biden’s administration is also cracking down on cryptocurrency firms to prevent them from helping Russia evade sanctions. Last October, you suggested that Bitcoin ultimately has little to offer beyond a “puerile libertarian fantasy” and support for criminal activities. How salient is the risk of sanctions-evasion via alternative currencies, and how would an appropriate regulatory response work? Does Ukraine’s embrace of cryptocurrencies to help fund its war effort point to genuine benefits that should be taken into account?

DA: It is a huge risk. Digital currencies are part of the reason why fighting money-laundering is much harder today than in the past. As for Ukraine, I don’t think cryptocurrencies are really helping; after all, it has the West’s support, so it doesn’t need cryptocurrencies to receive funding. What is helpful is a good digital infrastructure, which is completely separate from crypto tools and may or may not benefit from a blockchain-type de-centralised ledger, as it enables the rapid transfer of funds from individuals, charities, and nongovernmental organisations.

As far as I can see, cryptocurrencies are helping only Russia. So now we can add “helping a truly evil regime” to cryptocurrencies’ rap sheet, right under “boosting carbon emissions” and “facilitating crime”.

By the Way…

PS: The US Labour Department’s March jobs report showed unemployment declining to just 3.6 per cent, nearly a 3 per cent drop from when Biden took office. Clearly, the US has made progress in creating jobs. But to what extent are they the kind of “good jobs” you have called for? More broadly, one would expect today’s employment picture to benefit the party in power, so why are the Democrats projected to take a shellacking in November’s midterm elections?

DA: Headline unemployment is only one of the statistics we should consider. The employment rate among men in their prime working age, for example, is much lower than it was a few decades ago. More importantly, many of the jobs that are being created are not “good jobs”. While wages have risen over the last few years, inflation has risen faster, meaning that real wages have declined for many workers.

True, wages at the bottom of the distribution have increased faster, and the conditions of some of the lowest-paid hospitality workers have improved. But, while this is to be celebrated, my belief continues to be that the US has a good-job problem, which can be tackled only with much more concerted efforts to redirect technology and create labour-market institutions that encourage investments in labour and labour-complementary innovation.

PS: Your 2012 book Why Nations Fail: The Origins of Power, Prosperity, and Poverty, co-authored with James A. Robinson, examines the role of political and economic institutions in countries’ development. When it comes time for Ukraine to rebuild, an outpouring of international support is likely. How can these resources be leveraged to help Ukraine, where governance was rife with weaknesses before the war, establish an institutional framework capable of supporting the country’s reconstruction?

DA: Yes, rebuilding Ukraine will absolutely be a top priority, and success will require not only pouring resources into the country, but also building better institutions. On that front, I think there are reasons to be hopeful.

Even before the Russian invasion, Ukrainian democracy was on a positive trajectory, with Ukrainian youth, especially in major cities, among the most politically active and pro-democratic groups in the West. The war has united Ukrainians and deepened their commitment to freedom and democracy. I expect this to translate into a post-war consensus on the need to build institutions that are capable of delivering justice, controlling corruption, and creating a level playing field for new investments in technologies.

The West can help, but I hope that the West will also learn from its past mistakes, not least in Afghanistan, where its 20-year “nation-building” adventure was a colossal failure. The key lesson is that the West cannot just pour money into a country and dish out advice without understanding the local context. Ukrainian democracy can be built only by Ukrainians, and the West should humbly recognize that.

PS: You have described your 2019 book, The Narrow Corridor: States, Societies, and the Fate of Liberty, also co-authored with Robinson, as a kind of continuation of Why Nations Fail, as it takes a broader view of political and economic development and the dynamics of institutions. What topics are you taking up in your next book?

DA: I am currently working with Simon Johnson on a book on technology and inequality. The main argument is that policymakers and economists have been mesmerised by technology, as if it will by itself create shared prosperity and solve our deep-rooted social problems.

Using a rich array of historical evidence, Simon and I argue that technology brings benefits for most people only when it is not biased against labour, and when it is embedded in an institutional framework that empowers workers and citizens. Shared prosperity is much more contingent than we have come to believe. This is important today, because current digital technologies and, increasingly, artificial intelligence are going in the opposite direction, increasing inequality, impoverishing low-skill workers, and strengthening authoritarian governments and large, centralised (and, in essence, anti-democratic) companies.

Beyond elucidating the problem, Simon and I try to articulate new ideas for how to reverse these trends.

Daron Acemoglu,  professor of Economics at MIT, is co-author (with James A. Robinson) of “Why Nations Fail: The Origins of Power, Prosperity and Poverty” (Profile, 2019) and “The Narrow Corridor: States, Societies, and the Fate of Liberty” (Penguin, 2020). 

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