Creative Reconstruction

Larry Summers argues the financial crisis is an opportunity to address some long-standing structural problems, and to implement "transformational technologies" that "stimulate demand in the short run and have a positive impact on productivity":

The pendulum swings towards regulation, by Lawrence Summers, Commentary, Financial Times: ...Discussions of the policy implications of the crisis have primarily focused on the immediate economic demands. The need to ensure the capital adequacy of financial institutions, maintain important credit flows, support the housing sector and the real economy, contain international spillovers and reform regulation ... have rightly been the priority. ...

However, policies that contain the crisis, support the economy and generate recovery are not sufficient to meet the historic challenge of this moment. ... In important ways,... the crisis creates space to address longer standing problems. Just as patients hear advice regarding diet and exercise differently after a heart attack, so recent events should make it possible for the next US administration to accomplish more than might previously have been thought possible.

These broader goals depend on achieving the rapid and sustained growth that restores business confidence and generates the resources for investment. Economists do not understand what drives productivity growth very well. However, we know these facts: productivity grew rapidly after the second world war and then sometime between the late 1960s and mid-1970s it slowed dramatically only to re-accelerate to record levels in the mid-1990s. Unfortunately, even before the downturn, underlying productivity growth appeared to be slowing.

The most plausible explanation is that an array of transforming investments and technologies – the interstate highway system, widespread air travel and the expansion of electronics – were spurs to growth during the postwar period. Eventually their impact dissipated and, ... growth slowed until the information technology revolution kicked in during the 1990s. Unfortunately, the IT supply shock ... appears to be diminishing.

So there is a need to ensure that the pressure to increase spending is directed at areas where it will have the most transformational impact. We need to identify those investments that stimulate demand in the short run and have a positive impact on productivity. ...

The crisis has also reminded us of the lessons of the technology bubble, Japan’s experience in the 1990s and of the US Great Depression – that finance-led growth is problematic. ... In retrospect, the fact that 40 per cent of American corporate profits in 2006 went to the financial sector, and the closely related outcome – a doubling of the share of income going to the top 1 per cent of the population – should have been signs something was amiss.

Therefore we need to reform tax incentives that encourage financial risk taking, regulate leverage and prevent government policies that give rise to a toxic combination of privatised gains and socialised losses. This offers the prospect of a prosperity that is more firmly grounded and more inclusive. ...

All of these considerations suggest that the pendulum will swing – and should swing – towards an enhanced role for government in saving the market system from its excesses and inadequacies. Policymakers need to be attentive to potential government flaws as well. For example, they need to recognise that, even as events compel larger deficits in the short run, they reinforce the need for longer-term measures to keep government finances on a sound footing. ...

The gravity of our situation is matched only by the opportunity it presents.

I've been making the same point, so I have no disagreement with this. We need a fiscal policy package that contains a short-run component that hits demand and employment with as little delay as possible, and longer-run components that provide a continuing stimulus to output and employment through the downturn and also address fundamental structural problems that we are facing.