The Market Confidence Bugaboo

Of course, markets are unlikely to do any such thing. This is not just because markets comprise a multitude of investors and speculators who are unlikely ever to get together to publish a party program, but more fundamentally because markets have little clue themselves.

A government’s capacity and willingness to service its debt depend on an almost infinite number of present and future contingencies. They depend not just on its tax and spending plans but also on the state of the economy, the external conjuncture, and the political context. All of these are highly uncertain, and require many assumptions to reach some form of judgment about creditworthiness.

Today, markets seem to think that large fiscal deficits are the greatest threat to government solvency. Tomorrow they may think the real problem is low growth, and rue the tight fiscal policies that helped produce it.

Today, they worry about spineless governments unable to take the tough actions needed to deal with the crisis. Perhaps tomorrow they will lose sleep over the mass demonstrations and social conflicts that tough economic policies have spawned.

Few can predict which way market sentiment will move, least of all market participants themselves. Even with hindsight, it is sometimes not clear why markets go one way and not the other. Similar policies will produce different market reactions depending on the prevailing story, or fad of the moment. That is why steering the economy by the dictates of market confidence is a fool’s errand.

The silver lining in all this is that, unlike economists and politicians, markets have no ideology. As long as they make money they do not care if they have to eat their words. They simply want whatever works—whatever will produce a stable, healthy economic environment conducive to debt repayment. When circumstances become dire enough, they will even condone debt restructuring—if the alternative is chaos and the prospect of a greater loss.

This opens up some room for governments to maneuver. It permits self-confident political leaders to take charge of their own future. It allows them to shape the narrative that underpins market confidence, rather than play catch-up.

But to make good use of this maneuvering room, policymakers need to articulate a coherent, consistent, and credible account of what they are doing, based on both good economics and good politics. They have to say: we are doing this not because the markets demand it, but because it is good for us and here is why.

Their storyline needs to convince their electorates as well as the markets. If they succeed, they can pursue their own priorities and maintain market confidence at the same time.

This is where European governments (along with their economist advisors) have kept missing the boat. Rather than face up to the challenge, leaders first procrastinated and then buckled under pressure. They ended by fetishizing the pronouncements of market analysts. In doing so, they have denied themselves economically desirable policies that have greater chance of garnering popular support.

If the present crisis gets worse, it will be political leaders that bear primary responsibility – not because they ignored markets, but because they took them too seriously.

Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.

Copyright: Project Syndicate, 2010.www.project-syndicate.orgFor a podcast of this commentary in English, please use this link:

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