[David Ignatius] Democracy challenged again

WASHINGTON ― Free markets, in theory, are supposed to be self-correcting. When they’re knocked off balance, changes in prices should gradually bring the system back to equilibrium. The same process of regeneration is supposed to operate with democratic political systems, too. 

What we have been experiencing lately ― in dizzying falls in financial markets, and the failure of political institutions to solve problems ― is disorienting. But it’s a reminder that in the real world, systems that are knocked off balance do not automatically return to the center point.

This is a time of what we can call “undampened oscillation.” The system gets a shock, economic or political. In theory, this should generate forces of market adjustment or political consensus that restore equilibrium. Instead, the oscillation seems to get wider. A disruption that initially seems manageable gets bigger and more dangerous as the system oscillates up and down.

We are coming up to the 10th anniversary of one of the biggest shocks ever to the U.S. political system ― the terrorist attacks of Sept. 11, 2001. Here, too, you can argue that the healthy dampers didn’t work. Instead, the initial tremor of the attacks was magnified by the reaction. The terrorist assault, horrible as it was, led to what historians are likely to see as an overreaction ― two foreign wars and national exhaustion.

Think of our political-economic system as a top that has been knocked off balance: Rather than coming back to its center point, it has been wobbling ever more. Staying within our analogy, this is because the top has lost some of its spin. It’s less dynamic and adaptive.

It’s a comfort, of sorts, that economists and political scientists recognized these problems of disequilibrium a century ago. Indeed, the effort to understand market failure and social disorder helped create modern economics and political science.

It was the central insight of John Maynard Keynes that the self-correcting mechanisms of classical economics didn’t always work. Markets got stuck at less than full employment. The market forces that should have restored full use of idle workers and machines didn’t work ― partly because individuals got scared and preferred to hold cash rather than invest in productive assets, no matter how low interest rates fell.

This was why Keynes argued for government intervention to nudge the economy from the low-output trap where it had gotten stuck. It wasn’t that he liked government spending, but that he recognized that markets sometimes overreact ― amplifying the fears and preferences of individuals into collective behavior that makes everyone worse off. We have been seeing a contemporary version over the past several weeks, with frightened investors bouncing the global economy like a pingpong ball.

The lesson for Keynesians in the 1930s was that government intervention could compensate for market failure. A similar faith in government ― not simply in the efficacy of fiscal policy, but in the ability of democratic political systems to solve problems ― propelled the spread of American democratic values around the world after the defeat of fascism in 1945 and, later, after the collapse of communism in 1989. Free markets and democratic political systems weren’t just desirable; they seemed inevitable.

The scariest aspect of the current political-economic crisis is that it tests this faith in democratic governance. The political systems in the United States and Europe have proved unable over the past year to solve crucial financial problems. The political system has been no more self-regulating than the economic.

That was the real message of Standard & Poor’s downgrade of America’s credit rating after the debt-limit debacle. This was, indeed, a self-inflicted wound. It had two essential causes: the intransigence of Republican members of Congress who put their own ideology ahead of pragmatic solutions, and the inconsistent leadership of President Obama. I think Republicans deserve a greater share of the blame because they had an opportunity to avert the train wreck with the $4 trillion “grand bargain” on the budget and refused. But you can’t exempt Obama from blame: He simply has not risen to the challenge.

Europe, too, is a study in political dysfunction. It has been clear for years that you can’t have a single European currency but 16 different fiscal policies in the eurozone; this mismatch subverts the necessary process of economic adjustment for chronic debtors such as Greece. Yet the politicians of Europe haven’t been able to address this core weakness. Their failure is as acute as that of U.S. politicians.

What does that leave as political-economic models? China, Russia, India, Turkey? No wonder the world is depressed. 

By David Ignatius

David Ignatius’ email address is davidignatius@washpost.com ― Ed.

(Washington Post Writers Group)