The Crisis Paradox

Robert Higgs offered the "Crisis Hypothesis," that the supply of and demand for government oversight and control of a market economy increases in times of crisis, in "Crisis and Leviathan."  Rahm Emanuel turned this hypothesis into the political dictum, "Never let a crisis go to waste."  I believe that the dictum is widely accepted.  Higgs offered another hypothesis, that increased government oversight and control during the Great Depression dampened investment resulting in what he terms, "the Great Duration," in "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War" (The Independent Review, Vol. 1, No. 4, Spring 1997).  I synthesize the two hypotheses into the Crisis Paradox: crisis is the best time politically and the worst time economically to enact fundamental economic reform.

Gary S. Becker, Steven J. Davis, and Kevin M. Murphy describe the motivation of "Liberal Democrats" to enact economic reform and its consequences in "Uncertainty and the Slow Recovery" in the Wall Street Journal, January 3, 2010.  Their analysis could be squeezed into the Crisis Paradox.  Their take on the motivation of the reform is that,

...Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health-care and many other areas. So in addition to continuing and extending the Bush-initiated bailout of banks, AIG, General Motors, Chrysler and other companies, Congress and President Obama signaled their intentions to introduce major changes in taxes, government spending and regulations—changes that could radically transform the American economy...

The authors give several examples of major reforms that are one of two causes for the current prolonged recession (the other is the severe financial crisis) including large increases in marginal tax rates for higher incomes, the introduction of cap-and-trade legislation, tougher enforcement of antitrust laws, health care reform, and possibly more politicized monetary policy.  They briefly describe the state of the economy which I quote in part...

Business investment in the third quarter of 2009 is down 20% from the low levels a year earlier. Job openings are at the lowest level since the government began measuring the concept in 2000. The pace of new job creation by expanding businesses is slower than at any time in the past two decades and, though older data are not as reliable, likely slower than at any time in the past half-century. While layoffs and new claims for unemployment benefits have declined in recent months, job prospects for unemployed workers have continued to deteriorate. The exit rate from unemployment is lower now than any time on record, dating back to 1967.

According to the Michigan Survey of Consumers, 37% of households plan to postpone purchases because of uncertainty about jobs and income, a figure that has not budged since the second quarter of 2009, and one that remains higher than any previous year back to 1960.

Becker, Davis, and Murphy summarize their findings.

In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors.

These facts suggest that it was a serious economic mistake to press for a hasty, major transformation of the U.S. economy on the heels of the worst financial crisis in decades. A more effective approach would have been to concentrate first on fighting the recession and laying solid foundations for growth. They should have put plans to re-engineer the economy on the backburner, and kept them there until the economy emerged fully from the recession and returned to robust growth. By failing to adopt a measured approach to economic policy, Congress and the president may be slowing the economic recovery, and thereby prolonging the distress from the recession.

As always, I encourage you to read the complete article.  I have rearranged a couple of paragraphs to fit the "Crisis Paradox," and the squeezing may detract from their writing and analysis.