Reflections on policy errors

On this of all days, when we remember the centenary of the Armistice that ended World War I, it is worth reflecting on policy errors and their consequences. War is perhaps the ultimate policy error. No rational country chooses to go to war. The decision can usually be linked to a chain of circumstances which, if they had been dealt with differently, could have produced an entirely different outcome.

Unsurprisingly big conflicts generate the biggest headlines which explains why the western world still remembers the two global conflicts that scarred the twentieth century, whilst the US was scarred by the experience of the Vietnam War: For anyone who is interested in the scathing criticism of the errors of that campaign from the people who were there, the film by Ken Burns and Lynn Novik is a must-see (currently available on Netflix). There again, whilst history focuses on the consequences of events that went wrong, there are some instances where things went right that otherwise could gone tragically wrong. For example, history suggests that had the Cuban missile crisis of 1962 not turned out the way it did, we might not be here today to tell the tale.

We tend to remember wars in terms of the human cost. Anywhere between 15 and 19 million were killed during WW I and a further 23 million were wounded. Estimates of global fatalities during WW II are even higher, at over 60 million (3% of the world population in 1940). But there are also significant economic costs associated with wars. According to an authoritative study by Stephen Broadberry and Mark Harrison, World War I cost France and Germany more than 50% of their pre-war national wealth. In Germany’s case, this was primarily the result of the huge reparations bill imposed after the war, which is now perceived to have been a major mistake. Indeed, the economist John Maynard Keynes wrote a best-selling book in 1919, The Economic Consequences of the Peace, in which he warned of the adverse consequences of a punitive settlement.

It is interesting to note the contrasting British and German approaches to dealing with the huge debt incurred as a result of WWI. Both had debt-to-GDP ratios in excess of 100% in 1918. But the German government printed vast quantities of currency, and the resultant collapse in the value of the mark led to hyperinflation and a sharp decline in the value of public debt relative to GDP (see chart). The British approach was to deflate the economy, with the Geddes Axe of the early-1920s designed to slash public spending. It became a byword for how not to conduct fiscal policy, since the huge cuts  were made all at once rather than being phased gradually, with the biggest falls in social security spending, defence and education rather than ‘equal misery’ across all policy areas. It succeeded only in exacerbating the already-sluggish economic performance and the high levels of unemployment it was intended to mitigate, and had no impact on the debt burden.

Fortunately, most policy errors have less grave consequences but the economic costs can still be enormous. The bubble economy that developed post-2002 in the western world was largely the result of policy failures, driven by a laissez-faire attitude towards debt/credit creation that eventually produced the biggest economic crisis in 80 years. It is also notable that many European governments have subsequently adopted a 1920s-style UK approach to fiscal management (including the UK) by tightening fiscal policy at a time when the economy least needs it. In an economic sense, it is as though we have learned nothing from past experience.

They do say that those who cannot remember the past are doomed to repeat it. If nothing else, the day of remembrance across Europe serves to remind us of the futility of war and that it should only ever be the last option. On the whole, generations of Europeans have absorbed the lessons of history well. Whether economic policymakers have been quite as diligent is a matter for debate.