Sometimes things move one step forward, even in the Economics profession.

Significantly, a recent paper by economists Daren Acemoglu and James Robinson reminds us how time is way overdue for economic theories to take into account the pitfalls of economic advice to policy-makers when one ignores its impact on the political dynamics it might engender:

“Economic advice will ignore politics at its peril but also that there are systematic forces that sometimes turn good economics into bad politics, with the latter unfortunately often trumping the economic good. Economic analysis needs to identify, theoretically and empirically, conditions under which politics and economics run into con‡flict, and then evaluate policy proposals taking this confl‡ict and the potential backlashes it creates into account.”

An example they focus on is policies that reduce the power of trade-unions, which might have an economic sense but might strongly back-fire:

“In most situations, unions clearly create economic distortions by pushing the wages of their members up relative to non-unionized employees … As a result, reducing the power of unions to push up wages is often mainstream economic advice.

In the context of our framework, the key point is that any policy choice that reduces the ability of unions to push for high wages—even if it does not involve directly making it harder to organize unions will indirectly reduce union activity. After all, many workers may no longer find joining unions worthwhile when the premium they receive is limited… Moreover, in many settings, despite the power of unions in the status quo, the balance of power is already tilted in favor of large employers so that weakening unions might create a more tilted balance of political power in society, with the potential dynamic costs that this will engender.

The decline in union membership may have had various political economy consequences, for example, as an important contributing factor to the rise in income inequality. More  speculatively, it may have also contributed to the explosion in compensation of chief executive offers and to the rapid deregulation of the financial sector.”

This is why they conclude: ”one should be particularly careful about the political impacts of economic reforms that change the distribution of income or rents in society in a direction bene…fiting already powerful groups“. An argument that has been made often these days by readers of this blog in strongly criticizing my benevolence toward the character of Mrs. Thatcher.

But their paper brings an argument also for the current euro scenario. As they recall, ”one reason that economic policy reform is so seldom implemented … is because politicians know that it is expected to lead to the breakdown of political order“.

Take the euro exit. I agree with many of my colleagues who argue that economically it might make sense for Italy to get out of the common currency agreement to achieve a (temporary) relief in output through larger exports.

But the point we make in this blog is that, once the break-up has occurred, the process of European integration will stop and slide backwards, distressed by the numerous reciprocal (violent) accusations across former euro countries that will occur on who is to blame for the failure of the common currency.

In  the process, what might have seemed a sensible economic strategy will have turned out to be a political nightmare, generating much greater (permanent) economic losses for all European citizens and future generations.