Who's Right, McCain or Gramm?

Both, actually, but we need to be careful not to make things worse with knee-jerk policies.

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John McCain says the economy is in "shambles." McCain economic adviser Phil Gramm says we're merely in a "mental recession." One perspective is political, one economic. Clearly the housing, finance, and auto sectors are indeed in a mess. The rest of the economy, not so much. Unemployment remains relatively low, and the economy is still expanding.

But for me, the interesting question is not whether Gramm is about to join Wes Clark in presidential adviser limbo. Rather it's this: Is there something so fundamentally wrong with the U.S. economy that it requires massive and sweeping change? Voters might well think so. A just-released survey of middle-class voters conducted by Third Way asked which nation had the strongest economy. The responses: China (16 percent), European Union (15 percent), United States (6 percent), and India and Japan (4 percent each). Voters also said they want to see America as the "world economic leader."

To many folks, it doesn't look as if the world's largest economy is the world's economic leader. That negative attitude has led some people to advocate a full retreat from America's generation of free-market reforms. Here is liberal columnist E.J. Dionne today:

This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early '80s undermined New Deal ideas and called forth a rebirth of radical free market notions. What's becoming the Panic of 2008 will mean an end to the latest Capital Rules era.... In the campaign so far, John McCain has been clinging to the old economic orthodoxy while Barack Obama has proposed a modestly more active role for government.

More activist government. Like Europe. But take a look at this piece of analysis from a British economics professor writing over at VoxEu (bold mine):

Paul Krugman once observed that 3% per year is about as good as it gets for GDP growth in advanced economies. While the United States has achieved this since 1995, the EU15 have fallen well short—averaging only 2.3%. The real European problem is in sluggish labour productivity growth—over the same period it averaged 1.4% per year compared with 2.1% in the United States—so that Europe has been falling behind rather than catching up during the last decade, in contrast with the whole of the post-war period until the mid-1990s.... Standard American criticisms of European economies stress that there is too much taxation, too much regulation, and too little competition. All these points were at least equally valid from the mid-1970s to the mid-1990s, when Europe continued to grow faster than the U.S. The point then is not that economic regulation has become more stringent or that competition has weakened in the recent past but rather that existing policies became more damaging as catch-up (mostly) completed and the information and communication technology era arrived.

It is also noticeable that coordinated market economies such as Germany have generally experienced lower productivity growth after 1995 whereas the opposite is the case in liberal market economies such as United Kingdom.... A key difference between "coordinated market economies" and "liberal market economies" is that the scope for creative destruction is greater in the latter. Whereas the former did well in the catch-up of the Golden Age, their institutions and policies are less well suited to the early 21st century.... Against this background, it is disappointing to note that regulations that inhibit competition and the rapid take-up of new technologies are still prevalent in many European economies.

Something to think about before we switch economic models.