Why do Europe's politicians seem to be behind the curve on the euro?

Why, people ask, can't politicians see the abyss that yawns before them and come together to resolve the euro-zone crisis once and for all? Raghuram Rajan takes a look.

On a recent visit to Europe, I found economists, journalists and business people thoroughly frustrated with their politicians. Why, they ask, can't politicians see the abyss that yawns before them and come together to resolve the euro-zone crisis once and for all?

Even if there is no consensus on what a solution might be, can't they meet and thrash out a plan that goes beyond their repeated half-measures? It is only because of the European Central Bank's bold decision to undertake long-term lending to banks that we have seen some respite recently, or so their argument goes. Politicians, in contrast, are failing Europe by being forever behind the curve. Why do they find it so hard to lead?

One answer that can be easily dismissed is that politicians simply don't understand the gravity of the situation. Political leaders need not be economic geniuses to understand the advice that they hear, and many are both intelligent and well-read.

A second answer - that politicians have short time horizons, owing to electoral cycles - may contain a kernel of truth, but it is inadequate, because the adverse consequences of timidity often become apparent well before politicians are up for re-election.

The best answer that I have heard comes from Axel Weber,a former president of Germany's Bundesbank and an astute political observer. In Mr Weber's view, policymakers simply do not have the public mandate to get ahead of problems, especially novel ones that seem small initially, but, if unresolved, imply potentially large costs.

If the problem has not been experienced before, the public is not convinced of the potential costs of inaction. And, if action prevents the problem, the public never experiences the averted calamity, and voters therefore penalise political leaders for the immediate costs that the action entails. Even if politicians have perfect foresight of the disaster that awaits if nothing is done, they may have little ability to persuade voters, or less insightful party members, that the short-term costs must be paid.

Talk is cheap, and, in the absence of evidence to the contrary, the status quo usually appears comfortable enough. So leaders' ability to take corrective action increases only with time, as some of the costs of inaction are experienced.

Calamity can still be averted if the costs of inaction escalate steadily. The worst problems, however, are those with "inaction costs" that remain invisible for a long time, but increase suddenly and explosively. By the time the leader has the mandate to act, it may be too late.

Non-linear costs of inaction are most obvious in the financial sector. At the same time, financial-sector problems may be particularly difficult to address: if politicians emphasise the need for action too strongly in order to get a mandate, they might precipitate the very turmoil that they seek to contain.

Between the Bear Stearns crisis and the failure of Lehman Brothers, the US government could do little to get ahead of the growing problem (though, of course, the government-backed mortgage underwriters Fannie Mae and Freddie Mac were placed under conservatorship in the interim). It took the post-Lehman panic for Congress to authorise the Troubled Asset Relief Program, which threw a financial lifeline to banks and the motor vehicle industry, among others. And only frenetic action by the Federal Reserve and Treasury (with authorities around the world joining) prevented a systemic meltdown.

A subprime-mortgage problem that was initially estimated to imply losses of a few hundred billion dollars imposed far higher costs on the entire world.

Similarly, euro-zone politicians have obtained a mandate to take bolder action only as the markets have made the costs of inaction more salient. Even setting aside Germany's understandable attempt to limit how much it would have to pay, it is difficult to see how politicians could have gotten ahead of the problem.

Don't blame the leaders for appearing short-sighted and indecisive; the fault may lie with us, the public, for not listening to the worrywarts.

Raghuram Rajan is a professor of finance at the Booth School of Business, University of Chicago, and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.

* Project Syndicate