I don’t mean this to apply to any specific country, but the recent reaction of Chinese policymakers to their stock market crash got me thinking.

Imagine two equilibria. In the first, repression is harsh. Policymakers don’t have to do such a good job with the economy, because they keep their jobs no matter what.

In the second equilibrium, people recently have come out of the first equilibrium, and so they do not trust policymakers very much. They judge policymakers by outcomes, and so policymakers feel compelled to perform and to deliver high rates of economic growth.

When the tailwinds are positive, political stability is fairly high and policy is good and growth is robust too, the best of all possible worlds. Policymakers take a long-term perspective because the favorable tailwinds still enable them to meet the expectations of the citizenry, and the long-term perspective keeps them in power for a while to come. Of course you can think of catch-up growth, and the seizing of low-hanging fruit, as one form of positive tailwinds.

But recall that the “citizen trust contract” with policymakers is ultimately a fragile one and based on a series of quite short-term evaluations. When the tailwinds are less positive, the policymakers must take on a much shorter time horizon. They will prop up stock prices now, or try to, even if that is foolish. They are quite afraid to show their impotency as policymakers in some realms, for fear of looking weak more generally. Their favorable performance in the previous periods was in fact based on relatively modest levels of talent advantage, relative to other potential leaders, and so they are reluctant to see the citizens asking so many questions. They want to keep all of the economic reports positive, rather than look like people who would allow 80 million citizens to lose most of their savings.

But avoiding the unpleasant outcome is not possible, and so these bad policies in turn make the tailwinds yet more negative. An unwinding begins, as both policies and outcomes become less positive, and the contract with the citizens is based on actual trust less and less.

The same leadership structure can perform either very well or very poorly, with both the same leaders and the same citizens. And the switch can come fairly quickly, and be occasioned by events which are significant but not transformative on a world-historic or even a country-historic scale.

But fortunately this is a model only, and as well all know, models are false.

Addendum: Here is Christopher Balding on recent developments in China. But he seems to be more worried since he wrote that post. At the moment, trading in 89% of the stocks on the Chinese market is halted. My own tweet was: “One subtext is how much the 2008 crash caused Chinese loss of faith in the USA.”