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The Vindication of Joe Stiglitz

Why is there a reasonable risk of another financial crisis within five to ten years?

March 19, 2010

Why is there a reasonable risk of another financial crisis within five to ten years?

Joseph Stiglitz “remains a professor, not a player… And yet, somehow, the issues he cares about most always make it onto the agenda.” The New Republic’s Jonathan Chait wrote these words about the Nobel Prize-winning economist a decade ago.

The financial crisis of 2007-09 put the issues Stiglitz cares about back on the agenda. During the Asian crisis of 1997-99, Stiglitz said the crisis should be seen as a broad failure to tame the powers of financial markets.

And he said the macroeconomic policy remedies being followed were wrong. There should be stimulus, not austerity, and countries should be allowed to use capital controls as one of their tools.

While his words were not heeded then, the recent crisis has seen the Columbia University-based Stiglitz vindicated. Financial markets have come in for criticism, even from many on the right. Many countries provided unprecedented monetary and fiscal stimulus, often at the urging of the IMF — and capital controls are no longer a taboo subject.

Wall Street vs. Main Street

LOUNGANI: What do you think of the financial rescue of banks during the crisis?

STIGLITZ: People in the financial markets were facing a near-death experience — Lehman Brothers was like a financial 9/11 — and they were obviously driven by self-interest. And policymakers who were sympathetic to them had an incentive or were naturally inclined to buy into the fear story that the world would collapse unless the banks were bailed out.

They wanted to give away money, because they bought into that particular view. What’s so remarkable is that people on both the left and the right were agreeing that this was not the right way of doing things. So it’s only a small and narrow group of people who see things through the lens of the big banks.

LOUNGANI: Given your views, doesn’t that make you a little pessimistic or angry?

STIGLITZ: Yeah. It is upsetting. We face a reasonable risk of another financial crisis within five or ten years. If that happens, the likelihood that the banks will get their way again in the second round is much smaller. There will be greater impetus for genuine democratic reforms, because people will realize we failed in the first round.

LOUNGANI: Some people say it might have been better to get a few more things right after this first round …

STIGLITZ: Of course. From society’s point of view, if you had gotten more returns for the money we gave the banks, and, therefore, in the long run lower fiscal deficits, would we be in better shape? Absolutely, yes. I don’t think anybody can question that.

But you had a policy driven by financial markets. And you know, the financial markets didn’t talk about the risk of fiscal deficits until they got all the money that they could get, and then, all of a sudden, they’re back to talking about [the dangers of] fiscal deficits.

LOUNGANI: There’s also criticism that some of the people who caused the problems have been brought in to fix it.

STIGLITZ: Yes, I’ve been very critical on that score. Ironically, some of the people who favor markets haven’t understood incentives. If you have incentives that are short-sighted and encourage excessive risk-taking on the part of bank managers, why should you be surprised that you get bad behavior?

The remarkable thing is that some of the market advocates do not seem to understand that well-functioning markets don’t arise by themselves. You have to have rules. Unlike other U.S. administrations, this one knows what I’ve written [on this topic]. Still, I do think they would gain from having a broader set of views in the decision-making process.

There is a tendency of anybody in a political situation to try to focus on the short-run, saying, “Can’t I just get over the next six weeks?” and not think about the risks that that might pose for the long run.

Across the pond: Is Europe better?

LOUNGANI: We’ve been talking about the United States. Some think that the importance given to financial markets here is part of the elevation of Wall Street over Main Street concerns like jobs, the quality of life, the environment. Do you think it’s different elsewhere? Do you find Europe different?

STIGLITZ: I would say most leaders in Europe, on the left and the right, are very sensitive about issues of quality of life and the environment.

LOUNGANI: When you travel between here and Europe, do you feel that they balance work and leisure better, balance work and other aspects of life better?

STIGLITZ: Well, that’s obviously difficult to say, but what is very true is the following: There’s been a productivity dividend [in both the United States and Europe], improvements in technology. That meant that an increasingly smaller fraction of our time had to be devoted to meeting the necessities of life. And the question is: What did we do with the surplus?

Europe and America have gone different routes. While Europe has decided to consume a larger fraction of the surplus in leisure, we’ve decided to not only take all the surplus in material goods, but actually to work more. If you look at the average amount of work that an American does vis-à-vis a European, Americans are working more. In 1970, there was much less difference between the two.

It’s obviously a judgmental question if one is better than the other. But I think in terms of the sustainability of the world, environment and material goods, the U.S. model obviously can’t work for the world as a whole. So there’s a problem.

The Middle Kingdoms: China and India

LOUNGANI: The United States and Europe are still so much more richer than the Chinas and the Indias. Is it really fair to tell China and India to start already thinking about these issues of sustainability?

STIGLITZ: There are increasingly large groups within these societies that do have to think about this — these are both very large societies with an increasing middle class by almost any standard. Decisions that are being made today will affect many aspects of their lifestyle 50 years from now. You know, time goes very quickly.

When we built our interstate highway system in the 1950s, we didn’t think through the implications that it would have for the design of our cities, urban usage, land usage and the growth of suburbia and exurbia.

China and India have to begin thinking about where their economy is going. Even though the kinds of constraints on the emission of carbon will be different for the developing countries, implicitly or explicitly they will be facing a higher price of carbon. And that will change the way they consume and will change patterns of living.

LOUNGANI: How do you think China is positioned after this financial crisis?

STIGLITZ: What I’ve seen already is sort of renewed confidence in China. Now that doesn’t mean that they might not have some bumps ahead, but I think one is likely to see a China — and an Asia — that is much more influential, both economically but also in political discourse.

The movement from the G8 to the G20 represented, in a sense, a big step. When I was in the White House over 15 years ago, there was [already] a recognition that you could not have global discussions in which you didn’t have China and India.

LOUNGANI: How do you see China’s institutions evolving?

STIGLITZ: We’ve already had a significant opening up economically in China, and in some ways you might say even politically. In terms of broad access to information, access to global knowledge, access to what is going on in the rest of the world, China is not an insular society. It’s not like we thought of Albania and Romania [in the Cold War days].

China is much more open to the world and to what’s going on. The Internet has fundamentally changed the ways in which both economies and polities work. It’s pretty much impossible to run a functioning globally integrated economy without access to the world’s knowledge. It’s hard to predict exactly how that will impact the evolution of political institutions, but that it will have some impact seems to be pretty clear.

LOUNGANI: I know you talk at universities in China …

STIGLITZ: Yeah. I am — quite honestly — constantly amazed at some of the questions that I get asked.

LOUNGANI: Better than Columbia [University]?

STIGLITZ: You know, no different from Columbia. No different. And, you know, by Chinese students, not foreign students. The Chinese students raise very deep, difficult questions about politics and political processes.

The Commanding Heights: Markets & the State

LOUNGANI: Your critics to the left say that you always talk about the market failures, but you are not really working to bring about fundamental change. Your discussion is always, “What can we do to fix markets?” — rather than, “Can we think beyond markets?”

STIGLITZ: I don’t agree with them. It may sound conservative, but I mean markets do have certain powers. They may not work as perfectly as the market fundamentalists assert, but it would be wrong to say that markets have not been a part of every big success, but then so has government.

And then from an analytical point of view, one has to try to understand which assumptions are critical, because if we think the markets don’t work in a particular way, we want to say, “What can we do to make either markets work or something else work?”

LOUNGANI: How do you see the world 20 years from now? Resurgent capitalism? Back to socialism?

STIGLITZ: We will look back at the time from the 1980s to 2008 as one of market fundamentalism, where we lost the balance [between markets and the state], in some countries at least. That was preceded by a period of the socialist-communist experiment, as the other extreme, where again we lost the balance. We are working at getting a new balance. Twenty years from now, we will be in a mixed market economy with the government playing an important role, and there may be also an important role for the third sector, the NGOs.

And we’ll need a different kind of capitalism. Nineteenth century capitalism was driven by the wealthy people who managed their own firms, using their own savings. Twenty-first century capitalism is in some ways more democratic. Lots of people have savings, for example through pension funds. But they don’t manage it for themselves.

It’s managed for them by others and in ways that often doesn’t reflect their interests, and in ways that often exhibit a kind of shortsightedness. So how we make this kind of capitalism work better is going to be one of the big issues.

LOUNGANI: Some of what you say reminds me of what Michael Moore says in his movie, “Capitalism: A Love Story.” But you seem much less frustrated and angry than him.

STIGLITZ: (Laughs.) I think Moore is very effective. But frustration doesn’t do any good. I guess I haven’t lost my Midwestern optimism that things will improve over the long run.


We will look back at the time from the 1980s to 2008 as one of market fundamentalism, where we lost the balance.

I haven't lost my Midwestern optimism that things will improve over the long run.

In the second round, there will be greater impetus for genuine democratic reforms, because people will realize we failed in the first round.

Developing countries will be facing a higher price of carbon. And that will change their patterns of living.

After this financial crisis, we are going to see a China — and an Asia — that is much more influential.