The 2001 winner of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, Professor Joseph Stiglitz, was in Edinburgh last week to give two talks as part of the Edinburgh International Book Festival. He is a pioneer of the economics of information, showing how markets can produce unexpected outcomes because information is unequally available to parties to a contract. These outcomes can include bankruptcies that transmit further failures. So he was one of the few economists to whom collapse of the financial system did not come as a complete surprise. He noted the irony of his appearance in a large tent sponsored by the Royal Bank of Scotland, an institution that perceptively backed a large tranche of mortgage-backed securities, and ended up mainly owned by the UK government as a result!
Professor Stiglitz is also famous for turning on his previous employers, the World Bank, and criticising the policy of ‘structural adjustment’ imposed by this institution and the IMF on developing world borrowers. These arguments appear in his book Globalisation and its Discontents.
I attended the first of his Edinburgh talks, in which Professor Stiglitz started by pointing out that the three decades of crisis-free rapid growth that followed the Great Depression were primarily a result of the financial regulation introduced following it. As that regulation has been removed crises have become more frequent and more damaging.
He is fairly gloomy about the US economic outlook, pointing to a large and continuing increase in US savings rates as an indicator of poor consumer demand. While the government ‘stimulus’ was essential, he argued that it was ‘too small, too short and not well designed’. He is particularly critical of the US bank bailout, which will only yield a return to the US taxpayer of 67c in the dollar. Most of the money received by the banks has ended up as bonuses and shareholder dividends. He commended the UK’s approach as much superior. The result of the bailouts was in any case to concentrate the banking sector, reducing competition and accessibility of loans.
The austerity approach, he believes, has been shown by the effects of IMF policies to be unambiguously disastrous. As he pointed out, whatever the faults of government, they have never wasted as much cash as the US financial markets! A particular problem that needs to be addressed in recessions is the damage done to people’s long-term employment prospects, the so-called ‘hysteresis‘ effect. Professor Stiglitz argued that
this needs to be addressed by measures such as expanding education and providing apprenticeships.
His recipe for future stability includes correcting the misallocation of physical and human capital to finance, the creation of new credit institutions to provide the missing lending and helping deeply indebted home-owners to pay off their mortgages. There needs to a new balance between markets and government. He is not impressed with the new US financial regulation Bill, which he believes has been severely impaired by financial sector lobbying. Such lobbying influence is an inevitable outcome of a situation where the Supreme Court can rule that corporations have the right to free speech, and where there are five financial sector lobbyists for every US Congressman!
Specific finance issues that need to be addressed involve the competition between the ratings agencies to ‘bless’ asset-backed securities such as the mortgage securities that triggered the financial crisis, and the aggregation of high risk investment banking activity with the retail banking needs of individuals and smaller businesses that results in conflicts of interest and banks that are ‘too big to fail’.
Prof Stiglitz also criticised the focus of economic policies on measurements of economic progress such as GDP that fail to account for costs such as those to the environment. Having spent the last 100 years finding innovations that save labour, Professor Stiglitz claims we could now, with the right incentives and the right regulation, find innovations to save energy.
Noting that Professor Stiglitz characterised many of the issues as conflicts between government and market institutions such as banks and corporations (with the latter generally winning), I would have liked to ask him if he didn’t feel that while these different social institutions had purposes that so often conflicted we were not locked into a perpetual cycle of deregulation, crisis and re-regulation? I would have asked him if we ought therefore to be considering how to better align banks and corporations with human, social and environmental needs through innovations in corporate governance? Sadly, there wasn’t time for my question!