Stiglitz on free markets and sinking of world economy

FREEFALL: Stiglitz on free markets and sinking of world economy Review by Andrew Jackson Free/all: America, Free Markets and the Sinking of the World Economy, Norton, New York, 2010; hardcover, $35 Canadian.

Joesph Stiglitz is an unusual economist, a consummate insider turned outsider. Awarded the Nobel Prize in economics for his technical work on imperfect information which subverted a key assumption of free market economics, he served as chair of the Council of Economic Advisors to President Clinton, and then as chief economist of the World Bank in the late 1990s. In that role, he became a fierce critic of neoliberal economic orthodoxy and the Washington Consensus, especially as reflected in the austerity-imposing response of the IMF and the World Bank to the East Asian crisis.

Today, Stiglitz is the leading progressive professional economist of his era, and an important economic advisor to the United Nations.

Author of two major critical books on globalization, Stiglitz has now turned his attention to the causes and consequences of the Great Recession, with a major focus on its roots in neoliberal economic orthodoxy, and in the peculiarities of ultra-free market, financedominated U.S. capitalism. His book spares few punches and takes direct aim, not just at Greenspan and Bernanke who led the way into crisis under the Bush dministration, but also at the Clinton Democrats such as Larry Summers and Tim Geithner, who currently dominate the economic thinking of the Obama administration.

This book will keep Stiglitz, like Paul Krugman, very much on the outside of the White House, despite his combination of impeccable professional and progressive credentials.

The central argument of Freefall is that the key causes of the U.S.-made Great Recession lie in deregulated U.S. and global financial markets, the development of complex and toxic new financial instruments, and the collapse of the housing bubble. He provides a detailed analysis of "innovation" in financial markets, the rise of securitization of highly risky debt instruments like sub-prime mortgages, the sharp increase in leverage which inflated risk-taking to new levels, and the development of dangerous derivatives such as credit default swaps.

Perverse incentives, like sky-high bonuses for short-term trading profits, led almost everyone to disregard the fact that all bubbles ultimately burst.

Siglitiz digs deeper into the roots of the crisis, arguing that the apparent prosperity of the United States since 2000 was based on a sequence of asset bubbles fuelled by low interest rates and inflated by rapid credit growth and financial "innovation." He rightly puts the onus for the collapse of the housing bubble, sub-prime securities, and ultimately of much of the U.S. and global banking system on the failure of governments and regulators to see that the whole house of cards would inevitably collapse.

Unlike Simon Johnson, former chief economist of the IMF (who has also now gone renegade in his recent book, 13 Bankers), Stiglitz places only minor emphasis on the political leverage of the U.S. financial oligarchy. Johnson argues that Wall Street relied intimately on compliant U.S. legislators to keep the party going, and that buying influence counted for at least as much as ignorance, let alone bad economic theory.

Going even deeper, Stiglitz notes that the bubble hid serious external balances, and argues that the housing bubble was itself fed by the recycling of U.S. trade deficits back into U.S. securities and financial assets. Had surplus countries like China, Japan, and Germany not been prepared to finance the unsustainable growth of U.S. household debt, the bubble would have burst much sooner. In effect, the recycling of the global financial surplus back to the U.S. temporarily papered over the underlying economic issue: the fact that global productive capacity has been rising at a much more rapid pace than effective global demand.

While Stiglitz goes beyond the financial crisis story to look at the deeper roots of the crisis in the structure of the real global economy, his analysis remains largely limited to the theme of global financial and trade imbalances. Digging even deeper, many left economists would argue that neoliberal globalization and the shift of new investment to developing countries, especially China, has expanded production while repressing the growth of wages and thus of purchasing power in all countries. The weakness of labour and the strength of capital - evident in the rise of the global profit share, rising inequality, and widespread wage stagnation - have left the global economy dangerously reliant on debt-financed consumer spending, with no obvious alternative in sight so long as private investment remains very weak.

Stiglitz does a fine critical job when he looks at the economic policies of the Obama administration. Building on the failure of the Robert Rubin and other Goldman Sachs alumni to see the coming crisis, or to do anything about it, he notes that the new Obama team have not been up to the challenges they inherited from Clinton and Bush. He argues strongly that the mega-billion-dollar bailout of the Wall Street banks was costly and unnecessary. Although the banks should indeed not have been allowed to fail, the government could and should have forced a financial reorganization in which holders of equity and the bondholders would have taken a much bigger hit. Stiglitz rightly denounces "ersatz capitalism" where financial sector gains are privatized, but losses are socialized.

Going forward, he sides with those who would re-regulate the financial sector with stringent new rules and taxes. "American banks have polluted the global economy with toxic assets, and it is a matter of equity and efficiency - and of playing by the rules - that they must be forced, now or later, to pay the price for the cleanup, perhaps in the form of taxes." He outlines an agenda for financial re-regulation to deal with excessive risk: taking on perverse incentives, including regulation to limit leverage and the over-thecounter sale of high-risk products like credit default swaps, as well as new rules (since embraced by Obama) to confine commercial banks to narrow banking and to block them from risky speculative trading on their own behalf.

Stiglitz also argues that the Obama fiscal stimulus package was far too small and poorly targeted, and that the real danger today is not large deficits, but a relapse into double-dip recession or secular stagnation marked by prolonged high unemployment. He makes the key point that a more investment-focused stimulus package, emphasizing medium-term goals such as expansion of basic public infrastructure and new green industries, would have put the economy in a better position to bear the increase in public debt.

A major part of the book is directed to the need for longer-term economic reforms, and the need for the U.S. in particular to replace debt-based consumption with a new source of economic growth. He broaches some familiar themes, such as the need to shift to a greener and more innovative economy, and to broaden social protection. He cites the challenge to create a "New Capitalism," but ultimately disappoints in that his agenda amounts to little more than the familiar tenets of mainstream social democracy.

His prescriptions for coordinated international action to resolve the global crisis are stronger and more radical, including a call for major reforms to the IMF to give developing countries much more weight, and a call for a new global reserve system. Last but not least, Stiglitz outlines some of the key elements of a New Economics to replace discredited neoliberal doctrines.

Freefall is a good account of the roots of the current crisis, and certainly touches on many of the key elements of an alternative. If the book disappoints, it is because it is clearly aimed at pushing liberal Americans towards a more progressive politics without scaring them off. That is a laudable aim, but one suspects that Stiglitz could embrace a much more radical vision. Some of the key elements of that alternative are to be found in a recent report he prepared on measuring social and economic progress, at the request of President Sarkozy of France. Here he sided with those who would be much more critical of growth as the key economic objective, and stressed the need for much more inclusive, equitable, and environmentally sustainable societies.

[Author Affiliation]

(Andrew Jackson is National Director of Social and Economic Policy for the Canadian Labour Congress.)