Sunday, February 21, 2010

The Role of Government & Global Economic Challenges

In his new book, Freefall: America, Free Markets, and the Sinking of the World Economy, Stiglitz outlines six economic challenges the world has to address:

  1. mismatch between global demand and supply because productive capacity is underutilized and necessary economic and social needs are unmet;
  2. climate change because environment prices are distorted leading to unsustainable use of resources;
  3. global imbalances because of excess consumption in the developed countries and excess savings in the developing countries;
  4. manufacturing conundrum because increase there is increase in productivity but decrease in employment;
  5. inequality because it is affecting overall aggregate demand as there is more money with rich and less with poor people, whose marginal propensity to consume is higher;
  6. and growing financial instability leading to unmanageable risks.

Addressing these challenges is crucial for global economic stability. And, these challenges calls for a new economic model.

Stiglitz argues that this new model should include a bigger role for government as markets do fail sometimes. It is the government's responsibility to ensure that errant markets do not lead to catastrophic situations. In fact, the government should play a vital role in escorting the market in the right direction so that there is no unhealthy competition and excessive risk-taking that could endanger the whole economy. There are certain things markets cannot do by themselves. The government should play a critical role in maintaining full employment and a stable economy; promoting innovation; providing social protection and insurance; and preventing exploitation by "correcting" market distortion of income.

One of the key roles of the government is to write rules and provide referees. “The rules are the laws that govern the market economy. The referees include the regulators and the judges who help enforce and interpret the laws. The old rules, whether they worked well in the past, are not the right rules for the twenty-first century.”

This post comes from sticky notes I used while reading Stiglitz’s book. Here is previous post (Botswana versus USA) based on the same book.