[A review published in Trade Insight, Vol 6. No.1, 2010]
Joseph Stiglitz, a 2001 Nobel laureate in economics and a professor at Columbia University, had severely criticized the International Monetary Fund and the United States (US) Department of Treasury for their handling of the East Asian crisis in 1997, which cost him his job as Chief Economist at the World Bank. The global ﬁnancial crisis of 2008, which he had predicted, has vindicated him of his incessant rant on and viliﬁcation of the “market fundamentalists” and their ﬂawed models.
In his new book Freefall: America, Free Markets, and the Sinking of the World Economy, Stiglitz explains the causes of the Great Recession that started with the collapse of Lehman Brothers on 15 September 2008, exposes main players in the ﬁnancial industry, berates the state of economics, and outlines what lies ahead for the global economy. Though the book is mostly about the US economy, it also contains interesting discussions about global economic challenges and their potential solutions.
He thinks that the unraveling of the causes of the global ﬁnancial crisis is like "peeling back the onion", i.e., ﬁguring out what lies behind each blunder. The markets failed because of the presence of large externalities, which in turn is caused by misalignment of incentives in the banking sector and information asymmetry in the asset market. Digging deeper would reveal that this was caused by blind faith in a ﬂawed economic ideology about markets. He argues that “economics has moved—more than economists would like to think—from being a scientiﬁc discipline into becoming free market capitalism's biggest cheerleaders". Dancing to the tune of the market cheerleaders, the people responsible to oversee the ﬁnancial industry either failed to see the crisis coming, or did nothing to stop it when warned, or did too little too late when the downward spiral began.
An advocate of a Keynesian ﬁscal stimulus to overcome the adverse impact of the economic crisis, Stiglitz is dissatisﬁed with the structure, size and progress of US President Barack Obama’s stimulus package. An ideal stimulus is fast; effective in increasing employment and output; addresses long-term problems such as low savings, trade deﬁcit, social security and infrastructure; investment-oriented; fair (relief for the middle-class, not the richest 5 percent); deals with short-run exigencies (insurance and mortgage payment); and targets job loss ( to retain skills and workers). Australia was the ﬁrst country to design a stimulus package in line with these principles, and, no wonder, the ﬁrst advanced country to emerge out of recession.
Stiglitz advocates a second round of stimulus in 2011 and a redistribution of income with progressive taxation in the US. He advises the US government not to "give into deﬁcit fetishism" because as long as returns on investment in technology, education, and infrastructure are greater than the size of the deﬁcit, it should not be a problem to roll out another stimulus. He also pitches for a coordinated global stimulus as global multiplier is greater than national multipliers.
The world has to address, argues Stiglitz, six economic challenges: (i) mismatch between global demand and supply; (ii) climate change because environment prices are distorted, leading to unsustainable use of resources; (iii) global imbalances due to excess consumption in advanced countries and excess savings in developing countries; (iv) manufacturing conundrum because there is increase in productivity but decrease in employment; (v) inequality because it is affecting overall aggregate demand as there is more money with the rich and less with the poor; (vi) and growing ﬁnancial instability leading to unmanageable risks.
These challenges call for a new economic model, which should include a bigger role for government. It is the government's responsibility to ensure that errant markets do not lead to catastrophic social and economic situations. It 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 distribution.
Stiglitz censures economists who pushed their model of rationality beyond its appropriate domain and blasts inﬂation-targeting ideology, predicting that it will die after this crisis. Even if this ideology persists, the crisis has revealed the limitation of markets and resurrected Keynesian economics. Indeed, “the fall of Lehman Brothers may be to market fundamentalism what the fall of Berlin Wall was to communism”.