[Peace-discuss] The recent economic unpleasantness

[C. G. Estabrook]

"Never has so much money been transferred from so many to so few ... Here it was 
the poor and average transferring money to the rich. Already heavily burdened 
taxpayers saw their money - intended to help banks lend so that the economy 
could be revived - go to pay outsized bonuses and dividends ... All that 
happened was that average taxpayers gave money to the very institutions that had 
been gouging them for years..."


	Harsh lessons we may need to learn again
	By Joseph E. Stiglitz (China Daily)

The best that can be said for 2009 is that it could have been worse, that we 
pulled back from the precipice on which we seemed to be perched in late 2008, 
and that 2010 will almost surely be better for most countries around the world. 
The world has also learned some valuable lessons, though at great cost both to 
current and future prosperity - costs that were unnecessarily high given that we 
should already have learned them.

The first lesson is that markets are not self-correcting. Indeed, without 
adequate regulation, they are prone to excess. In 2009, we again saw why Adam 
Smith's invisible hand often appeared invisible: it is not there. The bankers' 
pursuit of self-interest (greed) did not lead to the well-being of society; it 
did not even serve their shareholders and bondholders well. It certainly did not 
serve homeowners who are losing their homes, workers who have lost their jobs, 
retirees who have seen their retirement funds vanish, or taxpayers who paid 
hundreds of billions of dollars to bail out the banks.

Under the threat of a collapse of the entire system, the safety net - intended 
to help unfortunate individuals meet the exigencies of life - was generously 
extended to commercial banks, then to investment banks, insurance firms, auto 
companies, even car-loan companies. Never has so much money been transferred 
from so many to so few.

We are accustomed to thinking of government transferring money from the well off 
to the poor. Here it was the poor and average transferring money to the rich. 
Already heavily burdened taxpayers saw their money - intended to help banks lend 
so that the economy could be revived - go to pay outsized bonuses and dividends. 
Dividends are supposed to be a share of profits; here it was simply a share of 
government largesse.

The justification was that bailing out the banks, however messily, would enable 
a resumption of lending. That has not happened. All that happened was that 
average taxpayers gave money to the very institutions that had been gouging them 
for years - through predatory lending, usurious credit-card interest rates, and 
non-transparent fees.

The bailout exposed deep hypocrisy all around. Those who had preached fiscal 
restraint when it came to small welfare programs for the poor now clamored for 
the world's largest welfare program. Those who had argued for free market's 
virtue of "transparency" ended up creating financial systems so opaque that 
banks could not make sense of their own balance sheets. And then the government, 
too, was induced to engage in decreasingly transparent forms of bailout to cover 
up its largesse to the banks. Those who had argued for "accountability" and 
"responsibility" now sought debt forgiveness for the financial sector.

The second important lesson involves understanding why markets often do not work 
the way they are meant to. There are many reasons for market failures. In this 
case, too-big-to-fail financial institutions had perverse incentives: if they 
gambled and succeeded, they walked off with the profits; if they lost, the 
taxpayer would pay. Moreover, when information is imperfect, markets often do 
not work well - and information imperfections are central in finance. 
Externalities are pervasive: the failure of one bank imposed costs on others, 
and failures in the financial system imposed costs on taxpayers and workers all 
over the world.

The third lesson is that Keynesian policies do work. Countries, like Australia, 
that implemented large, well-designed stimulus programs early emerged from the 
crisis faster. Other countries succumbed to the old orthodoxy pushed by the 
financial wizards who got us into this mess in the first place.

Whenever an economy goes into recession, deficits appear, as tax revenues fall 
faster than expenditures. The old orthodoxy held that one had to cut the deficit 
- raise taxes or cut expenditures - to "restore confidence." But those policies 
almost always reduced aggregate demand, pushed the economy into a deeper slump, 
and further undermined confidence - most recently when the International 
Monetary Fund insisted on them in East Asia in the 1990's.

The fourth lesson is that there is more to monetary policy than just fighting 
inflation. Excessive focus on inflation meant that some central banks ignored 
what was happening to their financial markets. The costs of mild inflation are 
miniscule compared to the costs imposed on economies when central banks allow 
asset bubbles to grow unchecked.

The fifth lesson is that not all innovation leads to a more efficient and 
productive economy - let alone a better society. Private incentives matter, and 
if they are not well aligned with social returns, the result can be excessive 
risk taking, excessively shortsighted behavior, and distorted innovation. For 
example, while the benefits of many of the financial-engineering innovations of 
recent years are hard to prove, let alone quantify, the costs associated with 
them - both economic and social - are apparent and enormous.

Indeed, financial engineering did not create products that would help ordinary 
citizens manage the simple risk of home ownership - with the consequence that 
millions have lost their homes, and millions more are likely to do so. Instead, 
innovation was directed at perfecting the exploitation of those who are less 
educated, and at circumventing the regulations and accounting standards that 
were designed to make markets more efficient and stable. As a result, financial 
markets, which are supposed to manage risk and allocate capital efficiently, 
created risk and misallocated wildly.

We will soon find out whether we have learned the lessons of this crisis any 
better than we should have learned the same lessons from previous crises.

Regrettably, unless the United States and other advanced industrial countries 
make much greater progress on financial-sector reforms in 2010 we may find 
ourselves faced with another opportunity to learn them.

The author is an Economics Nobel laureate and university professor at Columbia 
University. He has many books, including Globalization and Its Discontents and 
The Roaring Nineties, to his credit. His latest book, Freefall, will be 
published in January.

(China Daily 12/31/2009 page9)