The response by both the Bush and Obama administrations to the economic crisis “has been flawed,” says Nobel laureate and Columbia University Professor Joseph Stiglitz.
“I don’t think the Bush administration understood the depth of the crisis, nor the complexity of what was going on — that there was both a financial crisis and an economic crisis,” he said in a recent talk at Mississippi State University.
“They also didn’t understand some of the fundamental economic problems and some of the basic failings of the situation: for example, that there was a misalignment between the incentives of the banks and the interests of the economy.”
What should have come first, but didn’t, was the economic stimulus,” says Stiglitz, a former chairman of the Council of Economic Advisors. “The real economy was weak, and standard Keynesian economics says that in that kind of situation you need to stimulate the economy.
“What we got was too small and not well-designed. About a third of it went to tax cuts, and it was predicted — and predictable — that tax cuts would not be very effective. The reason is that they knew that people were going to save much of that money; they weren’t going to spend it. The goal of a stimulus is to spend money, not save it.
“My criticism of President Obama is that to a too large extent he has continued that policy. In that particular area, I think there has been bipartisan failure. The Bush administration didn’t do anything about the mortgages, and while I’m critical of the Obama administration for not doing enough, at least they’ve done something, and I have to give them kudos for that.”
About 50 percent of the stimulus money went into savings, Stiglitz says, and “it didn’t give the boost to the economy that was needed,” he says. “While $800 billion sounds like a big number, in reality it was too small.
“What you have to remember is that it’s over a period of two years, and at the same time revenue in the states has been falling precipitously. There’s a shortfall at the state level across the country of about $200 billion per year, or $400 billion for the two years of the stimulus — so the negative for the states is about half the size of the positive of the $800 billion stimulus. The net from the stimulus from the government sector was only about $400 billion, which was just not enough to get the economy going again.”
The second part of the problem, Stiglitz says, was that “giving money to the banks without doing something about mortgages was like giving blood transfusions to a patient with massive internal hemorrhages — it does nothing to stanch the bleeding.
“We didn’t do anything about it until March of this year, and when we did it wasn’t designed well enough to do anything about the problem of millions and millions of Americans whose mortgages exceeded the value of their houses. The result: very little success in restructuring mortgages and millions of Americans losing their homes. We’ve got a lot of empty houses and a lot of homeless people, and that’s not the way the economic system is supposed to work.
“We’ve poured massive amounts of money into the banks. The first proposal was something I called ‘Cash for trash’ — we’d give banks cash and they’d give the government all their toxic mortgages. But that proved too complex to deal with, so they just ended up giving large amounts of money to the banks, without any controls on what they did with the money.
“What anyone with sense would understand was that they would have incentive to use the money not for lending, but to take the money out of the bank as fast as they could before it went bankrupt. So, they took it and paid out a large part of it in bonuses and dividends.”
What the government failed to do, Stiglitz says, was to “ask the fundamental question: What kind of a banking system, what kind of a financial system do we want?
“The answer is that we want is a financial system focused on lending — lending to new businesses, to old businesses, providing venture capital. But what we did was channel most of the money into big banks that were involved in speculation and other dubious activities. We’ve allowed the banks to become even more concentrated and less competitive than they were before. The problems of too-big-to-fail banks are now even worse. And we so far haven’t passed any legislation to address those problems.”
There has been continued consolidation and reduced competition, Stiglitz says, and the spread between lending rates and borrowing rates has increased.
“The banks will be recapitalized, but very slowly, and that means also that the recovery is going to be very slow.”
Now, he says, “We have this anomaly of a country and a world with huge needs and problems — hunger, poverty (40 percent of the world still lives on less than $2 a day), global warming, a crumbling infrastructure. We have all these needs, but at the same time we have excess capacity, and that’s not the way a robust free market economy should be functioning.”
To “build a better economy from the ashes of past failures,” Stiglitz says, “The first thing we need to do is to have a clear view of where we want to go. One of the failures is that they didn’t ask, what kind of financial system do we want?
“A good financial system makes an economy more productive by allocating capital, managing risk, and doing it all with low transaction costs. Our financial system mismanaged risk, mismanaged capital, and did it all with high transaction costs — more than 40 percent of corporate profits were in the financial sector in the years leading to the financial crisis. That in itself says the structure of our economy was wrong.”
One of the problems, he says, is “the way we look at the economy through GDP (Gross Domestic Product), which is actually a bad measure both of economic activity and societal well-being.
“We manage many sectors by input, not output. Judging the health care sector on the basis of input, we get a picture of a healthy population. The more we spend on health care, the more the GDP goes up. The result is that we’re spending 16 percent to 17 percent of GDP on health care and getting very poor results from it.
“GDP per capita in the U.S. in 2008 was about 10 percent below where it was in 2000, adjusted for inflation. Most Americans are now worse off than they were at the turn of this century. … Median household income in 2008, adjusted for inflation, was 4 percent less than in 2000. The vast majority of Americans were worse off in 2008 than they were in 2000, and 2009 figures are going to be even worse.”
A third issue arising from the crisis is sustainability, Stiglitz says.
“GDP doesn’t reflect whether the economy is sustainable, and what we were doing prior to 2007 was not sustainable. A larger issue is environmental sustainability for the world as a whole. If everyone on the planet lives the way Americans have been living, the planet cannot survive. There is going to have to be some adjustment, but our crisis doesn’t reflect this.”
Globalization, technology, climate change, and other problems present challenges going forward, he says.
“We’re going to have to take advantage of our strengths in dealing with these problems, and it will require a very large restructuring of our economy. Pivotal in this restructuring process, I believe, will be our education system.
“Other countries have actually been able to maintain a manufacturing economy, doing highly skilled manufacturing. Germany, for example, continues to be very successful in sophisticated manufacturing and capital goods. They have a very strong education system that focuses on the skills necessary to compete globally in high-skilled manufacturing.”
One of the problems with the auto industry bailout, Stiglitz says, was that “it was very much looking to the past and not to the future.
“The question that should’ve been raised was whether these companies, with a quarter century of failure, were likely to be turned around when economic forces were going against them, or would it be better to use the capacity they have to try and go in some other direction, to create other products rather than continuing to imitate things where competitors have clearly shown themselves to have a comparative advantage.”
The financial sector also has to be restructured, Stiglitz says. “That’s what we should be doing right now — restructuring our financial system so we can provide the financing that’s needed for creating new jobs in new industries, rather than focusing on financial speculation.
“We are facing some difficult times, I think. I’ve been told that the Chinese character for ‘crisis’ can represent both danger and opportunity. Every crisis has many dangers, including the danger of not rising to the opportunities that are provided.
“I think if we seize the opportunities, we can restore the kind of prosperity we Americans have come to take for granted and that we will be able to afford a sound economy and a sound society going forward.”