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The Roaring Nineties by Joseph Stiglitz
The Roaring Nineties by Joseph Stiglitz
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In his new book,
The Roaring Nineties
, Professor of Economics, Columbia University, and former World Bank Chief Economist, explains why greed is not good for companies, individuals, or societies. Moreover, if left unchecked, it leads to deceptions, distortions, and disasters. During a recent presentation at the World Bank, Stiglitz described his primary motivations for writing the book as an attempt understand how the seeds were sown for the economic bubble which burst in 2001 and how thinking at the time contributed to the backlash against globalization. In his presentation, he focused on macroeconomic and microeconomic issues that led to the mismanagement of the US economy. He also commented on how economic policies dictating liberalized capital markets and reductions in public expenditures created greater instability in developing countries and eventually bred resentment and distrust of globalization.
Stiglitz began by questioning the basis for the economic recovery that began in the early 1990s. He noted that there are many people who believe that the growth that occurred for much of the decade was facilitated by reducing the US federal budget deficit which in turn allowed interest rates to decline which then resulted in sharp increases in investment and growth. Stiglitz noted that this very argument goes against the fundamentals taught in macroeconomics: that you should institute counter- cyclical policies of increasing both spending and budget deficits to get out of a recession. He explained that believing in the deficit reduction theory gave validity to bad prescriptions for the Argentine and East Asian crises. In both instances, taxes were increased and expenditures were cut. As a result of following this doctrine, these countries economies got worse instead of better.
Furthermore, Stiglitz noted that there is no evidence that the Federal Reserve can lower interest rates only when the budget deficit is low. To understand what really happened, Stiglitz said one must understand what precipitated the initial economic downturn. He explained that the economic downturn of the early 1990s was partially due to banks shifting from lending to buying long-term government bonds. He noted that much of the move towards bonds was based on bad information. As a result, long-term bonds were considered safe investments although their prices were quite volatile. When banks shifted away from lending, it was more difficult for businesses to expand and this hurt the economy.
Stiglitz stated that a more plausible reason for the improving economy was that as the budget deficit was reduced and long-term interest rates fell, the price of these long-term bonds went up. As a result, the banking system was re-capitalized, alleviating the credit crunch, and allowed banks to start lending again. He then noted that this scenario is unlikely to be repeated in most countries because the problems in the US stemmed from a bad regulatory environment and bad information that would not necessarily exist in other countries. Therefore, the standard medicine for dealing with recession should remain increasing deficits rather than reducing them.
Afterward, Stiglitz commented more on the effects of bad information which led to the growth of the economic bubble and what Federal Reserve Chairman Alan Greenspan termed the "irrational exuberance" of the 1990s. He noted that the Federal Reserve was attempting to use one instrument (raising interest rates) to achieve two objectives: contain inflation and slowly deflate the economic bubble. He stated that microeconomic instruments such as increasing margin requirements (similar to increasing down payments in real estate) could have helped, but were not utilized perhaps because the Federal Reserve does not like to use micro-instruments because of their perceived interference with efficient resource allocation in the economy.
Stiglitz then addressed how policy choices affect the stability of the economic system. Specifically, he noted that policy choices are always important, not just when the economy is in a downturn. Not only should policies be designed to repair economies, but also to contain volatility and allow for the absorption of shocks. He then provided examples of polices that were put into place in the 1990s that created instability.
He cited the capital gains tax reduction as "feeding the frenzy" as people speculated even more because their taxes would go down as well. The shift from defined benefit programs (which insulate households from the volatility of the stock market) to defined contribution programs (which are not insulated) increased the potential for more volatility in household balance sheets. This put a squeeze on personal consumption and negatively affected the economy which is driven by consumption. A third change occurred with a shift to short-term, bottom line economics. Previously, companies had kept excess employees through the bad times because they would once again be needed once the economy began to grow. It was easier to keep them through the cycle and maintain loyalty than go through the process of rehiring them later on. With the emergence of bottom-line economics, businesses began to dismiss workers during downturns in an effort to improve balance sheets and stock prices. Stiglitz noted that while this has contributed to gains in productivity, it has also led to higher unemployment and greater volatility in the labor market.
Stiglitz also addressed a number of microeconomic issues that contributed to economic mismanagement. He cited bad accounting procedures that promoted the use of stock options for Chief Operating Officers (CEOs) which, in turn, diluted the stock prices for other shareholders. Then, CEOs began to look for accounting measures that would boost stock prices even more. Stiglitz described how creative accounting, combined with bad information, boosted stock prices. In these scenarios, conflicts of interest began to arise in the accounting industry and microeconomic distortions grew as there was more of an incentive to provide bad information. This led to over-investment and excess capacity in sectors such as telecommunications, and ultimately, to the recession.
He then commented on the effects of deregulation during the decade and described how in some cases it had gone too far. Stiglitz stated that by the 1990s many regulatory frameworks were outdated and needed revision, but the sweeping deregulation of many industries was poorly designed and did not address weaknesses effectively. He stated that three of the most problematic sectors of the economy in the 1990s, banking, telecommunications, and electricity, were also subject to the most sweeping deregulation.
Stiglitz concluded by commenting on globalization and how polices created since the end of the Cold War have shaped perceptions about the new global economy. He noted that the Uruguay Round of trade talks created an unfair international trade arena as wealthy countries sought to open up the markets of poor countries, but not their own. Additionally, instability was heightened in developing countries because they were being told to liberalize their capital markets which was the opposite of what successful countries had done in developing their economies. As a consequence, the mismanagement of globalization created distrust throughout the world as was evident at recent international trade negotiations in Seattle and Cancun.
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