This paper aims to give an overview of Joseph E. Stiglitz ideas about the origins of the economic crisis that started in 2008 in United Stated (US) and spread around the global economies. It’s not the paper idea (and wouldn’t it be possible in this short paper) to have a more complex and needed discussion over other authors ideas and explaining all sides of the history.
The paper starts by discussing the role of Joseph Stiglitz in the current economic scenario, passing to his background – or in other words, his ‘looking glasses’ – to finally reach a brief overview of his ideas about the crisis.
Why Joseph Stiglitz?
Right after the boom of the USA financial crisis in 2008 many economists declared that they already had seen it coming and in little time the complexity of a financial crisis that is even today felt was explained in little words – and even in cartoons for children. Nowadays is pretty much common sense that the cause of the crisis was a bubble of speculation in the real estate markets caused that spread along the US economies and quickly affected the globalized economy. But before the crisis gave its first signs few economists were loudly pointing out the global imbalances in the system summed with the fragility of the financial system as a risk to the global economy, and even less received some attention from the governments and media and Joseph Stiglitz was one of this very select group.
Joseph Stiglitz occupied the ‘Chair of the Council of Economic Advisors’ in Clinton Government and was ‘World Bank Chief Economist (1997 – 2000)’ and achieving these great positions in times and places where the neoliberal economical thinking was predominant made the world to believe that he was a neoliberal. This picture changed when he was forced to resign his position at the World Bank and won in the following year the Nobel Prize for Economics jointly with A. Michael Spence and George A. Akerlof for their analyses of markets with asymmetric information. Since that Stiglitz it’s known as a hard critic of the current financial architecture:
Most economists are quite familiar with Stiglitz’s repeated attacks on the narrow ideological policy prescriptions of the IMF and the latter’s “cookie-cutter” policies applying “standard” or neoclassical solutions in a world that is everything but neoclassical. (Gnos & Rochon, 2004, p.615)
For his past positions and current critics on the system his economic analyses have been reaching great repercussions among governments and international organizations. In February 2008 the President Nicholas Sarkozy asked Joseph Stiglitz, Amartya Sen, and Jean Paul Fitoussi to address his dissatisfactions with the statistical information about the economy and the society. To fulfil this assignment they created the subsequently called “The Commission on the Measurement of Economic Performance and Social Progress” (CMEPSP):
The Commission’s aim has been to identify the limits of GDP as an indicator of economic performance and social progress, including the problems with its measurement; to consider what additional information might be required for the production of more relevant indicators of social progress; to assess the feasibility of alternative measurement tools, and to discuss how to present the statistical information in an appropriate way. (Stiglitz et al, 2009, p.7)
Another important work done was for the United Nations from October 2008 and September 2009 when he had the honour to be the Chief of the ‘Commission of Experts of the President of the UN General Assembly on Reforms on the International Monetary and Financial System’. The mandate of this commission included:
The Commission will seek to identify the broad principles underlying needed institutional reforms required to ensure sustained global economic progress and stability which will be of benefit to all countries, developed and less developed. It will suggest a range of credible and feasible proposals for reforming the international monetary and financial system, in the broad interest of the international community, and identify and evaluate the merits and limitations of alternatives that are at the center of current global debate. (UN, 2008, p. 3)
The Commission reached a final report on September 2009, the document called ‘Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System’ contains several indicators of how the economic crisis was created, spread and also have several suggestions on how to reform the international monetary and financial system in order to prevent new crisis.
In 2010 his book ‘Freefall: America, Free Markets and the Sinking of the World Economy’ was published and this will be the centre document of analysis of the author’s perspective on the economic crisis. This article will also take into account some of the author’s ideas explained in his latest book ‘The Price of Inequality: How Today’s Divided Society Endangers Our Future’ published in 2012.
Joseph Stiglitz declares himself as a Keynesian economist right in the Preface of his 2010 book by saying:
I believe that markets lie in the heart of every successful economy but the markets do not work well on their own. In this sense, I’m in the tradition of the celebrated British economist John Maynard Keynes whose influence towers over the study of modern economics. Government needs to play a role, and not just in rescuing the economy when markets fail and in regulating markets to prevent the kinds of failures we have just experienced. Economies need a balance between the role of markets and the role of government—with important contributions by nonmarket and nongovernmental institutions. (Stiglitz, 2010, p. 16)
But here it’s needed to understand that the economic theory developed by Keynes was meant for another era, when the economic system was very much different from nowadays. Keynesian economists use Keynes works as references but not as only source, adapting it to each new content and many times reaching disagreements between them. So to say that Stiglitz is Keynesian is not a limitation of his background.
An interesting explanation of Stiglitz relation to Keynesian theories is found at Gnos & Rochon, (2004). “Indeed, Stiglitz’s worldview is very much Keynesian—perhaps of the bastard-type—where a lack of aggregate demand policies resulting from insufficient fiscal expansionary stimulus is to blame for unemployment and growth.” (p.615)
Joseph Stiglitz is in many occasions calling attention to the social impacts of the current financial structure. He chairs the ‘University of Manchester’s Brooks World Poverty Institute’, the ‘Socialist International Commission on Global Financial Issues’ and is a member of the ‘Pontifical Academy of Social Sciences’. Also, in his latest book, ‘The Price of Inequality’ and in the so-called Stiglitz Report written by CMEPSP he discusses the concept of wellbeing. With this approach the economic concern goes beyond economic growth as a good in itself and pursues a more human-centred view, playing an important paper as bringing the wellbeing concept back to the mainstream of public policy debates. Because of this critical approach, combining economics and social sciences Stiglitz reminds us of the first economists in history that also had these multilateral ‘looking glasses of the world.
About the financial crisis
Stiglitz main arguments are based on the idea that the global economy is suffering with global imbalances due to the globalization and deregulation. His main point is not a critique of the globalized markets itself, but the lack of regulation in case of market failure, which he points to be the current case.
Therefore his arguments are against the free and deregulated markets which are based on the ideas that ‘free and unfettered markets are efficient; if they make mistakes, they quickly correct them; the best government is a small government; and regulation only impedes innovation; central banks should be independent and only focus on keeping inflation low.’ (Stiglitz, 2010, p.16)
The idea that the markets could correct themselves was led by the fact that on every economic crisis held in the last 25 years the state has intervened, rescuing it, but many authors have not observed the role of the state in these cases. “From the system’s survival, we drew the wrong lesson—that it was working on its own” (Stiglitz, 2010, p.16). By analyzing the scenario without taking into account the role of governments the economic theories were incorrectly analyzing the reality and by consequence recommending incorrect policies.
The economic crisis that began in 2008 in US was generated by this fatal combination of global markets and global imbalances. But this was not actually the only crisis generated by these factors and the developing countries were clearly suffering. According to the author, between 1970 and 2007 there were 124 economic crises in developing countries (Stiglitz, 2010). All these crises were similar in a point: there was a bubble and as it broke it bring devastation in the economy. The bubble is in each crises developed in a different area, in the weakest point of the system but it can achieve the whole market economy.
In the US case it was pretty much the same history, the bubble started to develop in the real estate’s markets due to constant innovation in the mortgages products leading to fraudulent lending. This time the surface of the crises was much more complex, counting with new financial products, subprime mortgages, and collateralized debt instruments but beneath all that it was just another bubble (Stiglitz, 2010).
The only surprise about the economic crisis of 2008 was that it came as a surprise for so many. For a few observers, it was a textbook case that was not only predictable but also predicted. A deregulated market awash in liquidity and low interest rates, a global real state bubble, and skyrocketing subprime lending were a toxic combination. Add in the U.S. fiscal and trade deficit and the corresponding accumulation in China of huge reserves of dollars – an unbalanced economy – and it was clear that things were horribly awry. (Stiglitz, 2010, p. 26)
The bubble inflated the value of collateral assets, used by banks to lend more money that they were supposed to. All this bad lending was hidden from the balance sheets by new financial instruments, such as credit default swaps. These new instruments that were supposed to help banks to manage the lending risks made the bubble greater and more complex, deceiving regulators and amplifying the collateral damage when it burst. (Stiglitz, 2010, p.26)
The problem began when banks deviated from their core functions in the system, which are to facilitate the transactions to hold an efficient payment mechanism; assessing and managing risk and making loans; and lending to small-and medium-sized businesses (basis of jobs creation). Instead of this they ‘concentrated on promoting securitization, especially in the mortgage market’ (Stiglitz, 2010, p.27).
To clarify the mechanism of crisis spreading, please observe the Figure 1, created using Stiglitz ideas and words.The result of these practices and the lack of proper regulation was that ‘the economy was out of kilter: two-thirds to three-quarters of the economy (of GDP) was housing related’ (Stiglitz, 2010, p.26). And as soon as the bubble burst the first affected was the subprime mortgages lent to low-income individuals, but it soon spread all over the US economy, that playing a center role in the global markets affected all these.
The result of this crisis is still felt in the global markets – especially in the Euro Zone area that received the US crisis as a trigger to their own crisis, and also still in the US economy that had never recovered to the pre-crisis point, despite the many recovering plans.
As already mentioned Stiglitz is playing an important role by supporting governments and international organizations such as UN to understand the crisis and recommending reforms to avoid new ones. And his work on the reforms deserves a long study that unfortunately cannot be done in this paper.
As final though it’s also important to point out one class of the long list of blamers for the economic crisis which is, according to Stiglitz in a brave declaration, himself together with all those in the economics profession:
for it provided the special interests with arguments about efficient and self-regulating markets – even though advances in economics during the preceding two decades had shown the limited conditions under which that theory held true (Stiglitz, 2010, p.18).
It is impossible to conclude an overview on a scenario that is still on the move, so the best that can be done at this point of this paper is to remember that the idea that the 2008 crisis began with only another economic bubble. And about economic bubbles much has been studied since the tulips bubble in Netherlands. Although the system is every day more complex one should be able to look beyond the surface and to observe the usual signs of trouble.
The real estate market in US is now better regulated, but the global imbalances and the lack of regulation in other sectors of the global markets continues to be an alarming factor. The scenario described by Stiglitz as the beginning of the crisis was:
It may be difficult to have a strong global economy so long as part of the world continues to produce far more than it consumes, and another part—a part which should be saving to meet the needs of its aging population — continues to consume far more than it produces. (Stiglitz, 2010, p.19)
And this scenario has not yet changed – the global imbalances were not treated by the many rescuing plans, demanding an urgent reform in the global financial architecture and giving incentives to markets in crisis and in development in the measure and way they need – studying each of this incentives case by case.
Gnos, C., & Rochon, L. (2004). Reforming the international financial and monetary system: from Keynes to Davidson and Stiglitz. Journal Of Post Keynesian Economics, 26(4), 613-629.
Keynes, John Maynard. (1933). “National Self-Sufficiency.” Yale Review 22, 4: 755-769.
Keynes John Maynard. (1941) “Post-War Currency Policy.” September 8, 1941. Reproduced in The Collected Writings of John Maynard Keynes: Volume XXV: Activities 1940-44, Shaping the Post-War World: The Clearing Union, edited by Donald Moggridge. London: Macmillan.
United Nations. (2008). The President of the General Assembly. Letter to all Permanent Missions and Permanent Observer Missions to the United Nations transmitting a set of documents relating to the establishment of a Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System. Doha, 28 November 2008. Retrieved from: http://www.un.org/ga/president/63/letters/doha281108.pdf
Stiglitz J, Sen A, Fitoussi J-P. (2009) Report of the commission on the measurement of economic performance and social progress. Available at: http://www.stiglitz-sen-fitoussi.fr/documents/rapport_anglais.pdf
Stiglitz, Joseph (2010). Freefall: America, Free Markets and the Sinking of the World Economy. New York, W. W. Norton & Company.
Stiglitz, Joseph (2012). The Price of Inequality: How Today’s Divided Society Endangers Our Future. New York. W.W. Norton & Company
White, S. C., Gaines, S. r., & Jha, S. (2012). Beyond Subjective Well-Being: A Critical Review of the Stiglitz Report Approach to Subjective Perspectives on Quality of Life. Journal of International Development, 24(6), 763-776.
Liza Valença Ramos, Master in Public Policy, Lawyer and Internationalist (firstname.lastname@example.org)