Joseph E. Stiglitz – Economy Watch

Is Africa Sowing Seeds Of Its Own Subprime Crisis?: Joseph Stiglitz & Hamid Rashid

Joseph E. Stiglitz — Wed, 26 Jun 2013 07:35:33 +0000

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There are no easy, risk-free paths to development and prosperity but borrowing money from international financial markets is a strategy with huge downside risks. It is no secret that sovereign bonds carry significantly higher borrowing costs than concessional debt does, so why are an increasing number of developing countries, particularly Sub-Saharan economies, resorting to sovereign-bond issues? And why have lenders suddenly found these countries desirable?

NEW YORK – In recent years, a growing number of African governments have issued Eurobonds, diversifying away from traditional sources of finance such as concessional debt and foreign direct investment. Taking the lead in October 2007, when it issued a $750 million Eurobond with an 8.5% coupon rate, Ghana earned the distinction of being the first Sub-Saharan country – other than South Africa – to issue bonds in 30 years.

This debut Sub-Saharan issue, which was four times oversubscribed, sparked a sovereign borrowing spree in the region. Nine other countries – Gabon, the Democratic Republic of the Congo, Côte d’Ivoire, Senegal, Angola, Nigeria, Namibia, Zambia, and Tanzania – followed suit. By February 2013, these ten African economies had collectively raised $8.1 billion from their maiden sovereign-bond issues, with an average maturity of 11.2 years and an average coupon rate of 6.2%. These countries’ existing foreign debt, by contrast, carried an average interest rate of 1.6% with an average maturity of 28.7 years.

It is no secret that sovereign bonds carry significantly higher borrowing costs than concessional debt does. So why are an increasing number of developing countries resorting to sovereign-bond issues? And why have lenders suddenly found these countries desirable?

With quantitative easing having driven interest rates to record lows, one explanation is that this is just another, more obscure manifestation of investors’ search for yield. Moreover, recent analyses, carried out in conjunction with the establishment of the new BRICS bank, have demonstrated the woeful inadequacy of official assistance and concessional lending for meeting Africa’s infrastructure needs, let alone for achieving the levels of sustained growth needed to reduce poverty significantly.

Moreover, the conditionality and close monitoring typically associated with the multilateral institutions make them less attractive sources of financing. What politician wouldn’t prefer money that gives him more freedom to do what he likes? It will be years before any problems become manifest – and, then, some future politician will have to resolve them.

To the extent that this new lending is based on Africa’s strengthening economic fundamentals, the recent spate of sovereign-bond issues is a welcome sign. But here, as elsewhere, the record of private-sector credit assessments should leave one wary. So, are shortsighted financial markets, working with shortsighted governments, laying the groundwork for the world’s next debt crisis?

The risks will undoubtedly grow if sub-national authorities and private-sector entities gain similar access to the international capital markets, which could result in excessive borrowing. Nigerian commercial banks have already issued international bonds; in Zambia, the power utility, railway operator, and road builder are planning to issue as much as $4.5 billion in international bonds.

[quote] Evidence of either irrational exuberance or market expectations of a bailout is already mounting. How else can one explain Zambia’s ability to lock in a rate that was lower than the yield on a Spanish bond issue, even though Spain’s credit rating is four grades higher? Indeed, except for Namibia, all of these Sub-Saharan sovereign-bond issuers have “speculative” credit ratings, putting their issues in the “junk bond” category and signaling significant default risk. [/quote]

Signs of default stress are already showing. In March 2009 – less than two years after the issue – Congolese bonds were trading for 20 cents on the dollar, pushing the yield to a record high. In January 2011, Côte d’Ivoire became the first country to default on its sovereign debt since Jamaica in January 2010.

In June 2012, Gabon delayed the coupon payment on its $1 billion bond, pending the outcome of a legal dispute, and was on the verge of a default. Should oil and copper prices collapse, Angola, Gabon, Congo, and Zambia may encounter difficulties in servicing their sovereign bonds.

[quote] To ensure that their sovereign-bond issues do not turn into a financial disaster, these countries should put in place a sound, forward-looking, and comprehensive debt-management structure. They need not only to invest the proceeds in the right type of high-return projects, but also to ensure that they do not have to borrow further to service their debt. [/quote]

These countries can perhaps learn from the bitter experience of Detroit, which issued $1.4 billion worth of municipal bonds in 2005 to ward off an impending financial crisis. Since then, the city has continued to borrow, mostly to service its outstanding bonds. In the process, four Wall Street banks that enabled Detroit to issue a total of $3.7 billion in bonds since 2005 have reaped $474 million in underwriting fees, insurance premiums, and swaps.

Understanding the risks of excessive private-sector borrowing, the inadequacy of private lenders’ credit assessments, and the conflicts of interest that are endemic in banks, Sub-Saharan countries should impose constraints on such borrowing, especially when there are significant exchange-rate and maturity mismatches.

Countries contemplating joining the bandwagon of sovereign-bond issuers would do well to learn the lessons of the all-too-frequent debt crises of the past three decades. Matters may become even worse in the future, because so-called “vulture” funds have learned how to take full advantage of countries in distress. Recent court rulings in the United States have given the vultures the upper hand, and may make debt restructuring even more difficult, while enthusiasm for bailouts is clearly waning. The international community may rightly believe that both borrowers and lenders have been forewarned.

There are no easy, risk-free paths to development and prosperity. But borrowing money from international financial markets is a strategy with enormous downside risks, and only limited upside potential – except for the banks, which take their fees up front. Sub-Saharan Africa’s economies, one hopes, will not have to repeat the costly lessons that other developing countries have learned over the past three decades.

By Joseph E. Stiglitz and Hamid Rashid

Copyright: Project-Syndicate, 2013

Joseph E. Stiglitz is a Nobel laureate in economics and University Professor at Columbia University. Hamid Rashid is a senior economic adviser at the United Nations Department of Economic and Social Affairs. The views expressed here do not reflect the views of the United Nations or its member states.

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What Africa Can Learn from East Asia’s Developmental Success: Joseph E. Stiglitz

Joseph E. Stiglitz — Tue, 04 Jun 2013 08:52:33 +0000

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The world has changed markedly since East Asia began its remarkable developmental transition more than a half-century ago: Their development policies worked while all too often, those that followed the neo-liberal “Washington Consensus” policy prescriptions failed miserably. In the decade to come, African countries will benefit from reflecting on these successes and failures, and on what they mean for their own development strategies.

NEW YORK – On June 1-3, Japan is hosting the fifth meeting of TICAD, the Tokyo International Cooperation on African Development. The meeting is a reminder that, while the rest of the world obsesses over Europe’s economic travails, America’s political paralysis, and the growth slowdown in China and other emerging markets, there remains a region – Sub-Saharan Africa – where poverty is almost the rule, not the exception.

From 1990 to 2010, the number of people living in poverty ($1.25 per day) across Sub-Saharan Africa rose from less than 300 million to nearly 425 million, while the number living on less than $2 a day grew from about 390 million to almost 600 million. Still, the proportion of those living in poverty declined from 57% to 49% in this period.

[quote] Developed countries have repeatedly broken their promises of aid or trade. Yet Japan, still suffering from two decades of economic malaise, has somehow managed to remain actively engaged – not because of its strategic interests, but in order to meet a genuine moral imperative, namely that those who are better off should help those in need. [/quote]

Africa today presents a mixed picture. There are some notable successes – from 2007 to 2011, five of the world’s ten fastest-growing countries with a population of more than 10 million were in Africa. And their progress has not been based solely on natural resources.

Among the best-performing countries have been Ethiopia, where GDP grew by roughly 10% annually in the five years ending in 2011, and Rwanda, Tanzania, and Uganda, where annual output has grown by more than 6% for a decade or more. But, while some sources indicate that there are now more middle-class families in Africa (defined as having annual incomes in excess of $20,000) than in India, the continent also contains countries with the world’s highest levels of inequality.

In Pictures: 12 Fastest Growing Economies for 2013

Agriculture, on which so many of the poor depend, has not been doing well. Yields per hectare have been stagnating. Only 4% of arable and permanent cropland is irrigated, compared to 39% in South Asia and 29% in East Asia. Fertilizer use in Africa amounts to just 13 kilograms per hectare, compared to 90 kilograms in South Asia and 190 kilograms in East Asia.

Most disappointing, even countries that have put their macroeconomic house in order and have made progress in governance have found it difficult to attract investment outside of the natural-resource sector.

Japan’s engagement is particularly important not only in terms of money and moral support, but also because Africa may learn something from East Asia’s development experience. This may be particularly relevant today, with China’s rising wages and appreciating exchange rate underscoring rapid change in global comparative and competitive advantage.

Some manufacturing will move out of China, and Africa has a chance of capturing some fraction of it. This is especially significant, given that, over the last 30 years, Sub-Saharan Africa has suffered from de-industrialization. Indeed, by the late 2000’s – owing partly to the structural-adjustment policies pushed by the international financial institutions – manufacturing as a share of GDP in developing African economies was lower than it was in 1980.

But a manufacturing boom will not happen by itself. African governments must undertake industrial policies to help restructure their economies.

Such policies have been controversial. Some argue that government is not good at picking winners. Some argue that it makes no difference whether a country produces potato chips or computer chips.

[quote] Both perspectives are misguided. The purpose of such policies is to address well-known limitations in markets – for example, the important learning externalities, as skills relevant to one industry benefit nearby industries. [/quote]

The goal of industrial policies is to identify these spillovers, and governments have done a very credible job in this respect. In the United States, the government promoted agriculture in the nineteenth century; supported the first telegraph line (between Baltimore and Washington, demonstrated in 1844) and the first transcontinental line, thereby launching the telecommunications revolution; and then nurtured the Internet revolution. Inevitably, government – through its infrastructure, laws and regulations (including taxation), and education system – shapes the economy. For example, American tax and bankruptcy laws, combined with deregulation policies, effectively encouraged the creation of a hypertrophied financial sector.

With resources so scarce, developing countries cannot afford the luxury of such waste. They have to think carefully about the future direction of their economies – about their dynamic comparative advantages.

The world’s most successful developing countries – those in East Asia – did just this, and among the lessons to be shared are those concerning how they conducted industrial policies at a time when their governments lacked the sophistication and depth of talent that they have today. Weaknesses in governance may affect the instruments of industrial policy, but not its use.

Japan has other lessons to teach as well. Key elements of its development strategy – including its stress on education, equality, and land reform – are even more important today in Africa. The world has changed markedly since East Asia began its remarkable developmental transition more than a half-century ago; and differences in history, institutions, and circumstances mean that policies must be adapted to local conditions.

But what is clear is that Japan and other East Asian countries followed a markedly different course from that recommended by the neo-liberal “Washington Consensus.” Their policies worked; all too often, those of the Washington Consensus failed miserably. African countries will benefit from reflecting on these successes and failures, and on what they mean for their own development strategies.

By Joseph E. Stiglitz

Copyright: Project-Syndicate, 2013

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy (2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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The post What Africa Can Learn from East Asia’s Developmental Success: Joseph E. Stiglitz appeared first on Economy Watch.

Gene Patents Are Sacrificing Human Lives For Profits: Joseph Stiglitz

Joseph E. Stiglitz — Tue, 07 May 2013 07:33:07 +0000

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The US Supreme Court recently began deliberations in a case that will determine whether human genes may be patented. But we already know that permitting gene patents results in inefficiencies – including monopoly profits and a failure to maximize the use of knowledge – that impede the pace of innovation.

NEW YORK – The United States Supreme Court recently began deliberations in a case that highlights a deeply problematic issue concerning intellectual-property rights. The Court must answer the following question: Can human genes – your genes – be patented? Put another way, should someone essentially be permitted to own the right, say, to test whether you have a set of genes that imply a higher than 50% probability of developing breast cancer?

To those outside the arcane world of intellectual-property rights, the answer seems obvious: No. You own your genes. A company might own, at most, the intellectual property underlying its genetic test; and, because the research and development needed to develop the test may have cost a considerable amount, the firm might rightly charge for administering it.

But a Utah-based company, Myriad Genetics, claims more than that. It claims to own the rights to any test for the presence of the two critical genes associated with breast cancer – and has ruthlessly enforced that right, though their test is inferior to one that Yale University was willing to provide at much lower cost.

[quote]The consequences have been tragic: Thorough, affordable testing that identifies high-risk patients saves lives. Blocking such testing costs lives. Myriad is a true example of an American corporation for which profit trumps all other values, including the value of human life itself.[/quote]

This is a particularly poignant case. Normally, economists talk about trade-offs: weaker intellectual-property rights, it is argued, would undermine incentives to innovate. The irony here is that Myriad’s discovery would have been made in any case, owing to a publicly funded, international effort to decode the entire human genome that was a singular achievement of modern science. The social benefits of Myriad’s slightly earlier discovery have been dwarfed by the costs that its callous pursuit of profit has imposed.

More broadly, there is increasing recognition that the patent system, as currently designed, not only imposes untold social costs, but also fails to maximize innovation – as Myriad’s gene patents demonstrate. After all, Myriad did not invent the technologies used to analyze the genes. If these technologies had been patented, Myriad might not have made its discoveries. And its tight control of the use of its patents has inhibited the development by others of better and more accurate tests for the presence of the gene. The point is a simple one: All research is based on prior research. A poorly designed patent system – like the one we have now – can inhibit follow-on research.

That is why we do not allow patents for basic insights in mathematics. And it is why research shows that patenting genes actually reduces the production of new knowledge about genes: the most important input in the production of new knowledge is prior knowledge, to which patents inhibit access.

Fortunately, what motivates most significant advances in knowledge is not profit, but the pursuit of knowledge itself. This has been true of all of the transformative discoveries and innovations – DNA, transistors, lasers, the Internet, and so on.

A separate US legal case has underscored one of the main dangers of patent-driven monopoly power: corruption. With prices far in excess of the cost of production, there are, for example, huge profits to be gained by persuading pharmacies, hospitals, or doctors to shift sales to your products.

The US Attorney for the Southern District of New York recently accused the Swiss pharmaceutical giant Novartis of doing exactly this by providing illegal kickbacks, honoraria, and other benefits to doctors – exactly what it promised not to do when it settled a similar case three years earlier. Indeed, Public Citizen, a US consumer advocacy group, has calculated that, in the US alone, the pharmaceutical industry has paid out billions of dollars as a result of court judgments and financial settlements between pharmaceutical manufacturers and federal and state governments.

Sadly, the US and other advanced countries have been pressing for stronger intellectual-property regimes around the world. Such regimes would limit poor countries’ access to the knowledge that they need for their development – and would deny life-saving generic drugs to the hundreds of millions of people who cannot afford the drug companies’ monopoly prices.

The issue is coming to a head in ongoing World Trade Organization negotiations. The WTO’s intellectual-property agreement, called TRIPS, originally foresaw the extension of “flexibilities” to the 48 least-developed countries, where average annual per capita income is below $800. The original agreement seems remarkably clear: the WTO shall extend these “flexibilities” upon the request of the least-developed countries. While these countries have now made such a request, the US and Europe appear hesitant to oblige.

[quote]Intellectual-property rights are rules that we create – and that are supposed to improve social well-being. But unbalanced intellectual-property regimes result in inefficiencies – including monopoly profits and a failure to maximize the use of knowledge – that impede the pace of innovation. And, as the Myriad case shows, they can even result in unnecessary loss of life.[/quote]

America’s intellectual-property regime – and the regime that the US has helped to foist upon the rest of the world through the TRIPS agreement – is unbalanced. We should all hope that, with its decision in the Myriad case, the Supreme Court will contribute to the creation of a more sensible and humane framework.

By Joseph E. Stiglitz

Copyright: Project-Syndicate, 2013

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy(2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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The post Gene Patents Are Sacrificing Human Lives For Profits: Joseph Stiglitz appeared first on Economy Watch.

Japan’s Gamble on Growth: Joseph Stiglitz

Joseph E. Stiglitz — Mon, 08 Apr 2013 06:27:21 +0000

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Despite persistent deflation and tepid economic growth, things are looking up for Japan under the new Prime Minister. Shinzo Abe’s Keynesian-inspired reform programme is essentially a replay of what Takahashi Korekiyo achieved in the 1930s, when Japan escaped the Great Depression with a triple-barrelled blast of monetary, fiscal and structural stimulus.

TOKYO – Japanese Prime Minister Shinzo Abe’s programme for his country’s economic recovery has led to a surge in domestic confidence. But to what extent can “Abenomics” claim credit?

Interestingly, a closer look at Japan’s performance over the past decade suggests little reason for persistent bearish sentiment. Indeed, in terms of growth of output per employed worker, Japan has done quite well since the turn of the century. With a shrinking labour force, the standard estimate for Japan in 2012 – that is, before Abenomics – had output per employed worker growing by 3.08 percent year on year. That is considerably more robust than in the United States, where output per worker grew by just 0.37 percent last year, and much stronger than in Germany, where it shrank by 0.25 percent.

Nonetheless, as many Japanese rightly sense, Abenomics can only help the country’s recovery. Abe is doing what many economists (including me) have been calling for in the US and Europe: a comprehensive programme entailing monetary, fiscal, and structural policies. Abe likens this approach to holding three arrows – taken alone, each can be bent; taken together, none can.

The new governor of the Bank of Japan, Haruhiko Kuroda, comes with a wealth of experience gained in the finance ministry, and then as President of the Asian Development Bank. During the East Asia crisis of the late 1990’s, he saw firsthand the failure of the conventional wisdom pushed by the US Treasury and the International Monetary Fund. Not wedded to central bankers’ obsolete doctrines, he has made a commitment to reverse Japan’s chronic deflation, setting an inflation target of 2 percent.

Deflation increases the real (inflation-adjusted) debt burden, as well as the real interest rate. Though there is little evidence of the importance of small changes in real interest rates, the effect of even mild deflation on real debt, year after year, can be significant.

Kuroda’s stance has already weakened the yen’s exchange rate, making Japanese goods more competitive. This simply reflects the reality of monetary-policy interdependence: if the US Federal Reserve’s policy of so-called quantitative easing weakens the dollar, others have to respond to prevent undue appreciation of their currencies. Someday, we might achieve closer global monetary-policy coordination; for now, however, it made sense for Japan to respond, albeit belatedly, to developments elsewhere.

Monetary policy would have been more effective in the US had more attention been devoted to credit blockages – for example, many homeowners’ refinancing problems, even at lower interest rates, or small and medium-size enterprises’ lack of access to financing. Japan’s monetary policy, one hopes, will focus on such critical issues.

But Abe has two more arrows in his policy quiver. Critics who argue that fiscal stimulus in Japan failed in the past – leading only to squandered investment in useless infrastructure – make two mistakes. First, there is the counterfactual case: How would Japan’s economy have performed in the absence of fiscal stimulus? Given the magnitude of the contraction in credit supply following the financial crisis of the late 1990’s, it is no surprise that government spending failed to restore growth. Matters would have been much worse without the spending; as it was, unemployment never surpassed 5.8 percent, and, in throes of the global financial crisis, it peaked at 5.5 percent. Matters would have been much worse without the spending; as it was, unemployment never surpassed 5.8 percent, and, in throes of the global financial crisis, it peaked at 5.5 percent. Second, anyone visiting Japan recognises the benefits of its infrastructure investments (America could learn a valuable lesson here).

The real challenge will be in designing the third arrow, what Abe refers to as “growth.” This includes policies aimed at restructuring the economy, improving productivity, and increasing labour-force participation, especially by women.

Some talk about “deregulation” – a word that has rightly fallen into disrepute following the global financial crisis. In fact, it would be a mistake for Japan to roll back its environmental regulations, or its health and safety regulations.

What is needed is the right regulation. In some areas, more active government involvement will be needed to ensure more effective competition. But many areas in which reform is needed, such as hiring practices, require change in private-sector conventions, not government regulations. Abe can only set the tone, not dictate outcomes. For example, he has asked firms to increase their workers’ wages, and many firms are planning to provide a larger bonus than usual at the end of the fiscal year in March.

Government efforts to increase productivity in the service sector probably will be particularly important. For example, Japan is in a good position to exploit synergies between an improved health-care sector and its world-class manufacturing capabilities, in the development of medical instrumentation.

Family policies, together with changes in corporate labour practices, can reinforce changing mores, leading to greater (and more effective) female labour-force participation. While Japanese students rank high in international comparisons, a widespread lack of command of English, the lingua franca of international commerce and science, puts Japan at a disadvantage in the global marketplace. Further investments in research and education are likely to pay high dividends.

[quote] There is every reason to believe that Japan’s strategy for rejuvenating its economy will succeed: the country benefits from strong institutions, has a well-educated labour force with superb technical skills and design sensibilities, and is located in the world’s most (only?) dynamic region. It suffers from less inequality than many advanced industrial countries (though more than Canada and the northern European countries), and it has had a longer-standing commitment to environment preservation. [/quote]

If the comprehensive agenda that Abe has laid out is executed well, today’s growing confidence will be vindicated. Indeed, Japan could become one of the few rays of light in an otherwise gloomy advanced-country landscape.

By Joseph E. Stiglitz

Copyright: Project-Syndicate, 2013

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Europe’s Austerity ‘Cure’ Will Never Work: Joseph Stiglitz

Joseph E. Stiglitz — Tue, 05 Mar 2013 07:29:04 +0000

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While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. Indeed, it will now take a decade or more to recover from the losses incurred by misguided austerity policies – a process that may eventually force Europe to let the euro die in order to save itself.

NEW YORK – The outcome of the Italian elections should send a clear message to Europe’s leaders: the austerity policies that they have pursued are being rejected by voters.

The European project, as idealistic as it was, was always a top-down endeavor. But it is another matter altogether to encourage technocrats to run countries, seemingly circumventing democratic processes, and foist upon them policies that lead to widespread public misery.

While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930’s. Greece’s youth unemployment rate now exceeds 60 percent, and Spain’s is above 50 percent. With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy.

The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labeled as populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease. Indeed, it will take a decade or more to recover the losses incurred in this austerity process.

[quote]In short, it is neither populism nor shortsightedness that has led citizens to reject the policies that have been imposed on them. It is an understanding that these policies are deeply misguided.[/quote]

A Better Cure?

Europe’s talents and resources – its physical, human, and natural capital – are the same today as they were before the crisis began. The problem is that the prescriptions being imposed are leading to massive underutilization of these resources. Whatever Europe’s problem, a response that entails waste on this scale cannot be the solution.

[quote]The simplistic diagnosis of Europe’s woes – that the crisis countries were living beyond their means – is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.[/quote]

An alternative set of well-discussed policies could work. Europe needs greater fiscal federalism, not just centralized oversight of national budgets. To be sure, Europe may not need the two-to-one ratio of federal to state spending found in the United States; but it clearly needs far more European-level expenditure, unlike the current miniscule EU budget (whittled down further by austerity advocates).

A banking union, too, is needed. But it needs to be a real union, with common deposit insurance and common resolution procedures, as well as common supervision. There will also have to be Eurobonds, or an equivalent instrument.

European leaders recognize that, without growth, debt burdens will continue to grow, and that austerity by itself is an anti-growth strategy. Yet years have gone by, and no growth strategy is on the table, though its components are well known: policies that address Europe’s internal imbalances and Germany’s huge external surplus, which now is on par with China’s (and more than twice as high relative to GDP). Concretely, that means wage increases in Germany and industrial policies that promote exports and productivity in Europe’s peripheral economies.

What will not work, at least for most eurozone countries, is internal devaluation – that is, forcing down wages and prices – as this would increase the debt burden for households, firms, and governments (which overwhelmingly hold euro-denominated debts). And, with adjustments in different sectors occurring at different speeds, deflation would fuel massive distortions in the economy.

[quote]If internal devaluation were the solution, the gold standard would not have been a problem in the Great Depression. Internal devaluation, combined with austerity and the single-market principle (which facilitates capital flight and the hemorrhaging of banking systems) is a toxic combination.[/quote]

For Europe To Be Saved, The Euro Must Die

The European project was, and is, a great political idea. It has the potential to promote both prosperity and peace. But, rather than enhancing solidarity within Europe, it is sowing seeds of discord within and between countries.

Europe’s leaders repeatedly vow to do everything necessary to save the euro. European Central Bank President Mario Draghi’s promise to do “whatever it takes” has succeeded in providing a temporary calm. But Germany has consistently rejected every policy that would provide a long-term solution. The Germans, it seems, will do everything except what is needed.

Of course, the Germans have reluctantly come to accept the necessity of a banking union that includes common deposit insurance. But the pace with which they accede to such reforms is out of kilter with the markets. Banking systems in several countries are already on life support. How many more will be in intensive care before a banking union becomes a reality?

Yes, Europe needs structural reform, as austerity advocates insist. But it is structural reform of the eurozone’s institutional arrangements, not reforms within individual countries, that will have the greatest impact. Unless Europe is willing to make those reforms, it may have to let the euro die to save itself.

[quote]The EU’s Economic and Monetary Union was a means to an end, not an end in itself. The European electorate seems to have recognized that, under current arrangements, the euro is undermining the very purposes for which it was supposedly created. That is the simple truth that Europe’s leaders have yet to grasp.[/quote]

By Joseph E. Stiglitz

Copyright: Project-Syndicate, 2013

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy(2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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The Davos Disappointment – Growing Complacency in a Leaderless World?: Joseph Stiglitz

Joseph E. Stiglitz — Thu, 07 Feb 2013 08:30:13 +0000

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Despite the global economy’s myriad of problems, leaders at the World Economic Forum in Davos, particularly those from Europe, seemed more interested in celebrating the euro’s survival, rather than in tackling long-term concerns. Over the last 25 years, our world has moved from one dominated by two superpowers to being dominated by just one, and now to a leaderless, multi-polar world. While we may talk about the G-7, or G-8, or G-20, the more apt description is G-0.

DAVOS – The World Economic Forum’s annual meeting in Davos has lost some of its pre-crisis panache. After all, before the meltdown in 2008, the captains of finance and industry could trumpet the virtues of globalization, technology, and financial liberalization, which supposedly heralded a new era of relentless growth. The benefits would be shared by all, if only they would do “the right thing.”

Those days are gone. But Davos remains a good place to get a sense of the global zeitgeist.

It goes without saying that developing and emerging-market countries no longer look at the advanced countries as they once did. But a remark by one mining company executive from a developing country caught the spirit of change:

[quote]In response to one development expert’s heartfelt despair that unfair trade treaties and unfulfilled promises of aid have cost the developed countries their moral authority, he retorted: “The West never had any moral authority.” Colonialism, slavery, the splintering of Africa into small countries, and a long history of resource exploitation may be matters of the distant past to the perpetrators, but not so to those who suffered as a result.[/quote]

The Inequality Issue

If there is a single topic that concerned the assembled leaders the most, it is economic inequality. The shift in the debate from just a year ago seems dramatic: no one even mentions the notion of trickle-down economics anymore, and few are willing to argue that there is a close congruence between social contributions and private rewards.

While the realization that America is not the land of opportunity that it has long claimed to be is as disconcerting to others as it is to Americans, inequality of opportunity at the global scale is even greater. One cannot really claim that the world is “flat” when a typical African receives investment in his or her human capital of a few hundred dollars, while rich Americans get a gift from their parents and society in excess of a half-million dollars.

A high point of the meeting however was the speech by Christine Lagarde, the International Monetary Fund’s managing director, who stressed the marked change in her institution, at least at the top: deep concern about women’s rights; renewed emphasis on the link between inequality and instability; and recognition that collective bargaining and minimum wages could play an important role in reducing inequality. If only the IMF programs in Greece and elsewhere fully reflected these sentiments!

The “Productivity vs. Job Creation” Problem

The Associated Press organized a sobering session on technology and unemployment: Can countries (particularly in the developed world) create new jobs – especially good jobs – in the face of modern technology that has replaced workers with robots and other machines in any task that can be routinized?

Overall, the private sector in Europe and America has been unable to create many good jobs since the beginning of the current century. Even in China and other parts of the world with growing manufacturing sectors, productivity improvements – often related to job-killing automated processes – account for most of the growth in output. Those suffering the most are the young, whose life prospects will be badly hurt by the extended periods of unemployment that they face today.

The New “G-0”

But most of those in Davos put aside these problems to celebrate the euro’s survival. The dominant note was one of complacency – or even optimism. The “Draghi put” – the notion that the European Central Bank, with its deep pockets, would and could do whatever necessary to save the euro and each of the crisis countries – seemed to have worked, at least for a while. The temporary calm provided some support for those who claimed that what was required, above all, was a restoration of confidence. The hope was that Draghi’s promises would be a costless way of providing that confidence, because they would never have to be fulfilled.

Critics repeatedly pointed out that the fundamental contradictions had not been resolved, and that if the euro was to survive in the long run, there would have to be a fiscal and banking union, which would require more political unification than most Europeans are willing to accept. But much of what was said in and around the meetings reflected a deep lack of solidarity.

[quote]One very senior government official of a northern European country did not even put down his fork when interrupted by an earnest dinner companion who pointed out that many Spaniards now eat out of garbage cans. They should have reformed earlier, he replied, as he continued to eat his steak.[/quote]

IMF growth forecasts released during the Davos meeting highlight the extent to which the world has become decoupled: GDP growth in the advanced industrial countries is expected to be 1.4 percent this year, while developing countries continue to grow at a robust 5.5 percent annual rate.

While Western leaders talked about a new emphasis on growth and employment, they offered no concrete policies backing these aspirations. In Europe, there was continued emphasis on austerity, with self-congratulations on the progress made so far, and a reaffirmation of resolve to continue along a course that has now plunged Europe as a whole into recession – and the United Kingdom into a triple-dip downturn.

Perhaps the most optimistic note came from the emerging markets: while the risk of globalization was that it implied a new interdependence, so that flawed economic policies in the US and Europe could torpedo developing countries’ economies, the more successful emerging markets have managed globalization well enough to sustain growth in the face of failures in the West.

With the US politically paralyzed by the Republicans’ infantile political tantrums, and Europe focused on ensuring the survival of the ill-conceived euro project, the lack of global leadership was a major complaint at Davos.

[quote]In the last 25 years, we have moved from a world dominated by two superpowers to one dominated by one, and now to a leaderless, multi-polar world. While we may talk about the G-7, or G-8, or G-20, the more apt description is G-0. We will have to learn how to live, and thrive, in this new world.[/quote]

By Joseph E. Stiglitz

Copyright: Project-Syndicate, 2013

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy(2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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The Global Economy’s Dangerous Myopia – Are We Ignoring Future Crises?: Joseph Stiglitz

Joseph E. Stiglitz — Tue, 08 Jan 2013 08:29:27 +0000

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As global leaders continue to deal with their economies’ immediate problems, long-term issues such as global warming, inequality and poverty are being compromised – with potentially dangerous ramifications. Although today’s crises undoubtedly warrant immediate action, we should be asking whether we are responding in ways that will exacerbate our long-term problems.

NEW YORK – In the shadow of the euro crisis and America’s fiscal cliff, it is easy to ignore the global economy’s long-term problems. But, while we focus on immediate concerns, they continue to fester, and we overlook them at our peril.

The most serious is global warming. While the global economy’s weak performance has led to a corresponding slowdown in the increase in carbon emissions, it amounts to only a short respite. And we are far behind the curve: Because we have been so slow to respond to climate change, achieving the targeted limit of a two-degree (centigrade) rise in global temperature, will require sharp reductions in emissions in the future.

[quote]Some suggest that, given the economic slowdown, we should put global warming on the backburner. On the contrary, retrofitting the global economy for climate change would help to restore aggregate demand and growth.[/quote]

Stuructural Shifts

At the same time, the pace of technological progress and globalization necessitates rapid structural changes in both developed and developing countries alike. Such changes can be traumatic, and markets often do not handle them well.

Just as the Great Depression arose in part from the difficulties in moving from a rural, agrarian economy to an urban, manufacturing one, so today’s problems arise partly from the need to move from manufacturing to services. New firms must be created, and modern financial markets are better at speculation and exploitation than they are at providing funds for new enterprises, especially small and medium-size companies.

Moreover, making the transition requires investments in human capital that individuals often cannot afford. Among the services that people want are health and education, two sectors in which government naturally plays an important role (owing to inherent market imperfections in these sectors and concerns about equity).

Global Trade Imbalances

Before the 2008 crisis, there was much talk of global imbalances, and the need for the trade-surplus countries, like Germany and China, to increase their consumption. That issue has not gone away; indeed, Germany’s failure to address its chronic external surplus is part and parcel of the euro crisis. China’s surplus, as a percentage of GDP, has fallen, but the long-term implications have yet to play out.

America’s overall trade deficit will not disappear without an increase in domestic savings and a more fundamental change in global monetary arrangements. The former would exacerbate the country’s slowdown, and neither change is in the cards. As China increases its consumption, it will not necessarily buy more goods from the United States. In fact, it is more likely to increase consumption of non-traded goods – like health care and education – resulting in profound disturbances to the global supply chain, especially in countries that had been supplying the inputs to China’s manufacturing exporters.

Worldwide Crisis in Inequality

Finally, there is a worldwide crisis in inequality. The problem is not only that the top income groups are getting a larger share of the economic pie, but also that those in the middle are not sharing in economic growth, while in many countries poverty is increasing. In the US, equality of opportunity has been exposed as a myth.

While the Great Recession has exacerbated these trends, they were apparent long before its onset. Indeed, I (and others) have argued that growing inequality is one of the reasons for the economic slowdown, and is partly a consequence of the global economy’s deep, ongoing structural changes.

[quote]An economic and political system that does not deliver for most citizens is one that is not sustainable in the long run. Eventually, faith in democracy and the market economy will erode, and the legitimacy of existing institutions and arrangements will be called into question.[/quote]

The good news is that the gap between the emerging and advanced countries has narrowed greatly in the last three decades. Nonetheless, hundreds of millions of people remain in poverty, and there has been only a little progress in reducing the gap between the least developed countries and the rest.

Here, unfair trade agreements – including the persistence of unjustifiable agricultural subsidies, which depress the prices upon which the income of many of the poorest depend – have played a role. The developed countries have not lived up to their promise in Doha in November 2001 to create a pro-development trade regime, or to their pledge at the G-8 summit in Gleneagles in 2005 to provide significantly more assistance to the poorest countries.

The “Public Goods” Problem

The market will not, on its own, solve any of these problems. Global warming is a quintessential “public goods” problem. To make the structural transitions that the world needs, we need governments to take a more active role – at a time when demands for cutbacks are increasing in Europe and the US.

As we struggle with today’s crises, we should be asking whether we are responding in ways that exacerbate our long-term problems. The path marked out by the deficit hawks and austerity advocates both weakens the economy today and undermines future prospects. [quote]The irony is that, with insufficient aggregate demand the major source of global weakness today, there is an alternative: invest in our future, in ways that help us to address simultaneously the problems of global warming, global inequality and poverty, and the necessity of structural change.[/quote]

By Joseph E. Stiglitz

Copyright: Project-Syndicate, 2013

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy (2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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One Month Later – How America Should Rebuild Itself Post-Elections: Joseph Stiglitz

Joseph E. Stiglitz — Fri, 07 Dec 2012 08:51:05 +0000

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After a hard-fought campaign, it seems that not much has changed in American politics. Rather, the main cause for celebration has been that America has avoided policies that would have pushed it closer to recession and increased inequality further.

NEW YORK – After a hard-fought election campaign, costing well in excess of $2 billion, it seems to many observers that not much has changed in American politics: Barack Obama is still President, the Republicans still control the House of Representatives, and the Democrats still have a majority in the Senate. With America facing a “fiscal cliff” – automatic tax increases and spending cuts at the start of 2013 that will most likely drive the economy into recession unless bipartisan agreement on an alternative fiscal path is reached – could there be anything worse than continued political gridlock?

In fact, the election had several salutary effects – beyond showing that unbridled corporate spending could not buy an election, and that demographic changes in the United States may doom Republican extremism. The Republicans’ explicit campaign of disenfranchisement in some states – like Pennsylvania, where they tried to make it more difficult for African-Americans and Latinos to register to vote – backfired: those whose rights were threatened were motivated to turn out and exercise them. In Massachusetts, Elizabeth Warren, a Harvard law professor and tireless warrior for reforms to protect ordinary citizens from banks’ abusive practices, won a seat in the Senate.

[quote]Some of Mitt Romney’s advisers seemed taken aback by Obama’s victory: Wasn’t the election supposed to be about economics? They were confident that Americans would forget how the Republicans’ deregulatory zeal had brought the economy to the brink of ruin, and that voters had not noticed how their intransigence in Congress had prevented more effective policies from being pursued in the wake of the 2008 crisis. Voters, they assumed, would focus only on the current economic malaise.[/quote]

The Republicans should not have been caught off-guard by Americans’ interest in issues like disenfranchisement and gender equality. While these issues strike at the core of a country’s values – of what we mean by democracy and limits on government intrusion into individuals’ lives – they are also economic issues. As I explain in my book The Price of Inequality, much of the rise in US economic inequality is attributable to a government in which the rich have disproportionate influence – and use that influence to entrench themselves. Obviously, issues like reproductive rights and gay marriage have large economic consequences as well.

In terms of economic policy for the next four years, the main cause for post-election celebration is that the US has avoided measures that would have pushed it closer to recession, increased inequality, imposed further hardship on the elderly, and impeded access to health care for millions of Americans.

[quote]Beyond that, here is what Americans should hope for: a strong “jobs” bill – based on investments in education, health care, technology, and infrastructure – that would stimulate the economy, restore growth, reduce unemployment, and generate tax revenues far in excess of its costs, thus improving the country’s fiscal position. They might also hope for a housing program that finally addresses America’s foreclosure crisis.[/quote]

A comprehensive program to increase economic opportunity and reduce inequality is also needed – its goal being to remove, within the next decade, America’s distinction as the advanced country with the highest inequality and the least social mobility. This implies, among other things, a fair tax system that is more progressive and eliminates the distortions and loopholes that allow speculators to pay taxes at a lower effective rate than those who work for a living, and that enable the rich to use the Cayman Islands to avoid paying their fair share.

America – and the world – would also benefit from a US energy policy that reduces reliance on imports not just by increasing domestic production, but also by cutting consumption, and that recognizes the risks posed by global warming. Moreover, America’s science and technology policy must reflect an understanding that long-term increases in living standards depend upon productivity growth, which reflects technological progress that assumes a solid foundation of basic research.

Finally, the US needs a financial system that serves all of society, rather than operating as if it were an end in itself. That means that the system’s focus must shift from speculative and proprietary trading to lending and job creation, which implies reforms of financial-sector regulation, and of anti-trust and corporate-governance laws, together with adequate enforcement to ensure that markets do not become rigged casinos.

Globalization has made all countries more interdependent, in turn requiring greater global cooperation. We might hope that America will show more leadership in reforming the global financial system by advocating for stronger international regulation, a global reserve system, and better ways to restructure sovereign debt; in addressing global warming; in democratizing the international economic institutions; and in providing assistance to poorer countries.

[quote]Americans should hope for all of this, though I am not sanguine that they will get much of it. More likely, America will muddle through – here another little program for struggling students and homeowners, there the end of the Bush tax cuts for millionaires, but no wholesale tax reform, serious cutbacks in defense spending, or significant progress on global warming.[/quote]

With the euro crisis likely to continue unabated, America’s continuing malaise does not bode well for global growth. Even worse, in the absence of strong American leadership, longstanding global problems – from climate change to urgently needed reforms of the international monetary system – will continue to fester. Nonetheless, we should be grateful: it is better to be standing still than it is to be heading in the wrong direction.

By Joseph E. Stiglitz

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy (2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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Mitt’s Misguided Beliefs – Why The World Faces Greater Risks Under A Romney Presidency: Joseph Stiglitz

Joseph E. Stiglitz — Fri, 02 Nov 2012 08:14:27 +0000

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The world has a lot riding on the upcoming U.S. presidential elections. Overwhelmingly, non-US citizens favour Barack Obama’s re-election over a victory for his challenger, Mitt Romney – and for good reason.

NEW YORK – Most people around the world will not be able to vote in the United States’s upcoming presidential election, even though they have a great deal at stake in the result. Overwhelmingly, non-US citizens favour Barack Obama’s re-election over a victory for his challenger, Mitt Romney. There are good reasons for this.

In terms of the economy, the effects of Romney’s policies in creating a more unequal and divided society would not be directly felt abroad. But, in the past, for better and for worse, others have often followed America’s example. Many governments quickly subscribed to Ronald Reagan’s mantra of deregulated markets – policies that eventually brought about the worst global recession since the 1930’s. Other countries that followed America’s lead have experienced growing inequality – more money at the top, more poverty at the bottom, and a weaker middle class.

Romney’s proposed contractionary policies – the attempt to reduce deficits prematurely, while the US economy is still frail – will almost surely weaken America’s already anemic growth, and, if the euro crisis worsens, it could bring on another recession. At that point, with US demand shrinking, the rest of the world would indeed feel the economic effects of a Romney presidency quite directly.

That raises the question of globalization, which entails concerted action on many fronts by the international community. But what is required with regard to trade, finance, climate change, and a host other areas is not being done. Many people attribute these failures partly to an absence of American leadership. But, while Romney may summon bravado and strong rhetoric, other world leaders would be unlikely to follow him, owing to the belief (correct in my judgment) that he would take the US – and them – in the wrong direction.

Romney: The Next Bush?

American “exceptionalism” may sell well at home, but it does poorly abroad. President George W. Bush’s Iraq war – arguably a violation of international law – showed that though America spends almost as much on defense as the rest of the world combined, it could not pacify a country with less than 10 percent of its population and less than 1 percent of its GDP.

Moreover, it turned out that US-style capitalism was neither efficient nor stable. With most Americans’ incomes stagnating for a decade and a half, it was clear that the US economic model was not delivering for most citizens, whatever official GDP data said. Indeed, the model blew up even before Bush left office. Together with the abuses of human rights under his administration, the Great Recession – the predictable (and predicted) consequence of his economic policies – did as much to weaken America’s soft power as the wars in Iraq and Afghanistan did to weaken the credibility of its military power.

In terms of values – namely, the values of Romney and his running mate, Paul Ryan – things are not much better. For example, every other advanced country recognizes the right to accessible health care, and Obama’s Affordable Care Act represents a significant step toward that goal. But Romney has criticized this effort, and has offered nothing in its place.

America now has the distinction of being among the advanced countries that afford the least equality of opportunity to their citizens. And Romney’s drastic budget cutbacks, targeted at the poor and middle class, would further impede social mobility. At the same time, he would expand the military, spending more money on weapons that do not work against enemies that do not exist, enriching defense contractors like Halliburton at the expense of desperately needed public investment in infrastructure and education.

[quote]While Bush is not on the ballot, Romney has not really distanced himself from the Bush administration’s policies. On the contrary, his campaign has featured the same advisers, the same devotion to higher military spending, the same belief that tax cuts for the rich are the solution to every economic problem, and the same fuzzy budget math.[/quote]

Romney Down The Wrong Path

Consider, for example, the three issues that are at the centre of the global agenda mentioned earlier: climate change, financial regulation, and trade. Romney has been silent on the first, and many in his party are “climate deniers.” The world cannot expect genuine leadership from Romney there.

[quote]As for financial regulation, while the recent crisis has highlighted the need for stricter rules, agreement on many issues has proven to be elusive, partly because the Obama administration is too close to the financial sector. With Romney, though, there would be no distance at all: metaphorically speaking, he is the financial sector.[/quote]

One financial issue on which there is global agreement is the need to close down offshore bank havens, which exist mainly for purposes of tax evasion and avoidance, money laundering, and corruption. Money does not go to the Cayman Islands because sunshine makes it grow faster; this money thrives on the absence of sunshine. But, with Romney unapologetic about his own use of Cayman banks, we are unlikely to see progress even in this area.

Romney’s “Trade War” With China

On trade, Romney promises to launch a trade war with China, and to declare it a currency manipulator on Day One – a promise that gives him little wiggle room. He refuses to note the renminbi’s large real appreciation in recent years, or to acknowledge that, while changes in China’s exchange rate may affect the bilateral trade deficit, what matters is America’s multilateral trade deficit. A stronger renminbi would simply mean a switch in the US from China to lower-cost producers of textiles, apparel, and other goods.

The irony – again lost on Romney – is that other countries are accusing the US of currency manipulation. After all, one of the main benefits of the Federal Reserve’s policy of “quantitative easing” – perhaps the only channel with a significant effect on the real economy – derives from the depreciation of the US dollar.

[quote]The world has a lot riding on America’s election. Unfortunately, most people who will be affected by it – almost the entire world – will have no influence on the outcome.[/quote]

By Joseph E. Stiglitz

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy (2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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Monetary Delusions – Why Added Liquidity Alone Will Not Revive The Economy: Joseph Stiglitz

Joseph E. Stiglitz — Fri, 05 Oct 2012 08:45:55 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Central banks on both sides of the Atlantic took extraordinary monetary-policy measures in September, sending stock markets soaring. But politicians – and markets – in both Europe and America are mistaken if they believe that monetary policy can restore economic growth and boost employment.

NEW YORK – Central banks on both sides of the Atlantic took extraordinary monetary-policy measures in September: the long awaited “QE3” (the third dose of quantitative easing by the United States Federal Reserve), and the European Central Bank’s announcement that it will purchase unlimited volumes of troubled eurozone members’ government bonds. Markets responded euphorically, with stock prices in the US, for example, reaching post-recession highs.

Others, especially on the political right, worried that the latest monetary measures would fuel future inflation and encourage unbridled government spending.

In fact, both the critics’ fears and the optimists’ euphoria are unwarranted. With so much underutilized productive capacity today, and with immediate economic prospects so dismal, the risk of serious inflation is minimal.

Nonetheless, the Fed and ECB actions sent three messages that should have given the markets pause. First, they were saying that previous actions have not worked; indeed, the major central banks deserve much of the blame for the crisis. But their ability to undo their mistakes is limited.

Second, the Fed’s announcement that it will keep interest rates at extraordinarily low levels through mid-2015 implied that it does not expect recovery anytime soon. That should be a warning for Europe, whose economy is now far weaker than America’s.

Finally, the Fed and the ECB were saying that markets will not quickly restore full employment on their own. A stimulus is needed. That should serve as a rejoinder to those in Europe and America who are calling for just the opposite – further austerity.

[quote]But the stimulus that is needed – on both sides of the Atlantic – is a fiscal stimulus. Monetary policy has proven ineffective, and more of it is unlikely to return the economy to sustainable growth.[/quote]

In traditional economic models, increased liquidity results in more lending, mostly to investors and sometimes to consumers, thereby increasing demand and employment. But consider a case like Spain, where so much money has fled the banking system – and continues to flee as Europe fiddles over the implementation of a common banking system. Just adding liquidity, while continuing current austerity policies, will not reignite the Spanish economy.

So, too, in the US, the smaller banks that largely finance small and medium-size enterprises have been all but neglected. The federal government – under both President George W. Bush and Barack Obama – allocated hundreds of billions of dollars to prop up the mega-banks, while allowing hundreds of these crucially important smaller lenders to fail.

But lending would be inhibited even if the banks were healthier. After all, small enterprises rely on collateral-based lending, and the value of real estate – the main form of collateral – is still down one-third from its pre-crisis level. Moreover, given the magnitude of excess capacity in real estate, lower interest rates will do little to revive real-estate prices, much less inflate another consumption bubble.

Of course, marginal effects cannot be ruled out: small changes in long-term interest rates from QE3 may lead to a little more investment; some of the rich will take advantage of temporarily higher stock prices to consume more; and a few homeowners will be able to refinance their mortgages, with lower payments allowing them to boost consumption as well.

But most of the wealthy know that temporary measures result only in a fleeting blip in stock prices – hardly enough to support a consumption splurge. Moreover, reports suggest that few of the benefits of lower long-term interest rates are filtering through to homeowners; the major beneficiaries, it seems, are the banks. Many who want to refinance their mortgages still cannot, because they are “underwater” (owing more on their mortgages than the underlying property is worth).

[quote]In other circumstances, the US would benefit from the exchange-rate weakening that follows from lower interest rates – a kind of beggar-thy-neighbour competitive devaluation that would come at the expense of America’s trading partners. But, given lower interest rates in Europe and the global slowdown, the gains are likely to be small even here.[/quote]

Some worry that the fresh liquidity will lead to worse outcomes – for example, a commodity boom, which would act much like a tax on American and European consumers. Older people, who were prudent and held their money in government bonds, will see lower returns – further curtailing their consumption. And low interest rates will encourage firms that do invest to spend on fixed capital like highly automated machines, thereby ensuring that, when recovery comes, it will be relatively jobless. In short, the benefits are at best small.

In Europe, monetary intervention has greater potential to help – but with a similar risk of making matters worse. To allay anxiety about government profligacy, the ECB built conditionality into its bond-purchase program. But if the conditions operate like austerity measures – imposed without significant accompanying growth measures – they will be more akin to bloodletting: the patient must risk death before receiving genuine medicine. Fear of losing economic sovereignty will make governments reluctant to ask for ECB help, and only if they ask will there be any real effect.

There is a further risk for Europe: If the ECB focuses too much on inflation, while the Fed tries to stimulate the US economy, interest-rate differentials will lead to a stronger euro (at least relative to what it otherwise would be), undermining Europe’s competitiveness and growth prospects.

[quote]For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending.[/quote]

The current downturn, already a half-decade long, will not end any time soon. That, in a nutshell, is what the Fed and the ECB are saying. The sooner our leaders acknowledge it, the better.

By Joseph E. Stiglitz

Joseph Eugene Stiglitz is a professor at Columbia University and the recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979. Stiglitz has authored numerous books including Freefall: America, Free Markets, and the Sinking of the World Economy (2010), Globalisation and its Discontents (2002) and Making Globalisation Work (2006). Learn more about Joseph E. Stiglitz and his work at EconomyWatch.com.

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