Current Economic Crisis Critique by Stiglitz - Essay Example

? MD- Critical Perspectives Assignment 2 Semester 2, Fauzia Rafi A critique of the current economic crisis by a former Chief Economist of the World Bank and Nobel Prize winner and a professor of Economics is worth reading. It’s about politics, it’s about economics and it’s about socio-cultural issues too, yes this is Freefall. Joseph Stiglitz in his book Freefall talks about the failure of the markets (economy) to function on its own. He also talks about how the government has failed to play a supporting role for the economy during the recent crisis. This book analyses the causes and consequences of the financial meltdown that stated in 2008. As Jeremy (2011) points out that after the collapse of financial system, the efforts were directed towards repairing the system without realizing that the “system itself needed to change”. This book by the Nobel Prize winning economist appeals to rethink and reconsider the present capitalist structure in the markets. The author talks about how overspending and low savings have brought down the financial meltdown. He is very skeptic about the conditions prevalent in housing market. He criticizes how low interest rates to boost consumption and monetary expansion have brought lax control over the economy. Stiglitz predicts that it will take a long time before USA markets fully recover as he calls it “Japanese style recovery”, where markets will face low aggregate output and low wages. In his opinion America needs to fix its macroeconomic structure through increasing savings, reducing consumption and more allocation of funds towards issues such as town planning and climate change. Turner (2010) states in a review that Stiglitz has made it the sources of the current crisis very obvious for those who argue that the current crisis was “unforseen”. He criticises the policies of Bush and Obama for bringing the economy to collapse in 2008. Stiglitz has criticized Obama for not developing a clear vision and strategy to improve the conditions of the economy. In fact Stiglitz accuses his lack of control over the economy which left the economy even more vulnerable at the hands of those running the financial sector than ever before. Stiglitz is also skeptical about how members of Bush’s administration continued their role in present government and are not rectifying the errors that created huge ups and downs in the business cycle previously. He has mentioned that the policies are made in a manner that increases the burden on taxpayers in case of any loss or bailout situation. Moreover Freefall also criticizes the role of retired bankers in policy formulation and regulation of the financial sector, which according to Stiglitz has created a greater imbalance in power. Stiglitz strongly advocates imposition of stringent regulations and restructuring of banks. He accuses Obama administration for come under the influence of finance tycoons and failing to exercise control over the banks and other financial institutions which became too giant to handle a crisis. He still believes that large banks need to be broken up in order to right-size them; an example is Citigroup, which is too huge in size to handle. He also is dejects the use of mortgage securitization, and encourages to police derivatives. Analysis Economic Policies Stiglitz considers Keynesian economics to be the solution for the current prevalent problems, however there are a number of factors that place a question mark on this proposition. Firstly we need to understand that in order to predict the impact of an injection of funds into the economy, we need to know the GDP multiplier. This GDP multiplier is dependant over the banking system because they are the ones to extend credit to the private sector. Now if the banking system is itself so weak and in need of funds, it is difficult to say that it can bring the economy out of recession. Moreover we also need to understand the flaws of government control, an example here is for people to decide if they want to rely on private pensions or social security. Social systems are also inefficient and can be unmanagable, which is also a peril. Stiglitz’s criticism over macroeconomic theory stands correct to an extent. Firstly because rational assumpthtion have little value in real world where people follow herd mentality, are irrational and adaptable in their preferences. Even the financial models seem inadequate and flawed in the presence of various factors influencing the economy today. There is also a need to make changes in government policies regarding redistribution of capital. This book lacks the depth in argument of why is the mismanagement of banks so common, even in the presence of presence of well-known reforms such as Basel 1 and Basel 2; why regulations always create a contractionary impact on the economy, and why even in the presence of mixed economies are there erratic business cycles. What we can clearly understand is that there is no such thing a self-regulation and the need to increase due diligence is important. He hopes that Americans realize how markets have failed to provide solutions to problems and to stabilize automatically. He indicates that people will realize the flaws of capitalism after the bankruptcy of Lehman Brothers, just like the flaws of communism were exposed after the fall of Berlin Wall. According to Stapleton (2010) the rating agencies have also failed to asses the risk that institutions were undertaking, and people did not know what they were buying. In the review of Freefall by Wood (2010), he describes the details of practices in the mortgage industry and especially the sub-prime mortgage industry in US and UK are ample to make the “jaw drop”. Use of toxic assets, non-transparent transactions, and off balance sheet transactions have created a domino effect in the economy and thus the collapse was borne by all. Elliott, (2010) in an article published in Guardian does not agree to what Stiglitz said this will be “Japanese style recovery”, because the conditions have improved and markets are growing again by the third quarter of 2009. He however agrees to Stiglitz opinion that there is a severe imbalance debtor and creditor nations. Through serving the World Bank as chief economist, Stiglitz has noticed the asymmetries in free trade and the rising imbalances between nations as they move towards globalization (Turner, 2010). Politics Stiglitz is of the opinion that if adequate measures are not taking in due course, the recovery of American economy will be slow, the debt situation is unlikely to improve, and financial system will be more vulnerable to crises. Stiglitz criticizes the previous political leaders and their administration of blindly supporting capitalism. He describes that after the great depression, the governments of Ronald Regan, the two Bush’s and Clinton gave unwarranted position to capitalism in the economy. As part of Clinton’s Council of Economic Advisors, Stiglitz criticizes the role of the Treasurer (Rupert E Rubin and later Lawrence H Summers) for not practicing due diligence in the economy and promoting needless deregulatory policies (KAKUTANI, 2010). According to an article published in The New York Times by Leonard (2010), the book has incidences of his work as part of Clinton’s administration, for instance how his former colleague Mr. Summers tried to stop the regulation of derivatives, which later became a upsetting financial instrument. And that he was “too accomodating” of what Wall Street wanted in 90s (Elliott, 2010). As for Stiglitz’s disapproval of Obama and Bush’s administration for being unable to manage the crisis, he does not bring the Clinton years into light when most of deregulatory reforms were enforced. In fact we should note that Obama’s administration comprises of a number of members who were also part of Clinton administration. So the fact remains that those who were called to rescue the banking system were because they were the ones who started it all. So they applied the same procedures that got the financial sector into problems (The-Huffington-Post, 2010). He criticizes Obama for failing to sustain growth in economy and moreover failing to provide formal, adequate and sustainable solutions to the problems inflicted in the American economy. Stiglitz’s proposed solutions are inadequate The book Freefall is of interest to anyone concerned about the details of the current crises, even the author’s credentials are enough for one to take the opinion seriously, but one does get skeptical at a few places. It is to note that Stiglitz does not provide a proposal or formula about the role of government in the economy; he does not clearly define his solution to the issue of “right balance” between free markets and government intervention. In my opinion he has not proposed a solution because in today’s world, restructuring such a huge economy is not a good idea and would face resistance from all factions. Mason ( 2010) in an article writes how Stiglitz is criticized for having existence of “two Joes”, that is, his skepticism towards capitalism and at the same times its advocacy in his lectures that it is beneficial if organizations are effective. In my opinion, the few policy options that Stiglitz proposes in his books are not adequate and unrealistic. It is very unlikely that they will win public support and will ever get recognition by congress. We all agree on the need for redistribution of wealth but there has to be a practical and concrete procedure of following it. I support the concept that government should not only emphasis on GDP (Gross domestic product) only but on improving the living standards of its people; on sustainability through taking account of resource depletion; and on health and education (Abhijit, 2010). In a review on the forum Purple Nation, a critic calls Stiglitz’s argument as a strawman fallacy. Although Stiglitz criticises free market and deregulation of the economy being a failure, however it is the fraudulent activities and misuse of power by few people who created a disaster. Even in case of bailouts of financial institutions, it is actually the government and not the free markets which privatizes profits and puts the burden of losses on the taxpayers. So we can confidently say that he financial fiasco was not a failure of free markets but a failure of risk management and the disappointing abuse of authority by people. Just as checks and balances are maintained in our political democracy, same should be the case with market structures that competitors should police each other to improve and regulate the financial sector. Moral Values Mr. Stiglitz also talks about how capitalism has promoted greed in American society, how it is promoting inequality of wealth, exposing flaws in accountability and a general trend of emphasizing on short-term goals rather than long-term. This is a fact that in market economy the only motivation to perform an action is self-interest which directly promotes greed and the concept of invisible hand is taken for granted. Adam Smith and other capitalist philosophers have pointed out that greed can be harnessed to serve social ends. It can spur entrepreneurial innovation, leading to good prosperity. It is the society that channels greed to such constructive purposes. Today America society takes more interest in how its capital markets are working compared to other countries. If we go into the background, according to an article published in Harvard Business Review by Diane L. Coutu, it was actually in 1990s that corporations began compensation plans such as employee stock options programs, thus the number of Americans holding stocks doubled from the number in 1980s. People began to realize that they can make unlimited amount of money through capital markets. Nowadays business schools are teaching finance, management, marketing etc., these disciplines encourage greed, self-interest and the drive to gather wealth. Students are not given adequate moral education at home or in schools, which makes them unable to do good for the society or each other, unless it is publicized, or stop them from doing harm to others unless it’s made against the law. Even the media today does not police market activity today, as it used to do at least a decade ago. In fact it glorifies the lives of executives, politicians and business tycoons as celebrities, who have amassed wealth on the toil of others. In my opinion it is important to have more stringent checks and balances on organizations and accountability for executives and politicians, and that they need to be more humble and responsible because of the governing positions that they are in. Stiglitz believes that it is important to restructure the economy and to find the balance between free market and government intervention and ownership. He also suggests America to utilize this crisis to address flaws in the economy (KAKUTANI, 2010). However it need to be understood that redesigning the whole global financial architecture is not an easy or feasible task, a better policy will be to bring about policies that exercise due diligence and bring about a less radical change. Works Cited Abhijit. (2010, sep 8). Freefall: The world according to Joseph Stiglitz. Retrieved jul 23, 2011, from Pressrun.net: http://www.pressrun.net/weblog/2010/09/freefall-the-world-according-to-stiglitz.html Coutu, D. L. (n.d.). I was Greedy, Too. Harvard Business Review. Elliott, L. (2010, jan 30). Freefall: Free Markets and the Sinking of the Global Economy by Joseph Stiglitz. Retrieved jul 23, 2011, from The Guardian: http://www.guardian.co.uk/books/2010/jan/30/freefall-global-economy-joseph-stiglitz Jeremy. (2011, jan 13). Freefall, by Joseph Stiglitz. Retrieved jul 23, 2011, from Make Wealth History: http://makewealthhistory.org/2011/01/13/freefall-by-joseph-stiglitz/ KAKUTANI, M. (2010, Jan 18). Skepticism for Obama’s Fiscal Policy. Retrieved July 22, 2011, from The New York Times: http://www.nytimes.com/2010/01/19/books/19book.html?pagewanted=all Leonard, D. (2010, jan 30). What Happened to Regulatory Reform? Retrieved jul 23, 2011, from The New York Times: http://www.nytimes.com/2010/01/31/business/31shelf.html Mason, P. (2010, Jan 21). Review of Freefall: Free Markets and the Sinking of the Global Economy. Retrieved July 22, 2011, from NewStatement: http://www.newstatesman.com/books/2010/01/stiglitz-obama-state-market Purple-Nation. (2010, Oct 29). Review of "Freefall" by Joseph Stiglitz. Retrieved July 23, 2011, from Purple Nation: http://policriticblog.blogspot.com/2010/10/review-of-freefall-by-joseph-stiglitz.html Stapleton, M. (2010, feb 11). Towards a Better Kind of Capitalism. Retrieved jul 23, 2011, from Amazon.com: http://www.amazon.co.uk/Freefall-Markets-Sinking-Global-Economy/dp/1846142792 The-Huffington-Post. (2010, mar 21). 'Freefall' Excerpt: Too Late To Fix The Biggest Banking Blunder In History? Retrieved jul 23, 2011, from Huffington Post Books: http://www.huffingtonpost.com/2010/01/19/freefall-excerpt-its-not_n_427509.html Turner, E. (2010, jul 17). Book Review: Freefall by Joseph Stiglitz. Retrieved jul 23, 2011, from Wall St cheat sheet: http://wallstcheatsheet.com/reviews/book-review-freefall.html/ Turner, E. (2010, jul 17). Book Review: Freefall by Joseph Stiglitz. Retrieved jul 23, 2011, from Wall st cheat sheet: http://wallstcheatsheet.com/reviews/book-review-freefall.html/ Wood, S. (2010, jul 27). The Great Free Market Failure. Retrieved jul 23, 2011, from Amazon.com: http://www.amazon.co.uk/Freefall-Markets-Sinking-Global-Economy/dp/1846142792 Read More