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Economist and Nobel Laureate, Joseph Stiglitz, talks about the policy mistakes that led to the GFC and the lessons to be drawn from it. The key question is: what will fill the gap in total demand left by the bursting of the bubble? A Centenary Oration from the University of Queensland.
Photo by Jeremy Patton.
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[Duration: 25'37" 12MB]
Chris Bullock: Hello, this is Background Briefing on ABC Radio National; I'm Chris Bullock.
This week we hear from economist and Nobel Laureate, Joseph Stiglitz, on the policies that led to the global financial crisis, and what's needed for a return to economic stability and prosperity.
Joseph Stiglitz: My main point is to argue that we can't go back to the world as it was before 2007. We had a very badly distorted economy. One indicator was 40% of all profits were in finance. The financial sector is supposedly a means to an end, it's not an end in itself. You don't eat finance, you don't wear it. The justification for finance is that it helps allocate capital, allocate resource, manage risk and if it does its job well, then the economy is more productive, we all grow faster, and in return for that contribution, they get a fair return. That's the way things are supposed to be. But somebody who was facilitating the growth of others to get them to have 40% of all corporate profits, suggested that something was out of kilter. And even more so when they were getting profits when they weren't doing what they were supposed to do; they didn't allocate capital, well they misallocated capital. They didn't manage risk, they created risk.
So the financial sector was not only bloated, it had failed to perform its essential functions.
Chris Bullock: Professor Joseph Stiglitz was in Australia two weeks ago, and he spoke at the University of Queensland, where he is the inaugural Rod Wyllie eminent visiting fellow.
Winner of the 2001 Nobel Prize in Economics, Joseph Stiglitz is internationally known for his research on the way markets operate, and his assertion that markets rarely work well without selective government intervention.
Currently a Professor of Economics at Columbia University, Stiglitz is a former Chief Economist and Senior Vice President of the World Bank, Chair of the UN Commission of Experts on reform of the international financial and monetary system, and the author of many books. One of them, Globalisation and its Discontents has been translated into 35 languages.
His lecture, at the University of Queensland, was titled Freefall: Free markets and the sinking of the global economy.
Joseph Stiglitz.
Joseph Stiglitz: Well it's a real pleasure to be here and to participate with you in your centenary celebration. What I'm going to talk about is a little bit less celebratory. It's about the sinking of the global economy, the mistakes in economic policies that contributed to it, and the lessons that ought to be drawn for economic policy, but also for economic theory, the kind of economics that we teach in academia.
So there are three questions I'm going to be dealing with this evening. First, where are we in the global crisis? You here in Australia have been spared a great deal of the crisis, and you may not really fully realise the impact that it is having in the rest of the world. You've contributed by an acronym, the GFC, which is not yet used elsewhere in the world, but I think will eventually spread around. But the crisis, as I'll try to explain, is only part way through, and is likely to last for at least several years.
Much of what I want to talk about though, is how did we get here, and what are the lessons? How do we get to a more stable and prosperous economy?
Chris Bullock: In terms of the broad outlook, Joseph Stiglitz said although we have pulled back from the brink of September 2008, the world is not yet on the road to recovery. The most positive signs are in Asia, including Australia. Europe and the United States are making slow progress, and some countries are heading for a double-dip recession. Joseph Stiglitz began by explaining what went wrong.
Joseph Stiglitz: The key problem is that before the crisis, global growth was supported by a series of bubbles. First we had the tech bubble and we replaced the tech bubble with the housing bubble. The housing bubble was - there were real estate bubbles in many countries around the world, but perhaps the largest was in the United States. Many economic leaders, people like Alan Greenspan, talked about a new economy, and they thought that financial innovation and deregulation had brought us to this new economy in which economic downturns would be a thing of the past; recessions would be things we no longer had to talk about.
But in fact this financial innovation, this deregulation, actually allowed the bubble to grow bigger and bigger. And actually, as you look at what happened in this crisis, for all the innovation, the crisis in fact is much like the crises that have plagued capitalism throughout its history. So in that sense it's nothing new. There are a couple of new words, like CDOs, derivatives that didn't play a role in previous crises, but actually if you look at the history of crises, in many of the previous earlier crises, there was some form of innovation that was associated with the crisis, the financial innovation.
If we look at the history of capitalism, the history of market economies, there've only been a short period of three decades, the three decades after the great depression, when the world did not face crisis after crisis. And the reason was that in response to the great depression in the United States, and in most other countries of the world, there were a set of regulations. Regulations like regulatory institutions like the securities and exchange commissions, and these actually worked, and worked reasonably well, in preventing crises.
The result was that in fact a mistaken view arose. The view was that markets on their own were efficient, were self-correcting, and in that sense were stable. But in fact, as I've said, the markets worked well in the decades after the great depression because we had good regulation. And then, in the three decades after deregulation began under Thatcher in the UK, under Reagan in the United States, there have been crises after crises. More than 100 financial crises around the world, most of them in developing countries, but some of them in developed countries. We had an S.L. crisis, Scandinavia had its crisis, and in each case the financial sector, the banks, were bailed out, as they have been bailed out in this case. But because they were bailed out, they came to believe that the markets were working, because things didn't fall apart. But the reason they didn't fall apart, the reason things didn't get worse and worse, was that government had to repeatedly come in and save them from themselves.
And so you've had bail-out after bail-out. Most of these bail-outs have names of countries: Korea, Indonesia, Thailand, Argentina, Brazil, Russia, I could go on, it's a long list. But actually these are not bail-outs of countries, these were bail-outs of banks, of the financial system who had not performed their key role of ascertaining credit worthiness, and lent money beyond people's ability to repay, and when they couldn't repay, governments came to the rescue.
Well the result was this mistaken view, as I say, that markets work, and rather than re-regulating, what they did is they continued in the path of deregulating. They didn't adopt the new regulations required for the 21st century or even the late 20th century. In the United States, we passed a law as the problem of the derivatives were getting larger and larger, as they became more and more apparent, as the Federal Reserve helped organise a bailout of Long-Term Capital Management, I don't know if you remember this in 1998, one hedge fund's failure threatened to bring down the entire global economy, one hedge fund had exposure of a trillion-and-a-half, and the response in the US Congress was to pass a law saying that derivatives could not be regulated. And some of the people who were responsible for that, are still in charge of the US financial system.
Well not surprisingly, with this mindset, we also appointed regulators who didn't believe in regulation. And with regulators who don't believe in regulation, you're not going to get very good regulation. And so it's not a surprise that you have people like Alan Greenspan surprised that we had a financial crisis.
Chris Bullock: Joseph Stiglitz said that over the past quarter of a century, economic theory has provided a much better understanding of why markets fail. The bottom line of his research, and that of others, is that Adam Smith's 'invisible hand', the term used by economists to describe how markets self-regulate, is invisible because it's not there.
Joseph Stiglitz said there was no invisible hand guiding financial markets, just greed and self-interest, inflating bubbles.
Joseph Stiglitz: The bubbles allowed everyone to live beyond their means. And that was one of the reasons the regulators didn't want to do anything. There was a party going on, and nobody wanted to be a party pooper. This was especially important in America; we were discussing before this meeting, a very different picture between America and Australia. In America, most Americans' incomes have been stagnating. GDP has been going up, but it hasn't been widely shared. In 2007 for instance, before the crisis, most Americans' income was lower than it was in 1999. Their incomes have been going down year after year. All the increase in GDP has been going to a few people at the top. So it isn't trickle-down economics that growth benefits all, it's been trickle-up economics; people at the bottom have been giving up incomes so the people at the top can enjoy ever more.
Well, in order to avoid lowering their standards of living, what we told people, 'Don't worry about the fact that your income is going down, spend as if it's going up'. And the one thing that Americans do very well is spend. Now there's only one way, if your income is going down and your spending is going up, the only way to square this particular circle, is to borrow. And they did that. But what allowed this to happen was this real estate bubble, the housing bubble; so they thought they were getting wealthier and wealthier, even though they were spending more and more, and our incomes were going down. Well it was clearly not sustainable. It's not feasible for incomes to be going down and house prices to be going up. You don't have to have a PhD to figure out that you can't spend more than 100% of your income on housing.
Well it should have been clear that this was not sustainable, and as one of my predecessors as Chairman of the Council of Economic Advisors said, 'That which is not sustainable, won't be sustained.' And this wasn't sustained.
But it wasn't only the households that were living beyond their means. In a way governments were, too, although they didn't fully understand it, because they were getting income, tax income, from the housing bubble. They were getting capital gains, they were all sharing in this bubble. So the United States was not a prudent economy. We were spending beyond our means, but there were other economies around the world - Spain had a surplus on its budget. It thought it was doing very well, but it was spending money that was phantom money, it was spending money that was based on tax revenues, based on the bubble.
Globalisation and financial and capital market liberalisation allow these toxic assets, these bad mortgages, and I can't here describe how bad these mortgages were. We invented a concept called low documentation loans, more familiarly known as 'liar loans,' where you could state down whatever your income was that they figured out the mortgage broker told you what income you needed to have to buy the house that you wanted to buy, and then they would write that down and since you didn't have any documentation required, that was what showed up in the form. So this was where the innovation was, it was actually quite marvellous.
Unfortunately, people in the rest of the world didn't fully appreciate the creativity in America, and as I said, globalisation and financial and capital market liberalisation, allowed us to sell these toxic assets all over the world. The securitisation process that was widely vaunted, was based on what I call the 'greater fool theory', that you could always find a fool foolish enough to buy these assets. Globalisation had opened up a global marketplace for fools. And our marketing found them all over the world. Most of them actually we found in Europe. 40% of our toxic mortgages we sold to Europe, and when I give a talk in Europe, I always thank the regulators there for inviting our guys, our mortgages in, and for buying so many of our toxic mortgages, because if they hadn't bought 40% of our toxic mortgages, the downturn in the United States would have been much, much worse. So I can't thank Australia quite as much as I thank Europe, you didn't buy that many because you had the misfortune of having good regulators.
Chris Bullock: Joseph Stiglitz told his University of Queensland audience that the challenge is to fill the gap in aggregate demand left by the bursting of the bubble. He said consumption in the United States should not return to where it was, because household savings had fallen to zero and that's not the foundation for prosperity in the long run.
In the East Asia crisis of the late '90s, countries recovered fairly quickly by way of exports, but Stiglitz made the point that it's not so easy to achieve an export-led recovery in a global crisis, because not everyone can boost their exports, unless trade with the planet Mars is established.
And history shows that raising tariffs and just buying products from your own country, doesn't work either.
Joseph Stiglitz.
Joseph Stiglitz: In the great depression, countries tried to get themselves back to prosperity through 'beggar thy neighbour' policies. What they did is, they increased tariffs and so took their limited amount of demand and said, 'We'll spend it at home rather than abroad and that will get us prosperity at home.' It didn't work though, because everybody else retaliated and it was part of the downward spiral that led to the weakening of the global economy, the great depression.
Today, people aren't doing that, or aren't doing it very much after the G-20 meeting in Washington, where they all agreed not to engage in protectionism. 17 of the 20 countries ran home and enacted protectionist measures. The United States was the most famous. We had a 'Buy America' provision in our stimulus package, and then when it was pointed out that it was probably WTO illegal, we put a clause in that said, 'except against with countries that we had a procurement agreement', which meant that we would only not buy from poor countries with which we did not have procurement agreements, so we decided to really target those countries who were the innocent victims of the crisis.
But the main mechanism today for this kind of 'beggar thy neighbour policy', is called competitive devaluation, where you lower your exchange rate relative to that of your competitors. When your exchange rate gets low, your products are cheaper and you sell more. And while every US Secretary of Treasury says he believes in a strong dollar, if you look what they're doing, is they're trying to get the dollar weaker and weaker. You just don't want to admit that you believe in a weak dollar.
So we've been engaged in this kind of - the hope was that we would get the dollar down and that would help US exports. But exchange rates are what I call a negative beauty contest; the question is, which country is the ugliest? And for a while the US was winning that contest hands-down. We had really bad economic policies. But then Europe decided to compete, and right now I think it's winning, and the result is that when exchange rates takes the relative price, when everybody's so pessimistic about Europe, the euro goes down, the dollar is stronger, and that means US exports are having troubles.
But it's not just the negative sum where one country gets an advantage relative to the other, it's actually a negative sum game, because the uncertainty of these volatility in exchange rates is bad for everyone, actually. It has adverse effects on investment.
Of course, when exports are weak and when consumption is weak, investment will be weak. The only answer is government, and government did step in to fill in the gap, and it did this through a global Keynesian stimulus . It should be clear, it worked. Without the Keynesian stimulus, the world would have faced I think, a global depression. In the case of the United States, without our stimulus, our unemployment rate, instead of going to 10% would have been probably 12%. But the unemployment still did go to 10%, and the reason was very simple: the US stimulus package was too small, and it was not well-designed. Too much was spent in ineffective tax cuts. Obviously with people burdened with the kind of debts that Americans were burdened, it was clear that they would not go to the shopping malls and spend, and there was also too little aid in states and localities. The result is that while the federal government was spending more the states were contracting, and we had this anomalous position, situation, where states were laying off workers, premier education institutions like the University of California, are putting the teachers on furlough two days a month on the way to laying off teachers.
The one country with a really large stimulus, relative to its GDP was China, and it resumed strong growth. China and India have managed, at least temporarily, to have growth even when the rest of the world economy is weak. But they are too small economically, to save the rest of the world.
I should comment that the Australian stimulus was not only timely, it was actually one of the best-designed stimulus packages of any of the countries of the world, and the result of that is that Australia had among the advanced industrial countries, the shortest and the shallowest of economic downturns.
Well in the United States, we made a big economic and political mistake, and similar mistakes were made in some other countries. We left those who had created the mess in charge, both in politics and the banks. And the reason why I say it was a mistake is that it was very difficult for these individuals to admit easily the magnitude of the mistakes that they had made. Difficult for a Secretary of Treasury to had previously been in charge of the one of the financial institutions, who had been responsible for the bad lending to say, 'Boy, did I blow it', and so they were all trying to minimise the significance of the mistakes that they had created. And you can't change mindsets that quickly. The people in the Obama Administration, among the people in charge, are the people who were responsible for the deregulation that caused the problem that we faced.
They also had an incentive to hide the mistakes, to continuing faulty accounting and the hidden bail-outs and practices called pretend and extend, so that people wouldn't have to face - the banks wouldn't have to face up to reality. In a sense, they wanted to believe that the bubble was reality, that the economy was going through a temporary bump that the breaking of the bubble was a nightmare. But in fact of course, the bubble was a fantasy and the reality was where we were moving towards.
So the basic economic strategy was to give the economy a little bit of assistance, enough to get over the current bump, don't change things too much and the world could go on as before.
Chris Bullock: This is Background Briefing on ABC Radio National; a slightly edited version of a speech by Professor Joseph Stiglitz, at the University of Queensland.
Stiglitz is a Nobel Laureate, a Professor of Economics at Columbia University, and the Inaugural Rod Wyllie Eminent Visiting Fellow at the University of Queensland. His address, based on his latest book, was titled, Freefall: Free markets and the sinking of the global economy.
As we heard earlier, Joseph Stiglitz said we cannot go back to 2007, when the economy was so badly distorted that 40% of all profits were in the finance sector, a part of the economy that's supposed to help allocate capital and other resources and to manage risks and which instead misallocated resources and created risk while talking up innovative approaches to financing.
Joseph Stiglitz: Much of the innovation that they continually talked about was directed at circumventing tax accounting and financial regulations, not at enhancing the productivity of the economy. Paul Volcker, who was the Chairman of the Federal Reserve Board before Greenspan, recently commented that the only financial innovation the American financial markets had made that increased our productivity, was the ATM machine. But he was wrong, because the ATM machine was actually invented in the UK, not in the United States.
In a sense, what we've been seeing is a slow train wreck. In a way as the bubble began, as the bubble grew in 2003, 2004, and 2005, you could see things developing, and visions of what was going to happen became clearer and clearer. The consequences of the bubble were predictable, and they were predicted, though not by those who believe the markets always work, because people like Alan Greenspan when asked about a bubble said, 'Oh no, there's no bubble' because he believed the markets could not make a mistake. He said, 'There's just a little froth in the economy.' But after the bubble broke, it was clear where we were going to go. There was going to be an economic meltdown of weaknesses and aggregate demand, and a financial meltdown. The banks knew that they had been engaged in massive deception, of moving things off balance sheets so nobody, the regulators, couldn't tell what was going on, that was part of their innovation. But as the crisis developed, at that point they knew that they didn't know their own balance sheet. So they knew that they couldn't know the balance sheet of any other bank. They knew that there was no reason to trust themselves, so they knew that there was no reason to trust each other. And that was, in a nutshell, why the credit markets froze. Nobody would trust anybody else, for good reason. And the only reason that credits started to flow again was the government stepped in and said, 'We'll back these people up', and what really caused the meltdown after the Lehman Brothers was very simple: the Secretary of Treasury said, 'Well maybe the government won't back you up', and once it became clear the government wouldn't back you up, the whole private sector collapsed. But it was only the government guarantee that had kept things going as they were.
But this economic meltdown and the financial meltdown, although they're related, are really distinct. And the US, and many other countries made a crucial mistake focusing on only one of these two, focusing on the financial sector, assuming that if they could fix the financial sector, everything else would be solved. They didn't fix the financial sector in the right way, and I'm going to come and talk to you about that, but because they only focused on the financial sector and they didn't even save the banks in a way which helped restore the broader economy their strength, and the result of that is this prognosis that I have, of a long, malaise, a very long period of slow global economic growth in the United States and Europe particularly.
Well let me say a few words about saving the banks. The focus was originally on saving not just the banks, but the bankers and their bond-holders, and their shareholders. And this broke the ordinary rules of the market economy. We have clear rules of what happens when firms go bankrupt. They can't pay their creditors, you can't pay your creditors, you go into bankruptcy, and bond-holders become the new shareholders. Banks are just like that except for a couple of minor differences. One of them is that because deposits are insured, the government plays a more important role because finance is so important for the economy, you're more likely - you want to make sure that the financial system remains stable, and you don't want to wait until the bank is really bankrupt. To put it another way, when you put your ATM card into the ATM machine, and it says, 'Insufficient Funds', you want it to be because there's insufficient funds in your account, not because there's insufficient funds in the bank. So that's why we tried to shut down the banks before there was insufficient funds.
Well, we have laws about how that's supposed to be done. But the Bush and Obama Administrations broke those laws effectively. And what they did is rather than applying the standard rules of conservatorship, what they did is, they bailed out the bankers, the banks and the shareholders. This is a system that I call Ersatz Capitalism, where you socialised losses, even though you allowed the privatising of gains. And this system distorts incentives, it is not the basis of an efficient market economy.
But the other problem was that no conditions were put on the bankers. And so not surprisingly, they fouled their own incentives. Their incentives were to take the money we had allocated $700-billion, to take the money and pay them out in bonuses and dividends, rather than to make them available for credit. And the result of this is that while the intent of the mega-bailout was resumption of credit, it hasn't happened. Credit today is substantially lower than it was before the crisis. Moreover, the way the banks were bailed out, basically gifts, the country's fiscal position is worse than otherwise would have been. Much of the assistance was hidden. For instance by lending to them at zero interest rate, allowing them to invest, to gamble. I mean many of you are business people, I'm sure if the central bank lent you money at zero interest rate you could figure out a way of making money, and claiming that you were very smart. And that's what our banks have been doing. And the government's also been engaged in restructuring the mortgages by taking the bad mortgages off the books of the banks and putting them on the books of the government.
But as I said, the issue is there's both a financial crisis and an economic crisis, and we have to look beyond the financial crisis because what's affecting most Americans and most people in Europe, is not just the financial crisis, but the fact that they can't get jobs. And that's an economic crisis.
Chris Bullock: In the United States, one in six Americans who want a full-time job, still can't get one, three years after the bubble broke. And long-term unemployment is the highest on record. Hundreds of thousands of Americans have run out of unemployment benefits, and have nowhere else to turn. Two million Americans lost their homes in 2008, '09, and Joseph Stiglitz said even more could lose their homes this year. The property market is still a shambles. This is an economic problem and a social problem.
Joseph Stiglitz.
Joseph Stiglitz: A quarter of all Americans have mortgages more than the value of their home. Just try to imagine what that would mean for yourself. For most middle-class people, their home is their most important asset. But all of a sudden, their home is not an asset but a liability. They owe more on their home than the value of their house. Weak banks, with large losses, are facing problems not just in residential real estate but also in commercial mortgages, where the problems may be even worse. And not surprisingly, with weak banks, credit flow is impaired, States and localities, revenues are plummeting, they represent about a third of all expenditures; they've been having to cut back on spending or raise taxes, but in either case a negative stimulus to the economy.
As if all of this were not bad enough, further problems have begun to emerge since the beginning of this calendar year. The worries have been growing about large debts created to save the global economy, and that's leading the cutbacks in spending in many of the European countries, and in the United States the likelihood of a second round of stimulus, which I think is needed, is very small, even though the economy is very weak. And the effects of these cutbacks, of not renewing the stimulus will be to dampen global growth, possibly leading to recession, at least in some countries.
I want to spend a moment on this myth of austerity, because it's playing a role in the discussions here in Australia, and it's been playing a very big role both in the United States and in Europe. This is a debate that goes back a long way, back to the Great Depression. Whenever economies go into a recession, deficits rise for the obvious reason, tax revenues go down and spending on things like unemployment has to go up, and revenues down, spending up, the deficits rise. That's true - before the recession you have a surplus, as in the case of Spain. It's true if you have it, even more true if before the crisis you have a deficit as in the United States. Well the current conservative response is cut the deficit, through austerity, through raising taxes, one way, but usually not the way they talk about, but mainly through cuts in expenditure. The idea is that this austerity will restore confidence and with this restoration of confidence, economic growth will be restored.
In their minds, some notion of a confidence fairy that descends from somewhere, that drops its little drops of confidence dust on businessmen, and all of a sudden, as they see these government deficits down, they rush in and start to invest. Well, I wish it were true. But this is a theory that has been debunked over and over again. In this part of the world, in East Asia, you saw very clearly in the last crisis, in 1997-98, the IMF had that same philosophy. The IMF has been engaged, in you might say, experiments on this austerity philosophy, and they've tried it out in Korea, Indonesia, Thailand. For the economist, these experiments are wonderful. We get new data. But for the people in the country, these experiments are a disaster. And everyone of these experiments has come out with the same conclusion: that that confidence fairy never seems to appear as the economy goes down, confidence erodes, investment declines, and the downturn gets worse. Downturns turn into recessions, recessions turn into depressions.
If Europe follows this route, it will be a disaster both for Europe, and I think for the global economy.
Now central banks often respond, 'Don't worry'. You have to understand, these are some of the same Central Bankers who got us into the mess in the first place; why we should pay any attention to those Central Bankers is a mystery to me. But they say, 'Don't worry, monetary policy can fill the gap.' In other words, 'We'll lower interest rates and that will stimulate the economy.' In Europe and the United States, interest rates can't go much lower. You know, you can't go much below zero. So in these countries, monetary policy has reached its limits. It has not been able to restore the economy to full employment, and in the US, the unusual measures that have been taken, very unorthodox, have left the US government with large amounts of implicit liabilities; the Fed now has on its book, over a trillion dollars of mortgages. I'd like to have a trillion dollars, but I'm not sure I'd want a trillion dollars of mortgages on my books.
Or there is an alternative, and that is fiscal policy. We can't ignore the deficit, but the way to respond to the deficit is to shift more spending towards higher return investments that lead to growth in short run and in the long run, and the result of the growth will be more tax revenue. Tax policies too, should shift taxes to encourage investment, and towards individuals with high marginal propensity to consume. So in other words, raise taxes on corporations that are not investing, and maybe lower them on corporations that are.
There's also a need for credit policies, for instance, creating new financial institutions rather than pouring money into old institutions bogged down by the legacy of bad debts, and bad business practices and mentality, banks who are no longer banks in the sense of providing credit.
Such a policy I believe can lower national debt in the long run, and even in the short, and create a more dynamic and fair economy.
Chris Bullock: You're listening to a slightly edited version of a speech by Professor Joseph Stiglitz, at the University of Queensland.
In the last part of his speech, Joseph Stiglitz turned to what he said was the problem of global market failure, a failure to address large unmet needs posed by climate change and global poverty, and the wastage of enormous amounts of human and capital resources.
Joseph Stiglitz: There's an irony that most of the waste of the resources occurs after the bubble breaks, and amounts of wasted resources, in the United States alone, is in the trillions of dollars. If we look at it in the global perspective, it looks even larger, obviously. And this waste of resources is a result of mistaken economic policies, again demonstrating that markets are not self-correcting, at least in the relevant time frame. And here it's important to keep in perspective, certain basic points. All human institutions, all humans, are fallible; we don't have any institution that is infallible. And that means there is going to be some waste, no matter what one does. So it's not a choice between having a perfect government, or a perfect market, and we always have to keep that perspective in mind. There will be waste in the private sector, there will be waste in the public sector. We should strive to minimise the waste in both the public sector and in the private sector, and there are things that we can do to reduce that waste. One of the most interesting initiatives I was involved in when I was in the Clinton administration was an initiative called Reinventing Government. It was designed to reduce the waste. But no matter how hard you try, in both the public and the private sector, there's going to be some waste.
Now in the case of this last crisis, we should be clear, the waste by the private sector, the misallocation of capital, is a waste of resources, the under-utilisation of resources is a waste of resources. That waste of resource, is greater than almost any government outside of war that has ever been engaged in. So we have to have some prospective. Yes, there was a little waste in the public sector, but the waste in the private sector is an order of magnitude larger, and it's hard to really keep this in mind, but that's true.
And the second thing to keep in mind is that if you hadn't spent money to stimulate the economy, even if some of that money was wasted, if you hadn't spent money, you would have another kind of waste, because you would have under-utilised your human and capital resources. That's a waste. So your choice wasn't between one perfect policy and another perfect policy, it was between two imperfect policies. And in that choice, the right one was made. That you had to have some kind of spending to get your economy going; if you hadn't done that, you would have wasted huge amounts and that if in that process a little bit was wasted, well next time you try to do better or you won't have another next time, and if you get the right policies in place you won't, but it's part of the fallibility of institutions, of human institutions, that we have to work to try to improve.
Well I want to spend just a minute talking about the sources of a weak global aggregate demand. I already mentioned the obvious point, the bubble had artificially supported demand and with the bursting of the bubble, there's going to be inevitably a weakening of demand. But two other points I want to make though: the first is the fact that there is growing inequality all over the world, in most countries around the world, and that means that in effect you're shifting money from those who would spend it to those who don't, and in the United States the way we sustain demand, was to tell people to borrow and borrow and borrow, and that was clearly not sustainable.
But there's another feature of a global economy that has not gotten as much attention, and that is the large accumulations of reserves in the trillions of dollars again, and much of this in response to the mismanagement of the East Asia financial crisis by the US Treasury, and the IMF in the East Asia crisis.
The Prime Minister of one of the countries involved put it very bluntly: he said, 'We were in the Class of '97. We learned what happens if you don't have enough reserves. The IMF marches in, you lose your sovereignty, it pushes on these policies of austerity that don't work, forcing you into depression. I said, never again.' And so they, and other countries started increasing their reserves. Now why is that a problem? Well, when you're saving, putting the reserves, it puts you in a better financial position, it's a good thing, but it's money not spent, and money not spent, leads to lower aggregate demand, and today, with the world facing an insufficiency of global aggregate demand, that's a problem.
Well there's some hope that American consumers will return, but that would be a mistake because that would not be sustainable. Savings rate were zero.
I want to say just a minute about global imbalances and global reserves. There's long been a worry that the disorderly unwinding of the imbalances would lead to global crisis, it didn't lead to this current crisis but could contribute to the next. The basic problem is that some countries are producing more than they are consuming, and contributing to weak global aggregate demand. The response of the G20 was for the US to consume less and China to consume more. I think is not the right approach, mainly because the world cannot survive if everyone consumes in a profligate manner as the US, it's just the planet can't survive. What is needed is a new economic model focusing on saving resources, investments to respond to the challenges of global warming and poverty, a new global reserve system, a new global regulatory system.
Let me turn to the big picture, which is that to put it bluntly, markets failed miserably, and we all are paying a very high price. Government came to the rescue, but in ways that were not as effective as they could have been, and left a legacy of debt. The choices many governments are making today are likely to make the global downturn last longer, possibly much longer, than if they had engaged in alternative policies.
There were alternatives. There were alternative ways of bailing out the banks, or dealing with the financial crisis. There were alternatives that would have stimulated the economy more and left less of a legacy of debt, and even today, there are alternatives that can set the global economy on a course for return to a stronger recovery in a more stable future.
One of the things I wanted to mention just very briefly, is that while we've been focusing on the short run, the long run problems have not gone away. But the resources available to deal with them, have been greatly diminished.
One of the aspects of these alternative strategies is that we could have combined a focus on the long run and the short run. There are strategies for dealing with the short run problems that will simultaneously address the long run. An example is investments to deal with global warming. Success in dealing with both will require getting a better sense of the appropriate balance between markets and the government.
A short way of summarising what went wrong in the years before the crisis was that we lost the balance in the run-up to the crisis, and now is the time to restore it.
Thank you.
APPLAUSE
THEME
Chris Bullock: That was Professor Joseph Stiglitz, speaking at the University of Queensland in the last week of July. His speech: Freefall: Free markets and the sinking of the global economy was part of the university's centenary celebrations.
Time prevented us from broadcasting the questions from the floor that followed Professor Stiglitz's address, but you can download a separate 25-minute audio file of this question and answer session if you go to the Background Briefing website.
I'm Chris Bullock, and you're listening to ABC Radio National.
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Nasser Shiyoukhi
