JS's views are always interesting and are posted here in full.
This latest interview is part of a series by Managing Globalisation.
We’re truly fortunate to have Joseph Stiglitz’s responses to readers’ questions today.
Joseph StiglitzI sent Professor Stiglitz nine representative questions and asked him to answer five or six. He answered them all - thoroughly - which is a boon for us. As you can probably tell by reading below, there are plenty more insights in Professor Stiglitz’s latest book, Making Globalization Work. Next month’s guest will be Jeffrey Sachs.
Q. Since the beginning, economics has sought to perfect “economic well-being” as in, lay down the conditions to maximize well-being and explain faltering well-being. What does this well-being entail? There should be a definition of economic well being that functions independently of capitalist or socialist classifications. Would you care to explain your definition of the one entity that guides all economic theories: “economic well-being”?
A. There is no simple measure of economic well-being, and unfortunately, the standard measure, gross domestic product per capita, is misleading. This is important, because what we measure affects what we do; and if we try to “maximize” the wrong thing, there can be serious adverse consequences.
I stress the importance of equitable and sustainable development and growth. GDP can be going up, yet most individuals can be worse off (as has been happening in the United States during the past 5 years).
Similarly, GDP can be going up, yet standards of living going down, as the environment becomes degraded, so much so that life expectancy can even decrease. When I was chairman of the Council of Economic Advisers, I pushed for the use of Green GDP, where account is taken both of the depletion of natural resources and the degradation of the environment.
If a country’s growth is based on depleting renewable natural resources, its growth will not be sustained. Neither will growth be sustained if it is based on borrowing—when debt is used to finance consumption, not investment. Argentina’s growth in the early 90s was based on debt financed consumption, and selling off its national assets (often at unreasonably low prices). The inevitable day of reckoning came, and the country’s economy collapsed. Today, many are worried about America, whose growth is based on borrowing more than $3 billion a day from abroad.
GDP may be a misleading measure for another reason: it measures the value of what is produced in the country, not the income of the citizens of the country. When a developing country opens up a mine, with low royalties, most of the value of what is produced may accrue to the foreign owners; and when account is taken of the environmental degradation and resource depletion, the country may actually be worse off.
Q. What I find difficult to imagine is why a “superior authority,” such as the government or an international organization, would be able to regulate/decide what is the best trading strategy for any given country/region/community. Why shouldn’t we let the free market forces determine what is the best for the world? What is your opinion on the issue on free worldwide market forces vs. regulation?
A. Adam Smith, the father of modern economics, is often cited as arguing for the “invisible hand” and free markets: firms, in the pursuit of profits, are led, as if by an invisible hand, to do what is best for the world. But unlike his followers, Adam Smith was aware of some of the limitations of free markets, and research since then has further clarified why free markets, by themselves, often do not lead to what is best. As I put it in my new book, Making Globalization Work, the reason that the invisible hand often seems invisible is that it is often not there.
Whenever there are “externalities”—where the actions of an individual have impacts on others for which they do not pay or for which they are not compensated—markets will not work well. Some of the important instances have been long understood—environmental externalities. Markets, by themselves, will produce too much pollution. Markets, by themselves, will also produce too little basic research. (Remember, the government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and most of the advances in bio-tech.)
But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always.
Government plays an important role in banking and securities regulation, and a host of other areas: some regulation is required to make markets work. Government is needed, almost all would agree, at a minimum to enforce contracts and property rights.
The real debate today is about finding the right balance between the market and government (and the third “sector”—non-governmental non-profit organizations.) Both are needed. They can each complement each other. This balance will differ from time to time and place to place.
Q. What is the future of globalization where there is an increasingly greater disproportion between the movements of capital and goods and that of people?
Nabil El Aid El Othmani
A. This disparity in the liberalization of capital and labor is a major problem. Enormous energy has been focused on facilitating the flows of investment and capital, while movements of labor remain highly restricted. This is so, even though the gains to global economic efficiency from liberalizing labor flows are an order of magnitude greater than the gains from liberalizing capital flows. Indeed, liberalizing movements of short term speculative capital has been associated with increased instability, but does not bring enhanced economic growth. (Premature capital market liberalization was the basic cause of the East Asian crisis of 1997.)
This disparity has large distributional consequences. Because capital can move easily, it threatens to leave a country if it is taxed, or if wages are not tamed, or worker benefits are not cut. The disparity in liberalization is one of the reasons for the growing inequality in incomes that have marked most countries around the world. It is one of the reasons that even when globalization has brought increases in GDP, it has led to the lowering of incomes of many workers.
There is a risk that unless globalization can be made more fair, so that there are more winners and fewer losers, there may well be a back lash. We should remember that globalization is not inevitable. The degree of global integration, as measured, for instance, by the ratio of trade or capital flows to GDP, was higher before World War I than during the interwar period.
Q. Poverty continues to remain a big problem in the emerging economies. Poverty alleviation programs have failed to lift millions from the grip of hunger and disease. How can we marry the goals of globalization with reducing poverty as rich are getting richer with globalization while the poor remain where they are for centuries?
A. The impact of globalization is complex. The world is not flat—and in many ways, it is not getting flatter. The good news is that India and China, two huge countries with 2.4. billion people, have been narrowing the gap between themselves and the advanced industrial countries. China has managed globalization in a way that has led hundreds of millions out of poverty (even though there has been increasing inequality within China.)
But inequality within most countries, and the disparity between the richest and the poorest countries, have been increasing, and globalization, as it has been managed, has sometimes contributed to these problems. The last global trade agreement, the Uruguay round, was so unfair that the poorest countries of the world were actually worse off. As I explain in Making Globalization Work, the North American Free Trade Agreement did not live up to its promise of reducing the disparity between the U.S. and Mexico; in its first decade, the disparity actually increased, and in some ways, NAFTA contributed to the problems.
Globalization can be made to work, and work in a way that the number of people in poverty are reduced. But it has not been working that way. These are among the central messages in my book, where I spell out a wide agenda of what needs to be done. For instance, there is a rich trade agenda—going well beyond agriculture on which the Development Round seems to have become bogged down—which would help the poorest countries grow; but that agenda is a far cry from the trade agenda that America and Europe tried to sell as the Development Round.
We have the knowledge to deal with many of the diseases confronting the developing countries; but the Agreement on Trade-Related Aspects of Intellectual Property Rights (part of the Uruguay Round) was designed to make generic medicines less accessible. The result was that thousands are dying unnecessarily because they cannot afford the brand-name medicines.
But the current system also provides little incentive for drug companies to do research on the diseases, like malaria, that are largely found in developing countries, simply because even if a cure or vaccine were found, they don’t have the money to pay the high prices the drug companies demand. The current system clearly is not working. Again, there are alternative ways of financing research and the delivery of drugs, alternatives which are both more efficient and more equitable.
Q. What is the long-term future of globalization, and indeed the global economy as whole, if core problems like the world’s coming water crisis are not addressed? In what innovative ways can we think about harnessing the power of the global economy to address big questions that are for now being left unanswered? Will it take government regulation, an expanded international framework (such as Kyoto), or both? Where would you start?
A. The concerns you raise are real. That was why I devoted one of the chapters of my new book to “Saving the Planet.” What good would it do, I argued, if we made economic globalization work if, at the same time, we all fried as a result of global warming. Worse still, too often the poor are the most vulnerable. A third of Bangladesh will be underwater as a result of global warming, and with more people crowded together, incomes there, already miserably low, will fall even further.
On the other hand, globalization has the potential of helping us address these problems. The Montreal Convention, dealing with ozone-destroying gases, included a provision for trade sanctions against any country that did not comply. The threat of these sanctions was one of the reasons that the agreement was so effective.
The WTO seems to have recognized that trade sanctions can legitimately be imposed to ensure compliance with global environmental agreements. Indeed, one can argue that American firms today have an unfair trade advantage over others because they do not have to pay the full cost of their production—a hidden subsidy. They do not have to pay the cost of their greenhouse gas emissions, as firms in Europe and Japan do. We can actually measure the magnitude of this implicit subsidy.
Q. I would like to know what your thoughts are on China’s ever-increasing strength (dominance) in the global trading system and its effects on small, wealthy, developed nations. Will there be serious consequences to domestic production and exports, and are there areas in which Iceland could gain an advantage?
A. China will have an impact on almost every country in the world, rich or poor, small or large, but its impacts will differ markedly from country to country. Overall, I believe that growth is positive sum, not zero-sum: China’s growth benefits not only the citizens of China, but contributes to a strong global economy. Many around the world benefit from the inexpensive goods it produces; China’s large purchases abroad have benefited many producers around the world; and competition from China has kept inflation in check, and that has allowed Central Banks to maintain lower interest rates than they otherwise would have had; and that too has contributed to strong global growth.
But the impacts are varied. China’s rapid growth has been contributing to high commodity prices, which have been enormous benefit to the producers of these commodities, but imposed additional costs on competing users. Many factories both in the advanced industrial countries and in developing countries have found that they cannot compete; factories have been shut down and workers face unemployment, or, when they do get another job, lower wages.
Small economies both are more vulnerable and face more opportunities. They are more vulnerable, because they are often less diversified, and an industry in which they have specialized can be wiped out almost overnight. But they face more opportunities, because if they find a niche in which China has a strong demand, their prospects may be very bright. Parts of Ethiopia are doing so much better today than they have in the past, because China has begun to buy sesame seeds. Iceland, with its highly educated labor force, will almost surely find a niche in which it will excel.
Q. You have suggested a ‘tax switch’ and expenditure cuts as possible solutions to the United States fiscal deficit - without hurting growth significantly. What monetary and fiscal steps should China take to reduce its over-dependence on United States consumers and settle down to more sustainable growth rates?
A. China has been intensely concerned about its over-dependence on the United States consumers. As part of its 11th five year plan, announced last March, it has stressed increasing aggregate domestic demand, including consumption.
China is in a good position to make the switch. In effect, it has been providing “vendor finance” to the United States, both sending the goods and providing the money. But China can as well provide vendor finance to others—including its own consumers.
The challenge facing China (unique in the world) is how to get its citizens to consume more. One way is to provide better public social security, health care, and education. Its citizens save as much as they do (savings has amounted to 42 percent of GDP) because they worry about the future; savings are required to protect them. Again, its recent initiative to provide free education in the rural areas seems a step in the right direction.
Ironically, some outsiders have been advising China to adopt the same consumption-based value-added tax that has been sold elsewhere; but it has been sold to countries that need to encourage savings, while China’s problem is just the opposite. That is why I have been arguing for a broad-based VAT., not a consumption-based VAT.
There is considerable debate about what a sustainable growth rate is. China has to grow very rapidly if it is to provide jobs for the new entrants into the labor force and those wishing to migrate from the rural sector. Part of its growth is based on investments in human and physical capital, but part of its growth is based on reducing the gap in knowledge between it and the advanced industrial countries. Standard economic theories have discussed the pace at which savings can be invested well—and the limits that that provides for sustainable growth. But there is no economic theory that specifies a limit on the rate at which the knowledge gap can be closed. It may well be that China can sustain growth rates in excess of 7, 8 or 9 percent.
Q. I would like to have your opinion on the recent reconfiguration of voting powers at the International Monetary Fund, and your assessment of how it compares to the dictates for stability of the international financial architecture of the realities of global payments-settlement imbalances and the prevailing situation of accumulated foreign exchange reserves.
A. As the IMF has increasingly lectured others about the importance of governance, problems in its own political legitimacy have increasingly impaired its efficacy. Granting more voting powers to China and a few other countries that are under represented is a step in the right direction. But even the IMF recognizes that it is only the first step. Critics point out that these changes are unlikely to have much effect on its decisions, and they worry that having granted the most powerful of the underrepresented more voting power, the drive for further reform will weaken.
That would be a shame. The U.S. still is the only country with veto power. The choice of the heads of both the IMF and the World Bank make a mockery of legitimate democratic governance. Neither asks who is most qualified, regardless of race, color, nationality. The American president appoints the head of the World Bank and Europe chooses the head of the IMF. The recent selection of the head of the World Bank highlighted the problems.
The IMF’s new focus on global imbalances is also a step in the right direction. These imbalances are at the root of much of the financial instability and uncertainty of recent years, and portend even more serious problems in the future. The IMF should have long been focusing on such issues—its real mandate—rather than on development and the transition from Communism to the market economy, areas that are clearly not within its core competence, and where its policies were often badly misguided.
The problem is that it has been focusing on symptoms rather than underlying causes; and curing some of the problems without dealing with others may actually make matters worse. If, for instance, China were to revalue its currency, it would do little to improve America’s overall trade deficit; America would simply buy its apparel and textiles from Cambodia or Bangladesh rather than China. But China is more willing to buy U.S. Treasury bills than these other countries, who are more likely to want to put their export earnings to work at home, or if they send them abroad, to invest them in a strong Euro rather than in a weak and weakening dollar.
There is a fundamental problem—the dollar global reserve system. It is a system which is unstable, and inherently so. And as hundreds of billions of dollars are put into reserves every year, global aggregate demand is diminished; the only reason that it has performed as well as it has is America’s willingness to be the consumer of last resort. But there is something unseemly about a global financial system that requires the richest country in the world to spend beyond its means in order to keep it going. More importantly, it is not sustainable. Indeed, the dollar reserve system is already fraying.
Keynes proposed an alternative, and as I explain in my new book, his ideas can be adapted to today’s global economy: we can have a global financial system which is both more stable and more equitable.
Q. Has the World Bank changed since you were there, and if so, is it for better or for worse?
A. Of course, the World Bank has changed, and it will continue to change. The world is changing, and any institution that did not change would quickly find itself in deep trouble.
During my time there, the World Bank began to take on an advocacy role—advocating policies that are needed for the successful development of poor countries, even when they were opposed by some of the advanced industrial countries. It has continued to do that, most notably in its opposition to agricultural subsidies by the U.S. and EU which depress agricultural prices and so hurt the developing countries which depend on agriculture.
But a central achievement of this period was the recognition that successful development requires a comprehensive approach—there is no magic bullet. For instance, trade liberalization unaccompanied by policies that lead to new jobs replacing the old jobs that are lost may simply lead to a growth in unemployment, not growth in GDP. We took a comprehensive approach to poverty as well, recognizing that the poor also lacked security and voice.
Today, it often seems that the only issue that the Bank talks about is corruption. It sermonizes, but does not have a comprehensive set of policies and approaches to attack it. For instance, secrecy in Western banks facilitates this corruption. The Bush Administration vetoed an OECD effort to circumscribe bank secrecy in August 2001; it then found that these secret bank accounts are also used by terrorists. Since, it has shown that bank secrecy can be effectively attacked, but the U.S. has only been willing to do so to curtail terrorism, not to curtail corruption. The World Bank should add its voice in criticism of the Bush Administration’s policies.
But even were it to succeed in addressing the corruption, that would not be sufficient to address poverty in the Third World. Money can be spent honestly, but incompetently; and even when money is well spent, unless there are appropriate institutions and policies in place, success will be limited.
The challenges facing the Bank are enormous. There is now a consensus on the failures of the Washington consensus; the free market ideology one size fits all policies failed almost everywhere they were tried. Iraq, already suffering from so many other afflictions, is the latest country to be afflicted with the imposition of these policies, part of the conditions for debt relief. The failures there go, of course, well beyond economic policies; but that is all the more reason to be worried about imposing a set of doctrines with a proven track record of failure.
Hopefully, as the Bank strives to devise a strategy for itself going forward, it will not revert to these failed doctrines, even if put in new terms. What is needed is a new vision.