Globalization and Its Discontents Revisited

by Joseph E. Stiglitz

  Two papers with Bill Easterly and Roumeen Islam that I wrote while I was at the World Bank showed empirically that financial market deepening (usually associated with deregulation) could lead to more volatility: “Shaken and Stirred: Explaining Growth Volatility,” Annual Bank Conference on Development Economics 2000 (Washington, DC: World Bank, 2001), pp. 191–212; and “Shaken and Stirred: Volatility and Macroeconomic Paradigms for Rich and Poor Countries,” in Jacques Drèze, ed., Advances in Macroeconomic Theory, IEA Conference Volume 133 (Houndsmill, UK: Palgrave, 2001), pp. 353–72.

  3 The story of the financial crisis is told more fully in my book Freefall (New York: W. W. Norton, 2010).

  4 The figures are 9.2 percent for China, -2.8 percent for the United States.

  5 This includes Brazil (U.S. receives 13 percent of Brazil’s exports and China 18 percent; and U.S. is 15 percent of Brazil’s imports and China is 18 percent); and Argentina (U.S. is 6.1 percent of Argentina’s exports and China is 8.9 percent; U.S. is 13 percent of Argentina’s imports and China is 20 percent). Source: The Observatory of Economic Complexity from UN COMTRADE data, 2015, available at http://atlas.media.mit.edu/.

  6 See discussion “Capital controls” on p. 352.

  7 There were, of course, many others that advised the president on economic matters, but typically from the perspective of one part of the economy or the other—Labor Secretary Robert Reich had much to say about what was happening to workers and the inequality which even then was at a worrisome level; Treasury Secretary Robert Rubin reflected the perspectives of financial markets, and particularly, of the large multinational banks like Goldman Sachs, from which he came, and Citibank, to which he went after leaving government service; and Commerce Secretary Ron Brown represented a variety of business interests. The Council of Economic Advisers uniquely took a national, and often a global, perspective. I explained these differences in a speech to the American Economic Association in January 1997, subsequently published as “Looking Out for the National Interest: The Principles of the Council of Economic Advisers,” American Economic Review 87 (2) (May 1997), pp. 109–13.

  8 Including George Akerlof and Michael Spence, with whom I shared the Nobel Memorial Prize in economics; and a large number of coauthors with whom I had worked over the years, including Michael Rothschild, Bruce Greenwald, Andy Weiss, Carl Shapiro, Patrick Rey, Yungyoll Yun, Andrew Kosensko, Thomas Hellman, Kevin Murdoch, Sanford Grossman, Richard Arnott, and Thomas Hellmann.

  9 The particular notion of efficiency was called Pareto efficiency, after the great Italian economist, Vilfredo Pareto (1848–1923)—no one could be made better off without making someone else worse off.

  10 See D. Newbery and J. E. Stiglitz, “Pareto Inferior Trade,” Review of Economic Studies 51 (1) (1984), pp. 1–12.

  11 See “Capital-Market Liberalization, Globalization, and the IMF,” Oxford Review of Economic Policy 20 (1) (Spring 2004), pp. 57–71. Later, in response to a subsequent IMF attempt to defend their model, I extended the analysis: see chapter 2 in J. E. Stiglitz and J. A. Ocampo, eds., Capital Market Liberalization and Development (New York: Oxford University Press, 2008), pp. 76–100. That volume contains other critiques of capital market liberalization—a view that since the crisis has become mainstream.

  12 See the introduction for a discussion of the origins of the Washington Consensus and some of the controversy over what it entailed. GAID (Part II of this volume) was, of course, centered on a critique of Washington Consensus policies.

  13 As I also explain in GAID, Adam Smith was keenly aware of some of the limitations of markets, far more so than modern advocates of free markets.

  14 The work for which I received the Nobel Prize in 2001. With Michael Rothschild, I showed that even a little bit of information imperfection could drastically change the nature of the equilibrium (“Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information,” Quarterly Journal of Economics 90 [4] [November 1976], pp. 629–49); with Carl Shapiro, now at the University of California, Berkeley, I showed that competitive markets could have persistent unemployment—as is evidently the case (“Equilibrium Unemployment as a Worker Discipline Device,” American Economic Review 74 [3] [June 1984], pp. 433–44). With Andy Weiss, I showed that even in competitive markets there could be credit rationing (“Credit Rationing in Markets with Imperfect Information, American Economic Review 71 [3] [June 1981], pp. 393–410). With Bruce Greenwald, now of Columbia University, I showed that with imperfect information and incomplete risk markets, competitive markets were not, in general, efficient (“Externalities in Economies with Imperfect Information and Incomplete Markets,” Quarterly Journal of Economics 101 [2] [May 1986], pp. 229–64).

  15 The consensus was forged at Saltsjöbaden, Sweden, on September 16–17, 2016, at a meeting sponsored by the World Bank and the Swedish Aid Agency. See https://www.wider.unu.edu/news/stockholm-statement-%E2% 80%93-towards-new-consensus-principles-policy-making-contemporary-world.

  16 E.g., in chapter 10, I describe the U.S. privatization of uranium enrichment. At the time, it seemed set for failure. What happened since confirmed those expectations.

  17 Michael Seigel and Elliott Young, “Privatization in Mexico Is a Road to Nowhere,” Quartz, August 9, 2013, available at qz.com/113017/privatization-in-mexico-is-a-road-to-nowhere. Foreign Minister Jorge Castañeda is quoted describing the private road project as “a dumb idea that didn’t work.”

  18 See “The Liberalization and Management of Capital Flows—An Institutional View,” November 14, 2012 (press summary available at http://www.imf.org/external/pubs/ft/survey/so/2012/POL120312A.htm).

  19 Elsewhere in this book (see chapter 1, section “Increased Risk” and the references cited there), we have noted how without a complete set of risk markets, markets are not efficient. The problem with markets is worse than that they don’t efficiently manage risk. It is that they sometimes undertake excessive risk, failing to take into account the effects of their actions on others. See note 44 for a discussion of these macroeconomic externalities. Moreover, in the absence of adequate government regulation, they are prone to create credit and asset bubbles. For an historical discussion, see C. P. Kindleberger and R. Z. Aliber, Manias, Panics, and Crashes: A History of Financial Crises, 6th ed. (New York: Palgrave Macmillan, 2011). For a broader theoretical analysis, see Joseph E. Stiglitz, Towards a General Theory of Deep Downturns (New York: Palgrave Macmillan, 2016), also available, as NBER Working Paper 21444, August 2015, originally presented as Presidential Address to the 17th World Congress of the International Economic Congress, Dead Sea, Jordan, June 2014.

  20 In particular, Larry Summers, who was undersecretary of the Treasury and later secretary of the Treasury during the events described in GAID, and head of the National Economic Council under President Obama; and Tim Geithner, who was undersecretary of the Treasury under President Clinton, and secretary of the Treasury under Obama. They would, of course, argue that the circumstances were different, and different circumstances require different policies.

  21 By announcing that some private banks would be closed an the depositors not bailed out—but not disclosing which banks—a run on virtually all of the private banks was induced.

  22 See Joseph E. Stiglitz, Freefall, op. cit. At the time I wrote GAID, bail-ins (forcing depositors to bear part of the cost of a bank restructuring) and bailouts were subjects that had at the time received scant attention, and as a result, much of the policy advice was based on, at best, incomplete analyses that did not take adequate account of how various market participants would respond to whatever policy the government announced.

  There has since developed an extensive literature, including Olivier Jeanne and Anton Korinek, “Macroprudential Regulation Versus Mopping Up After the Crash,” NBER Working Paper 18675, 2012; Martin Schneider and Aaron Tornell, “Balance Sheet Effects, Bailout Guarantees, and Financial Crisis,” Review of Economic Studies, 71 (3) (2004), pp. 883–913; Emmanuel Farhi and Jea
n Tirole, “Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts,” American Economic Review 102 (1) (2012), pp. 60–93; and A. Caproni, B. Bernard, and J. E. Stiglitz, “Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability,” Columbia University working paper, 2017.

  23 As I noted in the introduction, the increase in reserves, in the trillions of dollars, had one very peculiar aspect: because most of the reserves were held in dollars (U.S. Treasury bills), it meant that poor countries were lending money to the United States, at very low interest rates, and often simultaneously borrowing back money at much higher interest rates.

  24 Source: IMF World Economic Outlook (WEO), April 2017.

  25 Some of the economically successful countries of East Asia have had a hard time making a smooth transition to democracy, and similar worries are being raised in Africa.

  26 Source: World Bank, World Development Indicators (WDI), August 2017.

  27 Source: UN World Population Prospects. Median estimate.

  28 Several years after leaving the World Bank, I undertook a reexamination of the data on the relative performance of the countries undertaking the two different strategies, using the nearly ten years’ additional data that was available then. The results reinforced the conclusions reached in GAID. See S. Godoy and J. E. Stiglitz, “Growth, Initial Conditions, Law, and Speed of Privatization in Transition Countries: 11 Years Later,” in S. Estrin et al., eds., Transition and Beyond (Hampshire, UK: Palgrave Macmillan, 2007), pp. 89–117. More recently, with still more data available, I reexamined the matter once again—and the results were if anything still stronger. As I also note later, many of the shock therapy countries never succeeded in constructing a diversified economy, so that they were particularly hard hit by the 2008 financial crisis.

  29 Average annual growth rates between 1980 and 2010 for China and between 1990 and 2016 for Vietnam. Sources: IMF World Economic Outlook (WEO), April 2017, and World Bank.

  30 See his blogpost, “For Whom the Wall Fell? A Balance-Sheet of Transition to Capitalism,” glineq.blogspot.com, November 3, 2014, available at http://glineq.blogspot.com/2014/11/for-whom-wall-fell-balance-sheet-of.html.

  31 Source: IMF World Economic Outlook (WEO), April 2017.

  32 The fact that even in Poland there is growing concern that the principles of constitutional democracy are being undermined shows that economics is not the only determinant of these political evolutions.

  33 The G-7 consisted of the United States, the UK, France, Germany, Canada, Italy, and Japan.

  34 The only African country of the G-20 is South Africa. Other countries have participated as “guests.”

  35 At the Gleneagles G-8 meeting in 2005, the developed countries committed themselves to increasing financial aid to Africa by $50 billion a year, and to spend 0.7 percent of their GDP on aid. Few of the countries have come anywhere near living up to their promise.

  36 U.S. Senate, Committee on Homeland Security and Governmental Affairs, “Offshore Profit Shifting and the U.S. Tax Code—Part 2 (Apple Inc.),” May 21, 2013, p. 47, available at https://www.gpo.gov/fdsys/pkg/CHRG-113shrg81657/pdf/CHRG-113shrg81657.pdf. There was no suggestion that Apple was doing anything illegal in the United States. In Europe, however, the European Commission argued that Apple and Ireland had secretly worked together to circumvent European laws, with Apple owing some $14.6 billion (or €13 billion).

  37 There is a tax committee within the UN that would have to be “elevated” in order to enable it to address such issues. The OECD has brought emerging markets within its deliberations, but they feel that within the OECD, the advanced countries, and especially the United States, dominate.

  38 As noted in the introduction, at a special meeting held on July 9, 2009, the UN General Assembly, following the report of a Commission of Experts on Reforms of the International Monetary and Financial System that had been appointed by its president in the aftermath of the global financial crisis, expressed overwhelming support for the Commission’s recommendations. Even the United States supported the resolution, though noting reservations that the subject of global reserves was an area that should be the responsibility of the IMF. The report of the Committee of Experts is available as The Stiglitz Report: Reforming the International Monetary and Financial Systems in the Wake of the Global Crisis, with Members of the Commission of Experts on Reforms of the International Monetary and Financial System appointed by the President of the United Nations General Assembly (New York: New Press, 2010).

  39 The Obama administration’s position was especially peculiar because of concerns that it might lead countries around the world to look askance at borrowing in U.S. markets. It provided another instance of a weakness in governance in the advanced countries, and of the revolving door which I so sharply criticize in GAID. Among the lobbyists for the hedge funds was someone who had formerly had a senior position in Obama’s National Security Council. Hedge funds were put ahead not only of the interests of the Argentine people, but of other parts of the financial sector.

  In effect, the lobbying worked. After a new government took office in Argentina in December 2015, it settled with the vulture funds, some of which made an enormous return on their investments. The estimated return of NML Capital Ltd., the leading litigant, was 1270 percent. See Martin Guzman, “An Analysis of Argentina’s 2001 Default Resolution,” Centre for International Governance Innovation (CIGI) Papers No. 110, October 2016.

  40 The issue of reform, which I cannot treat adequately here, is so important that I devoted a whole chapter to it in Making Globalization Work (chapter 9).

  41 World foreign direct investment inflows and portfolio equity net inflows were, respectively, 2.6 and 2.1 times higher over the period from 2002 to 2016 than between 1988 and 2002. Source: World Bank. Portfolio equity includes net inflows from equity securities other than those recorded as direct. Both Portfolio Equity and FDI inflows are highly volatile from one year to the next.

  42 See Olivier J. Blanchard et al., eds., In the Wake of the Crisis (Cambridge, MA: MIT Press, 2012); and George Akerlof et al., eds., What Have We Learned? Macroeconomic Policy After the Crisis (Cambridge, MA, and London: MIT Press, 2014).

  43 Alan Greenspan, the chairman of the Federal Reserve from 1987 to 2006, was often given credit for the long period of seeming stability, sometimes referred to as the Great Moderation. The pinnacle of this hagiography was a book by Bob Woodward, called Maestro: Greenspan’s Fed and the ­American Boom, published in 2001 just before the breaking of the tech bubble, in response to which Greenspan let loose the real estate bubble that was to bring down the global economy a few years later.

  44 Macroeconomic externalities was another area in which, as I wrote GAID, I felt the need for more research—the conventional models gave little insight, with sometimes wrong, sometimes contradictory, policy recommendations. Consider the issue of contagion. Everybody, including the IMF, talked about it and about the dangers that it presented: a downturn in one country could quickly spread to others. This is clearly an example of an extreme externality. But contagion occurs when there is financial integration—the kind the IMF had been advocating. Before the crisis, the IMF heralded the virtues of financial diversification and integration; afterward, they worried about the consequences. Their advice was obviously intellectually incoherent—and the models they used before crises occurred focused only on the benefits, not the costs. Indeed, the economics profession as a whole was weak in that respect. The theory of diversification that they focused on would have meant that if 100 individuals exposed to Ebola arrived in New York, the response would be to send 2 to each state to diversify the risk. Work in this area has continued—with the global financial crisis providing a big impetus. Before the crisis, I had begun work with a group of European economists on the question of when does diversification increase risk (through contagion), with most of the results published after the 2008 crisis. See, for example, “Credit Chains and Bankruptcy Propagation in Production Networks,” wit
h S. Battiston, D. Delli Gatti, and B. Greenwald, Journal of Economic Dynamics and Control 31 (6) (2007), pp. 2061–84; and two papers with S. Battiston, D. Delli Gatti, M. Gallegati, and B. Greenwald: “Default Cascades: When Does Risk Diversification Increase Stability, Journal of Financial Stability 8 (3) (2012), pp. 138–49, and “Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk,” Journal of Economic Dynamics and Control 36 (8) (2012), pp. 1121–41. I published two articles on contagion in the immediate aftermath of the 2008 crisis: “Risk and Global Economic Architecture: Why Full Financial Integration May Be Undesirable,” American Economic Review 100 (2) (2010), pp. 388–92; and “Contagion, Liberalization, and the Optimal Structure of Globalization,” Journal of Globalization and Development 1 (2) (2010), Article 2.

  45 In congressional testimony, Greenspan admitted that there was a “flaw” in his reasoning—a flaw that cost the economy trillions of dollars. He had thought that the banks would be able to manage their risks better. In saying this, he admitted that he had paid insufficient attention to one of the key developments in modern economics emphasizing corporate governance. It should have been obvious that the banks gave their executives incentives to engage in excessive risk taking. Thus, the excessive risk taking was predictable, and predicted. And even then, he seemed not to recognize the key role of externalities. The case of Bernanke is different. He was overly influenced by the models which he and others had constructed—models which typically left out banks and bankruptcy, and simply ignored systemic externalities. That was partly why the Fed seemed so unprepared for the consequences of shutting down Lehman Brothers. The possibility, or even likelihood, of Lehman Brothers going bankrupt had been widely discussed in financial markets for months before the event. With the Fed having even better data on the situation, the failure to be prepared was hard to explain, other than by noting that the Fed, in this period, seems to have been overly influenced by free-market ideology.