March 2, 2010

A rare growth industry following the 2008 financial crisis has been financial-crisis commentaries. An apparently endless stream of books and articles from assorted pundits and scholars continues to explain what went wrong and how to fix our present problems. In this context, it was almost inevitable that Joseph E. Stiglitz would enter the fray of finger-pointing and policy-proposing. He’s a Nobel Prize winner, former chief economist for the World Bank, former chairman of the President’s Council of Economic Advisors, and member of the Pontifical Academy of Social Sciences, so it would be surprising if he had nothing to say.

Moreover, Stiglitz has assumed the role of social-democratic public-intellectual-in-chief since his door-slamming departure from the World Bank in 1999. From this standpoint, Stiglitz opines about, well, pretty much everything. He also increasingly labels anyone disagreeing with him as a “market fundamentalist” or a “conservative journalist.”

Yet despite his iconoclastic reputation, Stiglitz reveals himself in his latest offering, Freefall: America, Free Markets, and the Sinking of the World Economy, as a rather conventional Keynesian-inclined economist who, like most Keynesian-inclined economists, thinks everything went wrong in the early 1980s.

But before detailing the problems with Stiglitz’s analysis, let’s note what Freefall gets right. Stiglitz correctly observes that the financial crisis reveals deep-seated problems in mainstream economics. These include overreliance on mathematical modeling and questionable assumptions about the character of rationality. His laments about the lack of accountability on Wall Street for excessive risk-taking, the conflicts of interest that impaired ratings agencies’ objectivity, and the Fed’s mismanaged monetary policy are also on target.

Stiglitz’s argument, however, quickly begins fraying when he claims that the origins of the current financial mess lie in the economic liberalization that began in the late 1970s. If that’s true, how do we explain the fact that Western Europe’s hyper-regulated economies are currently in even worse shape than America’s? Today Greece is a nation on financial life support. Yet it has long been one of the most regulated and interventionist economies in the entire EU.

This doesn’t stop Stiglitz from proposing a massive expansion of regulation, which, he says, should be shaped “by financial experts in unions, nongovernmental organizations . . . and universities”: i.e., people like Joseph E. Stiglitz.

More generally, there’s nothing new about what Stiglitz calls “New Capitalism.” It’s a return to old-fashioned Keynesian demand-management and the pursuit of “full employment” — that old Keynesian mantra — through the government’s direction of any number of economic sectors. You’d think the fiasco of Fannie Mae and Freddie Mac — government-sponsored enterprises (GSEs) with a congressionally approved social-engineering mandate — would underscore the folly of such approaches. But here it’s worth noting that Stiglitz coauthored a paper in 2002 titled “Implications of the New Fannie Mae and Freddie Mac Risk-Based Capital Standard.” This paper stated that “on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero.”

That little detail isn’t mentioned in Freefall.

Then there’s Stiglitz’s proposal for a Global Reserve System to effectively undertake demand-management for the world economy. To be fair, this is not an instance of megalomania on Stiglitz’s part. Keynes argued for something similar almost 75 years ago. But here Stiglitz wraps himself — again — in contradiction. Why, having stressed the Fed’s inability to manage America’s economy, does he imagine that a global central bank could possibly manage monetary policy for the entire world economy? What precisely, we might ask, is the optimal interest rate for the global economy? Surely only God could know that.

It is, however, in his last chapter — “Toward a New Society” — that Stiglitz becomes truly unstuck. Having stated that economic life should be organized in ways such that political and economic rights are taken seriously, Stiglitz claims: “What should be clear . . . is that these matters of rights are not God given. They are social constructs. We can think of them as part of the social contract that governs how we live together as a community.”

Are rights mere social constructs? That might be the view of your average U.N. bureaucrat or Ivy League professor, but it wasn’t the opinion of the signatories of Magna Carta or the Declaration of Independence. In short, it’s not so obvious that rights are man-made. If rights are simply social constructs, they’re not really rights in the sense of inalienable duties owed to people which cannot be created or extinguished at will by governments. Instead, they become privileges conceded to us by the state. And what the state gives, the state can take away.

In the end, Freefall is a book in which an old-line modern liberal gives us an old-line-modern-liberal response worthy of FDR or LBJ to the worst economic downturn since the Great Depression. It’s sad to see someone who has made considerable contributions to economics be so unoriginal. But in this instance, it seems that Joseph E. Stiglitz, like the Bourbons, has learned nothing and forgotten nothing. 

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