Participation, Growth, and Equity: the Global Economy in a Time of Crisis and Change

1. Participation, Growth, and Equity: the Global Economy in a Time of Crisis and Change Joseph E. Stiglitz Oaxaca Oct 27, 2011

2. From Tunisiato the indignaDosto Occupy Wall Street • Protests are no surprise • Real surprise is they didn’t come sooner • OWS numbers may be small, but many share their views • The market is unfair • “We are the 99%” • Inequalities not justified by relative contributions (old fashioned theory of “marginal productivity theory”) • Inequities major complaint in each of the protests • The political system is unfair, has been captured by the 1%

3. The market hasn’t worked like it should • Competitive theory: • Profits are supposed to be zero • Supply is supposed to equal demand • In practice • High unemployment • Credit not available, even for good borrowers • Banks make large profits, use market power over the payments system, engage in predatory lending • In crisis, we socialized losses while allowing the privatization of gains

4. The market hasn’t worked like it should • We have homeless people and empty homes • Millions of Americans have lost their homes • We have vast unmet needs and underutilized resources • Retrofitting the global economy for global warming • Investments in infrastructure • Needs for development • Understandable why young people in Spain were indignant • Youth unemployment rate more than 40%

5. Overregulation is notthe problem • Rather, we don’t have the right regulations • In any society, individuals can take actions that harm others • Preventing such harm (externalities) is one of the main objectives of regulation • In the US protest, megaphones prohibited • But corporations have unbridled spending to amplify political views • Banking system is underregulated, which allowed the banks to impose huge costs on the rest of society

6. The political system hasn’t Worked • Banks and their shareholders, bondholders, and bankerswere bailed out • Those who caused crisis have done well, the rest of society has suffered • Banks bailed out without conditions • But assistance to ordinary citizens comes with many conditions • Banks were supposed to use the money to restart lending • Hasn’t happened -- used the money for bonuses, dividends • No one held accountable for what went wrong • Culprits seem to have been rewarded—by the victims • This was not just an accident—it was a manmade event

7. BANKS haven’tchanged behavior • Predatory lending • Credit card practices • Foreclosures—even on people who owe nothing on their homes • Standard of justice—most of the people thrown out of their homes did owe money—not acceptable • Burden of proof changed—guilty until proven innocent • Robo-signing epitomizes fraudulent and near-fraudulent practices • Political influence used to stop effective reforms

8. IncompleteReform • Problem of too-big-to-fail worse • Non-transparent CDS’s continue • Derivatives continue to be underwritten by US taxpayer • Capital is still inadequate • Accounting practices still deficient • Explains fragility of global credit markets • Banks know that they can’t trust anyone else—risk of credit markets freezing

9. Not the way democracyis supposed to work • Example: the debate on reform of bank regulation • Most Americans want banks to be regulated • But political influence of few banks roughly balanced that of 350 million Americans • Theory: “median voter” is supposed to be decisive • In practice, doesn’t seem to be the case

10. Explaining the political process • Campaign contributions • Lobbying • Revolving door • American process: “best government that money can buy”

11. Key Problems • Persuading voters to vote • They feel participationwon’t make a difference • Self-fulfilling prophecy • In 2010 election—youth voter turnout almost same as youth unemployment rate: a dismal ~20% • Informing voters on complex issues • Confusion between household and government finance • Belief that austerity is the solution • But public skeptical of experts • Not surprising: economic experts brought on the recession, and financial experts couldn’t manage risk

12. Agency issue • Ensuring that government officials act on behalf of citizens • Information is key—which is why transparency, right-to-know laws are so important • Incentives are important—which is why revolving doors are so dangerous and why campaign finance reform is so important

13. Designing systems of accountability • Always difficult • But especially in areas of “expertise” • Is independent central bank “right” system? • Political independence  easier to be “captured” by financial market • Less independent central banks (like those of India and Brazil) performed better • If independent, still could/should be representative • US Fed was not representative, not transparent—major flaws in governance which have inflamed popular reaction

14. Dysfunctional Dynamics • Large inequalities can undermine social cohesion • Which In turn may undermine the political process • Worry that state will engage in redistributions • And wealthy are less dependent on public provision of services • Result: constraints on spending, weakening of government • Impairing crucial investments in education, infrastructure, technology • Decaying education, social protection more inequality • Contrast with successes in Scandinavia • GDP is a bad measure, but even on that measure they perform well • Even the successful East Asian countries had low inequality • Key to their success

15. The world at the brink • Unemploymentin Europe and America stillunacceptably high • Even 4 years after bubble burst, hundreds of billions spent on banks • Riskof another financial crisis and another downturn • 2008—US exported toxic mortgages and crisis • Now Europe is returning the favor • Europe’s political problems worse than those of the US • European project was “top down” • Inadequate participation from citizenry • Lack of support for “European solution” not surprising • Evidence that we didn’t do what was needed to be done • If another financial crisis occurs, won’t be able to take same actions as last time • And global coordination that marked last response will be missing

16. Underlying crisis is another redistributive battle • Resources (human, physical, intellectual, and natural capital) same as before the crisis • Though management of crisis may have undermined social capital • Real output after the crisis—after we eliminate distortions associated with the bubble—should be even higher than before the crisis • Key problem—claims on resources exceed resources • Battle over whose claims are honored • In that battle, all will lose, as wealth gets destroyed • Debt restructuring can make everyone better off • Inflation is a slow process of writing down the “real” debt • But in current environment, neither is likely to happen • Implying extended period of malaise

17. Long-run prosperity requires BALANCE of market and government • Restoring social cohesion • Creating a “fairer” society • Necessary to make our economy function better, more stably • Increasing recognition of link between instability and inequality (IMF) • But also necessary to make our politics function better, more stably • We need to create a more responsive politics, with more inclusive participation

18. Creating a more responsive and inclusivepolitical process • Changes in technology have given us new tools • Changes in technology/information make failures even more apparent • Political reforms can change current unfavorable dynamic • Campaign contributions, mandatory voting, more effective right-to-know laws • “Reinventing government” to make it more responsive and accountable • Public support of media, restrictions on media concentration

19. Politics and economics: inseparable • Politics sets the rules of the game • Unless the rules are set right, the game is neither efficient nor fair • And such a political/economic system will not be sustainable