Davos Man’s Depression

by Joseph E. Stiglitz

Joseph E. Stiglitz, professor of economics at Columbia University, and recipient of the 2001 Nobel Prize in Economics, is co-author, with Linda Bilmes, of The Three Trillion Dollar War: The True Costs of the Iraq Conflict.

NEW YORK - For 15 years, I have attended the World Economic Forum in Davos. Typically, the leaders gathered there share their optimism about how globalization, technology, and markets are transforming the world for the better. Even during the recession of 2001, those assembled in Davos believed that the downturn would be short-lived.

But this time, as business leaders shared their experiences, one could almost feel the clouds darkening. The spirit was captured by one speaker who suggested that we had gone from "boom and bust" to "boom and Armageddon." The emerging consensus was that the IMF forecast for 2009, issued as the meeting convened, of global stagnation - the lowest growth in the post-war period - was optimistic. The only upbeat note was struck by someone who remarked that Davos consensus forecasts are almost always wrong, so perhaps this time it would prove excessively pessimistic.

Equally striking was the loss of faith in markets. In a widely attended brainstorming session at which participants were asked what single failure accounted for the crisis, there was a resounding answer: the belief that markets were self-correcting.

The so-called "efficient markets" model, which holds that prices fully and efficiently reflect all available information, also came in for a trashing. So did inflation targeting: the excessive focus on inflation had diverted attention from the more fundamental question of financial stability. Central bankers' belief that controlling inflation was necessary and almost sufficient for growth and prosperity had never been based on sound economic theory; now, the crisis provided further skepticism.

While no one from either the Bush or Obama administrations attempted to defend American-style free-wheeling capitalism, European leaders argued for their "social market economy," their gentler form of capitalism with its social protections, as the model for the future. And its automatic stabilizers, with spending automatically increasing as economic woes increased, held out the promise of moderating the downturn.

Most American financial leaders seemed too embarrassed to make an appearance. Perhaps their absence made it easier for those who did attend to vent their anger. The few labor leaders who work hard at Davos each year to advance a better understanding of the concerns of working men and women among the business community were particularly angry at the financial community's lack of remorse. A call for the repayment of past bonuses was received with applause.

Indeed, some American financiers were especially harshly criticized for seeming to take the position that they, too, were victims. The reality is that they were the perpetrators, not the victims, and it seemed particularly galling that they were continuing to hold a gun to the heads of governments, demanding massive bailouts and threatening economic collapse otherwise. Money was flowing to those who had caused the problem, rather than to the victims.

Worse still, much of the money flowing into the banks to recapitalize them so that they could resume lending has been flowing out in the form of bonus payments and dividends. The fact that businesses around the world were not getting the credit they need compounded the grievances expressed at Davos.

This crisis raises fundamental questions about globalization, which was supposed to help diffuse risk. Instead, it has enabled America's failures to spread around the world, like a contagious disease. Still, the worry at Davos was that there would be a retreat from even our flawed globalization, and that poor countries would suffer the most.

But the playing field has always been unlevel. How could developing countries compete with America's subsidies and guarantees? So how could any developing country defend to its citizens the idea of opening itself even more to America's highly subsidized banks? At least for the moment, financial market liberalization seems to be dead.

The inequities are obvious. Even if poor countries were willing to guarantee their deposits, the guarantee would mean less than that from the United States. This partly explains the curious flow of funds from developing countries to the US - from whence the world's problems originated. Moreover, developing countries lack the resources to engage in the massive stimulus policies of the advanced countries.

Making matters worse, the IMF still forces most countries that turn to it for help to raise interest rates and lower spending, worsening the downturns. And, to add insult to injury, banks in advanced countries, especially those receiving aid from their governments, seem to be pulling back from lending in developing countries, including through branches and subsidiaries. So the prospects for most developing countries - including those that had done everything "right" - are bleak.

As if all this were not enough, as the Davos meeting opened, America's House of Representatives passed a bill requiring American steel to be used in stimulus spending, despite the G-20's call to avoid protectionism in response to the crisis.

To this litany of concerns we can add the fear that borrowers, wary of massive American deficits, and holders of US dollar reserves, worried that America may be tempted to inflate away its debt, might respond by draining the supply of global savings. At Davos, those who trusted the US not to inflate away its debt intentionally worried that it might happen unintentionally. There was little confidence in the none-too-deft hand of the US Federal Reserve - its reputation marred by massive monetary-policy failures in recent years - to manage the massive buildup of debt and liquidity.

President Barack Obama seems to be offering a needed boost to American leadership after the dark days of George W. Bush; but the mood in Davos suggests that optimism and confidence may be short-lived. America led the world in globalization. With American-style capitalism and America's financial markets in disrepute, will America now lead the world into a new era of protectionism, as it did once before, during the Great Depression?


Copyright: Project Syndicate, 2009.

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