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Stiglitz: the full transcript

Ben Chu

Pg 6 bank charlie1 150x150 Stiglitz: the full transcriptMy interview with Nobel economics laureate Joseph Stiglitz in the Indy this morning is here. Please ignore the exaggeration in the headline; he didn’t “run” the World Bank. He was its chief economist and senior vice president for development policy.

Space in the paper was limited so, for those interested, the full transcript is below.

There’s some interesting stuff in there. Stiglitz says that the Vickers reforms to ringfence retail banking pobably don’t go far enough. He proposes a theory on why Germany practices left-wing economics at home but right-wing economics abroad (there’s a solidarity gulf). He also explains why China can combine high growth with high inequality. Have a look at his answer, too, to the question of how high marginal tax rates should be to curb inequality and discourage rent seeking. 70%? That’s just the start…

Enjoy:

One of your great economic contributions to economic theory was showing that information asymmetry unravelled the theory that markets were perfectly efficient. But that that didn’t really change the wider culture and many people carried on believing that markets were perfect. The Libor fixing scam is, in one sense, an example of information asymmetry in practice. So could this be a “teachable moment”?
Exactly. In so many ways it’s a textbook illustration. Where there are these asymmetries a lot of these activities are directed at rent seeking – that was one of my original points. It wasn’t about productivity it was taking advantage. It was clear that was what these guys [at banks] were about – it wasn’t about creating wealth. The other point I raised in my research is that the asymmetries were endogenous and could have been affected by policy. The banks created the non-transparent market. And policies that force them to be more transparent would have curtailed this.

What should those policies be? In the UK we’re ring-fencing retail banks. Does that go far enough? Or should we have a complete separation?
There are several lines to the policy debate. One line I’ve been emphasising is greater transparency. So there’s part of the debate about the ability of the banks to impose risks on others. There’s part of the debate which is about trying to get the banks to do for others what they’re supposed to do – perform a social function. Part of the debate is about reducing their scope for manipulation. All these are part of the debate. The Libor scandal is on the transparency side. The ring fencing is about the risk of imposing costs on others. The original Glass-Steagall Act [in the US, which mandated a separation of retail and investment banks after the Wall Street Crash] was actually an attempt to encourage the commercial banks to both focus on lending and an attempt to prevent a conflict of interest, which are very strong when you have the two sides together. It was a dual function. The kind of ring-fencing in the UK, does it go far enough in protecting and redirecting? Probably not. Plus, if you haven’t addressed the other issues of conflict of interest, excessive risk taking, you can still have to bail out…remember Lehman Brothers was an investment bank, it was ring-fenced! We need to think about the structural. It’s an important component. But the structural reform is necessary, but not sufficient.

You say economic actors shape markets via policymakers. We have a lot of lobbying by bankers of politicians. Should that be banned? Or is it inevitable?
You would not want government not to know what the industry believes. The problem is when the government takes seriously what the industry says.

So where do you draw the line?
For every meeting that the government has with business leaders, it [should] have to have a meeting with the labour groups and the representatives of civil society and with the think tanks. The problem today is that there’s not equality of access. People today are worried they’re hearing the banks’ view. Take, for instance, the example of leverage. Banks say that increased capital requirements, reduced leverage, will force them to increase the cost of capital. Most economists think that’s nonsense. The bankers who are supposed to know about finance, show no evidence of understanding finance. I don’t know if you know about the Modigliani Miller theorem…

The more capital you have the cheaper your funding costs because you’re less likely to go bust…
Well, the only reason that it would not be true is that the more leverage, the bigger the bailout. So every economist understands, the more leverage, the higher the cost of capital, the more risk. The bankers don’t. They may be right [in the view that more capital pushes up the cost of capital], but that only reinforces the bail-out problem. So every time you have a banker in there, if you had a group of economists in there saying, I’m sorry, they’ve just proven once again that they don’t know their job. They have just proven why you have to regulate them.

But that raises something you raise repeatedly in your book. Finance plays such a major part in campaign finance and the funding of political parties.
And that’s why the rules of governance are critical. That’s why the key part of the book is the connection between inequality of politics and inequality of economics. That brings us to these rules that reinforce inequality. Everybody knew that there was this scope for Libor manipulation. Many economists couldn’t believe that it wasn’t going on. We’re focusing on the bankers but at the micro economic level this goes on all the time. I was party to a suit in the state of Alaska. Oil companies were supposed to pay the state royalties – 60 per cent of the net price, the price of oil net of their transportation costs. They manipulated the transportation costs. They had to pay the state of Alaska $1bn. Stealing a penny a time. For every gallon, they stole a penny, or a fraction of a penny. This is in the nature Adam Smith’s invisible hand when there is a lack of transparency.

There is a lot of talk here about changing the culture – that we have to make these people better people. You seem to be saying, no, it’s about the incentive structures.
In one of my earlier books I said, bankers weren’t born bad, for the most part. They were often some of our best students. But when you give people that much money, make it so easy to steal, it makes corruption easy. Not everybody. I don’t want to underestimate the value of improving the culture. Better teaching of ethics – that has a role. But the reality is that if you have enough temptation – ie you don’t solve the policy problem – then it will be corruption.

The present generation of financiers – it’s pretty much the same people in charge as before the crash. Doesn’t that whole generation needed to be cleared out because they are so entrenched and have so much invested in the status quo? Or can they survive if you change the incentive structure? Can it still work with them in charge?
Not all of them are bad. Different parts of the banking system had different cultures. The trading part of the banking system had a particularly bad culture from what most people say. Those focusing on long term deals were better. Private equity had a very bad culture. The stories of Bain in the US – excess leverage, firing workers, taking your money out and letting a company go bankrupt. [That was] a business model that worked for a few people, but didn’t work for our economy. Banking is not one activity. But I think there is a sense in which a cohort effect – that cohort was a go-go cohort. One of the questions that I have not seen in the British press is the extent to which British culture has been affected by American banking culture. Particularly certain people [Bob Diamond]. After the [1986] Big Bang, you attracted the worst behaviour form the US. It’s probably not an accident that the AIG office was here…It was an example of this race to the bottom, with disastrous consequences. The reason I like this scandal is that it illustrates the main thesis of the book. A lot of inequality is rent seeking. Inequality doesn’t lead to more efficiency. This rent-seeking activity actually interfered with the workings of a very important market. So it was negative sum.

If Bob Diamond rode out this wave of outrage, would you regard that as a worrying sign about our ability to hold these people to account?
Obviously there will be some consequences. But what I find surprising is that Diamond didn’t say, “my bonus in the past was based on profits, part of which were attributable to manipulation. I’m going to give up my past bonuses that were in any way touched by that”. He didn’t say that. It’s all about my future bonus. The question is: what about your past bonus? That was all based on phoney numbers.

If the Government was to say  previous bonuses should be clawed back – is that a something you’d advocate? It would be difficult legally…
We have a legal system that may not force full accountability. That says clearly these guys have gotten away with it. That ought to change. That means legislation. We should recognise that we’ve seen so many events were the banks and others have engaged in rent seeking, creating inequality, ripping off other people, and none of them have gone to jail. None of them have been prosecuted individually. Banks are people. The irony is that most of these cases, if you look at what happened, the bank pays a fine. Who pays the fine? It’s the shareholders. But the shareholders have usually been ripped off as well by the managers. So the managers sit there exploiting not only borrowers but also the shareholders. In the case of the UK, I gather the fines go to the FSA [Financial Services Authority], reducing the need for the tax that they impose on the banks. So the banks pay the fine and other banks benefit. It’s redistribution among the banks. They’re all guilty of these things. You pay this time, I’ll pay this time. It costs them zero. So we have a system of very weak accountability and no individual accountability. And clearly that’s the way they wanted it, but that’s not a system of justice. That’s another theme of my book. Not only have we paid the price in terms of economic performance, but in terms of our democracy and in our system of justice. How to fix that? In New York we have a very broad law called the Martin Act, which basically says if you commit things that are equivalent to fraud, you’re liable. We’re not going to spell out every possible thing you could, because there are an infinite number. Even if you did not have a law against manipulation of the market, you should have had legislation that was broad enough to say “this is market manipulation, if you do this you’re guilty”. If you don’t have legislation like that, there’s something wrong. This [the Martin Act]  was a state law, in only one state. No one was prosecuted over robo-signing [a scandal of automatic foreclosures by US banks]. You don’t have a robo signing system without someone above designing it.

You wrote a whole book about how wrong the IMF was in its attitudes in the 1990s. Do you think it has reformed as an institution now?
The IMF under Dominique Strauss-Kahn in the European crisis was the best. That was pretty well known. They argued that you needed to restructure the debts, write down the losses, you couldn’t push excessive austerity. In the Iceland programme you even had capital controls. [But] these are large organisations, and many country officers weren’t fully on the programme. So there’s a diversity. In Ireland they were probably the best of the Troika.

But they didn’t prevail. The ECB and the EC have been almost as hard line as the IMF was in South Asia. That must be depressing for you to see Europe going that kind of ideological route…
Not a total surprise because Europe’s view are very strongly affected by Germany’s. Germany’s views have often been very orthodox neo-liberal. Strauss-Kahn was a good economist and he understood that was the effect of austerity, the need to stabilise financial markets, the need to restructure debt. So he was reflecting the non neo-liberal view. You would have thought that 2008 would have destroyed the neo-liberal school, this view that markets always work. And yet, what is striking about the German view today, about Merkel, is she keeps saying you do the right thing and reward you. As if markets are these rational…Secondly, she doesn’t understand that to the extent that markets are rational, if you have austerity, the economy goes down, budgets don’t improve, so they don’t reward you. They don’t look at this as a morality play, they want to get their money back. We saw in the East Asia crisis [of the 1990s] that austerity was not rewarded. Exchange rates went down, no evidence of any effective bailout. So for me there’s some nostalgia here. Over and over in east Asia the US Treasury and the IMF would do something, it would have no effect, they would be surprised, they would do it again, it would have no effect, they would be surprised. We come back to Europe and we see exactly the same scenario. They have a given model, they try a little bit, it doesn’t work, they try a little bit more, it doesn’t work…but I don’t want to be too harsh. The course of economists has begun to get reflected in their rhetoric but not full in their actions. In the [EU] communiqué that came out last week they did two things that reflected what economists have been saying since the beginning. One is if the bailout is senior to other creditors you move everybody down and the markets don’t like that. So you bail it out and – boom – things get worse. It took them two years to discover one of the main lessons of the history of bailouts. The second thing, they said give money for governments to bail out banks and for money to banks to bail out governments is a bootstrap that is not going to work. They figured that out. But again it took them two years to figure that out. It makes you a little bit amazed that it took so long.

But the destructive forces of austerity have done so much damage already. Could this be a train that can’t be stopped now?
It is a train that still be stopped. But the relevant question is the politics in Germany. Have they created a in their rhetoric a dynamic that makes it difficult to stop. In particular Merkel’s rhetoric that the crisis was caused by profligacy. You know Spain had a surplus, Ireland had a surplus. Every belt tightening, the economy goes down and the results are disappointing. It’s been one tightening of the belt after another. The adjustments have been unprecedeneted. She’s hoisted herself on her own petard. She’s framed the issue as profligacy, rather than framing it as “the European system is fundamentally flawed”. We have a banking system that’s backed by each government. A banking system that is backed by its own government is state aid. Germany is providing more state aid than Ireland, than Spain, because Spain can’t. Money is going to flow to the banking system with more state aid. So it’s a violation of the basic principle of Europe. She has not recognised this yet.

You describe the German economic mentality as neoliberal. That’s interesting because it’s a much more social democratic place than the US and the UK. And yet these doctrines have taken root there. Isn’t that a puzzle to you?
There’s a distinction between the macro and the micro. And it raises the fundamental problem of solidarity. Within Germany there is a kind of solidarity, which has led them to help people who are disadvantaged. It’s worked pretty well. And so they believe you can have a European social model work without free riders. But there isn’t that solidarity outside the German borders. There’s a presumption that everyone is lazy and if you help them they will take advantage of you. That’s the contradiction. So you can see it as a lack of solidarity – people outside of your family don’t behave as they should.

Doesn’t it go further than that? The doctrine of the expansionary fiscal expansion, they thought it would work. They thought Greece would be growing by now. So it’s not just that the Greeks are lazy.
The macro model is widely held in Germany. They would likely impose on themselves. It is conceivable to me that they would take their own medicine. They have a very strongly held model that has been proven wrong over and over again.

That’s what’s interesting to me. They have the same ideology as Mitt Romney and David Cameron in terms of macro worldview…
You’re right. There’s a disjunction between this extraordinary right-wing macro and yet a micro that is more humane. And it’s partly because their micro works, that they’ve been deceived about the macro. There’s a lot of automatic stabilisers built into their system. They worked well in the crisis because incomes did not fall, the economy recovered more robustly. So they’ve got a micro that makes the macro perform better. We don’t have that. We’ve constructed a micro system – weak unemployment assistance, individual defined contribution pension schemes – all these kind of things make the system an automatic destabiliser. So we’ve weakened the safety net, made our system more unstable, increased inequality, made sure that in a downturn the bottom really suffer. In 2010 93% of all the gains went to the upper 1%. The median wealth was 40% in 2007-10, putting America’s real wealth back to early 1990s levels. So all the wealth accumulation over a two decade period went to the top.

But what about somewhere like Greece where there is widespread tax evasion. How do you tackle that?
Greece is another aspect of the flawed European system – system of full labour mobility in a world where you have national debt. What that means is that if you’re a young talented Greek person and you don’t want to pay back you parents’ debt you move. They thought complete labour mobility creates and efficient labour market, but the set of rules they have creates an inefficient labour market, because it’s driven not by where your productivity is highest but by your ability to escape liabilities. And that’s not efficient. I could be more efficient in Greece but because of the inherited debt I’ll have to pay higher taxes. And so I’ll leave. They didn’t grasp that free mobility without a European-wide tax system leads to inefficient labour allocation. This is another example of what you might call fake neo-liberalism. You pick up some doctrines, but not the others. And the other is corporations being able to move anywhere. That means you move to where the taxes are lowest. And so you get a race to the bottom in taxes as you do in regulation.

So you’d agree with Merkel on that point – that you need to harmonise tax rates?
Oh you clearly do – the basis of Ireland’s growth was tax competition, not efficiency. If I’m a rich Greek person I’m going to find a place to put up my residence and run my business. If you raise the taxes people are going to leave. So the reality is they’re not going to collect taxes from the rich.

When you put it like that it’s impossible to see a solution for Greece…
There is no solution for Greece by itself. But if Europe agreed to have a harmonised tax structure…If you’re going to participate in European business, for anybody [earning] over €100,000, you’re going to pay a European-wide surtax. And we’ll find some way of divvying it up. That would be part of a European fund that would make Europe work. That’s the way you get out. But you are not going to get a small country…

You say high inequality reduces growth. But that’s not true of China where there is huge inequality but 8-10% annual growth. So you’re talking about developed nations?
I’m talking mostly about developed countries. But two points about China. Different parts of the country have grown differentially, especially in the earlier stages. So the increase in inequality is as much a geographic dispersion. Those are not characteristics of Europe. And it’s a huge country, so geographic differences have more of an impact than they would in the UK. Every economy needs lots of public investments – roads, technology, education. Investments in the common goods. In a democracy you’re going to get more of those investments if you have more equity. Because as societies get divided, the rich worry that you will use the power of the state to redistribute. They therefore want to restrict the power of the state – as [Mitt] Romney does, it’s not a surprise – so you wind up with weaker states, weaker public investments and weaker public growth. China’s not a democracy. It actually works the other way round. Their sole legitimacy is economic growth so they have to deliver. Because they’re not a democracy they have been so good at growth. Not only are they good at growth, they’re good at poverty alleviation, because they have to deliver for the vast majority who were poor. So they deliver growth, poverty reduction. So in a way it’s a nexus between politics and economics, in a way that’s very different and works in just the opposite of ours.

In your book you say the maximum optimum tax rate may be as high as 70%. How would you advise governments to reach that? Should they simply put up taxes until revenues fall?
In fact the study on the 70% rate leaves out that a lot of the incomes at the top are rent seeking. And therefore if you tax that the economic consequences are positive. That means you ought to have even had a higher rate, which discourages rent seeking activities. I would tax speculators at a higher rate. That goes back to what we said about banking, because you diverting scarce resources from lending to gambling. So you redirect and make the economy more efficient. And land. You don’t get more land by taxing land at a lower rate – the supply of land pretty much is inelastic. But in a democracy you have to get a consensus and right now there is not a consensus behind a 70% rate. So what I would do is to raise it with the understanding that doing experiments is very difficult. There are lots of things that go on and the general electorate doesn’t always understand the counterfactual. So we do an experiment like raise the tax rate and we have a euro crisis and the economy goes down and somebody will say it’s because you raised the taxes. So one has to try to make people understand was there an adverse effect on the things that we care about.

Putting taxes on things that are “socially bad” implies a degree of expertise on the part of policymakers that many would say they simply don’t have. Is that fair?
If you think about the categories – there are things like inelastic like land, oil, natural resources. Not a lot of disagreement about that. Bads? Environmental, pollution – not a lot of disagreement. There are some areas like speculation where I think there’s a broad social consensus. But obviously the speculators think they’re engaged in constructive activities. That’s going to be a challenge. But no more difficult than any other tax. Because most people think that what they do is special. So there’s enough there. The hardest part is trying to identify monopoly rents. Because the natural response is that if we can identify, the anti-trust authorities ought to have dealt with it. That’s the one area where I can think it will be more difficult.

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  • http://twitter.com/Shinsei1967 Nick Reid

    I suggest Ben Chu has a look at one of his economics text books because he clearly misunderstands Modigliani Miller. It doesn’t state that the more capital you have the cheaper your funding costs. It states that (various things like taxes being excluded) there is no difference between funding your business with debt or equity.

  • http://twitter.com/BenChu_ Ben Chu

    Modigliani Miller showed that the argument of banks – that equity somehow “required” a higher rate of return than debt – was wrong. That is what the banks still argue today. If they are right in practical terms that is only (as Stiglitz points out) because of the implicit subsidy on the liabilities side of the balance sheet that these massive banks get from being too big to be allowed to fail by governments. Stop subsidising debt – ie create a credible threat that bond holders will lose their money if the bank is run badly – and its cost of capital for debt and equity will come into line.


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