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Continually Mistaken, Chronically Admired

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Continually Mistaken, Chronically Admired

The work of Nobel Prize-winning economist Joseph Stiglitz is a study in elite myopia. September 20, 2018
Economy, finance, and budgets

In 2006, Nobel Prize–winning economist Joseph Stiglitz praised the economic policies of Hugo Chávez. The Venezuelan president ran one of the “leftist governments” in Latin America that were unfairly “castigated for being populist,” Stiglitz wrote in Making Globalization Work, published in September of that year. In fact, the Chávez government aimed “to bring education and health benefits to the poor, and to strive for economic policies that not only bring higher growth but also ensure that the fruits of the growth are more widely shared.” In October 2007, Stiglitz repeated his praise of Chávez at an emerging-markets forum in Caracas, sponsored by the Bank of Venezuela. The nation’s economic growth rate was “very impressive,” he noted, adding that “President Hugo Chávez appears to have had success in bringing health and education to the people in the poor neighborhoods of Caracas.” After the conference, the Nobel laureate and the Venezuelan president had an amicable meeting.

Stiglitz is a figure to be reckoned with, not just for his past impact on policy but for the influence that he might wield in future Democratic administrations. University Professor at Columbia, former chairman of President Bill Clinton’s Council of Economic Advisers, former chief economist at the World Bank, and author of more than 30 books, Stiglitz has been publicly associated with New York mayor Bill de Blasio and Senator Elizabeth Warren of Massachusetts, both of whom might bring him along if they win higher office. But how could an economist with his presumed sophistication publicly endorse the disastrous policies of Hugo Chávez?

A former academic wunderkind, Stiglitz became a full professor at Yale at 26 and received the prestigious John Bates Clark medal in 1979 for economists under 40. He rose to distinction with research on the nature of “market failure” while giving scant attention to the failures of government, the intervention of which he usually advances as a needed remedy. Stiglitz won the Nobel in 2001, along with two other economists, for his analysis of “markets with asymmetric information,” which, in his own words, involves cases in which “some individuals know something that others do not”—a category with broad applicability, since relatively few transactions between humans involve the same amount of knowledge. A general name for Stiglitz’s field is “information economics,” which—again, in his words—has “explored the extent to which markets and other institutions process and convey information.”

From Stiglitz’s perspective, markets are rife with failure in processing and conveying information, and government must be ready to correct these failures. In his Nobel lecture, Stiglitz spoke of having “undermined” the free-market theories of Adam Smith, asserting that Smith’s “invisible hand” either didn’t exist or had grown “palsied.” He noted that major political debates over the past two decades have tended to focus on the “efficiency of the market economy” and the “appropriate relationship between the market and the government.” His approach favored government. This context helps explain his endorsement of Chávez; his public assent to a minimum-wage hike, a policy that he had earlier opposed, in a textbook he authored; and his notorious 2002 finding that the risk of government-sponsored enterprises Fannie Mae and Freddie Mac defaulting on their debt was “effectively zero.”

As Stiglitz stressed in his Nobel lecture, “perfect competition is required if markets are to be efficient” (italics his). He was right that by challenging the idea of perfectly competitive markets, information economics signified a paradigm shift. But perfect-competition theory is so abstract that only economists blinded by their own mathematical proofs could possibly subscribe to it. Any institutions created and run by fallible human beings are bound to fail. Then again, these same human beings run the governments in which Stiglitz places such trust.

Stiglitz has largely gone silent on the calamity in Venezuela, though he had praised the country’s socialist economic policies in earlier years. (AP Photo/Ariana Cubillos)

Stiglitz’s advocacy for a higher minimum wage is a curious tale, involving, as it does, a renunciation—without ever saying so—of his own scholarly work. As chairman of Clinton’s Council of Economic Advisers from 1995 to 1997, Stiglitz faced a common dilemma among economists in progressive policy circles: whether to support a higher wage floor. If you’re explaining economics in a textbook, it’s difficult to avoid pointing out that when something costs more, people will buy less of it. As Stiglitz had sensibly written in his 1993 book, Economics, “If the government attempts to raise the minimum wage higher than the equilibrium wage, the demand for workers will be reduced and the supply increased.” Yet it was hard to imagine Clinton, who proposed raising the federal minimum wage, taking the opposite tack on the grounds that those “who might have been employed at the lower market equilibrium wage . . . [would not] find employment,” as Stiglitz had written. Stiglitz had even opined that the minimum wage was “not a good way to deal with the problems of poverty. Other government programs need to be designed to address these problems.” But as Clinton’s chief economic advisor, Stiglitz gave a thumbs-up to raising the federal wage floor.

An April 12, 1996, editorial in the Wall Street Journal cannily quoted from Stiglitz’s textbook and wondered why he no longer agreed with it. In a letter to the editor, Stiglitz conceded that the minimum-wage hike would have a negative effect on employment but not a “significant” one. He did not quantify the insignificance.

In the fourth edition of his textbook, in 2006, coauthored with another economist, Stiglitz endorsed the minimum wage on the grounds that it benefits firms by discouraging shirking. He writes: “Workers have to be motivated to work hard. High wages lead to increased productivity, less absenteeism, and lower labor turnover.” Why don’t profit-seeking employers already know this and set wages accordingly? Anticipating this point, Stiglitz adds: “Presumably, rational firms would take these consequences into account in setting wages.” But instead of permitting firms to sort this out on their own, the government must act: “Even so, if the government forces firms to pay higher wages through minimum wage legislation, the increased productivity may largely offset the increased wages, making the employment effect very small.”

Those seeking to assess Stiglitz’s record honestly should consider his work on mortgage markets in the years leading up to the financial crisis. In 2010, Stiglitz published Freefall, a book about the bursting of the housing bubble and the ensuing massive defaults on mortgages that triggered the financial meltdown of 2008–09. Freefall was a more personal version of a September 2009 study that he had done for the UN, published as The Stiglitz Report, on the financial crisis, which declared: “Governments, deluded by market fundamentalism, forgot the lessons of both economic theory and historical experience which note that if the financial sector is to perform its critical role, there must be adequate regulation.” Echoing this judgment in Freefall, he speaks of market failures that policymakers must fix.

Stiglitz’s proposal for how future meltdowns can be prevented: empower incorruptible regulators, smart enough to do the right thing. “[E]ffective regulation requires regulators who believe in it,” he wrote. “They should be chosen from among those who might be hurt by a failure of regulation, not from those who benefit from it.” Where can these impartial advisors be found? His answer: “Unions, nongovernmental organizations (NGOs), and universities.” An effective regulator, in other words, sounds a lot like Joseph Stiglitz.

In fact, regulatory agencies are already well staffed with economists boasting credentials of this sort, yet they still managed to get things wrong. Perhaps their collective failure stemmed from their lack of training from Stiglitz himself. “As I approached the crisis of 2008, I felt I had a distinct advantage over other observers,” he wrote in Freefall. “I was, in a sense, a ‘crisis veteran,’ a crisologist.”

Omitted from his credentials, however, was any mention of an August 1996 study titled “Some Lessons from the East Asian Miracle,” which failed to anticipate the crisis that erupted in East Asia the following year. In Stiglitz’s view, things were then working miraculously well in the region. Others had expressed skepticism; economist Alwyn Young of the London School of Economics, for example, took a somewhat dour view. By contrast, Stiglitz was consistently upbeat. For him, the key lesson of the “remarkable” and “sustained” success of these economies was that “government undertook major responsibility for the promotion of economic growth.”

Even more damning to Stiglitz’s “crisologist” credentials was another paper he failed to mention in Freefall: a March 2002 study, coauthored with Jonathan and Peter Orszag, on the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, and commissioned by Fannie Mae. Six years later, of course, the government bailed out these GSEs because of massive defaults on the mortgages that they held. Yet according to Stiglitz and his coauthors, the “probability of default by the GSEs” was “extremely small,” and “the risk to the government from a potential default on GSE debt” was “effectively zero.” Washington’s GSE bailout has been estimated at about $200 billion.

This research certainly bears on Stiglitz’s argument in Freefall that regulators should be trusted to prevent financial meltdowns. Yet the paper isn’t even cited on Stiglitz’s website, among hundreds of others listed. The staff at Fannie Mae must have agreed that the study was worth burying, since they removed it from their website, too.

Since the study was commissioned by Fannie Mae, the authors would presumably have gotten access to the GSE’s books to conduct their assessment. But in their report, they make no mention of mortgages held or guaranteed. Had Stiglitz and his collaborators done their due diligence, they would have uncovered a disconcerting trend. A team of economists at the American Enterprise Institute later revealed that, by 2001, the mortgages held or guaranteed by Fannie and Freddie were getting noticeably riskier. One cause for concern was that monthly mortgage payments had risen sharply relative to borrower income. Another was that a growing share of borrowers weren’t even fully documenting their income. Noticing these trends, Stiglitz and the Orszag brothers might have advised Fannie to try to determine why risk was increasing, and consider steps to curtail it. That didn’t happen. In the years following 2001, the risk profile of the mortgages held by Fannie and Freddie grew far worse.

In a 2011 book, Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation, Jeffrey Friedman and Wladimir Kraus contest Stiglitz’s claim that regulations could have prevented the disaster, if implemented by the right people. Speaking of the regulators whom Stiglitz impugns, Friedman and Kraus observe: “Virtually all decision-making personnel at the Federal Reserve, the FDIC, and so on, are . . . university-trained economists.” However, “[t]hey simply interpreted the information they possessed differently from the way Stiglitz thinks, in hindsight, they should have interpreted it.” The authors argue that Stiglitz’s mistake is “consistently to downplay the possibility of human error—that is, to deny that human beings (or at least uncorrupt human beings such as himself) are fallible.”

In speaking of the failure of regulation, Friedman and Kraus articulate a Hayekian view of the dispersion of imperfect information. Since mortgages were perceived, wrongly, as relatively safe—including by Stiglitz—regulators had provided incentives for banks to hold them. But had there been less regulation, there would have been a diversity of views, rather than a homogeneous view imposed by the regulators. Some financial institutions would have held mortgages; but others, which perceived greater risks in these instruments (and the authors provide examples), would have stayed away. The system as a whole would have been less vulnerable.

Without the benefit of hindsight, did Hugo Chávez deserve Stiglitz’s praise in October 2007 for a commitment to “economic policies that . . . bring higher growth” and to improving the lot of the poor? Writing in the New York Review of Books about the “humanitarian crisis of immense proportions” that has gripped the country, journalist Enrique Krauze observes: “None of the present crises seemed likely in 2007 and 2008.” He then clarifies the main source of the complacency: “Caracas was seen as the new Mecca for the European, Latin American, and American left.” Regarding those to whom the crises did not seem likely, Krauze rounds up the usual suspects. “Progressive news organizations, magazines, and newspapers,” he writes, “including The Guardian, The New Yorker, and the BBC reported favorably on Hugo Chávez,” as did “writer Alma Guillermoprieto,” who had “succinctly noted” that the Venezuelan president was “indisputably fascinating, and often even endearing.”

It’s true that Stiglitz had plenty of company among progressives in endorsing Chávez, but this hardly absolves him. When he met with the Venezuelan president in October 2007, there might have been no point in confronting the “endearing” leader with the civil rights abuses cited against him at the time. (In May, the Americas director of Human Rights Watch had publicly protested Chávez’s decision to shut down a television station critical of his policies.) As an economist with prestige and influence, though, Stiglitz might have urged that Chávez loosen his government’s chokehold on the private sector before it did lasting damage to the economy.

Stiglitz himself had acknowledged that the soaring price of oil was largely fueling Venezuela’s growth. When Chávez took office in February 1999, the world price of a barrel of crude was a little over $10. By October 2007, it had vaulted to more than $82, and would soon rise above $100. A prolonged slump in the oil price, which no responsible steward of a major exporting nation can rule out, would likely bring stagnation or worse, hitting those “poor neighborhoods of Caracas” especially hard. (Over the past three and a half years, the price of oil has averaged $55 per barrel.)

If Caracas had achieved status as the Mecca of the Left, that in itself should have been regarded as an indication that the government’s policies would be—and already were—a major drag on the economy. An AP story in February 2007 conveyed the chaotic effects of the government’s extensive price controls. The story reported shortages “since early 2003, when Chávez began regulating prices for 400 basic products as a way to counter inflation.” Stiglitz was aware of Venezuela’s 15.3 percent inflation rate but said that it posed no great problem. By 2017, the inflation rate was more than 2,000 percent.

Stiglitz also would have had access to two authoritative sources released in September 2007 on the Chávez government’s leap to the left. One was an update of the Fraser Institute’s report, “Economic Freedom of the World.” Based on the institute’s index of economic freedom for 141 countries through 2005, the most recent year for which comprehensive data were available, the study found that Venezuela ranked 135th—down substantially since 2000, the first full year of the Chávez presidency—and was now grouped with impoverished African countries, whose governments were notorious for throttling markets. Key components of Venezuela’s index that had declined since 2000 included free trade, the integrity of the legal structure, and the security of property rights. Research had long shown that countries with more economic freedom grow more rapidly and achieve higher levels of per-capita GDP—and vice versa.

Also in September 2007, the World Bank—Stiglitz’s former employer—released “Doing Business: 2008,” which reported that Venezuela was among the countries that “had the largest negative reforms.” As of June 2007, it ranked 172nd out of 178 countries surveyed in terms of the overall measure of “ease of doing business.” According to the report: “Doing business [in Venezuela] was already hard. In 2006/07 it got harder. Exporters now need a separate license for each transaction. To get the license, they must submit proof of identity and solvency—documents that themselves must be frequently renewed. The time to export stretched to 45 days, barely faster than in landlocked Burundi.” The report’s authors added, with intentional irony: “But slow clerks need not worry about losing their job: Venezuela also expanded its ban on firing workers to cover anyone who earns less than three times the minimum wage.”

By 2013, when Chávez died of cancer, Venezuela’s index of economic freedom had fallen to 157th out of 157 countries surveyed in that year. Its “ease of doing business” ranking had ticked down to 181st place out of 189 countries surveyed. According to New York University development economist William Easterly, by 2013 the government’s interest-rate controls had destroyed the banking sector. Adjusted for inflation, interest on savings deposits ran negative 19 percent—and by 2015, negative 48 percent. Today, under President Nicolás Maduro, the country’s “ease of doing business” ranking has fallen even further, to 188th out of 190.

The decline in the oil price from triple-digit levels removed the one major source of income supporting the economy—though the $55 average price remains nearly three times higher than in the 1990s. Not that Stiglitz has tried to blame the country’s economic collapse solely on the slump in the oil price. Instead, he seems to have gone silent on the subject. In his 2017 book, Globalization and Its Discontents Revisited, he analyzes economic successes and failures in Asia and Latin America, but except for brief references, he makes no mention of the calamity in Venezuela.

By late 2017, Venezuela’s inflation rate exceeded 2,000 percent. (Photo by Roman Camacho/SOPA Images/LightRocket via Getty Images)

Chávez wasn’t the only economic strongman and human rights abuser who won Stiglitz’s endorsement. Meles Zenawi, Ethiopia’s dictator from 1991 until his death in 2012, hosted the Nobel laureate in September 2007. “It’s good to be back in Ethiopia,” Stiglitz wrote that month in the New York Times. “I met with the Prime Minister and several of his economic advisors last week to talk about how Ethiopia can keep its economy growing.” He observes: “Ethiopia also receives a lot of aid from Western countries, partly because they feel the government uses it in ways that benefit the vast majority of the citizens.”

In his 2014 book The Tyranny of Experts, Easterly offers a corrective. On Zenawi’s concern for the public good, Easterly reports that, in 2005, the dictator’s security forces gunned down more than 100 students demonstrating against his refusal to accept the results of elections that went against him. On the trust that “Western countries” placed in Zenawi’s government, Easterly notes that donors were changing how aid was given in order “to respond to the public embarrassment of supporting a dictator who shot down demonstrators and jailed the opposition.” The changes involved “directing the aid to local governments rather than to the discredited national government. However, the tactic overlooked the reality obvious to everyone—that the national government controlled the local governments.” In 2010, Human Rights Watch documented that Zenawi had been withholding aid-financed famine relief from everyone except ruling party members.

“In his focus on market failure,” says Easterly, who has known Stiglitz since their World Bank days, “Joe often misses the bigger problem—the need to roll back the disastrous distortions of markets by government—such as government-induced hyperinflation, negative real interest rates, severe price controls, and punitive taxes on exports.”

Stiglitz’s apparent assumption that smart and right-thinking regulators can’t make mistakes can manifest itself in an evident contempt for those with opposing views. In July 2002, just after the publication of Stiglitz’s book Globalization and Its Discontents, Kenneth Rogoff, then director of research at the International Monetary Fund, released an open letter to the author, objecting to Stiglitz’s penchant for lashing out at intellectual adversaries. Stiglitz had publicly insulted IMF staff as “third-rate economists from first-rate universities.” Stiglitz had also made the unsubstantiated accusation that a potential job offer from Citibank had compromised IMF managing director Stanley Fischer’s integrity. This character assassination enraged Rogoff and disturbed Easterly, who had also worked with Fischer and deeply respected him.

In his open letter, Rogoff recalls a story from the late 1980s. Stiglitz was asking Rogoff and another colleague whether Paul Volcker merited his vote for a tenured appointment at Princeton. “At one point,” Rogoff wrote, addressing Stiglitz, “you turned to me and said, ‘Ken, you used to work for Volcker at the Fed. Tell me, is he really smart?’ I responded something to the effect of ‘Well, he was arguably the greatest Federal Reserve Chairman of the twentieth century.’ To which you replied, ‘But is he smart like us?’ ” Rogoff tells Stiglitz that the story is “emblematic of the supreme self-confidence you brought with you to Washington, where you were confronted with policy problems just a little bit more difficult than anything in our mathematical models.” Rogoff’s letter continues: “Throughout your book, you betray an unrelenting belief in the pervasiveness of market failures, and a staunch conviction that governments can and will make things better. You call us ‘market fundamentalists.’ We do not believe that markets are always perfect, as you accuse. But we do believe there are many instances of government failure as well and that, on the whole, government failure is a far bigger problem than market failure in the developing world.”

Other Stiglitz critics see stubbornness as a key flaw. “There are many things wrong with Stiglitz as a policy economist,” says economist​ Jagdish Bhagwati, also a University Professor at Columbia. “One is that he doesn’t learn from his mistakes. A New York Times story once quoted me as saying his ‘Initiative for Policy Dialogue’ should more accurately be called ‘Initiative for Policy Monologue.’ ” An even harsher judgment comes from another Columbia colleague, who spoke on condition of anonymity: “Joe’s career tragically demonstrates that if one combines legitimate credentials as a clever and creative theorist with extreme left-wing bias and a colossal ignorance of history, one can accomplish a great deal of harm in the world.”

Though he has amassed a track record scarred with dubious prognostication and mistaken analysis, Stiglitz remains highly regarded among mainstream media elites, including the New York Times’s Paul Krugman, who calls him “an insanely great economist.” And Stiglitz remains influential in policy circles. In October 2017, he was named cochair of the Commission on Global Economic Transformation, teaming up with NYU professor Michael Spence, one of the economists who shared the Nobel with him in 2001. Though the Obama administration treated him like an outsider, Stiglitz could make a comeback if a Democrat wins the White House in 2020. He joined Senator Warren in criticizing Obama for supporting the Trans Pacific Partnership, or TPP, which Trump has since scuttled. He serves as chief economist with the Roosevelt Institute, which, according to its website, exists “to carry forward the legacy and values of Franklin and Eleanor Roosevelt by developing progressive ideas and bold leadership in the service of restoring America’s promise of opportunity for all.”

In May 2015, Senator Warren and Mayor de Blasio, two ambitious Democrats, joined Stiglitz at a press conference to release the Roosevelt Institute report “Rewriting the Rules of the American Economy: An Agenda for Growth and Shared Prosperity.” The report—which proposes to “make health care affordable and universal by opening Medicare to all” and to “create a public option for the supply of mortgages”—was aimed at influencing Hillary Clinton, then seen as the next president. Perhaps Warren will succeed where Clinton did not. Stiglitz may then have a final shot at shaping U.S. economic policy. If he becomes chairman of President Warren’s Council of Economic Advisers in early 2021, he’ll be 78. Alan Greenspan did not step down from the chairmanship of the Federal Reserve until age 80, and Paul Volcker was well past 80 when he served as advisor to President Obama. Stiglitz’s worst may be yet to come.

Top Photo: Though he has amassed a track record scarred with dubious prognostication and mistaken analysis, Stiglitz remains highly regarded among mainstream commentators, including the New York Times’s Paul Krugman, who calls him “an insanely great economist.” (Jacques Demarthon/AFP/Getty Images)

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