Joseph Stiglitz: Economy Is In Shambles -- But So Is Our 'Economic Paradigm'

ft.com:

Today, not only is our economy in a shambles but so too is the economic paradigm that predominated in the years before the crisis -- or at least it should be.

It is hard for non-economists to understand how peculiar the predominant macroeconomic models were. Many assumed demand had to equal supply -- and that meant there could be no unemployment. (Right now a lot of people are just enjoying an extra dose of leisure; why they are unhappy is a matter for psychiatry, not economics.) Many used "representative agent models" -- all individuals were assumed to be identical, and this meant there could be no meaningful financial markets (who would be lending money to whom?). Information asymmetries, the cornerstone of modern economics, also had no place: they could arise only if individuals suffered from acute schizophrenia, an assumption incompatible with another of the favoured assumptions, full rationality.

Read the whole story: ft.com

Comments

[themodernleader]

10:05 PM on 08/22/2010

I doubt if there will result a paradigm shift to a more rational economic model. There is too much concentrated economic power to deny a model that has brought undreamt wealth and power to the few. That predatory capitalistic model will remain, until and if we elected courageous, prudent and democratic leaders.

[MuchMadness]

07:49 PM on 08/22/2010

Just make sure that economists start incorporating original sin and human depravity into their models, Professor Stiglitz.

[angry expat]

12:11 PM on 08/22/2010

Blah blah blah... The whole arena of economics is inherently fraudulent. It makes it difficult to impossible to live simply - to have shelter, to eat and to work in uncomplicated circumstances.

We have all been dragged into something even the top economists barely understand and cannot master. Welcome to the new slavery.

[AyeChart]

11:53 AM on 08/22/2010

Some make excuses for Obama: The economy took time to go bad, so he needs more time to fix it. That assumes that he is doing anything to fix it!

The US economy, big and unwieldy, indeed has some inertia--about 16-18 months, actually, for policy changes to be manifest. But Obama's tippy-toeing past that line already. And things are NOT getting better, but worse. The transient unemployment improvement was for census workers, mostly, and came and went. The bailout of teachers doesn't improve the economic outlook so either that has to run out or be reinstated at a cost of MORE deficit spending. Same with the bailouts of state budgets.

It's time to return to sanity, stop investing our time and money and lives in Utopian liberal schemes which are doomed to failure (stimulus, growing government, trying to micromanage the macroeconomy, trying to pick which technologies will be feasible some misty day in the misty future), and go back to what has worked.

"Let the free market run,
Let all the Dreamers wake the nation..
Come...the new Jerusalem!"

Paraphrasing the lovely and great and talented Carly Simon in her Oscar-winning song, "Let the River Run."

[shamanbart]

04:33 PM on 08/22/2010

Your Obama-bashing proves itself to be self-contradictory. In one breath you imply that he's not doing enough to help it, in the next breath, you suggest a hands-off approach.

The truths that Stieglitz touched on -- that incentives for banks and investors were for their own short-term good, not the good of the economy at large and that their models failed to predict the disaster, and that the "invisible hand" of the market is a fraud -- are all things that point to the fact that a change to these incentives, models and beliefs are necessary to rebuild the economy.

While the existing free market/capitalist system has been an efficient economic system, reforms are sorely needed to maintain the employment base in this country. Without that, we won't have the spending needed to sustain the whole economy.

My prescription for an economic stimulus would be to 1.) make student loan payments fully tax deductable and 2.) to offer government re-financing of consumer unsecured debt at good interest rates ( 1 - 4 %). That way, the young and the debt-ridden consumers can pay their debts off over time and free up spending money for the items that are needed. Much better than corporate giveaways or paltry tax reductions.

[AyeChart]

09:35 PM on 08/22/2010

Sorry for your reading comprehension problem. I said nothing of the sort. I didn't say he wasn't doing enough--I was saying he was doing precisely the wrong things!

Student loan payments would have nothing much to do with stimulating the economy, but make them tax deductible all you want. Heavens NO, no more governmental guarantees, refinancing, of consumer debt or anything else. That was a major cause of the problem. The government can't help politicizing these sorts of projects and creating havoc in the private sector.

[AyeChart]

11:41 AM on 08/22/2010

The Prof clearly exposes some irrational thinking in the economic models, just as the fallacies in the climate computer models have been exposed. The point about both is that there is simply insufficient knowledge and insufficient facts upon which to allow ivory-tower theorists to manage either the economy or the climate!

That's the beauty of the free market capitalist system. It manages the allocation of resources much more efficiently and wisely than all the ivory-tower professors and politicians and lawyers in the world combined.

It isn't perfect--it's just better than anything else!

In order to try to produce the economic Utopia of which liberals dream, they destroy the economy and impoverish more and more.

Has happened time after time, with Marx and Lenin and the SovUnion, for example, and even back in Roman days, and now the Obamians are trying it here. And it isn't working and it won't work. The problem is, can they be deposed before they finish the destruction?

[Lorianne]

12:46 PM on 08/21/2010

All this talk of recovery but no one ever asks: What are we recovering?

The economic system we had has made no sense and was unsustainable no matter who was in charge. An economy based on unsustainable levels of consumer spending, based on unsustainable levels of consumer debt, fed by unsustainable real estate valuation rise is NOT SUSTAINABLE.

The perpetual growth model we've had for the last 30-40 years is NOT SUSTAINABLE.

So, why are we trying to 'recover' ourselves back into an unsustainable economic system that both parties subscribe to?

[AyeChart]

11:42 AM on 08/22/2010

See above.

[AyeChart]

11:47 AM on 08/22/2010

Let's recover freedom and the free market (as free as we can make it while proscribing actual criminal behavior) and let it start cranking the economic engines and get us back on the road to reasonable and sustainable prosperity.

The dot-com bubble ginned up under Clinton burst; the housing bubble under Carter-Clinton-Bush finally burst. Bubbles will always come and go. But we don't have to let them take the economy down with them. The current problem is not that the housing bubble burst, but that the taxpayers were on the hook! Without the government backing of mortgages (through corrupt Fannie-Freddie), the banking institutions would not have had an incentive to package mortgages known to be risky. Without the Carter-Clinton administrations' mandating bad loans, banks would have had no incentive to make bad loans!

It was government interference in sound business principles that caused the problem. The solution is not more government, but less.

[Lorianne]

02:33 PM on 08/22/2010

Exactly, and as always, big lumbering inefficient centralized government causes problems when they interfere (and corrpt) the economic system. It does so no matter what the system, capitalism, socialism ... whatever.

Big is bad.
Small is beautiful.

[shamanbart]

04:50 PM on 08/22/2010

"It was government interference in sound business principles that caused the problem" -- FALSE
Lest you forget, it was the banking/mortgage/investment industry that
1. offered mortgages to buyers that couldn't handle them,
2. repackaged those as securities and sold them,
3. rated those securities as AAA rated,
4. sold credit default swaps and derivatives that were toxic.

The government assumed this industry would act in its self-interest and would correctly offer mortgages/sell securities/rate them, etc. reasonably and in accordance with good business practices. The industry monumentally failed to do those things.

You are correct though in saying we need to re-incentivize the banking/mortgage/investment industry to act responsibly. Taking away government backing such as FHA mortgages isn't the way, but perhaps greater government scrutiny of the products plus requiring banks maintain some "skin in the game" would do that.

[Chip W]

09:18 AM on 08/21/2010

How about one of the fundamentals of the current paradigm: We must have perpetual growth.
Of course that's not sustainable, and I wonder if the worldwide economic malaise is an indication that we're reaching the limits of growth.

[HMDMSR]

08:48 AM on 08/21/2010

http://openeconomicsnd.wordpress.com/2010/04/15/stiglitzs-new-agenda-economics-still-as-a-science/

Stiglitz is often said to practice heterodox economics.
From the above:
Stiglitz’s “New Agenda”: Economics Still As a Science
April 15, 2010 by Nick Krafft
As this Newsweek article points out, the INET conference challenged much of the previously accepted wisdom in mainstream economics:
Again and again, in different ways, the most perspicacious observers at the Cambridge conference drove this point home: rational models don’t work because there are too many unknowns to justify them. There is no real equilibrium in the real world. The models don’t compute. Literally.

See also:
http://rdwolff.com/content/100-words-heterodox-economics

[schatsie]

11:32 AM on 08/22/2010

Great links. and I like the term Heterodox economics.....

[HMDMSR]

11:51 AM on 08/22/2010

Thank you. If I might be so obnoxious as to recommend two more:

http://www.scientificamerican.com/article.cfm?id=brother-can-you-spare-me-a-planet
http://www.scientificamerican.com/article.cfm?id=the-economist-has-no-clothes

These were written by Robert Nadeau, and I think they could count as heterodox. In any case, he has several good books on Amazon.com that pursue the same line of thinking.

[guveqzero]

06:26 AM on 08/21/2010

Our economic model is still broken, after two years of nothing. The current policy makers move like snails recognizing that there is a problem let alone trying to fix one. Still, no action on trade, no action on companies exporting jobs, no action to improve the quality of our lives.

[ajwriter]

04:20 AM on 08/21/2010

This idea, that people acting in their own self interest will lead to the best outcome for the whole, has been misinterpreted as meaning that greed is good.
Actually, the need for autonomy is the primary self-interest. The greatest good comes about when the most people have the most control of their lives, time, and destinies possible in a world they must share with everyone else. The quest for money is usually part of that quest for autonomy. (See Daniel Pink’s book Drive.)

The Declaration of Independence mentions “Life, Liberty, and the Pursuit of Happiness” rather than money. Democracy was so successful because it has afforded more ordinary people more autonomy than ever.

Communism failed because it stripped ordinary people of that autonomy. The neoconservative idea of capitalism has also failed – ironically, for the same reason as communism (and the stratified tsarist system) did -- because concentrations of wealth can and do strip ordinary people of their autonomy just as effectively as (or, more efficiently than) malfunctioning government.

Laws to give ordinary people balancing powers -- for example certain kinds of strong consumer laws -- would have given the system necessary corrections all along (an invisible hand…) Individuals need power to make the right things happen at the level of every important interaction without requiring huge expenditure of resources like time (in a lawsuit, for example), which is finite for individuals.

(continued below)

[outnow]

10:33 AM on 08/23/2010

"individuals need power to make the right things happen at the level of every important interaction without requiring huge expenditures of resources like time (iun a lawsuit, for example), which is finite for individuals..."

Have you tried a magic wand to resolve disputes? An invisible hand?

It doesn't hurt to go to law school if you really want to change the situtaion in favor of comsumers; at least you would understand the issues.

When you can write consumer laws thart are self-enforcing, let me know.

[ajwriter]

09:30 PM on 09/04/2010

outnow,
Two things have to happen for consumer laws to be "self-enforcing":
-The law has to allow individuals the balancing power to make the right thing happen at the level of every interaction, without requiring a life-altering fight (like a lawsuit).
-The law has to incorporate a realization that individuals have finite time.

For example: a provision in the Fair Credit Billing Act basically says, if a consumer has a dispute with a bank, the bank has to refund the money to the consumer until the dispute is resolved. This acknowledges the reality of the unfair power relationship between banks and consumers, and the fact that consumers have finite time. Banks, insurance companies, etc., use people's finite time against them to basically steal from them. Banks can easily take small amounts of money from lots of people that they can keep if people can't fight it. This rule wiped away much of that ability.

The Do Not Call List is consumer protection in that spirit. Also, giving people the right to go after unsolicited telemarketing callers in small claims court, for relatively large amounts of money. The goal wasn't to increase small claims court cases -- it really didn't -- it was to give consumers the balancing power so bad behavior in the marketplace stopped, which is mostly what has happened. (Things got even better with the Do Not Call List.)

My favorite example of a "self-enforcing" law is more specific to your request. (cont next post)

[ajwriter]

09:49 PM on 09/04/2010

Decades ago, mail order was a dirty business, with a reputation akin to used car sales. The main thrust of business was to send unsolicited merchandise, banking on the fact that not everyone could or would return it. Aggressive collection actions ensued.

The problem became so pervasive and odious, Congress took up the issue. They debated and argued, amid much lobbying by mail order companies that any restrictions would destroy business.

Congress COULD have made all kinds of detailed rules about how long people had to return things, what recourse people had, in what court, for what amount of money. They could have required post-paid return labels, or even set up an agency to monitor disputes.

Instead, they made an eleventh hour rule: if you receive merchandise in the mail that you did not explicitly order, it’s yours to keep, free.

Ended the problem overnight. Not only did it completely solve the problem for every consumer, individually, but it redeemed the mail order industry. Those doing the bad stuff disappeared, and those operating legitimately thrived. Mail order is now a respected and important part of our economy.

Insurance laws should be written in this spirit, because although bad faith laws can sometimes be a deterrent, insurers get around them, and they bank on the fact that most people cannot fight insurers’ massive paperwork wars. (Hence much of the odious $450 billion in administrative expenses in our healthcare system, largely due to insurers.)

[ajwriter]

04:19 AM on 08/21/2010

(continued from above)

Unfortunately, concentrations of wealth have successfully portrayed such balancing forces as government intrusion or even class warfare, and their ability to extract profits by whatever means as important to free markets, all the while portraying laws affirming the ability of ordinary people to have the most control over their assets and time as contrary to free markets.

Get ordinary people to hate the form of government that gives them the power to restore that autonomy, and you win the Monopoly game…

(please ignore my attempt below...)

[Chip W]

09:14 AM on 08/21/2010

Good post.
I'll sort of disagree with: self-interest doesn't correlate to greed-is-good.
Self-interest often becomes self-interest without regard to impact - on others, or on the system. That's what happened on Wall St, that's what's going on in the military industry. I'd correlate this with greed. Money for me, and screw everyone else.
Your last sentence refers to the free market worshipers, who seem unwilling to think through what free market without oversight really means.

[shamanbart]

05:03 PM on 08/22/2010

Very insightful post. Thanks!

I would also argue to that end that the concepts of corporations possessing personhood, the legal Ponzi scheme we call the stock market, and the concept of unending corporate growth all need to be revised if not rejected. Sustainability is the ultimate autonomy for all parties.

[ajwriter]

04:18 AM on 08/21/2010

(continued from above)

all the while portraying laws affirming the ability of ordinary people to have the most control over their assets and time as contrary to free markets.

Get ordinary people to hate the form of government that gives them the power to restore that autonomy, and you win the Monopoly game…

[jazzofcourse08]

01:44 AM on 08/21/2010

OT: Keith Olberman: Secret Muslim? A look into Obama's past.

http://www.msnbc.msn.com/id/3036677/#38793172

[schatsie]

11:35 AM on 08/22/2010

So let me get this right, we have Obama a muslim in Cahoots with Wall Street.....Sounds like Bush in Cahoots with the Saudis, I mean really holding hands with Bandar Bush....I guess that is what you would expect from a man who has a gay prostitute in the White House over 200 times.....

[hedylamarr]

12:10 AM on 08/21/2010

This is what we get when the economy is run by nothing but a bunch of Business Majors, supervised by a bunch of Poli Sci majors and lawyers who have never lawyered. Manipulated by special interests from the left and right. Followed in good faith by a gullible population who are working at least two full-time jobs per family to maintain the earning power of one full-time job 25 years ago. And what has been one of the most often cited pieces of evidence of rising living standards in this country over the past generation? Answer: shrinking family sizes. Maybe shrinking family sizes are a sign of declining, not rising, living standards.

[iconoclast1]

11:31 PM on 08/20/2010

With the efficient markets hypothesis and full rationality presumptions, it's no wonder the economy crashed and burned...again. If these were cornerstones of recent economic paradigms, I'd say the economics profession has a long way to go.

It makes one wonder how much the prevailing wisdom in the economics profession is influenced by the profit motives of Big Business and Wall Street, and the desires of the wealthy. Is it a coincidence that economic theory was wrong in a way that has demonstrably favored the rich?

[schatsie]

11:36 AM on 08/22/2010

Have you read Shock Doctrine, the gift from the Chicago School of Economics...?

[iconoclast1]

04:45 PM on 08/22/2010

No, I haven't. I'll check into it.