CAMBRIDGE – As the world economy tumbles off the edge of a precipice, critics of the economics profession are raising questions about its complicity in the current crisis. Rightly so: economists have plenty to answer for.

It was economists who legitimized and popularized the view that unfettered finance was a boon to society. They spoke with near unanimity when it came to the “dangers of government over-regulation.” Their technical expertise – or what seemed like it at the time –gave them a privileged position as opinion makers, as well as access to the corridors of power.

Very few among them (notable exceptions including Nouriel Roubini and Robert Shiller) raised alarm bells about the crisis to come. Perhaps worse still, the profession has failed to provide helpful guidance in steering the world economy out of its current mess. On Keynesian fiscal stimulus, economists’ views range from “absolutely essential” to “ineffective and harmful.”

On re-regulating finance, there are plenty of good ideas, but little convergence. From the near-consensus on the virtues of a finance-centric model of the world, the economics profession has moved to a near-total absence of consensus on what ought to be done.

So is economics in need of a major shake-up? Should we burn our existing textbooks and rewrite them from scratch?

Actually, no. Without recourse to the economist’s toolkit, we cannot even begin to make sense of the current crisis.

Why, for example, did China’s decision to accumulate foreign reserves result in a mortgage lender in Ohio taking excessive risks? If your answer does not use elements from behavioral economics, agency theory, information economics, and international economics, among others, it is likely to remain seriously incomplete.

The fault lies not with economics, but with economists. The problem is that economists (and those who listen to them) became over-confident in their preferred models of the moment: markets are efficient, financial innovation transfers risk to those best able to bear it, self-regulation works best, and government intervention is ineffective and harmful.

They forgot that there were many other models that led in radically different directions. Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks –�at least those used in advanced courses – are fine.

Non-economists tend to think of economics as a discipline that idolizes markets and a narrow concept of (allocative) efficiency. If the only economics course you take is the typical introductory survey, or if you are a journalist asking an economist for a quick opinion on a policy issue, that is indeed what you will encounter. But take a few more economics courses, or spend some time in advanced seminar rooms, and you will get a different picture.

Labor economists focus not only on how trade unions can distort markets, but also how, under certain conditions, they can enhance productivity. Trade economists study the implications of globalization on inequality within and across countries. Finance theorists have written reams on the consequences of the failure of the “efficient markets” hypothesis. Open-economy macroeconomists examine the instabilities of international finance. Advanced training in economics requires learning about market failures in detail, and about the myriad ways in which governments can help markets work better.

Macroeconomics may be the only applied field within economics in which more training puts greater distance between the specialist and the real world, owing to its reliance on highly unrealistic models that sacrifice relevance to technical rigor. Sadly, in view of today’s needs, macroeconomists have made little progress on policy since John Maynard Keynes explained how economies could get stuck in unemployment due to deficient aggregate demand. Some, like Brad DeLong and Paul Krugman, would say that the field has actually regressed.

Economics is really a toolkit with multiple models – each a different, stylized representation of some aspect of reality. One’s skill as an economist depends on the ability to pick and choose the right model for the situation.

Economics’ richness has not been reflected in public debate because economists have taken far too much license. Instead of presenting menus of options and listing the relevant trade-offs – which is what economics is about – economists have too often conveyed their own social and political preferences. Instead of being analysts, they have been ideologues, favoring one set of social arrangements over others.

Furthermore, economists have been reluctant to share their intellectual doubts with the public, lest they “empower the barbarians.” No economist can be entirely sure that his preferred model is correct. But when he and others advocate it to the exclusion of alternatives, they end up communicating a vastly exaggerated degree of confidence about what course of action is required.

Paradoxically, then, the current disarray within the profession is perhaps a better reflection of the profession’s true value added than its previous misleading consensus.  Economics can at best clarify the choices for policy makers; it cannot make those choices for them.

When economists disagree, the world gets exposed to legitimate differences of views on how the economy operates.  It is when they agree too much that the public should beware.

NAIROBI – With unemployment soaring, bankruptcies climbing, and stock markets in free-fall, it may at first glance seem sensible to ditch the fight against climate change and put environmental investments on hold. But this would be a devastating mistake of immediate, as well as inter-generational, proportions.

Far from burdening an already over-stressed, over-stretched global economy, environmental investments are exactly what is needed to get people back to work, get order books flowing, and assist in powering economies back to health.

In the past, concern for the environment was viewed as a luxury; today, it is a necessity – a point grasped by some, but by no means all, economic architects yet.

A big slice of President Barack Obama’s $825 billion stimulus package for the United States includes a boost to renewable energy, “weatherizing” a million homes, and upgrading the country’s inefficient electricity grid. Such investments could generate an estimated five million “green-collar” jobs, provide a shot in the arm for the construction and engineering industries, and get America back into the equally serious business of combating climate change and achieving energy security.

The Republic of Korea, which is losing jobs for the first time in more than five years, has also spotted the green lining to grim economic times. President Lee Myung-Bak’s government plans to invest $38 billion employing people to clean up four major rivers and reduce disaster risks by building embankments and water-treatment facilities.

Other elements of Lee’s plan include construction of eco-friendly transportation networks, such as high-speed railways and hundreds of kilometers of bicycle tracks, and generating energy using waste methane from landfills. The package also counts on investments in hybrid vehicle technologies.

Similar pro-employment “Green New Deal” packages have been lined up in China, Japan, and the United Kingdom. They are equally relevant to developing economies in terms of jobs, fighting poverty, and creating new opportunities at a time of increasingly uncertain commodity prices and exports.

In South Africa, the government-backed Working for Water initiative – which employs more than 30,000 people, including women, youth, and the disabled – also sees opportunity in crisis. The country spends roughly $60 million annually fighting invasive alien plants that threaten native wildlife, water supplies, important tourism destinations, and farmland.

This work is set to expand as more than 40 million tons of invasive alien plants are harvested for power-station fuel. As a result, an estimated 500 megawatts of electricity, equal to 2% of the country’s electricity needs, will be generated, along with more than 5,000 jobs.

So it is clear that some countries now view environmental investments in infrastructure, energy systems, and ecosystems as among the best bets for recovery. Others may be unsure about the potential returns from investing in ecosystem services such as forest carbon storage or in renewable energy for the 80% of Africans who have no access to electricity. Still others may simply be unaware of how to precisely follow suit.

In early February, the United Nations Environment Program will convene some of the world’s leading economists at the UN’s headquarters in New York. A strategy for a Global Green New Deal, tailored to different national challenges, will be fleshed out in order to assist world leaders and ministers craft stimulus packages that work on multiple fronts.

The Global Green New Deal, which UNEP launched as a concept in October 2008, responds to the current economic malaise. Spent wisely, however, these stimulus packages could trigger far-reaching and transformational trends, setting the stage for a more sustainable, urgently needed Green Economy for the twenty-first century.

The trillions of dollars that have been mobilized to address current woes, together with the trillions of investors’ dollars waiting in the wings, represent an opportunity that was unthinkable only 12 months ago: the chance to steer a more resource-efficient and intelligent course that can address problems ranging from climate change and natural-resource scarcity to water shortages and biodiversity loss.

Blindly pumping the current bail-out billions into old industries and exhausted economic models will be throwing good money after bad while mortgaging our children’s future. Instead, political leaders must use these windfalls to invest in innovation, promote sustainable businesses, and encourage new patterns of decent, long-lasting employment.

Source: www.project-syndicate.org

Achim Steiner, a UN Under-Secretary General, is Executive Director of the UN Environment Program

CAMBRIDGE ­– Capitalism is in the throes of its most severe crisis in many decades. A combination of deep recession, global economic dislocations, and effective nationalization of large swathes of the financial sector in the world’s advanced economies has deeply unsettled the balance between markets and states. Where the new balance will be struck is anybody’s guess.

Those who predict capitalism’s demise have to contend with one important historical fact: capitalism has an almost unlimited capacity to reinvent itself. Indeed, its malleability is the reason it has overcome periodic crises over the centuries and outlived critics from Karl Marx on. The real question is not whether capitalism can survive – it can – but whether world leaders will demonstrate the leadership needed to take it to its next phase as we emerge from our current predicament.      

Capitalism has no equal when it comes to unleashing the collective economic energies of human societies. That is why all prosperous societies are capitalistic in the broad sense of the term: they are organized around private property and allow markets to play a large role in allocating resources and determining economic rewards. The catch is that neither property rights nor markets can function on their own. They require other social institutions to support them.

So property rights rely on courts and legal enforcement, and markets depend on regulators to rein in abuse and fix market failures. At the political level, capitalism requires compensation and transfer mechanisms to render its outcomes acceptable. As the current crisis has demonstrated yet again, capitalism needs stabilizing arrangements such as a lender of last resort and counter-cyclical fiscal policy. In other words, capitalism is not self-creating, self-sustaining, self-regulating, or self-stabilizing.

The history of capitalism has been a process of learning and re-learning these lessons.  Adam Smith’s idealized market society required little more than a “night-watchman state.” All that governments needed to do to ensure the division of labor was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.

Through the early part of the twentieth century, capitalism was governed by a narrow vision of the public institutions needed to uphold it. In practice, the state’s reach often went beyond this conception (as, say, in the case of Bismarck’s introduction of old-age pensions in Germany in 1889). But governments continued to see their economic roles in restricted terms.

This began to change as societies became more democratic and labor unions and other groups mobilized against capitalism’s perceived abuses. Anti-trust policies were spearheaded in the Unites States. The usefulness of activist monetary and fiscal policies became widely accepted in the aftermath of the Great Depression.

The share of public spending in national income rose rapidly in today’s industrialized countries, from below 10% on average at the end of the nineteenth century to more than 20% just before World War II. And, in the wake of WWII, most countries erected elaborate social-welfare states in which the public sector expanded to more than 40% of national income on average.

This “mixed-economy” model was the crowning achievement of the twentieth century. The new balance that it established between state and market set the stage for an unprecedented period of social cohesion, stability, and prosperity in the advanced economies that lasted until the mid-1970’s.

This model became frayed from the 1980’s on, and now appears to have broken down. The reason can be expressed in one word: globalization.

The postwar mixed economy was built for and operated at the level of nation-states, and required keeping the international economy at bay. The Bretton Woods-GATT regime entailed a “shallow” form of international economic integration that implied controls on international capital flows, which Keynes and his contemporaries had viewed as crucial for domestic economic management. Countries were required to undertake only limited trade liberalization, with plenty of exceptions for socially sensitive sectors (agriculture, textiles, services). This left them free to build their own versions of national capitalism, as long as they obeyed a few simple international rules.

The current crisis shows how far we have come from that model. Financial globalization, in particular, played havoc with the old rules. When Chinese-style capitalism met American-style capitalism, with few safety valves in place, it gave rise to an explosive mix. There were no protective mechanisms to prevent a global liquidity glut from developing, and then, in combination with US regulatory failings, from producing a spectacular housing boom and crash. Nor were there any international roadblocks to prevent the crisis from spreading from its epicenter.

The lesson is not that capitalism is dead. It is that we need to reinvent it for a new century in which the forces of economic globalization are much more powerful than before. Just as Smith’s minimal capitalism was transformed into Keynes’ mixed economy, we need to contemplate a transition from the national version of the mixed economy to its global counterpart.

This means imagining a better balance between markets and their supporting institutions at the global level . Sometimes, this will require extending institutions outward from nation states and strengthening global governance. At other times, it will mean preventing markets from expanding beyond the reach of institutions that must remain national. The right approach will differ across country groupings and among issue areas.

Designing the next capitalism will not be easy. But we do have history on our side: capitalism’s saving grace is that it is almost infinitely malleable.

Source: www.project-syndicate.org

Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.

CAMBRIDGE – Governments around the world are now developing massive fiscal stimulus packages that will cause unprecedented peacetime budget deficits. The fiscal deficit in the United States this year is likely to exceed 10% of GDP. A substantial part of the increased deficit will be due to a wide range of new government spending.

Under normal circumstances, I would oppose this rise in the budget deficit and the higher level of government spending. When an economy is closer to full employment, government borrowing to finance budget deficits can crowd out private investment that would raise productivity and the standard of living. Budget deficits automatically increase government debt, requiring higher future taxes to pay the interest on that debt. The resulting higher tax rates distort economic incentives and thus weaken future economic performance.

Of course, some government spending is desirable or necessary. But an increase in government outlays often means wasteful spending that produces less value than consumers would get from those same dollars.

Now, however, increased government spending and the resulting rise in the fiscal deficit are being justified as necessary to deal with the economic downturn – a sharp change from the reliance on monetary policy that was used to deal with previous recessions. Countercyclical fiscal policy had been largely discredited because of the delays involved in implementing fiscal changes and households’ weak response to temporary tax cuts. By contrast, the central bank could lower interest rates rapidly, which worked to raise household and business spending through a variety of channels.

Nevertheless, I support the use of fiscal stimulus in the US, because the current recession is much deeper than and different from previous downturns. Even with successful countercyclical policy, this recession is likely to last longer and be more damaging than any since the depression of the 1930’s.

The 40% decline in the US stock market and the dramatic fall in house prices have reduced American households’ wealth by more than $10 trillion, which is likely to reduce annual consumer spending by more than $400 billion. And the collapse of housing starts has lowered construction spending by another $200 billion. This $600 billion fall in demand is more than 3% of GDP. If not reversed, it will cause further cuts in production, employment, and earnings, leading to further reductions in consumer spending.

The usual monetary-policy response of lowering interest rates is unable to reverse this sharp drop in demand. The dysfunctional credit markets caused by the uncertain value of asset-backed securities means that banks and other financial institutions are unable to raise funds and are unwilling to lend. As a result, the central bank’s lower interest rates do not translate into increased spending on interest-sensitive investment and consumption.

So there is no alternative to fiscal policy if we want to reverse the current downturn. The resulting increase in the national debt is the price that we and future generations will pay for the mistakes that created the current economic situation. Those mistakes led to an underpricing of risk and the resulting increase in excessive leverage.

There are many reasons for the underpricing of risk and the rise in leverage. The exceptionally easy monetary policy at the start of the decade contributed to financial investors’ willingness to buy low-quality financial assets in order to get higher yield and to an explosive rise in house prices. The rating agencies miscalculated the value of asset-backed securities.

The increase in leverage was driven in part by government policies aimed at expanding home ownership among lower-income groups that have proven unable to afford that life style. Banking supervisors did not deal with many institutions’ low levels of capital and poor asset quality. A major challenge for the future is to fix the institutional policies that led to these problems.

The new Obama administration and the Congress are still working out the structure of the fiscal stimulus for the US. Although I support the need for a large fiscal package, I disagree with many of the specific features of the plans now under consideration.

Regardless of what is done to provide a fiscal stimulus, governments around the world must act to fix dysfunctional credit markets. Otherwise, credit will not flow and growth will not resume. In the US, reviving the credit markets requires stopping the mortgage defaults driven by negative equity. The US Treasury Department wasted valuable time in 2008 by not using the funds provided by Congress to deal with those housing-market problems. There is hope that the Congress and the new administration will now address that issue.

When the recession is over, the US and virtually every other country will have substantially higher debt-to-GDP ratios. At that point, it will be important to develop policies to reduce gradually the relative level of government spending in order to shift to fiscal surpluses and reduce the debt burden.

Source: www.project-syndicate.org

Martin Feldstein, a professor of economics at Harvard, was formerly Chairman of President Ronald Reagan’s Council of Economic Advisors and President of the National Bureau for Economic Research.

COPENHAGEN – As Barack Obama prepares for his inauguration, it is worth contemplating a passage from his book Dreams from My Father . It reveals a lot about the way we view the world’s problems.

Obama is in Kenya and wants to go on a safari. His Kenyan sister Auma chides him for behaving like a neo-colonialist. “Why should all that land be set aside for tourists when it could be used for farming? These wazungu care more about one dead elephant than they do for a hundred black children.” Although he ends up going on safari, Obama has no answer to her question.

That anecdote has parallels with the current preoccupation with global warming. Many people – including America’s new president – believe that global warming is the preeminent issue of our time, and that cutting CO2 emissions is one of the most virtuous things we can do.

To stretch the metaphor a little, this seems like building ever-larger safari parks instead of creating more farms to feed the hungry.

Make no mistake: global warming is real, and it is caused by manmade CO2 emissions. The problem is that even global, draconian, and hugely costly CO2 reductions will have virtually no impact on the temperature by mid-century. Instead of ineffective and costly cuts, we should focus much more of our good climate intentions on dramatic increases in R&D for zero-carbon energy, which would fix the climate towards mid-century at low cost. But, more importantly for most of the planet’s citizens, global warming simply exacerbates existing problems – problems that we do not take seriously today.

Consider malaria. Models shows global warming will increase the incidence of malaria by about 3% by the end of the century, because mosquitoes are more likely to survive when the world gets hotter. But malaria is much more strongly related to health infrastructure and general wealth than it is to temperature. Rich people rarely contract malaria or die from it; poor people do.

Strong carbon cuts could avert about 0.2% of the malaria incidence in a hundred years. The cheerleaders for such action are loud and multitudinous, and mostly come from the rich world, unaffected by malaria.

The other option is simply to prioritize eradication of malaria today. It would be relatively cheap and simple, involving expanded distribution of insecticide-treated bed nets, more preventive treatment for pregnant women, increased use of the maligned pesticide DDT, and support for poor nations that cannot afford the best new therapies.

Tackling nearly 100% of today’s malaria problem would cost just one-sixtieth of the price of the Kyoto Protocol. Put another way, for each person saved from malaria by cutting CO2 emissions, direct malaria policies could have saved 36,000. Of course, carbon cuts are not designed only to tackle malaria. But, for every problem that global warming will exacerbate – hurricanes, hunger, flooding – we could achieve tremendously more through cheaper, direct policies today.

For example, adequately maintained levees and better evacuation services, not lower carbon emissions, would have minimized the damage inflicted by Hurricane Katrina on New Orleans.  During the 2004 hurricane season, Haiti and the Dominican Republic, both occupying the same island, provided a powerful lesson. In the Dominican Republic, which has invested in hurricane shelters and emergency evacuation networks, the death toll was fewer than ten. In Haiti, which lacks such policies, 2,000 died. Haitians were a hundred times more likely to die in an equivalent storm than Dominicans.

Obama’s election has raised hopes for a massive commitment to carbon cuts and vast spending on renewable energy to save the world – especially developing nations. As Obama’s Kenyan sister might attest, this could be an expensive indulgence. Some believe Obama should follow the lead of the European Union, which has committed itself to the ambitious goal of cutting carbon emissions by 20% below 1990 levels within 12 years by using renewable energy.

This alone will probably cost more than 1% of GDP. Even if the entire world followed suit, the net effect would be to reduce global temperatures by one-twentieth of one degree Fahrenheit by the end of the century. The cost could be a staggering $10 trillion.

Germany has subsidized solar panels, as some hope Obama might. Thus, everybody, including the poor, pays taxes so that mostly wealthier beneficiaries can feel greener. But climate models demonstrate that Germany’s $156 billion expense will delay warming by just one hour at the end of the century. For one-fiftieth of that cost, we could provide essential micronutrients to 2-3 billion people, thereby preventing perhaps a million deaths and making half the world’s population mentally and physically much stronger. Again and again, we seem to choose the dubious luxury of another safari park over the prosaic benefits offered by an extra farm.

Most economic models show that the total damage imposed by global warming by the end of the century will be about 3% of GDP. This is not trivial, but nor is it the end of the world. By the end of the century, the United Nations expects the average person to be 1,400% richer than today.

An African safari trip once confronted America’s new president with a question he could not answer: why the rich world prized elephants over African children. Today’s version of that question is: why will richer nations spend obscene amounts of money on climate change, achieving next to nothing in 100 years, when we could do so much good for mankind today for much less money? The world will be watching to hear Obama’s answer.

Source: www.project-syndicate.org

Bjørn Lomborg, adjunct professor at the Copenhagen Business School, is the author of The Skeptical Environmentalist and Cool It: The Skeptical Environmentalist’s Guide to Global Warming. He is the organizer of the Copenhagen Consensus. 

NEW YORK – A consensus now exists that America’s recession – already a year old – is likely to be long and deep, and that almost all countries will be affected. I always thought that the notion that what happened in America would be decoupled from the rest of the world was a myth. Events are showing that to be so. 

Fortunately, America has, at last, a president with some understanding of the nature and severity of the problem, and who has committed himself to a strong stimulus program. This, together with concerted action by governments elsewhere, will mean that the downturn will be less severe than it otherwise would be.

The United States Federal Reserve, which helped create the problems through a combination of excessive liquidity and lax regulation, is trying to make amends – by flooding the economy with liquidity, a move that, at best, has merely prevented matters from being worse. It’s not surprising that those who helped create the problems and didn’t see the disaster coming have not done a masterly job in dealing with it. By now, the dynamics of the downturn are set, and things will get worse before they get better.

In some ways, the Fed resembles a drunk driver who, suddenly realizing that he is heading off the road starts careening from side to side. The response to the lack of liquidity is ever more liquidity. When the economy starts recovering, and banks start lending, will they be able to drain the liquidity smoothly out of the system? Will America face a bout of inflation? Or, more likely, in another moment of excess, will the Fed over-react, nipping the recovery in the bud? Given the unsteady hand exhibited so far, we cannot have much confidence in what awaits us.

Still, I am not sure that there is sufficient appreciation of some of the underlying problems facing the global economy, without which the current global recession is unlikely to give way to robust growth – no matter how good a job the Fed does.

For a long time, the US has played an important role in keeping the global economy going. America’s profligacy – the fact that the world’s richest country could not live within its means – was often criticized. But perhaps the world should be thankful, because without American profligacy, there would have been insufficient global aggregate demand. In the past, developing countries filled this role, running trade and fiscal deficits. But they paid a high price, and fiscal responsibility and conservative monetary policies are now the fashion.

Indeed, many developing countries, fearful of losing their economic sovereignty to the IMF – as occurred during the 1997 Asian financial crisis – accumulated hundreds of billions of dollars in reserves. Money put into reserves is income not spent.

Moreover, growing inequality in most countries of the world has meant that money has gone from those who would spend it to those who are so well off that, try as they might, they can’t spend it all.

The world’s unending appetite for oil, beyond its ability or willingness to produce, has contributed a third factor. Rising oil prices transferred money to oil-rich countries, again contributing to the flood of liquidity. Though oil prices have been dampened for now, a robust recovery could send them soaring again.

For a while, people spoke almost approvingly of the flood of liquidity. But this was just the flip side of what Keynes had worried about – insufficient global aggregate demand. The search for return contributed to the reckless leverage and risk taking that underlay this crisis. 

America’s government will, for a time, partly make up for the increasing savings of US consumers. But if America’s consumers go from their near zero savings to a modest 4% or 5% of GDP, then the depressing effect on demand  (in addition to that resulting from declines in investment, exports, and state and local  government expenditures) will not be fully offset by even the largest government expenditure programs. In two years, governments, mindful of the huge increases in the debt burden resulting from the mega-bailouts and the mind-boggling deficits, will be under pressure to run primary surpluses (where government spending net of interest payments is less than revenues.) 

A few years ago, there was worry about the risk of a disorderly unwinding of “global imbalances.” The current crisis can be viewed as part of that, but little is being done about the underlying problems that gave rise to these imbalances. We need not just temporary stimuli, but longer-term solutions. It is not as if there was a shortage of needs; it is only that those who might meet those needs have a shortage of funds.

First, we need to reverse the worrying trends of growing inequality. More progressive income taxation will also help stabilize the economy, through what economists call “automatic stabilizers.” It would also help if the advanced developed countries fulfilled their commitments to helping the world’s poorest by increasing their foreign-aid budgets to 0.7% of GDP.

Second, the world needs enormous investments if it is to respond to the challenges of global warming. Transportation systems and living patterns must be changed dramatically. 

Third, a global reserve system is needed. It makes little sense for the world’s poorest countries to lend money to the richest at low interest rates. The system is unstable. The dollar reserve system is fraying, but is likely to be replaced with a dollar/euro or dollar/euro/yen system that is even more unstable. Annual emissions of a global reserve currency (what Keynes called Bancor, or the IMF calls SDRs) could help fuel global aggregate demand, and be used to promote development and address the problems of global warming.

This year will be bleak. The question we need to be asking now is, how can we enhance the likelihood that we will eventually emerge into a robust recovery?

source: www.project-syndicate.org

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.

GENEVA – Is China an island of stability in the midst of the gathering global financial storm, or will it, too, soon be sucked into the vortex?

Chinese officials have said that the crisis that began in the United States will not slow down long-planned reforms in China’s financial markets. They insist that China will go ahead with plans to introduce margin trading, short selling, and futures contracts on share prices. But China slowed capital-account liberalization after the Asian financial crisis ten years ago, so it is possible that America’s troubles could make China more cautious.

China has played an important role in financing the US budget deficit in recent years, thanks to its effort to manage the renminbi’s exchange rate against the dollar. China does not want its large current-account surplus to cause the currency to overshoot on the upside, and it may now want to slow the renminbi’s appreciation because of concern about the global economic slowdown.

If so, China would have to expand its foreign exchange reserves by another $300-400 billion, which would allow it to finance the large expansion in the US fiscal deficit.  Recent slight declines in the value of the renminbi suggest that China’s exchange rate policy may be changing following its 20% appreciation of the currency since July 2005.

Germany’s finance minister, Peer Steinbrück, has said that the crisis will reduce US financial hegemony and create a more multipolar world. The September 26 edition ofThe China Daily carried an article asking, “Is the Sun Setting on US Economic Supremacy?” The article reviewed examples of how foreign investors have lost money in the US market and concluded, “The outbreak of the latest crisis shows that the neo-conservative revolution launched in the 1980’s has already come to an end.” The article attributed the crisis to policies that “called on market forces to be given full play with the scrapping of government controls, especially on the financial market.”

Chinese officials have not yet echoed Steinbrück’s comments, but the US experience will naturally make them more suspicious of Western investment bankers and US-style regulation. China has so far lost money on two of its major investments in Western financial firms (Morgan Stanley and Blackstone). It could have helped to contain the current crisis if it had accepted invitations to invest in Lehman Brothers, but, given its previous losses on Wall Street, it declined.

As a result of concern about the global economy, the People’s Bank reduced interest rates two weeks ago and joined the coordinated global interest rate cut on October 8 – the first time that China ever participated in a global monetary policy move. The government also announced plans earlier this month to increase infrastructure spending by $586 billion during 2009 and 2010.

The projected spending increases are equal to 15% of GDP, and are the largest that any country has undertaken so far in response to the financial crisis. They demonstrate clearly that China is prepared to compensate for export weakness by stimulating domestic demand. China must now take further action to bolster consumer spending, which slumped to only 36% of GDP in 2007, from over 50% during the 1980’s, owing to the economy’s heavy dependence on exports and capital spending since the late 1990’s.

The Chinese government’s goal will be to keep annual growth above 8% in order to generate sufficient employment to maintain social stability. It is currently also more sensitive to employment risks than usual, because several thousand small factories in the textile and toy sectors have closed this year as a result of the impact of rising labor costs and the appreciating renminbi on profit margins. China wants to shift from low value-added, labor-intensive industries such as textiles to higher value-added sectors such as electronics and capital goods. But it does not want to generate high levels of unemployment as this transition occurs.

China has the resources to cope with the current financial crisis. Foreign exchange reserves are an immense $1.9 trillion. Booming tax receipts have provided the government with a fiscal surplus. The critical issue has been policymakers’ willingness to act promptly, before there is clear evidence of an economic downturn. The government’s stimulus package demonstrates that it is aware of the risks in the global economy and is prepared to act decisively.

The current crisis marks an important step in China’s evolution as a great economic power. China has been pursuing a policy of extreme Keynesianism at a time when Europe and the US are also undertaking massive interventions in their financial systems to prevent the current crisis from leading to a global financial collapse.

Thus, there is a growing convergence between Chinese and G-7 economic policy, born of the need to compensate for massive failures in US financial regulation and monetary policy. The US has been lobbying China for some time for economic policy changes aimed at stimulating domestic demand and open markets. The irony is that, to compensate for a crisis that America’s own policies have created in global financial markets, the US is now getting what it has long sought from China.

source: www.project-syndicate.org

David Hale is Chairman of David Hale Global Economics and a long-time analyst of China’s economic reform process

NEW YORK – The financial crisis has been uppermost in the minds of most world leaders. Yet, however high the price of a global bail-out, we know one thing: it pales next to the enormous costs – and profound human consequences – of delaying action on climate change.

There is a sort of beauty in this predicament: if we act wisely, we can tackle both crises at once. Climate change negotiations over the next year offer an unprecedented opportunity to build a more profitable, safer, and sustainable global economy.  

Today’s challenges – finance, food, and energy, for example – are many. Yet they share a root cause, whereby speculative and often narrow interests have superseded the common interest, common responsibilities, and common sense.

This same short-term thinking characterizes the world’s dependence on fossil fuels. We cannot break that dependence overnight. Yet we recognize that continuing to pour trillions of dollars into carbon-based infrastructure and fossil-fuel subsidies is like investing in sub-prime real estate. In essence, we are mortgaging our children’s future to pay for an inherently unsustainable and inequitable way of life.

The greatest risk we face lies in continuing down this path. So how do we begin to tackle the massive challenge of retooling our global economy, preserving the planet, and lifting billions out of poverty?

The answer is to deal seriously with climate change. And this is the time to do it – not in spite of the financial crisis, but because of it. As the saying goes, a crisis is a terrible thing to waste.

This week’s gathering in Poznan is an important step. We have only 12 short months to hammer out the elements of a global climate change accord before world leaders convene next December in Copenhagen. If we work together, guided by a sense of urgency and common destiny, these negotiations can help steer the ship of the global economy toward less turbulent, greener waters and into a safe harbor.

We believe that the best investment in our collective future is to scale up the green, low-carbon economy. It is an investment with enormous potential for prosperity and profit. But it requires us to put in place a new climate change agreement now – one that all countries can accept. It must be comprehensive and ambitious, and it must set clear targets for emission reductions, adaptation, financing, and technology transfer.

In Poznan, developed and developing nations must find a shared vision of how this will work, striking a deal whereby rich countries lead by example in cutting emissions while providing the developing world with resources and know-how to ramp up their own climate change efforts.

Energy investment decisions made today will lock in the world’s emissions profile for years to come. Meanwhile, the clock is ticking. Potentially catastrophic consequences await, not just for polar bears, but for millions of people.

Adaptation must be a vital part of the negotiations. So must mitigation. In the cruel calculus of disasters, those least responsible for causing climate change will suffer first and worst from its inevitable effects. Developing nations will need increased financial support to protect the poorest and most vulnerable.

Reaching an accord in Copenhagen is critical. But the route to a greener, lower-carbon future already is being forged in countries from Brazil to Bangladesh, Denmark to Indonesia. From investments in renewable energy and flex-fuel vehicles to reforestation, countries everywhere are realizing that green is not an option, but a necessity for recharging their economies and creating millions of jobs.

For example, with the right investments, tropical countries could significantly reduce emissions from the forestry sector while also creating green jobs. De-forestation currently accounts for roughly a fifth of all greenhouse-gas emissions.

Last month, China announced a $586 billion economic stimulus package, some 25% of which is to help bolster conservation, environmental protection, and renewable energy efforts. We hope that the new stimulus package helps to move China toward greener development, and that countries follow suit.

The United States has also signaled a fundamental, abrupt shift in its global climate policy. In his first, post-election public address, Barack Obama declared that his presidency “will mark a new chapter in America’s leadership on climate change that will strengthen our security and create millions of new jobs.”

In marrying the issues of economic revitalization, energy security, and climate change, Obama has articulated clearly the benefits of any Green New Deal. We welcome US re-engagement in global climate negotiations and await its leadership in transforming words into concrete policies that promote global green growth.

As the US, China, and many other nations now realize, climate change is much more than an environmental issue. It is an energy, finance, and security issue. Indeed, it is a Head of State issue. We urge other world leaders to join us in forging a shared, long-term vision for cooperative action that is realized at next year’s conference in Copenhagen.

Global cooperation has been key to managing the financial crisis. It is no less vital to managing climate change, for which the stakes are far higher. Together, we must invest in the safest, surest option – the green economy.

Source: www.project-syndicate.org

Gro Harlem Brundtland is a former Prime Minister of Norway

Ricardo Lagos is a former President of Chile

Festus Mogae is a former President of Botswana

Srgjan Kerim is a former President of the UN General Assembly

They are the UN Secretary-General’s Special Envoys on Climate Change

NEW YORK – We are all Keynesians now. Even the right in the United States has joined the Keynesian camp with unbridled enthusiasm and on a scale that at one time would have been truly unimaginable.

For those of us who claimed some connection to the Keynesian tradition, this is a moment of triumph, after having been left in the wilderness, almost shunned, for more than three decades. At one level, what is happening now is a triumph of reason and evidence over ideology and interests.

Economic theory had long explained why unfettered markets were not self-correcting, why regulation was needed, why there was an important role for government to play in the economy. But many, especially people working in the financial markets, pushed a type of “market fundamentalism.” The misguided policies that resulted – pushed by, among others, some members of US President-elect Barack Obama’s economic team – had earlier inflicted enormous costs on developing countries. The moment of enlightenment came only when those policies also began inflicting costs on the US and other advanced industrial countries.

Keynes argued not only that markets are not self-correcting, but that in a severe downturn, monetary policy was likely to be ineffective. Fiscal policy was required. But not all fiscal policies are equivalent. In America today, with an overhang of household debt and high uncertainty, tax cuts are likely to be ineffective (as they were in Japan in the 1990’s). Much, if not most, of last February’s US tax cut went into savings.

With the huge debt left behind by the Bush administration, the US should be especially motivated to get the largest possible stimulation from each dollar spent. The legacy of underinvestment in technology and infrastructure, especially of the green kind, and the growing divide between the rich and the poor, requires congruence between short-run spending and a long-term vision.

That necessitates restructuring both tax and expenditure programs. Lowering taxes on the poor and raising unemployment benefits while simultaneously increasing taxes on the rich can stimulate the economy, reduce the deficit, and reduce inequality. Cutting expenditures on the Iraq war and increasing expenditures on education can simultaneously increase output in the short and long run and reduce the deficit.

Keynes was worried about a liquidity trap – the inability of monetary authorities to induce an increase in the supply of credit in order to raise the level of economic activity. US Federal Reserve Chairman Ben Bernanke has tried hard to avoid having the blame fall on the Fed for deepening this downturn in the way that it is blamed for the Great Depression, famously associated with a contraction of the money supply and the collapse of banks.

And yet one should read history and theory carefully: preserving financial institutions is not an end in itself, but a means to an end. It is the flow of credit that is important, and the reason that the failure of banks during the Great Depression was important is that they were involved in determining creditworthiness; they were the repositories of information necessary for the maintenance of the flow of credit.

But America’s financial system has changed dramatically since the 1930’s. Many of America’s big banks moved out of the “lending” business and into the “moving business.” They focused on buying assets, repackaging them, and selling them, while establishing a record of incompetence in assessing risk and screening for creditworthiness. Hundreds of billions have been spent to preserve these dysfunctional institutions. Nothing has been done even to address their perverse incentive structures, which encourage short-sighted behavior and excessive risk taking. With private rewards so markedly different from social returns, it is no surprise that the pursuit of self-interest (greed) led to such socially destructive consequences. Not even the interests of their own shareholders have been served well.

Meanwhile, too little is being done to help banks that actually do what banks are supposed to do – lend money and assess creditworthiness.

The Federal government has assumed trillions of dollars of liabilities and risks. In rescuing the financial system, no less than in fiscal policy, we need to worry about the “bang for the buck.” Otherwise, the deficit – which has doubled in eight years – will soar even more.

In September, there was talk that the government would get back its money, with interest. As the bailout has ballooned, it is increasingly clear that this was merely another example of financial markets mis appraising risk – just as they have done consistently in recent years. The terms of the Bernanke-Paulson bailouts were disadvantageous to taxpayers, and yet remarkably, despite their size, have done little to rekindle lending.

The neo-liberal push for deregulation served some interests well. Financial markets did well through capital market liberalization. Enabling America to sell its risky financial products and engage in speculation all over the world may have served its firms well, even if they imposed large costs on others.

Today, the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. Have those who pushed deregulation ten years ago learned their lesson? Or will they simply push for cosmetic reforms – the minimum required to justify the mega-trillion dollar bailouts? Has there been a change of heart, or only a change in strategy? After all, in today’s context, the pursuit of Keynesian policies looks even more profitable than the pursuit of market fundamentalism!

Ten years ago, at the time of the Asian financial crisis, there was much discussion of the need to reform the global financial architecture. Little was done. It is imperative that we not just respond adequately to the current crisis, but that we undertake the long-run reforms that will be necessary if we are to create a more stable, more prosperous, and equitable global economy.

Source:www.project-syndicate.org

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.

WASHINGTON, DC – The era of free-market capitalism launched in the 1980’s by Margaret Thatcher and Ronald Reagan – often called “neoliberalism” by its opponents – is over. This ideological wave has crashed with the ongoing financial market crisis, but its decline was a long time coming. In the last few years, while American leaders continued to ride the neoliberal wave, much of the rest of the world was already standing on the shore.

Disenchantment with “neoliberal,” pro-market ideas began in developing countries that had once been their ardent admirers. Latin American countries that embraced free-market policies in the 1990’s rejected them in the mid-2000’s, as a new wave of left-leaning leaders came to power. Russia, which adopted market-oriented reforms in the 1990’s, moved to a managed form of state capitalism in the 2000’s with “oligarchs” forced to submit to state control.

As a result, the United States, the European Commission, and the multilateral development banks have become increasingly isolated in their efforts to advance free-market thought and policies worldwide. The deepening financial crisis weakens their position further. After all, how can the US or the Western multilateral institutions advocate bank privatization now?

The decline of free-market orthodoxy in the rest of the world was caused by two factors: its failures as an approach to economic policy and the decline of US prestige and “soft power.”

“Neoliberalism” grew in popularity as a result of its successes in jump-starting economic growth in the US, the United Kingdom, and some developing countries in the 1980’s and 1990’s. However, its weaknesses also became apparent during the mid- to late-1990’s. The attempt to implant free-market philosophy in Russia, for instance, proved catastrophic. Whereas the Russian experience clearly demonstrated the importance of strong state institutions in regulating a market economy, the free-market model’s fierce ideological opposition to a large state role in the economy offered a poor guide to building them.

After some successes, most notably in Chile, “neoliberal” advice in Latin America also failed, most dramatically in the case of Argentina’s currency board, but most damagingly by increasing inequality, which worsened the continent’s central political-economic problem. In Brazil, President Luiz Inácio Lula da Silva showed that significant departures from free-market prescriptions worked better. Worldwide, most of the high-growth countries of the 1990’s and 2000’s broke with free-market orthodoxy by maintaining a stronger state hand in the economy.

Belief in “neoliberalism” also was based on the success of the US economy, which for much of the 1990’s seemed to demonstrate the superiority of free markets. But the rapid decline of US prestige and “soft power” during the 2000’s sowed doubt outside the US. As the global agenda shifted to concerns about global warming, inequality, and the stability of the international system, the US no longer seemed to be a shining example, but rather an immovable obstacle on many of these issues.

America’s elites turned a blind eye to these developments, rejecting all criticism, together with the crude anti-Americanism with which it was often expressed. Today, the story is different. A massive reassessment is finally in progress, with US elites now recognizing that market capitalism is in crisis, and that the world will not blindly follow their lead.

But that leaves some large questions unresolved. If “neoliberalism” has failed, what comes next? And what must the US do to regain its stature and influence in the international economy?

As New York and London lose their undisputed claim to being the world’s financial capitals, the rising centers of the global economy will gain an increasing say in international economic policy. Most, if not all, are located in countries that have a stronger tradition of state involvement in the economy. Jeffrey Garten, the dean of Yale’s School of Management, got it right when he labeled this the era of “state capitalism.” The state is on its way back as an economic player – not least in the US.

But is that a good thing? While many critics will be tempted to celebrate the end of “neoliberalism,” it remains to be seen whether or not what succeeds it represents an improvement. Various forms of statism have been tried before; all have been found lacking. After all, while “neoliberalism” was criticized as technocratic and elitist, it was nonetheless a form of liberalism, and it was also consistent with the spread of democratic governance worldwide.

The new era may not be so propitious for political liberties. As rising authoritarian powers, China or Russia, for example, have no reason to use their growing international influence to promote democracy; on the contrary, they increasingly counterbalance the efforts of Western countries to promote political liberty. As statist models of economic development become more appealing, democratic governance will become less so. Nor is it clear that “state capitalism” can generate the same degree of innovation and entrepreneurship as the liberal models did in their prime.

In order to redeem the liberal project, American and European leaders will need to reformulate it in such a way that it can provide convincing solutions to problems such as environmental degradation and economic inequality. This will be no easy task, and one that may be far from policymakers’ minds as they grapple with the current crisis. But, unless they do, the emphasis on economic and political freedom that lies at the heart of liberalism may not survive.

Source: www.project-syndicate.org

Mitchell A. Orenstein is Professor of European Studies at Johns Hopkins University’s School of Advanced International Studies