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Book Review of Joseph E. Stiglitz, Free Fall: America, Free Markets, and the Sinking of the World Economy (NY:W. W. Norton, 2010)
Raymond Richman, 4/19/2012

Beginning with his preface, Prof. Stiglitz,  author of a popular textbook for the introductory college course in economics, reveals that he confuses economics and politics. He writes: “Whenever one sees problems as persistent and pervasive as those that have plagued the U.S. financial system, there is only one conclusion to reach: the problems are systemic.”

My own experience is that there are no persistent and pervasive problems. Every economic problem can be solved using the tools of economic analysis. The one that liberal economists consider persistent and like to talk about is the unequal distribution of income. Economists can explain why some households have low incomes and others high incomes, why some countries are poor and others rich, why average incomes have been rising in Communist China, why even the poor in the U.S. have incomes greater than the median income in many countries.

Stiglitz seems to have no idea. Indeed, the title of this book, Free Fall: America, Free Markets, and the Sinking of the World Economy, raises questions about his analytical capacity. The U.S. is not in a free fall, the only U.S. markets that are not free are those that government controls, and the world economy is rising, not sinking. We shall look at what he calls fundamental flaws and, subject to limitation of time and space, analyze his arguments. We shall analyze his solution, restructure the economy and impose world government.

That the Federal Reserve System has occasionally pursued foolish and costly policies cannot be denied. But since the end of the gold standard, it has provided a stable money supply that is modestly inflationary, That such foolishness is inherent in the FRS is deniable.  The notion that government or global bureaucrats can do better, to which Stiglitz a former international bureaucrat, subscribes, is baseless. We subscribe to the theory that government policies are at the root of most financial crises including the one that precipitated this Great Recession.

Stiglitz’s acknowledgments are very extensive. He is name-dropper. They include talks before the crisis with Prof. Nouriel Roubini, George Soros, Paul Krugman and others, “all of whom shared my pessimism for what lay behead.”  They include words of gratitude to members of the Commission of Experts of the President of the UN General Assembly on Reforms of the International Monetary System, which he chaired.  “I was also in the fortunate position of not only seeing firsthand how it was affecting countries in every continent but also discussing the impacts with the presidents, prime ministers, finance and economic ministers, and/or central bank governors and their economic advisers ..”  “I am indebted to ..”  naming  his coauthors of books at Stanford, the World Bank, and Williams College and about a hundred from all sorts of governments, international organizations, government agencies like Arthur Levitt former head of the SEC, plus seven journalists,  and Congresswoman Carolyn Maloney, co-chair of the Joint Economic Committee, Congressman Barney Frank, who was at the time of writing Chair of the House Financial Services Committee (whom we have described as one of the those responsible for the housing bubble), and Pres. Obama’s economic team (Geithner, Summers, Furman, Goolsbee, and Orszag), and Dominique Strauss-Kahn,  then manager Director of the IMF. He failed to mention the members of the Nobel Prize committee that awarded him the Nobel Prize in Economics. They should all disclaim responsibility for this atrocious book.

Stiglitz criticizes the government assistance to homeowners facing foreclosure as being less than he would have expected. Whose incomes would he tax to finance this new entitlement?  Of course, it is true that many facing foreclosures are unable to make their mortgage payments because of circumstances beyond their control. But those circumstances were caused by the bursting of the government-caused house price bubble.

The house price bubble became likely as a result of Sen. Proxmire’s Community Reinvestment Act (CRA) of 1977, endorsed and signed by Pres. Carter, which, to make a long story short, had the effect of forcing banks to lend to unqualified borrowers. Some economists studied the data and concluded that the number of mortgages in default did not differ significantly from mortgages in the suburbs. That was only true when house prices were rising.

The house price bubble was precipitated by President Clinton's and Congress' foolish decision to eliminate the capital gains tax on real estate for most homes in 1998, even though President Truman's roll-over treatment of real estate capital gains had produced 47 years of price stability in a growing real estate market. This tax change encouraged real estate speculation to earn tax-free capital gains.

The house price bubble was fed by the decision of the Clinton and Bush administrations to tolerate the foreign loans from the mercantilist governments, loans that they made in order to keep their people from buying American products with the dollars earned from trade. Throughout the bubble, and continuing to this day, the US government has failed to invoke the WTO rule which lets any country running trade deficits impose import restrictions or duties to require balanced trade.

When the bubble burst and housing prices began to fall in 2006, foreclosures hit the fan. Stiglitz blames the banks and Wall Street for creating the bubble instead of putting the blame where it belongs, on the government of the United States.

In the first chapter, he argues that the financial crisis was predictable.  “A deregulated market awash in liquidity and low interest rates, a global real estate bubble, and .. an unbalanced global economy .. it was clear that things were ‘horribly awry’.”  “Low interest rates and lax regulations fed the housing bubble.” He blames Wall Street.  Who does he mean , investors, brokers, the stock exchanges, the mutual funds, and options traders or just the investment bankers? He blames the mortgage originators and their exotic mortgages and financial instruments. He mentions that the Federal Reserve Board, first led by Greenspan and then by Bernanke, stayed laid back. Indeed, the Fed, together with the other bank regulating agencies, were in charge of enforcing the CRA!

We are in agreement with him when he writes, “What worries me is that because of the choices that have already been made, not only will the downturn be far longer and deeper than necessary, but we will emerge from the crisis with a much larger legacy of debt, with a financial system that is less competitive, less efficient, and more vulnerable to another crisis, and with an economy less prepared to meet the challenges of this century.”  And when he writes, “Regrettably, the Obama administration didn’t present a clear view of what was needed. Instead it largely left it to Congress to craft the size and shape of the stimulus.”  (Readers will note that we criticized in these pages the Recovery Act of 2009.)  But he wants the recovery program to be fair, to support people struggling to make mortgage payments, to provide retraining “with the skills they will need for their future jobs”. (What jobs?) He believes “the multiplier is large” while we believe the Keynesian multiplier is zero or negative.  He argues that spending money to bail out auto companies saves jobs temporarily and like investing “money in roads may contribute to global warming, one of the world’s most important long-term problems; it would be much better to create a high-speed public  transportation system” that would take people out of their autos and save the environment. He apparently subscribes totally to the notion of man-made global warming.  We do not. There is hardly anywhere in the U.S. that high-speed public transportation is feasible without huge permanent subsidies. It is another policy that would help cause a free-fall.

He believes the stimulus package was too small.  Apparently, a budget deficit of $1.5 trillion per year is not enough. He believes the federal government did not do enough to support state spending and failed to fill “the holes in the safety net” like mortgage payments. Another contribution to America’s free fall.

He believes that  “deficit financed stimulus spending remains a temporary palliative.” The economy needs to be restructured. “ For total American stimulus spending to be restored on a sustainable basis, there would have to be a large redistribution of income, from those at the top who can afford to save, to those below who spend every penny they can get. More progressive taxation ...would not only do that but also help stabilize the economy. If the government raises taxes on upper -income Americans to finance an expansion of government spending, especially on investment, the economy will expand—this is called a ‘balanced budget multiplier.’ We would argue that these policies would ensure a free-fall as would all uneconomic projects.  

He states that supply-side economists argue that such taxes will discourage work and savings and thus lower GDP. But their analysis (if correct at all) applies only to situations where production is limited by supply; now there is excess capacity, and production is limited by demand.”  Bu it is production that creates incomes that increase demand. We should also increase the capacity of the third world to consume.  “The international community will have to provide more help to poor countries and China will have to have more success in reducing its saving rate..”  Need to increase “sustainable aggregate demand, strong enough to ensure global full employment; the reconstructing  of the financial system so that it performs the functions that a financial system is supposed to,…and the restructuring of the U.S. and other world reflect, for instance, shifts in global comparative advantage and changes in technology.” International trade is obviously not one of his strengths.

He attributes the decline of manufacturing in the U.S. to a shift from manufacturing to services as a result of  increasing productivity in manufacturing  and to the comparative advantage of China, India, and other developing countries.”  None of it apparently is due to mercantilist practices of Japan, China, Germany, and OPEC. He makes no suggestion that we do anything about the trade deficits and the loss of jobs that outsourcing was causing. No criticism of the economically disastrous “free trade” policy to which he subscribes, or the budget deficits caused by wasteful government spending resulting from government’s addiction to the AGW (man-made global warming) theory, and government stifling of oil drilling on public lands. Instead, he recites, “Obama was conservative: he didn’t offer an alternative vision of capitalism.”  Obama, conservative?

What is the New Capitalist Order he would install?  “In the Fall of 2008, the global economy ... was at the brink of a complete meltdown.”  This recession is different, he argues. “We neither can nor should return to the world as it was before.” What needs to be done to be done in the face of an aging population, banks in distress, the need for universal health care, climate change, the decline in the manufacturing sector due to productivity increases, increasing inequality, and instability.  “A central part of restructuring the economy entails going from manufacturing to a service-sector economy.” In our view, this is absolutely nonsensical. We believe that the future of the U.S. is in manufacturing, which does have a multiplier, in expanded production of fossil fuels, and innovation, new products that are manufactured here.

He believes, “The biggest environmental challenge is, of course, that of climate change.”  Economics does not make one a climate change scientist. We believe that the AGW theory of global warming is unproven. An experiment is underway at CERN, the world’s leading nuclear research facility testing the theory that climate warming is the result of changing patterns of cosmic rays caused by disturbances in the sun’s magnetic forces. Why not wait until the experiment is completed before spending trillions internationally on wind and solar energy which cannot be produced economically?

As for trade deficits, he writes, “The G-20 has proposed a coordinated macroeconomic response – the U.S. to increase its savings and Chinese reduce its – so that the imbalances will be reduced in a way that maintains a strong global economy.” In other words he wants global government.  He argues that American manufacturing is in  a shambles, increasingly energy unsustainable, and our  education sector in efficient. What is our “competitive advantage”? “As hard as it is for most Americans to admit, in many areas, including key areas of the ‘old’ economy like steel and autos, the country is no longer the technological leader; it is no longer the most efficient producer; and it no longer makes the best products. America no longer has a comparative advantage in many areas of manufacturing. A country’s comparative advantage can change; what matters is dynamic comparative advantage.” And how do you achieve that? You guessed it, he believes that the world needs restructuring.

“Achieving the restructuring ... will require will require government taking on a greater role.” “Sweden’s public sector has managed to spend its money well; America’s private financial sector has done a miserable job.” Really? We still are the world’s leading power but probably not for long with economists like Stiglitz making economic policy. He argues that the Internet was created by government funding but overlooks that taxpayers provided the resources. “So what should government be doing?” “Maintain full employment and a stable economy.”  Yes, how? “Promote innovation.” We have plenty of innovation but the innovative products like I-pad are produced abroad.  “Provide social protection,  “Prevent exploitation” i.e  pay a living wage! He cites the health consequences of the  tobacco industry not the higher living standards of every other industry that is making it possible to live healthier lives. He cites the financial industry failures not its successes.  He cites patent abuses but not the great inventions that made America great.  

“Deregulation played a central role in the crisis, and a new set of regulations will be needed to prevent another crisis.” Presumably he would restore the Glass-Steagull act. That may be a good idea but if it existed would it have prevented  the housing bubble that the government instigated?  He claims there has been “A loss of faith in American-style capitalism”. Yet former Communist countries, China for example, have grown by embracing capitalism!   

“Most Americans don’t understand the principles of comparative advantage—that each country produces the goods that it is relatively good at; and they find it difficult to grasp that the United States may have lost its comparative advantage in many areas of manufacturing. If China (or any other country) is outcompeting the United States, they believe it has to be because they are doing something unfairly: manipulating exchange rates or subsidizing their products or selling products below costs (which is called ‘dumping’).”  Apparently, he has never read Baumol and Gomory’s  contributions to comparative advantage theory.

Still he agrees something needs to be done about the trade deficits.   He suggests “A New Global Reserve System” that was recommended by a UN commission of experts, chaired by Stiglitz himself, on the restructuring of the global financial and economic system”.  Other possibilities include regional currency arrangements (like the euro!), and IMF SDRs. We fail to see how these would have a positive effect on the U.S. economy.

The switch to a single currency eventually caused the current economic crises in the trade deficit countries of Europe. When Keynes proposed that world trade switch to an international currency, he realized that it wouldn't work unless balanced trade was also required, so he argued that trade deficit countries be permitted to impose tariffs and subsidize their exports. What would the Stiglitz system do to maintain balanced trade? Establish a world government which tells the Chinese people how much they should save?

Siglitz writes regarding the 1929-1939 depression, that “American disciples of Keynes, like my teacher Paul Samuelson, argued that once the economy was restored to full employment, one could return to the marvels of the free market.”  The reason that the depression lasted so long, he writes, was that Pres. Roosevelt failed to have a consistent, national expansionary spending policy.

We believe otherwise. The evidence is that the “New Deal” was an unmitigated failure. We climbed out of the depression by going to war. And what brought prosperity to the U.S. was the dynamic private sector post WWII that innovated with passenger airplanes, home appliances, autos, radio and televisions, computers, and so on and so on. What innovations did the post WWII government in the Soviet union create?

Stiglistz criticizes neo-classical general economics equilibrium theory which  dominated economics for two centuries. Stiglitz argues, a la Keynes, that free market theory requires perfect markets with perfect information, an absence of monopoly, etc. With perfect markets (including perfect information), there would  always  be full employment. And he argues, “it was not true that the markets were efficient in determining the ideal amount of spending or the best direction of research.”  What a reading of history? Who better? It ignored the importance of firms financing by equity or by borrowing and racial discrimination, etc. He makes no mention of unions and appears not to understand the importance of competition in free markets. “When these conditions were not satisfied, there were always some government intervention that could make everyone better off.” Everyone? Very unlikely!

He sees no scientific basis for the presumption that markets are efficient. He writes, “Markets did provide incentives but market failures were pervasive, and there were persistent differences between social and private returns.” What was even more pervasive than market failures were market successes. What about the achievement of the high standards of living that relatively free markets produced?  Neo-classical economists ignored repeated episodes of massive unemployment. Really? How did we exit them before Keynes and what successes did Keynesian policies have? “In all successful countries government has played a key role in that success.”  Yes, government has played a role but not the key role. No, in all successful countries there has been a preponderant relatively free private  market.

Finally, he concludes,“Of course governments, like markets and humans, are fallible. But in East Asia, and elsewhere, the success far outweighed the failures.”  Really. Where were they in the eighteenth, nineteenth, and twentieth centuries. They succeeded finally by copying Western  capitalism.  Not until they embraced relatively free markets did they achieve success.

Microeconomics, he writes, focuses on the behavior of firms, macro on the behavior of the “overall economy.” The “high priests” of the Chicago school, he writes, believe that “government spending does not stimulate the economy.”  Yes, I am one of those believers. The failure of Keynesian policies to achieve anything resembling recovery after government expenditures in excess of many trillions of dollars seems to prove that the University of Chicago’s high priests were right.

What kind of society does Stiglitz believe we should have? We created “a society in which materialism dominates moral commitment, in which the rapid growth that we have achieved is not sustainable, environmentally or socially.”  It has lasted for more than two centuries. Communism and fascism, toward which we seem to be heading, lasted only a few decades. All over the world, a vast majority of people are living longer and better. Capitalism so far appears to be sustainable with even communist countries copying and experimenting with competitive if not free markets.

What appears to be unsustainable is the environmental movement which appears to be led by quacks as the scandal in East Anglia demonstrated and appears to be coming apart as more and more countries are forced to reduce the massive subsidies wind and solar energy require. Stiglitz, by embracing environmental fanaticism, is on the unsustainable path.

What appears to be unsustainable is the United States tolerating $600 billion per year trade deficits which sap our Aggregate Demand and lower our interest rates to negative real rates, all because the US government fails to impose trade balancing tariffs. Stiglitz, by embracing free trade fanaticism, is on the unsustainable path.

This book is basically fiction and its arguments are mostly political not economic. The author writes, “The current crisis has uncovered fundamental flaws in the capitalist system.” No, the flaw is in government policy-making, i.e., politics.

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Comment by , 4/16/2015:

Was the govt spending on wwii a great Kensian win? 


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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]