Joseph E. Stiglitz's Blog, page 13

Joseph Stiglitz | Africa's natural resources can be a blessing, not an economic curse

Resource-rich countries have, on average, done poorly but progress is possible if they get economic and political support

New discoveries of natural resources in several African countries – including Ghana, Uganda, Tanzania and Mozambique – raise an important question: will these windfalls be a blessing that brings prosperity and hope, or a political and economic curse, as has been the case in so many countries?

On average, resource-rich countries have done even more poorly than countries without resources. They have grown more slowly, and with greater inequality – just the opposite of what one would expect. After all, taxing natural resources at high rates will not cause them to disappear, which means that countries whose major source of revenue is natural resources can use them to finance education, healthcare, development and redistribution.

A large literature in economics and political science has developed to explain this "resource curse", and civil-society groups (such as Revenue Watch and the Extractive Industries Transparency Initiative) have been established to try to counter it. Three of the curse's economic ingredients are well-known:

• Resource-rich countries tend to have strong currencies, which impede other exports

• Because resource extraction often entails little job creation, unemployment rises

• Volatile resource prices cause growth to be unstable, aided by international banks that rush in when commodity prices are high and rush out in the downturns (reflecting the time-honoured principle that bankers lend only to those who do not need their money).

Moreover, resource-rich countries often do not pursue sustainable growth strategies. They fail to recognise that if they do not reinvest their resource wealth into productive investments above ground, they are actually becoming poorer. Political dysfunction exacerbates the problem, as conflict over access to resource rents gives rise to corrupt and undemocratic governments.

There are well-known antidotes to each of these problems: a low exchange rate, a stabilisation fund, careful investment of resource revenues (including in the country's people), a ban on borrowing, and transparency (so citizens can at least see the money coming in and going out). But there is a growing consensus that these measures, while necessary, are insufficient. Newly enriched countries need to take several more steps in order to increase the likelihood of a "resource blessing".

First, these countries must do more to ensure that their citizens get the full value of the resources. There is an unavoidable conflict of interest between (usually foreign) natural-resource companies and host countries: the former want to minimise what they pay, while the latter need to maximise it. Well-designed, competitive, transparent auctions can generate much more revenue than sweetheart deals. Contracts, too, should be transparent, and should ensure that if prices soar – as they have repeatedly – the windfall gain does not go only to the company.

Unfortunately, many countries have already signed bad contracts that give a disproportionate share of the resources' value to private foreign companies. But there is a simple answer: renegotiate; if that is impossible, impose a windfall-profit tax.

All over the world, countries have been doing this. Of course, natural-resource companies will push back, emphasise the sanctity of contracts, and threaten to leave. But the outcome is typically otherwise. A fair renegotiation can be the basis of a better long-term relationship.

Botswana's renegotiations of such contracts laid the foundations of its remarkable growth for the last four decades. Moreover, it is not only developing countries, such as Bolivia and Venezuela, that renegotiate; developed countries such as Israel and Australia have done so as well. Even the United States has imposed a windfall-profits tax.

Equally important, the money gained through natural resources must be used to promote development. The old colonial powers regarded Africa simply as a place from which to extract resources. Some of the new purchasers have a similar attitude.

Infrastructure (roads, railroads, and ports) has been built with one goal in mind: getting the resources out of the country at as low a price as possible, with no effort to process the resources in the country, let alone to develop local industries based on them.

Real development requires exploring all possible linkages: training local workers, developing small- and medium-size enterprises to provide inputs for mining operations and oil and gas companies, domestic processing, and integrating the natural resources into the country's economic structure. Of course, today, these countries may not have a comparative advantage in many of these activities, and some will argue that countries should stick to their strengths. From this perspective, these countries' comparative advantage is having other countries exploit their resources.

That is wrong. What matters is dynamic comparative advantage, or comparative advantage in the long run, which can be shaped. Forty years ago, South Korea had a comparative advantage in growing rice. Had it stuck to that strength, it would not be the industrial giant that it is today. It might be the world's most efficient rice grower, but it would still be poor.

Companies will tell Ghana, Uganda, Tanzania, and Mozambique to act quickly, but there is good reason for them to move more deliberately. The resources will not disappear, and commodity prices have been rising. In the meantime, these countries can put in place the institutions, policies, and laws needed to ensure that the resources benefit all of their citizens.

Resources should be a blessing, not a curse. They can be, but it will not happen on its own. And it will not happen easily.

• Copyright: Project Syndicate, 2012

Natural resources and developmentCommoditiesEconomicsAfricaOil and gas companiesMiningJoseph Stiglitz
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Death-row euro gets another last-minute stay of execution | Joseph Stiglitz

Like medieval blood-letters, Germany refuses to see medicine of austerity doesn't work and insists on more – until the patient dies

Like an inmate on death row, the euro has received another last-minute stay of execution. It will survive a little longer. The markets are celebrating, as they have after each of the four previous "euro crisis" summits – until they come to understand that the fundamental problems have yet to be addressed.

There was good news in this summit: Europe's leaders have finally understood that the bootstrap operation by which Europe lends money to the banks to save the sovereigns, and to the sovereigns to save the banks, will not work. Likewise, they now recognise that bailout loans that give the new lender seniority over other creditors worsen the position of private investors, who will simply demand even higher interest rates.

It is deeply troubling that it took Europe's leaders so long to see something so obvious (and evident more than a decade and a half ago in the east Asia crisis). But what is missing from the agreement is even more significant than what is there. A year ago, European leaders acknowledged that Greece could not recover without growth, and that growth could not be achieved by austerity alone. Yet little was done.

What is now proposed is recapitalisation of the European Investment Bank, part of a growth package of some $150bn (£95bn). But politicians are good at repackaging, and, by some accounts, the new money is a small fraction of that amount, and even that will not get into the system immediately. In short: the remedies – far too little and too late – are based on a misdiagnosis of the problem and flawed economics.

The hope is that markets will reward virtue, which is defined as austerity. But markets are more pragmatic. If, as is almost surely the case, austerity weakens economic growth, and thus undermines the capacity to service debt, interest rates will not fall. In fact, investment will decline – a vicious downward spiral on which Greece and Spain have already embarked.

Germany seems surprised by this. Like medieval blood-letters, the country's leaders refuse to see that the medicine does not work, and insist on more of it – until the patient finally dies.

Eurobonds and a solidarity fund could promote growth and stabilise the interest rates faced by governments in crisis. Lower interest rates, for example, would free up money so that even countries with tight budget constraints could spend more on growth-enhancing investments.

Matters are worse in the banking sector. Each country's banking system is backed by its own government; if the government's ability to support the banks erodes, so will confidence in the banks. Even well-managed banking systems would face problems in an economic downturn of Greek and Spanish magnitude; with the collapse of Spain's real-estate bubble, its banks are even more at risk.

In their enthusiasm for creating a "single market", European leaders did not recognise that governments provide an implicit subsidy to their banking systems. It is confidence that if trouble arises the government will support the banks that gives confidence in the banks; and, when some governments are in a much stronger position than others, the implicit subsidy is larger for those countries.

In the absence of a level playing field, why shouldn't money flee the weaker countries, going to the financial institutions in the stronger? Indeed, it is remarkable that there has not been more capital flight. Europe's leaders did not recognise this rising danger, which could easily be averted by a common guarantee, which would simultaneously correct the market distortion arising from the differential implicit subsidy.

The euro was flawed from the outset, but it was clear that the consequences would become apparent only in a crisis. Politically and economically, it came with the best intentions. The single-market principle was supposed to promote the efficient allocation of capital and labor.

But details matter. Tax competition means that capital may go not to where its social return is highest, but to where it can find the best deal. The implicit subsidy to banks means that German banks have an advantage over those of other countries. Workers may leave Ireland or Greece not because their productivity there is lower, but because, by leaving, they can escape the debt burden incurred by their parents. The European Central Bank's mandate is to ensure price stability, but inflation is far from Europe's most important macroeconomic problem today.

Germany worries that, without strict supervision of banks and budgets, it will be left holding the bag for its more profligate neighbours. But that misses the key point: Spain, Ireland, and many other distressed countries ran budget surpluses before the crisis. The downturn caused the deficits, not the other way around.

If these countries made a mistake, it was only that, like Germany today, they were overly credulous about markets, so they (like the US and so many others) allowed an asset bubble to grow unchecked. If sound policies are implemented and better institutions established – which does not mean only more austerity and better supervision of banks, budgets and deficits – and growth is restored, these countries will be able to meet their debt obligations, and there will be no need to call upon the guarantees. Moreover, Germany is on the hook in either case: if the euro or the economies on the periphery collapse, the costs to Germany will be high.

Europe has great strengths. Its weaknesses today mainly reflect flawed policies and institutional arrangements. These can be changed, but only if their fundamental weaknesses are recognised – a task that is far more important than structural reforms within the individual countries. While structural problems have weakened competitiveness and GDP growth in particular countries, they did not bring about the crisis, and addressing them will not resolve it.

Europe's temporising approach to the crisis cannot work indefinitely. It is not just confidence in Europe's periphery that is waning. The survival of the euro itself is being put in doubt.

Copyright: Project Syndicate, 2012

Eurozone crisisEuropean UnionEuropean monetary unionEconomicsEuroEuropeJoseph Stiglitz
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The price of inequality

Lack of opportunity in the United States means the country's most valuable asset – its people – is not being fully used

America likes to think of itself as a land of opportunity, and others view it in much the same light. But, while we can all think of examples of Americans who rose to the top on their own, what really matters are the statistics: to what extent do an individual's life chances depend on the income and education of his or her parents?

Nowadays, these numbers show that the American dream is a myth. There is less equality of opportunity in the United States today than there is in Europe – or, indeed, in any advanced industrial country for which there are data.

This is one of the reasons that America has the highest level of inequality of any of the advanced countries – and its gap with the rest has been widening. In the "recovery" of 2009-2010, the top 1% of US income earners captured 93% of the income growth. Other inequality indicators – like wealth, health, and life expectancy – are as bad or even worse. The clear trend is one of concentration of income and wealth at the top, the hollowing out of the middle, and increasing poverty at the bottom.

It would be one thing if the high incomes of those at the top were the result of greater contributions to society, but the great recession showed otherwise: even bankers who had led the global economy, as well as their own firms, to the brink of ruin, received outsize bonuses.

A closer look at those at the top reveals a disproportionate role for rent-seeking: some have obtained their wealth by exercising monopoly power; others are CEOs who have taken advantage of deficiencies in corporate governance to extract for themselves an excessive share of corporate earnings; and still others have used political connections to benefit from government munificence – either excessively high prices for what the government buys (drugs), or excessively low prices for what the government sells (mineral rights).

Likewise, part of the wealth of those in finance comes from exploiting the poor, through predatory lending and abusive credit-card practices. Those at the top, in such cases, are enriched at the direct expense of those at the bottom.

It might not be so bad if there were even a grain of truth to trickle-down economics – the quaint notion that everyone benefits from enriching those at the top. But most Americans today are worse off – with lower real (inflation-adjusted) incomes – than they were in 1997, a decade and a half ago. All of the benefits of growth have gone to the top.

Defenders of America's inequality argue that the poor and those in the middle shouldn't complain. While they may be getting a smaller share of the pie than they did in the past, the pie is growing so much, thanks to the contributions of the rich and superrich, that the size of their slice is actually larger. The evidence, again, flatly contradicts this. Indeed, America grew far faster in the decades after the second world war, when it was growing together, than it has since 1980, when it began growing apart.

This shouldn't come as a surprise, once one understands the sources of inequality. Rent-seeking distorts the economy. Market forces, of course, play a role, too, but markets are shaped by politics; and, in America, with its quasi-corrupt system of campaign finance and its revolving doors between government and industry, politics is shaped by money.

For example, a bankruptcy law that privileges derivatives over all else, but does not allow the discharge of student debt, no matter how inadequate the education provided, enriches bankers and impoverishes many at the bottom. In a country where money trumps democracy, such legislation has become predictably frequent.

But growing inequality is not inevitable. There are market economies that are doing better, both in terms of both GDP growth and rising living standards for most citizens. Some are even reducing inequalities.

America is paying a high price for continuing in the opposite direction. Inequality leads to lower growth and less efficiency. Lack of opportunity means that its most valuable asset – its people – is not being fully used. Many at the bottom, or even in the middle, are not living up to their potential, because the rich, needing few public services and worried that a strong government might redistribute income, use their political influence to cut taxes and curtail government spending. This leads to underinvestment in infrastructure, education, and technology, impeding the engines of growth.

The great recession has exacerbated inequality, with cutbacks in basic social expenditures and with high unemployment putting downward pressure on wages. Moreover, the United Nations Commission of Experts on Reforms of the International Monetary and Financial System, investigating the causes of the great recession, and the International Monetary Fund have warned that inequality leads to economic instability.

But, most importantly, America's inequality is undermining its values and identity. With inequality reaching such extremes, it is not surprising that its effects are manifest in every public decision, from the conduct of monetary policy to budgetary allocations. America has become a country not "with justice for all", but rather with favouritism for the rich and justice for those who can afford it – so evident in the foreclosure crisis, in which the big banks believed that they were too big not only to fail, but also to be held accountable.

America can no longer regard itself as the land of opportunity that it once was. But it does not have to be this way: it is not too late for the American dream to be restored.

Joseph E Stiglitz, a Nobel laureate in economics, is professor of economics at Columbia University. His latest book is The Price of Inequality: How Today's Divided Society Endangers our Future.

Copyright: Project Syndicate 2012.

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Developing countries deserve a greater say in World Bank governance | Joseph Stiglitz

Should America continue to insist on controlling the selection process, it is the World Bank itself that would suffer

Barack Obama's nomination of Jim Yong Kim for the presidency of the World Bank has been well received – and rightly so, especially given some of the other names that were bandied about. In Kim, a public health professor who is now president of Dartmouth University and previously led the World Health Organization's HIV/AIDS department, the United States has put forward a good candidate. But the candidate's nationality, and the nominating country – whether small and poor or large and rich – should play no role in determining who gets the job.

The World Bank's 11 executive directors from emerging and developing countries have put forward two excellent candidates, Ngozi Okonjo-Iweala of Nigeria and José Antonio Ocampo of Colombia. I have worked closely with both of them. Both are first-rate, have served as ministers with multiple portfolios, have performed admirably in top positions in multilateral organizations, and have the diplomatic skills and professional competence to do an outstanding job. They understand finance and economics, the bread and butter of the World Bank, and have a network of connections to leverage the Bank's effectiveness.

Okonjo-Iweala brings an insider's knowledge of the institution. Ocampo, like Kim, brings the advantages and disadvantages of being an outsider; but Ocampo, a distinguished professor at Columbia University, is thoroughly acquainted with the World Bank. He previously served not only as minister of economics and finance, but also of agriculture – a critically important qualification, given that the vast majority of the developing countries' poor depend on farming. He also brings impressive environmental credentials, addressing another of the Bank's central concerns.

Both Okonjo-Iweala and Ocampo understand the role of international financial institutions in providing global public goods. Throughout their careers, their hearts and minds have been devoted to development, and to fulfilling the World Bank's mission of eliminating poverty. They have set a high bar for any American candidate.

Much is at stake. Almost two billion people remain in poverty in the developing world, and, while the World Bank cannot solve the problem on its own, it plays a leading role. Despite its name, the Bank is primarily an international development institution. Kim's speciality, public health, is critical, and the Bank has long supported innovative initiatives in this field. But health is only a small part of the Bank's "portfolio," and it typically works in this area with partners who bring to the table expertise in medicine.

Rumours suggest that the US is likely to insist on maintaining the perverse selection process in which it gets to pick the World Bank's president, simply because, in this election year, Obama's opponents would trumpet loss of control over the choice as a sign of weakness. And it is more important for the US to retain that control than it is for emerging and developing countries to obtain it.

Indeed, the more powerful of the emerging markets know how to live within the current system, and they may use it to their advantage. They will, in effect, obtain an IOU, to be cashed in for something that is more important. The realpolitik of the moment makes fighting over the presidency unlikely; America may well prevail. But at what cost?

Should America continue to insist on controlling the selection process, it is the Bank itself that would suffer. For years, the Bank's effectiveness was compromised because it was seen, in part, as a tool of western governments and their countries' financial and corporate sectors. Ironically, even America's long-term interests would be best served by a commitment – not just in words, but also in deeds – to a merit-based system and good governance.

One supposed achievement of the G20 was an agreement to reform the governance of the international financial institutions – most importantly, how their leaders are selected. Since expertise on development by and large lies within the emerging and developing countries – after all, they live development – it seems natural that the World Bank's head would come from one of those countries. To maintain a cabal among developed countries, whereby the US appoints the World Bank president and Europe picks the International Monetary Fund's head, seems particularly anachronistic and perplexing today, when the Bank and the Fund are turning to emerging market countries as a source of funds.

While the US, the international community, and the Bank itself repeatedly emphasise the importance of good governance, a selection procedure that de facto leaves the appointment to the US president makes a mockery of it.

Okonjo-Iweala put the matter forcefully in an interview with the Financial Times: what is at stake is a matter of hypocrisy. The integrity of the advanced industrial countries, which have a majority of the votes at the World Bank, is being put to the test.

Copyright: Project Syndicate, 2012.

World BankEconomicsGlobal economyJoseph Stiglitz
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European Central Bank in a fix over Greek debt

The ECB may be putting the interests of the few banks that have written credit-default swaps before those of Greece, Europe's taxpayers, and creditors

Nothing illustrates better the political crosscurrents, special interests, and shortsighted economics now at play in Europe than the debate over the restructuring of Greece's sovereign debt. Germany insists on a deep restructuring – at least a 50% "haircut" for bondholders – whereas the European Central Bank insists that any debt restructuring must be voluntary.

In the old days – think of the 1980s Latin American debt crisis – one could get creditors, mostly large banks, in a small room, and hammer out a deal, aided by some cajoling, or even arm-twisting, by governments and regulators eager for things to go smoothly. But, with the advent of debt securitisation, creditors have become far more numerous, and include hedge funds and other investors over whom regulators and governments have little sway.

Moreover, "innovation" in financial markets has made it possible for securities owners to be insured, meaning that they have a seat at the table, but no "skin in the game". They do have interests: they want to collect on their insurance, and that means that the restructuring must be a "credit event" – tantamount to a default. The ECB's insistence on "voluntary" restructuring – that is, avoidance of a credit event – has placed the two sides at loggerheads. The irony is that the regulators have allowed the creation of this dysfunctional system.

The ECB's stance is peculiar. One would have hoped that the banks might have managed the default risk on the bonds in their portfolios by buying insurance. And, if they bought insurance, a regulator concerned with systemic stability would want to be sure that the insurer pays in the event of a loss. But the ECB wants the banks to suffer a 50% loss on their bond holdings, without insurance "benefits" having to be paid.

There are three explanations for the ECB's position, none of which speaks well for the institution and its regulatory and supervisory conduct. The first explanation is that the banks have not, in fact, bought insurance, and some have taken speculative positions. The second is that the ECB knows that the financial system lacks transparency – and knows that investors are aware that they cannot gauge the impact of an involuntary default, which could cause credit markets to freeze, reprising the aftermath of Lehman Brothers' collapse in September 2008. Finally, the ECB may be trying to protect the few banks that have written the insurance.

None of these explanations is an adequate excuse for the ECB's opposition to deep involuntary restructuring of Greece's debt. The ECB should have insisted on more transparency – indeed, that should have been one of the main lessons of 2008. Regulators should not have allowed the banks to speculate as they did; if anything, they should have required them to buy insurance – and then insisted on restructuring in a way that ensured that the insurance paid off.

There is, moreover, little evidence that a deep involuntary restructuring would be any more traumatic than a deep voluntary restructuring. By insisting on it being voluntary, the ECB may be trying to ensure that the restructuring is not deep; but, in that case, it is putting the banks' interests before that of Greece, for which a deep restructuring is essential if it is to emerge from the crisis. In fact, the ECB may be putting the interests of the few banks that have written credit-default swaps before those of Greece, Europe's taxpayers, and creditors who acted prudently and bought insurance.

The final oddity of the ECB's stance concerns democratic governance. Deciding whether a credit event has occurred is left to a secret committee of the International Swaps and Derivatives Association, an industry group that has a vested interest in the outcome. If news reports are correct, some members of the committee have been using their position to promote more accommodative negotiating positions. But it seems unconscionable that the ECB would delegate to a secret committee of self-interested market participants the right to determine what is an acceptable debt restructuring.

The one argument that seems, at least superficially, to put the public interest first is that an involuntary restructuring might lead to financial contagion, with large eurozone economies such as Italy, Spain, and even France facing a sharp, and perhaps prohibitive, rise in borrowing costs. But that begs the question: why should an involuntary restructuring lead to worse contagion than a voluntary restructuring of comparable depth? If the banking system were well regulated, with banks holding sovereign debt having purchased insurance, an involuntary restructuring should perturb financial markets less.

Of course, it might be argued that if Greece gets away with an involuntary restructuring, others would be tempted to try it as well. Financial markets, worried about this, would immediately raise interest rates on other at-risk eurozone countries, large and small.

But the riskiest countries already have been shut out of financial markets, so the possibility of a panic reaction is of limited consequence. Of course, others might be tempted to imitate Greece if the country were indeed better off restructuring than not doing so. That is true, but everyone already knows it.

The ECB's behaviour should not be surprising: as we have seen elsewhere, institutions that are not democratically accountable tend to be captured by special interests. That was true before 2008; unfortunately for Europe – and for the global economy – the problem has not been adequately addressed since then.

Copyright: Project Syndicate, 2012.

EconomicsEuropean Central BankEurozone crisisEuropean banksCredit crunchBankingBanking reformFinancial crisisGreeceGermanyEuropean UnionJoseph Stiglitz
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Many Americans gave up hope last year – 2012 will be worse

The chance of realising the American dream is receding for millions as jobs are lost, savings run out and houses are repossessed

The year 2011 will be remembered as the time when many ever-optimistic Americans began to give up hope. President John F Kennedy once said that a rising tide lifts all boats. But now, in the receding tide, Americans are beginning to see not only that those with taller masts had been lifted far higher, but also that many of the smaller boats had been dashed to pieces in their wake.

In that brief moment when the tide was indeed rising, millions of people believed that they might have a fair chance of realising the "American Dream". Now those dreams, too, are receding. By 2011, the savings of those who had lost their jobs in 2008 or 2009 had been spent. Unemployment cheques had run out. Headlines announcing new hiring – still not enough to keep pace with the number of those who would normally have entered the labour force – meant little to the 50-year-olds with little hope of ever holding a job again.

Indeed, middle-aged people who thought that they would be unemployed for a few months have now realised that they were, in fact, forcibly retired. Young people who graduated from college with tens of thousands of dollars of education debt cannot find any jobs at all. People who moved in with friends and relatives have become homeless. Houses bought during the property boom are still on the market or have been sold at a loss. More than seven million American families have lost their homes.

The dark underbelly of the previous decade's financial boom has been fully exposed in Europe as well. Dithering over Greece and key national governments' devotion to austerity began to exact a heavy toll last year. Contagion spread to Italy. Spain's unemployment, which had been near 20% since the beginning of the recession, crept even higher. The unthinkable – the end of the euro – began to seem like a real possibility.

This year is set to be even worse. It is possible, of course, that the United States will solve its political problems and finally adopt the stimulus measures that it needs to bring down unemployment to 6% or 7% (the pre-crisis level of 4% or 5% is too much to hope for). But this is as unlikely as it is that Europe will figure out that austerity alone will not solve its problems. On the contrary, austerity will only exacerbate the economic slowdown. Without growth, the debt crisis – and the euro crisis – will only worsen. And the long crisis that began with the collapse of the housing bubble in 2007 and the subsequent recession will continue.

Moreover, the major emerging-market countries, which steered successfully through the storms of 2008 and 2009, may not cope as well with the problems looming on the horizon. Brazil's growth has already stalled, fuelling anxiety among its neighbours in Latin America.

Meanwhile, long-term problems – including climate change and other environmental threats, and increasing inequality in most countries around the world – have not gone away. Some have grown more severe. For example, high unemployment has depressed wages and increased poverty.

Good news

The good news is that addressing these long-term problems would actually help to solve the short-term problems. Increased investment to retro-fit the economy for global warming would help to stimulate economic activity, growth, and job creation. More progressive taxation, in effect redistributing income from the top to the middle and bottom, would simultaneously reduce inequality and increase employment by boosting total demand. Higher taxes at the top could generate revenues to finance needed public investment, and to provide some social protection for those at the bottom, including the unemployed.

Even without widening the fiscal deficit, such "balanced budget" increases in taxes and spending would lower unemployment and increase output. The worry, however, is that politics and ideology on both sides of the Atlantic, but especially in the US, will not allow any of this to occur. Fixation on the deficit will induce cutbacks in social spending, worsening inequality. Likewise, the enduring attraction of supply-side economics, despite all of the evidence against it (especially in a period in which there is high unemployment), will prevent raising taxes at the top.

Even before the crisis, there was a rebalancing of economic power – in fact, a correction of a 200-year historical anomaly, in which Asia's share of global GDP fell from nearly 50% to, at one point, below 10%. The pragmatic commitment to growth that one sees in Asia and other emerging markets today stands in contrast to the west's misguided policies, which, driven by a combination of ideology and vested interests, almost seem to reflect a commitment not to grow.

As a result, global economic rebalancing is likely to accelerate, almost inevitably giving rise to political tensions. With all of the problems confronting the global economy, we will be lucky if these strains do not begin to manifest themselves within the next 12 months.

Copyright: Project Syndicate, 2012

Global economyEconomicsUS economyJoseph Stiglitz
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Meltdown: not just a metaphor | Joseph Stiglitz

Vested interests cause both our financial system and the nuclear industry to compulsively underestimate risk

The consequences of the Japanese earthquake – especially the ongoing crisis at the Fukushima nuclear power plant – resonate grimly for observers of the American financial crash that precipitated the Great Recession. Both events provide stark lessons about risks, and about how badly markets and societies can manage them.

Of course, in one sense, there is no comparison between the tragedy of the earthquake – which has left more than 25,000 people dead or missing – and the financial crisis, to which no such acute physical suffering can be attributed. But when it comes to the nuclear meltdown at Fukushima, there is a common theme in the two events.

Experts in both the nuclear and finance industries assured us that new technology had all but eliminated the risk of catastrophe. Events proved them wrong: not only did the risks exist, but their consequences were so enormous that they easily erased all the supposed benefits of the systems that industry leaders promoted.

Before the Great Recession, America's economic gurus – from the head of the Federal Reserve to the titans of finance – boasted that we had learned to master risk. "Innovative" financial instruments such as derivatives and credit default swaps enabled the distribution of risk throughout the economy. We now know that they deluded not only the rest of society, but even themselves.

These wizards of finance, it turned out, didn't understand the intricacies of risk, let alone the dangers posed by "fat-tail distributions" – a statistical term for rare events with huge consequences, sometimes called "black swans". Events that were supposed to happen once in a century – or even once in the lifetime of the universe – seemed to happen every 10 years. Worse, not only was the frequency of these events vastly underestimated; so was the astronomical damage they would cause – something like the meltdowns that keep dogging the nuclear industry.

Research in economics and psychology helps us understand why we do such a bad job in managing these risks. We have little empirical basis for judging rare events, so it is difficult to arrive at good estimates. In such circumstances, more than wishful thinking can come into play: we might have few incentives to think hard at all. On the contrary, when others bear the costs of mistakes, the incentives favour self-delusion. A system that socialises losses and privatises gains is doomed to mismanage risk.

Indeed, the entire financial sector was rife with agency problems and externalities. Ratings agencies had incentives to give good ratings to the high-risk securities produced by the investment banks that were paying them. Mortgage originators bore no consequences for their irresponsibility, and even those who engaged in predatory lending or created and marketed securities that were designed to lose did so in ways that insulated them from civil and criminal prosecution.

This brings us to the next question: are there other "black swan" events waiting to happen? Unfortunately, some of the really big risks that we face today are most likely not even rare events. The good news is that such risks can be controlled at little or no cost. The bad news is that doing so faces strong political opposition – for there are people who profit from the status quo.

We have seen two of the big risks in recent years, but have done little to bring them under control. By some accounts, how the last crisis was managed may have increased the risk of a future financial meltdown.

Too-big-to-fail banks, and the markets in which they participate, now know that they can expect to be bailed out if they get into trouble. As a result of this moral hazard, these banks can borrow on favourable terms, giving them a competitive advantage based not on superior performance, but on political strength. While some of the excesses in risk-taking have been curbed, predatory lending and unregulated trading in obscure, over-the-counter derivatives continue. Incentive structures that encourage excess risk-taking remain virtually unchanged.

So, too, while Germany has shut down its older nuclear reactors, in the US and elsewhere, even plants that have the same flawed design as Fukushima continue to operate. The nuclear industry's very existence is dependent on hidden public subsidies – costs borne by society in the event of nuclear disaster, as well as the costs of the still-unmanaged disposal of nuclear waste. So much for unfettered capitalism!

For the planet, there is one more risk, which, like the other two, is almost a certainty: global warming and climate change. If there were other planets to which we could move at low cost in the event of the almost certain outcome predicted by scientists, one could argue that this is a risk worth taking. But there aren't, so it isn't.

The costs of reducing emissions pale in comparison to the possible risks the world faces. And that is true even if we rule out the nuclear option (the costs of which were always underestimated). To be sure, coal and oil companies would suffer, and big polluting countries – like the US – would obviously pay a higher price than those with a less profligate lifestyle.

In the end, those gambling in Las Vegas lose more than they gain. As a society, we are gambling – with our big banks, with our nuclear power facilities, with our planet. As in Las Vegas, the lucky few – the bankers that put our economy at risk and the owners of energy companies that put our planet at risk – may walk off with a mint. But on average and almost certainly, we as a society, like all gamblers, will lose.

That, unfortunately, is a lesson of Japan's disaster that we continue to ignore at our peril.

© Project Syndicate 2011

JapanNuclear powerNuclear wasteFinancial crisisBankingRegulatorsGlobal recessionClimate changeNatural disasters and extreme weatherPollutionGlobal economyJoseph Stiglitz
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The Mauritius miracle, or how to make a big success of a small economy | Joseph Stiglitz

The US ought to learn a thing or two from Mauritius, where all citizens enjoy high standards of healthcare and education

Suppose someone were to describe a small country that provided free education through university for all of its citizens, transport for school children and free healthcare – including heart surgery – for all. You might suspect that such a country is either phenomenally rich or on the fast track to fiscal crisis.

After all, rich countries in Europe have increasingly found they cannot pay for university education, and are asking young people and their families to bear the costs. For its part, the US has never attempted to give free college for all, and it took a bitter battle just to ensure that America's poor get access to healthcare – a guarantee that the Republican party is now working hard to repeal, claiming the country cannot afford it.

But Mauritius, a small island nation off the east coast of Africa, is neither particularly rich nor on its way to budgetary ruin. Nonetheless, it has spent the last decades successfully building a diverse economy, a democratic political system and a strong social safety net. Many countries, not least the US, could learn from its experience.

In a recent visit to this tropical archipelago of 1.3 million people, I had a chance to see some of the leaps Mauritius has taken – accomplishments that can seem bewildering in light of the debate in the US and elsewhere. Consider home ownership: while American conservatives say the government's attempt to extend home ownership to 70% of the US population was responsible for the financial meltdown, 87% of Mauritians own their own homes – without fuelling a housing bubble.

Now comes the painful number: Mauritius's GDP has grown faster than 5% annually for almost 30 years. Surely, this must be some "trick". Mauritius must be rich in diamonds, oil, or some other valuable commodity. But Mauritius has no exploitable natural resources. Indeed, so dismal were its prospects as it approached independence from Britain, which came in 1968, that the Nobel prize-winning economist James Meade wrote in 1961: "It is going to be a great achievement if [the country] can find productive employment for its population without a serious reduction in the existing standard of living … [The] outlook for peaceful development is weak."

As if to prove Meade wrong, the Mauritians have increased per capita income from less than $400 around the time of independence to more than $6,700 today. The country has progressed from the sugar-based monoculture of 50 years ago to a diversified economy that includes tourism, finance, textiles, and, if current plans bear fruit, advanced technology.

During my visit, my interest was to understand better what had led to what some have called the Mauritius miracle, and what others might learn from it. There are, in fact, many lessons, some of which should be borne in mind by politicians in the US and elsewhere as they fight their budget battles.

First, the question is not whether we can afford to provide healthcare or education for all, or ensure widespread home ownership. If Mauritius can afford these things, America and Europe – which are several orders of magnitude richer – can too. The question, rather, is how to organise society. Mauritians have chosen a path that leads to higher levels of social cohesion, welfare and economic growth – and to a lower level of inequality.

Second, unlike many other small countries, Mauritius has decided that most military spending is a waste. The US need not go as far: just a fraction of the money that America spends on weapons that don't work against enemies that don't exist would go a long way toward creating a more humane society, including provision of healthcare and education to those who cannot afford them.

Third, Mauritius recognised that without natural resources, its people were its only asset. Maybe that appreciation for its human resources is also what led Mauritius to realise that, particularly given the country's potential religious, ethnic, and political differences – which some tried to exploit in order to induce it to remain a British colony – education for all was crucial to social unity. So was a strong commitment to democratic institutions and co-operation between workers, government, and employers – precisely the opposite of the kind of dissension and division being engendered by conservatives in the US today.

This is not to say that Mauritius is without problems. Like many other successful emerging-market countries, it is confronting a loss of exchange-rate competitiveness. And, as more and more countries intervene to weaken their exchange rates in response to America's attempt at competitive devaluation through quantitative easing, the problem is becoming worse. Almost surely, Mauritius, too, will have to intervene.

Moreover, like many other countries around the world, Mauritius worries today about imported food and energy inflation. To respond to inflation by increasing interest rates would simply compound the difficulties of high prices with high unemployment and an even less competitive exchange rate. Direct interventions, restrictions on short-term capital inflows, capital gains taxes and stabilising prudential banking regulations will all have to be considered.

The Mauritius Miracle dates to independence. But the country still struggles with some of its colonial legacies: inequality in land and wealth, as well as vulnerability to high-stakes global politics. The US occupies one of Mauritius's offshore islands, Diego Garcia, as a naval base without compensation, officially leasing it from the UK, which not only retained the Chagos Islands in violation of the UN and international law, but also expelled its citizens and refuses to allow them to return.

The US should now do right by this peaceful and democratic country: recognise Mauritius's rightful ownership of Diego Garcia, renegotiate the lease and redeem past sins by paying a fair amount for land that it has illegally occupied for decades.

Copyright: Project Syndicate, 2011.

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Steadying Tunisia's balancing act | Joseph Stiglitz

Tunisia is off to an amazingly good start, but the international community must now help it become a beacon for democracy

The whole world celebrates Tunisia's democratic revolution, which has set off a cascade of events elsewhere in the region – particularly in Egypt – with untold consequences. The eyes of the world are now set on this small country of 10 million, to learn the lessons of its recent experience and to see if the young people who overthrew a corrupt autocrat can create a stable, functioning democracy.

First, the lessons. For starters, it is not enough for governments to deliver reasonable growth. After all, GDP grew at around 5% annually in Tunisia over the last 20 years, and the country was often cited as boasting one of the better-performing economies, particularly within the region.

Nor is it enough to follow the dictates of international financial markets – that may get good bond ratings and please international investors, but it does not mean that jobs are being created or that standards of living are being increased for most citizens. Indeed, the fallibility of the bond markets and rating agencies was evident in the run-up to the 2008 crisis. That they looked with disfavour at Tunisia's move from authoritarianism to democracy does not redound to their credit – and should never be forgotten.

Even providing good education may not suffice. All over the world, countries are struggling to create enough jobs for new entrants into the labour force. High unemployment and pervasive corruption, however, create a combustible combination. Economic studies show that what is really important to a country's performance is a sense of equity and fair play.

If, when jobs are scarce, those with political connections get them, and if, when wealth is limited, government officials accumulate masses of money, the system will generate outrage at such inequities – and at the perpetrators of these "crimes". Outrage at bankers in the west is a milder version of the same basic demand for economic justice that we saw first in Tunisia, and now across the region.

Virtuous though democracy is – and as Tunisia has shown, it is far better than the alternative – we should remember the failures of those who claim its mantle, and that there is more to true democracy than periodic elections, even when they are conducted fairly. Democracy in the US, for example, has been accompanied by increasing inequality, so much so that the upper 1% now receives about a quarter of national income – with wealth being even more inequitably distributed.

Most Americans today are worse off than they were a decade ago, with almost all the gains from economic growth going to the very top of the income and wealth distribution. And corruption American-style can result in trillion-dollar gifts to pharmaceutical companies, the purchase of elections with massive campaign contributions and tax cuts for millionaires as medical care for the poor is cut.

In many countries, democracy has been accompanied by civil strife, factionalism, and dysfunctional governments. In this regard, Tunisia starts on a positive note: a sense of national cohesion created by the successful overthrow of a widely hated dictator. The country must strive to maintain that sense of cohesion, which requires a commitment to transparency, tolerance and inclusiveness – both politically and economically.

A sense of fair play requires voice, which can be achieved only through public dialogue. Everyone stresses the rule of law, but it matters a great deal what kind of rule of law is established. For laws can be used to ensure equality of opportunity and tolerance, or they can be used to maintain inequalities and the power of elites.

Tunisia may not be able to prevent special interests from capturing its government, but, if public financing of electoral campaigns and restrictions on lobbying and revolving doors between the public and private sectors remain absent, such capture will be not only possible, but certain. Commitments to transparent privatisation auctions and competitive bidding for procurement reduce the scope for rent-seeking behaviour.

There are many balancing acts to be mastered: a government that is too powerful might violate citizens' rights, but a government that is too weak would be unable to undertake the collective action needed to create a prosperous and inclusive society – or to prevent powerful private actors from preying on the weak and defenceless. Latin America has shown that there are problems with term limits for political officeholders, but not having term limits is even worse.

So constitutions need to be flexible. Enshrining economic-policy fads, as the European Union has done with its central bank's single-minded focus on inflation, is a mistake. But certain rights, both political (freedom of religion, speech and press) and economic need to be absolutely guaranteed. A good place for Tunisia's debate to begin is deciding how far beyond the rights enshrined in the universal declaration of human rights the country should go in writing its new constitution.

Tunisia is off to an amazingly good start. Its people have acted with purpose and thoughtfulness in setting up an interim government, as Tunisians of talent and achievement have, on a moment's notice, volunteered to serve their country at this critical juncture. It will be the Tunisians themselves who will create the new system, one that may serve as a beacon for what a 21st-century democracy might be like.

The international community, which so often has propped up authoritarian regimes in the name of stability (or on the principle that "the enemy of my enemy is my friend") has a clear responsibility to provide whatever assistance Tunisia needs in the coming months and years.

Copyright: Project Syndicate, 2011

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Let's ignore the 'financial wizards' in 2011 | Joseph Stiglitz

My new year's hope is that we stop listening to those calling for austerity and use some common sense to restructure debt

For Europe and the United States, 2010 was a year of disappointment. It's been three years since the bubble burst, and more than two since Lehman Brothers' collapse. In 2009, we were pulled back from the brink of depression, and 2010 was supposed to be the year of transition: as the economy got back on its feet, stimulus spending could smoothly be brought down.

Growth, it was thought, might slow slightly in 2011, but it would be a minor bump on the way to robust recovery. We could then look back at the "great recession" as a bad dream; the market economy – supported by prudent government action – would have shown its resilience.

In fact, 2010 was a nightmare. The crises in Ireland and Greece called into question the euro's viability and raised the prospect of a debt default. On both sides of the Atlantic, unemployment remained stubbornly high, at around 10%. Even though 10% of US households with mortgages had already lost their homes, the pace of foreclosures appeared to be increasing – or would have, were it not for legal snafus that raised doubts about America's vaunted "rule of law".

Unfortunately, the new year's resolutions made in Europe and America were the wrong ones. The response to the private sector failures and profligacy that had caused the crisis was to demand public sector austerity. The consequence will almost surely be a slower recovery and an even longer delay before unemployment falls to acceptable levels.

There will also be a decline in competitiveness. While China has kept its economy going by making investments in education, technology and infrastructure, Europe and America have been cutting back.

It has become fashionable among politicians to preach the virtues of pain and suffering, no doubt because those bearing the brunt of it are those with little voice – the poor and future generations. To get the economy going, some people will, in fact, have to bear some pain, but the increasingly skewed income distribution gives clear guidance to whom this should be: approximately a quarter of all income in the US now goes to the top 1%, while most Americans' income is lower today than it was a dozen years ago. Simply put, most Americans didn't share in what many called the "great moderation", but was really the mother of all bubbles. So, should innocent victims and those who gained nothing from fake prosperity really be made to pay even more?

Europe and America have the same talented people, the same resources and the same capital that they had before the recession. They may have overvalued some of these assets; but the assets are, by and large, still there. Private financial markets misallocated capital on a massive scale in the years before the crisis and the waste resulting from underutilisation of resources has been even greater since the crisis began. The question is, how do we get these resources back to work?

Debt restructuring – writing down the debts of homeowners and, in some cases, governments – will be key. It will eventually happen. But delay is very costly – and largely unnecessary.

Banks never wanted to admit to their bad loans and now they don't want to recognise the losses, at least not until they can adequately recapitalise themselves through their trading profits and the large spread between their high lending rates and rock-bottom borrowing costs. The financial sector will press governments to ensure full repayment, even when it leads to massive social waste, huge unemployment and high social distress – and even when it is a consequence of their own mistakes in lending.

But, as we know from experience, there is life after debt restructuring. No one would wish the trauma that Argentina went through in 1999-2002 on any other country. But the country also suffered in the years before the crisis – years of IMF bailouts and austerity – from high unemployment and poverty rates and low and negative growth.

Since the debt restructuring and currency devaluation, Argentina has had years of extraordinarily rapid GDP growth, with the annual rate averaging nearly 9% from 2003 to 2007. By 2009, national income was twice what it was at the nadir of the crisis, in 2002, and more than 75% above its pre-crisis peak.

Likewise, Argentina's poverty rate has fallen by some three-quarters from its crisis peak, and the country weathered the global financial crisis far better than the US did – unemployment is high, but still only around 8%. We could only conjecture what would have happened if it had not postponed the day of reckoning for so long – or if it had tried to put it off further.

So this is my hope for the new year: we stop paying attention to the so-called financial wizards who got us into this mess – and who are now calling for austerity and delayed restructuring – and start using a little common sense. If there is pain to be borne, the brunt of it should be felt by those responsible for the crisis, and those who benefited most from the bubble that preceded it.

• Copyright: Project Syndicate, 2011

EuropeEuropean debt crisisUS economic growth and recessionBankingEconomicsGlobal economyUS economyUnited StatesJoseph Stiglitz
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