Unlearnt lessons from the financial crisis may spell disaster

JOE Stiglitz has seen the future, and he is worried. He had hoped that the global financial crisis would force reforms to ensure that it never happened again. He had hoped that Western governments would stick to their stimulus spending as long as it was needed to offset the weakness in household spending and business investment. But neither is happening.

One of the world's most eminent economists, Stiglitz has long warned that the West risks a "double-dip" recession next year as the stimulus is removed faster than private spending comes back. He is not predicting such an outcome, but with the US economy still "anaemic" and austerity measures now sweeping Europe in the wake of the Greek sovereign debt crisis, he sees the risks mounting.

"What is almost certain is that growth will slow down markedly," he says. "Whether it will slow down to the point where growth becomes negative is not clear.

"I don't think the markets or governments have taken on board the consequences of simultaneous austerity policies in the UK, Germany and others.

"Some governments have put out rosy forecasts of how little it will hurt. It's as if they

can engage in contractionary policies without getting the contraction.

"When a number of countries take these policy actions together, the effects might be very severe."

Winner of the 2001 Nobel Prize for economics, former chief economic adviser to US president Bill Clinton and chief economist of the World Bank, Stiglitz is one of the few economists who have earned a worldwide following: among economists, for his work on the adverse consequences of market players having different levels of information, and among the broader world of people who think about issues, for his penetrating criticism of the economic shibboleths of free market fundamentalism, and his articulate advocacy of an economics that makes improving human welfare its core mission.

Stiglitz, now 67, spoke to The Age yesterday from Perth, where he has just arrived for a three-week tour that will take him all over Australia, combining holiday sightseeing with 12 lectures, two of them in Melbourne, mostly on the lessons of the global financial crisis and the prospects for recovery.

If you've read his recent bestseller on the crisis, Freefall: Free Markets and the Sinking of the Global Economy, you will know that his views are bleakly pessimistic. He puts the blame for the crisis squarely on Wall Street, and the politicians and regulators who gave it free rein partly for ideological reasons, partly because of its role in financing their campaigns.

"The big question in the 21st century global economy is: what should be the role of the state?" he writes. "Today only the deluded . . . would argue that markets are self-correcting and that society can rely on the self-interested behaviour of market participants to ensure that everything works honestly and properly let alone works in a way that benefits all.

"I believe that markets lie at the heart of every successful economy but that markets do not work well on their own.

"Economies need a balance between the role of markets and the role of government. In the last 25 years, America lost the balance, and it pushed its unbalanced perspective on countries around the world.

"The problem was not so much [former US Reserve chief Alan] Greenspan as the deregulatory ideology that had taken hold."

The financial reforms passed by the US Congress this month will not stop risky lending, Stiglitz warns. While they enshrine four important principles restricting banks from investing in risky activities, forcing derivatives trading into the open, cutting bank fees on debit card transactions, and setting up a consumer product safety commission "every one has a carve-out, a big exception" that will allow the banks largely to carry on as before, he says.

To Australian readers of Freefall, it's hard to believe that two countries so similar could have taken such different approaches to market regulation. In Australia, John Laker and his team at the Australian Prudential Regulation Authority were real watchdogs, keeping the banks from risky lending strategies by warning they would have to put aside more capital to offset the risk. So our banks didn't fail, and our crisis ended up as the mildest recession since World War II.

Finding out why Australia survived the global slump so well is one of Stiglitz's goals here. "Australia is a fascinating country for me to visit, because it shows that you can actually have a capitalism that works," he quips.

Another priority here is to explain an intriguing report last year by a commission he chaired on "the measurement of economic performance and social progress". Commissioned by French President Nicolas Sarkozy, it argued that our usual measure, gross domestic product, is a poor guide to progress. Rather, we need new measures that focus on sustainability, income distribution and quality of life, as well as output.

"It's had a lot of resonance," Stiglitz says. "It's a long-term agenda, and there are a lot of issues. We're now in the process of setting up a unit within the OECD that will take it forward."

It could be one of the lasting legacies of the economist from a midwest steel town, for whom economics is about making ordinary people better off.