http://news.xinhuanet.com/english/2009-12/31/content_12734316.htm
BEIJING, Dec. 31 -- The best that can be said for 2009 is that it
could have been worse, that we pulled back from the precipice on which
we seemed to be perched in late 2008, and that 2010 will almost surely
be better for most countries around the world. The world has also
learned some valuable lessons, though at great cost both to current
and future prosperity - costs that were unnecessarily high given that
we should already have learned them.
The first lesson is that markets are not self-correcting. Indeed,
without adequate regulation, they are prone to excess. In 2009, we
again saw why Adam Smith's invisible hand often appeared invisible: it
is not there. The bankers' pursuit of self-interest (greed) did not
lead to the well-being of society; it did not even serve their
shareholders and bondholders well. It certainly did not serve
homeowners who are losing their homes, workers who have lost their
jobs, retirees who have seen their retirement funds vanish, or
taxpayers who paid hundreds of billions of dollars to bail out the
banks.
Under the threat of a collapse of the entire system, the safety
net - intended to help unfortunate individuals meet the exigencies of
life - was generously extended to commercial banks, then to investment
banks, insurance firms, auto companies, even car-loan companies. Never
has so much money been transferred from so many to so few.
We are accustomed to thinking of government transferring money
from the well off to the poor. Here it was the poor and average
transferring money to the rich. Already heavily burdened taxpayers saw
their money - intended to help banks lend so that the economy could be
revived - go to pay outsized bonuses and dividends. Dividends are
supposed to be a share of profits; here it was simply a share of
government largesse.
The justification was that bailing out the banks, however messily,
would enable a resumption of lending. That has not happened. All that
happened was that average taxpayers gave money to the very
institutions that had been gouging them for years - through predatory
lending, usurious credit-card interest rates, and non-transparent
fees.
The bailout exposed deep hypocrisy all around. Those who had
preached fiscal restraint when it came to small welfare programs for
the poor now clamored for the world's largest welfare program. Those
who had argued for free market's virtue of "transparency" ended up
creating financial systems so opaque that banks could not make sense
of their own balance sheets. And then the government, too, was induced
to engage in decreasingly transparent forms of bailout to cover up its
largesse to the banks. Those who had argued for "accountability" and
"responsibility" now sought debt forgiveness for the financial
sector.
The second important lesson involves understanding why markets
often do not work the way they are meant to. There are many reasons
for market failures. In this case, too-big-to-fail financial
institutions had perverse incentives: if they gambled and succeeded,
they walked off with the profits; if they lost, the taxpayer would
pay. Moreover, when information is imperfect, markets often do not
work well - and information imperfections are central in finance.
Externalities are pervasive: the failure of one bank imposed costs on
others, and failures in the financial system imposed costs on
taxpayers and workers all over the world.
The third lesson is that Keynesian policies do work. Countries,
like Australia, that implemented large, well-designed stimulus
programs early emerged from the crisis faster. Other countries
succumbed to the old orthodoxy pushed by the financial wizards who got
us into this mess in the first place.
Whenever an economy goes into recession, deficits appear, as tax
revenues fall faster than expenditures. The old orthodoxy held that
one had to cut the deficit - raise taxes or cut expenditures - to
"restore confidence." But those policies almost always reduced
aggregate demand, pushed the economy into a deeper slump, and further
undermined confidence - most recently when the International Monetary
Fund insisted on them in East Asia in the 1990's.
The fourth lesson is that there is more to monetary policy than
just fighting inflation. Excessive focus on inflation meant that some
central banks ignored what was happening to their financial markets.
The costs of mild inflation are miniscule compared to the costs
imposed on economies when central banks allow asset bubbles to grow
unchecked.
The fifth lesson is that not all innovation leads to a more
efficient and productive economy - let alone a better society. Private
incentives matter, and if they are not well aligned with social
returns, the result can be excessive risk taking, excessively
shortsighted behavior, and distorted innovation. For example, while
the benefits of many of the financial-engineering innovations of
recent years are hard to prove, let alone quantify, the costs
associated with them - both economic and social - are apparent and
enormous.
Indeed, financial engineering did not create products that would
help ordinary citizens manage the simple risk of home ownership - with
the consequence that millions have lost their homes, and millions more
are likely to do so. Instead, innovation was directed at perfecting
the exploitation of those who are less educated, and at circumventing
the regulations and accounting standards that were designed to make
markets more efficient and stable. As a result, financial markets,
which are supposed to manage risk and allocate capital efficiently,
created risk and misallocated wildly.
We will soon find out whether we have learned the lessons of this
crisis any better than we should have learned the same lessons from
previous crises.
Regrettably, unless the United States and other advanced
industrial countries make much greater progress on financial-sector
reforms in 2010 we may find ourselves faced with another opportunity
to learn them.
The author is an Economics Nobel laureate and university professor
at Columbia University. He has many books, including Globalization and
Its Discontents and The Roaring Nineties, to his credit. His latest
book, Freefall, will be published in January.
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