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Guided by an invisible hand

The bank meltdown marks a turning point in our thinking about how the world works writes the Nobel L

Make no mistake: we are witnessing the biggest crisis since the Great Depression. In some ways it is worse than the Great Depression, because the latter did not involve these very complicated instruments - the derivatives that Warren Buffett has referred to as financial weapons of mass destruction; and we did not have anything close to the magnitude of today's cross-border finance.

The events of these weeks will be to market fundamentalism what the fall of the Berlin Wall was to communism. Last month in the United States almost 160,000 jobs were shed - making more than three-quarters of a million this year. My guess is that things will get considerably worse. I have been predicting this for some time, and so far, unfortunately, I have been right.

There are several reasons for my pessimism. The extreme credit crunch is a result of the banks having lost a lot of capital. And there is still uncertainty about the value of the toxic mortgages and other complex products on their balance sheets. The US economy has been fuelled by a consumption binge. With average savings at zero, many people borrowed to live beyond their means. When you cut off that credit you reduce consumption. This, in turn, will dampen the US economy, which helps keep the global economy growing. The American consumer has not only sustained the US economy, he has sustained the global economy. The richest country in the world has been living beyond its means and telling the rest of the world it should be thankful because America fuelled global economic growth.

There are further reasons for my pessimism about short-term economic prospects, in America and Europe. In the second quarter of this year, growth in the US would have been negative were it not for the growth in exports. But with the slowdown in Europe and problems in Asia it is difficult to see how we can maintain net export growth. The strengthening of the dollar - due not to greater confidence in the US but to reduced confidence in Europe - will make matters worse. The fall of energy prices will help a little, but not enough.

Treasury Secretary Hank Paulson has now come up with a new bailout scheme. The original plan - buying up the thousands of "troubled assets" (read: bad loans and complex products based on them that Wall Street created) - was badly designed and rife with problems. How would they have been priced? Call in the same Wall Street experts who got us into the mess and mispriced risk before? It is a heads I win, tails you lose situation.

The worry is that the taxpayer will be left holding the short end of the stick.

The British approach, which Paulson seems to be following, is far better, involving capital injections into banks, with preferred shares to protect against losses and warrants to share in some of the upside potential. This is the approach that I - along with most US economists and people with good street sense, like George Soros - had been saying America should adopt.

Ironically, though Paulson wouldn't listen to us, he seems to have listened to Gordon Brown.

Many of the problems our economy faces today are the result of the use of misguided models. Unfortunately, too many took the overly simplistic models of courses in the principles of economics (which typically assume perfect information) and assumed they could use them as a basis for economic policy. Many central banks use the notion of inflation targeting - that they should focus exclusively on inflation, raising interest rates when inflation increases. But I would argue that central banks have a broader responsibility; they are supposed to ensure the stability of a country's economy. While monetary authorities in the US and elsewhere focused on price stability, they allowed the financial system to undertake risks that put the whole economy in jeopardy.

This crisis is a turning point, not only in the economy, but in our thinking about economics. Adam Smith, the father of modern economists, argued that the pursuit of self-interest (profit-making by competitive firms) would lead, as if by an invisible hand, to general well-being. But for over a quarter of a century, we have known that Smith's conclusions do not hold when there is imperfect information - and all markets, especially financial markets, are characterised by information imperfections. The reason the invisible hand often seems invisible is that it is not there. The pursuit of self-interest by Enron and WorldCom did not lead to societal well-being; and the pursuit of self-interest by those in the financial industry has brought our economy to the brink of the abyss.

No modern economy can function well without the government playing an important role. Even free marketeers are now turning to the government. But would it not have been better to have taken action to prevent this meltdown? This is a new kind of public-private partnership - the financial sector walked off with the profits, the public was left with the losses. We need a new balance between market and government.

Professor Joseph E Stiglitz is chair of the Brooks World Poverty Institute at the University of Manchester and a 2001 Nobel prizewinner

This article first appeared in the 20 October 2008 issue of the New Statesman, My year with Obama

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The spread of Wahhabism, and the West’s responsibility to the world

In 2013, the European Union declared Wahhabism the main source of global terrorism. But it's not just a “Middle East problem”; it is our problem, too.

François Hollande’s declaration of war against Isis (also known as Islamic State) was, perhaps, a natural reaction to the carnage in Paris but the situation is now so grave that we cannot merely react; we also need sustained, informed and objective reflection. The French president has unwittingly played into the hands of Isis leaders, who have long claimed to be at war with the West and can now present themselves as noble ­resistance fighters. Instead of bombing Isis targets and, in the process, killing hapless civilians, western forces could more profitably strengthen the Turkish borders with Syria, since Turkey has become by far the most important strategic base of Isis jihadis.

We cannot afford to allow our grief and outrage to segue into self-righteousness. This is not just the “Middle East problem”; it is our problem, too. Our colonial arrangements, the inherent instability of the states we created and our support of authoritarian leaders have all contributed to the terrifying disintegration of social order in the region today. Many of the western leaders (including our own Prime Minister) who marched for liberté in Paris after the Charlie Hebdo massacre were heads of countries that, for decades, have backed regimes in Muslim-majority countries that denied their subjects any freedom of expression – often with disastrous results.

One of these regimes is Saudi Arabia. Despite its dismal human rights record, the kingdom has been central to western foreign policy in the Middle East since the 1970s and western governments have therefore tacitly condoned its “Wahhabisation” of the Muslim world. Wahhabism originated in the Arabian peninsula during the 18th century as an attempt to return to the pristine Islam of the Prophet Muhammad. Hence, Wahhabis came to denounce all later developments – such as Sufism and Shia Islam – as heretical innovations.

Yet this represented a radical departure from the Quran, which insists emphatically that there must be “no coercion in matters of faith” (2:256) and that religious pluralism is God’s will (5:48). After the Iranian Revolution, the Saudis used their immense wealth to counter the power of Shia Islam by funding the building of mosques with Wahhabi preachers and establishing madrasas that provided free education to the poor. Thus, to the intense dismay of many in the Muslim world, an entire generation has grown up with this maverick form of Islam – in Europe and the US, as well as in Pakistan, Jordan and Malaysia.

In 2013, the European Union declared that Wahhabism was the main source of global terrorism. It is probably more accurate, however, to say that the narrowness of the Wahhabi vision is a fertile soil in which extremism can flourish. In the 19th and early 20th centuries, Wahhabi chieftains did indeed conduct violent military expeditions against the Shia but, during the 1930s, the Saudi kingdom abandoned military jihad and Wahhabism became a religiously conservative movement. Today, some members of the Saudi ruling class support Isis but the Grand Mufti has condemned it in the strongest terms. Like Osama Bin Laden, Isis leaders aim to overthrow the Saudi regime and see their movement as a rebellion against modern Wahhabism.

Military action in Syria will not extirpate Islamist extremism elsewhere. In order to be fully successful, President Hollande’s campaign must also include a review of domestic policy. France has signally failed to integrate its Muslim population. Most of the terrorists responsible for the atrocities of 13 November appear to have been disaffected French nationals. So, too, were the Kouachi brothers, who committed the Charlie Hebdo massacre, and Amedy Coulibaly, who hijacked the Jewish supermarket in January. All three lived in notoriously deprived suburbs of Paris and – evoking France’s colonial past – were of Algerian and Malian descent. Psychiatrists who have investigated people involved in the 9/11 plot and in subsequent attacks have found that these terrorists were not chiefly motivated by religion. Far more pressing has been the desire to escape a ­stifling sense of insignificance. Powerless at home, many of them alienated by the host culture, young Muslim men in the West are attracted by the strong masculine figure of the jihadi and the prospect of living in a like-minded community, convinced that a heroic death will give their lives meaning. 

As they debate the feasibility of British air strikes in Syria, some MPs have insisted that they must be accompanied by negotiation and diplomacy. Again, these cannot be conducted in a spirit of superior righteousness. There must be a recognition that the West is not the only victim of Muslim extremism. We seem curiously blind to this. Far more Muslims than non-Muslims have been killed by Isis, yet this is rarely mentioned. Two weeks before the Charlie Hebdo atrocities in January, the Taliban murdered 145 Pakistanis, most of them children; two days after it, Boko Haram slaughtered as many as 2,000 villagers in Nigeria. Yet, compared with the Paris attack, the media coverage in the West was perfunctory. There has been little acknowledgment that the refugees whom many would seek to exclude from Europe have experienced the horrors we saw in Paris on a regular basis in Syria or Iraq. Already we seem to have forgotten that more than 40 people in Beirut were killed by two Isis suicide bombers on 12 November.

This heedlessness – a form, perhaps, of denial – does not go unnoticed in the Muslim world. The Iraq War showed that a military campaign cannot succeed if it fails to respect the sensibilities of the local people. Western governments must understand that their ­nations bear considerable responsibility for the present crisis – Isis is, after all, the product of the ill-considered Iraq War. And, as long as we mourn only our own dead, we cannot escape the accusation – frequently heard in the developing world – that the West has created a global hierarchy in which some lives are more valuable than others.

Karen Armstrong is the author of “Fields of Blood: Religion and the History of Violence” (Vintage)

This article first appeared in the 26 November 2015 issue of the New Statesman, Terror vs the State