Inside the bubble
The Roaring Nineties: seeds of destruction
Joseph Stiglitz Allen Lane, the Penguin Press, 389p
This book is the story of the forces that drove the American economy to frenzy in the 1990s and collapse in 2000. It is much better than Professor Stiglitz's last offering, Globalization and Its Discontents (2002), which was largely a rant against the IMF and the World Bank. Diatribe is not absent from this book. But it is much more solidly rooted in his own path-breaking work on the economics of risk and information, for which he won a Nobel prize in 2001. Stiglitz is not an elegant, nor even a punchy writer. But when he relates the politics of the 1990s to the economics he knows well, the discussion becomes exciting.
In Stiglitz's view, markets suffer from pervasive "failures", resulting mainly from "imperfect and particularly asymmetric information" which, unless corrected by governments, can make them seriously unstable. His account of the "Roaring Nineties" focuses on the inability of the Clinton administration to put the right incentives in place to curb these failures.
Instead, misguided deregulation, misguided accounting practices and misguided tax policies all produced perverse incentives to boost the prices of stocks ahead of their real value, thus inflating a bubble which was bound to collapse. The chief gains from this fraudulent bonanza accrued to corporate executives, whose compensation packages skyrocketed while those of their employees stagnated. The stock market "correction" of 2000-2002 - with the bankruptcy of giant companies such as Enron and the exposure of huge accounting frauds - marked the belated onset of reality.
This is not the whole story. There was also an element of what Alan Greenspan in 1996 called "irrational exuberance", which was largely independent of any particular set of incentives. In this respect, the dotcom bubble of the late 1990s resembles the South Sea Bubble of 1720 and the railway booms of the 19th century.
Given that Stiglitz was first a member, then chairman, of President Clinton's Council of Economic Advisers for most of the 1990s, he cannot absolve himself, or the president he was proud to serve, from all blame. His defence is that the political and economic forces in favour of letting the market rip were too strong to contain. The old balances in the economy, particularly between markets and government, were swept away by the ideology of the free market, the capture of commanding positions in politics by the Republicans and the explosive force of the New Economy itself. There is something else. While an unsustainable boom is building up, there is any number of people who know it cannot last; but to say so publicly - and even more, to do something that might moderate it - seems a kind of treason against prosperity. So as in the 1920s, almost everyone was complicit in the fantasy until the moment of its collapse.
Stiglitz's main attack is directed against the deregulation mania that swept through the United States in the 1980s and 1990s. The deregulation of telecommunications in 1996 led to an overinvestment bubble, which burst in 2001. Deregulation of electricity in California led to market manipulation, which hugely inflated energy prices to consumers (and Enron's profit) at the expense of Silicon Valley, the heart of US innovation. Deregulation of banking - notably the repeal of the Glass-Steagall Act 1933, which had separated investment from commercial banking - set up conflicts of interest between the two branches and led to corrupt synergies between banks and companies. Although highly profitable to both sets of executives, these were often damaging to their depositors and shareholders. Lax regulation of the accounting sector led to the boom in share options that greatly boosted managers' pay and artificially inflated company profits. (By 2000, American CEOs were being paid 500 times more than the average employee, up from 85 times in 1990.) Finally, the frenzy was fed by the temporary cut in capital gains tax of 1997, which Stiglitz calls "one of the most regressive tax cuts in America's history". All in all it is a sorry tale, in which the retreat of the state from social protection made it more difficult to shield people from the consequences of collapse, even as business deregulation made collapse more likely.
The indictment seems damning, but one must remember that this is the case for the prosecution. Stiglitz is a strongly partisan Democrat, and it is often hard to separate the scientist from the preacher. Thus he attributes the failure of energy deregulation in California to bring down consumer prices to market manipulation by Enron, but fails to note that this was a predictable consequence of deregulating wholesale, but not retail, prices. This was a government, not a market, failure. In Britain, a better-managed deregulation caused consumer prices to plummet. There is no reason to think up fancy explanations whenever the market works more or less as common sense would lead one to suppose it would.
The preacher is very much in evidence when Stiglitz contemplates the effects of US policy and advice to developing countries. His theme is that America (often via the IMF and the World Bank) pushed on to the rest of the world free-market policies - "Cut that budget. Lower that trade barrier. Privatise that utility" - that it would not have dreamt of following itself. But this is only partly true. Stiglitz talks about what government needs to do, but there is no such thing as government, only particular governments, which differ enormously in capacity. Things governments can and should do in some countries would be the road to ruin if they did them in others. The right balance between governments and markets shifts between countries and also from period to period. As a rule, rich countries need to worry less about government failure, more about market failure; in poor countries the reverse is true.
Like Keynes, to whom he has been likened, Stiglitz overemphasises stability at the expense of dynamism. The ability of capitalism to "roar" is part of its virtue, even if the roaring does contain the "seeds of destruction". And we should not be misled by such mixed metaphors to exaggerate the scale of the "destruction" that struck in the new millennium. Between 1929 and 1931, US GDP contracted by more than 25 per cent. Between 2001 and 2003, US GDP grew by 1.8 per cent. Even subliminal comparison with the Great Depression is way off target.
"Third Way" thinkers draw inspiration from Stiglitz rather than Keynes, because he provides a rationale for tinkering with markets, now that tinkering with budgets is out of fashion. Our own Chancellor of the Exchequer, with his "active" labour and capital-market policies, is a Stiglitzian rather than a Keynesian. This book explains why.
Robert Skidelsky is professor of political economy at Warwick University. His single-volume life of John Maynard Keynes is published in November by Macmillan