BOOK LAUNCH: The Roaring Nineties: A New History of the World’s Most Prosperous Decade
Stiglitz’s focus on the ‘Roaring Nineties’ is only part history. In seeking to learn from the successes, mistakes, and unfinished business of the 1990s, Stiglitz is intent on drawing lessons for the future. He explained that his students know him as a very tough grader and that toughness was very much on display as he discussed the Clinton Administration’s mixed record on deregulation and public investments. At the end of every class, however, Stiglitz said he awarded final marks on a curve. Compared to the policies that came before and after the Clinton Administration, he awarded the 1990s a solid A+.
He started with a review of monetary and fiscal policy in the 1990s. When President Clinton took office in 1993, he was faced with a slow economic recovery that had not yet translated into significant job growth. Stiglitz noted that the standard approach to a slow recovery would be to add some stimulus – further loosening monetary policy, adopting tax cuts, or increasing spending. Instead, President Clinton and his economic team opted to attack the large budget deficit by raising taxes and reducing spending. And it worked.
Stiglitz asked if sixty years of fiscal policy (including the treatment in his own textbooks) should be rethought? The success of the 1993 tightening of fiscal policy is usually attributed to the confidence it created among long-term investors that the risk of inflation had been sharply reduced. As a result, long-term interest rates went down, investment (in plant, equipment, and housing) went up, and the economy grew more rapidly. The Clinton economic team, including Stiglitz, was careful to backload the fiscal tightening so that they could target expectations without immediately draining purchasing power from the economy. A strong emphasis on managing expectations is generally credited to Fed Chairman Alan Greenspan. Alan Blinder and Janet Yellen (both members of the Clinton’s Council of Economic Advisors) also subscribe to the ‘reducing inflationary expectations’ school of thought.
Stiglitz’s new explanation revolved around the treatment of long-term government bonds held by the banks. In general, banks need to hold a certain amount of reserves to offset the risk of its investments. Although government bonds carried no risk of default, their value would fall as interest rates rose. In 1993, however, banks were allowed to treat government bonds as if they entailed no risk. With interest rates on long bonds relatively high, it meant that banks could earn a healthy return without having to set aside any reserves. As interest rates came down in 1993 and following years, the value of the bonds went up and the banks were able to sharply improve their financial position (or recapitalize). With healthy balance sheets and long-term bonds offering only low interest rates, Stiglitz argued that the banks returned to corporate and other lending which, in turn, stimulated the economy.
In effect, Stiglitz argued that deficit reduction worked because of some very special circumstances. Although emphasizing expectations, Blinder, Yellen and others also see the 1993 deficit reduction success as depending on specific circumstances rather than establishing a general rule. Stiglitz was at pains to remind the audience that deficit reduction in the early Clinton years came at the expense of added public investments and spending on social needs. In his work in the international arena, Stiglitz has also pointed to the belt tightening policies of the International Monetary Fund coming at the expense of growth with the already poor paying the heaviest price.
When it comes to the financial bubble and financial scandals that are also part of 1990s history, Stiglitz assigned some blame to 1990s policies for exacerbating the excesses of the decade. In 2001, Stiglitz shared the Nobel Prize for Economics for his work on “asymmetric information” (where some people know more than others), which contributes to imperfect markets and may create a need for compensating government action. He blamed many of the irrational excesses of the 1990s on imperfect markets built on imperfect information.
He started his catalogue of 1990s mistakes with stock options – the right to buy shares of a company’s stock at a specific price. At the time (and today) a company did not have to deduct the value of the stock options from its reported profits. The Financial Accounting Standards Board (FASB), (the institution that sets accounting standards generally followed in the United States), decided to require that companies estimate the cost of stock options and deduct them from reported profits. In accounting parlance, they were to be reported “above the line.”
In much of the private sector, certainly in the high tech community, and in the accounting profession itself there were serious criticisms of the FASB proposal. Opponents argued that there was no accurate way to measure the value of stock options, that estimates would distort the value of stock, and that the volatility of stocks would only increase. The Clinton Administration seriously considered two policy arguments. First, progressive companies were awarding stock options to all employees, a practice that promised to widely distribute the future gains of a corporation. It was feared that expensing (or deducting from profits) the cost of stock options would discourage this kind of broad-based incentive. Second, stock options had become a common feature of the companies in Silicon Valley and other high-tech centers around the country. Silicon Valley argued that expensing options would reduce reported profits and that, especially in the case of small, new to market companies, investors would not look beyond the balance sheet to the underlying promise of the company. For a Clinton Administration focused on developing an effective civilian technology policy and actively encouraging innovation, there was concern that FASB rule would disrupt an innovation machine that was the envy of the world.
In the end, FASB backed down and instead required that stock options be reported in a footnote, “below the line.” Stiglitz argues that the use or misuse of stock options created a powerful incentive for chief executive officers and other senior corporate officers to focus on short-term measures. For some companies, better short-term results could come at the expense of critical investments in research and development, training, or organizational innovation. In Stiglitz’ view, the carrot of stock options pushed too many corporations to hide losses or commit outright fraud as long as the stock price continued to rise.
Stiglitz was also critical of the Congress and others for resisting proposed rules that would have separated accounting from consulting – just the kind of practice that contributed to the demise of Arthur Anderson. It was, also a mistake, Stiglitz believes, to eliminate the Glass-Steagall rules, which kept commercial banks (making loans to companies and individuals) separate from investment banks that marketed (or underwrote) stocks for corporations. Stiglitz saw an inherent contradiction in the financial community’s approach to deregulation – they saw major synergies (economies of scope) from having a number of financial services under one roof but promised to avoid any conflicts of interest by erecting Chinese walls between their different divisions. In practice, their self-regulation failed to keep the financial Mongols at bay with stockbrokers shading (and actively misrepresenting) the strength of stock to garner investment banking business.
Stiglitz is still puzzled about the role of Chairman Greenspan and the Federal Reserve Board. In a much-quoted December 1996 speech, Greenspan warned of “irrational exuberance” in the stock markets. Stiglitz agrees that it would have been a mistake to raise interest and sacrifice real growth to deal with stock market (or general asset) inflation. But, he notes that the Fed could also have simply raised the margin requirement for buying stocks. At the time, individuals had to provide only 50 percent of the value of stock and could borrow the rest. If, the Fed had raised the margin (like a down payment on a house) requirement to 75 percent or more would that have slowed the “irrational exuberance.” While generally emphasizing the need for action and not only rhetoric, Stiglitz does criticize Greenspan for becoming something of a cheerleader for the new (high productivity growth) economy rather than continuing to warn about inflated stock market values.
In his earlier book, Globalization and Its Discontents, Stiglitz had been harshly critical of the U.S. Treasury and the International Monetary Fund’s (IMF) promotion of inappropriate policies in the developing world. He reprises some of that thinking in The Roaring Nineties. In sum, he feels that the Clinton Administration failed to articulate a post-Cold War vision for the developing world. In practice, elements of the Uruguay Round (adopted as American law in 1994) actually put the developing countries at a disadvantage. In particular, Stiglitz criticized the emphasis placed on protecting intellectual property protection at the expense of providing inexpensive medicines to the developing world. Costly years of neglect and intermittent negotiations followed. It was only in 2003 that an agreement was reached that allowed developing countries to import generic copies of patented medicines.
In both books, Stiglitz criticizes the U.S. Treasury and the IMF for pressuring many developing countries to open their financial markets to short-term capital flows. Large financial institutions drove this policy while nothing in economic theory, evidence, or practice suggests that there would be large development gains from short-term, often speculative capital. Short-term capital flows became particularly damaging when countries followed what was at the time IMF advice to link their local currency to the dollar or another key trading currency. The combination of speculative markets and linked currencies played a major role in the 1997 Asian Financial Crisis as most developing countries did not have the institutions, regulations, or banking experience to deal with the short-term capital.
Stiglitz deftly fielded a wide range of questions that raised questions about future deficits, the durability of increased productivity growth, and the implications of limited increases in population. As noted above, he concluded by giving the Clinton Administration a curve based A+. Stiglitz managed to cover potentially dense and technical material in a manner that was both enlightening and entertaining. I suspect that the entire, standing room only audience was ready to enroll in one of Professor Stiglitz’ classes.
Kent Hughes, Director, Project on America and the Global Economy