Nobel Prize winning economist Joseph Stiglitz reviews Robert Skidelsky's new book about Keynes …
We should be clear about this: economic theory never provided much support for these free-market views. Theories of imperfect and asymmetric information in markets had undermined every one of the ‘efficient market’ doctrines, even before they became fashionable in the Reagan-Thatcher era. Bruce Greenwald and I had explained that Adam Smith’s hand was not in fact invisible: it wasn’t there. Sanford Grossman and I had explained that if markets were as efficient in transmitting information as the free marketeers claimed, no one would have any incentive to gather and process it. Free marketeers, and the special interests that benefited from their doctrines, paid little attention to these inconvenient truths.
… As financial market regulations were stripped away, crises became more common: we have had more than 100 in the last 30 years. The present crisis should lay to rest any belief in ‘rational’ markets. The irrationalities evident in mortgage markets, in securitisation, in derivatives and in banking are mind-boggling; our supposed financial wizards have exhibited behaviour which, to use the vernacular, seemed ‘stupid’ even at the time.
If unemployment is caused by real wages being too high, the obvious remedy is to lower wages. Hence the standard call of conservative economists for more ‘labour market flexibility’, ensuring that the wages of workers – which have stagnated in the US for a quarter of a century – will drop even further. But traditional Keynesian economics argues that what matters is aggregate demand, and that lower wages reduce aggregate demand. The current crisis demonstrates what can happen: countries with stronger systems of social protection and less labour market flexibility have, in many ways, fared better.
…The financial markets that caused the crisis – which in turn caused the deficits – went silent as money was being spent on the bail-out; but now they are telling governments they have to cut public spending. Wages are to be cut, even if bank bonuses are to be kept. The Hooverites – the advocates of the pre-Keynesian policies according to which downturns were met with austerity – are having their revenge. In many quarters, the Keynesians, having enjoyed their moment of glory just a year ago, seem to be in retreat.
We can’t pass laws that ensure that people won’t suffer from irrational optimism or pessimism. We can’t even be sure that banks will make good lending decisions. What we can do, however, is ensure that those who make mistakes bear more of the consequences of their decisions – and that others bear less. We can ensure that those entrusted with the care of other people’s money do not use that money for gambling. This is true whether those decisions are based on flawed models of risk or irrational perceptions of uncertainty. Taxpayers, workers, retirees and homeowners all over the world suffered because of the mistakes of America’s financial markets. That is unacceptable, and it is avoidable.