The New York Times - May 31, 1998
Economist's Theories Get Another Hearing
By LOUIS UCHITELLE
WASHINGTON -- No group in America seems more resistant to economic theory than politicians. For them, it is quixotic, and economists who stand on theory are like politicians who cling to principles that don't play well at the polls. So when prominent economists take big jobs in Washington and use them to push theory, the response from their bosses is often skepticism and resistance -- or outright rejection.
President Johnson ignored his chief economist, Arthur M. Okun, when he insisted, accurately, that inflation would accelerate if Johnson cut taxes while spending heavily on both the Vietnam War and social programs. Similarly, Ronald Reagan ignored Martin Feldstein's theorizing about the dangers of big tax cuts and a rising budget deficit. And the deficit saga played itself out over the next 15 years.
Now it is Joseph E. Stiglitz's turn. Though he is perhaps the most prominent economic theorist of his generation, Stiglitz was not paid much heed during his four years on the president's Council of Economic Advisers, the last two as chairman. But give him points for persistence. Rather than retreat to his professorship at Stanford University, Stiglitz, 55, shifted last year to a high-prestige job as chief economist and senior vice president at the World Bank. And there, away from the levers of power he never managed to manipulate, the Asian crisis has given him an opening to quietly shape policy with theory.
Invoking theories that bear his stamp and are taught today in most college economics courses, Stiglitz is publicly criticizing the austerity measures -- high interest rates, bank closings and sharp cuts in public spending -- favored by the Clinton administration and the International Monetary Fund as solutions to Asia's economic woes.
Other economists who have sounded warnings about the IMF's prescriptions -- including Feldstein, back at Harvard -- are linking their criticism to Stiglitz's prestige. Republicans who oppose the White House's request to Congress for $18 billion in new IMF funding are beginning to deploy Stiglitz's name and standing as a Democrat, if not his thinking, on behalf of their cause.
And Stiglitz is finding it invigorating to be listened to for a change.
"People underestimate the role that ideas play in politics, or should play," he said. "I sometimes use the analogy of children playing soccer: Everyone wants to be around the ball. The ball in Washington is politics." Yet smart athletes learn to play away from the ball, and Stiglitz has embraced that strategy. "I had to separate economic judgments from politics," he said.
Not just for Asia. From his new perch, Stiglitz is re-fighting other battles he lost as an adviser to President Clinton. Leaving his office on a recent morning, he drove to the private high school that two of his four children attend for a guest lecture to the economics class, which turned out to be three young men. The talk, in a sunny parlor setting, became a review of his White House record. As he ticked off issues -- the capital gains tax (it should be higher, he argued), auctioning the television spectrum (good economics), privatizing the enrichment of uranium (bad economics) -- his audience heard him out with more respect than he had often received at the White House, which vetoed him on these issues and so many others.
"Joe thinks that if he repeats the logic of his position often enough, he will bring people to that position," said Laura D'Andrea Tyson, dean of the Haas School of Business at the University of California at Berkeley, who preceded Stiglitz as chairman of the Council of Economic Advisers. "The problem is that people are not always interested in the economic logic, or economic logic alone does not always carry the day," she said. "Joe does not want that to be the case."
Ms. Tyson, like most presidential economic advisers, learned to read the political signals and then back off, or compromise, or enlist just the right political allies. Stiglitz never managed all this.
"When I was at the White House, in an environment dominated by lawyers and politicians, I often felt that I had arrived in another world," he said in a recent speech, and explained: "I had expected lower standards of evidence for assertions than would be accepted in a professional article, but I had not expected that the evidence offered would be, in so many instances, so irrelevant and that so many vacuous sentences -- sentences whose meaning and import simply baffled me -- would be uttered."
The eye of the beholder plays a role here. Democracy runs on political give and take, not on the translation of theory -- even accurate theory -- into policy, said James Carville, whose political skills as a campaign adviser played a big role in getting Clinton to the White House in the first place.
"I am beginning to think that resilience ain't a bad thing to have," Carville said, in a gracious nod to Stiglitz. "But when you look for and vote for candidates, you ought to vote for skilled politicians. Whenever anyone tries to get something through without using political skills, it ends up biting you."
Still, there is something edifying, in a "Mr. Smith Goes to Washington" sort of way, about seeing someone get attention simply for the power of his ideas.
Stiglitz's views on Asia, for instance, contradict the policy of the World Bank, and that has raised speculation that his boss, James Wolfensohn, the bank's president, privately shares his chief economist's stance.
Wolfensohn denies this. "I do support the IMF on what it has done," he said. "But you cannot and should not muzzle someone of the quality of Joe Stiglitz, although sometimes it causes me embarrassment."
Stiglitz, good-natured, optimistic, given to explaining himself in speeches that drone on amiably for two hours, is a giant in his profession. Many economists view him as a shoo-in for a future Nobel prize -- perhaps with George Akerlof, a Berkeley economist who has done similar work. The Stiglitz fame is based on a theory that, stripped to simple terms, sounds like common sense to many noneconomists.
Where traditional economics holds that free, unregulated markets raise the well-being of society in general as individuals pursue their separate self-interest, Stiglitz says the real world does not work that way. Instead, he says, markets function imperfectly, often to people's detriment, because the information available to market participants is inadequate. So government and other institutions have to intervene, adroitly, to make markets function properly.
What has won Stiglitz a following among economists, particularly younger economists, is that he has used the profession's most revered tools -- mathematics and computer models that simulate economic behavior -- to amend the traditional thinking.
"I took the logic that had led people to be convinced that markets were efficient," he said. "I changed one assumption -- that there was perfect information. I found a general way to model imperfect information. And when you plugged this in, you found markets to be almost always inefficient."
Consider insurance, the subject of a study in the 1970s that first made Stiglitz's reputation. Insurance companies cannot fully distinguish between high-risk and low-risk customers -- between the homeowner whose dwelling is likely to burn down and the one less likely to have a damaging fire. Charging the same high rate to both for the same substantial coverage tends to draw mostly the high-risk customers, while the low-risk households are more likely to go without insurance. And with so many high-risk customers, claims mount.
So the insurance companies "intervene." They ration coverage, giving neither family as much as it would like -- an incentive to install fire safety devices and take other precautions. In addition, premiums are very high for the most complete coverage; low-risk customers, by raising their deductibles, can pay much less.
Or consider the employer-employee relationship, another area in which Stiglitz's research brought new insights. A pure market system assumes that the employer possesses an uncanny amount of information about each worker on the payroll: the employee's energy level, his skills, his pattern of absences, his dedication. If so, pay could be adjusted constantly to elicit the greatest output -- the greatest efficiency -- from each individual, and shirkers would earn less than hard workers.
But employers do not have all this information. So they take shortcuts, a form of intervention. They subsidize everyone's lunch in the company cafeteria, for example, to raise morale and, with it, average productivity. Or, to reduce absenteeism and turnover and encourage greater effort, they institute an "efficiency wage" that is higher than the marketplace requires to fill positions but prompts workers to bend to their tasks, knowing that they won't be able to find other jobs that pay as well. Stiglitz did not invent efficiency wage theory, but he certainly elaborated on it. He explained, for instance, why high unemployment can persist without wages falling.
Similar logic, Stiglitz argues, justifies government intervention. His introductory textbook, "Economics" (W.W. Norton & Co., second edition, 1997), a best seller in China and Japan, although not in the United States, cites the federal bailout of Chrysler Corp. in 1980 as an example of policy that worked.
Free-market dogmatists argued that a Chrysler bankruptcy would have freed up factories, workers and materials for more efficient uses, however painful the transition. But Stiglitz notes that Chrysler flourished after the bailout, which took the form of loan guarantees that were never invoked. Not only were jobs preserved, he says, but the government saved tens of millions of dollars in guaranteed pension payments that it would have had to make to Chrysler retirees if the company had failed.
Chrysler is the rule, not the exception: "I could always find, in my modeling, a particular intervention that made everyone better off," Stiglitz said.
Imperfect information also means that interventions can have unintended consequences. And that is the theoretical grounding for Stiglitz's objections to prevailing policies in Asia.
The IMF insists that a country in trouble should raise interest rates, on the assumption that higher rates will attract foreign investors and lenders. As their money comes in, the thinking goes, confidence is restored and the value of the local currency rises. With the help of the IMF's emergency loans, the country can move back toward normalcy, and interest rates can soon decline before doing much damage to the economy.
Not so, Stiglitz says: "Like a lot of economic lore, the evidence that higher rates provide the right incentive is less than overwhelming."
Absent adequate information, lenders and investors, he contends, cannot distinguish easily between safe and risky deals. And thus high interest rates are taken as an indication that those offering to pay them are likely to default. Instead of flowing in, money leaves, and exchange rates fail to recover -- the case in much of Asia today.
Meanwhile, the IMF's other austerity measures -- closing insolvent banks, cutting back government spending, pressing for price increases -- multiply the damage.
"What is quite remarkable," Stiglitz said, "is that those who favor this approach have not come up with an intellectually coherent view."
That's not the right question in the IMF's eyes. "We agree that raising rates can have adverse consequences," a senior IMF staffer said. "But in a crisis there are not easy alternatives. We have cases, like Brazil last year, where raising rates worked."
Ask Stiglitz how his thinking evolved, and he mentions his parents and his upbringing in Gary, Ind., where his public-school classmates, the children of steelworkers, made him familiar with layoffs and mill closings and -- though he would not have so labeled it at the time -- imperfect markets.
"You are not isolated from what is going on in the way people who grow up in the suburbs are isolated and protected," he said.
His father, now 95, recently retired as an insurance agent; his mother, 84, became an elementary school teacher at 50, and retired at 67 from a ghetto school only because she was required to. Unwilling to quit, she taught remedial reading and, finally, citizenship until eight months ago.
"They were liberal Democrats," Stiglitz said, "not revolutionary, but very dedicated."
High grades, particularly in math, won Stiglitz a scholarship to Amherst College, where, in 1963, his junior year, he was student body president and joined in the march on Washington that culminated in Martin Luther King's "I have a dream" speech. He earned his Ph.D. in economics from the Massachusetts Institute of Technology. His mentors included Paul Samuelson, who besides writing his famed textbook helped so much to imbue economics with the legitimacy of mathematics.
"We got this very mixed message at MIT," Stiglitz recalled. "We were taught the perfect-market-competition model, and then we were told that only at the University of Chicago, a center of conservative economics, did they take the model seriously. We agreed with our professors that there was something wrong, but we were not given an alternative."
So he went to work on a fix, often collaborating with other economists on this odyssey. "If I had believed that markets worked, and you don't have to do anything, it would have made more sense for me to go into business and make a lot of money," he said.
Brilliant and original, Stiglitz flourished in his profession from the start. At 23, he became an assistant professor at Yale, where his contract included the proviso that he wear shoes, in and out of class, and show proof that he leased an apartment. (There were doubts; he had slept too many nights on an office sofa after hours of research.) He taught at Cambridge University and over the years shifted easily between tenured professorships at Yale, Princeton and Stanford, from which he is now on leave.
He has done well financially, without going into business. As a star professor, he earned $500 an hour busily consulting, in addition to a six-figure salary. At the World Bank, his pay tops the $130,000 that he earned in the Clinton administration -- he won't say by how much. His books bring in six-figure royalties each year. His wife, Jane Hannaway, an expert in the sociology of educational institutions, earns six figures, too, running a study center at the Urban Institute in Washington.
"The constraints in our household are time, not money," she said.
Travel has long played a role in Stiglitz's research, and a world map covers most of one wall in the dining area of the family's Washington home. During dinner, he sometimes examines the map for the few places he has not yet visited.
He is just back from a trip to Bhutan, the tiny mountain kingdom between India and China where the government's development strategy bans television and limits tourism -- the boon of many exotic lands -- as too great a blow to the native culture. The approach fascinates Stiglitz, who argues that trying to impose development strategies from the central councils of the industrial world too often backfires.
But the same restless travel that pleases the World Bank, with its lending programs in so many struggling countries, diluted Stiglitz's influence at the White House. "You have to be at the table explaining your view," said one administration official who insisted on anonymity. "You cannot go away for two weeks and come back and be involved. Most meetings that take place you don't even know about when you come to work in the morning."
None of the issues that Stiglitz struggled with as chairman of the Council of Economic Advisers represents, in his mind, a more harmful violation of good economic theory than the administration's decision to endorse the privatization of the U.S. Enrichment Corp. Fifteen months after leaving the White House, he is still fighting that battle, accepting every speaking invitation that offers an opportunity to make his case.
The corporation, an obscure government-owned concern, processes uranium for nuclear bombs and various nonlethal uses. It also buys up Russia's enriched uranium, the goal being to prevent its sale to terrorists or America's enemies.
The argument for privatizing the corporation, of course, is that private owners, driven by the profit incentive, will operate the company more efficiently. But that runs head-on into another objective of the enrichment corporation: preserving national security. Stiglitz contends that this is a case in which the free market and its incentives fail to do the job as well as government.
The reason is that the company cannot make a profit on imported Russian uranium, which costs substantially more than enriching American uranium. So, responding to the profit incentive, managers of a privatized enrichment corporation would find excuses and subterfuges for not importing very much Russian uranium, while they push the sale of their own, homemade brand, Stiglitz says. To a startling degree, he notes, that has already happened even without privatization.
Nonetheless, the administration -- favoring privatization as a proper, free market goal -- concluded that government surveillance would be enough to prevent the company from shirking its obligation to buy large quantities of Russian uranium.
The Treasury Department still has the power to cancel the pending privatization, and that keeps Stiglitz going.
"Everyone said, while I was still at the White House, that it was a done deal and why fall on your sword over a done deal," Stiglitz said. But he argues that by falling insistently on his sword, he has already managed to delay the privatization. And he has come to realize that, imperfect as it is, the power to delay in Washington is often an economist's most powerful tool.
"My view," he said, "is that it is not over until the fat lady sings."