Boom and bust

BOOKMARK

The much-trumpeted triumph of global capitalism looked pretty tarnished at the World Social Forum in Mumbai earlier this month. But the ball that all was not well with globalisation had been set rolling by Joseph Stiglitz, a Nobel Prize winner (2001), chief economist of the World Bank (1997-2000), chairman of President Clinton's Council of Economic Advisers and currently professor of economics and finance at Columbia with his Globalization and its Discontents (2002).

What he talked about in this book was "the devastating effect that globalization had on developing countries, especially the poor within these countries". And he added, that "while the removal of barriers to free trade and the closer integration of national economies had the potential to enrich the world the way globalization has been managed, including international trade agreements need to be radically rethought".

Professor Stiglitz carries forward the argument in The Roaring Nineties: Seeds of Destruction (Allen Lane/Penguin India, £13.50) but this time round the target is not the IMF but the American president and American-style capitalism.

Stiglitz describes the book as "a natural history of the world's most prosperous decade". At the centre of the American-style economy was what came to be called the New Economy, symbolised by the dotcoms that was revolutionising the way America and the world did business, changing the pace of technological change itself and increasing the rate of productivity growth to levels not seen for a quarter of a century or more.

Even more than the Industrial Revolution the New Economy represented an equally momentous change: a shift from the production of goods to the production of ideas that entailed the processing of information, not of people or inventories.

The New Economy promised also the end of the business cycle, the ups and downs of the economy that had, until now, always been part of capitalism, as new information technologies allowed businesses to better control their inventories.

But the tech bubble burst that sent the fortunes of the New Economy into reverse and America experienced recession. How had things changed so radically? What were the seeds of destruction? The first was the boom itself.

Bubbles are based, Stiglitz says to irrational exuberance, that is, each investor believes that he could sell the stock at a still higher price. Add to this, bad accounting provided bad information and part of the irrational exuberance was based on this bad information.

Accounting systems had a major flaw and the "system of CEO compensation provided incentives to take advantage of the limitations of the accounting systems". CEOs simply looted the companies by faking the figures.

Besides, conflict of interests simply ran out of control. "The short term and special interests prevailed over the long-term and general interests," and in most cases, at the expense of the ordinary shareholders.

Stiglitz believes there were two principal reasons for the failure. First, losing sight of the balanced role of the government. For 12 years American economic policy had been shaped by free market ideologues who idealised the private sector and demonised government programmes and regulations.

Behind this philosophy was the belief that markets lead by Adam Smith's "invisible hand" to economic efficiency. Even in very developed countries, markets worked differently from the way envisaged by the "perfect markets theories" There will always be gaps in information very simply because all the variables in a given situation can never be known or anticipated.

The second reason for the failure was very simple: America and the so-called New Economy wanted growth on the cheap. Agreed, ideas can change the world, but the shelf life of ideas has never been very long. They are always superseded and the old tossed aside.

But the real interest in the book lies in Stiglitz's descriptions of life at the top of the economic ladder, the brutal world of Washington's politics and policymaking.

And the lesson is simply this: when economics meets politics, you don't need to guess who wins. We see this happening all the time, especially when we are getting into election mode.