The power of retrospect

If you're wondering whether Stiglitz deserves his reputation of being an unfair critic of the West after his last book, Globalization and its Discontents, this latest offering helps explain why he got that reputation.

Stiglitz was part of the Clinton team that helped revive the economy from the Bush Senior era "" as compared to 2 million jobs lost at the beginning of the Bush administration, Clinton created 16 million new jobs in 8 years "" yet the author is at pains to explain, the fact that the Clinton formula of deficit reduction worked was nothing more than a lucky mistake!

For one, Stiglitz says the economy was beginning to recover even before Clinton came to office. According to him, the theory was that once deficits were lowered, interest rates would fall, and so investments would recover, and this would more than offset lower government expenditure.

This theory, Stiglitz says with sore grace, had no real chance of working since increased government spending was what was really needed, but what happened was that with interest rates falling, bond holdings by banks increased in value, and with the banks re-capitalised and bonds no longer attractive at the lowered interest rates, they began lending afresh to industry.

As in Globalization, Stiglitz weaves together a brilliant tapestry, of a Wall Street consensus this time around, of how the government contributed to it by amending/repealing various laws, and created the hype of the roaring nineties that eventually led to the kind of losses the US economy had never seen before "" when the tech meltdown happened, $8.5 trillion were wiped off the value of US stock, an amount that exceeded the income of the entire world except the US.

While the analysis is important, though dated since several books like Molly Ivins' Shrub or all the Enron books make much the same point, a caveat needs to be made. Stiglitz pays absolutely no attention to the fact that the policies of the 1990s also lead to sharp productivity hikes.

He cites AOL Time Warner's writing down of $100 billion of investment as a sign of the irrational exuberance of the past, yet as he himself notes, at the beginning of the 1990s, there was no company even worth $100 billion.

Similarly, it is clear that while the US economy spent billions on computers and IT in the 1990s, it was only the meltdown of the 2000s that forced businesses to restructure dramatically and that's the reason for the massive productivity hikes currently being seen in the US.

Stock options, and government's policies on it, Stiglitz shows, were one of the central pillars of the roaring nineties. In 2001, options accounted for 80 per cent of the compensation of American corporate managers "" if Microsoft, for instance, was to acknowledge the value of the options it had dished out that year, its profitability would have been reduced by a third.

This is why, in 1993, the Financial Accounting Standards Board recommended that firms be forced to put a value to their options and account for them as expenses.

Thanks to the protest by corporate America, the government allowed options to be treated as expenses only in the year they were actually encashed (Arthur Levitt, the SEC chief who campaigned in favour of this later called it the "biggest mistake" of his tenure). Since much of executive compensation then depended on the market, priming up stocks was the natural and rational outcome.

Other government actions that contributed to the hype, and not just in the 90s, were ones that allowed firms to account for "goodwill" (this was Reagan's contribution) or their anticipated future profits in their current balance sheets "" when WorldCom went bust, $50 billion of its claimed assets of $107 billion comprised of "goodwill".

The repeal of the Glass-Steagall Act (done by Clinton) is another important part of the Stiglitz tapestry. It allowed banks to lend to corporates whose securities banks were also dealing in, and so ensured they kept quiet about the dubious state of these companies.

WorldCom, for instance, gave a lot of underwriting and other business to Citibank and its associates, and Citibank in turn lent to WorldCom and companies controlled by its CEO Bernie Ebbers.

While many will disagree with Stiglitz since he doesn't take into account productivity hikes, the points he makes about the losses due to deregulation are important.

While Reagan's deregulation of the S&L's and the tax breaks for real estate resulted in a $100 billion cost to the taxpayer when the bubble burst, when the telecom bubble burst (following the deregulation), half a million people were out of work, $2 trillion was lost in market capitalisation, 23 telecom firms were bankrupt, and investments of $65 billion that were made in the industry between 1997 and 2001 were worth just $4 billion by the end of the period, "a magnitude of waste few governments had managed to ever achieve".

One assumes that Stiglitz's numbers are correct, for they are critical to his arguments. In the case of Enron's Dabhol plant, however, they are terribly wrong. A stunning indictment of both Enron and the government of India, Stiglitz says the Indian government underwrote take-or-pay provisions of over $30 billion over the life of the contract, and the contract equalled 7 per cent of India's GDP.

Well, in actual fact, the Indian government's underwriting was restricted to well under a few billion for the life of the project, or about half a per cent of GDP each year!

Yet, Stiglitz's central point remains that markets are never perfect, and so using them as the sole signalling authority is bound to create a serious problem. His telling examples make the book a compelling read.

THE ROARING NINETIES
Seeds of destruction

Joseph Stiglitz
Published by Penguin/Allen Lane
Pages: 389
Price: £13.50