Shoeless Joe Stiglitz

Joseph Stiglitz can't be a very popular figure within President Clinton's circle of power. When he first arrived in Washington in 1993 to join Clinton's Council of Economic Advisers (CEA), he had a persistent habit of saying what he thought instead of what he was supposed to think. After leaving that position to become chief economist and executive vice president at the World Bank, Stiglitz publicly challenged the International Monetary Fund's prescriptions for the Asian economic crisis, which embarrassed the White House economic team and shattered the usual unity of the two sister institutions. To the White House, Stiglitz is a loose cannon, thwarting its efforts to craft a coherent international economic policy under American auspices.

It is not so much that Stiglitz has set out to become a thorn in Clinton's side. Rather, he goes about his troublemaking with a bemused detachment, as if he were oblivious to the consequences of his heresy. Though he has become a powerful policymaker, Stiglitz behaves as though he were an obscure academic, writing and speaking for no purpose beyond his own enlightenment. And somehow, despite this apparent naiveté, he has sounded the one discordant note in the Clinton international economic policy apparatus—and a constructive one at that.

It is not surprising that Stiglitz hasn't conformed to Washington power culture. He is known as a stereotypical absentminded professor, crooked of tie and unkempt of hair, never showing much concern for hierarchy and order. A prodigious student, Stiglitz became a full professor at the Massachusetts Institute of Technology at the age of 26. The job, however, was offered only on the condition that he sleep in an apartment instead of in his office (Stiglitz had to present a lease as proof that he had obtained a private residence) and wear shoes around the office. Subsequently he won the John Bates Clark Medal, an annual award given to the economist who has done the best work under the age of 40.

Two years after joining President Clinton's Council of Economic Advisers, Stiglitz became the chairman. Here he did not advance a particularly distinct ideological agenda, but instead focused on enacting small reforms that made economic sense. For instance, he proposed a scheme to allow private firms to bid for the right to compete with government-subsidized hydroelectricity, with the dual intent of aiding consumers and reducing carbon emissions into the atmosphere. Stiglitz also advocated making housing vouchers portable, rather than city-specific, so that poor workers who moved in search of better job opportunities would not lose their access to subsidized housing. The general theme in these ideas was correcting the incentives of government programs.

This may sound like the quintessentially Clintonian notion of government—a series of bite-sized, cost-free initiatives. And yet surprisingly, not all of these proposals were easily accepted, even by Stiglitz's colleagues in the administration. The problem was not so much Stiglitz's ideas as the fact that he did not adapt his intellectual style to the mores of Washington. He thinks out loud, and sometimes goes on too long. He at times seems more interested in fulfilling his intellectual curiosity than in advancing policy. For example, in recent years economists have begun to question the previously unchallenged notion that the economy had a "natural rate" of unemployment of 6 percent—the rate of unemployment below which inflation would inevitably ensue. This debate had crucial policy implications for the Federal Reserve, which decides how low it should allow joblessness to sink before raising interest rates. Stiglitz declared in 1996 that he thought perhaps the natural rate was lower than it was generally believed to be—a position that, just a few years later, has gained almost unanimous acceptance. Maybe Stiglitz considered this nothing more than innocent intellectual speculation, but, to a White House obsessed with avoiding any hint of dictating policy to the Federal Reserve, this musing verged on insubordination.

In a paper published last year, Stiglitz recounted his travails at the CEA with astonishing bluntness. "When I was in the lawyer- and politician-dominated White House environment, I often felt that I had arrived in another world," he recounted. "I had expected lower standards of evidence for assertions than would be expected 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."



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The Outsider

Stiglitz's cultural alienation within the White House became most obvious in the matter of privatizing uranium stores, one of those obscure yet important issues that Stiglitz loves to latch on to. When the Soviet Union collapsed in 1991, it had large stores of high-grade, weapons-quality uranium lying about, vulnerable to theft or sale. The Bush administration proposed to purchase that uranium, convert it into lower- grade, fuel-quality uranium, and sell it to nuclear reactors—removing the dangerous uranium from the hands of terrorists and rogue nations, and providing work for Russian scientists who might otherwise be tempted to put their services and wares at the disposal of those same bad guys. Everybody agreed on the basic approach; the controversy came when Bush sought to privatize the plutonium company—the United States Enrich ment Corporation—on the grounds that the profit incentive would spur it to carry out its work more efficiently. Privatization had not yet taken effect when Clinton took office, and Stiglitz vigorously pleaded to overturn it. He argued that a private company would not, in fact, have the correct incentives; since Russian uranium is expensive and not profitable, the corporation would seek to obtain cheaper uranium elsewhere. Other White House officials considered privatization a fine example of reinventing government, and maintained that proper federal oversight would correct for any misincentives. This view prevailed.

The trouble, as far as the White House was concerned, was not that Stiglitz took the wrong side of the argument, but that he wouldn't shut up. Stiglitz made his case very publicly, speaking on the record with reporters and holding forth in speeches. Even after losing the internal battle, Stiglitz continued to wage a public campaign against privatization. To the White House this dissent was irritating, but even more than that, it was simply baffling. In Wash ington, advisors to a powerful figure such as the president must husband their precious political capital. Why squander it on an issue you've already lost? Stiglitz's apparent inability to recognize that he was licked and cut his losses marked him not just as a malcontent, but, even worse, as somebody who didn't know how to play the game.

Even Stiglitz's political victories often failed to endear him to fellow members of the Clinton team. In one instance, Stiglitz waged a protracted squabble with the Treasury Department over a proposal, which he favored, to issue a new kind of federal bond whose value would be indexed for inflation. This would benefit consumers, who could invest without the risk of inflation, as well as the government, which could pay out lower interest rates in return for offering a safer bet. Ultimately the Treasury Department acceded to his view, but only after a long and (to Stiglitz) frustrating internal debate. The crux of the disagreement, as Stiglitz has portrayed it, was the fact that the Treasury Department incorrectly feared that such bonds would weaken the government's resolve to fight inflation by insulating some investors from the effects of rising prices. Stiglitz dismissed such objections as uninformed, later writing, "As is so often the case with inflation hawks, they did not bother to look at the relevant empirical literature, or at the counterargument that with indexed bonds, inflation has an immediate and direct budgetary impact, thus encouraging governments to act against it."

Wintry Summers

Nobody likes to be told that his opinion is based on simple ignorance, but very few people like it less than Larry Summers, the deputy treasury secretary. Summers, one of Stiglitz's inflation-hawk foes, is now also his nemesis on the issue of IMF policy. Also a prodigy, Summers is widely known for an intellectual self-regard that more than matches his brilliant academic credentials. During Stiglitz's tenure at the CEA, he and Summers clashed repeatedly.

The disputes in academia are so intense, the joke goes, because the stakes are so small. The quarrel between Stiglitz and Summers might have remained a private debate between two Clintonite academics had not two things happened. First, as noted, Stiglitz left the CEA to become the chief economist at the World Bank. Second, a severe economic crisis in Asia blew apart the emerging American consensus on international economic policy. As a result, the once-inconspicuous dispute between Summers and Stiglitz became a rare thing in this administration: a public debate on economic policy.

Why is an open debate so rare? Because on the major economic questions of the day, the Clinton White House has forged a consensus that dates back to the first year of the Clinton presidency. In 1993, fiscal conservatives in the Treasury Department persuaded President Clinton to throw in his lot with Federal Reserve Chairman Alan Greenspan. As a result, the administration's economic policy has largely fallen into the hands of Greenspan, Treasury Secretary Robert Rubin, and his deputy, Summers. (In February, Time put the troika on its cover with the headline, "The Committee to Save the World.") The result of this arrangement is that, within the administration, the Treasury Department runs everything.

At first glance, it would appear that Stiglitz's move from the CEA to the World Bank would grant him more decisionmaking autonomy. The CEA, after all, works directly for the president, whereas the World Bank is an international institution. In fact, though, the World Bank is also expected to be a part of the White House team. The World Bank and the IMF, while owned by all the nations of the world, are both located in Washington, and grant control in proportion to financial contributions. The United States has always been the largest donor to both. Moreover, Summers himself was once the chief economist of the World Bank, and aspired to become the president. (Summers, reportedly, has been effectively debarred—unfairly—from holding that position because, during his tenure at the bank, he once signed on to a memo that claimed some Third World nations are "underpolluted.") So, while the IMF faithfully reflects the viewpoint of the Treasury Department, the World Bank has come under the sway of the maverick Stiglitz. This has not always made things pleasant for the Committee to Save the World.

A Clarifying Argument

Stiglitz and his antagonists at the Treasury Department all fall under the broad category of moderate liberals—economists who accept the basic premises of the free market, with certain essential limitations. Despite that broad ideological affinity, though, there is a gulf of intellectual proclivity and life experience between them. While the Treasury Department could be considered generally liberal on domestic policy (particularly in contrast to the conservative Republicans who have set the agenda in the last few years), it has also advocated staunchly orthodox views on international economics. Rubin and many of his confidantes come from Wall Street and keenly appreciate the need to reassure investors. The Treasury has not only made the expansion of international trade the cornerstone of Clinton's foreign policy, it has also tended to espouse the view that rapid liberalization is unambiguously good and requires little restraint. While supporting modified Keynesi anism at home, that is, the Treasury Department has advocated unbridled lassiez-faire abroad.

Stiglitz, by contrast, made his mark by identifying ways in which the unregulated market does not work. The free market model, in its purest form, assumes that all actors have access to perfect information. Stiglitz's most influential work has begun with the assumption that people often act on imperfect information. If you assume imperfect information, he has found, an unregulated market often will fail to produce an optimal result.

One way he has explained this is through the example of interest rates. Imagine a bank lending out money at a rate of interest at which the demand of the borrowers outstrips the bank's supply of money. Under the classic market model, the bank will raise its interest rates until the demand no longer exceeds the supply—that is, it will find the rate of interest that creates an equilibrium. But now suppose that the bank cannot distinguish the high-risk borrowers from the low-risk borrowers. This means that if the bank raises its rates high enough, then only high-risk customers—who have the greatest potential for gain—will be able to borrow. Those who want to borrow money for safer but lower-yielding ventures won't be able to afford the cost of the interest rates. This creates an adverse selection problem for the bank. The rational response for the bank, then, is not to raise interest rates to the equilibrium point, but to ration credit.

The economic import of this example is that it shows how a free market can produce a result in which supply does not meet demand. And the reason is imperfect information—in this case, the bank does not have enough information about its customers to make an informed judgement. But Stiglitz has also shown how this happens in other industries. Insurance agencies, for example, realize that high premiums will attract only those customers most in need of insurance. So instead they keep their rates artificially low, and pare back benefits or try to deny coverage to risky customers.

Keep this critique in mind and consider the recent financial crisis in Asia. When nations like Malaysia and Thailand faced attacks upon their currency and dramatic losses of investor confidence, the IMF came in with an orthodox prescription. In order to restore investor confidence, the IMF, as a condition of its aid, insisted that the afflicted nations raise interest rates, reduce their budget deficits, and reform their corrupt networks of business and governmental associations.

Now apply Stiglitz's theories on information economics. The IMF held that raising interest rates in stricken Asian nations would boost the rate of return for investors there, hence restoring business confidence. But Stiglitz believed that interest rate hikes would increase the likelihood that businesses that borrow money would default, and as a result, make a given economy less desirable for investment.

The popularity of the anti-IMF economists attested to a fact that had largely escaped the attention of the popular press: the IMF's thinking was not entirely based on economics. The IMF's austerity measures were designed to restore investor confidence—essentially, a psychological strategy. The psychology failed, though, because the economics were unsound. The fund asked countries facing severe recessions to do things—raise interest rates, slash spending—that the United States would never contemplate in similar circumstances. While such austerity measures may have succeeded in the past for debt-ridden Latin American countries, most Asian nations had miniscule national debts.

Saying the Unspeakable

At Stiglitz's behest, the World Bank began to publicly criticize the IMF's package in late 1997. This shocked the IMF and its allies in Washington. From the point of view of the Committee to Save the World, the IMF reforms represented the unanimous thinking of all the economic players, a test of economic seriousness, even a symbol of internationalism itself. Anyone opposing this policy would appear shrill, or naive, or isolationist. Throwing the prestige of Stiglitz and the World Bank—which could hardly be called protectionist—behind the anti-IMF view suddenly lent it an undismissable intellectual heft. Indeed, Stiglitz's critique lent respectability to the second thoughts of other prestigious, moderately liberal dissenting economists, including Jeffrey Sachs of Harvard and Paul Krugman of MIT. These economists have come to question whether orthodox austerity measures are always appropriate in the developing world, and, more broadly, to question the American commitment to pure laissez-faire internationalism. The IMF, meanwhile, has admitted to making some mistakes in Asia, although it remains furious at Stiglitz for pointing it out so publicly.

Washington's view of Stiglitz is the same now as it was when he was at the CEA: he is too impolitic to have much influence; he remains a professor, not a player. And certainly he does not play the game in the normal fashion. And yet, somehow, the issues he cares about most always make it onto the agenda. Even after Stiglitz left the CEA, a spate of sympathetic articles in the popular press drew attention to his concerns about privatizing the United States Enrichment Corporation. On the international economy, he has reopened a debate that far more powerful men had put to rest. Sometimes, in politics, losing isn't the worst thing in the world.



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