Mainstream economics and the global crisis

Joseph Stiglitz in Izmir, Turkey.

At this month’s economics conference in Turkey, some economists discussed the causes and projections of the global economic crisis, plus the adequacy of Economics in predicting and dealing with the crisis. Martin Khor, executive director of South Centre, summarized the more important contributions on his column for The Star, one of the leading Malaysian newspapers, and for Agenda Global.

Khor’s column reads as follows

Addressing the global crisis
By Martin Khor

With the world engulfed in the aftermath of a financial crisis and the midst of another one, have mainstream economists changed their theories and policy prescriptions to be more accurate in depicting reality and more relevant to policy makers?

To a large extent, the big crisis sparked by the Lehman Brothers collapse of 2007 and the Euro crisis sparked by the Irish and Greek debt problems have shaken the dominant assumptions that the financial markets are efficient and governments should leave them alone.

These assumptions should have already been questioned as a result of the Asian financial crisis of 1997-99.

But Western governments and the International Monetary Fund were able to divert the blame away from developed countries’ speculative funds and recipient countries’ deregulated credit markets to allegations of crony capitalism and government mismanagement.

With the crises in the United States and Europe, it is more obvious now that the financial institutions and markets themselves are the cause.

The belief in the theory of the efficient market that can do no wrong, and the policy of financial liberalisation and deregulation based on this theory had facilitated the freedom of the markets that then led to the recent and present crises.

At a conference last week in Izmir, Turkey, well-known economists and policy makers debated the state of the global economy and of economics.

Most speakers concluded that the crises were caused by deregulation that unleashed the beast of financial speculation by big banks and investment firms.

They also agreed that economists and policy makers have not yet learnt the right lessons.

As a result, the needed basic reforms have been avoided while wrong policies are being pursued. The world is on the brink of new financial crises and a recession.

Joe Stiglitz, the Nobel laureate and former World Bank chief economist, gave a blistering critique of how the standard economics model had failed to deal with the financial crisis because wrong assumptions were made and wrong questions posed.

The orthodox model also could not handle current issues being debated, such as the multiplier of government spending, the nature of deleveraging and the liquidity trap.

In the aftermath of the crisis, orthodox economists and the policy makers in the United States made wrong policies.

Stiglitz called for a new economics model that asked the right questions and one that could anticipate abnormal times, the sources of shocks and is able to properly describe what is happening.

On the sidelines of the conference, the Turkish Central Bank co-organised a roundtable on capital flows.

The central bankers and international institutions seemed to agree that volatile short-term flows were having damaging effects on developing countries, including financial instability, housing price, stock market bubbles, currency appreciation that made exports uncompetitive and destablisling effects of sudden stops or reversals of the inflows.

The Turkey Central Bank’s Gover­nor spoke of new policy tools be­­­­ing used by Turkey to discourage un­­­wanted short-term capital inflows.

The G24’s director Amar Bhattacharya summarised developing countries’ concerns over the effects of capital inflow surges and outlined the range of policies they were taking to address these, including macro-economic policies and prudential measures including market intervention as well as capital controls.

While most of the discussion on capital controls were on regulating inflows, I brought up the successful Malaysian example of controlling outflows selectively and accompanied by several other measures.

The position of the IMF, which traditionally championed free capital flows and which once wanted to prevent countries from using capital controls, was interesting.

Its official recognised the adverse effects that free capital flows can have, and the possible benefits of capital controls, which are significant changes from the Fund’s old rigid view.

But this IMF official also cautioned against using these measures as they could have bad effects on the country itself and on other countries. One example given was diverting unwanted funds to other countries that did not regulate.

The counter to this was that more attention or even blame should be placed on the “source countries” that allow its banks and investment funds to move their massive funds around the world in search of quick profits, with devastating effects on recipient countries, rather than prevent or discourage the targeted countries from taking defensive measures.

At sessions on developing country issues, He Fan of the Chinese Academy of Social Sciences analysed the present imbalances in China’s economy and the prospects of future growth driven by urbanisation and consumer spending on services to offset falling exports.

The South Centre’s chief economist Yilmaz Akyuz argued that developing countries had not de-coupled their economies from the developed countries.

With the prolonged global slowdown, they have to change their export-dependent development strategies.

Malaysian economist Lim Mah Hui outlined measures being taken in Asia towards regional financial and monetary cooperation.

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