Joseph Stiglitz: Wrong on Housing and Wrong on China

Here is Mark Pennington’s first regular post.  He’ll have his own by-line as soon as we can get it up and running.

Joseph Stiglitz is quite rightly in my view, one of the most respected economists of his generation. Whatever one thinks about the interventionist policy conclusions that he derives from the ‘economics of information’ (I argue in chapter 2 of my book Robust Political Economy, that they are incoherent) there can be no doubt that Stiglitz’s reputation as an innovator in the field of technical economics is well deserved. More puzzling is the willingness of various media outlets (such as the BBC and CCN) to warrant Stiglitz top billing as a commentator on contemporary events. The examples of housing finance and the analysis of institutional developments in China since 1979 are just two instances which call into question the reliability of this particular Nobel Laureate.

In the case of housing finance, writing with colleagues in 2002 Stiglitz suggested that the probability of a shock as severe as that anticipated in the new risk-based capital standards for Fannie Mae and Freddie Mac was less than one in five hundred thousand and possibly less than one in three million.[1] And that, given the extremely small probability of a default by these institutions the expected monetary costs from exposure to their insolvency would be ‘relatively small’. By any stretch of the imagination this must count as a serious error of judgement – though of course Stiglitz was not alone in failing to perceive the seeds of the housing meltdown that arrived just 5 years later. One would have thought though, that in light of such error Stiglitz might have cause to question his frequent assertions  that the likelihood of future financial crises would be lessened if only there could be more powers for regulators informed by his particular vision of an activist state.

 Turning to China, Stiglitz and Yusuf claim –on the basis of just a few hours spent interviewing some local officials – that stunning economic growth since 1979 is due to the existence of Township and Village Enterprises (TVEs) which are publicly owned but which simulate market competition owing to their being controlled by lower tiers of government.[2] This structure of local government ownership alongside a significant role for higher tiers of the state in the financial sector and an active industrial policy are, according to Stiglitz, the key ingredients of China’s success and not the ‘neo-liberal’ prescription of private ownership and financial liberalisation. In what is probably the most comprehensive empirical analysis of Chinese economic institutions ever conducted, however, Huang exposes this view as completely at odds with reality. Of the 12 million recorded TVEs it turns out that 10.5 million are in fact privately owned or in a position of de facto private ownership  – many of them having arisen following the process of rural privatisation that ran from 1979-1989. Similarly, far from China’s system of financial and industrial planning being the cause of its success, it has been the ability of entrepreneurial start-ups to exit from the Chinese system of financial and industrial controls and to re-enter China on the more liberal terms granted to ‘foreign investors’ that has been critical.[3] Insofar as the Chinese have been able to create successful companies of their own such as Lenovo, these are Chinese in location alone. Nearly all such companies are formally owned and registered in Hong Kong, where they have access to one of the most liberal capital markets anywhere in the world.

So, what explains the popularity of this particular Nobel Laureate with the media? In part it appears to be the self-confidence of the man himself and his determination to convince us that the ills of the world are due to misplaced ‘market fundamentalism’. More significantly, it may reflect the eagerness of certain media outlets to give privileged access to those who offer succour, however ill-informed, to their own ideological predilections.

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[1] Stiglitz, J., Orszag, J.   Orszag, P. (2002) Implications of the New Fannie Mae and Freddie Mac Risk-Based Capital Standards, Fannie Mae Papers, Vol.1, No.2.

[2] Stiglitz, J., Yusuf. S. (2001) Rethinking the East Asian Miracle, New York: Oxford University Press.

[3] Huang, J. (2008) Capitalism with Chinese Characteristics, Cambridge: Cambridge University Press.