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The Roaring Nineties: A New History of the World's Most Prosperous Decade

Authors: Roger M. Kubarych, and Joseph E. Stiglitz
October 27, 2003
Council on Foreign Relations

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Speaker: Joseph A. Stiglitz, Author, The Roaring Nineties
Moderator: Roger Kubarych, Council on Foreign Relations

October 27, 2003
COUNCIL ON FOREIGN RELATIONS
New York, New York


Roger Kubarych [RK]: (In progress)…over the years has written a combination of brilliant and really path breaking technical work on the economics of information, won the Nobel Prize for it two years ago. And for that he is well deserved, well deserved. But he's also a policy expert, a policy commentator, and a player, somebody who knows how to argue not only in print, but in the messier back rooms of Washington. And he's still at it.

And we're delighted to have him to talk about the new book, The Roaring Nineties, which is just coming out. I read a good chunk of it over the weekend, when I could keep away from the tears of some of my friends and family and neighbors, after that shut out on Saturday night [reference to Game 6 of the United States Major League Baseball Championship when the New York Yankees lost to the Florida Marlins]. I, being from a different persuasion, was not that upset.

And as I was mentioning, you know as the former batting practice pitcher for the Rochester Red Wings, back when they were a Baltimore Orioles farm team, you know where my sentiments may lie. But Rod and Joe's book does have to do with the role of money in politics. Money, or sometimes with its euphemism, Wall Street, and he must have been tickled by the idea of a team with a $50 million pay roll beating a tremendous team with a $180 million pay roll. At least on some playing fields, money is not all that matters. Occasionally hitting with runners on base helps. (Laughter)

Now, I've been around the Council for a long time. And many of you have forgotten me because I broke my leg in February. And so for months I was never here. But I'm glad to be back and participating. Somewhere, I've got to go through the rules.

Generally, I think, well, it's here. You know them. (Laughter) You can use the information. You can't attribute it. And for Heaven's sakes, don't go around telling your friends about the silly questions that your neighbor asked. You know, Joe's on the record in his book. So obviously anything that he says is relevant to thing book is on the record. But it helps the discussion if the questions and answer are treated with that respect.

No cell phones. I know that's new. Other beepers, anything else that will disturb the gentility of this discussion, which is Joe Stiglitz against, well, you name it. (Laughter) His enemies in the Clinton Administration, Wall Street, and just the facts of life that some people are richer than others. Tell us to start, Joe. I will do a dialogue for about 15 minutes and then take lot of questions.

Tell us what's new in your book. The globalization and its discontents which many of us read, was an outstanding commentary on the world, and on the role of the IMF, not always felicitous, in helping to manage that difficult role. What are the new things in this book?

Joseph Stiglitz [JS]: Well, I guess there's a couple of things I'd emphasize. In the area of globalization, I took, in the book, much more of the perspective of the United States, rather than the world as a whole and said, "After the end of the cold war, there was an opportunity for the United States as the sole super power economically and militarily, to try to create a new global economic order."

You know, the rules of the game had clearly changed. And what I try to suggest is that we lacked a vision about what would be that kind of global economic order, based on principles, principles like social justice. And that instead of creating one that we would feel comports with our fundamental values, in fact the agenda was taken over by some special interest. And the result of that was the kind of misshapen form of globalization I talked about in the other book, the problems that were going round, the problems in managing the global economic system.

The second thing that's news, most of the book is really devoted to American economic policy, but with an objective of using that in the context of as a teacher telling a number of lessons that I think are of importance. The first one is actually going back historically at the beginning of the Clinton Administration, we recovered from the recession. And the question was, "Why?" And there was a standard story that was told by the Clinton Administration, there was deficit reduction that allowed interest rates to fall. That allowed the economy to be stimulated. And that was the source of the recovery.

Now, what was very disturbing for an economist is that this is the thing opposite of what we teach in every course in economics around the world. And for 70 years, conservatives have been trying to kill Keynesian economics. And I felt very bad, being in a position of a democratic administration killing Keynesian economics. So, my view was that we had to at least understand what was going on.

And in particular, that particular recipe, deficit reduction as a way of getting out of recession, had been tried before and failed, and then was tried in East Asia, in Argentina. And each of the times, it failed dramatically. So anybody reading that history, the traditional interpretation that deficit reduction leads you out of a recession, would be very badly guided by that historical experience.

RK: So you're delighted with what the Bush Administration has done. They're pumping up the deficit in order to revive the economic.

JS: No. No.

RK: Oh.

JS: That's what I talk about at the end of the book.

RK: I didn't read that chapter. (Laughter)

JS: That's at the end of the book, because deficits do matter for long term growth. And that deficit reduction was the right long term policy. But it wasn't what got us out of the recession. Now what I try to suggest is that the Bush Administration is showing that deficits do not necessarily lead you into a strong recovery. You can spend money that does not, in ways that does not stimulate the economy.

And that's what's been happening. We've amassed massive deficits, particularly going out in the long run, so the long run consequences are adverse, but they've been as badly designed as you could imagine in terms of stimulating the economy in the short run. So we don't get the short run benefit, we get the long run cost. And I try to explain that in some detail in the last chapter which is ...

RK: So maybe a critic, a friendly Bush critic may argue you're just a little impatient, that in fact, they're looking for something like six percent growth for the current quarter, the recently completed quarter. And they have something like three and a half percent growth in the second quarter. So, what they've got is them phenomenal productivity increase, over five percent last year, and over five percent per annum this year.

JS: Two points on that. One of them is that, remember, the tax cuts first began, massive tax cuts ...

RK: In 2001.

JS: In 2001, spring of 2001. And that that turned a surplus of around two percent of GDP into a deficit of around three percent of GDP. That's a huge turn around in the fiscal position of the United States.

RK: One of the biggest ever.

JS: One of the biggest ever. And then we've added another two percent. I mean, some of this has to do with misforecasting and that. But there's absolutely no doubt, a huge turn around. And the lags that normally take place out, we're well beyond that. No, in other words, you usually - six months, nine months, the longest lags you talked about were two years, and just did not have the bite. And it was forecastable. It was predictable because of the way it was designed.

The productivity story is, going a little bit away from my book, but anyway, because I talk about this a little bit, the productivity story is a little bit more complicated, because it is a two edged sword. That was one of the drivers of the '90s, was the technology, improving the technology. And it underlay the strength of the economy. But it means that you have to grow that much faster to keep the economy at its potential.

So productivity is growing at six point five, that means that with the labor force growing about one percent, we could be growing at seven percent. You know, that potential growth is that much higher. We are well below our potential. And that's really one of the important lessons. We've measured whether we are in trouble by whether we have negative growth. These not the right way a measuring it. The right way of measuring it is whether we're living up to our potential.

We have a higher potential now. And there's a significant gap between our growth and our potential, which is reflected in the fact that there have been about 3 million jobs lost in the last three years. Whereas to keep up with the new entrants in the labor force, we should have created 3 million new jobs. So there's a huge gap there. And that is one that will take a long, long while to regress.

RK: Now, let's turn to your very, very tough, I mean very toughly worded, and really quite persuasive arguments about the reactions of the Clinton Administration to the emergence of the bubble in the stock market.

JS: Here is my argument. And it wasn't just the Clinton Administration. It was also the Fed, that had a role. The issue here behind the book, in a way, is the following observation I should have mention in the beginning, which is that the 'roaring nineties' was a period of optimism. We all thought things were great. The economy was going up. Globalization was going to embrace the whole world. Everybody was going to benefit.

And by the end of the '90s, all that had unraveled so much faster, I think, than anybody anticipated. Globalization starting unraveling in '97, with the East Asia crisis, in '98 with the global financial crisis, '99 with the riots in Seattle saying, "No more free trade." You know that the Uruguay round that we talked about so proudly was really resented in most of the world. And, I think, quite rightly.

On the economic side, the bubble broke just after the new millennium. You know, too fast for it to have been just a change in administration. And that leads to the conclusion that there must have been some, or at least raised the question, were there some seeds of distraction enterprise on in the earlier period? And that led me to recount some episodes that I thought help expect what shows going on.

Let me first give the short answer, the economic answer, and then give a little bit of some of the political stories. The short answer was that there were put into place a set of incentives, CEOs, accounting, bank, a whole set of incentives that led to distorted information. The information that people had to evaluate stock prices, to evaluate what was going on, was distorted.

The result of distorted information is that prices do not reflect reality. As an economist, we know how important price are. They give signals to where investment ought to go. If prices are distorted, investment decisions are going to get distorted. The result of that is you've got excess investment in some areas, and shortages of it in other areas, particularly the excesses. And whenever you get these excesses, eventually you get over capacity, and you get a bubble. And the bubble breaks. So that is, in some sense, a short description of what was going wrong.

In terms of what my own economic theories were, my own economics were, it was very much related, because my work was economics of information. One of the main results of my work was to suggest that in rules in which there are problems of asymmetric information, it just means different people held different things, where asymmetric information is important, the standard analysis of economics often doesn't work.

One of the most important ideas in economics is Adam Smith's invisible hand, that pursuit of self interest that leads, as if by an invisible hand, to general well being. My theoretical research has shown that one of the reasons the invisible hand often seems invisible is that it's not there. (Laughter) And what we saw in practice was that greed on the part of CEOs, and investment banks and accountants, didn't lead to efficiency of the economy.

And then I go on to describe in the book a couple of instances of this. I sum up a couple of the battles that we fought. In '93, '94, there was a very big battle over stock options, which I view as one of the key issues, and I think more and more people are. But this was '93, '94, when this was not an issue that people were talking about. And our view was, our council of economic advisors, our view was that the counting of stock options meant that shareholders did not really know what was happening to their companies.

They were, effectively, diluting their shares to executives. And they really didn't understand what was going on. And there was an Initiative Financial Counting Standards Board pushing it. We supported them. That called for a better accounting procedure. U.S. Treasure, Commerce, and the National Economic Council came up with a view that the people knew what was going on. They changed the account framework. Share prices will go down. We thought that was an argument for the reform, because it was saying if people really knew what was going on, the way they would value it would lower.

And our view is that you, eventually this information always comes out. But when it would come out, there would be a crash of the stock market. We ought to make sure that they have accurate information, as quickly as possible. And so, what we thought was an argument for reform, they took as an argument against reform. That was one example. Another example is…

RK: Plus they had quite considerable allies in Congress ...

JS: They did.

RK: ... who were listening to business executives, either rightly or wrongly, defending this practice.

JS: In Silicon Valley, there were a lot of people who were benefiting from it quite clearly. But that illustrates the problem that those who benefited, their voices were being heard. Those who were being hurt didn't know they were being hurt. And so their voices couldn't be heard. And, you know, one of the reasons that the Council of Economic Advisors was created was to look for things like this. And we were doing what was our job. But unfortunately, it didn't have the effect that we wanted.

Another example was the repeal of the Glass Steagall Act, which was a separation between commercial banks and investment banks. One of the reasons for this separation was worries about conflict of interest. That became very clear in the Enron episode and in other episodes. Again, we had a debate, the Council took the view that this would be opening up new sources of conflict of interest that we, you know, had been recognized. And this would open up new sources.

They said, "Don't worry. We'll create Chinese Walls." And first our view was some degree of skepticism about whether these Chinese Walls, how high they would be, and how easy it would be to climb over. But the other argument that we put forth was if there really were Chinese Walls that were really separating the two, then why put the companies together? The reason for putting them together was synergies.

And you could only get those synergies if you talked to each other. So if you really kept them separate, then there is no argument. And you're just opening up a potential risk.

RK: Do you think that any of your colleagues in the Administration, where you were raising these issues, in their wildest nightmares, ever believed that there would be things like Enron, Worldcom, and some of these disgraceful episodes that we had subsequently?

JS: No. I think it just didn't occur to them. I really think it just didn't occur to them. They thought, you know, they knew about the episodes in the '20s, you know? But that was history. And they said, "Well, we've solved that problem. We've created the FEC. And we have group bank regulation. And so, you know, these are matters of the past." As an economist, I just looked at the issue from the point of view of incentives.

RK: Right.

JS: And I asked the question, you know, individual's incentives, and if the information is imperfect, they have incentive, you know, take the stock option, they have incentives to, they get more money by giving bad information than they do by creating wealth. And so you put into place an incentive to have distorted information. And one of the things I assume very clearly, American, the enormous amount of innovation in American financial institutions, including in tax evasion, and tax avoidance. I should say tax avoidance.

And one of the things that we were involved in a lot was trying to close some of these loopholes. And some of these just wouldn't, amazingly. What was very clear to me was that some of those techniques could be also used, not only to provide distorted information to the IRS, they could also be used to provide distorted information to their shareholders. And that is, of course, one of the main things that came out of the Enron episode. And the banks were complicit in this.

And again, they were being driven by some of the same incentives that were driving the corporations. The CEOs with stock options, did better with higher accounting profits, whatever the real long term prospects might adversely be affected.

RK: One of my friends on Wall Street has always encouraged me to look dubiously at companies that have high reported earnings and don't pay any tax.

JS: Yes. Yes.

RK: That came through clearly. Let's now shift to questions. By the way, I stand corrected. It's not just Joe's remarks now that are on the record, the whole thing is on the record. That's my own mistake and I apologize for that. Everything's on the record today. Different than normal Council rules. One last take away from the book, to encourage everybody to buy it. What is there here? Or, to put it another way, which chapter should they read first? I like the chapter on myths. He's very good at debunking myths, even the one that I really still believe. (Laughter)

JS: The main message of the book is that we got some things wrong in the '90s. We've gotten some things very wrong since then. Wrong both in terms of managing globalization and managing our economy, that these are opportunities for learning what we did wrong. I come across, that, my perspective is very much that we need a balanced role between government and the private sector, the market. The market's the heart of the economy.

But any system, to work, needs rules and referees, and you have to try to get that balance. That balance is going to change across countries. That top balance is going to change over them. It is absolutely right that when you do change the regulatory framework that we had, the regulatory framework that we had that we began the '90s with, was out of date. The world had changed enormously.

But, at the same time, rather than asking the question, "What was the right regulatory framework that we needed for the economy as it is today?" it was having taken too much with the deregulation mantra, "Let's strip away regulations." Where we should have recognized that there are some new problems that will arise in the areas of accounting, in the areas of banking. Globalization requires new ways of, you know, new frameworks. All of that needed change, but we didn't begin with a set of principles. We really began with a narrow set of ideology.

I guess, a final thing. Responding, some of you may have seen a review in the New York Times yesterday.

RK: Yes. I brought it in case anybody wants to look at it.

JS: Just read the last paragraph.

RK: It says it's brilliant. (Laughter) "The powerful intellect," even better than brilliant.

JS: The point, the tone of the review was that I was anti-business. And I think that's absolutely wrong.

RK: The tone was that you're anti-business. But you're not anti-business.

JS: That's right. The tone of the review was...

RK: What?

JS: I just want to correct it. That's not correct about my position in this book. My view is that this is a very pro- business book. But it says that if the market economy is going to achieve what it can achieve, there have to be some rules and regulations, that investors won't put money into companies that they don't know whether the money's being stolen by the CEOs.

All CEO's are not engaged in that kind of activity. They're tainted by the fact that some of them are. But at the same time, if you look at the problems, there are enough companies that were involved. There are enough banks that were involved that you can't just say, "It was a rotten apple." You know, if it was one bank, you'd say it was a rotten apple. It was enough that you rationally asked the question, "Was there a systemic problem?"

And the thrust of my book is to try to analyze and to say, "Yes. There were incentives at work that were misaligned. And we now need to correct those incentives to make the economy work better." We'll never get it perfectly. But at least we can do better than we did.

RK: And think that's, from my reading the book, that's a very fair summary. And I really encourage you to read it. And I'm going to call on people kind of randomly. But I really want you to give your name and affiliation. I know it's so easy to forget to do that. You really want to make these questions, and keep the questions as short as possible. I'd like to get through as many people ... I've got a record around the Council of getting through the most number of questions by being ruthless. And the mic [microphone] will help. So, we'll start over here with Steve. But please say your name.

Audience: Thank you. Steve Shepherd from Businessweek. You say that historically deficit reduction is not a great way to stimulate economies, which is true. The Clinton tax increases of '93, or the Bob Rubin tax increases-deficit reduction plan led conservative economists to say, "Oh, my God! There's going to be a recession." We didn't have a recession. We had an enormous historic economic boom. How do you reconcile these two things? Clearly something worked. And it wasn't all thievery on the part of CEOs.

JS: One of my chapters is devoted to trying to answer this question. There are two parts to this. One, it was a very carefully designed deficit reduction. And I think once you've recognized that, two for design in two respects. Most of it was what we call, "backloaded." So, and here Rubin made an important contribution, it was able to convince the market that there were going to be real deficit reductions in years two, three, four, and five. And that helped lower long term interest rates.

But not that much deficit reduction was done in one. So the impact of that was not a strong negative. And the positive interest rate, in terms of the term structure, was positive. The second thing is that a lot of the deficit in terms of design, a lot of the deficit reduction was aimed at - the tax increases were all aimed at upper income individuals, upper two percent. There was a little on the gas tax, but that was a very small percentage. It was the upper two percent.

Their response, in terms of reduction consumption is not like the response that you get in lower income people, which is exactly the opposite of what's been going on more recently. If you give tax cuts to the unemployed, to lower income people, they spend the money, because tax cuts to upper income individuals, they tend not to spend it as much. They spend it some. But just much less.

So, one of them was the careful design of the tax cut. The second point was that there was a peculiar configuration of our banking system at that time, that I describe as a consequence of a series of lucky mistakes. What had happened as a result of the rise of the ... History's always interconnected. There was a rise in interest rates back in the beginning of the '80s that made many of the S&L's [Savings and Loans] bankrupt. Those chickens didn't come home to roost until 1989. We had deregulation, bad accounting in the S&L's that allowed them to stay alive for about nine more years.

And then '89 came along, and new strong regulations were put into place, and an injection of government money was put in. And that was one of the reasons we got in a recession in '90-'91. Lending was cut back. But there was one peculiar provision of the Fed that made no economic sense and contributed to the economic downturn of '90-'91. And it was opposed by the Council of Economic Advisors at that time, Mike Boskin, my colleague at Stanford.

And that was following, they treated long term government bonds as if they were safe for regulatory purposes. Long term bonds, you won't give U.S. Government bonds. A U.S. Government bond does not go bankrupt normally, as long as, you know? And so in that sense, they were right. But variations in long term interest rates means that the value of the line of the bond can vary enormously. They are highly risky.

What that meant was, and the fact that they were risky is reflected in the fact that the interest rate they play is considerably higher than the short term interest rate. You're getting compensated for that risk. Well, what does that mean? They were able to treat these long term government bonds as if they were safe, but yet a risk premium, but not account for it in the accounting framework.

So it was a bad accounting framework again that was partly in play, a bad regulatory framework. Well, one of the reasons for exacerbating the downturn was that the banks, rather than doing what they should be doing, which is lending, were buying long term government bonds. Highly risky, because that meant if U.S. long term interest rates rose, which they could have done if our deficit had increased, it would have meant that long term bonds would decrease in value, and all our banks would have been in really bad shape. And we would have had another bail out.

What happened was we succeeded in getting the long term interest rates down. And it was like an equity injection into our banking system. Our banks were recapitalized indirectly. And you can see in the data how quickly they started lending. And it was that robust lending, not the interest rates themselves that were so important, but it was the recapitalization of the backing system.

Let me make just one more remark. I know you want to get a lot of questions. But I wanted to emphasis this particular point. One of the reasons that I was so concerned with the argument that was put forth by the Fed and by others was it made no sense, because it seemed to say that the Fed can only stimulate the economy when there's a low deficit. If lower interest rates are the key to recovery, then the Fed could have done it whatever the deficit was.

There is nothing in theory or history that say says that you could only lower interest rates when there is a low deficit. It was a very disingenuous argument which was said with such conviction that it was believed by all the media, and told over and over again. But of course, we know what happened in the spring of 2001. The same Fed became very supportive of tax cuts that led us from a surplus into a deficit.

RK: But that's another question, much later in the program.

Audience: Charles Ferguson at Brookings. I was surprised, I haven't read your book yet. I was surprised that you put so much emphasis in your remarks on stock options as opposed to corporate governance, which I think many people regard as a far more fundamental problem. Stock options, if properly structured, if they have long vesting periods, required holding periods, et cetera, are perfectly legitimate instruments.

The reason that they frequently didn't have those conditions attached to them was that boards of directors didn't attach them. So I would like your comments on whether you think there are systemic, or major problems of American corporate governance?

JS: In a sense, these problems are reflections of problems of corporate governance. And I was looking in that sense at more of the symptomatic. But the symptoms that were directly translatable into what went wrong in the '90s and afterwards. So that's really what I was focusing on.

The fact that executives were able to give themselves these stock options is a manifestation of problems of corporate governance. And let me just make two points about this. The first is that these stock options were often described as providing go incentives. But in fact, if you look at them, and there was an economic literature to with I contributed, explaining why they're not well designed for incentive, because most of the money, whether you did well or not, didn't depend on how well you did in your firm. It depended on the movement of the stock market as a whole.

There were a few firms that recognized this and made it pay, based not on how well you know your company did, but how well your company did relative to other companies in your industry. So you don't get a bonus simply because everybody decides to buy your product, or buy your industry. And so there was a recognition of this. And it was very clear that that was going on.

The second point is that what we've seen since then is that when the stock market wound down, what happened to CEO pay? Based on stock options, and that was an incentive pay, in the old form, it would have gone down. CEO/executive pay continued to go up. What was the trick? Well, what you do is you find when the stock markets go down, you find other ways of compensating people. And they're doing these statistical studies that show target if you relate not the nominal design of the contract, the actual compensation, it is not that closely related to performance.

When it does well, they get paid well. And where it does poorly, they al find ways of getting paid well.

RK: Was your problem, to follow on Charles's question, that you couldn't find anybody out there in the financial community to support you? Because lately Buffett [Warren Buffett] has taken the lead in being a big critic of stock options. And now, I would say that the conventional wisdom is more like yours. This is a dangerous contraption. It can be misused and so on. But where you were making this case, I didn't hear very many people in the business community at large on your side. You couldn't convince them? Or, you didn't think you needed their help?

JS: No. I clearly did. But the Financial Standards Board, which is the group that is supposed to oversee the standards, they couldn't get support for it, I mean. And they were much more immersed into that. I think it's one of those things that the theory was very clear, so clear that you could bet on it. But until you have the hard evidence, it's very hard to convince people.

And one of the reasons for my writing the book is not to repeat the journalistic stories. And there have been a lot of those. It's not to repeat those stories but to try to make the link between how these stories of stock options, the stories of bank deregulation and so forth, how they're related to the performance of the economy. So, it's really that analytic stuff which is inside the core of what I tried to do in the book.

RK: I've got (unintelligible) and then Bob, and then George.

Audience [unknown]: I read the Times review yesterday a little too quickly I think. But it seems to me that one of the things that was indicated was a negative feeling about the way Alan Greenspan handled allocation of the problems with comments about irrational exuberance. There was an implication that there should have been a lot more than that. And of course, the hundreds of thousands of stockholders who lost a lot in the market probably would agree. What kinds of things could Greenspan, in your opinion, have done without creating some kind of a panic in the market?

JS: Yes. That's a good question. I think that when Greenspan gave that speech in '96, it was a wide spread concern that there was a bubble. And that's why you use the irrational exuberance and I was at the speech where he gave it. And it was very clear what he was trying to do. He was trying to use words to deflate the bubble.

As economists, words can have a little bit of an effect. But they tend not to have that much effect. You have to do more than that. And what was striking in my mind was how, in '97, '98, '99, when, you know, after a few days the market is where it did have a slight negative effect for a few days. And then a new report came out. And, you know, it just went on as if he's never given the speech.

And as you looked at the numbers, it became clear, if you thought that there was a bubble in '96, you should have been really worried by '99, or '98. And if you were, you know, on the edge in '96, by '97, '98, '99, you were worried. What you did instead was actually to start talking it up about the new economy, technology, and in some sense contributed to making people feel more relaxed.

And we now have, one of the great advantages we now have is the release of the minutes of meetings, five years later. And so we can look back. And he actually recognized that there is both a bubble and he had an instrument for dealing with it, namely increase the margin requirements.

But most economists would say an increase in margin requirements, by doing it gradually, he would have dampened the bubble without causing, you know without causing a crash. It might not have worked. But it would certainly have been a movement in right direction. And it could have tamed the bubble. And that's what I think he should have done.

RK: Good. Bob?

Audience: Bob Glauber, NASD. I guess this is in the form of a follow up. Are there any other policies the Fed could have followed, monetary policies, that might have had some effect on the bubble as well?

JS: The hard question, and he actually raised this in that speech, the hard question to the Fed is that it didn't want to dampen the real economy. But it did want to dampen the asset bubble. Interest rates are high enough, is one tool. And I think he was rightly thinking that if he raised the interest rates, he would dampen the economy unnecessarily. There was no real sign of inflation. It would have dampened the bubble. But it would also have led unnecessarily to a reawakening of the economy.

So in that sense, I'm sympathetic with his reserve about not raising interest rates. And that's where going to some other instruments, micro economic instruments, like margin requirements, is what he really needed to have done. Obviously, I think he should not have given the speeches. But I don't actually think those speeches in the end, had that much of an effect.

The other thing, one other thing. I don't know whether he is to be blamed, but one of the things the Clinton Administration did in conjunction with Congress, is in '97, they cut capital gains taxes. And in a way, that helped feed the frenzy. It was a bad time to cut the capital gains tax.

And if you look at it, what that meant for what happened to the tax structure of the U.S., from '93 to '97, we raised income taxes on upper middle income Americans who were working, and lowered taxes on upper income Americans who were speculating in the stock market. It's hard to think about whether this was a system with a well defined philosophy, and certainly with what you would have thought as a liberal, democratic philosophy.

RK: George, you had your hand up, too.

Audience: George de Menil, NYU. Joe, you seem to suggest that a lot of the conflicts of interest, the scandals are traceable to Glass Steagall. I ask you the question, could we have had all of this with the repeal of Glass Steagall at all? And lending to sham corporations, insuring, not telling the public what lies behind, something that you're underwriting, you don't need the repeal of Glass Steagall for that to happen.

JS: No. I was giving Glass Steagall as just another example of another piece that added into a brew that was already problematic. So for example, let me give you, you know, in the chapter where I describe the problems in the financial sector, this is one small piece. The conflict of interest between analysts and investment banks, where the analysts are supposed to provide information to the investors, but also are being paid by the investment banks, it naturally gives it a difficult conflict of interest arises.

And there are people, we were talking before, we were talking before this meeting with Henry Kaufman, had been talking about that issue, that conflict of interest since '85, or maybe before that.

RK: Earlier.

JS: So that was one that had nothing to do with Glass Steagall, was inherent in the problem, without the investment banks themselves.

RK: Although he did testify to Congress that Glass Steigal would make it worse.

JS: Yes. And that's really the point. It was one more piece that made an already existing set of conflicts of interest even more difficult. So that's really the way I would try to characterize it.

Audience: Pietro Ginefra, the Bank of Italy, Banco d'Italia. Do you think that the bubble in the asset market can hurt the American pension system, in the sense that people can be less comfortable with the pension funds?

JS: Yes. I attack - there are several problems and several of which I discuss actually in the book. One of the problems, to go back to an accounting problem that has been very troublesome, it's come into the news much more since I wrote the book - you know, there's always a lag between writing a book - is on the side of the defined, what I called define benefit programs, the defined benefit programs are those where the worker gets a defined benefit and the risk is borne by the companies.

And what they did during the '90s is they were allowed to use projections assuming a nine percent return on their investments and stock. What that meant was that to provide the benefits that they promised to their workers in 20 years, 25 years, or 30 years, you didn't have to put away very much money. And that meant that they didn't have to put away very much money. They could treat the rest as profits. And so that gave an uplifted view of profits.

Now, two things happen. First they didn't get the nine percent return over the period of 2000 to 2002, 2003, it wasn't, they didn't actually increase at the 27 percent that they had expected. And it went way down. And that meant two things. One, because they were way down, they had to fill in the hole. But then at that point, to calculate they were no longer able to use that nine percent projection. That was so unrealistic. They had to bring down the numbers they were using for projection.

And that meant to me the obligation they had to put in ... They needed even more. So that meant that their pension funds were vastly under funded. And to replenish that, that's taking away profits that could be used for a variety of other purposes and is one of the sources of anxiety. Some of the magnitude of these numbers are absolutely incredible. I mean, one estimate had over $300 billion of gap. Some companies, like GM [General Motors], their pension liabilities exceed the value of their assets. So, this is not a minor problem. On the other side...there had been a big shift towards defined contribution programs, where you put in a certain amount every year into your pension fund. And people were very enthusiastic about these when the market was going up. And they were reasoning in the same way: I only need to put in a certain amount and I'll have enough for my retirement.

Well, what happened is, when the stock market crashed, their pension retirement savings went down with it. Those who are 30 don't have to worry about it. I mean, they see 30 years more of work. Those who are 50 are often in a very difficult position right now. And I, it is undermining support for those who…we ought to move more and more towards the defined contribution system. It has left the risk in the hands of many people who are not really able to bear that risk.

One of the curious things is many of us had thought that one of the reasons that the U.S. savings rate was so low during the '90s -we borrowed a lot to finance our boom. I mean, one of the other things is we were going on the cheap, getting money from other countries to finance our growth. One of the arguments for why our savings rate was so low is that Americans were implicitly saving because their stock values were going up so much.

If you believe that explanation, it led many of us to think that with the stock market going down, they should save a lot more. Savings rates have increased a little bit, but nothing commensurate with what we would have anticipated. That is another source of anxiety about the strength of the U.S. economy going forward. At some point, it is conceivable that more Americans might say, "We don't have enough retirement savings." And that might lead to more savings, which in the long run would be good, but in the short run configuration of our economy, with the weaknesses it has, would present some serious problems.

RK: Yes. Instead in the short run, they're borrowing against their houses.

JS: Exactly.

RK: John Watts.

Audience: Hi. John Watts, FFTW. You've been talking about the efficiency of tax cuts and that they weren't very efficient in terms of the objective of stimulating the economy. They also have increased some distribution effect. If you accept that the last sale of tax cuts has added to the situation in the United States where we've had an extraordinary increase in the unevenness of income distribution, with the effect of those tax cuts going roughly, as I recall, about half to the upper two percent of the income grade. Is this due to a poor, in effect, economics behind the decisions, principally? Or do you think it was due to more of an ideological bend toward rewarding the well-to- do, that were supporters of the Administration?

JS: (Laughter) That might be said as leading the witness, as they would say on TV. (Laughter) I think one has to recognize that it was largely done to help those who had supported the Administration in the campaign. And let me just give you one example. Probably the most egregious aspect of the last tax cut was the dividend tax cut.

There was behind that dividend tax cut, a grain of a valid argument, which was a concern about what's called, "double taxation." You pay taxes at the corporate level and the individual level, twice. Originally, there was supposed to be a provision that you could only get the exemption at the individual level if you, in fact, paid the taxes at the corporate level.

But as it wended its way up through Congress, that was dropped. So now, the issue is not double taxation, it's really zero taxation. But then more to the point, in Europe, a number of countries have addressed this issue of double taxation. There are ways of addressing the issue of double taxation that do not undermine the principle of progressivity of the tax structure.

So for instance, what we use today in our "S" corporations, where if you're a shareholder, you would be attributed one percent of a firm, you would be treated as if you received one percent of the income, the profits of the company, and you paid one percent of the corporate profits tax, as a withholding tax, so you could have converted the corporate profits tax into withholding tax, and really get rid of the whole corporate taxation, as anything other than a withholding tax.

That would have retained progressivity. It would have eliminated double taxation. But that was never even discussed as an alternative, because that was not on the agenda, eliminating double taxation was not on the agenda. It was really reducing progressivity of the tax structure.

RK: You have that in the book, this discussion?

JS: Some of that I have in the book. I mean, as a magnitude on this one provision ... I know in the end they didn't actually eliminate all the dividend taxes. But the numbers were astounding. In the regional proposal, something like 126,000 of the wealthiest Americans would get the same benefit in total as the 100 million, 100 million tax filers with incomes under $100,000. So, it's just astounding in terms of the degree of disparity in that so called reform.

RK: Mike Oppenheimer, and then John, and then back here. And that's probably all we're going to have time for. (Background Conversation)

Audience: Michael Oppenheimer, Global Scenarios. A question about the global economy. We just had another trade system melt down in Cancun that is reminiscent somewhat of Seattle but without the street violence and so forth. Have we made any progress since you wrote your globalization book in managing this system?

JS: Well, I think that what has happened, both before and after writing my globalization book, is that I think that there's a widespread recognition that the rules of the game in trade are vastly unfair. And, you know, when I talk to your groups, not just to NGOs, you talk anywhere, and I don't think I can find anybody that will defend…as it was passed. You know, that the fact that we ask developing countries to take away their barriers to our goods and eliminate their subsidies, and we kept our subsidies. And even worse, after in the last couple of years, we've actually doubled our subsidies.

And the understanding was that we were going to phase them out. So, here we said we're going to...okay. '94 is the beginning of agriculture. We just brought it in. We're going to be phasing it out. And what do we do? We doubled it. And what people were saying, you know, people were very involved in these talks.

What they thought would be a good outcome is that if we went back to where were in 1994. That was the biggest concession that they thought they could get out of the United States. So what has happened since 1994 is a recognition of the problems. The same thing on intellectual property rights. The fact that we fought, when I was in the Council of Economic Advisors, we fought this battle about access to drugs for the developing countries.

We knew that the provision to the Uruguay Round would mean that some of the poorest people in the less developed countries would die, would not have access to these life saving drugs. And we tried to stop it. And the Office of Science and Technology policy also opposed the intellectual property agreement on the grounds that access to research findings are the most important ingredient to research. And that was bad for America science. And it was all driven by the pharmaceutical entertainment industry.

So these kinds of problems, I think have now become widely recognized. I could go on. I think that what has happened is that as they become more widely recognized, the strengthening of democracies in many of the countries of the world, and a more active involvement of the media, has meant that the only kind of agreement that we will get is a fairer agreement.

And basically what happened in Cancun is - in the past, the U.S. Trade Representative would go to the negotiations. And the stance would be something like the following. They would say, "You know, we agree with you that our position on agriculture is unreasonable. We know that it's unfair. But we have a Congress. And our Congress ties our hands."

And so, you know, they try to be sympathetic and empathetic towards the developing countries. But given this democracy tying their hands and saying, "You know, what can we do? We're trying to do the best we can for you." Well, now the developing countries are coming back and saying, "Our hands are tied, too. If we come back from Cancun with an agreement as unfair as the one we signed in Uruguay, we would be out of office. It's become a major issue. It's become a major political issue.

And the press was there, putting an enormous amount of pressure on them. And I think that is one of the reasons for the failure in Cancun. And I think that has a lot to say about how we are going to have to reconfigure even the negotiation processes to make them more out in the open. It's going to be a very different kind of framework than in the past.

RK: Jon.

Audience: Jon Hartzell, KWR International. Coming back to productivity, you talk a little bit already about the implications of a higher, consistent growth in productivity. Part of the exuberance back in the late '90s was everybody's feeling that something was happening. And it was interesting to see Greenspan gradually let himself be persuaded, presumably on evidence, that that was happening. But do you think these larger levels of productivity growth are sustainable? What were the sources of those? What is the source of it? And is it going to continue?

JS: Yes. I think that the new economy was hyped. It was exaggerated. But it was real. There were real changes going on. Any of us who know the Internet, you know, know how it changed the way we do business. As an aside, an important point that I emphasize is that, you know, the Internet was based on research funded by the U.S. Government.

And that we, in the '90s, were benefiting from research that was done in the '70s and '80s. And one of my criticisms is that we didn't, during the '90s, invest in as much technology and underlying basic science as we should have, that are going to feed the innovations that are going to lead to productivity in ten or 20 years. And that, I think, is a real problem, that we really do need to invest more in our basic science.

I can't tell you exactly, you know, what the numbers are going to be, whether it's going to be productivity increases, three, four, or five percent on a sustained basis. But I see no reason why we won't have a significantly higher productivity than we had in the period from '73 to '93, where productivity went down to about 1.1 percent. I think there's every reason to believe it will continue at a much higher pace than in the past.

Then one final comment. Some of what is going on in the numbers today, people are saying, "Oh, isn't this amazing, this productivity, even in a recession." I think those numbers, I think one has to look with a little bit more circumspection. Historically, when economies enterprise into a recession, productivity went down. Because of the phenomena that economists refer to as "labor hoarding."

There in an agreement between workers and their firm that, "I won't fire you the minute you're not needed, that I'll keep you on when times are bad, and you stick with me when times are good." I mean, it sort of a bond between workers and their firms. And that meant that when you went into recession, you keep on more workers than you absolutely needed.

And the result, of course, was that product declined. Not because innovation was disappearing, but because you kept on unneeded workers. One of the things that's happened in the mentality, I think, in the '90s, is we move much more towards in the short run, bottom line economics, myopia, drill of the day. And that's one of the themes in the book, that myopia is, we are focused on deficits. We didn't focus on long run investment in science.

Here, we focus on how we save a dollar today by firing a worker. But in the long run, they're a valuable asset. And we're going to have to retrain these people. And it's going to be taking away from profitability in the future. So some of what you're seeing today in the productivity in the recession is the flip side of the increase layoffs and firings because of this ruthless bottom line mentality.

RK: Well, I'm going to have to disappoint you, because we have the absolutely requirement that we increase everyone's productivity by ending it. Thank you all for coming. And thank you Joe. (Applause)

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When the United States has succeeded in the world, it has done so by changing course—usually amid deep controversy and uncertainty....