Nobel Prize Laureate Joseph E. Stiglitz has written a timely and passionate critique of American-style capitalism in an age of profound discontent over the way in which capitalism has been hijacked by economic elites he describes as ‘free-market fundamentalists’ for their own selfish gain at the expense of the American and world economies. What he describes is been the triumph of ideology over experience and fundamental fairness. That ideological triumphalism is also, the expense of democratic politics and good and effective governance.
In reviewing this excellent book, I need not go into the train of abuses of economic power that parallels the complaint of the American founding fathers in their indictment of King George III of Great Britain in 1776. What is particularly troubling is that the mantra of free-market economics, while making a tiny fraction of the world’s population and enormously wealthy and politically influential, has precipitated economic calamity on a global scale, and has put national and global economies on the brink of destruction twice since the beginning of the 21st century. The economic catastrophe that now faces the American and world economy consequential to the COVID 19 pandemic is directly related to the economic, social, and political policies of the Trump Administration on multiple levels of fecklessness, ignorance, sheer recklessness, racial bigotry, and narrowly focused partisan electoral policies and practices.
Instead, I want to focus on something that is implicit in Professor Stiglitz’s argument, but which he does not deal with directly, and that is that the world economy, of which the American economy is a vitally important constituent part, and in which it has played a role as first among equals, is a complex, fragile system in which scaling and time, and the ways they interact, matter immensely.
Before 1981, the American people and its government lived with the memories and consequences of the Great Depression of the 1930s, and the legal and structural changes that were incorporated into the American social, economic, and legal fabric to prevent the catastrophic dislocations that occurred during those years from reoccurring. Three generations later, America was a different place, with much of the economic pain and dislocation of those early years replaced by a postwar world in which the United States was the preeminent superpower, but still locked in fierce competition with a Eurasian bloc represented by Russia and its postwar satellites comprising the former Soviet Union, and China. Beginning in 1974, China and the United States had commenced a long-term economic relationship in which the United States had exploited its preeminent economic power to conclude a bilateral trade relationship with the Beijing regime that served to immensely benefit American business and financial corporations looking to transfer their manufacturing operations offshore, thereby diminishing the size, cost, and political influence of their manufacturing employee workforce.
At the same time, China became the U.S. Government’s principal creditor by purchasing long-term U.S. Treasury notes, enabling successive American administrations to finance extensive overseas military operations without having to raise additional tax revenues from American taxpayers and corporations. Republican administrations in particular were anxious to project American military power overseas; first, with the military buildup against an economically decadent Soviet Union, which led to the breakdown and ultimate dissolution of the Soviet bloc in 1989; second, there was the short, and successful Gulf War of 1991, when Iraq, under its dictator, Saddam Hussein, invaded Kuwait; following that came the Civil War in Syria that served to disrupt the entire Middle East as Al Qaeda, Russia, Iran, and Saudi Arabia competed for influence; all of which culminated in the Saudi-inspired attack on the World Trade Center in New York in 2001. The Bush administration’s precipitous and ill-advised attack on Iraq plunged the United States into another two decades of inconclusive war, which further served to deteriorate the American economy. Compounding that was the 2008 financial collapse that wiped out hundreds of thousands of jobs, and the financial hopes of millions.
The Democratic Obama Administration’s response to that financial collapse saved the world economy, but it lost its reputation when it failed to extract retribution against the financial chieftains and CEOs in the business community that had allowed it to happen. Financial success coupled with political failure. There was no one in the Obama Administration willing to recognize, and act upon, the idea that punishing the most egregious of the bad actors in the financial services and banking industry was not only politically popular, it could be fatal for democratic government to NOT exact some form of serious retribution against those who caused the hardship.
But that did happen. The Obama Administration chose to act like an insurance adjuster rather than as a prosecutor seeking to redress the balance of the scales of justice. President Obama forgot that it is possible to win a war, and yet lose the peace. And, ultimately that happened. The financial disaster had been contained by 2012 so that Barack Obama was able to win a second term as president, putting into effect a national healthcare system now known as ObamaCare, but without addressing the festering ill will of America’s traditional white working class toward those they saw as having passed them by. These were the people who had traditionally suffered when good times ended; now, new and better jobs went to college graduates, or who were able to migrate to the large urban employment centers in California, Washington State, Texas, Colorado, and elsewhere. All of this had happened before, beginning in the 1890s when homesteaders began to realize that they could not compete against Eastern bankers, railroad corporations, and business combinations that sucked the Farm Belt dry of money and credit. But this was the 21st century in which banking and telecommunications were all interconnected, and everything was out in the open, except how to explain why we got this way. The silence of Progressives, and their lack of awareness earned them no friends, and offered unlimited opportunities to their enemies. How we bring those lost souls back into the American fold while retaining our own self-respect is going to take tact, and firmness as to the consequences of willful misbehavior. Likewise, those who abuse their power must be punished.
In 2008 and 2009, the Treasury decided as a matter of policy that it would repurchase all holders of dollar-denominated securities that had been purchased through the Wall Street-City of London financial Consortium. True, the Treasury recouped money advanced, making a modest profit, but that profit was small change when measured against the damage that was done to the American economy, and most particularly the sectors of the American economy that were most vulnerable. Millions of American homeowners (including those who had received ‘liar loans’) lost their homes to foreclosure; millions of others lost their jobs; entire communities saw themselves transformed into economic wasteland. Much of this occurred in the American rural heartland, and in the South.
No one in the Treasury insisted that the financial services community leadership suffer in any way for the damage they caused; and neither did the President. None of the banking chieftains lost their jobs or their perquisites; and that failure of nerve on the part of the government has come back to haunt us time and again.
The ongoing COVID 19 pandemic is a stark reminder that complexity and interconnectedness come at a cost; the full extent will not be known for several years. Professor Stiglitz has proposed a catalog of remedial measures that he says will help address the balance that has been lost over recent decades. Maybe so; but it is also evident that the fundamental notions about managing economic activity are in desperate need of updating. What concerns me is economic orthodoxy is now properly described as a branch of metaphysics. The standard model of economic activity and markets has heretofore been linear, with activity moving along a continuum, with succeeding events occupying a cause-and-effect relationship to one another. That notion of linearity is no longer sustainable, for the simple reason that complexity has overtaken linearity in the control of our commerce, the world economy, and the ways in which we live and do business.
What began in the study of the life sciences, specifically biophysics and biochemistry, has been applied to the ways in which people live and behave. The world we live in has been infused top to bottom with complexity, comprising elements of diversity, scale, concavity and convexity, network modeling, entropy, and more recently, impacts of contagion. As of this moment, national economies around the world have been paused, and numerous of them crippled, by the effects of the COVID 19 pandemic. In standard economic theory, none of these matters a whit because classical physics and its mathematical underpinnings cannot account for them. Instead of simple mathematical formulae, so-called ‘Black Swan’ events grounded in the mathematics of power laws become significant, not because they are predictably rare, but because they defy the notion of predictability itself.
Complex systems are defined by their interdependencies – hard to detect – and their non-linear responses to events (Taleb, Anti-fragile: Things That Gain from Disorder; Prologue (paperback ed., 2014, page 7). It follows that extreme complexities generate extreme interdependencies, which themselves generate nonlinear outcomes and emergent behaviors that are themselves disorderly and disruptive to societal institutions and the protocols by which they operate. Turbulence and volatility (Mandelbaum & Hudson, The (mis)Behavior of Markets (2004, 2008) push institutions beyond their collective capacities to predict or to respond effectively to events, and the increasing velocity of those events occurring, such as computer-controlled markets, have made them increasingly unstable.
Into this volatile mix we see venture capitalists and entrepreneurs insisting on their rights to do as they please, because historically they were able to do so with the tacit approval of political and legal . The 2008 economic meltdown (Tooze, Crashed: How a Decade of Financial Crises Changed the World (2018) shows just how close we had come to destroying the world economy.
Stiglitz is not saying to his fellow economists that we all need better modeling in order to capture the essence of what is going on around us. Economists, and those that ape them (viz. the Laffer Curve), are forever touting their own mathematical models in support of their pet theories, especially those who are devoted followers of untrammeled growth. But whatever they do, they must be known by their consequences.
It has become increasingly apparent that in economic matters, matters of scale account for far more than is usually acknowledged. Geoffrey West, author of Scale: The Universal Laws of Growth, Innovation, Sustainability, and the Pace of Life in Organisms, Cities, Economies, and Companies (2017), postulates that social and economic entities are subject to the same mathematical laws regarding size, scale, and lifespans, as those in the living world from the smallest biological organisms to the largest living things. These mathematical laws apply not only to size, weight, and lifespans, but also to the length of time they can remain viable.
West does not discuss the lengths of time that business relationships may remain viable, but social/transactional relationships in the form of joint ventures, limited partnerships, special purpose entities, and the like are forever rising to the surface like bubbles in a simmering pot of broth. By nature, and design, these are special purpose entities designed to exist only for as long as it takes to consummate a single transaction, after which the entity dissolves, and the constituent parties go their own way. The lack of permanence itself and the ever-shifting array of alliances among the participants serves to emphasize the anomie towards one another. These groupings of self-interested individuals cannot be properly described in sociological terms as having any social sense or loyalties other to themselves, and their closest analogy to the natural world might be a school of sharks on a feeding frenzy where the market mechanism itself is simply a killing ground.
Where there is risk, along with the possibility of an enormous reward, the likelihood of something going sideways is palpable and ever present. Backstabbing and betrayal are the norm; so that it is in everyone’s interest to keep business relationships short, limited to people one knows, and tightly circumscribed. The comparison between these groups and criminal gangs is that they are functionally indistinguishable, with the only objective to separate the suckers from their money. Consequently, the social networks that these individuals inhabit exhibit self-similar, fractal-like behaviors, where scalability of the social environment might top out at 3 levels of magnitude or less, depending upon personal histories and levels of confidence. Larger social networks translate into a wider array of actionable intelligence; but the flipside of that is the risk of being exposed to double-dealing or outright betrayal. Elevate those behaviors into international markets, and one sees clear examples of that behavior in President Trump’s personal lawyer Rudolph Giuliani and his Ukrainian business associates. But for our purposes, the risk is that these entities cannot be adequately regulated, and they put too much else at risk.
Even when business arrangements are ostensibly honest and aboveboard, large and diverse business organizations, perhaps scattered over several continents, present seemingly insurmountable problems of organizational management and accountability. All it takes is a single individual who is permitted to place outsize bets under circumstances where there is a failure of supervisory oversight. In 2012, a high risk/low frequency sequence of events occurred in the London office of J.P. Morgan’s Chief Investment Office in the person of one Bruno Iksil, an employee whose job it was investments using bank funds that at the time were surplus to J.P. Morgan’s investment needs, what were useful as investments to protect the bank against losses and interest rate risk by using those investments as a hedge to offset the bank’s other credit risks. Iksil acquired the nickname “London Whale” on the strength of his habit of taking enormous financial risks, theretofore successful, except for the last. Iksil’s big bets had paid off handsomely in previous years. In 2009 alone, his office generated $1.05 billion for J.P. Morgan. Iksil’s luck ran out in 2011, when his office was racking up daily losses to the tune of hundreds of millions of dollars by investing in synthetic derivatives (i.e. Credit Default Swaps, or CDS) which were essentially insurance policies protecting 125 companies against default on their own obligations, and the bet was that those companies would enjoy improved credit ratings, and J.P. Morgan would never be called upon to make good on its financial commitments. These were the same toxic financial instruments that sank AIG during the 2008 financial crisis. When news got out about the London Whale’s trades in May 2012, Morgan’s capitalization suffered a loss of $14.4 billion; by the end of the month Morgan’s synthetic derivatives portfolio alone had lost $2 billion, eventually topping $6.2 billion by the end of the year.
Iksil’s managers within J.P. Morgan compounded the problem by attempting to hide the loss from public knowledge. That ploy failed spectacularly; the entire sordid story played out in a Senate hearing, ultimately costing J.P. Morgan’s CEO Jamie Dimon a sizable fraction of his year-end bonus. More importantly, the outsize loss (both in J.P. Morgan share values, and out-of-pocket transactional losses) exceeded $22 billion. More importantly, it strengthened the call for tightened regulation, specifically the Volcker Rule, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act that bans high-risk trading inside commercial banking and lending institutions.
Within these hierarchical formations, meaningful work is accomplished; but requiring close and continuous attention to all levels of detail. When supervision is lax, bad things happen. In mathematical terms, risk goes up according to a logarithmic scale, often referred to as a power law. In statistical parlance, these are known as ‘long tail’ events. From a probabilistic standpoint, the ‘long tail’ stretching out to the right of the median signifies that the predictability of some event happening diminishes with the length of the tail; but positive feedbacks associated with those long-tailed distributions are what compound interest is to bank loans. Cumulative additive impacts act as force/clustering multipliers. Mathematical models that produce power laws include the ‘preferential attachments’, as probability of joining an existing group is proportional to the size of that entity, and is exemplified by the notion that ‘like attracts like’. Thus, books sold on Amazon become bigger bestsellers because they are bestsellers.
Capitalism is value neutral; but it is a force multiplier. Like the Laws of Thermodynamics, capitalism extracts energy from fuel sources in the ambient universe surrounding the system. Some of that energy is converted to useful work (i.e., resource extraction; trade; manufacturing and marketing). The remainder of that energy is dissipated as externalities or consequences. But, in order to perform useful work, energy must be isolated and canalized; and unwelcome externalities must be eliminated or minimized. The 19th century model for extracting and utilizing energy was the steam engine. The mechanics of steam locomotion needed to obey natural physical laws in order to succeed. Insufficient containment of steam pressure lead to explosions that kill people and destroy property. Locomotive fireboxes and smokestacks needed to be equipped with spark arresters in order to minimize wildfires along railroad rights-of-way. In sum, to remain useful, energy engines needed to be modulated. In the modern age, nuclear reactors need to be modulated to reduce their potential for meltdown and explosion. So, it is with capitalism; but capitalism is behavioral, meaning that the actors respond to the rules of logic and positive law. Nonetheless, the energy released by capitalism must be modulated and canalized in order to optimize productive work without blowing up the human society that creates it. In today's world the rules by which capitalism operates have shown themselves to be insufficient counterweights to the unwanted energy that is released, and from which destructive consequences follow. That needs to change.
The upshot is that even if Donald Trump is ousted from the presidency in the upcoming presidential election, a dysfunctional banking and financial system that fails to impose accountability on its constituent parts cannot and will not reform itself. The mantra has been ‘Too big to fail; too big to jail’. What about simply, too big to manage; that which is too big to manage is unsustainable. And it is dangerous.
Top reviews from the United States
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Arthur R. Silen
Everything Stiglitz says is true, but he ignores fundamental problems of scale and complexity
Reviewed in the United States on April 22, 2020
David Lindsay
Stiglitz argues that we need to become more like Sweden
Reviewed in the United States on June 29, 2019Top reviews from other countries
Tushar khosla
In pursuit of Decent Middle-class life for All (Americans)
Reviewed in India on June 23, 2019
Ian Hassall author of Hamba Gashle
Informative
Reviewed in the United Kingdom on December 9, 2019
Ian Hassall author of Hamba Gashle
Reviewed in the United Kingdom on December 9, 2019
A good read, not at all heavy perhaps a little repetitious and wordy.
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Dan
Another special from Prof Stiglitz.
Reviewed in the United Kingdom on November 7, 2022