IBJ: Where do you think the U.S. economy is headed?
JS: Well, first of all it is in terrible shape, but I don’t think we’re facing a crisis, just a run-of-the-mill recession/depression.
Run of the mill. Really?
I’ve got to be a little facetious about this. But I think we’re going to be grappling with a whole series of problems that will be a drag on the economy for a prolonged period. I’m pretty sure we’re head for a Japanese-style malaise. The major bump is likely to be commercial real estate, and we’re not sure how big it’s going to be. We know it has to be rolled over; we know it’s under water, all those securitized loans, we know they will be much more difficult to roll over than the loans for residential real estate. Japan’s malaise lasted for 20 years. Maybe ours won’t last that long and one of the aspects that would differentiate ours is that Japan had zero labour force growth. If we grow at one percent, it’s equivalent in some sense to the same kind of stagnation. But it’ll be worse because Japan managed to keep their unemployment rate down to about 5 percent. We’ve already lost that battle; we’re already at, depending on how you measure it, ten or 20 percent.
There’s great concern that Greek could default on its debt. Are you worried?
I feel completely confident that they can make their payments but I’m not so confident that the financial markets might not attack another country and cause panic. So, you know, the financial markets can cause panic. So the question is, you know, where are some of the risks ahead? What countries? I’m not willing to say right now.
So many jobs have been permanently eliminated but there is hope that positive employment data will lead a sustained recovery. Can more new jobs be created in light of that?
Well, markets will eventually create more jobs in one way or another. I mean, I do feel somewhat confident of that. The question is how long and what kind of jobs will they be? Flipping hamburgers or the middle class jobs that we’ve had before?
But let me first say that I think the grasping at the positive news of, you know, only 36,000 jobs were lost is a totally wrong way of framing it. That represents the business community and market’s attempt to give an artificial sense of optimism. Because the way that they should have framed it is—we have roughly a 10 million jobs deficit now. We’ve lost 8 million jobs since December 2007. We should have created more than 2 million within the labour force, so we have a 10 million jobs deficit.
If we’re going to get back to normal anytime say before mid-2013, 2012, mid-2012, okay, a long way away, you know, thinking about the election, the next presidential election, we have to create more than half a million jobs a month. So the gap between 36,000 —you know, the gap is over half a million jobs a month. That’s a big turnaround, and no sign that we’re anywhere near that.
So I think we’re far from able to celebrate a turnaround.
Would you feel any better if there was a second stimulus round?
Yeah, we absolutely have to have that. But I don’t think we’ll get it. One of the reasons for my pessimism is the belief that it will be very difficult to get a second round of stimulus through Congress and that means that we will have the negative stimulus of states cutting back because of their shortfall of $200 billion a year in their revenues. When you withdraw stimulus, that’s a negative to the economy. It dampens growth. So we will be withdrawing the stimulus at the beginning, late 2010/2011.
Is trying to cut the deficit a right approach?
No. It’s terribly wrong. Now, the focus on deficit reduction is likely to be counterproductive, even in the short run and almost surely in the long run. In the short run, I say it’s counterproductive because it will lead to a slowing down of the economy lower tax revenues and therefore…you cut, you know, a billion dollars off of spending and the deficit doesn’t go down but your revenues do.
It’s counterproductive in the long run because the things you tend to cut out first are investments, long run spending, and that means growth in the long run is going to be slower. Therefore, lower tax revenues in the long run and the national debt could actually go up. The financial markets have a fantastic record of being short sighted, bad economics, and they are now doing exactly the same thing to the government that they did to themselves. And so, it’s extraordinarily risky for them to be pushing deficit reduction now.
Now, there are things you could do to help stimulate the economy and reduce the deficit or modulate the deficit, you know. And those would be things like changing the structure of taxation and tax, higher capital gains higher, lower taxes on lower-income people. That would encourage spending and you could balance it out in a way that the deficit would be slightly smaller than it otherwise would have been. But those things are not what I hear from Wall Street.
There’s a pretty healthy tradition in the U.S. of socializing debt and privatizing gain. I don’t think it’s worked out very well.
Is there a chance that it could be broken?
Well, in the past it was typically smaller and more hidden. The positive aspect of this particular crisis is that it has been so blatant and so large that people talked about it. People understand that this is not market economics. This is some kind of peculiar corporate capitalism.
Most of the bank bailouts occur in the rest of the world, not in the United States, but they were less visible. I saw them, because I was chief economist at the World Bank and I saw them all the time. But the crisis clearly brought that home and so there’s a lot of demand to do something about it.
On the other hand, the banks are incorrigible and they are doing everything they can to resist changing the rules that would prevent this. You know, the way they frame it is, “You shouldn’t make the rest of us pay for failed banks. So when a failed bank fails, it should pay for its bailout.”
And you start scratching your head. The nature of a failed bank is that it has no resources to pay. So, you know, the question is the financial system as a whole has been subsidized and we can’t tell which one is going to be subsidized, but on average—just like when you drill oil wells, one out of ten is a strike – the argument for that one getting a higher return is that there were nine that failed. You don’t say, “Oh, well you succeeded and therefore, you shouldn’t get any return.” You say, “We have to pay — part of the cost of this system is that you pay for the nine to fail.” And part of the cost of the financial system is that we can’t predict today which of the banks is going to fail. And we’re going to bail it out but the sector has to bear the cost.
With respect to oversight, a motion to take the oversight role over the big banks away from the Fed was just defeated in Congress. Is that a good thing?
Anybody who believes in accountability has to be disappointed because the Fed failed. It failed miserably. And to say the reward for the failure is to be given more power is a peculiar response, especially in the absence of deep reforms in the structure.
The good news, to go back about, you know, how the crisis has some positive affects by exposing the flaws in our system. If we had seen a developing country with a governance structure of its financial system, of its federal bank like the U.S.,we would have said this is unacceptable.
You have people like Tim Geithner, effectively appointed by the heads of AIG, Goldman Sachs, who he then rescues. Now if that’s not a conflict of interest, I don’t know what is.
Now, they will say, “Of course, we behaved badly. We would never, in our role …” And somehow, these bankers, who everywhere always talk about incentives, somehow when it comes to their own behaviour of—their own bad behaviour, seem to—they say “Incentives are good but we won’t talk about adverse incentives for short-sighted behaviour, risk taking or conflicts of interest.”
The revolving door, where the head of Goldman becomes Treasury Secretary and then returns to the private sector is a long-established tradition. Does it serve the nation’s interest?
Well, it’s more complex than just saying it’s a revolving door and that shouldn’t be. The argument that they would give is that managing these complex financial institutions or the system requires expertise and if you don’t have the expertise, you can’t manage it. Well the question is: Is that valid? Is it (private sector) the only source of expertise and are the advantages outweighing the disadvantages?
Well clearly Paulson didn’t show the expertise. I mean, Greenspan didn’t show the expertise. And for a good reason. They are totally taken up with the mindset of those that they’re supposed to be regulating and overseeing. Therefore, they can’t be an effective regulator. So, in fact, what was argued as an advantage I would argue is a disadvantage.
Secondly, there are other experts. Look at people like Elizabeth Warren (Chair of the Congressional Oversight Panel), It’s interesting. Some countries do not allow people from the financial sector to be in the central bank.
What do you say to that?
There’s a lot of merit in that. Other countries say, “Well, at least it has to be counterbalanced by people not from the financial sector” and they have to have somebody from labour because workers are affected. The monopoly of expertise is no longer there and it’s even questionable whether they have the expertise. I mean how do you explain the Fed’s decision to pay 100 cents on the dollar to settle the AIG derivatives case. I have not talked to a single person who believes that was the right decision. They say, “We had no choice.” Now all of the evidence is that they had a choice but whether they did or not, no one puts any credibility in that statement.
What’s the point of trying to regulate markets if a Robert Rubin (former Treasury Secretary) can so easily marginalize someone like Brooksley Born (former chair of the Commodity Futures Trading Commission, who wanted to regulate derivatives trading)?
Well, you know, first of all, in principle, I know in the Clinton administration we were very clearly of the belief that we should not legally, morally try to intervene in the regulatory decisions. We could have legislation to change the regulation but the regulators are independent regulators. So there’s a real question about that kind of intervention being legal … I mean, as I say, not to say that’s a matter of law but we were told not to do it and in other areas, you know, it was really quite a scandal.
And we had always criticized the Bush administration for doing that. Our, you know—and so here was the Clinton administration doing the same thing that the Bush administration was doing.
But the answer to your question is that it leads one to put more reliance on rules-based regulation. So you need a rule that says, “Depository institutions insured by the government cannot issue credit to certain parties, period.” Or “Cannot do it unless you know that they are covering a position.” So you put a burden of proof on to say, “You have to show that this is not a speculative move but one that is covering a bond position that you could not otherwise have handled.”
What’s so disturbing, and this goes back to your question about the Fed, what’s so disturbing is that we haven’t changed the structures and you say, “Well maybe Bernanke learned his lesson.” Maybe he has and in some of the speeches you sort of begin to wonder. You know, obviously, he wouldn’t do exactly what they did before but would they, at the next level, would a different story happen?
In Freefall, you propose a new model of capitalism. Could you describe the model?
Yeah, the thing that I stress is twofold. It is that unfettered capitalism has never worked, even in terms of the narrow objective of efficiency, let alone a broader agenda of social justice. The role of government, and more broadly what I call “collective action”, is not just to restrain bad behaviour but it’s also part of positive agenda.
So, for example, the Internet was financed by government; most of the basic research was financed by government. The first telephone, telegraph line was financed by government. So we underestimate the positive role. Well I don’t think we do. The conservatives underestimate the positive role the government plays as well as the restraining role.
And the system of Bush, Reagan was not capitalism. It’s corporate welfarism or ersatz capitalism but it’s not true capitalism. And it’s inefficient, socially unjust, not dynamic. What I’m calling for is a balance of the roles of the market, government, third-party actors like NGOs and a whole variety of, kinds of institutions.
Thank you very much.