A Loss of Faith

By Joseph E. Stiglitz ’64


In the United States, calling someone a socialist may be nothing more than a cheap shot. Fanatics of the Right have tried to tar Obama with the label, even as the Left criticizes him for his excessive moderation. In much of the world, however, the battle between capitalism and socialism—or at least something that many Americans would label as socialism—still rages. In most of the world, there is a consensus that government should play a larger role than it does in the United States. While there may be no winners in the current economic crisis, there are losers, and among the big losers is American-style capitalism, which has lost a great deal of support. The consequences in shaping global economic and political debates may be felt for a long time to come.

The fall of the Berlin Wall in 1989 marked the end of communism as a viable idea. The problems with communism had been manifest for decades, but after 1989 it was hard for anyone to say a word in its defense. For a while, it seemed that the defeat of communism meant the sure victory of capitalism, particularly in its American form. Francis Fukuyama, in the early 1990s, went so far as to proclaim “the end of history,” defining democratic market capitalism to be the final stage of societal development and declaring that all humanity was now heading inevitably in this direction. In truth, historians will mark the 20 years since 1989 as the short period of American triumphalism.

Sept. 15, 2008*, the date that Lehman Brothers collapsed, may be to market fundamentalism (the notion that unfettered markets, all by themselves, can ensure economic prosperity and growth) what the fall of the Berlin Wall was to communism. The problems with the ideology were known before that date, but after, no one could really defend it. With the collapse of great banks and financial houses and the ensuing economic turmoil and chaotic attempts at rescue, the period of American triumphalism is over. So too is the debate over market fundamentalism. Today only the deluded (which includes many American conservatives, but far fewer in the developing world) would argue that markets are self-correcting and that society can rely on the self-interested behavior of market participants to ensure that everything works honestly and properly—let alone works in a way that benefits all.

The economic debate takes on particular potency in the developing world. Although we in the West tend to forget, 190 years ago almost 60 percent of the world’s GDP was in Asia. But then, rather suddenly, colonial exploitation and unfair trade agreements, combined with a technological revolution in Europe and America, left the developing countries far behind, to the point where, by 1950, Asian economies constituted less than 18 percent of the world’s GDP. In the mid-19th century the United Kingdom and France actually waged a war to ensure that China remained “open” to global trade. This was the Opium War, so named because it was fought to ensure that China didn’t close its doors to the West’s opium: the West had little of value to sell to China other than drugs, which it wanted to be able to dump into Chinese markets, with the collateral effect of causing widespread addiction. It was an early attempt by the West to correct a balance-of-payments problem.

Colonialism left a mixed legacy in the developing world, but one clear result was the view among the people there that they had been cruelly exploited. Among many emerging leaders, Marxist theory provided an interpretation of their experience; it suggested that exploitation was in fact the underpinning of the capitalist system. The political independence that came to scores of colonies after World War II did not put an end to economic colonialism. In some regions, such as Africa, the exploitation—the extraction of natural resources and the rape of the environment, all in return for a pittance—was obvious. Elsewhere it was more subtle. In many parts of the world, global institutions such as the International Monetary Fund and the World Bank came to be seen as instruments of postcolonial control. These institutions pushed market fundamentalism (“neo-liberalism,” it was often called), a notion Americans idealized as “free and unfettered markets.” They pressed for financial-sector deregulation, privatization and trade liberalization.

The World Bank and the IMF said they were doing all this for the benefit of the developing world. They were backed up by teams of free-market economists, many from that cathedral of free-market economics, the University of Chicago. In the end, the programs of the “Chicago boys” didn’t bring the promised results. Incomes stagnated. Where there was growth, the wealth went to those at the top. Economic crises in individual countries became ever more frequent—there have been more than 100 in the past 30 years alone.

Not surprisingly, people in developing countries became less and less convinced that Western help was motivated by altruism. They suspected that the free-market rhetoric—the “Washington consensus,” as it is known in shorthand—was just a cover for the old commercial interests. The West’s own hypocrisy reinforced the suspicions. Europe and America didn’t open up their own markets to the agricultural produce of the Third World, which was often all these poor countries had to offer; instead, they forced developing countries to eliminate subsides aimed at creating new industries, even as they provided massive subsidies to their own farmers.

Free-market ideology turned out to be an excuse for new forms of exploitation. “Privatization” meant that foreigners could buy mines and oil fields in developing countries at low prices. It also meant they could reap large profits from monopolies and quasi-monopolies, such as in telecommunications. “Financial and capital market liberalization” meant that foreign banks could get high returns on their loans, and when loans went bad, the IMF forced the socialization of the losses, meaning that the screws were put on entire populations to pay the foreign banks back. Then, at least in East Asia after the 1997 crisis, some of the same foreign banks made further profits in the fire sales that the IMF forced on the countries that needed their money. Trade liberalization meant, too, that foreign firms could wipe out nascent industries, suppressing the development of entrepreneurial talent. While capital flowed freely, labor did not—except in the case of the most talented individuals, many of whom found good jobs in the global marketplace.

Of course, there were exceptions. There were always those in Asia who resisted the Washington consensus. They put restrictions on capital flows. The large giants in Asia—China and India—managed their economies in their own way, producing unprecedented growth. But elsewhere, and especially in the countries where the World Bank and IMF held sway, things did not go well.

And everywhere, the debate over ideas continued. Even in countries that have done very well, there is a conviction among the educated and the influential that the rules of the game have not been fair. They believe that they have done well despite the unfair rules, and they sympathize with their weaker friends in the developing world who have not done well at all.

For the critics of American-style capitalism in the Third World, the way that America has responded to the current economic crisis has smacked of a double standard. During the East Asian crisis, just a decade ago, America and the IMF demanded that the affected countries reduce their governments’ deficits by cutting back expenditures—even if, as in Thailand, this resulted in a resurgence of the AIDS epidemic, or even if, as in Indonesia, this meant curtailing food subsidies to the starving, or even if, as in Pakistan, the shortage of public schools led parents to send their children to the madrassas, where they would become indoctrinated in Islamic fundamentalism. America and the IMF forced countries to raise interest rates, in some cases (such as Indonesia) to more than 50 percent. They lectured Indonesia about being tough on its banks and demanded that the government not bail them out. What a terrible precedent this would set, they said, and what a terrible intervention into the smooth-running mechanisms of the free market.

The contrast between the handling of the East Asian crisis and the American crisis is stark and has not gone unnoticed. To pull itself out of the hole, the United States engaged in massive increases in spending and ran up massive deficits, even as interest rates were brought down to zero. Banks were bailed out left and right. Some of the same officials in Washington who dealt with the East Asian crisis are managing the response to the American implosion. Why, people in the Third World ask, is the United States administering different medicine to itself?

It was not just a matter of a double standard. Because the developed countries consistently follow countercyclical monetary and fiscal policies (as they did in this crisis), but developing countries are forced to follow pro-cyclical policies (cutting expenditures, raising taxes and interest rates), fluctuations in developing countries are larger than they otherwise would be, while those in developed countries are smaller. This raises the cost of capital to the developing countries relative to the facing developed countries, increasing the latter’s advantage over the former.

Many in the developing world still smart from the hectoring they received for so many years: adopt American institutions, follow American policies, engage in deregulation, open up markets to American banks so they could learn “good” banking practices and—not coincidentally—sell their firms and banks to Americans, especially at fire sale prices during crises. They were told that it would be painful, but in the end, they were promised, they would be better for it. America sent its treasury secretaries (from both parties) around the planet to spread the gospel. In the eyes of many throughout the developing world, the revolving door, which allows American financial leaders to move seamlessly from Wall Street to Washington and back to Wall Street, gave them even more credibility, for these men seemed to be able to combine the power of money and the power of politics. American financial leaders were correct in believing that what was good for America or the world was good for financial markets; but they were incorrect in thinking the converse, that what was good for Wall Street was good for America and the world.

It is not so much schadenfreude that motivates the intense scrutiny by developing countries of America’s economic system. Instead, it is a real need to understand what kind of an economic system can work for them in the future. Indeed, these countries have every interest in seeing a quick American recovery. They know firsthand that the global fallout from America’s downturn is enormous. And many are increasingly convinced that the free and unfettered market ideals America seems to hold are ideals to run from rather than embrace.

Even advocates of free-market economics now realize that some regulation is desirable. But the role of government goes beyond regulation—as a few countries are beginning to realize. For example, Trinidad has taken to heart the lesson that risk must be managed and that the government has to take a more active role in education—they know they can’t reshape the global economy, but they can help their citizens deal with the risks it presents. Even primary-school children are being taught the principles of risk, the elements of homeownership, the dangers of predatory lending and the details of mortgages. In Brazil, homeownership is being promoted through a public agency, which ensures that individuals take out mortgages that are well within their ability to manage.

In the end, why should we Americans care that the world has become disillusioned with the American model of capitalism? The ideology that we promoted has been tarnished, sure, but perhaps it is a good thing that it may be tarnished beyond repair. Can’t we survive—even thrive—if not everyone adheres to the American way? Inevitably, our influence will be diminished, as we have not been a reliable role model, but that, in many ways, was already happening. We used to play a pivotal role in managing global capital because others believed that we had a special talent for managing risk and allocating financial resources. No one thinks that now, and Asia—where much of the world’s saving occurs today—is already developing its own financial centers. We are no longer the world’s chief source of capital. The world’s top three banks are now Chinese; America’s largest bank is down at the number-five spot.

Meanwhile, the cost of dealing with the crisis is crowding out other needs, not only those at home but also those abroad. In recent years China’s infrastructure investment in Africa has been greater than that of the World Bank and the African Development Bank combined, and it dwarfs America’s. Anyone visiting Ethiopia or a host of other countries in the continent can already see the transformation, as new highways join together what had been isolated cities and towns, creating a new economic geography. It is not just in infrastructure that China’s impact is being felt, but in many other aspects of development—for instance, in trade, resource development, enterprise creation and even agriculture. African countries are running to Beijing for assistance in this crisis, not to Washington. And it is not just in Africa that China’s presence is being felt: in Latin America, in Asia, in Australia—anywhere there are commodities or resources—China’s rapid growth provides an insatiable appetite. Before the crisis, it had contributed to growth in exports and export prices, which had led to unprecedented growth in Africa and many other countries. After the crisis, it is likely to do so once again—indeed, many were already reaping the benefits of China’s strong growth in 2009.

My concern here is more with the realm of ideas. I worry that as many in the developing world see more clearly the flaws in America’s economic and social system, they will draw the wrong conclusions. A few will learn the right lessons. They will realize that what is required for success is a regime where the roles of market and government are in balance and where a strong state administers effective regulations. They will realize, too, that the power of special interests must be curbed.

For many other countries, however, the political consequences will be more convoluted, and possibly profoundly tragic. The former communist countries generally turned, after the dismal failure of the postwar system, to capitalism, but some turned to a distorted version of a market economy; they replaced Karl Marx with Milton Friedman as their god. The new religion has not served them well. Many countries may conclude not simply that unfettered capitalism, American-style, has failed, but that the very concept of a market economy itself has failed and is indeed unworkable under any circumstances. Old-style communism won’t be back, but a variety of forms of excessive market intervention will return. And these will fail.

The poor suffered under market fundamentalism. Trickle-down economies didn’t work. But the poor may suffer again if new regimes again get the balance wrong, with excessive intervention in the markets. Such a strategy will not deliver growth, and without growth there cannot be sustainable poverty reduction. There has been no successful economy that has not relied heavily on markets. The consequences for global stability and American security are obvious.
There used to be a sense of shared values between the United States and the American-educated elites around the world, but the economic crisis has now undermined the credibility of these elites, who advocated American-style capitalism. Those who opposed America’s licentious form of capitalism now have ample ammunition to preach a broader anti-market philosophy.

Faith in democracy is another victim. In the developing world people look at Washington and see a system of government that allowed Wall Street to write self-serving rules, which put at risk the entire global economy, and then when the day of reckoning came, Washington turned to those from Wall Street and their cronies to manage the recovery—in ways that gave Wall Street amounts of money that would be beyond the wildest dreams of the most corrupt in the developing world. They see corruption American-style as perhaps more sophisticated—bags of money don’t change hands in dark corners—but just as nefarious. They see continued redistributions of wealth to the top of the pyramid, transparently at the expense of ordinary citizens. They see the institutions that oversaw the growth of the bubble, like the Federal Reserve, being given more power as a reward for its failures of the past. They see, in short, a fundamental problem of political accountability in the American system of democracy. Seeing all this, they take but a short step to conclude that something is very wrong, and perhaps inevitably wrong, with democracy itself.

The U.S. economy will eventually recover, and so too, up to a point, will America’s standing abroad. Like it or not, America’s actions are subject to minute examination. Its successes are emulated. But its failures—especially failures of the kind that led up to this crisis and are so easily mocked as hypocrisy—are looked upon with scorn. Democracy and market forces are essential to a just and prosperous world. But the “victory” of liberal democracy and a balanced market economy are not inevitable. The economic crisis, created largely by America’s (mis)behavior, has been a major blow in the fight for these fundamental values, more damaging than anything a totalitarian regime ever could have done or said.

Winner of the 2001 Nobel Prize for Economics, Joseph E. Stiglitz ’64 teaches at Columbia University and is on the Amherst Board of Trustees. This article is reprinted from his latest book, Free­fall: America, Free Markets, and the Sinking of the World Economy. Copyright © 2010 by Joseph E. Stiglitz. Used with permission of the publisher, W.W. Norton & Company, Inc.

Image by Ken Orvidas

*The original version of this article mistakenly said that the Lehman Brothers collapse took place in 2009. It occurred in 2008.