Why Joseph Stiglitz is wrong on many counts

Joseph Stiglitz, former World Bank economist, economics Nobel prize winner, and a sharp critic of Wall Street, made some unusually strong points during his CD Deshmukh Memorial Lecture yesterday. A lot of it does not make eminent sense in the Indian context.

Even as Reserve Bank of India (RBI) Governor Duvvuri Subbarao called for greater central bank independence in the context of expanded mandates “and their more explicit pursuit of real sector targets such as growth and unemployment,” Stiglitz threw cold water on the idea, reports The Times of India. He said the RBI, with more limited autonomy, had fared much better than those with more autonomy, including the US Fed.

He also expressed serious doubts on the issue of giving corporates banking licences, on the ground of conflicts of interest.

[caption id=“attachment_578319” align=“alignleft” width=“380”]  Stiglitz is surely right when he makes his point about the nexus between the Wall Street buccaneers and the US Fed, but his comments on the RBI’s independence and the evils of corporate banking are a bit off the mark. Reuters[/caption]

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Stiglitz said: “In the (2008) crisis, countries with less independent central banks - China, India, and Brazil - did far, far better than countries with more independent central banks, Europe and the US. There is no such thing as truly independent institutions. All public institutions are accountable, and the only question is to whom.”

This may be a statement of fact, but is this a conclusive reason to say central banks need less autonomy?

Stiglitz says the Lehman crisis exposed the unholy alliance between Wall Street and the Fed. It undermined the credibility of central bankers in general. “Before the crisis, American financial institutions and American regulatory institutions (including the Fed) were often held up as models for others to imitate. The crisis has not only undermined confidence in these institutions, but has also exposed deep institutional flaws. It has shown that one of the central principles advocated by Western central bankers - the desirability of central bank independence - was questionable at best.”

This argument cuts both ways. Independent regulators may, on hindsight, not have made the best decisions, but this does not mean independence should not be valued in a regulator. The thing with independence is that you can also make wrong judgments, and US Fed Chairmen - from Alan Greenspan down to Ben Bernanke - have been shown to have made their fair share of mistakes. Greenspan’s unwillingness to raise interest rates when the housing bubble was building is a case in point. This could have prevented a Lehman-type blowout.

But the question is this: if central bankers did not have the independence, would their judgments have been better? Would a less autonomous Fed, controlled more by politicians, have been more keen on raising interest rates? Just check what P Chidambaram has been shouting about from the rooftops, and there is no basis to think lack of independence is a good thing for central banks.

It is like saying a free press has often chosen the wrong stories to highlight, and so a free press is not needed at all.

Stiglitz’s corollary, that central banks with less autonomy - as in India and China - had better success during the crisis is also not an argument for less independence. China’s is a political command economy, and India does not have capital account convertibility or a huge dependence on international trade - which is what prevented the Lehman crisis from rocking our boat too much. It had very little to do with the RBI’s great regulatory abilities or prescience.

India’s problem is that the central bank has been able to do very little to penalise profligate fiscal policy. The RBI effectively guarantees government borrowing - thus monetising the deficit whenever banks do not subscribe to any loan. An autonomous RBI could have raised the costs for politicians seeking to mess around with huge fiscal deficits, feeding inflationary expectations. Over the last one year, the RBI’s relative meekness made its monetary policy ineffective in the face of gross fiscal waywardness.

Stiglitz’s second point - that corporates should not be allowed to run banks - needs closer examination. Business Standard quotes him thus: “One of the real problems in the financial sector is there are issues of conflict of interest. And, when you have corporates opening their own banks, you are opening up a venue for corporate conflict of interest. If you want to take your own money, that is one thing. If you take depositors’ money, you became a part of public responsibility,” he added.

This writer will not hold any brief for corporates getting into banking, except to say that the antidote to bad governance in private banks is more effective regulation and oversight, not barring them from the business altogether.

On the other hand, Stiglitz has not commented on what really happens in India. Has the lack of corporate ownership prevented big business from hijacking bank funds? How is a Kingfisher able to run up overdues of Rs 8,000 crore from banks without any murmur? Surely, Kingfisher does not own the SBI or other banks that it owes money to? If Mallya had his own bank lending money to a bleeding Kingfisher, the chances are he would have been more careful about letting both his airline and the bank go bust.

On the other hand, even without giving corporates bank licences, groups like Sahara have been running deposit-like schemes, forcing the RBI to clamp down.

But the biggest issue is really the conflict of interest that Stiglitz does not talk about: the government’s large ownership stakes in public sector banks and insurance companies, which are often directed to lend to this lobby or that, this group or that. What about the serious conflicts of interest arising from politically-mandated lending and the systemic issues arising from bad loans, including frequent loan waivers and loan restructuring?

Just because a government can always print more money for bank bailouts does not mean there is no problem is letting public sector banks be run recklessly.

A regulator with greater independence would be asking banks to provide more capital against mandated lending. But the RBI is busy telling banks what they should do, and whom to lend in the name of priority sector and “inclusive banking”.

Stiglitz is surely right when he makes his point about the nexus between the Wall Street buccaneers and the US Fed, but his comments on the RBI’s independence and the evils of corporate banking are a bit off the mark.