Joseph Stiglitz: You Ask The Questions

This whole crisis has been caused by a bankers' bonus system which rewards them for risky purchases. Should they be capped?

Connie Seltzer

Gillingham

The system of compensation almost surely contributed in an important way to the crisis. It was designed to encourage risk taking – but it encouraged excessive risk taking. In effect, it paid them to gamble. When things turned out well, they walked away with huge bonuses. When things turn out badly – as now – they do not share in the losses. Even if they lose their jobs, they walk away with large sums.

The solution is not so much to cap the bonuses, but to make sure that they share the losses as well as the gains – for instance, holding the bonuses in escrow for 10 years; if there are losses in the second or third or fourth years, the bonuses would be reduced appropriately.

What are the implications of recent economic developments for the teaching of economics?

John Baxter

London N1

The idea that markets are "self adjusting," that free, unfettered markets lead as if by an invisible hand to the well being of all, has been repeatedly refuted (the Great Depression was the most telling refutation). But it is a lesson that has to be learnt over and over again.

The challenge is to get the right balance between markets and government, to get the right form of regulation that allows for innovation – but not the kind of financial innovation that we have just seen. Instruments that were supposed to reduce risk actually increased it.

The credit crunch was caused because banks were buying securities they didn't fully understand. Isn't it time these CLOs, SIVs etc were regulated?

John Fortisque

Cambridge

The regulators were clearly not doing what they should have been doing; and the regulations themselves have not kept pace with innovations in financial markets.

Financial markets were very sophisticated in slicing and dicing risk, but bad at assessing risk. They did not understand the nature of systemic risk, underestimated the correlations, underestimated the likelihood of "small probability events" (once in a hundred year events seem to happen every decade), and did not understand how securitisation increased problems of information asymmetries, distorted incentives, and made the problems of resolving bad debts more difficult.

Is this really the worst financial crisis since the Second World War? And is it largely as a result of the Iraq war?

Mohin Khan

by email

The Iraq war had a very negative effect on the economy. The Fed offset the effects through a flood of liquidity and lax regulation. But this simply postponed the problems. Low interest rates and lax regulation led to a housing bubble and a consumption boom. Savings rates plummeted to zero. The situation was unsustainable. It was only a matter of time before a day of reckoning came.

The only similar post -Second World War crisis was the 1991 recession, which involved the Savings and Loan institutions, a small part of America's financial system. This crisis involves all of the main players.

With the City, which creates half our GDP, about to go into mortal shock, what economic strategy would you advise the UK to take?

B Thornton

by email

Unfortunately, monetary policy can only go so far. What is needed is a bigger dose of fiscal policy, to prevent the economy going into a tailspin.

While charges for energy, taxes and council rates are all increasing, we are told the inflation is a low 2.5 per cent. How can that be?

Richard Haynes

by email

Inflation rates are an average – some prices may go up while others fall. The averages are based on the expenditure patterns of a typical household. That means that for many households, the "average" inflation rate underestimates the impact of rising prices.

Can you please explain the reasons for the continual slow decline of the pound against the euro?

TIm Cassidy

by email

Many factors go into determining exchange rates – differences in interest rates, views about the future of the economy, expectations about inflation. Predicting exchange rate movements – or even explaining past movements – is one of the areas in which economic science has the most difficulty.

Capital flows have been heading out of poor countries and funding consumption in rich countries. How can this quirk of economics be reversed?

William George

Plymouth

An enormous amount of money has been flowing the wrong way – it's almost as if water were flowing upstream. Several factors have contributed to the problem. The most important perhaps is America's reckless macro-economic policies. Household saving is now zero, and the government is likely to run an all-time-record deficit this year. So money is flowing from all over the world – including from poor countries – into the US.

Eventually, the situation will probably get reversed – but the unwinding of these imbalances is likely to be disorderly.

The most important reform that would prevent a potential disaster and reverse the current situation is a new global reserve system. Currently, countries hold dollars as backing for their country and currency. But the dollar reserve system is fraying.

Does aid do more harm than good in Africa?

Linda Raymon-Smith

by email

Aid has played an important role in helping Africa. In the past, some of the structural adjustment loans (part of IMF and World Bank assistance) demanded policy changes that were counterproductive. An argument could be made that these loans did as much harm as good. But, for the most part, aid has been reformed for the better.

Aid is only part of the story. African countries need better access to Western markets; there are still big trade barriers.

Are fair trade products a solution to poverty, or just a form of charity?

Daniel Hernandez

by email

Fair trade products can help. In many cases, a great deal of effort has been put into ensuring that workers have better conditions, that the children of workers have access to education and health care, and that more money goes into the hands of those who work in the fields. But this, like aid, is only part of the story. We need to eliminate trade barriers, we need to help workers increase their productivity.

You are a big critic of the World Bank. Do you think it is now moving in the right direction?

Francis Odonga

London

In some cases, it seems as if it takes two steps forward, one step backward. There were marked improvements under president James Wolfensohn, but big reversals under Paul Wolfowitz.

Which country will be the world's economic superpower in 50 years?

Hal Rogers

by email

Economic power will be more widely distributed among countries in 50 years. The gap between China and the US, for instance, will be greatly narrowed.

If you count factors such as the increased cost of oil in the Iraq war, shouldn't you also include the money saved from Saddam's poor running of Iraq's economy?

Donal O'Hara

Dublin

We focused our estimates ($3trillion [£1.5trn], in our book, The Three Trillion Dollar War) on the US. The costs to the rest of world probably double that. We did take into account the savings – in the case of the US, the fact that we did not have to spend money to enforce the no-fly zone.

As bad as Saddam was for the Iraqi economy (compounded by sanctions), things have been worse since his fall. Electric supply is still below the level before the war. Because there is less access to clean water, parts of the country face the worst outbreak of cholera in Asia in recent years. Unemployment remains at 25 per cent. Half of the doctors have been killed or have fled the country. There are four million refugees.

Surely the cost of Iraq depends on the timescale you look at. If Iraq becomes a peaceful country in 30 years,won't $3trn look cheap?

John Thomas

Bedford

$3trn is a lot of money, no matter how you look at it: enough to at least make a dent in many of America's most important problems. For a fraction of the cost of the Iraq war, we could have put the social security programme on sound financial footing for the next 50 to 75 years. For a few days' fighting, we could have provided health insurance for America's children, which the President said we could not afford.

Isn't it damaging for an economist to have such an obvious political bias?

Shane Kay

Hove

We were upfront in our book about our position on the war, and we made conservative estimates in tallying the war's costs. We assumed, for instance, that the war was responsible for only $5 to $10 of the $85 increase in the price of oil, and that the price would remain above the pre-war level for only seven to eight years. Almost surely, the impact of the war on the price of oil was greater and will be longer lived.

Should Afghanistan's poppy fields be destroyed, even though this would mean the collapse of its economy and huge resentment against the US?

Sarah Harris

Luton

The increase in the production of drugs is one of the many manifestations of how badly things have gone in Afghanistan – with global consequences. One of the reasons for this is that attention was shifted from Afghanistan to Iraq. Now we have two failed wars.

The strategy of destroying poppy fields (or other drugs) has typically not worked well – production is quickly restored, or just shifts elsewhere. It would be better to try to provide alternative sources of income. In Latin America, for instance, some of the areas where drugs are grown might grow sugar – but the US will not buy the sugar. In spite of all of its free trade rhetoric, it imposes quotas on sugar.

Africa, the World Bank, and now Iraq. Will you take on the cost of climate change next please?

Y Shazir

by email

You are right – climate change is one of the most pressing problems facing the world today. We know what needs to be done. One of the difficulties in making progress is figuring out how to share the burden of saving the planet between developed and developing countries.

Could the US economy benefit from investing in green technology that would reduce reliance on fossil fuels?

Amalio Escobar

Arlington, VA

Very much so, and in many ways. The world would benefit from lower greenhouse gases. The lower demand for oil would lower oil prices – and help the US economy. There will be a huge demand for these new technologies, and if America pioneers them, America will have a competitive advantage in spreading them around the world.

Apart from yourself, which writers would you advise me to read in order to survive these uncertain times?

Gordon Mutch

Surrey

Paul Krugman (New York Times) and Martin Wolf and John Kay (Financial Times) are among the best economic columnists. Their articles are accessible and thoughtful – which means I usually agree with what they say.

Has George Bush been the worst-ever US President?

David Willis

by email

In a recent issue of Vanity Fair I debate whether Herbert Hoover or George Bush is the worst president for economic leadership. By the time I conclude the article, it is fairly clear that George Bush wins.

Who would you like to see next in the White House?

Ed Tucker, Manchester

Someone committed to getting us out of Iraq, someone committed to democratic multilateralism, someone committed to doing something about global warming, someone willing to do something about the problem of growing inequality in America, willing to fix our health care system, and smart enough to know what to do to fix our ailing economy – or at least listen to advice from those who do know what to do.

The Three Trillion Dollar War: The True Cost of the Iraq Conflict by Joseph Stiglitz and Linda Bilmes is published by Penguin, £20.

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