Two overarching themes in this book are the need for a balance between free markets and government intervention and the need for a fundamental change in governance of international agents of globalization. Stiglitz does a great job of showing how important both of these are and what can happen, or has happened, as a result of not meeting these needs. This is a book to be taken seriously and one that should compel its readers to watch more closely the process of globalization as well as the international organizations entrusted to facilitate it.

Balance between Free Markets and Government Intervention

“I tried to forge an economic policy and philosophy that viewed the relationship between government and markets as complimentary, both working in partnership, and recognized that while markets were at the center of the economy, there was an important, if limited, role for government to play.“

Stiglitz did a superb job of illustrating where markets rely on government to function efficiently. For example, a clear prerequisite for a market system to operate is the establishment of a rule of law that protects property rights as well as the courts to enforce them. Well established property rights create an incentive in society to build wealth. Competition is another area of the market that requires some form of government intervention. U.S. experience is a testament to this with the age of the robber barons, U.S. Steel, and Standard Oil, where restrictions were put into place to keep a small number of firms from controlling output and thereby maximizing the price at which those products could be sold.

Sometimes governments are required to serve an area of the market that is underserved or not served at all. Some forms of insurance, for example, are provided by the government in the U.S. because of an inadequate or nonexistent supply by private firms. The IMF made some mistakes in its programs by pushing for rapid privatization; simply because it “assumed that markets arise quickly to meet every need, when in fact, many government activities arise because markets have failed to provide essential services.”

The Dangers of Financial and Capital Market Liberalization

The East Asia Crisis

Stiglitz comments that, “excessively rapid financial and capital market liberalization was probably the single most important cause of the [East Asia] crisis.” Before the crisis hit, the East Asia countries were outperforming most of the world’s developed nations. They were experiencing phenomenal growth. One important factor that led to this growth was the level of saving in those countries. He shows how speculative attacks on currencies can cause pandemic problems for the world economies. The collapse of the Thai Baht induced a domino effect on the East Asia economies that created a regional exchange rate emergency and threatened entire world economies.

The IMF’s reaction and strategy towards the crisis not only exacerbated the problem, but as Stiglitz points out, it was “partially responsible for the onset”.  It pushed for rapid capital market liberalization which would open the door to outside investment.  In the case of the countries in East Asia, there was no need for additional capital, precisely because of their high savings rate. The IMF, however, continued to push for liberalization. After the crisis hit, the IMF agitated the problem by not allowing the East Asia countries to control capital flows.

Malaysia, the only country that did institute capital controls, was able to outperform all of the other countries hit in terms of recovering from the crisis. Stiglitz makes it clear that although there is little evidence that liberalization policies promote growth, there is “ample evidence that they [impose] huge risks on developing countries.  Even a developed nation would be hurt by a considerable speculative attack or sudden change in investor sentiment that could create a sudden vacuum of capital from one country into another.

Russia and the 1998 Bailout

“There was one important difference between the transition from war to peace, and from communism to a market economy: Before World War II, the United Sates had the basic market institutions in place, even though during the war many of these were suspended and superceded by a ‘command and control’ approach. In contrast, Russia needed both resource redeployment and the wholesale creation of market institutions.”

 Stiglitz illustrates how Russia provides another case study where rapid financial and capital market liberalization was the impetus for declining real wages, corruption, and a blatant robbery of the national stock of Russia’s assets by the rich.

Perhaps of all the IMF’s blunders, it is the mistakes in sequencing and pacing, and the failure to be sensitive to the broader social context, that have received the most attention forcing liberalization before safety nets were put into place, before there was an adequate regulatory framework, before the countries could withstand the adverse consequences of the sudden changes in market sentiment that are part and parcel of modern capitalism; forcing policies that led to job destruction before the essentials for job creation were in place; forcing privatization before there were adequate competition and regulatory frameworks.

As Russia began to convert itself into a more democratic country it also began to reestablish its economy. As Stiglitz points out, there were crucial elements that were needed for Russia to obtain before it could effectively begin a transition. One was the establishment of the appropriate market institutions needed to provide protections, through regulations and statutes, as well as the mechanisms to enforce them. The IMF pushed for rapid privatization of national industries while there were no effective mechanisms to allow for an equitable redistribution of resources. As Stiglitz points out, privatization done the wrong way had not let to increased efficiency or growth but to asset stripping and decline.  He gives a vivid account of how the rich oligarchs and political leaders were enabled to strip Russia of crucially needed resources and international aid; [capital] market liberalization and privatization made it easier to take money out of the country; privatization before a legal infrastructure was in place enhanced the ability and incentive for asset stripping rather than reinvesting in the country’s future.

The Need for a Change in Governance

Stiglitz makes it clear, through his exhaustive accounts of policy failures, that there is a need for fundamental change in the governance of the international agents of globalization. He shows how the International Monetary Fund, the World Bank and the World Trade Organization all have consistently failed to deliver on their mandates. He cites among other reasons the lack of transparency, the inclination for these institutions to assume a larger role than that of their mandates, and the insufficient, if not inexistent, level accountability.

Because so much of its decision making was done behind closed doors… the IMF left itself open to suspicions that power politics, special interests, or other hidden reasons not related to the IMF’s mandate and stated objectives were influencing its institutional policies and conduct.  As Stiglitz points out, not only did this lack of transparency preclude these institutions from obtaining the international support that it should have bolstered, but it engendered a level of distrust and perhaps even animosity towards their existence.

The IMF was supposed to limit itself to matters of macroeconomics in dealing with a country, to the government’s budget deficit, its monetary policy, its inflation, its trade deficit, its borrowing from abroad; and the World Bank was supposed to be in charge of structural issues – what the country’s government spent money on, the country’s financial institutions, its labor markets, its trade policies.  Stiglitz provides clear examples of how these institutions assumed roles that did not fall within their stated mandate.

The institutions [the IMF and the World Bank] are not representative of the nations they serve.  Perhaps the most important feature Stiglitz mentions is the need for accountability. Many of the mistakes made by the IMF, the World Bank, and the WTO could have been corrected with the appropriate levels of accountability in place. Unfortunately, however, this was not the case and therefore allowed mistakes of regional and global economic, social, and political proportions to take place. The lack of accountability has sponsored a new wave of distrust, animosity, and opposition to the international institutions of change that are crucial to developed as well as developing nations.

What I Have Learned from this Book

Globalization and Its Discontents offers a different perspective of globalization from what I have learned in the classroom. It has shown me what globalization, in terms of global economic policy and the role of international institutions, can do for developed and developing countries when good as well as bad policies are instituted. It has taken me out of the realm of possibility and exposed me to actual results of what economic theories imply. I learn by example, and the examples I have read from Stiglitz have allowed me to understand how important the material I learned is.

Some of the accounts Stiglitz gives are appalling and embarrassing. It allows me to understand how important it is to hold political leaders accountable for their actions. I am embarrassed of how U.S. special interests, whether originating in Wall Street or coming from the Treasury, took a disregard for their responsibilities. Paul O’Neil’s proposal and the U.S.’s proceeding adoption of an aluminum cartel is an outright and blatant show of unilateral policy and susceptibility to special interest. The 1998 bailout for Russia, and the subsequent theft of over $20 billion by a small group of people was nothing less than appalling.

The implications of actions such as these do not bode well for the credibility of globalization and the international institutions put into place to facilitate it. If credibility becomes a problem, support for the institutions themselves as well as the policies they implement will dwindle. Although these institutions have made mistakes, it is important to continue their existence and compel a change in their governance. Their mandates were established to provide the international forum for participation and cooperation needed for a truly global society. Globalization is not a force we can stop, but is one we can use to our advantage. These institutions must, among other responsibilities, respond to emerging threats of political, social and economic hegemony and special interests.

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Olson begins his discussion of groups by explaining their purpose – to further the common interest of a group of individuals. As Olson explains, the “provision of group goals is the fundamental function of organizations”. Rational individuals join associations or groups to achieve a goal or benefit which they cannot achieve themselves alone. Individuals are capable of furthering their own interests more effectively alone and therefore will not, as rational decision makers, organize to provide an individual good or benefit.
Olson continues by defining the properties characteristic of large and small groups relative to their ability to achieve their objectives. He argues that when groups form to achieve a common goal, they are inherently seeking to provide a collective good for that group. Therefore, any member of a group, that provides a collective good, will receive that good regardless of their individual contribution. Olson argues that this property of non-excludability compels the rational individual to restrict his own contribution to maximize his individual welfare.

This dynamic is dependent upon the size of the group, however. Small groups tend to more effective in providing collective goods, although the good will be provided at a suboptimal level. Olson explains that this tendency for small groups to provide collective goods at suboptimal levels is dependent on the cost of providing the good and the amount of benefit derived by a single individual in that group. If an individual in a group receives a benefit equal to or greater than the cost of providing that good, then “there is some presumption that the collective good will be provided”. This can be illustrated with use of a lighthouse. Once a lighthouse has been constructed, it is impossible to exclude others from using it. It becomes a collective good which can be used by any other ships. Although the individual firm may face difficulty in compelling each firm to pay a proportionate share of the burden of providing that good, it may still be beneficial to that firm to provide the good by itself. If the cost of constructing and operating the lighthouse can generate enough savings to pay for the costs associated with not having it, then the firm will most likely provide the good. However, since that firm is the only firm bearing the costs of providing the good, it will only provide the good to the point when the cost of providing it is less than or equal to the benefit received. This will lead to an undersupply of the good or a suboptimal level of provision.

Large groups face a more serious problem of providing a collective good. In the case of the large group, provision of the collective good will not take place without some level of coercion or inducement. As Olson argues, the rational and self-interested individual will not contribute to a common group goal. Since group objectives are public goods, just as in small groups, the individual member will receive the collective good regardless of the level of contribution made on his part. Some kind of coercion or inducement must take place in order for a large group to provide a collective good; because the individual contribution of a group member will be insignificant to the overall provision of any collective benefit. Olson argues that the rational individual understands this and that since his contribution will have no perceptible effect on the outcome of the provision of any collective good, he will not make any contribution. This is referred to as the problem of the ‘free-rider’ in economics.

What Olson has established here is that groups, large or small, exist only to provide a common good and that, generally, the rational, self-interested individual will not participate in the furtherance of obtaining a collective good unless he either benefits enough to provide the good himself or he is forced to bear some of the cost by means of inducement or coercion. He mentions an objection made against his theory that claims that “attitudes in organizations are not at all like those in markets”. Olson provides a compelling test of his argument by considering what happens if an “emotional or ideological element” is involved and asking if it makes “the argument offered here practically irrelevant”. He concludes that although “patriotism is probably the strongest non-economic motive for organizational allegiance in modern times…no major state in modern history has been able to support itself through voluntary dues or contributions.” The end result is that in the provision of a collective good, there will be a ‘tendency’ for the “exploitation of the great by the small”. He provides evidence of the need for compulsion with the case of labor unions; where labor organizations only began to succeed after they were able to negotiate with the firms directly and establish ‘closed-shop’ policies. The only way an individual was able to become employed in certain firms was to join the related labor union and act to support its common interest.

Olson compares his theory with orthodox theories of state and class as well as various theories of pressure groups. In considering Marxian theory, he argues that Marx was inconsistent in his arguments by expecting a ‘class’ to organize and act for the interest of the group as a whole. Precisely because a group is composed of ‘rational utilitarian’ individuals, they will not organize to act. I disagree with Olson’s argument that Marx did not overestimate the strength of class action through rational behavior. Where Olson attributes an inconsistency in thought between rational behavior and class action I see an idealistic, yet unrealistic, argument proposed by Marx. Marx may have been arguing that the rational individual is aware that, as Olson explains, individuals will not work towards a collective good if they know that they can benefit regardless of their contribution, and that very awareness may compel the rational individual to make a contribution.

In his consideration of pressure groups, Olson argues that again there is an inadequacy in thought about the importance of the individual in group theory. Pluralist writers have “assumed’ away the individual and have explained their theories solely in terms of the group. Writers such as Bentley, Truman and Commons “take for granted that such groups will act to defend or advance their group interests, and take it for granted that the individuals in these groups must also be concerned about their individual economic interests.” Olson provides an insightful comparison to the thoughts of the pluralist writers with that of anarchist theory. By expecting groups to join out of “suffering”, “dislocation” or “disturbance” spontaneously, Olson argues that the pluralist theories resemble characteristics of anarchist thought.

Olson’s last chapter on “By-product” and “Special Interest” theories offers an interesting new perspective on modern pressure groups with large lobbying capabilities. He argues that the “common characteristic which distinguishes all of the large economic groups with significant lobbying organizations is that these groups are also organized for some other purpose.” He helps to strengthen his argument by placing these large organizations in the context of his theory. The example of the American Medical Association and the various state bar associations offer compelling evidence to support his claims. The example of the bar associations is especially interesting. The point of these examples is to illustrate that these organization have significant lobbying power, insofar that their strength is not derived from it but from their ability to ‘mobilize’ their members through compulsion. As Olson explains, this ability to ‘mobilize’ a ‘latent’ group of members is the by-product of another function the organization is performing.

In Olson’s discussion of large groups, he asserts that there are three factors that preclude large groups from achieving the provision of a collective good. His arguments here can be weakened by certain circumstances. In the first factor he mentions that the larger the group is, the smaller the fraction of the total group benefit will be. If I use the lighthouse example again, it can be argued that the ‘total group benefit’ is indivisible. No one individual’s use of the lighthouse will detract or preclude any other individual from using it concurrently. Therefore, whether the group is composed of 10 or 10,000 individuals, the total group benefit will be the same as well as the fraction allotted each member of the group. Perhaps an even stronger argument weakening Olson’s argument is national defense. National defense is a public good by definition, in that no one individual can be excluded from its provision. This group is composed the largest possible group of individuals within a national context. Olson’s argument is unable to explain this situation adequately. His second argument that, given his first argument, it is less likely that any individual will want to bear the burden of paying for the good because his share of the benefit will not be sufficient helps to strengthen his theory of groups, however. Taxation of citizens is the only method in which the government can support public goods like that of a national defense program. Olson’s third factor, that as the group gets larger, the greater the cost of organization, and thus the less likely it will provide any public good at all can also be weakened. Using the lighthouse example again, even if there are 1,000 ships benefiting from the use of the lighthouse but there is insufficient collective action to bear the cost of provision, it is still likely that the lighthouse will be provided if the cost of providing it is greater than or equal to the benefit any one individual or firm receives from its use. This is because of the indivisibility of the total group benefit. I think that the weaknesses I discuss here are more of an exception to Olson’s argument and that his theory holds true in most situations.

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