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Whither Socialism? (Wicksell Lectures)

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Joseph Stiglitz makes a powerful argument that neither capitalism nor socialism can achieve the economically efficient outcome suggested by the neo-classical model. Neither markets nor central planners can optimally direct resources to their most productive uses. The information required to do so is simply not available.

The neo-classical model suggests that the forces of supply and demand result in equilibrium, market clearing prices - a single price for each commodity. We see all around us evidence that real world processes to not achieve this optimal end. The same items sell for different prices at different stores; it is possible for significant numbers of workers to remain unemployed for long periods of time. Stiglitz explains that this outcome reflects informational imperfections in market generated prices. It is costly for shoppers to compare prices in every store before they make purchases. Employers may pay employees higher than market clearing wages to increase worker productivity, resulting in prolonged unemployment. If market generated prices and wages were as informationally efficient as the neo-classical model suggests, Stiglitz argues that market socialism could be just as efficient as free market capitalism. Markets could be permitted to function to the degree necessary to generate prices, which central planners could use to direct the economy. Stiglitz further argues that the most critical information planners need, to plan large scale investments, are not generated by markets anyway, because the appropriate futures markets (where investors could insure against bad investments) can not exist.

Stiglitz's explanation of how the neo-classical model of constrained optimization cannot describe real world phenomena is compelling, as is his argument that both market socialism and market capitalism face problems of information and incentives. Where Stiglitz is weakest is when he casually asserts, as he often does in this book, that government intervention could resolve some of these problems under either system. He routinely asserts that government intervention could address, for instance, problems of externalities through the application of Pigouvian taxes. He does not, however, discuss how government might determine the proper tax,(in the absence of a market in the externality), or how it might insure its application in the face of special interest political pressure. In his calls for government intervention, government is treated as benevolent, omnipotent and omniscient.

Stiglitz presents a coherent argument of why market socialism failed in the real world, and further, why market capitalism, as we see it practiced around us, does not live up to the promise of the neo-classical model.

This book possesses two distinct features. First, it errs frequently. Second, it errs amateurishly. Perhaps the most important error in this book is in how it was researched. It references nothing that Lange and Hayek wrote during the Interwar Debate on Socialism. It references none of the articles that Lerner or Knight published in this debate. It references nothing by Mises, Robbins, Durbin, Dickinson, or Dobb at all. The only article from this debate that Stiglitz read was Taylor's 1929 article- the worst one from the socialist side. Stiglitz also ignores the work of interpreters of this debate. He does not reference Bergson, Heilbroner, Lavoie, Kirzner, T Hoff, Roberts, Murell... In other words, Stiglitz barely scratched the surface of what was actually written in this debate- yet HE claims that THEY did not know what they were talking about. Of course, he did do some research for this book. Stiglitz referenced 126 of his own publications.

The shoddy research of this book shows up in its arguments. Stiglitz refers to the Arrow-Debreu model in discussing the debate between Lange and Hayek. In the ADM scheme of things there is a complete set of markets where unrestricted competition among perfectly informed persons reigns. Naturally, such perfect conditions yield perfect results- on paper. Actual markets do not deliver these results so "the competitive paradigm is not robust" (p107). Of course, it makes no sense to think of the Lange-Hayek debate in terms of Arrow Debreu anyway. This debate over socialism took place mainly in the nineteen thirties. The ADM was published in 1954. Socialism also suffers from incentive problems, so Stiglitz tells us that the Lange-Lerner model of market socialism does not depict reality either. He claims that Lange did not understand the difficulties in allocating capital. In reality, Lange (1938) and Dickinson (1939)wrote explicitly about severe problems in allocating capital.

For those who have actually read and understood the writings of the old socialists, like Lange, Schumpeter, and Dickinson, and their opponents Mises, Hayek, and Robbins this debate looks quite different. All of these economists recognized problems in both systems and wrote about them explicitly. Lange is well known for admitting to the danger of the bureaucratization of economic life under socialism. Hayek stressed the problems with information under both systems, and in fact spelled out the crucial informational imperfections in markets by 1937. Mises, Hayek, Lange, and Schumpeter all thought in dynamic terms that went far beyond the models with which Stiglitz likes to play. Stiglitz tries to reduce Schumpeter's process of creative destruction to a simple (and weak) game theoretic argument. He also ignored Mises completely- this is an unforgivable error.

The main purpose of this book is to play up the importance of its authors prior writings on imperfect information. All past accomplishments on both sides of this debate get recast into a form that makes the author of this book the only one who has made a worthwhile contribution, when in reality it is the contributions of intellectual giants like Hayek, Mises, Lange, Dickinson, and Schumpeter that rise above all else. Modest scholars recognize the shoulders that they stand upon from the past. The author of this book shows little such modesty, and even less in terms of important and original advances. This book should not be taken seriously.

Stiglitz shows how much things can change, when you drop assumtions like costless information, zero transaction costs etc. According to the general equilibrium theories he crizices, a central planner could archive an outcome that is at least as efficient or better than the market, by imitating perfect competition (Lange-Lerner-Taylor Theorem). Stiglitz shows that by dropping unrealistic assumptions both real markets and market socialism aren't that efficient as the perfect competition paradigma predicts. What is needed is competition and some state regulation. He makes a good case for a third way between neoliberalism and central planning.

There is no math in the book, so it can be read at many levels. It covers a broad range: Competition policy, privatization theory, forms of competion and much more. After reading it, I had a much better understanding of real world problems economies face.

On a side note: Nicholas review is simply wrong. Stiglitz employs almost only rational choice models. Problems occur because information is costly, not because people are dumb.

This book has three purposes. The first is to bring Stiglitz's technical work in economics to a popular audience. The second is to criticize both socialism and laissez faire capitalism and explain the collapse of the Soviet Union. The third is shameless self promotion far beyond the requirements of the first purpose. 1 succeeds somewhat, 2 fails miserably, and 3 succeeds perfectly.

For the most part, Stiglitz's criticisms of market socialism are based upon the idea that all planned or market socialist schemes are based on the assumption that economies behave in classical Walrasian fashion. At times, it almost seems like he thinks market socialists want a completely "free" market, only with worker ownership! While some socialists in the calculation debate believed in classical Walrasianism, no modern socialists or existing socialist planers did. As supporters of the discredited von Mises like to point out, Oskar Lange never used the scheme he developed in the calculation debate when he became an important central planner in Poland.

Do Stiglitz's arguments have any bearing on whether socialism has inherent efficiency problems? Very questionable. Do they say anything about why actually existing socialism "failed"? Give me a break.


In terms of presenting his own innovations in economic theory, Stiglitz does a decent job that could be better. In the 1970s and 1980s, Stiglits used theories of imperfect, costly and asymmetric information, costly and incomplete contracting, and separation of ownership from control to outline a whole host of market failures that have generally been glossed over. This book would be very valuable to many people if he had merely stated the "Greenwald-Stiglitz theorem" or his credit rationing hteory in plain English and did so in some depth. However, gives bits and pieces of his theories because they are most relevant to his dead end plan of generating insights about socialism.

I notice some free marketeers here criticizing the book's focus on market failure caused by imperfect information because we can't assume that the state has better information than private agents. These people miss the point and it makes me wonder if they read the book. Stiglitz shows how the nature of information generates INCENTIVE problems. Everyone may be informed of these problems, but it would be unprofitable for private firms to correct them.

To see a better perspective than Stiglitz's on the implications of his arguments see John Roemer's article "An Anti-Hayekian Manifesto," New Left Review (May/June 1995)

The American economist Joseph Stiglitz argues that the neoclassical model (`the competitive paradigm') propped up the idea of market socialism, so the failure of market socialism also refutes the neoclassical model.

In market socialism, governments use prices, just like market economies do, to allocate resources. But as Stiglitz points out, in the real world of imperfect information and incomplete markets, "there is no presumption that markets are efficient." He concludes, "the first fundamental theorem of welfare economics - asserting the efficiency of competitive economies - is fundamentally flawed."

The second fundamental theorem - that market mechanisms allocate resources efficiently - is also flawed. He writes, "Quite to the contrary of the contention of the market paradigm, reliance on the stock market may actually result in a distortion of the allocation of resources. ... The stock market ... does not provide the information required to make rational investment decisions."

In fact, "Information acquisition activities relating to the stock market are basically rent-seeking activities." Early information gets the rent, as when the Rothschilds made millions from being first to hear the result of the Battle of Waterloo.

Stiglitz writes naively, "the takeover movement itself seems somewhat of a puzzle since the firms taking over seem to gain little if anything." It is not a puzzle if you check who gains from these dodgy deals - top executives (primed by bribes, bonuses and share options) and those who take the fees and commissions. As management guru Peter Drucker commented mordantly, "Dealmaking beats working."

Stiglitz shows, "We cannot, in general, be assured that private production is necessarily `better' than public production." "There are some free marketeers who say that the first step to success is to privatize the state enterprises. ... They have no scientific basis for that conclusion." More recent research by Massimo Florio (in The great divestiture, 2006) found that Britain's privatisations did not improve efficiency and had a net social cost. The only gainers were the top managers.

He observes, "perhaps no myth in economics has held such sway as that which I will refer to as the property myth. This myth holds that all that one has to do is correctly assign property rights, and economic efficiency is assured." But as he points out, China's growth shows that well-defined property rights are neither necessary nor sufficient for success.

I read this book in contrast to Friedrich von Hayek's "The Road to Serfdom," which is a a manual for the type of classic liberalism/neoclasicalism that Stiglitz attacks. The following is my comparison of the two.

In concluding Whither Socialism, Joseph E. Stiglitz states that "if I were to claim that socialism as an ideology can now officially be declared dead, I do not think it would be an exaggeration." This declaration is made after a lengthily and sustained attack on socialism in the form of market socialism and communism as described by models based on the central tenets of capitalism. Stiglitz's supposed frontal assault on socialism is in all actuality a flanking maneuver against capitalism.
As Stiglitz is berating socialism from one side of his mouth he is suggesting a move away from liberal economics through greater governmental intervention on the other. The changes Stiglitz supports are of just the type warned against in Friedrich A. Hayek's The Road to Serfdom. Hayek notes that in theories like Stiglitz's "the question is no longer how we can make the best use of the spontaneous forces found in a free society. We have in effect undertaken to dispense with the forces that have produced unforeseen results and to replace the impersonal and anonymous mechanisms of the market by collective and `conscious" direction of all social forces to deliberately chosen goals." Hayek would see the direction Stiglitz seeks to push the economy as the first leg of a trip on the road to serfdom.

Walrasian model via Arrow and Debreu
Hayek was strongly influenced by the work of the Austrian school and therefore, would undoubtedly (as evinced by his writing) feel that the complexity of subjective individual human choices in the market would leave models lacking at best. Nonetheless, Hayek alludes to some of the elements of the Walrasian model throughout his book but in many respects he attacks them. It is precisely this model that Stiglitz spends approximately the first third of his book attempting to disprove.
The Walrasian model "postulates large numbers of profit- (or value-) maximizing firms interacting with rational, utility-maximizing consumers on and an economy in which there is a complete set of perfectly competitive markets--for all goods, in all periods, in all states of nature (for all risks), at all locations." In less technical terms this model first supposes "that it is possible for markets to engender a general economic equilibrium, a set of trades between economic actors in which every firm demands resources and labor and sells outputs in a profit-maximizing fashion, subject to its technological constraints." Consumers provide labor then purchase goods at utility maximizing market prices that do not exceed the value of the labor or resources they are willing to sell. "This set of trades is equilibrium in the sense that no demand (by a firm or consumer) goes unfulfilled and no supply (of a resource or commodity) goes unpurchased."
Hayek generally applies his ideas in a Walrasian setting as far as capitalism is concerned. He certainly envisions the give and take of the market as described above noting that "our freedom of choice in a competitive society rests on the fact that, if one person refuses to satisfy our wishes we can turn to another." This satisfying of wishes would of course include a value maximizing decision by the consumer in an attempt to better his position. Hayek however does not follow the mathematical formulation of the Walrasian model in respect to the presumption of perfectly competitive markets. This presumption relies on perfect information related to all goods at all locations at all times. Hayek writes that "we may have to sacrifice a possible immediate gain as the price of our freedom--but we avoid, on the other hand, the necessity of making future developments dependent upon the knowledge which particular people now possess."
Stiglitz uses the formal description of the Walrasian model to build an argument against the Lange-Lerner-Taylor theorem, which was derived from the Walrasian model. The Lange-Lerner-Taylor theorem is a theory of market socialism which presumes that "if the government allocates capitol in exactly the same way the private firms would allocate it' then the resource allocations emerging from the two systems would be identical." Stiglitz concedes that "Hayek had rightly criticized this view that the central planner could never have the requisite information." Within this statement lies the heart of Stiglitz's argument against the Walrasian model. Stiglitz, however, carries the effects of imperfect information over from its effect on a central planner to its effects on consumers and producers.
"What is generally referred to as the first fundamental theorem of welfare economics shows that under certain conditions every competitive equilibrium is Pareto efficient--that is no one can be made better off without making some one worse off." This theorem is a modern rendition of Adam Smith's invisible hand wherein "it is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest." Smith goes on to describe how this self love promotes societal good as a side effect writing "by pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."
Hayek concurs with the notion that a person in a society acting in their own interest tends to promote the good of the whole society. Hayek does not limit this to its application to economic effects; however, he would argue that this ability to pursue one's best interest also has bearing on political good. Of self-seeking efforts bettering one's position Hayek states that "what in ordinary language is misleadingly called the economic motive means merely the desire for general opportunity, the desire to achieve unspecified ends. If we strive for money it is because it offers us the widest choice in enjoying the fruits of our efforts." Hayek notes that the "argument in favor of economic freedom was the outcome of a free growth of economic activity which had been the undesigned and unforeseen by-product of political freedom." He uses this notion to serve as a warning that governmental control over economic activities is tantamount to government control over every aspect of the citizenries' lives. As economic freedom has had the byproduct of political freedom in Hayek's view, loss of economic freedom would result in loss of political freedom. This tying together of economic and political good differs greatly from the traditional notion of Pareto optimality. Since Hayek does not presume perfect information about the effects of market decisions on conditions in the future he implies an added value to decentralized decisions that outwardly may appear inefficient. He states that "in the short run the price we may have to pay for variety and freedom of choice may sometimes be high, in the long run even material progress will depend on this very variety, because we can never predict from which of the many forms in which a good or service can be provided something better may develop."
Stiglitz takes a purely formal economic approach in analyzing the first fundamental theorem of welfare economics. He argues "that the first fundamental theorem of welfare economics -asserting the efficiency of competitive economies -is fundamentally flawed" and that "quite contrary to that theorem, competitive economies are almost never efficient." Stiglitz again attacks the lack of perfect information as is assumed in the rigid formal model of Pareto efficiency. Stiglitz notes that "the incompleteness of the market can itself be explained by transaction costs, and important component of which is information costs." Stiglitz sees these information costs as precluding any possibility of having a Pareto efficient market. Stiglitz uses asymmetries of information as an example of a situation where the market is not efficient. If one party has more, or more accurate, information they may be able to strike a bargain wherein they come out as the winner over the other. Additionally, Stiglitz posits that the high cost of information creates barriers to Pareto efficiency. Where one firm lowers its price for a good the "low-priced firm can gather for themselves a larger customer base, but the high-priced firms can survive, serving only those who have high search costs and who have not had the good fortune to find a low priced firm." Stiglitz concludes his analysis of the first fundamental theorem of welfare economics by describing that the failures of market socialism are due to the fact that like capitalism, market socialism failed to pay any attention to the problems posed by imperfect information.
Hayek in the Austrian tradition would tend to look in a negative light on the formalistic model driven approach to the first fundamental theorem of welfare economics. Undoubtedly he would consider the information costs as Stiglitz describes them to be a problem, though he may view them as a part of the whole of the transaction. Hayek does however express that:
In a competitive society the prices we have to pay for a thing , the rate at which we can get one thing for another, depend on the quantities of other things of which by taking one, we deprive the other members of society. This price is not determined by the coconscious will of anybody. And if one way of achieving our ends proves too expensive for us, we are free to try other ways. The obstacles in our path are not due to someone's disapproving our ends but to the fact that the same means are also wanted elsewhere.
This statement clearly mirrors the formal description of Pareto optimality, Hayek doesn't mention this as a specific model, rather, he seems to feel that it is an accurate description of competitive society. Perhaps Hayek does believe in the underlying notion of Pareto optimality though he does not seem to have a rigid conception.
"What is generally referred to as the second fundamental theorem of welfare economics provides conditions under which any Pareto-efficient allocation of resources can be obtained through market mechanisms?" Stiglitz, apparently presuming that the current allocation of resources is not Pareto efficient as indicated by his analysis of the first fundamental theorem of welfare economics, extrapolates this theorem to state that "all that is needed is to have the government engage in some initial lump sum redistributions" then allow market mechanisms to create a Pareto efficient outcome. Stiglitz is critical of the prospects of lump sum redistributions; the main basis he cites for this problem is that the government lacks sufficient information to make these redistributions. Stiglitz is also critical of the idea that the decentralized price mechanism could lead to a Pareto efficient allocation of resources. Stiglitz states that "Pareto-efficient allocations cannot generally be obtained without some form of government intervention." Stiglitz concludes of the first fundamental theorem of welfare economics that "efficiency requires not the complete decentralization suggested by the neoclassical paradigm but partial decentralization."
In many regards Stiglitz's critique of the Walrasian view is Hayekian. Throughout The Road to Serfdom Hayek repeats that there is no way that the central planner could have the requisite information to make effective decisions. "What economic actors really do in a market economy is much more complex than what they are postulated to do in the Arrow-Debreu or Walrasian model." Sitglitz and Hayek would agree that economic actors make a myriad of different decisions involving production that could not conceivably be communicated to a central planner. The central planner likewise could not express the correct course of action back to the producers though a directive to maximize profits or an input to output schedule.
While Stiglitz and Hayek would agree that there are fatal problems in applying the Walras model to the informational complex reality, their responses to these problems are in many cases polar opposites. Hayek's answer to the complexities of economic decision making is that the government should as much as is possible disappear from the market. Stiglitz on the other hand is concerned with trying to find the optimal balance between private and public economic activity.

Of Public and Private
One role of government in the market on which Hayek and Stiglitz agree is in the establishment of the rule of law. While they agree that government must establish the rule of law the conclusions to which they come are markedly different. In Hayek's view the rule of law "stripped of all its technicalities," "means that the government in all its actions is bound by rules fixed and announced before hand -rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one's individual affairs in the basis of this knowledge." Stiglitz writes that "there is one vital role that the government must perform in any economy, and that is establishing the rules of the game - rules that will govern the interactions among private parties and between these private parties and the government." The important difference between Stiglitz and Hayek's conception of the rule of law is the role that the government will play. In Stiglitz's view the government should be an important player in the market. This is totally inconsistent with Hayek's conception of the rule of law. In Hayek's view there cannot be planning (or economic competition) by the government and the rule of law. He feels that "the distinction between the creation of a permanent framework of laws within which the productive activity is guided by individual decisions and the direction of economic activity by a central authority is thus really a particular case of the more general distinction between the rule of law and arbitrary government." Stiglitz presupposes a benevolent government that would create the "rules of the game" and make them apply fairly to both itself and private actors. Hayek takes a more cynical approach to government as an economic actor. He writes that "the planning authority cannot confine itself to providing opportunities for unknown people to make whatever use of them they like. It cannot tie itself down in advance to general and formal rules which prevent arbitrariness." Stiglitz even seems to support some flexibility when he notes of the rule of law that "it is impossible to anticipate every contingency." According to Hayek in a country with a flexible rule of law `contingencies' will arise where government must "decide questions that cannot be answered by formal principles only, and, in making these decisions, it must set up distinctions of merit between the needs of different people."
Hayek is not purporting that there is no role for government in the market, he is strictly concerned with so great a role that it amounts to direction. He notes that "it is important not to confuse opposition against this kind of planning with dogmatic laissez attitude. The liberal argument is in favor of making the best possible use of the forces of competition as a means of co-ordinating human efforts, not an argument for leaving things just as they are." Hayek supports intervention by the government in cases of, what Stiglitz would term, market failures.
The market failures approach argues that there is indeed a role for government, but it is a limited role: Government simply needs to correct the well-defined market failures, which it can do with simple tools having minimal effects on the mode of operation on the economy. For instance, problems of externalities can be addressed through corrective (Pigouvian) taxes. Even when the government is uncertain of the tax rate that will achieve particular pollution control objectives, market mechanisms can be employed: The government can issue marketable pollution permits. To be sure the government has further, limited responsibilities: It might also have to take actions to ensure that markets are actually competitive.
While Stiglitz agrees that governmental involvement in the market is necessary he feels that that the market failures approach is not enough and that a much greater governmental role would be preferable.
Stiglitz divides (or adds in the case of new market failures) market failures into new and old market failures. He defines new market failures as, "market failures, based on imperfect and costly information and incomplete markets" the old market failures are "associated with, for instance, public goods and pollution externalities" and imperfections in competition. Stiglitz agrees that the government is the best mechanism for dealing with the old market failures. Stiglitz even hints that a market socialist system is as effective as capitalism at fixing old market failures "like those concerning air pollution, for which a well defined and effective government policy can often easily be designed." However, he feels that these interventions are not enough. In Stiglitz's view "market failures are indeed pervasive in the economy. They appear in virtually every transaction among private parties in the economy, and while they may be small in each case, cumulatively they are important." Since in the formal sense the market failures approach is intended to internalize externalities to restore Pareto optimality as described in the first fundamental theorem of welfare economics, Stiglitz's informational arguments as described above against the first fundamental theorem of welfare economics apply to the market failures approach and the new market failures as he describes them. While he is concerned with imperfect information, Stiglitz feels that the government is best equipped (better than market mechanisms) to improve Pareto efficiency. Specifically, he believes that "the government's power of compulsion gives it a distinct advantage." According to Stiglitz "when markets are incomplete and information is imperfect, the actions of individuals have externality-like effects on others," and since the government is better equipped to deal with externalities it follows that it would be better equipped to deal with these externality like effects. The (internal) externalities that Stiglitz feels could be improved by government intervention go well beyond those prescribed by Hayek. The following are examples of where Stiglitz feels the government could improve Pareto efficiency through intervention. In incomplete risks markets where anyone can enter production of a commodity the new entrants alter the distribution of returns from the commodity and the "individual's actions in that probability distribution can thus be viewed as an externality." While Stiglitz does not specify how this "externality-like effect" could be internalized, presumably it would involve subsidization, barriers to entry, taxation, or production quotas; though it seems odd that there should be concern for externalities that are internal among producers when market mechanisms would seem to be just as effective if the government did not have perfect information. Incentive (moral hazard) problems like when individuals buy insurance because they are risk adverse, but since they do not have to bear the full costs of the insured against event their incentives to avoid the insured against event are attenuated. According to Stiglitz "this example shows how the government can effect Pareto improvement. By taxing [think cigarettes and triple cheeseburgers] and subsidizing [think stationary bikes and tofu] various commodities, the government can encourage individuals to take greater care." Stiglitz presumes that "while the government and private insurers lack the information necessary to prevent moral hazards--they cannot directly control action--the government has the instruments with which to alleviate the effects of moral hazard and the information required to use those instruments.
Hayek agrees that when there are market failures, of the "old" type as described above, the government has a role in correcting these failures or he would at least agree that the government within limitations should be allowed to correct these failures. Hayek states "to prohibit the use of certain poisonous substances or to require special precautions in their use, to limit working hours or to require certain sanitary arrangements, is fully compatible with preservation of competition. The only question here is whether in the particular instance the advantages gained are better than the social costs which they impose." "But the fact that we have to resort to the substitution of direct regulation by authority where the conditions for the proper workings of competition cannot be created does not prove that we should suppress competition where it can be made to function." Hayek would have no qualms about internalizing the costs of an externality on a business or industry if it would be socially efficient and could not be done through competition. In many cases, however, Hayek would see intrusions by the government as the cause of the apparent externality. As example he cites "the magnificent roads in Germany" as an example where the government has intervened to create technical excellence in a particular field but this excellence is a "misdirection of resources" given the volume of traffic on them compared to the side streets. Hayek may respond to examples of externalities like traffic congestion and pollution by pointing out market distortions caused by governments that stifle or prohibit private road construction and dismiss liability for reductions in property value caused by the pollution.
Hayek would not agree with Stiglitz that there would be a role for government in the "new market failures." The propositions that Stiglitz makes for government expansion would, in Hayek's view, certainly create market distortions. The moral hazards example from above is in perfect contrast with Hayek's view of the role of government. Stiglitz seeks to alleviate the problem of actors who are insulated from risk taking those risks, by creating an additional deterrent in the form of taxes. However, this would create greater market distortions in an insurance scheme since the premiums would be lower based on the higher cost of doing the thing insured against which may entirely offset the higher cost. Stiglitz states that the taxes should be set at a high enough level to prevent these dead weight losses. There is, however, in many cases no tax on goods that would fully eliminate them form the market. Stiglitz curiously states that "while the government and private insurers lack the information necessary to prevent moral hazards--they cannot directly control action--the government has the instruments with which to alleviate the effects of moral hazard and the information required to use those instruments." In Hayek's view the real hazard is that government is in fact quite capable of controlling action and does not have the information required to use instruments to alleviate moral hazards. Hayek is concerned with the lack of information by the government to make judgments on moral hazards. In an insurance moral hazard scheme the insurance companies would presumably have better access to information related to risks and could assign premiums accordingly. Government intervention would require it to presume a comprehensive moral, ethical, and economic code where none exists. "Not only do we not possess such an all inclusive scale values: it would be impossible for any mind to comprehend the infinite variety of different needs of different people which compete for the available resources and to attach a definite weight to each." Of the type of externality like effects that would have to be determined by the moral code envisioned by the government, Hayek gives the example "we could reduce causalities by automobile accidents to zero if we were willing to bear the cost--if in no other way--by abolishing automobiles." Stiglitz it would seem would have the government construct its intervention to prevent moral hazards based solely on economic concerns. Hayek would argue that this type of valuation is not compatible with individualism. While Sitglitz may not ban cars due to their economic uses, he may see taxing them for all uses other than in traveling to and from work and in the transport of commercial goods as an effective intervention into moral hazards.
In regard to financial and management moral hazards Stiglitz has a somewhat Hayekian view though his is interestingly nuanced. Financial moral hazards are where a financial institution is insulated from the hazards of its investments and therefore is more likely to make riskier investments. An example would be if a financial sector became heavily invested in mortgage backed securities whose cash flows are backed by principle and interest payments on subprime mortgages that are unlikely to be paid. If the financial sector suspects that they can receive a government bailout if these investments fail, they are more likely to invest in them since they will reap the benefit of high returns if the investment turns out well but will not have to fully shoulder the burden if the investment fails. Stiglitz terms these financial moral hazards problems "soft budget constraints." Stiglitz emphasizes the need for government's commitment, "particularly its commitment to tough budget constraints." Stiglitz states that "soft budget constraints are like a disease: They can be highly contagious. If the banks face soft budget constraints, they will not impose discipline upon their borrowers." However Stiglitz warns that when faced with hard budget constraints "competent firms may fail the market test as a result of bad luck, and bad firms may pass, as a result of good" so caution must be exercised in establishing hard budget constraints. Of managerial moral hazards Stiglitz notes a variety of problems that arise. Managerial moral hazards can occur when management is shielded from poor decision making. There are problems of accountability and incentives especially in firms where management and ownership are separated. In this situation, managers have incentives to further their career and therefore an incentive to avoid accountability. Managers may be shielded when there are poor decisions in their division but it has a minimal effect on the overall firm. The interesting turn in Stiglitz's view of financial and managerial moral hazards is that government can be just as good (or bad) at addressing them if it is a market player. Stiglitz states that:
Government can create government enterprises that are given hard budget constraints; it can set up a set of procedures that can at least increase the transaction costs associated with softening the budget constraints. It can impose procedures and rules that effectively increase the ability of government enterprises to make commitments. Government-owned corporations can be made to have the same legal status of privately owned corporations, differing only in who owns the shares. While these changes will not obliterate the differences between private and public enterprises, they will reduce their differences, to the point where behavior will be indistinguishable.
This is where Hayek and Stiglitz diverge on financial and management moral hazards. While Hayek would agree with government imposing hard budget constraints and letting competition weed out bad firms he would not believe that the government would do the same for itself if it were a market actor. Hayek notes that "although competition can bear some admixture of regulation, it cannot be combined with planning to any extent we like without ceasing to operate as an effective guide to production." Stiglitz does not address how a government enterprise should be created to eliminate the managerial moral hazards problems associated with private enterprises. Worse yet, he seems to open the door for further moral hazards up to and including abuse by reducing the additional constraints that the populace imposes on government enterprises. The constraints imposed on governments include constraints on wages, outcry at mistakes that waste taxpayer money, aversion to government monopoly, and civil service regulations that restrict the ability to fire workers. Stiglitz writes that "just as greater tolerance of mistakes--or more accurately, the recognition that mistakes are inevitable and costly to avoid--would enhance the efficiency and effectiveness of public organizations, so too would greater tolerance of inequities--or more accurately, the recognition that (perceived) inequalities are inevitable and costly to avoid." Although Stiglitz maintains a cynical view of managers in private enterprise, because of their moral hazards problems, their abuses of public interest and share holders, and their attempts to gain monopoly control to maximize profits, he ignores the implications of adding a governmental monopoly on the power of coercion to the mix. Hayek is not concerned with abuses by private enterprises when they can be made accountable by the government. If, however, the government becomes abusive there is no higher power to make it answerable. Furthermore, this idea of creating a class of workers in government enterprises that are closely tied to the government, leads to a consolidation of governmental power. Every slip by the government outside of fair competition would lead to government enterprises gaining a greater market share and a larger work force identified with the goals of the government. This work force would, in their own interest, be hostile to competition from private firms. "As in the course of the progressive advance toward socialism it becomes more evident to everyone that his income and general position are determined by the coercive apparatus of the state, that he can maintain or improve his position only as a member of an organized group capable of influencing or controlling the state machine in his interest." This snowballing effect will lead to an ever greater portion of the populace identifying themselves with government enterprises in opposition to competition from private competition. As the government gains a majority of market share and a majority of employment, it follows that the perception of what is fair among the populace will shift. If profits from these government enterprises are divided among the entire population the employees of the government enterprises will feel that they are not receiving allocation proportionate to their effort and seek to retain all of the profits, while if the profits are distributed among only the government employees the private sector will seek to join the government apparatus to receive a share of the profits. While Stiglitz is wary that the worst get on top in the leadership in the private sector he seems to presume benevolence from the governmental economic actors. Hayek on the other hand presumes that the same kind of flexible morals that allow the worst to get on top in private corporations are effective in government. Hayek notes that "just as the democratic statesman who sets out to plan economic life will soon be confronted with the alternative of either assuming dictatorial powers or abandoning his plan, so the totalitarian dictator would soon have to choose between disregard of ordinary morals and failure."

Philosophical Speculations against Capitalism
In the Section of Whither Socialism entitled "Philosophical Speculations" Stiglitz attacks the central dogmata of Hayekian economics. In this chapter Stiglitz largely agrees with conventional socialist notions. Stiglitz notes that "one cannot simply dismiss Marxist concerns." Stiglitz rejects the notion, dating back to Adam Smith and beyond, that self-interest is a positive force in society stating that, "capitalism may encourage self-interestedness, but is that desirable?" "By changing the locus of caring and responsibility from the individual to the government--not only for the needy, but for oneself, one's parents, one's children--we change society and we change ourselves" and this redistributive role for government, through the eyes of a chang

If you are like me and you have a journeyman's interest in economics, this is NOT your book. There are a good number of interesting sections in the book but overall, I have no idea what is being discussed.
I have been watching Mr. Stiglitz on TV and he is frank and clear speaking. I am sure that he must have written a book that is right for me - this book is not it.
If this is an effort to determine why Russian Communism collapsed, I have an opinion and it has nothing to do with economics or economic dogma. It has to do with the moral and ethical collapse of the Russian ruling class. What happened to Communist Russia is exactly what is now happening to the free capitalist world. Its ruling class has gone sour.
The Russian people finally lost the "faith" in their elitist ruling class. The free world is hanging onto its faith but by a hair. If Obama can save America - never mind the whole world - it will be amazing. This collapse is a question of "trickle down" greed, corruption, selfishness and immorality in terms of social justice. The Russians collapsed sooner than the free world simply because they had fewer assets to be criminalized, skimmed, and pillaged. But their problem is no different than our problem. The names of the stars are spelled differently but the characters are the same in this traditional morality play. This entire world failure had nothing to do with communism, capitalism or God in my opinion.

Richard Edward Noble - The Hobo Philosopher - Author of:

America On Strike - Labor History

Although, as Stiglitz points out several times, capitalism is not perfect at transmitting information through the pricing system, he fails to demonstrate how state controlled firms could possibly do any better. He correctly observes that firms operate internally without a price system, but he also fails to observe that individual firms are small in comparison to the market, which is what allows firms to calculate how resources are used internally. This book is full of large errors and over simplifications of the regulatory and market process. However, if you're a serious socialist, it's the best book out there for you.

The author of this book has shown that market socialism would go to the dead end. China and Vietnam are not exceptional cases. Furthermore, by the approach of imperfect information, the arguments of the author against neoclassical and property theories are strongly persuadable to me.However, some political economy approach has not been mentioned in this book. I think this appproach is also useful to analyze the constraints on market socialism.

An interesting book, perhaps worth more than a single star, but, please, how silly are people according to great economists? The premise of the market failures of the book is the inability of writing complex contracts. A smoking at home paradox disappears if you can contract with the insirance company about fires from smoking. A race-to-the-bottom collective action problem between lessors and lessees disappears if the lessee can be induced to use specific types of care--type of paint when refinishing or type of fertilizer when planting, for example.