14th Sir Arthur Lewis Memorial Lecture 4 November 2009 Sir Cecil Jacobs Auditorium, ECCB Headquarters St Kitts and Nevis
One thing is clear however, and that is that the school of thought built on rational expectations in which individuals act with perfect foresight cannot be the guide to policy. We can all agree that this lesson has been learned the hard way.
On the issue of false sophistication, let me give you a very practical example on the use of financial markets for better or for worse. I was involved in the bailout of Korea in 1997 and o n e o f t h e d a m n i n g c r i t i q u e s o f t h e K o r e a n s y s t e m o f f i n a n c e , w h i c h h a d i t s s h a r e o f f l a w s ,
was that the Chaebol, the Korean conglomerates that had been encouraged in order to create corporations large enough to matter in exports markets (the Hyundais, LGS, and Samsungs) were highly leveraged). They had debt that normally exceeded equity by 3 to 1 and in the crisis this leverage rose even higher. This model was excoriated by the IMF, the US treasury and others as being excessively risky and government inspired. But what did these companies do with this leverage? They created jobs. They produced cars. They produced cell phones. They produced TV sets. In other words, they supported economic development and the progress of Korea in raising its living standards. They used leverage to improve national welfare.
Contrast this with the actions of hedge funds, where the leverage ratios were often 20 to 1 and
the motives were to bet that the hedge fund manager could anticipate market sentiment correctly. What is the economic benefit that society derives from these actions? More efficient markets? Not really, since you will recall that the word hedging is supposedly synonymous with reducing not increasing risk.
When the Germans raised this in 2006 at the G8, they were ignored by so-called market purists, led by John Taylor at the US treasury. When some academics like Joe Stiglitz rang alarm bells, they were ignored. In fact, one wanted to turn people away from the punchbowl as William McChesney Martin said decades ago.
So let's not confuse financial sophistication with economic progress.
Allow me now to turn to a second critical topic, namely the role of government in economic policy.
In the growth report issued in May 2008 by a distinguished commission led by nobel laureate, Mike Spence and including Sir Dwight, we came to the view that it was not the size of government that mattered, but rather its effectiveness. This contrasted with the views of another Nobel Prize winner, Bob Lucas, who advised the commission that the trilogy of "stabilise, liberalise, and privatise" was a sufficient policy admonition for policymakers.