The Map and the Territory, by Alan Greenspan

Alan Greenspan’s ideas for the future of financial regulation. Lawrence Summers reviews ‘The Map and the Territory’

Alan Greenspan, former chairman of the US Federal Reserve

The Map and the Territory: Risk, Human Nature, and the Future of Forecasting, by Alan Greenspan, Allen Lane RRP£25/Penguin Press RRP$36, 400 pages

It was my privilege to work closely with Alan Greenspan for the eight years I served at the Treasury during the Clinton administration. His new book, The Map and the Territory, brings me back to fond memories of our conversations over the years. I haven’t always agreed with my friend but he has always left me wiser and with something to ponder.

I have been struck in our interactions by the way in which his approach to the economic world draws both on commitments to an individualist, libertarian philosophy and on extensive and deep immersion in economic statistics. No other American economic policy maker in the past half-century could have written so thoughtfully about the implications of the Enlightenment for economic policy or have attempted, as Greenspan did while in office and does again here, to compute the physical weight of all the goods that comprise American gross domestic product. The range of topics and arguments makes this book a very important statement, whether one ultimately agrees or disagrees with the author. I found myself doing plenty of both.

Greenspan’s range, vision and boldness is especially important at a time like the present, when Washington is preoccupied with the political and petty.

His first book was entitled The Age of Turbulence but it was published before the financial crisis of 2008. Now that we have seen what real turbulence is, Greenspan has much to reflect on. And he acknowledges having changed his mind in some quite fundamental ways, in particular by greatly elevating the significance he attaches to “animal spirits”, especially fear and panic, as a driver of economic behaviour.

Reluctantly but clearly, he sees a stronger warrant for regulation – particularly with respect to the capital and liquidity position of major financial institutions – than he did while in office. He is rightly dismissive of the notion that financial crises can ever be completely avoided, or that governments can totally avoid bailout responsibilities. With all of this, and with the emphasis on “animal spirits”, one can only agree and hope that rational expectation theorists will take Greenspan on board.

In what will come as a surprise to some, he is very worried about the problem of “too big to fail”, suggesting that systemically important institutions around the world now get the kind of dangerous subsidy from an aura of government support that the US GSEs (government-sponsored enterprises) Fannie Mae and Freddie Mac got before their failure. On this he is surely right. A variety of studies by academics, central bankers and international financial institutions demonstrate that systemic institutions around the world are able to fund their activities considerably more cheaply than they would in the absence of an aura of government support.

Strikingly, Greenspan joins many of his traditional opponents in suggesting that “too big to fail” can very easily lead to crony capitalism. “Too big to fail” is surely the besetting challenge for financial regulation in the years ahead. I wish Greenspan had been more specific in his recommendations, although “too big to fail”, like nuclear deterrence, may be an area where ambiguity is essential. It is not clear that breaking up firms is the answer. Smaller firms acting in parallel may be just as great a source of risk, as the US found out during the Depression and the Savings & Loan crisis. And, as the example of farming suggests, less concentrated industries are often more powerful in seeking rents from the government. Perhaps the best answer lies in sufficiently high capital, liquidity, loss reserves, and debt that can be bailed in so that firms are impregnable even against a once-in-a-century event.

One of the areas where Greenspan has been most extensively criticised is in the failure of the Federal Reserve to do a better job of protecting consumers in the run-up to the financial crisis. He sidesteps the issue by asserting his focus on regulation, rather than fraud issues. But matters may not be so simple. An essential insight of the new sub-field of behavioural economics that Greenspan quotes approvingly is that people can be manipulated without being defrauded. If, as JK Galbraith observed, “Conscience is the knowledge that someone is watching”, then questions of regulation and fraud are closely related.

Apart from the questions of the role of human emotion in economic life and policy towards financial regulation, Greenspan stays with his long-held beliefs, though he marshals data in support of them in intriguing ways. He shows, for example, that much of the rise in the income share of the top one per cent is explainable by a tendency for some wages, such as those of asset managers and chief executives, to track stock prices closely. He shows that the tendency towards ever-increasing social and entitlement spending that he deplores has occurred disproportionately under Republican administrations. And he illustrates the nature of technological progress by noting that the weight of all US imports has steadily fallen, even as their value has continued to increase. Many talk about infrastructure: Greenspan brings together disturbing data on how the average age of highways, warships and much else has shot upwards.

I found myself disappointed that the events of the past few years had not led Greenspan to any revision of his anti-Keynesian views on macroeconomic policy. Perhaps understandably, he sidesteps monetary policy issues in the post-crisis period. He is dismissive of the role of fiscal policy in helping the economy out of the 2009 trough and the role of fiscal policy contraction in perpetuating slow recovery. Even in retrospect, he regrets the decision to save hundreds of thousands of jobs by having the government provide financing in connection with the GM and Chrysler bankruptcies.

Greenspan regards raising the US saving rate as a central priority. At a time when output appears to be constrained by demand rather than by supply and when even long-term real interest rates are at near-record low levels, it is much less clear to me than Greenspan that raising savings rates is the right growth strategy.

And in an economy that is changing rapidly in ways that leave many behind, Greenspan seems much more concerned with the possibility that help for the victims will foster dependency – going so far as to raise questions about tax credits for the working poor put in place by Ronald Reagan – than he is about mitigating inequality, preventing suffering or maintaining demand.

No important book on economics – and Greenspan has written a major work – fails to generate controversy. My disagreements with some important policy conclusions that he reaches do not detract at all from my admiration for the power of the thought that has gone into this splendid book.

Lawrence Summers is Charles W Eliot university professor at Harvard and a former US Treasury secretary

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