Eric Maskin (Nobel Prize in Economic Sciences 2007): “Austerity must be gradual”

Hasty budgetary adjustments can prolong depression and increase the risk of a double-dip recession in Europe, the region most affected by sovereign debt crises.

A CONVERSATION WITH NOBEL ERIC MASKIN by Jorge Nascimento Rodrigues
(Adapted from an Interview for Expresso weekly newspaper in Portugal)
Translation: (c) JPO/LisWires, 2012

Eric Maskin, Nobel Prize Economics 2007

“I understand the argument that no country can live above its means. But imposing austerity when economies are in bad shape, does not seem appropriate, and it is not what economic theory advises. The slump will be longer. Austerity must be gradual. So sharply is counterproductive,” points Eric Maskin, Prize in Economic Sciences in memory of Alfred Nobel, who came to Lisbon to receive the honorary degree of Doctor (honoris causa) from Universidade Técnica de Lisboa, at the Instituto Superior de Economia e Gestão (ISEG).

“Budget adjustments must be implemented in the long run, not immediately. This increases the risk of a double-dip recession in some countries,” continues this mathematician by passion since high school who became involved with the economy almost accidentally. “I do not think, however, it is likely at this point that the world economy returns to recession. At individual countries, yes. For the world Economy it could happen if Europe blows-up”, stresses Maskin, which is very critical of the pathways taken in recent decades. “Economic theory says that the proper manner is to try to reduce budgets in good times, not when they are bad. Budgets should have been reduced during the good times. But this wasn’t done,” he continues criticizing the blindness during the “bubble” times fueled by Alan Greenspan, then Federal Reserve Chairman, and by trends in Economics saying that financial markets would spontaneously self-regulate. “I think it was a failure to recognize that financial markets are not self-regulated. I criticized Greenspan on his idea of self-regulation. What we saw was the high leverage ratio of the financial system,” recalls Maskin. These leverage ratios of many financial institutions reached extraordinary levels that led to a major financial crisis. That was a failure of government regulation. A “big mistake” at that period, in the words of Eric Maskin. “That can’t be fixed, nowadays, with hasty austerity.”

Maskin on Eurozone flaws
“the biggest engineering flaw in the Eurozone is the monetary and fiscal integration. The Eurozone did centralized monetary policy, but did nothing to centralize the fiscal policy.”

Even in the case of Europe, Maskin thinks the main problem is not the welfare state. “I think the biggest engineering flaw in the euro zone is not the welfare state, but the monetary and fiscal integration. The euro zone have centralized monetary policy, but did nothing to centralize the fiscal policy. So today, first, we must do the fiscal integration. That includes to make decisions on the welfare state. Obviously, it doesn’t make sense to have seventeen different welfare policies on the ground.”

Accidental Economist

Despite this incursion on macroeconomic policy, Eric Maskin is from microeconomics. When he was awarded the Nobel Prize, he regretted that he hadn’t learned more macroeconomics and economic history. His passion, however, has always been to combine the purity and beauty of mathematics with complex problems involving social choices. His guide and role model was Kenneth Arrow, the creator of the social choice theory, who would win the Nobel Prize in Economics in 1972. He owns him the “accident” of opting for Economics as a way of life. “I took his class on Informational Economics almost by accident. I remember it very clearly. Probably, I could have done some other else.”

During his Ph.D. studies, in late 1970s, he gets to know the then rising trend of “mechanism design theory.” In this area, he would eventually became known by his original contributions, and definitively associated to a theoretical word: “monotonicity” (known as Maskin monotonicity). He believes that “luck” knock on his door in all these chances of his student and Ph.D. studies. “I was exceptionally lucky to have discovered Economics in the first place, to have entered the field at a time when mechanism design was just beginning to bloom, and, most crucially, to have had a succession of remarkable teachers, students, colleagues, and friends in the profession,” he wrote in his Autobiography for the Nobel Prize.

Although difficult for ordinary people to enter these areas, “the mechanism design theory” (in face of certain social goals, procedures and institutions are drawn up to allow to reach them in an optimal mode, and compatible incentives are set up), and game theory to which it is associated, has real public policy applications, for example, in privatizations (where maximizing the revenue isn’t always the most important reason), competition, regulation and control of pollution. And even in the electoral area (where multiple choices could mean wasted votes).

Maskin is particularly critical of everything that favors rent-seeking by economic agents, due to monopolistic or oligopolistic power in the market, “collusion” between agents, regulators and policy makers and the capture of rents by economic agents, benefiting from public policies, even when claimed on behalf of innovation or the support of “strategic” sectors. “Economics teaches us that having too much power concentrated is not good because you have rent-seeking, and you get collusion. My rule is to stimulate competition. You have to have other competitors in the arena. I think it is difficult for governments to play favorites. Governments do not do a good job picking sectors. You can only admit exceptions in times of emergency, in very special circumstances,” he stresses.

To Eric Maskin, the Austrian economist Friedrich Hayek was right on the superiority of the market over planning (and its smoother derivatives) and the English economist John Maynard Keynes on the virtues of economic policy in times of recession and depression.

This year he is teaching “Game Theory and Economic Applications” at Harvard and plans to lecture on social choice theory later this year.

PROFILE | Eric Maskin

He was awarded the Sveriges Riskbank Prize in Economic Sciences in Memory of Alfred Nobel in 2007 for his contribution to mechanism design theory, along with Leonid Hurwicz (at that time aged 90) and Roger Myerson (a colleague as student).
He developed a passion for math in high school and got his doctorate in applied mathematics at Harvard University. Accidentally attended a class on “information economics” by Kenneth Arrow, who would eventually become his Ph.D. supervisor and his guide and role model. He then met with the mechanism design theory, created by the Russian Leonid Hurwicz, who became a friend.
He did research and taught at the University of Cambridge, UK, at the Massachusetts Institute of Technology, at Harvard University, at the Institute for Advanced Study, in Princeton University, and after the Nobel Prize, he returned to Harvard.
What impressed him the most on the day he knew of the Nobel Prize award was the call from Kenneth Arrow, who told him that he was triply satisfied. The Nobel was awarded to two of his students (Eric Maskin and Roger Myerson) and to an old friend (Leonid Hurwicz, who would die one year after).

Maskin on famous theoretical “battles”
“In the battle between “Austrians” (Hayek and Von Mises) and “Hungarians” (Oscar Lange and Abba Lerner), in the 1930s and 1940s, in regard to private goods, the first won, with no doubt.”

“But ultimately, Keynes won with regard to the response to recessions and depressions. This was even admitted by Hayek, who didn’t like the policy advocated by Keynes, but admitted its need in certain circumstances.”

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