Glenn Hubbard & Joseph Stiglitz

Winter 2019

Glenn Hubbard was named dean of Columbia Business School on July 1, 2004 and has been a Columbia faculty member since 1988. He received his B.A. and B.S. degrees summa cum laude from the University of Central Florida. He also holds AM and PhD degrees in economics from Harvard University. In addition to writing more than 100 scholarly articles in economics and finance, he is the author of three popular textbooks, as well as co-author of The Aid Trap: Hard Truths About Ending Poverty, Balance: The Economics of Great Powers From Ancient Rome to Modern America, and Healthy, Wealthy, and Wise: Five Steps to a Better Health Care System. His commentaries appear in Business Week, the Wall Street Journal, the New York Times, the Financial Times, the Washington Post, Nikkei, and the Daily Yomiuri, as well as on television and radio.

In government, he served as deputy assistant secretary for tax policy at the U.S. Treasury Department from 1991 to 1993. From February 2001 until March 2003, he was chairman of the U.S. Council of Economic Advisers under President George W. Bush. In the corporate sector, he is a director of ADP, BlackRock Fixed Income Funds, and MetLife. Hubbard is co-chair of the Committee on Capital Markets Regulation; he is a past Chair of the Economic Club of New York and a past co-chair of the Study Group on Corporate Boards.

Joseph E. Stiglitz is an American economist and a professor at Columbia University. He is also the co-chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and the Chief Economist of the Roosevelt Institute. A recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the John Bates Clark Medal (1979), he is a former senior vice president and chief economist of the World Bank and a former member and chairman of the (US president’s) Council of Economic Advisers. In 2000, he founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. He has been a member of the Columbia faculty since 2001 and received that university’s highest academic rank (university professor) in 2003. In 2011 Stiglitz was named by Time magazine as one of the 100 most influential people in the world. Known for his pioneering work on asymmetric information, Stiglitz’s work focuses on income distribution, risk, corporate governance, public policy, macroeconomics and globalization. He is the author of numerous books, and several bestsellers. His most recent titles are Globalization and Its Discontents Revisited, The Euro, Rewriting the Rules of the American Economy and The Great Divide.

Graham & Doddsville (G&D): Bloomberg’s Matt Levine sometimes writes about the idea that common ownership of firms in the same industry through passive index funds could, in theory, be anti-competitive. He writes that “the premises of the theory — that managers are responsive to shareholders, that shareholders are increasingly diversified, and that the joint interests of companies in an industry can conflict with the interests of consumers — ‘all seem, not just reasonable, but like basic textbook stuff’.” Martin Schmalz, a finance professor at Oxford and a leading proponent of the theory, asks, “Is there any plausible story for why these secular changes in the ownership structure of firms would not lead to a lessening of competition?” So, should index funds be illegal?

Glenn Hubbard (GH): That is absolutely silly. Full disclosure: I am a Director of the BlackRock Fixed Income Funds, and BlackRock definitely has a point of view on this subject. It is crazy to imagine that the existence of large passive investors like index funds and ETFs is facilitating anti-competitive behavior. BlackRock or Vanguard or State Street own X% of every large-cap company. Take the example that critics of common ownership use: the airline industry. The same people who own X% of the airlines also own hotels and everything else, so trying to monopolize the airlines would hurt them elsewhere. And there is just no evidence of this actually happening.

The bigger question surrounds how you would get discipline on companies if all investment were passive. That’s a more interesting question. If all investment were truly passive, it would be hard to have corporate control. You always need a strong, active market for corporate control. I think there will always be a need for active investors to help solve agency problems in corporate governance, whether that’s a large fund, a rich person, or a private equity organization.

Joseph Stiglitz (JS): The reason index funds became so popular was that they were doing a better job managing funds for ordinary investors, net of fees and transaction costs. The one caveat I would add to what Glenn said is, as more of the stock market is owned by passive funds, assuming they’re really passive and do not exercise any control, that means that you can get control of a firm with a lot less capital. If you had a company that’s worth $10 billion and is 95%-owned by index funds, then you can get control with $500 million. So you lower the threshold for getting de facto control. It becomes an empirical question. I haven’t seen that as a major problem, but I haven’t really been following it.

GH: On the competition point, what are the policy implications of banning index funds? For the average person, index funds are the low-cost, efficient way to invest.

JS: What Vanguard has done has just been amazing.

GH: It’s ironic for me to see these arguments and then simultaneously see Jack Bogle being rightly lionized after he passed away, because he truly made enormous contributions to the welfare of society at large.

JS: He didn’t make a lot of money out of it.

GH: By my standards he did! Fortunately, Columbia Business School is blessed to have some non-ordinary investors as donors, otherwise we wouldn’t be building Manhattanville. But most people aren’t those star investors. Index funds are, in my opinion, the right investment vehicle for most investors. If you ban them, how are average people better off as a result? They would be thrown back into a world where fees are relatively high and performance is relatively low. That doesn’t strike me as a good idea.

JS: I think the real issue is the danger that someone could get control of a firm with relatively little money. But with regards to index funds reducing competition between firms, there has been some literature recently on cross-ownership.

GH: Yes, and I don’t buy it.

JS: I’ve been very skeptical. I just don’t see the mechanism for it.

GH: You’ll be seeing some papers coming out on the other side of that argument.

G&D: The trade war is top of mind for a lot of investors right now. What is the political rhetoric getting right and what is it getting wrong?

JS: Well, the focus is on the bilateral trade deficit — I don’t think you can get any economist to say that makes sense.

GH: Except Peter Navarro.

JS: Yes, except Peter Navarro. You’re not even an economist if you say that, almost by definition. Whether you believe in free trade or not, bilateral trade deficits are not what matters. Trade agreements don’t determine the multi-lateral trade deficit. That’s determined mostly by macro.

GH: Meaning the financial gains and the opportunity for investment and savings.

JS: Trade agreements, i.e. what you import from which country, affect standards of living but don’t affect the macroeconomy. As macroeconomists, if there is an unemployment problem you use macroeconomic tools: monetary and fiscal policy. If they’re not working, something’s wrong. Some discussions on China are obscured by the fact that there is a very big difference between value-added production and gross production. A lot of what we import from China is stuff that is not Chinese. Probably 90% of the iPhone is not made in China. The value added in China is 10%. But when we talk about imports, we treat it as a $1,000 phone imported. In the case of China, the confusion between the gross numbers and the value-added numbers is a big deal.

That in turn relates to some of the confusion about what is at stake. The things that we export to China are by-and-large much closer to 100% value-added. When we export soybeans, 100% of the soybeans are made in America. When you account for the difference in value-added trade, it significantly changes the numbers and the trade deficit appears much smaller.

And finally, I think there is a broad issue that has come to the fore. It has always been with us, and we have never been able to face up to it. And that is managing trade with countries that have different value systems and different regulatory systems. We see it in the controversy between the U.S. and Europe on GMO. Europe says it cares about GMO, while many Americans think it is just superstition. But if Europeans really do worry about it, and it affects their utility, their view is they should have the right to regulate it.

We view GMO as a trade barrier. Even transparency is an issue. If Europe passes a law saying that you have to disclose GMO, then Europeans won’t buy American wheat, and we view that as a trade barrier. That has been a source of contention between the U.S. and Europe for a long time. That’s a narrow area, but you can see how two differing societies with different values come into tension over the right legal framework. We are so deep into GMO that if they restrict GMO, we can’t export many of our agricultural commodities.

Where this is coming up now is in privacy, secrecy, AI, big data — and I think I’m more on the European side of those issues. Privacy and the norms around cyber security are really important. But there are still huge benefits from trade. The question is: what are the appropriate rules for getting those gains from trade on something that might be called a roughly level playing field?

GH: I think that’s one of the reasons we’re struggling with the trade discussions, even though everything you learned in freshman economics is still true. Free trade is a good thing. But, the thing we always say under our breath, as economists, is that the gainers will compensate the losers. Well, we’re not doing that, and it’s a shame that elites around the industrial world are telling average people they should just suck it up because we’re going to be better off collectively. We are better off collectively, but not every person is better off.

JS: It could even be the majority of Americans are worse off.

GH: Yes. The majority could be worse off and measured GDP could still rise. I think this problem is a big one. The other issue is China. China is a bad actor in international trade. I think the President rightly called them out. But his problem is that of the dog chasing the car. What are you going to do when you catch it? To me, if you really want to tackle China you go after the fact that China made promises it did not keep. I was one of the people who pushed hard for China to go into the WTO, but China made promises it has not kept. Thus, I think there’s a real reason to challenge China in the WTO. But if President Trump wants to do that, he shouldn’t simultaneously attack the EU, Japan, and Canada.

JS: When he says that steel and autos are national security issues, he loses credibility.

GH: I’m not sure I would want to live in 1955, but even if I did, it’s not on offer. We shouldn’t be telling the public we can make it 1955 again, because we can’t. What we need to be doing is helping people prosper in 2019, or 2055. I think that’s the bigger issue surrounding trade. The ugliness on the trade issue has to do with a lot of people feeling left behind. Nobody lied to them. Trade does generate prosperity, it just doesn’t generate it for everyone.

JS: Economic theory predicted there would be losers from trade.

GH: Right, but if the surplus is large enough you can compensate them so that collectively we are all better off. But that hasn’t happened.

JS: Another aspect of the trade dispute is that we haven’t distinguished areas with international rules from areas without international rules, and this undermines the credibility of our contentions. For instance, there is no international investment agreement. There could have been one, but I think the U.S. overreached. China’s view on joint ventures is that everyone who came into China knew the rules of the game. You might say the rules aren’t fair, but there’s no international agreement saying you can’t do what they’ve done.

GH: They forced technology transfer, and that’s against the WTO protocol. But they say they’re not really forcing it.

JS: They’re not forcing it. Companies knew the terms. China’s view is that there’s no investment agreement saying that you can’t require joint ventures. There could have been, but it wasn’t negotiated and therefore they had the right to do it. But there was an agreement on cyber security with the Obama administration. All the evidence is classified so we can’t fully know, but everyone who looks at it says they violated the Obama agreement. That is a situation where I think they should more clearly define the rules in international or bilateral agreements. But we’re losing credibility by mixing “national security and steel” arguments (which are not credible) with arguments where there are genuine concerns.

GH: I’ve been on the U.S.-China Economic and Security Commission for the past few years. If you look at our reports, you will see that we hold hearings on all of these issues. The U.S. has blown its opportunity to lead a big WTO challenge of China because we don’t have any allies. It makes it hard. I always thought you were supposed to unite your allies and divide your enemies, but we seem to be doing the opposite.

JS: To increase your credibility and acquire allies, you use international laws. And there is a WTO forum for trade disputes.

GH: Which, by the way, we win much more often than we lose.

JS: Almost always. We win most of the cases.

GH: If you say, “The WTO is in our way,” that is not true.

JS: If Glenn and I brought a case to the WTO and they agreed with Glenn rather than me, I’d say, “That’s the law.” I’m very impressed with the quality of the judges at the WTO.

G&D: How is Jerome Powell doing as Fed Chairman?

GH: He is a good pick for that job in some sense because of politics, and I mean that with a small “p”. I don’t mean that he is political. I mean he is very good at “small p politics.” When I saw Jay in meetings of the American Economic Association, he was very good at calming people down, and this is a time when both Democrats and Republicans have their knives out for the Fed. Someone like Jay has exactly the right integrity and personality for the job.

I think he has made some missteps in communication, and that has contributed to market volatility. One is clearly about the size of the balance sheet. If you want to reassure markets, you need a theory of how big a balance sheet you need. Sometimes The Wall Street Journal editorial page writes as if we are going to go back to the pre-crisis balance sheet, but that’s an era when the federal funds rate was determined in the market for reserves, and reserves had a positive shadow price.

That isn’t the world we live in today. We now have foreign corridor systems, large balance sheets, lots of excess reserves, and interest on excess reserves. I think it’s naïve to think the balance sheet will be small. If the Fed were to say, “Okay, here’s where we think the balance sheet will be, and here’s our path to get there,” I think that would be much more reassuring to markets than saying “We’re data-dependent,” whatever that means. I give them some good marks, but I think there’s some work to do.

JS: Besides the messaging, I’m actually sympathetic to the Fed’s open-mindedness because, just to reflect what Glenn said, we’re in a new world now. There’s no a priori right size for the balance sheet. There’s no theory that dictates that…

GH: Right, so you say, “Here is how I, the leader, am thinking about it.”

JS: I think I would have been inclined to say what he said, because I don’t know what the right answer is either. That’s not good messaging; I wouldn’t be a good Fed Chairman. But what he said is an honest reflection of our current state of ignorance. But it also may be far less important than a lot of people in the market believe. My general view is that it is probably large changes that matter — and expectations of large changes — more than the level. GH: Also, many fingers are now pointing at the Fed with how the balance sheet rolls off, but a nearly trillion dollar annual budget deficit has a much bigger effect on the supply of Treasuries. Politicians should stop and say, “Wait a minute, where did all those Treasuries come from? From us, not the Fed.”

G&D: Which sector of the economy do you think will cause the next crisis?

JS: Some part of the financial sector. I think that’s where the fragility is in our economy for the most part. There are many parts of the economy where there is a lot of leverage. Debt is different from equity in a fundamental way — you have promises to repay which you will or will not fulfill. With equity there’s no promise, so you go up and down. It’s more of a continuous variable. But with debt you lend out money with the hope of getting repaid, and then if you make large misjudgments and people don’t get repaid, that has big effects throughout the economy.

I worry there are places where lending has gotten displaced out of our banking system. We have figured out how to control the banking system a little better, but that leads to non-bank lending that may not be monitored as closely.

GH: I would agree. Financial crises require leverage. If you look at the tech bubble collapse in the early 2000s, the economy barely hiccupped because the collapse was all about a decline in just equity value — some tech investors lost a lot of money, but the economy as a whole was fine. The financial crisis involved a lot of largely implicit debt that people didn’t even realize was debt but was effectively debt through securitization and tranching. And I worry about shadow banking for all the reasons Joe said. Shadow banking was a core problem of the financial crisis, and it’s still here. In many cases, it is worse and harder to find now because we have doubled down so much on bank regulation.

JS: Banks have lent money to firms that are engaged in shadow banking, so we haven’t done a great job at regulating what you might call “indirect lending.” If payday lending increases, who finances the payday lenders? The banks might.

GH: I worry that we haven’t learned the lesson from the Queen of England’s question after the last financial crisis. At the London School of Economics, she asked economists like Joe and me, “Why did nobody see it coming?” And the answer to her question was that nobody was talking to each other. So-called experts weren’t talking to practitioners. That has not gotten any better. I don’t think the Fed is aware of all the financial innovations actually happening in the country. And I don’t know that all the finance academics are either. I remain very worried. Everyone says we’re safe now. I don’t think so.

And the politics of it are so wicked. I will go to my grave believing that one of the reasons we see populism today is that during the financial crisis we bailed out the banks and failed to assist homeowners who could not refinance their mortgages. That pain and that memory will last a generation. I worry that if it happens again, we’ll be in trouble.

JS: I totally agree with Glenn. That was a really bad mistake on the part of Obama.

G&D: Should practitioners be paying more attention to academic research?

GH: The most successful investors I’ve known are actually pretty close to research, and they enjoy it because they can dig up opportunities that others might not see. Most successful investors I know listen a lot, and they don’t talk much. I often get people asking me for opinions and I say, “What do you think? You’re a billionaire. I’m going to learn more from you!” But they don’t say anything. These investors go to me, to Joe, and to a hundred other economists and synthesize the information like a honey bee going to different flowers. People say investing is not academic, but it’s very academic. And it’s not just financial research, it’s also economic research. I think Warren Buffett spends his time productively figuring out market structure questions and what I would call industrial organization questions. I’m not sure he’s as interested in finance as much as he is interested in economic intuition. The most successful investors I know talk to a lot of people in the business: not just in the company in which they’re interested but to people in the industry as well.

JS: Market structure is important because in competitive markets, profits are going to be competed away quickly. That’s why Warren Buffett always talks about building moats and making them wider. Lots of people would like to cross those moats. There is a tension here between what’s good for the economy and what’s good for the firm, but Buffett has a very intuitive sense of where there are sustained profits.

G&D: Can we get your views on the causes of recent market volatility, as well as your thoughts on Brexit?

GH: The recent market volatility is a result of both perceptions of Fed policy as well as overall policy uncertainty. Also, small movements in a few important variables can have big effects. Whether we can grow GDP at 1.8% or 2.8% over the long run is important — changes in views on that question can move markets dramatically, and policy uncertainty amplifies that. With regards to Brexit, there has been just an extreme lack of competence. Putting your country up on a 51/49 vote is unwise, and it has been negotiated terribly since then. Having said that, the frustration that led to Brexit is the same sort of populism we already discussed. There are people who point their fingers at the Leave voters saying, “They’re stupid, they didn’t understand it.” I don’t think so. I think they very well understood the implications.

And I think they very well understood that the country might on average be worse off under Brexit, but they felt they weren’t getting their fair share and they didn’t like the control issues with the EU. And I think that’s really the wild card of Brexit. It’s not just what happens between Britain and the EU, but what it means generally: are elites capable of selling average people on the benefits of the EU?

JS: The recent market volatility is not the result of a major change in the functioning of the financial markets. It’s not like high-frequency trading was just invented. By the way, I do think high-frequency trading adds to volatility and is not necessarily a socially productive activity, but it’s not the driving force behind the increase in volatility we’ve seen recently. I think it is exactly what Glenn said: we’re entering a world in which there is more uncertainty surrounding the parameters of the economy, i.e. what is the growth rate, etc. In a more normal world, the broad consensus would be that the economy is going to grow at population plus productivity. Productivity could grow at maybe 1.4–1.6%, but volatility in productivity is very small. In a normal world there would be a more broadly accepted consensus about the underlying parameters of the economy.

Yet, recent policy uncertainty has introduced a lot of uncertainty about medium and long-term growth rates. If anybody takes seriously what Trump says, and some people do, he says we can grow at 3–4%. To me that’s a fantasy, but I think some people believe it because they’re not decomposing the recent growth rate into the impact of a fiscal shock and the true long-term growth rate. When you have a big increase in the deficit, that will grow the economy faster than the underlying fundamentals. Saying, “Oh, we just grew at 3.5%, we’re in a new world” is really stupid. But some people out there want to believe that, and so we’ve seen a lot of uncertainty in the underlying parameters of the economy that we didn’t used to see. We had similar uncertainty back in ’08-’09, but we haven’t had it for a while.

G&D: Will the uncertainty continue for as long as Trump is President?

JS: The policy uncertainty will continue. It could even get worse. Remember we’re not only talking about economic policy, we’re talking about war — a President announcing foreign policy perspectives that are counter to what the foreign policy establishment says. These are not minor issues. There are people betting that within X months we’ll have a war in the Middle East.

G&D: What are your views on secular stagnation, and what are the implications for asset managers?

GH: I don’t believe in it.

JS: I don’t either.

GH: Yet, it is definitely important for asset managers to consider this question. Permanently low levels of real interest rates would affect the rate of return on all assets. But I’m not so pessimistic about long-run productivity growth. The way I see it, artificial intelligence and machine learning have all the attributes of what economists would call a General Purpose Technology (GPT), and if you look at previous GPTs, it takes a long time to see the full effects. I mean, Bob Solow’s famous quote “You see productivity everywhere except for in the productivity statistics” was uttered just before you could see it in the productivity statistics.

Part of the problem is not that scientific progress takes a long time, but that it takes a long time to change the way firms are organized. Whether you’re considering electrification or the internal combustion engine or mainframe computing, previous GPTs took a long time to become incorporated into the economy. I believe we are going to see a productivity transformation. We are not going to see the same favorable tailwind from the labor market because right now our society is both aging and not favorably disposed toward immigration, and the way you bolster your hours worked is through native demographic improvements and through immigration. So that’s less of a good news story. But if we’re talking about productivity, I’m pretty optimistic.

JS: There are two parts to secular stagnation. One is the short-run component, which you might call “macro management,” and the other is the long-run component, which depends on the rate of technological change. And we can never perfectly know about the long-run component until we experience it. I am mostly a techno-optimist with regards to productivity and artificial intelligence. I am a little more pessimistic about the way we manage our workforce, with a fraction of the American population either addicted to opioids or not well-trained, and with our average exam scores low relative to peers. There are two countervailing forces: our human capital is not doing well, but our technology is doing really well. How those will balance out, no one knows.

GH: The silver lining is that some of those things are fixable. Turning around demography is hard, but achieving an adequate healthcare system and treating the sociological pathologies that lead to alcoholism and drug abuse — these are problems we can actually address. The politics are admittedly difficult.

JS: I think there is a bit of a macro problem, and that is the increase in inequality combined with lower marginal propensities to consume at the top than at the bottom. The massive change in the distribution of income has macro consequences. And we know how to deal with that. There are clear needs for new infrastructure and labor force training. I think there is wide agreement over how to technically solve these problems. We just do not have the political will to solve it.

G&D: Do you have any advice for MBA students going into investment management?

JS: Buy low, sell high. Be smarter than everybody else.

G&D: Brilliant!

JS: My serious advice would be to think about market structure — not just good ideas, but market structure. In a sense, economists would call it arbitrage. Intellectual arbitrage. Take something that has worked in one place and try it somewhere else. If you can be the first person in, you get something out of it. Many of our advances are in one way or another intellectual arbitrage.

GH: I agree. The successful evaluation of entrepreneurial opportunities is all about putting a puzzle together in a way nobody else saw. To me that is also the secret to great investing. My other admonition to you is Biblical: To whom much is given, much will be required. You all need to care about the welfare of society, and we are depending on you.

G&D: Thank you for your time.