Stiglitz: Jail Bankers

In this article, Joseph Stiglitz, arguably one of the most famous economists of the modern era, makes the case for the fact that bankers with privileged information who use this information unethically ought to be jailed.

For those of you who don't know, Stiglitz received the Nobel Prize in 2001 for his work on "asymmetric information" - information that distorts the free market economy and stunts growth instead of welcoming it.

I'll try to explain the basic idea, given my rudimentary understanding of economics.

Markets are claimed to be inherently efficient when operating under a capitalistic or free market system. You know, that "invisible hand" that Smith talked about, the magical essence that solves everything that is lauded by Libertarians and Chicago economists, etc. Stiglitz demonstrated that when information is imperfect, competitive market allocation is not Pareto efficient (i.e. someone can benefit without compromising the well-being of another individual).

Obviously, this relates to taxation. In a system in which imperfection information is used to gain an advantage, one party benefits at the clear expense of another party (see Barclays recent scandal, and just about every other banking scandal in history). But in a Stiglitz world, a greater degree of government intervention can take place before Pareto optimality is reached. And due to the fact that these information asymmetries are not Pareto optimal, government intervention becomes necessary.

To a layperson like me, this is actually fairly confusing. Pareto optimality states that a system is most efficient when one cannot benefit without reducing the welfare of another. Stiglitz essentially argues that tax interventions do not detract from the well-being of one party but do add to the well-being of a second -- how do tax interventions not detract from the well-being of Party A? Am I missing something here?

In any case, this all relates to why bankers need to be jailed. The use of asymmetric information is the transverse of Pareto optimality, and curbs economic growth instead of furthering it. A great market inefficiency is rent-seeking, and that is what super-banks and financial institutions have been able to due (with amassed political and economic power).

All this would imply that the power of banks ought to be curbed, but we're taught that curbing banks' powers will be counterproductive in the greater realm of the economy. What do you all make of this tension? Who is right? Do we jail bankers, or take some other means to lessen the power of large financial institutions?

Happy 4th.