JUDY WOODRUFF: Now, part three of our economic look, a Paul Solman conversation about the financial crisis with Nobel Prize-winner Robert Solow of MIT. He won the economics award in 1987.
PAUL SOLMAN, NewsHour Economics Correspondent: Bob Solow, welcome.
ROBERT SOLOW, Nobel-Prize Winning Economist: Thank you. Glad to be with you.
PAUL SOLMAN: You’ve been around for a while. How bad is this?
ROBERT SOLOW: Well, you know the famous phrase, “It depends what the meaning of ‘is’ is”? Well, it depends what the meaning of “bad” is here.
As a financial crisis, it has got to be quite bad. Oh, it probably verges on the very bad. The worst aspect is that it has already begun to eat away at the health of the real economy.
PAUL SOLMAN: Explain that, if you wouldn’t mind. I mean, we have just as many people. We have the same land. We have the same structures. And we have more technology. So how can we be less rich?
ROBERT SOLOW: Suppose I were some fabulously wealthy potentate, and I was considering buying the United States, but I wasn’t really considering buying it until 50 years from now. In that case, the value of this bauble that I’m considering buying hasn’t changed much.
But what has changed is the short-run prosperity of the country. What happened in the course of the financial crisis is that the institutions, mostly banks, but also including insurance companies, and credit unions, and all sorts of that — of institutions whose normal business is to finance industry, to finance people who want to buy cars, to finance people who want to buy houses.
PAUL SOLMAN: To finance farmers who want to plant, but…
ROBERT SOLOW: Yes, and finance farmers…
PAUL SOLMAN: … the crop won’t come in for a while.
ROBERT SOLOW: And they’ve been paralyzed. So businesses that would normally be investing in a new computer or a new fleet of trucks or whatever would need to borrow from that, and it can’t borrow. And if it could borrow, it would be paying a very high rate of interest. They stop doing that.
And then the real economy begins to slow down, and people lose their jobs because their firms can’t sell. They can’t sell to consumers. They can’t sell to other businesses.
And that creates the sort of recession that we probably have now.
Modern economy is vastly complex
PAUL SOLMAN: But if everybody was going along on the assumption that things were going to continue to grow, and so you would lend me money and I would lend somebody else money, and so forth, and we would all be as productive as we have been...
ROBERT SOLOW: Yes?
PAUL SOLMAN: ... just because the institutions that funnel the credit to us suddenly freeze up, and suddenly things aren't worth as much we think as they were worth, that we then stop making the effort?
ROBERT SOLOW: Well, you've got these hands that you've been waving, and suppose just suddenly the arteries that brought blood to them got somehow clogged up.
They're hands. They're just as good as they were before. You're telling -- you could tell them what to do. But they might not do it, because it's -- because a modern economy is a more complicated piece of machinery than a simple -- sort of simple thing that you could imagine.
PAUL SOLMAN: You mean the old barter economy, where I give you the food...
ROBERT SOLOW: Yes, or...
PAUL SOLMAN: ... and you give me the iron, whatever.
ROBERT SOLOW: Yes, that's right. Whereas now production is very complicated, you start with God knows what, and you end up with some extraordinarily complicated piece of equipment or the machinery that appears in my dentist's office when I sit down, that can't be directed without a good deal of action which is taken now and can only pay off many stages later.
Housing, credit woes connected
PAUL SOLMAN: And that's what credit is.
ROBERT SOLOW: And that's where the credit mechanism comes in.
PAUL SOLMAN: And if it messes up for whatever reasons?
ROBERT SOLOW: Then the industry that depends on it has to slow down, simply because it can't get the funds that enable each stage in production to pay off the previous stage.
We have fluctuations all the time, business cycles, and they come about in various ways, but normally what sets them off is some reduction in the willingness of our population, our businesses, and foreigners to buy.
And that reduction in willingness to buy, you know, which then, you know, gets forced back through the system -- I won't buy from you, so you can't buy from whomever you normally buy from, and so on -- that reduction can come about in all sorts of ways.
It can come about purely for psychological reasons, from pessimism. If businesses that are normally investing in new equipment and building new plants and all that become, for whatever reason -- it's usually not for crazy reasons, it's for a sensible reason -- become more pessimistic, they'll stop, and the whole machine will slow down.
What we're experiencing this time is a kind of slowdown of this sort, worse than a slowdown, a reduction, which is set off primarily by initially this enormous over-building of houses that took place during the boom period.
So we have stopped building houses essentially. The number of housing starts in construction is very small. And that affects the suppliers of the materials, and the appliances, and the whatnot that go into those houses...
PAUL SOLMAN: And in our audience, a lot of the brokers...
ROBERT SOLOW: ... as well as the workers. From that, the thing got into the credit markets. And that's an easy way of -- that's a culture medium for trouble.
PAUL SOLMAN: You mean like as bacteria...
ROBERT SOLOW: Yes.
PAUL SOLMAN: ... growing or something?
ROBERT SOLOW: Yes, and adding to the burden of trouble.
Another depression is unlikely
PAUL SOLMAN: You don't think we're going to a Great Depression? You don't think we're going to social unrest? You don't buy the...
ROBERT SOLOW: No, no, I don't think we're going into a depression like the 1930s.
Look, to put it quantitatively, when I was a boy in the Great Depression, the unemployment rate in the U.S. reached something between 25 percent and 30 percent. That's an enormous number.
We're talking now -- I, for instance, am horrified at the thought that the unemployment rate might go to 8 percent. But 30 percent? No, we're nothing like that, I think, is going to -- is going to happen. We know -- we know more about what to do. And piece by piece, we're doing it.
PAUL SOLMAN: Bob Solow, thank you very much.
ROBERT SOLOW: You're welcome.