Monday 18 March 2019 8:42 am

Raghuram Rajan: The central banker trying to save globalisation from itself

Political and economic debate generally divides around two pillars: markets and state.

Free-marketeers see a world where, when people are free to buy and sell according to the laws of supply and demand, business competition naturally drives quality up and prices down, resulting in prosperity and productivity for all.

At the other end of the spectrum are those who believe that an interventionist state must curb or even take control of self-interested businesses, which will otherwise distort society in their single-minded quest for profit above all else.

A lot of people, and a lot of political projects, fall between these extremes. Tony Blair advocated “the third way”, and David Cameron was a fan of so-called to “compassionate Conservatism”.

Raghuram Rajan is the latest to explore the fertile ground between the two poles. The Chicago Booth professor of finance and former governor of the Reserve Bank of India has written a new book , The Third Pillar, in which he lays out a comprehensive narrative of what has gone wrong, politically and economically, over the past half-century – and how to fix it.

The missing link according to Rajan in society’s battle between markets and the state? Community.

Citizen of nowhere

Rajan might appear an unlikely advocate of localism and devolution. An Indian national who now works in the US at one of the top universities in the world, via being chief economist at the IMF, and tipped in some circles as a contender to run the Bank of England, he seems to fit Theresa May’s description of a “citizen of nowhere” more than a community champion.

But perhaps it is Rajan’s globe-trotting background that has led to his faith in communities as the neglected third pillar of society – he’s observed the problems arising from disengaged communities across the world, from forgotten steel towns just outside Chicago, to developing villages strewn with litter in rural India.

Wherever you go, the problems of unchecked markets and overbearing states are the same – and both are in part down to weakened communities.

According to his book, society can only function properly when the three pillars are balanced.


The democratically elected state aims for a degree of fairness in economic outcomes, limiting markets and ensuring that they are competitive.

These competitive markets drive efficiency and, as long as the state is not too heavy-handed, produce wealth.

People, organised in strong local communities, can make their voices heard and inoculate both the state and markets from the forces of corruption. That’s the theory, anyway.

Secession of the successful

I point out to Rajan that many from his discipline adopt a more radically liberal approach to economics, and might bristle at his assertion that markets need keeping in check.

“Free and competitive markets are a beautiful thing, but that should be distinguished from a laissez-faire attitude, because the natural tendency of markets is to concentrate and create structures that reduce opportunity,” he warns, emphasising how crucial it is that people have the skills and potential to participate in the market.

“Sometimes we have this naive view that we’re thrown into the markets fully prepared. But as the technology revolution has progressed, the entry requirements to the market have increased, and the ability to participate gets diminished.”

Of course, we have seen technological revolutions displace jobs before, from farmhands to wool-workers to typists. Why is this time different? And isn’t there a case that technology, in a number of areas, actually makes market participation far easier?

“Each time there is a revolution, the requirements for market participation increase. So what was adequate for the previous revolution is no longer adequate for this one.

“In the second industrial revolution, what was required of workers in new industries was basic numeracy. Today, in order to work in some of the most promising technological fields, you need an undergraduate degree.

“We’ve upped the requirements, and in many cases we haven’t upped the ability to achieve those requirements.”

It’s all very well for economic liberals to see rising GDP figures and ignore the regional and educational inequalities that are worsening as a result, but such short-sightedness has a cost.

As economic opportunities are geographically clustered, particularly in certain industries like technology, people with the skills to take advantage of them will coalesce, moving out of their communities.

Their children will be raised among others with similarly talented and driven parents, and have better opportunities themselves to acquire the skills needed for the new job market.

But the communities which these high-achievers leave behind will suffer an exodus of talent. Rajan calls this the “secession of the successful”, which can lead to a “hereditary meritocracy”. It is no wonder that resentment builds up, and that the system, endorsed by both markets and the state, is seen by many as inherently unfair.

Worse, with powers – and public funds – resting with a central government that may not understand local priorities, people in deteriorating areas can quickly end up feeling ignored and left behind.

This is especially true when governments listen too much to powerful business lobbies and are overly keen to promote superstar industries that may not be accessible to the majority.

This can spread disengagement and apathy, which can be seized upon by populist voices. From the election of Donald Trump to the Brexit vote to rising anti-establishment movements across Europe, recent years have shown the political fallout when vast swathes of society feel that neither the economy nor the government are working for ordinary people.

Community spirit

Untangling this Gordian Knot is no easy task, but Rajan believes that the answer starts with the communities themselves – getting talented individuals to stay, and giving neighbourhoods the tools to drag themselves out of decline. “The whole idea of capitalism is free entry, for everyone. We need to reduce the incentive to leave, by spreading opportunities.”

Obviously, it’s human instinct to do what’s best for yourself and your children. But Rajan’s idea is that, if people can be convinced to maintain a connection with their old communities, you can create “hubs of excellence” within the communities themselves, and break the vicious cycle.

And with devolution, communities can, with the help of these engaged individuals, start to rebuild. After all, who knows better what a struggling community needs: politicians far away in the capital, or local residents?

“Central top-down policies are relatively ineffective here,” he says, touching on another theme of the book: the misguidedness of too much centralisation in solving local problems.

“The one-size-fits-all centralised national or supranational policy is doomed to fail, because it doesn’t address the needs of specific areas. Each neighbourhood has a very different set of problems, and globalisation accentuates the difference.”

The book is full of examples of communities across the world that, once given agency, turned around their failing fortunes and learned how to thrive again. But central politicians governing out of prosperous capital cities will likely be reluctant to cede power – and, just as importantly, money – to a local level.

“There’s an unwillingness to trust locals, because those guys aren’t experts, so how do they have the ability to make better decisions than us?” he admits. “That’s what we need to combat.”

While Rajan sees an important role for central government in terms of policy areas like infrastructure and education, he says that, were he put in charge, his first move would be to reach out to local leaders and listen.

“We need to trust communities more to figure out what makes sense for them,” he says.

That means devolving some funding, and channelling central programmes into locally-run initiatives. This is unlikely to be popular, but he stresses the importance of doing it anyway.

“As far as possible, what you don’t need to pull up, you should push down, so that people can make more effective governing decisions.”

And while Rajan avoids making any predictions on Brexit, he does point out that at time when, in the UK at least, central government seems gridlocked on one specific issue, perhaps now is a better moment than ever to let local communities take the reins on addressing problems that Westminster is too distracted to fix.

Purpose over profit?

There’s a growing school of thought that argues for business to have a purpose beyond profit, like protecting the environment or championing diversity. Terms like ethical capitalism and benefit corporations have sprung up in recent years, in part because of the backlash following the financial crisis.

But Rajan sees an issue with asking markets to “play the role of the state” – say by creating a safety net, or taking a more radical approach to environmental sustainability than the law requires – as it blurs the lines between the responsibilities of each pillar.

“I think we have to be very careful about making any of the three pillars do something different from what it’s intended to do,” he cautions.

“The purpose of markets is to have productive efficiency. That typically should be what they strive to do.”

Profits, he says, are one measure of business success, but not if they come at the expense of competition, as big firms consolidate power and resources to form monopolies and cartels.

Again, his remedy for out-of-control companies comes down to the balancing roles of the two other powers – the state and communities – rather than expecting business to fill the gaps.

“It’s a healthy role for communities to ask for change and force the state to control the markets appropriately.”

Monetary policy magic

As the former head of the Reserve Bank of India, I’m curious as to what role Rajan thinks central banks can play in this trichotomy. He is broadly complimentary of how institutions like the Bank of England, Federal Reserve, and European Central Bank responded in the aftermath of the financial crisis, yet feels that perhaps too much is expected of central banks now, particularly by fixating on the two per cent inflation target.

“I think that central banks after the crisis performed incredibly well in terms of cleaning up the system. But I think beyond that, a lot of pressure has been put on them to promote growth, and my sense is that some of that pressure is probably more than central banks can deliver, and is a recipe for disappointment.”

Central banks have delivered programmes such as quantitative easing designed to spur growth, but Rajan worries that a reliance on monetary policy distracts politicians from focusing on other factors, like productivity, business concentration, or the impact of an ageing population. He would doubtless find an ally at the Bank of England in chief economist Andy Haldane, who is trying to remedy this.

“If you don’t have a job, lower interest rates are not going to help you. You need to first get the skills to participate in the market. If there’s a lot of crime, you’re not going to go out onto the street and work, because crime is keeping you at home. Those disconnects between various communities and the mainstream economy need to be rectified.

“Often we sit and wait for monetary policy to do its magic. But beyond a certain point, it can’t.”

Not only will financial risks build up if monetary policy is loosened in pursuit of elusive growth targets, but it gives politicians an excuse to avoid confronting other barriers that require potentially unpopular solutions.

“My concern is that expecting too much of monetary policy encourages financial risk-taking without encouraging real activity. It gives comfort to those who should be acting that somebody else is acting, so why take the risks right now?”

To illustrate this, he quotes an unlikely source. “I love Jean-Claude Juncker. He has this phrase: ‘We all know what to do, we just don’t know how to get elected after we do it’.”

Global versus local

The world faces many problems to which increased localism, however worthy, can never be a sufficient answer: climate change, civil conflict, mass migration, and the growing power of multinational corporations, in particular the tech giants. Surely Rajan accepts the need for supranational organisations to have some role in addressing these challenges?

“I worry that we don’t have the right global cooperation to address these,” he acknowledges. “Certainly climate change is something that we need global dialogue on, and when we’re either shooting actual bullets or trade bullets at each other, it becomes harder to have that dialogue.

“But I also think that we should push back the tendency to pull many issues that are sovereign into the international arena and find a one-size-fits-all policy, often driven by the needs of the strongest companies and the strongest countries. Instead, let’s push things back down, so that people have more of a sense of engagement.”

That might feel riskier than ever at a time of heightened nationalistic sentiment, with populist rhetoric – in America and Europe – raging against the globalist world outlook.

That’s an outlook that Rajan both embodies and champions, which is why he’s so passionate about rebuilding the consensus of liberal market democracies, rather than imposing the approach on anyone.

“We shouldn’t minimise the benefits of global peace which we’ve had for 70 years, which is based on trade and investment, but also on a sense of trust that we’re not trying to steal a march on each other, that I benefit when you grow. It’s not a zero-sum game.

“I fear that we’re throwing the baby out with the bathwater and saying ‘none of this works’ – it does work. It’s worked for decades. We need to understand why that system has been so successful, so we can figure out why it stopped working.”

His warning to those on both the left and the right who call for the entire system to be torn down is stark.

“Take away the markets and democracy suffers. We don’t have a single socialist country that is also a true democracy. Similarly, you can’t have unbridled free markets without creating people who don’t have the capabilities to take advantage of that.

“How we rebalance so that all the parts work together, that’s our challenge. It’s very easy to go socialist or go fascist, but those aren’t outcomes that we want.”

Finally, what of those rumours that his name is being mentioned in talks about who could replace Mark Carney when his term as Bank of England governor is up in January 2020? I ask Rajan what future plans he has, and he laughs, and leans in conspiratorially.

“I’m going to go back to Chicago – and get some sleep!”

Not a denial, then.

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