Raghuram Rajan has an unparalleled view into the social and economic consequences of globalization and their ultimate effect on our politics.
Rajan’s background is extraordinary: He has served as Chief Economist at the International Monetary Fund and Head of India’s Central Bank. He’s written several books, including one that won the Financial Times-Goldman Sachs prize for best business book in 2010. Today he is the Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business.
Rajan’s new book is an important must read that explains the dangerous connections among inequality, globalization and populism – and will change the way you think about the markets, government and local communities. It’s titled: The Third Pillar: How the State and Markets are leaving Communities Behind.
What made this conversation so good is not just what he says, but how he tells the story. As Rajan puts it: “All economics is actually socioeconomics – all markets are embedded in a web of human relations, values and norms… Throughout history, technological phase shifts have ripped the market out of those old webs and led to violent backlashes, and to what we now call populism. Eventually, a new equilibrium is reached, but it can be ugly and messy, especially if done wrong.”
Transcript: Raghuram Rajan, “The Third Pillar”
Chris Riback: Professor Rajan, thanks so much for joining me. I appreciate your time.
Raghuram Rajan: Most welcome.
Chris Riback: There is so much in your book and your thinking, but to my mind, if I had to, I would boil it down to the concept of balance and the need for balance and the loss of balance that occurs and I think to get into that conversation, we really need to understand the three pillars. So, what are the three pillars and what does it look like when they operate in harmony?
Raghuram Rajan
Raghuram Rajan: Well, in a sense, you’ve hit the nail on the head. This book is about the kind of balance that capitalism need to work. And it’s really a balance between the three pillars that hold society up. I would argue they are first the state, in other words, the political pillar, then markets or the economic pillar, and finally the community, the social pillar, but also in some sense in the modern world, the democratic pillar. And all three work to enhance the other pillars, but also to constrain them and if you think about the kind of society that emerged in the West, in the post-war era, the liberal market democracies, in many ways they worked because these pillars held each other in balance. And what happens every so often to upset the balance is either great calamity. One could argue that the Black Death, the various industrial revolutions and the two Great Depressions, one in the 19th Century and one in the 20th Century, all of them jolted the system and required the system to change.
Today, the information communications technology revolution is forcing us again to think about whether the system actually works and what needs to change to restore the balance and that’s really the question before us today.
Chris Riback: It sounds, and I don’t know if you have an interest in this type of area, but I almost hear a Star Wars type theme, that something external occurs to disrupt the force or the balance, some exogenous event, whether that’s a catastrophe like the Bubonic Plague, which you note, or a technological change, like the ICT revolution, the communications and technology, and something knocks that balance and knocks the force out of place. I’ve got a question. I want to ask you about the history a little bit, but before we get to it and I don’t want to jump too quickly to the punch line, but your focus and the subtitle of your book, How Markets and the State Leave the Community Behind, you are clearly focused on the community.
Raghuram Rajan: Yes.
Chris Riback: And again, I don’t want to get too much to the punch line, because we’ll get there, but we live in a globally interconnected time, obviously and we’ll talk about how things are shifting for populism, to nationalism, to trade partnerships and tariffs, but many argue that these shifts are exactly what happens as a world manages through a new internationally integrated reality. And so, given that, at the highest level, why is now the moment to think hyper-locally, rather than globally?
Raghuram Rajan: Well, it’s action and reaction. The action that we’ve seen over the last few years is, as you correctly point out, a globally integrated economy where the cost of doing business at a distance is falling because markets are becoming much more integrated across countries, there is an equal pressure for the state to become not just more powerful at the national level, but more powerful at the international level. International bureaucracy is getting stronger. International agreements are getting stronger. A lot being determined at the global level, rather than at the local level. And there’s a couple of things. One, it disempowers the local. Power shifts up towards the national and the international level, which then gives the local very little sense of agency, of being able to do anything about the forces that are hitting them. And second, because the local is extremely important to prepare people for capitalism, for the market economy, to prepare them in schools and community colleges and so on and, at the same time, it is important as a sort of safety net if the official safety nets don’t work, if there is a local calamity, big business is shut down locally, there is very little work, people come together to help because unemployment insurance goes only so far, because not too many people have other sources of income.
And so there is a need for collective insurance at that point. So the local becomes much more important, but if it’s not working, if the community is breaking down, if it is dysfunctional, it also doesn’t act as a support and then you have people faced with the full force of globalization, but very little to go back to and what’s the alternate about that point? They get angry.
Chris Riback: And we’re starting to see that anger and you talk about that and that’s one of the big concerns and big threats to, I think … And I’m paraphrasing you, to society at large, that that anger can be one of the driving forces. Help me understand how we got here. You talked about the various types of catastrophes and eternal impacts or changes. You’ve noted that the one … Well, is it fair to say that the one that we’re dealing with now is the digital revolution? But it’s more than that. It’s also globalization. So how do you see the digital revolution interacting with globalization and I guess why is it bad? So, what happened and then talk to me a little bit about why it’s bad because I’m sure many of your colleagues locally there at the University of Chicago can explain all of the reasons why markets work perfectly and the results of globalization and digital transformation have been excellent?
Raghuram Rajan: Well, it has its good and bad sides. Let’s talk first about what would happen and why they connected. And to some extent, we’ve entered a period of what some people call hyper-globalization. It’s not just about producing for exports or importing goods. It’s also producing back and forth across borders through global supply chains. We send stuff to Germany to form part of a car. The engine block comes back to, you know, goes to France, then gets [inaudible 00:09:40], et cetera, et cetera. Nothing is entirely produced within a country anymore. And we need to understand that that is part of the informational and communications technology revolution because now it’s possible to control these global supply chains. Earlier, you were worried about producing in Thailand for your plant in the United States, because what happens if there is some blockage? It takes time to know that there is a problem and it takes time to fix it when you don’t have the kind of communications that we have today.
But today, with that kind of inter-linkages, in that quality of communication, you can run these global supply chains very effectively, so you can produce in the most efficient parts of the world. Now, why is that important? Well, what that has done is, it’s in a sense when you look at the supply chain, the pieces that should belong in the developed countries most, are the pieces where there’s tremendous value added because of knowledge, because of intellectual property. The design parts, the financing parts, the marketing parts. Which are the parts that least belong in the developed countries, where labor is required, labor is cheaper and sometimes equally qualified in some of the developing countries whether it’s China, or Vietnam, or Thailand, and so the supply chain has been broken up. With the very high value added parts retained in the industrial countries, low value added parts sent abroad. Who does this affect? This affects the manufacturing worker.
So, that’s one constituency, which has often been adversely affected by the process of globalization and this has been happening for the last 30, 35 years. Of course, there are new jobs being created, but many of these jobs require higher skills. The older welder doesn’t work anymore, but the new computer-trained technologist has a job in growing our companies like that. So there has been a significant shift away from the low skilled to the high skilled jobs in the industrial countries and the effects have been felt in the small towns in the rural areas across the industrial world. So that’s one effect. The other, through technology, is what one might call, winner-takes-most jobs. Because technology expands your reach, one person can now do a job for many, perhaps by writing the appropriate software or the AI program which displaces many others. The rents go to fewer people.
These winner-take-most professions used to exist primarily in entertainment. It used to be the case that an opera singer in the United Kingdom, the most famous opera singer in the United Kingdom in the early 1800s used to make something like a million dollars in today’s money for performing the entire season. You know, that was considered a huge salary at that time. And, of course today, in the United Kingdom, Adele makes something like a hundred million pounds. That’s many, many times what opera singers used to make at that time. This kind of expansion in the salaries of those who affect a lot of people because the professions have become more winner-take-most. You prefer to listen to a singer on the radio today, rather than go to your local theater or your local community to hear a local singer. That’s happened across many professions. You want to hire the best and, therefore, the returns to capabilities have also increased tremendously.
So, both of those things, the globalization as well as the returns to capabilities because of the winner-take-most nature of professions have increased the returns high up in the scale, but have reduced the jobs as well as the salaries in the middle and the lower middle of the scale.
Chris Riback: Was there anything that could have or should have been done during that transformation? So, in taking the two areas, the dislocation of low skill, middle skills workers and what happened there and then separately the winner-takes-most, was it that the technological change and the effects of globalization happened too quickly and so our political structures and maybe even our market structures couldn’t react quickly enough in terms of retraining. You talked about perhaps the manufacturer, the laborer who takes a job instead at Boeing, but that takes a lot of free training and that sort of thing. Did it occur too quickly for the state or the markets, two of those pillars to react? On the other hand, the winner-takes-most, is that not the market working? If I really love Adele and I’m willing to support her at a hundred million pounds per season or the AI developer or the trader at Salomon Brothers, is that bad? Isn’t that the way … Did the market work the way it’s meant to? I realize those are two different questions, but you kind of identified two different areas of the spectrum.
Raghuram Rajan: No, I think the market is working as it ought to. The market is essentially expanding opportunities and, in this case, it’s expanding opportunities for some. It could expand opportunities for many more if the other two pillars worked properly. And this is where I think it’s important to note that people don’t enter a market at birth. There’s a process of preparing them for the labor markets. There’s a process by which they go through schools, they maybe go on from schools to colleges and eventually, at some early adulthood, they enter the labor market, fully prepared to engage in it and that’s when they take advantage of the opportunities it creates. The problem, I think, has been that on the one hand, our ability to prepare people has been weakening.
The quality of the schools varies considerably across regions in every country. The schools in New York and even in New York there’s a lot of variety, but in general, schools are better in New York than perhaps they would be in Oklahoma or Alabama in the United States. And, similarly, you see the same sort of disparity in Europe. The schools in London are better than the schools in more rural areas. So, one, people don’t get prepared the same way and the markets as we talked earlier are much more demanding of skills than they used to be in the past. A lot of people enter college, for example in the United States, but many drop out because they haven’t had appropriate training in the schools and they simply cannot take the courses that the colleges offer, even if they choose the right college and the right course and get in. They simply don’t succeed because their early training is not adequate.
So, in a sense, the state and the community which is supposed to prepare people for markets, has been failing and this is not a recent phenomenon. We’ve known that this is a process for the last 30, 35 years. It’s only with the kinds of elections we’ve had and the message that people outside the big coastal urban cities have been sending, saying, “Look, you’ve left us behind. Pay attention to our problems,” where, in the United States or in France or in Britain through the Brexit vote, these are all people sending the message, we’ve been forgotten. Take care of us.
Chris Riback: And you write about how they have been forgotten. How the incentives exist for the successful, particularly, I think, in a winner-takes-most environment, where the winners want to exit the failing communities and you just kind of explained it right there. There’s this … Evil, I guess, is a judgmental statement, but there’s a detrimental multiplier effect, I think, where the successful want to be with the successful and burgeoning communities, leaving the crumbling communities or slightly failing communities to go on, perhaps an accelerated path downward, further deepening the gap, so if that gap was measured at two inches 30 years ago, it’s now at, to exaggerate the point, multiple miles because of exactly what you just described. Am I understanding?
Raghuram Rajan: Absolutely. Because the market is creating such high returns to being well-educated, today an upwardly mobile couple looking around to see where they want to live so that the kids have the best possibilities for the future, are going to look for communities which have rich upwardly, mobile couples like them because one of the most important factors in how well you do in school is not so much the teacher, it’s not even the school, it’s the kids around you and how eager they are to learn, how prepared they are to learn, because that also sets the level at which the teacher can teach the class, so essentially, if you’re looking for people like you, there is this sorting that takes place and you can see it in the data, that if you look across communities in the United States, there used to be much more grouping around the middle and, today, there are far more communities in the extreme, extremely poor communities and extremely rich communities.
And you can see that one of the big factors in driving this is really couples with kids because they’re going to where … If I were deciding today … Fortunately my kids are grown up, but if I were deciding today just on the basis of what would be best for them, a reasonable metric would be what is the highest priced housing I can afford, because that tells me what other parents would be around in that neighborhood, how much time and energy they can devote to preparing the kids at an early age for school and how successful my kids will be in that school because they’re surrounded by kids like that.
Chris Riback: It’s not just winner-takes-most individuals and workers, it’s winner-takes-most communities.
Raghuram Rajan: Absolutely. One of the tragedies is that we are reaching that nirvana for the middle class, the meritocracy. But, unfortunately, it’s becoming a hereditary meritocracy. Only a few, the upper middle class, can achieve that. And because the bars to that success is largely blocked for people outside the small group who can go to those really good schools, the anger is exploding.
Chris Riback: Yes, let’s talk about that anger and on that previous point, you write about the pulling up of the ladders, once one reaches a successful area or a successful level, the puling up of the ladders to kind of block others from reaching as well and that is part of what leads to the anger. So, you talk about that and you outline circumstances in which popular resentment can turn to rage. What does that look like? I think we can all kind of imagine what that would look like, but maybe what are the precursors to it? We can imagine what it looks like in its ultimate state. We’ve all seen pictures of the American Revolution and the French Revolution, et cetera, but what do the symptoms look like and how close to that rage exploding do you feel we are?
Raghuram Rajan: Well, there are different forms of that rage. There is the populism of the left, which essentially says, look, we are not getting the opportunities in the market that we ought to, perhaps because we’re not being prepared. Our schools are failing. And therefore, in the United States, the social contract has always been we prepare you for the markets and, therefore, we don’t have too much of safety net. We don’t have strong unemployment insurance. We don’t have universal healthcare because we expect that you’ll figure it out, given that you’ve been prepared for the market and that, I thought, was always the social contract in the United States, very strong schooling, but then you’re let loose and you make of your life what you will and the safety nets are relatively thin though, of course, they’ve been strengthened over the years.
Today, however, when you’re not prepared for the markets, then the climate comes for a much stronger safety net. If, in fact, we’ve not been prepared, then what about these other things that we’ve left with big holes, universal healthcare, much stronger unemployment insurance and, perhaps, other forms of transfers. Now there’s a lot of talk of a universal basic income. So, that’s the populism of the left. The populism of the right is a little different because it’s not so much saying that I want handouts. In fact, there’s a sense amongst the community that’s been targeted by the right wing populists that you are the chosen. You have always been the strong in this country. The reason you’re not doing well is because the elites have messed things up for you. And so what we need to do is essentially create a much more level playing field, make sure that all these people who got extra benefits, the immigrants, the minorities, that they’re put back in their place, even while making sure that those cheaters from abroad, who are sending their goods here without playing by the rules, that their stuff is also kept out.
So, it’s a protectionist, nativist agenda and you can see similar themes across Europe, as well as in the United States. And these are two somewhat different reactions. But, unfortunately, I think neither of them recognize the fact that really, what is needed is strengthening the community to help people actually participate in full measure in this globalized economy.
Chris Riback: Which leads me to the key question. What is inclusive localism?
Raghuram Rajan: Well, I argue that we have to give a stronger sense of agency back to the community and in a sense, the problem we have in many developed countries is we have strong pockets of underdevelopment. We have communities with very little economic activity because the big firm has left town or left the country for Mexico or China. And this is not much different from the problem of underdevelopment in countries. How do you revive the community so that there is economic activity, so that there is better local institutions like schools and so on. And to do this, I think if you take the lesson from successful communities that have revived themselves, that have pulled themselves up, there has to be a much greater sense of agency in the community. So, yes, the federal government is important or the state government is important and them helping with the resources when needed is useful, but ultimately, the agency has to come from within the community. A sense of here’s who we are, here’s what we need to do, here’s how we revive ourselves.
The story of successful communities always comes from the community pulling itself up and so, to that extent, I argue we need to restore their ability to do that, perhaps with moving more funding into the local community and sometimes more bars that have been taken away. That’s the localism part. But the worry in strengthening communities is always the sense that they become parochial. They start erecting walls around the community, they benefit much less from being part of an integrated nation and that’s the inclusive part. That is, we need them not to raise high walls. Low walls are okay to preserve the sense of community, but raising high walls, keeping out goods from the rest of the country, keeping out people from other places, that doesn’t make sense. That’s not something that will allow it to benefit from being part of a large nation and that’s where both the state and the markets work to make the community inclusive, rather than the exclusive traditional parochial communities of the past. And again, the example I give in the introduction of the Pilsen community is one example of such an inclusive community.
Chris Riback: Yes, the west side of Chicago, but you are really arguing for or describing the best of both worlds, or the best of all worlds, and we all want that. We all want the best of all worlds. We all want our cake and we want to eat it, too. What is the magic, if you will, what is the incentive to entice communities to bind themselves together toward some sort of nationalist goal, collective goal? How do we keep from reverting and I know you kind of just were talking about this, because this is the big concern, to becoming a futile society? A set of societies with the high walls and the interest of interacting with other localities, extends only so far as maybe a little bit of local trade. Maybe there’s some natural good that the other local community is on Lake Michigan on the sore, whereas Pilsen is on the west side, so closer to Chicago Stadium and you get watch the Bulls and the Blackhawks and so, fine, there’s a trade. I’ll trade you some access to Lake Michigan and you give me some Bulls tickets. But, how do you entice a broader relationship than that if you’re putting so much power back into the local communities?
Raghuram Rajan: Right, and this is where the balance is, again, the critical word. You need more of a sense of agency in the local community, but not so much that the community can essentially become a futile locality with high walls around it and keeping out everything else. Now, what is important to consider is the alternative that we’re going towards, which is very worrisome, where because we have no, in many communities which are breaking down, we have no sense of community identity, of community health. The identity that seems to work then, as an alternative, is a more nationalistic majoritarian identity, people like me at the national level. And that’s a dangerous process, because what that works on is exclusion. It is only the Hindu majoritarian in India, who is the true born and everybody else is outside and not deserving of first level citizenship.
That’s a dangerous part for countries to take, because eventually, once you’ve reduced the internal enemies to second class citizens, then you look for enemies outside to bind your majority together because there’s very little binding that majority. Hindus are very different in different parts of India, so to bind them, you have to find external enemies. So, this is a dangerous movement in every country and I would rather that we found identity in the local community. Yes, it may be a community largely of Hispanics. It may be a community which is largely white or African-American, but it doesn’t keep out other people and that’s where the national laws come in that you cannot discriminate. But there may be a tendency for people to come together who have similar beliefs. A lot of cities would be very mixed, people of different communities living together.
But some communities may want to live with people of who they think are their own kind. It seems to me this is far less dangerous, especially if the walls around the community are porous. It gives people a sense of identity. It gives people a sense of agency. It may be that we, at least for a while, will live side-by-side in different communities and eventually will cross over into each other’s community. But the alternative of finding the only community at a national level with internal enemies and external enemies, which is what we are drifting towards, is extremely frightening and is something we have to combat.
Chris Riback: Would someone push back on you, professor, and say that sounds wonderful and now let me go through the history of local communities that have been created by the religious or racial identities of those people, whether that’s Iraq or the U.S. or other places in the Middle East or India, and I can show you throughout history the ways in which creating local communities based on identities, not only has not worked, but has resulted in fighting, war, increase in hatred, and so yes, it would be great if we had a world where that could all occur and everyone could just get along, which is what you’re describing and maybe there’s some civic nationalism that ties people together, but where’s the … You’ve got a couple of examples, Galena, the Pilsen neighborhood, [inaudible] India, but historically, is history on your side? Can that actually work?
Raghuram Rajan: I think it can be and I think that what we’re missing in this is that the nation has to be a nation that allows for all communities and allows for intermingling. That’s where the civic nationalism comes. It doesn’t anoint a particular community as the national community. Some of these examples you offered were essentially examples of countries where there is this one dominant community, there is one dominant religion, and everything else is excluded in favor of that. And that, to my mind, is the danger we have to avoid certainly in the west, but also in a number of emerging markets. And the onset seems to me, is at the national level of binding together through the national constitution, through the civic nationalism, through the anti-discriminatory laws that are in place. But at the local level, the possibility that if you do want to … Nothing prevents anybody else from coming into this community, but if the Mexican-Americans want to live together in Pilsen, yes, they live, but now increasingly, whites are coming into Pilsen and they find a way to live together.
And this is not a pipe dream. There are many neighborhoods in the United States, Jackson Heights is an example, where many communities live together side-by-side and over time, at the borders, they mingle more and more, and eventually it becomes a multiracial, multiethnic community. I think this is the history of the United States. How the melting pot happens. And all I’m arguing for is that we send a few more bars into the community, more funding, so that there is more of a sense of agency to combat the kind of disappearance of bars that happens as markets integrate and governments want to grow side-by-side with markets.
Chris Riback: Is it fair to characterize what you’re describing as local mono-culturalism, yet national multiculturalism or are you describing something where, yes, there may be local mono-culturalism, but it holds open the possibility for integration as you just described as maybe happening a little bit in the Pilsen neighborhood?
Raghuram Rajan: Well, I would love for there to be local multiculturalism and I think there will be plenty of it. All I’m saying is we shouldn’t rule out the possibility of local mono-culturalism also, to slate the appetite of those who want to preserve their culture, who find that their culture is being eroded by foreign elements that they weren’t used to in the past. If they want to preserve it that way, by all means, let them try and preserve their culture that way. But, by allowing communities to live side-by-side, you essentially make it such that one community doesn’t have to force its culture on the other, and that is the danger, to my mind, that many multicultural societies now face because the majority community feels that its culture is escaping. It thinks the only way to preserve that is to establish it at a national level and force it down on everybody. You’re not allowed to say “Feliz Navidad,” you have to say “Merry Christmas,” because otherwise somehow we will lose our cultural heritage. And that, to me, is extremely dangerous and probably even problematic for the majority community.
Chris Riback: And to close out, professor, the question of finding a new balance, where are we, in your sense, on that path? Is the pendulum still swinging away from that new balance? Do we have more division to go or are you starting to see the signs that the new balance is possible? Where are we?
Raghuram Rajan: Well, I think the questions are being asked very strongly. I see one of the virtues of democracy is that when the pressures have mounted enough, you see a vote which makes you ask, but why did people vote this way? I think the 2016 election in the United States, the Brexit vote, the ongoing concerns in France, all these are suggesting that things aren’t working. They’ve come to a boil. So the questions are being asked. Now I think we have to provide answers. And the answers are not some more monetary stimulus, some more fiscal stimulus, it’s about rethinking our societies. How have we got you? What kind of societal change do we need in order to accommodate the society of the future that is coming? And my worry is that unless these questions are forced upon us, we tend to ignore them because, after all, much of the problem is in the flyover states, but once they hate us, our initial impulse is to go to the old tried-and-tested answers.
But I think we need radical answers and we need to think of how society should look going forward and we need to make it a society that works for all, so I think we’re at the point where we actually realize there are serious questions. Answers? This book is an attempt to force people to say, well, let me think about my answer because I don’t agree with any of the answers that Raghuram Rajan talks about, which is fine. Let’s start the debate because it’s an extremely important one.
Chris Riback: It’s a terrific debate and my condolences to the person who takes their argument straight to your face. Because I think that you’ve thought about this so much and the questions that you raise and the ideas that you raise in the book, they are important and needed. And I thank you for them. Thank you for the book and thank you for your time.
Raghuram Rajan: Thank you very much.