This wide-ranging interview by Wharton finance professor Jeremy Siegel with Raghuram Rajan, an economics professor at the University of Chicago and former Governor of the Reserve Bank of India, covers topics ranging from his new book to the economic future of China and India. Joining the discussion, which occurred on Wharton Business Radio’s Behind the Markets show on SirusXM, were Jeremy Schwartz, Liqian Ren and Gaurav Sinha from WisdomTree ETF Investments. Schwartz is also the regular moderator for the show, which features Siegel.
In summarizing his new book, The Third Pillar: How Markets and the State Leave the Community Behind, Rajan explained how the deterioration of support for people from their local communities, themselves left behind by markets and governments, has been the key reason for the rise in different varieties of populism, which he says now threaten capitalistic economic systems.
Rajan became one of the world’s most-respected economists in the wake of the financial crisis. That is because not long before the crisis — in 2005 at the Jackson Hole economic conference — he warned about significant gathering risks to the world’s financial system. His warnings went ignored and were dismissed by most prominent economists at the time. He came to be viewed as one of the very few economists to foresee the worst financial and economic collapse since the Great Depression. (Listen to the podcast of the show above).
An edited transcript of the conversation appears below.
Jeremy Siegel: Your book is wonderful. Would you summarize it?
Raghuram Rajan: It’s a book which says much of the debate in the 20th century was about “how much government, how much markets?” I argue that a critical component of a well-functioning capitalist society is not just the markets, not just the state or the government — but the third pillar, which is the community. That’s central to preparing people to participate in markets that are giving them the early childhood education, the values, the nutrition, the health that makes them adequate market participants, but also in many countries in supporting them, when they fall off the markets.
When you lose your job, when you run out of your savings — where did people in Southern Europe, for example, go during the Great Recession? They went back to their families. They went back to their villages, because that was the structure that supported them. And similarly in the U.S., we have this phenomenon of many kids not leaving home and living in their parents’ basement post-Great Recession, because they simply couldn’t find jobs.
So the community in a sense is both pre-market preparation — helps you become adequate market participants — but also it’s post-market support. It’s a kind of safety net. And perhaps most important of all, it is also the basis for democratic action. What I document in the book is that many times, the basis for capitalism — opportunity for all — has been protected by democratic protests, for example, in the 19th century by the early populist movement — the farmers protesting against the monopolies — the railroad monopolies, the banking monopolies — and in that process trying to open up capitalism wider and preventing the nexus between the big capitalists and various aspects of the government.
“The way to deal with this very differentiated impact of technological and globalization across communities within a country is to start at the community level itself — to repair our communities.”
So the central thesis in the book is the reason we feel uneasy about capitalism today — the reason there is so much protest across the world — why we see the rise of populist nationalism – I relegate it all largely to weakness in the community.
Across the industrial world, we have communities that have been hit three times. First because trade and technology have hit some communities really hard. Granite City, Illinois — which is a steel city — essentially lost an enormous number of jobs. And you can find places like that across the industrial world. The places that, for example, the French Gilets Jaunes are protesting from. Second, in these very places, you also see that soon after there’s an economic loss of jobs, you also see social dysfunction creeping in. Because people don’t have jobs, you see marriages breaking up. You see substance abuse. You see teenage pregnancies. And as social dysfunction sets in, the local institutions start breaking down. Schools no longer are adequate and don’t teach as well as other places.
And then what you have is the third problem, which is in order to get the jobs in a technologically advanced economy, you need superior skills in order to move up from where you were. And that’s much harder when your local institutions aren’t functioning, when your schools aren’t providing — or your community colleges aren’t providing the kind of training that you actually need.
So essentially I would argue the way to deal with this very differentiated impact of technological and globalization across communities within a country is to start at the community level itself — to repair our communities. And that’s the way we’re going to deal with technological change. In part, the reason I keep saying we need to start in the community, rather than in Washington, is because each community has a different problem, and the specific problems of the community have to be dealt with there itself, by the people who know it best. And how do we make that happen in these communities which are breaking down? This is the key problem, to my mind, of industrial countries today.
Siegel: It’s a very interesting question — is this rise of this populist/nationalist really due to a pushback on capitalism or markets, or is its source something different?
Now there was an interesting article recently suggesting that the rise is not really anti-capitalist, but more anti-immigrant, anti-others imposing their way of life. If you’re anti-capitalist, you wouldn’t vote for Republicans and Trump. I don’t think you’d vote for Boris Johnson and Brexit. And even Modi — these populist leaders are seen as more pro-market or more capitalist. In Poland they wanted to purge the Communists that they thought were still running. And it was more of a “Don’t tell us what to do. There’s this liberal elite world that’s all integrated, and they all have their set of values, and they think everyone should have this set of values. And I don’t agree with that.”
Rajan: Professor Siegel, I didn’t say it was anti-capitalist. I said it was a threat to capitalism. And I’ll tell you why. The premise of capitalism is largely open markets — that means open flows of people, goods, capital, et cetera. And there are various forms of populism. There’s the populism of the left, which is more about redistribution. “We’re losing, therefore we want redistribution, even while erecting barriers to trade.” There’s populism of the right, which is certain forms of nationalism. Again, there are many varieties of that.
But often the component that’s most anti-market is the protectionism in that populism of the right. But there’s also anti-competition — “Oh, these migrants are taking our jobs, so let’s keep out the migrants.” Or “Oh, these foreigners are competing with us, let’s keep out foreign trade.” So those are elements of the anti-market. And this goes back to my point about the community. One of the features of integrated markets and technological change is precisely that markets come together across the world. And what market participants want essentially is a common playing field. But they also want it to be the same pretty much where they go. They want the same rules, because they want to be able to essentially minimize transaction costs as they go across markets.
So the tendency of markets when they integrate is to essentially imply an integration of governance, also. To give an example, it used to be when banks were in a town, the town used to set capital requirements for banks. That used to be regulation for banks. Now as banks became state-wide, the state capital used to set capital requirements. As banks became national, they were set at the national capital. Today they’re international, so Basel — a small town in Switzerland where central bankers meet — that’s where capital requirements are set for banks internationally.
The point here is that governance tends to migrate up. In fact, if you think about the European Union, the entire project is about harmonization of governance across European countries so that there is a common market. And that will allow for the free flow of goods and people across that market — the “four freedoms” that Europe talks about. The problem with that is people are not happy when they don’t have control, when they see decisions being made.
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