RAGHURAM RAJAN IS not just a former governor of the Reserve Bank of India (RBI) but an academic savant as well. As a theorist, he prophetically cautioned against imbalances in financial markets years before the global economy went into a crisis in 2008. He was at the helm of the RBI when the taper tantrum hit the Indian economy in 2013 and successfully steered from dangerous shoals. He was in New Delhi recently after the release of his new book, The Third Pillar: How Markets and the State Leave the Community Behind (HarperCollins; 464 pages; Rs 799), when Open caught up with him. He dwelt on issues ranging from central-bank balance sheets, economic reforms to the nature of political populism across the world. Excerpts:
Your two books—Saving Capitalism from Capitalists (2003) and Fault Lines (2010)—looked at troubled features of free markets. The Third Pillar looks at the social effects of lack of coordination between markets and the state. Together they suggest a crisis of Capitalism. Would you agree with that assessment?
Yes and no. I certainly think what I have been trying to do over the course of all these books is figure out why Capitalism worked and what’s making it not work. Obviously my latest book is my recent and best one. And what I try and outline are the various aspects of working Capitalism. It is not the caricature that some people have in mind of free markets meaning no regulation, no constraints and that all that is needed is for governments to enforce property rights. I talk about how the balance sort of emerged between, on the one hand, markets and, on the other hand, governments, providing not just contract enforcement, security of property but also support for people to participate in markets as well as safety net if they fall off and also what role the community played including in one of the most capitalist societies—the US.
I also talk of how community-provided education was central to the success of Capitalism in the US. So, that is to first build the picture of what true capitalism is and not dog-eat-dog. There’s more to it than that and then ask what is breaking down. That’s where I come down to the notion that technology keeps creating disruption and this time is no different. The mistake is to sort of think of this as temporary and that somehow by more stimulus we will deal with it. The reality is that it is a deeper, longer lasting problem that we need to fix through serious societal change. Now, one answer [Third Pillar] proposes is strengthening community because that can provide some of the underpinnings that are weakening—better schooling, better education, capability building. Of course that’s one answer and some people will say we need a stronger state; some people will want to suppress markets. I want to create a new balance where everything is more elevated rather than suppressed.
You recently wrote calling for a better populism, one that puts more trust in communities. Do you think in a polarised political environment across the world where there are stark Left and Right divisions, political parties are interested in empowering communities?
If you look at the present, the temptation is cynicism. After all, who is interested in change and who is interested in losing power? There’s a very nice episode of Yes, Prime Minister where Sir Humphrey Appleby says ‘Bernard, are you crazy? You want to empower communities?’ The reality is that, I think, power has been sort of accumulated increasingly at levels which are very far from the grassroots. In our country, of course, we’ve had a very strong empowerment of the Centre and sometimes state governments as opposed to the local and as a result the local is always looking for states or the Centre to do what needs to be done. If you need to clean a ditch out, it is not community activity: it is waiting for workers to come.
Not all solutions lie at the local level obviously. There are many solutions that lie at the national level. But to the extent that you can push powers back down as, for example, every finance commission in India over the last three or four times has tried to do, I think you get both more decentralisation and a stronger democratic engagement
That I think creates a couple of things. It creates a strong sense of powerlessness and it creates a willingness to essentially blame others for your plight rather than understand that much of the response is within your grasp. But this is true not just in India but also in the US and many countries in the West. One answer is let people have an ability to solve problems. Not all communities will rise to the occasion but many can, provided they have the powers and the resources. With new technology we have much better ability to do this, both in sending money—your Direct Benefits Transfer in India— and also in terms of monitoring the use of that money. How much has been spent locally and by whom? Do they have the bills? And so on. I think there is scope for change. Not all solutions lie at the local level obviously. There are many solutions that lie at the national level. But to the extent that you can push powers back down as, for example, every finance commission in India over the last three or four times has tried to do, I think you get both more decentralisation and a stronger democratic engagement.
Empowering local communities, you have said, requires improvement in local governance and maybe a different way of educating people so that they have skills to get good jobs. As you say, these are areas neglected for long and one reason given by governments is lack of resources. If communities are to be empowered, where will the money come from? More taxation?
No, from the resources the Central Government and state governments are clinging on to. If teachers know the state government is paying their salaries, they respond only to the state bureaucracy. If they know the local village is paying their salaries, then they are more responsive to the local level. That ability to hold local funds also gives people more of a sense of responsibility that this is our school, we have to make it better… it is about local monitoring.
The central bank’s balance sheet is one of the most misunderstood concepts. Ultimately the central bank is a wholly owned subsidiary of the government. So the central bank’s assets are those of the government; the central bank’s liabilities are those of the government. You cannot separate the two from the government
Modern Monetary Theory (MMT) seems to be turning many economic ideas upside down. For example, it has been argued that one does not have to worry about accumulating debt as long as you can print money. How do you react to that?
I think what [MMT proponents] are basically saying is that the constraints on raising money by the government are less severe than we thought. I think that may be true at this point when interest rates are low. It may not be so true when real interest rates went up. I think the notion that if you can issue in your own currency, then you have unlimited ability to issue is belied by the Indian experience. What is important is that the public trusts you to have the capacity to repay. You can always inflate it away. But if the public believes that you are going to inflate away the debt because you’re issuing in your own currency, it demands a higher and higher interest rate. The broader point about sensible economics that is you have a budget constraint and that you have to live within that budget constraint… you can take on some debt but you have to be growing at a pretty strong clip for people to believe that as the debt grows you can continue to service it. But at some point you’ve got to run out of borrowing capacity also. I think none of those are refuted by any theories that you can put together. So in that sense, if the assumption is that there are no limits—which I think [MMT theorists] will back off from—that’s clearly wrong. If they think the limits at this point are bigger than you think, maybe. But the history of government action is always to misuse the limit it has and spend more than its limits, so that you cannot constrain the spending at the time you want it. They sort of are thinking more of a tap that you open and shut. It is much harder to shut the tap and so it is much easier to get into deep trouble very quickly. That’s why I think all these theories need to be taken with a pinch of salt. There may be some value in what they are saying but be careful about adhering to their prescriptions.
In many countries a suggestion has been made on the part of right-wing populists that if central banks part with their reserves, then jobs, money for the poor and investments can all be undertaken. Purely in economic terms, does that make sense?
The central bank’s balance sheet is one of the most misunderstood concepts. Ultimately the central bank is a wholly owned subsidiary of the government. So the central bank’s assets are those of the government; the central bank’s liabilities are those of the government. You cannot separate the two from the government. What the central bank can do—and this is Modern Monetary Theory— is it can issue currency. But that is a liability of the central bank, very much like debt. And in fact at low interest rates there is no real telling between currency and debt. They’re both obligations of the combined balance sheet of the government and the central bank. At some point, when people come to redeem those obligations and assets, both [government and the central bank] have to pay. So there’s a limit to how much you can issue of each.
Some of the Third Pillar was written because I wanted to understand why democracy works sometimes in India, why it doesn’t work sometimes and when does apathy set in democracy
Now when people talk of central bank reserves they typically mean the foreign exchange reserves of the central bank. So it is largely a developing-country phenomenon or an emerging-market phenomenon because industrial countries don’t have huge reserves. And there they are saying that you have these assets, why don’t you use them for some good purpose like giving it to me or my uncle? And usually the arguments are that you’re investing in US treasuries at 2 per cent, why don’t you invest in my company which will pay you 3 per cent? The reason you want the central bank to lend you money at 3 per cent is because if you go to the market, you can only borrow at 6 per cent. So you’re essentially asking the central bank to give you a subsidy: lend at 3 per cent when the market wants 6 per cent. But this is never stated.
The other issue that this use of reserves forgets is that against the reserves you have liabilities already. You have currency liabilities; you have short-term debt, so how can you just give away assets to somebody when in fact you have liabilities against them? Reserves aren’t free: they’ve already been committed to pay down liabilities that the central bank has. So there’s lot of loose thinking about this. If you really think the project is worth doing, let the entity borrow from the market and subsidise its cost of financing with a direct subsidy from the finance ministry. Don’t ask the central bank to lend to that entity at the subsidised rate because the central bank is holding foreign exchange reserves for a different purpose—to provide stability to the economy, to provide liquidity when you need it.
In economic terms there is much that is common between Right and Left populists, for example, antipathy towards a liberal global trade regime. Don’t you think that is a bit strange as originally the two had very different economic ideas? What has changed in recent times?
To some extent Right populists are not your traditional conservatives. ‘Populist’ in general means you are anti-elite: you think the elite are corrupt, you think the people have a better sense of where to go. So that’s common to the Left and the Right. The Left think the enemy are the rich; the right-wing populist, as in the populist-nationalist, thinks the enemy are foreigners, immigrants, minorities… people not like us… that is the enemy. So they have very different enemies that they point out. The common factor is the anger against the elite, which is why I think we have to ask why in these times there is so much anger and I would say the reduction in opportunities for the broader masses, the sense that they don’t have the same chances as people before them is a big factor.
You’ve argued that if India manages its land acquisition processes carefully, then it has a lot of catch-up growth ahead of it. This has not happened across political regimes. How would you assess the chances of this happening in future, realistically speaking?
I think the lack of jobs eventually will force us into a situation where we have to do something—hopefully not on an emergency basis. But we certainly are seeing the difficulties. We don’t have good infrastructure. To get good infrastructure we need easy land acquisition. I mean getting decent office space in Delhi is extremely difficult. It costs more to get office space in Delhi than say in Beijing or anywhere else. For building a factory you need power, logistics, access to ports, airports and so on. We don’t do well there. Which is why when China is slowing and manufacturers are moving away into other producing countries, many think of Vietnam in preference to us. Vietnam started its liberalisation process as a communist country probably after we did. So we really have to think if we want to create those jobs that we need, whether in services or manufacturing… don’t we need to get our act together? Create the next generation of reforms. Now when we will see the imperative to do that, I don’t know. But certainly, I think the job issue is important and to tackle it before a full-fledged jobs crisis hits us we need to take up these reforms seriously. Will it take a crisis to push us into that? I hope not.
A slightly different question: Many academics of Indian origin come to India and hold policymaking jobs. But when they go back to academic life they never use their Indian experience to build grand theories, new theorems or models. George Akerlof came to India and observed the functioning of its economy. He returned to create the lemons model of adverse selection in markets. He got the Nobel Prize for that. I can count at least four or five top- notch Indian academics in such a setting. Where are the theories and models?
I think people do translate elements of their Indian experience into broader ideas. Some of the [Third Pillar] was written because I wanted to understand why democracy works sometimes in India, why it doesn’t work sometimes and when does apathy set in democracy. So you do learn from your experiences. I would push back a little on the claim of people not using what they’ve learnt. My sense is that Abhijit Banerjee [the Ford Foundation International Professor of Economics at Massachusetts Institute of Technology], one of the great economists of our time, has used a lot of learning from what he has done in India. I don’t think he’s had an official job in India. But he’s been here in and out many times.