New Delhi: Raghuram Rajan, former International Monetary Fund chief economist and currently professor of finance at the University of Chicago’s Booth School of Business, is known for his candid views. Rajan was in the Capital ahead of the launch of the Indian edition of his latest book, Fault Lines. He spoke to Mint about his book and other issues. Edited excerpts:
What inspired the book?
It all started when I was thinking what new I could say about the crisis. Why do checks and balances break down? That is when I realized that this is part of a bigger problem in the US. In some sense the US is a metaphor for industrialized countries. The issues there are those that countries could identify as their own; inequality for one. Inequality is a problem because when people don’t stand at the same level in the long run and see very different opportunities, then their attitudes towards reforms are very different. So ultimately, the destruction of a society is when you have extreme levels of inequality and you don’t have an agreement on anything. I think in the US there has been creeping inequality for reasons I document in the book—different access to education.
What about emerging markets?
For the emerging markets, particularly those that have focused on export-led growth, the lesson is that you need someone to buy. And in the last 10 years, it has been the industrial countries. But they are in deep crisis, so who do you sell to? And so, they have to adjust their pattern of growth. Fortunately for India, it neither became producer biased nor did it force exports. While this slowed the growth rate, it facilitated a much more vibrant domestic economy to grow. And when we liberalized, we did so across the board. In that sense, we have a more balanced economy.
Unprepared: India will not be able to survive if hit by a crisis similar to the one that hit the US, says Rajan. Priyanka Parashar/Mint
What I worry about India, however, is the problem of inequality. The rural areas, in many ways, are falling behind because they are not connected to the urban and coastal areas. Many of the ones that are backward do not have access to education, healthcare. It is very much a thing that the US has; so, in that sense, while 8-10% growth is fantastic, we also need to figure out how to expand opportunities for those being left behind.
Are the Indian social safety nets sufficient?
There is no substitute for giving people the capabilities to be productive workers. We are not a rich country. How much redistribution can we afford? Which means schools, healthcare, some level of insurance, financing, access to markets; roads that connect them to bigger markets; railway and transport lines. In a sense you have to move the vibrant economy into interior parts of India. So, I would say that many of these schemes are palliatives to keep the pressure down before they explode. I think they are necessary, but you can’t let palliatives overcome what is essential—creating those capabilities. There are ways, but they are enveloped in the old ways of socialist thinking, which I think is holding us back in tremendous ways.
But this will take time, while aspirations have taken flight. So will people have the patience to wait?
They won’t. This is why governance is difficult. I can sit here and preach, but somewhere out there someone has to balance it. While they are acquiring those capabilities, you have to allow them to live. Which is why targeted subsidies are fine.
But time is short?
This is where the politics comes in. The dangerous political path is to say we can protect you from all problems. If petrol prices go up, we will buffer them; if food prices go up, we will buffer those. Ultimately, food prices going up is telling you something and you need to respect that. The broader issue is that you can draw a social safety net for the poorest of the poor and this is where targeting is important. Targeting through UID (the government’s unique identity programme) could reduce leakages appropriately. I think we also need a mindset, which says that we cannot afford to go beyond this. Beyond that, the only way forward is to create capabilities. We have to some extent be careful about promising too many rights that we can’t deliver upon in an effective way or deliver in a distortionary way.
Your book talks about how foreign investments, while important, hold the threat of collateral damage. Doesn’t this pose a serious challenge to public policy in a country such as India?
That is why the Reserve Bank of India’s task is complicated at this point. On the one hand, these flows can be and need to be used. We are running a current account deficit—our savings are less than our investments. This is not necessarily a bad thing at our stage of growth..., but (we) also (need to be) improving the quality of the financial system to ensure that it can allocate these resources coming from outside appropriately. A key to this is the resolution of distress, where we are still inadequate. What if a firm goes bust? Even when the new Companies Act, which has a bankruptcy system in place, is passed, we have to ensure they are implemented properly by the courts. But if we can’t reallocate resources from entities that are failing or products that are failing, we are going to have very high costs of using this money...the plumbing of the system so to speak (has to be fixed). We can gloat for all we want (that) we bypassed the crisis…, but at the same time we must recognize that if a crisis of that magnitude hit our system, would we survive as well as the US system has? My sense is that, probably not. Because we don’t have the resolution mechanisms for deep distress and we haven’t tested our existing systems…we haven’t been tested. Till such time we can’t be complacent.
Is the worst behind the global economy?
I would stick my neck out and argue that we are on the recovery path of the global economy. I think we will have weakness in the second half of the year, but to go back to strong negative growth—I can’t see what will compel that.
What about China?
It is a big question mark, more because of the medium-term pattern of growth. Obviously, people are worried about the credit boom; they will have some problems there. But the big question is whether the inequality question that is building up will create an implosion at some point or whether it will somehow be managed away. I think the jury is out on that.
The fixes you are proposing in your book for the US as well as India will take time. For a politician, this is an uncomfortable reality.
I am saying that there are no magic bullets. Let us start with that. Everybody is looking for a quick and dirty answer. In fact, the whole search for the magic bullet is part of the problem. We thought we could deal with the problem through monetary or fiscal policy and find that doesn’t work. Once you accept this, then you realize you have to work for the long haul. What about the short term? I think the answer there is precisely the one India has given, which is you have to paper over the problems in the short term without doing long-term damage.
Going by what you say, politicians the world over are facing their most compelling challenge ever.
It’s a fair point. Politicians understand that long-term solutions are hard and so across the world they have focused on short-term solutions. Take China, for example. Its entire effort during the crisis has been to revitalize its exports without focusing on the fact that changing the pattern of growth is also important. Why? Because politicians know that one is a tried and tested path. Why go down the untested path right now? In the US, the Fed (the Federal Reserve) is on hold because monetary policy is a low-cost way of trying to get the economy back on a growth path. No matter if there are old problems—we are creating a bubble economy—we can live with that so long as the economy is back to where it was because then the jobs will be back and the politicians are back. To my sense, you are absolutely right and that is the central problem: the fixes every country has are very short-term, which ensures that the deeper fault lines are never addressed.