It’s been back to work with Raghuram Rajan’s Fault Lines: How Hidden Fractures Still Threaten the World Economy as
my Tube reading. Professor Rajan is one of the economists who warned in advance
of the impending financial crisis – there were more of them than received
wisdom holds, but he was certainly one of the most prominent. His highest
profile warning came at the 2005 Jackson Hole Conference, when he presented a
paper arguing that recent financial developments had greatly increased risk in
the world economy and financial markets. At the time he was mocked for his
pessimism, but of course turned out to be correct.
Having been both right and brave enough to say so ahead of
the Crash, Prof Rajan has instant moral authority when it comes to diagnosis of
what happened and what to do next. His thesis is that the catastrophe was the
result of several deep systemic problems in the world economy, the faultlines
of the title.
Some of these are reasonably familiar. One is the imbalances
arising from the focus of certain major economies – Germany, Japan, China – on
export-led growth as opposed to domestic consumption. When some economies for
long periods run current account surpluses, others will have to over-consumer
and run deficits, and the US largely played that role. Martin Wolf focussed on
this issue in his book Fixing Global Finance.
Another is the clash between relatively transparent and
contract-based financial systems and those that are relationship-based rather
than market-based. Rajan makes some very interesting points about how the
information asymmetries arising from these differences affect the structure of
international financial flows – in particular, channelling them through banks,
in short-term instruments, and with an over-reliance on credit ratings.
Most interesting of all, though, is his analysis of the
political fractures contributing to systemic financial weakness. In short, he
argues that the massive increase in income inequality – especially the
politically salient gap between the 90th and 50th
percentiles of the income distribution – was patched over by easy credit. For
some years this meant that consumption inequality did not rise as fast as
income inequality. Rajan writes: “Easy credit has been used as a palliative
throughout history by governments that are unable to address the deeper
anxieties of the middle class directly.” Even more fundamentally, he notes the
tension between capitalism and democracy – identified of course by other
thinkers in the past such as Daniel Bell in his Cultural Contradictions of
Capitalism. And yet, we need both, as each mitigates the other’s deficiencies.
Rajan is somewhat pessimistic about fixing the structural problem. As he
writes: “Politicians today vow ‘Never again!’. But they will naturally
focus on
dealing with a few scapegoats, not just because the system is harder to
change,
but also because if politicians traced the fault lines, they would find a
few
running through themselves.” (p5)
Still, the book goes on to ask how we can fix the system to
enjoy the benefits of capitalism but in a politically tolerable way that doesn’t
rely on unsustainable fixes. Not an easy question, and no silver bullet
answers. Let’s hope politicians have the appetite for the long hard slog of
policies we all know are needed to fix the deep faults in western economies.
Anyway, a terrific book, clear and authoritative, from one
of the economists who was spot on about the crisis.
