April 12, 2017

Rajan: Expect "significantly greater turmoil"

I recently came across a fantastic interview with Chicago Booth School of Business professor Raghuram Rajan. Rajan was the 23rd Governor of the Reserve Bank of India and former Director of Research at the IMF.

He is one of the world’s most respected economic thinkers.

In 2005, Rajan warned about the ticking economic time bomb in the US housing market and global financial system. Today he warns about the continued slide into economic abyss that started in the 2000s and will continue for years to come.

Below are a few key extracts from his interview. (Full interview here.)

On the long-lasting economic malaise is fueling populist movements around the world:

We are experiencing a technological revolution and our society hasn’t responded fully to it, except in some smaller countries which historically have responded quickly to change. For example, the Scandinavian countries have always been subject to huge fluctuations in trade and therefore have responded quickly to external factors and changed the skill base of their economy. I assume that’s also true for Switzerland. But large economies tend to be much slower in adapting to change.

Why?
They often try to mute the effects of change as long as they can. In the US, the construction boom was an attempt to ward off the changes caused by technological progress, global trade and the disappearance of many middle-class jobs. The adaptation would have to been to improve skills and education. But that takes time. So the short sighted answer was to let the housing sector boom. That makes everyone feel happy and it creates construction jobs for the people who were being laid off from the factories. So you didn’t have to worry a lot about those fundamental changes until everything exploded. Now, we have to worry once again and I think that’s directly responsible for the populist movements we are seeing today.

In the US as well as in Europe, the populist movements feed off of anger against the establishment. Where does this fury come from?
Our leadership has been continuously saying that the solutions to our problems are easy and that it’s just a matter of stimulus: Some more fiscal stimulus and some more monetary stimulus and the economy will get going again. But our problems go much deeper and can’t get solved just with stimulus. How does it help the guy who left the labor force if the economy revives moderately? He’s not going to come back to work because he can’t really fit into the jobs that he needs. He wants to get a good job and the only jobs that are available to him are basically of very low quality. So he’s going to remain dissatisfied and becomes prey to the anger that radical politicians are sowing.

On the future:

The fundamental problems that led to the financial crisis are still with us. The economic forces that have been playing out over the last couple of decades are probably going to get worse. So unless we change the structure of our economy and society, we’ll probably risk significantly greater turmoil.

On the demise of confidence:

Across the industrial world there is fear of the future. In the 1960s with some distance to World War II and then again in the 1990s after the victory over Communism, people had confidence that the future will be bright and that the free market economy was here to stay. That certainty and that confidence has disappeared. An important part of the reason for this is the rising inequality before the financial crisis and the slow recovery after the recession. To some extent, our leaders are succumbing to this anxiety rather than standing up and saying: “Let us not shut ourselves up back into a box. It took us long enough to open up this box. Let us not go back into it. Let us adapt rather than shut down.”

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