In Search of Dynamism
A Crisis in Two Narratives
Raghuram Rajan
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In the related Project Syndicate video, Raghuram Rajan expands upon the views expressed in this commentary. Click here to watch.
CHICAGO – With the world’s industrial democracies in crisis, two competing narratives of its sources – and appropriate remedies – are emerging. The first, better-known diagnosis is that demand has collapsed because of high debt accumulated prior to the crisis. Households (and countries) that were most prone to spend cannot borrow any more. To revive growth, others must be encouraged to spend – governments that can still borrow should run larger deficits, and rock-bottom interest rates should discourage thrifty households from saving.
Under these circumstances, budgetary recklessness is a virtue, at least in the short term. In the medium term, once growth revives, debt can be paid down and the financial sector curbed so that it does not inflict another crisis on the world.
This narrative – the standard Keynesian line, modified for a debt crisis – is the one to which most government officials, central bankers, and Wall Street economists have subscribed, and needs little elaboration. Its virtue is that it gives policymakers something clear to do, with promised returns that match the political cycle. Unfortunately, despite past stimulus, growth is still tepid, and it is increasingly difficult to find sensible new spending that can pay off in the short run.
Attention is therefore shifting to the second narrative, which suggests that the advanced economies’ fundamental capacity to grow by making useful things has been declining for decades, a trend that was masked by debt-fueled spending. More such spending will not return these countries to a sustainable growth path. Instead, they must improve the environment for growth.
The second narrative starts with the 1950’s and 1960’s, an era of rapid growth in the West and Japan. Several factors, including post-war reconstruction, the resurgence of trade after the protectionist 1930’s, the introduction of new technologies in power, transport, and communications across countries, and expansion of educational attainment, underpinned the long boom. But, as Tyler Cowen has argued in his book The Great Stagnation, once these “low-hanging fruit” were plucked, it became much harder to propel growth from the 1970’s onward.
Meanwhile, as Wolfgang Streeck writes persuasively in New Left Review, democratic governments, facing what seemed, in the 1960’s, like an endless vista of innovation and growth, were quick to expand the welfare state. But, when growth faltered, this meant that government spending expanded, even as its resources shrank. For a while, central banks accommodated that spending. The resulting high inflation created widespread discontent, especially because little growth resulted. Faith in Keynesian stimulus diminished, though high inflation did reduce public-debt levels.
Central banks then began to focus on low and stable inflation as their primary objective, and became more independent from their political masters. But deficit spending by governments continued apace, and public debt as a share of GDP in industrial countries climbed steadily from the late 1970’s, this time without inflation to reduce its real value.
Recognizing the need to find new sources of growth, towards the end of Jimmy Carter’s presidency, and then under Ronald Reagan, the United States deregulated industry and the financial sector, as did Margaret Thatcher in the United Kingdom. Productivity growth increased substantially in these countries over time, which persuaded Continental Europe to adopt reforms of its own, often pushed by the European Commission.
Yet even this growth was not enough, given previous governments’ generous promises of health care and pensions – promises made even less tenable by rising life expectancy and falling birth rates. Public debt continued to grow. And the incomes of the moderately educated middle class failed to benefit from deregulation-led growth (though it improved their lot as consumers).
The most recent phase of the advanced economies’ frenzied search for growth took different forms. In some countries, most notably the US, a private-sector credit boom created jobs in low-skilled industries like construction, and precipitated a consumption boom as people borrowed against overvalued houses. In other countries, like Greece, as well as under regional administrations in Italy and Spain, a government-led hiring spree created secure jobs for the moderately educated.
In this “fundamental” narrative, the advanced countries’ pre-crisis GDP was unsustainable, bolstered by borrowing and unproductive make-work jobs. More borrowed growth – the Keynesian formula – may create the illusion of normalcy, and may be useful in the immediate aftermath of a deep crisis to calm a panic, but it is no solution to a fundamental growth problem.
If this diagnosis is correct, advanced countries need to focus on reviving innovation and productivity growth over the medium term, and on realigning welfare promises with revenue capacity, while alleviating the pain of the truly destitute in the short run. For example, Southern Europe’s growth potential may consist in deregulating service sectors and reducing employment protection to spur creation of more private-sector jobs for retrenched government workers and unemployed youth.
In the US, the imperative is to improve the match between potential jobs and worker skills. People understand better than the government what they need and are acting accordingly. Many women, for example, are leaving low-paying jobs to acquire skills that will open doors to higher-paying positions. Too little government attention has been focused on such issues, partly because payoffs occur beyond electoral horizons, and partly because the effectiveness of government programs has been mixed. Tax reform, however, can provide spur retraining and maintain incentives to work, even while fixing gaping fiscal holes.
Three powerful forces, one hopes, will help to create more productive jobs in the future: better use of information and communications technology (and new ways to make it pay), lower-cost energy as alternative sources are harnessed, and sharply rising demand in emerging markets for higher-value-added goods.
The advanced countries have a choice. They can act as if all is well, except that their consumers are in a funk, and that “animal spirits” must be revived through stimulus. Or they can treat the crisis as a wake-up call to fix what debt has papered over in the last few decades. For better or worse, the narrative that persuades these countries’ governments and publics will determine their future – and that of the global economy.
Raghuram Rajan is Professor of Finance at the Booth School of Business, University of Chicago, and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Copyright: Project Syndicate, 2012.
www.project-syndicate.org
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Zsolt 11:20 27 Jan 12
I think we humans, since we think we are such sophisticated creatures, we tend to overcomplicate things, always chosing some very high level solution.
In my opinion the situation is very simple, a wise person always examines the conditions he finds himself in, evaluates his own qualities, capabilities, resources and then chooses the solution that fits these factors the most and tries to balance things most effectively.
Today we have a vast amount of information around us both about our conditions, and about our own character, quality and psychological makeup. We also know a lot about our environment and our resources.
According to these data we live in a closed, finite, interconnected and interdependent system but due to our inherent selfish nature we have been using the network in a negative way, for our own benefit, profit, exploiting everything and everybody in the process. According to the first narrative we have built bubble on top of bubble which has now become unsustainable, ready to burst, this is what the crisis is signaling to us.
Since we are tied together and depend on each other in this complex network which is closed and finite with limited resources with no further room for expansion, the only solution for a sustainable future is a resource and necessity based system where the planning, execution and distribution is done mutually and equally. This solution agrees with the natural law of homeostasis which sustains all living systems, and as human society is only part of the vast system of living nature around us we are obliged to adjust until we are in harmony with the whole system.
ravikunjurs 05:49 28 Jan 12
Why isn't Prf Rajan taking a position on the debate? and why isn't he recommending a solution? Do we really have a choice? Perhaps Prof Rajan overlooked the PentHouse (Pentagon-Whitehouse) theory: Bomb Iran, Russia and China - and all external debts automatically vaporizes!
wilds 02:15 29 Jan 12
"Three powerful forces, one hopes, will help to create more productive jobs in the future: better use of information and communications technology (and new ways to make it pay), lower-cost energy as alternative sources are harnessed, and sharply rising demand in emerging markets for higher-value-added goods."
A key element seems to be missing from expert commentary on the future. The 37.5% of the people have an IQ of 95 or below. It is doubtful that many of them will be able to contribute to the creation of higher-value-added goods and applications of high technology. The reality would seem to be that these people will become more unemployable as we move to the future in advanced economies. So the fundamental question is what do these people do to earn a living in a society where they do not have the intellectual firepower to perform. Talk of cutting
Galan 12:42 30 Jan 12
Zsolt, you have interesting ideas. But, can we implement your idea without some sort of global governance. We may need a loose confederation at the global level. This can be augmented by a fitting new global human culture. If we can find ways for individual freedom, and group rights within this type of governance it may work. The structural conditions are ripe, our emotions are not ready yet. But, it may still catchup.
Dtarlinghunter 07:56 30 Jan 12
I struggle with this. First of all Mr Rajan is taking the side of the no pain no gain camp, the second narrative.
Really though why is the keynesian narrative mutually exclusive with a refocus in the developed economies? Surely during a slump investment into more productive industries, "where payoffs occur beyond electoral horizons"is exactly what the opportunity of low cost debts provides? If it also spurs output and supports a return to growth then all the better.
Even the likes of Cowen accept this as good economics these days.
ravikunjurs 03:27 31 Jan 12
@ Dtarlinghunter
I'm not sure Prof Rajan is taking a position on either of the narrative. And, I suppose this is a problem for me - when learned scholars abstain from recommending a solution, while pointing out a problem, is indeed a problem!
gamesmith94134 07:02 31 Jan 12
Gamesmith94134: Business schools and globalisation
MasahikoF,
What Mr Ghemawat’s question was, “if there is some impulse to get them to pay attention to local realities? Wouldn’t you want some differentiation on that basis?”
This situation will continue until there is real competition from emerging-market schools, which can teach globalization from their own viewpoints. So, the present school of economics teaches macro and micro economics based on the data and theorems of the western culture which the basis of marketing is not integrated to the standard of Globalization. So, the advanced students must understand the burgernomics statistics; that what your burger values different to mine; in competitive labor markets, currencies, commodities that regions of local and foreign make its own stands to both micro and macro economics.
It is not how the students of foreigner to integrate in a school that called international or globalization. It is not just international laws on trade or treaties either; perhaps, the present approach toward globalization is to understand many competitive markets with different angles.
“Why there isn’t a real economist talk of my 30K custodian is worth more of two RMB110000 MBAs financial planners I can hire in Shanghai; and I must pay my custodian’s health care $6000 more just to keep him working in US? It is my Fear Factor in operating in United States.”
From the recent loss of the oil contracts to Nigeria, Angola, Iraq and more, our American flied back in secret private airplane; and locals welcome Chinese, who sent them their medical and technical team with olive branches. What is about trade? Or how did American attempt to purchase their politicians to cut their deals? What advantage of trade and purchase in a specific culture?
Everyone study Globalization must acknowledge the clientele of the Starbuck in Shanghai is different to ones in California. A cup of coffee, worth $4 in California with the equal value of a RMB35 in Shanghai have made the divisions of businessmen with Jeans and suits, and ones with computers and the other with financial newspapers. What do they order after Coffee?
How do Japanese, German or Brazilian drink theirs? To-day, our macroeconomic became their microeconomic, since emerging market produced 60% more of American or Developed nations. It is a great opening to all knowledge and not all students of kinds; languages of economic do not make the category of Globalization. It is the culture, competition, market, currencies, resources and more to combine. Integrate is a half baked.
May the Buddha Bless you?
pmcdonald 10:40 31 Jan 12
How disappointing that Raghuram Rajan, feels the need to revise the history of the global economy to fit his narrow technical and ideologically based education. He really needs to read more widely first. He is the perfect example of a naive Indian who goes to America and gets brainwashed by a system that actively generates inequality and poverty and then returns to Asia to preach that system. How disappointing.
HistorySquared 02:40 05 Feb 12
"37.5% of the people have an IQ of 95 or below. It is doubtful that many of them will be able to contribute...."
Here we get to the crux of the issue. People either people believe in fixed intelligence and DNA, or people believe people respond to incentives and the growth mindset. Stanford Professor Carol Dweck has done much research into this matter.
The people that advocate a large welfare state believe there is an elite class of people born more intelligent than the populace. If we could just annoint these people as politicians, let them do the central planning and transfer wealth away from the "lucky" then society would be harmonious. The warren Buffets of the world believe people will work just as hard and take just as much risks with a 70% tax rate as they would with a 30%.
This philosophy is a fallacy, intelligence is malleable, not fixed. Intelligence is hard work. The brain is a muscle that can be strengthened, and while yes, a few are blessed with strong bodies from birth, others can train. Read any memory training book and it will typically state; 'there are no poor memories, only untrained memories.' New research confirms this hypothesis; IQ fluctuates depending on training.
People are resilient, but the elitistis have no faith in them. if low end manufacturing jobs go overseas, after an adjustment period, they will adapt and see a shortage of nurses. Implying everyone has to become a tech entrepreneur is ridiculous; 40% of people can't find qualified workers, thanks to an poor, perverse educational system that does not train people for the jobs, and incentives people to the lowest common denonominator through subsidies that pay regardless of major chosen. People respond to incentives, including the incentive to be poor dependents. This enslavement benefits the politicians, who now have captive voters.
theartteacher 03:21 16 Feb 12
I'm afraid that pmcdonald's first line seem to have some validity. After some of the superb analysis in Faultines this article is very disappointing.
The description of the development of economic theory and practise (particularly from the 60s/70s) misses out elementary key aspects of the story - only the narrow technical-economic featues of this history are presented. His analysis is far stronger in other writings. I would like to say that the enforced brevity of the article has led to the skewing, but it almost seem to directly contradict his earlier arguments regarding financialisation, and their framing with regard to inequality, democratic/private power and broader, less technocratic, conditions and circumstances.
I also think one can express a fundamental scepticism towards growth - a perfectly reasonable response. I ordinarily wouldn't expect a Professor of Finance at Chicago question a fundamental assumption of the current capitalism. I just expect more from Prof Rajan.
christnr 06:12 27 Jan 12
Indeed, both narratives require a solution to the question: what will drive future growth. Even the "borrow today for a better future" strategy requires that the borrowed funds be invested in platforms to generate growth. Otherwise, it just adds to the already high debts to be repayed later without expanding the capacity to repay them.