The Third Pillar

COPYRIGHT

William Collins

An imprint of HarperCollinsPublishers 1 London Bridge Street London SE1 9GF WilliamCollinsBooks.com This eBook first published in Great Britain by William Collins in 2019 Copyright © 2019, 2020 by Raghuram Rajan Cover design by Darren Haggar. Illustration by ottoGraphic Raghuram Rajan asserts the moral right to be identified as the author of this work A catalogue record for this book is available from the British Library All rights reserved under International and Pan-American Copyright Conventions. By payment of the required fees, you have been granted the non-exclusive, non-transferable right to access and read the text of this e-Book on-screen. No part of this text may be reproduced, transmitted, downloaded, decompiled, reverse engineered, or stored in or introduced into any information storage and retrieval system, in any form or by any means, whether electronic or mechanical, now known or hereinafter invented, without the express written permission of HarperCollins Publishers. Source ISBN: 9780008276300 Ebook Edition © 2020 ISBN: 9780008276294 Version: 2020-02-12

PRAISE FOR THE THIRD PILLAR

‘A strikingly insightful analysis of the penalties of neglecting the critically important role of community, by concentrating too much on the perceived efficacy of the markets and the state. Rajan brings out loudly and clearly why this imbalance needs urgent correction’

AMARTYA SEN, Professor at Harvard University,

winner of the 1998 Nobel Memorial Prize in Economic Sciences

‘Rajan brings his unparalleled knowledge and experience to bear on the problem. Rajan’s account of corporate misbehaviour is very well told, and it is all the more effective coming from a professor at a prominent business school’

ANGUS DEATON, winner of the Nobel Memorial Prize

in Economic Sciences in 2015

‘The Third Pillar is a must read for everyone seeking a way to preserve democracy as we’ve known it. In Rajan’s brilliant new perspective, successful democracies require balance between competitive markets, honest governments, and healthy, local communities’

JANET YELLEN, Distinguished Fellow in Residence at

Brookings Institution, Chair of the Federal Reserve between 2014 and 2018

‘Skilfully unpicks the tensions between capitalism, democracy and community … An important and timely new book … His outlook is broadly promarket … But he has also won a reputation as a teller of uncomfortable economic truths’

Financial Times

‘Insightful and impressive … As local governments get to work, they could certainly use the help of more thinkers of Mr Rajan’s calibre’

Wall Street Journal

‘An incisive critique of how economists and policymakers abandoned community’

New York Times

‘A superstar economist … Looks at ways to restore the glory years of liberal democracy when there were widespread opportunities to prosper’

Daily Telegraph

‘An important contribution to understanding why, a decade after the crisis, the world’s politics and economics remain so brittle … Rajan, a critic trying to save capitalism from itself, makes his point in accessible, clear prose’

The Times

‘Compelling … urges economists to recognize a blind spot … Having been insufficiently mindful of this over the past few decades, business and government leaders may have little option but to brace themselves for frustrated communities demanding change’

The Economist

‘Fresh, insightful and engaging. Offers a brilliant reckoning with one of today’s most important and potentially crippling challenges … [His] clear and compelling case goes well beyond protecting the vulnerable. It’s also, critically, about enhancing the whole’

Mohamed El-Erian, author of

When Markets Collide and The Only Game in Town

‘We all need to start thinking about this issue right now and this book is a place to begin’

JAMES A. ROBINSON, Professor at the University of

Chicago, co-author of Why Nations Fail

‘Few economists span the worlds of policy and scholarship with such distinction as Raghu Rajan … Rajan presents a bold, original vision that significantly advances our contemporary debate on the ills of democracies and moves it onto new terrain’

DANI RODRIK, Professor at Harvard University,

author of The Globalization Paradox

‘A remarkably original and insightful take on the evolution, foundations and future of capitalism … Rajan argues convincingly that the conventional dichotomy between the state and markets misses the critical role of communities … A landmark treatise of profound depth’

KENNETH ROGOFF, Professor at Harvard University,

former IMF Chief Economist, author of The Curse of Cash

‘The Third Pillar is a work marked by depth, reach and assurance. Its author engages with the main economic issues of the day, and by never hesitating to speak truth to power leaves us wanting to engage him in argument’

The Hindu

‘Insightful and thought-provoking’

Publishers Weekly

‘A welcome survey of a big-picture problem’

Kirkus Reviews

‘A fascinating account of how markets and the state overcame the shortcomings of feudal communities’

International Monetary Fund

To Radhika

CONTENTS

Cover

Title Page

Copyright

Praise for The Third Pillar

Dedication

Preface

Introduction: The Third Pillar

PART I

HOW THE PILLARS EMERGED

1. Tolerating Avarice

2. The Rise of the Strong but Limited State

3. Freeing the Market … Then Defending It

4. The Community in the Balance

PART II

IMBALANCE

5. The Pressure to Promise

6. The ICT Revolution Cometh

7. The Reemergence of Populism in the Industrial West

8. The Other Half of the World

PART III

RESTORING THE BALANCE

9. Society and Inclusive Localism

10. Rebalancing the State and the Community

11. Reinvigorating the Third Pillar

12. Responsible Sovereignty

13. Reforming Markets

Epilogue

Acknowledgments

Notes

Index

About the Author

About the Publisher

PREFACE

We are surrounded by plenty. Humanity has never been richer as technologies of production have improved steadily over the last two hundred fifty years. It is not just developed countries that have grown wealthier; billions across the developing world have moved from stressful poverty to a comfortable middle-class existence in the span of a generation. Income is more evenly spread across the world than at any other time in our lives. For the first time in history, we have it in our power to eradicate hunger and starvation everywhere.

Yet even though the world has achieved economic success that would have been unimaginable even a few decades ago, some of the seemingly most privileged workers in developed countries are literally worried to death. Half a million more middle-aged non-Hispanic white Americans died between 1999 and 2013 than if their death rates had followed the trend of other ethnic groups.1 The additional deaths were concentrated among those with a high school degree or less, and were largely due to drugs, alcohol, and suicide. To put these deaths in perspective, it is as if ten Vietnam wars were simultaneously taking place, not in some faraway land, but in homes in small-town and rural America. In an era of seeming plenty, a group that once epitomized the American dream seems to have lost hope.

The anxieties of moderately educated middle-aged whites in the United States are mirrored in other rich developed countries in the West, though perhaps with less tragic effects. The primary source of worry seems to be that moderately educated workers are rapidly losing, or are at risk of losing, good “middle-class” employment, and this has grievous effects on them, their families, and the communities they live in. It is widely understood that job losses stem from both global trade and technological progress leading to automation of old jobs. What is less well known is technological progress has been, by far, the more important cause. As public anxiety turns to anger, radical politicians find it easier to attack visible and better understood targets like imports and immigrants. They propose to protect manufacturing jobs by overturning the liberal rules-based postwar economic order, the system that has facilitated the flow of goods, capital, and people across borders.

There is both promise and peril in our future. The promise comes from new technologies that can help us solve our most worrisome problems like poverty and climate change. Fulfilling it requires keeping borders open, in part so that these innovations and associated investments can be taken to the most underdeveloped parts of the world. The peril stems from influential communities not being able to adapt and instead impeding progress. If we are to harness technology’s promise, our values and institutions must change as innovations disproportionately empower and enrich some.

disruptive technological change

Every past technological revolution has been disruptive, prompted a societal reaction, and eventually resulted in societal change that helped us get the best out of the technology. Since the early 1970s, we have experienced the Information and Communications Technology (ICT) revolution. It built on the spread of mass computing, made possible by the microprocessor, and mass communication, enabled by the internet and the mobile phone. It now includes technologies ranging from artificial intelligence to quantum computing, touching and improving areas as diverse as international trade and gene therapy. The effects of the ICT revolution have been transmitted across the world by increasingly integrated markets for goods, services, capital, and people. Every country has experienced disruption, punctuated by dramatic episodes like the Global Financial Crisis in 2007–2008 and the accompanying Great Recession. We are now seeing the reaction in populist movements of the extreme Left and Right. What has not happened yet is the necessary societal change, which is why so many despair of the future. We are at a critical moment in human history, when wrong choices could derail human economic progress.

This book is about the three pillars that support society and how we get to the right balance between them again so that society continues to prosper. Two of the pillars I focus on are the usual suspects, the state and markets. Many forests have been consumed by books on the relationship between the two, some favoring the state and others markets. It is the neglected third pillar, the community—the social aspects of society—that I want to reintroduce into the debate. When any of the three pillars weakens or strengthens significantly, typically as a result of rapid technological progress or terrible economic adversity, the balance is upset and society has to find a new equilibrium. The period of transition can be traumatic, but society has succeeded in rebalancing repeatedly in the past. The central question in this book is how we restore the balance between the pillars once again in the face of ongoing disruptive technological change.

I will argue that many of the economic and political concerns today across the world, including the rise of populist nationalism and radical movements of the Left, can be traced to the diminution of the community. The state and markets have expanded their powers and reach in tandem, and left the community relatively powerless to face the full and uneven brunt of technological change. Importantly, the solutions to many of our problems are to be found in bringing dysfunctional communities back to health, not in clamping down on technology or on markets. This is how we will rebalance the pillars at a level more beneficial to society and preserve the liberal market democracies many of us live in.

definitions

To avoid confusion later, let us get over the tedious but necessary issue of definitions quickly. Broadly speaking, the state in this book will refer to the political governance structure of a country, usually the federal government. In addition to the executive branch, the state will also include the legislature and the judiciary.

Markets will include all private economic structures facilitating production and exchange in the economy. The term will encompass the entire variety of markets, including the market for goods and services, the market for workers (the labor market), and the market for loans, stocks, and bonds (the capital or financial market). It will also include the main actors from the private sector, such as businesspeople and corporations.

According to the dictionary, a community “is a social group of any size whose members reside in a specific locality, share government, and often have a common cultural and historical heritage.”2 This is the definition we will use, with the neighborhood (or the village, municipality, or small town) being the archetypal community in modern times, the manor in medieval times, and the tribe in ancient times. Importantly, we focus on communities whose members live in proximity—as contrasted with virtual communities or national religious denominations. We will view local government, such as the school board, the neighborhood council, or town mayor, as part of the community. A large country has layers of government between the federal government (part of the state) and the local government (part of the community). In general, we will treat these layers as part of the state. Finally, we will use the terms society, country, or nation interchangeably as the composite of the state, markets, communities, people, territory, and much else that compose political entities like China or the United States.

why the community still matters

Definitions done, let us get to substance. For early humans the tribe was their society—their state, markets, and community rolled into one. It was where all activities were conducted, including the rearing of children, the production and exchange of food and goods, and the succor of the ill and the elderly. The tribal chief or elders laid down the law and enforced it, and commanded the tribe’s warriors in defense of their lands. Over time, as we will see in Part I of the book, both markets and the state separated from the community. Trade with more distant communities through markets allowed everyone to specialize in what they were relatively good at, making everyone more prosperous. The state, aggregating the power and resources of the many communities within it, not only set common regulations for markets but also enforced the law within its political boundaries, even as it defended the realm against aggressors.

Markets and the state not only separated themselves from the community over time, they also steadily encroached on activities that strengthened bonds within the traditional community. Consider some functions the community no longer performs. In frontier communities, neighbors used to help deliver babies; today most women check into a hospital when they feel the onset of childbirth. They prefer the specialist’s expertise to their neighbor’s friendly but amateurish helping hand. The community used to pitch in to rebuild a household’s home if it caught fire; today the household collects its fire insurance payment and hires a professional builder. Indeed, given the building codes in most developed countries, it is unlikely that a home reconstructed by neighbors would be legal.

However, the community still plays a number of important roles in society. It anchors the individual in real human networks and gives them a sense of identity; our presence in the world is verified by our impact on people around us. By allowing us to participate in local governance structures such as parent-teacher associations, school boards, library boards, and neighborhood oversight committees, as well as local mayoral or ward elections, our community gives us a sense of self-determination, a sense of direct control over our lives, even while making local public services work better for us. Importantly, despite the existence of formal structures such as public schooling, a government safety net, and commercial insurance, the goodness of neighbors is still useful in filling in gaps. When a neighboring engineer tutors our son in mathematics in her spare time, or the neighborhood comes together in a recession to collect food and clothing for needy households, the community is helping out where formal structures are inadequate. Given the continuing importance of the community, healthy modern communities try to compensate for the encroachment of markets and the state with other activities that strengthen community ties, such as social gatherings and neighborhood associations.

Economists Raj Chetty and Nathaniel Hendren attempt to quantify the economic impact of growing up in a better community.3 They examine the incomes of children whose parents moved from one neighborhood into another in the United States when the child was young. Specifically, consider neighborhood Better and neighborhood Worse. Correcting for parental income lets the average incomes of children of longtime residents when they become adults be one percentile higher in the national income distribution in neighborhood Better than it is in neighborhood Worse. Chetty and Hendren find that a child whose parents move from neighborhood Worse to Better will have an adult income that is, on average, 0.04 percentile points higher for every childhood year it spends in Better. In other words, if the child’s parents move when it is born and they stay till it is twenty, the child’s income as an adult will have made up 80 percent of the difference between the average incomes in the two neighborhoods.

Their study suggests that a child benefits enormously by moving to a community where children are more successful (at least as measured by their future income). Communities matter! Perhaps more than any outside influence other than the parents we are born to, the community we grow up in influences our economic prospects. Importantly, Chetty and Hendren’s finding applies for a single child moving—movement is not a recipe for the development of an entire poor community. Instead, the poor community has to find ways to develop in situ, while holding on to its best and brightest. It is a challenge we will address in the book.

There are other virtues to a healthy community. Local community government acts as a shield against the policies of the federal government, thus protecting minorities against a possible tyranny of the majority, and serving as a check on federal power. For example, sanctuary communities in the United States and Europe have resisted cooperating with national immigration authorities in identifying and deporting undocumented immigrants.

Although no country can function if every community picks and chooses the laws they will obey, we will see that some devolution of powers to the community can be beneficial, especially if there are large differences in opinion between communities so that centralized “one-size-fits-all” solutions do not work.

Furthermore, community-based movements against corruption and cronyism prevent the leviathan of the state from getting too comfortable with the behemoth of big business. Indeed, as we will see in the book, healthy communities are essential for sustaining vibrant market democracies. This is perhaps why authoritarian movements like fascism and communism try to replace community consciousness with nationalist or proletarian consciousness.

In sum, the proximate community is still relevant today, even in cosmopolitan cities where ties of kinship and ethnicity are limited, and even in individualistic societies like those of the United States and Western Europe. Once we understand why community matters, and that people who value staying in their community are not very mobile, it becomes clear that it is not enough for a country to experience strong economic growth—the professional economist’s favorite measure of economic performance. Since such people cannot abandon their community easily to move to work where growth occurs, they need economic growth in their own community. If we care about the community, we need to care about the geographic distribution of growth, and about “place-based” economic policies that affect that distribution.

What then is the source of today’s problems? In one word, imbalance! When the three pillars of society are appropriately balanced, society has the best chance of providing for the well-being of its people. The modern state ensures physical security, as it always has, but also tries to maintain fairness in economic outcomes, which democracy demands. To do this, the state tries to enable most people to participate on equal terms in markets, while buffering them against their fluctuations. It may also set limits on markets. The competitive markets provide people innovative products and abundant choice. Competition ensures that those who succeed in it are efficient and produce the maximum output with the resources available. The successful have both wealth and some independence from the state, thus they have the ability to check arbitrary actions by the state. Finally, the people in industrial democracies, engaged in their communities and thereby organized socially and politically, enforce the necessary separation between markets and the state through their democratic voice. They do so because they want sufficient political and economic competition that the economy does not descend into authoritarianism or cronyism.

Society suffers when any of the pillars weakens or strengthens overly relative to the others. Too weak the markets and society becomes unproductive, too weak a democratic community and society tends toward crony capitalism, too weak the state and society turns fearful and apathetic. Conversely, too much market and society becomes inequitable, too much community and society becomes static, and too much state and society becomes authoritarian. A balance is essential!

why the community has weakened

The pillars are seriously unbalanced today. Communities have been especially impacted. In the United States, minority and immigrant communities were hit first by joblessness, which led to their social breakdown in the 1970s and 1980s. In the last two decades, communities in small towns and semirural areas, typically white, have been experiencing a similar decline as large local manufacturers close down. Often, this results in the loss of comfortable middle-income jobs held by the moderately educated. Families have been tremendously stressed, with an increase in divorces, teenage pregnancies, and single-parent households. In turn, these have led to a deterioration in the environment for children, resulting in poor school performance; high dropout rates, the increased attractiveness of drugs, gangs, and crime; and persistent youth unemployment. The opioid epidemic is just one symptom of the hopelessness and despair that accompanies the breakdown of once-healthy communities.

The technological revolution has been disruptive even outside such economically distressed communities. It has increased the wage premium for those with better capabilities significantly, with the most capable employed by high-paying superstar firms that increasingly dominate a number of industries. This has put pressure on upper-middle-class parents to secede from economically mixed communities and move their children to schools in richer, healthier communities, where they will learn better with other well-supported children like themselves. The poorer working class are kept from following by the high cost of housing in the tonier neighborhoods. Their communities deteriorate once again, this time because of the secession of the successful. Technological change has created that nirvana for the upper middle class, a meritocracy based on education and skills. Through the sorting of economic classes and the decline of the mixed community, however, it is also becoming a hereditary one, where only the children of the successful succeed.

The rest are left behind in declining communities, where it is harder for the young to learn what is needed for good jobs. Communities get trapped in vicious cycles where economic decline fuels social decline, which fuels further economic decline . . . The consequences are devastating. Alienated individuals, bereft of the hope and the feeling of belonging that comes from being grounded in a healthy community, become prey to demagogues on both the extreme Right and Left, who cater to their worst prejudices.

When the proximate community is dysfunctional, alienated individuals need some other way to channel their need to belong.4 Populist nationalism offers one such appealing vision of a larger purposeful imagined community—whether it is white majoritarianism in Europe and the United States, the Islamic Turkish nationalism of Turkey’s Justice and Development Party, or the Hindu nationalism of India’s Rashtriya Swayamsevak Sangh.5 It is populist in that it blames the corrupt elite for the condition of the people. It is nationalist in that it anoints the native-born majority group in the country as the true inheritors of the country’s heritage and wealth. Populist nationalists identify minorities and immigrants—easily identifiable targets and the supposed favorites of the elite establishment—as usurpers, and blame foreign countries for keeping the nation down. These fabricated adversaries are necessary to the populist nationalist agenda, for there is often little else to tie the majority group together.

While the populist nationalists raise important questions, the world can ill afford their shortsighted solutions. Populist nationalism will undermine the liberal market democratic system that has brought developed countries the prosperity they enjoy. Within countries, it will anoint some as full citizens and true inheritors of the nation’s patrimony while the rest are relegated to an unequal, second-class status. It risks closing global markets down just when these countries are aging and need both international demand for their products and young skilled immigrants to fill out their declining workforces. It is dangerous because it offers blame and no real solutions, it needs a constant stream of villains to keep its base energized, and it moves the world closer to conflict rather than cooperation on global problems.

reviving communities

Schools, the modern doorway to opportunity, are the quintessential community institution. The varying qualities of schools, largely determined by the communities they are situated within, dooms some youth while elevating others. When the pathway to entering the labor market is not level, and steeply uphill for some, it is no wonder that people feel the system is unfair. The way to address this problem, and many others in our society, is not primarily through the state or through markets. It is by reviving the community and having it fulfill its essential functions, such as schooling, better. Only then do we have a chance of reducing the appeal of radical ideologies.

We will examine ways of doing this, but perhaps the most important is to give the power that markets and the state have steadily taken away back to the community. Historically, as markets became integrated within the nation, power migrated to the national capital, with the federal government usurping community powers in order to harmonize regulations across domestic communities—after all, no manufacturer wants to have to deal with different regulatory standards each time his product crosses a community border. As markets have become global, sovereign powers have similarly become constrained by international treaties or have migrated away from nations into international bodies like the European Union. Once again the intent is to allow global firms and markets to function seamlessly across political borders.

We must reverse this to the extent possible. Unless absolutely essential, power should devolve from international bodies back to countries. Furthermore, within countries, power and funding should devolve from the federal level to the communities. Fortunately, the automation of procedures will help market participants, such as firms, cope at relatively low cost with the ensuing diversity of regulations. Moreover, easier communication and better data will allow both the federal government as well as people in the community to monitor how local government uses its new powers and funding. If effected carefully, this decentralization will preserve the benefits of global markets while allowing people more of a sense of self-determination. Localism—in the sense of centering more powers, spending, and activities in the community—will be one way we will manage the disorienting tendencies of global markets and new technologies.

inclusive localism

Instead of allowing people’s natural tribal instincts to be fulfilled through populist nationalism, which combined with national military powers makes for a volatile cocktail, it would be better if they were slaked at the community level. One way to accommodate a variety of communities within a large diverse country is for it to embrace an inclusive civic definition of national citizenship—where one is a citizen provided one accepts a set of commonly agreed values, principles, and laws that define the nation. It is the kind of citizenship that Australia, Canada, France, India, or the United States offer. It is the kind of citizenship that the Pakistani-American Muslim, Khizr Khan, whose son died fighting in the United States Army, powerfully reminded the 2016 Democratic National Convention of, when he waved a copy of the United States Constitution—for it defined his citizenship and was the source of his patriotism.