The Third Pillar – Imbalance is the Problem!

The Third Pillar, by Raghuram G Rajan (Katherine Dusak Miller Distinguished Service Professor & ex RBI Governor), is a stellar piece of work that beautifully explains the concept of a functional society. The world view offered to understand evolution of State, Markets & Community along with his view of the future balance of the 3 pillars is worth noting.

To begin with, let us understand what are the 3 pillars & the fundamental imbalances –

• State: political governance of a country. In addition to the executive branch, the state will also include the legislature and the judiciary
• Market: all private economic structures facilitating production and exchange in the economy. Includes market for goods and services, market for workers, market for loans, stocks and bonds
• Community: a social group of any size whose members reside in a specific locality, share government, and often have a common cultural and historical heritage. It will also include local governments such as school board, neighbourhood council, town mayor etc

Too weak the markets and society becomes unproductive, too weak a community and society tends toward crony capitalism, too weak the state and society turns fearful and apathetic. Imbalance is the problem!

Below is my interpretation of the book:

• We are predisposed to be social. We are genetically hardwired; Altruism toward kin is a genetic trait that helped survival.
• Community is critical in filling the holes that are left by formal government and market systems. Communities can be more than the sum of individuals who compose them
• Communities aid the individual, preventing them from drifting – untaught, unaided and unanchored – in life
• Dysfunctional communities can be virtual war zones, with widespread drug addiction, crime, failing schools, and broken families. When economic opportunity is very limited, economic activity might be seen as a zero sum game – your gain comes at the expense of mine
• This state of amoral familism is visible in many developing countries, where you keep your house spotlessly clean but unceremoniously dump the garbage collected inside on the street outside – We know this very well as Indians!
• Too many options or too little incentive to change is why communities are doomed (eg local library and weavers in England)
• The essence of modern capitalism is the steady accumulation of wealth, not because of the pleasures it can buy or the material needs it can satisfy, but for its own sake

Let us try and understand a bit of history to learn the fundamentals of society & figure out if we’re still making the same mistakes.

The rise of the state – 3 tasks :

• 1. the king had to obtain monopoly of military power within his territory so that it was a unified whole with a common market
  2. Create an identity that would replace religion since religion did not distinguish one nation-state from another in Europe
  3. Enhance ability to raise revenues
• With all three tasks done, they still had to respect private property rights of its citizens. The constitutionally limited state was an important milestone in the path towards free markets. Security of private property allowed them to compete as individuals (rather than form associations to safeguard property) which raised efficiency and output. The markets and state pillars now fortified each other
• Mercantilism prevailed in the monarchies as they had a very short term view of the economic might, perhaps influenced by the multiple reign ending military threats they faced. Thus, sought to discourage imports and encourage exports as they thought this would create more domestic jobs and income – Exactly the argument given by some of today’s populist politicians
• Humans don’t have an uncontrollable urge to reproduce. Prosperity has been a powerful contraceptive, with people becoming less willing to have children, even as they can afford more of them
• The poor and the underprivileged need the politician to help them get jobs and public services. The crooked politician needs the businessman to provide the funds to allow him to supply patronage to the poor and fight elections. The corrupt businessman needs the crooked politician to get monopoly rights, public resources and contracts cheaply – The cycle well explained. This exists all because the typical civil servant is neither civil nor a servant to the poor.
• Technological change and financial crises go hand in hand as markets turn overly optimistic before the technology can deliver on its promise. These are also the times that impel social and economic reforms. Adversity, though, can also give rise to demagogues who can get the votes to do irremediable long term damage
• Community welfare programmes were quite effective in earlier times. Who was responsible for supporting the destitute migrant – the migrant receiving community or the migrant sending community? Even today, European Union struggles with this question
• Religion and traditions were perhaps the last protection against a total social breakdown. To the upper middle class, this seemed like hypocrisy. To the working class, this was survival. It was natural for the newly disadvantaged to remember the rosier past where families were stronger and bound together in a prosperous community. Religion and traditions provided hope to regain the past glory

China & India

• China could suppress markets more, and repress households more, as it did not have to contend with democracy. This allowed it to generate faster growth, but skewed in favour of state Corporations over Households, Savings and Investment over Consumption, and benefitting foreign investors more than citizens. A variety of imbalances have built up –
  1. over capacity in industries because of excess investment
  2. excessive corporate and local govt debt burdens as consequence
  3. over dependence on investments and exports for growth

• Chinese private consumption to GDP fell from about 50% in 1990 to 47% in 2000 to 35.5% in 2010. Chinese household paid a price for the jobs that growth generated but the growth was spectacular. China is one emerging market that is aging rapidly. Even though the one child policy has been relaxed in recent years, the Chinese are increasingly reluctant to have more children. China, therefore may grow old before it grows rich. They need to plan for a future society where the resources it will have will be far lower than what western populations have
• For socialist economies: it will not be able to shut down failing firms, especially if failures are bunched. Instead, it will rescue them and waste resources. As the party’s reputation for infallibility will be at risk. Control is not free, it comes with people assigning responsibility to the party. The party will be tempted to periodically substitute its wisdom for the wisdom of the market. If so, the market will never be able to mature to guide resource allocation and risk management ensuring the Chinese markets remain an unreliable allocator of funds
• India with its more pluralistic and open-access political system, is better positioned for the community to create more separation between the state and markets. Its weakest pillar is the state. India will have to improve state capacity significantly, something that may come as a surprise to those who think India has excess bureaucracy. India has plethora of rules and red tape, but it has relatively few officials employed by the state, given the population. Officials are poorly trained or motivated, and the good ones are overburdened
• Democracy makes inaction easier. The party in power doesn’t have to take responsibility for everything, and it does not have to maintain a pretender of infallibility since it derives legitimacy from election, not perfection. Democracy creates a separation between the state and the markets in yet another way than the populist and progressive movements. It allows the state to be decoupled from markets making them function better without cross linkages
• Unlike the US markets where still independent private sector criticises government policy, the Indian private sector – the market pillar- largely applauds all government policy. Eg president Obama visited India and dignitaries were lined up to shake hands with him. Prime minister, former prime minister, cabinet ministers, leader of opposition, military heads, retired dignitaries from ruling party, Indian president’s grandson, serving bureaucrats and then finally at number 83 was chairman of India’s largest private sector group accounting for more than $100bn in market value. Isn’t number 83 alarmingly low? (This is crazy!!)
• When I worked at the finance ministry as Chief Economic Adviser, I was shocked by the heavy paper files that came across my desk – shocked first that we still use paper files in 21st century and second at the amount of back papers I had to read to understand the note tagged on to the front of each file that required my comments and signature. A veteran bureaucrat gave me a solution backed by impeccable logic and experience- “spend the least time on thickest files and these issues are going nowhere, which circulate back and forth wasting everyone’s time by adding more comments. Devote all your time on thin files. Those are fresh issues where cogent opinion may actually make things happen”. Broader message here for India – “the state can do more by trying to do less”

• China has a strong state. For democratic India, the challenge is to make the state more effective while placing stronger constitutional limits on it. This requires a more independent private sector. As these countries play a greater role in global governance, the future is worrying. Populist nationalism in developed countries will strengthen incipient nationalism in the emerging markets, and make divisive conflict at the international level more likely

 

The US & Europe

• In 1940s, the average age of machinery in France (one of the more advanced European economies) was 20 years old, compared to 5 years in the US. The US was itself not uniformly developed. One sixth of farms in southern US had electric lights, over 80% still used kerosene or gasoline for lighting. Fewer than 69% households in the US had an exclusive flush toilet. The next 3 decades post war saw massive resurgence driven by 5 elements :

• 1. Reconstruction
  2. Resumption of trade
  3. Technological upgradation with movement of workers away from agriculture
  4. Greater education and labour force participation
  5. The broad political consensus for growth. All led by the US in form of very well planned generous grants (importer would ask for goods and machinery from US trader, who would get paid by US government while the importer can pay to its local government thereby mitigating dollar shortage and increasing jobs in the US)
• As citizens moved up into better paying jobs, countries needed workers for the jobs they vacated. Hence, Immigration. Initially it was under the condition that they’d come to European countries as guest workers and would eventually return
• Perhaps Europe’s mistake was to go beyond a common market in goods and services before solidarity has built up. The idea of Europe, indeed of world citizenship, is as much about idealism as it is about practicality

Information & Computer Technology + Immigration

• With the ICT (Information & Computer Technology) revolution, humans have moved to handling exceptions, and to intermediating between ordinary people and the system. Technology induced inequality and human induced inequality have built upon each other. The communities that are required to adapt the most, as always, are the communities that have been experiencing the greatest adversity, and have the least resources to cope
• The data are consistent with an increase in number of jobs at both ends of the skill spectrum, and a decline in the middle
• The fall from comfortable middle class unionised jobs into the struggle to make ends meet is extremely painful, but at least there are jobs. While better educated management workers move quickly elsewhere to jobs in new industries, many of the moderately educated seem to have clung on to nearby, and progressively less well paid, manufacturing jobs for as long as they could
• With higher than warranted demand for job candidates with degrees and lower than desirable demand for candidates with high school diplomas, it is less surprising that wage premium in the US is higher than elsewhere despite the high average years of education. Since schooling quality has deteriorated due to decline of the economically mixed communities, employers cannot trust students know what they must know in school
• Perhaps more important than hard work and a good education, technological change helps explain the rise in inequality at the very top – it has created a winner takes most economy. Furthermore, the larger the accessible market, the more the performer will get paid
• The pace of new business creation in the US has fallen steadily since late 1970s. The pace of exits – being taken over or shutting- has remained fairly constant. Small startups are selling out to large companies rather than staying independent and going public. In last decade, google bought 120, Monsanto 30 and oracle 80
• In recent years, a strong positive correlation has emerged between the concentration of industry and the profitability of firms in it. Growing profitability by Concentration may not only be a sign of monopolistic practices, it could be a sign of greater efficiencies of large incumbents. Stock market also favours the monopolistic firms
• Venture capitalists refuse to fund startups whose projects lie within the “kill zone” that can be replicated or acquired by dominant platforms. This reinforces the platform’s dominance. Eg pharmaceutical firms that can easily be killed by generic drugs
• Somewhat paradoxically, despite being able to work at a distance, more and more skilled people seem to be attracted to places where there already are plenty of skilled people. Perhaps this is because serendipitous human interaction still matters. The whole is greater than the sum of parts when capable people congregate together is a form of what economists term ‘agglomeration economies’

Remedy – Inclusive Localism! & the Risks to be wary of

• The only risk of empowering communities is the fear that they may turn into havens for racists. But these will be checked by the other two pillars of the state and markets. Also, aging population will lead the countries to allow immigration thereby providing a balance
• Apart from productivity, another value of skilled immigrants is that they facilitate ties between their home and host countries, this increasing economic activity on both sides as they help bridge cultural and trust gaps. Australia has changed its ethnic character from largely whites to Eurasian. Foreign born account for 28% with 10% Asians. Not coincidentally, Australia has strong economic links with Asia today
• Immigrants also spend their wages on consumption, something the robots do not do
• Communities must NOT have the power to impose tariff or non tariff barriers, else the national market will be fragmented to everyone’s detriment
• In the trade off between Inclusion and Localism, inclusion must be given more weight
• UBI (Universal Basic Income) is an all or nothing scheme. UBI essentially assumes that most people will not have a job, and there will be no point in them searching for one or attempting to retrain themselves since no new jobs will be possible. It is a counsel of despair not just for job seekers but job creators as any new job will have to be more attractive in pay and responsibilities than paid leisure, a difficult hurdle for any job to cross
• US government debt will hit 100% of GDP by 2028 (80% currently), trust fund for Medicare runs out in 2029, social security in 2035. Working population with aging is going down. We must remember, that worse than unfunded liabilities is to hand out children a broken system
• Friendship will be what holds the communities of the future together when the older bonds of economic necessity weaken
• Technologies tend to polarise communities – given the easy access to diverse opinions, people might dwell on the opinions or websites that most accord with their prejudices, and see their opinions reaffirmed by the comments therein
• It seems paradoxical that as technology is bringing the whole world to us, the proposed solution to some of our problems is to embrace what is near – the community – rather than what is far. What is near anchors us, a necessity as our experiences become more virtual
• No matter how we count and what we count, the world has become multipolar. Economically speaking, we have at least 3 big blocks – the US, China and the EU. Militarily, we should add Russia too. In this multipolar world, our institutions of global governance that have been structured for a unipolar world could get paralysed if we do not reform them
• These are dangerous times. If people have lost faith in their ability to compete in markets, if their communities continue to decline, if they feel that the elite have appropriated all opportunities for themselves, both by monopolising the markets and by monopolising the access to capability building, popular resentment can turn into rage. Democracy requires equal access, and when access is unequal, democracy reacts. More populist nationals will be elected. Of course, it’ll be better if they push for reforms that ‘include’ rather than ‘exclude’

 

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