Raghuram Rajan (2010). Fault
Lines, Princeton University Press, Princeton and Oxford, pp. 279
Raghuram
Rajan has essayed many diverse roles with panache- as a distinguished professor
of monetary economics at the University of Chicago, Chief Economist at the IMF
and the Governor of the Reserve Bank of India, to name a few. He has been at different
vantage points of conceptual analysis as an academic, policy maker and
independent regulatory authority. In this book, he examines the financial
crisis of 2007 and the role of different agents in building up the crisis. The
core argument of the book is that not only was the financial crisis a result of
problems of regulation and management, it was also the result of failure of neoclassical
economic theory to understand the real-life enactment of its principles. For
instance, even when individual agents behaved rationally in a given situation,
the aggregate impact was often sub-optimal. What flows from this argument is
that while short-term policies aim at quick recovery by reaffirming the status
quo, in the long-term the structural fault lines that underpins the economic
system needs to be re-examined.
Three fault lines
Using
a geological metaphor to illuminate the hidden fundamental forces that are evolving,
Rajan identifies three different types of ‘fault lines’ that the global
economic system has to contend with. The first is the hidden fractures of politics
that deals with regulation of economic systems around the world. Providing
illustrations from various contexts, Rajan points out how political
considerations trump rational economic policies because of short-term and
domestic concerns. For example, many developed economies have grown on the
strength of globally competitive manufacturing market while retaining domestically
inefficient markets in retail, banking, construction and restaurant-chains.
This creates monopolistic or cartel-like industries that are inefficient and
productive competitive industries not just in the same economic system but in
the same political jurisdiction.
The
second fault line lies in the trade imbalances that different type of economies
has with each other. Ideas about growth trajectory, role of the state,
priorities of investment and regulatory architecture is determined politically
across countries. There are forces of tension that arise out of different types
of rationale as well as between the cohort of developed and developing
countries.
The
third fault line is observed when different economic systems are allowed to
interact with each other. There are economies with an ‘arms-length’ regulatory
system of state intervention with a relatively high degree of transparency in
information available to investors. Compared to this, there are other types of publicly
regulated economies in which information is mediated through networks. When
these types of systems come into contact with each other for investment, there
is a lot of asymmetric information and inability to effectively regulate the
system.
The
importance of understanding the idea of fault line is that it is not easily
observable, is fundamental to the entire system and leaves deleterious effects
on every one involved in terms of a crisis. Going beyond speculation, creation
of bubbles and role of different sectors, Rajan argues for a more fundamental
redesigning of risk distribution in the system. His policy prescriptions
include stronger social security nets, increasing access to opportunity for different
segments within a country as well as different countries and reforming how banking
and finance is enacted in the real world. In an era, when the dissonance
between theoretical assumptions and actual decisions are increasingly apparent,
Rajan illustrates how theory can enlighten itself from practice and how getting
the fundamentals rights might be the key to the future.
