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Are capitalism and democracy failing us? Raghuram Rajan.

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Presentation on theme: "Are capitalism and democracy failing us? Raghuram Rajan."— Presentation transcript:

1 Are capitalism and democracy failing us? Raghuram Rajan

2 Capitalism and democracy in crisis Crisis and bail out. Technocratic governments, central banks around the world. Enormous levels of youth unemployment, foreclosure crisis. Meanwhile the “one percent” have received much of the gains in recent years in the United States. The rise of oligarchies elsewhere? Have the capitalists captured policy? Is “labor” powerless? Is democracy dead?

3 Outline of talk The crisis was not caused by elitist or corporatist policies. It had macro/populist underpinnings But the elite is in disrepute because the consequences of the crisis have been broadly felt, even while the elite have escaped. Moreover To deal with the legacy of the crisis, a variety of quasi-property rights of the masses will have to be violated. The property of the elite is better protected. If popular perceptions go against the elite, capitalism and democracy are in trouble. To strengthen both we need to restore opportunity to the middle class. Is it possible without massive intervention?

4 Macroeconomic underpinnings of the crisis Strong growth post war, especially in Europe. Reconstruction Resumption of trade Spread of new technologies Spread of education Rents shared, labor peace Expansion of welfare state: Promises as if growth would not end. But then low hanging fruit plucked, oil shock, growth slowed. Robert Gordon, NBER WP 2004

5 Reactions Keynesian stimulus – stagflation Monetary rigor – Volcker disinflation United States and United Kingdom: focus on supply side Deregulation started under Jimmy Carter, continued by Ronald Reagan Margaret Thatcher Continental Europe Reforms slower, push by European Commission for integrated market

6 Deregulation Increases competition Increases returns to innovators, the skilled, and the creative When accompanied by financial sector deregulation, increases returns to/power of talented human capital vs returns to financial or physical capital. Consider the financial sector in the United States

7 Source: Philippon and Reshef (2009)

8 Technology and globalization further exacerbate the demand for talent RoutineNon-Routine Skilled Clerk: Analyst; Discovery Replaced by program/machine, Outsourced Consultant, Corporate Lawyer, Doctor, Engineer, Medical technician UnskilledTextile worker Globalized Gardener, McCook, construction

9 But education (and skill building) has not kept up in the United States. Race between technology and education (Golden and Katz (2009)) Those aged 25 to 34 are less likely to have a degree than 45-54 year olds. Skill mismatch: STEM vs social sciences. Probably due to inadequacies in families, communities, pre-school preparation, and K- 12 schooling experience.

10 Source: Autor (2010)

11 Source: Golden and Katz 2009 Implication – stagnating middle in the United States

12 Nuances Caveat: New elite based on educational attainment and capabilities (and luck) rather than primarily race, gender, or even university. CEO background and tenure Nevertheless, increasing entrenchment – children of rich much more likely to complete college than children of poor, and difference increasing.

13 Consequence: Let them eat credit As more Americans left behind in perception if not in fact, increasing polarization. Rising inequality and political pressure to do something. But education difficult to tackle Redistribution? No political support + huge costs But people care about consumption. So what if they don’t have income growth. Consumption growth through credit growth Better still, home ownership: stake in the future as well as means to borrow Affordable housing (Clinton), ownership society (Bush) Instruments: FHA, Fannie, Freddie

14 Even while income inequality increased, consumption inequality has not increased commensurately…

15 Was deregulation a failure? No, helped household as consumer Walmart effect Would have helped household as producer if skill-building had responded. Financial deregulation helped innovation, but financial sector went off track. Make finance boring? Can we tame finance instead?

16 Turning to the Euro Area Milder reforms prior to Euro accession Southern Europe: Insider vs Outsider economies High unemployment before Euro accession After Euro accession – booms Housing (Spain) Local government spending (Spain) Federal government spending (Greece) Cyclically adjusted government spending rises. Unit labor costs rise => competitiveness falls

17 Unemployment in Periphery

18 In sum, have the capitalists subverted democracy? Democracy created pressure to keep growth going. Populist policies produced fast- working but unsustainable solution Easy credit Government spending Private financiers were neither blameless nor unwilling tools. Convergence between business and politics But to argue that policy was solely elitist in origin and intent is a total misreading of what happened.

19 Post Crash Policies Resolution means altering property rights. Bank bailouts – could have imposed more costs on shareholders and bondholders Dividend restrictions Capital raising rather than asset shrinkage Moratorium on bonuses Increasing pressure to renegotiate other promises – pensions, social security, healthcare. Will property rights be differentially enforced? How will the public see this?

20 Technocratic governments and institutions Are the technocrats put in power only to violate property rights selectively? Unelected troika Central banks Technocratic governments What will the violations do to future property right protection?

21 Democracy and Capitalism There is a growing tension between democracy and free enterprise post-crisis. When the masses do not see opportunity, they have little incentive to support property and free enterprise. When they see selective enforcement of property rights, property becomes less sacrosanct As capitalists get delegitimized, an important constraint on arbitrary government also is weakened. Russia under Putin Democracy suffers.

22 Restoring opportunity We need to restore opportunity and hope to the middle class. Policies will pay clear dividends only in the long run. Education and skills Innovation Need to address distress in short run How to get the unemployed, especially the young, into the labor force? How to retrain those in sunset industries? How to engage the unemployable? How to persuade the working rich to go along?

23 Restoring faith in property What promises will governments keep? What will be defaulted on? What will be inflated away? What will be bailed out? Who will pay? How will decisions be made? How legitimate will it appear?

24 Bottom line Our problems are not elite capture (at least not any more than in the past). Industrial democracies are facing up to developmental problems that they thought they never would have to face again. Electorates are impatient and divided, so politicians respond with short term policies. These policies can make things worse, and reduce support for free enterprise. Loss of capitalist legitimacy can reduce an important check on arbitrary government. Can we afford to let that happen?


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