raghuram rajan

Seeds of Disaster and Lords of Finance @ BYOB Party in April 2017 (Part 2)

Ralph found yet another academic book called Seeds of Disaster, Roots of Response: How Private Action Can Reduce Public Vulnerability edited by Philip E. Auerswald. The book is the first systematic attempt to make sense of how private leadership can provide critical services during bad times. The book stresses the importance of both the public and private sectors joining hands as a prerequisite to accountability in society. The book presents multiple perspectives and draws on experts from various disciplines. Ralph drew on his observations of crises in India and the fallacy of resilience as a tool to mitigate disaster.

One book Mandar was particularly inspired by was Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed, a writer of Pakistani origin. The book was shortlisted for the Samuel Johnson Prize in 2009. The book delves into the economic recession of the 1930s that led to WWII. He speaks of the four central bankers of the premier banks of the world who mismanaged the crises since the 1920s which ultimately led to the Great Depression. He also mentions how John Maynard Keynes’ economic predictions were conveniently ignored for the sake of short-term interests. Mandar mused about how there are many lessons in this book for dealing with the current economic crises, though as is usually the case, history tends to repeat itself. Mandar read out an interesting passage from the book about remonetization:

“The task of keeping Germany adequately supplied with currency notes became a major logistical operation involving ‘133 printing works with 1783 machines . . . and more than 30 paper mills.’  By 1923, the inflation had acquired a momentum of its own, creating an ever-accelerating appetite for currency that the Reichsbank, even after conscripting private printers, could not meet. In a country already flooded with paper, there were even complaints of a shortage of money in municipalities, so towns and private companies began to print their own notes. Over the next few months, Germany ex-perienced the single greatest destruction of monetary value in human history. By August 1923, a dollar was worth 620,000 marks and by early November 1923, 630 billion.

Basic necessities were now priced in the billions—a kilo of butter cost 250 billion; a kilo of bacon 180 billion; a simple ride on a Berlin street car, which had cost 1 mark before the war, was now set at 15 billion. Even though currency notes were available in denominations of up to 100 billion marks, it took whole sheaves to pay for anything. The country was awash with currency notes, carried around in bags, in wheelbarrows, in laundry baskets and hampers, even in baby carriages.”

Ralph mentioned another financial story called Fault Line: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan (Governor of the Reserve Bank of India between September 2013 and September 2016) who warned about the impending financial crises before it occurred. Raghuram exposed not just the central bankers but the chinks in the economy and spending habits that could lead to such crises. This is the first time that we have had such an extensive discussion of financial books at the BYOB Party and it opened up the need to understand the economy better. A sick economy once nurtured Nazism and could only be cured by the ensuing destruction of a World War and now the financial crises that plague the world reflect directly in a realpolitik and the rise of populism world over. Food for thought.

More books in Part 3.

Article of the Week: Dr. Raghuram Rajan’s speech on Democracy, Inclusion, and Prosperity

The question that Dr. Raghuram Rajan, governer of RBI in his professor of political economy avatar, asks is

But how do countries ensure political freedom and economic prosperity? Why do the two seem to go together? And what more, if anything, does India have to do to ensure it has these necessary underpinnings for prosperity and continued political freedom?

Dr. Rajan starts by explaining Fukuyama’s three pillars of a liberal democratic state

  1. Strong Government: Strong government does not only mean one which has great military power or effective intelligence against enemies, but one that can provide effective and fair administration too. Dictatorships are usually weak governments. They can terrorize their citizens, but not provide good governance.
  2. Rule of Law: Government’s actions are constrained by rule of law, which might be enforced by religious, judicial or moral authority.
  3. Democratic Accountability: Government has to be popularly accepted.

Strong governments do not always move in the right direction.

Hitler provided Germany with extremely effective administration – the trains ran on time, as did the trains during our own Emergency in 1975-77. His was a strong government, but Hitler took Germany efficiently and determinedly on a path to ruin, overriding the rule of law and dispensing with elections.

Both rule of law and democratic accountability are needed to steer a strong government on the right path. (Why both? Read the explanation in the full text of the speech.)

Dr. Rajan then goes on to introduce a fourth pillar in his discussion – free enterprise.

Why are political freedoms in a country, of which representative democracy is a central component, and free enterprise mutually supportive?

It isn’t quite obvious that they should be. Democracy treats everyone equally. Free market system does not. Income and property decide an individual’s power in a free market system. But despite this difference there are certain circumstances in which they go hand and in hand.

(To) the extent that the rich are self-made, and have come out winners in a competitive, fair, and transparent market, society may be better off allowing them to own and manage their wealth, settling in return for a reasonable share of their produce as taxes. The more, however, that the rich are seen as idle or crooked – as having simply inherited or, worse, gained their wealth nefariously – the more the median voter should be willing to vote for tough regulations and punitive taxes on them.

The key, then, is level playing field. When there is a perception of fairness in competition, inequality does not breed resentment. Democracy and free market support each other by giving everyone the opportunity.

The level playing field, however, is easier hoped than achieved.

(In Western democracies) quality higher educational institutions are dominated by the children of the rich, not because they have unfairly bought their way in, but because they simply have been taught and supported better by expensive schools and private tutors. Because middle class parents do not have the ability to give their children similar capabilities, they do not see the system as fair.

This is something India needs to be careful about. Right now we are moving in the direction of providing level-playing field to more and more people by giving access to education. But it would not automatically remain so.

In the concluding part, Dr. Rajan makes an interesting point about India’s political situation. He is of the view that (despite many shortcomings), the checks and balances on the government is not in a bad shape. The rule of law and democratic accountability is functional here. But strong government is still wanted. This is a situation unique to India because in most parts of the world, strong governments have emerged first and checks and balances have followed.

Let me emphasize, we need “checks and balance”, but we should ensure a balance of checks. We cannot have escaped from the License Permit Raj only to end up in the Appellate Raj!

Read the complete speech on scroll.in.