Tuesday, August 20, 2013

Raghuram Rajan's Tryst with India's Destiny

(This article is written by Dr Anand V P Gurumoorthy Associate Professor in Chemical Engineering at VIT University, Vellore Campus. The author has a PhD from IIT-Bombay and can be reached at anandg61@yahoo.com.) 
On August 10, 2012,. Raghuram G Rajan was appointed as Chief Economic Advisor of the Indian government. Rajan has had a stellar career thus far and is something of a hero in Indian circles – a local boy done the motherland proud. After an undergraduate degree in Electrical Engineering from  Indian Institute of Technology – Delhi, he  went on to do an PG-Diploma in Business Administration from the Indian Institute of Management – Ahmedabad (“I always was interested in finance and economics”). Then he moved to the US to complete a PhD in Management from MIT. He joined the Faculty in the University of Chicago Booth School of Business where he is now Eric Gleacher Distinguished Service Professor of Finance. He had a stint as Chief Economist at the IMF between 2003 and 2006.  His academic career must have been exemplary given that he won the inaugural Fischer Black prize awarded by the American Finance Association. He was also one of the very few who correctly predicted the 2008 financial crisis.
What does Raghuram Rajan stand for? What toolkit does he bring with him to fix the ailing Indian economy? Rajan is well known for his free-market capitalistic views. (Indeed, after his scathing criticism of Prime Minister Manmohan Singh’s government, it came as a surprise when he was selected for the top economic post.) How will his views fare in the socialist ethos that pervades India? Will Rajan be able to make an impact in Indian governance and improve the infrastructure of the Indian economic system?
A glimpse of his views can be had by a reading of his recently published books. The first one, co-authored with Luigi Zingales is Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity (2003). In this book, the authors develop the viewpoint that free markets are best suited to benefit human society and improve the human condition. Governments should have a limited intervention in free markets, otherwise they would be subjected to lobbying from various pressure groups (the capitalists) in taking decisions favoring those particular groups. The books advocates creating awareness and educating the public about the merits of free markets. While it is not a defense of laissez-faire capitalism, the book does set Rajan firmly among the free marketeers.
The next and more important book is Fault Lines: How Hidden Fractures Still Threaten The World Economy (2010). This book won the prestigious FT-Goldman Sachs Business Book of the Year Award for 2010. This book is an analysis of the state of the world economy in 2010 with special emphasis to the 2008 financial crisis that originated in the US. Rajan traces the roots of the 2008 crisis to the easy credit policies of the US government that led to the housing bubble. While greedy bankers had their role to play in the ensuing mess, they were behaving rationally to US government incentives. Rajan denounces the use of easy credit and other forms of aid to alleviate the lower income groups. As he points out, “Few ‘solutions’ hold more support and promise up front, and lead to more recrimination after the fact, than opening the spigot of lending. For poor countries there is a strong parallel with the past enthusiasm for foreign aid. Now we know that aid leads to dependency, indebtedness, and poor governance and rarely leads to growth.”
But Fault Lines is about more than just the 2008 crisis. It is a fundamental look at the imbalances in the world. In the current scenario, developing countries (like China) with current account surpluses are propping up the consumption in developed countries (like the US) with huge current account deficits. This is a highly unsustainable state of affairs. (The US is clamoring for the devaluation of the Chinese currency to solve the problem but the fault of high consumption in the US is hardly China’s.) Meanwhile developing countries need to wean themselves away from export dependence. But “[t]here is no natural, smooth and painless movement away from export dependence to becoming a balanced economy.”
Rajan has a lot to say about India in his book. On subsidies and easy loans, Rajan’s stand can be guessed at given the earlier discussion. But India is a country heavily invested in subsidies. A recent statistic shows that around 75 - 80 percent of all the tax revenues collected by the Indian government is diverted towards subsidies. Many in the government are waking up to the unsustainable nature of their policies but their hands are tied since it is these subsidies that have put them in power. A recent attempt at some preliminary reforms led to widespread protests from not only opposition parties but also coalition member parties.
With this attitude Rajan faces an uphill task. He has said in his first meeting with the media that the government should let the highly subsidized fuel prices to come up to international levels. Other alternatives (such as distortionary taxation of diesel vehicles) will not work in the long run. He has also suggested that prices of several goods like milk are outside our control and subsidizing all these goods is not advisable. It needs to be seen how these suggestions are received by the Indian public.
Rajan also makes a case for land reforms in his book. “In India,” he states, “…land rights are often poorly demarcated. In the poorest states, land and revenue records are not well maintained. Moreover, a number of communities, such as the tribal populations that are spread throughout India, do not have formal title to land but have been customary users of it over centuries.” A process has been initiated to sort out the issues but is sluggish. Says Rajan: “Reforms clarifying who owns what, and giving them full and clear title to the land will create a much more vigorous and liquid market for land transactions, and will smoothen the way for land acquisition that is necessary for the creation of infrastructure and for industrialization. Unfortunately, powerful interests who benefit from the murkiness of land rights oppose these reforms.”
Lest it be mistaken, Rajan is not a ruthless ideologist harping on a social Darwinist survival of the fittest. He states to be a pragmatist and his books show his genuine concern for the poor and the down-trodden. He is in favor of strengthening social safety nets such as providing unemployment insurance, medical care and pension schemes. Perhaps not coincidentally, the Indian government has recently taken steps to introduce 100 percent foreign direct investment (FDI) in insurance and pension.
It remains to be seen how Rajan will succeed in implementing his reform policies in India. Clearly a tough commitment.
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