The Third Pillar: How Markets and the State are Leaving Communities Behind

Copyright

William Collins

An imprint of HarperCollinsPublishers 1 London Bridge Street London SE1 9GF WilliamCollinsBooks.com This eBook first published in Great Britain by William Collins in 2019 Copyright © 2019 by Raghuram Rajan Cover design by Jack Smyth Raghuram Rajan asserts the moral right to be identified as the author of this work A catalogue record for this book is available from the British Library All rights reserved under International and Pan-American Copyright Conventions. By payment of the required fees, you have been granted the non-exclusive, non-transferable right to access and read the text of this e-Book on-screen. No part of this text may be reproduced, transmitted, downloaded, decompiled, reverse engineered, or stored in or introduced into any information storage and retrieval system, in any form or by any means, whether electronic or mechanical, now known or hereinafter invented, without the express written permission of HarperCollins Publishers. Source ISBN: 9780008276263 Ebook Edition © February 2019 ISBN: 9780008276294 Version: 2019-02-06

To Radhika

CONTENTS

Cover

Title Page

Copyright

Dedication

Also by Raghuram Rajan

Preface

Introduction: The Third Pillar

PART I

HOW THE PILLARS EMERGED

1. Tolerating Avarice

2. The Rise of the Strong but Limited State

3. Freeing the Market … Then Defending It

4. The Community in the Balance

PART II

IMBALANCE

5. The Pressure to Promise

6. The ICT Revolution Cometh

7. The Reemergence of Populism in the Industrial West

8. The Other Half of the World

PART III

RESTORING THE BALANCE

9. Society and Inclusive Localism

10. Rebalancing the State and the Community

11. Reinvigorating the Third Pillar

12. Responsible Sovereignty

13. Reforming Markets

Epilogue

Acknowledgments

Notes

Index

About the Author

About the Publisher

ALSO BY RAGHURAM RAJAN

I Do What I Do

Fault Lines

Saving Capitalism from the Capitalists

(with Luigi Zingales)

PREFACE

We are surrounded by plenty. Humanity has never been richer as technologies of production have improved steadily over the last two hundred and fifty years. It is not just the developed countries that have grown wealthier; billions across the developing world have moved from stressful poverty to a comfortable middle-class existence in the span of a generation. Income is more evenly spread across the world than at any other time in our lives. For the first time in history, we have it in our power to eradicate hunger and starvation everywhere.

Yet even though the world has achieved economic success that would have been unimaginable even a few decades ago, some of the seemingly most privileged workers in developed countries are literally worried to death. Half a million more middle-aged non-Hispanic white American males died between 1999 and 2013 than if their death rates had followed the trend of other ethnic groups.1 The additional deaths were concentrated among those with a high school degree or less, and largely due to drugs, alcohol, and suicide. To put these deaths in perspective, it is as if ten Vietnam wars were simultaneously taking place, not in some faraway land, but in homes in small-town and rural America. In an era of seeming plenty, a group that once epitomised the American dream seems to have lost hope.

The anxieties of the moderately educated middle-aged white male in the United States are mirrored in other rich developed countries in the West, though perhaps with less tragic effects. The primary source of worry seems to be that moderately educated workers are rapidly losing, or are at risk of losing, good ‘middle-class’ employment, and this has grievous effects on them, their families, and the communities they live in. It is widely understood that job losses stem from both global trade and the technological automation of old jobs. Less well understood is that technological progress has been the more important cause. Nevertheless, as public anxiety turns to anger, radical politicians see more value in attacking imports and immigrants. They propose to protect manufacturing jobs by overturning the liberal rules-based postwar economic order, the system that has facilitated the flow of goods, capital, and people across borders.

There is both promise and peril in our future. The promise comes from new technologies that can help us solve our most worrisome problems like poverty and climate change. Fulfilling it requires keeping borders open so that these innovations can be taken to the most underdeveloped parts of the world, even while attracting people from foreign lands to support aging rich country populations. The peril lies not just in influential communities not being able to adapt and instead impeding progress but also in the kind of society that might emerge if our values and institutions do not change as technology disproportionately empowers and enriches some.

DISRUPTIVE TECHNOLOGICAL CHANGE

Every past technological revolution has been disruptive, prompted a societal reaction, and eventually resulted in societal change that helped us get the best out of the technology. Since the early 1970s, we have experienced the Information and Communications Technology (ICT) revolution. It built on the spread of mass computing made possible by the microprocessor and the personal computer, and now includes technologies ranging from artificial intelligence to quantum computing, touching and improving areas as diverse as international trade and gene therapy. The effects of the ICT revolution have been transmitted across the world by increasingly integrated markets for goods, services, capital, and people. Every country has experienced disruption, punctuated by dramatic episodes like the Global Financial Crisis in 2007–2008 and the accompanying Great Recession. We are now seeing the reaction in populist movements of the extreme Left and Right. What has not happened yet is the necessary societal change, which is why so many despair of the future. We are at a critical moment in human history, when wrong choices could derail human economic progress.

This book is about the three pillars that support society and how we get to the right balance between them so that society prospers. Two of the pillars I focus on are the usual suspects, the state and markets. Many forests have been consumed by books on the relationship between the two, some favouring the state and others markets. It is the neglected third pillar, the community – the social aspects of society – that I want to reintroduce into the debate. When any of the three pillars weakens or strengthens significantly, typically as a result of rapid technological progress or terrible economic adversity like a depression, the balance is upset and society has to find a new equilibrium. The period of transition can be traumatic, but society has succeeded repeatedly in the past. The central question in this book is how we restore the balance between the pillars in the face of the ongoing disruptive technological and social change.

I will argue that many of the economic and political concerns today across the world, including the rise of populist nationalism and radical movements of the Left, can be traced to the diminution of the community. The state and markets have expanded their powers and reach in tandem, and left the community relatively powerless to face the full and uneven brunt of technological change. Importantly, the solutions to many of our problems are also to be found in bringing dysfunctional communities back to health, not in clamping down on markets. This is how we will rebalance the pillars at a level more beneficial to society and preserve the liberal market democracies many of us live in.

DEFINITIONS

To avoid confusion later, let us get over the tedious but necessary issue of definitions quickly. Broadly speaking, the state in this book will refer to the political governance structure of a country. In much of this book, it will refer to the federal government. In addition to the executive branch, the state will also include the legislature and the judiciary.

Markets will include all private economic structures facilitating production and exchange in the economy. The term will encompass the entire variety of markets, including the market for goods and services, the market for workers (the labour market), and the market for loans, stocks, and bonds (the capital or financial market). It will also include the main actors from the private sector, such as businesspeople and corporations.

According to the dictionary, a community ‘is a social group of any size whose members reside in a specific locality, share government, and often have a common cultural and historical heritage’.2 This is the definition we will use, with the neighbourhood (or the village, municipality, or small town) being the archetypal community in modern times, the manor in medieval times, and the tribe in ancient times. Importantly, we focus on communities whose members live in proximity – as contrasted with virtual communities or national religious denominations. We will view local government, such as the school board, the neighbourhood council, or town mayor, as part of the community. A large country has layers of government between the federal government (part of the state) and the local government (part of the community). In general, we will treat these layers as part of the state. Finally, we will use the terms society, country, or nation interchangeably as the composite of the state, markets, communities, people, territory, and much else that compose political entities like China or the United States.

WHY THE COMMUNITY STILL MATTERS

Definitions done, let us get to substance. For early humans the tribe was their society – their state, markets, and community rolled into one. It was where all activities were conducted, including the rearing of children, the production and exchange of food and goods, and the succour of the ill and the elderly. The tribal chief or elders laid down the law and enforced it, and commanded the tribe’s warriors in defense of their lands. Over time, as we will see in Part I of the book, both markets and the state separated from the community. Trade with more distant communities through markets allowed everyone to specialise in what they were relatively good at, making everyone more prosperous. The state, aggregating the power and resources of the many communities within it, not only regulated markets but also enforced the law within its political boundaries, while defending the realm against aggressors.

Markets and the state have not only separated themselves from the community in recent times but have also steadily encroached on activities that strengthened bonds within the traditional community. Consider some functions the community no longer performs. In frontier communities, neighbours used to help deliver babies; today most women check into a hospital when they feel the onset of childbirth. They naturally prefer the specialist’s expertise much more than they value their neighbour’s friendly but amateurish helping hand. On a more mundane level, we used to offer to take our elderly neighbour shopping because she did not have a car. Today, she orders her groceries online. Similarly, the community used to pitch in to rebuild a household’s home if it caught fire; today the household collects its fire insurance payment and hires a professional builder. Indeed, given the building codes in most developed countries, it is unlikely that a home reconstructed by neighbours would be legal.

The community still plays a number of important roles in society. It anchors the individual in real human networks and gives them a sense of identity; our presence in the world is verified by our impact on people around us. By allowing us to participate in local governance structures such as parent-teacher associations, school boards, library boards, and neighbourhood oversight committees, as well as local mayoral or ward elections, our community gives us a sense of self-determination, a sense of direct control over our lives, even while making local public services work better for us. Importantly, despite the existence of formal structures such as public schooling, a government safety net, and commercial insurance, the goodness of neighbours is still useful in filling in gaps. When a neighbouring engineer tutors our son in mathematics in her spare time, or the neighbourhood comes together in a recession to collect food and clothing for needy households, the community is helping out where formal structures are inadequate. Given the continuing importance of the community, healthy modern communities try to compensate for the encroachment of markets and the state with other activities that strengthen community ties, such as social gatherings and neighbourhood associations.

Economists Raj Chetty and Nathaniel Hendren attempt to quantify the economic impact of growing up in a better community.3 They examine the incomes of children whose parents moved from one neighbourhood into another in the United States when the child was young. Specifically, consider neighbourhood Better and neighbourhood Worse. Correcting for parental income, the average incomes of children of longtime residents when they become adults is one percentile higher in the national income distribution in neighbourhood Better than it is in neighbourhood Worse. Chetty and Hendren find that a child whose parents move from neighbourhood Worse to Better will have an adult income that is, on average, 0.04 percentile points higher for every childhood year it spends in Better. In other words, if the child’s parents move when it is born and they stay till it is twenty, the child’s income as an adult will have made up 80 per cent of the difference between the average incomes in the two neighbourhoods.

Their study suggests that a child benefits enormously by moving to a community where children are more successful (at least as measured by their future income). Communities matter! Perhaps more than any outside influence other than the parents we are born to, the community we grow up in influences our economic prospects. Importantly, Chetty and Hendren’s finding applies for a single child moving – movement is not a recipe for the development of an entire poor community. Instead, the poor community has to find ways to develop in situ, while holding on to its best and brightest. It is a challenge we will address in the book.

There are other virtues to a healthy community. Local community government acts as a shield against the policies of the federal government, thus protecting minorities against a possible tyranny of the majority, and serving as a check on federal power. Sanctuary communities in the United States and Europe have resisted cooperating with national immigration authorities in identifying and deporting undocumented immigrants. Under the previous US presidential administration, communities in the state of Arizona resisted in the opposite direction, ignoring the federal government while implementing stern penalties on undocumented immigration.

Although no country can function if every community picks and chooses the laws they will obey, we will see that some decentralisation in legislative powers to the community can be beneficial, especially if there are large differences in opinion between communities.

A critical function the community plays in modern market democracies is to serve as a training ground for aspiring politicians – recall that Barack Obama was a community organiser – with the community itself constituting a ready-made structure for political mobilisation. Furthermore, it is community-based movements against corruption and cronyism that time and again prevent the leviathan of the state from getting too comfortable with the behemoth of big business. Indeed, as we will see in the book, healthy communities are essential for sustaining vibrant market democracies. This is perhaps why authoritarian movements like fascism and communism try to replace community consciousness with nationalist or proletarian consciousness.

In sum, the proximate community is still relevant today, even in cosmopolitan cities where ties of kinship and ethnicity are limited, and even in individualistic societies like those of the United States and Western Europe. Once we understand that the community matters, then it becomes clear why it is not enough for a country to experience strong economic growth – the professional economist’s favourite measure of economic performance. How that growth is distributed across communities in the country also matters immensely. People who value staying in their community are not very mobile. Since they cannot move to work where growth occurs, they need economic growth in their own community. If we care about the community, we need to care about the geographic distribution of growth.

What then is the source of today’s problems? In one word, imbalance! When the three pillars of society are appropriately balanced, society has the best chance of providing for the well-being of its people. The modern state provides physical security, as it always has, but also tries to ensure fairness in economic outcomes, which democracy demands. To do this, the state sets limits on the markets while also ensuring they offer people a level playing field. It also has to make sure that most people have the ability to participate on equal terms in the market, and are buffered against its fluctuations. The competitive markets ensure that those who succeed in it are efficient and produce the maximum output with the resources available. The successful have both wealth and some independence from the state, thus they have the ability to check arbitrary actions by the state. Finally, the people in industrial democracies, engaged in their communities and thereby organised socially and politically, maintain the necessary separation between markets and the state. By doing this they enable sufficient political and economic competition that the economy does not descend into cronyism or authoritarianism.

Society suffers when any of the pillars weakens or strengthens overly relative to the others. 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. Conversely, too much market and society becomes inequitable, too much community and society becomes static, and too much state and society becomes authoritarian. A balance is essential!

THE EFFECTS OF TRADE AND THE ICT REVOLUTION ON THE COMMUNITY

The pillars are seriously unbalanced today. The direct effects of the ICT revolution through automation, and the indirect but more localised effects through trade competition, have led to large job losses in some communities in developed countries. Typically, these have been middle-income jobs held by the moderately educated. With male workers least able to adjust, families have been tremendously stressed, with an increase in divorces, teenage pregnancies, and single-parent households. In turn, these have led to a deterioration in the environment for children, resulting in poor school performance; high dropout rates, the increased attractiveness of drugs, gangs, and crime; and persistent youth unemployment. Importantly, community decline tends to feed on itself, as still-functional families escape so that their children do not get affected by the unhealthy environment.

In the United States, minority and immigrant communities were hit first by joblessness, which led to their social breakdown in the 1970s and 1980s. In the last two decades, communities in small towns and semirural areas, typically white, have been experiencing a similar decline as large local manufacturers close down. The opioid epidemic is just one symptom of the hopelessness and despair that accompanies the social breakdown of once-healthy communities.

The technological revolution has been disruptive even outside economically distressed communities. It has increased the wage premium for those with better capabilities significantly, with the best employed by high-paying superstar firms that increasingly dominate a number of industries. This has put pressure on upper-middle-class parents to secede from economically mixed communities and move their children to schools in richer, healthier communities, where they will learn better with other well-supported children like themselves. The poorer working class are kept from following by the high cost of housing in the tonier neighbourhoods. Their communities deteriorate once again, this time because of the secession of the successful. Technological change has created that nirvana for the upper middle class, a meritocracy based on education and skills. Through the sorting of economic classes and the decline of the mixed community, however, it is also becoming a hereditary one, where only the children of the successful succeed.

The rest are left behind in declining communities, where it is harder for the young to learn what is needed for good jobs. Communities get trapped in vicious cycles where economic decline fuels social decline, which fuels further economic decline … The consequences are devastating. Alienated individuals, bereft of the hope that comes from being grounded in a healthy community, become prey to demagogues on both the extreme Right and Left, who cater to their worst prejudices. Populist politicians strike a receptive chord when they blame the upper-middle-class elite and establishment parties.

When the proximate community is dysfunctional, alienated individuals need some other way to channel their need to belong.4 Populist nationalism offers one such appealing vision of a larger purposeful imagined community – whether it is white majoritarianism in Europe and the United States, the Islamic Turkish nationalism of Turkey’s Justice and Development Party, or the Hindu nationalism of India’s Rashtriya Swayamsevak Sangh.5 It is populist in that it blames the corrupt elite for the condition of the people. It is nationalist (more precisely, ethnic nationalist, but I will leave the nitpicking for later) in that it anoints the native-born majority group in the country as the true inheritors of the country’s heritage and wealth. Populist nationalists identify minorities and immigrants – the favourites of the elite establishment – as usurpers, and blame foreign countries for keeping the nation down. These fabricated adversaries are necessary to the populist nationalist agenda, for there is often little else to tie the majority group together – it is not really based on any true sense of community, for the differences between various subgroups in the majority are usually substantial.

Populist nationalism will undermine the liberal market democratic system that has brought developed countries the prosperity they enjoy. Within countries, it will anoint some as full citizens and true inheritors of the nation’s patrimony while the rest are relegated to an unequal, second-class status. It risks closing global markets down just when these countries are aging and need both international demand for their products and young skilled immigrants to fill out their declining workforces. It is dangerous because it offers blame and no real solutions, it needs a constant stream of villains to keep its base energised, and it moves the world closer to conflict rather than cooperation on global problems. While the populist nationalists raise important questions, the world can ill afford their shortsighted solutions.