Raghuram Rajan on what makes a successful capitalist society

By Chrystia Freeland
December 7, 2010

Raghuram Rajan of the University of Chicago Booth School of Business is #26 on Foreign Policy’s list of the 100 Top Global Thinkers of 2010. His big idea is: “capitalist economies work well when everybody has access to the basic conditions they need to compete: access to education, access to health care, and access to finance.” In the absence of these conditions, Rajan argues that a capitalist society will be beset by income inequality, political frictions, and rent-seeking behaviors that subvert healthy competition. Capitalism is at its best when it creates equal opportunity:

If we all started off at age 21, 22, somewhere there, with all the education we needed, all the access to finance we wanted, and reasonable health, and we were told, ‘Here’s a level playing field. Go out and compete.’ And 25 years later some did very well, some did not so well, I think we would all be reasonably satisfied with that outcome. And that’s really the ideal of capitalism. But we’re very far from that ideal. Where you’re  born matters a lot. Of course, what you make of it also matters, but to the extent that you can reduce the impact of where you’re born, what conditions you’re born under, and what kind of impediments that creates, I think capitalism is better for it.

Rajan’s recent book, Fault Lines — the most recommended book on FP’s survey of the Global Thinkers — looks at the recent financial crisis through this lens. In the lead-up to the crisis, many citizens of the United Stated lacked access to higher education, a prerequisite for many of today’s jobs. Median wages stagnated as a result, and the government faced pressure to do something about it. Washington responded with the short-term fix of expanding cheap credit, notably through Fannie Mae and Freddie Mac, which temporarily masked the rise in income inequality but ultimately did nothing to address the structural issues of the U.S. economy.

For his next big idea, Rajan looks to examine the evolution of corporate responsibilities and objectives. In the earliest days of the corporation 400 years ago, Rajan observes that there was a sense that profits were dirty and that people shouldn’t earn more than a certain, predetermined level. Contrast that with the sense in some boardrooms today that a corporation’s guiding principle should be maximizing shareholder value. Rajan wants to find a happy medium between the two which is “less fuzzy than corporate social responsibility but is something which reflects the sense that corporations do have some responsibilities in some areas.”

Foreign Policy anointed Rajan a Global Thinker jointly with Paul Krugman for “their spirited debate over the roots of the global financial meltdown”:

In invariably stinging tones, Nobel laureate Paul Krugman uses his influential New York Times column to place himself at the center of international debates. In the United States, he has held the banner for unabashed deficit spending, ripping Barack Obama’s administration for not pushing for a bigger stimulus package, while excoriating Republicans for demanding austerity. His advice may be predictable, but it never lacks a certain power — or a certain provocation for economists who think differently.

Chief among them at the moment is Raghuram Rajan, former IMF chief economist and now a finance professor at the University of Chicago’s Booth School of Business. This year Krugman and Rajan have fought a running battle across the pages of a half-dozen publications over the causes of the financial crisis.

Rajan … argues that Krugman understates the role mortgage giants Fannie Mae and Freddie Mac played in the crisis because their culpability is inconvenient for Krugman’s big-government liberalism. “U.S. policies encouraged over-consumption and over-borrowing,” he wrote on ForeignPolicy.com, “and unless we understand where these policies came from, we have no hope of addressing the causes of this crisis.” Krugman disses Rajan’s thesis as “a structure built on foundations of sand” and places the brunt of the blame on imbalances in the global economy. Pass the popcorn.

Foreign Policy has Rajan’s recommended reading list and more.

Posted by Peter Rudegeair.

5 comments

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At fundamental level, capitalism with good sense of social responsibility is deemed healthy with the hallmark of gradual prosperity and sustenance for the long term.

As the fruits of capitalism corrupt the goodwill over time, capitalism takes on an ugly-head of greed in the form of ever increasing profits in shorter timeframes at the cost of – public health, environment and global balance. This is the form of corruption that we see today and the polarity (of rich and poor) is its signature that brings down a great developed nation to its knees (in terms of senseless compromises).

Krugman seems to be much in favor of this type of capitalism that broods polarization and is not sustainable for the long term.

Posted by Mott | Report as abusive

A broken model will always be a broken model. Our leaders were dead wrong that our economy was healthy in 2007, but little economic thinking has changed. The failure to regulate private sector irresponsibility, and malfeasance has been extremely well documented as the cause of our economic debacle. Tragically, both parties still look to Wall Street for support. Independent Congressman Bernie Sanders sponsored an audit of the Fed that recently revealed the extent of the international pyramid scheme our leaders helped Wall Street to rebuild.  As Reagan said, “There they go again.” We are repeating a proven formula for breeding locusts.  

Posted by loguealator | Report as abusive

Capitalism will be an ideal system only if it operated in a level playing field where everyone in a corporation could reap the harvest of profits equally and went down together bearing the losses as per their fare wage structures determined by independent boards and subject to scrutiny and regulation.shareholders will be natural winners as the element of risk will be curtailed by the quality of info that went out to the public.
Capitalism as we have come to experience is a corrupting force that preys on the body politic of the land its laws and policies which then renders the governing and welfare of the electorate meaningless and helps in the concentration and transfer of the nations wealth in the hands of speculative few,leaving the system in shambles and requiring help from the rest of us serfs.

Posted by cosmicinsight | Report as abusive

What part of capitalism is most sick and unhealthy? Is it natural, human, social capital, infrastructure or the financial capital? It is the last one that has become cancereous, speculative and parasitic. Is any Nobel prize winning economist giving any serious attention to diagnose the root of the problem (like centralized privatized fractional reserve banking or money as debt) let alone fix it?

Posted by Mireu | Report as abusive

Rajan’s thesis on the U.S. economy works best if you don’t dive into the details.

Core to his argument is that income disparity is caused by the failing U.S. education system. Except that in the case of the highly documented abuse of the H1B program there is overwhelming evidence that even where there is an abundance of educated qualified applicants, U.S. employers are simply breaking the law to force down wages.

It leaves you pondering why Rajan, who both directly and indirectly benefits from the abuses in that process, fails to even remotely consider them in his analysis.

Posted by ARJTurgot2 | Report as abusive