| Raghuram Rajan, Princeton University Press, 2010, 260 pages, £18.95.
|
This is a book that is intriguing, depressing and annoying
simultaneously. And that is why it is worth reading.
The intrigue comes from presenting arguments and observations that are
not necessarily new but rather placed together in a way that is
interesting, making the title, Fault Lines, appropriate.
|
| Rajan argues that economic agents, each behaving rationally, can
lead to unintended consequences – much as the earth’s tectonic plates
move independently and rub against each other along fault lines,
sometimes with devastating effects. According to Rajan, the rise and
fall of US house prices was due to several factors and cannot be blamed
solely on greedy bankers. US politicians and policy makers needed to
offset slow job growth and rising income inequality in the aftermath of
the recessions of the early 1990s and 2000s. To offset both, interest
rates were kept low for longer than was appropriate. Low interest rates
helped job growth but allowed credit to expand so the lower paid could
enjoy a debt-financed lifestyle. Politicians encouraged and guaranteed
home loans as a way to offset widening income disparity. Extending home
ownership to less wealthy enabled them to participate in the increased
wealth of country even if their incomes were not rising as much as those
of the rich. Developing nations were happy to oblige the increase in US
debt, supplying goods aplenty through their export-led growth. |
| An arguably original case is made that the lack of a more developed
social security system in the US played a part in encouraging the credit
boom. A more generous system of unemployment benefits would have reduced
the pressure on politicians to encourage home ownership and for interest
rates to be kept low. In a similar vein, there is a call for a reform of
medical insurance and improvement in education to reduce the possibility
of an underclass developing |
| The depressing aspects of the book come from the sections suggesting
reforms that could prevent these factors leading to another crisis.
Rajan does not shrink from the task. Three chapters are devoted to this.
The trouble is the suggested reforms are unlikely to be enacted. |
| On finance, the benefits associated with advances in managing money,
risk and credit are recognised but so too are the risks. Rajan’s
suggestions for reform are not aimed at restricting financial innovation
but ensuring instead the risks are internalised and held by the
institutions and their owners. The suggestions are made as general
principles rather than technical details, making them more powerful. Yet
what do we see in reality? Reforms designed to increase bank capital
that will not be completed until 2019, with little sign of costs and
risks being internalised. |
| Similarly, his warning to developing counties about the ultimate
futility of export-led growth will fall on deaf ears. The
inappropriateness of developing countries banning agricultural exports
when food prices rise because it limits the income of farmers is noted
in the book. Yet with food prices now rising rapidly, this is what we
are seeing. Similarly Japan decides to protect its exporters by selling
the yen. |
| Rajan hopes that multi-national institutions, such as the IMF (where
he was the Chief Economist between 2003 and 2006) and the World Bank can
reach out beyond officialdom to people in general, using the web and
social networking to put pressure on governments to make decisions more
aligned with the global than the national good. Yet this seems to be a
pipe dream as his own description of Gordon Brown’s reaction to the
IMF’s criticism in 2005 of the UK’s budget position makes clear |
| There is much to recommend this book despite some annoyances. There
are no tables or graphs. Some points could have been made better with
them. The book has a significant US focus. This is understandable but
more time spent on the European predicament would have been useful. But
that is no reason to ignore the book’s insights and suggestions. |
Ian Bright
ING |