Back in 2005, some of the world’s top economists gathered at Jackson Hole, Wyoming (USA). This place is known for gathering of top central bankers around the world. That year, the gathering was primarily meant to celebrate the storied career of the retiring Chairman of US Central Bank (‘the Fed’), Alan Greenspan – who had a stellar run as the Fed’s Chairman, overseeing one of the most successful times for the US economy, especially under President Bill Clinton.
Majority of the speakers showered accolades on the outgoing chairman, equating his stint with financial stability and dynamism. There was one exception, though. Raghuram Rajan, an Indian-American professor of Finance, sounded a warning instead. His speech, heavily centred around his paper ‘Has financial development made the world riskier?’, took the position that years of weak, liberal oversight of the financial sector had induced such risks within the system that it could prove to be a major catastrophe in the future. These risks, he argued, came from financial engineering and skewed incentives that motivated high risk taking.
But nobody took him seriously. And there was a basis for their skepticism of Raghu’s thesis: since the Great Depression of 1929, no major catastrophe had struck the world economy. There had been crisis like the East Asian financial turmoil, but these were either local level or were contained without much damage to the world economy. Therefore, the thinking went, even if there were a crisis in the future, it would be contained without much damage.
On September 15, 2008, Rajan’s words reverberated through the global financial markets and economies as the wheels of the ‘Great Recession’ were set in motion by the act of a financial firm (Lehman Brothers) going bankrupt. Suddenly, everything started to come apart. The contagion spread quickly, out of America to other parts of the world - especially the European Union. To their dismay, the central bankers realised that years of lax regulations had led to such dangerous and toxic financial products like the ‘subprime mortgages’ and ‘credit default swaps’, based upon questionable assumptions rather than economic fundamentals. And the financial sector was heavily awash with these products. The lax regulations and oversight encouraged financial engineering to the extent that it put the whole economic order at risk.
A decade after the world economy was struck by this jolt, the damage is still to be undone completely. Although governments around the globe stepped in an unprecedented display of publicly-funded help, with the central banks also getting involved directly in buying assets, the industrialised periphery of the global economy is still growing at an anemic pace. According to calculations, America alone lost 9 million jobs and more than $8 trillion in wealth due to the Great Recession. The losses acquire even more gigantic proportions if one were to consider the losses accrued around the globe. And lest we forget, it gave birth to the Wall Street vs Main Street movement, the 99 percent against the one percent.
Rajan later went onto serve as the chief economist at the IMF and as governor of the Indian Central Bank, where his work has been lauded widely. Back to teaching at University of Chicago, he has now come up with another warning. But instead of finance and economics, the risk this time emanates from the political landscape around the globe. And it comes in the form of ‘populism,’ a movement that is based on the grievances (perceived or real) of the people. As this movement spreads gradually around the globe, helping usher in the likes of Donald Trump (USA) and now Jair Bolsonaro (Brazil), Rajan sees risks associated with such populism and the bombast of the men that such political movement help anoint to highest posts.
One common theme that runs through this ideology, wherever one looks, is the notion that our country is being unfairly taken advantage of by other countries in terms of economic transactions. Trade especially is high on their radar, and it is an important lever through which they exploit popular opinion. Take Trump’s example. A major part of his election campaign was built on the platform of the effects of trade with China. Although the evidence largely refuted his claim, Trump was able to convince the American voter that America and their economic troubles were largely the result of trade with China, which cost US jobs and trillions of dollars.
By now, the US and China are embroiled in a trade war, with both sides slapping tariffs worth billions of dollars on each other’s products. Brexit is another example, whereby firebrand politicians in the UK were able to convince people that being part of the EU was a bad idea. By now, UK and EU are locked in an intense drama over the costs and repercussions of this move. And this is not limited to US and China, as other nations in the world are explicitly or implicitly moving towards protecting their economic interests through various means. This, along with slower growth in demand, explains why global trade has slowed down.
Rajan, and many others, worry that such developments have historically led to unfortunate consequences. The prime example is the First World War. Before the war, from last quarter of 19th century onwards, trade between nations grew at an amiable pace. This continued a few years before the WWI, an era called the first era of globalization. But as nations retreated from their trade commitments and relations, animosity gradually built up as trade retreated. The context was the same even at that time: other nations are taking advantage at our cost. Ultimately, misgivings exploded into one of the most epic disasters of mankind’s history. We surely do not want that kind of a thing to be repeated.
If the world economy is to face another mammoth challenge in the future, as Rajan envisions, what can be done to avert or mitigate it? At the end of the 2005 event, two very senior central bank economists came up to him and rubbished his predictions. It was their belief that the private sector is smart enough to know what they are doing, and had the right information to price-in risk appropriately. They later came to regret their belief, as did many others. So, one lesson is that the government has to be vigilant enough to see through the fog of economic risks, and not to leave it completely to the market power to take a self-corrective course. Also, it is imperative upon the leadership to realize that political rhetoric can result in follies whose later consequences can be unfathomable.
The writer is an economist
Majority of the speakers showered accolades on the outgoing chairman, equating his stint with financial stability and dynamism. There was one exception, though. Raghuram Rajan, an Indian-American professor of Finance, sounded a warning instead. His speech, heavily centred around his paper ‘Has financial development made the world riskier?’, took the position that years of weak, liberal oversight of the financial sector had induced such risks within the system that it could prove to be a major catastrophe in the future. These risks, he argued, came from financial engineering and skewed incentives that motivated high risk taking.
UK and EU are locked in an intense drama over the costs and repercussions of Brexit. Other nations in the world are also explicitly or implicitly moving towards protecting their economic interests through various means
But nobody took him seriously. And there was a basis for their skepticism of Raghu’s thesis: since the Great Depression of 1929, no major catastrophe had struck the world economy. There had been crisis like the East Asian financial turmoil, but these were either local level or were contained without much damage to the world economy. Therefore, the thinking went, even if there were a crisis in the future, it would be contained without much damage.
On September 15, 2008, Rajan’s words reverberated through the global financial markets and economies as the wheels of the ‘Great Recession’ were set in motion by the act of a financial firm (Lehman Brothers) going bankrupt. Suddenly, everything started to come apart. The contagion spread quickly, out of America to other parts of the world - especially the European Union. To their dismay, the central bankers realised that years of lax regulations had led to such dangerous and toxic financial products like the ‘subprime mortgages’ and ‘credit default swaps’, based upon questionable assumptions rather than economic fundamentals. And the financial sector was heavily awash with these products. The lax regulations and oversight encouraged financial engineering to the extent that it put the whole economic order at risk.
A decade after the world economy was struck by this jolt, the damage is still to be undone completely. Although governments around the globe stepped in an unprecedented display of publicly-funded help, with the central banks also getting involved directly in buying assets, the industrialised periphery of the global economy is still growing at an anemic pace. According to calculations, America alone lost 9 million jobs and more than $8 trillion in wealth due to the Great Recession. The losses acquire even more gigantic proportions if one were to consider the losses accrued around the globe. And lest we forget, it gave birth to the Wall Street vs Main Street movement, the 99 percent against the one percent.
Rajan later went onto serve as the chief economist at the IMF and as governor of the Indian Central Bank, where his work has been lauded widely. Back to teaching at University of Chicago, he has now come up with another warning. But instead of finance and economics, the risk this time emanates from the political landscape around the globe. And it comes in the form of ‘populism,’ a movement that is based on the grievances (perceived or real) of the people. As this movement spreads gradually around the globe, helping usher in the likes of Donald Trump (USA) and now Jair Bolsonaro (Brazil), Rajan sees risks associated with such populism and the bombast of the men that such political movement help anoint to highest posts.
One common theme that runs through this ideology, wherever one looks, is the notion that our country is being unfairly taken advantage of by other countries in terms of economic transactions. Trade especially is high on their radar, and it is an important lever through which they exploit popular opinion. Take Trump’s example. A major part of his election campaign was built on the platform of the effects of trade with China. Although the evidence largely refuted his claim, Trump was able to convince the American voter that America and their economic troubles were largely the result of trade with China, which cost US jobs and trillions of dollars.
By now, the US and China are embroiled in a trade war, with both sides slapping tariffs worth billions of dollars on each other’s products. Brexit is another example, whereby firebrand politicians in the UK were able to convince people that being part of the EU was a bad idea. By now, UK and EU are locked in an intense drama over the costs and repercussions of this move. And this is not limited to US and China, as other nations in the world are explicitly or implicitly moving towards protecting their economic interests through various means. This, along with slower growth in demand, explains why global trade has slowed down.
Rajan, and many others, worry that such developments have historically led to unfortunate consequences. The prime example is the First World War. Before the war, from last quarter of 19th century onwards, trade between nations grew at an amiable pace. This continued a few years before the WWI, an era called the first era of globalization. But as nations retreated from their trade commitments and relations, animosity gradually built up as trade retreated. The context was the same even at that time: other nations are taking advantage at our cost. Ultimately, misgivings exploded into one of the most epic disasters of mankind’s history. We surely do not want that kind of a thing to be repeated.
If the world economy is to face another mammoth challenge in the future, as Rajan envisions, what can be done to avert or mitigate it? At the end of the 2005 event, two very senior central bank economists came up to him and rubbished his predictions. It was their belief that the private sector is smart enough to know what they are doing, and had the right information to price-in risk appropriately. They later came to regret their belief, as did many others. So, one lesson is that the government has to be vigilant enough to see through the fog of economic risks, and not to leave it completely to the market power to take a self-corrective course. Also, it is imperative upon the leadership to realize that political rhetoric can result in follies whose later consequences can be unfathomable.
The writer is an economist