The Third Pillar

by Raghuram Rajan

  LOW SCHOOL QUALITY AND CREDENTIAL INFLATION

  The uneven quality of school education even within a school district has other ramifications. We noted in the last chapter the high-wage premium associated with degrees in the United States, and indicated it was a puzzle, given the high fraction of workers with degrees. Certainly, many jobs do require more skills as a result of technological change—the worker who used the machine lathe may be unprepared to program the robotic arm that now does the job. Nevertheless there seems to be something more at work in the high wage premiums—a study by researchers at Harvard Business School finds that in 2015, 67 percent of production supervisor job postings in the United States asked for a college degree, while only 16 percent of employed supervisors had one.28 While companies may be trying to make up their skills gap with more-qualified new entrants, the difference in credentials between that of those employed and those sought in job postings seems too large to be accounted for by just catch up.

  Companies seem to be rating jobs as requiring higher credentials, simply because schools are not teaching basic skills well; there is a greater likelihood of finding a capable candidate who writes reasonably and has simple numeracy skills among those who have completed college.29 International assessments seem to verify the low average quality of US schooling. In the latest PISA assessments of the quality of fifteen-year-old students across countries, the United States came in thirtieth in mathematics and nineteenth in science among the thirty-five-member OECD group of rich countries.30

  A college degree is then valued because it signals the candidate’s competence in high school skills, rather than any additional capabilities picked up in college. The degree may also signal the candidate’s determination and ambition, as evidenced by her ability to survive the rigors of college. Indeed, at the risk of oversimplifying economist Michael Spence’s Nobel Prize–winning theory of signaling, it was just this: College may teach students nothing of use in a job. It is particularly costly, though, to complete for those who do not have basic skills. Those who have solid basic skills can then separate themselves from those who do not by acquiring a college degree. The human resource departments of companies seem to believe something like this, and have simplified hiring by demanding a college degree even when it is not needed for the position they need to fill.

  The harm done is worse than simply too much time spent by students who do not need degrees acquiring them at great expense, firms overpaying for qualifications they do not need, and a higher-education system that consumes enormous resources. It causes professions to inflate their own minimum credential requirements as they strive to gain in prestige—it would be nice for preschool teachers to have degrees in child development or education but would we not lose a lot of perfectly capable teachers by requiring it?31 The barriers to getting good jobs increases for those who have basic skills but do not have the money, aptitude, or interest in college. It becomes nearly impossible for those who have been consigned to bad schools and never had a chance of acquiring basic skills.

  THE CONFLICT OVER VALUES AND POLITICS

  Even though the upper-middle-class elite seceded from the integrated community into gated ones, their social values were lobbed over the battlements for all to consider and adopt. To many among the elite, birth control and feminism became the nonnegotiable terms of their engagement with the rest of society, with liberals among them adding abortion rights and gay rights to their creed. Yet such new freedoms were not easy for those outside the walls to espouse.

  Divorce would free the partners in an unhappy marriage, but as social commentators Ross Douthat and Reihan Salam argue, divorce is much costlier for a low-income family, where no parent individually has the resources to give children a comfortable upbringing.32 Facing rising and costly social ills like teenage pregnancies and broken families, it was natural for the newly disadvantaged to remember a rosier past where families were stronger and bound together in a prosperous community. They had reason to hold on to religion and traditions in the hope that these would help reverse their deteriorating present. Conversely, they rejected the modern values of the upper-middle-class elite transmitted through mainstream media, not because their own social life was exemplary, but because they believed that religion and traditions were perhaps their last protection against total social breakdown. To the upper middle class, this seemed like hypocrisy. To the working class, this was survival.

  The differences also translated to the political. Democrats have historically been the party of the state and the worker, while Republicans have been the party of the market and business. The social divisions gave the parties additional identities. The Democrats became pro-choice and the party for social liberals, the Republicans became pro-life, and thus more closely aligned with religious conservatives and traditionalists. The parties also divided on ethnic and racial identity. Ever since the Civil Rights movement, the Democrats have found their natural sympathizers among the traditionally downtrodden—racial and sexual minorities, immigrants, and women. The Republican Party, which ironically was the party that emancipated the slaves, has disproportionately attracted white voters who were upset with the Democratic Party’s new leanings. Consider these numbers: In the 1976 presidential elections, white voters voted for Republican Gerald Ford over Democrat Jimmy Carter, 52 percent to 48 percent. In 2016, white voters chose Donald Trump over Hillary Clinton, 57 percent to 37 percent, the same twenty-point margin by which they had chosen Republican Mitt Romney over Democrat Barack Obama in the previous election.33

  Perhaps the most dramatic example of the divide is a 2012 study that examines attitudes toward interparty marriage.34 In 1960, only 5 percent of Republicans and four percent of Democrats felt “displeased” if their son or daughter married someone from the other political party. By 2010, fully 49 percent of Republicans and 33 percent of Democrats indicated they would be somewhat or very unhappy if their child married outside the party.

  Many countries in Europe started with fewer of the problems experienced by the United States because of the greater ethnic and racial homogeneity of their populations. However, some of the undercurrents—especially of an elite increasingly divorced from the masses in favoring trade and immigration, and of domestic communities very differently affected by economic change—exist in continental Europe also. For instance, Marine Le Pen, the French nationalist leader, developed her political views while serving as a regional councilor in a constituency ravaged by the loss of factory jobs, and where constituents felt the mainstream parties in Paris no longer understood their concerns.35 In Germany, the mainstream parties declared, after months of negotiation over their joint program in 2018, their intent to focus more attention on neglected small towns, and rural areas, many of which did not even have decent broadband access.36 The lack of jobs for youth, and large income differences between the rich industrialized North and the poorer industrializing South in an ever-integrating Europe, are added complications. As we will see shortly, so is immigration.

  Many of the causes for public anger have been growing for some time, as has populism. Why is it so strong now, both in the United States and Europe? Averaged across EU states in 2000, the populist vote was 8.5 percent. By 2017, it had moved up to 24.1 percent.37 The United States elected a populist president in 2016. Certainly, the effects of technological change have coursed steadily through developed economies, and the consequent resentment has built. In addition, though, the Global Financial Crisis of 2007–2008 and its aftermath had an enormous effect on popular perceptions.

  THE FINANCIAL CRISIS

  Democracy does not allow politicians to ignore problems for long. In the early years of this century, it was clear something had to be done for those falling behind. The easy answer through much of the developed world seemed to be to paper the problem over with debt. In the United States, the government sought to boost housing demand in the pre-crisis years through easier housing loans. Not only did rising house prices encourage ne
w construction, which created jobs for the moderately skilled who had been laid off by manufacturing, it also allowed the owners of the existing homes to feel richer, and spend more by borrowing against the higher value of the house.38 Their stagnant paychecks were not so worrisome when their house was a piggybank that could support their consumption. Debt-fueled housing purchases offered the economy a new avenue for growth. The problem was that it was unsustainable.

  In Europe, the move toward a common Euro currency allowed all countries to benefit from the low common nominal Euro interest rate. It was low because everyone trusted the inflation-averse European Central Bank to keep overall inflation low. Yet, in countries at the periphery that had historically not maintained a tight control over inflation, inflation was still high. This further reduced the effective cost of borrowing in those countries, for borrowers had inflated revenues to repay cheap Euro borrowing. Having endured the discipline (or cooked the books) to meet the entry requirements into the Euro, a number of countries abandoned caution as they found they could now borrow easily and cheaply. In Greece, the government splurged, expanding both government spending and government jobs.39 Not all European countries that got into trouble relied on government borrowing and spending. In Spain, a combination of a private-construction boom fueled by easy credit and spending by local governments created jobs. In Ireland, it was primarily a bank-lending-fueled housing bubble that did the trick. Regardless, the common thread was easy borrowing.

  The mix of rising credit and rising house prices was immensely risky, but the accompanying job growth took pressure off the politicians. Bankers, motivated by large bonuses to maximize short-run profits and lulled by easy financial conditions, took too much risk. Central banks across the world were too complacent, both about the consequences of the very low interest rates they maintained, as well as about the extent of risk-taking. The boom turned to bust, and seventy years after the Great Depression, the world looked like it was entering a new depression. Governments and central banks intervened very actively, including bailing out big banks and financial companies. They helped avoid a financial sector meltdown, but they did not explain the necessity for their actions to the public other than saying the alternative would have been Armageddon. It was a grave mistake because the rescues looked like an unfair stitch-up to the angry public.

  Judicial investigations in the United States and Europe have since revealed how bank traders blatantly manipulated markets, ranging from securities to foreign exchange. Nevertheless, these very banks received government assistance, even while ordinary people lost their jobs, their houses, and now saw their taxes used to pay down the sovereign debt accumulated during the bailouts. Public anger was further aroused by the haste with which bailed-out bankers went back to receiving large bonuses, and by the difficulty the judicial system had in putting any senior banker in jail for their behavior. Perhaps the government bailout was warranted in order to stave off a complete collapse of the banking system. But should this not have resulted in more severe prosecutions of unscrupulous bankers for putting public money at risk? The public conclusion was the market was no longer evenhanded, with one treatment for privileged bankers and another for the rest.

  In Europe, the costs of the bank rescues, coupled with the increase in spending during the Great Recession, weighed on government finances. As governments in Greece, Ireland, Portugal, and Spain found markets unwilling to continue lending to them, they tottered on the brink of default. They needed a bailout, and Northern European countries suddenly found that their ant-like discipline—for example, Germany reformed its labor market in the early 2000s by reducing unemployment benefits and job protections, while restraining wage growth—made them responsible for bailing out their more irresponsible grasshopper cousins. No one told the German people (or the Dutch or the Finns . . .) that this would be a consequence of entering the Euro. Equally, no one told the people in the countries that were being rescued that part of the funds from the new borrowing they undertook from their rescuers would flow out immediately to help their banks repay German (and Dutch and Finnish . . .) banks. A Union where substantial transfers were to take place between countries required trust, solidarity, and empathy. There was precious little of these on display because the public had never really been asked whether they wanted in. The lack of transparency on the European rescues, and the sense among each country that it was paying for the mistakes made by others, created widespread dissatisfaction, both among the ostensible rescuers and the rescued.

  Apart from its direct economic effects in slowing growth and increasing government indebtedness still more, the financial crisis destroyed the public’s belief that developed country markets are largely fair and clean. Perhaps more problematic, the public lost faith in the governing elite and the system they had created. Why could they not see the crisis coming? Why did they take so long in pulling economies out of the recession that followed? Why did they not jail any prominent bankers? The growing consensus was that the elite must be both incompetent and biased toward protecting their own favorites. If so, everything in the postwar consensus was now fair game for questioning.

  For instance, could biased policies be responsible for the cheapness of imports, the loss of the good old jobs, and the rising competition from women, immigrants, and minorities for jobs held by the majority-group male worker? With entrepreneurial political leaders sensing opportunity and articulating such grievances aloud, and social media making it easy for aggrieved groups to organize and spread messages that the elite would have disregarded or even blocked in the past, it was not surprising that many people were convinced the system was broken. Indeed, the financial crisis triggered two essential factors that researchers find explains increased votes for populism across developed countries—economic distress as measured by an increase in unemployment and distrust in the political institutions of the country.40 All that was needed was a spark.

  THE AMERICAN TRIGGER

  In the United States, the Affordable Care Act, or Obamacare, was an important catalyst in the organizing of the Tea Party movement, a forerunner of the populist nationalist movement. Berkeley sociologist Arlie Russell Hochschild, who studied blue-collar workers in Louisiana, offers an account of Tea Party supporters’ views. As she surmises through her interviews, the white Southern male believed he had been trudging steadily in line toward the American dream, respecting the rules of the game.41 The line moved more slowly than it had in his father’s days, as economic opportunity dwindled. The worker was disappointed but not angry because he believed the system was fair. As he looked around, though, he saw others cutting in line ahead of him, complaining about their past victimization and suffering. Initially it was minorities, then women, and now immigrants. They were getting opportunities to go to college and earn better livelihoods, opportunities that he never had. Why, the worker thought, did he have to pay for the sins of his father, if in fact they were sins? As Hochschild writes, anxieties were heightened by the election of the nation’s first nonwhite president:

  “. . . And President Obama: how did he rise so high? The biracial son of a low-income single mother becomes president of the most powerful country in the world; you didn’t see that coming. And if he’s there, what kind of a slouch does his rise make you feel like, you who are supposed to be so much more privileged? Or did Obama get there fairly? How did he get into an expensive place like Columbia University? How did Michelle Obama get enough money to go to Princeton? And then Harvard Law School, with a father who was a city water plant employee? You’ve never seen anything like it, not up close. The federal government must have given them money . . .”

  Not surprisingly then, the Obama administration’s effort to reduce the numbers of those without health coverage in the United States was seen as yet another attempt to benefit the undeserving clients of the Democratic Party, the poor, the minorities, and the immigrants, rather than as an attempt to bring the United States up to the standards of universal heal
th care of the civilized world. What especially enraged the members of the Tea Party movement was the expansion in free health care for the poor, as well as the compulsion for all others to sign up for insurance plans. The proponents of Obamacare thought that compulsion would reduce overall health insurance premiums by reducing the extent of adverse selection (the phenomenon where the healthiest young people do not sign on because they least need health care). The angry Tea Party opponents instead felt they were subsidizing undeserving others through their own overly expensive premiums.42

  Many among the Democratic leadership believed Tea Party members were protesting against their own interests, but they did not appreciate the extent to which the white majority had become angry about what they thought were the unfair privileges given to the clienteles of the Democratic Party, and the anxiety they had about their own slipping social status. Better, it seemed, that no one be helped, than undeserving get a free ride. It is easier, then, to understand why there is strong support among Tea Party supporters for entitlements they have ostensibly paid for like Social Security and Medicare (old-age health insurance) while Obamacare is anathema.

  POPULIST NATIONALISM IN EUROPE

  In Europe, the sovereign debt crisis brought to the fore the growing resentment people felt about increasingly powerful pan-European institutions that were dictating policy to nations. The undercurrents of anger were barely below the surface, and ran in every direction. Strong rich nations like Germany feared they would forever be paying for the profligacy of the rest of Europe. Angela Merkel was the first German chancellor born after the Second World War, and many in Germany believed it was time for the country to move on from paying explicitly or implicitly for Germany’s past behavior. Slow-growing, economically vulnerable countries resented the tough economic conditionality imposed by European institutions in return for help. They saw the barely hidden hand of a resurgent Germany behind the conditionality, and complained that through the idea of Europe, Germany had finally obtained the hegemony it always desired. Small countries, having lost their veto over much of European policy, felt helpless in the face of policy determined by the large powerful countries.