The Third Pillar

by Raghuram Rajan

  All these resentments came to the fore with the immigration crisis. In 2015 and 2016, over a million refugees each year applied for asylum in Europe. The would-be migrants were largely Muslim and typically came from war-torn countries like Syria, Iraq, and Afghanistan. These were not, however, the only migrants. Droughts in Sub-Saharan Africa pushed many Africans to also try their chance, some as asylum seekers from conflict-ridden countries like Somalia, Sudan, and the Congo, but others simply as undocumented economic migrants. Many migrants sought to go to immigrant-friendly countries like Germany, Sweden, and the United Kingdom. European regulations required them to apply in the first country they arrived in. Greece, Italy, and Hungary were where many asylum seekers first entered the European Union. It was hard for these “frontier” countries to absorb the enormous inflows. As the number of refugees built up in Hungary, Austria and Germany opened their borders in September 2015. That year, Germany accepted over a million migrants.

  Easier immigration when welfare benefits are high is bound to raise concerns about freeloading, especially when immigrants are economically and culturally distant. This is exacerbated by misperceptions. A detailed survey by Harvard researchers suggests the extent of misinformation about even legal immigrants is substantial. In Italy and the United States, where the actual population share of such immigrants is around 10 percent, the average perception is that it is 26 percent and 36 percent respectively.43 Respondents systematically overestimate the share of Muslim immigrants and the dependence of immigrants on welfare, while underestimating immigrant education and employment. The extent of misinformation increases for the low-skilled who work with immigrants, the non–college educated, women, and right-wing respondents. Those who personally know an immigrant tend to have more accurate responses, while those in the United States who live in an area with more immigrants tend to have greater misperceptions. Finally, those who see immigrants as better educated and more hardworking tend to be more supportive of policies favoring immigration and redistribution.

  The immigration crisis still roils the European Union, even though the numbers of potential immigrants has fallen dramatically. A number of countries like the Czech Republic, Hungary, and Poland, with strong anti-immigration movements, resented the imposition of immigration quotas by the Union, no matter how small they might be, and refused to take their shares. At the time of writing, the European Union is contemplating reducing its funding for the recalcitrant countries. In Europe, therefore, two concerns have come together in the immigration crisis. One is a fear of losing sovereignty and control, the other is the fear of being swamped by foreigners with alien cultures and religions, especially if they also tap into Europe’s generous welfare state without having paid into it—a similar fear to that of the Tea Party in the United States.

  In Britain, those who campaigned in the 2016 referendum to exit the European Union emphasized both these fears. More generally, while the initial idea of a European common market without customs or tariffs separating countries was widely accepted as economically beneficial, the push toward full integration was not. Presumably, Europhilic politicians and bureaucrats hoped that once people were in it together, empathy would build. The financial crisis, followed by the immigration and refugee crisis, tested the European project before strong bonds of empathy were built. Equally to blame were Eurosceptic politicians, who attributed all difficult national policies to an unelected bureaucracy in Brussels, while taking credit for all the benefits of an integrated market. So Europe remains an important, potentially valuable idea, but with only modest popular support.

  CONCLUSION

  A decade after the crisis, the world economy has recovered, in part by pumping up debt once again. Even as financial vulnerabilities build again, technology progresses further, and many people are still unprepared for the new economy. Society needs to rebalance. Both the state and community pillars have to give people the support they need to engage in global markets. Only then will they resist the urge to balkanize it with specific protections.

  Unfortunately, far too many people now distrust the elite. The policies of openness that served the world well after the Second World War are now being questioned, and it is hard for the mainstream politician to explain in simple words why they still are relevant when confronted by the simplistic but more direct arguments of the populist. The value of the postwar trust enjoyed by technocrats was that they did not have to spell out these arguments to the wider public; they were generally trusted to do what was right. Now they are not.

  Some commentators argue that deep divisions between mainstream parties, the demonizing by each mainstream party of the others, and their inability to cooperate, exacerbates the trust breakdown and pushes people to search for radical alternatives. Perhaps. Yet equally, too cozy an arrangement between mainstream parties can also make people upset because they feel establishment parties are all the same. When they are distressed and they have lost trust, the aggrieved masses are fertile ground for the radicals no matter what the configuration of the mainstream.44

  These are dangerous times. If people have lost faith in their ability to compete in markets, if their communities continue to decline, if they feel that the elite have appropriated all opportunities for themselves, both by monopolizing the markets and by monopolizing access to capability building, popular resentment can turn to rage. Democracy requires equal access, and when access is unequal, democracy reacts. More populist radicals will be elected. Of course, if these radical populist movements push for reforms that include rather than exclude, that tackle the cronyism and the usurpation of opportunity by the elite—as did the Populist and Progressive movements in the nineteenth-century United States—they would be very healthy correctives for restoring the balance.

  More likely on offer are populist nationalist movements led by charismatic leaders who seek to exclude rather than include, and thus tend to skew rather than restore the balance. While the populist nationalist does not offer lasting solutions, she still has the power to damage. Institutionalized checks and balances may contain new Napoleons for a while. Yet rare is the institution that can stand up to popular will for a sustained period of time, without support from other sources of power. A key element of the populist nationalist’s agenda is to undermine those sources.

  Authoritarian crony capitalistic states, hostile to the ties between nations that come from trade and the flows of people and capital, hostile to any multilateral agreements and multilateral governance, but nevertheless having to live together on this planet . . . Such a disunited world will inevitably revive the specter of global big power conflict that we hoped was a relic of the twentieth century.

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  THE OTHER HALF OF THE WORLD

  So far we have focused primarily on Europe and America. Before we discuss solutions, we should examine the countries that will grow in the future, including the countries currently labeled “emerging markets”—such as Brazil, China, India, Mexico, Saudi Arabia, South Africa, Turkey, and Vietnam—as well as the developing countries of Africa and Asia like Ethiopia and Myanmar. Any developed-country policy maker has to recognize that while it may seem that trade and immigration are polarizing today, they will be solutions to the problem of population aging that almost every developed country will have to confront soon. The future markets for developed-country goods, the destinations for their citizens’ excess savings as they prepare for old age, and the source of the labor they will need to support an aged society will lie in the growing and still-young emerging markets and developing countries.

  This is why it would be myopic for the developed world to erect high barriers separating themselves from the rest as it deals with its current political problems. Moreover, problems that need global solutions, such as climate change, which threatens the quality of our existence, and volatile global capital flows, which cause periodic crises, need global engagement.

  Our existing structures for global governance are outdated.
Developed countries account for less and less of global economic heft, yet they still hold all the meaningful reins in the institutions of global governance. Before the next decade is out, barring serious calamity, China’s economy will be bigger than the United States’s, while India’s economy, already bigger than France’s, will be the third-largest in the world. In the past, the belief that the large developed countries were responsible custodians of the global rules-based order that the United States built after World War II gave the rest pause in their demand for a more equitable sharing of power. Even though the system was designed so that the United States could break free of the rules, for the most part it acted as if it was bound by them. Now that it has shown it can elect administrations that do not respect norms, can the world accept any nation that is above the rules?

  Yet, even though populist nationalists have no respect for global institutions, they will resist ceding power. This impasse is not good. Either the rest will stop respecting global institutions and create their own, or there will be a vacuum in global governance until the rest become powerful enough to take over global institutions directly. In the latter case, the largest emerging markets will inherit the skewed distribution of power that now favors the developed countries. Developed countries will regret their reluctance to reform if the emerging markets impose on them the power structure that is currently being imposed on the emerging markets.

  There is always the possibility that we abandon the rules-based international order that has helped the world focus on collective mutually beneficial interests rather than self-interest. When every country wants to make itself great again, the zero-sum economic machinations of the pre–Second World War world will return. To make sense of these issues, the reader needs a view from the emerging and developing world. We will focus on the two largest emerging markets, China and India, partly to understand some of the challenges these countries face—including rebalancing the pillars in their own countries—and partly to understand how important it is for the world to engage these countries as responsible members of the community of nations.

  ARE CHINA AND INDIA AT ALL SIMILAR?

  The Communist Party took over China after the Second World War. At about the same time, India became democratic and independent from the British Empire. In India, every government has to fight periodically for a renewed mandate, which has meant that the government is more constrained in its actions, not just by the power of democratic protest and numerous civil society organizations, but also by institutions like the judiciary and the opposition. Critics like Lee Kuan Yew, the creator of modern Singapore, have argued that poor countries cannot afford democracy. Indeed, in the race between China and India for growth, it would seem that authoritarian China beats democratic India hands down. Simple extrapolation then suggests India should never be spoken of in the same breath as China; China has an economy as well as a per capita income (since the two countries have about the same population) that is nearly five times as large as India’s at market exchange rates.

  Yet, there are more similarities between the two countries’ growth paths than we allow for. Both China and India were government-dominated systems with weak markets at the beginning of their respective reforms. China’s government, under the centralized control of the Communist Party, was more able to execute, while India’s markets and private sector were a little stronger at the outset. The initial liberalizations, prompted by the end of Maoism in China and a financial crisis in India, greased by corruption since both systems were still overregulated, produced strong growth. China could suppress markets more, and repress households more, because it did not have to contend with democracy. This allowed it to generate faster growth, but its growth was more skewed—in favor of state corporations over households, in favor of savings and investment over consumption, and benefiting foreign investors more than citizens.

  A variety of imbalances have built up in China—overcapacity in industries because of excess investment; excessive corporate and local government debt burdens as a consequence; and overdependence on investment and exports for growth. Also, China is close to catching up to the global productivity frontier in a number of industries. The state will find it hard to continue making economic decisions in such a modern complex economy, for these are best left to the market—China is trying to allow the market more freedom to make allocations and to reward or punish. It will have to move to a more constitutionally limited state if it wants the private sector to have the confidence to make investments. Yet China’s Communist Party wants to continue to maintain its monopoly over political power, and there are signs that intraparty democracy is also weakening. Can China pull all this off?

  India, with its more pluralistic and open-access political system, is better positioned for the community to create more separation between the state and markets. Its weakest pillar is the state.1 To match what China has already done successfully, India will have to improve state capacity significantly, something that may come as a surprise to those who think India has excess bureaucracy. In reality, India has a plethora of rules and red tape, but it has relatively few officials employed by the state, given the nation’s population (which is one reason why it takes so long to get applications cleared). Officials are all too often poorly trained or motivated, and the good ones are overburdened. Much of what an effective state should do, including providing public services and infrastructure, enforcing regulations, or clearing court cases, is left unattended because the state tries to do too much else with too few resources.

  India also has a private sector that is still dependent on the state, which makes it a feeble constraint on it. So India has the paradox of having an ineffective but only moderately limited state. India’s challenge in the years to come is not its democracy, which is probably the only way to keep a country with such varied communities together, but the need to strengthen both state capacity and private-sector independence. Will India make the transition to a liberal market democracy? Let us look for answers.

  THE CHINA STORY: MARKET LIBERALIZATION UNDER PARTY CONTROL

  Chairman Mao Zedong became increasingly erratic in the last two decades of his life. His Great Leap Forward (in which millions of Chinese died of hunger in the early 1960s as he tried to move rural areas away from food production into industry) as well as his Great Proletarian Cultural Revolution (in which many intellectuals were persecuted, humiliated, jailed, and killed in order to purify the Communist movement and purge it of capitalist tendencies) left the country traumatized. China’s next leader, Deng Xiaoping, was determined that the country should not be dominated by a single person ever again. Deng, who had been purged by the Communist Party twice, and whose son was crippled by the Red Guards during the Cultural Revolution, gradually ratcheted up change after 1978.

  THE PATH NOT TAKEN

  The early reforms were often implicit—for example, the authorities turned a blind eye to private commercial activity even though it was technically illegal under the Communist regime. Growth picked up in rural areas, far from the reach of the central bureaucracy, for it was in the rural areas that the party had not entirely snuffed out the notion of private property. Under the Household Responsibility System, rural households contracted land and machinery from farmer collectives and kept any surplus they generated beyond a required payment. It was an important step toward greater agricultural productivity.

  A number of private firms also started, cloaked in the permissible garb of collectives known as Town and Village enterprises.2 Marxist ideologues had determined that these enterprises would become exploitative if they exceeded seven members, yet the rule was rarely enforced. Such enterprises produced a range of goods, from radios to refrigerators, and many farmers grew rich. Reforms even touched state-owned enterprises, where the better-performing ones were allowed to keep profits and pay their workers more. Growth soared, and with that came some political liberalization as the liberal faction of the Communist Party gained credibility. Vi
llagers were allowed to elect their representatives. With growing prosperity, village governments acquired the funds for meaningful activity.3 The rural community became the center of both economic revival and an emerging democratic spirit. The press obtained more access, with even foreign reporters invited to hobnob with Politburo members at the conclusion of the 1987 party congress.4 Reformers like Zhao Ziyang, the general secretary of the Communist Party and a Deng protégé, emphasized the need to distance the Communist Party from the government, a necessary first step toward a multi-party system.

  Yet clouds were gathering. In a socialist economy, many prices are fixed, and essential goods like grain are distributed through the public distribution system. As the Chinese authorities sought to harness market forces, they allowed the prices of some goods to fluctuate. Speculators diverted goods to the open market where prices were highest. As a result, shortages developed in the public distribution system where prices were fixed at affordable levels, especially as people, anticipating price rises, bought to hoard. Inflation soared. Workers in poorly performing factories or in salaried sectors of the economy started feeling the pinch, even as they feared further reforms would take their jobs away. They also resented the access the party elite had to goods in short supply. Growing evidence of party corruption, as local authorities took bribes to overlook the breach of regulations by new enterprises, further angered them.