In his forthcoming book Fault Lines — haven’t read it yet, but I hope to read it in the next week or so — Raghuram Rajan, co-author with Luigi Zingales of one of my favorite books, makes a provocative argument that I like because, well, it jibes with my own assessment. David Wessel has written his latest column on the Rajan thesis. Many on the left will focus on the first of Rajan’s three “fault lines,” rooted in the increase in income and wealth dispersion in the United States. Because he doesn’t see state-sponsored green jobs or punitive taxation as a lasting solution, this is a very good thing: like Jeffrey Sachs, he is making a strong case for stable policies.
The first Rajan fault line lies in the U.S. As incomes at the top soared, politicians responded to middle-class angst about stagnant wages and insecurity over jobs and health insurance. Since they couldn’t easily raise incomes—Mr. Rajan is in the camp that sees better education as the only cure and that takes time—politicians of both parties gave constituents more to spend by fostering an explosion of credit, especially for housing.
This has happened before: Farmers’ grievances led to a U.S. government-backed expansion of bank credit in the 1920s; India’s state-owned banks pump credit into poor constituencies in election years. But one thing was different: “When easy money pushed by a deep pocketed government comes into contact with the profit motive of a sophisticated, amoral financial sector, a deep fault line develops,” Mr. Rajan writes. House prices shot up, banks borrowed cheaply and heavily to build leveraged mountains of ever more risky mortgage-linked securities.
That is, rather than engage in explicit transfers, the U.S. placed heavy emphasis on implicit transfers, ranging from tax subsidies to more direct methods of encouraging problematic mortgage originations. The United States really did have a postwar industrial policy as big and consequential as those pursued in South Korea and Japan. Rather than focus on building up heavy industry, it was focused on transferring wealth to homeowners and the housing sector more broadly, and, to a somewhat lesser extent, the defense industrial base. The beauty of this approach is that it is hard to detect — a kind of invisible statism that allowed conservatives to believe that they were adhering to laissez-faire and liberals to craft social policies on the cheap. But hiding the cost of these transfers doesn’t make them go away.
This first fault line is tightly linked to the third fault line Rajan identifies.
The U.S. approach to recession-fighting—unemployment insurance and the like—and its social safety net are geared for fast, quick recoveries of the past, not for jobless recoveries now the norm. That puts pressure on Washington to do something: tax cuts, spending increases and very low interest rates. This leads big finance to assume, consciously or unconsciously, that the government will keep the money flowing and will step in if catastrophe occurs.
Compounded by hubris, envy, greed, short-sighted compensation schemes and follow-the-herd habits, these expectations that the government will save us all leads big finance to borrow cheaply and take ever bigger risks. No democratic government can let ordinary folk suffer when the harshness of the market brings the party to an end, as it inevitable does. Big finance exploits what Mr. Rajan calls this “government decency” and bets accordingly.
We might be better off by strengthening the visible welfare state, by adopting wage subsidies for example, and gutting the invisible welfare state. And rather than continue with the extreme macroeconomic policy swings of the Greenspan-Bernanke era, we should consider more balanced, sustainable fiscal policies that give up on the foolish project of trying to fine-tune the economy, an effort that may well have exacerbated the bubble problem.
