Pod Insights Freakonomics Radio 366. This Economist Predicted the Last Crisis. What’s the Next One? About this episode In 2005, Raghuram Rajan said the financial system was at risk “of a catastrophic meltdown.” After stints at the I. M. F. and India’s central bank, he sees another potential crisis — and he offers a solution. Is it stronger governments? Freer markets? Rajan’s answer: neither.
Transcript 8,347 words · 15 speakers
Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
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2:36 Stephen J. Dubner? In 2005, you attended the U.S. Federal Reserve's annual symposium in Jackson Hole, Wyoming, and it was essentially a celebratory send-off for Alan Greenspan, the outgoing Fed chairman. But you, going quite against the grain, gave a talk based on a paper you'd written that was called "Has Financial Development Made the World Riskier?" And your answer was a firm yes. You argued that financial engineering and skewed incentives in banking and elsewhere could create, and I quote you, "a greater, albeit still small, probability of a catastrophic meltdown." Again, this is 2005.
3:15 Speaker 01 Yeah, well, let me put it this way. It was clear there was a reason for concern, but what was comforting was that we hadn't had a crisis in major economies for 70 years.
3:29 Stephen J. Dubner? What lessons are we to draw, we non-economists, from that severe miscalculation, or mischaracterization at least, by most economists?
3:40 Speaker 01 I think there was a sense of complacency. Put differently, we were living in well-run houses where the plumbing was not a problem. And the reality was, the plumbing was actually getting corroded by poor incentives in that system. And we didn't realize it until it backed up in a really big way, and we said, you know, what is that smell?
4:05 Stephen J. Dubner? I'd like you to meet today's guest.
4:07 Speaker 01 My name is Raghu Rajan. I'm a professor at the University of Chicago's Booth School.
4:13 Stephen J. Dubner? Rajan is more than just a professor, as we'll hear. That said, it's likely you've never heard of him. You should have. And not just because he was one of the very few people who foresaw the risk of a catastrophic meltdown that indeed came to pass in the form of a global financial crisis and the Great Recession that followed. You probably remember this.
4:36 Speaker 02 Lehman Brothers bankrupt. Merrill Lynch sold in haste.
4:40 Stephen J. Dubner? And then this.
4:41 Speaker 03 Breaking news here. Stocks all around the world are tanking because of the crisis on Wall Street.
4:47 Stephen J. Dubner? And then this.
4:48 Speaker 04 The federal government loans. American International Group, AIG, $85 billion. The House of Cards was much bigger.
4:56 Speaker 05 The president's plan would allow the Treasury to buy up to $700 billion worth of bad loans.
5:02 Stephen J. Dubner? The US Senate held some investigations. How much of that shitty deal did you sell to your clients?
5:10 Speaker 06 How do you account for all of these references to the Big Short?
5:15 Stephen J. Dubner? I think that's very unfortunate to have on email.
5:20 Stephen J. Dubner? But the damage had been done. The recession caused by the financial crisis cost the US alone nearly 9 million jobs and more than $8 trillion in household wealth. But of course, the recession spread around the world. It had massive economic, social, and political ramifications, many of which are still being felt today, a decade on. The crisis was all the more distressing because the political and economic elite had been so badly blindsided. In fact, they had been basking in what they called "The Great Moderation", an almost magical era in which financial crises were inconceivable.
6:02 Speaker 01 During the Great Moderation, there was a general sense that the system worked and that the plumbing was all fine, incentives were all fine. I remember, you know, after I gave my speech at Jackson Hole, two very senior people in the Federal Reserve system came up to me and said, you know, this is not a problem because the private sector knows how to take care of itself. These are very smart people who are very well-paid. They would simply not take these risks that you're talking about.
6:33 Stephen J. Dubner? Raghu Rajan draws a straight line between the financial crisis and what he sees as one of the biggest dangers in the world today: the rise of populism on both the right and left, driven by a deep distrust of those same elites who told everyone not to worry the last time around. Rajan has developed this perspective while serving as chief economist of the International Monetary Fund, as well as the head of India's central bank.
6:59 Speaker 01 If you start thinking about the responsibility, it becomes overwhelming, so you try not to think about it.
7:06 Stephen J. Dubner? Rajan's prescription for addressing the risks of runaway populism? That may surprise you, especially coming from an economist.
7:14 Speaker 01 In this anonymous world with anonymous markets and anonymous bureaucracy, what allows you to have meaning in your life is really the people around you.
7:37 Speaker 07 From Stitcher and Dubner Productions, this is Freakonomics Radio, the podcast that explores the hidden side of everything. Here's your host, Stephen Dubner.
7:52 Stephen J. Dubner? Professor Rajan, can you hear me okay? This is Stephen.
7:55 Speaker 01 I can, and please do feel free to call me Raghu.
7:58 Stephen J. Dubner? Very good, I will, thank you. So, let's do a very quick biography. You were born in India but then moved about quite a bit with your family, returned for university in India, got an MBA in India, and then a PhD in finance at MIT. And you ultimately took up what turned out to be a very lengthy residence at the University of Chicago, where you still are now. In 2003, after several years in academia and zero years in policy, you became chief economist of the International Monetary Fund in DC. You were the youngest economist ever in that post, also the first non-Western economist. You also weren't known for doing macroeconomics at all.
8:42 Stephen J. Dubner? So why did you get that job and why did you take it?
8:46 Speaker 01 Well, I think the IMF realized that it needed to understand finance a little better, that they were composed largely of macroeconomists. So they were interested in getting somebody who knew finance. And I had met the deputy managing director, Anne Krieger, at a number of conferences. And I'd sent her my first book, Saving Capitalism from the Capitalist. It happened to arrive at the time they were looking for a new chief economist. So she called me and she said, why don't you interview for this post? I said, Anne, I don't know any macroeconomics. She said, that makes two of us. I was sold.
9:26 Stephen J. Dubner? Many people who are not economists, when they hear these different sections of economic thinking and research, macroeconomics, finance, microeconomics, et cetera, it's all a little bit murky to them. What would you say that your finance background brought to an institution that did macroeconomics that maybe was missing?
9:45 Speaker 01 So the difference between these various streams is like the difference between various streams in engineering. The civil engineer knows how to build bridges, but doesn't sort of fully understand the motors that drive the machines he uses to build the bridges and so on. So the electrical engineer knows more about the motor. So similarly, in economics, the macroeconomist worries about monetary policy, fiscal policy, and what the financial economist, especially somebody who has experience in banking and so on, does is brings an understanding of the financial system and how it interacts
10:25 Speaker 01 with these other pieces. And so, to give an example, one reason we have financial crises is because in a period of moderation, perhaps interest rates are kept really low. With plentiful liquidity around, people are willing to take on more debt. And as they take on more debt, it increases the risk that when the environment changes, when growth slows, when liquidity dries up, these companies and these banks that have taken on more debt will be left high and dry. And that's what often happens in these crises.
11:08 Stephen J. Dubner? Rajan here is essentially describing the risks he warned about back in 2005 at the Federal Reserve's Jackson Hole Symposium in front of the financial system's architects, Larry Summers, Tim Geithner, and the Fed Chairman himself, Alan Greenspan. Rajan was at the IMF at the time.
11:26 Speaker 01 I was asked to give this talk because, you know, I was a finance guy and I would probably end up saying all these wonderful things that have happened in finance over the last 20 years in Greenspan's time. And so, that was also my expectation when I agreed to give the talk. But then, as I started writing, I said, this is standard sort of conventional wisdom. What is it that I'm missing? Why am I writing this? And as I started probing and I looked at the numbers on the risk of bank equity, for example, I started, you know, wondering whether the conventional wisdom was in fact right.
12:06 Stephen J. Dubner? Rajan learned, for instance, that credit default swaps, a relatively new and potentially volatile financial instrument, were surging. In 2001, they made up just 5% of private sector bank credit. By 2004, they made up more than 30%. So he told the symposium about that. He also warned that investment managers were concealing tail risks. That is, adverse events that had a very small probability, but if they did come to pass, would have catastrophic consequences.
12:38 Speaker 01 And, you know, it was a strange paper to give in the midst of a conference where the question was whether, you know, Mr. Greenspan, a really formidable central banker, was either the best central bank in history or the second best central bank in history. And it was a little bit sort of raining on a parade of compliments.
13:00 Stephen J. Dubner? So you were heavily criticized, as you recall later yourself. Quote, "I felt like an early Christian who had wandered into a convention of half-starved lions." And yet, just a couple of years later, the catastrophic meltdown that you warned could happen, did happen. And it was largely caused by the very factors that you had identified. I am curious whether, over the years, as the financial meltdown happened and the recession deepened, I am curious how the academic economist community responded to you over time. Did people call or write to you or say to you, you know, "I thought you were nuts, but you really called it."
13:44 Stephen J. Dubner? Explain to me how and why? Did that kind of thing happen?
13:47 Speaker 01 No, I think you see more of the, "I also thought it wasn't working and I agree that we could have done more." I mean, the reality is that in a period of, you know, fairly peaceful growth, there are a lot of people who warn about problems. Today, there are people who are warning about problems, say, with leveraged loans, which I am worried about also. But for a policymaker who's at the receiving end of all this advice, you have to ask, what do I really want to pay attention to? And what do I want to dismiss? If you take all the warnings to heart, you will never, ever let the system grow.
14:29 Speaker 01 You will never, ever let the system take risks because, you know, everything could actually implode. So it is a tough act for regulators to figure out what they should pay attention to and what they should not.
14:46 Stephen J. Dubner? In 2010, Rajan published a book called Fault Lines about what he saw as the underlying causes of the financial crisis. One big factor was a rise in income inequality, coupled with weaker social safety nets. Rajan paid particular attention to what he called the college premium for workers, or really, the non-college penalty. That is, the median high school graduate was earning 72% less than the median college graduate. He also identified the many components of the housing bubble, financial profiteering, consumer overreach, and a federal government that pushed homeownership too far in both Democratic and Republican administrations.
15:27 Stephen J. Dubner? All this led to too much credit that was too easy to get, which led to too many bad loans that were too aggressively commodified and ultimately blew up, like, well...
15:39 Speaker 01 We said, you know, what is that smell?
15:42 Stephen J. Dubner? Rajan also warned that these underlying problems, societal, financial, and political problems, would need to be addressed to prevent a recurrence. So here we are roughly 10 years out from the crisis. Talk to me about the degree to which you believe these underlying factors have or have not been addressed.
16:03 Speaker 01 Well, I think I was talking at two levels. One was the deeper, underlying societal problems. And I thought that that was an important factor in why credit was emphasized so much in Western economies as the answer. Because once you can see your house as an ATM from which you can take out the home equity and spend, you're much less worried about your stagnant income. And consumption inequality went up much less than income inequality.
16:35 Stephen J. Dubner? So the easy credit was kind of a compensation for the lack of wage growth, then, yes?
16:39 Speaker 01 Absolutely. And far too many politicians ran away from the problem, saying they were nowhere near it, when in fact, the whole political system was pushing for easier credit in the years preceding the crisis. Now, that said... I think there was a second level, which was, you know, given these broader incentives, I think the the financial system also went haywire. It's very easy to look for scapegoats for a few bad apples. Much more worrisome is when the whole system is is sort of part of the problem. And then you have to do much more careful work. I think we've done some of that.
17:20 Speaker 01 I think the mandating banks to carry more capital was part of the answer. But we mustn't become complacent and think that's solved everything. Because even as you ask banks to carry more capital, they still have to make profits and they have to find new ways of making profits because the old ways don't work. But my sense is also that, you know, risks in the system don't necessarily go down. They get shifted. And so even as we've made the banks safer, there are parts of the system which may in fact have taken on some of those risks.
17:55 Stephen J. Dubner? Can you give some details? What do you mean? Where where do those risks lie now or where do you suspect they may lie now?
18:00 Speaker 01 Okay, so let me give you an example. The problem before the financial crisis in the United States was households levered up too much with this home equity line of credit and so on, right? I think households have become more sort of careful, given their experience during that crisis. But corporations, which didn't lever up that much before the crisis, have levered up more. In private equity, the kind of leverage ratios you see today for transactions that are done are approaching the ones that were done before the crisis. Also, loans without covenants, loans without controls for the lender. And who's holding these loans?
18:44 Speaker 01 Well, it turns out they're pension funds, insurance companies, all those entities.
18:54 Stephen J. Dubner? Here's some data to consider. US corporate debt grew from around $5 trillion in 2007 to more than $9 trillion in 2018. At the same time, about 60% of the activity in the leveraged loan market now falls under what's called covenant-light terms, that is, with fewer restrictions on collateral, payment terms, and income levels, and fewer protections for the lender. Given Rajan's history of correctly identifying risks in the past, it's probably worth hearing him out today. That said, it's one thing for an academic or an IMF economist to point out risks in the system, and quite another for a policymaker to strike the proper balance.
19:38 Stephen J. Dubner? As it happened, Rajan soon got his turn in the policymaker role too, back in India. He was an economic consultant to the federal government, and then, in 2013, he was installed as governor of the Reserve Bank of India, the RBI. His job was the equivalent of chairman of the Federal Reserve in the US. And your appointment was met with devout enthusiasm, I guess I'd call it. The rupee immediately rose 2% against the dollar. There was a big rally in the sensex, the stock market. One commentator said that you put the sex back into the limp sensex.
20:17 Stephen J. Dubner? So you were cast as a sort of economic superhero, and additionally, a homecoming hero. Can you, before we get into the policy and the things that you actually did, tell me a bit about the state of the Indian economy when you first began consulting? Because as I understand it, there was a rather deep crisis, a multi-level crisis. I'm very curious to see what you saw and what you thought policy should do to help correct that.
20:47 Speaker 01 Well, we were one of the countries that essentially was growing quite strongly before the global financial crisis, and then growth started dropping off very sharply post-crisis. So... As growth started dropping off, the government did what governments naturally do, which is expand spending so that growth would keep up. And the central bank essentially, you know, was more easy on policy. And before we knew it, first, growth had picked up after the recovery in Western economies, and growth was actually very strong.
21:29 Speaker 01 But we had all the sort of problems of an overheating economy. We were running large fiscal deficits. We had very high inflation. So we had the classic symptoms of a country which was going towards, you know, financial difficulty. As we went into 2013, with all these numbers really large and alarming, when Ben Bernanke speculated about ending the era of easy money, money started leaving the Indian economy and our exchange rates started plummeting. So that was a really difficult period because we had elections coming in 2014. And usually, the uncertainty created by elections creates more anxiety amongst investors.
22:13 Speaker 01 And that coupled with our bad numbers meant we really had to do something to build confidence.
22:19 Stephen J. Dubner? Had you had Ben Bernanke's job at that moment, and India said to you, listen, if you do this the wrong way, it's going to punish us unduly, what would you have done? Would you have changed the method or rate at which you pulled the money back?
22:33 Speaker 01 No, look, I think every central bank has a mandate of its own, and it has to respect that mandate. I think, given the mandate of the Federal Reserve, I think you really don't have the ability to take significant cognizance of the effects of your policies on other countries, except to the extent it feeds back onto your own country.
22:58 Stephen J. Dubner? You once said in an interview during the time that you were governor of the RBI, you said, "Central bankers have had enormous responsibilities thrust on them to compensate, essentially, for the failings of the political system." And my worry is we don't have sufficient tools to do that, but we're not willing to say it. And as a result, we push as hard as we can on the existing tools and they may create more risk in the system. Can you talk about that for a moment? What do you mean by central bankers compensating for the failings of the political system?
23:27 Speaker 01 I think the problem was that governments weren't even doing some of the basic stuff that governments do in recovery. And as a result, monetary policy was, as Ben Bernanke once said, the only game in town. Moving interest rates up and down is not going to improve the quality of education or the ability of the fired worker to essentially retrain himself or herself. Yes, you can recreate some of the old jobs, but they may not be what the worker needs or wants. So that's the sense in which what really industrial countries need is structural change.
24:05 Stephen J. Dubner? So in retrospect, what would you say were some of your best decisions?
24:09 Speaker 01 Well, I think to stabilize the currency, we needed to bring inflation down.
24:15 Stephen J. Dubner? Which you did.
24:16 Speaker 01 And we moved to creating a structure which would create credibility that we would do it. And that structure is in place today. We have an inflation targeting framework. We have a monetary policy committee. And inflation is still low. In fact, is probably where we wanted it to be, 4%. This is a problem India has grappled with for decades. To my mind, the fact we could bring it down is very important. But of course, this was not all that we needed to do. You know, liberalizing the markets. We licensed 23 new banks in an environment where there was enormous worry that this process would be corrupt. The Economist ran a feature saying, you know, people were selling these licenses for 75 million apiece.
25:01 Speaker 01 I said, where's that money? I haven't seen any of it. No, we created a really transparent process with three layers of committees to ensure that no single person controlled the process and gave away licenses. And nobody has raised a peep about how those licenses were granted. So, you know, on the payment system... We transformed the payment system from, you know, especially on the retail level. Now in India, you can send money from my bank account to your bank account without knowing anything else. You just tell me where your bank is and I can zap it across. And I'm not locked into a monopoly provider, you know, one of the big tech companies. It's done over public bridge.
25:45 Stephen J. Dubner? Now, shortly after your departure as governor of the RBI, Prime Minister Modi executed a sudden controversial plan to abolish 500 and 1,000 rupee banknotes, hoping to crack down on the shadow economy and tax evasion. I understand you had not been in favor of that idea, correct?
26:05 Speaker 01 Absolutely. It didn't make sense. I was asked for my opinion and I said, look, it is taking away money that people use in transactions. It's going to create enormous disruption unless we replace it overnight with freshly printed money. And it's very important that we have all that in place, difficult to maintain secrecy. And then the fundamental sort of objective of this, which was to get people to bring out the money that they hoarded in their basements and pay taxes on them. I said, that's probably not going to work out because they're going to find ways to infuse the money back into the system without paying those taxes.
26:46 Stephen J. Dubner? It's been roughly two years now. What have been the effects of this demonetization?
26:52 Speaker 01 Well, I think more than the numbers suggest because India was growing at that time. And we had numbers which were in the seven and a half percent growth range at that point, at a time in 2016 when the world was actually growing quite slowly. So when growth picked up in 2017, instead of going along with the world, which we typically do and we exceed world growth significantly, we went down. So that suggests it had a tremendous effect on growth. But that, the numbers don't capture it all because what, what actually got killed was the informal sector. The people who were doing work with, you know, notes rather than with checks, who didn't have formal bank accounts.
27:35 Speaker 01 And when you look at the job numbers that some private sector people estimate, you know, 10, 12 million jobs were lost in that episode. And of course, we haven't recovered them yet. So it was one of those places where, you know, more economic thinking would have helped.
27:57 Stephen J. Dubner? Was it a coincidence that Prime Minister Modi went ahead with the plan only after you'd left?
28:03 Speaker 01 Well, I can't speak on that. I can only say that I made my objections very, very clear.
28:10 Stephen J. Dubner? Some of your comments as governor were not well received by some members of the political class, and you did not seek a second term as governor of the RBI. Could you just describe that decision for us, please?
28:24 Speaker 01 Well, I think that was relatively straightforward. My term, I had a three-year term that came to an end. I think we, the government and I, talked about whether I could be useful for a little more while. And I think we really didn't agree on an extension. I mean, they didn't want to sort of extend it, and I didn't at that point on those terms want an extension.
28:49 Stephen J. Dubner? Your name has been mentioned as a potential Prime Minister of India. What sort of probability would you assign to that?
28:56 Speaker 01 Pretty close to zero. Look, I'm not a politician. That requires enormous capabilities in a very different direction, which I don't have. I certainly will stick to what I know, which is advice and policy. If I can have some influence on on public policy in the future, I certainly would would think about it, but I'm perfectly happy where I am.
29:26 Stephen J. Dubner? For what it's worth, the man who succeeded Rajan at the Indian Central Bank didn't even last his full three-year term, resigning over frustration with the government. And the Modi government, heading into a reelection campaign, was recently accused of having suppressed troublingly high unemployment numbers. It's really too soon to judge Rajan's term as India's central banker. It is worth noting, he did help stabilize a fragile economy. It was also an economy that, over the past decade or so, had gravely disappointed a lot of global investors. India had been one of the fastest-growing economies in the world, but as India faltered, China started running away with the race. Over the past few years, that dynamic has been reversed.
30:10 Stephen J. Dubner? The Indian stock market has absolutely crushed the Chinese markets, and it's outperformed the US markets by a good bit, too. If your job was to look around the world and hire a central banker with crisis experience, a good track record, and sort of equanimity that is rare among the political and economic elite, you would almost inevitably cast your eye on Raghu Rajan. So what's he worried about now?
30:37 Speaker 01 The kind of disruption we're seeing, the rise of strong authoritarian regimes across the world, too many strong leaders around, if you will, for a peaceful world.
30:48 Stephen J. Dubner? We'll hear more from Rajan right after this.
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33:07 Stephen J. Dubner? Raguram Rajan is a professor of finance at the University of Chicago. He's also been chief economist for the International Monetary Fund and head of India's central bank. His first book, Saving Capitalism from the Capitalists, helped get him his IMF job. His second book, Fault Lines, performed a postmortem on the Great Recession and the underlying financial crisis, a crisis that Rajan was nearly alone in warning about. In this month, he's publishing a new book called The Third Pillar: How Markets and the State Leave the Community Behind. It's a fairly radical argument for an economist. To understand where Rajan is coming from and where his economic and political views
33:50 Stephen J. Dubner? developed, it's maybe best to go back to his beginnings.
33:55 Stephen J. Dubner? You were born in India. I understand your father worked in intelligence for the Indian government. He was a spy, although you didn't know it at the time and that you moved around a lot. India, Indonesia, Sri Lanka, Belgium, back to India. Talk about what that experience, what your family was like.
34:13 Speaker 01 Well, it was a very warm childhood. We were four siblings and parents tried to give us the best education they could. Part of that education was moving to really interesting places. We were in Indonesia during the year of living dangerously when there was a coup. And I remember gunfire in the evenings as the army executed, some people say, over 250,000 communist sympathizers. And, you know, we were at home worrying about what was happening, but it was still a very warm and loving environment. We went to Sri Lanka, there was an insurgency there.
34:57 Speaker 01 So we had a year off because the rebels were on the streets.
35:01 Stephen J. Dubner? A year off from school, yes?
35:03 Speaker 01 Yeah, a year off from school. And my parents were really worried that we weren't really getting any education. So the next place we moved to was really state and boring Belgium.
35:14 Stephen J. Dubner? You got back to India in time for what's referred to as the emergency. For those who don't know about it, just describe what the emergency was. And I'm particularly interested to hear how it affected you and your family.
35:27 Speaker 01 Well, India is a democracy. And Indira Gandhi, who was the prime minister at that time, in 1975, the courts ruled against her and said that she had won her seat illegally. Instead of accepting the ruling of the court, Indira Gandhi declared an emergency where she basically shut down all questioning of her authority. And this was a two-year period where she attempted to run India on authoritarian lines. And, you know, as with such regimes, initially, people were very happy the trains ran more on But then some of the excesses started showing up.
36:08 Speaker 01 For example, to control population, there were camps where people were forcibly sterilized. There was heavy censorship of the press and there's of course the jailing of the opposition.
36:18 Stephen J. Dubner? Right.
36:19 Speaker 01 And you know, she eventually, two years later, decided to go for elections. And there's a lot of controversy about why she did that. Some people say it was because she was going back to her democratic instincts. Some people say it was just that in that authoritarian regime, the domestic intelligence agencies basically told her, you're going to win for sure. They were being psychophantic and she actually believed them.
36:48 Stephen J. Dubner? Gandhi lost that election, but she ran again and won in 1980 in what was considered a fair and free election. Four years later, she was assassinated by her own bodyguards.
37:00 Speaker 01 It was an interesting time because that is when India realized how fragile its democracy was.
37:06 Stephen J. Dubner? The fragility of democracy is essentially the theme of Rajan's new book, The Third Pillar.
37:12 Speaker 01 The book emphasizes a society held up by three pillars.
37:17 Stephen J. Dubner? The first pillar is?
37:19 Speaker 01 Markets, which ensure the society is productive and efficient by allocating resources to the right place and taking them away from places where the resources aren't being used well.
37:30 Stephen J. Dubner? The second pillar is?
37:33 Speaker 01 The state, which is the composite of the executive, the judiciary, the legislature, and its role really is security.
37:42 Stephen J. Dubner? And the third pillar?
37:43 Speaker 01 It's the third pillar which has been underemphasized, that is, the social aspects. We've talked about economic, we've talked about political, the social aspects, that is the community, which, you know, ultimately offers meaning in our lives.
37:57 Stephen J. Dubner? The Third Pillar is an interesting book and an odd book. It's largely a work of economic history, even though Rajan isn't an economic historian. It covers a lot of politics and sociology, even though he's not a political scientist or sociologist either. More than anything, it is a plea to reset society. It's a cri de coeur, really, although given Rajan's rather moderate bearing, it's a somewhat moderate cri de coeur. His main argument is that the markets and the state have grown so big and powerful and institutional that they're choking off the lifeblood of actual communities. That we've gotten so good at scaling up that it's time for a concerted effort to scale down.
38:42 Stephen J. Dubner? Because when communities erode, when people feel the state and the markets are running their lives, the result is often an angry populism.
38:51 Speaker 08 The breaking news is the far-right candidate Zéb Bolsonaro has won Brazil's presidential race. A four-point lead for leaving the EU, and that's the result. The shock result was the AFD, which became the third-largest party.
39:09 Speaker 09 There are more protests in France today, even after President Emmanuel Macron promised concessions to angry demonstrators.
39:16 Speaker 10 Thank you. Thank you very much, everybody. Sorry to keep you waiting, complicated business.
39:28 Speaker 01 Most people actually are quite frightened. We see strong political movements around the world which are looking to disrupt the kind of system we've had for the last 70 years. And people are asking, why now? What's going on? And what's the future hold for me? At the same time, they see technological disruption create threats to the jobs they have, and they worry whether their children will have as good a life as they've had, let alone a better life.
40:00 Stephen J. Dubner? The populism Rajan's talking about exists on both the left and right wings of the political spectrum. In each case, there's deep dissatisfaction and distrust of political institutions. It wasn't always thus.
40:15 Speaker 01 The balance before was what one might call liberal market democracies, which essentially created the prosperity that we've seen post-World War II. Now, that is under threat, and a part of the reason for that threat is because the community in many parts of the developed world is imploding under the pressure of both global markets as well as technological change.
40:42 Speaker 01 As well as a government which isn't doing the right things to support both the opportunities that people should have as well as the safety nets that they should have.
40:53 Stephen J. Dubner? What you're describing sounds foreboding to the point of dangerous. How much danger do you think we're in?
41:00 Speaker 01 Well, I think there is a danger for sure. And I think we've seen these kinds of environments before. It's all too easy to point to the 1930s and say, it looks like that. Nothing really looks like the past in exact detail. But the kind of disruption we're seeing, the rise of strong authoritarian regimes across the world, too many strong leaders around, if you will, for a peaceful world. I think all this makes you wonder if the risks have gone up, and I think they have.
41:33 Stephen J. Dubner? In the book, you write that, quote, "A populist movement believes that ruling elite are corrupt and undemocratic, that the masses have been treated poorly, and that the system ought to be changed because the general will of the people demands it." So that sentence, to my ear, doesn't sound nonsensical, especially given the fact that governments and markets can both be fairly punishing to the median person. So why does populism, or maybe it's populism with a capital P, have such a terrible reputation at the moment?
42:09 Speaker 01 So I don't think the problem is identifying what's going wrong. I absolutely think populists are necessary to jolt the establishment, to say, look, this is not reaching so many people. It's the answers they provide, which often are too easy and wrong at the same time. So let's take a standard answer, which has appealed to both sides, the left and the right. Let's close down trade. Free trade is very problematic, right? Or let's put constraints on it. So what do we do? We raise steel tariffs, right? The economists would tell you, okay, but be aware of the unintended consequences. As you raise steel tariffs, the price of steel domestically goes up.
42:52 Speaker 01 As the price of steel goes up, car companies find it harder to compete because they buy a lot of steel. Now, remember, they're competing with car companies abroad who don't have the tariffs that you just put on your steel. They're buying steel cheap, in fact, even cheaper, because steel that used to come to the States now is going elsewhere. So their prices actually are much more competitive than car companies in this country. So GM announces it's going to close down a bunch of plants. That is the consequence of the easy solution. The cost of saving a steel job could be jobs lost in other industries, and typically economists say more than the jobs that you save in steel, and you're increasing costs overall for the consumer also to boot.
43:36 Stephen J. Dubner? So you argued that communities have been left behind often by technological change and globalization, and that the solution lies in restoring power to communities. Now, what do you mean by that, restoring power to communities?
43:52 Speaker 01 One of the tendencies with the growth of markets is for government to also grow. And then, in order to maintain uniformity across which markets can operate, there's a tendency to take more decisions into the government. There's also the problem when markets sort of implode, again, government grows to bail out individual communities, right? And what I'm arguing is, this essentially leaves people in the community frustrated. There's much less to engage on when, for example, your school is being paid for largely
44:30 Speaker 01 out of state or federal grants, and the state or federal bureaucracy is what decides what will be taught and how it will be taught and how teachers will be compensated. The school no longer pays attention to the local community. Similarly, if regulations on how you can produce locally are determined elsewhere, then I think you have a sense of disempowerment. And, you know, why bother about the local ward elections when the ward does pretty much nothing?
45:03 Stephen J. Dubner? So when community is successful, and it's not always, but when it is, how important is simply the fact that it operates in much smaller units than the typical government or market? You write about a poverty relief program in Germany called the Elberfeldt System. Talk about how that worked and why you think it worked.
45:26 Speaker 01 Well, this was, you know, in the first flush of industrialization in Germany. Germany was one of the first countries to put together some kind of social support in an explicit way, as in the town of Elberfeldt. And there, what they did was they got volunteers from each ward who would come together under an overall structure run by the city. They would go into the homes of people who were not doing well and ask them what their needs were and essentially approve very quickly some kind of financial support for those
46:07 Speaker 01 for those families, but also give them contacts, give them opportunities. Here is where there might be jobs. Here is what... They were essentially acting as voluntary counselors. And, you know, a lot of people volunteered. The engagement helped, in a sense, tie people back into the community and help them stand on their feet. And this wasn't, you know, these were people volunteering to do this rather than, you know, part of a bureaucracy. This was what they did in their spare time. And therefore, you got engagement and enthusiasm. And the people doing this got, you know, local social prestige. As we go forward into a more technologically enhanced world,
46:52 Speaker 01 it's the people around us who are going to be much more important. In this anonymous world with anonymous markets and anonymous bureaucracy, what allows you to have meaning in your life is really the people around you.
47:08 Stephen J. Dubner? I have to say, some of these words that you're using now, Raghu, community and meaning, if I did not know better, I would not think that you were an economist at all. I'm curious whether this represents an evolution for you as a human and economist, or was this always who you were and economics was just a route that helped you further your thinking?
47:28 Speaker 01 I think as you sort of progress in life, more you understand a little more.
47:36 Speaker 01 And to some extent, I think as you read outside your field, you learn what's been done elsewhere. You realize there are many parts which are missing. I mean, look, to be fair to economists, they've they've expanded what they focus on so much.
47:53 Stephen J. Dubner? You do argue in the book that community has long been undervalued as the third pillar of a society, and especially undervalued by economists. I'm curious why you think that is.
48:06 Speaker 01 Well, I think it's harder to analyze. I think that we are very comfortable with explicit contracts. We sort of understand prices. But in a community, many of these transactions are not priced. You may do more favors than you get. And the compensation may not, you may not even get, you know, greater status as a result. I mean, sometimes you do. But sometimes you do it because it's ingrained in your sense of who you are that you have to help the community. And I mean, think of it as almost seared in your utility function.
48:47 Stephen J. Dubner? Yeah.
48:49 Speaker 01 So I think some of these features are hard for economists to analyze. For example, we don't have a good theory of what sometimes is called the norm of reciprocity, that when people get a favor, they feel almost compelled to return it at some point. And why do we feel that that norm so strongly? Unclear.
49:14 Stephen J. Dubner? Have you lost some faith in the markets, or would you not put it that way?
49:19 Speaker 01 I would say the capacity of markets to take care of themselves, which I was much more convinced about. I've lost some faith. Now, it's not the automatic answer doesn't mean that you replace them with governments. It's all about balance.
49:35 Stephen J. Dubner? In some ways, your book is frightening, and it describes the potential for really disaster. You, however, sound in this conversation and in some moments in the book to be quite hopeful. Can you just distill your kind of over-under for the hope factor in terms of the global economy and society continuing to enjoy prosperity and progress versus potentially backsliding?
50:09 Speaker 01 Look, I think the potential for progress is certainly there. I mean, if you look at what's happening across the world, certainly in many of the emerging markets, how tremendous changes have happened in the last few decades. You have to be really happy that a country like Vietnam, which was enmeshed in war 50 years ago, is now where it is. The dangers, well, we see them when we read the papers every day. I mean, this fight between China and the United States just now on trade, but there are geopolitical concerns. You know, if we have another Cold War or potentially even, you know, places of hot war,
50:54 Speaker 01 here are two enormously rich countries. If they go at each other and use all the capabilities that they have for new technologies in fighting each other rather than building a common sort of world, I think the path down could be very, very steep. So we need to engage with each other for the good, and we need to figure out ways to do that. So I am worried. But what gives you some confidence is we've always figured it out.
51:24 Stephen J. Dubner? Raghu, I so enjoyed the conversation. I know our listeners will as well, and I thank you very much for your time.
51:31 Speaker 01 Thank you, Stephen.
51:37 Stephen J. Dubner? Coming up next time on Freakonomics Radio.
51:39 Speaker 11 In a lot of the developing countries, when consumers get a little more income in their pocket, one of the first things they do is want to add high-value proteins to their diet.
51:50 Stephen J. Dubner? High-value proteins that are often meat.
51:54 Speaker 12 You can't go wrong with barbecue chai tip. And I love a good ribeye. And then I would say a New York.
52:00 Stephen J. Dubner? One big problem.
52:01 Speaker 13 The most environmentally destructive technology on earth, using animals in food production. Nothing else even comes close.
52:09 Stephen J. Dubner? Because why?
52:10 Speaker 13 Because the cow didn't evolve to be meat. The cow evolved to be a cow and make more cows and not to be eaten by humans. And it's not very good at making meat.
52:18 Stephen J. Dubner? So what happens now? As the meat wars heat up, you've got people like this.
52:24 Speaker 13 I am currently the CEO and founder of Impossible Foods, which is a company whose mission is to completely replace animals as a food production technology by 2035.
52:36 Stephen J. Dubner? And you've got people like this.
52:38 Speaker 12 We want to keep the term meat to what is traditionally harvested and raised in the traditional manner.
52:45 Stephen J. Dubner? The future of meat. That's next time on Freakonomics Radio.
52:53 Stephen J. Dubner? Freakonomics Radio is produced by Stitcher and Dubner Productions. This episode was produced by Zach Lepinski. Our staff also includes Alison Kreglow, Greg Rippon, and Harry Huggins. Our theme song is "Mr. Fortune" by The Hitchhikers. All the other music was composed by Luis Guerra. You can subscribe to Freakonomics Radio on Apple Podcasts or wherever you get your podcasts. The entire archive is available on the Stitcher app or at Freakonomics.com, where we also publish transcripts and show notes and more. We can also be found on Twitter, Facebook, and LinkedIn, or via email at [email protected] . Freakonomics Radio also plays on most of your better NPR stations, so check your local station for details. As always, thank you for listening.
53:47 Stephen J. Dubner? Freakonomics Radio is sponsored by Ozempic. Innovation happens through rethinking what's possible. And when it comes to GLP-1s, Ozempic pill does just that. Learn more about Ozempic semaglutide tablets, 4 and 9 mg, by calling 1-833-OZEMPIC or visit Ozempic.com to view the medication guide and ask your doctor what's possible with FDA-approved Ozempic pill.
54:18 Stephen J. Dubner? Freakonomics Radio is sponsored by US Bank Smartly Checking and Savings. You know, US Bank Smartly Checking and Savings are bank accounts that work harder for you. You get better savings rates, fee waivers, and rewards from day one. So you spend less time worrying about money and more on what matters. Sign up for US Bank Smartly Checking and Savings today at usbank.com/smartly. Member FDIC. Copyright 2026 US Bank.
54:50 Stephen J. Dubner? Freakonomics Radio is sponsored by Southern Company. The world and its energy needs are always changing. Southern Company's commitment to meeting this demand stays the same. That's because Southern Company believes energy is more than a utility. It's what powers possibilities. So they are looking ahead and investing $80 billion in infrastructure upgrades and are committed to fueling growth in ways that benefit all customers so that reliable and affordable energy is accessible for generations to come. Go to southerncompany.com to learn more. Southern Company, building the future of energy.
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