The Third Pillar

by Raghuram Rajan

  In a society where the typical government civil servant is neither civil nor a servant to the poor, the MP is the intermediary who will help them navigate the treacherous world. While the poor do not have the money to “purchase” public services that are their right, they have a vote that the politician wants. The politician does what he can to make life a little more tolerable for his poor constituents—a land right enforced here, subsidized medical services honored there. For this, he gets the gratitude of his voters, and more important, their vote. Tied to their MP via patronage, they do not really care about how the MP will vote on the bigger issues of the day, whether he supports tax-evading liquor barons, illegal miners, or industrial polluters, so long as these do not intrude directly on their already-hard lives.

  Far from rewarding honesty, the system favors the corrupt politician because he is not just richer but, being adept at the game of favors, is better at making the wheels of the bureaucracy creak in favor of his constituents. Such a system is self-sustaining. An idealist who is unwilling to work the system can promise to reform it, but the voters know there is little one person can do. Moreover, who will provide the patronage, the jobs and the wedding gifts, while the idealist is fighting the system? So why not stay with the known fixer even if it means the idealist is defeated? Thus the circle is complete. The poor and the underprivileged need the politician to help them get jobs and public services. The crooked politician needs the businessman to provide the funds that allow him to supply patronage to the poor and fight elections. The corrupt businessman needs the crooked politician to get monopoly rights, public resources, and contracts cheaply. The politician needs the votes of the poor and the underprivileged. Every constituency is tied to the other in a cycle of dependence.

  Furthermore, there is little incentive for anyone to improve public administration and public services, because it is by filling the gaps left by the incompetent public administration that the corrupt politician maintains his vital role. Indeed, he is responsible for some of the incompetence of the administration, since it is he who overfills its positions with unqualified but loyal supporters.

  More generally, when the state has limited capacity to meet the genuine needs of the people, democracies could turn into machines doling out patronage rather than checks on corruption.9 One clear counter to apathy is local political engagement, which helps communities come together in broad-based movements, as in the United States. The reintroduction of elected village councils (panchayats) in India in the early 1990s helped energize public political engagement. There is more room today, as a result, for those who want to challenge the system. A second counter to apathy is better public services, which reduces the need for patronage. India is making progress, albeit slowly, here.

  Let us turn now to yet another reason people in communities withdraw their support for markets: when most people feel markets are unfair and thus have no desire to protect them. This is perhaps most dangerous for a functioning market democracy, and it typically occurs when jobs are uncertain in the face of large-scale economic adversity or technology-induced change, and the community and state offer little support.

  WHEN COMMUNITIES LOSE FAITH IN MARKETS

  What does it mean for a market system to be fair? The libertarian philosopher would say that so long as none of the trading choices of market participants are constrained in any way, any outcome they achieve from a set of trades they willingly enter into should be seen as fair. It does not matter if some prosper while others are ruined; what matters is that all transactions are between consenting parties.10 The Marxist would argue that everything starts from the initial endowment of property or capabilities that people have, and if that is unequal, then everything from then on is unfair. Indeed, because property has often been accumulated in the distant past through theft, conquest, or exploitation, all subsequent property rights are also dubious even in the libertarian light.11 The followers of philosopher John Rawls might hold that a system that theoretically maximizes the well-being of the worst-off in society, other things equal, is what we would think most just if none of us knew whom we might end up as.12

  The voting public obviously has a more intuitive and less theoretical sense of fairness. What might be its minimum common demands from an economic system? Importantly, the individual cares about how she is treated by the system. Did she get a chance to get the capabilities that would give her a reasonable chance of success? Does the system give her second chances if she made mistakes with early choices? Is she fairly well protected against the vicissitudes of fortune, against the loss of a job, against illness or disability, and against the misfortune of not having saved enough for old age? The individual also cares about how others are treated, with the degree of care depending on their social proximity, the unfortunate’s own efforts to resolve their problems, as well as their degree of misfortune. In assessing whether the market is fair, therefore, individuals primarily examine its operations on both themselves and their community.

  TECHNOLOGICAL CHANGE AND PUBLIC ANXIETY

  Most anti-market movements start or gain steam in economic or financial downturns, where the productive efficiency of markets is particularly hard to see, while the damage they do is clear. Nevertheless, we do not see every downturn producing strong anti-market forces. Many voters will stay the course so long as they have some hope they will participate in the recovery, especially if they have some support from the community or the state until it materializes. So long as the perturbations in the environment are small, a liberal market democracy is naturally self-correcting. Its strength is to react and adapt to small pressures. It can even react to large shocks to the environment such as war or natural disasters so long as it is clear they are temporary.

  Problems arise when there are large permanent changes in the environment—changes such as the advent of new technologies. In such an environment, people need help to adapt their capabilities, even as they need significant support to cushion the blows to their existing economic activities. When a section of the public is so bereft of the capabilities the market requires of them, such as the handloom workers during the Industrial Revolution, and sees no assistance forthcoming to help them face the long run, their despair combines with their fear to create widespread anti-market revulsion. The market is no longer seen as fair because it excludes many who want to participate and does not help those who simply cannot.

  Since the invention of the steam engine, there have been a number of episodes of massive technological change, when vast sections of the population of developed countries have had to upgrade their skills and move to new unfamiliar industries or geographic locales. Economic historians differ on which episodes they think important, but many would agree on three. The First Industrial Revolution, starting with the invention of the steam engine and followed by the development of railroads and steamships, played out between 1775 and 1875 approximately. The Second Industrial Revolution started with the near-simultaneous invention of the internal combustion engine, wireless transmission, and the use of electricity for light and power.13 These permeated in various ways into the global economy between 1875 and 1970. We are now in the midst of the Third Industrial Revolution, starting with computers in the 1950s and 1960s (the revolutions overlap). Some term the invention of the microprocessor in the early 1970s, continuing with the development of the internet and its applications in the 1990s, and now extending into the use of artificial intelligence, robotics, and big data, as well as their extension into nanotechnology, developments in medicine, and the production, storage, and use of energy as the Fourth Industrial Revolution.14 As indicated in the Introduction, we will refer to the gamut of recent technological changes as the Information and Communications Technology (ICT) Revolution to avoid confusion in numbering.

  Technological revolutions rarely occur suddenly or linearly. It takes time for business to learn the practical uses of scientific discoveries, and to embed them in new products and services. It takes
time for people to envisage what is possible with the novel output from business, and to find uses that go beyond what the inventors contemplated. Thomas Edison did not intend the phonograph for playing music; he thought of it as a device for businessmen to dictate letters for their secretaries to type.15 It also takes time for business and its workers to change their production methods and their own skills so as to take full advantage of the new technologies and the uses that have been uncovered, and yet more time for adoption to move from the early knowledgeable risk-takers to the larger population. Technology rolls out slowly, and in fits and starts, with many mini-revolutions.

  By the time the new technology has rolled out fully, though, it ends up affecting every facet of society. For example, the electrification of the home during the Second Industrial Revolution, with electric lighting followed by the washing machine, the steam iron, the refrigerator, and the dishwasher, greatly simplified household chores. Women, and it was only women then, could consequently contemplate working outside the house, even while having a family. Arguably, then, the Second Industrial Revolution helped increase female participation in the labor force outside the house, but few foresaw such an important change with its attendant social implications when the home was first electrified.

  The typically long lag between when society anticipates disruption and when the fruits of the technology are finally reaped is beneficial for it gives society time to adjust. It can also be a time of great worker anxiety as uncertainty hangs over which jobs will be needed. Financial markets also try to anticipate, and often overextrapolate, the speed and direction of beneficial change, with attendant booms . . . and busts (when they are proven wrong), further complicating the process of societal adjustment.

  TECHNOLOGICAL CHANGE AND FINANCIAL CRISIS

  Episodes of innovation have often been punctuated by financial crises and severe economic downturns. The Panic of 1873 in the United States followed speculation in railway stocks, the Crash of 1929 followed a boom in industrial stocks, including utilities, and the Dot-Com Bust in 2000–2001 can be traced to the euphoria surrounding advances in internet technology and commerce. Such a combination of technological innovation followed by financial crisis has been regular enough that economic historian Carlotta Perez argues the two are related—the tendency of financial markets to become overoptimistic about the possibilities for new technologies invariably leads to a financial frenzy followed by a crash, way before the technology delivers on its promise.16 Eventually the new technology does deliver stronger productivity, growth, and well-being if the market system survives, but this invariably means that society has to deal with the public’s fears about the future at a time when the market system does not seem to be working, and when countries have limited resources to help people cope or adjust. The market system, and indeed democracy itself, is extremely vulnerable at such times.

  Such times can impel economic and social reform and necessary change, as we saw with the American reform movements around the turn of the nineteenth century. Adversity can also give rise to demagogues who can get the votes to do irremediable long-term damage. The electorate may discover too late that they prefer measured reform to ignorant revolution. Indeed, Greek historian Polybius believed that democracies inevitably succumbed to demagogues.17

  WHAT KINDS OF SUPPORT DO COMMUNITIES NEED?

  New technologies typically required workers to have new capabilities. So communities needed to provide their members a pathway to acquiring these capabilities, or obtain state help to do so. The technology-induced global economic downturns that periodically hit communities prompted two other demands. One was for financial support as the integrated market unleashed mass economic distress that was hard for any individual community to cope with. Communities often appealed for help from the state. While the state typically responded with ad hoc efforts to address crises, over time it created formal safety nets to assuage its anxious population.

  The second demand came to the fore during the Great Depression, a calamity that hit just as the fruits of the Second Industrial Revolution were ripening. The destruction of any savings invested in risky assets, the deep and sustained unemployment across every sector of the economy except the state, the belief that corporate titans and bankers had been engaged in excessive speculation, all brought calls to curb competition and markets. Public sentiment across the industrial world during the Depression now turned to supporting cartels as a way to preserve employment. Let us examine all these issues, focusing first on education and capability building, then on support to the economically distressed, and finally on the curbs on competition.

  BUILDING CAPABILITIES

  Arguably, the United States has been predisposed to markets because its people, by and large, have had the capabilities to participate in them. For much of American history, people have obtained the high-quality schooling they needed, largely at public expense.

  THE COMMUNITY AND THE COMMON SCHOOL

  The central purpose of early schools in Massachusetts in the seventeenth century was to teach children to read the Bible, so it was natural that schools supplemented family and community practice. With the American Revolution came additional rationales for schooling—identifying and preparing the talented to govern the new republic as well as improving the ability of the general populace to participate in democratic discourse. Thomas Jefferson pushed the Second Continental Congress in 1787 to take steps toward public funding of schools. It passed the Northwest Ordinance, calling for the sale of federal lands to support education, stating, “Religion, morality, and knowledge being necessary to good government and the happiness of mankind, schools and the means of education shall forever be encouraged.”18 Under the Ordinance, new towns would be laid out over thirty-six square miles, of which one square mile would be sold to finance the schooling of children.19

  The traditional one-room schools in older, existing towns in the early republic were largely community funded. These common schools, “common” because they bound the community together and taught common skills like reading, writing, basic mathematics and computation, and sometimes history and geography, typically did not separate students into grades. All students were taught in one big room. Households subscribed to the initial capital fund of the school, with wealthier households subscribing more. School teachers were hired annually, with the expenses of the school year (the school teacher’s wages, his board, books, and the wood for heating the school) and the length of the school year (sometimes as short as the four or five winter months) determined at the beginning of the year. These expenses were apportioned across the community, and certain members were entrusted with collecting the apportioned amounts either in cash or in kind—many poorer members paid with firewood or helped board the teacher.20 Poor children could attend for free, but were often stigmatized with the label “charity cases.”21

  With the school situated within the community, and the schoolmaster (and occasionally, schoolmistress) contracted annually, the community had enormous control over what was taught. Because communities had different degrees of engagement, there was considerable variability across common schools in the length of the school year, the subjects taught and the depth of knowledge imparted, the provision of supplies like books and firewood, the enthusiasm and diligence of the schoolmaster, and his basic training for the job. In the early years of the republic, when schools, especially in rural areas, were not really necessary for economic livelihoods, such variability did not matter much. What mattered was that the school drew the community together in a common endeavor, offered a meeting place for community members, and allowed them to exercise democratic oversight over what their children learned, even as the children grew up together. The little red schoolhouse has an enduring place in the mythology of the early US republic as a coming together of voluntary initiative and group responsibility.

  As manufacturing started picking up with the Industrial Revolution traversing the Atlantic Ocean, and as agricultu
re became more scientific and commercial, education could usefully be more oriented toward preparing children for jobs. Reformers like Horace Mann, the secretary of the Massachusetts State Board of Education from 1837 to 1848, saw the need to improve the quality of schooling to meet these needs. They sought to professionalize teaching by instituting teacher training programs, examinations, and certificates. Professionalization would enhance the status of the teacher, thus attracting more talented people into teaching. Reformers also sought to bring some uniformity to the student experience by setting a minimum length to the school year.

  These reformers were not just motivated by the growing economic needs of the nation, they also saw the school as essential to welding the nation’s people together, to inculcating lessons in good citizenry and sound republican values in the young. To combat what they saw as religious sectarianism and intolerance, especially with the growing immigration of the Irish, they sought to separate the schools from the churches. They also wanted every child in school, so they worked hard to ensure that schools were funded by local taxes, and not by fees. To persuade the rich to pay the property taxes that would be required, they emphasized that education was a public responsibility, which would improve the productivity of workers and help bridge the gap between the wealthy and the working classes. Mann argued that as the “balance wheels” of society, schools would reduce social tensions.