India adviser discusses financial crisis

Raghuram Rajan is an economic adviser for the prime minister of India, but most of his talk in Sheffield-Sterling-Strathcona Hall on Thursday focused on what the U.S. government should do about the global financial crisis.

Before an audience of about 120 people, Rajan, also a professor at the Booth School of Business at the University of Chicago, said a handful of factors starting after World War II, including the government allowing the private sector to get away with risky investments, caused the recent financial crisis. He said the government must now solve the core problems and create a plan for education reform that resists political pressure. Otherwise, another crisis will occur.

The public sentiment that greedy bankers and ideological regulators caused the crisis holds no traction, Rajan said, because this explanation fails to establish why the crisis happened now. He said bankers have always been greedy.

Rajan said that after World War II, many states, such as Japan, grew extremely quickly through exporting goods and generating great surpluses from these exports. In the 1990s, corporations absorbed these funds, leading to the 2001 dot-com bubble burst, during which shareholders lost billions of dollars as stock prices of several online companies suddenly dropped.

Now that corporations no longer controlled these funds, someone else had to absorb them, and the United States obliged. Low-income households began borrowing more to have money to spend. Rajan said deficits financed by foreign capital lead to crises, because when foreign investors become uneasy, the government has to bail out the system.

Rajan said another contributing factor to the financial crisis was the government’s response to the growing socioeconomic inequality. Many jobs require higher levels of education than in the past, so the demand for higher education has increased. But over the decades, high school graduation rates remain stagnant and college completion rates have shown no significant improvement.

“Many Americans are being left behind in perception if not in fact, increasing polarization,” he said.

Low-income households still wanted to spend money at the same level as before the U.S. class-based achievement gap worsened, so the government encouraged them to own houses through programs such as “Affordable Housing” under President Bill Clinton LAW ’73 and “Ownership Society” under President George W. Bush ’68.

During the dot-com crisis, jobs took longer to rebound than in previous downturns, causing political pressure on the government to pass hastily-written laws to lift the country from recession, Rajan said.

Through these laws, the government encouraged the private sector to take huge risks, such as mortgage-backed securities, by ensuring that if a liquidity problem should arise, the government would support the market.

Rajan said another crisis could be avoided if the government figures out a way to keep low-income households happy until the achievement gap improves. He stressed that redistribution of wealth is not the answer, because it stifles innovation. He said the government should craft a plan of action for future crises before they occur so that it is not influenced by political pressure.

All five students interviewed enjoyed the talk, and three said Rajan’s point about political pressure on government policy was interesting.

But Lawrence Jin GRD ’15 said Rajan did not propose concrete steps for the future.


  • Yale ’08

    Interesting take on the causes of the crisis. I wish he had focused more on India, where in fact redistribution of wealth strategies and policies are much more important (but often underdeveloped or neglected). Overall I’d really disagree that redistribution should be minimized because it stifles innovation. It is an effective way of directly reducing inequality. Education remains more important, as do all public goods allocation strategies that are centered around improving delivery and equality of access/opportunity. He should have talked much more about India’s massive education problems, the excellent gains made in recent years at the primary level, the awful state of higher education in India, the very low number of annual degree graduates who are globally competitive, and the way that education directly affects social development and improves equality of access.