Raghuram Rajan, ex-governor of the Reserve Bank of India. (Photographer: Dhiraj Singh/Bloomberg)

Populist Governments Threaten Central Banks’ Independence, Says Raghuram Rajan

Populist governments are threatening the independence of institutions, according to Raghuram Rajan.

A “sense of populism” is prompting elected governments to subscribe to the view that there should be fewer checks and balances, the former Reserve Bank of India governor said. Rajan, who was speaking at an event hosted by the Brookings Institution in Washington, said that such governments think that their view is supreme.

“That view is… because people gave us votes,” said the former RBI governor, who recently authored the book, “The Third Pillar: How Markets and the State Leave the Community Behind”. “We know that it’s not the way effective societies work.”

But these issues were addressed during the formation of some of these institutions, he said. Citing India’s Election Commission’s evolution as an independent authority, Rajan said the evolution is never unidirectional but takes time.

The professor at University of Chicago Booth School of Business also urged corporations to look beyond creating shareholder value and focus on interests of all stakeholders.

Here’s the video of the full event:

Here are the excerpts from the interaction:

You believe in politically independent central banks. You made a number of changes in India to put them on course to having a central bank that looks success for capitalist democracies. There has some hesitation. You were appointed. Your successor was fired. Why is it that happening and how serious is it for India’s growth?

The broader thinking of what is happening in the world, the sense of populism that people have the right to determine things and therefore the government should have more of a say. Checks and balances are constraints on government. Once the people have elected it, that view says there should be relatively few checks and balances. Our view is supreme because people gave us votes. We know that it is not the way effective societies work. We need to respect checks and balances. In India, it is a process of creating these institutions. It is not unidirectional. We go forward and backwards a little bit, but generally there is progress.

For example, take the Election Commission. Elections were not that clean in India earlier. There used to be a notion of booth capturing.Thugs could come and chase the government officials away and start marking the ballot boxes. It doesn’t happen anymore because we have one strong election commissioner who got the paramilitary forces to man the booths. So, there is a guy with a semi-automatic rifle sitting there and you can’t grab the ballot boxes without some risk to your life. So, in that sense, that fixed elections.That made it much cleaner and every election commissioner has followed it.  

So, we build institutions which takes time. It is not unidirectional but over the long run, we do.

Your opinion is of the principle of subsidiarity means things should be done locally should be done locally and things which have to be done at the centre should be done at the centre. Brussels thinks everything should be done at the centre and voters think everything should be done at Dover. Is this example of a community trying to reassert itself or is it ugly nationalism as a consequence of neglecting community?

It is both. Many people were worried about the uncontrolled immigration that they face in Britain as a result of the rules of the union they have to obey before freedom.

Also, it was a sense that we have no control. Union sent out rules on the curvature of cucumbers. You cannot sell cucumbers which have curved more than certain angle because that doesn’t meet the requirement of what a cucumber should be. That is a nutty rule. I am sure there was a rationale that the bureaucrats had. That gives you the sense of central rule making which becomes disreputable.

The idea that they are going to put walls and not allow immigrants, you are not comfortable with it?

I don’t think that was the intent. I think it was more control over immigration. We don’t want to be completely open. That is a reasonable thing for a country to have. I am not okay with walls within the country, around communities, people moving from different areas. Around the country, you have to have some sense of who you are letting in.

I hope that is not an endorsement of Trump’s wall.

I have no views on the suitability of the wall. Most people reject it as it is not effective. A country has, because of where we are, the right to control flows into the country. It is not a bad thing for a country who want to regain control. And that’s how I see Brexit as. Some of it is driven by the fact that our sense of powerlessness is augmented by not just by people flooding in but the fact that we can’t determine very much as everything is constrained by process.

India is an under-developed stage and China is at over-developed state. Sometimes we think that our views are right, and we have figured the things out. Chinese seem to be doing good in their way and one makes us sure that we are the right recipe.

I argue in the book that China has an effective system to get to middle income. Building roads, bridges, highways are easy when you have that kind of system of the more centralised authoritarian system. We don’t get a protest at every street if you take land away. I am not talking about moral and ethical structures. I am talking about can they produce growth.

From middle income to developed country status is much harder with that kind of system. I make arguments in the book that given the party requires legitimacy there is constant incentive to intervene in markets when they go south to protect that sense of legitimacy. Eventually, that makes you go little too far into the right directions. I would argue the need to separate the state from the private sector for a more democratic structure.

Whatever form of Chinese democracy that there is, it would serve them well in the next phase of growth. India has a great system from the movement of middle income to the first world. But first it needs to get to middle income and that’s where we are finding it harder. You need to acquire land and you have a whole bunch of people protesting rightfully as they are a democratic protest. So, it becomes harder to get that infrastructure to the first stage.

I won’t give up India system as there is so much value. It prevents the harder transition once we get to middle income. It does means that we get to middle income slowly and we have to work on it.

Do you think for a developing country to get from middle income to success is because they have democracy, higher education system?

Chinese education system, today, is fantastic. The democratic environment, the openness to dialogue is all that. We need to improve the higher education system. But we have the political apparatus to

handle that next phase. I don’t believe that it is a given that China will chug along at this pace without altering its political system. Not because it is good but simply because it is needed as they get to those things.

What is the role of big corporations? You make a distinction in the book that you have said profit maximization too far and you talk about the concept of value maximization. If these were the room of Fortune 500 CEOs, what would you tell them they have to be doing differently than what they are doing now?

Many of them are doing what I suggest what they should be doing, except they don’t talk about it that way and this is shooting themselves in the foot. When Milton Friedman talked about that the only job of a corporation is to maximise profits. He said that at a time when corporations were asked to hold prices because inflation was high. It was a national duty to keep prices low and from a person from Chicago, it is waving a red rag. You are trying to intervene in prices. They are supposed to tell you where you should be producing, and you are eliminating the price signal by fixing pricing. Friedman believed that all the CSR was being proposed by activists through the backdoor and what they didn’t get through the front door through Congress, here are things which corporations should do. Those are reasonable arguments to think about.

He was wrong in thinking that primary duty of a corporation is maximising shareholder value. The reason he said that if we think about it theoretically shareholders have a residual claim. Everybody else has fixed claims like debt holders, workers get paid a wage which is fixed. Therefore, if you are maximizing the residual, you are maximizing the whole. From societies’ perspective, that was the right thing in his view.

Reality is that shareholder is not the only residual claimer. If I am a worker having strong skills and I am not commodity labour, I become a partner in an enterprise. I get some share of future profits. So, I become a stakeholder in the firm. If as a manager of the firm if I want to maximise the value for a whole, you have to take the interest of long-term workers who are stakeholders also into account. You can’t just say to shareholders if you fire workers when in fact retaining them would be better for the whole then firing them perhaps, that’s the right decision to make for the whole. Maximising the whole maximise the value of shareholders. So, it is not contrary to what they do.

I will tell them to think about the broader perspective. Not about what good I will do for the society but how I would do good for the corporations and the stakeholder in a corporation. Focus the corporation on what it is supposed to do. Efficiency choice. But you can do that by taking a broader view. That will sell much better. Today a lot of people are worried that in the interest of shareholders, you are sacrificing the interest of others who make investments in the firm like the workers. There is a case to be made that their investments are as important as the investments shareholders make. They also ought to be protected. Occasionally, there would be a reason to fire workers as it is better for the whole.