Rajan On Rising Inequality, Lost Generation, Competition Problem And China Clampdown

Premium on effective government has gone up, says Raghuram Rajan.

<div class="paragraphs"><p>Raghuram Rajan, former governor of the Reserve Bank of India (RBI), speaks during a Bloomberg Television interview at the World Economic Forum in Davos, Switzerland, on Jan. 22, 2019. (Photographer: Simon Dawson/Bloomberg)</p></div>
Raghuram Rajan, former governor of the Reserve Bank of India (RBI), speaks during a Bloomberg Television interview at the World Economic Forum in Davos, Switzerland, on Jan. 22, 2019. (Photographer: Simon Dawson/Bloomberg)

The effectiveness of governments is even more important at a time like this, says former Reserve Bank of India Governor Raghuram Rajan while commenting on the widening inequality gap in developing countries like India on account of the pandemic.

In a conversation with Raghav Bahl, editor-in-chief of Quintillion Media Pvt., Rajan discussed post-pandemic challenges facing India—ranging from shut schools to forced formalisation, protectionism and a China-made opportunity to show up China.

Here are the highlights.

Rising Inequality

Cash transfers by governments of developed nations have helped reduce inequality in those nations but poorer countries have seen inequality widen, says Rajan.

The incomes of some Americans during the quarters of this pandemic have been higher than their incomes before because of the transfers that were made. When combined with less consumption in this time it has resulted in more savings and that has permeated down to the lower and middle income segments of the population. "In the poorer countries, because there haven't been these transfers, what we've seen instead is lower, middle incomes have slipped into poverty."

Consumption of poorer households in India has become more restricted in this pandemic and that's a huge worry because of the longer-term consequences, says Rajan.

Lost Generation(s)

One of them is the lost years of schooling for children of poorer families that have no access to online education.

"Kids forget. If you've been out of school for a year and a half you are probably three years behind. I really hope that our state governments and our central government are thinking very hard about how to bring these kids back to school, especially the poorer segments. Otherwise we've lost generations of kids. This is not a small thing in the life of a country."

You have to spend where you have to spend, Rajan says in answer to a question on India's fiscal response towards pandemic relief. You have to be very careful when you don't have the money. But you risk being penny wise and pound foolish on issues like education, he adds.

He emphasises the need to spend effectively while being innovative about raising resources. "India must raise resources for necessary spending, otherwise we’ll end up scarring the economy even more and hold back growth for decades to come."

That means the premium on effective government goes up. We need to be much more effective and we need to be very clear about what we are going to do and how we are going to do it.

A China-Created Opportunity To Better China

Even in an environment of rising interest rates and the Federal Reserve potentially withdrawing stimulus prompting capital outflows, India can look good by laying out a path to growth, stable polity and a number of dimensions. For instance, Rajan lauds the government's decision to settle the retrospective tax cases on indirect transfers.

China is doing a lot to harm its own private sector, for some good reasons and for some not so good reasons, he says. In that environment, India, if it obeys the rule of law, looks a lot better.

"What we should do is emphasise that as a difference and say there is protection for the private sector here, we don't do it arbitrarily based on the needs of the government. We should emphasise that."

Rajan says there are ways India can differentiate itself so that capital sees it as a safe haven, even when the Fed is raising interest rates, so it doesn't flow out.

Forced Formalisation

The informal sector has been hurt disproportionately by the pandemic, Rajan says while pointing to a rise in unemployment, gold loan collateral sales, two-wheeler demand and other indicators. Longer term this will affect demand, he adds.

"Formalisation, broadly, is a good thing if you allow the informal sector an easy way to become formal. But if the informal sector survives because of its informality and as soon as they start paying taxes they simply cannot survive, then what you've done is you've forced them to formalise at the worst time. Yes, longer term this makes sense but forcing them to formalise when the whole economy is being hit means basically they close down."

Because of the loan moratoriums it's tough to understand the full extent of the damage to small and medium enterprises, he says. That will be evident only when the economy fully reopens.

When asked about safety nets for the informal sector, Rajan recommends a two-pronged approach.

1. Make it easier for informal businesses to become formal. That requires meaningful, serious ease of doing business reform being discussed over years. Not just to meet the World Bank's assessment.

2. Many such entities have borrowings. The government needs to think about the indebtedness of this sector and find easy ways to renegotiate the debt. Using speedier, quasi-judicial structures to help them do that.

Focus on debt restructuring as much as possible and try and push towards easing credit flows to these once the debt restructuring happens. Because clearly in an attempt to come back they need a lot of credit flows.

Too Little Competition

"I would club protectionism with internal competition," Rajan says when asked about the growing trend of protectionism across the world and India's big push towards self reliance or Atmanirbhar Bharat.

He sees both, protectionism and increased concentration in India's corporate sector as creating a "problem of competition".

"One of the consequences of the pandemic is that formal, large corporations have grown bigger. In India... we have a few business houses which dominate relative to the rest and have gotten bigger over the past so many years."

"I'm not saying every big (business) house is a problem, but I am saying too little competition is a problem."

Where there is too little competition, close access (for some business) to the government, the ability to change laws for your business, that becomes a problem for the country, Rajan says. So India has to be very careful on domestic competition (it needs to be much more stronger and effective) and external competition—as they work together.

Given the weakness of demand in developing countries because of the consequences of the pandemic, Rajan says this is the worst time for India to push protectionism. A tax on imports is a tax on exports, he reminds, while making the case for expanding exports to selective service areas and not just rely on manufacturing.

"We think Atmanirbhar is all about manufacturing—be like China. That is a lack of creativity. We have other strengths. Why don't we think about exploiting those other strengths."

Watch the full interview with Raghuram Rajan, Professor of Finance at the University of Chicago Booth School of Business.