Journal Issue

Interview with Raghuram Rajan: Protectionist Backlash still a Risk to Global Economy

International Monetary Fund. External Relations Dept.
Published Date:
January 2007
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At end-2006, Indian-born Raghuram Rajan stepped down as Economic Counsellor and Director of the IMF’s Research Department to resume his career as an academic and researcher at the University of Chicago’s Graduate School of Business. When Rajan joined the IMF in September 2003, he was the first chief economist to come from a developing country and the first to specialize in international finance rather than macroeconomics. Earlier that year, he won the Fisher Black prize for the person under 40 who had contributed the most to the theory and practice of finance. Laura Wallace of the IMF Survey spoke with him about global economic issues, the IMF’s role in furthering economic and financial stability, and being in the hot-seat job of chief economist.

IMF Survey: How do you see the IMF’s role evolving, particularly when we have fewer crises?

Rajan: We should be happy that there are fewer crises of the old sort requiring bucket loads of money. Perhaps the next crises will be different in nature—they may be slower in developing but more costly and widespread in consequence. For instance, insufficient investment in energy in the past, and even today, will have consequences for some time. The large global imbalances create the possibility of a protectionist reaction, or a sharp adjustment in asset prices, in the future. Some of these slow developments are obvious at the multilateral level, but not at the level of an individual country.

As another example, with demographic changes, capital has to be able to flow out of countries where populations are aging to the countries where populations are still young so capital can be matched with labor to boost production. Similarly, manufacturing is increasingly taking place in developing countries. But if their markets are in developed countries, the developing countries need to have entities there to handle design and marketing. This means emerging market investment in upstream assets like research and development and in downstream assets such as distribution in developed countries. It is thus in the interest of all countries to keep barriers to cross-border investment from rising.

The IMF has a very important function in fostering multilateral dialogue to deal with problems that have multilateral solutions and using that process to encourage change in individual countries. One of its new tools to do this is the multilateral consultation, which it began using in 2006 to promote dialogue on the enormous global imbalances. The virtue of this device is that it brings together the right people to discuss a particular issue. Until now, the various international forums have been either too big or not inclusive enough.

The IMF also has its traditional bilateral surveillance role, and we need to keep rethinking that role to ensure that it’s top-notch and provides value even as member countries increase in sophistication. Right now, a new area of emphasis is improving the integration of financial sector surveillance with the regular country consultations.

The bottom line is that even if there are no fires, the fire department should be thinking about precautions to make sure a fire doesn’t break out. But this also means staffing should be sufficiently flexible—crudely speaking, more resources in regional departments (the fire-fighters) in bad times and more resources in functional departments (the ones building knowledge of risks and necessary precautionary measures) in good times. This remains a challenge.

Perhaps the next crises will be different in nature—they may be slower in developing but more costly and widespread in consequence.

—Raghuram Rajan

IMF Survey: You mentioned the IMF’s first venture into resolving global imbalances—meeting bilaterally with Japan, China, Saudi Arabia, the United States, and the euro area—but so far, there’s very little to show for it. What will it take to get progress?

Rajan: Managing Director Rodrigo de Rato once said it took us years to get to this point on the global imbalances, so they aren’t going to be solved overnight. It’s really important to see this as a process rather than a grand agreement where countries suddenly get religion and do the right thing, and then the problem is solved. In fact, if you look at the Plaza Accord or the Bonn Accord, history now suggests that they weren’t particularly effective, or that they didn’t even go in the right direction. So the key is to create a structure to manage this process over time. The virtue of the dialogue is for the important countries to acquire a shared understanding of what needs to be done, which feeds into their own internal country debates. It also creates an atmosphere of trust so that when problems do arise, countries have the rapport to talk and resolve them.

IMF Survey: Are you optimistic?

Rajan: Yes, of course. Without hope, any multilateral enterprise is a nonstarter. The fact that we have this group together and talking is itself a minor victory.

IMF Survey: If crises do erupt, will the IMF play an important role, as in the 1990s, given that emerging markets have built up big war chests of reserves and our main shareholders continue to disagree on whether large-scale lending is a good thing or not?

Rajan: We may have some of the old-style crises, but I sense that future crises, unless our member countries have learned nothing—and I think they’ve learned a fair amount—will be very different. So I’m not sure whether we’ll need to deploy large sums of money, but I do think we’ll need to play a role in building confidence in these countries. The precise mechanism by which we build confidence is something we need to think about. In particular, should we wait for a crisis to develop before we step in? As you know, the IMF’s Research Department has been working with the Policy Development and Review Department on a variety of possible insurance schemes that offer countries more certainty of funds in return for a greater scrutiny of policies before a potential crisis. As [IMF First Deputy Managing Director] John Lipsky says, we need to weigh how we can help the markets do the right thing rather than stand in their way.

IMF Survey: In the medium term, what worries you the most on the macroeconomic front?

Rajan: My single biggest concern is that with rising inequality in many countries—industrial and emerging markets, including China and India—the forces that want to constrain markets and protect livelihoods against competition are getting stronger. Typically, if there’s growth, there’s enough consensus to suppress these forces and ensure that the growth process isn’t stopped. But if there’s a serious global downturn, these forces could assert themselves with a vengeance. We’ve seen this happen before. We have to pay more attention to promoting more inclusive growth without compromising growth itself. And usually this means trying to broaden the base of opportunity for people—not only through health care, education, and access to finance but also by ensuring that good macroeconomic policies create an environment for growth to be widely spread.

IMF Survey: You mentioned India and China. Is India’s current obsession with how China is doing a healthy one?

Rajan: In some ways. After all, one reason reform in India took off was that Indians saw that a large neighboring country with similar problems could grow fast. Previously, they had always dismissed the East Asian miracle as a “small country” phenomenon. What’s dangerous is that now that the world is talking about “Chindia,” Indian reformers might sit back and say, “We’ve arrived.” As the Indian Prime Minister recognizes, India still has a long way to go. Indian growth rates are approaching Chinese growth rates, but China has been growing at this rate for at least 25 years. India has only about 15 years under its belt, and a lot has to go right for it to be truly in the same league as China.

IMF Survey: How about longer-term economic worries? And is the IMF taking longer-term issues seriously enough?

Rajan: Invariably, when you look out 40 years, you always miss the issue that’s going to be the most important. In the 1960s, people thought the year 2000 would see people flying around with motorized backpacks. Their view of the future wasn’t the Internet, with millions of people spending five hours a day in a virtual world, spending virtual money on virtual real estate, and dating virtual people. So it’s not clear to me that the problems that we’ll be confronting in 40–50 years are precisely the problems we’ve identified now. That said, we’ll certainly have to deal with looming issues like aging populations and global warming, as well as, unfortunately, old issues like poverty and economic volatility.

The question that a number of IMF staffers have is how longer-term issues might affect our policy advice. Climate change is a good example. For the most vulnerable countries, clearly the more flexible their economies, including how much open land they have, the more they’ll be able to adapt—whether that means abandoning or entering certain industries or forms of agriculture, or even moving physically. Canada, which has lots of open spaces and the ability to move north over time, has more flexibility than Bangladesh, which is pretty crowded through and through. Given that any adaptation will not take place overnight, we have to embed these longer-term issues into our regular policy advice. It will either strengthen the urgency of our policy advice or change its nature for some countries.

IMF Survey: From your interactions with policymakers, do you get the sense that the Fund would be more effective as a trusted confidential advisor or as a key player in shaping public national and international debates? Is there, in fact, a conflict between these approaches, or can they complement each other?

Rajan: It depends a lot on a country’s sophistication. In emerging markets and developing countries with still-low levels of economic capability—and this group is getting smaller over time—we sometimes have to do the work that would ordinarily be done by finance ministry and central bank officials. In these cases, we’re true insiders. And, since we need access to inside information, it would be unfair for us to use that information publicly. That doesn’t mean we wouldn’t have a role in shaping public opinion, but we would need to do it in a way that isn’t confrontational.

In more sophisticated and transparent countries that have a private industry analyzing economic data, our value stems largely from our independence. We come without the biases of the existing country authorities or even the private sector. In these cases, we can play a larger role in the national debate because we don’t have privileged access to nonpublic information. While the objective is not confrontation with governments, we have greater leeway and responsibility to participate in debates, where our analysis and opinions, rather than nonpublic data, are what we bring to the table.

IMF Survey: How important is it that emerging markets and developing countries feel more represented in the decision making of the Fund? Will quota reform be enough?

Rajan: Quota reform is critical because a country’s quota is ultimately the number that reflects its representation and voice in the Fund. The quota has to reflect economic importance, however we define it. And we need to find a way to constantly revise quotas without turning it into a major uproar. But if we achieved serious quota reform today, would it overnight change the pattern of power in the Fund? No, because the major industrial economies would still be large and thus retain a lot of voting power.

This is why on top of quota reform, we need to find other ways to give emerging markets and developing countries a bigger say and a bigger stake. If we don’t, the danger is that they’ll stop paying a lot of attention to the IMF—just as the industrial countries have done unless they happen to find the policy analysis useful—because right now emerging markets have enough foreign reserves to guard against everything except Armageddon. Part of the solution rests in the hands of those who feel underrepresented. They need to put more ideas on the table and build coalitions, pulling in members with greater voting power. Currently, there are a number of small countries whose Executive Directors on the IMF’s Board punch far above their weight in quotas, and they should be emulated.

IMF Survey: Is IMF research sufficiently independent and protected from the politics of the place? Or is it important that it be somewhat integrated to make it effective?

Rajan: I think it’s sufficiently protected. On independent research, management has stood its ground, insisting that if we suppress bad news, all our research findings will be suspect and totally useless. Of course, we take seriously our counterpart responsibility that the research has to have great integrity. The Executive Board has also been protective on a number of occasions when, for example, World Economic Outlooks came up with findings that were less than palatable to some of the membership.

Of course, when the Research Department gets into Fund policy issues, we enter the debate within the Fund and that debate is a very intense, vigorous one. Clearly, we need to hold off publishing until there’s more of an internal consensus. At the same time, the internal debate could be enriched if we got more outside views. The Fund has to find ways to introduce a debate outside, without ideas immediately being construed as the official position of the Fund. This is where I think we need more work.

IMF Survey: How do you think an economic counselor should balance the duties of spokesperson of the IMF and the role of a researcher generating new ideas, especially when such ideas conflict with IMF orthodoxy?

Rajan: You can’t be considered a complete flake. Academia tends to emphasize the innovative, the out-of-the-ordinary, because that’s what’s new and interesting. But policymakers have to look at magnitudes, how it all adds up. And sometimes the innovative, the out-of-the-ordinary may not be the most important factor. The best academics, of course, recognize this. The economic counselor has to attempt to offer innovation to the academic audience while giving sensible advice to policymakers, and it isn’t an easy task.

But the real difficulty comes when the message is unpalatable to the policy establishment outside the Fund. For example, I became convinced early on in our research that there wasn’t much evidence that foreign aid had worked particularly well. That message wasn’t palatable to some of the establishment. There is indeed an industry that has become dependent on aid, and, like all industries, it too seeks protection. So it prompted a certain amount of reaction, but once the initial reaction subsided, the message got seriously taken up in a number of places and is making its way into better policies.

I’ve also become more worried that the financial sector in developed countries could be a source of global instability. The reaction when I first made these points to an audience of central bankers in 2005 was not warm and fuzzy, to say the least, but I think I touched on a worry that many of them are increasingly articulating.

IMF Survey: Do you see a need for the IMF to do a better job of absorbing ideas from outside—for example, from academia?

Rajan: I don’t think the problem is absorbing outside ideas. There’s always somebody in the Fund who’s up to the mark. I think the problem is convincing Fund researchers that they have the right to be unorthodox and innovative in their own work, without waiting for the outside to first legitimize an idea. It’s easy for me to say what I think—I can’t be demoted or promoted. But we have very smart economists who need to be convinced that they can think outside the box without being deemed unreliable by their colleagues. During my tenure, the Fund did indeed promote researchers who have been unorthodox, and I think this sends a strong message within the Fund. Too often, there’s self-censoring that tends to produce “lowest common denominator” research—minor technical advances or variations on existing themes.

I think the problem is convincing Fund researchers that they have the right to be unorthodox and innovative in their own work, without waiting for the outside to first legitimize an idea.

—Raghuram Rajan

IMF Survey: What areas of research have you had the most impact on during your tenure?

Rajan: Briefly, I think we’ve done substantial and influential work on low-income countries, including tracking the integration of China and India; we’ve started investigating the political economy of reform more closely; and we’ve done more work on the financial sector and its impact on the macroeconomy. We haven’t, however, neglected traditional areas—our work in explaining the rise of global imbalances has been extremely influential, and our work on macroeconomic modeling and exchange rate analysis is filtering to area department work. I also believe the work of the department has helped the evolution of the Fund’s medium-term strategy.

IMF Survey: What influence will your stay at the IMF have on your personal research and your career?

Rajan: I have a far better sense now of how various macroeconomic forces fit together, and that will feed into my research. I’ll probably do more work on development because it’s so tremendously important. And I’ve made so many friends here with whom I can bandy ideas about and do research that I think I’ll never really leave the Fund.

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