Raghuram Rajan, a professor at the University of Chicago's Booth School of Business and a former chief economist with the International Monetary Fund, saw the global financial crisis coming as early as 2005. Brian Milner talks to him about his latest book, Fault Lines: How Hidden Fractures Still Threaten the World Economy, which exposes misconceptions about the causes of the debacle-and warns that, as the world slowly recovers, a much worse crisis lurks in the bushes.
What's the biggest mistake policy makers have made in dealing with the crisis? Both in 2001 and now, we've tried to deal with the problem only through fiscal and monetary stimulus, when it seems to me the fundamental problem is more a structural one, which will need a variety of other methods and may in fact take longer. What we really have is a skill mismatch [in the labour market] In the U.S., there seems to be a sense that stimulus will bring back the jobs-and if the jobs aren't coming back, it is the fault of a lack of adequate stimulus.
What we're doing is trying to revive those interest-rate-sensitive sectors of the economy [including housing] It seems to me that we're not recognizing the real problem-that we overextended this segment of the market. It absorbed a lot of people who were relatively unskilled, in areas like construction and even real estate brokerage and finance.
Given your pessimistic outlook, where do you put your own money? For a long time, I have been in high-grade corporate bonds, and I am reasonably well diversified. I don't think I know for sure what's going to make money and what's not.
You're an adviser to the Indian government. What are you telling them these days? It's longer-term, big-picture advice. India's always a cup half-full, half-empty. There is tremendous scope for continuing the growth at the level it has been, if not higher, for many years. I wouldn't be surprised if it continued for a couple of decades, which would put India quite solidly in the ranks of the middle-income countries. However, it's always dangerous to extrapolate growth, because the history of growth has been spurts that stop. And the question is, what could stop India? There are enormous problems which need to be addressed.
Are you dismayed by what's happened to your profession? There is a danger in our profession of claiming that we know more than we do. This is why I myself am very resistant to the label that I was prescient about a fall coming. We're always working with inadequate data and, to some extent, inadequate theories. The public image of what the economist can do differs very much from what we know we can do. The public imagines we can predict how the economy is going to develop, what growth rates are going to be, aided and abetted by the 24/7 economic news. Every small number is analyzed to death. The truth is, it's very hard to predict this quarter's growth, let alone a few years ahead. And yet everyone wants to know and expects us to respond.
You originally studied to be an engineer. What led you into the "dismal science" of economics? I read books by people like Galbraith. He wrote in a very engaging way, with dry humour. That made me think that the economic issues were interesting. I read about Keynes's big ideas, and I thought: Here's a guy who has actually changed the world. And so it was a combination of the notion that economics had great power and was very interesting that sort of moved me away from my boyhood dream of becoming a fighter pilot.