The persistence of underdevelopment: Raghuram Rajan

by aaditeshwar on Sep 10, 2007      Category: Economics & Business Tags: education economics politics democracy reforms

Although I haven't been able to completely read or understand this paper, some parts of it sound really interesting. Raghuram Rajan is director of research at IMF, and has proposed an explanation of why countries like India and Mexico, which are "vibrant democracies", are still plagued with underdevelopment. Why do people choose poverty, is the question under concern!

It assumes that comprehensive reforms, defined as (pro-market reforms) + (education for all), are needed for the collective development of all groups of people. This seems to be justified because without education, the uneducated would not be able to take advantage of the pro-market reforms. And pro-market reforms are in general considered to be good because they promote competition and lead to lower prices for goods and services.

Then it goes on to show that educational reforms might never happen because of the diverse interests of different groups of people. For example, the uneducated people might vote for them, but the educated people would want to preserve their elite status. Or, even if the reforms do get voted through, their success would depend upon factors such as the price of educational services, which are again provided by the educated people.

In the absence of educational reforms, the pro-market reforms would never gain consensus. This is because (a) without education, the uneducated would not be able to take advantage of the opportunities created by pro-market reforms, and (b) pro-market reforms would create additional employment for the educated, which would lead to higher prices for services such as healthcare provided to the uneducated by the educated. Thus, the real wage of the uneducated might actually decrease with pro-market reforms.

The bottomline is that different groups of people want to preserve their current rents, while also trying to expand their opportunities. But opportunity expansion is always good for some and bad for some, and everybody cannot preserve their rents. As a result, the people "may act like crabs in a bucket, willing to pull down any crab that appears to be climbing out..."

The general suggestions for policy formulation are not different from what we already know: pro-market reforms should be accompanied with reasonable endowments for education to different groups of people. However, this is easier said than done. What is a "reasonable endowment"? What should be the sequencing of pro-market reforms and endowments for education? How can the government persuade diverse groups of people to follow a coordinated reform process? The last question indeed seems to be the crux of the problem, to persuade uncoordinated masses of uneducated and educated people to think in a coordinated manner. Even the other questions are not answered in a straight-forward manner because economics and its implementation is still a science (?) under development.

Although this is a highly academic paper, I think it provides a framework to understand the complexities of much that is going on in India these days, especially with regard to OBC reservations, SEZ expansions, the Narmada Bachao Andalon, etc. And it shows that it is wrong to analyze these problems from highly simplified viewpoints such as corrupt politics, or manipulative corporations, or "irrational mobs" in a democracy. In fact, they subsume the media, civil services, democratic politics, economics, and what not. An utterly complex world that humans have woven for themselves! Compared to this, small indeed seems to be beautiful :)

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aaditeshwar's picture


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nitiniitk's picture

"the educated people would want to preserve their elite status" - I doubt if this is true.
The article seems to suggest that underdevelopment is a policy/choice matter, and if all people were to agree on a coordinated policy, we can get rid of it quickly! Is it really so?

aaditeshwar's picture

Well, it's the view of somebody from the IMF! But I think there is some reason to it -- how to persuade people in a democracy to choose an alternative that will be better in the long term, rather than resort to numerous conflicting short term alternatives that may not be efficient? Of course, this can be challenged in many many ways, the most significant probably being whether the policy is correct or not in the first place! To sound geeky, does this sound like a tussle between efficient growth and robust growth? The interesting point however is that coordination will be beneficial for higher efficiency in this capitalist democratic system if robustness can be guaranteed somehow. But this is very hard, and that is probably why everything is so complicated.

Therefore, should people instead resort to a simpler system of local economies and small companies, such as the one outlined in 'Small is Beautiful'?

Or, with reference to the article submitted by Diwaker on the myth of the rural-urban divide, should people go ahead with the complications, because things probably do seem to work. After all, even though governments have changed in India, nobody stopped the economic reform process started in 1991, showing that some degree of coordination is present in the Indian political system.

Btw: coordination should not be confused with planning. Planning an economy is almost always doomed to failure!

ameetdesh's picture

I think, beauty is a personal choice, and it is best to let people decide for their own. I think big can be beautiful :-) after all it has survived evolution. I think, it is responsibility of government to take economic best practices, which ensures that economy pays for its externalities, (environment, pollution), opportunity cost for future generations (cheap oil), ensure equitable access to means of prosperity (education), encourage cooperation, fair competition (efficient markets), punish exploitation. Once such boundaries are set, even if people pursue short term interests, they will achieve long term goals. It is job of economists to find out such a framework. The bottleneck is design of political process which will elect politicians serving long term interests. Part of it, is independent media, democracy.. but such is still far from exact science. I think spirituality, religion, philanthropy i.e any kind of principal which enables a person to be happy from other's wellbeing, can be very strong driver of societal cooperation.
Haven't yet read the article :p, but I have read 'small is beautiful'. The main point in it is current growth is unsustainable since problem of production is not solved, as it will come to halt once oil is over. I don't disagree with it, but would like to contrast it with what somebody said in GE, "Stone age was not over due to lack of stones. Similarly for oil. Something better will come along to replace it."

aaditeshwar's picture

I think 'Small is Beautiful' says much more than the unsustainability of growth, which as you correctly point out, is quite debatable.

For example, it talks about is the human need for creative employment of ones faculties, and that 'big' destroys this personal creativity. I don't remember correctly, but I think this was the starting point for the whole argument about 'appropriate technology' that supports local economies. Of course, nobody knows whether we like to be creative or we are fine with working as robots on an assembly line, but it's definitely something to think about.

Another point it touches upon is about realizing ones social responsibilities, which can probably be considered as a link between morality (or religion/ philanthropy/ etc) and economics. For example, it says that the problem of education in India cannot be solved by opening more and more schools because there are just not enough teachers; the problem is so large in scale that it will take the whole educated population of India to take care of the rest of the people, and that is why we should volunteer our time to help others. Another example is drawn from China, where he says that it is the agricultural output of 150 farmers that is able to support the education of 1 person through college, and that is why the lucky people who get to go to college should give back to society.

I've read it twice but I still haven't understood it. The problem is that it's written more as a compilation of essays without any theoretical groundings. But it's a beautiful book, nonetheless.

My point was that keeping things small probably keeps them simple. Big might be beautiful too, but it is so complicated to maintain. Economics is such an incomplete science. It believes in attaching a price to everything, but how is that even possible given that our knowledge of complex systems is so limited. What is the right price for pollution? What is the right price for CO2 emissions? What is the right price for a crime? What is the right price for cultural disturbances? Nobody knows. The pro-market economists believe in the infinite intelligence of the free-market, and that it will somehow discover the truth. Maybe it can, I don't know. But it can do so only under ideal conditions of competition, free information, and what not. These conditions are never met, which makes the pro-market stance equally questionable as the extreme socialist stance of state control and planning. Both aim to achieve the same ends through different means, but can succeed only under ideal conditions. The point is to realize that nobody knows what is the "truth"! In the absence of this knowledge, on what principles should we govern our lives? I think this is point of the book, that keep things small, because if something goes wrong, then it should be easier to fix while it is small.

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