Social Inequality Helped Stoke Financial Crisis

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National Public Radio
June 21, 2010

RENEE MONTAGNE, host:

And when we talk about the financial crisis, we often hear about inadequate regulation, greedy bankers, irresponsible consumers. University of Chicago economist Raghu Rajan points to another cause: social inequality. He says disparity in income is one of the fault lines that contributed to the recent financial earthquake. Rajan's new book is called "Fault Lines," and he joined us to talk about it.

Professor RAGHU RAJAN (Economist, University of Chicago; Author, "Fault Lines"): This wasn't the typical boom and bust that characterizes the housing economy. This was a boom where the poorest people and their houses went up the most in price and came down the most, and I point to income inequality.

The problem in the United States is that incomes for people with college degrees, has grown much faster than income of those only with high school degrees. And the reason, really, is that technology implies that people today require much more of an education, you know, to the jobs that are available. But the supply of the educated is not keeping pace with the demand for them. As a result, people who have the education are growing much richer than people who don't.

MONTAGNE: So you're not talking about the very rich. You're talking about middle-class, maybe upper-middle-class, versus people who are what we might call working-class.

Prof. RAJAN: Absolutely. And I'm saying that people in the working class need a better education. But education is very hard to fix. So with the American middle class slipping behind, there's immense pressure on the politicians to do something.

The buttons that were easy for them to push was more credit, because some of the institutions that offer credit, especially in housing, were affiliated or controlled by the government.

Now, what I want to argue is that housing credit became a palliative which had support from both the left and the right. And so you had President Clinton talking about the affordable housing mandate. You have President Bush talking about the ownership society. But both pushed government agencies and the quasi- government agencies to send a lot of money towards low-income housing, and that did push up housing prices a lot at the lower end and eventually led to a collapse in those prices.

MONTAGNE: You draw comparisons to history, in particular, I'm thinking the 1910's and 1920's, the years leading up to the stock market crash that kicked off the Great Depression.

Prof. RAJAN: Absolutely. We had another big transformation towards the end of the 19th century. And again, at that time, you had a rise in inequality and you had the farmers falling behind. And at that time, the farmers pushed again politically for more credit, and the outcome was an expansion in banking, a tremendous expansion in banking in the early part of 20th century.

And in many ways, the farm sector was a subprime sector of the Great Depression. There were lots of farm foreclosures. "The Grapes of Wrath" is a classic book on that phenomenon. And many banks who had lent to these farmers, again, went out of business. So this is not a new phenomenon in U.S. history. And instead of doing the things that are needed to make society transition towards a better distribution of income, we use credit to fill the gap.

MONTAGNE: You've just spoken about one fundamental problem or fault line. What would be another one?

Prof. RAJAN: Well, the second fault line I want to talk about is the fact that the recovery from recessions has become much more prolonged, especially in terms of jobs. Because the United States has very narrow safety nets, or very limited safety nets, there's a tremendous amount of anxiety created amongst the unemployed. There's huge anxiety, while in Spain, they endure 20 percent unemployment without a revolution or without the kind of anxiety that we have here.

So the point I'm trying to make here is the nature of U.S. recessions were compatible with the U.S. safety net in the past: quick recessions, short safety net. Now what has happened is that with the recessions - at least the jobless part of it - lasting much longer, the safety net is inadequate. And we have to think about this, whether we can afford the kinds of policies that come into substitute for the safety net, policies that expand the deficit widely, policies that lead to very low interest rates for a sustained period in a somewhat futile attempt to get funds to higher.

MONTAGNE: Raghu Rajan is a professor at the University of Chicago's Booth School of Business. His new book is "Fault Lines."

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This page contains a single entry by CFED published on June 22, 2010 3:35 PM.

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