Raghuram Rajan: Democracy, inclusion, and prosperity
Speech by Dr Raghuram Rajan, Governor of the Reserve Bank of India, at the D D Kosambi
Ideas Festival, Goa, 20 February 2015.
* * *
Thank you for inviting me to this Festival of Ideas. Since this festival is about ideas, I am not
going to tax you with the Reserve Bank's views on monetary policy, which are, by now, well
known. Instead, I want to talk about something I have been studying for many years, the
development of a liberal market democracy. In doing this, I will wear my hat as a professor in
the field known as political economy, and discard my RBI hat for the time being. If you came
here expecting more insights on the path of interest rates, as I expect many of you did, let
me apologize for disappointing you.
My starting point is the truism that people want to live in a safe prosperous country where
they enjoy freedom of thought and action, and where they can exercise their democratic
rights to choose their government. But how do countries ensure political freedom and
economic prosperity? Why do the two seem to go together? And what more, if anything,
does India have to do to ensure it has these necessary underpinnings for prosperity and
continued political freedom? These are enormously important questions, but given their
nature, they will not be settled in one speech. Think of my talk today, therefore, as a
contribution to the debate.
Fukuyama's three pillars of a liberal democratic state
In his magisterial two-volume analysis of the emergence of political systems around the
world, political scientist Francis Fukuyama builds on the work of his mentor, Samuel
Huntington, to argue that liberal democracies, which seem to be best at fostering political
freedoms and economic success, tend to have three important pillars: a strong government,
rule of law, and democratic accountability.1 I propose in this talk to start by summarizing my
(necessarily imprecise) reading of Fukuyama's ideas to you. I would urge you to read the
books to get their full richness. I will then go on to argue that he leaves out a fourth pillar, free
markets, which are essential to make the liberal democracy prosperous. I will warn that these
pillars are weakening in industrial countries because of rising inequality of opportunity, and
end with lessons for India.
Consider Fukuyama's three pillars in greater detail. Strong government does not mean one
that is only militarily powerful or uses its intelligence apparatus to sniff out enemies of the
state. Instead, a strong government is also one that provides an effective and fair
administration through clean, motivated, and competent administrators who can deliver good
governance.
Rule of law means that government's actions are constrained by what we Indians would term
dharma - by a historical and widely understood code of moral and righteous behaviour,
enforced by religious, cultural, or judicial authority.
And democratic accountability means that government has to be popularly accepted, with the
people having the right to throw unpopular, corrupt, or incompetent rulers out.
Fukuyama makes a more insightful point than simply that all three traditional aspects of the
state - executive, judiciary, and legislature - are needed to balance one another. In sharp
contrast to the radical libertarian view that the best government is the minimal "night
watchman", which primarily protects life and property rights while enforcing contracts, or the
radical Marxist view that the need for the government disappears as class conflict ends,
Fukuyama, as did Huntington, emphasizes the importance of a strong government in even a
developed country.
No matter how thuggish or arbitrary the government in a tin-pot dictatorship, these are weak
governments, not strong ones. Their military or police can terrorize the unarmed citizenry but
cannot provide decent law and order or stand up to a determined armed opposition. Their
administration cannot provide sensible economic policy, good schools or clean drinking
water. Strong governments need to be peopled by those who can provide needed public
goods - it requires expertise, motivation, and integrity. Realizing the importance of strong
government, developing countries constantly request multilateral institutions for help in
enhancing their governance capacity.
Strong governments may not, however, move in the right direction. Hitler provided Germany
with extremely effective administration - the trains ran on time, as did the trains during our
own Emergency in 1975-77. His was a strong government, but Hitler took Germany
efficiently and determinedly on a path to ruin, overriding the rule of law and dispensing with
elections. It is not sufficient that the trains run on time, they have to go in the right direction at
the desired time. The physical rail network guiding the trains could be thought of as
analogous to rule of law, while the process by which consensus is built around the train
schedule could be thought of as democratic accountability.
But why do we need both rule of law and democratic accountability to keep strong
government on the right path? Would democratic accountability not be enough to constrain a
dictatorial government? Perhaps not! Hitler was elected to power, and until Germany started
suffering shortages and reversals in World War II, enjoyed the support of the majority of the
people. The rule of law is needed to prevent the tyranny of the majority that can arise in a
democracy, as well as to ensure that basic "rules of the game" are preserved over time so
that the environment is predictable, no matter which government comes to power. By
ensuring that all citizens have inalienable rights and protections, the rule of law constrains
the majority's behaviour towards the minorities. And by maintaining a predictable economic
environment against populist democratic instincts, the rule of law ensures that businesses
can invest securely today for the future.
What about asking the question the other way? Would rule of law not be enough? Probably
not, especially in a vibrant developing society! Rule of law provides a basic slow-changing
code of conduct that cannot be violated by either government or the citizenry. But that, by
itself, may not be sufficient to accommodate the aspirations of new emerging groups or the
consequences of new technologies or ideas. Democratic accountability ensures the
government responds to the wishes of the mass of the citizenry, allowing emerging groups to
gain influence through political negotiation and competition with others. Even if groups
cannot see their programs translated into policy, democracy allows them to blow off steam
non-violently. So both rule of law and democratic accountability check and balance strong
government in complementary ways.
Where do these three pillars come from?
Much of Fukuyama's work is focused on tracing the development of each pillar in different
societies. He suggests that what the nature of states we see today is largely explained by
history. For instance, China had long periods of chaos, most recently before the Communists
came to power; groups engaged in total war against one another. Such unbridled military
competition meant groups had to organize themselves as hierarchical military units, with
rulers having unlimited powers. When eventually a group was victorious over the others, it
was natural for it to impose centralized autocratic rule to ensure that chaos did not remerge.
To rule over the large geographic area of the country, China needed a well-developed elite
bureaucracy - hence the mandarins, chosen by exam based on their learning. So China had
strong unconstrained effective government whenever it was united, and Fukuyama argues,
unlike Western Europe or India, did not have strong alternative sources of power founded in
religion or culture to impose rule of law.
In Western Europe, by contrast, the Christian church imposed constraints on what the ruler
could do. So military competition, coupled with constraints on the ruler imposed by canon
law, led to the emergence of both strong government and rule of law.
In India, he argues, the caste system led to division of labour, which ensured that entire
populations could never be devoted totally to the war effort. So through much of history, war
was never as harsh, or military competition between states as fierce, as in China. As a result,
the historical pressure for Indian states to develop strong governments that intruded into
every facet of society was muted. At the same time, however, the codes of just behaviour for
rulers emanating from ancient Indian scriptures served to constrain any arbitrary exercise of
power by Indian rulers. India, therefore, had weaker government, constrained further by rule
of law. And, according to Fukuyama, these differing histories explain why government in
China today is seen as effective but unrestrained, while government capacity in India is seen
as weak, but Indian governments are rarely autocratic.
Any of these grand generalizations can, and should, be debated. Fukuyama does not claim
history is destiny, but does suggest a very strong influence. Of course, the long influence of
history and culture is less perceptible when it comes to democracy where some countries like
India have taken to it like a duck to water. A vibrant accountable democracy does not only
imply that people cast their vote freely every five years. It requires the full mix of a raucous
investigative press, public debate uninhibited by political correctness, many political parties
representing varied constituencies, and a variety of non-governmental organizations
organizing and representing interests. It will continue to be a source of academic debate why
a country like India has taken to democracy, while some of its neighbours with similar
historical and cultural pasts have not.
I will not dwell on this. Instead, I turn to a different question that Fukuyama does not address.
Clearly, strong governments are needed for countries to have the governance to prosper.
Equally, free markets underpin prosperity. But why is it that every rich country is also a liberal
democracy subject to rule of law?
I will make two points in what follows: First, free enterprise and the political freedom
emanating from democratic accountability and rule of law can be mutually reinforcing so a
free enterprise system should be thought of as the fourth pillar underpinning liberal market
democracies. Second, the bedrock on which all four pillars stand is a broadly equitable
distribution of economic capabilities among the citizenry. That bedrock is fissuring in
industrial countries, while it has to be strengthened in emerging markets like India.
Free enterprise and political freedom
Why are political freedoms in a country, of which representative democracy is a central
component, and free enterprise mutually supportive?
There is, of course, one key similarity: Both a vibrant democracy and a vibrant free enterprise
system seek to create a level playing field which enhances competition. In the democratic
arena, the political entrepreneur competes with other politicians for the citizen's vote, based
on his past record and future policy agenda. In the economic sphere, the promoter competes
with other entrepreneurs for the consumer's rupee, based on the quality of the product he
sells.
But there is also at least one key difference. Democracy treats individuals equally, with every
adult getting one vote. The free enterprise system, by contrast, empowers consumers based
on how much income they get and property they own. What then prevents the median voter
in a democracy from voting to dispossess the rich and successful? And why do the latter not
erode the political rights of the ordinary voter. This fundamental tension between democracy
and free enterprise appeared to be accentuated in the recent U.S. Presidential elections as
President Barack Obama appealed to middle-class anger about its stagnant economic
prospects, while former Massachusetts governor Mitt Romney appealed to business people,
disgruntled about higher taxes and expanding healthcare subsidies.
One reason that the median voter rationally agrees to protect the property of the rich and to
tax them moderately may be that she sees the rich as more efficient managers of that
property, and therefore as creators of jobs and prosperity that everyone will benefit from. So,
to the extent that the rich are self-made, and have come out winners in a competitive, fair,
and transparent market, society may be better off allowing them to own and manage their
wealth, settling in return for a reasonable share of their produce as taxes. The more,
however, that the rich are seen as idle or crooked - as having simply inherited or, worse,
gained their wealth nefariously - the more the median voter should be willing to vote for
tough regulations and punitive taxes on them.
In some emerging markets today, for example, property rights of the rich do not enjoy
widespread popular support because so many of a country's fabulously wealthy oligarchs are
seen as having acquired their wealth through dubious means. They grew rich because they
managed the system, not because they managed their businesses well. When the
government goes after rich tycoons, few voices are raised in protest. And, as the rich kowtow
to the authorities to protect their wealth, a strong check on official arbitrariness disappears.
Government is free to become more autocratic.
Consider, in contrast, a competitive free-enterprise system with a level playing field for all.
Such a system generally tends to permit the most efficient to acquire wealth. The fairness of
the competition improves perceptions of legitimacy. Moreover, under conditions of fair
competition, the process of creative destruction tends to pull down badly managed inherited
wealth, replacing it with new and dynamic wealth. Great inequality, built up over generations,
does not become a source of great popular resentment.
On the contrary, everyone can dream that they, too, will become a Bill Gates or a Nandan
Nilekani. When such universal aspirations seem plausible, the system gains added
democratic support. The rich, confidant of popular legitimacy, can then use the
independence that accompanies wealth to limit arbitrary government, support rule of law, and
protect democratic rights. Free enterprise and democracy sustain each other.
There are, therefore, deeper reasons for why democratic systems support property rights
and free enterprise than the cynical argument that votes and legislators can be bought, and
the capitalists have the money. The cynics can only be right for a while. Without popular
support, wealth is protected only by increasingly coercive measures. Ultimately, such a
system loses any vestige of either democracy or free enterprise.
The bedrock: equitable distribution of economic capabilities
There is, however, a growing concern across the industrial world. The free enterprise system
works well when participants enter the competitive arena with fundamentally equal chances
of success. Given the subsequent level playing field, the winner's road to riches depends on
greater effort, innovation, and occasionally luck. But success is not pre-determined because
no class of participants has had a fundamentally different and superior preparation for the
competition. If, however, some group's economic capabilities are sufficiently differentiated by
preparation, the level playing field is no longer sufficient to equalize a priori chances of
success. Instead, the free enterprise system will be seen as disproportionately favouring the
better prepared. Democracy is unlikely to support it, nor are the rich and successful as likely
to support democracy.
Such a scenario is no longer unthinkable in a number of Western democracies. Prosperity
seems increasingly unreachable for many, because a good education, which seems to be
today's passport to riches, is unaffordable for many in the middle class. Quality higher
educational institutions are dominated by the children of the rich, not because they have
unfairly bought their way in, but because they simply have been taught and supported better
by expensive schools and private tutors. Because middle class parents do not have the
ability to give their children similar capabilities, they do not see the system as fair. Support for
the free enterprise system is eroding, as witnessed by the popularity of books like Thomas
Pikkety's Capital in the 21st Century while the influence of illiberal parties on both the Left
and Right who promise to suppress competition, finance, and trade is increasing. The mutual
support between free enterprise and democracy is giving way to antagonism.
Moreover, as class differences create differentiated capabilities among the public,
governments can either continue choosing the most capable applicants for positions but risk
becoming unrepresentative of the classes, or they can choose representativeness over
ability, and risk eroding effectiveness. Neither biased nor ineffective government can
administer well. So government capacity may also be threatened.
Thus, as the bedrock of equitable distribution of capabilities has started developing cracks in
industrial countries, all four pillars supporting the liberal free market democracy have also
started swaying. This is, to my mind, an enormously important concern that will occupy
states across the world in the years to come.
Lessons for India
Let me conclude with lessons for India. India inherited a kind of democracy during British rule
and has made it thoroughly and vibrantly her own. Of the three pillars that Fukuyama
emphasizes, the strongest in India is therefore democratic accountability. India also adheres
broadly to the rule of law. Where arguably we may have a long way to go, as Fukuyama has
emphasized, is in the capacity of the government (and by this I mean regulators like the RBI
also) to deliver governance and public services.
This is not to say that we do not have areas of excellence strewn throughout central and
state governments - whether it is the building of the New Delhi Metro, the reach of the public
distribution system in Tamil Nadu, or the speed of the roll-out of the Pradhan Mantri Jan
Dhan Yojana - but that such capabilities have to permeate every tehsil in every state.
Moreover, in many areas of government and regulation, as the economy develops, we need
more specialists, with the domain knowledge and experience. For instance, well-trained
economists are at a premium throughout the government, and there are far too few Indian
Economic Service officers to go around.
An important difference from the historical experience of other countries is that elsewhere
typically strong government has emerged there first, and it is then restrained by rule of law
and democratic accountability. In India, we have the opposite situation today, with strong
institutions like the judiciary, opposition parties, the free press, and NGOs, whose aim is to
check government excess. However, necessary government function is sometimes hard to
distinguish from excess. We will have to strengthen government (and regulatory) capability
resisting the temptation to implant layers and layers of checks and balances even before
capacity has taken root. We must choose a happy medium between giving the administration
unchecked power and creating complete paralysis, recognizing that our task is different from
the one that confronted the West when it developed, or even the task faced by other Asian
economies.
For instance, a business approval process that mandates numerous government surveys in
remote areas should also consider our administrative capacity to do those surveys well and
on time. If it does not provide for that capacity, it ensures there will be no movement forward.
Similarly, if we create a multiple appellate process against government or regulatory action
that is slow and undiscriminating, we contain government excess but also risk halting
necessary government actions. If the government or regulator is less effective in preparing its
case than private parties, we ensure that the appellate process largely biases justice towards
those who have the resources to use it, rather than rectifying a miscarriage of justice. So in
thinking through reforms, we may want to move from the theoretical ideal of how a system
might work in a country with enormous administrative capacity, to how it would work in the
actual Indian situation. Let me emphasize, we need "checks and balance", but we should
ensure a balance of checks. We cannot have escaped from the License Permit Raj only to
end up in the Appellate Raj!
Finally, a heartening recent development is that more people across the country are
becoming well-educated and equipped to compete. One of the most enjoyable experiences
at the RBI is meeting the children of our Class IV employees, many of whom hold jobs as
business executives in private sector firms. As, across the country, education makes our
youth economically mobile, public support for free enterprise has expanded. Increasingly,
therefore, the political dialogue has also moved, from giving hand outs to creating jobs. So
long as we modulate the pace of liberalization to the pace at which we broaden economic
capabilities, it is likely that the public will be supportive of reform. This also means that if we
are to embed the four pillars supporting prosperity and political freedom firmly in our society,
we have to continue to nurture the broadly equitable distribution of economic capabilities
among our people. Economic inclusion, by which I mean easing access to quality education,
nutrition, healthcare, finance, and markets to all our citizens, is therefore a necessity for
sustainable growth. It is also, obviously, a moral imperative.