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The Roots of Our Discontent

By Tito Boeri and Raghuram G. Rajan
With industrialized countries beset by a political backlash against trade, technology, migration, and other hallmarks of the modern global economy, expert solutions are needed now more than ever. But until the experts themselves can reclaim the public’s trust, populists will continue to dictate the terms of policymaking.

Every spring, the Trento Festival of Economics convenes some of the world’s leading economists to discuss the issues of the day in open dialogue with one another and the public. In the following interview, the festival’s director, Italian economist Tito Boeri of Bocconi University, and Raghuram G. Rajan, former Governor of the Reserve Bank of India and currently Professor of Finance at the University of Chicago Booth School of Business, discuss a wide range of topics relating to this year’s theme: “Globalization, Nationalism, and Representation.”

Tito Boeri: Countries around the world are experiencing a crisis of political representation and a revival of nationalism. Finding remedies to counter the darker impulses of populism is proving difficult. Though the policies being adopted by some populist governments are clearly mistaken, it is not obvious what can be done to address the underlying issues that populists have seized upon.
In medical terms, we have a rather good diagnosis, a debatable prognosis, and no well-defined treatment. The underlying causes include economic shocks – the information and communications technology (ICT) revolution, globalization, financial and refugee crises – as well as cultural factors, some of them related to the loss of ideological anchors following the fall of the Berlin Wall. Analyses of recent European voter behavior by economists Barbara Petrongolo and Josef Zweimüller suggest that the populists have built up majority support in the small towns, villages, and municipalities where many “permanent losers” of the ICT revolution and globalization are concentrated. In the United States, similarly situated voters have supported President Donald Trump in droves.
You’ve just written an enlightening book on this subject, The Third Pillar: How Markets and the State Leave the Community Behind, which outlines a number of ways to cope with populism. What should we do to restore these communities? We could provide them higher fiscal transfers. But if the communities’ institutions are dysfunctional, don’t we run the risk of wasting resources? We could expand infrastructure (such as broadband and transportation). But what if such interventions merely displace other worthwhile projects? Should we support local revival projects like the one in Chicago’s Pilsen neighborhood, which you highlight in the book?
Raghuram G. Rajan: We understand the causes of the problem much better than we did a few years ago, but finding solutions is difficult. From what we’ve seen in the years since the 2008 financial crisis, and from the past 30 years of technological revolution, we should recognize that the problem is not merely cyclical.

Whatever the solution is, it can’t be just about increased fiscal or monetary stimulus, which is what governments have resorted to time and again. In developed countries, there are large pockets of underdevelopment, entire areas that can no longer keep up with the global economy. They are falling further and further behind, and not just economically, which is merely the first thing that happens. As they lose jobs, their social structure also starts to break down. You start seeing more divorces, more teenage pregnancies, and more substance abuse. The schools deteriorate, the still-successful families leave, and a vicious cycle ensues. This has certainly been the experience in the US.

To answer your question, the first step is to recognize the policies that don’t work: namely, stimulus, which is no substitute for growth. If you go to a developing country and tell policymakers that they just need more stimulus measures, they will laugh at you. Development is a different problem entirely.

The second approach that does not work is development orchestrated from the center. Each community has its own problems. In the case of Pilsen, the main obstacle standing in the way of growth was crime. If you don’t solve that problem, no amount of fiscal or monetary stimulus will persuade anybody to open a business in that area. How do you clean up crime? In the case of this community, the first step was to close down the bars where the criminals congregated, by asking the city to revoke their licenses.

The point is that much of the action has to shift from centralized policies to what economists call “place-based” measures. The center can be supportive, but the policy agenda must come from the community itself. If you look at the history of development around the world, that’s how successful countries have done it. It is not because they received a flood of foreign aid; rather, they decided to move forward, and they came up with their own plan for doing so.

To some extent, this makes the problem very difficult, because it means that someone sitting in Rome or Washington, DC, cannot simply press a button to make changes in a local community. It is incumbent upon the community itself to act. But as the Pilsen example shows, even the poorest, most downtrodden communities can find the will to effect change. What’s needed is leadership. The center can and should help by building infrastructure and providing funding. But the will has to come from the local level.

TB: Making matters even more complicated is the fact that the people from these communities with the best prospects often leave. That is one of the implications of globalization: they migrate elsewhere …
RR: … which is one of the issues that the center actually can help with. How do you provide incentives for those who can leave to stay? To take one example, in Zambia, the authorities identified capable individuals who were needed to help with health care in a given community. So, they made them part of a central civil service, saying, “This is your lifeline. If you cannot bear staying in the community any longer, you can leave and come to the center. But until that time, please stay in your community, and we will pay you for staying there.” It worked: qualified people stayed, and they performed good work while additional infrastructure was built up around them.1

The point is to think creatively about how we can channel people to where they are most needed. In the US, a lot of people leave declining communities for college, which is, of course, expensive. One way to help the community, then, is to offer to pay recent graduates’ college debt if they return for some predetermined amount of time.

TB: And even if they ultimately leave, they will be more likely to maintain solid ties with their community of origin, providing positive spillover effects. While we’re on the topic of mobility, let’s discuss a hotly debated issue at this year’s Festival of Economics: migration. The success of right-wing populist parties worldwide is strongly correlated with perceived increases in migration.
Populists have even been attacking the non-governmental organizations that help refugees. At the festival this year, Filippo Grandi, the United Nations High Commissioner for Refugees, demonstrated clearly that NGOs had reduced the casualties associated with the refugee crisis, but that the death toll has begun to increase now that organizations operating in the Mediterranean Sea have been sidelined. Moreover, the economists Kevin O’Rourke, Joel Mokyr, and Marco Tabellini have reminded us that this is hardly the first time the world has experienced large migration flows. In the late nineteenth century and early twentieth century, the US labor force increased by some 25% as a result of migration. The Canadian labor force grew by almost 50%; and Argentina’s expanded by as much as 80%.
One problem, as Alberto Alesina of Harvard University noted at the festival this year, is that migration makes it difficult to compensate the losers of the ICT revolution and globalization through an expanded welfare state. Native workers fear that such transfers will attract more migrants. These fears are based on misperceptions of the number of migrants and their participation in labor markets, but they nonetheless affect voting behavior. Indeed, populists are always promising to exclude migrants from social transfers, and to make life as difficult as possible for newcomers, thereby preventing their integration. The result is a vicious circle of mutual distrust. Discriminatory policies prevent migrants from paying social-security contributions, and then segregate them in rural areas that have already been hit by globalization, where they stand out even more.
Should we be avoiding residential segregation of migrants and refugees? Do we need rules for conditioning citizenship on contributions to social security? Should we support a federal (pan-European) program to extend provisions to areas where migrants are concentrated?
RR: You’ve hit on all the important issues. Beyond a certain level, migration can become an economic problem; but it’s important to remember that below a certain level, it is often a solution. The question is where to draw the line. We know that industrialized countries are aging, and thus will need a certain level of immigration to keep the population relatively young and the labor force stable. One can already see the problems associated with a shrinking labor force in Japan, which has an excess of capital, too little labor, and a growing dependence on foreign demand.

In addition to an optimal level of migration, there is also an optimal distribution of the quality of migrants. The argument that a country should accept only the best-educated or most highly skilled migrants doesn’t really work in practice, because if those are the only immigrants you take, they will compete only for the best jobs, which creates its own kind of political and social irritation. Governments need to bear all of this in mind when deciding on the level of migration.

Once migration exceeds the accepted level, there’s a question of who bears the costs of absorption. Migrants tend to be relatively poor, so they end up in low-income neighborhoods that already have stressed social services. Local schools can end up with a disproportionate number of migrant children who don’t know the language and thus hold back the class. So, it isn’t surprising that some poorer native-born workers would feel that they are bearing the burden of migration, especially if they are also facing labor-market competition.

You mentioned the late nineteenth century. Interestingly, the native-born population in the US at that time found a way to compete with the immigrants, who were mostly Europeans skilled in woodwork, carpentry, and plumbing, but not very well educated. This is also when the US began to extend secondary education to all children, who were then better suited for the kind of factory jobs that were opening up. As a result, the immigrants didn’t particularly trouble the native-born workers, who took the better, newer jobs while the newcomers filled in as craftspeople.

Nowadays, we are concerned about the workers at the lower end of the education scale, but the problem isn’t one of competition; migrants, after all, do a lot of the jobs that the native population will not do. The problem, rather, is with social services and the sense of cultural change. Some people are asking themselves, “What does it mean when my country’s capital looks nothing like it did 20 years ago?” One hears this in some parts of the US, but particularly in Europe, owing to the faster pace of immigration in recent decades.

In The Third Pillar, I point out that, because richer societies have lower birth rates, their demographic makeup must become more varied if they are going to grow and maintain their place in the world. The question is how to maintain a sense of cultural continuity. At the national level, you can advocate a set of values that new arrivals must adopt. It is reasonable to demand that immigrants understand the country’s history and speak the language. But when it comes to more specific cultural matters, the community can be far more effective in maintaining continuity.

You cannot force everyone to adopt a uniform cultural view from the national level. As our countries become more diverse, we will have to find a new kind of societal structure that allows for the preservation of the native population’s culture as well as the integration of new cultures. There will always be people who refuse to take part in some elements of the overall culture, but by focusing on discrete communities, you can at least avoid the problem of cultural apartheid between the old and the new.

TB: Cultural proximity is very important, and could be a way to foster cultural convergence. Say a young person born elsewhere learns Italian and wants to invest in our country. We should reward him or her by providing citizenship.
Refugees in Europe are often sent to rural areas, where it’s very difficult for them to integrate. Apparently, this is meant to discourage them from moving. But, in fact, it merely prevents their integration and sows domestic opposition to migration.
RR: Well, what if those who want to immigrate on economic grounds – doctors, technocrats, and so forth – were required to spend four years in an area that wants them? The value of this approach is not just that it provides local services, but also that it fosters leadership. The introduction of skilled immigrants could replenish the human capital of declining communities. Their children will go to school with native-born children, and those in the left-behind community will see that not all immigrants are uneducated freeloaders who want to take their social security.

This is how we change the larger dialogue. Generally, the communities that are most resistant to immigration are the ones that have the least exposure to them. Because the rural areas you mentioned have so few immigrants, they fear the possibility of immigrants, rather than the actuality.

This gets at my broader point in the book: in the long run, the world will become much more integrated in terms of trade, capital flows, and people. That means we should start preparing our societies now for that world of tomorrow. Shock treatment and the sudden mixing of cultures on a large scale is not possible, and will always generate a reaction. But we can start to mix around the edges, which will allow people to build confidence in their own community’s capacity to preserve its culture, history, language, and so forth. In the long run, this gradual mixing will leave us with a more varied and richer composite culture, both within and across communities.

TB: What you said about gradualism is very important. Of course, in the case of a refugee crisis, such as the one Europe faced in 2015, that isn’t an option. So migration, along with other external factors such as globalization and import competition, gets all the blame in the populist narrative, while the consequences of technological change are played down or ignored.
But as Elhanan Helpman of Harvard University has shown, technological change is responsible for far more job casualties than globalization is. Moreover, at the festival this year, Rafael di Tella of Harvard Business School presented the results of an experiment in which he studied people’s reactions to different kinds of shock. He finds that if displaced workers know their job was lost to technological change, they will be less resistant to accepting compensation in the form of unemployment benefits than if they think their job was lost to penetration by imports from China.
Meanwhile, Princeton’s Andrew Moravcsik has argued that the current US flirtation with protectionism is more bark than bite, and that overall trade flows are unlikely to change much. Given that Chinese supply is extremely elastic, it is US consumers who will bear most of the costs of import duties. But another consequence of protectionism is that it can increase migration flows. What can we do in this respect? Should we find a new external enemy, such as tax havens? Should we expand trade-related unemployment assistance at the supranational (for example, pan-European) level?
RR: It is the nature of populism to offer easy solutions – usually solutions that blame others. It’s easy to say, “I’m going to shut those people out. I’m going to change the rules to protect you.” It’s much harder to say, “Part of the problem lies with you. Your skills are obsolete, partly because you have never had to adapt.” Across advanced economies, governments haven’t made it easy for workers to retrain. So, even if politicians recognize that there is no future in coal mining, they have no easy solution to that problem.

By contrast, if a politician says, “I’m going to bring back coal mining and steel mills by shutting out imports,” people don’t necessarily have to believe him to prefer that course of action to the alternatives. They would rather get that old job back than take a new one that requires hard-to-acquire skills.

I was shocked when I read Janesville: An American Story, journalist Amy Goldstein’s account of what happened to a Wisconsin town after the closing of a General Motors plant there. Goldstein interviews former GM workers who had never even used a computer. Imagine being 45 or 50 years old and having never used a computer! For these workers, retraining is exceedingly difficult, simply because they have fallen so far behind.

Now, there are places that have insisted on continuous training and retraining, not least Sweden, with its active labor market policies. In factories there, workers are told, “You may lose your job, so you should be thinking about alternatives. What courses do you need to keep your skills up?” There is a coalition comprising employers, the government, labor unions, NGOs, and private-sector consultants, all of which come together to assess and keep current employees’ skills base. When a company closes down a facility or sheds labor, the consultants come in and tell each worker, “Okay, you have the skills to move to this industry, but you’ll need to take this or that course.” To my mind, this seems like a far more streamlined way of dealing with technological change. It certainly beats having workers who have learned nothing new in 30 years. Countries like the US need to rethink the entire process of retraining and reskilling.

As for protectionism, US President Donald Trump would like to think that trade wars are “easy to win.” They’re not, but when a politician can offer a narrative that protectionist tariffs save workers’ jobs, the political battle, at least, does become easier. In fact, the real mystery is how we managed to reduce tariffs for 60-70 years after World War II without ever provoking the burst of protectionism that we have today.

Unfortunately, with the country at the center of the global order now tearing that order apart, we are in a very dangerous situation. The problem isn’t just trade protectionism, but also investment protectionism. The argument seems to be: “I don’t want these kinds of investments in my country, and I’m not going to let my companies invest in your country.” Not surprisingly, all the global supply chains that have been built up for decades are now starting to break down. We are at the beginning of a process that is very, very dangerous, especially for industrial countries, with their aging populations. Future demand will increasingly come from the rest of the world. The last thing industrialized countries need is for the world economy to break up into smaller fragments.

TB: We have aging societies as well as labor markets generating “permanent losers” as a result of technological change and trade. This is why we must rethink welfare systems, to make them more proactive and capable of finding remedies for people who have been displaced. We cannot simply offer temporary relief.
RR: For sure. We need to pay far more attention to those left behind. The best outcome would be better training systems, so that displaced workers don’t experience a significant loss of income. But the reality is that for those who haven’t kept up, the future is will be difficult.

The second-best alternative is for workers to take lower-level jobs with a supplementary income, so that they don’t fall off too much. But even if we can’t solve the problem for those past a certain age, we need to make sure that younger people don’t fall into the same trap. We should be looking for ways to regenerate human capital; for that, we need to change our systems considerably.

TB: The psychologist David Leiser points out that non-economists often use misleading cognitive shortcuts to form opinions about economic issues, and thus end up offering misleading metaphors. Consider the recent public debate in Italy about reintroducing early-retirement schemes. The proposal was sold as a way to create jobs for young people, as if there were a fixed number of jobs. Yet if you look at data series of employment and unemployment by age, you find that when employment grows, it grows for young and older workers alike, and for natives and migrants; when employment declines, it declines for all cohorts.
Making people understand how economics actually works is not easy. Within the straitjacket of eurozone rules, populists can survive longer politically, but they can also be neutralized, in terms of their effect on macroeconomic stability, as the Greek experience shows. This is a mixed blessing, because a long-lived populist government can pose a threat to social norms, trust in experts, and evidence-based policymaking more generally.
But long-established elites bear some responsibility for the rise of populism. “Illiberal democracy” is a response to undemocratic liberalism, and to a scientific community that has spent too long in the ivory tower. Do we need to democratize the economic-policy debate? Can the Trento Festival of Economics serve as a model? What else can we do?
RR: It’s a hard issue. As the great nineteenth-century French journalist Frédéric Bastiat said, the value of an economist lies not in the first-round effects of his policies – what the layman can see – but in their second-round effects. What happens after the first round as people react to the policy? That’s where the economist has something to contribute.

Of course, this contribution is much harder to see and explain. The protectionist might think, “If I prevent that fellow from producing the good, my people can produce the good instead. Protectionism will create jobs.” But as an economist would point out, “You will produce that good much less efficiently; that is why you bought it from abroad in the first place. In the long run, producing something more inefficiently in your own country is going to register as a loss, not a gain.”

Moreover, sometimes these costs can show up even as job losses. If you slap tariffs on imported steel, you force your automakers to buy steel at a higher price, which means they can no longer produce cars as inexpensively as competitors elsewhere, so they may have to fire some workers. Protecting steel workers comes at the expense of autoworkers. These are the kinds of second- and third-round effects that economists talk about.

To take another example, why does a central bank raise interest rates to bring down inflation? Why does inflation even matter? Shouldn’t we care much more about jobs today than about inflation tomorrow? Those familiar with economics will already understand the kind of tradeoffs that are involved here. But explaining them to the public isn’t always easy, especially when the president is attacking the central bank for preventing job growth and hurting the recovery through interest-rate increases.

Whenever you have to defend an expert against a politician, you are already at a disadvantage, because that politician speaks the language of the people. Moreover, the expert is trying to talk about the kind of nuances that often subvert the first-round effects the politician wants. To this, the politician will say, “This guy talking about all these side effects doesn’t know anything. He sits in an ivory tower and writes papers that nobody reads. I know the real world; here’s what it’s like.” As an ordinary citizen, whom are you going to believe?

The hope, then, is that the experts will marshal enough evidence and examples over time to make their case and build trust. That trust is critical. When the public trusts experts to do the right thing, experts are empowered to make policy. This kind of trust in expertise was present in Europe for 30-40 years after WWII; it resulted in substantial growth and was thus justified in the minds of voters. But when that trust breaks down, policymaking becomes much harder.

TB: It is important that we democratize the debate to show people that there are different opinions in the profession. That may weaken how experts are perceived to some extent, but it is necessary to show that economics is a method offering common ground for conflicting opinions about complicated issues.
RR: On this point of “four economists having five or six opinions,” I think the truth is that there is a fair amount of consensus in the profession on many things, but that it’s always possible to find some outliers. When it comes to policymaking, it doesn’t really matter what the profession thinks, because politicians are looking for those who already think like they do. That’s how this or that economist gets the stage at any given point. So, there is some gamesmanship here, and that can make the economics profession seem disunited. We do have a lot of internal debates, but they’re often about second-order effects. We tend to agree on the first-order effects.

(Author Tito Boeri, former president of the Italian Social Security Administration, is Professor of Economics at Bocconi University and Author Raghuram G. Rajan, Governor of the Reserve Bank of India from 2013 to 2016, is Professor of Finance at the University of Chicago Booth School of Business and the author, most recently, of The Third Pillar: How Markets and the State Leave the Community Behind.)

Published Date: Saturday, June 29th, 2019 | 06:29 PM

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