Friday, April 15, 2011

Living on the San Andreas

Fault Lines by Raghuram Rajan is one of the more interesting 70 page works of non-fiction I have read in a while.  Unfortunately, the book is actually 229 pages long.  It’s a common problem in the non-fiction book world.  What do you do if you are an author with a thesis that needs between 70 and 100 pages to explain?  The idea is too big for a journal article, because a short version won’t be nearly as compelling.  But, there isn’t, it turns out, a particularly big market for 100 page books—I suspect the market for 100 page books is thin because the fixed costs of publishing means that it costs about the same amount to publish a 100 page book as it does to publish a 250 page book, and if you see two books, one of which is 100 pages and the other is 250 pages, and they cost the same amount, which are you more likely to buy?  And won’t you feel like you are overpaying for a 100 page book when there are those 250 page books which cost the same amount?  And so, a nice 70 page book becomes a 230 page book.

This leads to the next problem—what do you do if you have to triple the length of a book?  Padding the argument isn’t enough—that gets Rajan up to 153 pages.  Still too short.  So, he adds three more chapters of “policy suggestions” which a) have only a slight resemblance to the interesting part of the argument, b) are all really superficial, and c) read like a laundry list of suggestions for things that Rajan clearly likes whether they relate to the argument or not.  In other words, I have a hard time imagining anyone getting much of anything at all out of pages 154 to 229 of this book.

But, enough about the bad.  I liked this book.  The first 150 pages has a really interesting argument, well worth reading.

Rajan’s general thesis is that the 2007-2009 economic problems were fundamentally the result of a series of fault lines (hence the title) in the world economy.  The fault lines analogy is cute (see, we had an economic earthquake!), but despite that, the general argument is thought-provoking.  The major fault lines:

1) The gap between the wealthiest and poorest Americans.  As a result of the wealthy getting wealthier, Washington wanted some means to buy off the poorer members of society (poorer here means the middle and lower classes, by the way).  So, we had a deliberate attempt to make getting credit easier, so people could consume at levels above their income.  In particular, there was a deliberate attempt to make getting a home mortgage easier, so that the poorer members of society will see themselves achieving the American Dream, rather than noticing that their incomes aren’t rising at 10% a year.

2) A number of countries which had staggering economic growth rates in the last 50 years did so by focusing their economies on the rapid rise of exporting industries.,  Such economies became seriously unbalanced.  As a result, the economies need to maintain a big demand for their products outside their borders.  When external demand became weaker, these countries were in serious trouble because they did not have well-developed internal industry.  Rajan notes, “There are no large Japanese banks, for example, that rival HSBC in its global reach, no Japanese retailers that approach Wal-Mart in size or cost competitiveness, and no Japanese restaurant chains that rival McDonald’s in its number of franchises.”  That’s a tough problem to overcome; if your domestic service market is small, and your export industry can’t find buyers, what happens?   A slump that last decades.

3) Many developing countries had weak financial systems, but decent prospects for growth.  As a result, capital flowed in from outside, but always on short term contracts; you want to save in a country with high growth prospects, but you also want to be liquid enough that if things go bad, you can get out.  For a small, poor country, chasing this hot money became a temptation and a trap.

The result of all these fault lines?  The crisis of 2007-2009.  In summary, superficial form:  item 1) gets you the US housing bubble; item 2) gets you a demand to sell goods in the US, which means capital must flow in from aboard (the trade deficit is by definition equal to the inflow of capital from abroad)—that capital provides the funds in the domestic markets which allow for the housing bubble; and item 3) meant that when all that hot money was looking for a home, a stable financial system in a booming economy was really attractive.  Then item 1) hits a wall and the housing bubble bursts, the US goes into a recession meaning it can’t buy as many goods in 2), and the hot money in 3) is left homeless.  Result: worldwide recession.

Is this right?  I’m not sure; I am a bit skeptical that these fault lines are as important as Rajan makes them sound, but there is no doubt the general idea is intriguing.  There is enough there that is true that there is at least a plausibility about the story.  And it leads to a really tough problem—if Rajan is right, what is the solution to the problem?  There really isn’t one.  Rajan tries to offer solutions (as noted above), but his solutions really don’t get anywhere—these are deep, deep problems that are not fixed by some more IMF meet-and-greets.

In the end, this is a book well worth reading if you have the patience to wade through a book that is much longer than it should be.

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