A review of Raghuram Rajan’s “The Third Pillar”

Rajan, R. (2019).  The Third Pillar: How Markets and the State Leave the Community Behind.  Penguin Press.  430 pages.

Overview

The Information Communications Technology (ICT) revolution, beginning in the 1970s and 1980s, ushered in a new era of automation and outsourcing economic activity at the expense of moderately educated, working-class people.  High-skilled and high-knowledge professions had higher premiums.  Communities declined and struggled to maintain an adequate standard of living compared to their wealthier metropolitan peers.  “Many of the economic and political concerns today across the world, including the rise of populist nationalism and radical movements of the Left, can be traced to the diminution of the community” (p. xiii), argues Raghuram Rajan in his book “The Third Pillar: How Markets and the State Leave the Community Behind.”  

Rajan has the expertise to share his insights on the community’s importance.  He is a former Governor of the Reserve Bank of India, former Chief and Economist at the International Monetary Fund, and currently a Finance professor at the University of Chicago.  

The Third Pillar is divided into three parts.  It explores the history and emergence of the state, market, and community; the imbalance between the three pillars; and the workable solutions at restoring the balance by reviving communities.  The United States, Britain, the European Union, China, and India receive special attention.

It is a shame that this book had to be written, not just as a prescription for declining communities but as a needed reminder of why communities are essential.  The community attaches the individual to real-world human networks, creating bonds that foster social relationships, rites of passages, values, norms, identities, and the means of conflict resolution (p. 8).  Communities also aid commercial and non-commercial transactions and solutions to incomplete transactions, such as gaps in the legal frameworks (p. 10).  Most importantly, communities allow for more political engagement, influence, and self-determination for their members (p. 11).  Nothing is more potent than the feeling and realization of empowerment and autonomy.

A compelling case

Rajan thoroughly fleshes out the main theories and definitions for the Third Pillar.

The definitions of states and markets are self-evident.  The community, however, is defined as individuals who live in proximity, not virtual communities or those belonging to religious denominations (p. xiv).  Though an extension of the state, local government is part of the community.

Communities can be dysfunctional, characterized by poverty, crime, drugs, and broken families (p. 11).  There is often distrust amongst people within dysfunctional communities, stifled with limited economic opportunity making jobs and wealth creation feel like a zero-sum game where people become apathetic.  People in dysfunctional communities resent those who are more affluent and may also display an unwillingness to help people with less because of the pernicious belief that helping someone will allow them to overtake the helper (p. 13).  Needless to say, broad public spirit is limited in these types of communities.

To counter dysfunctional communities, “inclusive localism” is necessary.  Rajan says that inclusive localism pertains to several principles, notably that citizenship is based on agreeing and supporting common values and laws that define the nation while allowing people to freely associate with whomever they wish, so long as they do not discriminate.  Inclusive localism requires markets to be inclusive by reducing barriers to entry to increase competition (p. xxi – xxii).  Rajan adds that inclusive localism is by no means an end.  Instead, it is a steppingstone to embrace our cultures, traditions, identities, and broader sense of humanity (p. 285).

It sounds lovely, but why did many communities throughout the developed world decline initially?

During the post-WWII reconstruction efforts, federal governments of the developed world started creating more federal responsibilities and, towards the 1990s, dramatically reduced the bureaucratic and economic powers of local entities (chapter 5).  The ICT Revolution, also following the Second World War, reduced transportation and communications costs, resulting in the disappearance of middle-class jobs and an increased share of low-skill and high-skill jobs (p. 178-179).  Rajan clarifies that wages did not stagnate for those in the middle (50th percentile) in the United States since the 1970s, contrary to popular belief.  Indeed, Middle-income individuals saw their wages increase faster than the Consumer Price Index (CPI) when factoring in taxes and transfers (p. 187).  Nevertheless, these rapid technological changes resulted in a higher concentration of large firms that drove and choked out the small-firm competition.  Large firms were successful because they could lock consumer data with products or services.  They also bought out the competition, influenced regulatory policies through excessive lobbying, won patent and copyright grants, issued non-compete agreements, and forced licensing programs onto potential new entrants (p. 201-204).

Rajan’s argument is persuasive.  The Third Pillar is a normative text that explores potential solutions to restore economically distressed communities, rather than merely studying the subject for its own sake – an approach far too common in academia.

Two solutions include premarket support and post-market support.  Premarket support involves expanding a community’s capabilities through education and skills development so its inhabitants can better compete in an ever-changing economy.  Post-market support includes policies like social safety nets.  Local officials and community members can help specify how and what types of aid to provide with superior government oversight and financing (p. 127).  

Rajan specifies that there is no cookie-cutter model to community development.  Community redevelopment may consist of common themes, like proactive leadership or the identification, revivification or attraction of assets like libraries, government offices, and firms to increase human capital, to name just two.

Aside from those two policy approaches, states can empower communities in the following ways: building physical and communications infrastructure to ease the flow of people, goods and services; preventing tariffs and non-tariff barriers between communities like zoning standards against low-income developments (apartments and tiny homes, for instance); prosecuting corrupt officials and upholding civil rights; providing financial support in times of distress as top-up payments to prevent any community from falling too far behind (p. 302).  The main goal of these types of policies is to grant communities greater autonomy over their local affairs, whether it be setting regulations on the types of stores allowed in a neighbourhood or providing training programs tailored to local economies.  Rajan presents more policy solutions and addresses criticisms and counterarguments to each, too many to list in this review, all of which are thorough and persuasive.

A key strength of The Third Pillar is that Rajan addresses numerous criticisms, none of which are straw-man fallacies.  For instance, he agrees that both left and right-wing populists are correct when they say elites have ignored and worked against them.  He explains to the reader that “populism, at its core, is a cry for help” (p. 215) – readers can appreciate the author’s sympathetic tone.  Minorities and immigrants are often scapegoats for populist resentments, but the populist approach is unfeasible for this very reason because it paints minorities into a corner where they must further assert their rights and identity.  The majority’s cultural imposition on others is imprudent.  It disregards that new minorities may become the new majority and could, theoretically, impose their values on the former majority.  It is, therefore, better to allow cultural diversity under an umbrella of shared values, explains Rajan (p. 294).  He also mentions that narrow, tribal instincts and disengagement from international institutions would be disastrous considering the rise of foreign economies like China and India.  They may fill the governance void following Western retrenchment (p. 244).

Critics may disapprove of Rajan’s suggestion that communities set their unique production guidelines.  An example of how this would be disastrous would be automobiles.  It would be a mess for automakers to design cars to meet emission standards for multiple municipalities.  That may be true, but Rajan responds by saying, “localism need not balkanize the market even when a national standard is warranted,” because communities will not receive cars or manufacturers if they are too strict (p. 305).  He admits it may complicate trade matters, but the trade-off for greater community empowerment is worth it.  Ultimately, it pays to be relatively open and accessible.  Besides, considering today’s advanced information and communications technologies, it would not be difficult for local governments to provide and communicate clear trade guidelines for producers, consumers, and investors.  However, as a Canadian, I am skeptical, as I am somewhat familiar with the disastrous consequences of interprovincial trade barriers on both producers and consumers.  In many cases, it might be easier for Canadian entrepreneurs to conduct business with firms and individuals from another country rather than from another province.  (To learn more, check out some of the excellent content by the C.D. Howe Institute, Canadian Chamber of Commerce, and the Canada Free Trade Agreement website itself).

Rajan also recognizes that some communities are too small and remote to justify federal financing or infrastructure development.  He says that these communities may have a large young population in which the government could help ease emigration efforts to relocate for better, more abundant schooling and jobs (p. 344).  This is where portable safety nets are crucial so that no one is bound to the welfare policies of a specific community, offering individuals more options.  It’s a critical counterargument.  In some countries, like Canada, there are many remote and northern Indigenous and non-Indigenous communities where financing large infrastructure projects is unfeasible.  The situation is complicated because some locals may not wish to leave or integrate with larger populations.  But the point is that everyone, regardless of who or where they are, should have a reliable safety net to assuage the financial risks of moving for school or employment.  They could always send money back home as remittances, financially developing their previously neglected, remote communities.

Lastly, Rajan’s argument is compelling because he provides alternatives to common policy options to revive communities.  For instance, he says that tax credits and deductions for firms to relocate to remote or underdeveloped communities are not ideal because they cost taxpayers considerably.  Large firms usually set up skeleton offices that provide little to no employment.  What is worse is that large companies tend to siphon the money to their headquarters located elsewhere, probably in an economically robust metropolitan city.  A better approach is to have a federal government provide municipalities with untied financial top-ups with federal oversight because the community will know its priorities.  When necessary, the federal government can always prevent and punish local corruption (p. 342).

What could be better?

Rajan’s thesis and supporting evidence are not biased, exaggerated, or cherry-picked, but more rigorous analysis may be required.

When discussing the importance of competition for market economies and communities, Rajan argues that antitrust authorities should not only focus on customer service but also prohibit acquisitions that absorb a competitive or innovative threat (p. 377), such as a new company.  This appears logical because a diversified market of competing entities reduces prices for goods and services and should, theoretically, promote more research and development for innovative products and services.  However, Rajan does not acknowledge one of the main issues associated with antitrust authorities prohibiting acquisitions: an owner of a competitive start-up may want to sell their company to a conglomerate, and that is their prerogative.  After all, it is their private property, and they should probably have a right to complete a transaction as they see fit.  Even if Large Company A purchases Small Company B and manages to capture more supply chain levels (vertical integration) or different types of consumers (horizontal integration), it does not mean that Large Company A controls all supply chains.  Rajan does not suggest this, but it’s an important reminder.  There are likely competing large conglomerates.  Consider, for instance, how McDonald’s maintains robust supply chains across the world.  Yet, its magnitude and success do not prevent competition from other large fast-food establishments, let alone burger joints.

The theories and evidence presented in The Third Pillar are fascinating and informative.  But Rajan’s approach to arguing why today’s issues are traceable to the community’s decline comes across as too broad in scope and sometimes repetitive.

Though the book falls under political science and economics, it mostly takes a world history approach.  It details historical events such as feudalism, the Great Depression, WWII, post-WWII growth, the Reagan-Thatcher era, and the ICT Revolution.  Readers already familiar with these subjects will find the book uninteresting, despite the necessary context.  Perhaps a comparative approach of community decline in one country compared to others would have been better, including a special focus on the types of policies intended to revive communities across varying localities.  

Rajan also repeats the arguments mentioned in Chapter 6 on market power and reformation in Chapter 13 regarding intellectual property, data, and regulatory frameworks.  However, the outlined issues and solutions are discussed further and include different examples, but the overall arguments are the same.  In particular, licensing is a contentious problem, especially for professions that are highly technical and require specific health and safety practices like food, medicine, pharmacology, or even construction.  Rajan acknowledges and admits that these regulations are helpful (p. 382-383) and that it would be beyond the book’s scope to explore them at length.  But additional details on how to start the process towards “lighter, more meaningful regulation” (p. 383) to encourage more small and medium firm entry would have been helpful.  It is much easier said than done, even if it’s a goal most would support. 

How is this book relevant?

The Third Pillar is a timely analysis of today’s major political and economic issues engulfing much of the world, whether it’s the rise of populism, globalization, or unfettered capitalism.  In a globalized world with increasing inequality, Rajan reminds readers that Adam Smith, in his seminal masterpiece “The Wealth of Nations,” was pro-competition, not pro-businessman.  The businessman is interested in creating and maintaining monopolies and cartels that fix prices and eliminate competition, whereas competition does the opposite.  Moreover, Rajan highlights how Smith supported public education and other public services that should not be private (p. 81).  Despite his support for free markets and increased local autonomy, Rajan is by no means a libertarian.  He is objective, level-headed, and focuses on what would work best for communities and nations rather than peddling ideological narratives with too much emotional baggage.

On global governance and growing nationalism across the western world, Rajan reminds us how the current international order favours those with economic might.  This arrangement may be a problem for countries like the United States.  Many constituents vote for administrations opposed to global governance and are increasingly looking inward, making it difficult for member states in international organizations to take the US seriously.  Rajan explains that this is a problem considering how Article VII, Section 1 of the International Monetary Fund’s founding statutes says that the organization’s head office should be in the territory of a member state with the largest economy.  Today it is headquartered in Washington, but Rajan asks, what will happen if China or India catch up and overtake the US?  Perhaps, it will be Beijing.  It is better to reform the system now and tie member nations to international responsibilities while maintaining state sovereignty in an increasingly multipolar world.  Otherwise, by the time the others advance, they will have greater agenda-setting abilities (p. 364-365).  So long as the issues addressed are international and negatively affect multiple states, such as climate change or overfishing, countries must learn to work together sooner rather than later.

As for the more significant concentration of wealth and economic power by a few key players, Rajan optimistically highlights how the owners of technology and capital may find their excessive wealth unseemly and will thus give back to communities and distressed people.  As an example, he cites the Giving Pledge (p. 391-392).  However, he may be thinking too rosily.  Many of the world’s uber-wealthy evade taxes through donation tax credits/deductions to supposedly non-partisan, non-profit organizations and charities, which only peddle their narratives and lobby governments to suit their narrow needs at society’s expense.  Our values, after all, are not static.  Throughout history, we venerated warriors, then merchants and bankers, and now young entrepreneurs.  Perhaps we will soon hold community and social workers in high esteem or even those who make our lives liveable and easier, like grocery store workers, nurses, and delivery people.

Overall impression

The biggest takeaway is that community autonomy and empowerment are essential.  Providing communities with top-up financing addresses their affairs, creates more economic dynamism, and improves society.  Local actors know what is best for themselves since they live their daily realities, unlike a distant bureaucrat in a federal capital.  Give communities the chance to prove their capabilities and watch them flourish.  There will always be winners and losers within and between communities, but the overall benefits override the inevitable adverse outcomes.

This book is for anyone interested in intergovernmental relations and the role of local politics and economics.  Anyone looking for solid but brief analyses on high school and university education, competition policy, intellectual property, licensing, or antitrust will find several insightful golden nuggets.