Journal Issue

Interview with Raghuram Rajan: Top economist calls for rethink of IMF’s role

International Monetary Fund. External Relations Dept.
Published Date:
December 2003
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In October, Raghuram Rajan took up the reins as Economic Counsellor and Director of the IMF’s Research Department—the first chief economist to come from a developing country and the first to specialize in international finance rather than macroeconomics. Rajan, an Indian national, joins the IMF staff after a distinguished career as an academic and a researcher, most recently as Professor of Finance at the University of Chicago’s Graduate School of Business, where he spent much of the past 12 years. In January 2003, he won the Fisher Black prize for the person under 40 who has contributed the most to the theory and practice of finance. He spoke with Laura Wallace about his new post.

IMF Survey: Were you appointed to change the role of the Research Department—to make it less focused on macroeconomics and more focused on financial and institutional policy issues?

Rajan: There is a desire on the part of management that we increase the weight we put on the microeconomic and financial underpinnings of economic growth and financial stability. However, it’s not so much taking weight off macroeconomics, which is always going to be the bread and butter of the IMF, as it is saying we’re very good in this area and now we need to strengthen some of the areas that we’ve just started exploring in the past few years.

IMF Survey: What is your vision for the Research Department? What role should it play internally and externally? What critical issues should it explore?

Rajan: We can start by reexamining the role of the IMF itself. After all, in a changing world, research can give us useful pointers. We need to ask where have we been particularly successful and where have we been less successful. We need to see what a detailed analysis of what we’ve done in the past would tell us about what we should be doing in the future. We should also spend more time thinking about how all of the research done on developed countries—especially on fiscal and monetary policies—translates not only for emerging markets but also for the underdeveloped areas of the world. The IMF is in an ideal position to have access to the necessary data and experiences. It would be useful, too, to put more weight on researching the process of reform, including the political dimensions. How do policymakers actually get the reform process to work? And, finally, we should do more research on microeconomic and financial issues.

IMF Survey: Your work looks surprisingly nonmathematical for a high-flying economist of today. What do you make of the heavy emphasis these days on mathematics?

Rajan: If you look at my work, I have a fair number of theoretical papers, which are about as mathematical as economists get. My papers run the gamut from low-tech work to reasonably high-brow theory. However, I believe that it is very important for economists to communicate not just with each other but with a larger public. For that reason, every so often I write a piece that people who are not economists can understand. And often, it seems, that’s the piece that everybody reads, rather than the other stuff that is more targeted to a specialist audience. My philosophy is that if you can’t say in simple words what it means and why it’s of reasonable importance, you should wonder whether, in fact, the work is useful.

IMF Survey: Recent IMF research seems to show that the benefits of a floating exchange rate regime increase as economies develop. Does this mean that we can expect the exchange rate system to evolve toward more and more floaters, rather than toward one world currency, which is the dream of some?

Rajan: The idea of one world currency is a little unrealistic, and perhaps not economically sound, because it wouldn’t give countries enough flexibility. One world currency essentially means one monetary policy and thus doesn’t allow monetary policy to adapt to the situations of particular countries. The idea of emerging markets moving toward greater flexibility is, in many ways, a sound one, and something I think countries do on their way to full development. It goes to the broader issue that as their institutions develop, countries can and should look for flexibility in a variety of areas, not just the exchange rate. For example, labor regulations can become more flexible and allow more wage and contract flexibility.

IMF Survey: How much can the IMF do to identify exchange rate manipulation and to counter the practice—a responsibility enshrined in its founding Articles of Agreement?

Rajan: I would suspect that there are very few situations in which the IMF has brought a charge of exchange rate manipulation against a country, and even if it did, I doubt the country immediately gave in and said “yes, we’re manipulating our exchange rate.” But the IMF does have a role in pointing out situations where a lack of exchange rate flexibility tends to create worse imbalances than one might desire. It’s useful for us to point out things that individual countries cannot because it would be seen as interference. That said, we have to couch whatever we say in fairly delicate terms. We should focus on pointing out the many benefits that an offending country would get from stopping its manipulation.

IMF Survey: Recently, the heads of the IMF and the World Bank sent a letter to world leaders urging them to get the Doha trade talks back on track. Just how important is Doha?

Rajan: Trade talks are very important, and free trade is extremely important. Not just for the benefits that trade brings directly to countries but also for the spillover benefits that trade generally has in strengthening institutions, thereby enhancing growth prospects. And this holds for developing and developed countries. That said, the breakdown of trade talks at Cancún highlighted legitimate concerns on the part of some developing countries, and these need to be brought to the fore. At the same time, however, all countries need to remember that they all gain from trade liberalization. So one shouldn’t let this degenerate into a debating society where you score points but don’t move forward on the broader agenda.

IMF Survey: What do you think the IMF’s role should be in low-income countries, and what role should it play in the global war on poverty?

Rajan: It’s not an obvious role, because the IMF has historically been more concerned with stability than with development. We’ve left development more to the World Bank. That said, there’s no escaping the fact that underdevelopment can be a source of fragility—not just for the country itself but also for the rest of the world. We can’t wash our hands of underdeveloped countries and say “other institutions are responsible for this. We’ll take care of the policies once these countries develop.” We have to engage, asking questions about the growth process and carrying out pertinent research.

IMF Survey: How can poor countries, such as those in Africa, take concrete steps to build stronger institutions and grow given their limited financial and human resources?

Rajan: This is the question of the ages. The issue of development, especially in parts of Africa, is something that—as we move more into the 21st century—is going to become front and center. Better communication and transport have brought countries closer and made the world smaller and, in the process, have also brought the consequences of the lack of development closer to the developed world. We can’t hide from it, and we shouldn’t. We have both a moral and practical duty to think about development. We also need to care because as populations age in the developed world, other countries will need to take up some of the slack, especially in terms of being able to generate resources for the rest of the world to live on. This development dilemma is the single biggest economic challenge the world faces in the longer term. And there isn’t an easy solution. It isn’t just a case of pouring in more money. We need to better understand how successful development has occurred. Indeed, one of the areas that I find most frustrating is the complete lack of guidance in economics as to how to start a virtuous cycle of development in the poorest parts of the world.

IMF Survey: Where does good governance fit in? Which comes first, good governance or development?

Rajan: That’s like asking, which came first, the chicken or the egg? Suppose you say good governance precedes development. Then what do you do about those countries that don’t have good governance? And there are many of them. Do you just leave them to their fate or does the developed world come in from outside and impose good governance by a very strong, extensive monitoring system? And then what happens to the idea of sovereignty? And whose idea of governance? Our idea of governance or the people’s idea of governance? The problem here is that even the little evidence that we have on aid going to well-governed countries and then enabling them to develop and grow very fast is being questioned by economic studies. We really don’t have much to go on. We don’t know how to build good governance. And even if good governance exists, we don’t always know how to take full advantage of it. This sounds very pessimistic, but I think it also suggests that there’s a tremendous amount of work that can be done and needs to be done quickly.

IMF Survey: Is this an area that your department will be researching?

Rajan: Yes.

IMF Survey: Should the IMF be more politically aware? How can it further reforms in a politically challenging environment?

Rajan: This is a very good question. Part of our problem is that we get it from both sides. One side says that we’re politically too sensitive and we don’t force reforms that are necessary because we’re worrying too much about the current political leadership—that it’ll be forced out of power, with terrible consequences for the country. Another view holds that we’re not paying enough attention to the fragility of the political coalition in power and that we should be more supportive of it. There’s a dilemma here.

We often assume, or at least some people assume, that governments are always working in the best interest of their citizens. But if that were true all the time and in all situations, we wouldn’t have to go in and point out certain things that they should be doing to get their budgets in order, to get more investment in primary education, and so on. So when we’re confronted with a government that doesn’t have those interests at heart, what do we do? If we intervene too much and prescribe ‘x, y, and z,’ we’re accused of interfering in the country’s sovereignty. But, if we stay away and let the status quo continue, that doesn’t serve the country well either. And we’ve seen some problems emerging recently in Latin America, for example, as a result of governments that haven’t carried out essential policies.

What does this mean for the IMF? In situations where we feel the government isn’t doing the best thing for its people, we need to be a little more prescriptive—but prescriptive in a way that convinces the leaders to take ownership of the necessary reforms because it’s in their long-term interest, not because we’re saying “do this or else.” Occasionally, we’re going to face situations where the government isn’t going to be persuaded; and, at that point, we should find ways to disengage until we can work with a more willing government.

IMF Survey: Your recent book Saving Capitalism from the Capitalists [co-authored with Luigi Zingales] suggests that interest groups that may block socially beneficial reforms could come either from the “left” (labor unions, for example) or from the “right” (powerful capitalists). What implication does this have for IMF policy advice?

Rajan: The IMF has always had to deal with interest groups from every direction, but it has done so on a case-by-case basis, often taking the politics as a constraint that needs to be navigated through to get programs going. It would be good if we could have a more systematic way of thinking about dealing with politics, because, ultimately, all economic reforms have political trappings.

IMF Survey: We know that developed countries have a variety of financial systems, with some relying relatively more on stock markets, such as the United States, but others relying relatively more on banking systems, such as Germany and Japan. What should developing countries make of these models?

Rajan: This goes back to the issue of whether one size fits all. A lot depends on the country’s state of development and the rate of technological progress. If one were to make a perhaps overly broad-brush statement, one would say that for developed countries, at times of very fast technological progress and when research and development is critical, market-based financing tends to work reasonably well. However, for developing countries and in situations when technological progress has slowed down and the emphasis is on reconstruction and consolidation, bank-based systems tend to work reasonably well.

IMF Survey: In terms of crisis resolution, the IMF has been very involved in the debate over whether there should be a sovereign debt restructuring mechanism (SDRM). For now, that’s been put on the backburner in favor of collective action clauses. What are your thoughts?

Rajan: We can’t stop now and say we’ve solved the problem of how to restructure a country’s debt in an effective way that is reasonably low cost and carries legitimacy with it. The problem is still with us. I worry that the IMF is sometimes called in to substitute through its lending for what should effectively be the job of a restructuring mechanism. So we need to continue exploring ways to get an effective system, while taking into account the objections that people have raised in the past to proposals such as the SDRM.

IMF Survey: How do you see the role of the IMF evolving in the coming years and decades?

Rajan: It is hard to predict how the world economy will evolve, and our role will naturally have to evolve with the way it does. However, simply extrapolating trends, we can expect that, as financial markets around the world become stronger and deeper over time, our mission should be evolving even more toward advice and coordination—technical assistance, surveillance, designing reform programs—rather than just providing finance. As a multilateral organization with a broad shareholding, we can play the role of honest broker—saying things and coordinating international responses to problems that individual countries might find harder to do.

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