Mr. Free Market, Raghuram Rajan, Goes to India

A University of Chicago academic tests his theories in a turbulent economy
Photograph by Pier Marco Tacca/Getty Images

Raghuram Rajan fit in quite comfortably at the University of Chicago. Like other free-marketers, the Indian-born economist and professor at Chicago’s Booth School of Business was inspired by Friedrich Hayek, the Austrian thinker. On the wall of his Hyde Park office, Rajan had an autographed photo of conservative icons Milton and Rose Friedman. Rajan warned of a global economic crash three years before it happened, and his 2010 book on the financial crisis, Fault Lines, got a scathing review from Princeton professor and Keynesian guru Paul Krugman, cementing Rajan’s Chicago School credentials.

Today Rajan’s office is in the red sandstone headquarters of India’s Ministry of Finance, where he has served as chief economic adviser to the government since last August under the direction of Finance Minister Palaniappan Chidambaram. Instead of the Friedmans, portraits of two well-known local critics of capitalism, Mahatma Gandhi and Jawaharlal Nehru, gaze down at him.

Rajan’s view of India’s problems, as stated in a number of withering speeches, is that corrupt politicians, officials, and middlemen have hobbled free markets by monopolizing licenses, government funds, infrastructure projects, and more. Despite India having “a ton of billionaires,” Rajan says that only 42,000 people report incomes of more than $180,000. “There are a large number of people who ought to be paying their taxes who are not,” he says, likening India’s business elite to Russian oligarchs. On March 13 he told Indian broadcaster New Delhi Television that India is overregulated, and that sick companies don’t die quickly enough.

This candor is what helped get Rajan his current job. As the International Monetary Fund’s former chief economist, he also lends credibility to Prime Minister Manmohan Singh’s beleaguered government coalition, which has been hammered by a weak economy, corruption scandals, and the recent desertion of a regional party from the coalition. Despite the dissimilarities between free-market Chicago and interventionist India, Rajan says he is not out of place. “I’m a believer in free markets, but I’m not a believer in laissez-faire,” he says. “There is a distinction.” India, he says, is still working out the difference.

Singh, an economist who managed India’s first wave of market-opening reforms in 1991, has presided over quickening inflation and slowing growth as prime minister. Rajan’s solutions, which he laid out in the annual “Economic Survey” published in February, include cutting the number of regulations to reduce opportunities for corruption, tearing down trade barriers to allow more foreign competition, dismantling labor laws that stifle hiring, and overhauling the financial system to make it more responsive to ordinary customers. An important item on his agenda is to replace India’s mishmash of state and local taxes with a broad-based tax on goods and services.

Too many of India’s small businesses are stuck in the informal economy, with no access to capital to improve productivity and no protections for workers. Rajan, who won’t comment on Indian media reports that he will be the next central bank governor, says that a “second generation of reforms” to improve infrastructure, schools, and manufacturing is critical to ensuring long-term success. “India’s continuing on a rapid growth path is not preordained,” he wrote in the annual Economic Survey.

Rajiv Biswas, Asia-Pacific chief economist for IHS Global Insight, says Rajan and his boss Chidambaram are making progress in reducing subsidies and improving the business climate for foreign investors. Rajan “is definitely one of the brightest, most cogent economists around,” says Glenn Levine, senior economist with Moody’s Analytics in Sydney. Levine says he’s impressed with moves to open closed industries like retail and insurance to foreigners. Subsidy and spending cuts, higher taxes, and asset sales have trimmed the budget deficit from 5.8 percent of gross domestic product last year to a more manageable 5.2 percent this year. In 2014 the budget deficit is expected to slip to 4.8 percent. The government’s handling of its fiscal woes over the last six months has been “fantastic,” says Levine.

Recent success isn’t enough to conquer the cynicism born of decades of mismanagement. “Turning that country around strikes me as a tall order,” says Tim Condon, chief Asian economist for ING in Singapore, who notes India is at risk of stagflation. “The confidence switch is off.” Both Standard & Poor’s and Fitch Ratings have negative outlooks for India amid concern that government spending on the rural population will wipe out the benefits of deficit-cutting elsewhere. The Bombay Stock Exchange’s Sensex is down 2.79 percent for the year, one of the worst performances in Asia.

Although Rajan would be the last to play down India’s challenges, he says critics need to take the long view. “Sometimes India can become a darling and can do no wrong,” he says. “Then something happens, and the market tanks, and it’s all doom and gloom. But the growth rate over the last 20 years has been much more stable. The growth has stability which is not reflected in the gyrations of sentiment.”

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