In "The Third Pillar: How Markets and the State Leave the Community Behind," economist Raghuram G. Rajan presents a compelling analysis of the imbalances in modern society and offers a blueprint for creating a better world. Rajan argues that society rests on three fundamental pillars: the state, markets, and communities. Each of these pillars plays a crucial role in maintaining social stability and promoting human flourishing. However, when these pillars become imbalanced, as they are today, society suffers.
Rajan takes readers on a journey through history, exploring how the relationships between these three pillars have shifted over time. He examines the rise of nation-states, the expansion of markets, and the changing role of communities. Through this historical lens, he helps us understand how we arrived at our current predicament and what we can do to address the challenges we face.
The book offers a nuanced critique of both state-driven and market-driven models of social organization. It argues that while both have their merits, they have also contributed to the erosion of community life and the rise of inequality. Rajan proposes a new approach, which he calls "inclusive localism," as a way to rebalance society and address the root causes of populism and social unrest.
The Three Pillars of Society
Rajan begins by explaining the roles of the three pillars that form the foundation of society:
The State: This pillar is responsible for maintaining law and order, providing essential infrastructure, and creating a framework for social and economic activity. It sets the rules of the game and ensures that they are followed.
Markets: This pillar drives economic growth and innovation. Markets provide opportunities for individuals to create wealth and pursue their ambitions. They are the engines of progress and prosperity.
Communities: This pillar provides a sense of belonging, identity, and social support. Communities are where people form relationships, develop shared values, and build social capital.
Rajan argues that a healthy society requires all three pillars to be strong and in balance. When one pillar becomes too dominant or too weak, problems arise. Throughout history, societies have struggled to find the right balance between these pillars.
Historical Shifts in the Balance of Power
The Medieval Era: Strong Communities, Weak State and Markets
Rajan takes us back to medieval Europe to illustrate how the balance of power between the three pillars has shifted over time. In the feudal system, communities were strong, but the state and markets were weak. Society was organized around manors owned by noble families, where peasants worked the land in exchange for protection and the right to keep a portion of their harvest.
These self-contained communities were governed by lords who settled disputes and administered justice. The Church played a significant role in community life, prohibiting usury (charging interest on loans) and promoting a culture of mutual aid. People helped each other not for monetary gain, but out of social obligation and the expectation of reciprocity.
The Rise of Nation-States: Strengthening the State Pillar
The balance began to shift in the 15th century with technological advancements like the siege cannon. These innovations made warfare more expensive and required larger armies and stronger defenses. Small manors couldn't afford these costs, leading to the consolidation of power and the emergence of nation-states.
By the end of the 15th century, the number of sovereign entities in Europe had halved. This marked the beginning of the age of nation-states, where the state pillar grew in power and influence. Monarchs expanded their authority, often at the expense of the Church and local communities.
Rajan uses the example of Henry VIII in England to illustrate this shift. Henry seized Catholic monasteries and sold their lands to create a new class of landowners called the "gentry." This entrepreneurial class invested in agricultural productivity and used their profits to acquire more land, further strengthening the state's power base.
The Expansion of Markets: The Rise of Capitalism
As nation-states consolidated their power, a new force emerged to challenge their dominance: the market. The transfer of land from unproductive aristocratic and Church ownership to the commercially-minded gentry led to a period of economic growth and innovation.
Rajan points to the Glorious Revolution of 1688 in England as a pivotal moment in this shift. When English Parliamentarians deposed King James II and replaced him with William of Orange, they ushered in an era of greater economic freedom. This set the stage for the rise of capitalism and the market-driven society celebrated by philosophers like Adam Smith in his influential work "The Wealth of Nations" (1776).
However, the unchecked expansion of markets led to abuses. Rajan discusses the "robber barons" of 19th-century America, such as John D. Rockefeller, who used monopolistic practices to eliminate competition and amass enormous wealth. These excesses eventually provoked a public backlash and calls for greater regulation.
The Return of Community: Labor Movements and Welfare States
The exploitation of workers in industrial factories gave rise to labor movements demanding better working conditions and greater political representation. This marked a resurgence of the community pillar, as workers organized to protect their interests against both the state and powerful market actors.
The pressure from these movements led to the expansion of voting rights and the creation of welfare states in the early 20th century. This shift represented an attempt to rebalance the three pillars by giving communities a stronger voice in governance and economic affairs.
The Post-World War II Era: Unprecedented Growth and Prosperity
Rajan examines the extraordinary period of growth and prosperity that followed World War II. The Great Depression had dealt a severe blow to faith in free markets, leading to increased government intervention in the economy. The war effort then jumpstarted economic recovery, setting the stage for a remarkable period of expansion.
In the three decades following the war, Western economies experienced unprecedented growth. For example, average real income per person grew by around 6% annually in Germany and 4.2% in France between 1946 and 1975. This newfound prosperity allowed governments to make ambitious promises to their citizens, such as the creation of the National Health Service in the UK in 1946.
The post-war boom also led to increased immigration, as countries sought to fill labor shortages. By 1973, one in nine workers in France and one in eight in West Germany were foreign-born. This influx of workers contributed to economic growth but also laid the groundwork for future social tensions.
However, this "golden age" couldn't last forever. By the 1960s, cracks began to appear in the economic model. Government deficits increased as spending commitments outpaced GDP growth. As economies slowed, unemployment and inflation rates began to rise, creating a new set of challenges for policymakers.
The Neoliberal Turn: Markets Ascendant
In response to the economic challenges of the 1970s, many Western countries, led by the United States and the United Kingdom, embarked on a program of deregulation and privatization. This shift, often associated with leaders like Ronald Reagan and Margaret Thatcher, represented a dramatic swing back towards market dominance.
Rajan describes how this ideological shift played out in practice. In the US, Reagan famously fired 11,000 unionized air traffic controllers in 1981, banning them from ever working for the federal government again. In the UK, Thatcher waged a year-long battle against striking coal miners, ultimately closing down their mines and breaking the power of the unions.
These actions symbolized a broader shift in economic thinking. The idea that corporations should contribute to society as a whole gave way to a narrower focus on maximizing shareholder value. Influential economists like Milton Friedman argued that the only "social responsibility" of business was to increase its profits.
This new ethos encouraged efficiency and innovation, but it also led to greater inequality. The pay gap between top executives and average workers widened, and job security for those at the bottom of the ladder became increasingly precarious.
Technological Disruption and Growing Inequality
Rajan argues that the market-driven model of the past few decades has been further complicated by rapid technological change. These innovations have created what he calls a "winner-takes-most" economy, where a small number of highly skilled individuals or successful companies capture a disproportionate share of the rewards.
He uses the music industry as an example of this trend. Digital technology has made it possible for global superstars like Taylor Swift to reach enormous audiences and earn unprecedented sums. However, this same technology has made it harder for local musicians and smaller acts to make a living, as consumers can easily access the most popular content at little to no cost.
This winner-takes-most dynamic isn't limited to entertainment. Across many sectors of the economy, technological change is eliminating routine jobs while creating new, highly specialized positions. The workers who fill these new roles tend to be highly educated and comfortable in globalized labor markets. Meanwhile, less-skilled workers find their jobs threatened by automation or outsourcing to lower-wage countries.
The Rise of Populism
The growing inequality and social stratification resulting from these economic shifts have created fertile ground for populist movements. Rajan explains how moderately educated groups have become increasingly resentful of elites, especially in the wake of the 2008 financial crisis.
In the United States, the author points to the debate over healthcare reform as a catalyst for populist sentiment. The perception that the Affordable Care Act (Obamacare) favored minorities at the expense of tax-paying blue-collar households fueled the rise of the Tea Party movement.
In Europe, the 2015 refugee crisis played a similar role. When Germany admitted over one million refugees from war-torn countries in the Muslim world, it sparked anxiety about cultural change and the sustainability of welfare systems. These concerns contributed to the growth of anti-EU sentiment, culminating in events like Brexit in the UK.
Rajan argues that populist movements claim to offer solutions to the problems caused by the imbalance between state, market, and community. They promise to revitalize national identity and implement protectionist economic measures. However, he warns that these policies are ultimately counterproductive, undermining both domestic economies and international relations.
Challenges Facing Emerging Markets
While much of the book focuses on developed Western economies, Rajan also examines the challenges facing emerging markets, particularly China and India. He argues that the fate of these countries is inextricably linked to that of developed nations through immigration, trade, and investment flows.
China's Economic Model at a Crossroads
Rajan acknowledges China's impressive economic gains, with annual GDP growth averaging 8.7% between 1980 and 2015. This growth was largely driven by state-owned enterprises that benefited from cheap credit and subsidized inputs. The government funded these advantages through taxes on households and foreign investment.
However, Rajan argues that this model is becoming unsustainable. Global shifts towards protectionism and changes in investment patterns mean that China can no longer rely on export-driven growth. Instead, it must transition to a model based on domestic consumption.
This transition presents a significant challenge for China. To succeed, it will need to eliminate market-distorting measures that have given state-owned enterprises an artificial advantage. The key question, according to Rajan, is whether China can liberalize its markets while maintaining central party control.
India's Struggle with Corruption
India, as a vast democracy with enormous linguistic and cultural diversity, faces different challenges. Despite averaging 7% annual GDP growth over the past 25 years, Rajan argues that corruption is undermining the country's democratic institutions.
He cites examples of government officials selling state assets, including land and mineral deposits, to cronies at steep discounts. This entanglement of state and market interests hinders the development of a truly independent private sector.
Rajan warns that the rise of Hindu populism, which promises to use state power to protect Hindu identity, threatens to reverse India's progress towards economic liberalization. This trend, he argues, comes at a time when India needs to embrace market reforms more than ever.
Inclusive Localism: A New Approach
In response to the challenges posed by market dominance and populist backlash, Rajan proposes a new approach he calls "inclusive localism." This model aims to rebalance the three pillars of society by empowering local communities while maintaining the benefits of markets and effective governance.
Key Principles of Inclusive Localism
Decentralization of Power: Rajan argues for delegating as many responsibilities as possible from the state to local communities. This would give communities more control over their economic and political destinies.
Community Autonomy: Under this model, local communities would have the power to make decisions about issues that directly affect them. For example, a small town could choose whether to allow large chain stores or preserve space for local businesses.
State as Facilitator: While ceding some control, the state would play a crucial role in bridging gaps between communities. This could involve building physical infrastructure, providing communications networks, and implementing policies to encourage social mobility.
Inclusive Education: Rajan proposes using digital technologies to create a national curriculum accessible to all children, regardless of their location or socioeconomic status. This would help level the playing field and reduce the need for affluent families to cluster in expensive neighborhoods with the best schools.
Community Engagement: Inclusive localism requires active participation from community members. Rajan suggests tying government subsidies to community service as a way to encourage engagement and provide additional income for low earners.
Examples of Successful Community Revitalization
To illustrate the potential of inclusive localism, Rajan shares the story of Indore, a city in Madhya Pradesh, India. When Malini Gaud became mayor in 2015, the city was plagued by uncollected garbage and unsanitary conditions. Through a series of innovative measures, including modernizing the municipal cleaning team and introducing fines for littering, Gaud transformed Indore into the cleanest city in India by 2017.
This success story demonstrates how inspired local leadership and community engagement can lead to dramatic improvements in quality of life. More importantly, it shows how such efforts can foster a sense of pride and unity among residents, strengthening the community pillar.
The Role of the State in a Balanced Society
While Rajan advocates for empowering local communities, he also recognizes the continued importance of the state in creating a fair and functional society. He outlines several key areas where state action is crucial:
Promoting Fair Competition
Rajan argues that states need to ensure that markets remain competitive and are not dominated by a small number of powerful corporations. One area he highlights is data rights. Currently, large e-commerce platforms like Amazon and Alibaba own the transaction histories of merchants using their services, giving them a monopoly on valuable data. Rajan proposes giving individuals ownership of their own data, allowing them to decide who to share it with and fostering more competition in areas like credit scoring.
Balancing Global Trade and National Sovereignty
At the international level, Rajan calls for a careful balance between promoting global trade and preserving national sovereignty. He suggests keeping tariffs low for goods and services but resisting the urge to harmonize all regulations and standards across countries. This approach would protect diversity and allow nations to maintain some control over their domestic affairs.
Regulating Financial Flows and Information
Given the lessons of the 2008 financial crisis, Rajan argues for tighter regulation of financial trade. He also advocates for more control over information flows in an age of increasing cybercrime and social media manipulation.
Coordinating Global Challenges
While emphasizing national sovereignty in many areas, Rajan recognizes the need for international cooperation on issues that affect all countries. He calls for global agreements to address challenges like overfishing and carbon emissions.
Rethinking Economic Policy
Rajan's vision of inclusive localism has significant implications for economic policy. He argues for a shift away from top-down, one-size-fits-all approaches towards more flexible, locally-tailored solutions. Some key policy recommendations include:
Investment in Local Infrastructure: Governments should prioritize investments in local infrastructure, both physical and digital, to support community development and connectivity.
Education Reform: Rajan advocates for a national digital curriculum to ensure equal access to quality education, combined with local flexibility in implementation.
Labor Market Policies: He suggests policies to support worker retraining and mobility, helping communities adapt to technological change and economic shifts.
Community Development Funds: Rajan proposes creating funds to support local economic development initiatives, potentially funded through a combination of public and private sources.
Regulatory Flexibility: He argues for allowing communities some leeway in adapting regulations to local conditions, within a broader national framework.
Addressing Global Challenges
While much of Rajan's focus is on empowering local communities, he recognizes that many of the challenges we face are global in nature. He argues that inclusive localism can actually make us better equipped to address these issues by creating more resilient and adaptable societies.
Climate Change
Rajan suggests that local communities, when given the power and resources to act, can be more nimble in adapting to climate change and implementing sustainable practices. At the same time, he acknowledges the need for international cooperation to reduce global emissions.
Technological Disruption
By strengthening local communities and improving education, Rajan's approach aims to help societies better navigate the challenges posed by rapid technological change. This includes preparing workers for new types of jobs and fostering local innovation ecosystems.
Migration and Cultural Integration
Inclusive localism provides a framework for managing immigration in a way that benefits both newcomers and existing residents. By empowering local communities to make decisions about integration policies, Rajan argues that we can reduce tensions and create more harmonious multicultural societies.
Critiques and Challenges
While Rajan's vision of inclusive localism offers a compelling alternative to both unfettered markets and heavy-handed state control, it's not without its challenges and potential criticisms. Some of these include:
Implementation Difficulties: Shifting power from centralized institutions to local communities is likely to face resistance from entrenched interests.
Risk of Fragmentation: There's a potential for increased inequality between communities if some are more successful than others in attracting investment and talent.
Balancing Local and National Interests: Finding the right balance between local autonomy and national cohesion could prove challenging.
Global Competitiveness: There may be concerns about whether a more localized approach can compete effectively in a globalized economy.
Overcoming Existing Inequalities: The success of inclusive localism may depend on first addressing deep-seated inequalities in education, wealth, and opportunity.
Conclusion: A Path Forward
In "The Third Pillar," Raghuram Rajan offers a thoughtful and nuanced analysis of the challenges facing modern societies. By tracing the historical shifts in the balance between state, markets, and communities, he helps us understand how we arrived at our current predicament of rising inequality, social fragmentation, and populist backlash.
Rajan's proposal of inclusive localism presents a promising path forward. By empowering local communities while maintaining the benefits of markets and effective governance, this approach aims to rebalance the three pillars of society. It offers a way to address the root causes of discontent without resorting to the false promises of populism or the excesses of unfettered capitalism.
The book serves as both a warning and a call to action. It warns us of the dangers of allowing the imbalance between state, markets, and communities to persist. At the same time, it calls on policymakers, business leaders, and citizens to work together to create a more balanced and inclusive society.
Implementing Rajan's vision will not be easy. It will require significant changes in how we think about governance, economic policy, and community development. However, the potential benefits – a more resilient economy, stronger communities, and a more cohesive society – make it a goal worth pursuing.
As we face the challenges of the 21st century, from climate change to technological disruption, the ideas presented in "The Third Pillar" offer a valuable framework for creating a more sustainable and equitable world. By recognizing the crucial role of communities alongside the state and markets, we can work towards a future that balances economic prosperity with social cohesion and individual fulfillment.
Ultimately, Rajan's book is a reminder that our economic systems should serve human needs and values, not the other way around. By rebalancing the three pillars of society, we have the opportunity to create a world that is not only more prosperous but also more just, inclusive, and fulfilling for all its inhabitants.