Education Failings At Root Of Economic Crisis

Published on June 15, 2010

The failure of education to keep pace with the higher-paying jobs created by technology is one of the root causes of the current economic crisis, according to Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance.

In fact, education gaps have carved a deepening disparity in wages between the managerial class and the industrial worker. “The manager’s income is running away from the factory worker,” he said. “Why is this happening? Because the 90th percentile has a college degree and the person at the 50th percentile stopped at high school.”

Rajan, author of Fault Lines, How Hidden Fractures Still Threaten The World Economy, outlined the reasons behind the financial crisis for alumni and business professionals at a Global Leadership Series event in Washington DC on June 15.

He said technology today has created jobs that require a higher degree. “High school graduation rates have been stagnant since the 1970s. College completion rates today are no different from cohorts born in the 1970s and the 1940s, especially for males. In general, education rates have not kept pace with technology. As a result, because the supply of the educated has not kept pace with the demand, the incomes of the highly educated are running away from the incomes of the high school educated. That creates a problem because the median wage is stagnant.”

According to Rajan, the only genuine solution to growing income inequality is to “upscale” the education level of high school graduates. However, that goal would take years to achieve, involving comprehensive changes in schools, communities, nutrition levels, and even the family.

“It takes a long time and hard work, and may be impossible for some. How do you tell a 35-year-old single mother with two kids who has a Graduate Equivalency Diploma that she cannot get one of the good jobs in the economy?”

The Clinton and George W. Bush administrations, with bipartisan blessings, decided the easier answer to rising income inequality was housing credit, said Rajan, who served as chief economist at the International Monetary Fund between 2003 and 2006.

“Home ownership gives people a stake in the future, as well as a means to borrow— consumption growth through credit growth.”

Both presidents succeeded in spectacularly increasing home ownership rates in the country. “They used the instruments of the government, using the Federal Housing Administration, pushing on Fannie Mae and Freddie Mac to loan more to low-income sectors.”

As a result, people who ordinarily would never have been able to borrow suddenly became homeowners. But unfortunately, too many could not afford to become owners, and now are drowning in debt. The problem with the government is rarely intent but the unintended consequences of its actions.

One factor that gave rise to risky lending was the anonymity of the modern banking system, Rajan said. “When you are a relationship banker working in a community and you put a homeowner into the house, you could see them making payments, you knew when they had difficulty, and you paced the cost when they ran into difficulty. What we’ve got with the current system, when stuff is sold off to somebody else, things become much more anonymous.”

Simultaneously, the system went haywire because the massive influx of government money corrupted most everyone who touched it. “The system was not pricing in the risk and telling us that things were going wrong because the flood of money going into the system was corrupting rating agencies, corrupting judgments, and corrupting prices. People at the end of the line were not asking any questions; guys buying the mortgage-backed securities were not asking if the underlying mortgages were sound.”

Rajan predicted it will take four to five years to get back to 5 percent unemployment.

In the end, Rajan believes innovation is the way to economic recovery for the U.S. and other nations with high debt loads. “The U.S. is a dynamic society. There needs to be a whole new thinking and a sense of mission.”

Rajan also said it’s vital for parents and communities to take a more active role in improving schools and pushing their children to get a better education.

— Mary J. Paleologos