Raghuram Rajan's The Third Pillar explained: markets, the state and the community left behind

Raghuram Rajan has spent his career inside the two big institutions of modern economic life. He has taught at the University of Chicago's Booth School of Business since the early 1990s, and in between he was chief economist of the International Monetary Fund and governor of the Reserve Bank of India. In The Third Pillar: How Markets and the State Leave the Community Behind, published by Penguin Press in 2019, he argues that those two institutions have grown so strong that they crowded out the third thing a society stands on: the community where people actually live.

For a week on social mobility and young people, the book is a good place to start, because Rajan's sharpest pages are about schools and who gets a chance.

Three pillars

Rajan defines the pillars carefully. Markets are goods, labour and capital markets plus firms, and their job is to raise productivity and widen choice. The state is the executive, the courts and the legislature, mostly at national level: it provides security and justice, builds people's capabilities before they reach the market through schooling, and catches them afterwards with unemployment insurance, health cover and pensions. The community is the proximate one: the neighbourhood, the village, the municipality, its local government and local institutions like schools.

The community does many of the same things as the state, Rajan said when he presented the book at Brookings in February 2019, and it runs on relationships: people get support because of who they know and who they are. It is a source of identity and values, it teaches children before they get to school, it fills holes in the safety net, and it is the easiest place for people to organise politically. He insists on the local, physical community, because trust and long-term engagement are easier to build there than online.

The first half of the book is history. As Edward Glaeser summarised it in his review for the Wall Street Journal, medieval communities were largely self-sufficient; military and transport technology then required bigger states, which brought roads, cities and wider markets, and as states and markets grew the community weakened. Welfare states took over what parishes had done. For a long time this looked like progress, and much of it was. Then the information revolution raised the rewards for skills, concentrated prosperity in big hubs and left peripheral towns to decay. Rajan reads the populist anger of the last decade, on left and right, as a correct diagnosis of that imbalance followed by poor remedies.

The secession of the successful

This is where schools come in. Technology raised the returns to capabilities, Rajan argues, so good schooling and a degree matter more than ever. Parents know that their child's classmates matter too: a class where everyone arrives well prepared moves faster. So families with means move to the best neighbourhood they can afford. Rajan calls this the "secession of the successful". Mixed communities break up into successful ones and struggling ones, and the people left behind get weaker schools, worse access to college and fewer chances to start a business. In the United States, he adds, zoning rules keep poorer families from following, because they forbid the apartment blocks they could afford.

Spain has its own version of this. Families compete for places at the schools with the best reputations, often through the address on the census, and our week 3 showed how housing costs decide who can live near them. Rajan's account explains why social mobility and housing are one problem.

Inclusive localism

His remedy has two halves. The local half: push decisions and money down to communities, because they know their needs, and let them spend on what they want, better schools, a community college, a workshop for small entrepreneurs. Glaeser notes that he opposes top-down instruments like America's Common Core, preferring broad minimum objectives with methods left to schools. National government keeps a basic safety net, open markets and free education up to community college level, which Rajan considers the minimum for a decent job today.

The inclusive half: the state and markets keep the walls around communities low. Exclusionary zoning that keeps poorer families out has to be re-examined, even if it gives a place a strong sense of identity. Rajan admits this is a trade-off and says he prefers inclusion when the two collide. He also sees technology on the side of the solution in schools: pupils study material at home and use class time for help at their own level, which eases the old dilemma of teaching to the average.

What the critics say

Diana Thomas, reviewing the book, calls it an important diagnosis and only the beginning of a theory: the concept of community stays thin, and the tension between thick local identity and openness is the crux the book leaves unanswered. She thinks Rajan could have built on Elinor Ostrom, whose design principles we explained in week 2. Glaeser, more sympathetic, doubts that local power makes places more welcoming, since many localities already use housing rules to keep the poor out; still, he concludes the experiment is worth trying.

What radical centrism takes from it

The left is right, and Rajan agrees, that a market which rewards skills so heavily makes families sort by income and leaves the children of struggling places with less, so public money has to build capabilities exactly there. The market-liberal tradition is right that decisions and budgets work best close to the people they affect, with national rules kept to the minimum. What fits neither is the specific package Rajan calls inclusive localism: real power and money for the neighbourhood school and town hall, and national rules whose main job is to keep those communities open. In Spain that means the school gets more say over how it teaches and more money where the need is greatest, and the town loses the power to block the homes that would let poorer families move in.

That combination is the thread of this week. A child's chances depend on the family, the school, the neighbourhood and the state together, and the Democracia 21 speech that frames this series names restoring social mobility as Spain's first priority. Rajan gives us a way to think about the pillar that most mobility policy forgets.