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Did America's Schools Cause the Financial Crisis?

In 2006 economist Raghuram Rajan gave a speech at the Jackson Hole Conference, which brings together central bankers and other economics bigwigs. In it Rajan warned that developments in the financial sector "create a greater (albeit still small) probability of a catastrophic meltdown." His speech, it's safe to say, did not go down a storm, but since the mayhem in the market Rajan has emerged as one of the few economists with the foresight to see the crisis coming.

Today on the fabulous NY Times Freakonomics blog he is promoting his new book Fault Lines and also answering questions on the underlying causes of the crisis. And while bankers don't come off as snowy white innocents in his explanation, Rajan points to an interesting and less often heard root cause for the financial crisis -- America's failing schools and politicians' unwillingness to fix them.

Why did the "greedy" bankers suddenly develop a social conscience and start lending to poor people? The answer is that they were guided to lending to the poor by the money directed into low-income housing, much as sharks are drawn to blood. And why did so much money flow to the low-income housing? Because the government was trying to solve a deeper problem -- growing income inequality.
Since the 1970s, the wages of workers at the 90th percentile of the wage distribution in the US -- such as office managers--have grown much faster than the wages of the 50th percentile worker (the median worker) -- typically factory workers and office assistants. A number of factors are responsible for the growth in the 90/50 differential. Perhaps the most important is that although in the US technological progress requires the labor force to have ever greater skills -- a high school diploma was sufficient for our parents, whereas an undergraduate degree is barely sufficient for the office worker today -- the education system has been unable to provide enough of the labor force with the necessary education.
The everyday consequence for the middle class is a stagnant paycheck as well as growing job insecurity. Politicians feel their constituents' pain, but it is very hard to improve the quality of education, for improvement requires real and effective policy change in an area where too many vested interests favor the status quo. Moreover, any change will require years to take effect and therefore will not address the current anxiety of the electorate. Thus politicians have looked for other, quicker ways to mollify their constituents... Cynical as it may seem, easy credit has been used as a palliative throughout history by governments that are unable to address the deeper anxieties of the middle class directly.
Rajan concludes that "we need to tackle inequality at its root, by giving more Americans the ability to compete in the global marketplace." What do you think of his explanation of the deeper causes of the crisis?

To read the rest of this thought-provoking and in-depth interview check out the Freakonomics blog.

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(Locker image by House of Sims, CC 2.0)
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