Out of the Academy, into the Fire
Behind the scenes and in front of microphones, what Booth professors say and do shapes public policy around the globe.
Over the years, Raghuram Rajan has acquired a reputation as an incisive and prescient commentator on the Indian economy - including its failure to live up to expectation. After serving as an economic adviser to prime minister Manmohan Singh for four years, Rajan was urged to do more. "Why don't you come back and do something instead of being outside and commenting?" Singh asked Rajan. Sometimes a professor has to "put up or shut up," Rajan concluded. In September, he accepted an appointment as the Indian government's chief economic adviser.
During the economic turmoil of the past decade - through corporate governance scandals, economic crises, and recession - Booth professors have been in high demand by government officials around the world for their broad and deep knowledge, analytical capabilities, and credibility.
In recent months, the administration of British prime minister David Cameron enacted policies based on the behavioral research of Richard Thaler that suggests people can be "nudged" to make better choices. Antitrust expert Dennis Carlton helped shape policy during a stint at the US Department of Justice (DOJ), and research papers by economist Anil Kashyap influence monetary policy at the Federal Reserve System. Other professors such as Rajan, Randall Kroszner, and Austan Goolsbee, have been tapped as advisers to heads of state.
They say what they think behind closed doors, helping kill bad ideas, tweaking others. They are comfortable with debate and often take public roles, their opinions sought out widely in media ranging from the New York Times to the Times of India. Goolsbee, the former chairman of the Council of Economic Advisers (CEA) under President Obama, was a prolific commentator on Twitter in the run-up to the election.
Academics can do this precisely because, unlike the politicians they advise, they don't seek public approval in a quest for reelection or higher office. So they float policy, provide cover, and serve as lightning rods. They are the perfect group to point out when the emperor has no clothes, because their public policy tenure is short (usually two years) and they speak from a platform of almost unassailable knowledge. Their teaching extends beyond the classroom, into government chambers, and their students are some of the most powerful people in the world.
Micro Policies, Macro Results
You don't need to be a business school professor to know that these are difficult economic times. Governments are looking for pennies between the sofa cushions. But austerity is difficult politically and personally, and isn't enough to solve the problem entirely. True savings don't result from one-time cuts: they result from long-term reform. They result from, say, collecting £30 million (about $48 million) in additional tax revenues without a tax increase.
Rohan Silva believed he'd found a way to do just that in 2009 after reading Richard Thaler's Nudge: Improving Decisions about Health, Wealth, and Happiness. Silva, then senior policy and economic adviser to George Osborne, at the time the UK's shadow chancellor of the Exchequer, gave the book to David Cameron, who then gave copies to his party's members of Parliament as a summer reading assignment. When the Tories came to power in the general election of 2010, Cameron formed the Behavioural Insights Team, also known as "the Nudge Unit."
The premise of Nudge is based on what Thaler calls "libertarian paternalism," the idea that although we should be free to do what we want, decisions can be influenced "in order to make [our] lives longer, healthier, and better." For instance, if we knew that our neighbors paid their taxes on time, would we be more likely to as well? If we did, regulators could spend less time and money on enforcement - a small change, but one with potentially huge impact. Cameron's Nudge Unit set out to put hypotheticals like these to practice.
Although it has a small staff, the unit has cabinet-level status and is run by David Halpern, an academic social psychologist who seems comfortable both in the ivory tower and in the halls of power and was the chief analyst in prime minister Tony Blair's Strategy Unit from 2001 to 2007.
Over the course of its initial two-year mandate, the unit has worked with UK government departments to conduct randomized controlled trials (RCTs) to test what will work in different situations and, then, to try things that gently prod people toward the best decision.
For instance, a standard tax collection letter that was rewritten to spell out how many neighbors had paid their taxes on time boosted payment rates by approximately 15 percent. Rolled out nationally, that initiative would result in an additional £30 million in tax revenues, or $48 million.
"The tax thing was something we [the Nudge Unit] needed," Thaler said, "a quick win that demonstrated that these ideas could work and pay for themselves. It's kind of a no-brainer. If you can take a letter and rewrite it and collect more taxes, why wouldn't you do that?" As he wrote in the New York Times, "increasing tax revenues without raising rates is a trick worth learning."
In all, revenues reaped from six Nudge projects have paid for the team's budget 22 times over and will save the government an estimated £300 million, or $482 million over the next five years. "We deliberately chose areas in which there would be a quick payoff," Halpern said. "Tax fraud and error were obvious targets." A variety of tactics nudge those who haven't paid their fines, for instance. For court fines, switching from increasingly threatening snail mail letters to personalized text messages resulted in a sixfold jump in collections.
Such early victories helped the unit provide a proof of concept that it can apply to larger concerns, such as job creation and small-business growth. The team has been so successful that its funding not only was renewed, but increased in June 2012 to enable four more hires. It also has taken on two additional clients: the government of New South Wales, Australia, and the Freebridge Housing Association on England's northeast coast.
One important development for the Nudge Unit is a citizens' information portal, Midata, which will give citizens access to their own usage data collected by private companies such as supermarkets with frequent shopper programs. British consumers know that they have a right to such data, but it hasn't been available in an easily downloadable format. With easier access, consumers can be more informed shoppers, able, for example, to avoid foods with certain ingredients, or find a better smartphone plan by knowing how much data they use and how many calls they make. A similar program from the Obama administration, Smart Disclosure, is also based on Thaler's work.
Midata and Smart Disclosure are examples of initiatives that would not have happened without Thaler's push, Halpern said. "When last he was here, we worked him quite hard. We must have had 10 ministerial meetings, including one with the prime minister. Richard kept saying, 'If there's one thing we ought to do, it's Midata.'"
Thaler maintains a lasting change will be governments' use of RCTs for economic policy research. Already in wide use in the private sector, RCTs would allow policy makers to base decisions on evidence rather than political expediency and reduce the pitched personal battles that take place in politics. Still, Thaler acknowledges the challenges. "Political leaders don't want to admit that they aren't sure," Thaler said. "It's difficult for a presidential candidate, for instance, to say, 'We're going to try to figure out what to do once we're in office' because the other guy will say, 'I already know what to do.'"
Halpern and his Nudge Unit understand the particular challenges RCTs present for government officials. "In one way, it's all downside for politicians," he said. "They need a solution. But with trials, you say, 'We can try this. It will take two years and then we'll tell you what to do.' Governments can't just sit around and do nothing for two years."
The trick is to provide "an unusually short loop" from action to results, according to Halpern. "I've been in policy off and on for a decade, and it is usually a struggle to make that connection. When you start to see these results, there are two outcomes. First, it's a no-brainer. There's no marginal cost to it. Second, public opinion said, 'That's obvious, so why didn't we do it already?'" Now, with a little nudging and Thaler as a guide, policy makers are doing it.
When he served at the DOJ, antitrust expert Dennis Carlton demonstrated the potential to nudge larger entities in important but subtle ways. He started a program that brought regulators from foreign governments to the United States to sit in on classes that the DOJ provides for entering attorneys. "We were not telling them what to do," Carlton said, "but equipping them with information so they could think about competition and regulation in a certain way. It's an important role for the antitrust division, because we hope that other countries will see competition in the same way we do."
The antitrust division of the DOJ in which Carlton worked has about 60 economists, all PhDs, backed by a larger group of junior staffers. This is not unusual for academics working in the public sector, who often find themselves in large departments with many career civil servants, along with multiple consultants from academia and the private sector. But much of the time, and at the highest levels of government, academics function in smaller bodies.
The CEA, which Austan Goolsbee chaired, has only three members, backed by a staff of 50 or so. The top decision-making body in India's Ministry of Finance on which Rajan serves has four members. Thaler's Nudge Unit has only nine members and a budget of less than £1 million (about $1.6 million).
Working in these so-called "hot teams" enables academics to play to their strengths of deep subject-matter expertise and high-quality analytical thinking. It helps, of course, that they are often placed at the very top of governments. "It's our job to propose these crazy ideas that the government doesn't have to implement," said Halpern, who calls the Nudge Unit "a skunkworks meets 'The Dirty Dozen.'" He added, "We have the ear of the prime minister." Often these teams of academics work side by side with the leaders of nations. The Nudge Unit is based at No. 10 Downing Street, while the CEA meets behind closed doors with the president in the Oval Office.
The CEA traditionally is made up of academics - it's the president's think tank. "The most far-ranging decisions should be based on evidence that is naive of politics," said Andrew Metrick, a Yale professor of finance who worked with Goolsbee at the CEA. "Although it is only one part of the advice coming in, academics provide whole branches of knowledge that you would like to see incorporated into policy. And when you're in the middle of the maelstrom, who do you want around you? People who are loyal to the task and going to get it done on their own."
Besides, academics are seldom intimidated by authority: an important trait to possess when offering policy advice on hot-button issues. "When you're an academic, no one is your boss," Goolsbee said. "You just get on with it on your own." Thomas Barnett, cohead of global antitrust at Covington & Burling LLP in Washington, DC, and former assistant attorney general, said, "I am probably the only boss Dennis Carlton has ever had."
Admitting that it's difficult not to be intimidated by the Oval Office, Goolsbee said that deferring to the president is not what the president needs. Rather, presenting evidence and making sure that he knows what he needs to know in order to see the consequences of major actions are why the CEA is valuable. Before taking over as chair in 2010, Goolsbee called several previous chairs to ask advice. One of his Republican predecessors told him, "It [the CEA] only succeeds if you have better arguments than anyone else has."
Youth, stamina, and a strong stomach, not to mention a sense of humor, help as well. Rajan was the youngest-ever director of research at the International Monetary Fund, essentially chief economist. When Goolsbee first went to work for then-congressional candidate Barack Obama, he was only 35 years old. When he became chairman of the CEA, he was 41 and the youngest member of the cabinet. His two colleagues on the three-member council were well shy of 50.
Goolsbee characterizes his time in the White House by saying, "there was a lot of yelling." He recalls arriving in Washington at "a terrifying moment," when the economy was losing 167,000 jobs a week. "It was an absolutely epic and existential crisis for our economic system." That he maintained his sense of humor is evidence of how he kept his sanity through the worst recession in 80 years.
In the blocking and tackling necessary to get anything done in Washington, Goolsbee admitted he had to learn as he went along. "I went in thinking we were going to race cars," he said, "and it turns out it's a demolition derby." There is very little in Washington in the way of honest debate, he concluded. "People are putting on the battle armor. People are going to war. It turns out that politics is very political. There are a whole bunch of skills that one needs to learn that you don't acquire in getting a PhD." Halpern, himself an academic, added, "In government, a lot of people are trying to stop things from happening."
One of the biggest adjustments academics must make is the loss of reflective time, said Cecilia Rouse, dean of the Woodrow Wilson School of Public and International Affairs at Princeton University and one of the two advisers on the CEA with Goolsbee. Time is "one of the joys of being an academic," she said. "We are paid to do research and to teach and so paid to learn new things. We're paid to stay on top of an issue." The expert opinion acquired through all that research and thinking is one of the main things that makes a skunkworks like the CEA invaluable. It is also the solid grounding that enables people such as Goolsbee to make recommendations based on intuition.
But once you make the transition to the public sector, "you don't have the luxury to track down multiple datasets, run down every robustness measure you'd like," Goolsbee said. "If we had till the end of the week, we were lucky."
Rajan's second turn as a political adviser to India began to take shape at an April 2012 event honoring the rerelease of a book by Prime Minister Singh. During the event, Rajan criticized India's "asymmetric reform process" and chastised lawmakers for politically expedient "reform by stealth." He laid out a road map to extricate India from the "dangerous place" the country finds itself in. In the short term, he advocated raising fuel prices, being kinder to foreign investors, and resolving supply chain bottlenecks. Longer term, he advised elimination of barriers to entry in education, retail, and the media; privatization of more government-owned companies; and development of a "transparent means" to price and allocate the country's natural resources.
It wasn't the first time Rajan had found himself in the awkward position of presenting hard-to-refute evidence to a less-than-receptive audience. In 2005 he spoke at a symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming, to honor Alan Greenspan's retirement, telling the august central bankers that the Federal Reserve under Greenspan systematically had increased risk in the financial sector.
"I felt like an early Christian who had wandered into a convention of half-starved lions," he wrote later, pointing out that most of the convention talk focused on Greenspan's exalted place in history. Skepticism turned to admiration when the financial crisis hit in 2008. His outspokenness and foresight earned Rajan the number one ranking on the Economist's list of most influential economists.
Singh's recently appointed finance minister, P. Chidambaram, named Rajan his chief economic adviser. The government effectively has fewer than two years before the next election to show what it can accomplish. The Economist pronounced: "a world-class economist takes on the world's most poisoned chalice."
That "poisoned chalice" includes slowing growth rates, withering foreign direct investment, and a declining rupee. Politics is deadlocked or in noisy opposition to already announced economic reforms. The country lacks what Ajay Shah, a professor at the National Institute for Public Finance and Policy in New Delhi, calls "a macroeconomic tool kit." The list is long. "Raghu should be judged by the extent to which he is able to influence the direction they are going," Shah said. Already two of the reforms outlined in a 2010 policy paper on the service sector have been proposed as law - foreign ownership in the retail sector and in airlines.
It will be small things rather than large that reform the vast Indian economy, said Rajan, who continues to be associated with Chicago Booth and the university, having restructured his academic commitments to meet his responsibilities in India. "The question is not, can you change this huge country?" he said, but, "Can you even make a small difference? Look at what that small difference would do in the lives of 1.2 billion people."
In a report to the government in 2009, Rajan outlined "a hundred small steps" to reform the financial services sector. "If you try to make something look big in India, it gets a lot of opposition," he said. "But if you cut it up into smaller pieces and those little things get done, eventually they add up. Where we are, with a fairly fractured political establishment, we need to concentrate on the things we can get done."
Whatever happens in India - and the government could fall due to the economic reforms - Rajan will "have a seat at the table," Shah said. "He will get an opportunity to participate in all of that. His life and his time will matter."
What Difference Does It Make?
Academic assignments typically are short-lived. A university usually will give professors two years before they lose tenure. Thaler's bias, as he calls it, is that such assignments should have a built-in sunset provision. "People get stuck in ruts, and we shouldn't continue to exist just because we have existed," he said. "We should be there only if we succeed."
Not only do academics have a brief time to make a difference - their accomplishments can be difficult to pinpoint. Halpern said he has known several academics who "came and went without a trace."
"I don't think of the policy team around a president as having accomplishments," Rouse said. "It's very difficult for an economist in an advisory role to directly impact policy that's enacted." Having said that, she asserted that Goolsbee had a significant role in the decision to bail out the auto industry and in how it was done, and on how to handle the ailing government-sponsored enterprises Fannie Mae and Freddie Mac.
Randall Kroszner played a major role in the government's response to the Enron corporate governance scandal when he served on the CEA for president George W. Bush from 2001 to 2003. Following the 9/11 attacks, he developed policy on terrorism reinsurance, according to his boss at the time, Glenn Hubbard, now dean of Columbia Business School.
Later, when Kroszner sat on the Board of Governors of the Federal Reserve in the opening days of the recession, he was called to act under emergency powers given to the Fed in the 1930s during the Great Depression.
"They call on the Fed to act in 'unusual and exigent circumstances,'" he said. "Unfortunately those became weekly events." Normally the board has seven people, but starting in early 2007 it had five because Congress wanted unanimity. "That gave each of us veto power over any of the others," Kroszner said. "The decision was on each of our shoulders. There was no way to say my vote didn't really matter. Any dissent would have meant that an extraordinary action couldn't take place. That was transformative, to make those decisions in real time on limited information."
Much of the value of having academics work in the public sector is invisible, Hubbard said, because "a lot of it is killing bad ideas, and they can come from very important people. It takes tact and diplomacy. A lot of times people don't want economists in the room. There's a politically expedient way to do it and an economist comes in and says, 'but, but, but.' That's not always welcome."
The short-term impact may be difficult to discern, but over the long term, academics sometimes change the way policy is thought about and written. "The policy is to set the fine," said Owain Service, deputy director of the Behavioural Insights Team. "The policy is not to think about how the fine might be paid." The man in the basement creating the forms and processing the payments can have the biggest impact on what actually happens, Halpern said. "Increasingly, policy is coming out of the basement."
Thought of another way, Kroszner's work on corporate scandals predates Sarbanes-Oxley. He is careful not to take credit or draw a direct line between the two, but "the Worldcom scandal raised questions as to whether new legislation would be necessary or not," he said, and indeed President Bush supported an early version of the legislation. Rajan's suggested financial reforms, privatization, and a more liberal foreign direct investment policy could mean a return to the sort of economic growth that created India's burgeoning middle class. As with killing bad ideas, sometimes the biggest impact comes from what does not happen. "I believe that historians will look back on the avoiding of a depression as a major accomplishment," Goolsbee said.
At the end of the day, an academic's job is to think and to encourage those around them to do the same. The extent to which they succeed is what makes them good teachers, whether they are working with students or with politicians. Especially with people at the highest levels of power, their ability to shape how policy is thought about is their single most important contribution. Rajan has advised the prime minister of India for the past four years. Thaler speaks of conversations with UK Prime Minister Cameron in the hallway at No. 10 Downing Street. Carlton had the rare experience of several antitrust cases ending up before the Supreme Court. Kroszner worked through President Bush's ambitious tax plan while on the CEA. Goolsbee worked for president Barack Obama during his congressional and presidential campaigns.
"He changed the president's mindset," Metrick said. "How do you put a value on that?"