November 22, 2020

Ludger Schuknecht

German. Economist, former Chief Economist at the German Ministry of Finance, former Deputy Secretary-General of the OECD

1. Why does economics matter?

Economics matters because it is about one of the fundamental aspects of our life. It looks into the question of how we make our livelihoods, how we can satisfy our basic needs. But of course, economics is about much more. It’s about the exchange between people in the marketplace. It’s another very fundamental human desire: trade in order to exchange and interact. And, it’s also about putting to the best use the resources that we have on this planet. So, economics is really fundamental for all of us.

2. What are the differences between economic science (academic economics) and economic engineering (policymaking)?

Economic as a science analyzes economic actions and actors, and how they react to changing signals from prices and the market. That is microeconomics, as a science. Macroeconomic science looks at how things get aggregated, and how the aggregates change. You know, when behavior changes, when shocks happen, when the macroeconomic environment changes.

I wouldn’t call economic policymaking economic engineering. I think that’s a deep misunderstanding, and part of the problem of our times.

It is true that a lot of what we do in economics is practically a kind of examination of what would happen with economic engineering… If you raise government spending, then what happens to aggregate demand and GDP, and so on. But that’s actually, to my mind, part of the problem. Economic policymaking is very rarely done with the desire to actually produce a precise change by a certain policy action. It aims at achieving certain objectives, but [what happens] is the result of the interaction of the actors in the political process.

And in that sense, there are, of course, many economists who think policymakers should behave like engineers, but they don’t. And they don’t have the knowledge and they don’t have the incentives to do so. So this is part of the problem of our science and – to my mind – it’s part of the reason for the widespread lack of success of our science, because we tell policy makers to do one thing and then we are surprised that maybe they do something else instead of reflecting on what the incentives are, what the marketplace is they’re operating in, and how then, so to speak, policy should be designed and what policies would help, so to speak.

This policy makers object to function and at the same time perhaps also achieve the economic objectives. So, I mean, this is not black and white. You know, economists say “a” and policymakers do “b”. Reality is somewhere gray, different shades of gray. But I think it would do us a lot of good as economists if we understood and acknowledge better the world policymakers are living and operating in.

3. What role does economics play in society? Does it serve the common good?

Interesting question. I think much of economics does indeed serve the common good and does help society in the sense that it provides conceptual frameworks and data and empirical analysis to look at real world phenomena, to understand real world phenomena better. And from that perspective, I think much of economics, perhaps not all of it, but much of economics really provides value, whether the marginal costs always justify, as always justified by the marginal benefits. That’s a different matter.

But on the whole, I would say it’s good.

What perhaps is a challenge is the normative part of economics where, as I said, as the reply to the previous question, we are often extrapolating from our armchair world, which by definition and by necessity has to be simple so that we can kind of tease out, can extract the results and the findings, you know, the analytical findings and the messages.

If you know this is the world we are living in, then this should be the response. But we are not paying enough attention to this in the sense that, you know, we often give advice without looking really at the way policymakers are living. And then another challenge is, of course, long term versus short term, special interest versus general interest. So some economists give special interest advice, you know, which then becomes a general interest claim.

And some economists make suggestions for the long term, which are difficult to implement in the short term and the other way around. So these are difficulties: kind of extracting the maximum value of what economists do as analysis, to my mind.

Another excellent question. First, let me start with what economics deals today. I mean, what you are describing is, to a significant extent, one branch of economics that admittedly today dominates. I mean, it’s macro and micro… The classical economists put much more emphasis on the market process and institutions.

And so to speak, if you look at what does economics do, the canon of economics, I think I would add these key words to that as really essential contributions for understanding of, you know, why… how economies work, politics works or not doesn’t work. So so that’s kind of like on the first point, I would emphasize that economics is not just, you know, about the efficient allocation of means to an end. It’s also about, you know, analyzing the processes, the market processes… The market processes where the economic exchange of goods and services takes place and the political market processes where incentives operate…

Which brings me to the second real question of yours.

You know, what about the issues that also matter? And I would say that climate change, environment is, in a way, another public good externality element that has always been on the on… maybe not always, but for a long time been on the radar of economists. But in terms of cost gain, much more prominence with the debate about climate change and as by now, global shortages in a healthy environment that have emerged. So environmental economics is a long standing branch of economics. I’ve studied it already when I was a student, that was many, many years ago. But it’s become more prominent and it does… economics, to my mind, actually does provide an excellent tool kit to analyze this. I think without economics, it would be, you know, without a proper application of economic thinking, we will face great difficulties in mastering our environmental and climate challenges.

You know, I’ve been thinking about it for a while, also because of the OECD, I was strongly involved in this area, especially to the question of carbon pricing. I was responsible for the tax side there and also for trade, because carbon pricing is the way where you say, I mean, you have a scarce good, which is difficult to… where you want to reduce consumption, but it is difficult to achieve that because, you know, so far we have treated it like a free good.

And carbon pricing is in a way to internalize the externalities on climate change and on other negative side effects that pollution and carbon CO2 has.

So I think and that is now becoming in more and more countries the accepted way how we can master the climate change challenge. Of course, economists also provide other instruments in this area: regulation and subsidies and so on, which, you know, and like discussing trade offs, you know, carbon pricing is kind of a good Kompass. But, you know, is it really good to let prices fluctuate all the way to the top or to the bottom because of some temporary factors that might actually have an inbuilt destructive effect on the market.

So, you know, economies provide a lot of tools there for the debate. And they also can help to explain why, for instance, certain measures are less efficient. You know, that you get less bang for the buck, you get less carbon prevention for the euro or the dollar, than say through carbon pricing. In Germany we are very good at this by spending lots of money on insulating buildings and subsidizing renewable energy without having checked, you know, whether this is the best way to spend the money in terms of getting climate change mitigation.

So economics, I dwell a bit on this example because by extrapolation, you know, some of the other challenges you mentioned are different. But in any case, for all these challenges, we can provide a toolkit. Admittedly, you know, it’s admittedly an imperfect tool. And to ?? tease out messages, we have to simplify. So one always has to be careful, but it’s a good tool kit. And then, you know, as regards the other issues you mentioned, I mean, going beyond GDP, for instance, going to Wellbeing. Clearly, you know, if a clean environment is part of the wellbeing index, then you know that economics can help to get a kind of good combination of, you know, prosperity and a clean environment.

Then we get into difficult issues. Even GDP is something that’s difficult to measure, something scientific like, you know, the pollution: that we can measure, but we don’t clearly understand the path (?) of these things and how, you know, how much CO2 emissions are really impossible. We all have a lot of uncertainty, not so much about measurement, but about the impact of the pollution. There are other areas where we have a lot more problems with measurement: happiness, for instance. You know, ultimately we want to be happy.

And can economic say something about happiness? A lot, yes, there is happiness literature. But one has to be a bit more careful that one doesn’t kind of move into a brave new world type setting where you say, OK, I mean, if happiness means you are not depressed or not worried, well, then let’s all take Soma or, you know, some of these other drugs. And then for very little money, we’re all very happy.

So it’s more complicated when the measurement of the goals is difficult. Well, then also you may have different theories on how to achieve it. And you don’t know which of the theories is really the one that is describing, so to speak, the problem. You know, like the pills theory versus the more integrated, better life theory and so on. So and then you have to look at the political incentives in the other areas.

You know, what kind of incentives do then policymakers have going back to environment? You know, policymakers are elected by voters and many of them are may be craftsmen or, you know, other people who say, I mean, if there’s a lot of money in this, you know, let’s get some of it fast.

And so then you get building insulation programs and subsidies and stuff like that, or you get the lobby of the solar panel owners on roofs.

So if you find it’s maybe not the most efficient way to reduce carbon emissions, you will still find that a lot of people will hate you if you don’t want to reduce their subsidies. So it’s, so to speak: the less monetary and measurable something becomes the more difficult to my mind it becomes to really draw clear lessons from an economic perspective. But in terms of behavioral patterns and the role of constraints and the importance of efficiency, I think that can be applied to many more areas.

And I have not commented on any of the other ones you mentioned. If you want me to comment on any particular issue, I’m happy to do that. But I think as a principle, it is a very good development that we are becoming much more sophisticated also in terms of what we actually want to achieve as economists. Thanks to the feedback also from our population who are not just happy anymore with getting more cars or more money or whatever.

5. As we live in an age of economics and economists – in which economic developments feature prominently in our lives and economists have major influence over a wide range of policy and people – should economists be held accountable for their advice?

Well, there is a market for advice by economists, you know. That market is not perfect. And economists are held accountable to some extent. Say, you advise a minister or an association, you know, doesn’t just have to be policy makers, it can be lobbies. And your advice is not comprehensible, you already have a problem and you will probably find your market value to be very low very quickly. Then if your advice turns out to be leading to bad results, you might also be punished by the market and by the demand for your services, but maybe not because memories are short and sometimes it’s also difficult to allocate, you know, outcomes to measures. And that’s often very murky. I mean, for instance, if you look at issues like debt crisis, if you see it as… Take the global financial crisis, I mean, some people warned beforehand of high levels of debt, of bubbles and so on. They didn’t have a high market value for their advice. While others, you know, warned more about… You know, it doesn’t matter whether, you know, house prices go up a lot and private debt, who cares?

Interest rates are low, public debt also. And so then the crisis came and, yeah, what happened to the people who gave the advice before the crisis? Things became so topsy turvy that… not really, I mean, it wasn’t really us, it was us to some extent. What what was the origin and why, what happened?

But, you know, you didn’t go and say, well, because economist X told us it doesn’t matter to have a housing bubble… He has to pay a fine now or pay back his consultancy fees or pay a penalty for the publication. So it’s very difficult because a lot of what is picked up as advice and analysis and advice, I should say, analysis and advice is not really picked up at the request of the economist who does it.

And it’s in a way, part of the freedom of analysis and speech, you know, to say what you think is the right thing. So I would say, no, you can’t hold economists accountable if they write nonsense or stuff that turns out to be nonsense, ex-post or if not nonsense, not practically relevant or even damaging. If people kind of give advice on the commercial basis, I would say there is some control through the market, but it’s always also an individual responsibility on the demand and supply side.

You know, it’s not just the economist who provides the advice that matters. It’s also the policy makers, the lobbyist, the public, the public, you know, who should scrutinise what they listen to. And if they don’t understand something, if it’s too complicated or if it doesn’t make sense, why, you know, then why do they follow the Pied Piper? So, I mean, our whole system believes in a way the competence and autonomy of the individual.

Now, we all know that’s limited, our rationality is limited and so on. But if you give up that principle, then you are lost. So to say the public can now sue Keynes or Hayek for giving advice eighty years ago, which got us into trouble. You know, where would we be? So I think that principle of responsibility on both sides, so to speak, of the market, is very important.

And as long as there’s, so to speak, not to be a misconduct, you could have people who deliberately give wrong advice because they don’t want to promote the objective that they were asked to promote but something else. So you may have liking corporates in politics, you may have misconduct, misrepresenting and then, of course, faked data, false data, for instance or deliberately wrong conclusions. But that’s kind of the liability you have in a business interaction. That I think should always apply. That kind of liability for good or bad advice, I think would kill the market, so to speak, because people would just simply not say anything and do anything anymore because there’s just too many…

It’s too difficult to find, so to speak, and to assess the quality of the advice and then actually assign the liability to make people accountable. I mean, we see a bit of this now where people start saying, for instance, you know, Milton Friedman is responsible for the excess application of the profit motive, which I think is a gross simplification. And if you read Milton Friedman, what he said has been much more sophisticated than that.

He may have said, I understand, that the profit motive is perhaps not a great motive. It’s a bit like democracy. It’s very imperfect motive, but it’s perhaps the best of the ones that could drive corporate behaviour.

And when I see that, you know, Milton Friedman gets blamed… But what is the alternative? You know, if the alternative is some social good, but it is hard to measure and so on, you know… What happens to shareholders who have saved the money and put it in with the trust that it would be put to good use, may find themselves expropriated because the managers suddenly say: sorry, forget about your profits, I am now doing some good for society or the climate… The policy makers may say, OK, this means we can expropriate the shareholders and force companies to go in a certain direction.

So this is just an example how, again, one has to look at the incentive effects of such conclusions.

And my conclusion would be that given all the uncertainties and the lack of information and the incentive effects, I would not go that far, except in the case of, so to speak, deliberate misconduct.

6. Does economics explain Capitalism? How would you define Capitalism?

Economics explains capitalism depending on how you define capitalism. I don’t like the term capitalism too much because it’s a bit loaded. Personally, I think it is unfairly negatively loaded, because if you think about what the alternative is, socialism, you know, then I prefer capitalism over socialism.

But the better term for capitalism, to my mind, is the market economy model. I personally would even prefer the social market economy model, which is kind of the buzzword the Germans love, in particular, where you have the market mechanism responsible for allocating resources, but government setting the rules of the game and providing goods and services, public goods and services and social safety nets, social insurance being one of those public goods and services which makes the market economy a social market economy and where strong education systems provide opportunities to everybody, a good infrastructure provides opportunities to everybody.

So social is not just an income distribution… has not just an income distribution dimension. It also has an opportunity dimension to my mind. You know, what help is it if only the rich can get onto the freeways and get good education? You know, economically, it’s terribly inefficient and socially it is totally unsustainable.

So the social market economy is, so to speak, my compass about what economists should strive for. Now, that is a variant of a capitalist economic model, but it is not robber baron capitalism or the jungle, the Hobbesian jungle without rules. So the term is used also sometimes to discredit certain ways of looking at the economy and economic policy making.

And we should be careful with that.

7. No human system to date has so far been able to endure indefinitely – not ancient Egypt or Rome, not Feudal China or Europe, not the USSR. What about global Capitalism: can it survive in its current form?

Again, if you mean by global capitalism the compass of a social market economy model, I think under different terms, because, you know, the Anglo-Saxon don’t use the word social market economy model… But that concept and compass, I think, will stay with us for a long time.

Whether more countries will follow on that route and implement that system is difficult to say, because I think we have two challenges. The first one is that in many or all of our countries, the model is not done in a perfect manner. You know, the markets don’t function perfectly. The governments provide public goods and services, but not in a perfect manner. Some better. Some less good. And we have new challenges that arise all the time, the climate change challenges is probably the most… apart from the military, that we don’t hate each other over the head and kill each other thanks also to our prosperity, because, you know, we would all be dead very quickly if we started hitting each other over the head today, given the degree of specialization of our economy. Nobody knows how to farm any more, we have way too many people and so on.

So you call it the global capitalism, or the widespread application of a social market economy type model which has, I think, already helped to reduce the threat of one of the most formidable, one of the worst human sufferings: the war. I really think that our economic model has helped prevent more wars. And when you look at where the wars take place, then it’s usually very local ones and typically in poorer countries, unfortunately, where it’s actually still possible to fight such wars.

So I think, as we get richer, the incentive to engage in war falls. The newest, really super formidable challenge is probably climate change, where in a way we all globally, at least like at least 60, 70 percent of the global economy, have to cooperate to master that. And there, using, to my mind, market instruments, the capitalist model to master this in the best way. But you need policy makers and national and international collaboration to do this, the market alone clearly will not solve this.

The market provides instruments that can help us solve it in the least, so to speak, with the least tradeoffs. And then the pandemic shows us that we also have to keep an eye on some other things. We have become extremely vulnerable for certain events like pandemics. The risk is also that the baby is thrown out with the bathwater: More state controlling systems like China maybe find it easier to deal with challenges like the pandemic.

For them, it’s easier to limit individual freedom to an extent that it prevents the pandemic from spreading or it can help eradicate it. And so the market economy model, with the political system attached that we have of individual freedom and autonomy of consumers and so on is not best at dealing with all challenges.

And it is conceivable that people think, OK, it is much more important to solve the pandemic than to preserve our individual freedom and the market economy.

And we allow the government to lock us all up. One of the worst conclusions after this pandemic would be exactly that, that people see aha: the Chinese are better able to deal with this, so maybe they have the better economic model. Because it’s not capitalism that… It’s the combination of the market economy, of capitalism with our individual freedom that makes us less able to to deal with it. So it is possible that our system… I mean, we all say covid has been the worst crisis in the century.

And that’s true economically. But it could be much worse because the death rate from the infection could be not one percent, but 10 or 50. And then things would really collapse. And then afterwards, you know what conclusions would be drawn from that?

So I think we are actually quite lucky that we got a pandemic like this one where where we can kind of still maintain a system that preserves the individual freedom and allows to also use the market economy model to solve it.

And I hope this will be the conclusion afterwards.

But you see already from the discussions that we are leading about more role of the state, more public spending. You know, drawing the right conclusions, is not so obvious. Our medical system is really underfunded or is the money just poorly targeted? Is it market failure or government failure? And if it’s both or if it’s mainly government failure, then how can we improve the functioning of our governments? And if the government was the problem at the root of the crisis, more spending, more government may not solve this. And it is not the trade of indebtedness, so we might stumble and stumble into the next debt crisis, given how the numbers are developing. So and then if we do that, thanks to covid, and then we have problems in Europe that we might, for the time being we have found solutions, but there is no certainty that our economic model will become the global economic model. For economic reasons, because we may not be able to handle certain problems, and we may not draw the right conclusions. Then we have a system competition where leaders of other approaches may also invest time and energy to preserve their privileges as dictators or whatever because they want to eliminate a competitor.

I mean, our system is a competitor and we are not competing in a fair political global market, but we are competing in a market where some countries may invest a lot of money to kind of undermine our system. So, in short, my answer is no. There is no predetermined path, but it speaks for a close and good analysis of what, so to speak, successful systems are and alertness by our governments to improve for their own, for the sake of their own survival…

But individual politicians, of course, have very little incentive to do that. But as a society, we have a huge incentive to do so. And that requires, of course, good analysis and a good historic thinking also, which is sometimes a bit neglected. We kind of operate on a day to day basis, instead of kinda taking a bit the longer view. But yeah, I’m still optimistic. And in a way, the fact that a system like the Chinese one, you know, which adopted a lot of market mechanisms and incentives, to be successful and survive and make its population better off… In many countries, this has been also the transition then to more free societies. I mean, if you look at Germany in the 19th century, with rudimentary elements of democracy… It was not a politically free system. And we went through terrible turmoil in the following decades. But I think there is a chance that over time, our system, our market economy system will prevail more.

8. Is Capitalism, or whatever we should call the current system, the best one to serve the needs of humanity, or can we imagine another one?

Give me a minute, because I think to synthesize key messages from different angles is always good. Capitalism as such.

No. Capitalism defined as the system of reckless, uncontrolled rule of the market, with elements of the jungle, where the stronger dominates… No. That system will not prevail. And frankly, I think it doesn’t really exist in that form anymore. I mean, the Manchester capitalism, that’s history, long ago. The social market economy model, where it is applied with diligence, taking into account, so to speak, from the micro and macro level of our constraints, I think has a good chance to prevail as the, you know, the best possible system.

It’s always possible and it will differ across countries because of culture, because of history, because of institutions. There is a risk that the state capitalist system will prevail… Not prevail, will be seen as a success story to copy by more countries in the coming decades. But I think anybody who wants to follow that model has to understand also why and how it works, to some extent, in China and in what conditions and why it might not work elsewhere.

You know, like we had the time between 45 and 90, was the competition between communism and Western market economies, the coming decades will be the competition between state capitalism and a more social market economy model. And it’s the more complicated challenge because the state capitalist system is the more successful one, is the better competitor. Socialism ignored the lessons of micro and macro economics because of budget constraints on the macroeconomic side and ignoring incentives on the macro side. But state capitalism doesn’t do that to the same extent. It does to some extent, because it keeps people out of the political market or it keeps the involvement very controlled and very limited. To my mind, economic freedom without political freedom is very difficult to marry.

So I don’t think that they will succeed, but it will be a great competitor and a great temptation, a great temptation for many countries, perhaps even more in developing and emerging countries, to follow that model.

So we are doubly challenged internally to improve our own countries and externally to win in that competition.

About Ludger Schuknecht

Schuknecht studied Economics at Ludwig Maximilian University of Munich and George Mason University. In June 2000 he obtained his habilitation from the University of Constance. Previously Schuknecht was Chief Economist at the German Ministry of Finance and heading the Directorate General Fiscal Policy and International Financial and Monetary Policy there. In this role he advised Minister Wolfgang Schäuble on economic policy issues in the domestic and international sphere. Schuknecht left after the departure of the fiscally conservative Schäuble and the arrival of his social democrat successor Olaf Scholz. In 2019, he was replaced with Jakob von Weizsäcker. Before that Schuknecht was Senior Advisor in the Directorate General of Economics of the European Central Bank where he prepared monetary policy decision making. Schuknecht had also headed the ECB’s fiscal surveillance section and served with the World Trade Organization and the International Monetary Fund. As a scholar, Schuknecht’s research focuses on public expenditure policies and reform and the analysis of economic boom-bust episodes. Together with Vito Tanzi he published “Public Spending in the 20th Century: A Global Perspective”.

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