Scottish. Economist, author, William R. Rhodes Professor of International Economics at Brown University
1. Why does economics matter?
OK, why does economics matter? Economics matters because it’s the only social science that manages to do two things. The first thing is to explain the world. So does anthropology, so does political science. Right. What’s so special about economics? Economics is also a thing in the world. Economic knowledge is not just endogenous, it’s causal.
If markets believe certain things to be true, they will make allocation decisions which affect the world. This is what Donald MacKenzie, the economic sociologist, referred to, quoting a line from Milton Friedman, that financial theory it’s not just financial theory, economic theory in general is an engine, not a camera. It’s something that is powering the world in a certain direction rather than simply passively recording it. So it’s a way to explain market relationships. It’s a way to talk about certain sort of causal dynamics in the world.
But what it also does is it sets off this boundary between the world politics, the social, the family, etc., and then draws these rather bright line on this thing called the economy, the world of market exchange, and then also uses a set of technical or set of mathematical and other statistical techniques to describe that world and sense bring it into being. And that is what we react to in terms of politics, if you will, the political economy.
Now, nobody else gets to do this, right? That’s what makes it very powerful. And the last thing that economics does, it’s a language of power.
If you get to dictate what is efficient and what is inefficient, if you get to say what is optimal, I mean, think about the whole language of constrained optimization. This is an optima. This is an equilibrium. Clearly, that’s a good thing. You don’t want to be out of equilibrium, right? Then you’re in a very interesting position politically because you’re able to set boundaries on what we can and cannot try in the world.
I will give you a very simple example of this. The way that we mean thinking and modeling the economy for the past 30 years with a vertical Phillips curve and a natural rate of unemployment. All that sort of stuff… Means that wage militancy - attempts by workers to bargain for and improve their law - simply can’t work. It will simply disappear in the form of inflation or higher unemployment. And yet we actually look at the world now and we know that that curve is completely horizontal or at least highly skewed. You can have any amount of unemployment you want at a pretty much constant rate of inflation. In fact, we haven’t seen inflation anywhere significant from the way we usually think about it for 30 years.
And what we found in the United States, for example, is that over the past three to four years, you can’t raise wages at the bottom and it doesn’t result in inflation. So that means that’s wrong.
Now, that’s important, because what you’re saying is you can’t try that, you shouldn’t try that. It will end badly. And then when it happens, you go well, well, it seems to work out OK. That’s politics, not just economics.
2. What are the differences between economic science (academic economics) and economic engineering (policymaking)?
If only that distinction were as clear as we would like it to be, there is the question to what extent economic knowledge is science with a capital s? To me, science relies upon constants and really doesn’t try and model social entropic system, highly complex, open with non-linear dynamics as engineering equilibrium, which is essentially what economics does. And that’s part of the reason it kind of gets into trouble. It’s not fit for purpose for the system it’s examining, hence the calls that various people are making for new models and new ways of thinking about economics.
Now, do policymakers really do engineering? Well, they’d love to think so, but I’m not sure that they do either. The ability to look up different policy interventions, to cure social problem X and look at the requisite RTC score and say that’s the one. I think that’s hubris. I don’t think that’s really engineering in that sense. So I would sort of question, if you will, those two starting points on this one and I’d add another one to it, which I think is important.
What matters less are the formal models that we work with and more the folk models that are in people’s heads. That’s what politicians ultimately have and that’s what they respond to. And I’ll give you a couple of examples of this. Back in 2014, the Bank of England did a quarterly report on how money is made, money creation in the economy. And they basically said, yeah, it’s endogenous money. The loanable funds theory is pretty much crap, really.
Banks get banking licenses so they can get insurance. Most of the money in circulation is in the form of credit. Pretty much got it backwards. No, this is hugely consequential as an admission because it means that things you get taught in economics, like crowding out and all the rest of it are probably deeply flawed. So it matters, the politicians know this so well. Of course, they gave that report to all the people in the House of Commons and then a couple of years later, someone went along and kind of pop-quizzed them and said: how is money made anyway? Well grandma goes and puts our money in the bank and then that’s loaned out to a firm.
So you didn’t break the folk model. You can have all the kind of technical knowledge you want, you can have that debate inside the economy and inside policymaking circles. But you’ve got to be able to actually hit the folk models that are in the heads of policymakers and in the heads of people out in the world. Right? I’ll give you another example… MMT theorists love to say that, well, if there’s a public sector deficit, that means there is a private sector surplus.
So that means that’s good because the private sector will pay more. Well, accounting identities are not causal identities. If you go to Germany, for example, German economists love to point out that the 1979 and 1981 Economic Advisers report pointed out that when there was a large budget deficit in Germany, the public saved more rather than spent more. And what matters is the behavioural response. And what is it that primary behavioural response? Is the folk models in your head, not the formal models that we write down.
So I think that those relationships are much more contested and need to be more contested than they actually are.
3. What role does economics play in society? Does it serve the common good?
It can do, absolutely. I mean, I’m not saying that this is sort of some set of bogus math foisted upon the world, it can be incredibly useful and incredible illuminating. I wouldn’t waste my time and large chunks of my life thinking about it and writing about it. I don’t think that was the case. But there’s the way that we think about it can also have deleterious effects.
So let’s go back to the OECD 1984 jobs report, which made the case for flexibility in labour markets. When you read that now, it’s a very interesting document because at a time when we’re concerned with the fragility of labour markets, the costs have been thrown onto workers, the lack of compensation mechanisms and insurance mechanisms, we talked about precarity, all these sorts of things. None of that is imaginable in a world where basically allowing markets to be more liquid, allowing labour markets to be more flexible.
But there’s no people in that report. There’s no question as what will these policy reforms do to single mothers trying to get to work, right.
And I think what’s happened… Partly this is the past 15 years of the turn towards kind of empirical micro and the way that sort of macroeconomics is reconfigured itself after the Great Recession and also a generational shift in what economics is interested in and economists are interested in general. I don’t think that report could be written now. I think that what we’re writing now is… When Piketty first started doing his work, the kind of the mainstream old guard was like, oh, we don’t do this, that’s nonsense, you don’t have to think about distribution. I can’t imagine an economist actually coming out and saying, you don’t have to think about distribution. Right. So I think that there’s been a shift in orientation and that then leads us into where should economics be applied. And if one thing is clear, it’s in the economics of the climate crisis. But there’s been a great deal of consternation on Twitter and elsewhere about whether the economics we are using is actually adequate.
I remember an OECD meeting and someone pointed out that if you basically run the models backwards on the estimates of economic losses from climate change, using the standard models, then essentially if you go back to the Ice Age when New York City was under several hundred metres of ice, you should only be losing four percent of GDP.
So clearly, that’s wrong and that type of thinking can do harm. But if we are aware of those limitations, if we’re sensitive to those limitations, then it can be applied in ways that are incredibly helpful to society going forward.
We have to do a green transition. Every country has to do it. We have to do it as a planet. The costs of this are huge, but what’s even more important is how you get there.
And that’s going to require enormous amounts of FEMA bribery to the most vulnerable and most affected groups to basically wean them off of carbon. How do you do that? Well, partly it’s politics, but partly it’s economics. And partly it’s thinking about how do we do this in the best, most equitable way. That’s a question of justice, but it’s also a question of efficiency and economics.
William Hynes: Yeah, the the environment workers you referred to was by Steve Keen looking…
That’s right, it was Steve. You’re right. Absolutely. It was a great presentation. Very, very disturbing. Yeah.
William Hynes: And criticizing Nordhaus, William Nordhaus, the Nobel Prize winning economist. But I did want to ask one follow up. You mentioned the 1984 report and how things have changed, but structural reforms are still essentially the centerpiece of economic policy and the advice is still about flexibility and competition. What’s your assessment on that today? Do you think it’s changed to reflect these realities and how the discipline has changed? Or is there still a sense that if we get the structure of policy settings right, the market will self organize? And so therefore it hasn’t changed that much in terms of what the fundamental advice is?
I think that you’re still right, but it will become less right over time. I think that there’s a shift away from the kind of standard, sort of three equation new Keynesian model where the supply side determines everything. I think that people are once again thinking about demand as its own thing and the importance of demand and rethinking a lot of the fundamental architecture to do with trade offs between unemployment, inflation, et cetera, that are built into those supply side models which lead you then to see structural reform is what you need to do.
No, the thing about is, it’s not as if structural reform is meaningless. I mean, Italy hasn’t grown in 20 years. Is it all because of structural reform? No. If you look at the structural reform indices during the 1990s and the early 2000s, Italy was one of the best performers. So clearly that’s not the only thing holding them back, being in possibly the wrong currency and then being having a very old society that doesn’t generate a lot of domestic demand when that’s what the growth model demands, that’s probably it. And I think there’s a beginning to be a realisation of this. I saw something very interesting the other week, and it was a research publication from one of the hedge funds.
And they’re a good bellwether for like how people in the mainstream think about economics, call them the economic users, the customers in a sense. And that was a very interesting piece because what they said was, if we all accept now - interesting he said this - there’s no such thing as a good recession. Right. It’s not therapeutic, It doesn’t clean up the system. You never get back to where you are before. And the IMF basically crunched the numbers on all the recessions they could find and they basically proved this.
But what they also showed was that countries that did have good structural reforms were the ones that had more flexibility, better buffers, et cetera. And it depends on what you mean by structural reform. In many ways, Denmark is a wonderful example of structural reform, but that’s not what’s usually in the folk model of structural reform.
But nonetheless, the countries that have actually got good structural policies tend to do better coming out of recessions. I totally accept that, I think that’s probably true, right? If you have a crappy sclerotic cartilages labour market that’s resistant to change and you have a recession, it will probably be harder to get out than one allocates labour a bit more efficiently. I’ve got no problem with that. Is that the answer to everything? Is that what we do in policy?
I think that’s part of the problem that we’ve been facing up to for the past decade or so. And I think that the wheels are beginning to turn on that.
William Hynes: Yeah, it’s also very related to this issue, which is everybody talks about right now, which is resilience and it’s very clear that if you talk to economists who believe very much in structural, they’ll argue that basically the more flexible things are, the more you’ll be able to absorb a shock. So more structural reform means more resilience. Whereas if you come at it from more an engineering natural science point of view, then the more efficient you tried to make these markets, the problem you create for resilience. So there’s very different perspectives, it’s really hard to reconcile them as we move forward. And there’s still a lot to talk, by the way, on the cleansing effect of recessions and the zombie firms will go out of business. And, you know, this is a good thing, but yeah.
Yeah, I’m not sure. Not one note. I think this is slightly different. The real example of the cleansing recession one, is the expansionary fiscal contraction. And I just do not see that one coming back anytime soon after the disaster that was the European and British experiments with this. So that one’s got no… Ask about the latter one. Are we basically holding up sectors which are never going to come back?
Maybe. Is that actually the case that the American solution of giving expanded unemployment benefits may actually be better in the long run for getting out of a recession and putting everything in mothballs for a year and a half?
Maybe. I’m even willing to go probably on this. Like I say, it’s not as if structure doesn’t matter. It deeply matters. But I think we have to recognize that it’s not “the thing” that matters, and I think that’s where the essence is - where the wighting is changing, shall we say.
4. Economics provides answers to problems related to markets, efficiency, profits, consumption and economic growth. Does economics do a good job in addressing the other issues people care about: climate change and the wider environment, the role of technology in society, issues of race and class, pandemics, etc.?
Apropos what I said earlier, it can do, and I think the economics more and more is beginning to focus on these things. But let’s take a couple of them, for example, right. So that was caused by the contrast between the old and the new on this. For a very long time, the go to answer from the entire profession on climate change was carbon tax, carbon tax, carbon tax. And as a sort of a technical solution, a sort of Pigovian tax on this. Yeah, it totally makes sense. Get it, great, wonderful.
Why is it happened then? Well, and then basically everyone gets some bottles and walks out of the room. And the reason is politics, because for it to actually matter, it would have to be levied in such a way. It would make those sectors extinct. Now, in a way, that’s kind of what has to happen and it’s a very blunt weapon for doing that, there are other ways of getting there. No, but the fact that we don’t think of it that way, we think of it as something akin to basically a VAT tax or a sin tax or maybe some kind of pollution tax.
It’s just completely inadequate for the task at hand, unfortunately, because if that’s your main policy, till you’re going to have to do it at such a level that it just basically destroys the thing you’re trying to regulate. And then basically economics doesn’t have an answer. It just doesn’t have an answer. Well, other economics and other economists do have answers to that, which is basically things like, hey, we seem to be in this environment that Sebastian Mallaby recently called Magic Money loans. Because people are willing to lend us trillions of dollars of states at a negative real rate, which we can lock in for 20 years.
Why don’t we just use that and just decarbonise society through massive investments?
Yeah, well, that’s still an economic argument, right? So basically, it depends. This sort of the old standard school that we’ve been criticizing, a structural reform supply side, dominants, monetary dominance, everything that we’ve grown up with, that is changing. And it’s changing because the world has changed. And it’s also changing because economists have changed and they’re beginning to realise the limitations of looking at the world in this way. We don’t live in that world anymore. And in a sense, our economics has got to change and catch up with the world that we live in and the world that we’re going to have to live in going forward.
Can it work with race and class? Yes, absolutely. And if you think about Mehrsa Baradaran’s book, The Color of Money, just a brilliant sort of exposé of the systematic exclusion of African-Americans from finance in the United States. It’s an economic argument and good economic arguments that point out not just injustices, kind of blind spots in our logic, are incredibly important weapons in the arsenal of reform and stability. So, again, I think the economics can do a fantastic job.
Whether it has done a fantastic job is a different question.
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?
Right. This is great. This is the Taleb on the “skin in the game”, right. Should you have skin in the game? So here’s an interesting… I was thinking about this just a while ago because the skin in the game question for economists is the same one that was asked around 2008 and 2009 with credit rating agencies. So in order to get listed, you need to have a CRA say that you are OK, so they issue a report on you and give you a rating.
And then when it turns out your rating complete junk in the world blows up, you should be liable for it, right? No, it was just an opinion.
Right. And I think that basically economics and economists have exactly the same thing going on. So if you think about the effect of the late Alberto Alesina on economic decisions at the European Commission and other areas around 2010 with the expansionary austerity argument, well, that basically caused the lost decade of growth in Europe arguably.
It led to the impoverishment of hundreds of thousands of people in southern Europe. Lives and businesses were destroyed because they tried something which was prima facie logical and actually, when you thought about it for five minutes, just more than a wee bit daft, and it blew up in the face. Now, should he be partially responsible for that? That’s an interesting question. I don’t know how to call that one.
If you did what you’re doing, as you’re presuming a degree of scientific exactitude in economics, which simply isn’t there and I think it would be unreasonable to expect that. But then by the same token, if they want that protection, if you want that liability protection, economists should be a lot more careful about what they propose. Right. You can’t have it both ways. If you don’t believe that you have the scientific exactitude to make exact point predictions that when they go wrong, you’re willing to have skin in the game for, then don’t say that you actually are the master of science that has it all figured out.
That’s basically what to press on there.
6. Does economics explain Capitalism? How would you define Capitalism?
God, that’s like the question of what do we mean by value? If you ever want to confuse a Marxist, just basically set him or her down and say: tell me about value and then come back two weeks later, they’ll still be talking.
As to what capitalism is. So one way to think about capitalism is the way Karl Polanyi, the Hungarian historian and kind of economists from the 19th century and the mid 20th century thought about it, which was the commodification of everything, the creation of everything for sale value rather than use value, and the rise of one big market that is completely interconnected. So that’s one way of thinking about it. The updated version of that is probably Branko Milanović, his book on capitalism as the only game in town.
And I used to spend a lot of time thinking about what this thing was. And then I just finally realized that I didn’t need to. So here’s how I think about it. The following is absolutely true. Markets and market exchange and very complex market societies have existed for thousands of years. The Romans had mortgage markets. The French, at the time of the revolution, and the era of paper money, had derivatives floating around.
So we can be quite sophisticated in this and use value versus exchange value, although I’m not sure that they really work as concepts. Are markets prevalent? Yes. Are the useful? Yes. Do people use them? Yes. Are they great ways of passing information around and all the rest of it? Yes, absolutely.
And the form that we have now is one that works on a kind of linear process. And here’s what I mean by this. You have X, you want to turn it into Y, you may or may not add value in the process and then you end up with a ton of waste. And that kind of linear version of capitalism and markets has been powering us for about two hundred years. I think that’s coming to its end.
And in fact, given the need for a green transition, it is coming to its end. So in opposition to the sort of the Branko view of the world, you have the Kate Raworth view of the world as the doughnut. Now, I like that as a metaphor. But in terms of the practicalities of building the doughnut, Branko had a couple of nice tweets on this, where he just did back of the envelope calculations, he said: if you want to bring up the bottom to even halfway up the OECD, you basically have to take half of the OECD’s wealth and give it to the bottom.
This would be the largest redistribution project in human history. It’s just never going to happen. But I’m not sure you have to think about it that way. I think we can think of a different form of capitalism, one that people who talk about, which is related to the doughnut stuff but is different. The circular economy, the whole idea of treating waste no longer as waste, of thinking about these as closed loop systems of going to flows rather than linear processes.
And the fact that you have things like large mining companies around the world, for example, thinking about just stopping mining because the grades are so low now and the technology is better that they can go back and mine all the waste that they dug out the ground. So you can go there rather than go further down, shows that there’s a way in which we can get much better at this. Like no one’s really ever cracked recycling. If you do, right, and you think about plastic recycling through bacteria, all the rest of it.
Then the gains you can get in this are enormous. And then you can do these scale tricks whereby you could have closed loop systems interacting at different levels, which is much, much more of a kind of complex systems, natural systems, biological systems way of thinking about capitalism. And modelling and doing it, rather than the kind of 19th century equilibrium engineering approach, which I think has really reached the end of its tether. So long winded answer to say essentially: capitalism is what capitalism is, but the form that we’ve been using has hit the buffers. What we now need to do is get off a kind of a linear process model into a much more circular model and then work at different scales of deployment of firms, at industries and households to make that work and become more sustainable. And that’s part of what we’ll have going forward. Now, if we crack this, we will still have capitalism because I will have stuff and you will sell stuff and we will exchange through the market.
But it will be a very different one. And that’s what’s important.
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?
Yeah, I mean, I just go back to where we left it off before, I don’t think it can survive in its current form because it’s essentially it’s a kind of a linear process monster that uses tremendous amounts of energy, badly, to create enormous amounts of waste that we can’t deal with. And we need to basically get to a much more closed loop circular form of capitalism operating at different scales with multiple levels of redundancy.
And that can be done. So I think that’s it. But here’s the weird thing. Let’s go back and think about capitalism as a thing. If you define capitalism as voluntary interaction through a price mechanism in order to exchange goods and services, then we’ve always had capitalism.
The Roman Empire was capitalist. But that’s a crazy thing to say because 90 percent of the work was done by slaves. So if 90 percent of a society run by slaves is also a capitalist, and we’re also capitalists, then the word becomes meaningless. So in a sense, you can sort of elevator up and say, well, we’ve always had markets, always had market exchange, We’ve always been capitalist . And I think that’s kind of right. But at the same time, when you think about concrete historical social formations where markets have been employed, pace, the Roman Empire, et cetera, et cetera, then they’re massively different. And surely the fact that 90 percent of production was done by slaves matters more than the fact that they had a mortgage market for very rich Romans. So, again, the devil is in the details here. If we define it in a broad way, it lasts as long as we last because market exchange is really, really efficient.
And until we get to the point of having Star Trek matter-replicators, where literally there are no more resource constraints, then we will have market exchange and we will have price mechanisms, etc. It’s going to be very different once we really grapple with the green transition and hopefully get to the other side. Hopefully that happens in my lifetime and I get to see it. But it will, you know, to quote Star Trek again, it’s capitalism, Jim, just not as we know it.
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?
So it’s a very interesting question because in a sense, if you go with that broad definition of capitalism, does it serve the needs of humanity? Well, the fact that we’ve got about seven point two billion people on the planet, if you look at Branko’s work on global inequality, while the Midwest and the north of England have been slashed, Asia has grown more than it’s grown in one hundred years, et cetera, et cetera. There’s lots of stuff there that seems to be working.
But again, it’s working against limits and it basically is unsustainable and it can’t go on that way. So does it serve those needs? I think on a short term basis, the efficient allocation of goods and services through a price mechanism, using some form of money that is reasonably well accepted, if not guaranteed, is a pretty reasonable way of organizing stuff.
Is it the zenith of human civilization, is it sort of like, you know, as Hayek would have, basically, there’s a line beginning with Tacitus running through the Middle Ages and ending with the British Empire and the rise of Sterling before it all goes wrong with socialism? I don’t think it is a sustainable claim. Alongside these markets that are always states and states come in lots of different flavors. So Chinese communism, which is a phrase that we thought we’d forgotten until Xi reminded us: no, we are actually communists, we’re quite serious about this. That’s one. Russian petrol, crypto capitalism is another one. American, we don’t really give a damn about anybody else or really care about inequality and we might not even care about climate change, is another one.
There are a lot of different formations out there. They are the things that matter most impacting people’s lives, not the fact to all of those countries use markets. So I think we need to dial back the sort of center of civilization is the rise of market society and think about the sort of real states and social formations and social movements, etc. That is the world that we live in. It isn’t the economic right, because that’s what people react to, that’s where they live.
That’s what’s important. I used to say to my students years ago: if you think about it, they used to be the show on CNN, probably still there called Headline News. At ten minutes to the hour, at the start of the hour and for ten minutes you get the news. And the news is about stuff. It’s about people, right? People and politics and sports games and whatever. And then ten minutes after the commercial break comes the economy. As if it would be an entirely separate sphere of the world. So I get up in the morning, it’s like, well, until one o’clock I’m going to be dealing with the polity and family, from two on, we can do the economy. Right? And that kind of weird sort of bifurcation that economics also encourages us to make, to think about it the world in that way.
I think that’s got to go. I think that that’s really what’s got to go for it to become sustainable.