Irish. Economist, Head of the New Approaches to Economic Challenges Unit (NAEC), OECD
1. Why does economics matter?
Economics really matters because of the way that we organize our society and the way we think about progress in our economies. In societies all over the world, we’ve basically made economic growth essentially the number one objective of public policy. And this is what people pursue: people want higher incomes, they want better quality of life, they want opportunities. And we’ve chosen to design a system which organizes a lot of these ideas in terms of markets and in terms of our economies.
Economics is a way of understanding that. It’s a way of understanding people, how they behave, how they optimize, what sort of preferences they have and what decisions they make; and then taking all the individuals and all the agents in our economies – consumers, firms, countries: they all interact in a way which leads to this systemic outcome, which we call the economy. So economics is really important for helping us understand people in a certain way and then also understanding the economy.
The question is then: can we engineer the system? Can we actually institute policies which help us achieve certain economic objectives and therefore help people achieve their objectives and what they would want from a good life? Why does it matter? It matters first because of what I’ve said: to understand these things, you need theories, concepts. You need data and evidence. And you need a way of thinking about how to optimize the system, how to increase economic growth, to think about society as a whole, and to think about the ecological foundations on which the economy rests. Economics has provided us the tools to do that, to analyze this very complex system of the economy, but also the very complex nature of human beings and how they make choices. I think it certainly matters because it influences a lot of the policies that governments institute. It influences the activities and behaviors of firms. And it also affects everyday life, everyday interaction.
So it’s tremendously important. But it’s a framework. It’s a way of thinking about all these issues. What we’re going to discuss is that there are other ways of thinking about this, that economics is maybe too rigid a framework. And of course, economics doesn’t speak with one voice. There are many different economic theories and ideas which have very different takes on how to generate these positive outcomes and how to essentially manage and run an economy.
Economics matters because of the way we think about our world, essentially. It matters in the way we think about ourselves as individuals. It matters because ultimately we all want to have a better life. And we need to have a system that will generate benefits, that will be able to realize the benefits of technology, of commerce, of interaction, of building our economies, our infrastructures, and selling goods and services to each other.
Economics matters because we need a framework for understanding all of that. And then, in a second step, we need to design policies and measures that will help to maximize the opportunities of people who would be operating within that system. And we also need to think about the rules of the game that will create a level playing field for people to compete, for firms to compete. So that we can have the forces of competition generating benefits for people. And markets are a good way of allocating resources in our society.
So economics is extremely influential and more influential, perhaps, than is often thought: it often is the dominant philosophy in designing public policies. So it really matters in its influence. James Carville once said that he didn’t necessarily believe in reincarnation, but if he could come back, he’d come back as the bond market because then he could intimidate everyone. And so economics really does matter.
Financial markets, the role of the state, economic performance: all of these things are not minor aspects of life in the 21st century, they’re dominant features. And economics can help give us a handle on these things. And I think the promise of economics is that it actually can make people’s lives better. But as we talk about it in this conversation, that potential hasn’t always been realized.
2. What are the differences between economic science (academic economics) and economic engineering (policymaking)?
I think to answer this question, we really need to understand the origins of economics. Where did it come from and, in a second step, why did it become so influential in informing public policy? Contemporary economics is rooted in classical physics. In the 19th century, people like Walras believed that to understand the economy and societies, we could actually look to the natural sciences. And just as we understand how the planets orbit around the sun, there are similar mechanisms which help us understand how an economy functions, that the economy essentially is like a machine that we can tool up and we can tinker around with. We can make it work better. And that’s really the origin: that we thought that equilibrium, that gravity models were very good ways of thinking about the economy as a whole, about trade relations and about some of these big topics.
So that’s where the science comes from. It does have its roots in physical sciences. The problem is that while classical physics has really moved on (and we’ve moved into string theory and a whole range of other things), economics remains stuck in the past and in its origins as a scientific discipline.
For instance, Paul Romer, who recently won the Nobel Prize in Economics, has written a paper called the “Problem with macroeconomics”. And he basically argued that while physicists might lament the fact that physics hasn’t moved forward or there have been periods when it hasn’t moved forward, macroeconomics actually moved backwards in the last 30 years. We actually understand less about the macroeconomy.
I think the question that you asked is very much inspired by Gregory Mankiw, who was the chairman of the Council of Economic Advisers under President Bush. He said that the economic science had very little to do with the economic engineering that policymakers use. In other words, the academic discipline had become detached from the tools and the techniques and the theories that policymakers need. Why did that emerge? Well, again, Romer gives us some clues. He argues that a big problem in the academic discipline is the deference to authority, that essentially the economics culture is one that tends to keep out new ideas and it tends to reward those who follow the authorities in the discipline.
So the science has become more and more insular and detached from policymakers. Policymakers have very specific goals and this is politically charged: if GDP goes down, governments get voted out; if prices are rising, consumers are unhappy and then, again, there’s going to be a political backlash. At the moment there’s a lot of concern about how the Covid crisis is being handled and what is going to be the impact for jobs.
There’s dysfunction in the machine. The policymakers just want to find ways of making things work better. And if they look to the scientists, the economic science, they don’t always find the answers. And there’s a good example of this. When the Nobel Prize winners of economics in 2008, just after the global financial crisis hit, were asked the most obvious question you could imagine of an economist in November 2008, which was: how is your research relevant to understanding the global financial crisis? Sargent and Sims, the two Nobel Prize winners, had to reflect that actually the research didn’t really tell you anything about the financial crisis. And this was two macroeconomists.
This disconnect between economics that’s useful for solving problems and economics, that is essentially like poetry, you’re writing for other poets – it’s not necessarily something that’s really helping us solve societal problems. And I think this is a major problem.
For instance, I was chairing a discussion in Spain once, and there was an economist who had a Ph.D. from Harvard, a very celebrated economist in Spain for his understanding of the housing crisis and other phenomena. And I put this to him, saying that a lot of academic work in economics was just not relevant to understanding these problems. And his response was quite revealing. He said, well, who ever said that economics should be relevant for policy? It’s a perfectly respectable academic discipline and academic pursuit. So, what’s the problem? I think we do place a lot of expectation on what economists can tell us. There’s a lot of very serious problems before them to solve. The economists are very good at solving certain problems, particularly problems that can be solved with markets. But the problem in policy is we’ve tried to apply that logic and that reasoning to too many disciplines, to too many questions. I don’t think, for example, traditional economics is very good when it comes to understanding climate change and the policies that we need to address a big systemic problem like that. It’s also that for policymakers we want, you know, immediate answers. Well, economists haven’t ever really been able to figure out what caused the Great Depression or the global financial crisis. There’s still a debate on what caused these bigger eruptions. That’s another reason why there is a disconnect. Academia can spend a long time trying to work out some of these answers, using very sophisticated approaches. But the problem is that we do policies in real time. We need to respond in real time to these issues. That would happen in any academic discipline that academia would be operating at a different speed to the world of policy. The difference is that we rely so much on economists for dealing with everyday issues. So I think that’s one of the issues.
What the previous crises have also told us, is that if there is going to be a change in economics, it’s probably more likely to come from the engineering side, from the policymaking institutions than it is from the academic side, because policymakers have to face the consequences of their mistakes. Academics can retreat into their beliefs, but policymakers can’t do that. If they get things wrong, there will be a price to be paid. And so if there is a push for changing economics, I think it’s coming more from the policy side than from academia.
3. What role does economics play in society? Does it serve the common good?
I think the question might not be what role should economics play, but what sort of economics. I think it’s very clear we do need a discipline that helps us understand consumers and firms, and this cat’s cradle of connections that we have between different entities in an economy. We need something to help us navigate all that complexity. The problem is that economics has generally tended to simplify, to make an economy, which is a very complex system, tractable, to make it understandable, to reduce it, in a sense, to a set of equations based on a few assumptions about individuals and about the system as a whole.
But in a way, we’ve lost the complexity with these frameworks because they’re too narrow in their construction. We assume that the economy is a closed equilibrium system that will get knocked off track but will converge back to that equilibrium. Again, like the old classical physics ideas. But the economy isn’t like that. It’s constantly evolving, changing, reorganizing, and it can break down. It’s not that it gets knocked off track and then it just will automatically through a combination of structural reforms… it won’t find its way back to the steady state. It actually can fail and it can take a long time for it to reorganize and to find a new way of operating. And to be resilient to shocks.
To do that, we need a different type of economics, to really understand that the economy is a complex system we need what I call integrative economics. Integrative economics is essentially one that borrows from other disciplines, that does have the rigour and the analytical tools and techniques from the hard sciences, from physics and biology. But also is cognizant of our societies, our histories, our cultures, because all of these things matter. It’s not just that we’re all individuals who make the same sort of decisions and optimize the same sort of way. All of us are different. And crucially, what traditional economics misses is that we we don’t make choices in isolation. We actually make a lot of decisions based on group think and on what our neighbors are doing, on status anxiety, on keeping up with the joneses. All these things influence our decisions. So we need a richer framework for decision science, cognitive science, understanding the brain and neuroscience, because ultimately a good understanding of economics is all about understanding people. So we need to have those sciences and we need the humanities.
Essentially good economics has good narratives. Then we need to understand history and we need to understand political science: why do people make certain decisions? Why did they vote in certain ways? How are they influenced by what happens in the economy? This is a lot of disciplines. You can’t get this richesse, you can’t capture it with the frameworks of economics. You need to go much beyond that.
I think economics has its place, but a different form of economics would have an even more important role to play in society, by integrating all these different aspects of human beings and society. And that will help us to solve human problems. I don’t think the economic frameworks as they are will really help us to do that.
So, to answer the question, if it’s the existing economics, it probably should have much less influence. But if it’s a new form of economics, then I think its role is legitimate. And if the objective is still to boost economic growth, then economics gives us a better handle on that issue than many other disciplines. But it’s incomplete.
Because economic growth and even markets – markets are not cars following natural laws. These are human constructs, we’ve built these human made systems. So we can create the rules, the regulations, the safeguards, the buffers to make these operate in a way which will benefit people and not at the expense of the environment. These are choices. These are things we can do. So it’s not that we need to rely on the very narrow definition of economics. But economics is a way of helping us understand some aspects of these complex systems.
Does economics serve the common good?
Let’s look at the results of our economic system. How are we doing? Now, some economists, who would defend the existing discipline and approach, would say: look at economic growth, look at poverty reduction, which globally has been falling for decades. Look at health improvements. Look at life expectation: it’s been growing for centuries, two centuries now, in very dramatic ways. And this is spilling over to the whole planet.
Obviously, something’s gone well. And we have an economic system which generates growth – it’s slowed somewhat in the OECD countries, but the emerging economies are still growing very rapidly and developing countries are starting to expand as well. Six of the fastest growing countries in the world a few years ago were from Africa. So there is this catch up and, true, countries reaching the technological frontier have been able to take advantage of these things and through trade and investment they’ve been able to grow. So there must be something good about economics and the way we’ve proceeded.
The problem is exactly the question you mentioned. It’s not necessarily about the aggregate. The aggregate story is pretty good. The problem is the distribution. So if 90 percent of the gains of growth go to the top one percent of the people, then that’s going to generate dysfunction and problems in our society. We may have a successful economy. It doesn’t necessarily mean that we have a good society and a society that works.
I think we’ve generated a very unequal system. And that’s a major problem, too, for its stability, that the gains of economic growth are captured. People like Angus Deaton and his wife Anne Case have tried to understand: why are people so dissatisfied? And they’ve argued that it’s not inequality. You know, we hear a lot about income inequality – that’s been gradually rising in most OECD countries. In the emerging economies it’s been going down, but inequality with Thomas Piketty has captured a lot of attention. But they argue that it’s not necessarily income inequality. Actually, if you ask people: should some people be paid more than others, you know, should we reward movie stars and sports stars? They’ll generally say, yes, they probably deserve a bit more. So we don’t believe in a totally equal, flat society. But what people don’t like is a sense of unfairness.
How have certain people become wealthy? Essentially it’s been about rent seeking, that some people have essentially taken advantage of the system. They’ve exploited the financial markets, which then periodically blow up, causing problems for all of us. They’ve exploited monopoly power, that their firms have had power to extract rents from an economy. They’ve exploited their workers, haven’t paid them enough. This is really what generates the social problems and the political backlash against our economic system: it’s the sense of unfairness, that we don’t necessarily have equal opportunities anymore. And that those who are born with a set of advantages will be able to augment those over the life course, and those that are born into disadvantage, again, that will factor into going to a worst school, having a poor diet and having health, which is not as good. We estimated in the OECD that inequalities were reducing the lifespans of the poorest people in the distribution by about 10 years.
So this is a real issue. And the question is why? Why have we a system which is generating this unfairness? I think it’s partly because we have tried to make economic growth central. The dominant ideas around growth are basically that we should take away frictions, we should make the market mechanism work better. So we should make everything very flexible in the labor market. How do we do that? Well, just get rid of minimum wages or reduce them so that they don’t introduce rigidities; make everything very competitive, so if a firm is what we would consider low productivity, that should go to the wall. But, of course, if you have a system that is about making everything very efficient, it might not necessarily be leading to good outcomes for a lot of people. And so we shouldn’t judge the success of an economy by the efficiency of the market. That’s way too narrow and that can be generating a lot of problems.
If we look at lagging regions, for example, and lagging firms, the standard economic policy advice is that, well, you should just reallocate resources. So people should move from poorer regions to richer ones. And then the market mechanism will sort things out. But if we think about people as a bit more complex than ones that just respond to prices and wages, then people actually have good reasons why they don’t want to move to different regions. They don’t want to reskill. If you’re working in a coal mine or in a job that is automated away, you know, it’s very difficult to reskill, and to generate a new set of skills if you’re in your 50s. So the economic idea that the market can reallocate resources to their most efficient purpose, leaves a lot of people behind.
The political economy is that we often have the issue of power. So how we design antitrust policies, when the big monopoly power has a way of influencing the type of regulations we put in place. Look at the way that the financial system has been regulated. Why do we tolerate a system that generates enormous liabilities for the public, while the benefits of the financial system are mostly captured by the participants of the market itself? You know, this doesn’t seem to be a very fair system.
We organized our economies these ways. We tried to optimize them. We tried to grow. We tried to make them efficient. And we gesture in the direction of things like fairness. So we say things like: early childhood education and more progressivity in the tax and benefits system. And these are all very good. But these are very incremental. And they’re not going to make a huge impact, because it’s a systemic unfairness that we have. We need to not try and just fix up the machine and make it run a bit better for more people. It takes a much more systemic overhaul of the way we think about the economy, how it works and the policies, then, that serve that understanding.
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.?
You know, there’s a lot of uncertainties about climate and understanding the environmental issues. But we only have one planet in which to conduct the experiment. This is something that we need to be very wary of and very careful about. In the past, in the 19th century, if you go back to think about the issue of resources and the industrial revolution – probably the industrial revolution happened in the U.K. because you had coal, you had a cheap energy supply. And this is probably why it didn’t happen in China in the fifteen hundreds. So energy and resources are essential inputs into the economic machine. And I think for a long time we considered that using up resources was essentially not a constraint. There was plenty of resources out there. In eighteen hundred, the population of the planet was about one billion people. We’re now up to seven-eight billion. And we probably will reach 10 billion by mid century.
We also have consumption which is very different from what it was. While economics often has stood still in terms of the analytical framework, the demands on resources and energy in our economy have changed dramatically. So we need to change the way we think about the planet and our economies and the way in which the economy is connected to the natural environment. It’s not that the environment has an infinite amount of natural resources to be plundered. That’s not a useful way of thinking about it, because a lot of these things are non-renewable. And once they’re gone, that’s it. So we need to be able to rethink.
The traditional way economists have thought about environmental problems is to essentially think of the environment as an externality, that this is external to the economy. So if we’re serious about the environment, all we need to do is essentially internalize it and bring it into the understanding of the market. Put a price on it. Get the prices right. So how do we do that? Well, you do it through payment for ecosystem services, so that if people have to pay for water, they might actually use it more responsibly. We do it through environmental fiscal reform. If you put a tax on pollution, if you make the polluter pay, then they’ll probably produce less of it. You can use markets to help solve some of these discrete environmental problems.
That’s been a plank, essentially, of environmental economics since the 70s and 80s: that we just need to internalize this, put a price on these sort of things, and then let the market self-organize to solve it in a way that generates growth and generates more environmental sustainability. We’ve also had the logic of what’s called the Kuznets curve. When it comes to the environment, the idea there is that as economies grow, they will pollute a lot. But then as they develop, they should start to think about the environment, when they’re at a later stage of development. So the idea is that you grow dirty and you clean up later.
That probably worked for certain things like heavy metal pollutant or particulate matter in the atmosphere. We did institute environmental laws, we did have the Clean Air and Clean Water Acts legislation across the world. And so as we grew, we did start to clean things up. That logic holds for certain discrete environmental problems. There is an open question about whether that holds for carbon. There we’ve basically been growing, and carbon has generally been increasing at an even greater rate than growth. So now there’s the discussion about, well, whether we can decouple: can growth be decoupled from carbon. But we have so little time to deal with this problem. We have probably 10 years – and maybe even less, when you look at some of these tipping points: Johan Rockström, of course, says look at these ecological limits! He basically said there were about seven limits, of which we’ve already exceeded three.
So we already have done considerable damage. And the problem with tipping points is once we get beyond a certain level, it’s not going to be possible to reverse it. So when it comes to the economy, often what policymakers will say is that, yes, we need to grow the economy, we need to create jobs. And environment is not a high priority. But unless we start to deal with the environment, there isn’t going to be an economy.
I think we’ve been poorly served by many aspects of economics. To give you an example, William Nordhaus won the Nobel Prize in economics. He won the prize for modeling climate damages, climate change damage and macroeconomics, essentially. And among his findings, he said: well, if we have a six degree increase in the average mean temperature from industrial levels, six degrees, that will reduce global GDP by about eight percent. Now, this is lunacy, and this is a Nobel Prize winning idea. And it goes back to what I was saying about how economists think about the economy: if it’s a closed equilibrium system, then it’s very insensitive to shocks. Because you assume that it self-stabilizes and it will self-correct, essentially. So if it gets hit by a shock, it gets knocked off, then it will converge back. But that means that any shock will have relatively small impacts, largely because of the assumptions we make about the model itself of the economy.
That makes it dangerous. Also the idea that optimization, you know, that we should just try to grow as quickly as we can. Well, we should, but if that’s destroying natural assets and coming at the expense of the environment, it’s a false economy. You might be generating growth, but you’re running down the stock of the things that future generations will depend on. So we really need to think intergenerationally about these sort of issues and be very clear about what the science tells us, which is that at four degrees, we’d have massive change, disastrous change on our economies. Essentially it would change existence on this planet. So it’s not a matter of 8 percent of global GDP.
A lot of these studies that economists have undertaken about the impacts of climate have tended to suggest that by 2050, 2060, we’re going to have a reduction in global GDP by maybe three, two to three percent. Maybe four percent. And what policymakers today will say is that, well, you know, by 2050 we’ll all be a lot richer and technology will be a lot better. So we don’t really need to take any action on this. This will be a problem that sorts itself up. And that’s why tipping points are so dangerous, because if we leave it too late to take action, it will be too late. This is a very fundamental issue and economics needs to be part of the solution, and not part of the problem on this one, because there’s a lot of denial when it comes to the environmental issue.
I think we’re getting over the denial that this isn’t a real problem. I think more and more it’s accepted that the science is unequivocal. But there’s other people who believe in the denial that, well, something will turn up. You know, science will solve this problem for us. But science never cured cancer and has never actually cured the common cold. So to leave the planet in the hands of science alone is a very dodgy proposition.
The other denial is that, well, it’s too late to do anything about it anyway. And that, too, we should just try and deal with the contemporary problems and just pretend it’s not real. These are dangerous approaches to this issue. We are not set up to deal with this type of problem, which is very slow moving and with its impact spread over a long period of time. But one in which we’ll go right over the cliff and we’ll be mid air with our legs still moving. But it’ll be too late by then and we’ll be headed down. We should be very concerned about this. And we need much better economics to deal with these sort of problems.
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?
Should they be accountable? Yes, but I think a problem is that in many ways it’s up to policymakers to decide which economic ideas they’re going to use. Policymakers and politicians, ultimately, have an accountability to their voters. Take, for example, in the aftermath of the global financial crisis: there was a lot of discussion about austerity. And there were strong forces arguing that the financial crisis opened up these enormous deficits and we need to close those deficits as soon as possible, and true austerity and true fiscal consolidation became very quickly adopted – even though the world economy was crying out for stimulus. It needed more spending. It needed investment in infrastructure, needed public programs to create jobs, it needed social welfare. But yet policymakers adopted in Europe policies of austerity and in other parts of the world.
In some cases this was generated by two pieces of work from academia. One was by the late Alberto Alesina who recently died. And he basically argued that there were optimal debt levels, that if debt levels went beyond a certain amount… actually I’m confusing things here: Alesina’s idea was actually the growth enhancing effects of austerity, that if you have fiscal consolidation, you reassure investors and they’ll feel that they will invest in the economy because the public finances are in good order. So that was one idea. The second idea was by Reinhart and Rogoff, they were the ones who argued about optimal debt levels: if debt was about 90 percent of GDP, you wouldn’t have any problems. But if debt went beyond that, then it would start to create all sorts of negative impacts. Investors won’t invest. People won’t spend because they’ll be saving for a rainy day and they’ll expect higher taxes later on. And so these debt levels become very damaging on the economy, so we should embrace austerity.
These were two ideas which had a big influence on the policy debate. But the Alesina finding was very quickly refuted. That actually was an empirical finding: there are many different empirical findings which show the relationship doesn’t hold. So it’s a pretty fragile result, I wouldn’t say it was strong enough to carry the day. And Reinhart and Rogoff, it turns out there were actual mistakes in their spreadsheet, data errors, simple mistakes.
But there was a group of politicians for which these ideas made a lot of sense and actually lined up very well with what they wanted to do anyway. And this is the problem. This is the accountability. Because ultimately you can have good economics papers and bad economics papers, and which have influence, which are taken up by policymakers, is out of the hands of the profession. I mean, we do have peer reviewed papers, which are a good housekeeping seal of approval. But in this case, these were two papers that hadn’t been peer reviewed. That highlights that there is a lot of economics and you can choose whatever economics suits you, suits your political and policy priors, and you can cherry pick the evidence. And oftentimes our methods are just flexible enough to give you the answer that you want.
So, yes, economists have an obligation to do good science and good research and to have the highest standards in the work that they do, but that’s only half the story. How their ideas are used is an important part of the story as well. Since the global financial crisis, a lot more economists have wanted to be involved in policymaking and to make use of their expertise. And I think that’s a good thing. I think it’s not good if economists are essentially just catering for academic demands. There is a big public need to help understand a lot of issues and to use economic logic to deal with them. So that’s a good thing.
There is also one more thing to say on this. I think it was another Nobel Prize winner, Ned Phelps, who said that we should be very careful with evidence. So economists would always say, well, we’re an evidence based profession. Our research is based on evidence, is based on data. It’s based on models. There may be issues with the models, but, you know, they correspond to good analytical rigour and good scientific work. But Ned Phelps said that we should be careful in a way because the hard evidence that we produce is a product of the paradigm in which we operate.
So a lot of empirical work tends to confirm the tenets of the paradigm that we have or the paradigm that you believe in. Even the way we generate national statistics is based on a paradigm that we operate in. If your axiomatic assumptions are that markets generate efficient outcomes, and that’s the basis of your empirical work, then you’ll generally tend to find that, yes, markets are good ways of solving things. But that’s because it’s based within a paradigm. We have to be wary of that. There is good empirical work. There is less good empirical work, there can be improvements – and the improvements I mentioned before about taking this more integrative economics approach. You know, I’m sure that you can produce economics papers, which are correct based on the models that are used, and based on the perspective that the researcher has. But that can leave a lot off the table and it can be a very partial view. And if that’s just taken off saying, well, here’s the answer, we don’t generate products like that. So this sort of work should only be one input into a broader consideration of how we make policy and what ultimately will solve these problems. Don’t listen to the economists alone, listen to the other disciplines as well.
Within economics itself there is, of course, a lot of discord about a lot of big policy questions. That can be a challenge for policymakers. Who do we listen to? One thing that my program in the OECD is often accused of is that, well, you know, we’re very left wing, because we are basically arguing that the state should have a role in managing some of these complex systems, that markets can’t solve every problem, that we do need to think about inequality. This is based on rigorous analysis. But again, because the existing paradigm is based around neoclassical economics and essentially the use of markets and rational individuals operating within those markets, anything that is contrary to that is seen as essentially left wing, anti market, in bias.
I think this is a problem because economists can’t escape politics. Again, it isn’t a science in that there is a correct way of thinking about an economy or thinking about a particular policy question. There are different different perspectives and different views. And often it aligns with political views. One thing that I always like is that when we produce papers, the feedback we often get is that, well, this paper is ideological. And of course, anything that is operating according to the current paradigm, that isn’t ideological. That’s evidence. But anything outside of that, that is ideological. It’s a conceit, but it is a good way of keeping new ideas out of the discussion. And it’s very easy for the opponents of new thinking to essentially write it off as just political. But they have been political themselves. If you believe that making labour markets very efficient is not political or getting rid of unions because it’s just friction or rigidity in our labour market – that’s an inherently political position. That interplay between economics and politics, I think is one we need to be very wary of, and not let the political argument be used to cut off debate.
6. Does economics explain Capitalism? How would you define Capitalism?
I think capitalism is perfectly serviceable as a term to use. That still leaves the question: what sort of capitalism?
Essentially the way we have organized our economic system is through markets. This is often a question of whether we should have a market-led economic system or a state-led economic system. Capitalism and socialism – and the pendulum swings from one to the other over time, where the pendulum is probably swinging away right now from market-led to more of a public-private state intervention approach. But in a way the debate is a bit of a misnomer, because it’s not capitalism or socialism, because every economy in the world is a mixed economy. Even societies that are socialist are essentially mixed economies. We have aspects of our economies which are basically based on state provision. And we think that the state has an important role to play in regulating certain markets, in providing rules and standards and the rules of the game and a level playing field. So markets require these things. It’s not that markets left to their own devices will generate positive outcomes. What the neoliberals always say: there is no alternative. They’re right, but it’s not necessarily the alternative they always talk about, because they, too, believe in very state heavy intervention.
When these ideas are put into practice, there is no example where we’ve tried a pure market approach. We’ve always had the public and the private sectors working together. Now, I think the idea of the pendulum is quite useful, because maybe the pendulum does slightly shift to slightly more pro market, back to slightly more pro state, but I think that the pendulum isn’t swinging very far. It’s around a mixed economy idea.
What’s remarkable about the Covid crisis is that almost every economy in the world has basically accepted the social democratic position that the state has an obligation to look after people. We didn’t say let’s leave it up to the market to solve this Covid problem. We said that the state has to act. The state has to intervene. We need to lock down the economy. We have to put the economy essentially into a medically induced coma. And we need to then have the state bail out companies and bail out individuals. In the US they’ve been sending cash in the mail – this doesn’t sound very pro market to me. And, of course, it’s not, because to deal with certain problems, the state has to act. It’s the same when we had the financial crisis. We didn’t let all the banks go to the wall, say: well, this is what happens with markets, they take their risks, they go out of business. The state had to step in and provide that lender of last resort function to bail out the financial institutions and to stimulate the economy, to get us out of that emergency situation.
Another interesting aspect of the Covid crisis is that the states have taken an enormous action – an incredible action and historical hindsight to me. Forget capitalism. Capitalism did not solve this problem. And couldn’t solve this problem because there are lots of problems that markets can’t solve. But then now you hear voices that, well, you know, these ideas worked in an emergency situation, but now we should get back to normal. And you have a lot of appeals to let’s now worry about the debt and let’s try and withdraw the stimulus because we can’t afford it. But I don’t think people will accept that. I think people still need help and we still need to deal with this health crisis. And there’s no trade-off between health and the economy. The virus will tell the story. And if we don’t solve that problem, then the economic problem can never be solved.
So I think that capitalism is a fine philosophy when things are normal, when things are stable and stationary. But capitalism has the problem that our economies and our financial markets are not self stabilizing left to their own devices, they will not necessarily lead to good outcomes in terms of society and the environment. So you need to have a handle on these things and you need to have rules of the game that will ensure that we achieve a whole range of societal objectives and not just narrow economic objectives – where, again, as we were talking earlier, the benefits are often captured by a very small minority.
Those who advocated neoliberal economics have done very well. But in the 21st century, and given the nature of these systemic threats that we face, whether it’s cyber attacks or natural disasters or pandemics, these sort of issues can go around the world instantaneously. So we need to have a lot more resilience in our economic system, which the state has a role to play in. My fear is that we miss the opportunity of this crisis to really think about our economic system and about capitalism and what form of capitalism do we need for dealing with the 21st century issues. If the 20th century was all about competition and efficiency and economic growth, the 21st century is going to have to be about managing these complex systems, cooperating our global system a lot better, building the resilience of the systems so they don’t fail in response to a shock, like we’ve just seen, and also that you don’t have these cascading failures.
A shock can emerge from anywhere, but it can propagate through the entire system and cause subsystems to fail. We’ve seen that with the Covid crisis, which has had a big impact on not just health care systems, but also financial markets and global value chains, which have shut down all over the world. And that shows us that the world is efficient, but it’s very fragile. These things have to be managed and we need a lot more buffers and safeguards.
As Thomas Friedman said, over the last 30 years we’ve been stripping out and stripping away all those safeguards, buffers, regulations, and we’ve done this out of a need to increase efficiency or in some cases not thinking at all. So we really need to think about the resilience of our arrangements. That suggests that we really need to rethink this public-private dynamic. Capitalism in its pure form – I don’t think we’ve ever seen it and I don’t think it exists. But we do need to understand what the limits are, also what the benefits of a capitalist system are. For dealing with consumer goods and services it’s a pretty good system, pretty efficient, and efficiency works for dealing with certain problems. But not the big systemic ones. And I think that’s where our concern should be right now.
Just a last word on the Covid crisis: I think the mistake would be, and you hear it a lot from policymakers, that we should just fix things up and then get back on the road to disaster. And I don’t think that’s a very sensible way to go.
Capitalism is a system, and in many ways, capitalism is underpinned by a set of ideas from economics. Traditional neoclassical economics tends to place an emphasis on the virtues of markets to organize our resources in society and to put them to the most efficient use. And so neoclassical economics definitely reinforces the idea that capitalism is a good thing and a good way of organizing our societies. But it also perhaps highlights that the state can undermine the market by regulating too much, by having too many rigidities or creating rigidities, by intervening and distorting markets through subsidies or through taxes and transfer. That has often legitimized reducing taxes on corporates and reducing the regulatory burdens, moving us to a more market-led approach. That view has been really bolstered by a lot of economic analysis. I think capitalism has been underpinned by these ideas. The question is, again, as I said, moving towards solving the challenges of the 21st century we probably need a more expansive economics to really grasp the system and how the system is changing crucially. So, I think I said in response to another question, economics has to change because the facts on the ground are changing. Having an ideological approach, say: well, I’m for markets and I’m a capitalist, and if you disagree with my point of view, you’re a communist – we can’t have a debate. These labels are not very useful. Looking at economic analysis carefully, you’ll see that much economic analysis is also in the middle, that there’s different trade-offs to consider and there’s different balances to be struck between states, markets, between regulation and free enterprise, between taxes that provide enough resources to provide public goods versus distorter for disincentive effects that taxes can create. We learn this stuff by doing and we experiment with things and we try out things in policy and we have a set of overarching ideas, but we shouldn’t be so wedded to a narrow set of assumptions, because a lot of things are changing and changing very rapidly.
So it’s hard for economics to keep pace with that, as we’ve been talking about. We need to constantly rethink both capitalism and the economics that underpins it. And to experiment with different models and different institutional arrangements and to see what ultimately generates good results for people.
The economy as a very simple system was plausible in the 19th century where you had a very simple structure of the economy: trade was starting to take off, we had the Atlantic economy and trade relations have operated for centuries. But you didn’t have this very complex global economy that you have now, which is dominated by ICT and services. A lot of the ideas that we have about economics, for example on productivity, come from a time when the economy was mostly about products, hence the name. When it was about industrial products and industrial goods, manufacturing, agricultural output. Talking about the way the economy has changed – it’s no longer your grandfather’s economy. It operates completely differently and it’s a lot more complex.
Take international trade, for example. For centuries, we had the idea of comparative advantage, that it makes more sense for you to produce something that you have a comparative advantage for producing and let someone else produce other products that you don’t have a comparative advantage for. And then you should trade and you both benefit from that. But nowadays, trade is based on global value chains. It’s no longer country against country, it’s supply chain against supply chain. It’s no longer about building whole industries, it’s about business services and tasks. And we’ve fragmented and separated out the whole production process. So if you look at building computers, you know, the intellectual property might be in the United States, the sum of the components will come from Southeast Asia and they’ll all be shipped to China where they’ll be assembled, and then packaged comes in from another place and then they are dispersed out to markets all over the world. So production is deconcentrated and it’s fragmented. And that’s the nature of the economy now. There’s a whole set of flows of finance, of investment, of trade, products, knowledge crisscrossing across the global economy. So we can’t think of the national economy operating almost in isolation. We’re just a small external component. Nowadays countries are just components of a much broader system. There’s also digitalisation and changing practices. Just think about how much labour markets have changed because of these changing technologies.
I love the example of what’s called the fissured workplace, the idea being that companies now essentially focus on their comparative advantage and they tend to outsource all the other activities within their firms. So to take an example, Hilton Hotels, about 70 percent of the workers who are working for the hotel don’t work for Hilton Hotels. They work for agencies that clean the hotel rooms or provide the bed linen or provide the catering and the restaurant services. And all of these things have been essentially outsourced.
The result of that is, you used to have people who would enter a firm in the mail room or as a janitor, and would be able to work their way up within the firm. But nowadays, that’s not possible. We have tasks. So you’re a cleaner and until you retire, you’re going to be doing cleaning services. And it also means that workers rights are not always upheld, because if there’s an infringement by a high tech company and you say, well, you haven’t been paying some of your staff, they can say, well, that’s not us: that’s the agency we hired to take care of that service, to do our accounting or to do some ancillary service. So we’ve seen this fissuring, this fragmentation of services. And the gig economy also, we’ve seen that emerge. It means that there’s a lot of people who are working in very low wage jobs with often no access to Social Security, if work goes away, as we’ve seen during the Covid crisis. And technology has really enabled this, the gig economy that we can now buy services and goods online. And it’s changed fundamentally the way we provide services and the work that underpins that. That’s generating a lot of issues.
One thing that economists are puzzled by is that your wages are low, and in our standard approach, the macroeconomy, if wages are low and unemployment is low, which was the case before Covid, this is great news for an economy: it means that wages are low, so capital is doing very well, and unemployment is low, so people must be finding employment. But actually the type of jobs and the quality of the jobs that are being generated are not so good. If we take another example from the high tech industry, which gets so much attention, the big four Gafa, Google, Amazon, Facebook, Apple, there is a finding that, you know, five percent of the jobs of all these companies are really high tech jobs, software design, engineering, coming up with clever applications for IT. So maybe five percent or even less of the jobs generated by this whole sector are those good quality jobs, but about 95 percent is just people putting things in boxes. So we think about an equal society: this is not necessarily generating the sort of outcomes that we might want. And because we’ve broken the link of mobility within firms, it’s, again, an opportunity. But for economists, the way the economy functions is very different.
The same old macro framework doesn’t really work anymore. And also the crisscrossing of economic interrelations within countries and between them means we also need to think about interaction a lot more. The standard way of thinking about economy was that it was a system, a very top-down way of thinking about the economy. But what we see is that it’s all about the interaction of agents. So we need to really take a bottom up approach because it is that interaction which is generating these emergent phenomena.
For example, economists don’t often have a good theory of where financial crises come from, because the type of models we’re used to assume a shock comes from the outside. You know, we’ll get hit by an exogenous shock. But in a financial crisis, the shock actually is generated by the system itself. So, again, some complexity ideas help us understand that a lot better, because it’s the interaction of financial actors in markets which lead to these panics or bank runs, these emergent phenomenon which generate financial crises. We haven’t always had a good story on that.
The same with innovation. Where does innovation come from? Often in economics, in a standard growth model that’s treated as a residual, it’s a black box. We don’t really understand it, but that’s not a minor aspect of the economy. These aspects define what an economy is in the modern day world. So we have a discipline that, if it doesn’t embrace this complexity, doesn’t upgrade its capabilities to understand these types of dynamics, then it’s going to be left behind, it’s gonna be redundant. It’s very hard because oftentimes this requires us to understand machine learning, agent based modelling and big data. And if you’re used to undertaking economics in a certain way, it can be a real challenge. I mean, often you need data scientists to really be able to do these things. So economics on its own can’t take full advantage of these new windows of opportunities that are opening up. And that same technology, which is so changing our economies, that technology has to change economics as well.
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?
We had a meeting last September called Averting Systemic Collapse. And I think a lot of our members sort of rolled their eyes and thought this was a very dramatic title. And, you know, it’s so not in keeping with the OECD, which assumes that an economy is more or less stable and stationary and linear, and these guys talking about the end of the world, it’s like, you know, crazy talk.
So it’s quite interesting when the systemic collapse did come in March of this year, where you had the collapse of whole sets of human-based systems, that it didn’t seem so radical after all. But why did we choose this topic and why do we think systemic collapse is so important? Well, it’s basically because we have these threats that I was talking about, all these threats that face our modern societies and our societies are very interconnected and very complex. There’s all sorts of networks of firms and producers, and they operate in a very complex environment of rules and standards and regulations. So this is very complex. And the thing we know about complex systems is that they fail all the time.
The thing is, for policymakers, there’s no point in looking for a trigger to what could set off that collapse – that trigger could be a pandemic, it could be geopolitical tension, it could be a natural disaster, it could be a financial crisis. And that could set off this cascading failure and collapse. We really should not worry so much about the triggers because it could be anything and it could emerge anywhere: a pandemic could emerge from China or from Africa or anywhere, and it can spread globally almost instantly.
I mean, who knew that there were direct flights from Wuhan to the United States? So our world is very much interconnected and fragile. And because we have an economic system that’s based on optimisation, we’ve been trying to essentially grind out another unit of growth. What natural scientists tell us is that when you try to optimize complex systems, you make them unstable. So in trying to generate economic growth, we might actually be causing the very problems that we then have to respond to. And that might ultimately feed back and undermine economic growth.
Everything is very fragile. The interconnection is just one aspect. That’s then reinforced by the fact that we do have very high inequalities, we do have climate change and we have all these systemic vulnerabilities. The main point is that we have a global economy that is extremely fragile and our policy actions to try and generate economic growth have probably made it more unstable. We’ve organized it in this way, so can these systems collapse?
Of course they can. And we’ve seen examples of where there have been partial collapses. We were very close to seeing a much more dramatic collapse of the global economy than we’ve seen because of Covid. And the reason why we haven’t seen such a collapse is because the state really stepped in to bolster and reinforce the financial markets, to essentially keep the economy ticking over and to have social buy-in to measures that in normal times would have been considered unthinkable.
If we think about the United States and we think about an economic model, I think the economic model that we have, and modern capitalism, probably makes a lot of these systemic threats worse than they are. So that’s an issue.
The one thing about collapses, it doesn’t mean that everything will stop. It just means that the system will break down and then the system will reorganize and find a new way of operating. But what a paleontologist told us about looking at the fossil record – he said that collapse in the record, can happen very quickly, which for a geologist can be over tens of thousands of years. But it takes a long time to recover. Recovery can take place over hundreds of thousands of years or millions of years, when it comes to biodiversity and recovery of these natural systems. And it’s the same with these economic systems, I think they can collapse very quickly. And it might take a long time for them to be reconstituted, reordered and rebuilt. So we should be thinking about how we can reinforce and make these systems more resilient. That’s to do with not just preparing and planning for these shocks, but also building the systems in such a way that they can absorb these shocks when they do occur, then they can adapt and they can rebound, not just bounce back, but bounce forward. So these are the ideas of resilience that we need to start to build in.
I don’t like to think about any particular nation state collapsing because I think we’re all so interconnected now that if a systemically important country collapses, that’s not going to be confined. That’s going to have an impact on all countries in a very significant way. And it’s true, too, that the big systemic crises that we face are global in nature. So they’re not going to be concentrated or confined to one region or one country. The greenhouse, the climate change issue is a global issue. And the fact that the country with the largest emissions is not taking it very seriously is a problem which will visit it and the rest of the world. So that’s the nature of collapse. It’s not going to be the collapse of one country, or one part of a system or one subsystem. All of these subsystems are interconnected to a whole range of other systems. So if one goes down, they will cascade and will cause others to fail.
Many of our human-made systems are essentially built to fail. Because we built them for efficiency, so we built them to not have any redundancy or spare capacity. We’ve actually built them to be always at the point of collapse. So it’s not a system which is likely to be very resilient. And that’s by design. Again, these are human systems. We’ve constructed them in a way which is based on a very small set of principles of which efficiency is often the most important one.
Just the other thing about that is, although efficient systems are very fragile – it’s not that simple, you know: just let’s replace all our efficient systems with more resilient systems. If we take Japan, for example, Japan has weathered the storm of Covid very well and its health care system has really stood up to the challenge of the crisis. So it had a resilient health care system. But then the question for a policymaker is: does Japan’s better performance during Covid compensate for decades of inefficiency of its healthcare system? It’s not very obvious. Some of these trade-offs are very difficult because it’s very hard to say to a company that they should have lots of inventory and spare capacity waiting around just in case. And it’s not the way we’ve designed things at all. But I think for certain sensitive products, we do need to have more inventories, to deal with pandemics we need a sort of medical National Guard, we do need stockpiles of certain medical equipment, we do need to have the capacity to ramp up production of vaccines. There are examples where we probably do need resilient systems.
There are probably a lot of other systems that are fine if they’re efficient, and if they fail we should be able to reorganize them. You know, if people don’t get their iPhone, it’s a very different proposition than if they don’t get a vaccine during a pandemic.
Accumulation and consumption have been central tenets of Western society, and now that’s creeping into other societies, too: that we should be able to, we should have the freedom to be able to consume as much as we can, whenever we want, and there should be no constraints other than our income and the means that we have. That’s the idea. As we’ve talked about, the problem with the system is that certain firms and certain individuals have been able to accumulate most of the benefits of the system. It’s not that they’ve been equally shared out. So it’s the accumulation problem that is really at the heart of a lot of the problems we have.
If you look at taxes on wealth and taxes on income, you know, taxes on income on the top incomes has reduced a lot. Because the idea was that, you know, people with very high incomes, they would, of course, reinvest their money, so the benefits of their wealth will trickle down to the rest of society. So perhaps you shouldn’t tax that, it creates disincentive effects, and so forth. So we’ve been reducing taxes on the wealth. That did put a brake on this accumulation problem. If you look at growth in the 1950s and 60s, it was pretty inclusive. You know what? The benefits of growth were widely shared in Europe and in the United States. And now it’s not so. The capitalist system we have now has generated dysfunction.
That begs the question: well, what’s different about capitalism now than in the past? And it’s partly about the type of tax system that we have. We basically thought that maybe we should tax corporations a lot lower than workers because corporations create jobs. So that balance was lost. We’ve also tried to create all sorts of incentives in economies. So, again, wage suppression and getting rid of unions and things like that. All of these things have been motivated by essentially a view, a version of capitalism. I think where we’re moving to, is that we probably need to think less of, for example, maximizing shareholder value, which was a principle of corporate behavior – the idea being that companies have an obligation to maximize the benefit for their owners, which are the shareholders. And how do you do that? Well, you can do that by cutting costs, cutting workers, moving production to a lower wage economy. And that’s now being replaced in some circles by what we call stakeholder capitalism. That, in fact, corporate boards should represent not just the interests of shareholders, but also the interests of workers, the interests of their communities and the interests of society as a whole: because firms don’t exist just to generate benefits for their management and their owners. Firms are supposed to generate a lot of societal benefits. And if firms are polluting the atmosphere or polluting water resources and natural resources, then they should be fined, and in some cases put in prison. But they should have a societal goal of not doing that.
There was a McKinsey study, quite a few years ago now, which asked businesses if they thought climate change was a danger or an opportunity. And I think 80 percent of companies thought it was an opportunity. So business can do good things and, yes, regulations have their limits. It would be much better if companies just decided to operate in a way that was ethical and was in the interests of their workers, communities and the planet.
Failing that, failing responsible business conduct and corporate social responsibility, sometimes we do need to intervene in that and to provide the right incentives, but also the right rules of the game, if they do violate these things. And, you know, just to finish, Joe Stiglitz said once that we do need an invisible hand, the invisible hand of the market. But we also need a visible hand. So it’s not capitalism on its own. It’s capitalism plus the appropriate level of state involvement.
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?
What sort of capitalism: is capitalism in its pure form, is that going to help us? Well, probably not. But as I said, I don’t think we’ve ever had capitalism in its pure form. When Francis Fukuyama talked about the end of history and the triumph of liberal democracy, in a sense he was correct. I mean, it’s hard to think that we’re going to have a software for our societies that would be something other than capitalism. But it’s always going to be a capitalism tempered by essentially a degree of management organization and the role of the state as essentially underpinning and facilitating capitalism. But it’s just not the case that we’re going to leave it up to the markets to help us solve the problems of society. And I think after the global financial crisis, that kind of rocked the standard foundation of economics. It rocked the foundation. But the foundation – it turned out economics is very resilient because it was able to sustain and that window of opportunity for really changing things closed very quickly. Whether Covid president will now cause that foundation to crumble is an open question. Will it lead to dramatic change in the way that we approached our economic system? Will the extraordinary measures that have been taken, will they remain temporary, but then be replaced by more orthodox thinking and get capitalism back on the road? These are important and open questions.
I think that in terms of developing ideas to best serve humanity and the future of our planet and the future of our societies, we do need to change things. Because if you look at these metrics on the environment, on climate, these things are getting worse. Market forces and capitalism – there’s a big move now to green the economic system and to green investments. And we should be investing in green energy and green infrastructure, and putting in place the incentives for greener growth. But that’s very incremental in its effects. There’s a line by an environmentalist that if we’re winning slowly, we’re still losing.
Markets are very good after markets have reached certain tipping points. But we might not have time for markets to emphasize the importance of green technologies and green energy systems. So the state might have to give things a push and we might need a lot more intervention. Take industrial strategy, for example. There was a sense that picking winners and having state companies was very inefficient, and these things normally failed when exposed to international competition. But in the last few months, we’ve had company companies being ordered to produce certain things by governments because society needed them. We saw the same in World War Two: we don’t have time for you to build automobiles for public consumption, we need you to build airplanes and tanks and military equipment. So we can organize our system in a way that solves these problems for society. We have enormous potential to change things.
I don’t think we can leave it to markets to figure out what the right signals are, because often markets will direct you to things that might actually make the problem worse. So we really need to take charge of our destiny and the destiny of the planet and solve these problems. We’ve seen remarkable reductions in emissions during the last couple of months. We showed it can be possible: you can actually stop the workshop of the world and reduce emissions. You can stop international travel. These dramatic actions can be taken. These problems are solvable. But economics often gives us the wrong mindframe or the framework to deal with these problems. So we need to supplement it with other things.
There is great potential that we could take advantage of this crisis to design a better system. And as I’ve been saying throughout: we need a better economics and a new economics, as well as a new economy.
Interview by Chiara Somajni & Fabio Dondero.