Gabriela Ramos, OECD Chief of Staff and Sherpa to the G20
When the subprime crisis started, most economists, and the policymakers they advised, thought it would only affect people who had bought homes they couldn’t afford. They didn’t expect that national problem to trigger a cascade of events that almost caused the collapse of the world financial system. Nor did they foresee how the financial crisis would lead to the Great Recession. Global interconnectedness and the complexity it brings were not really understood, nor were the contagion mechanisms that they can trigger and that would impact other regions of the world.
Today, we’re trying to understand how the Great Recession and the other important trends that it aggravated such as growing income and wealth inequality, gave birth to the backlash against globalisation, and to the political crisis we are confronting in many countries, with divided societies and a lack of common purpose. At the OECD, we set up our New Approaches to Economic Challenges (NAEC) initiative to examine these failures and establish the basis of a better way of analysing economic challenges and producing policy advice based on that analysis.
The slogan of this year’s OECD Forum was “You talk, we’ll listen”, and that is what NAEC has been doing. Over the past few years, we’ve asked a wide range of people what was wrong with the way we were doing things. And they haven’t been shy about telling us!
At the Forum, we presented the views of a sample of around 20 world experts across a variety of fields – financiers managing billions of dollars, Nobel prize-winning economists, political scientists, social scientists… compiling the ideas they have shared all through the NAEC initiative.
As you’d expect from such a strong-minded group, they don’t always agree with us or each other, and we do not claim to buy all that they say. More importantly, to avoid the “herd thinking” prevailing before the crisis, and that prevented a better understanding of the imbalances that were accumulating to a tipping point, it is important to listen to those that think differently from us, and to remain open to criticism and honest exchanges.
But a number of common views do emerge from reading the draft report. Growing integration and connectedness is helping to improve living standards across the globe, but the traditional models we use to study today’s economy make too many assumptions that are at odds with the facts. The very name of these models, general equilibrium, shows that they assume that the economy is basically in balance until an outside shock upsets it. They assume that you can understand the economy by studying a representative agent whose expectations and decisions are rational.
This view is essentially linear, and the policy advice it generates is tailored to a linear system where an action produces a fairly predictable reaction. It looks at aggregate outcomes and at average results. It concentrates on flows and does not consider stocks. Real life is not like that.
Economic models that rely only on inputs such as GDP, income per capita, trade flows, resource allocation, productivity, representative agents, and so on can tell a part of the story, but they fail to capture the distributional consequences of the policies we make, and do not address the fact that the growth process has only benefited a few. They do not capture natural depletion, or incorporate environmental damage as liabilities. On the contrary, they assume that, by growing the pie, inequality of income and opportunities will diminish (the trickle-down effect), or that you can always clean after you grow. So we need a full re-vamp of our analytical frameworks and the assumptions that we make, to better capture the reality. At the OECD we have done so by proving that income inequality harms growth.
To start with, we need different more granular information, data and analysis, and definitely, better metrics. We have to be able to check how policies will impact different income groups, communities, regions and firms. We need to get away from growth first and distribute later, or clean later. The unintended consequences of policies should be considered beforehand, and so should equity.
Traditional models do not integrate important dimensions such as justice, trust or social cohesion that are not easily measurable. In fact these models are based on an ideology or narrative that claims that people are rational, take the best decisions according to the information they have to maximize utility, and that the accumulation of rational decisions will deliver the best outcome.
Real people are not like that. Their lives are shaped by their hopes, aspirations, history, culture, tradition, family, friends, language, identity, the media, community and other influences. As these other elements are not the core of macroeconomic models, they are neglected, and the social and human sciences (psychology, history, sociology…) that can explain these variables have been put aside in the modelling work to develop economic policy options. As the economic profession became highly quantitative, the non-measurable features of the economy were just ignored, such as people’s fears, expectations or sense of unfairness.
The world we live in is a system of systems, physical or not, that is complex. That means you have to take a systemic approach that can deal with tipping points, phase changes, emergent properties, and – very important for us – the fact that shocks do not come from outside. The system itself produces the shocks that destabilise it.
We need a new approach to economics that isn’t just about quantitative economics. An approach that integrates behavioural economics and complex systems theory, as well as economic history.
We also need a new narrative to integrate all these different, often conflicting influences. So what might such a new narrative look like? The report concludes that it should be based on the best facts and science available, and contain four stories: a new story of growth; a new story of inclusion; a new social contract; a new idealism.
The state can help empower the shift. An empowering state is one that focuses on strategic investments to allow people, firms and regions to fulfil their potential. That means putting people at the centre of our policy efforts, and broadening the objectives of policies to include not only material well-being but many other options that are important such as health, quality jobs, a sense of belonging, social cohesion, and environmental outcomes.
At the OECD we have made progress with NAEC and with the Inclusive Growth Initiative, inviting policy makers and stakeholders to consider different alternatives to the traditional framing of economic issues. We conclude that by being inclusive, economies can be more productive, and that fostering productivity growth in an inclusive manner makes growth sustainable. We call this the “nexus” or the need to foster “inclusive productivity”. We are making the call to turn this analysis into action, but this will require a re-engineering of the institutional settings in OECD economies, getting rid of silos and having a holistic approach for the well-being of people, that is multidimensional.
The lively and informative debate with the public at the OECD Forum suggests to me that the draft report touched on a number of subjects people care deeply about. But it is still a draft and we need to continue the conversation, so please send your comments, criticisms and suggestions to us at [email protected], and we’ll keep you informed on how the discussion progresses over the coming months.
William Hynes, OECD New Approaches to Economic Challenges (NAEC) initiative
The OECD launched its “New Approaches to Economic Challenges” (NAEC) initiative in 2012 to reflect on the lessons for economic analysis and policymaking from the financial crisis and Great Recession. European Central Bank Governor Jean-Claude Trichet said that: “as a policy-maker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools”. But even before the crisis Greg Mankiw from Harvard University lamented that “macroeconomic research of the past three decades has had only minor impact on the practical analysis of monetary or fiscal policy”.
NAEC examined the shortcomings of analytical models, and it promotes new policy tools and data. It questions traditional ideas and methods and challenges group-think and silo approaches by inviting comment and criticism from outside the Organisation, and by soliciting input from social sciences such as sociology, psychology, and history to enrich the policy discussions.
While the financial crisis struck at the core of traditional economic theory and models, it became apparent in 2016 that the failure of economic thinking and acting was far deeper and more destabilising than we thought, so part of NAEC’s mandate is to develop an agenda for inclusive and sustainable growth.
This is all the more urgent given the backlash against globalisation, increased inequalities of income and opportunities, and the negative impact of growth on the environment. We need to develop what Eric Beinhocker calls a “new narrative of growth”, one that puts people at the centre of economic policy. Therefore NAEC is helping to focus on redistribution, a concept neglected in economic analysis for many years, and helping to ensure that policy decisions improve the lives of those at the bottom of the income distribution.
It is also helping to consider the well-being of people as a multidimensional concept, which implies reconsidering important elements of the economic narrative, such as justice and social cohesion. NAEC does so by thinking “out of the box”, emphasizing the need to empower people, regions and firms to fulfil their full potential. This is at the core of the Productivity-Inclusiveness Nexus that considers how to expand the productive assets of an economy by investing in the skills of its people; and that provides a level playing field for firms to compete, including in lagging regions.
However, the challenges are too complex and interconnected for conventional models and analyses. As Andy Haldane argues, the global economy is increasingly characterised by discontinuities, tipping points, multiple equilibria, radical uncertainties and the other characteristics of complex systems. This is why a key theme of NAEC has been the complexity and interconnectedness of the economy, exemplified by the Productivity-Inclusiveness Nexus.
The contributors to this series argue that complexity and systems thinking can improve understanding of issues such as financial crises, sustainability of growth, competitiveness, innovation, and urban planning. Recognising the complexity of the economy implies that greater attention should be paid to interactions, unintended consequences, stability, resilience, policy buffers and safeguards.
Working with the European Commission and the Institute for New Economic Thinking (INET) Oxford, the NAEC initiative demonstrated in a number of workshops that complexity economics is a promising approach for delivering new insights into major public policy challenges and an exciting research agenda going forward.
The workshops offered a timely opportunity for policy-makers, academics and researchers to discuss the policy applications emerging from the study of complexity. The NAEC Roundtable in December 2016 discussed whether economics was close to a tipping point – a transition to a new behavioural complexity paradigm. There is wide agreement among economists on the limitations and the shortcomings of the rational expectations paradigm and much discussion on how to move forward.
The first phase of NAEC’s complexity work has made the case for further and deeper examination of complexity. Going forward, it will be important to demonstrate the value of complexity, systems thinking and agent-based models in a number of areas including financial networks, urban systems and the other issues highlighted in this series. The challenge is to demonstrate the value of the approach.
Complexity offers an opportunity for addressing long-held concerns about economic assumptions, theories and models. For the OECD, it also holds out the potential for creating better policies for better lives.
The OECD organised a Workshop on Complexity and Policy, 29-30 September 2016, at OECD HQ, Paris, along with the European Commission and INET. Watch the webcast: 29/09 morning; 29/09 afternoon; 30/09 morning
Towards an empowering state: turning inclusive growth into a global reality
Gabriela Ramos, Special Counsellor to the OECD Secretary-General and Sherpa to the G20. With thanks to Shaun Reidy, Acting Coordinator of the OECD Inclusive Growth Initiative.
This article is part of Inclusive growth: The state of the debate 2017 being published today by the UK All-Party Parliamentary Group on Inclusive Growth, that brings together reformers across politics, business, trade unions, finance, churches, faith groups and civil society, to forge a new consensus on inclusive growth and identify the practical next steps for reform.
We live in turbulent times. Nine years on from the eruption of the financial crisis, we remain stuck in a low growth trap. To make matters worse, the great upheaval in our economies has now transmuted into a profound political crisis in many countries.
The economic hardship of the last nine years has created many casualties, but chief among them has been trust – the glue that holds our societies together. Trust between different groups of people, and trust in institutions has plunged to record lows, with public belief in governments in the OECD standing at just 42% in 2016.[i] This has now spilled over into the social realm, stoking fear and provoking the rejection of global interconnectedness, trade, migration and technological progress.
Everywhere we look, globalisation is being called into question and the potential consequences of the rise of protectionist measures could scarcely be greater. The origins of this loss of faith in international integration are numerous and vary considerably from country to country, but there is a common thread running throughout: a growing sense that the global economy is delivering only for the lucky few.
International elites have categorically failed to deal with this. The benefits of globalisation and rapid technological change were understood in an overly simplistic economic framework that relied too heavily on averages and representative agent models, blurring the outcomes for different income groups.
Simplistic assumptions of how the economy operates prevented us from advancing better policies. Trade and investment became an end in itself, and the efficiency of markets became the ultimate goal of economic policy. We neglected the differentiated outcomes of policies for different income groups, and by relying on incomplete metrics – like GDP per capita alone – we ignored the distributional outcomes of the policies we undertook.
We have since learned that this was not the right choice – and we have learned it the hard way. . Policies have affected different groups in very different ways. The initiative I lead at the OECD on Inclusive Growth has charted how rising income inequalities have been blighting people’s opportunities, wasting their potential contribution to productive activity and limiting their ability to lead meaningful lives.
The numbers make for stark reading. Here in the UK, the average income of the richest 10% has gone from being eight times that of the poorest 10% in the late-1980s, up to almost ten times greater today. The situation is markedly worse at the very top, with the highest 1% of earners in the UK taking home around 20% of pre-tax national income in the last three decades.[ii]
Our report All on Board: Making Inclusive Growth Happen has set out how this reflects a more general trend seen across the OECD, where those at the top of the income distribution have pulled away from those at the bottom. We see this particularly in the period after the crisis, where across the OECD, the top 10% of income earners have managed to recover their pre-2008 income levels, while those in the middle and at the bottom have seen incomes fall and stagnate. The picture is even more troubling in terms of wealth, where the richest 10% in the OECD own around half of all household assets, whilst the bottom 40% own barely 3%. At the very top of the distribution, the Top 1%, holds a staggering 19% of total wealth.[iii]
All too often, wealth and income inequality stand in a symbiotic relationship with the intangible social trappings of success, such as cultural capital and access to parental networks. Together, they influence the key formative outcomes in children’s lives, helping to turn the unequal outcomes of one generation into the unequal opportunities of the next, affecting everything from employment to health status.
Nowhere is the damage more keenly felt than in education. OECD data shows that the children of poorer parents struggle to keep up with the social and cultural capital of their wealthier class-mates. From that initial disadvantage, many go on to lower educational attainment, with children whose parents did not complete secondary school having only a 15% chance of making it to university against a 60% chance for peers with at least one parent who had attained tertiary education.[iv] More troubling still is the fact that the very same children at a disadvantage in the education system typically go on to receive smaller salaries and, most worryingly of all, to lead shorter lives.
This is profoundly unjust. But it is not only those at the bottom who suffer when inequalities scale new heights – we all do. Of course, inequality has always been with us and it has often been presented as an engine for growth. When it derives purely from differences in efforts and investment, such an argument may have some merit, but with the levels of inequality we see today that is demonstrably not the case.
As OECD’s work on the Productivity-Inclusiveness Nexus spells out, when the poorest are unable to fulfil their potential, we all lose out on the visionary leaders, the innovators, and the economic growth that could have come to pass. Moreover, recent OECD research has highlighted how rising inequality knocked 6 to 10 percentage points of GDP growth between 1990 and 2010 across a range of OECD countries including the UK, Mexico, Finland, Italy, and the United States.[v]
With the ongoing global and technological transformation of our economies these issues are likely to be brought into starker relief. Digitalisation has the potential to unleash untold benefits for all of human kind, but if it is not managed properly, it could exacerbate inequalities by creating greater job insecurity and cementing ‘winner takes all’ dynamics in our most rapidly growing markets.
Already, since the early 90s, around half of the jobs created in the OECD have been in more insecure temporary, part-time or self-employed work. Over roughly the same period, the power of multinational firms at the global frontier to exploit their greater access to knowledge-based capital, digital technology, finance, cheap labour and low-tax jurisdictions have been able to lock-in their productive advantages. In the manufacturing sector for instance, since the early 2000s, labour productivity of OECD firms at the technological frontier has increased at an average annual rate of 3.5%, compared to just 0.5% for non-frontier firms.[vi]
Given the extent of these social and economic costs, it is hardly surprising that rising inequality has translated into growing political disaffection, anti-market sentiment and disenchantment with globalisation. In such a context, we desperately need to take action to promote inclusive growth and restore public confidence in the power of policy makers to improve people’s lives.
So what can we do to redress this situation and regain trust?
To start with, we need to listen to people. It is not enough to talk about a ‘post-truth’ environment. Or to say that people haven’t paid attention to facts and evidence. It is we that have not listened. We have to be honest with ourselves and acknowledge that the “truths” in our economic models have failed to capture much of what matters to people.
In short, we need to put people, and their multidimensional well-being, back at the centre. The OECD’s Inclusive Growth and New Approaches to Economic Challenges (NAEC) Initiatives are at the forefront of efforts to put people at the centre, to create social and economic models that provide a more accurate representation of the world around us. Today, advances in computing power are also opening up new tools to support our work, with possibilities for integrating complex systems dynamics and behavioural insights into our approaches with agent-based modelling and network analysis.
Yet, we also must recognise that economics does not have a monopoly on truth. In many countries, we have seen the bottom 40% left behind and their potential wasted. Only by recognising that mistakes have been made can we begin to build a new socio-economic narrative that goes beyond the old tropes of growth first, redistribution later; and beyond aggregate economic measures like GDP.
The false certainty provided by an all too literal interpretation of models needs to be balanced by a humbler, more grounded approach to economics that draws on the lessons of other disciplines like physics, biology, psychology, sociology, philosophy and history, to feed a richer, more nuanced policy discussion.
If we want to save open markets and globalisation, we need to re-write the rules of the economic system to make them work for everyone. We also need to bring back that much neglected concept, fairness, to the heart of the policy debate.
The role of the State is absolutely key to this discussion. We need to redefine and reimagine its role, to ensure that it is prepared for contemporary opportunities and challenges and is set up to empower people.
To begin with, we need a new approach to welfare that goes beyond just mitigating risk. The work of behavioural economists like Amos Tversky and Daniel Kahneman has shown us that people are not ‘risk averse’ so much as ‘loss averse’. If we are to create entrepreneurial societies that encourage everyone to fulfil their productive potential, we need to deploy this insight via welfare policy to reduce the consequences of failure.
To be sure, providing people with a social safety net is vital, but it is not enough. We need to move beyond this approach, to create an empowering State that serves its citizens as a launch pad by furnishing them with capacity enhancing assets.
Such a State would also seek to prevent disadvantage cascading down generations. It would recognise that its role was not simply to remove barriers to opportunities, but also to furnish people with the capacity to seize them. Crucially, it must see redistribution and social expenditure in vital areas like education and healthcare not as operating costs, but as investment in our most valuable assets – people.
In practice, this would mean deploying a coherent approach to intervention across individual’s life-cycles to provide high-quality early years education, comprehensive training throughout adult life, income and skills support to help people transition between jobs and perhaps even a universal basic income. But it wouldn’t stop there, because, when all is said and done, there is more to life than money. The key role of the State should be to support people helping them to have meaningful lives.
However we also need to face up to the big global challenges of dealing with concentration of wealth, international tax and competition issues, the mobility of tax bases, labour rights and regulatory standards. We need to ensure that globalisation is based on international rules that are respected. We have to create trade agreements that are comprehensive and, crucially, also inclusive. We must hold global firms to higher standards of responsible business conduct. OECD work on taxes, responsible business conduct, due diligence and anti-corruption will be key to ensuring better functioning global rules.
To restore the faith and trust of people in the role of governments, a priority for an empowering State must be to focus on the bottom 40%, who risk being trapped in a cycle of deprivation and lack of opportunity. We need to deploy targeted policies to help these groups access quality education, healthcare and the benefits of innovation, finance, and entrepreneurship.
Of course, giving people the chance to make the most of these opportunities is reliant on a thriving business sector. The State has a role to play to ‘crowd in’ financing in young and innovative sectors and in investing in basic R&D that will see positive spill-overs into countless other domains. We also need policies which support the diffusion of innovation through the economy, ensuring a level playing field for incumbents and challenger firms, enabling small companies to access finance, technology and high-quality skills.
Adopting such an approach will require some changes to the way we design and implement policies, with particular care taken to avoid the entrenchement of vested interests. One aspect of this will be ensuring that policy recommendations take regional and local circumstances into account. Regions and cities have a key role to play by adapting economy-wide policies to the characteristics of local communities, as well as by promoting local policies that reduce or remove the barriers limiting access to opportunities.
There is also a dire need to overcome traditional ‘silo-based’ approaches to policy making. This will require a renewed ‘whole-of-government’ push, where different government departments, agencies and ministries work together to deliver joined-up solutions as part of a coherent systemic approach.
The challenge before us is clear. Succeeding in our endeavours will demand a new approach, where political parties, and leaders from civil society and business come together to recognise that the long-term prosperity of a society depends on the success of its individual parts.
Together we can make inclusive growth a reality.
[i] Gallup World poll 2016
[ii] OECD Income Distribution Database
[iii] OECD Statistical Database
[iv] OECD (2016, forthcoming), calculations from PIAAC
[v] OECD (2015), In it Together
[vi] OECD (2015) The Future of Productivity, OECD Publishing, Paris
As well as Gabriela Ramos’s article, Inclusive growth: The state of the debate 2017 contains the following:
Welcome to the future of the political economy Rt Hon. Liam Byrne MP, Chair of the APPG on Inclusive Growth and Labour Member of Parliament for Birmingham Hodge Hill
Inclusive growth, the challenge of our times Professor Colin Hay, Co-Director of the Sheffield Political Economy Research Institute (SPERI)
Inclusive growth, a new agenda George Freeman MP, Conservative Member of Parliament for Mid Norfolk; Chairman of the Prime Minister’s Policy Board and Chairman of the Conservative Policy Forum
Inclusive growth: Turning aspiration into action Richard Samans, Member of the Managing Board, World Economic Forum
Globalisation and inclusive growth: the challenges for government and business Rt Hon. Dame Caroline Spelman MP, Vice-Chair of the APPG on Inclusive Growth and Conservative Member of Parliament for Meriden
The difference between economic growth, and economic growth for all Alison McGovern MP, Vice-Chair of the APPG on Inclusive Growth, Labour Member of Parliament for Wirral South
Social policy: a vital partner in any inclusive growth strategy Dr Hannah Lambie-Mumford, Research Fellow, Sheffield Political Economy Research Institute (SPERI)
We need to rethink economic policy to bring prosperity to the whole country Michael Jacobs, Director of the IPPR Commission on Economic Justice
Inclusive growth at city region level: a perspective from Greater Manchester Professor Ruth Lupton, Head of the Inclusive Growth Analysis Unit, The University of Manchester
The perennial curmudgeon H.L. Mencken is famously misquoted as saying: “For every complex problem there is an answer that is clear, simple, and wrong.” The ability to simplify is of course one of our strengths as humans. As a species, we might just as well have been called homo reductor—after all, to think is to find patterns and organize complexity, to reduce it to actionable options or spin it into purposeful things. Behavioural economists have identified a multitude of short-cuts we use to reduce complex situations into actionable information. These hard-wired tricks, or heuristics, allow us to make decisions on the fly, providing quick answers to questions such as ‘should I trust you?’, or ‘Is it better to cash in now, or hold out for more later?’ Are these tricks reliable? Not always. A little due diligence never hurts when listening to one’s gut instincts, and the value of identifying heuristics is in part to understand the limits of their usefulness and the potential blind spots they create. The point is, there is no shortage of solutions to problems, whether we generate them ourselves or receive them from experts. And there’s no dearth of action plans and policies built on them. So, the issue isn’t so much how do we find answers?—we seem to have little trouble doing that. The real question is, how do we get to the right answers, particularly in the face of unrelenting complexity?
There’s a nomenclature in the hierarchy of complexity as well as proper and improper ways of going about problem solving at each level. This is presented in the new publication “From Transactional to Strategic: Systems Approaches to Public Challenges” (OECD, 2017), a survey of strategic systems thinking in the public sector. Developed by IBM in the 2000s, the Cynefin Framework posits four levels of systems complexity: obvious, complicated, complex and chaotic. Obvious challenges imply obvious answers. But the next two levels are less obvious. While we tend to use the adjectives ‘complicated’ and ‘complex’ interchangeably, the framework imposes a formal distinction. Complicated systems/issues have at least one answer and are characterised by causal relationships (although sometimes hidden at first). Complex systems are in constant flux. In complicated systems, we know what we don’t know (known unknowns) and apply our expertise to fill in the gaps. In complex systems, we don’t know what we don’t know (unknown unknowns) and cause and effect relations can only be deduced after the fact. That doesn’t mean one can’t make inroads into understanding and even shaping a complex system, but you need to use methods adapted to the challenge. A common bias is to mistake complexity for mere complication. The result is overconfidence that a solution is just around the corner and the wrong choice of tools.
Unfortunately, mismatches between organisational structures and problem structures are common. For example, in medicine, without proper coordination, two specialists can work at cross-purposes on a single client. While the endocrinologist treats the patient’s hyperglycaemia (a complicated system) with pharmaceuticals and diet, the nephrologist might treat her kidney failure (also a complicated system) through a separate set of pharmaceuticals and dietary recommendations. Not only can these two pursuits be at odds (what may be good for the kidneys may be bad for blood sugar, for example), but both treatments can have effects on other systems of the body that may go unmonitored. Understanding these interactions and those of each treatment on the body’s individual systems as well as on the body as a joined up, holistic entity (which it certainly is) would be the broader, complex and more desirable goal.
The body politic may not be so different. Institutions have specific and sometimes rather narrow remits and often act without a broader vision of what other institutions are doing or planning. Each institution may have its specific expertise yet few opportunities for sustained, trans-agency approaches to solving complex issues.
Thus, top-down, command-and-control institutional structures breed their own resistance to the kind of holistic, whole-of-government approach that complex problems and systems thinking require. This may be an artefact of the need for structures that adapt efficiently to new mandates in the form of political appointees overseeing a stable core of professional civil servants. Also, the presence of elected or appointed officials at the top of clearly defined government institutions may be emblematic of the will of the people being heard. Structural resistance may also stem from competitive political cycles, discouraging candidates to engage in cycle-spanning, intertemporal trade-offs or commit to projects with complex milestones. In a world of sound-bites, fake news and scorched earth tactics, a reasoned, methodical and open-ended systems approach can be a large, slow-moving political target.
And that’s the challenge of approaching complex, ‘wicked’ problems with the appropriate institutional support and scale—there must be fewer sweeping revolutions or cries of total failure by the opposition. Disruption gives way to continuous progress as the complex system evolves from within. It is a kind of third way that eschews polarization and favors collaboration, that blends market principles with what might be called ‘state guidance’ rather than top-down intervention.
Global warming, policies for ageing populations, child protection services and transportation management are all examples of complex systems and challenges. To take the last example, in the US, traffic congestion is estimated to cost households USD 120 billion per year and 30 billion to businesses (OECD, 2016). But where to start? With a massive infrastructure building spree? Where would you add additional capacity? How much would you invest in roads, and how much in pubic transportation? What are the relative advantages of toll roads vs increases in gas or vehicle taxes? What are the likely effects of gas price fluctuations and the onset of fleets of electric, self-driving cars? What about the technologies that have yet to be invented? And what will be the impact of policies on income inequality, gender equality, the environment and well-being? Finally, how do you efficiently join up levels of government and all the stakeholders potentially involved?
Complex systems are hard to define at the outset and open ended in scope. They can only be gradually altered, component by component, sub-system by sub-system, by learning from multiple feedback loops, measuring what works and evaluating how much closer it takes you to your goals.
General Systems Theory (GST), that is, thinking about what is characteristic of systems themselves, sprang from a bold new technological era in which individual fields of engineering were no longer sufficient to master the breathtaking range of knowledge and skills required by emerging systems integration. That know-how gave us complex entities as fearful as the Intercontinental Ballistic Missile and as inspiring as manned space flight. Today, the world seems to be suffering from complexity fatigue, whose symptoms are a longing for simple answers and a world free of interdependencies, with clear good guys and bad guys and brash, unyielding voices that ‘tell it like it is’, a world with lines drawn, walls built and borders closed. Bringing back a sense of excitement and purpose in mastering complexity may be the first ‘wicked’ problem we should tackle.
In the meantime, we need to find a way to stop approaching complex challenges through the limits of our institutions and start approaching them through the contours of the challenges themselves. Otherwise too many important decisions will be clear, simple and wrong.
Gabriela Ramos, Special Counsellor to the OECD Secretary-General and Sherpa to the G20
In 2016, surprisingly for many, Oxford Dictionaries chose as their Word of the Year “post-truth”, an adjective defined as: “relating to or denoting circumstances in which objective facts are less influential in shaping public opinion than appeals to emotion and personal belief”. This runs contrary to the main tenet of the OECD, the “house of best practices” whose works and analysis depend on high quality statistics and solid empirical evidence. So how did we get here, and what does it means for our democracies?
As the OECD’s G20 Sherpa, I witnessed the evolution of what was originally a financial crisis into an economic crisis, and more recently, after eight years of low growth and very slow recovery, into a political crisis defined by the lack of trust of people in the institutions that we built over so many decades. It is also clear that the values of openness, mutual assistance, and international integration on which the OECD was founded are being questioned.
One reason for this is that while we have told “the truth and nothing but the truth”, we have not told “the whole truth”. Like people gradually enclosing themselves in media silos and social networks that only give them news and views they are comfortable with, we have been happy to rely on economic models that work with comfortingly quantitative facts on GDP, income per capita, trade flows, resource allocation, productivity, and the like. These standard economic models did not anticipate the level of discontent that was created by the skewed outcomes that they were delivering, and that have prevailed for so many years.
Our “truths” did not capture very relevant dimensions that inform people’s decisions (including recent political decisions), and particularly those that are intangible or non- measurable concepts. This is why such important issues as justice, trust or social cohesion were just ignored in the models. Indeed, neoliberal economics taught us that people are rational, and that they will always take the best decisions according to the information they have to maximize utility. And that accumulation of rational decisions will deliver the best outcome on the aggregates. In this model there is no room for emotions or for concepts like fairness or resentment.
Populism, the backlash against globalisation, call it what you will, recognises these emotions. We should do so too, especially since we actually have the data and facts that gave rise to these feelings in the first place. I am referring to the increased inequalities of income and outcomes that almost all the OECD economies experienced even before the crisis and that the crisis made worse.
If we go beyond averages and GDP per capita and look at the distributional impact of our economic decisions for instance, the picture is devastating. Up to 40 percent of people in the lowest tenth of the income distribution in OECD countries (and 60% in my own country, Mexico) have not seen their situation improve in the last decades. On top of that, lower income groups accumulate disadvantages, as their initial condition does not allow them to access quality education and health care or fulfilling jobs, while their children are facing a sombre future with less chance of improving their lot. At the OECD we have confirmed this. Our data show that if you are born into a family whose parents did not reach higher education, you have four times less chance of reaching middle school. You may encounter more health problems, and have less fulfilling jobs and lower wages. You are trapped in a vicious circle of deprivation.
Even the loosely-defined middle classes in OECD countries are fearful for their future and that of their children. They too feel betrayed and are angry that despite working hard, saving and doing everything else that was supposed to guarantee a good life, they see the fruits of success being captured by a tiny elite while they are left behind. No wonder they are attracted to solutions that resonate with their emotions and seem to give them some hope.
What should an organisation like the OECD, committed to evidence-based policy advice, do in this context? First, we must speak out when there is a deliberate misrepresentation of the facts and realities. Even if the people delivering these lies are not aware of it, it does not discharge them from the responsibility to check the evidence. Presenting a view that is based on lies by omission or on purpose should be recognised as such and not go unchallenged in the “post-truth” environment.
Second, instead of defending our selection of facts, recognise that they were also biased, and that in many instances they represented preconceived notions of how the economy functions that have been proven wrong. To rebuild trust in the facts we produce to explain social and economic phenomena, we must ensure that they really represent the whole reality and provide workable solutions. We may need to start, as the Chief Statistician of the OECD has said, “to measure what we treasure and not treasure what we measure”.
Most of all we need to understand that economic challenges are not just economic. That is why the OECD’s New Approaches to Economic Challenges (NAEC) initiative promotes a multi-dimensional view of people’s well- being, with tangible and intangible elements (including emotions and perceptions) all worthy of consideration. The NAEC agenda is ambitious, calling for a new growth narrative that recognises the complexity of human behaviour and institutions, and calls on sociology, psychology, biology, history, and other disciplines to help write this narrative and build better models to inform economic decisions.
We thought there was only one truth, and we promoted it without considering that it may have had faults. We defined reality in certain ways and ignored critics to the models. We strongly, and mistakenly, believed markets were the whole answer.
I think that as economists and policymakers, we should remember that in The Wealth of Nations, Adam Smith was drawing conclusions from not just the methodology, but also the ethics and psychology he explored in The Theory of Moral Sentiments. We may need to enrich our models to ensure that the outcomes respond to people expectations, and help us to recover the most important ingredient in our societies, which is trust.
French daily Le Figaro recently included Gabriela Ramos in a feature on “The New Untouchables”, four women leading the fight against corruption and for democracy (in French)
Eric Beinhocker, Executive Director, The Institute for New Economic Thinking at the Oxford Martin School
If 2008 was the year of the financial crash, 2016 was the year of the political crash. In that year we witnessed the collapse of the last of the four major economic-political ideologies that dominated the 20th century: nationalism; Keynesian Pragmatism; socialism; and neoliberalism. In the 1970s and 80s the centre-right in many countries abandoned Keynesianism and adopted neoliberalism. In the 1980s and 90s the centre-left followed, largely abandoning democratic socialism and adopting a softer version of neoliberalism.
For a few decades we thought the end of history had arrived and political battles in most OECD countries were between centre-right and centre-left parties arguing in a narrow political spectrum, but largely agreeing on issues such as free trade, the benefits of immigration, the need for flexible efficient markets, and the positive role of global finance. This consensus was reinforced by international institutions such as the IMF, World Bank, and OECD, and the Davos political and business elite.
In 2008 that consensus was rocked, last year it crumbled. Some will cling on to the idea that the consensus can be revived. They will say we just need to defend it more vigorously, the facts will eventually prevail, the populist wave is exaggerated, it’s really just about immigration, Brexit will be a compromise, Clinton won more votes than Trump, and so on. But this is wishful thinking. Large swathes of the electorate have lost faith in the neoliberal consensus, the political parties that backed it, and the institutions that promoted it. This has created an ideological vacuum being filled by bad old ideas, most notably a revival of nationalism in the US and a number of European countries, as well as a revival of the hard socialist left in some countries.
History tells us that populist waves can lead to disaster or to reform. Disaster is certainly a realistic scenario now with potential for an unravelling of international cooperation, geopolitical conflict, and very bad economic policy. But we can also look back in history and see how, for example, in the US at the beginning of the 20th century Teddy Roosevelt harnessed populist discontent to create a period of major reform and progress.
So how might we tilt the odds from disaster to reform? First, listen. The populist movements do contain some racists, xenophobes, genuinely crazy people, and others whom we should absolutely condemn. But they also contain many normal people who are fed up with a system that doesn’t work for them. People who have seen their living standards stagnate or decline, who live precarious lives one paycheque at a time, who think their children will do worse than they have. And their issues aren’t just economic, they are also social and psychological. They have lost dignity and respect, and crave a sense of identity and belonging.
They feel – rightly or wrongly – that they played by the rules, but others in society haven’t, and those others have been rewarded. They also feel that their political leaders and institutions are profoundly out of touch, untrustworthy, and self-serving. And finally they feel at the mercy of big impersonal forces – globalisation, technology change, rootless banks and large faceless corporations. The most effective populist slogan has been “take back control”.
After we listen we then have to give new answers. New narratives and policies about how people’s lives can be made better and more secure, how they can fairly share in their nation’s prosperity, how they can have more control over their lives, how they can live with dignity and respect, how everyone will play by the same rules and the social contract will be restored, how openness and international cooperation benefits them not just an elite, and how governments, corporations and banks will serve their interests, and not the other way around.
This is why we need new economic thinking. This is why the NAEC initiative is so important. The OECD has been taking economic inequality and stagnation seriously for longer than most, and has some of the best data and analysis of these issues around. It has done leading work on alternative metrics other than GDP to give insight into how people are really doing, on well-being. It is working hard to articulate new models of growth that are inclusive and environmentally sustainable. It has leading initiatives on education, health, cities, productivity, trade, and numerous other topics that are critical to a new narrative.
But there are gaps too. Rational economic models are of little help on these issues, and a deeper understanding of psychology, sociology, political science, anthropology, and history is required. Likewise, communications is critical – thick reports are important for government ministries, but stories, narratives, visuals, and memes are needed to shift the media and public thinking.
So what might such a new narrative look like? My hope is that even in this post-truth age it will be based on the best facts and science available. I believe it will contain four stories:
- A new story of growth
- A new story of inclusion
- A new social contract
- A new idealism.
This last point doesn’t get discussed enough. Periods of progress are usually characterised by idealism, common projects we can all aspire to. Populism is a zero-sum mentality – the populist leader will help me get more of a fixed pie. Idealism is a positive-sum mentality – we can do great things together. Idealism is the most powerful antidote to populism.
Economics has painted itself as a detached amoral science, but humans are moral creatures. We must bring morality back into the centre of economics in order for people to relate to and trust it. Some might question whether this is territory the OECD should get into. But the OECD was founded “to improve the economic and social well-being of people around the world” and provide a forum for governments to “seek solutions to common problems.” These issues will dramatically impact the well-being of people around the world for decades to come and are certainly a common problem.
So my hope is that the OECD will continue to play a leadership role, through NAEC and its other initiatives, on new economic thinking, not just in a narrow technical sense, but in the broad sense of helping forge a new vision that puts people back at the centre of our economy. We are truly at a fluid point in history. It could be a great step backwards or a great step forwards. We must all push forwards together.
The OECD organised a Workshop on Complexity and Policy, 29-30 September 2016, at OECD HQ, Paris, along with the European Commission and INET. Watch the webcast: 29/09 morning; 29/09 afternoon; 30/09 morning
Agent-based models to help economics do a better job
Richard Bookstaber, University of California
Economics has not done a very good job of dealing with crises. I think this is because there are four characteristics of human experience that manifest themselves in crises and that cannot be addressed well by the methods of traditional economics.
The first of these is computational irreducibility. You may be able to reduce the behaviour of a simple system to a mathematical description that provides a shortcut to predicting its future behaviour, the way a map shows that following a road gets you to a town without having to physically travel the road first. Unfortunately, for many systems, as Stephen Wolfram argues, you only know what is going to happen by faithfully reproducing the path the system takes to its end point, through simulation and observation, with no chance of getting to the final state before the system itself. It’s a bit like the map Borges describes in On Rigor in Science, where “the Map of the Empire had the size of the Empire itself and coincided with it point by point”. Not being able to reduce the economy to a computation means you can’t predict it using analytical methods, but economics requires that you can.
The second characteristic property is emergence. Emergent phenomena occur when the overall effect of individuals’ actions is qualitatively different from what each of the individuals are doing. You cannot anticipate the outcome for the whole system on the basis of the actions of its individual members because the large system will show properties its individual members do not have. For example, some people pushing others in a crowd may lead to nothing or it may lead to a stampede with people getting crushed, despite nobody wanting this or acting intentionally to produce it. Likewise no one decides to precipitate a financial crisis, and indeed at the level of the individual firms, decisions generally are made to take prudent action to avoid the costly effects of a crisis. But what is locally stable can become globally unstable.
The name for the third characteristic, non-ergodicity, comes from the German physicist Ludwig Boltzmann who defined as “ergodic” a concept in statistical mechanics whereby a single trajectory, continued long enough at constant energy, would be representative of an isolated system as a whole, from the Greek ergon energy, and odos path. The mechanical processes that drive of our physical world are ergodic, as are many biological processes. We can predict how a ball will move when struck without knowing how it got into its present position – past doesn’t matter. But the past matters in social processes and you cannot simply extrapolate it to know the future. The dynamics of a financial crisis are not reflected in the pre-crisis period for instance because financial markets are constantly innovating, so the future may look nothing like the past.
Radical uncertainty completes our quartet. It describes surprises—outcomes or events that are unanticipated, that cannot be put into a probability distribution because they are outside our list of things that might occur. Electric power, the atomic bomb, or the internet are examples from the past, and of course by definition we don’t know what the future will be. As Keynes put it, “There is no scientific basis to form any calculable probability whatever. We simply do not know.” Economists also talk about “Knightian uncertainty”, after Frank Knight, who distinguished between risk, for example gambling in a casino where we don’t know the outcome but can calculate the odds; and what he called “true uncertainty” where we can’t know everything that would be needed to calculate the odds. This in fact is the human condition. We don’t know where we are going, and we don’t know who we will be when we get there. The reality of humanity means that a mechanistic approach to economics will fail.
So is there any hope of understanding what’s happening in our irreducible, emergent, non-ergodic, radically uncertain economy? Yes, if we use methods that are more robust, that are not embedded in the standard rational expectations, optimisation mode of economics. To deal with crises, we need methods that deal with computational irreducibility; recognise emergence; allow for the fact that not even the present is reflected in the past, never mind the future; and that can deal with radical uncertainty. Agent-based modelling could be a step in the right direction.
Agent-based models (ABM) use a dynamic system of interacting, autonomous agents to allow macroscopic behaviour to emerge from microscopic rules. The models specify rules that dictate how agents will act based on various inputs. Each agent individually assesses its situation and makes decisions on the basis of its rules. Starlings swirling in the sky (a “murmuration”) is a good illustration. The birds appear to operate as a system, yet the flight is based on the decisions of the individual birds. Building a macro, top-down model will miss the reality of the situation, because at the macro level the movements of the flock are complex, non-linear, yet are not based on any system-wide programme. But you can model the murmuration based on simple rules as to how a bird reacts to the distance, speed and direction of the other birds, and heads for the perceived centre of the flock in its immediate neighbourhood.
Click to see ABM in motion. Original file on Reddit
Likewise, the agent-based approach recognises that individuals interact and in interacting change the environment, leading to the next course of interaction. It operates without the fiction of a representative consumer or investor who is as unerringly right as a mathematical model can dream. It allows for construction of a narrative—unique to the particular circumstances in the real world—in which the system may jump the tracks and careen down the mountainside. This narrative gives us a shot at pulling the system back safely.
In short, agent-based economics arrives ready to face the real world, the world that is amplified and distorted during times of crisis. This is a new paradigm rooted in pragmatism and in the complexities of being human.
Richard Bookstaber video contribution, OECD New Approaches to Economic Challenges (NAEC)
Richard Bookstaber will be giving a conference within the framework of the OECD NAEC initiative in Paris in June 2017. His latest book, discussing the ideas outlined above, has just been published by Princeton University Press: The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction
The OECD organised a Workshop on Complexity and Policy, 29-30 September 2016, at OECD HQ, Paris, along with the European Commission and INET. Watch the webcast: 29/09 morning; 29/09 afternoon; 30/09 morning