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Back to the 80s: Projections for living standards and inequality in the UK

2 February 2017
by Guest author

Adam Corlett, Economic Analyst and Stephen Clarke, Research and Policy Analyst, Resolution Foundation

The UK economy has, in many respects, performed well recently. Last week it was revealed that GDP grew by 2 per cent in 2016, above the OECD average, and higher than forecasters expected when the country voted to leave the European Union. Employment is at a record high and average wages, although still 4 per cent below their pre-crisis peak, have been growing at a rate of around 2 per cent a year in real terms. Yet dark clouds are forming on the horizon, particularly for those on low and middle incomes.

Our annual audit of Living Standards across the UK, which uses the macroeconomic forecasts of the independent Office for Budget Responsibility as well as expected tax and benefit rates, shows that growth in typical household incomes will slow sharply in the next few years.

Indeed, the strong income growth of the past few years has likely already ended. Very low inflation – driven by oil price falls – and rising employment could not have been expected to last forever, and inflation has picked up quickly since the EU referendum vote cut the value of Sterling. Looking at the next four years as a whole we project cumulative growth in average working-age incomes of only 1.7 per cent (or 0.4 per cent a year). This is the result of forecasts of above-target inflation, poor wage growth, no employment growth, and tightening fiscal policy.

But even more worrying is how this meagre growth is likely to be shared. While incomes are projected to stagnate for those in the middle, they are expected to rise (albeit weakly) for those at the top and fall significantly for those at the bottom – as shown in the figure below. The poorest quarter of working-age households are projected to be around 5-15 per cent worse off in 2020-21 than this year. In contrast, the highest income quarter would rise by 4-5 per cent.

The result is the worst period of household income growth for the poorest half of households since records began in the mid-1960s. The skewed growth would also represent the largest increase in inequality since the premiership of Margaret Thatcher, and would take inequality (measured here after housing costs) to new heights. This is illustrated below for three common inequality measures, with the most dramatic rise being in terms of the ratio of household income of the 90th percentile compared to the 10th, reflecting the extremely large fall in income at the bottom.

The large inequality increases of the 1980s – which until now have never really been repeated in the UK – can also clearly be seen. However, that was a period when incomes generally rose across the distribution – and significantly faster at the top. The current period is therefore unprecedented in combining weak overall growth with rising inequality and falling incomes at the bottom. To put it another way the next few years could be like the 1980s but without the feel-good factor.

Notes: The 80/20 ratio is the income of a household richer than eight out of ten households divided by that of one richer than only two in ten households; the 90/10 ratio is similarly constructed; and the Palma ratio is the income share of the top 10 per cent divided by the income share of the bottom 40 per cent.

So why does this projection look so bad and what can be done to change it?

The UK’s anaemic wage growth is linked to poor productivity growth, which has dogged the UK for a decade now. The OECD has drawn attention to the low levels of infrastructure spending in the UK and a lack of investment in human capital. Greater public and corporate investment could help spur greater productivity growth. Reducing the cost of housing could make a big difference too. Current mortgagors are benefiting from continued low borrowing costs but we can’t rely on record low interest rates forever.

There is also scope to continue the remarkable employment growth of recent years. Despite the record high, many parts of the country and many groups still have much lower labour market engagement. Our research suggests that addressing such disparities could put around 2 million more people in work by 2020-21.

But, beyond the rate of growth, how that growth is shared is in many ways a simple policy choice. The dismal projection for poorer working-age households (and those with children especially) is in large part due to welfare cuts of over £12 billion inherited by the new PM. These include a freeze in almost all working-age benefits until 2020, despite rising and higher-than-expected inflation; cuts to the generosity of in-work support; and large reductions in support for new families with more than two children. At the other end of the spectrum, the government is introducing tax cuts that will predominantly benefit middle to higher income households. While the government is seeking to bring down its fiscal deficit, how this burden falls – and what level of inequality it wants to see in this country – is entirely its own choice.

Useful links

OECD work on inequality

OECD work on the United kingdom

 

Telling the whole truth in a post-truth environment

1 February 2017
by Guest author

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.

Useful links

More from Gabriela Ramos on OECD Insights

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)

A Responsibility Revolution in the Fashion Industry: How OECD’s new Due Diligence Instrument can transform the global garment industry

31 January 2017
by Guest author

Roel Nieuwenkamp, Chair of the OECD Working Party on Responsible Business Conduct (@nieuwenkamp_csr)

The collapse of the Rana Plaza factory in 2013 with a loss of over 1,130 lives was a jarring reminder that though much has been accomplished to improve working conditions in global supply chains, more is needed. Following the tragedy, stakeholders worldwide, ranging from industry to labour organizations and civil society, mobilised to respond to this need. The breadth of initiatives launched to tackle these issues is impressive. Perhaps most visible are the Bangladesh Accord on Fire and Building Safety and the Alliance for Bangladesh Worker Safety. Together, these initiatives have joined over 250 brands, retailers and their suppliers to inspect and upgrade shared factories, demonstrating that a sector-wide approach to building safer supply chains is not only feasible but effective. During my last trip to Bangladesh, I witnessed the great progress these initiatives have made. The Accord and the Alliance are only two responses amongst many since the Rana Plaza tragedy.

A common understanding of company responsibility in an age of globalization

Rana Plaza was a subcontractor to many garment companies, meaning that in many cases global brands did not place their orders directly with factories operating out of Rana Plaza. Furthermore, in some cases the subcontracting was illegal. While there was already general agreement in the sector that companies should identify and address risks with direct suppliers, the complexities of Rana Plaza raised the question, whose responsibility is due diligence when we look beyond direct contractors and further up the supply chain?

The OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights are clear: companies have a responsibility to identify, prevent, mitigate and account for adverse impacts in their supply chains. In June 2015 the G7 promoted international efforts to promulgate industry-wide due diligence standards in the textile and ready-made garment sector.

On 8 February 2017 the OECD will launch a Due Diligence Guidance for Responsible Supply Chains in the Garment and Footwear Sector which responds to this call. This Guidance, developed through an intense multi-stakeholder process, supports a common understanding of due diligence and responsible supply chain management in the sector.

The Guidance is a global instrument

This is really a global instrument, contributing towards a level playing field for responsible business conduct. The OECD Guidelines apply to all companies operating in or sourcing from the 46 adhering countries, but they are likewise relevant for any company operating in their global supply chains. The Guidelines are relevant for a Bangladeshi factory that sells to companies in the US, even while Bangladesh itself is not an Adherent, just as they are relevant for cotton producers in Pakistan exporting to EU markets. OECD , demonstrating the global reach of the OECD Guidelines in the garment sector alone.

Adherents to the OECD Guidelines account for over 72% of world imports of clothing

The relevance of the OECD Guidelines globally is no longer hypothetical. The National Contact Points (NCPs), the globally active grievance mechanism of the Guidelines, have already handled several cases related to due diligence in the garment and footwear sector. For example, the Danish NCP recently concluded its consideration of a case involving PWT Group, a Danish retailer, for failing to carry out due diligence in relation to its textile manufacturer in the Rana Plaza building. Both the Guidance and the conclusions of the Danish NCP in this case are significant for the future of human rights due diligence in the textile sector globally.

The Guidance is progressive, realistic and balanced

The Guidance encourages the sector to think differently and to react differently, but does so in a progressive, balanced, and realistic way. Under the Guidance, companies are expected to scope risks across the full length of their supply chain, including risks related to subcontracting and homeworkers. Moreover, this assessment moves beyond auditing to not only identify labour, human rights and environmental impacts, but also understand why they are occurring. This tailor-made approach to risk assessment recognises that risks in the garment and footwear sector are very different and the assessment methodologies should reflect these differences. An assessment for child labour and forced labour should not be the same as an assessment of occupational health and safety or wage compliance. This Guidance also recognises the challenge of ‘audit fatigue’, so it pushes the sector towards harmonised assessments and most importantly effective monitoring.

While the Guidance is ambitious, it is also realistic. Addressing the full range of challenges in the sector all at once is mission impossible for brands with vast supply chains that go several layers deep. So brands will have to prioritise issues where the impacts are most severe. This could be, for example in relation to hazardous chemicals in finishing or forced labour in cotton.

Finally, the Guidance recognises the diversity of actors in this sector and the diversity of sourcing models. It does not prescribe a one-size-fits all approach, seeking rather to provide recommendations for how companies can carry out due diligence given their circumstances (size, context, etc). For example, the Guidance recognises that companies may source materials and products directly from suppliers or indirectly through buying agents and provides tailored recommendations for each. Similarly, it acknowledges the role subcontracting plays and therefore recommendations point more to ‘responsible subcontracting’ than always ruling out subcontracting altogether.

No more neo-colonial top-down system

In November of last year I participated as a panellist in India on responsible garment supply chains. A fellow panellist, a factory owner, called the traditional garment audit model a colonialist approach: ‘Western brands telling the developing country factories what to do’. With the new OECD Due Diligence Guidance we finally say goodbye to this neo-colonialist approach. It appreciates the importance of a partnership between buyers, suppliers and workers in identifying methods to address risks and monitor progress over time.

But just as important as this partnership, is the fact that due diligence is not merely about looking outward; it’s also about looking inward. Another remark made by my fellow panellist is that companies do not align their purchasing policies with responsible business policies. For example, brand purchasing officers often ask the factory to cut prices by 10%, while the brand ethical sourcing team asks for a 20% wage rise. In a study conducted by ETI Norway, Suppliers speak up, suppliers responded that paying legal minimum wage and legal overtime premiums would increase labour costs by 10-20%. However, despite this reality, little science goes into price-setting by brands and retailers. So functional alignment of brand policies needs to be part of due diligence.

Under the OECD Due Diligence Guidance, companies, particularly brands and retailers, are expected to assess their own purchasing practices and determine how their price setting and ordering may be contributing to excessive overtime, low wages, precarious contracts, illegal subcontracting, etc. Personally, I think that embedding responsibility indicators in the bonuses or performance appraisals of purchasing officers should incentivise due diligence; otherwise due diligence and respect for human rights will stay a peripheral issue.

The new global instrument for garment due diligence that will be launched next week at the OECD Roundtable on Due Diligence in the Garment and Footwear Sector can change the fashion industry worldwide. It is global, progressive, and realistic, and assists in more mature supply chain dialogues than the neo-colonialist audit system. Now is the time to implement and make fair fashion the standard.

Useful links

More on the garment industry and on due diligence on OECD Insights

A new narrative for a complex age

30 January 2017
by Guest author

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.

Useful links

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 morning29/09 afternoon30/09 morning

Going Digital – Making the transformation work for growth and well-being

24 January 2017
by Guest author

Coming soon to a job near you?

Douglas Frantz, OECD Deputy Secretary-General and Project Leader for the OECD’s Going Digital project

At a conference in China last year, the chief scientist of an American robotics firm predicted the world was approaching the “moment of singularity.” For the uninitiated, technological singularity is the hypothetical event in which artificial general intelligence allows robots and computers to replace human control and understanding.

Yes, it sounds like the plot of the Terminator movies or a William Gibson novel. And no one can lay out a credible time line. But not too long ago scepticism would have been just as high if you had suggested that, say, a computer could beat a human chess champion or that cars would drive themselves.

The digital economy is growing exponentially. It transcends borders, transforms economies and upends the policy landscape. We have gone from a society where technology made work more efficient to one where it is revolutionising every aspect of our lives, from where we work and play to how long we live.

Our response to these fast-moving changes will define whether the digital revolution contributes to global economic growth and improves human well-being – or not.

The digital revolution will backfire if it widens the gap between haves and have-nots and erodes the already-frayed trust between governments, companies and citizens. Failing to make sure that innovations in manufacturing, medicine and agriculture reach poor countries will threaten economic growth. Failing to prepare workers who lose their jobs to automation in wealthy countries will foster social instability.

The clock is ticking. Some estimates suggest that nearly half of existing jobs will be eliminated by automation in the next 20 years. Even in wealthy countries, some poor and uneducated people are still shut out of the new economy by a lack of Internet access. The benefits of the digital economy are not distributed equally, leaving behind economic sectors and entire countries.

So far, governments have struggled to respond to the complexity of this digital reality. They have been slow to develop and implement policies that take advantage of the truly global opportunity for increased growth, inclusion and well-being. And too many businesses treat people like a cost to be eliminated. No wonder so many people fear being left behind.

There is time to get this right. There is time to develop pro-active policies that come to grips with the promise and the peril of the digital economy. And there is time to come to grips with the need for ethical guidelines and regulatory limits on artificial intelligence. The leaders of the G20, who represent the world’s wealthiest countries, recognise that the digital economy offers challenges as well as opportunities. As part of its G20 presidency this year, the German government has made a priority of developing ways to share the benefits.

At the Organisation for Economic Cooperation and Development, we are confronting the digital revolution head on. We have started an ambitious, two-year project to examine how the digital transformation affects policy making across the broadest possible range of fields and topics.

The project is called “Going Digital.” The objective is to work with governments, business, labour and civil society to develop policies to harness the power of the digital revolution for OECD members and developing countries and unlock the benefits for everyone.

Fortunately, we are not starting from zero. The OECD and its member countries have done a lot of work analysing the impact of the digital economy and trying to shape policies that maximise its potential. The OECD’s Committee on Digital Economy Policy has tracked digital economic growth since 1982 and developed “soft law” on issues like privacy, security and trans-border data flows. The Committee will co-ordinate the new project.

But the global nature of the challenge dictates a global response. So the new effort will expand the consultation beyond the OECD’s 35 members to experts, social partners and officials from emerging economies and the developing world. We aim to listen carefully and consult thoroughly.

Just as the digital revolution affects every aspect of our lives, the project is founded on a whole-of-house perspective. The unique strength of the OECD is our ability to bring together our diverse Directorates to draw on experts on tax, competition, industry, innovation and entrepreneurship, insurance and private pensions, financial markets, fiscal affairs, science and technology, statistics, economics, education, employment, labour and social affairs, public governance and trade.

How will this unfold over the next two years? We will actively seek the support of the widest range of experts, countries and organisations through workshops and conferences. We will go on the road to brainstorm, consult and engage. We will use the OECD’s world-class capacity to gather evidence and provide critical analysis to underpin new policies.

In the end, the goal is simple: The OECD wants to work with others to make the digital transformation work for growth and well-being. If that moment of singularity arrives, we want to help make sure the world is ready to use it to promote fair economic growth and social equality.

Useful links

Agent-based models to help economics do a better job

23 January 2017
by Guest author

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.

Useful links

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 morning29/09 afternoon30/09 morning

The aid community should stop pretending to know the answers and start asking the right questions.

20 January 2017
by Guest author

Frans Lammersen and Jorge Moreira da Silva (Director) OECD Development Co-operation Directorate – DCD-DAC

In  The Wealth of Nations, Adam Smith wrote that: “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by natural course of things.” Others were less optimistic. They argued that nations are rich or poor because of differences in religion, culture, endowments, and/or geography.

Modern economic development theories originate from thinking about how to reconstruct Europe in the aftermath of World War II. The European Recovery Program – or the Marshall plan – was based on the notion that economic growth can be stifled by local institutions and social attitudes, especially if these influence the domestic savings and investments rate. According to this linear growth model, a correctly-designed massive injection of capital coupled with public sector intervention to address market failures would ultimately lead to industrialisation and economic development. Many other economic development theories have since followed, but none have been able to explain convincingly why some countries experience rapid economic growth and others not.

The development community has continued its quest for the missing ingredient to ignite economic growth. Candidates have included capital, technology, policies, institutions, better politics, and market integration. Every time we think we have identified what’s missing, we find that it is actually not something which can be provided from outside, but turns out to be an endogenous characteristic of the system itself. Traditionally, development assistance has been rooted in a type of engineering, mass production, conveyor belt mentality, with agencies promoting “silver bullet” solutions for such complex problems as eradicating malaria, reducing vulnerability, improving resilience, strengthening connectivity etc. Unfortunately, piecemeal or one step at a time development programmes often failed to deliver.

Increasingly, complexity thinking – a way of understanding how elements of systems interact and change over time – has found its way into the development discourse. After all, what could be more complex than promoting development, sustainability, human rights, peace, and governance? We should think of the economy and society as being composed of a rich set of interactions between large numbers of adaptive agents, all of which are coevolving. Based on this approach development is not just an increase in outputs, but the emergence of an interlinked system of economic, financial, legal, social and political institutions, firms, products and technologies. Together these elements and their interaction provide citizens with the capabilities to live happy, healthy and fulfilling lives.

Once we look at development as the outcome of a complex adaptive system instead of the sum of what happens to the people and firms, we will get better insights into how we can help accelerate and shape development. We would be more effective if we assess development challenges through this prism of complex adaptive systems. This could yield important insights about how best to prioritise, design and deliver holistic development programmes for achieving the multiple goals of inclusiveness, sustainability and economic growth that underpin the 2030 Sustainable Development Agenda. There is increasing support in aid agencies for the idea that solutions to complex problems must evolve, through trial and error – and that successful programmes are likely to be different for each local context, with its particular history, natural resources and webs of social relations. The key for anyone engaged in the aid business is to put their own preconceived ideas aside and first observe, map, and listen carefully to identify the areas where change for the better is already happening and then try to encourage and nurture that change further.

Complexity matters particularly when the knowledge and capacities required for tackling problems are spread across actors without strong, formalised institutional links. Inherent to many complex problems are divergent interests, conflicting goals or competing narratives. Moreover, it is often unclear how to achieve a given objective in a specific context, or change processes that involve significant, unpredictable forces. At the same time, it is important to emphasise that the counsel of complexity should not be taken as a counsel of despair for development. There has been immense social and economic progress, and development assistance has found to be helpful overall. Development co-operation has contributed to achieving economic objectives by helping developing countries connect their firms to international markets; to achieving social objectives by making globalisation pro-poor and reducing inequalities; and to environmental objectives by adapting to climate change while exploiting comparative advantages.

Not all development challenges are inherently complex though. For those that are, complexity should not be used as an excuse for fatalism and inertia. Instead we should strive to promote innovation, experimentation and renewal. We should build partnerships to learn about the past, allowing us to shape approaches that are more likely to work and that are owned by the people we are trying to help. They will tell us what is working and what is not. Together we should build a narrative for change involving many different voices and perspectives. We should also be modest and realise that it might better to start small and learn and adapt as we go along in iterative processes of dialogue. We should keep looking for change, scanning widely for new factors emerging in the wider world; listen to a wide range of opinions to be better able to anticipate and adapt and seize opportunities.

Embracing complexity where it matters will allow us to contribute more effectively to the 2030 Sustainable Development Agenda.

Useful links

The OECD and the Sustainable Development Goals

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 morning29/09 afternoon30/09 morning