The OECD as the cradle of the Club of Rome

Matthias Schmelzer, University of Jena, based on a newly published article on the origins of the Club of Rome within the OECD.

The Club of Rome’s first report, The limits to growth, appeared in 1972 and was ultimately published in thirty languages and sold over thirty million copies worldwide. It made many people aware for the first time that with continuing growth the world would eventually run out of resources. Today, 45 years later, its electrifying conclusions, which modelled the ‘overshoot and collapse’ of the global system by the mid twenty-first century, still provoke intense debates.

The report also brought international fame to the newly founded Club of Rome, which has since become a key reference point in the public memory of the 1970s and environmental discourses more generally. It boasts considerable authority as a private, non-state, and global group of experts concerned about the fate of humanity, and a wise warden for the ecological survival of planet Earth. However, this extraordinary public and academic attention has largely overlooked the constitutive entanglements with the OECD that characterise the Club’s foundation and early history.

This OECD–Club of Rome nexus needs explaining. The OECD, founded in 1961 as the successor of the Organisation for European Economic Co-operation (OEEC) that had overseen the Marshall Plan aid, soon became, in the words of one of its Directors, “a kind of temple of growth for industrialised countries; growth for growth’s sake was what mattered”. By the late 1960s, however, faced by increasing popular anxiety about unsustainable growth in Western societies, scientists and bureaucrats within the OECD launched a debate on “the problems of modern society”. The driving forces of this growth-critical and ecologically oriented debate were two of the most powerful men within the Organisation: the head of the OECD since its foundation in 1961, Secretary-General Thorkil Kristensen, and the Organisation’s long-time science director and unofficial intellectual leader, Alexander King. The topic assumed such importance that it was central to discussions at the OECD’s ministerial meetings in 1969 and 1970.

However, Kristensen, King, and their associates around the science directorate and the Committee for Science Policy were frustrated by governments’ inability to deal with long-term and interrelated ecological problems and thus looked for allies outside the OECD. They got together with Italian industrialist and global visionary Aurelio Peccei, at that time an executive of Fiat and the managing director of both Olivetti and Italconsult, and in 1968 this elite group of engineers, scientists, and businessmen, founded the Club of Rome. They were fundamentally sceptical about the potential of existing political institutions to catalyse the controversial global debate they deemed necessary, because they regarded these institutions as the “guardians of the status quo and hence the enemies of change”. They saw themselves “faced with the extraordinary arrogance of the economist, the naivety of the natural scientist, the ignorance of the politician, and the bloody-mindedness of the bureaucrat”, all unable to tackle the ensemble of problems they had identified.

Thus, they built a transnational network to advance their view of planetary crisis both through the OECD (thus targeting key economists and ministers from member countries) and through the Club of Rome, whose reports forcefully shaped public debates. This network blurred the lines between the “official” OECD and the “private” Club, not only in terms of overlapping membership but also in terms of discourses. While the Club functioned as a “detonator”, its core members used international organisations “as transmission belts”, as Peccei explicitly put it, and thus acquired a strong leverage.

The personal overlap between the OECD and the Club of Rome in its initial phase is remarkable. Not only were three of the four persons that founded the Club working in or with the OECD (King, the Austrian systems analyst, astrophysicist, and OECD expert; Erich Jantsch; and the Swiss director of the Geneva branch of the Battelle Memorial Institute and Vice-Chairman of the OECD’s science committee Hugo Thiemann). Besides the Italian industrialist Peccei and the German industrial designer Eduard Pestel, who secured the funding from the Volkswagen Foundation for the first report, all the crucial personalities in the formative period of the Club of Rome were closely connected to the OECD. Almost the entire core group of the Club of Rome, its “executive committee” – which has been characterised as the true “motor” of the Club of Rome, and who signed Limits to growth – also had positions within the OECD.

This transnational group of experts at the interface of national governments, international organisations, and the Club of Rome formed a unique circle of elite environmentally conscious planners. Even though claiming to speak for the entire globe, they represented a very narrow fraction of the global population, in part because of their organisational base in the OECD, often dubbed the “Club of the Rich”. They were all highly-educated and largely white men and thus reproduced the tradition of upper-class gentlemen’s clubs, and all came from countries in the global North (mostly European, some US and Japan). With close ties to elite universities, transnational business, and international organisations, they acted from economic positions of privilege and power. Furthermore, the entire network had academic backgrounds in the natural sciences (in particular chemistry and physics) or engineering, with only a few trained in economics, and none in the social sciences or humanities. Finally, almost all had spent at least part of their career as national government experts or administrators.

All these factors influenced the perspective and politics of the network at the heart of the OECD–Club of Rome nexus. A more profound appreciation of the gestation, midwifery, entanglements, transfers, and tensions that characterise this nexus opens up a more complex understanding of both organisations and the actors driving them. It puts in perspective the public perception of the Club of Rome as a private, non-governmental, and global think tank by analysing its origins within an all-male elite group of engineers, scientists, and businessmen, and its intimate interrelationships and personal overlaps with the OECD, an intergovernmental organisation representing the industrialised capitalist countries. This social positioning fundamentally shaped the network’s outlook, most importantly with regard to its systemic analysis of interrelated global problems in a computer-engineering perspective, the technocratic outlook from the perspective of the global North, and top-down management approach.

How did the cradle of the Club of Rome react when its offshoot published its first report in 1972? After all, Limits to growth was consciously set up as a “detonator” to give a jolt to established governments and international organisations. At first, it did indeed impress and unsettle the OECD. But once the public debate took off, the views expressed in Limits deepened the internal fractures within the OECD and provoked hostile reactions, leading to a revitalisation of the strong pro-growth position.

The strongest force behind the backlash against the critiques of growth came with the onset of economic turmoil, soaring energy prices, and stagflation from 1973-74 onwards. While the energy shortages and their effects on industrialised countries were largely interpreted by the public as proof of the Club of Rome’s predictions, within the OECD these developments did not strengthen the faction critical of growth. On the contrary, the debate on the “problems of modern society” was choked by a combination of changing member-state interests, an attempt by the top level of the Secretariat to better position the OECD, and a shift of influence within the Organisation.

The growth critique sparked a bitter controversy between the macro-economic branch of the Organisation and the science experts and environmental scientists around King, which the latter lost when the OECD refocused on trade, energy, and growth. In particular, the publication of the Club of Rome’s first report polarised the debate to such a degree that not only the OECD but Western policy-making circles more generally returned to the promotion of quantitative growth. While the Club of Rome was born in the corridors of the OECD, its first report effectively ended these intimate relationships.

Useful links

Matthias Schmelzer (2016), The Hegemony of Growth. The OECD and the Making of the Economic Growth Paradigm, Cambridge University Press

The OECD Interfutures project (1979)

Statistical Insights: Blowing bubbles? Developments in house prices

OECD Statistics Directorate

Few economic indicators make the newspapers’ front pages. One that often does though is house prices. This is because, as witnessed during the financial crisis, movements in house prices can have a direct impact on households’ wealth and economic growth. At the same time, fluctuations in economic activity can also drive trends in house prices. House price indicators are therefore among the indicators that are closely monitored by policymakers.

However, despite their importance, until recently, largely reflecting a variety of conceptual and measurement differences across countries, no harmonised internationally comparable measure of house prices existed. In 2013, a new statistical handbook on house price indices was endorsed by several international organisations, and since then the OECD has been working with countries to develop a new internationally comparable database on house prices.

The new data confirm the positive association between house prices and economic activity but they also reveal significant differences in the strength of the link across countries, especially in the wake of the recent financial crisis.

There is a positive correlation between fluctuations in house prices and in economic activity…

As Figure 1 shows, fluctuations in real house prices (i.e. adjusted for general inflation) and economic activity in the OECD are positively related (with a correlation coefficient of around 0.6 over the period 1971 to 2015). This relationship reflects three drivers, that may differ in intensity and over time: a leading component, as the wealth effects from increases in real estate prices can boost final consumption of home owners, through re-mortgaging for example; a lagging component, as stronger economic growth may boost house prices; and a co-incident component as both house prices and economic activity may be explained by the same underlying factors, such as credit market conditions and population growth.

house-prices-figure1

Note: The real house price index for the OECD area is computed from real house price indices for the 35 OECD countries, weighted using their nominal GDP weights in PPP terms. This real house price index is sourced from the OECD Analytical house price indicators dataset and real GDP from the OECD Quarterly national accounts database.

…but the relationship may have weakened over time…

Understanding the dynamic contribution these drivers make over time is clearly of interest, especially as they provide insights on the potential build-up of vulnerabilities stemming from strong household spending growth driven by rising leverage and inflated asset prices.

The latest edition of the OECD’s  Economic Outlook provides evidence of a post-crisis weakening of the relationship between house price growth and the propensity to consume, in part reflecting the changes in financial regulations and credit standards introduced after the crisis which have reduced the ability of households to use rising housing values as collateral for additional borrowing to fund current spending.

…and it differs across countries.

A number of factors influence house price movements, including real household incomes, real interest rates, mortgage market regulations and supervision, lending patterns (at fixed rate versus variable rates), tax relief on mortgage debt financing, and transaction costs such as stamp duty. Therefore, differences in institutional arrangements combined with differences in economic activity may explain heterogeneity in housing markets across countries.

The internationally comparable house price indices from the OECD database show that the relationship between house prices and economic activity is indeed stronger in some countries than others. For example, in countries like Finland, Ireland, Japan and the United Kingdom, fluctuations in house prices and economic activity are closely related, with a correlation coefficient of around 0.7 from 1971 to 2015, whereas it is much weaker in countries like France, Italy and Norway, with a correlation coefficient lower than 0.3 over the same period.

Similarly, while house prices dropped in many countries at the time of the crisis, factors that affect house price developments differ markedly across countries. Figure 2 shows how real house price developments have diverged significantly across countries since 2005. Notwithstanding some differences within each group, four broad groups of OECD countries can be distinguished:

  • An initial fall in real house prices followed by a subsequent rebound in New Zealand, the United Kingdom and the United States.
  • A continuous increase in real house prices pre and post crisis in Australia, Mexico and Sweden.
  • A severe and prolonged fall in house prices post the crisis with only recent signs of stabilisation in Greece and Spain.
  • Relatively stable house prices since 2005 in Belgium and Korea.

In respect of the above, it should also be noted that there may be significant differences across local housing markets within countries. Unfortunately internationally comparable data at sub-national level are typically not available.

house-prices-figure2

Note: House price indices for individual countries are sourced from the OECD RPPI – Headline indicators dataset and deflated by the Consumer Price Indices (CPIs) for all items. The real house price index for the OECD area is sourced from the OECD Analytical house price indicators dataset.

The measure explained

House price indices, also called Residential Property Prices Indices (RPPIs), are index numbers measuring the rate at which the prices of all residential properties (flats, detached houses, terraced houses, etc.) purchased by households are changing over time. Both new and existing dwellings are covered if available, independently of their final use and their previous owners. Only market prices are considered. They include the price of the land on which residential buildings are located.

Where to find the underlying data

The OECD database on house prices is available on OECD.STAT and includes the three following datasets:

  • Residential Property Price Indices – Headline Indicators: This dataset covers OECD members and some non-member countries. For each country, the RPPI that is available at the most aggregate level has been singled out in this dataset, but due to data availability, headline indicators are country specific. For example, the RPPI at the most aggregate level for the United States only covers single-family dwellings and not all types of dwellings as is the case for most other OECD countries.
  • Residential Property Price Indices – Complete database: This dataset contains nominal house price indices with various breakdowns for OECD members and some non-member countries. Headline indicators are a subset of this complete dataset.
  • Analytical house price indicators: This dataset contains, in addition to nominal RPPIs, information on real house prices, rental prices and the ratios of nominal prices to rents and to disposable household income per capita. It should be noted that for Brazil, Canada, China, Germany, the United States and the Euro area, the datasets “Analytical house price indicators” and “Residential Property Price Indices (RPPIs) – Headline Indicators” do not refer to the same nominal price indices. These differences are further documented in country-specific metadata that are attached to this dataset.

In the future, the OECD database on house prices will include other housing-related indicators in order to provide a more comprehensive picture of real-estate markets.

Useful links

ILO, IMF, OECD, UNECE, Eurostat, World Bank (eds.), (2013), Handbook on Residential Property Price Indices, Eurostat, Luxembourg

OECD Economic Outlook, Volume 2016 Issue 2

“A temple of growth”: The OECD and economic growth as its organisational ideology

HegemonyToday’s post is from Matthias Schmelzer of the University of Zürich, who has just published The Hegemony of Growth. The OECD and the Making of the Economic Growth Paradigm.

One of the OECD’s major tasks is to “redefine the growth narrative”, as stated repeatedly by Secretary-General Angel Gurría when specifying his mandate at the helm of the Organisation and at many high-level events since. For example, at the Ministerial Meeting in June 2016, the industrialised countries’ think tank lamented that the world economy is stuck in a “low-growth trap”, but faced with growing inequality, decreasing levels of well-being and climate change, Gurría also claimed that the OECD was inventing a new “growth narrative” aimed at overcoming the focus on GDP by promoting qualitative, inclusive, and green growth.

However, is this search for a new growth narrative really new? Taking a close look at the Organisation’s long history since the 1940s reveals that this is an ongoing quest full of arguments, episodes and dynamics well-worth studying if one wants to understand the OECD’s current difficulties in coming to terms with the predicament of growth.

The OECD is the international organisation most closely associated with economic growth: growth is its defining policy goal, it is the first aim in the OECD Convention, which prompts countries “to achieve the highest sustainable economic growth,” and growth has until nowadays been discussed centre-stage at all important meetings. One is thus tempted to interpret the focus on economic growth as the organisational ideology of the OECD, which was described by one of its most influential directors in the 1960s as “a kind of temple of growth for industrialized countries.”

In my new book I analyse the history of the OECD and its predecessor, the Organisation for European Economic Co-operation (OEEC), in order to understand, how economic growth became the primary goal pursued through policymaking in modern societies. I researched the archives of this organisation and of some of its key member countries, read texts by key protagonists on growth theory, growth debates and the critique of economic growth, and discussed my arguments with colleagues around Europe, North America, and Japan.

The book that resulted is both profoundly historical – retelling in detail the making and remaking of the growth paradigm in the second half of the twentieth century – and topical for current discussions. It argues that the pursuit of economic growth is not a self-evident goal of industrialised countries’ policies, but rather the result of a very specific ensemble of discourses, economic theory, and statistical standards that came to dominate policymaking in industrialised countries under certain social and historical conditions in the second half of the twentieth century.

Already at the Organisation’s first Ministerial meeting in November 1961, the OECD set a growth target – to increase the combined GDP of its member countries by 50 percent within a decade. It is important to note, however, that “sustainable growth” in the OECD Convention – even if often otherwise stated – does not refer to “sustainability” in the modern sense. Since the Brundtland Commission’s famous 1987 report, sustainable development is understood as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs” and aims at balancing economic, social and environmental issues. Within the context of the OECD, however, “sustainability” was understood in a strictly economic sense, meaning growth that is non-inflationary and does not destabilise the balance of payments.

Environmental concerns entered the OECD from the late 1960s onwards. In fact, it was a group of scientist and civil servants around the OECD’s science directorate that first launched a global debate about the “problems of modern society” and then founded the Club of Rome, whose 1972 report “Limits to Growth” became a hallmark of growth criticism. The OECD’s history since then can partly be interpreted as a continuous effort to redefine growth to account for the apparent failures of GDP statistics and growth-oriented policies.

However, while in the following almost five decades growth has been reframed as “sustainable”, “qualitative”, “inclusive” and “green”, the OECD’s major advice stayed in the quantitative framework. The OECD still advocates to “make growth the number one priority.” Symptomatic for modern states, this can at least partly be attributed to the Organisation’s silo structure, in which social and environmental concerns are not integrated into the key debates in the economics department. In this vein, a recent study by the London-based Institute for Human Rights and Business (IHRB) and the Heinrich-Böll-Foundation argued that the OECD’s advice on infrastructure investment – all geared towards increasing growth – thwarts the climate goals agreed to in Paris last November.

In fact, recent years, in particular in the context of reflections on the underlying causes of the world economic crisis, have seen an ongoing controversy within the OECD about the status and understanding of economic growth that culminated in the “New Approaches to Economic Challenges” (NAEC) initiative. In March 2016, I was invited to present the book in the context of the OECD’s NAEC seminar, resulting after a comment by former OECD director Ron Gass in an interesting discussion that revolved around what is currently labelled the “triangle” within the OECD – the relationship between the economy, society and nature.

This controversy, a critical analysis of the OECD’s history suggests, is complicated by the fact growth is the organisational ideology that defines not only the OECD’s core tasks but also its identity. Based on its longstanding history of promoting – but also questioning and further developing the growth paradigm – and also due to its functions – a think tank, ideational artist, forum – the OECD is in a particularly privileged position in taking a lead role to really advance towards a post-growth narrative for the early industrialised world. In this vein, the OECD could contribute to developing a societal narrative that leaves the policy focus on growth behind, because growth is a means to other ends – a means that, while arguably advantageous for a certain historical period, might become an obstacle for another.

Useful links

In The Hegemony of Growth. The OECD and the Making of the Economic Growth Paradigm, (Cambridge University Press, 2016) Matthias Schmelzer presents a critical examination of the historical trajectory of the OECD since the 1940s, setting it in the context post-war reconstruction, the Cold War, decolonization, and industrial crisis. The book has received three renowned prizes, including one from the International Economic History Association (IEHA)

OECD History Project at the University of Zürich, Switzerland

NAEC Seminar with Matthias Schmelzer

Hegemony NAEC seminar

OECD Economic Outlook 2016 sees global economy stuck in low-growth trap unless policymakers act now to keep promises

Eco outlook 2016Continuing the cycle of forecast optimism followed by disappointment, global growth has been marked down, by some 0.3 per cent, for 2016 and 2017 in the 2016 OECD Economic Outlook since the November 2015 OECD Interim Economic Outlook and the global economy is set to grow by only 3.3 per cent in 2017. This reflects a combination of subdued aggregate demand, poor underlying supply-side developments, with weak investment, trade and productivity growth, and diminished reform momentum.

OECD GDP growth is projected to be just under 2% on average over 2016-17, broadly in line with outcomes in the previous two years. Supportive macroeconomic policies and low commodity prices should continue to underpin a modest recovery in the advanced economies, assuming that wage increases and business investment growth both start to pick up and tensions in financial markets do not reoccur. However, weakness in external demand stemming from the emerging economies remains a drag on the advanced economies.

The potential exit of the United Kingdom from the European Union (Brexit) is a major downside risk. Brexit would have much stronger spillovers if it were to undermine confidence in the future of the European Union. In such a scenario, equity prices would drop further and risk premia for euro area sovereign and corporate bonds would increase by more, slowing GDP growth more substantially. Together with a fall in the euro, this would add to pressures on private and public finances, especially in countries where debt remains high. This risk would compound the existing political tensions in the European Union related to high refugee inflows and ongoing financial efforts to stabilise Greece. Other downside risks to global activity relate to a possible escalation of conflicts, including in Ukraine and the Middle East.

The prolonged period of low growth has precipitated a self-fulfilling low-growth trap. Business has little incentive to invest given insufficient demand at home and in the global economy, continued uncertainties, and a slowed pace of structural reform. In addition, although the unemployment rate in the OECD is projected to fall to 6.2 per cent by 2017, 39 million people will still be out of work, almost 6.5 million more than before the crisis. Muted wage gains and rising inequality depress consumption growth.

In per capita terms, the potential of the OECD economies to grow has halved from just below 2 per cent 20 years ago to less than one per cent per year, and the drop across emerging markets is similarly dramatic. It will take 70 years, instead of 35, to double living standards.

Global trade growth, at less than 3 per cent on average over the projection period, is well below historical rates, as value-chain intensive and commodity-based trade are being held back by factors ranging from spreading protectionism to China rebalancing toward consumption-oriented growth.

In trying to revive economic growth with monetary policy alone, with little help from fiscal or structural policies, the balance of benefits-to-risks is tipping. Financial markets have been signalling that monetary policy is overburdened. Pricing of risks to maturity, credit, and liquidity are so sensitised that small changes in investor attitude have generated volatility spikes, such as in late 2015 and again in early 2016.

Fiscal policy must be deployed more extensively, and can take advantage of the environment created by monetary policy. Governments today can lock in very low interest rates for very long maturities to effectively open up fiscal space. Prioritised and high quality spending generates the capacity to repay the obligations in the longer term while also supporting growth today. Hard infrastructure (such as digital, energy, and transport) and soft infrastructure (including early education and innovation) have high multipliers. The right choices will catalyse business investment, which, as the Outlook of a year ago argued, is ultimately the key to propelling the economy from the low-growth trap to the high-growth path.

Potential output per capita growth for the OECD as a whole is estimated at 1% in 2016, which is between ¾ and 1 percentage point below the average in the two decades preceding the crisis. Two main factors have contributed to this decline: weak capital stock growth accounts for around one-half of the slowdown, and the rest is accounted for largely by declining total factor productivity growth.

Sluggish demand and productivity growth, low inflation, substantial downside risks and, in some areas, high unemployment call for sustained well-balanced macroeconomic policy stimulus and productivity-enhancing structural reforms. Policy needs differ across countries, reflecting differences in their cyclical position, past policy measures and resulting policy space. Adopting a more co-ordinated and comprehensive policy approach both within and across countries offers the prospect of breaking out of the low-level global growth environment.

Useful links

Projections in Excel or OECD.Stat and Statistical Annex (PDF)

Interim Economic Outlook: Elusive global growth outlook requires urgent policy response

Global GDP growth in 2016 is projected to be no higher than in 2015, itself the slowest pace in the past five years, according to the latest OECD Interim Economic Outlook. The OECD projects that the global economy will grow by 3 percent this year and 3.3 percent in 2017, which is well below long-run averages of around 3¾ percent. This is also lower than would be expected during a recovery phase for advanced economies, and given the pace of growth that could be achieved by emerging economies in convergence mode.

The US will grow by 2 percent this year and by 2.2 percent in 2017, while the UK is projected to grow at 2.1 percent in 2016 and 2 percent in 2017. Canadian growth is projected at 1.4 percent this year and 2.2 percent in 2017, while Japan is projected to grow by 0.8 percent in 2016 and 0.6 percent in 2017.

The euro area is projected to grow at a 1.4 percent rate in 2016 and a 1.7 percent pace in 2017. Germany is forecast to grow by 1.3 percent in 2016 and 1.7 percent in 2017, France by 1.2 percent in 2016 and 1.5 percent in 2017, while Italy will see a 1 percent rate in 2016 and 1.4 percent rate in 2017.

With China expected to continue rebalancing its economy from manufacturing to services, growth is forecast at 6.5 percent in 2016 and 6.2 percent in 2017. India will continue to grow robustly, by 7.4 percent in 2016 and 7.3 percent in 2017. By contrast, Brazil’s economy is experiencing a deep recession and is expected to shrink by 4 percent this year and only to begin to emerge from the downturn next year.

Trade and investment remain weak. Sluggish demand is leading to low inflation and inadequate wage and employment growth.

Financial instability risks are substantial. Financial markets globally have been reassessing growth prospects, leading to falls in equity prices and higher market volatility. Some emerging markets are particularly vulnerable to sharp exchange rate movements and the effects of high domestic debt.

A stronger collective policy response is needed to strengthen demand. Monetary policy cannot work alone. Fiscal policy is now contractionary in many major economies. Structural reform momentum has slowed. All three levers of policy must be deployed more actively to create stronger and sustained growth. The recipe varies by country, especially with regard to needed structural reforms.

Real GDP growth to 2017

Interim outlook

Useful links

OECD Economic Outlook November 2015: Emerging market slowdown and drop in trade clouding global outlook

Read the Outlook online
Read the Outlook online

Global growth prospects have clouded this year. Global growth has eased to around 3%, well below its long-run average. This largely reflects further weakness in emerging market economies (EMEs). Deep recessions have emerged in Brazil and Russia, whilst the ongoing slowdown in China and the associated weakness of commodity prices has hit activity in key trading partners and commodity exporting economies, and increased financial market uncertainty.

Global trade growth has slowed markedly, especially in the EMEs, and financial conditions have become less supportive in most economies.

Global GDP

Growth in the OECD economies has held up this year, at around 2%, implying a modest reduction in economic slack, helped by an upturn in private consumption growth. However, business investment remains subdued, raising questions about future potential growth rates and about the extent to which stronger growth in the advanced economies can help to overcome cyclical weakness in the EMEs.

Sharp slowdown in EMEs is weighing on global activity and trade, and subdued investment and productivity growth is checking the momentum of the recovery in the advanced economies. Supportive macroeconomic policies and lower commodity prices are projected to strengthen global growth gradually through 2016 and 2017, but this outcome is far from certain given rising downside risks and vulnerabilities, and uncertainties about the path of policies and the response of trade and investment.

The outlook for the EMEs is a key source of global uncertainty at present, given their large contribution to global trade and GDP growth. In China, ensuring a smooth rebalancing of the economy, whilst avoiding a sharp reduction in GDP growth and containing financial stability risks, presents challenges. A more significant slowdown in Chinese domestic demand could hit financial market confidence and the growth prospects of many economies, including the advanced economies.

major economies

For EMEs more broadly, challenges have increased, reflecting weaker commodity prices, tighter credit conditions and lower potential output growth, with the risk that capital outflows and sharp currency depreciations may expose financial vulnerabilities. Growth would also be hit in the euro area, as well as Japan, where the short-run impact of past stimulus has proved weaker than anticipated and uncertainty remains about future policy choices.

There are increasing signs that the anticipated path of potential output may fail to materialise in many economies, requiring a reassessment of monetary and fiscal policy strategies. The risk of such an outcome underlines the importance of implementing productivity-raising structural policies, alongside measures to reduce persisting negative supply effects from past demand weakness in labour markets and capital investment, whilst ensuring that macroeconomic policies continue to support growth and stability. Early and decisive actions to spur reductions in greenhouse gas emissions via predictable paths of policy including tax reforms, or public investment programmes, or action on research and development might also help to support short-term growth and improve longer-term prospects.

Global recovery

Popes, miracles and development theory

Full proceedings in French and English
Full proceedings in French and English

Professor K. Vela Velupillai of Trento University and The New School, New York

Pope Francis has been in the news recently with his encyclical on climate change, but did you know that the Catholic Church helped to shape modern economic theory? When the Second Vatican Council was reconvened in September 1963 following the death of Pope John XXIII, it was asked to “start a dialogue with the contemporary world”. In October, the Pontifical Academy of Science invited 17 experts to “gather together the latest results of a new branch of science, econometry, and to present them to political economists in order to aid them in formulating those plans for a more stable security and for greater development which can contribute so much to the well-being and peace of nations.” Seven of the 17 would go on to become Nobel Laureates, and during that study week at the Vatican one of them, Tjalling Koopmans, outlined the mathematical foundations for the kind of economic growth theory that still dominates current orthodoxy.

Unfortunately, although Koopmans had revived a tradition underpinned by ethical and political considerations of intergenerational issues, initiated by Frank Ramsey in 1928, growth theory became formal and narrowly technical. By cutting itself adrift from the moral sciences, it became devoid of philosophical, epistemological and ontological significance. Hence, to the extent that any theory of development was underpinned by growth theory, it shared these deficiencies. More importantly, from an epistemological point of view – and, perhaps, also methodological – the uncertain, undecidable, complex, incomplete, unsolvable dimensions of development theory and policy were short-circuited by a reliance on trivially applicable mathematics, wholly without significance for the monumental issues that have to be tackled in the messy world of development. Above all, the element of humility that accompanies uncertain, tentative, undecidable, complex, incomplete, indeterminate dimensions, was pawned to a trivial dynamic formalization.

In some ways, this was a reaction to what Paul Krugman termed the “high development theory (HDT)” that flourished in the 1950s. At the 1992 World Bank Annual Conference on Development Economics (where incidentally future OECD Secretary-General Gurría gave the keynote address) Krugman argued that the core economic concepts of the HDT theorists- were not formulated and formalised in a language intelligible to the increasingly mathematised conventional economist. These concepts included increasing returns to scale, complementarity, extent of the market, and multiple equilibria with low-level equilibrium traps in poverty. Therefore, in a counter-revolution, the rich content of the HDT theorist was thrown away with the proverbial bathwater, prompting Krugman to call for a “counter-counterrevolution”.

Responding to Krugman at the same conference, Joseph Stiglitz was not entirely convinced, and in addition to questioning Krugman’s assumptions, raised two points that reflect what became known as the “Washington Consensus”: balanced budgets; relative price corrections (principally a competitive exchange rate); liberalisation of trade and foreign investment; privatisation; and domestic market deregulation. For Stiglitz, “the same currents that led to the dominance of free market ideology in the United Kingdom and the United States were reflected – at least in the United States – in the dominance of those ideas in certain intellectual circles. […] Krugman takes far too narrow a view of the development process and of what is wrong with both the standard neoclassical and the planning paradigms. […] If the central problems were those of externalities and increasing returns, the planning process would have been an appropriate remedy. But that assumption ignored informational problems, which are now regarded to be central.”

In short, Krugman says that HDT is dead and should be resurrected; Stiglitz thinks it never died, but lived on in other guises; and the Washington Consensus, simply ignored HDT. But despite their differences, they all attribute to the content of HDT a common set of characteristics predicated upon one or another form of competitive equilibrium theory.

In 1977, fifteen years before the World Bank conference, Graham Pyatt and Alan Roe highlighted another problem with development planning, one that had nothing to do with mathematical formalism or economic theory: “It is quite clear that many development plans are written with the sole objective of qualifying for foreign aid and that their existence implies absolutely nothing about a commitment to plan in any normally accepted sense of the word”.

Around the same time, Harry Johnson from the anti-Keynesian “Chicago School” identified the two theoretical culprits for the failure of multisectoral planning: “The Harrod-Domar equation […] automatically involved the same error as the ‘disguised unemployment’ concept, through its emphasis on physical investment and implicit disregard of the availability of labour, especially skilled and technical and scientific labour, to work with the material capital created by investment.” The solution was to enrich the growth models with human capital; underpin the generation of human capital with appropriate methods and frameworks for the generation of skilled, scientific and technical human capital; remove the mechanisms that would generate monopoly privileges; and decentralise the investment decision processes that lie at the basis of growth.

This was the basis on which the path towards “New Development Economics” was carved, via an “interregnum” with general equilibrium models for development policy. By the early 1990s, the time was ripe for miracles, and the clear message from analyses of the East Asian miracle was that a formula existed to replace poverty and misery with prosperity and plenty. Technology was the deus ex machina; competitive markets would provide the institutional setting in which decentralised decisions were implemented; the invisible hand replaced the dirigent’s fist; and efficiency was resurrected. But in this vision technology was wholly divorced from science and its institutionalisation. And so a rich vein of traditions and dilemmas that the early policymakers in Meiji Japan and the Nehru-era planners in India had grappled with when they were devising policies and visions of development was ignored.

Apart from the emergence of the Asian Tigers, two other facts of professional economics and economic life characterise this period: the “sudden” completion of the UN-ICP program on internationally comparative national income data, in the form of the Penn World Tables; and the emergence of New – endogenous – Growth Theory, going beyond the early Neo-classical models of (optimal) economic growth.

I do not find it credible to believe that the three great events listed above have anything to do with each other – either as a matter of fact, history or theory.

First, has there ever been the slightest investigation of the methods, sources, consistency and theory of the construction of the data that comes out of the Penn World Table stables? When I investigated the mathematical foundations of the construction of the index numbers that underpin the Penn World Table data, I was appalled to find that in the practical construction of the numbers that are used in international growth comparisons, the theoretical criteria are violated, which suggests that the actual numbers are unanchored in theory. (The Penn exercises and growth theory are analysed here.)

Second, there is very little evidence that any of the Tigers emerged as powerful economies following the policy precepts of New Growth Theory (and certainly not Japan in its transition from Tokugawa Feudalism to the Meiji Restoration and, then, through the Taisho and Showa eras). In other words, any underpinning of development theory on New Growth Theory is empirically meaningless.

Ultimately, there can be no theoretically closed system of development theory that can be encapsulated in a formal, mathematical, dynamic model with determinate solutions. But indeterminacy, undecidability and incompleteness can be formalised in algorithmic mathematics. I advocate such an approach to the formal study of development dynamics in the sense of Schumpeter and Paul Rosenstein-Rodan. No one would want to advocate an anarchistic theory of development; but it is entirely possible to advocate a mathematical formalism for development dynamics that suggests something like a formalisation of anarchy, however paradoxical this may sound.

Useful links

We would like to thank Professor Alberto Quadrio Curzio, Editor-in-Chief of Economia Politica, who graciously accepted our request to base this article on Development Economics without Growth Theory, in Economia Politica, 1/2010, aprile.

OECD work on the evaluation of development programmes

Perspectives on global development from the OECD Development Centre

Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University, discusses the Asian Tigers on the Insights blog here and Japan here