We need an empowering narrative

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.

Useful links

For globalisation to work for all, you have to level the playing field first

Adrian Blundell-Wignall, Special Advisor to the OECD Secretary-General on Financial and Enterprise Affairs, argues that key corporate and financial issues must be addressed if globalisation is to work better for all. These issues are examined in the new 2017 OECD Business and Finance Outlook.

Today the debate rages about whether the decline in living standards is due to the effects of globalisation or to poor domestic policies. Both have surely played a role. But the problems often associated with globalisation (inequality, the hollowing out of the middle class, employment of less-skilled workers in advanced countries, etc.) do not originate from “openness” as such. The problem is that not all countries are open to the same degree and the playing field in the cross-border activities of businesses is not level.

Since entering WTO in 2001, China has quickly become the largest exporting nation in the world, with 14% of merchandise exports and 18% of manufacturing. Hong Kong (China), Singapore and Korea together export as much as the United States or Germany. Companies may also set up production abroad, closer to foreign markets. China has increasingly joined this model too, and is now responsible for 11% of world merger and acquisition (M&A) outflows in 2016. In recent years it has been switching away from M&A in oil and gas much more towards high technology companies.

In parallel, the number of state-owned enterprises (SOEs) among the Fortune Global 500 companies grew from 9.8% in 2005 to 22.8% in 2014. Most are domiciled in Asia, and the largest among them are Chinese  banks. Distortions, resulting from subsidies and other advantages accorded to SOEs, often coming via cheaper finance from SOE banks, are important. But strong government ownership of shares in emerging economies is present across all industrial sectors. Emerging-market SOEs have greatly contributed to the  current excess capacity in key materials, energy and industrial sectors, contributing to a decline in the  average return on equity in many sectors and countries.

No matter where firms sit in the value chain, penetration of markets by emerging economies evokes responses from companies to move further up the value chain – forcing them to restructure and enhance  technology to remain competitive. If they don’t take advantage of global economies of scale, they will in any case find themselves facing strong competition from other successful firms, whether at home or abroad. The fastest productivity growth companies are also those that take advantage of foreign  sales—whether by exporting or by setting up subsidiaries that produce abroad to serve foreign markets.

There is nothing wrong with success in cross-border activities—provided of course that success is not based on unfair competition.

The leaps in productive potential can be enormous, but all of this requires investment, innovation and new technology. The company data shows that it makes no sense to try to separate these things out. The companies at the forefront of innovation and technology (as reflected in productivity growth) are often multinationals engaged in trade and foreign direct investment—they buy and sell business  segments, set up to produce abroad and the export from multiple global production bases.

The losers in this story—those workers affected by reduced hours, innovative work contracts and compressed wages—belong to companies that are scattered within their own industry. It is not that the  middle class as such is being hollowed out but that these ranks are swelled by those that work for less successful companies forced to restructure or exit.

Some large emerging economies have managed to pull millions of people out of poverty—and the long-term future of every country lies with continued success in this regard. Competition too is to be welcomed. Like any sporting match, let the best teams win. But also like any sporting match, the game needs to be played with the same rulebook. If the same rules do not apply to all, then fairness is put into question. If fairness is questioned, then sustainability of open trade and investment in the global economy is also put at risk.

Openness promotes opportunities for business. But the governance of trade, international investment and competition does not use a common rule book. Without this, the size and cost of the other policies needed to protect the losers will continue to be burdensome and possibly beyond reach.

This year’s OECD Business and Finance Outlook discusses many aspects of the lopsided nature of  the  world economy, among them: the growing role of state-owned enterprises (SOEs), uneven financial regulations, distorting capital account and exchange rate management, cross-border cartels that translate into benefits for companies and shareholders rather than into lower consumer prices, collusive behaviour  in investment bank underwriting practices, corner-cutting responsible business conduct, and the bribery  and corruption that distort international investment and misallocate resources.

We need improved rules of the game and enhanced international co-operation. OECD standards can play a leading role in shaping this conversation, and promoting a level playing field that ensures the benefits of globalisation are shared by all. This requires a commitment by economies participating in globalised markets to a common set of transparent principles that are consistent with mutually-beneficial competition, trade and international investment across a range of areas.

References

OECD Business and Finance Outlook 2017 is available at: http://oe.cd/BusinessAndFinanceOutlook2017

OECD Business and Finance Scoreboard 2017 is available at: www.oecd.org/daf/OECD-Business-and-Finance-Scoreboard.htm

Getting Globalization Right: The East Asian Tigers

Protecting the tiger

Today in collaboration with Americas Quarterly, we’re publishing the second of a series of three articles on globalisation and the fight against poverty by Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University.  You can read a print version in AQ’s Spring 2012 edition on social inclusion (online version here) and the first article in the series here

The experience of Asian tigers after the Second World War (South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Thailand, and Indonesia) reinforced the lesson from Japan’s economic history that economic growth was achievable even if a country started at the wrong end of the international division of labor, if you combined the efforts of a determined government with the energies of a vibrant private sector.

All of these countries benefited enormously from exports, and hence from globalization. But none, with the exception of British colony Hong Kong, came even close to being free-market economies. The state played an important guiding and coordinating role in all of them.

Consider two of the most successful countries of the region: South Korea and Taiwan.

In the late 1950s, neither of these economies was much richer than the countries of Sub-Saharan Africa. South Korea was mired in political instability and had virtually no industry, having lost whatever it had to the more developed North Korea. Taiwan, too, was a predominantly agricultural economy, with sugar and rice as its main exports. The transformation that the two economies began to experience in the early 1960s placed them on a path that would turn them into major industrial powers.

In many ways, their strategies mirrored Japan’s. They required, first, a government that was single-mindedly focused on economic growth. Prior land reform in both countries had established some space for governments to act independently from landed elites.

Both countries also possessed an overarching geo-political motive. South Korea needed to grow so it could counter any possible threats from North Korea. Taiwan, having given up on the idea of reconquest of mainland China, wanted to forestall any possible challenge from the Communists. The governments in South Korea and Taiwan understood that achieving their political and military goals required rapid economic growth. Developing industrial capabilities and a strong manufactured exports base became their predominant objective.

This objective was accomplished by unleashing the energies of private business.

Even though both governments invested heavily in public enterprises during the 1960s, the investment was designed to facilitate private enterprise by providing cheap intermediate inputs, for example, and not to supplant it. One plank of the strategy called for removing the obstacles to private investment that stifled other low-income countries: excessive taxation, red tape and bureaucratic corruption, inadequate infrastructure, and high inflation. These were improvements in what today would be called the “investment climate.”

Equally important were interventionist policies, government incentives designed to stimulate investments in modern manufactures. Both governments designated such industries as “priority sectors” and provided businesses with generous subsidies. In South Korea, these largely took the form of subsidized loans administered through the banking sector. In Taiwan, they came in the form of tax incentives for investments in designated sectors.

In both countries, bureaucrats often played the role of midwife to new industries: they coordinated private firms’ investments, supplied the inputs, twisted arms when needed, and provided sweeteners when necessary. Even though they removed some of the most egregious import restrictions, neither country exposed its nascent industries to much import competition until well into the 1980s.

While they enjoyed protection from international competition, these infant industries were goaded to export almost from day one. This was achieved by a combination of explicit export subsidies and intense pressure from bureaucrats to ensure that export targets were met. In effect, private businesses were offered a quid pro quo: they would be the beneficiaries of state largesse, but only as long as they exported, and did so in increasing amounts.

If gaining a beachhead in international markets required loss-making prices early on, these could be recouped by the subsidies and profits on the home market. But importantly, these policies gave private firms a strong incentive to improve their productivity so they could hold their own against established competitors abroad.

In the third and last article in this series, I’ll look at a third example of an “unorthodox” development strategy, China’s shift from a predominantly rural, centrally-planned economy to the industrial giant we know today.

Useful links

This series is adapted from Dani Rodrik’s The Globalization Paradox: Democracy and the Future of the World Economy published by Norton

Americas Society – Council of the Americas

Perspectives on global development (publications from the OECD Development Centre)

Natural Resources and Pro-Poor Growth: The Economics and Politics

OECD work on poverty reduction and social development

OECD work on the benefits of trade liberalisation

Busan: Yes we could (The Insights blog looks at Korea’s development success)

Getting Globalization Right: The Japanese Exception

明治大帝,before Westernisation

Today, in collaboration with Americas Quarterly, we’re publishing the first of a series of three articles on globalisation and the fight against poverty by Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University.  You can read a print version in AQ’s Spring 2012 edition on social inclusion (AQ’s own version of the article is here).

The proximate cause of poverty is low productivity. Poor people are poor because their labor produces too little to adequately feed and house them, let alone provide adequately for other needs such as health care and education.

Low productivity, in turn, has diverse and multiple causes. It may be the result of lack of credit, lack of access to new and better technologies, or lack of skills, knowledge or job opportunities. It may be the consequence of small market size, or exploitative elites, in cahoots with the government, who block any improvement in economic conditions that would threaten their power.

Globalization promises to give everyone access to markets, capital and technology, and to foster good governance. In other words, globalization has the potential to remove all of the deficiencies that create and sustain poverty. As such, globalization ought to be a powerful engine for economic catch-up in the lagging regions of the world.

And yet, the past two centuries of globalization have witnessed massive economic divergence on a global scale. How is that possible? This question has preoccupied economists and policy makers for a long time. The answers they have produced coalesce around two opposing narratives.

One says the problem is “too little globalization,” while the other blames “too much globalization.” The debate on globalization and development ultimately always comes back to the conundrum framed by these competing narratives: if we want to increase our economic growth in order to lift people out of poverty, should we throw ourselves open to the world economy or protect ourselves from it?

Unfortunately, neither narrative offers much help in explaining why some countries have done better than others, and therefore neither is a very good guide for policy. The truth lies in an uncomfortable place: the middle. It’s a point best illustrated by the country that has contributed the most—given its overall size—to the reduction of poverty globally: China. China, in turn, learned from Japan’s example, as did other successful Asian countries.

In the aftermath of the Industrial Revolution, globalization enabled new technologies to disseminate in areas with the right preconditions, but also entrenched and accentuated a long-term division between the core and the periphery. Once the lines were drawn between industrializing and commodity-producing countries, strong economic dynamics reinforced the division. Commodity-based economies faced little incentive or opportunity to diversify. As Jeffrey G. Williamson shows, this was very good for the small number of people who reaped the windfall from the mines and plantations that produced commodities, but not very good for manufacturing industries that were squeezed as a result. The countries of the periphery not only failed to industrialize; they actually lost whatever industry they had. They deindustrialized.

Geography and natural endowments largely determined nations’ economic fates under the first era of globalization, until 1914. One major exception to this rule would ultimately become an inspiration to all commodity-dependent countries intent on breaking the “curse.” The exception was Japan, the only non-Western society to industrialize prior to 1914. Japan had many of the features of the economies of the periphery. It exported primarily raw materials – raw silk, yarn, tea, fish – in exchange for manufactures, and this trade had boomed in the aftermath of the opening to free trade imposed by Commodore Matthew Perry in 1854. Left to its own devices, the economy would have likely followed the same path as so many others in the periphery.

But Japan had a local group of well-educated, patriotic businessmen and merchants, and even more important, following the Meiji Restoration of 1868 a government that was single-mindedly focused on economic (and political) modernization. That government was little moved by the laissez-faire ideas prevailing among Western policy elites at the time. Japanese officials made clear that the state had a significant role to play in developing the economy, even though its actions “might interfere with individual freedom and with the gains of speculators.”

Many of the reforms introduced by the Meiji bureaucrats were aimed at creating the infrastructure of a modern national economy: a unified currency, railroads, public education, banking laws, and other legislation. Considerable effort also went into what today would be called industrial policy – state initiatives targeted at promoting new industries. The Japanese government built and ran state-owned plants in a wide range of industries, including cotton textiles and shipbuilding. Even though many of these enterprises failed, they produced important demonstration effects. They also trained many skilled artisans and managers who would subsequently ply their trade in private establishments.

Eventually privatized, these enterprises enabled the private sector to build on the foundations established by the state. The government also paid to employ foreign technicians and technology in manufacturing industries and financed training abroad for Japanese students. In addition, as Japan regained tariff autonomy from international treaties, the government raised import tariffs on many industrial products to encourage domestic production.

These efforts paid off most remarkably in cotton textiles. By 1914, Japan had established a world-class textile industry that was able to displace British exports not just from the Japanese markets, but from neighboring Asian markets as well. (For varying accounts of the role played by the state and private industry in the take-off of cotton spinning in Japan, see W. Miles Fletcher and Gary Saxonhouse)

While Japan’s militarist and expansionist policies in the run up to the Second World War tarred these accomplishments, its achievements on the economic front demonstrated it was possible to steer an economy away from its natural specialization in raw materials. Economic growth was achievable, even if a country started at the wrong end of the international division of labor, if you combined the efforts of a determined government with the energies of a vibrant private sector.

In the next article, I’ll look at how the experience of Asian tigers after the Second World War (South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Thailand, and Indonesia) reinforced the lesson.

Useful links

This series is adapted from Dani Rodrik’s The Globalization Paradox: Democracy and the Future of the World Economy published by Norton

Americas Society – Council of the Americas

Perspectives on global development (publications from the OECD Development Centre)

Natural Resources and Pro-Poor Growth: The Economics and Politics

OECD work on poverty reduction and social development

OECD work on the benefits of trade liberalisation

Comparative advantage: Doing what you do best (from the Insights blog)

Who knows where the cold wind blows?

A volcano erupts in Iceland and thousands of Kenyan farm workers lose their jobs. An oil rig sinks in the Gulf of Mexico, and retirees in Britain could see their pensions cut. Globalisation and interdependence aren’t just slogans.

The Kenyans were working for companies that export flowers to Europe using airfreight. The 500 tonnes of flowers exported daily brought in 71 billion shillings last year (around $900 million) making horticulture the country’s main foreign exchange earner, ahead of tourism at just over 50 billion shillings.

Kenya is only one of many countries pushing non-traditional agricultural exports. The idea is to integrate the global economy by exploiting improved communications and marketing networks and the large numbers of customers for out of season and exotic products in developed countries.

One way of looking at this is that everybody wins – one partner gets income and development opportunities, the other gets cheap luxuries. When things go wrong though, the risks are very unevenly shared. It’s one thing to go without fresh flowers or pineapples, another to have no job.

Exporters rely on cheap transport, and that in turn needs oil. The IEA chief economist has repeatedly warned that “we need to leave oil before it leaves us”. In the meantime though, the search is intensifying for new sources and ways to squeeze the last drop from existing ones. That’s why US President Obama lifted the ban on drilling in certain parts of the Gulf and elsewhere, and why companies like BP that exploit the resource are among the world’s richest firms.

Oil prices and the profits of oil companies fluctuate, but in the long run, they’re seen as a sound investment, making them attractive to pensions funds. Funds based in the UK invest heavily in BP (and earlier this month backed BP management against a campaign by NGOs concerning oil sands developments in Canada ).

Around $24 billion has been wiped off BP’s market capitalisation (over $170 billion before the accident), and the estimates of $2 to $3 billion for cleanup are huge, but not crippling for a company that size. BP will probably recover long before the Gulf coastline does if history is anything to go by. Exxon shares outperformed the market as a whole and the oil industry following the Exxon Valdez disaster in 1989.

We’ll look in more detail about a number of the issues raised here in forthcoming Insights books. Global agriculture is discussed in “Feeding 9 Billion People”, while From Crisis to Recovery will have a chapter on pensions and financial markets.

While Stocks Last has a chapter on fishing and the environment, describing the impact of oil pollution and other hazards on marine habitats. The Gulf provides examples of many of the issues raised. It already has a dead zone where run-off from agricultural chemicals washed down the Mississippi has caused an algal bloom that starves everything else of oxygen. Atlantic bluefin tuna are due to start spawning in the Gulf around now. And commercial and recreational fisheries could be devastated by the pollution.