It’s not just the economy: society is a complex system too

NAECGabriela Ramos, OECD Chief of Staff and G20 Sherpa

Income and wealth inequality is not a new phenomenon. On the contrary, it seems that it is a permanent feature in human history, and over the years, its causes and consequences have become more numerous and more interconnected. The same is true for many social phenomena, and even though the world looks more complicated today, it is not. What is different is the increased number of domains where public policy is expected to play a role. Regarding inequalities of income and wealth, governments have to make decisions on several interlinked areas such as taxes, education or health.

Unfortunately, the tools at the disposal of policymakers have not always been updated fast enough to cope with these challenges and with their inter-linkages. Moreover, policies are often designed within the narrow confines of one issue, without taking into account their consequences elsewhere.

Economists have tried to simplify and abstract from reality with limiting assumptions like the representative agent and general equilibrium. They have also given primacy to the goal of effectiveness, in detriment to other important considerations such as fairness. Yet, the use of aggregate data obscures the distributional consequences of policies: an economy as a whole may be doing well, but – as we have seen in recent years – there are severe consequences for social cohesion, and ultimately growth itself, if large groups are excluded from the benefits of economic prosperity. In defining growth policies that aimed only at increasing GDP per capita, inadequate attention was paid to institutions, human behaviour, and culture. These approaches failed to adequately account for the realities of markets, consumer decisions, and the interconnectedness of economic, communications and societal networks.

In stark contrast to the assumptions of neo-classical economics, socio-economic systems are not stable, but in constant flux. Complexity science generates new insights and furnishes us with the analytical tools and instruments to help us, as individuals and societies, to navigate this new understanding of the economy. It addresses some of the limitations which constrain conventional economics and ultimately it is helping us to do a better job in advising governments and public institutions.

For example, taking a complexity-based approach we can begin to recognise that the causes and consequences of inequalities and major economic and societal problems are intertwined. Besides contributing substantially to the increase of wealth inequality, the financialisation of the economy also led to increased systemic risks where a problem in the subprime markets led to a major economic crisis that has set additional hurdles in the way of the most vulnerable groups all over the world.

Just like the financial system and its major risks, our social systems are complex and vulnerable. Considering the increased fragmentation and divisions in our societies (and adding the challenge of integration of migrants and marginalized groups) more attention should be paid to social stability. In this vein, policies to address societal problems, should not only rely on traditional economic tools and measures, but broaden them to bring insights of useful disciplines.

This more realistic approach to how people and the economy actually work is needed – an integrated inclusive growth agenda which also considers unintended consequences, trade-offs and complementarities between policy objectives.

Indeed, I believe that economists – and the policy makers they advise – can do better by listening to and learning from others. It’s not easy for an organisation that has “Economic” in it is name, but we need to break the monopoly of economics over policy – looking to other disciplines such as physics, biology, psychology, sociology, philosophy and history. Societies and economies are not static features that can be predicted, but evolutionary systems with breakpoints and changes that need to be better characterized.

At the OECD, we recognise the potential of new economic thinking, drawing on complexity theory, and evolutionary and behavioural economics. Technological and analytical innovations are driving a revolution in the physical sciences, biological sciences, and social sciences, breaking down the barriers between disciplines and stimulating new, integrated approaches to pressing and complex challenges. Advances in computing power are opening up new possibilities for integrating systems models, agent-based modelling and network analysis. It is only by properly utilising these new approaches that we can strive to create social and economic models that provide a more accurate representation of the world around us. These tools also allow us to get away from average representations, or to look at stocks and not only at flows in the economy (income vs wealth inequality).

And indeed, economics is starting to incorporate insights from other disciplines. For example, expectations may be admirably rational in traditional models, but by combining psychology and economics we are designing policies based on how real people actually behave, not on limited assumptions about how some fictional average person should behave. Taking a problem-based approach, we can design policies to influence people and nudge them in the right direction in areas such as consumer policy, regulation, and environmental protection.

The OECD is part of this revolution and we are already transforming our policy thinking and acting. With the New Approaches to Economic Challenges (NAEC) initiative, we are taking a hard look at our analytical methods, our data and policy advice.

Many articles in this series have argued that the economy is a complex adaptive system. Society is a complex system too. It is formed by the interaction and mutual dependence of individuals, and is pursuant to their spontaneous, natural behaviour. Since the emergence of hunter-gather societies inequalities have threatened to undermine and weaken the fabric of the social system. If we are to overcome the pernicious effects of these inequalities, we need to think about the interactions between our social and economic systems – which follow their own logics – and design policies which help our economies to grow. But growth isn’t an end in itself. It has to be inclusive to ensure that all segments of our societies prosper.

Systems thinking can lend us a hand to fight inequalities and develop an agenda for inclusive growth. As we draw out the inter-linkages between different policy areas, we begin to understand how the economic system interacts with other systems, as well as with the history, politics, and ambitions of countries. Our task now is to put this growing comprehension to good use, in order to make the economy work better for all people.

Useful links

The OECD organised a Workshop on Complexity and Policy, 29-30 September, OECD HQ, Paris, along with the European Commission and INET. Watch the webcast: 29/09 morning; 29/09 afternoon; 30/09 morning

Please consult the draft Agenda for more information, and a preliminary background paper “Insights into Complexity and Policy” regrouping articles from the insights blog and other sources.

The lost decade: in search of “Social Europe”

EU social jsutice reportToday’s post was written by Craig J. Willy for the Bertelsmann Foundation which will also be publishing it.

The Bertelsmann Stiftung’s new EU Social Justice Index is unequivocal: social conditions, notably in terms of poverty and unemployment, have worsened in most EU countries since 2009, often significantly so. This reflects the financial and economic crisis, but also the eurozone’s response to it, as “the rigid austerity policies pursued during the crisis and the structural reforms aimed at economic and budgetary stabilization have had, in most countries, negative effects with regard to social justice.” The Index adds: “the cuts induced by the crisis are not administered in a balanced way throughout the population.” Only three countries – Luxembourg, Germany and Poland – have seen significant improvement in recent years.

Much of Europe appears to be settling into a “lost decade” characterized by high long-term unemployment and underemployment, and weak or no economic growth (indeed the eurozone experienced zero percent growth in the second quarter of 2014, while Italy and Germany shrank 0.2 percent). The poverty rate has risen 1.7 points to 25.4 percent, including 28 percent of children in the EU. Unemployment has reached notoriously high levels in many countries.

The Social Justice Index notes that even where there is low unemployment “the emergence of a dual labour market has been increasingly evident, with poor vertical permeability from ‘atypical’ employment relationships (enlarged low-wage sector, temporary employment) to ‘normal working conditions’.” Just as Western Europe’s unionized working class has shrunk enormously, its postwar middle class appears to also be declining.

The challenges of a multinational union

The EU has been attempting to address these problems and has had some success in stabilizing the eurozone, but European officials are painfully aware of the challenges in creating a genuine “social Europe” and addressing the flaws of the common currency.

The first problem is the difficulty in managing a multinational union: it is far easier to have public support for solidarity (risk-sharing, wealth transfers) and shared government (respect for common rules) within a country than between them. As European Central Bank (ECB) President Mario Draghi laconically noted: “The Dutch have a problem with paying for the Greeks, but not with paying for other Dutch.”

The second problem is institutional: the EU and eurozone are not a federal state or a genuine government which might decisively tackle issues one way or the other. Instead, one has to work with rules laid out in the European Treaties, with any necessary changes to account for new problems requiring unanimity among national governments and legal creativity. This leads to a lot of procrastination on the road to consensus and brinkmanship as each government extracts maximum concessions for its agreement.

Putting aside the eurozone, the social challenges of the EU as such are probably manageable. Broadly speaking, inequality in EU countries is low by global standards, certainly much lower than in the United States or the BRICS, and Europeans are attached to social models which are diverse in implementation but similar in their concern for social equity and balance between solidarity and liberty.

True, low-wage competition from Central-Eastern Europe, either in the form of delocalization or immigration, may put downward pressure on wages in certain areas and sectors. This pressure will diminish as these nations develop, and indeed some Central-Eastern European countries – notably the Czech Republic, Slovenia, and Estonia – already score higher than many Western European countries on the Social Justice Index. There is also evidence that EU migration is a net positive for national coffers of the recipient country. The gradual increase in EU-wide social standards through legislation, already seen in the Social Charter and the Working Time Directive, is plausible.

“The Delors Paradox”

Things are more challenging for the eurozone. European Commissioner for Social Affairs László Andor has argued that any effect of the EU’s social standards legislation have tended to be counteracted by the existing deficiencies of the common currency, terming this “the Delors Paradox”: “On the one hand, we introduce social legislation to improve labour standards and create fair competition in the EU. On the other hand, we settle with a monetary union which, in the long run, deepens asymmetries in the community and erodes the fiscal base for national welfare states.”

The eurozone then needs reform and policy coherence. But the currency union’s management is notoriously complex – monetary policy run by the ECB, bailouts by national ministers by unanimity, the bulk of government spending at national level, but with deficit limits enforced by the European Commission and national judges – becoming confusing even for European political leaders. French President François Hollande for example, after the EU parliamentary elections in May, seemed to confess even he was at a loss with the euro-regime: “Europe has become unreadable, I’m aware of this, distant and to be frank incomprehensible, even for the States.”

There is consensus that significant reform is necessary. Europe’s Socialist and Social-Democratic parties have said that the elitist management of the eurozone’s “Troika” bailout/reform programs – headed by the European Commission, the ECB and the International Monetary Fund – should be replaced by something more democratically accountable. The new president of the European Commission, Jean-Claude Juncker, said in his political priorities: “We have to re-balance the relationship between elected politicians and the European Central Bank in the daily management of the Eurozone,” including a permanent president of the Euro Group of eurozone finance ministers.

In the long-term, many seem to want something like a fully-fledged government for the currency area. French economist Thomas Piketty, who has attracted global attention for his work on inequality, has taken the view that at least a “Eurozone Parliament” is necessary, collectively keeping the government accountable and deciding deficit levels and the amount of common debt issued by a European Treasury. And Jörg Asmussen, state secretary in the German Ministry of Labor and Social Affairs recently wrote: “And in my view the core of integration is the Eurozone with its own parliament and its own budget provided from its own revenue sources – with Germany and France in a position of special responsibility for integration.”

The Bertelsmann Stiftung has further studied the possibility of a substantial eurozone budget through an EU unemployment benefits scheme, which would both stabilize the currency area during economic shocks and help to address social concerns.

No conceptually cohesive strategy targeting social justice across the EU

Unfortunately, agreeing that reform is needed is not the same as agreeing what those reforms should be. In many countries there is little appetite for the laborious process of Treaty change, which would entail a major continent-wide debate and unanimous ratification by the 28 member nations, including possible referenda. With eurosceptic sentiment at an all-time high in many countries, transferring even more power to European institutions may be difficult to justify to voters.

EU and national leaders will then likely have to “muddle through” in the current framework for the time being and address citizens’ economic and social demands as best they can. Time is of the essence, as the Social Justice Index notes: “Should these social divisions persist for some time, or even worsen further, this will endanger the future viability of the entire European integration project”. But so far “a conceptually cohesive strategy explicitly targeting social justice across the EU has yet to be formulated.”

Useful links

OECD work on inequality

Better Plays for Better Lives: Romeo and Juliet

So wise so young, they say, do never live long
So wise so young, they say, do never live long

Today we publish the next article of a summer series in which Kimberley Botwright of the OECD Public Affairs and Communications Directorate looks at OECD work through a Shakespearean lens.

Before there was punk, there was Shakespeare, and his Romeo. Communication between generations has never been fluid. At the start of the play, Romeo is a brooding, isolated teenager, and his parents are at a loss about what to do with him; “Could we but learn from whence his sorrows grow / We would as willingly give cure as know.” Worse, Romeo is part of a brawling, bawdy gang-orientated youth culture. The overall context of the play appears to be one of society in crisis, parents can no longer control their children, whilst the presiding Prince of Verona has trouble maintaining law and order; “On pain of torture, from those bloody hands / Throw your mistempered weapons to the ground.”

Although emerging unrest continues to feature in our modern world, unlike Romeo’s father Old Montague, we can have a good guess at what ails today’s youth. OECD labour data indicate a 16.3% average OECD unemployment rate among 15-24 year olds in 2012, rising to 55.3% for Greece and 53.2% for Spain. Both these last figures have continued to climb into 2013. By way of comparison, in 2012 average unemployment rates (15-64 year olds) were 8.2% for OECD countries, 24.5% for Greece and 25.2% for Spain. Then there’s the NEET group (Not in Education Employment or Training); in 2012 12.9% of OECD 15-24 year olds fitted into this category. These individuals run the highest risk of long-term exclusion from the labour market. Youth in OECD key partner countries also suffered into 2012, with a 51.5% youth unemployment rate in South Africa and 14.8% in Russia.

Ok, ok, you say, but why all the fuss about youth unemployment? They’re young and fit, they’ll bounce back! After all, “Care keeps his watch in every old man’s eye” in contrast to the “unbruisèd youth with unstuffed brain.” Maybe not however, as the OECD Employment Outlook 2013 warns; “Youth need to be actively supported to avoid long-term “scarring” effects as a result of prolonged unemployment and low-income spells early in their careers.” This significantly affects society as whole, as individual scarring generates collective long-term, structural unemployment problems due to a loss of human capital and vital skills.

Furthermore, at OECD Forum 2013 Ian Hickie, Professor of Psychiatry at The University of Sydney, explained why scarring is particularly detrimental for young people. Rapid changes take place in the brain between the ages of 15-25, and participation has positive effects on these changes, while exclusion has negative ones. OECD Secretary General Angel Gurría reminds us that exclusion from the job market often leads to exclusion elsewhere; “Youth unemployment often means material hardship, dire future prospects and delaying vital steps into adulthood, such as leaving home, building relationships or starting a family.” Romeo himself does not fit into his friend Mercutio’s description of “lovers’ brains” that “dream of love”, but instead speaks with dread of a bleak future; “For my mind misgives / Some consequence yet hanging in the stars.”

What “cure” then for this crisis or is it to be governed by the “stars”?  The OECD Action Plan for Youth is designed to leverage OECD work on education, skills and youth-related employment policies, in order contribute to national and international youth unemployment reduction efforts. It calls for a two-pronged approach; tackle the current crisis, but also address structural problems, in order to ensure better outcomes for youth in the future.

Elements to aid the first objective include boosting job creation, addressing demand-side barriers to the employment of low-skilled youth, and encouraging employers to continue or expand quality apprenticeships. Examples of policy action would be stronger incentives for employers to hire new workers, with lower social security contributions where appropriate. Elements for the second objective include strengthening the role and status of Vocational Education and Training (VET), as well as matching education with employers’ demand for skills; “The co-existence of young unemployed or under-employed graduates, with employers who say they cannot find the people with the skills they need, suggests that there is scope to better link education systems with the world of work.”

On education policy design and investment, OECD Special Advisor on Education Policy Andreas Schleicher notes, “Our education today, is our economy tomorrow, so we are going to pay a price.” Romeo is “The only son” of the House of Montague. Likewise, Juliet is the only offspring of the House of Capulet, as Old Capulet makes clear: “Earth hath swallowed all my hopes but she: / She’s the hopeful lady of my earth.” Their passing away points towards something stronger than death: the end of hope, the onset of sterility and the destruction of all of tomorrow’s promise (“No future”, as the punks said). By the end of the play, the better part of Verona’s youth lie dead – Mercutio, Tybalt, Paris, Juliet and her Romeo. The Prince bitterly declares, “All are punish’d”; for without the youth, society will pay a very high price indeed. But the death of the young in Verona also finally paves way for reconciliation in society. The play embodies the concept of creative destruction, an old order dying and a new one emerging, often with violent side effects; “The earth that’s nature’s mother is her tomb / What is her burying grave, that is her womb.”

Fortunately for us today, “High youth unemployment is not inevitable, even during an economic crisis; it is the product of the interaction between economic context and particular policies. What matters more are the choices countries make in how to allocate…spending and the policies they design to improve the efficiency and relevance of the education they provide.”

There are choices to be made because ultimately, “we cannot afford this waste.”

Post Script

A glooming peace this morning with it brings;
The sun for sorrow will not show his head
Go hence, to have more talk of these sad things;
Some shall be pardon’d, and some punished:
For never was a story of more woe
Than this of Juliet and her Romeo.

Useful links

Give youth a chance by Monika Kosinska, Secretary-General European Public Health Alliance, at OECD Forum 2013

OECD educationtoday blog

Social cohesion: making it happen

Click to get the report from the OECD Online Bookshop

Today’s post is written by Anne-Lise Prigent, the editor in charge of development publications at OECD Publishing.

A famous Deng Xiaoping quote goes : “Let some people get rich first”. Yet, in Spring 2011, the Beijing city authorities banned all outdoor advertisement of luxury goods on the grounds that they might contribute to a “politically unhealthy environment”.

The trouble with growth is that inequalities tend to rise with it. Growth does not necessarily translate into better life satisfaction – far from it, as the experience of Thailand or Tunisia shows. What happens when the fruits of growth are not shared, when people feel that income inequalities are rising and food prices soaring? Well, that’s when the so-called “politically unhealthy environment” sets in.

Millions voiced their frustration during the Arab Spring. From Tahrir square to the streets of Tunis, a huge emerging middle class showed that it has a tremendous capacity to mobilize people. It demands governments that are open and transparent, as well as more and better services. How can governments answer these demands? How can they go about redistributing the fruits of growth?

A new policy agenda is needed: one that focuses not only on growth but also on openness, fairness and inclusion. Social cohesion needs to be at the centre of policy making. Failing this, we may (re)enter a vicious circle where inequalities create a sense of injustice, which in turn can lead to (mass) protest and sometimes violence. As a result, social peace and stability, as well as long-term growth, may be jeopardized.

How can governments foster social cohesion? Perspectives on Global Development: Social Cohesion in a Shifting World from the OECD Development Centre published today, answers this. With this latest report, the Development Centre again proves that it is engaged with the world we live in, whether discussing tax revenues or the merits of football as a factor of social cohesion: having a sense of community can make a difference. That, along with equality of opportunities is what social cohesion is all about.

The report first shows how the world has undergone a shift of historical significance over the past decade, with the centre of economic gravity moving towards the East and South. The figures speak for themselves: in 2000, OECD countries represented around 60% of global GDP but by 2010 this was down to 51%, and it will be only 43% by 2030. In fast-growing economies, per capita growth rate was more than double that of high-income OECD countries over the last decade.

It is precisely this shifting wealth that opens a window of opportunity for development and social cohesion. In fast-growing economies, fiscal revenues rose from 20% of GDP on average in 2000 to 27% in 2008. These countries now have the (fiscal) resources to finance social policies that can make the difference – or, can they?

This report argues that public policies can make a difference. OECD countries with initially high income inequalities manage to redistribute income through taxes and transfers. The challenge is to leave no one behind. A cohesive society reduces inequality between groups and ensures that all citizens – the poor, the middle-earners, and the rich – are socially included.

Over the last decade, hundreds of millions of people were lifted out of poverty. This report argues that the emerging middle class should not be ignored either. Today, nearly 1 billion out of the 2 billion people living on 10 to 100 dollars a day in the world – the global middle class – live in fast-growing countries. This number is projected to exceed 3 billion in 2030.

The emerging middle class is a critical economic and social actor because of its potential as an engine of growth, particularly in the largest developing countries such as China and India. Its contribution to social cohesion can be high, and its expectations are sharply rising. What is needed is a social contract between citizens and the state, which entails more and better services in exchange for paying taxes. This would foster a virtuous circle that boosts social cohesion as well as growth. Citizens are more willing to pay taxes in societies where they feel a sense of belonging. Fiscal policy is thus a good place to start.

As the report highlights, fiscal, social and employment policies should go hand in hand. With recent innovations in social protection, the poorest are covered by social assistance and the wealthy by either contribution-based or private alternatives. Yet, a considerable number of (informal) middle-class workers are stuck in the uncomfortable “missing middle” of coverage. More comprehensive social protection systems should protect all sections of the population.

Stronger labour market institutions are also needed. They should aim to create more “good” jobs and reduce the duality in labour markets – between standard and non-standard contracts or between formal and informal workers. This will be critical in reducing inequalities and fostering social cohesion.

A series of cross-cutting issues have to be addressed coherently as well, including education, gender equality, food policy, the integration of immigrants, and institutions.

As Albert Einstein once said, “Reality is merely an illusion, although a very persistent one”. Ignoring people’s desires and the reality in which they live is perilous. Technocratically good policies that do that just won’t work and giving space to dissenting voices is essential to the creation of a sustainable, socially cohesive society.

Social cohesion is a means for development as well as an end in itself. What if social cohesion were the 21st century’s holy grail? A holy grail that can only be attained with some long-term vision and commitment – and a smile. Failing that, there might be rough times ahead.

Useful links

Social cohesion on Wikiprogress

OECD Development Centre

2012 年全球发展前景:转变中世界的社会凝聚力

Focusing on inequality or poverty reduction is not enough

Click to go to the conference website

Our second post from the Annual Bank Conference on Development Economics (ABCDE) is from Mario Pezzini, Director of the OECD Development Centre. 

Day two of the 2011 ABCDE conference has just finished and so far, the conference has given me a lot to think about. There seems a growing consensus that high levels of inequality are not conducive to sustained growth and development.

At the Development Centre we go beyond this, arguing that societies that are growing rapidly and undergoing significant structural changes could see their growth trajectories compromised unless they put in place policies to help manage the process.

What is less clear is what policies should be employed, and in what order. Given the extensive changes that many countries are experiencing, focusing on inequality or poverty reduction is not enough.  Rapid economic growth may be instrumental to reducing poverty, but if large parts of the population get absorbed into the informal sector for example, then these “non-poor” will remain very vulnerable over time. 

In this context we need a broader policy objective, one which caters to the multi-faceted challenges that many emerging and developing countries face.  I would call this policy objective social cohesion: a combination of social inclusion, social capital and social mobility. These three dimensions all interact and influence each other, which is why they need to be viewed as part of a whole. 

I don’t mean to belittle what is being said at the ABCDE. On the contrary, the breadth of topics covered in both the plenaries and side-sessions is impressive. Yet there is still a tendency to fragment policies, focusing on isolated outcomes rather than broader development objectives. An example is education, where often the focus can often be on improving enrollment or raising completion rates. But if there is no coherence between education and labour market policies, aren’t today’s school children tomorrow’s (albeit higher qualified) unemployed?  

These issues are explored in a forthcoming OECD Development Centre publication, the second in our Perspectives on Global Development series which focuses on social cohesion in a world of Shifting Wealth.   

Finally, I would add that a broader policy framework requires new measures. More data detailing citizens’ perceptions and aspirations, and more robust tools capable of capturing new socio-economic realities. Combining traditional and subjective measures will help us get a better picture of the current state of social cohesion, and design policies to nurture it.

Fortunately, new measures and data availability are two areas that will be discussed at length during day three of the ABCDE, specifically during the roundtable on Democratising Development Economics.

I hope to see you there, or if not, that you get a chance to follow the debate online.

Useful links  

Mario Pezzini talks about “Shifting Wealth” to CNBC Africa

Chile, Haiti: The difference between 7.0 and 8.8, between 200 and 200,000

This post contributed by John Mutter, Professor of Earth and Environmental Sciences/Professor of International and Public Affairs and Director of PhD in Sustainable Development, Columbia University, NY, along with Belinda Archibong and Danni Pi, economics students at Columbia College.

Let’s imagine it is January 10th and I tell you that my seismologist colleagues and I have just found how to predict earthquakes. I can forecast that there will be two large earthquakes quite close in time, one of magnitude 7.0 in Haiti on January 12th and one of magnitude 8.8 in Chile on February 27th.

The well-known Richter scale measures amplitude of ground motion, not energy release; when comparing energy release, a magnitude 8.8 earthquake is about 500 times greater than a magnitude 7.0 earthquake, so those two are very distinct physical events.

But even though I can tell the time, location and magnitude of future earthquakes, even though I can rank them by their respective sizes, I don’t know how many people will die, or the financial losses, or any social outcomes. The difficulty to predict the consequences on the population constitutes an immense limitation to this imaginary forecasting.

How many people would have predicted that although the energy release was 500 times greater in Chile the loss of life would be a thousand times greater in Haiti –casualties were more than 200 in Chile, and in excess of 200,000 in Haiti. Also, how many would have suggested that looting would be so much greater a problem in Chile? (more…)