Beyond growth: towards a new economic approach
OECD NAEC Synthesis Report
BYFORUM NEW ECONOMY
PUBLISHED27. OCTOBER 2019
READING TIME20 MIN
1. Introduction: why we need a new economic approach
In the decade since the great financial crisis, it would be hard to claim that many OECD economies have been performing well. For most, the recovery after the recession was among the slowest on record; while economic growth has been restored in the last few years, it remains generally fragile. Productivity growth has stalled in some countries, and is historically low in many others. In most, unemployment remains high, particularly for young people. Many kinds of work have become more precarious. In many countries average earnings have stagnated, with living standards for many households barely above those of a decade ago. Inequalities have risen almost everywhere – particularly between the incomes and wealth of the top 1% of the population and those of the rest of society. In most countries the gap between richer regions and those on the periphery has widened.
These problems have had unsurprising and now familiar political consequences. Popular discontent with politicians and the political system has risen. Trust in established institutions and ‘elites’ has declined. Societies which once experienced high levels of social cohesion are now widely felt to be more fragmented, prone to cultural as well as economic divisions. In many countries large numbers of people report feelings of economic and political disempowerment – a sense that they are unable to determine their own fortunes, and that in a more globalised world national societies have somehow ‘lost control’ of their own destinies. Perhaps as a consequence, political parties which once dominated government have seen their vote shares fall, in some cases dramatically, with ‘populist’ parties of various kinds gaining ground, and some entering government. In many countries (though not all) there is a widespread sense of social and economic conflict and crisis.
At the same time, we have begun to understand the magnitude of the environmental challenge the world now faces. The 2018 report of the Intergovernmental Panel on Climate Change has made clear that, to achieve the international goal of holding the average surface temperature rise to 1.5 degrees Celsius, global emissions of greenhouse gases must be halved by 2030, and reach net zero by around the middle of the century. That is a transformative task of unprecedented proportions. It is made greater by the need to tackle simultaneously the wider problems of biodiversity loss, soil depletion and air and marine pollution, many of which were documented in the 2019 report of the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services.
Environmental breakdown is only one of many rising challenges our societies and economies face. Rapid technological change is transforming many aspects of our economies. It has led to the growth of major digital platform companies whose market dominance in key sectors is unrivalled in modern times. At the same time the development of automation technologies, including artificial intelligence, is changing both the ways jobs are organised and the form they take, leading to widespread concern about the ‘future of work’. New patterns of global investment and trade are emerging, as economic activity shifts to the south and east of the world, and transnational corporations – many now based outside the old industrialised countries – form new global production networks and supply chains. The ‘financialisation’ of most advanced economies continues, with higher levels of private debt than in the past, higher returns to holders of share capital, and in some cases larger financial sectors relative to the rest of the economy. All these trends are underpinned by demographic change, with many developed countries significantly ageing, and all experiencing the pressures of increased migration.
It is not surprising that in this context many politicians and commentators – not to mention many voters – are questioning whether current economic policies are sufficient to address the problems and challenges their countries face. Many of the policies which have been used across the OECD, not just over the last decade but over the last forty years or so, seem no longer able to improve economic and social outcomes in the ways they once promised. Ten years after the crisis, most OECD economies remain on the emergency life support system of ultra-low interest rates and hugely expanded central bank balance sheets. Systemic risk has not been eliminated from the financial system. Labour market and regional policies have not reduced overall inequality; environmental policy has been insufficient to prevent catastrophic risk; competition policy has not kept pace with the growth of near-monopoly companies.
Above all, economic growth as conventionally defined and measured no longer seems able to achieve countries’ principal economic goals. There used to be a strong correlation between aggregate GDP growth and improvements in living standards, higher wellbeing, reduced inequality, and even (in some cases) environmental improvement. But this seems no longer to be true. Many countries are experiencing growth, but these critical dimensions of social and economic progress have not been improving.
One consequence of this has been a renewed interest in how progress is measured – if GDP growth doesn’t capture all the elements of a well-functioning economy, what indicators would do so better? But underlying this debate is actually a more profound one. Many people, including many economists, have begun to ask whether the entire model of economic progress which has dominated policymaking for the last forty or so years need rethinking.
Of course, OECD countries have not all followed exactly the same path in this period. Economic policies have differed, not least under different kinds of governments. But it remains true that there has been a widespread consensus on the broad contours of what makes for a successful economy. It has been widely accepted, for example, that increasing global trade is a good thing, with countries doing better the more integrated they are into international trade and capital flows. Most countries have sought to make their financial and labour markets more ‘efficient’, deregulating and liberalising them where possible to widen the opportunities for financial activity and reduce restrictions on employers. Central bank independence to conduct monetary policy has been accompanied by constraints on public borrowing. Corporation taxes have been reduced almost everywhere, and in many cases marginal income tax rates too.
The economic problems and challenges countries are experiencing today have perhaps made it inevitable that this broad model of how economies work best should find itself under question – and from right across the political spectrum. But the questioning in fact goes deeper than this. For the model has been based on frameworks of economic understanding and analysis which are themselves now under challenge. Many of the economic theories which have underpinned the dominant economic policies of the last forty years have been subjected to serious critique – both from within the economics discipline and from outside it. New economic theories, evidence and techniques have emerged which offer richer ways of understanding how economies work, why they often now don’t, and how they can be made to work better. Analytical methods based on the new powers of data collection and computing, for example, have opened up insights not available to previous generations. Taken together, a 21st century economics has begun to come into view which looks more able to help policymakers find solutions to the 21st century economic problems they now confront.
Over the last seven years the OECD’s New Approaches to Economic Challenges initiative has attempted to bring together much of this new thinking, and many parts of the OECD and member states have engaged with it. The debates have been deep and much has been learned. It is now possible to see how many of the critiques and explorations can be brought together to create a ‘new economic narrative’. Broadly speaking, this consists of three elements:
- A new conception of economic progress – a deeper understanding of the relationship between growth, human wellbeing, a reduction in inequalities and environmental sustainability, which can inform economic policymaking and communication
- New frameworks of economic theory and analysis – a richer basis of understanding and evidence on how developed economies work, and new tools and techniques to help policymakers devise policy
- New approaches to economic policy – a wider set of policy and institutional reforms, based on the new frameworks and analysis, to achieve the new social and economic goals
This report aims to explain these elements and how they fit together. In doing so we hope to help economic decision makers and policymakers make better sense of the economies we live in today, and provide them with stronger tools to achieve their goals.
2. Economic progress and the goals of economic policy
For over seventy years, economic growth has been the primary goal of economic policy, and the principal measure of an economy’s success. And with good reason: for most of this period, rising national income signified rising household incomes, and with them average living standards. Economic growth raised employment levels, reduced poverty rates, and provided the tax receipts to finance higher government spending on public services. In most OECD countries, for a long time, economic growth was accompanied by falling inequality and – as higher GDP allowed more resources to go into air and water pollution control – better local environmental quality. So while governments always had a wider set of economic objectives than simply rising GDP, economic growth was a pretty good metric for overall performance.
It would be much harder to make this claim today. Three key developments have led to the widespread questioning of growth in recent years.
The first is the ‘decoupling’ of GDP growth from many other economic objectives. Today we are familiar with the phenomenon of ‘jobless growth’, in which employment does not rise proportionately with GDP. In a number of countries, perhaps more surprisingly, growth no longer translates into rising average earnings or living standards. It has also become clear that growth is no longer correlated with declining poverty or inequality – in the last decade, in many countries, the share of GDP taken by the richest groups in society has considerably outweighed that going to the poorest, while inequality of wealth has greatly increased.
The second is the acknowledgement that income is not a sufficient measure of wellbeing, either at the level of the individual or of society as a whole. The study of wellbeing has advanced greatly in recent decades. Income is important, particularly for those whose incomes are low. But we now understand that people’ sense of a fulfilled and flourishing life comes also from the security and satisfaction they experience in work; from their physical and mental health and personal and family relationships; and from social goods such as the levels of crime and trust in society, and the quality of public services such as health and education. For most people today, rising GDP is no longer a sufficient measure either of their own wellbeing or their sense of society’s economic progress.
Third, severe environmental degradation has forced a recognition that today’s patterns of economic growth are undermining our capacity to generate rising living standard in the future. An economic system based on fossil fuels, intensive agriculture and the exploitation of global natural resources is simply not sustainable. Climate change, air and marine pollution and ecological breakdown are already damaging the lives and livelihoods of millions of people around the world; they risk catastrophic damage to our economies and societies within the next few decades unless currently dominant forms of production and consumption are radically changed.
These developments do not mean that economic growth should be abandoned as a goal of economic policy. But they do suggest that politicians and policymakers need to go ‘beyond growth’. That is, they need to ensure that, alongside rising GDP – and as a result of it – economic policy is achieving a wider set of objectives and measures of economic and social progress. We can no longer rely on economic growth on its own to make our societies better off.
In our view, four objectives for economic policymaking should today be paramount:
- Environmental sustainability – understood as a path of rapidly declining greenhouse gas emissions and environmental degradation, consistent with avoiding catastrophic damage and achieving a stable and healthy level of ecosystem services
- Rising wellbeing – understood as an improving level of life satisfaction for individuals, and a rising sense of improvement in the quality of life and condition of society as a whole
- Falling inequality – understood as a reduction in the gap between the incomes and wealth of the richest and poorest groups in society, a reduction in rates of poverty, and a relative improvement in the incomes and opportunities of those experiencing systematic disadvantage, including women, members of ethnic minorities, disabled people, and those in disadvantaged geographic communities
- System resilience – understood as the economy’s ability to withstand financial, environmental or other shocks without catastrophic and system-wide effects
Countries which seek to achieve these four goals, rather than giving overwhelming priority to growth alone, will we believe experience a more balanced path of economic development, with fairer outcomes for both current and future generations.
Defining economic and social progress in terms of these goals, rather than those of economic growth alone, inevitably forces attention on the trade-offs between them. There is no question that such trade-offs exist: there can clearly be circumstances where societies may have to choose between rising household incomes and higher quality public goods; or between higher GDP growth and environmental sustainability; or between a more resilient economy and a faster-growing one. Such choices are the proper domain of public debate and political decision.
But it is also important to recognise that these trade-offs may not be as obvious as often thought. There are in fact strong synergies between these goals.
In particular, the rising weight of international evidence in recent years has shown that – contrary to the formerly received wisdom – reducing economic inequalities benefits rather than harms growth. There are multiple reasons for this. Most obviously, inequalities of income and opportunity prevent some people from achieving their full economic potential. Low educational attainment and skills, discrimination in the labour market, and the difficulties of working in the absence of adequate child and social care, all tend to constrain the productive resources of the economy. At the same time, people on low incomes tend to spend a higher proportion of their income than the wealthy, who are more likely to save. So improving the earnings of poorer people has a much larger impact on consumption and aggregate demand, and therefore growth, than raising the income and wealth of the relatively well off.
It is also now clear that inequality tends to make economies more unstable, as the higher savings of the rich are channelled into financial and real estate assets prone to volatility. More unequal economies tend statistically to have shorter periods of growth. And politically, rising inequality has tended to result in policies skewed towards the wealthy, including (for example) pressures to reduce tax rates. These in turn tend to reduce spending on the public goods, such as education, health and childcare, which can improve the economy’s productive potential.
If reducing inequality can boost growth, it also has an important impact on both social and individual wellbeing. Studies across developed countries show strong correlations between inequality and a variety of other social harms, including higher rates of mental and physical ill-health, obesity and crime, and lower levels of social trust, educational attainment and social mobility. This is true not just for those on low incomes, but across the population as a whole. Surveys of wellbeing consistently show that more equal societies are also those where life satisfaction and happiness are highest.
The trade-offs between economic growth and environment sustainability are deeper. But by changing what is produced in the economy and how, it is now clearly possible to reduce environmental damage very significantly even while output increases. Rapidly cutting greenhouse gas emissions, for example, will require significant investments in energy efficiency, renewable energy and sustainable transport technologies. These investment will inevitably act as a form of short-term economic stimulus, generating both jobs and incomes. In the longer term technological and social innovation will need to drive very different patterns of production and consumption from those we see today, with much lower levels of energy and material use, and much higher levels of waste reuse and recycling. We do not, if we are honest, know what impact this will have on long-term growth rates in developed countries. But there is little reason to doubt that a highly-productive, environmentally sustainable economy of this kind can generate a high standard of living, and one more fairly shared. Indeed, it is now evident that the alternative – an environmentally unsustainable economy – will cause very serious damage to wellbeing and resilience in the medium and long term, particularly to those on the lowest and most vulnerable incomes.
In recent years the terms ‘inclusive growth’ and ‘sustainable growth’ have been used to describe national economic pathways aimed at meeting wider objectives of the kinds we suggest here, and the OECD has taken an important lead in developing these ideas. The comprehensive concept of ‘sustainable development’, embodied in the Sustainable Development Goals adopted by the United Nations, reflects the same impulse. We are strongly supportive of these commitments. But it is also true that these terms can be used with a range of meanings, and have sometimes been accompanied by rather minimal policy changes in practice. As we discuss later in this report, the dynamics generating today’s economic crises are deeply embedded in the structure of our economies. So giving serious priority to improving wellbeing, reducing inequalities, and achieving sustainability and resilience will demand more than a minor adjustment to current economic policies. A deeper reappraisal is required.
There are three crucial dimensions to this process in practice. The first is the adoption of a wider set of primary economic indicators to guide policymaking. It is now well known that GDP is not a good measure of overall economic performance. It does not take any account of the distribution of income and wealth; it captures only flows of income not the stocks of capital that generate them; it ignores unpaid work; it fails to measure environmental degradation; it is not a good proxy for wellbeing. Over the last decade the OECD has therefore pioneered the development of economic indicators which better capture the multiple dimensions of economic and social progress, and a number of countries have begun to adopt them. This generally involves use of a ‘dashboard’ of key indicators, including measurements of economic security, subjective wellbeing, environmental quality and public goods. A particularly important new field is the development of ‘distributional national accounts’, which show not just the aggregate growth in GDP, but how it is distributed across income and population groups.
But adoption of a set of indicators is not sufficient on its own. These have to become the accepted measures of the success of economic policymaking. All too often governments have published sets of alternative indicators but then largely ignored them, both in making economic policy and in talking about it. For new indicators to be effective they must be communicated: politicians and policymakers (particularly in finance and economic ministries) must make clear in their public pronouncements that this is how they want economic performance to be judged, and media debate needs to reflect this. Going ‘beyond growth’ needs to be an explicit political aim.
Last, and most critically, the new economic indicators need to be attached to policies designed to improve them. It is no use adopting a new measure of performance, but then not having the mechanisms to influence it. This requires both an understanding of the causal factors which determine the level of the indicator; and the design of policies which can impact on them. It is for this reason that we argue in this report that policymakers need a deeper framework of understanding of how modern economies work, and the kinds of policies which can make them work more successfully. Multi-dimensional indicators require a more sophisticated menu of policies.
Most economic policy is made by national governments, but this process has a crucial international element too. In a globalised economy of complex supply chains and trading relationships, production and consumption patterns in one country powerfully impact on others, and many economic outcomes cannot be determined solely through national action. So there is a vital need to achieve new international agreements and coordination mechanisms in areas such as environmental degradation, labour standards and tax policy which can ensure that economic goals in one country are not met at the expense of others, and national policy is enhanced by international cooperation.
New frameworks of economic analysis
- Over the last twenty years or so, the discipline of economics has undergone something of a transformation. Major developments in both economic theory and the gathering of evidence have radically improved economists’ understanding of how modern economies work (and why they often don’t). But it is striking how few of these new insights have been incorporated into the analysis underpinning economic policymaking in most countries, and how little they have informed mainstream media commentary and political debate. There is a strong case for arguing that this is an important reason why economic policy has not been very successful in tackling many of the major challenges OECD economies face.
Economic policymaking and public discourse continues to be dominated by what might be called the ‘standard’ version of neoclassical economics. It is a model familiar from introductory economics textbooks. It rests on relatively simple assumptions about how economic actors behave, and the implications of this for the functioning of the economy as a whole. These in turn lead to a variety of ‘orthodox’ prescriptions for economic policy – many of which have formed the dominant approach to policymaking over the last forty years in many countries.
At the heart of this model is the assumption of ‘rational’ economic behaviour. Individuals are assumed to seek to maximise their utility, based on preferences which are formed outside of the economic process. Businesses are assumed to seek to maximise their profits. The ‘optimal’ level of output and consumption (and wages and profits) will then be achieved in markets that are as competitive as possible, where all actors have the freedom to act in pursuit of their interests. Not all markets are like this, of course – but the aim of policy should then be to make them more like it. In fields as varied as labour market policy, financial markets and international trade (and in some countries in the provision of public services too), the dominant view has been that markets should be liberalised if possible. This will maximise their efficiency, and lead to the highest gain in overall output and welfare.
The exception is in cases of ‘market failure’, where competitive markets do not produce optimal outcomes due to the existence of externalities (such as environmental degradation) or public goods (such as science or defence). In the standard neoclassical model it is market failure which justifies government intervention in the economy: appropriate policies range from environmental taxes to the public provision of services such as education, policing and research and development. But the neoclassical model notes that governments can also fail: states can be captured by the interests of their civil servants or politicians, or simply do not have the knowledge or capacity to improve market behaviour. As a result, much economic prescription based on neoclassical analysis has been sceptical about the role of government in trying to steer the economy towards ends other than those determined by existing markets and well-defined externalities.
At the level of the whole economy, the standard neoclassical model has underpinned the dominant approach to macroeconomics. The assumptions of rational economic behaviour and essentially competitive markets have informed the way in which macroeconomic models have traditionally been built. Such models typically assume that households and businesses behave in homogenous ways, as ‘representative agents’. They assume that markets tend to ‘clear’, leading the economy as a whole towards an equilibrium state, generally assumed to be at full employment. At the level of policy, the neoclassical framework has encouraged a view that high levels of government debt ‘crowd out’ private investment, so fiscal deficits should be limited, and monetary policy (adjustments to interest rates) should play the primary role in controlling inflation and managing overall demand.
The standard neoclassical framework provides a simple and clear way of understanding economic behaviour; one of its advantages is that has allowed a highly mathematical approach to economic analysis. But in this form it is now outdated. Over the last two or more decades almost all of its assumptions and approaches have been undermined, both by economists working out of the neoclassical tradition and by those in more ‘heterodox’ schools.
This is partly because the evidence shows that very few economic actors or markets function in the simple ways the model assumes or predicts. But it is also because economic analysis based on the model has not been good at predicting or explaining many of the economic phenomena which developed countries have actually experienced. The financial crisis, the growth and impact of inequality, the rise of environmental degradation, the slowdown in productivity growth: none of these were anticipated or were capable of being explained by the standard neoclassical model. So, unsurprisingly, economists have been seeking to develop new theories and analytical frameworks (and sometimes the re-formulation of old ones) which provide a better fit with the evidence, and in turn greater explanatory power. We list a few of the main developments here.
Economic behaviour. Very few economists now think that the model of rational ‘homo economicus’ is a useful way of explaining how people behave in real economic life. The field of behavioural economics, informed by experimental evidence in economic psychology, offers a more sophisticated way of understanding. People do not constantly calculate and optimise their self-interest: they use various forms of ‘bounded rationality’. To save the time and effort of calculation, many economic decisions are made using ‘heuristics’ and ‘rules of thumb’ of various kinds. At the same time, human reasoning is subject to many forms of bias. For example, people tend to operate within particular ‘frames’ of thought, rather than seeking a full range of information sources, and tend to draw general (and often mistaken) inferences from small samples of experience. ‘Herd behaviour’ (when people simply follow others’ example) can be common.
In a similar vein, economic psychologists and sociologists have emphasised the role of social influences on the formation of economic tastes and preferences. People do not act solely in their own self-interest: they have strong attachments and moral views which lead to various forms of co-operative and altruistic behaviour, alongside conformity to social norms. Economic action in this sense is powerfully ‘embedded’ in societal structures, institutions and relationships. Tastes and preferences are not somehow ‘given’, or exogenous to the economic system – they can be actively shaped by forces such as advertising, the impact of new technologies and new kinds of social networks and institutions. The narratives which are commonly told in society about how the economy works and how people behave in it themselves influence behaviour.
Markets, institutions and power. The neoclassical idea of the competitive market was always intended to be a formalisation of what in the real world is obviously a wide range of different kinds of market arrangements. But over recent decades institutional and political economists of various kinds have provided a more fundamental critique. They have pointed out that markets are brought into being by institutions and the social rules they embody: by law, custom, social norms, the structure and ownership of businesses, by public policy. All of these – and therefore reforms to them – can change the ways in which different kinds of market operate, and the outcomes they generate. The idea of ‘market competition’ is simply too narrow a frame to understand this. Such economists have noted, for example, that the different systems of corporate governance and financing in different countries lead businesses to behave in different ways; that the relationship between corporations and governments is a vital element in understanding how markets work in practice; and that the development of digital information has fundamentally altered the nature of economic production. It is hard to understand the growth and business models of the new giant digital platform companies, for example, without these insights.
Understanding markets as the outcome of the inter-relationships of institutions raises the inescapable issue of the role of power in the economy. The way in which today’s labour markets work, for example, is made more explicable by analysing the relative power which employers, individual workers and groups of workers (organised for example in trade unions) have within them. The growing concentration of many product markets in the hands of a small number of large corporations requires not just traditional analysis of monopoly and oligopoly, but of the impact of corporate lobbying on regulatory policymaking. To understand the effect of rising inequality on economic outcomes requires an examination of the influence of the very wealthy on public policies such as taxation and public spending.
Evolution and complexity. The standard neoclassical model has an essentially timeless frame of reference: understood as a set of equilibrating markets, the economy is analysed with little reference to its own history or to the processes of change. This makes it difficult to comprehend why and how economies develop over time. Various kinds of evolutionary economists have sought to fill this gap. They have shown how economies change in ways which mirror those of biological evolution, where differences in corporate behaviour and technological innovation generate advantages in markets and therefore get reproduced. They have analysed how change is ‘path dependent’, constrained by previous conditions and inertial forces. Many evolutionary economists and economic historians have focused on trying to understand innovation – the process of ‚creative destruction’ – as the key driving force of economic growth over time. They have explained innovation as an institutional process influenced not just by the processes of technological ‘invention’ within firms, but the wider system of ‘innovation networks’ and financial markets, and the often powerful role of public funding at various points in the innovation process.
The dynamics of innovation are hard to reconcile with the neoclassical view of the economy as an essentially equilibrating system: in reality it is always in turbulent flux. The school of complexity economics has sought to combine this insight with those of behavioural and institutional economics to understand the economy as a complex, adaptive system. Drawing on the modern systems theory developed to analyse complex systems in biology and engineering, complexity economics seeks to understand the ways in which the multiple and non-linear relationships between heterogeneous actors in a modern economy generate new, ‘emergent’ economic outcomes which would not be predictable through a mechanistic approach. Complexity economists have developed new kinds of ‘agent-based’ models which abandon the assumptions of rationality, representative agents, optimising behaviour and equilibrium of the standard neoclassical model. Utilising the new availability of big data and modern computing power, such models are able to represent the economy in more complex ways, offering the potential of better explanation and prediction.
Finance and macroeconomics. The failure of most macroeconomists to predict the financial crash of 2008, and the continued weakness of most developed economies despite the very low interest rates of the last decade, have led to a fundamental reassessment of neoclassically-based theory. A crucial dimension of this has focused on the role of the financial sector. Prior to the crash financial regulation was largely based on the neoclassical ‘efficient markets hypothesis’, which assumed that, with near-perfect information, liberalised financial markets would generate an optimal allocation of resources. The evident failure of this theory has renewed interest in ‘post-Keynesian’ analysis which explains how financial markets shift between stability and fragility, and their tendency to create asset bubbles and subsequent crises. As the ‘financialisation’ of many economies has increased, economists are analysing the impacts which different kinds of financial actors and assets have on economic performance: the role of speculative and short-term financial trading, for example, the critical role played by investment in real estate, and the rise of the ‘shadow banking’ system.
At the same time Keynesian and post-Keynesian economists have challenged the neoclassical orthodoxy around fiscal and monetary policy. Such economists emphasise the importance of effective aggregate demand in determining productivity and output growth, and the central role played by uncertainty in economic behaviour. They have focused on the role of fiscal policy in stimulating growth when interest rates are very low and monetary policy has largely run out of options. Contrary to neoclassical orthodoxy, it has been shown how high levels of public borrowing and debt can be sustained so long as the growth rate of the economy (which can itself be stimulated by public investment) exceeds the rate of interest paid. Public investment can ‘crowd in’, rather than ‘crowd out’, private finance. Post-Keynesian economists have shown how money is created ‘endogenously’ by commercial bank lending, rather than by central banks. Some (working within ‘modern monetary theory’) have indeed questioned the entire basis of monetary policy, proposing the use of monetary financing (‘printing money’) to finance public spending.
A key field has been the development of new kinds of macroeconomic models. The unrealistic assumptions and poor predictive performance of standard ‘dynamic stochastic general equilibrium’ (DSGE) models used by many central banks and finance ministries has led to a questioning of their neoclassical ‘micro-foundations’, such as rational expectations and representative agents. The new models incorporate financial assets of various kinds, can account for stocks as well as flows, and allow for more realistic behavioural and institutional assumptions, including the critical role of information asymmetries and uncertainty, and the possibility of structural breaks in economic evolution, such as financial crises.
The natural environment. Neoclassical economics understands environmental degradation as a form of market failure. It therefore seeks to find a monetary value for environmental resources or the damage caused to them, and to use environmental taxes or other incentive mechanisms (such as tradable permit systems) to ‘internalise’ the external cost and so correct the market failure. But this approach is not a satisfactory way either of explaining or addressing the prevalence of environmental degradation. Ecological economists have offered a more fundamental explanation. They have shown how the economy is in practice a subset of the earth’s biophysical systems: it depends on the natural environment to provide it with resources, assimilate its wastes, and to provide various life support services such as nutrient recycling and climatic regulation. These processes are governed by the laws of thermodynamics, which ensure that all resources are turned back into wastes, in a more ‘entropic’, or disordered (and therefore often polluting), state. Natural systems do not behave in linear ways but exhibit a range of thresholds and ‘tipping points’ which, when exceeded, risk catastrophic change, sometimes to local environments, sometimes (as with climate change) to the global one.
For these reasons, ecological economics seeks to bring the economy back within the earth’s ‘sustainability limits’, where environmental systems can naturally regenerate. This will involve, not the marginal changes assumed by the notion of market failure, but transformation in the environmental structures of modern economies: the use of carbon-based energy, car-based cities, intensive agriculture, the over-exploitation of soil, forests and fisheries. A wide range of policy instruments will be required to stimulate this. This will have powerful implications for macroeconomic policy: the notion of economic growth itself will need re-evaluating.
Inequality. As inequality has grown in recent years, a growing number of economists have sought to map its extent, and understand both its causes and its effects. In doing so they have challenged some of the fundamental tenets of the standard neoclassical approach. For example, it has become clear that the increasing liberalisation of international trade does not have the general economic benefits formerly assumed. Although greater trade may raise GDP, it frequently results in a highly uneven distribution of the benefits, with significant net economic costs being borne by particular industrial sectors and the geographic communities dependent on them. Actual experience in a variety of countries suggests that a non-liberalised, much more government-directed approach to trade and industrial policy may have a much stronger impact on growth and its distribution.
One of the key trends of the last forty years in many developed countries has been the declining proportion of national income which has gone to wages and salaries (the ‘labour share’) and the rising share going to the owners of land and capital. This has been explained in terms of the rising returns to capital (both of land and business profits) relative to the growth rate of the economy as a whole, and of the increasing ability of higher income groups to capture the unearned ‘rents’ or surpluses from economic activity. The relative power of employers and workers in the labour markets for different kinds of work has then magnified the difference in earnings between workers in different occupations. Rising inequality has been shown to have powerfully negative impacts on the wider economy, including on productivity and economic growth and on many indicators of individual and social wellbeing.
Gender. One of the persistent dimensions of inequality has been by gender. Women in all countries are systematically under-represented in high-status and high-earnings occupations, and over-represented in low-status, low-income ones. Neoclassical economic analysis cannot plausibly account for this. Feminist economists have sought to locate such gender stratification, rather, in the deeper structures in society which entrench the relative roles and power of men and women. Comparable analyses have examined how ethnic minorities also experience systematic discrimination and under-representation in higher-status and higher-income occupations, the basis of this in the colonial and slavery histories of western economies, and the ways in which inequalities of gender, race and class intersect. Analysis of economic and public policy outcomes without understanding their gender and racial dimensions is simply incomplete.
A critical feature of feminist economics has been a questioning of the boundaries of the economy and of economic analysis. It has emphasised the critical role which the unpaid work of raising children, very largely done by women, plays in maintaining the processes and structures of society (‘social reproduction’), and the way this is systematically ignored in mainstream economic accounting and analysis. This is also true of other forms of unpaid work, such as caring for elderly and disabled people and voluntary and community work of various kinds. Only by understanding the economic value produced by these activities, it is argued, can the functioning of the economy, and its embeddedness in social structures and relations, be properly understood.
Ethics and the role of the state. Inequality in its various dimensions forces a questioning of the ethical basis of economic analysis. The standard neoclassical framework assumes itself to be ethically neutral, since it seeks to optimise welfare given the existing tastes and preferences of consumers; it does not judge these. But in practice those tastes and preferences are highly dependent on the distribution of income. Since people’s tastes and preferences change as they move along the income scale, a different distribution would generate a different pattern of economic activity. This is even before we consider the moral claims of future generations. So regarding the optimisation of welfare under current conditions as ethically ‘neutral’ is in practice to accept the current distribution of income (including between generations). It is for this reason that environmental philosophers and political economists have argued for a more honest understanding of the inescapably ethical character of economic analysis. In turn this could lead to a more sophisticated public debate about the justice (or otherwise) of different economic arrangements and policies.
It would also suggest a re-examination of the role of the state in economic policy. The neoclassical model presupposes that well-functioning markets optimise overall welfare, and government policy is therefore justified to correct market failures. But if public policy is to aim at different ethical outcomes, the state may have a larger role in guiding, or steering, the overall patterns of economic activity to achieve them. Correcting market forces is unlikely to be sufficient.
These developments in economics and political economy over recent years (and this is by no means a complete account) have generated important new understandings of how economies work, and they have been widely backed by new empirical evidence. Many recent Nobel Memorial prizes have been awarded to the leading exponents in these fields. In some cases the key insights can be incorporated into neoclassically-based theories and models, relaxing simplistic assumptions and introducing ‘frictions’ or new explanatory variables of various kinds. In others they require a more fundamental abandonment or radical revision. The coming together of different disciplines (economics, political economy, sociology, history, anthropology and others) has been a particularly productive feature. The overall result is that within academic economics the simple neoclassical framework has been almost completely superseded.
As yet, there is no single synthetic theory which has emerged from these different schools of economic thought. But this is largely because they focus on different aspects of economic activity. It is not because they offer competing analyses of the same fields. Indeed in many cases there are strong synergies between them, and obvious ways they can be combined. The new macroeconomic models, for example, incorporate a variety of institutional economic insights. Policy aimed at transforming the economic structures generating environmental unsustainability can learn much from the approach of evolutionary and innovation economists. Insights from behavioural economics have been important for understanding how financial markets work in practice. Gender analysis has enhanced other analyses of inequality.
Many economists working in the complexity field have been explicit in making these links and incorporating insights from a wide range of economic analyses. Since their aim has been to understand in a more sophisticated way how economic agents behave and the outcomes which emerge from their interactions, they have drawn on a range of economic approaches which can help illuminate these. The field of political economy has encompassed a range of interdisciplinary approaches.
Perhaps most importantly, these new modes of economic analysis offer a much richer approach to economic policymaking than the simple neoclassical framework. They can help to explain why orthodox policies have not been working well in addressing the multiple challenges faced by OECD countries. And they can help point the way to alternatives that might more successfully do so. In some cases this has already been happening. For example, post-Keynesian economics has underpinned the turn to macroprudential financial regulation in recent years; behavioural approaches have been used to ‘nudge’ citizen behaviour in desired directions; institutional reforms such as renewable energy targets and industrial strategy are being used to steer innovation towards decarbonisation. But in others there remains considerable scope to utilise the new economics in pursuit of more successful policy.
New approaches to economic policy
- As the multiple problems and challenges facing developed economies have emerged over the last decade, many new approaches to economic policy have been developed in response. These have sought to contribute to the new goals of economic policymaking set out in chapter 2, drawing on the new frameworks of economic analysis described in chapter 3. Some have been developed and already implemented by governments; some are already under discussion within the OECD; others have been put forward by academic research institutes, think tanks and other organisations in civil society. We highlight a few examples here which illustrate some of the core themes of this report. These are in no sense intended to be comprehensive. In each case there is plenty of further work to be done to refine and tailor them to the particular circumstances of individual countries.
All of these approaches reflect a key insight. This is that the deep challenges facing OECD economies today will not be addressed simply by incremental changes to existing policies. Environmental unsustainability, low levels of investment and slow productivity growth, rising inequality, the power of monopoly corporations, growing financialisation, accelerating automation: each of these arises from structural features of modern economies. So they will require a more profound shift in the kinds of policy which governments use to address them.
For much of the last forty years, the dominant approach to economic policymaking in most OECD countries has been to focus on the ‘supply side’ of the economy – attempting to ensure that economic conditions such as infrastructure provision, competition and regulatory policy, and the education and incentives of the labour force, are supportive of private sector investment and growth. Macroeconomic policy has been aimed at the control of inflation. At the same time, some of the adverse impacts of growth have been ameliorated by redistributing income through the tax and benefit system, and though various forms of social and environmental policy. Meanwhile the central engine of the economy – the patterns of investment and forms of production that generate its shape, direction and scale – have been largely left to be determined by private sector businesses and finance.
Though both supply side and ameliorative policies are still extremely important, they are no longer sufficient to address today’s economic challenges. We need to pay attention to the way the engine itself works. For it is in the patterns of investment and forms of production themselves that the major problems and challenges arise. If we are to achieve the new economic goals we have set out – environmental sustainability, improved wellbeing, a reduction in inequality, and greater resilience – these need to be built into the structures of the economy from the outset, not simply hoped for as a by-product, or added after the event.
Sustainability and decarbonisation policy poses perhaps the most acute and urgent challenge in this respect. In the past, environmental policy has been aimed at improving the impacts of specific products and production activities – through regulatory measures such as energy efficiency and pollution standards and protection of natural areas. But it is evident that these have not been enough to drive aggregate environmental degradation – especially but not only greenhouse gas emissions – down to sustainable levels. So policymakers must now consider how long-term decarbonisation and sustainability targets can be given greater legal and economic force, and used to drive investment and production into more sustainable and resilient forms. This will involve detailed examination not just of the technological options which can achieve radically lower environmental impact (in sectors such as energy, transport, buildings, agriculture and industry) but the patterns of consumption and modes of living which will be associated with them. What would a truly sustainable urban transport system look like? What forms of food consumption would be compatible with limiting the average global temperature rise to 1.5C and the maintenance of soil fertility and biodiversity? What would be the macroeconomic impact of a genuinely ‘circular economy’ of sustainably reused resources and zero waste? To make choices of these kinds, it seems clear that governments will need to engage in much deeper forms of sectoral planning and public consultation than most have practised in the recent past.
Innovation and industrial policy will then have to play a crucial role. Over the last few years a number of governments and public institutions have taken up the idea of ‘mission-oriented’ innovation and industrial policy. This starts from the insight that economic development has a direction as well as a rate. So public policy can help drive innovation into meeting the major environmental and social challenges our societies face – such as decarbonisation, environmental sustainability, health and social care, and digital inclusion. Using a combination of policy targets, public procurement, innovation spending and ‘patient’ public investment, a more active industrial policy can help steer the economy, not just to support stronger industrial performance (with benefits to job creation, trade and regional growth) but social and environmental goals as well.
There is a strong case for a more active industrial policy to be supported by a more active macroeconomic policy. With interest rates still very low and quantitative easing still in place, many economists and economic institutions now accept that fiscal policy will be needed to ensure sufficient aggregate demand to create new jobs, particularly in the face of a global downturn. Although public debt levels remain high in many countries, it is now widely recognised that public borrowing for investment which supports economic growth (in, for example, infrastructure, innovation and public services) can be sustainable, paying for itself over time. It is notable that many public investments which support growth and job creation will also contribute to improved individual and social wellbeing.
Improving the resilience of the economy through stronger financial regulation remains an important priority. Though the period since the financial crash has seen stricter regulation of individual financial institutions, many analysts warn that the financial system as a whole remains fragile. While policymakers have been developing new forms of macro-prudential regulation aimed at preventing excessive credit growth, it is not clear that these are yet strong enough to prevent another crisis, with the growth of the largely unregulated shadow banking system a particular concern. So there are strong grounds for exploring stricter regulation of the types of assets which financial institutions can hold, penalising (through regulation or taxation) various forms of speculative finance, and incentivising long-term investment in productive sectors of the economy. In some countries this might include reforms to the ‘shareholder value’ model of corporate governance and executive pay, which it is argued has encouraged an excessive focus on short-term returns and a decline in long-term investment.
More widely, there is increasing interest in the role which reform of competition policy might play in regulating the growth of companies with powerful monopoly positions, particularly in key digital markets. While different countries have different competition regimes, the orthodox model of judging competition and market power largely through their impact on consumer prices has come under increasing challenge. With expanding influence on many aspects of life, from the media and privacy to the development of artificial intelligence, the structure and regulation of digital platform companies is a particular focus of policy concern. At the same time there is increasing scrutiny of the ways in which multinational corporations govern their global supply chains, particularly in relation to issues such as labour and environmental standards. Raising such standards through new forms of international trade agreements offers a potentially powerful approach. Coordinating corporate taxation regimes on an international basis to ensure that multinational corporations pay fair levels of taxation in the countries in which they operate will also be important.
Building dynamics to reduce inequality into the structures and institutions of the economy poses a real challenge to policymakers. It requires attention paid not just to the effects of inequality but to its causes. One of these lies in the ownership of wealth, which in many countries has become more concentrated over the last decade. A variety of approaches to spreading wealth more widely are now under discussion in many places, including mechanisms to broaden the ownership of companies, reforms to land ownership and housing markets, the design of ‘citizen’s wealth funds’ and proposals to increase the taxation of wealth.
Reducing inequality will require particular attention paid to labour market policies. The falling share of national income going into wages and salaries (relative to capital) over recent decades has reflected a decline in the effective bargaining power of workers, particularly in lower-skilled jobs. Reversing this would require a range of kinds of measures: raising minimum wages; employee profit-sharing schemes; improving the access of trade unions to workers, particularly in smaller firms; improving the regulation of working conditions, particularly in the so-called ‘gig economy’ of precarious work; improving the provision of childcare; increasing the role of collective bargaining, particularly at a sectoral level. The latter will be particularly important to manage the processes of automation, ensuring that the benefits of higher productivity do not accrue simply to the owners of capital, but also to employees. As both automation and decarbonisation accelerate, it will be important to design ‘just transition’ policies which enable displaced workers to retrain for and to access new jobs. There is increasing interest, for example, in the role of government ‘job guarantees’ in such circumstances. ‘Flexicurity’ welfare policies which combine flexibility for employers with income security for workers may also be important. There is growing interest in some circles in the idea of a ‘universal basic income’ for the same reason. Systematic measures will be needed to end discrimination against women, ethnic minorities and other minority groups in many countries.
The aim of each of these kinds of policy approaches – and this is not, of course, an exhaustive list – is to help shift the structure of economies so that their internal dynamics work towards the goals of environmental sustainability, improved wellbeing, declining inequality and greater resilience. Rather than bolting on policies which have to act against the dominant dynamics of the economic system, the aim should be to change the way the engine of the economy works, so that these goals are its primary outcomes.
This will be neither easy nor quick to do; it will take significant institutional reform, along with political imagination and courage. Many vested interests will no doubt stand in the way. But if policymakers are able to redefine the way they speak about economic progress, using new indicators to judge economic performance, there are many options available to change the dominant model of growth and address the challenges it has thrown up.
- In this report we have tried to set out a new way of thinking about economic policymaking. It includes a new set of goals and measures of economic progress; new frameworks of economic analysis; and new kinds of policies.
It is not new in the sense of ‘original’: on the contrary, a critical part of our argument is that
what we are doing is bringing together well-established ideas which have many authors and important intellectual histories. But we do believe it is new in the sense of offering an alternative to the approach to economic policymaking which has been dominant in OECD countries over the last forty or so years.
It is a way of thinking that has been gradually coming together over the last decade, as economists and policymakers have appreciated the extent of the problems and challenges faced by developed economies, and the inadequacy of the orthodox approaches to addressing them. The OECD, particularly through its New Approaches to Economic Challenges initiative, has played an important role in that process. We believe it is now time for it to be put into practice.
It is daunting for economic policymakers to contemplate a fundamental shift in the way they make policy. But this kind of change has happened twice before in the last century. In the 1940s, in the aftermath of the Wall Street Crash and the Great Depression, the economic orthodoxy of laissez faire, which had dominated analysis and policymaking in the preceding period, was replaced. Keynesian economic theory provided a better way of understanding how economies could be revived, and the economic policies of full employment and the welfare state won broad support across the political spectrum. But the ‘postwar consensus’ itself broke down amid the economic crises of the 1970s, and it too was replaced. The free market or ‘neoliberal’ model developed by economists such as Milton Friedman and Friedrich Hayek appeared to offer a better economic analysis, and a more dynamic policy prescription. Adopted originally (and most fully) by the US and UK under the governments of Ronald Reagan and Margaret Thatcher, the market-oriented model in various forms came to be applied widely across the OECD in the subsequent decades.
Social scientists describe these moments of economic change as ‘paradigm shifts’ – periods when old orthodoxies are unable either to explain or to provide policy solutions to conditions of crisis, and new approaches take their place. More than a decade after the financial crash, with our economies and political systems facing multiple crises, our argument is that the time is ripe for another such paradigm shift. The frameworks and prescriptions which have dominated policymaking in recent decades are no longer able to generate the solutions to the problems and challenges we face today. We need a new approach.
This will not be easy. There is no single prescription which fits all circumstances. Every country is different, and each will wish to find their own way. But we are struck by the wealth of insight and understanding which now exists across the field of academic economics and economic policymaking, from which solutions can be drawn. We applaud the OECD for its central role in supporting the development of these new approaches, and strongly recommend it continues to do so, engaging its members states not just to further discuss and develop them, but also to implement them. The prize is a considerable one.