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Caroline Webb and Matthew Bishop: After the Recession, What’s Next for Economics?

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Caroline Webb and Matthew Bishop: After the Recession, What’s Next for Economics?

Caroline Webb, author of How to Have a Good Day, specializes in the application of behavioral science to the workplace and beyond. Caroline is CEO of Sevenshift and a Senior Advisor to McKinsey and Company, where she was previously a Partner. She recently sat down for a Heleo Conversation with Matthew Bishop, senior editor, The Economist group, and a sought-after expert on philanthropy, as well as economics. They discuss the latest edition of Matthew’s seminal book, Economics: An A-Z Guide, the lessons we learned from the 2008 financial crisis, and the future of the sharing economy.

Caroline: I thought your book would be a wonderful way to structure a conversation about where economics is today. Where is the discipline going, and should we be optimistic or pessimistic? There have been versions of your book before, but this is the very first version that is coming out after the great crash of 2008.

Matthew: Yes, this book started as something called The Pocket Economist back in the early 1990’s. The big financial crash in 2008 and the Great Recession that followed has been such a challenge to economics that the book needed to be totally rewritten. This new version really is up to date with everything you want to know about how economics has started to respond to the seismic shock that hit it when the crash happened.

Caroline: It’s a fantastic book. And it gives you not just definitions, but also a bit of your wit. I’ve also noticed that it’s bigger compared with the original pocket version. Is that because economics is more interesting now?

Matthew: I think it has got more interesting because, prior to the crash, the dominant idea in economics was still basically that people are very rational. A lot of the economic models didn’t have real people written into them. What’s happened since the crash is that a lot of economists realized that the world works in a more complicated way.

A lot of the economic ideas now are including much more realistic models of how humans actually behave rather than this “ivory tower” academic view that was largely popular because it allowed them to use very simple mathematics to draw conclusions—conclusions that turned out to be wrong. This is an economics book with virtually no math in it at all.

Caroline: Oh, fantastic.

Matthew: There are numbers, but there are no long equations. If you look at academic journals in economics, until relatively recently they were page after page with equations.

Caroline: Absolutely, that’s how I started my career, reading those articles.

Matthew: That was symptomatic of the problem. Now, I think we are getting pieces written that have relatively little math in them and lots of thinking about the complex ideas that really affect our world.

Caroline: When I had my first career as an economist in the 90’s, I got really annoyed with economics for exactly this—what Paul Romer recently called “mathiness”, this obsession with boiling things down to the simplest possible set of equations, and therefore unsurprisingly not being able to predict anything too complex. I actually had an exit interview when I left the Bank of England which I’m really glad was not videoed because I was incredibly pompous in it. Essentially, I was saying I don’t think our mathematics is actually at the level that we think it is; that it’s simply not good enough in order to do a good job of modeling the economy. It’s encouraging if economics is moving in the direction of saying, “Let’s rely less on a simplistic set of equations and let’s think about more complex ways of understanding the economy.”

Matthew: The Bank of England was one of those central banks that was caught quite badly by all the bubbles that emerged that led to the crash. They bought this big idea called “The Great Moderation.” This was an idea that central banks—the Bank of England, the Federal Reserve—had figured out how to crack the big economic challenge of how you get low unemployment, low inflation, and steady growth. They felt really pleased with themselves.

Caroline: Yeah, there was a lot of confidence. There was a sense that macroeconomics had come of age and that we all now knew how economies worked.

Matthew: The complacency set in. Now you see the Bank of England is much more thoughtful about how all sorts of economic behavior in aggregate can be bad because of psychological and behavioral impulses that spread across the population.

Caroline: I’ve often called myself a lapsed economist. Perhaps now I’m a born-again economist, as those behavioral influences have come back into the discipline.

“When you decide to give money to charity you’re getting the same sense of happiness as you’re getting if you’re dancing or having sex.”

Matthew: I do think that is one of the reasons why economics today has become quite exciting. You have much more respect for real-world behavior and trying to understand it. You have a whole discipline now called “neuroeconomics” which is hooking up people’s brains to MRI scans and seeing how, if you ask them to make economic decisions while they’re being scanned, which parts of the brain are triggered when we’re actually making decisions. Are they emotional, are they rational, are they out of fear, out of love? When you decide to give money to charity you’re getting the same sense of happiness as you’re getting if you’re dancing or having sex.

Caroline: Absolutely, that pro-social spending is so powerful.

Matthew: The model a lot of people have of economics assumes people are only interested in selfish things. They are motivated by their own sense of happiness and fulfillment, but actually they can get that from being charitable and a good citizen and relating positively with other people. It’s not all about just piling up money.

Caroline: Yes, I did pick up that tone in this revamped edition of your book. There’s a kinder tone, there are a lot of new terms, like “philanthrocapital.” I made a list: Social Progress Index, B Corps, microfinance, financial inclusion, circular economy…

Matthew: The era of the 80’s and 90’s was very “We have to allow money to talk and decide.” A lot of the things that really made us human were squeezed out of the mainstream discussion of economics. Now we’re getting these ancient truths—for example, “far better to give than to receive”—being validated by the studies that are taking place. My hope is that now, as people are debating economic policy, they will be thinking about the broader questions. Like, how does this actually create a broader sense of well-being in society? Simply getting higher GDP year after year, which economists used to regard as the holy grail—

Caroline: The addiction to growth.

Matthew: In fact, you can have GDP go up and the broader well-being of society go down. Some countries are much better at taking their GDP and turning that into a well-functioning, happy society where people feel a sense of progress. Others take very high GDP and leave many people feeling quite miserable. It’s interesting that the United States, for example, does very well on GDP per capita, a lot less well on social progress per capita.

Caroline: Absolutely. The discipline of economics started out being called “political economy,” something which explains the totality of the human condition. And it feels as if a bit of that is coming back, 200 years later.

Matthew: Back in the Victorian period there was an economist called Edgeworth who is now famous for something called “The Edgeworth Box.”

He had this idea that scientists could come up with something called a “hedonometer” which would measure the brain functions of everyone in society and see when people were getting more or less pleasure, and then policy could be adjusted to take account of that in real time.

Caroline: Now we have fMRI scanning!

“There’s an urgent need for new policies that make sure that the average family feels they have some upside.”

Matthew: Exactly, and when you then think about social media, probably society is going to get much more data over the next few years. Maybe not quite the “hedonometer” that Edgeworth was talking about, but something equivalent, where we can have much more of a sense in real time of how the world is feeling, how decisions affect people. That should allow much better economic policy making, which is one of the reasons I’m quite optimistic about economics. Maybe it’s losing its reputation as a dismal science.

Caroline: Yes, reconnecting with the idea that it’s about well-being rather than just money. Any other causes for optimism?

Matthew: One of the areas where you’re seeing a lot of effort in academia is in parts of economics that have been neglected for a long time. For a long time, as an academic, you only succeeded if you did the math.

Caroline: The Dynamic Stochastic General Equilibrium models.

Matthew: Yeah, all these terrible, jargon-laden models. Now, academic economics is going to much more interesting areas. Equally, that is starting to affect politics, so you’re seeing things like nudging. The Nudge Unit that the British government has, for example.

Caroline: Which is close to my heart, obviously.

Matthew: You’re not going to force people to do things for their own good, but you can help frame a choice so that they are more likely to do something which the evidence shows is positive.

Caroline: They retain their autonomy, but there’s a framework around the decision which helps them see that this might be a good option.

Matthew: Yeah. That is an interesting way of maintaining the invisible hand but guiding it in the right direction, which is something that has been an elusive goal of economic policy makers, who have tended to either go down the line of, “We need central planning,” or complete freedom.

Caroline: Or we’ll just change the interest rate.

Matthew: Exactly. Where I’m more worried is that I still don’t think that the central banks and government have figured that out at the macro level.

Caroline: Yes. How do you take those behavioral ideas and scale them in a macro model? It’s still early days.

Matthew: At the moment, we are in this position where the response of policymakers and governments to the crash was to pump a lot of money into the banking system, just to stop it from collapsing.

It was like giving people an adrenaline shot after a heart attack, but fundamentally they haven’t figured out what steady state policy should be once you’ve got the banking system back on its feet. As a result, we stuck with this policy for far too long which has favored the rich, people who have assets, over those that have been borrowing. That’s part of the cause of this growing concern about inequality—clearly the biggest political challenge that the world has faced in a long time.

Caroline: And it’s behind so much of the political upheaval that we’re seeing across the world.

Matthew: There’s an urgent need for new policies that make sure that the average family feels they have some upside. That’s the biggest worry I have in terms of how the policy makers have responded after the crash.

Caroline: The other thing that I’m concerned about is that I don’t know that the seductiveness of math is going to go away. There is something very appealing about a simple model of equations that solves—”Tada!”—even if it doesn’t really explain what’s actually going on. By contrast, there is a certain messiness in the economics that strives to properly describe what you actually see in the real world. That’s not as intellectually cute or nicely structured, so I do think that it will take a while for the forces of messiness to be tolerated.

In policy circles, there was a twin track approach to thinking about forecasting. There was the nicely defined model and then there was off-model. You talk about, “How is this situation going to affect real people? What decisions might they make?” Then you tweak the model in the short term. That’s okay for incremental changes; it’s not enough for thinking about how you predict massive dislocation in the future.

And then think about how long it takes for thinking to change and to wash through universities and colleges. But I hope that the power of taking a more behavioral approach will be enough to draw a whole new generation of students.

“There’s a famous joke that economists have predicted eight out of the last two recessions.”

Matthew: There’s a famous joke that economists have predicted eight out of the last two recessions. People turn to economists and say, “Tell us how the economy is going to be next year. What’s the exchange rate going to be? Is the dollar going to go up or down?”

Caroline: Yes, exchange rate forecasting is a mug’s game.

Matthew: Basically, economics is not all that good at forecasting in that way. Where it’s much more useful is trying to help people think, “What are the incentives you’re creating here?”

Caroline: It puts structure around your thoughts so that you can make sure you’re not missing a part of the argument.

Matthew: There’ll always be a certain number of economists that see a payday in predicting the future. But it’s much more interesting to help people frame choices they have to make in a more sensible way.

Caroline: Yeah, and thinking about how small nudges at the national or international level can have disproportionate effects.

Matthew: I do think the world is getting more complex.

Caroline: Although we’ve been saying that for decades. Is it more true now than it was before?

Matthew: I think it is more true because there’s more interconnectivity, there’s a lot more data, there’s a lot more innovation, and certain technologies mean that people should expect more change in their lives. That does rub up against the fact that many of our institutions are not changing very fast, they’re not actually designed to be adapted.

Look at the retirement system, for example. When that was first instituted, governments thought that people wouldn’t live as long. They promised people lots of money for the rest of their lives and then it turned out instead of that being three to five, that’s now looking like 20 years. It’s going to be crippling for the younger generations that have to pay for that.

How do you design new institutions for the 21st Century that better reflect the fact that there is a lot of change and things in the future are likely to be better than they are today? That’s another area where economics can play a useful role.

Caroline: In reshaping institutions?

Matthew: Helping us redesign institutions. For example, to have pension arrangements that adjust, that are more tied to the average mortality rate rather than to an absolute age.

Caroline: So they can flex, depending on what’s going on?

Matthew: So they can flex. It’s like things like that economists ought to explore, since economists are supposed to understand how things change over time.

Caroline: Yes, that is a central part of the discipline! So, you’ve come out of your review of economics feeling more optimistic than pessimistic about the discipline?

“I feel that 2008 and the crash is such a wake-up call that for anyone who’s really ambitious in economics, there’s a tremendous agenda of new work that needs to be done.”

Matthew: I feel that 2008 and the crash is such a wake-up call that for anyone who’s really ambitious in economics, there’s a tremendous agenda of new work that needs to be done. I think that when there are tough questions, there ought to be economists that are taking them up. It’s an exciting time to be an economist if you’re willing to go into these new areas. Get away from the crowd of boring, math-oriented economists and get into the exciting real-world questions that the world is grappling with. I think this is a great time to be an economist.

Caroline: What was your favorite new term to add to the book?

Matthew: One I think we’ll have a lot more debate about is the “sharing economy.” It sounds lovely, but there are other ways of describing it: the gig economy, the economy where everyone’s going from a secure job to one where they’re having to be freelancers and wonder where their pay is coming from. I don’t know whether we’re still going to be calling it the sharing economy in the next edition, or if we’re going to call it—

Caroline: The desperate scrabbling economy.

Matthew: Yeah. In my optimistic mode, I’d like to think that we will figure out how to create a sharing economy, because there’s a more socially cohesive situation when we’re all better off. I’m slightly fearful that we’re moving into the era of the gig economy and the insecure economy where no one feels confident they’ve got a job, which would be a very bad outcome.

Caroline: Yes.

Matthew: That’s the biggest question we’re facing today: artificial intelligence is happening, machine learning, which—according to some people—is going to wipe out jobs that educated people have relied upon. The question is, how are we going to create new jobs? Economists tend to say technology changes don’t really hurt people.

Caroline: Yes, the economy would magically adapt.

Matthew: We’ve gone from having everyone working on farms to no one working on farms, and everyone working in manufacturing to very few people working in manufacturing. We could go from everyone working service jobs to very few people working that kind of job.

Caroline: Which glosses over the towns that have been decimated by those changes.

Matthew: The economists are quite complacent about that. But I like to be optimistic and think that human ingenuity is going to triumph. We’ll find ways to get machines to do all the dirty work and we can have more time to do enlightened things.

Caroline: Like having nice chats like this. Well, your book definitely made me feel more optimistic about my home discipline, so thank you.

The conversation above has been edited and condensed.

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