Who do economists serve, really?

[From left: Joseph Stiglitz, co-author of ‘Measuring What Counts’;  Esther Duflo and Abhijit Banerjee, co-authors of ‘Good Economics for Hard Times’. Image credits: Stiglitz by Fronteiras do Pensamento (CC BY-SA 2.0), Duflo by Centre for Global Development (CC BY 2.0), Banerjee by Financial Times (CC BY 2.0). Images cropped from original?]

A person walking at night sees a man searching for something under a lamppost, in an old Sufi story. The man says he is searching for his keys. The passer-by begins to search along with the man, then stops and asks if he is sure he lost them there. The man replies, no, he lost them in the park. The passer-by is incredulous. “Why then are you searching for them here?” he asks. “Because it is dark in the park and there is light here,” the man replies.

A few Nobel laureates say that their fellow economists should step out of their discipline’s limited circle of light if they want to find the keys to the complex issues that policymakers must grapple with. Joseph Stiglitz (who won the Nobel Prize in 2001), Jean-Paul Fitoussi and Martine Durand, provide a view from the policy-makers cockpit in Measuring What Counts: The Global Movement for Well-Being. It follows on from an earlier book, Mismeasuring Our Lives—Why GDP Doesn’t Add Up, published by Stiglitz and Fitoussi, along with Amartya Sen, another Nobel laureate, in 2010. Abhijit Banerjee and Esther Duflo, who won the Nobel Prize for economics in 2019 with Michael Kramer, provide a ground-up perspective in Good Economics for Hard Times—Better Answers to Our Biggest Problems.

These books combine top-down and bottom-up perspectives like Yin and Yang. Each includes the other perspective within it. Reading them together has provided an intellectual feast this holiday season. Measuring What Counts is focused on national score-cards— gauges for the pilots to steer the passengers aboard to where they want to go. Governments and economists must understand citizens’ aspirations much better, it says. Because, “The objective of economics and social progress is to increase people’s well-being. Who knows better than people themselves how well off they are and what most affects their lives? Money isn’t everything in life…”

Economists should understand the questions real people have and help people find answers to their real problems

Banerjee and Duflo, who have been recognized for their work in the poorest communities of India and Africa, concur. Human dignity must be restored to its central place in economic policies, they say. Macro-economists treat people as data—as numbers in their equations—to answer the ‘scientific’ questions that economists have. Both books urge economists and policymakers to listen to the people whose welfare must be improved. Economists should understand the questions real people have and use their tools to help people find answers to their real problems. 

Both books venture out of the lamplight of mainstream economics. They search for the keys to more inclusive and sustainable progress in a real world of real people. The first sentence in Measuring What Counts is, “The world is facing three existential crises: a climate crisis, and inequality crisis, and a crisis in democracy”. “Economics is too important to be left to economists”, is the very last sentence in Good Economics for Hard Times—Better Answers to Our Biggest Problems.

[“The gap between the ‘experts’ and the citizen…has played an important role in the bitter divisions within society that have been so visibly demonstrated in a number of recent elections”] 

[“Economics is too important to be left to economists”]

Economics’ holy cows

Eighty-four individuals have been awarded the Nobel prize in economics. Only two are women. Duflo is the second. The first was Elinor Ostrom who won the prize in 2009 for her work on community governance of shared resources. Duflo’s work—like Ostrom’s—has been grounded in communities. Duflo, Banerjee, and Kramer won the Nobel Prize for using the tools of ‘randomized control trials’ to understand how socio-economic systems actually work on the ground to improve delivery of health and education services, for example.

“It seems a large part of the general public has entirely stopped listening to economists about economics,” Duflo and Banerjee say. They add, “We, the economists…sometimes forget where science ends and ideology begins.” Their book traces the evolution of mainstream economics’ theories. And explains why they do not fit reality.

Free trade

One is the theory of free trade. That it will lift all boats. Which is founded on the logic of competitive advantage. It says if every nation produces what it can produce better than everyone else and bought from other nations what they can produce best, the whole world will be better off. Because global resources will be most optimally used. So, with the same resources, more will be produced overall. Therefore, free trade increases global efficiency.

Economists’ theories of free trade are stripped of social realities

This model ignores the complex process of transition—of going from a point where nations may already be producing some things that others can produce better than them to the point where they have given up production of these to produce more of what they theoretically can produce better than others’ can. (And who must also give up production of what they produce and make something else.) During the transition, there will have to be a large shuffling around among countries, and within countries, of people giving up what they are doing to do something else.

Economists’ theories of free trade are stripped of social realities, say Banerjee and Duflo. Who explain the ‘stickiness’ of socio-economic systems. Jobs are only one part of a human being’s life, albeit an important one. Jobs are embedded within complex social realities—of community life and family responsibilities. Therefore, people cannot just ‘up and go’ somewhere else when the process of ‘creative destruction’ demands they give up their jobs for something else. Even a change to another profession within the same community—if the new jobs are within the same locality—takes time. New skills must be learned. During that process too, family obligations have to be fulfilled. The process of shuffling around is messy and takes a long time. So, while free trade may increase GDP in the long run, it will produce many winners and losers during the transition. And transitions could take a generation or two or even more.

Trade economists have focused on the size of the pie. They have tended to stay away from thinking about how the pie is shared

When trade opens across borders, some sections of society benefit before others can. With volumes of trade increasing, traders will benefit first. Whereas, makers of products which were produced domestically but are now imported will take a long time to recover their levels of incomes—if they can. When they express their pain, they are labelled as anti-trade retrogrades who don’t want progress. Trade economists have focused on the size of the pie. They have tended to stay away from thinking about how the pie is shared. Dani Rodrik, another economist who has also challenged some holy cows of economics, has estimated that for every dollar increase in the size of the global pie with free trade, six or seven dollars’ worth of production and incomes will have to be shuffled around within countries.

When advocates of free trade also propound that governments should get out of the way and leave it to the market to facilitate the necessary adjustments in people’s lives, citizens become convinced that neither economists nor their governments understand or care about them. “The gap between the ‘experts’ and the citizen they are supposed to be serving has played an important role in the bitter divisions within society that have been so visibly demonstrated in a number of recent elections,” Stiglitz and his co-authors say.

Markets

The second holy cow is worship of markets. Unrestrained markets are the solution to everything for many economists, including the provision of public services. ‘Get government out of the way: leave it to the market’, they urge. Their diagnosis of the slow growth of jobs and incomes and slow-down in India’s GDP growth is: India has not opened to international trade enough, and has not reformed its land and labour markets sufficiently.

The more exposed a particular district was to international trade, the slower poverty reduction was in that district

Free trade and markets are not a panacea, Duflo and Banerjee explain. They refer to a study by Petia Topalova, a Ph.D. student at MIT, who studied the impact of India’s massive trade liberalization of 1991 on various parts of the country over the next 20 years. The national average poverty rate declined from 35% to 15% which is impressive (though it cannot be attributed only to trade liberalization). What Topalova found was that the more exposed a particular district was to international trade, the slower poverty reduction was in that district. Moreover, the incidence of child labour dropped less in districts more exposed to trade than in the rest of the country. Whereas districts less exposed to international trade had prospered faster.

The reaction in the economics profession to her findings was surprisingly brutal, Banerjee and Duflo note. How could trade actually increase poverty? The theory tells us trade is universally good for the poor in poor countries so her data must be wrong. She was blackballed by the academic elite.

Banerjee and Duflo explain that the slow improvement of welfare with free trade was due to the complex compositions of socio-economic clusters and their ‘stickiness’. Tight clusters are fertile grounds for innovation, entrepreneurship, and growth. They are fertile because they combine diverse resources through many economic as well as social interactions within the cluster. The stickiness which makes them fertile makes them resistant to being shaken up too.

Economists must be reminded that the purpose of economic growth is to improve the well-being of humans

The concept of a market for labour is controversial. ‘Labour’ is provided by human beings. Commodities can be bought and sold in markets. Humans are not commodities to be traded for prices determined by supply and demand, which they were in the slave trade. But that era should have passed entirely. Humans are not fodder for an economic machine to increase its GDP. They must be the principal beneficiaries of the growth of GDP. Economists must be reminded, says Stiglitz, that the purpose of economic growth is to improve the well-being of humans.

Human beings have the ability to learn and improve their own capabilities. Which, commodities do not have. Nor have machines so far. Machines will in the future with advances in artificial intelligence and robotics. Until then, humans are the only component of the production system that can improve its own productivity. It can improve the ‘total factor productivity’ of the whole system also with innovations in the utilization of machines and reductions in use of materials and energy.

Humans are stripped of their humanity when, in economists’ mathematical equations of resources and outputs, ‘labour’ appears as an input like any other. They become ‘objects’ to be counted and measured; and to be discarded if they have no apparent value for the economic process. Henry Ford I, a pioneer in the application of ideas of efficiency and scale in mass production systems, complained that when he wanted only a pair of hands, he had to suffer a whole human being with emotions and demands for justice.

Humans are not commodities; nor are they just labour; or disembodied technology. They are creatures with memories of their histories, an awareness of their identities, and emotions, fears, and aspirations. These powerful, non-homo economicus, forces have been known for millennia to philosophers and poets who have researched them and written about them. Only recently have mainstream economists begun to include emotions and identity into their calculus.  

A labour ‘market’ is not an economic construct only. It has social and power dimensions too. The aim of labour market reforms must be to improve the well-being of human beings who provide their labour, not just make it easy for employers to buy and sell—‘hire and fire’—workers, like they can buy and sell other inputs in their enterprises.

Tax-cuts for the wealthy

Economics’ ideology changed after the Great Depression in the last century. Keynes advocated a larger role for governments in stimulating economic growth with public investments that create employment. Governments built large social security nets for citizens. The shift of economic policies towards citizens’ welfare with larger government was supported by more taxation of those who could pay, i.e. wealthier citizens and corporations.

Ideology changed again in the 1970s. The ideology of free markets spread from the Chicago School into economics and into politics. Margaret Thatcher was its first powerful proponent. Then Ronald Regan declared, ‘Government is not the solution; it is the problem.’ In this ideology, taxation of the rich was a drag on economic growth. Their ‘animal spirits’—their greed to make more money—must be released, urged the economists. When the rich make more money, the benefits will trickle down to the people below.

Economic inequalities within societies have increased since then, Thomas Piketty, Oxfam, and many others point out. All boats seem to have been lifted with the rising tide. But, with the financialization of economies and reduction of taxes on wealth, some boats have become airplanes taking the wealth of the top 0.1% in them into the stratosphere. And some boats, in poorer countries, did not lift at all. The desperation of these people to escape from hopelessness made them risk their lives on boats to richer countries. They were turned away because many citizens in those countries felt they were not well off. They were losing their jobs with the ‘creative destruction’ of free markets. Their governments could not step in to help them. Their governments’ policies seemed to be dictated by financial institutions, supported by the economics’ ideology that less government and more privatization of assets was the best solution.

When the global financial crisis spread around the world destroying many livelihoods citizens rose up in many countries. They were angry that governments were protecting financial institutions, and not them. President Nicolas Sarkozy of France set up a commission, chaired by Stiglitz, Sen, and Fitoussi, to recommend what must be changed in government policies to improve the welfare of citizens. To whom heads of governments, especially elected ones, must be principally accountable, rather than to financial investors. The commission published its report, Mismeasuring Our Lives, in 2010.

Tax reductions for the wealthy did not contribute much, if anything, to overall economic growth

Measuring What Counts is written nine years later. Stiglitz and his co-authors provide evidence that tax reductions for the wealthy did not contribute much, if anything, to overall economic growth since the financial crisis—or even previously in economic history. On the other hand, tax reductions have been a principal cause of rising inequalities, and also the declining trust of citizens in their governments and in the motives of capitalists. Banerjee and Duflo say, “Bad economics underpinned the grand give-aways to the rich and the squeezing of welfare programmes, and sold the idea that the state is impotent and corrupt…and paved the way to the current stalemate of exploding inequality.”

Stiglitz begins Measuring What Counts with the observation that, in spite of so much evidence to the contrary, not much seems to have changed in the paradigm of government policies, and the ideologies of economists around them, for taxation of the rich and welfare of those not well off. Scientific paradigms can be sticky, Thomas Kuhn explained in his seminal book, The Structures of Scientific Revolutions. New ideologies threaten those who rose to social acclaim and to political power on the backs of ruling ideologies.

What to measure and how to measure

“[Our] central message is that what we measure affects what we do. If we measure the wrong thing, we will do the wrong thing. If we don’t measure something, it becomes neglected, as if the problem didn’t exist,” say the authors of Measuring What Counts.

Stiglitz and his co-authors recommend improvements of the gauges used by the pilots and the navigators in the cockpit of economic policymaking—government leaders and the experts who guide them.

1. Measure the shape of the system, not the size of the economy

“There is no simple way of representing every aspect of well-being in a single number in the way GDP describes market economic output. We need to move ‘beyond GDP’ when assessing a country’s health,” say the authors of Measuring What Counts.

No good physician would gauge the health of a human body by its size. The physician wants to know what is going on inside. She will use many diagnostic instruments to look inside, and require many pathological tests to assess how well the internal processes are functioning. She will want to see all reports, not their mathematical conversion into a single number. Then only can she gauge which organ in the body has become unhealthy. With their preference for a single number—GDP, and that too a measure of the size of the economy—economists disable themselves from prescribing good policies to improve an economy’s health.

The Indian economy is going through a ‘measurement crisis’. Employment and incomes’ trends reported by Indian statistical agencies, which do not show a healthy economy, are denied by the government. And the size of the GDP reported by the government is doubted by economists!

The Indian government and its spokespersons in the media and in business harp only on the goal of a $5 trillion economy—as if it will be the panacea for all the environmental, social, and economic problems ailing the country. How then can the citizens trust the government to find the right solutions?

2. Why the obsession with only one number?

Stiglitz and his co-authors laud the evolution of the 17 Sustainable Development Goals because they broaden the measurement framework and add more gauges. At the same time they worry that there may be too many numbers to enable comparisons across countries.

Single numbers make it easier to rank countries. Rankings attract attention. They spur losers to overtake the winners. Therefore rankings spur progress. The derivation of a single number from many measures of disparate conditions requires weights to be assigned to them. Which is not easy. How much weightage should a physician give to the heart, the brain, the liver, the kidneys, etc. in an assessment of human health? Is it necessary at all for determining which needs attention most? Surely, what needs attention would depend on the condition of that specific patient at that specific time.

It is more useful to display all the gauges side-by-side to make an all-round assessment. The OECD’s “How’s Life?—Assessment of the Comparative Strengths and Weaknesses in Current Levels of Well Being” framework presents data about 11 indicators for each country, which include ‘Income and Wealth’, ‘Subject Well-Being’, ‘Environmental Quality’, ‘Civic Engagement and Governance’, and seven others. They are presented in a ‘spider diagram’ form within a circle. Thus one may, at one glance, see the shape of the system. Which is the weakest organ in the country? Civic Engagement and Governance? Or, Income and Wealth?

Economists must develop frameworks for measurement and presentation of information that don’t squish complex shapes into a single number. The shapes of complex systems are better determinants of their health than are their sizes.    

3. Missing capital

Stiglitz points to a deficiency in national accounts. They include only financial capital and natural resources as assets of the economy. They should include human capital and social capital as assets too. Because these are the founts of innovation and productivity.

Productivity of countries when measured in the conventional way—which is output per person in the country—can be improved by reducing the denominator in the equation, i.e. the numbers of persons in the country. Restrict immigrants; reduce birth rates. However, immigrants add numbers and variety to human resources. More young people bring more new energy to human capital. Declining human resources, with reductions in birth rates and restrictions on immigration, in Japan and other economically rich countries is dampening their economic growth.

The neglect of public health and school education has weakened India’s growth story

More people can add to human capital. However, the number of people is not a sufficient measure of human capital. The quality of their health and education matters too. Indian economists, who projected that India would obtain a ‘demographic dividend’ because it has a large population of young people—as China had when its economy took off—have realized that the neglect of public health and school education (while they pressed the government to focus on GDP growth) has weakened India’s growth story.

People are the means for increasing the size of the pie, and not merely beneficiaries of a large pie made for them

A common saying, “First increase the size of the pie before it is shared with the people”, misses an essential requirement for economic growth. People are the means for increasing the size of the pie, and not merely beneficiaries of a large pie made for them.  

4. Trust

Measuring What Counts emphasises the importance of social capital. It is ‘the glue that holds society together’, the authors say.

Social capital is a fuzzy, and essential, ingredient for growth and well-being. The report focuses its attention on one aspect of social capital, albeit a very important one—trust. “We should think of trust as an asset, as a key part of social capital,” it says. It defines trust as “a person’s belief that another person or institution will act consistently with their expectations of positive behaviour.” Not surprisingly, trust is related to subjective well-being. For instance, cooperative social relationships with others, which are facilitated by trust and give rise to trust, affect people’s health and happiness above and beyond the monetary gains derived from cooperation.

Growing economic insecurity and higher unemployment lower trust in political institutions

Lack of trust has grave political consequences, the authors point out. Growing economic insecurity and higher unemployment lower trust in political institutions. This in turn leads to higher voting for populist parties, a noticeable trend in many countries.

The authors explain that actions and processes that are perceived to be “unfair” (for instance, in how people are treated in the processes by which decisions get made) undermine trust. In the United States the seemingly favourable treatment given to bankers, relative to that given to homeowners, undermined trust in government. So too in Europe, where the austerity measures imposed on crisis countries—with particularly adverse effects on the poor—were widely perceived as unfair, undermining trust in the key European institutions.

Countries with higher levels of trust tend to have higher per capita income

While research on the causes and consequences of trust is still in its infancy, it is proving to be a rich field of endeavour, the authors say, with promising insights into understandings of economic performance and social progress. From studies so far it can be concluded that countries with higher levels of trust tend to have higher per capita income. Another finding is that trust is negatively correlated with income inequality. And rising income inequality has also been related to lower trust in institutions.

“To date, we still have an imperfect understanding of causality, and indeed, causality may often run in both directions,” the authors observe. A lack of trust in public institutions may hamper their ability to engage in redistribution because there may be a fear that redistribution will go the wrong way, i.e., from the poor to the rich. But high levels of inequality, especially when they cannot be justified, also undermine trust in institutions. Similarly, a well-functioning legal system may enhance trust, while a lack of trust may lead to an overly rule-bounded legal system in which, in the process of following detailed rules, miscarriages of justice may end up undermining trust.

Dysfunctional institutions and unfair rules of the game create a ‘society of mistrust’

Trust takes time to build but can dissipate quickly when people perceive that others did not behave in a trustworthy way. When institutions are dysfunctional and the rules of the game are perceived as unfair, they lower people’s willingness to cooperate with each other, creating a “society of mistrust”. Good measures of trust have been lacking, and this has contributed to policymakers’ failure to focus adequately on trust. Given the importance of trust, policymakers should pay more attention to it, and to how their policies affect it.

Science advances when scientists sense that something is missing in their understanding of how the system works. Then they focus on it, understand what it is, and develop ways to measure it. Newton sensed there was a universal force that brought down everything that went up. Then he hypothesised what this force could be. And he experimented and measured it.

The pursuit of numbers, in the belief that numbers alone indicate accuracy, has become the bane of economics

The pursuit of numbers, in the belief that numbers alone indicate accuracy, has become the bane of economics. Many forces that shape societies and economies cannot be easily measured such as the trust of citizens in institutions. Such substantial forces must not be excluded from a model which seeks to explain the behaviour of the economy. Robert Lucas, who received the Nobel Prize in economics for expounding the ‘rational-expectations’ view of human behaviour, referred to a theory as something that can be put on a computer and run. Many economists insist on equations and numbers because that is all that computers can compute, whereas economists should study human behaviour as it is, not as they find easy to model.

Learning and listening

How do economists learn about how societies function? And, how do societies learn to improve themselves? These are fundamental questions running through both books.

Stiglitz and Bruce Greenwald examined how societies learn in Creating a Learning Society: A New Approach to Growth, Development, and Social Progress (published in 2014). They looked at the process of industrialisation, which has been the principal driver of economic growth for countries. Economies grow and living standards improve when countries move from agriculture and resource extraction to use machines to produce things they were producing with only labour—such as textiles, and move on to producing more complex things they could not produce before—such as automobiles.

An invention of a new product in a laboratory is not sufficient. The conversion of the idea into products that are sold and serviced, and bought and used creates new jobs and growth. Many people and many institutions must learn to do what they could not do before, and learn together. Some people must learn to operate machines they had never seen before. And others must learn how to make those machines! Managers must learn to manage more complex production systems. And governments must evolve their abilities to support and regulate activities they had not done before. All must learn, and learn to work together too, for the country to develop a competitive industrial capability.

Those that learned faster overtook those that had industrialised before them

All countries that have industrialised have taken this path of learning. Those that learned faster overtook those that had industrialised before them. They became more competitive. Thus, by focusing on learning and systems improvements on the shop-floor, and by learning how to coordinate actions across government ministries, in cooperation with industries—the vaunted MITI (Japan’s Ministry of International Trade and Industry) and 'Japan Inc’—overtook the West in many industries.

Many factors, and many actors, combine to create the complex capabilities required for industrial development and for the development of good educational and health systems too. Many must learn, and they must learn together, to understand the system of which they are a part. They must also learn to self-govern as a system. Elinor Ostrom, the first woman to get the Nobel Prize in economics was awarded for her work in community self-governance. Esther Duflo, the second, has also been awarded for the study of local systems (along with Banerjee and Kramer). ‘Sticky clusters’ are institutions essential for improvement and growth.

The first 16 of the 17 Sustainable Development Goals name the challenges humanity must find solutions to, faster. They range across a spectrum of environmental and social issues—from climate change, economic growth, to inequity. These challenges are manifested in different combinations in different countries. And, indeed, they appear differently in different parts of countries. Therefore, the solutions to them must fit local realities. ‘One-size fits all’ solutions will not achieve the SDGs. Local systems solutions are the way to solve global systemic problems.

The 17th goal is ‘partnerships’. Here is the solution to the dilemma Stiglitz alludes to—about too many measurements in the SDGs. Every community—a country, or a state, a city, or a village—is a system. The stakeholders within each system must map the relevant conditions in the system of which they are a part. They must understand the interactions among these forces, and see what actions they could take to improve their condition. Communities themselves can be the greatest beneficiaries of Randomised Control Trials conducted at community levels for which Banerjee, Duflo, and Kramer have been recognized. The trials provide insights that can empower communities. With a better understanding of what matters, they can negotiate with the larger system around them, and with the governance system above them, for what they really need.

A moral question for economists is, who do they serve? Stiglitz says that ‘well-being’ is subjective. It is difficult to understand objectively and to quantify. Are people objects, and merely data for scientists’ equations? Or, should economists, and the policy-makers they guide with their science, listen more deeply to people to understand what really matters to them?

A final philosophical question

Economists are envious of the precision with which physicists can predict the phenomena they study. Physicists are realising there may be limits to what they can know. Heisenberg’s Principle of Uncertainty, a seminal proposition in physics, states that observations will change what is observed. Moreover, in quantum physics, it is not possible to know everything about a particle exactly. The observer can either know its position or the speed of its motion.

Policymakers design measurement systems to manage the economy. They impose a ‘form’ on the system to make it easier for them to read it. People react to the ways in which they are measured, and the system changes its form. James C. Scott gives many examples in Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed.           

France introduced the ‘window tax’ to make it easier for assessors to calculate property values. They had observed that the numbers of windows in a house correlated well with the size of the house. So, by walking around the house and counting the windows, an assessor could gauge the size of the house fairly well. He did not have to go in to measure the space.

Citizens reduced the number of windows on the houses they built to reduce their tax assessments. (Hence old French houses have fewer windows). Fewer windows resulted in poorly ventilated homes, which caused public health problems. The unintended consequence of an efficient measurement system was another problem for the state!

Physicists study inanimate matter and energy. The mind of the electron the physicist observes is different, and perhaps less complex than the mind of the physicist. To understand the behaviour of economies, which are social systems, not merely material systems, economists must understand human behaviour. The minds whose reasoning they must understand are as complex as their own.

Physician, first heal thyself, is wise counsel. The core message of both books is: economists must step out of the circle of lamplight of their own rationales and mathematical calculations. They should step out into the real world to listen to real people for whose well-being they must find better solutions.