Learning from economic crises

First of all, is there something inadequate in the way we, economists, think about these recurrent crises? Shouldn't we be thinking beyond ordinary recessions and more about why substantial crises come about? How do we think about them, theoretically? How do we measure them in anticipation?

However, there’s also a political economy dimension to this. The great financial crisis of 2008 and 2009 had an immense impact on public finances, with governments having to cut their budgets, imposing austerity and causing much pain in people’s everyday lives. You could blame somebody for that – it was the greed, outright fraud, incentive structures, or certain kinds of financial innovations, of the financial sector; the origin of the crisis.

I expected there to be a substantial political reaction to the 2008 and 2009 financial crisis: stricter bank regulation, preventing them from paying ludicrous amounts of money to their traders, as well as clamping down on their speculation. Moreover, I expected governments to stop measuring financial speculation as a constructive part of economic activity, which we continue to do.

The most significant contribution to GDP growth recorded in the UK in any single quarter was in the final quarter of 2008 because we measure speculative activity.

There never was a political reckoning. There have been small changes to financial regulation and the amount of equity capital that banks need to safeguard against future crises. Therefore, one of the things that economists need to think about is the interaction between policy choices and the impact of an economic crisis.

Perhaps the impact of the pandemic will change things. We know that its effects are incredibly unequal and they're exacerbating existing economic inequalities: the places that are already left behind are getting left even further behind. They're the ones seeing the biggest collapse in economic activity and likely to see the most significant increases in unemployment. Ethnic minority groups are particularly affected by the pandemic health-wise and economically, in jobs and job prospects. Moreover, women are impacted by the push to work from home. They're the ones picking up the duties, the homeschooling, and they're also more likely to work in job sectors damaged by the pandemic, such as in hospitality and retail.

These inequalities have been exacerbated along with the impact of austerity measures since the financial crisis. You’d assume there’d be a political backlash to all of this, which is perhaps what we're witnessing in many of the elections across Western democracies today. We, economists, like to think of ourselves in a technocratic way: we measure things, and we advise about certain kinds of policies. We don't think about politics or about the decisions that depend on values and political choices. That's a more recent departure, and I think we're going back to an older kind of economics where you have to consider politics and sociology and all the other social sciences just as much as pure technocratic, economic matters.

Post-war economic policy has focused on increasing what we call efficiency: ‘How do we make things as productive as possible? How do we get the most output for the least possible input? How do we produce things at a lower cost? What's the best and most efficient place for the government to spend taxpayer money?’ We've got techniques for thinking about efficiency and, ultimately, we evaluate it by using a monetary metric, which we collapse into one number: a go or no go decision for a particular investment.

In hindsight, this is a mistake and part of the reason that we've arrived at the point we are at now. Efficiency is not the only value that we care about as citizens, as human beings. There are other values, too. Since the 1930s and the years of logical positivism, economists have separated themselves from philosophers, ethicists and politicians. Economics have put themselves into a distinct domain, the technocratic domain. Despite having subscribed to this way of thinking during much of my career as an economist, I see that distinction as fundamentally mistaken. I don't think you can separate these values. Efficiency is not the only, or even the primary, value for many economic policy decisions.

In recent years we've become particularly concerned about the geographic inequality of economic outcomes. People who live in big cities tend to be more educated, more productive in an economist's sense, and receive a higher salary. People in other kinds of places have seen their services cut, their incomes stagnate and have been left behind. This is not an efficiency question, but instead, it’s a question about what standard of living and opportunities you want everybody in your society to have.

Value decisions are economic decisions that say it's not efficient to put a new rail line through a town or a one that says it would be too costly to subsidise the bus routes that would enable people in the town to go somewhere else to do their shopping or to spend their leisure time. Criterion on efficiency is not the right way to think about these issues. I would argue that we must think about how we combine the different kinds of values that matter into policy.

Is the government going to pay for this investment or not? Should it put the money somewhere else? Ultimately, you have to make that decision. We're doing it in far too narrow a way, using a far too narrow lens, and that's part of the reason for the current issues.

None of the Victorian-era infrastructures that we continue to use today would ever have been built if Victorian economists had acted as we do now. It would have failed any cost-benefit analysis in efficiency terms. However, the great Victorian-era city builders thought that everybody deserved a wonderful town hall, libraries, sewer and water systems. Thus, these builders invested in them and gave us about 150 years’ worth of infrastructure that we're still using. Could we do that now? Do we share these values enough to implement such visions now? I don't think we do. One of the questions about the current pandemic situation is whether there will be such a fundamental re-questioning that we could develop that kind of vision of the society we want to build and make the sacrifices that we would need to build it.

I don't want to close the door to an innovative economy or to global trade, which has allowed increases in living standards in many low-income countries. Globalisation begets acceptable living standards. There are also global challenges that can't be addressed by local activities, like changing to green energy generation and distribution. Of course, you can try to use less, you can put insulation in your house, but that requires national governments to set technical standards and to enable investment in risky technologies. It also probably involves global coordination to agree on the incentive structures, the penalties or the technical standards that are going to be needed to achieve those kinds of green transitions that we need to avert climate catastrophe. Therefore, I think the local economy has great appeal, and in some areas, such as food production, it’s imperative, but it's not a panacea. We’re in a much more complicated world. We need to think more carefully about who can do something about what, who can coordinate collective activities in response to collective challenges. They span all the geographies. Some are local, but some are global.

We can't achieve any of these global goals, or even individual goals, if we don't have a high trust society. We know that we've had that because you can't have global production chains with people sending valuable blueprints by email or transacting with somebody they've never met at the other side of the world unless there's quite a high level of trust to start. Therefore, we have that bedrock, even if you think we've been squandering it through the way society has changed in the past 20 years. On balance, I'm optimistic that we can get to where we would want to be: new Victorians, new builders addressing global challenges like climate change or loss of biodiversity.

Funny enough, I think this crisis provides an opportunity. It's clearly causing people to reflect on what matters in life. During the pandemic, we've applauded and praised essential workers only to realise that they are some of the lowest-paid people in our societies, and those who are particularly vulnerable health-wise. That's a dissonance that makes people reflect, and my sense, from reading opinion polls, is that there is a broad appetite for change – half of the people say that they would like the management of the economy to change from how it has been in the past drastically. We squandered the opportunities we had in 2008 and 2009 to change things after the financial crisis, and I hope that we can take advantage of those opportunities this time around. However, that takes you back to the politics and the sharp divisions that we see in many countries, and it’s not going to be easy, but I think it's essential to try.