CORE Workshop�Input on certain key issues for The Economy 2.0

Dr Kenneth Creamer

Bath, UK

27 March 2023

Key focal points

• Offer more holistic and balanced narratives around the ‘hockey stick”
• Deepen understanding of systemic risk linked to financial markets, banking and asset prices
• Use systemic risk tools to analyse environmentally-relevant tipping points
• Show how the model of technological change operates in a dual economy

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More holistic and balanced narratives around the ‘hockey stick”

• CORE’s hockey stick analysis offers a broadly positive story of permanent technological change and rising GDP per capita as the world escaped the Malthusian trap from the 1800’s onwards (albeit at different times and at different rates in different regions)
• Important to be more explicit about:
• The historical realities of Slavery and colonialism
• The environmental impact of economic growth

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The historical realities of slavery and colonialism

• Impact of colonialism on India – it can be shown that the UK’s hockey stick moved upwards at the expense of colonised India which saw deteriorating economic conditions
• In South Africa we have used supplementary material to show that the Atlantic Slave trade was a powerful contributing factor for shaping the industrial revolution)
• Enslaved people taken form Africa to the America’s (to work in production of raw materials)
• Cheap raw materials taken to Europe from the America’s (stimulating economic growth and growth in manufactured outputs)
• Manufactured goods taken to Africa (to trade for enslaved people)

The environmental impact of industrial revolution

• The linkages between increased output, CO2 output and rising global temperatures and the economic impact on climate change should be strengthened
• As part of this it would be useful to consider including counter-arguments to degrowth arguments based on the syllogism:
• if economic growth has caused environmental degradation, and
• environmental degradation is bad for the people of our planet.
• then to save the people of our planet our policy should be to limit economic growth
• The counter argument should show that economic growth does not inevitably lead to environmental degradation
• It should discuss the role of technology in shaping growth that is not environmentally destructive
• Perhaps we could include reference to the “environmental Kuznets curve” that argues that as the economy grows environmental degradation initially increases and then falls
• We could also reference the nature of economic growth in that growth is not just more of x + y + z, but that with growth product types and product qualities change so growth is more like x + a + b

Deepening understanding of systemic risk

• Idiosyncratic risk and systematic risk are regarded as inherent and endogenous to the market (and action must be taken to manage such risks such as through portfolio diversification)
• Systemic risk appears to be exogenous, as the system seems to be working well as feedback mechanisms reinforce the overall the direction of the system until the ‘black swan’ appears and then assumptions break down, behaviours change and feedback mechanisms begin to work in reverse
• For example, with the bursting of a housing price bubble in 2008-09 and the resulting crisis for the banking and financial system
• The paradox being that systemic shocks seem to be impossible before they happen and inevitable after they occur.

Systemic Risk in finance and banking

• Idiosyncratic risk – some assets are at risk (response is portfolio diversification)
• Systematic risk – a wide range of assets at risk (response may be to look to an even wider range of asset classes)
• Systemic risk – the system as a whole is at risk (this requires an analysis of the properties of the system as whole and requires policy instruments to identify risks to the system as a whole)
• The Great Recession of 2008-09 has reminded us that to identify systemic risk in finance and banking, the units of analysis need to include economy-wide macro indicators such as household debt levels, house price and other asset price trends, financial sector balance sheets, etc.
• As Keynes wrote in Chapter 12 of the General Theory:

“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

The question is do we have the tools go detect such systemic risk?

Systemic Risk in financial and banking

• Systemic risk is often rooted in a common assumption which then leads to ‘risky’ behaviour (which is not be perceived to be risky), but when the common assumption is revealed to be false, then the system becomes unstable
• For example, the pre-2008 crisis assumption of ever rising housing prices led to reinforcing feedback mechanisms, as prices rise the demand for housing rises (driven be speculators), the size of collateral rises and the demand for housing and house prices rise further
• When the bubble bursts, bank balance sheets are damaged as assets are rapidly repriced
• From experience, the intuition of reinforcing feedback mechanisms and bursting prize bubbles is quite easy to teach and explain, but a lot of time needs to be spent in explaining the unstable equilibrium model with a tipping point and multiple equilibria, the first step is to explain the S the shape of the curves and then the factors that may cause the curve to shift up or down

More focus needed on Policy instruments

• It is recommended that there should be focus in The Economy 2.0 on policy instruments to detect and limit systemic risk in the financial and banking sectors, such as:
• Framing of prudential policies – which aim at avoiding calamitous events even though the policies are costly and there is uncertainty about the conditions that will cause the calamity
• Introduction to tools to identify and monitor Financial Cycles
• Policies aimed at reducing the over-leveraging of bank balance sheets
• Mention of policy instruments to cool ‘over-heating’ housing market prices, such as, requirements for deposit for housing purchase (disallowing of 100% bonds)
• The role of stress testing banks e.g. certain banks in the US where recently exempted from stress tests aimed inter alia at identifying the likely impact of significant interest rates increases (Silicon Valley Bank was one such bank exempted)

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Systemic Risk Tools and Climate Change

• It will be very useful in The Economy 2.0 to make use of use of systemic risk analysis in showing certain dynamics of climate change
• For example, how melting polar ice leads to temperature changes and to reinforcing mechanisms which will likely result in rapid shifts towards new equilibria and catastrophic effects
• The use of tipping point analysis to show how price signal and government support for electric vehicle could result in a rapid technological tipping points to electric vehicles in place of internal combustion engines
• Note: linkages should made to other units which explain technological shifts on the basis of relative price changes (e.g. how one of the driving factors of the capitalist revolution was the falling price of coal relative to labour)

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Show how the model of technological change operates in a dual economy

• The use of the Lewis dual economy model together with the Solow model of growth and technological change will offer useful insights into the linkages between the capitalist and informal sectors and how policies in the two sectors impact on each other, such as:
• If there is successful technological change in the formal sector this:
1. increases employment flows from the informal to the formal sector and

(2) leads to fewer people and rising productivity and incomes in the informal sector.  

• If there are measures raising productivity and incomes in the informal sector, such as:

(1) land reform and improved rural and agricultural services directly raising productivity and income in the informal sector

(2) this raise the level of the fallback option for workers employed in the formal sector, putting upward pressure on formal sector wages.

Final comment

• As a teacher who uses CORE in teaching economics students in South Africa it is very exciting that The Economy 2.0 is on the horizon
• It is fundamentally a healthy process that we continuously try to improve the way that we teach economics by thinking deeply about the models, data, examples and historical analysis that we use in our teaching
• This will help to improve the impact of our teaching and will strengthen the way that students engage with, and find uses for, the economic concepts that we teach.