Research Fellow, Institute for New Economic Thinking, University of Oxford and Bennett Institute for Public Policy, University of Cambridge. Seeking to better understand the economy as a complex system, Penny’s research looks at novel, data-driven ways of analysing economic growth and development,t occupational mobility and the future of work, and the transition to the green economy. Her broader research interests include economic complexity, technological evolution, transformational change, network science, machine learning and agent-based modelling. Penny completed a PhD at the Institute for New Economic Thinking (INET) at Oxford University. She has also worked as a postdoctoral fellow at the Oxford Martin School and the Bennett Institute for Public Policy at the University of Cambridge. Penny is currently a Research Fellow at SoDA Labs, a data-focused social sciences laboratory at Monash University. She is also affiliated with the Smith School of Environment and Enterprise and INET Oxford.
1. Why does economics matter?
Good question. I think economic matters, because it has, for better or worse, set out the broad principles around which we organize our societies, allocate resources and direct effort and human ingenuity to solving particular problems.
And I guess Keynes’s famous quote about how the world is essentially ruled by the ideas of defunct economists has frequently been debated, particularly following the global financial crisis, when many economists fell out of favor with policy makers and the general public for not saying such event could happen, or at least not doing enough to prevent it from happening. But regardless of whether you’re interested in economics or not, I think it is hard to deny that almost all collective challenges we face in the world, be it climate change, food security, pandemics, terrorism, populism, automation or whatever, all of these have an economic dimension, kind of like your computer’s operating system… All of these problems play out in a broader operating system that, rightly or wrongly, we refer to as the economy.
2. What are the differences between economic science (academic economics) and economic engineering (policymaking)?
So firstly, I probably wouldn’t describe policymaking as economic engineering because unlike physical systems where an engineer might use scientific principles to achieve some sort of global goal or defined objective, I think socio economic systems are made up of human beings that ultimately have agency. And this agency makes them very different to something like an electron or a falling apple where its behavior can be reliably predicted or controlled or engineered.
But from a scientific perspective, I think this agency is actually really what makes socio economic system so fascinating to study, because unlike apples or electrons, agents in socio economic systems behave in a household or firm or organization or government… They learn, they evolve, they adapt to new information, new contexts. And even the awareness of being studied can make them change their behavior. This agency, I think, is what makes policymaking, in particular this sort of delicate dance that it often is.
Well, as academic economists we are forced to usually care about publications. Our policymakers are ultimately answerable to people and politics. And so even if you’re academic economists and you can theoretically show or even point to some empirical evidence that a given policy would benefit society, the ability for policymakers to implement and enforce it, ultimately depends on how it is received and perceived by the agents comprising the socio economic system. And I think the varying responses, for example, to Covid 19, this is a really good example of this, climate policy is another good example where, you know, despite the huge amount of science evidence, showing the importance of taking stronger action to mitigate carbon emissions, the ability for policymakers to implement things like carbon taxes or emission trading schemes or so on, has unfortunately been relatively weak.
AOE: Yeah, you remind me of the start of the famous line, but I think it was Phil Anderson who said that, you know, physicists are used to deal with atoms and how they interact. But what if just imagine, as you have in a social system, if the atoms could think.
Absolutely. And most of them can, some better than others. Well.
3. What role does economics play in society? Does it serve the common good?
Yes, a good question. I guess if I can put a slightly normative spin on this… I think the role that economics ought to play in society should ultimately depend on its ability to serve the common good.
However you define that. So if economics can do a better job of serving the common good or can evolve to be more fit for purpose, then perhaps it is reasonable for it to retain its current prominence in policy discourse. But if it can’t, then perhaps policymakers and society at large should increasingly look to other disciplines for guidance on decision making. The question, of course, becomes how do we measure the extent to which economics does serve the common good and how might we do this better?
And I think there have been a lot of good examples of how the discipline is changing. So, for example, there’s been a lot of work highlighting the issues with gross domestic product as the key metric we use to assess the health or performance of the economy and how detrimental this can be as a proxy for capturing something that economic welfare. Because I mean, bad things like wars and earthquakes can make GDP go up. Well, things that are fundamentally good for society, like leisure time, domestic production and raising children, aren’t accountable with this measure.
But in response, you know, there’s been a lot of effort going into proposing alternatives. So things like more democratic measures of GDP that better account for things like inequality or broader measures that include life expectancy or life satisfaction. There has also been efforts to emphasize the fact that GDP, as it’s currently constructed, is really a flow variable. And if we actually care about cultivating and maintaining our productive capacities, we should probably be paying more attention to the underlying stocks.
So things like the physical and human capital that we draw on to generate future income flows, but also things like natural capital and the environment, which we fundamentally can’t exist without, as well as social capital and institutional capital, which underpin really important things like trust and cooperation in our societies. There have been other people, like my colleague Eric Beinhocker, for example, who proposed that we should actually maybe consider thinking about economic progress in terms of like the growth or the accumulation of solutions to human problems.
So, I mean, we could think about how good a society is at finding solutions in building houses that don’t fall down or generating cheap, clean, reliable electricity or finding a vaccine against a nasty disease like Covid. And if we could measure how good our society is at making these solutions available to people more broadly, then maybe we can better keep track of whether our economics and our economy is actually serving the common good. And I could go on on that in many ways in which I think there are efforts to improve the economics discipline as a profession.
But I think the fundamental point is that, in order for us to ensure the discipline does continue to keep serving the common good better, we do need to keep it encouraging many efforts to keep that discipline evolving. So it’s more and more fit for purpose.
4. Economics provides answers to problems related to markets, efficiency, profits, consumption and economic growth. Does economics do a good job in addressing the other issues people care about: climate change and the wider environment, the role of technology in society, issues of race and class, pandemics, etc.?
So I think climate change is something that economics could do a much better job on in academia, despite being one of the most fundamental challenges of our time, climate change research is an area that has received relatively little attention, particularly in the most highly ranked economics journals. So last year Nick Stern wrote a piece where he showed that the top econ journals, the Quarterly journal of Economics has published zero articles on climate change over the entire journals history.
So we’re talking about zero out of forty seven thousand articles. Other top journals, like Econometrica, has a total of two articles. The Review of Economic Studies has three, and I think of the top five journals, the AER came out as having actually published 19 articles over its history.
So when you think about how important economics is to addressing something like climate change, this is really quite astounding. Another important and particularly concerning thing is that some of the work on the climate change that has been quite influential in policymaking, is actually quite dangerously misleading. So the key example is the work by Bill Nordhaus, who won the Nobel Prize in twenty eighteen for many things. But one thing he did was developing a model that suggested that since the economic costs of transitioning to a zero carbon economy would be so expensive relative to the benefits we might achieve by transitioning the optimal amount of warming humanity should incur by the end of the century, is actually about three and a half degrees Celsius.
And of course, not only was this completely at odds with the climate science on the potential damages that we could experience from global warming, it fundamentally fails to account for a whole host of important factors, like the rate of technological progress that we’ve seen, which has been really rapid in the last decade for renewable energy technologies. And this is fundamentally changing the economic calculus of how much a transition to a clean energy system is likely to cost. It also assumes that our economy is in full employment.
So any benefits in terms of green stimulus measures or the green recovery measures that are receiving so much discussion at the moment, these tend to be completely negated. It also fails to account for distributional impacts of climate change. So the fact that some countries and some industries and some people groups will be disproportionately made much, much worse off compared to others, which in turn is likely to increase the probability of mass migration, conflicts and wars and other terrible things.
So while it is true that many economic models that are used by bodies like the IPCC to inform estimates of the costs and benefits of climate mitigation policies often have similar issues. I think there are some really encouraging developments in recent years to try to better model and account for things like the rapid learning rates of certain technologies like wind and solar and batteries that we’re experiencing. Also, I think now we’ve become much more aware about winners and losers of climate policies and the importance of ensuring that a transition to net zero is as just and equitable as possible.
Some of our models are now also incorporate the possibility for dangerous physical tipping points in our climate system. So things like melting ice sheets or the collapse of coral reefs or other critical systems, and incorporating these risks into what’s known as the damage function in these climate economy models. And we’re also exploring possibilities for policymakers to leverage a tipping point. So nonlinearities in socio economic systems where we can create rapid, runaway or cascading change towards de-carbonisation. So on the positive side, I think policymakers are increasingly calling for and seeking out advice based on these alternative approaches.
It just remains to be seen whether some work will be ever published in the top five econ journals. You know, we can but hope.
AOE: Just to add a question here: There’s a lot of discussion right now about the recovery and recovery plans and in a sense, in what we are concerned about that, there’s too much focus on just getting back on the road to disaster, whereas this other discussion, mostly rhetorical at this point, that, well, we’re going to use this recovery to transition to a green economy. But if in NAEC we’ve advocated the idea that what we need is not a stronger, inclusive, sustainable, resilient recovery, which is the kind of rhetoric of policy making, which really shows that the problem with our underlying model, that we have to keep adding things in to get what you want. But so we’ve had the idea that actually what we need is a systemic recovery. And that’s one where you can actually solve problems simultaneously, not just by thinking about trade offs and complementarities and managing them, which is kind of a linear way of thinking about things. But actually that in promoting a transition to a greener economy, you can actually address inclusiveness and resilience issues. And so you don’t need to put all these adjectives on the recovery. What you need is systemic change and to really change the way we understand and institute policies around the economy. But for you, what would you think the priorities should be in outlining a systemic recovery agenda?
It’s a wonderful question. I think, given the nature of COVID and in many ways the opportunity that a lot of people in so many countries had to sort of reflect throughout the lockdown period on what they were actually doing and whether they wanted to go back to the life that they were previously living - I mean, they’re actually quite mixed responses, not just in terms of going back to the day-to-day jobs, but also the way in which people were managing work-life balance and the opportunities that working from home were bringing.
And all these sorts of things, I think, created the opportunity that we’ve never had before for some kind of deeper reflection about an alternative possibility and also to really think more deeply about what’s fundamentally important to people and how they want to shape their lives and what they want to pursue if given that opportunity. And so I think absolutely when thinking about systemic change, it’s not only, as you mentioned, about better addressing negative externalities and trying to incentivize them and then price them accordingly or, you know, investing in things that have positive spillovers that we might want to encourage.
I think it’s also about really questioning what is the ultimate goal of what our economy is all about and why we have these sorts of systems in place… in the first place.
So I do think it’s an opportunity to reset in a very different way with a very different logic.
But whether we will actually take hold of the opportunity, whether we have the audacity to really drive such a change that people are open to and willing to go along. I mean, it really does depend on our capacity to generate more deliberative dialogue about the types of future that we want, the types of economies that we want, the types of systems we want to live within. And opportunities for that have been very limited, I think, of late. I mean that we know that our political election choices is really just: do you want this guy or this guy? And, not do you want this type of world or this type of world?
Or, do you want to collaborate or participate in designing a future, where we really want to live in? So I think, a huge opportunity. Whether we will really grab, hold and do it justice, remains to be seen.
5. As we live in an age of economics and economists – in which economic developments feature prominently in our lives and economists have major influence over a wide range of policy and people – should economists be held accountable for their advice?
Yeah, absolutely. It’s a no brainer As it is with any kind of system. You do want those who are influencing decision-making to have at least some skin in the game.
I also think that given the heavy reliance that economists place on economic models, we need to do a much better job of holding our models to account. And having confidence or trust in models based more on their ability to be appropriately tested or validated. So one thing I do find quite concerning is that despite the frequent use of general equilibrium models in policymaking to estimate things like the economic impact of a policy like carbon tax or an education subsidy or whatever on things like GDP and jobs, that doesn’t seem to be a lot of analysis on how these models perform after the fact.
And, you know, I mean, if policymakers did go ahead and enact a given policy, it’s probably quite useful to know how accurate the model was in its predictions about the change in GDP or jobs that was expected to result from that. Ultimately, the design of these models in particular and the fact that you can’t actually observe the counterfactual, make these sorts of analysis quite tricky. But at the very least, we can do a much better job of testing the model and seeing how it can reproduce certain characteristics of past data.
In energy modelling, for example, the International Energy Agency has a spectacularly bad record of making terrible forecasts on things like the uptake of solar PV, which, you know, over the last 20 years, every year, the World Energy Outlook predictions show an incredibly modest projection of solar PV growth. And every year there’s going to grossly underestimate the actual growth of solar PV. So the fact that despite enduring almost 20 years of being so wrong and so little has been done to update the models’ assumptions I think is fairly poor form.
But on the basis of this knowledge and the fact that you can look back at past data and see how the models are performing, at the very least, policymakers and the various companies and industries that rely on these information could decide how much faith or confidence that they want to put in model outputs.
And so, in addition to making economists more accountable for the advice they provide, I think it would also be quite helpful to have some sort of model accreditation scheme where we subject models to a bunch of validation exercises to see how well they perform. And then, I mean, you could imagine giving them some kind of rating, like a triple A rating down to kind of junk model status so that people might be a bit more wary or confident about placing trust in certain types of models.
And I think if you had this type of mechanism in place, it would hopefully lead to more transparent, empirically sound models that are more frequently updated in light of changing information, changing assumptions, technologies and so on. And ideally, this would in turn lead to a more accurate and well-informed input for decision making.
6. Does economics explain Capitalism? How would you define Capitalism?
I think capitalism is such a hard thing to define. There are many variations on the theme and there are also many different flavors of it expressed across countries and over the course of history. But, you know, historically, I think the arguments made for capitalism and free market have been based on the fairly traditional neoclassical economic framework. We have these fundamental welfare theorems that basically say that firms or consumers interacting in perfectly competitive markets will end up in some kind of Pareto optimal equilibrium where you can’t make anyone else better off without making someone else worse off.
And a key problem with this, of course, is that the assumptions under which these results hold are like hardly ever, if not ever met, in the real world. For this result to be true, we would lead to live in a world where all firms and consumers have perfect information. No one has an ounce of market power. So no Google, no Amazon, no Apple. And, all negative externalities like pollution, emissions, and all positive externalities like the knowledge spillovers from innovation, would be perfectly priced in and internalized.
And so since this is fundamentally not the world we live in, I do think is quite difficult to explain capitalism on these grounds.
But: I think there are other branches of economics that do a better job. So evolutionary economics, for example, would explain capitalism more as an evolutionary system where market forces perform a very useful selection mechanism, as the various goods and services that competing firms try to sell to consumers. And if you take a kind of Scumpeterian view, then capitalism can be seen as quite a dynamic process of creative destruction, where firms and entrepreneurs are incentivized to chase monopolistic profits by innovating to create better products and technologies that displace what currently exists.
I think what’s nice about this lens, and you can disagree with it of course, but at the very least we don’t need to impose these peculiar assumptions about everyone having perfect information, no market power and externalities. It’s quite the opposite. The lack of perfect information creates the need to innovate, to find better solutions through trial and error and learning and selection, and the desire for market power and monopolistic profits creates incentive for firms to actually engage in risky, uncertain, innovative behavior.
We can also think about the role of the state through this evolutionary lens, which ultimately does have the ability to shape the rules and the fitness landscape, if you like that: firms and workers and consumers interact within. But the state, of course, is also constrained and influenced by public perceptions, lobby groups with vested interests, new ideas coming out of academia and also the time horizon of the political cycle. So I think it’s important to stress that for something as broad and as multidimensional as capitalism we shouldn’t perhaps just look to economics to try to explain it. But other disciplines like political theory, political science and sociology also offer really important insights and theories that are incredibly relevant.
AOE: Great. Can I just follow up on where I’m not supposed to ask follow questions, but it’s too bad not to. When it comes to productivity and particularly the evolutionary economic perspective, the standard traditional neoclassical approach to the issue of productivity is that we just essentially need to reallocate resources from less efficient to more efficient practices and approaches. And so all the policymaker needs to do is promote reallocation. So make sure it’s easy for workers to transition, to move geographically, to other industries, et cetera.
So just mobility and reallocation, that’s our story. And then the market will self- organize and that will enhance productivity. And that kind of leaves out everything you would think would be important in enhancing productivity. But, this idea you mentioned that the market selects; it’s a survival of the fittest story. And so I’m just thinking about what this means for policymakers because one of the contributions of your work and the work of INET in Oxford in the complexity group is that we shouldn’t think of the economy as this kind of static top-down entity where all you do need to promote is reallocation and then the market will sort everything out. So you don’t really need to take a very strategic or active role because the market does that, essentially. But then, what about these networks of capabilities that we have where if we follow the logic of neoclassical economics, then if something is inefficient, you just close down, let it fail, reform bankruptcy laws so it’s easy to get these unproductive, inefficient firms out of the marketplace. But what we’ve seen in places like China is that there can be the “adjacent possible” if you want to use the [Ricardo] Hausmann idea or some set of capabilities that if applied to a different problem, could be much more productive.
And there’s also the way in which these things link up. So some firm might appear to be unproductive, but it actually might be a very valuable part of a bigger ecosystem or value chain. And so we can’t really think just simply about bad firms can die, good firms can grow in the marketplace. I think the actual ecosystem is a lot more complex. And so for a policymaker, I think it changes the discussion. And it’s perhaps justifies some of the discussion we’ve had about the entrepreneurial state.
And then the again, China is a good example of the state led capitalism or state centric capitalism. And I mean, what’s your thoughts on this? Does this network way of understanding the economy change this debate or is it essentially we still need reallocation that should be retained and essentially the neoclassical story works?
I think certainly the network’s perspective, both in terms of the Hausmann capabilities and also the work that’s been done also on the input output network structures. So we can really see how, you know, one economy, one sector of the economy is supporting another sector of the economy, do change the way that we look at questions of whether we should let seemingly unproductive or underperforming firms fail. I think there’s an interesting question about how long do you prop up industries that may be - I mean, productivity is one thing, but another question is whether they are serving a fundamentally good purpose for society. And so you could ask a question about fossil fuel industries. How long should we subsidize and prop up fossil fuel industries and when do you let certain industries fail? And I think one of the things that we can certainly do better now because of the networks’ view, because we can empirically measure capabilities and the way in which we can transition from being able to produce one product to another product on the basis of this “adjacent possible”, which we can now empirically measure. We can make much more informed decisions about - you know - if you are a country and maybe you have an industry that is fairly new and is trying to produce solar panels. So, let’s say you are trying to develop solar panels industry and you’re currently not competitive at all, and the question is, should the government continue to protect that industry and provide ultimately protection from free market forces, which would probably destroy that industry? And so one way in which I think we can make a much more nuanced argument for and against intervention policies is to say, well, you know, solar panels are something that we fundamentally want every country in the world to have for good reasons. And if a country isn’t able to produce it competitively, then all the consumers are essentially missing out on getting that at a cheaper price. But we could look at how far away empirically is that country from being able to make this product more cheaply or competitively. And what other opportunities, if we were to become competitive in this product, might that lead to being able to develop all these other products? So we can now put quantitative estimates on that.
And I think based on this analysis, we can actually say, you know, whether it does make sense to continue to pump public money into supporting certain industries that do have strategic values or whether, quite frankly, that given the nature of the capabilities in that country and, you know, it’s a possibility, put resources in other places. Maybe it’s actually better that we do reallocate those resources and we import solar panels from somewhere else you can do it much more cheaply and give our consumers the benefit of the lower prices.
So, yeah, I think there’s a lot more information we now have to make much better strategic decisions about these sort of things.
7. No human system to date has so far been able to endure indefinitely - not ancient Egypt or Rome, not Feudal China or Europe, not the USSR. What about global Capitalism: can it survive in its current form?
It’s a really interesting question. A little while ago, I was part of a workshop at the Santa Fe Institute, which was basically drawing attention to the fact that if you look at the increasingly global nature of many of our fundamental challenges, so things like climate change, but also pandemics and the global reach of many of our most powerful companies like Google, Amazon and so on. And if you look at the increasingly rapid pace of technological change, particularly in things like AI and robotics and genomics and cognitive enhancement and all of these sorts of things, this is real sense that our capacity to set appropriate and effective policies is really falling behind. And in part, I think this is due to the fact that so many of our existing institutional frameworks that ensure that markets function well, operate at the national level. And so when you have problems like climate change or pandemics that requires global cooperation, we run into issues.
And climate change in particular has taught us that we still have a lot to learn about how to develop appropriate mechanisms that take account of the incredibly diverse cultures and preferences and worldviews that people have, and incentivize individual nations to collaborate in equitable and mutually beneficial ways. And, unfortunately, I think unless we’re actually able to develop this learning and develop these better institutional frameworks for global cooperation, it’s hard to see how any form of global capitalism could be sustainable. But I think another really fundamental issue, which is a little outside the question of capitalism, but more relating to sort of the fundamental sustainability of human life on earth, is that if you consider the rate at which technologies are becoming more complex and more sophisticated and powerful in that consequence, and you compare this without ability not just to kind of create appropriate mechanisms, but also our ability to understand how these technologies work and what their impact might be, I think there’s a really important need to think quite seriously about how we continue to capture the benefits of technological progress while simultaneously mitigating the very real risk of societal harm. And, it kind of strikes me as odd when you think about it, that we have a World Trade Organization that sets the global rules on trade between nations, but we don’t have something equivalent like a world technology organization to sort of help direct human ingenuity or humanity’s most pressing problems, or kind of help mitigate against the potential risks of the technologies that we’re now seeing being developed and deployed in the world.
So I guess to summarize, I think the sustainability of capitalism at the global scale ultimately depends on both the speed and the effectiveness at which we’re able to kind of develop a global institutional framework around what we trade and the technologies that we’re developing.
Yeah, I think technology is a field where we are very competitive and nation states compete with one another, whereas if we actually cooperated and pooled our resources and ingenuity, we might be able to solve big problems. But we still have nation versus nation or even supply chain versus supply chain. And I think it goes back to what you were saying earlier. And it’s certainly a line that we’ve promoted that the 20th century was all about competition and I think that probably made sense. But given the types of problems we face in the 21st century, it’s probably going to have to be all about managing these complex systems and coordinating around the world. We will simply be overwhelmed by the types of global-level problems that we face.
8. Is Capitalism, or whatever we should call the current system, the best one to serve the needs of humanity, or can we imagine another one?
I think we can definitely make more use of our imaginative capacity to dream of alternative systems. I mean, it’s kind of interesting that we have in many ways advocated for the capitalist system, largely on the basis of the quote from Adam Smith’s Wealth of Nations, where he states: is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but for their regard to their own self-interest, yet missed the opportunity to actually consider the possibility of building a system based on another quote from his other book on The Theory of Moral Sentiments that states actually that, you know, the secret of education is to direct vanity toward proper objects. So that is if you recognize that for many human beings a very powerful and motivating force is actually status-seeking and aspiration. We want others to think good of us and that can be adaptive a positive thing. If you are able to direct this powerful force towards proper objects - so things that through education and deliberative processes, things that are recognized as being fundamentally good for society - then you can start to imagine how this might change what we divert our attention, our resources, our ingenuity and ultimately our lives, in pursuit of.
I think one of the key challenges, of course, is that even though there have been alternative systems that have been dreamed up in the past, many of them haven’t had very good outcomes. And so when thinking about the possibility of alternatives, many people have had perspective similar to Winston Churchill’s view about democracy, that democracy is the worst form of government except for all the others that have been tried for time to time.
But I do think one of the differences between the world we live in now and the world that Winston Churchill lived in was that today we can do a lot of imagining, a lot of experimentation in silico, in computer models. We don’t actually have to roll out every single idea. And there’s some fascinating branches of research that have used online gaming environments to try different system logics for interacting and trading or cooperating. And I think at this moment in history, there’s actually huge potential to leverage simulation, virtual world building exercises, and - we just talked about creative industries - to experiment and to try out different systems that could work better than the ones that we currently have. And actually put some of our imaginative capacities to good use. It’s not just children who can dare to imagine. I think there’s a lot of importance that all people should continue to imagine.