July 2016 newsletter – Conference Report 2016

The Society’s Annual Conference was held at the University of Sussex, 21-23 March. This report was prepared by Ferdinando Giugliano.1

The Royal Economic Society’s Annual conference was held this year at the University of Sussex in Brighton. It spanned all areas of the subject, but for convenience, I will focus on the four fields that I believe dominated the three days of the gathering: development economics, political economy, labour economics and macroeconomics.

The meeting showed that while economists are eager to explain via their models an ever-increasing number of areas of public and private life, their success at being relevant remains mixed. In particular, some areas of macroeconomics appear to have failed to learn adequately the lessons from the financial crisis. Several macroeconomic models are still too detached from reality and occasionally still miss crucial details, such as the role played by the financial sector. Conversely, microeconomists appear better-equipped to offer meaningful policy advice to politicians, who ought to take their lessons more seriously than they do right now.

The conference also included some light-hearted moments, courtesy of the outgoing president of the Society, John Moore (Edinburgh). Those who think economists can only be dull and dismal should have listened to his dinner speech, including a memorable fake phone conversation with UK Chancellor, George Osborne.

Development economics
The Economic Journal Lecture was given by Esther Duflo (MIT), the economist who — together with her co-author Abhijit Banerjee (MIT) — has revolutionised the world of development economics. Their ‘randomised controlled trials’ are one of the most important innovations introduced in the field in the last couple of decades. These experiments seek to overcome the problem that has long cursed economists: unlike many physical scientists, economists cannot test their theories in a controlled setting that allows them to isolate external factors. Duflo has addressed this problem by pioneering the use of field experiments, whereby economists offer a given policy to a selected set of people and then check its impact against what is happening to a so-called ‘control’ group.

This technique has raised both ethical and methodological concerns. One worry is that ‘randomised controlled trials’ may give the ‘treated’ individuals an unfair advantage over others. Politically, it is very hard to justify why a village may receive a given policy that is likely to produce positive effects, while another is left out. Moreover, some economists are worried that Duflo’s brainchild may be prompting researchers to address only very specific questions rather than tackling broader but potentially more meaningful issues.

In her lecture, Duflo addressed both sets of concerns. For a start, she said that one way to make experiments politically more palatable is to exploit their phasing-in period. This allows both the ‘treated’ and the ‘control’ group to experience a given policy eventually, though this will happen at different moments. While this solution is clever, it is not perfect: the later versions of the programme may be better than the initial one, as its design improves. Moreover, the behaviour of individuals may change if they know that a certain policy is going to take place in the future, biasing the results of the experiment.

Duflo also defended the technique from the accusation of producing results that are irrelevant for the subject. She said that randomisation is a natural and transparent way to provide a credible counterfactual — the holy grail of economics. Moreover, the communication of the results of experiments to policy-makers can be extremely simple. Finally, randomised controlled trials ensure that economists do not neglect details that are essential to draw policy conclusions. She cited the example of micro-credit, the idea of giving money to the ultra-poor even at high interest rates championed by Nobel peace prize-winner Muhammad Yunus. Randomisation has helped to show that it is typically ineffective.

Duflo also gave a separate, more technical presentation on her work on ‘Gossip’, joint with Banerjee, Arun Chandrasekhar (Stanford) and Matthew Jackson (Stanford). In spite of the colourful name, this is a mathematically dense paper that sits at the frontier of theoretical economics. But the central question of this study could not be more relevant for policy-makers involved in development: understanding who is influential in a given community is essential to ensure that a given piece of information on issues such as vaccination or contraception is disseminated widely.

Rather than seeking to assess who is influential, the paper cleverly turns the problem on its head, asking people in a village whom they have heard of the most. The evidence shows that using people identified via this technique is a more effective way of spreading information than, for example, simply relying on established figures, such as the village chief.

In a separate session, there was one other interesting piece of work on development economics. A paper by Marco Manacorda and Andrea Tesei (both Queen Mary, University of London) looked at the role played by mobile phones in protests in Africa. It tests the widely-held hypothesis that mobile phones have acted as ‘liberation technology’, helping citizens who are dissatisfied with their governments to mobilise against them. The two authors find that on average mobile phone coverage does not lead to more protests. However, during a downturn, the spread of mobile phones is associated with more episodes of organised political discontent. One hypothesis is that portable devices make individuals better informed about the state of the economy. Technology may therefore allow the channelling of discontent when this is caused by some external factor, such as a recession.

Political economy 
The RES conference did not shy away from the most important question facing the UK in 2016: whether or not it should remain as a member of the European Union (EU). The so-called ‘Brexit’ debate was too uncontroversial for my liking: all the panellists said that the UK would be better off by staying in the EU. However, this is largely a reflection of the consensus within the profession, rather than the consequence of a poor choice of participants from the organisers: most economists believe that the UK would become poorer, at least in the short run, if it were to leave the EU. A show of hands during the panel discussion also proved the audience was fully in favour of ‘Remain’.

During the discussion, Richard Baldwin (Graduate Institute, Geneva) made the useful point that Brexit would be particularly damaging for the UK’s trading prospects, since the very nature of trade has shifted. Countries that want to attract foreign direct investment need to guarantee that they will not disrupt the supply chains that are at the heart of the global economy. Brexit could create significant artificial barriers in the UK’s trade with the EU, hence dissuading companies from investing in the UK in the first place.

John Van Reenen and Swati Dhingra (both LSE) presented a study from the Centre for Economic Performance looking at the costs of Brexit. They found that this could be between 1.3 per cent and 2.6 per cent of gross domestic product just from a simple static model that only looks at trade. However, the cost could rise to between 6.3 per cent and 9.5 per cent of GDP if the dynamic, long-term losses are included. While these estimates are obviously imperfect, their central finding that Britain would suffer non-trivial losses in case of exit appears hard to rebut.

Enrico Spolaore (Tufts) looked at the political economy of the vote. He argued that while there are economies of scale from institutional integration, there are also high heterogeneity costs, since voters in different countries may have different preferences for public goods and policies. While economists have typically concentrated on the benefits of integration, the costs are left out of the analysis because they are harder to assess.

Spolaore argued that European monetary union may have been a step too far for participating countries, given the heterogeneous preferences of the different publics. However, the UK’s ‘partial’ membership (inside the EU, but outside the eurozone) may be optimal, as it allows the country to stay in the policy areas with little heterogeneity while avoiding those with larger differences — a point that seemed very well-taken.

During the Q&A, John Moore (Edinburgh) chose to side-step the trade issue and made a case for ‘Brexit’ based on sovereignty. He argued that just as there is an optimal size to a company, there is an optimal size to a country. Maybe the UK is closer to that particular size than the EU as a whole. He added that bringing people closer to the decision-making bodies is a good thing, as it allows us to reduce the democratic deficit.

This argument does not appear entirely convincing, as it treats the EU as if it were a single country. However, it was a useful reminder that there is a lot more at stake in the referendum than simple economic models can capture.

The other political economy session — on migration — was significantly more controversial. Some of the speakers on the panel made the case for restricting migrants’ rights as an effective way to decrease global inequality. This argument is extremely inconvenient for our liberal societies, but is very thought-provoking, since it is built on a careful evaluation of the trade-offs facing today’s policy-makers.

Glen Weyl (Microsoft) set the stage for the debate outlining how there are two clusters of wealthy countries in the world. One includes the members of the Organisation for Economic Cooperation and Development (OECD) and is characterised by fairly equal societies that are closed to migration. The second group includes the Gulf states: these are repressive and highly unequal societies, but they welcome a much larger number of migrants than the OECD states. Weyl outlined how, while the Gulf countries typically restrict the rights of migrants, their model does a lot more to help to reduce global inequality than what the OECD has to offer.

Branko Milanovic (City University, NY) showed that a large part of global inequality depends on economic differences between countries rather than within them. This creates some sort of ‘citizenship rent’, which the population of high-income countries enjoys vis-à-vis those living in poorer states. Milanovic describes migration as the attempt by inhabitants of the emerging world to appropriate some of this rent. Facilitating migration may therefore be the best way to reduce global inequality. However, local citizens do not want to suffer from the reduction in their income and welfare that may ensue from a policy of open borders. Milanovic’s solution is therefore to discriminate between migrants and locals to make migration more palatable for the natives. This could include asking migrants to pay higher taxes or forcing them to return to their home country every 4-5 years.

Suresh Naidu (Columbia) went into more detail about how the labour market in a Gulf state, the United Arab Emirates, actually works. He suggested that preserving democracy may be a value per se, adding that one may want to think of other ways to achieve greater inequality than simply copying the model of these countries. This appears to be a wise suggestion, as it is hard to see democratic countries turning their back on decades of history and embracing active discrimination.

Labour economics 
The debate over the minimum wage dominated the labour economics section of the conference. This is a subject of immense importance, in both the academic and policy literature. As Alan Krueger (Princeton) recalled, many economists were shocked by his finding, together with David Card (Berkeley), that raising the minimum wage in the US had no negative effect on employment. The conventional wisdom back then was that setting a wage floor would obviously displace some low-paid workers: this finding derived from the most basic model in economics, the Marshallian cross, which shows that any clearing wage above equilibrium would lead to an excess of labour supply over demand.

Card and Krueger showed that this result does not always apply. One reason, which has been studied among others by Alan Manning (LSE), is that the labour market for the low-paid often resembles a monopsony: the employer has the power to drive down wages below the equilibrium level by artificially restricting the number of workers hired. Government intervention can therefore simultaneously increase wage and employment levels, as a number of studies following Card and Krueger’s seminal paper have shown.

The debate over the minimum wage has acquired renewed policy relevance over the past couple of years. In the US, several states and cities have lifted the minimum wage substantially. The German government has also set one. In the UK, George Osborne has taken the bold step of raising the minimum wage well above the level recommended by the Low Pay Commission. This is part of a plan intended to reduce the amount of in-work benefits paid by the government to supplement income for the working poor.

These decisions have raised an important question: what is the turning point where the minimum wage becomes too high and starts having a detrimental effect on employment? This is one area where Krueger rightly asked for more work.

Arindrajit Dube (Amherst) showed that the US states that have chosen to raise the minimum wage are not random. They tend to have higher unionisation rates and tend to vote for Democratic candidates in elections. For this reason, his work has specialised in looking at inter-state borders, which let researchers control for these external factors. Dube also finds that a higher minimum wage tends to raise earnings and lower turnover, while having essentially no effects on employment, at least in the short-run.

Dube added, however, that the US is now going through a phase of substantially higher minimum wages, especially in cities such as San Francisco. In Los Angeles, between 30 and 40 per cent of the workforce will be affected by the minimum wage. This is remarkable and may have different effects from those we have seen in the past.

Stephen Machin (UCL, LSE) showed that in the UK the minimum wage has gone up since its introduction in 1999 by more than the average wage. Still, this increase has had no significant detrimental effects on employment. However, the introduction of the new ‘living wage’ announced by George Osborne this year poses significant challenges. The new minimum wage will be set at £7.20 an hour this year and will rise to £9 an hour by 2020, lifting the coverage of the living wage substantially. The question is therefore whether this new, higher, floor will have significant effects on employment and profits. The Office for Budget Responsibility only forecasts a reduction of around 60,000 jobs. Conversely, the value of shares of low-wage companies fell rather significantly on the day of Osborne’s announcement, offering provisional evidence that profits may fall in the future. Machin has looked at the company accounts published since the announcement finding that, indeed, most companies plan to take a hit on profits. However, there may still be an adjustment in terms of employment for those companies that earn little or no profits at all, for example, care homes.

Richard Blundell (UCL) looked at the interaction of the increase in the minimum wage in the UK with the reduction in tax credit. His main conclusion was that the increase in the living wage does not do much to compensate poorer people who have suffered from other reductions in their income. In fact, minimum wage and tax credit policies are complementary at the bottom end of the income distribution and one must think about this interaction when designing the right policy mix. He concluded that the minimum wage should not be seen as a way to reduce the welfare bill significantly, but more research is needed to understand exactly how these policies interact.

The financial crisis has exposed the limits of macroeconomics models. Not only did they typically exclude the financial sector, but, too often, they failed to make useful predictions or help to detect structural breaks. Unfortunately, the RES conference did not offer much hope for those concerned about the sorry state of the subject.

For example, a paper by Pietro Cova, Patrizio Pagani and Massimiliano Pisani (Bank of Italy) on the effect of quantitative easing on the European economy excluded the banking sector. Given the importance of banks in the transmission of monetary policy, to me this is a big enough failure to throw serious doubts over the results of the model.

The session on sovereign debt and austerity was also frustrating. The papers presented covered very topical questions, such as the design of rescue packages within Europe’s monetary union or the kind of fiscal policy governments should opt for during a crisis. However, the models were typically seeking to replicate the experience of recent crises, instead of offering predictions about the future.

Kristin Forbes (Bank of England) chose instead to discuss one of the most relevant topics for UK policy-making in a realistic and forward-looking way. Her lecture put forward a new framework to evaluate how dangerous a sizeable current account deficit really is. At 5.1 per cent of GDP, the UK’s current account deficit in 2014 was the largest in nearly 60 years and the largest of any advanced economy. Still, Forbes remains relatively sanguine about its size: she argued that the deficit is primarily driven by stronger relative growth in the UK vis-à-vis other countries, which has led to a deterioration of investment income from abroad. Forbes also believes that the UK has strong institutions, meaning that foreigners will continue to invest there. This means that the overall size of the external debt remains manageable.

Forbes said that in principle there are reasons to worry about a large current account deficit. It makes a country more dependent on foreign financing and therefore more vulnerable to ‘sudden stops’. It may also highlight the presence of vulnerabilities, such as a large fiscal deficit or lack of competitiveness. However, there are reasons why deficits can be optimal, for example in the case of a developing country that needs to attract foreign capital to grow.

The current account consists of both the trade balance and the investment income on international assets and liabilities. Forbes chose to concentrate on the latter, since this is the driver of the UK’s external deficit at the moment. She concluded that a large deficit on the investment side of the current account need not be a problem in the case of higher domestic risks in the UK. In fact, the current account acts as some sort of shock absorber, distributing part of the cost of the fall in asset valuation to foreign investors. Conversely, in the case of higher global risks, the large deficit in the investment balance of the current account can amplify the problems, since there is no risk sharing while there are still negative effects on the broader economy.

Forbes’ conclusion is extremely neat, though not fully compelling. Take, for example, the risk of the UK leaving the EU. Under her taxonomy, Brexit would qualify as a domestic risk: the current account would act therefore as a cushion, since some of the negative impact would be passed on to foreign investors holding UK assets. However, this explanation does not seem to fully account for the fact that foreign investors may be more risk-averse than domestic ones. As a result, a large current account deficit may be a prelude to a bigger sell-off in domestic assets than would otherwise be the case, causing significant problems for domestic investors too.

Overall, the Royal Economic Society conference offered a very good mix of purely academic and more policy-oriented research. I would encourage the organisers to continue on this path, as this is the right way to ensure that the subject stays relevant while maintaining its rigour.


1. Ferdinando Giugliano is economics commentator at La Repubblica in Rome. Between 2011 and 2015, he worked as economics journalist and leader writer at the Financial Times in London. He holds a master and doctorate in economics, both from the University of Oxford, where he has also worked as a lecturer.