Odd Lots - This Is How Prejudice Can Hinder the Economy

Episode Date: December 31, 2020

Economics is all about improving living standards, but rarely does the dismal science deal with social justice or talk about how a lack of it could actually hinder growth. In this episode, UBS Global Chief Economist Paul Donovan discusses how prejudice and labor markets are intertwined, and why discrimination can restrict development. Donovan describes how historical technological advances have often increased racism, sexism and other forms of prejudice as people sought out scapegoats to blame for lost jobs and wealth. He also describes how the current 'fourth industrial revolution' is fomenting more blame, and what economists can do about it.Odd Lots listeners are eligible for a 25% discount on the hardback or eBook edition of Paul Donovan’s new book, Profit and Prejudice: The Luddites of the Fourth Industrial Revolution, via the Routledge website by using the offer code “OL25” at checkout. See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthal. So, Joe, I think at this point, one of the themes that has been emerging from 2020 is the idea that we are seeing a number of trends that were already underway really accelerate. 100%. Yeah. And one of those trends is something that, again, we saw even before this year, and I would say we really saw it come into play after the financial crisis. It's the idea that the economics profession or the study of economics, the field of economics, is missing something fundamental or perhaps could be applied in a different way to, I guess, achieve.

a better outcome for human well-being. Is that a good way of putting it? Go further. I mean, yes, but go further. Well, so I think in the aftermath of the financial crisis, there was a lot of criticism trained on economists that not only had they missed this massive imbalance that ended up nearly taking down the financial system, but also that economics had somehow lost its way in its actual purpose. If you think about economics as the sort of studies of resource allocation and the decisions that go into making them, the ultimate goal should probably be making people better off than they would be otherwise. And I think there was a sense that economists in their sort of white tower in their academic bubble had forgotten that aspect of it, or at least hadn't paid

as much attention to it as they should have. I think that's right. I mean, I think like if you look at now, especially with this crisis versus 10 years ago, there's a lot more focus on like exactly what you say. What is the purpose of economics and what problems are people really trying to solve? And I think that like before the great financial crisis and the aftermath of the great financial crisis, there was a lot of focus on the beauty of models and getting everything into equilibrium and optimal balance and all this stuff. I don't know, but sort of forgetting us like, no, the point is human well-being and improving the sort of situation for humans. And I think, I don't know, I feel like probably always economists would recognize that that was the goal, but it got obscured. And I think like that you see the difference now on the sort of more clear focus on that when people think, no, just give people money. And I think that like that's part of this idea, like, in a lot of the solutions that get bandied about now in post-co.

COVID times or in the middle of COVID is like just give out more money. And I think part of the reason that some of these ideas have become more, gain more currency is because of this increased clarity of what are the problems we're trying to solve. Yeah, absolutely. And I think your mention of the models there is absolutely correct. There was this idea that an economic or an economy imbalance was a goal in and of itself. But people kind of forgot the reason they were targeting that, which was eventually to create better conditions for their citizens. So, all right. So today we're going to be talking about, I guess, the more lofty ideals of the economic

profession, but we're going to be doing it with someone who was actually writing and thinking about this, again, even before 2020, way back in 2011. We're going to be talking to Paul Donovan. He's the chief economist at UBS Global Wealth Management, and he wrote a book that came out in November called Profit and Prejudice, the Luddites of the Fourth Industrial Revolution. And I should just mention that this book was written in a personal capacity by Paul, but with the full support of his employer, UBS. It's a really interesting read, and it gets to some of the topics we just mentioned in the intro. Without further ado, why don't we bring on Paul? Paul, it's great to have you. Thanks very much for having me on.

So I guess the clue is in the title here, right? But profit and prejudice, there's an intimation there that prejudice has some sort of impact on profits. Why don't you go ahead and tell us your thesis on what that actually is? Well, I'd love to take credit for the thesis. But I mean, this comes out of Gary Becker's work in the 50. and countless economists since then. Basically, prejudice is bad for profit at a corporate sense, and it's bad for economic well-being in a macroeconomic sense. Essentially, the whole point about allocating your resources efficiently

and getting everything working is you need the right person in the right job at the right time. That's it. Now, prejudice is irrational discrimination, where you are, rejecting a person, not on rational grounds, not on reasonable grounds, but because you don't like their race or their sexuality or their gender or their hair color or whatever it is. It doesn't matter. If it's irrational, you're rejecting somebody from the possibility that they could work for you. And that then gives you a situation where you're not employing the right person in the right job. And that is enormously destructive, particularly so as we are going through,

the upheaval and the changes of the fourth industrial revolution because it becomes even more important to get the right people in place in order to maximize profits and gains at the moment. So explain that last part. What is the connection between the sort of economically corrosive aspects of prejudice and why it's particularly pronounced after in the wake of the fourth industrial Revolution? And while we're talking about that, what is the fourth industrial revolution? So the fourth industrial revolution is the latest period of economic upheaval. So this is about artificial intelligence, robotics, automation, the Internet of Things, changes in communication, all of that. Now, the point about a revolution, not to state the blindingly obvious, is it's

revolutionary. So actually, it's not the technology that matters. It's how we use the technology. and that has the power to change society, to change how we work, where we work, how we live, what we consume. All of these things change through the application of technology. That's the critical thing, the application. So it becomes critically important in this period of upheaval and success that you apply the technology appropriately. And how do you apply technology appropriately? Well, that's coming down to good old people, because they're the ones who are. are using the thing. And so that's why getting the right person and the right job is so

absolutely critical. But there's a fatal flaw in any period of structural upheaval is that the uncertainty, the shifting social positions that an industrial revolution creates also tend to encourage more prejudice. So the fourth industrial revolution has the seeds of its own destruction within the changes that it's bringing. Are there previous, well, obviously there are previous industrial revolutions, but are there any that engendered the type of prejudice or, you know, parallel prejudices to what we might be seeing now that we can kind of learn from? Yes, so, I mean, basically all three previous industrial revolutions

went through periods of prejudice. So the first industrial revolution, you saw the introduction of factory systems, mechanization in the UK in the mid and late 18th century. And that led to the Luddites who were going around and smashing up the equipment because the equipment was destroying their jobs. But it wasn't just equipment that was being destroyed. You were attacking Catholics. You were attacking Methodists because they were different. And if you'd lost your job and if you'd lost your job, and if you'd lost your social status, you couldn't really understand why you'd lost your job and social status, because it was the complex forces of the universe that had led to this situation.

So as far as you were concerned, you were doing your job as well as you'd always done it and as efficiently as you always done it. So why were you losing it? And so you search around for this simple solution, the scapegoat economics. And it's, well, there's a group, and they seem to be doing quite well, it must be their fault. So it's all the fault of the Methodists. It's all the fault of the Catholics. They're the ones who cost me my job.

And then in the second industrial revolution, we see exactly the same thing. And I talk in the book about my own family history. My family were dock workers in East London in the 1920s and 1930s. And of course, the chaos and disruption of the second industrial revolution caused them to lose their jobs, cause to be part of the mass unemployment. And some of my family appeared to turn to fascism. because they were being told, no, no, no, it's not your fault. Everything's the fault of the Jewish immigrants. And they are the ones that have cost you your job. You're great.

They're the ones that have taken your job away from you. This is the black shirt movement in the UK. Is that right? It is, which a lot of people tend to see the black shirt movement as being, you know, some middle class movement. It wasn't. It was working class. And it was deeply rooted in the east end of London because this was the area where

people were losing their jobs and couldn't understand why it was happening. And it was very reassuring to be told, no, no, no, you're better than they are and they've somehow stolen your job from you. It's not just the desire to have a scapegoat, it's also the desire to be told you're better. And we've got a simple solution, which if we follow, if we ban immigration or whatever it is, we will go back to this wonderful golden era where everyone is happy. It's all complete nonsense, of course, but you can see why it's a compelling story in the chaos of change. And as recently as the 1970s, the tail end of the third industrial revolution, which is all about computers and technology, I mean, if you go back and look at advertising, at newspapers

from that time, you know, a lot of the blame then was on women. Women are daring to work, and they're costing men jobs. And therefore, we just need to stop women working and everything will be wonderful again. And I mean, it's just this remarkable bizarre, but obviously very simple narrative. And it's that simplicity which is so appealing and so dangerous. So this gets to, I think, a question about, you know, you mentioned in the beginning this idea of irrationality. And in the current age, prejudice, racism, other forms of discrimination, extremely costly from an economic standpoint, extreme costs of this sort of irrational choices. Where does the irrationality lie, however?

I mean, you talk about these sort of past periods, like say the Luddites opposing increased mechanization and so forth. Were they being irrational given the information at hand? Or does the irrationality precede them in some other sort of meta-matter? I mean, they can't see the big picture. So I think it's definitely the latter that you're getting fake news. And this was, I mean, the whole Luddite movement. I mean, the UK had had plenty of uprisings and revolts in the past. What made the situation in the late 18th century so unusual was that it was branded.

Luddites. There was a common brand. There was a common theme. And there was this pamphleteering. And you got to a stage where quite a large part of the population could read. And so they were reading. I think, well, good. They're better informed.

well, only if they're reading well-informed documents, preferably written by economists, of course. But they weren't. They were reading propaganda. They were reading pamphlets, which were lying. And, you know, you get the Gordon riots in the UK, which is the anti-Catholic riots in the late 1700s, coming out of complete nonsense being spread around. And then exactly the same thing with fascism, the National Socialism, the British Union of fascists, etc., in the 1930s. of course, in the United States. And very often what we find is that irrationality exploits new means of communication. So back in the first industrial revolution, the irrationality was through pamphleting and printing and the fact that you've got a literate artisan class and pamphlets were suddenly the Twitter of their day. In the 1930s, there was a Catholic priest

who was preaching over the radio in America, who was more popular than the president was, and he was spewing at this extreme, racist, anti-Semitic view of the world to an enormous audience, because he was very good at adapting the new media. And of course, we see this today. The technology and the communications that we have now, also now fake news and the dissemination of prejudice.

technology is very, very much a double-edged sword in this whole fight against prejudice. So the suggestion, as you mentioned previously, is that prejudice ultimately costs the economy and cost people in various ways. Could you maybe explain how we actually judge the opportunity cost of irrational decisions? I understand, you know, maybe in the first industrial revolution, if the Luddites were smashing a question, you could go around and taught up the cost of all these destroyed machines, and maybe you could try to estimate lost productivity for the economy. But as economies grow more complex, and as we enter this fourth industrial revolution, how do you actually go about estimating that opportunity cost? So this is where things become very, very difficult to put a precise figure on it.

we can construct the narrative, which explains clearly where the costs come through. And essentially, the costs come in two ways. Firstly, if you've got prejudice, you're not employing the right person, the right job at the right time. You're not maximising productivity. But secondly, also, your decision-making is flawed. Because if you've got a monoculture sitting around a table and making decisions, if all of your decision-makers are white, middle-aged, old Anglo-Saxon men, not that I've got an thing against middle-aged, old Anglo-Saxon men being one myself,

but if they're all the same, you're not going to get a well-rounded view of the world. You're going to miss things. You're going to miss opportunities and worse, you're going to miss risks. So those are your two costs, wrong people in the job and bad decision-making, particularly when you're turning the world upside down. So how can we quantify this? Well, the problem we run into is that people don't admit to being prejudiced. They lie about it.

It's known as the Bradley effect after a political candidate in the United States, who was African-American, who always was polling far higher in opinion polls than the votes he actually received when he ran for office. And it's because people don't want to admit to other people that they are racist, but in the privacy of a voting booth, they are happy to act on their principles, as it were. What you get is an underreporting of the level of prejudice. And of course, you also have difficulties in that some forms of prejudice can be invisible. So, for example, sexuality is a very good case where people may not be out at work. They may hide who they are at work.

And you say, well, that's fine. They're not subject to prejudice, but they are. Because if they're hearing homophobic jokes or slurs around them, or if they're having to think twice before they speak in any kind of social occasion, if they're constantly having to edit themselves, That puts an enormous strain on them, and it is clearly damaging for productivity. But trying to identify that, you can't go around with a clipboard and say, okay, which category do you fall into and how does that affect your productivity? So very, very difficult to quantify. What we can do is we can look at some markers like race, which give us some hints.

These are obviously, race tends to be a more visible form of prejudice, as does gender. Not always, but they are generally more visible forms of prejudice. and we can look at the costs that have come through from that. Or we can look at times when we've seen changing behavior and see what's come about as a result of that to get a sense of the economic cost of prejudice. So to give two quick examples, in the United States, you can compare racial diversity

in different states by different professions, and there's been some work done on this by academics, and what they've shown is that there is a significant increase in productivity in more creative roles that are more diverse. So by creative, I mean things like financial services, where you need people who are thinking around problems in complex ways. If you've got a diverse firm, if you're in a diverse state, the productivity of financial service employees in that area is significantly higher than an estate which is relatively monopulture. Another study that I looked at is,

is in Saudi Arabia. So Saudi Arabia has recently lifted some of the restrictions on women being entrepreneurs, made it easier for women to set up their own businesses. They don't need on male guardian to support them and so on and so forth. And what you have seen there is an explosion in the number of women setting up businesses and contributing positively to the economy. I mean, Saudi Arabia is leading the world in female business creation at the moment because these restrictions have been lifted. But what that's telling you is just how much economic activity was being lost when they had these restrictions in place in the previous years. Let me ask you a question about the sort of upshot of your work or the consequences, because

it's all well and good to say things like prejudice, discrimination are costly, that firms that don't make an effort to change their ways and suffering. But, you know, to me, this sounds or this could sound a little bit like a sort of, I don't know exactly the term a little bit. You know, I remember this sort of like petty optimism of the late 90s where we thought that like free markets and if we reduce barriers to trade and deregulate and everything, we'd have all this world peace and stuff because people would find that it was, you know, the incentive was to trade instead of go to war and then that didn't really pan out like people expected. Other policy upshots that follow then from your work in terms of the government or regulators stepping in to correct this imbalance,

or is it in your view that of firms were more aware of the profit potential of making better decisions or having better decision makers would get better out? So I think the issue here is that there is a split. I believe that, large global businesses get this. They understand the issues around prejudice. They understand the damage that it does. And as a result, they are playing a more active role in fighting prejudice, for example. So fairly early on in my work on prejudice, I was writing on the economics of marriage equality because UBS was filing amicus brief before the US Supreme Court saying, yes, we want marriage equality because it will mean that we will be a better business.

Plus, obviously, it's morally the right thing to do. But the point was, we were taking a clear stance on this. And so I think global firms understand this because they're dealing with multicultural employees because they are looking to profit maximise, because they're always looking at ways to make their employees more productive. where I think the real danger is, is that with smaller firms, this is not necessarily always so obvious that you may be in a relatively homogenized community or you think is a relatively homogenized community and you may miss out on the upside. You may not realize that this upside exists. And if there isn't an imperative to sort of push you in this direction, then you may continue to make bad business decisions. which are damaging to the economy, which are damaging to your business, damaging to society at large.

So the US actually has a very good example of this from baseball, which as I understand it, is a sort of inferior form of cricket that's quite popular in the United States. I knew that was coming. Well, what happened is in the 1940s, baseball was segregated. Teams were segregated on racial lines, which is just insane. and then it desegregated. And a relatively small number of teams became integrated racially. And over the next decade, those teams outperformed in every possible way.

They played better. They won more games. They had more spectators. And consequently, they made more money. But it still took over a decade after you could voluntarily desegregate for the racist teams to start to become racially integrated teams. They continued with racist recruitment policies for years, even when it was blindingly obvious

that it was doing damage to their business. So I think that there is, there's a mix here that you've got the profit motive and the profit incentive and so on, and that's clearly going to be very useful, but then there is also a need, I think, for government to take action. And after all, when we're talking about government taking action,

What we're talking about here is treating everybody the same, saying no one group in society is less than another group. That's all we're talking about. It's not a huge ask, frankly, overall. And if that's your guiding principle, then I think that there is a need for government to nudge in that direction. So there's a broader economic implication here as well, which is that if you think about the past 10 years or so, the global economy has really been marked by this. sluggish productivity, which has in turn fed into low inflation and relatively low GDP growth. The implication, as I understand it, is that if you do away with prejudice, then you might end up boosting productivity and generating economic growth in one of the few ways that are sort of left

to us. Is that right? I think so. I mean, there's actually two possibilities here. One is, is that as we become more efficient, we create more growth. The alternative is that as we become more efficient, we stop using environmental credit, environmental resources in an unsustainable way. And I think we'll probably end up with a mix of the two, that we will end up becoming more environmentally efficient, which doesn't necessarily mean more growth, but it means we maintain our existing standard of living without doing so much environmental damage, or alternatively, we create a certain amount more growth in terms of living standards. Now, I think it's certainly the case that GDP, which is widely regarded in the economic profession as a rather outdated

statistic, may not capture everything that we're talking about here in terms of the efficiency and the changes. And this is something that we've known about for some time, that GDP is not well-suited to the 21st century. It was designed to maximize wartime production in the 1930s. It's not really suited to where we are now. So we may not necessarily see this in the GDP data, but we would end up with people having a higher standard of living in the future if we minimize prejudice.

We're never going to get rid of it. I mean, everybody is prejudiced, but we can try and minimize it as much as possible, make people aware of it as much as possible. And by doing that, we do create a more efficient society which maintains or improves our living standards whilst doing less overall damage to the planet. I'm curious what you think about.

I'm not actually sure over there, like how the Bank of England has thought about this question, but obviously here, the Federal Reserve in the last several years has taken a keener interest, I would say, on the unemployment gap between different races and this idea that's sort of late in the expansions, we started to see the benefits of an economic recovery spread out to previously marginalized groups. And prior to COVID, we saw it started to see a real acceleration in the lack unemployment rate in the U.S. Do you see implications and benefits from policymakers, including central bankers, taking a more expansive view of the benefits of full employment, and how to define employment and so forth by thinking more concretely about these gaps when

setting policy or when, say, thinking about when to tighten interest rates? Well, at the risk of sounding like a traditional economist, yes and no. So, yes, clearly unemployment matters. We know that if you've got better household income, you're particularly children in that household, will have better opportunities, education-wise, and things like that, all extraordinarily important. But to focus just on income is actually misguided. Because what we tend to find is that prejudice, and particularly more extreme forms of prejudice, it's not really about income and relative income. It's about social status. Now, of course, income and social status

are tied together. It varies from country to country, perhaps more closely tied in the United States than in the United Kingdom, but they are tied together. But there is a difference here. And what we tend to find is that if you're seeing big shifts in terms of relative income, then you'll get a bias towards what a European would call social democratic policies. So center-left policies, redistribution policies. But if you've also got a loss of social status, the income doesn't offset the loss of social status. And people, then turn to more extreme forms of politics. And that's where you get either extreme left or extreme right, populism for want of a better word. So I think that central banks can do quite a lot in this

regard in terms of trying to mitigate the damage. And certainly for the longer term, where things like equality of opportunity, getting the right education, that can be a very, very big thing. But central bank policy is not necessarily that well equipped to deal with. with social status over time. And so that, I think, is going to be one of the challenges that is going to be thrown up over the next few years, you know, that if you're a lawyer's clerk, for example, who's worked hard at school and studied to get that position and your social status is going down because your employment prospects are going down because your job's being automated away, you know,

there's a limit to what the Federal Reserve can do. Well, Paul, absolutely fascinating topic. And I mentioned in the intro that this was actually something you were paying attention to many, many years ago back in 2011. And you've followed through on it to write the new book. So thank you very much for joining Joe and myself to talk about it. Thanks, Paul. That was great. So, Joe, I know there's sometimes a tendency to think about prejudice or I guess. I guess diversity initiatives as the sort of corporate fluff. But I think Paul does lay out a very compelling, you know, rational argument for why companies and economies should be looking at this. And in particular, this idea that most of our future growth is probably going to become,

come through productivity improvements. And one of the ways we can improve productivity is by being more efficient with our human labor capital in addition to our, you know, machine-based capital. And by the way, I'm very, I'm aware that calling people human labor capital is a terrible thing. So forgive me for doing that. People. People. No, I mean, I think that's right. And I think, yeah, I've been thinking about economics for too long. I think, you know, Paul's arguments and his historical analogies, they're super interesting and compelling and sort of like thinking about like the sort of irrationality of people who only have access to part of the picture is a sort of very useful frame.

But I think, like, you know, I'm still, like, hung up on the solutions or, like, what the upshot is, because it doesn't seem like enough to just acknowledge that or for, like, more companies to, quote, get it. I think that, like, you know, there's still a good argument for, like, yes, but in the meantime, you know, give people money. You know, sort of going back to the original question or, or more explicitly, you know, sort of my question about like the Federal Reserve, it's like there are all kinds of issues. Like, yes, we can't solve prejudice. It's never going to go away.

There's more things to life than employment and income, but also employment and income are really good. Yes. Yeah, you know what I'm saying. Yeah, but also, I mean, I think we can agree that probably, you know, 15 or 20 years ago, we wouldn't have been having a conversation about economics and prejudice and what a central bank can do to diminish social injustice. Like, that just wouldn't have happened. So the fact that we're having this conversation already suggests that we've come a long way, or at least we're entering perhaps the start of a new economic paradigm.

Again, what we've been discussing all year, this notion that the events of 2020 have really accelerated some shifts that we've already seen in traditional economics. No, I completely agree. And I think like the fact that so many like traditional quarters of the economic world are talking about this, I think it's huge. And again, like going back to the Fed, like this was like a major thing under the Powell Fed and also under Yellen, like talking about economic inequality, sharing the benefits. of prosperity and they're being good long-term things to come from when prosperity is shared, I think is like one of the most promising things. And so the fact that it's coming from mainstream quarters, I think is encouraging. Yeah.

The idea that economics should ultimately improve people's well-being. Who knew? Okay. Should we leave it there? Crazy. I know. Outlandish. All right.

Let's leave it there. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthall. You can follow me on Twitter at The Stallwart. And you should check out our guest's book, Paul Donovan. He is the author of Profit and Prejudice, the Luddites of the Fourth Industrial Revolution. And here's something special.

Listeners to Odd Lots can get a 25% discount on the book if they go to the Rutledge website for the book and use the code, OL25. That discount applies to either the hard. hardback or the e-book version. So check it out and get a discount. Also, be sure to, in the meantime, follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy at Francesca Today. And check out all of our podcasts under the handle at podcasts. Thanks for listening.