Saturday, December 31, 2011

How should we measure progress?

There seems to be a lot of talk about progress, or lack of it, at the end of each year. I tend to get caught up in this even though a year is far too short a period to measure the kind of progress that most interests me.

Two years ago I wrote a post entitled ‘What is progress?’ This was the first post I had written with the ‘progress’ label on it. At the time I intended to read several books and articles relating to the concept of progress and then to write something more definitive about the meaning and measurement of progress.
Since then I have read several books and articles about progress – from an historical perspective and looking towards the future – and have written 38 posts related in some way to the concept of progress. However, I don’t think I have written anything as definitive as my first post on this subject.

The main point I made in that first post about progress is that if progress is to have any meaning from a public policy perspective it must mean movement toward a good society or movement from a good society to a better society.

A fairly obvious response that might come to mind is that it could be just about as difficult to define what we mean by a good society as to define what we mean by progress. As things happened, however, I had just spent a few months in 2009 thinking about the characteristics of a good society.

I had reached the conclusion that just about everyone should be able to agree that a good society is good for its individual members. Such a society would enable its members to live together in peace. It would provide its members with opportunities to flourish. It would also provide its members with some security against threats to their flourishing. I had also come to the conclusion that these characteristics of a good society are measurable.

It follows, or so it seems to me, that the best way to measure progress is to bring together relevant indicators of the peacefulness of societies, opportunities for flourishing (including consideration of economic, environmental and social capital indicators) and security (including consideration of security against misfortunes such as ill health and unemployment).

The approach I am suggesting is similar to that followed by the Australian Bureau of Statistics (ABS) in its ‘Measure of AustralianProgress’ (MAP). The difference is that ABS offers a smorgasbord of social, economic and environmental indicators which could, in principle, cover everything that anyone has ever suggested might have some relevance to the question of whether life is getting better. I think attention should focus on indicators that nearly everyone would agree to be closely related to important characteristics of a good society.

I strongly support the ABS’s approach of recognizing that progress is multidimensional and refraining from any attempt to combine indicators into a single measure. It seems to me that so called ‘genuine’ progress indicators which reflect the value judgements of individual researchers relating to such matters as income distribution and environmental values are useless. The relative importance of progress in various dimensions must remain a matter for public discussion and judgement by individual citizens. If a collective judgement is required about the priority that should be given to various dimensions of progress, we have constitutional processes including elections and parliamentary processes to perform this task.

Since the combining of progress indicators must involve individual value judgements, why not just ask individuals to make an evaluation of their own lives (on a scale of 1 to 10), combine these evaluations in some way and use this as our measure of progress? There are several problems with measurement of subjective well-being in this way, as discussed elsewhere on this blog. As I see it the main one is in ensuring that respondents have an appropriate benchmark in mind for measuring progress when they make their evaluations. If you ask people to assess their own lives relative to ‘the best possible life’ as in the Gallup surveys, the results of successive surveys cannot provide a measure of progress because perceptions about ‘the best possible life’ can be expected to rise as a result of progress. If I am climbing a ladder that is attached to a helicopter, my height above sea level depends on the height of the helicopter as well as on my ability to climb the ladder.

So, I think our measurement of progress should focus on widely accepted criteria that are relevant to the question of whether we are making progress toward more peaceful societies that offer greater opportunities and more security. There is also a more fundamental question, however, of whether the institutional drivers of progress – for example, institutional factors leading to productivity improvements - are also moving in the right direction. Perhaps I should write more about that next year.

Monday, December 12, 2011

Have important factors been omitted from the HALE index of well-being?

The aim of the Fairfax organization in sponsoring the development of the Herald/Age - Lateral Economics (HALE)  index of the well-being of Australians seems to have been to publish a broad indicator of social progress in the hope that this will help people to avoid viewing GDP as ‘the supreme indicator of our wellbeing’.

In contrast to some previous attempts to create ‘genuine’ progress indexes for Australia, which seem to have been aimed at maximizing the weight placed on possible negative spillovers associated with economic growth, the authors of this index seem to have adopted a fair-minded approach. However, I still have some concerns about the methodology adopted. I discussed one of those concerns in my last post – namely that it would be desirable for the index to take into account changes in uncertainty about the economic situation if it is to be taken seriously as an indicator of short term changes in well-being. In this post I want to identify important factors that have been omitted from the HALE index that might affect its use as an indicator of longer-term changes in well-being.

It seems to me that the most important factors affecting individual well-being are social capital (respect for person and property, quality of governance, individual safety, inter-personal trust) national security (peacefulness of the international environment, relations with other countries, security threats) physical and financial capital (financial wealth, housing, infrastructure, indebtedness, economic security) human capital (skills, health, personal relationships and emotional well-being) and natural capital (natural resources, environment). The relatively importance of different factors must ultimately be a subjective judgement, but this does necessarily mean that all important factors are taken into account when people are asked to rate their satisfaction with their lives. For example, there is empirical evidence that even though personal safety is obviously fundamental to individual well-being its contribution to measured life satisfaction is negligible in Australia (see, for example, a study I have undertaken using the Australian Centre on Quality of Life data set). One possible explanation is that most people feel so safe living in Australia that safety concerns do not even register in their minds when they are asked about their life satisfaction.

The most obvious omissions in the HALE index are social capital and national security. Those factors are unlikely to affect well-being much from year to year, but their impact over several decades could be substantial. For example, looking back over the last 40 years, there has arguably been a substantial improvement in the well-being of Australians as a result of improvements in relations among countries in the Asia-Pacific region.

Some less obvious omissions in the HALE index may also be important. The starting point of the index, net national income, reflects some flows of services from human, physical, financial and natural capital and one source of change in capital stocks (net investment in physical capital). Subsequent adjustments to take into account changes in environmental capital and human capital are presumably aimed at measuring changes in capital stocks more comprehensively to obtain a comprehensive income measure (based on the Haig-Simons definition of income i.e. consumption plus change in net wealth). I use the word ‘presumably’ because change in human capital from improvements in school education is measured in terms of the estimated effects of an improvement in current PISA scores on long-run GDP, without any discounting to take account of the passage of time required before improved PISA scores could possibly be reflected in the human capital of members of the labour force. It seems to me that, rather than fluctuating widely depending on literacy and numeracy skills of the current crop of school children, the value of human capital stocks probably changes gradually over time as people with differing skill levels enter and leave the labour force.

The market values of some forms of wealth obviously fluctuate fairly widely from year to year, but this is not taken into account in the methodology used in calculating the index. Changes in the value of financial capital and housing are ignored in calculating the index. This raises the question of whether the effects on well-being of such unrealized capital gains and losses are as great as for changes in current income. My feeling is that they are probably not as great. Investors are likely to view capital gains and losses in a different light to changes in dividends. Home owners who obtain unrealized capital gains on their homes would probably not generally feel that there has been much change in their well-being – their home still provides the same services to them as it did previously. Their lives probably remain largely unchanged unless, of course, they run down their liquid assets of borrow funds in order to spend their capital gains.

However, this brings me to what seems to be an important omission in the HALE index - it doesn’t make any allowance for changes in debt levels. Well-being is more closely related to net wealth than to total physical and financial assets. Looking at Australia as a whole, debts cancel out to a large extent – the liabilities of one person are the assets of another – but they do not cancel out completely. Changes in net foreign debt levels may have important implications for the average well-being of Australians. Changes in interest rates on foreign debt should also be taken into account because they influence the extent to which current income is available for purposes other than debt servicing.

Research by the Australian Centreon Quality of Life several years ago shows that people who have difficulty in repaying debt tend to have lower subjective well-being than those who do not have such problems (Survey 11, Report 11, August 2004). In the light of current debt problems in many developed countries it seems remarkable that happiness researchers have not given a great deal more attention to the effects of excessive debt on personal well-being. 

Saturday, December 10, 2011

What factors should be taken into account in assessing short term changes in well-being?

This is one of the questions I have been pondering as I have been reading about the Herald/Age - Lateral Economics (HALE) index of the well-being of Australians.

The aim of the Fairfax organization in sponsoring the development of this new index seems to have been to publish a broad indicatorof social progress in the hope that this will help people to avoid viewing GDP as ‘the supreme indicator of our wellbeing’.

The timing of publication – a few days after quarterly GDP data are published – is clearly intended to invite comparison with quarterly GDP data. Indeed, a report in the Sydney Morning Herald makes such a comparison:
‘Wellbeing grew twice as fast as GDP in the September quarter thanks to a big rise in national income from the boom in commodity prices and cheaper imports’.

The HALE index rose by 2.2% in the September quarter primarily because net national income (NNI) is the starting point for calculation of the index and NNI reflects terms of trade movements. I don’t have any problem at all with the idea that well-being is more closely related to NNI than to GDP, but I can’t help thinking that the relationship between well-being and short term fluctuations in the terms of trade must be tenuous, at best.

Perhaps the terms of trade improvement in the September quarter raised the well-being of some people by enabling them to enjoy an overseas holiday that they might not otherwise have been able to afford. People who purchased imported consumer durables might also have benefited. In general, however, it isn’t obvious to me that changes in the terms of trade have much effect on living standards unless they are sustained over several years. It is even possible that short term improvements in the terms of trade could have a negative impact on well-being by adding to uncertainty in the context of concerns about possible effects of increased import competition on jobs in some industries. Such impacts might, of course, be offset by optimism about improved employment prospects elsewhere in the economy.

It seems to me that uncertainty is a factor that should be taken into account in assessing short term changes in well-being. Research based on surveys data relating to subjective well-being suggests that increased uncertainty can have a substantial short-term impact on well-being. For example, Carol Graham has reported that average life satisfaction in the US fell by 11% during the 08-09 financial crisis, mirroring a larger fall in the stock market. However, life satisfaction bounced back to previous levels once the immediate crisis was over, even though the stock market remained relatively depressed (‘The Pursuit of Happiness’, pp 88-89). A fall of 11% in life satisfaction is a very large change in a statistic that is normally very stable over time.

In an earlier post I noted that there was even a blip in life satisfaction data for Australia at the onset of the global financial crisis. A much larger decline in consumer confidence occurred at that time reflecting, amongst other things, increased pessimism about the economic outlook for the next five years. Pessimism about the economic outlook hasincreased again over the last year or so and now stands at levels almost comparable to those during 08-09.

If the HALE index is intended to be taken seriously as an indicator of short term changes in well-being it seems to me that it would be desirable for it to reflect changes in uncertainty about the economic outlook.

Thursday, December 8, 2011

Is there a house price bubble in Australia?

An article in ‘The Economist’ last week suggests that the ‘bursting of the global housing bubble is only halfway through’ (‘Economics focus: House of horrors, part 2’, November 26, 2011).  On the basis of the measures used, the authors claim that home prices are over-valued by 25% or more in Australia, Belgium, Canada, France, New Zealand, Britain, the Netherlands, Spain and Sweden.

How did the authors arrive at this conclusion? Two measures of valuation were used in the analysis: the house price to income ratio, which is a gauge of affordability; and the house price to rent ratio, which reflects the relationship between house prices and the benefits of home ownership i.e. rents earned by property investors and rents saved by owner-occupiers.

The reasoning seems OK so far. If the price to income ratio is above an appropriate benchmark of affordability and the price to rent ratio is relatively high compared with an appropriate benchmark of returns available from owning other assets, then there might possibly be some grounds to suspect the existence of a housing bubble.

The critical issue is what benchmark should be used to make such comparisons. ‘The Economist’ asserts: ‘if both of these measures are well above their long-term averages, which we have calculated since 1975 for most countries, this could signal that property is overvalued’. In the chart below I have graphed the data from the table that the authors use to make their assessment.

The chart shows that the price to income and price to rent ratios for a heap of countries, including Australia, are well above long-term averages for the period from 1975 to the present. I think mean reversion (sometimes referred to as regression to the mean) deserves some respect. If we don’t have good reasons to expect a variable to remain substantially above or below its long term average at a particular point, it is often sensible to assume that deviation from the mean is more or less random and that the variable is more likely to return to the mean than to remain at extreme levels.

So, do we have good reasons to expect rental yields (the inverse of the house price to rent ratio) in Australia to remain below their long term average for the period since 1975? In order to answer this question it might be helpful to consider the level of rental yields in Australia at present and how much capital appreciation (expected growth in house prices) is implicit in current rental yields. The underlying reasoning is that if potential home buyers – including investors - perceive that there is likely to be substantial capital gain in the years ahead they will tend to bid up house prices to a greater extent (other things being equal) and thus tend to depress rental yields. You need to work out how much capital appreciation they anticipate in order to assess whether or not their expectations are excessively optimistic.

Current rental yields in Australia - of the order of 3% to 4% in net terms – do not seem to me to imply unduly optimistic expectations about future capital appreciation if we use an annual nominal return on investment of say 8% per annum as a benchmark. One way of looking at this is to ask yourself whether you would expect average house prices and rentals to grow more or less rapidly than nominal GDP. I expect average house prices and rentals to grow more rapidly than nominal GDP in Australia because the effects of growth of population and incomes will tend to intensify the locational advantages of the median house relative to houses in the outer suburbs. A recently published Reserve Bank research discussion paper by Mariano Kulish, Anthony Richards and Christian Gillitzer  (‘Urban Structure and Housing Prices: Some Evidence from Australian Cities’) uses a model to illustrate, among other things, how growth in population tends to raise house and land prices to a greater extent in suburbs that are closer to the CBD of large cities. This is consistent with the empirical evidence presented in the paper that house prices in the inner suburbs in Australia rose by about 1.3% more per annum more than in the outer suburbs over the period 1992/3 to 2009/10.

Why are rental yields in Australia currently so much lower than the long term average over the period since 1975? The most plausible reason, it seems to me, is that as in many other countries high nominal interest rates (reflecting high inflation rates) were suppressing demand for housing over the first half of that period. As inflation rates and interest rates came down, housing affordability improved markedly during the 1990s, but this led to increased demand for housing, a sharp rise in house prices and a decline in rental yields. Mean reversion doesn’t apply in this instance because the mean was distorted.

Why should we expect house prices in Australia to avoid the fate of house prices in the US in recent years? Luci Ellis of the Reserve Bank gave some reasons why the US housing market is different in a speech she made last year. Unlike other developed countries, mortgage arrears on home loans in the US started to rise in 2006, more than a year before the unemployment rate began to rise. The leverage of the housing stock in the US was substantially higher than in Australia before the global financial crisis.

In addition, the decline in housing prices in the US that resulted from the bursting of the housing credit bubble was exacerbated by deflationary monetary policies that led to a major recession. This suggests to me that current rental yields in the US (of the order of 8% to 12% in some areas) should be viewed as being extraordinarily high at present and unlikely to persist in the longer term.

The final sentence of the article in ‘The Economist’ states: ‘A credit crunch or recession could cause house prices to tumble in many more countries’. Well yes, that does seem quite possible. If it does happen, however, I think there is a good chance that rental yields in Australia will eventually return to somewhere near the ‘normal’ levels that currently exist in this country.

Sunday, December 4, 2011

What is the inner game of stress?

‘The Inner Game of Stress’, by Timothy Gallwey (with Edward Hanzelik and John Horton) is the latest of a series of inner game books.Tim Gallwey has previously written books about the inner game involved in several sports, including tennis and golf, and the inner game of work - based on his experience as a coach and trainer. Hanzelik and Horton are medical practitioners who conduct stress seminars drawing on their understanding of the inner game as well as on their medical knowledge.

I think it would be fair to say that all of Gallwey’s books are to a large extent about avoiding the adverse effects of stress on our ability to function. This book is as much a pleasure to read as Tim Gallwey’s other inner game books. Gallwey is an expert in getting his message across by telling interesting stories based on his own personal experience. I have read all but one of his books. I wrote an article a few years ago describing how the books had helped me in dealing with a stress-related problem.

The main point in this book is that stress involves an inner game as well as external stressors. The inner game arises largely from trying to live with illusions about our own identities. It is as though an internal ‘Stress Maker’ has stolen our identities and substituted an illusion in order to create fear, doubt and confusion. The illusions woven by the ‘Stress Maker’ originate from the concepts, perceptions and expectations of other people.

The great strength of the inner game approach, it seems to me, is that it encourages the belief that each of us has a real identity (a natural self) that we, as individuals, are ultimately responsible for developing. Other people may see our identities as illusions that we have created in our own minds, but we should know better. We know intuitively how to be who and what we are when we recognize our inner resources and the opportunities for learning and enjoyment that are available in association with pursuit of our performance goals. We can learn to trust ourselves to function more successfully.

The book provides practical guidance on how to break the momentum of stress – how to stop and become aware of what you are trying to control and what you can control. It discusses the potential we have to liberate ourselves from illusions by re-assessing the meaning of experiences.

From what I have written, some readers might be concerned that the book might encourage people to become too self-centred – to question the social norms that were instilled in them during childhood and to pursue their own interests at the expense of other people. I think such concerns are misplaced. People don't question norms that they have internalized - adherence to such norms is a matter of self-respect rather than fear. The book recognizes that it is important for individuals to have deep relationships with others. One of the exercises in the book involves seeing problems in a relationship from the perspective of the other person – to understand what they may be thinking, feeling and wanting.

Much of the advice presented in the book is based on individual case studies rather than experiments involving large numbers of people. I don't think that is a huge problem as long as the readers who try the exercises suggested in the book approach them as though they are conducting little experiments of their own. That is consistent with one of the themes of the book, which is to encourage readers to become more aware of what they are doing at present and of the effects of doing things differently.

It is possible that this book, and Tim Gallwey’s other inner game books, may benefit some people more than others. On the basis of my own experience, all I can say is that the ideas in Tim Gallwey’s books have served me well.

Anyone interested in learning more about the effects of stress on the body should click here to see a useful interactive chart.

Thursday, December 1, 2011

Does the modern world make us feel like powerless creatures in the coils of an invisible monster?

‘What most alarms us in our contemporary world, what unsettles and scares us, is the extent to which the forces that shape our lives are no longer personal – they know nothing of us; and to the extent that we know nothing of them – cannot put a face on them, cannot find in them anything we recognize as human – we cannot deal with them. We feel like small, powerless creatures in the coils of an invisible monster, vast but insubstantial, that cannot be grasped or wrestled with.’ 
That quote seems to me to sum up the main point that David Malouf was making in: ‘The Happy Life; The Search for Contentment in the Modern World’, Quarterly Essay, March 2011.

In the paragraphs preceding the quoted passage, the author argues that it is possible for humans to be happy even in the most miserable conditions if they perceive their world as having human dimensions. He explains that a world with human dimensions is one that humans can recognize and encompass. In his words:
‘We start always from the body, and relate everything back to it. In a way that goes back to our most primitive beginnings, we use it to establish direction – where we are facing, where we might move to; to gauge distance – how far off an object is and how far we have got along the way towards it; to determine how each thing we are observing stands in relation to our own being – its size in relation to ours, how light or heavy it is when we try to lift it or weigh it on our palm; how much it occupies of the space we share; how it smells and tastes, how it feels to the touch or when we roll it between finger and thumb’.

I feel in awe of people who manage to maintain tranquillity in the most miserable conditions. It is probably correct to say that such people do experience the sources of human misery as having human dimensions – they feel uncertainty, discomfort, pain, fear and anger just like the rest of us – but they are not overwhelmed by such feelings. The fact that they have normal human feelings doesn’t mean, however, that they necessarily see major sources of human misery – extreme climatic events, for example – as having human dimensions.

Irrespective of their capacity to maintain tranquillity in the face of misfortune, our ancestors saw God (or the gods) as the most likely explanation for extreme climatic events – and just about everything else they experienced. Malouf acknowledges this, but he suggests that when we were in the hands of the gods we had stories that made these distant beings human and brought them close. Of the gods, he writes:
‘They watched over us and were concerned, though in moments of wilfulness or boredom they might also torment us as “wanton boys” do flies. We had our ways of obtaining their help as intermediaries. We could deal with them’.

By contrast:
‘The Economy is impersonal. It lacks manageable dimensions. We have discovered no mythology to account for its moods. Our only source of information about it, the Media and their swarm of commentators, bring us “reports”, but these do not help: a possible breakdown in the system, a new crisis, the descent on Greece or Ireland or Portugal, like Jove’s eagle, of the IMF. We are kept in a state of permanent low level anxiety broken only by outbreaks of alarm’.

I admire David Malouf’s writing style, but I have a couple of problems with this line of reasoning. First, personal gods left good people bewildered as to why bad things were happening to them. Remember the biblical story of Job, the virtuous man who suffered from ‘acts of God’. Job was not a happy chappy – he cursed the day he was born. My reading of the story is that Job tried to deal with God, but that didn’t work. Job found tranquillity only after he accepted that God was not a person that he could deal with. He had to learn to accept that some factors affecting his life were beyond his capacity to understand and influence.

Second, many people seem to have difficulty in accepting that economic forces are impersonal. Economic crises, in particular, are often viewed in very personal terms – for example, in terms of the excessive greed of human agents, such as Wall Street bankers, or even in terms of conspiracies involving bankers and politicians. Modern conspiracy theories have their demons (and super-heroes) in much the same way as ancient religions had their personal gods.

One of the features of the modern world is that the role of the personal gods has tended to be displaced impersonal scientific explanations of the forces that shape our lives. Do these scientific explanations leave people feeling unsettled? I don’t think so. Psychological evidence discussed by Timothy Wilson (in his book ‘Redirect’, discussed recently on this blog) indicates that people who are affected by negative events tend to feel worse when they are uncertain about the nature of those events and why they occurred.  Reducing uncertainty about negative events is a good way to bounce back from those events.

It seems to me that it is the uncertainty associated with recent economic crises that has made them particularly unsettling. With the onset of the global financial crisis there was a great deal of public discussion among economists about the inadequacy of existing scientific explanations of what was happening. When leading economists admit that they can’t understand an economic crisis, other people have good reason to feel unsettled. Over the last couple of years, however, there has been growing support among economists for the idea that (unconventional) monetary policy can be influential in shaping expectations about the growth of aggregate demand, even when interest rates are very low. This provides grounds for optimism that the world will be able to avoid a major economic downturn over the next few years. (At the same time, as I suggested in a post a few weeks ago, there are still some grounds for concern that the European Central Bank will maintain deflationary policies that will exacerbate the financial crisis in Europe and impact adversely on the world economy.)

More robust scientific explanations of economic crises could be expected to help the people who have adversely affected to adjust to their misfortune, but would they not still feel like small, powerless creatures in the coils of an invisible monster? Quite possibly.  Yet, a better understanding of the economic forces involved may give them reason to hope for better outcomes in future. A surfer who is dumped by a wave might feel like a powerless creature in the coils of a monster, even if he has some understanding of wave mechanics. But his understanding of why he was dumped might give him reason to hope that in future he is more likely to experience the exhilaration of riding the wave.

Tuesday, November 29, 2011

Why occupy Sydney?

‘So, you think I am in favour of occupying Wall Street, do you? What makes you think that?’

I knew it was Jim as soon as he spoke, but it took me a moment to work out where his voice was coming from. When Jim wants to have a discussion with you, he seems to appear from nowhere and just start asking questions. I suppose he thinks that gives him some kind of advantage. It doesn’t work! Everyone I know just ignores his opening questions and goes through the usual preliminaries of saying hello and asking after his health while they compose a response.

Jim had obviously read a brief comment on my last post in which I had speculated that he might be in favour of occupying Wall Street, but not Sydney. I reminded Jim about our previous discussions about banking and limited liability. In our previous discussion about banking Jim had suggested that it was a scam for banks to promise to repay deposits on demand even though they knew that they would be unable to meet that promise if all depositors asked for their money at the same time. In our discussion about limited liability, Jim had suggested that it was wrong to allow owners of banks to gamble with borrowed money, secure in the knowledge that if their gambles do not pay off then the most they stand to lose is the value of their shares. I also mentioned that when banks have been declared by governments to be ‘too big to fail’, bankers have a strong incentive to take abnormal risks because they know that they will be bailed out by governments if they make large losses. I ended by telling Jim that I could picture him in Wall Street carrying a placard saying ‘Bankers are Wankers!’.

Jim seemed satisfied with my explanation, but when I had finished he asked: ‘So, doesn’t all that apply to Australia as well as the US? Don’t you think I should be in favour of occupying Sydney, too?’

I tried to explain that prudential regulation seems to have worked reasonably well in Australia, so there doesn’t seem to be much to protest about in terms of the way the financial system is working in this country.

Jim’s response was quite robust and is not quotable verbatim. After deleting expletives I think the message he was giving me was that although I tell people that I am a libertarian, he thinks I am actually a neo-socialist because I am in favour of some prudential regulation of the finance sector. (Jim can call me a neo-socialist if he likes – it makes a change from being called a neo-liberal. My views on banking regulation are actually fairly close to those of Adam Smith, so I am in good company.) Jim ended his outburst by telling me that while I was entitled to my own views, I should refrain from misrepresenting his views.

‘Well, does that means you actually support the Occupy Sydney movement?’, I asked.

Jim didn’t respond for a long time. Eventually, he asked, ‘What are the Occupy Sydney people actually on about?’ I wasn’t sure, but I suggested that the main theme of the Occupy movement all over the world seemed to be the injustice of unequal distribution of wealth and power – particularly the idea that the top 1% of the population in many countries tend to benefit disproportionately from economic growth.

‘And who do you think is responsible for that?’ Jim said. ‘It is the 99% who are responsible for making the 1% wealthy. We make a few film stars fabulously wealthy by going to the movies that they star in. We make a few sporting heroes fabulously wealthy by watching the games they play and buying the products they endorse. The same system applies in the business world. The CEO of a successful company develops a reputation as a star performer just like film stars and sporting heroes. Successful companies are only successful because the 99% buy the goods they produce’.

‘So’, I said, ‘you don’t think there is anything to protest about?’
Jim said, ‘No, that’s not what I mean. The Occupy Movement should be protesting about celebrity culture and the vacuousness of consumerism. They should be poking fun at the idea that a good is worth buying just because it is popular and that entertainment is worth watching just because the performer is a star. They should be asking people whether they actually get pleasure by helping Kim Kardashian to become wealthier’.

I was left wondering why Jim was picking on Kim Kardashian. One possibility that crossed my mind is that she might have green hair. Jim doesn’t like green hair.

Wednesday, November 16, 2011

Does Sophie know she is dumping on free trade?

When Jim asked me to have a drink with him I didn’t expect to be just sitting there watching him read ‘The Australian’ - and certainly not one that was a couple of days out of date. But when I looked more closely, he wasn’t actually reading. He was just scanning as though he was looking for something.

‘Ah, here it is’ he said at last. ‘What do you think of Sophie Mirabella?’

Sophie Mirabella is the federal opposition spokeswoman on innovation, industry and science. I told Jim that I thought Sophie was a clever lawyer. I said I would rather have her on my side of the argument than as an opponent.

‘What about the dumping issue?’ Jim asked.
I said that in my view she was out of order when she dumped on Julia Gillard a few months ago by comparing her to Muammar Gaddafi.

Jim replied: ‘Nah, I mean anti-dumping policy – preventing foreigners from selling goods here at prices lower than they charge in their home markets. Sophie writes here that dumping seeks to exploit Australia’s commitment to free trade and is a distortion of our domestic market’.

‘That’s crap!’ I said. ‘It is quite normal for firms to be able to sell goods in their home markets at prices that are higher than they can obtain in international markets. How could our domestic market be distorted by importing goods at the world price?’

Jim ignored my response and read on. After a minute, he said: ‘Sophie says that when Abbott comes to power she is going to provide for preliminary affirmative determinations (PADs) to “create a shift in the balance of anti-dumping investigations, requiring the foreign producer to prove its conduct hasn’t hurt the Australian industry”. What do you think of that?’

It was hard to know where to start. I could have said it seemed to me to be a peculiar legal principle to ask anyone to prove something that they are not capable of knowing. Instead, I reflected a little on the difficulty that lawyers often seem to have in coming to terms with economic issues. I said: ‘I think Sophie makes the same mistake that a lot of lawyers make when they get involved in economic issues. They see an economic practice that they can’t understand and assume that it must be unfair. In this instance, they see firms selling in export markets at a lower price than in their home markets and jump to the conclusion that they are engaged in some kind of unfair practice, such as predatory pricing. They don’t consider that the firms might be able to obtain higher prices on home market sales because of brand loyalty and other home market advantages. Her efforts to shift the balance in favour of domestic industry will just encourage the rent seekers.
Jim replied: ‘You don’t have a very high opinion of the ability of lawyers to understand economics, do you?’

When I protested to the effect that I think some lawyers have an excellent grasp of economics, he asked me to name one. The name that came to mind immediately was Richard Epstein. (Actually, that stretches the truth a little. I find that names rarely come to mind immediately. Richard Epstein’s name came to mind after just a moment’s reflection.)

Jim asked: ‘So, what does Richard Epstein say about anti-dumping policy?’ I mentioned that I had recently read a short article he wrote about the concept of fair trade that seemed relevant. I suggested that Epstein had made the point that it doesn’t make sense to view business practices in international trade as unfair that would be considered quite normal in inter-state trade within the United States. (When I just re-read Epstein’s article, ‘The “Fair” Trade Delusion’, however, I find that he didn’t quite use those words. And he seems to be implying that FTAs promote free trade – which is hard to sustain. But I am digressing - and at risk of spoiling my story!)

Jim’s line of questioning then took a surprising turn. He asked: ‘Do you think Craig Emerson would understand that the benefits of inter-state and international trade are basically the same?’

Craig Emerson, the current Minister for Trade, has a PhD in economics from a respectable university and knows quite a lot about international economics. I said I was sure that he would know that the benefits of trade between, say, Victoria and Western Australia would not be any less if Western Australia was in a different country.

Jim then said: ‘Then don’t you think you and your mates in Canberra should stop picking on Craig Emerson? How would you like to have Sophie Mirabella running trade policy? Or, perhaps even Doug Cameron, or Bob Katter?’

I responded that it must be time for me to buy Jim a drink.

On reflection, how can anyone respond to a suggestion that what seems to be a disappointment is actually a blessing compared with something worse that might happen? Even the GFC could look like a blessing compared to the aftermath of the European meltdown that the world might experience over the next few months if everything that could go wrong does go wrong. When I think about the approach that Sophie is proposing to take with anti-dumping policy, Craig does seem like a little blessing. My problem is that I thought having Craig in control of trade policy might be a huge blessing for the Australian economy, rather than just a little one.

Sunday, November 13, 2011

How should we encourage people to adopt more healthy lifestyles?

RedirectTimothy Wilson’s book, ‘Redirect: The Surprising New science of Psychological Change’, is primarily about what he describes as ‘story editing’ – a set of techniques designed to redirect people’s narratives about themselves and the social world in a way that leads to lasting changes in behaviour. Some of this story editing involves writing exercises, such as becoming more optimistic by writing about the process by which you have enabled everything in your future life to go as well as it could. But story editing also involves such things as providing information about social norms to correct mis-perceptions about what everyone else is doing. I suggest that anyone interested in a brief overview of the book should take a look at theinterview of Tim Wilson by Gareth Cook, for ‘Scientific American’ and a reviewby Mario Popova for ‘The Atlantic’.

I want to focus here on what light the book sheds on how we should encourage people to adopt more healthy lifestyles. Some people who are reading this will be thinking that I must have worked in the public sector for too long and become addicted to the ‘we’ word. Why should ‘we’ encourage people to live healthy lifestyles? Shouldn’t ‘we’ mind our own business? Well, in this instance I am using the ‘we’ word because it is appropriate. I think we would all want members of our own families and our friends to live healthy lifestyles, and probably feel that it would be good to encourage them to do that.

A logical place for an economist to begin would be to consider whether incentives - rewards, threats or punishments - should be used to encourage people to adopt healthy lifestyles. The message that I get from Tim Wilson’s book is that while incentives can change behaviour, they are not likely to bring about a desired change in the way people see themselves or in their intrinsic motivations. For example, in commenting on incentive programs designed to encourage kids to read more, Wilson writes:
‘If we want kids to read more, then rewarding them can work – as long as the incentives continue to be available. Rewards can produce compliance, just as punishment can. But … we want our kids to internalize desired attitudes and values … . After all, we can’t reward them for reading a book for the rest of their lives’.

Wilson also refers to experimental evidence that rewards can actually undermine intrinsic interest in an activity by convincing kids that they are doing it for the reward and not because it is enjoyable. When the reward is removed, participation in the activity was lower than in the pre-reward baseline period.

The conclusion Wilson comes to is that parents should use rewards and threats that are minimally sufficient to get kids to do the desired behaviours, i.e. not so strong that the kids view the threat or reward as the reason they are acting that way. If the child is told you will be ‘very upset and angry’ if she does something wrong she will desist to avoid getting in to trouble. If she is told you will be ‘a little annoyed’ she will still desist because she sees herself as a good kid.

So, incentives are no panacea. What else doesn’t work? The book provides quite a few examples of programs that bring people who are considered ‘at risk’ or ‘potential delinquents’ together in various ways (boot camps, counselling sessions etc.) to try to change their behaviour. The experimental evidence suggests that such programs don’t work because people who are brought together learn from each other and identify with group norms.

Another form of intervention that apparently doesn’t work is to scare the hell out of people by showing them very graphically what might happen if they engage in binge drinking, smoke cigarettes, take drugs and so forth. Threatening people with dire consequences for doing things they don’t want to do in the first place can have paradoxical effects. For example, some people may get the message that maybe they are tempted to engage in the undesirable behaviour, after all, since people are going to extreme lengths to talk them out of it.

So, what does work? One approach that works is autonomy support.  This involves helping young people understand the value of different alternatives facing them and conveying a sense that they are responsible for choosing which path to follow.

Encouraging young people to become involved in volunteering seems to have desirable effects on many aspects of their behaviour. The author writes:
‘Involving at-risk teens in volunteer work can lead to a beneficial change in how they view themselves, fostering the sense that they are valuable members of the community who have a stake in the future, thereby reducing the likelihood that they engage in risky behaviours …’

It may be possible to encourage young people to adopt healthier lifestyles by correcting incorrect perceptions about the behavior and attitudes of other young people.  For example, there is apparently a tendency for young people to over-estimate the amount of alcohol their peers drink. When correct information is disseminated, they lower their estimates of how much their peers drink and reduce their own drinking.

I don’t think Tim Wilson makes any broad generalizations in this book about how we should encourage people to adopt healthy lifestyles. In fact, he doesn’t make many generalizations about anything. One of the important messages in the book is the need for appropriate experimental testing to see what actually works. It seems to me, however, that it would be fairly safe to conclude from the book that the best way to encourage people to adopt more healthy lifestyles is through subtle interventions that redirect the narratives that they have about themselves.

Wednesday, November 9, 2011

Do commercial interests have excessive influence on people in modern societies?

Jeffrey Sachs makes it difficult for any libertarians who happen to look at his book, ‘The Price of Civilization’, to consider seriously his claim that powerful corporate interests have excessive influence in America. He claims that libertarians ‘hold that the only ethical value that matters is liberty, meaning the right of each individual to be left alone by others and by the government’.

There are a lot of other ethical values that matter to me – and probably to most others who view themselves as libertarians. In my view, liberty deserves primacy only because it makes it possible for people to live in peace – with minimal coercion of one person or group by another.

Perhaps I am excessively naïve, but it seems to me that anyone who is concerned that people are being manipulated by corporate propaganda might see libertarians as potential allies. Can a case for individuals to be protected from techniques of persuasion that undermine individual sovereignty be argued along similar lines as the case for laws to protect against force and fraud? If it could be, I imagine many libertarians would support additional action to protect individual sovereignty.

Why does Jeff Sachs think that corporate interests have too much influence in America? Dr Sachs, the clinical economist, identifies a range of symptoms. The media is privately owned and funded by advertising revenue. Corporate interests generate propaganda which the media disseminates. Corporate interests largely fund campaigns of candidates for political office. People spend a lot of time watching electronic media.
Sachs writes:
‘The relentless streams of images and media messages that confront us daily are professionally designed to distort our most important decision making processes. We are encouraged to act on fantasy instead of reason’.

Cartoon by Nicholson from “The Australian” newspaper:

Sachs claims that America has become a corporatocracy – a political system in which powerful corporate interests dominate the political agenda. As he sees it:
‘The media, major corporate interests, and politicians now constitute a seamless web of interconnections and power designed to perpetuate itself through the manufacture of illusion’.

So, some readers may ask, does this explain why Americans no longer see much merit in equality of opportunity, don’t think governments should do more to help people in need and don’t think the rich should pay more tax? No! Dr Sachs actually cites evidence that a high proportion of Americans still want more equality of opportunity, favour more help for those in real need who are prepared to help themselves and favour taxing the rich more heavily.

Where does that leave Dr Sach’s diagnosis? I’m not sure. Perhaps the disease has not progressed very far at this stage. Sachs claims that the patient is suffering from a disconnection between shared values and national politics. He sees the disconnection as arising from various aspects of the political system that enhance the power of corporate interests – particularly the military industrial complex, Wall Street, big oil and transport, and health care.

Jeff Sachs has left me as confused as ever about the American political system. He has not persuaded me that America is a corporatocracy. Corporate interests are powerful in America, but so is religion, the teaching profession, environmentalists, etc., etc.

It seems to me to be the main problem in American politics, which is shared by other modern societies, is the trivialization of politics by media that is primarily in the business of selling entertainment. The media can’t be expected to evaluate the claims made by interest groups, but if journalists have access to such evaluations from respected sources they can hold politicians to account for the views they express (or fail to express). Think tanks perform the task of policy evaluation to some extent, but can be too easily dismissed because they are not seen to be above interest group politics. Paradoxically, the government itself is the only organization capable of creating sources of policy advice that are sufficiently above interest group politics to have some hope of commanding widespread respect in the community at large.

Despite the reservations I have about ‘The Price of Civilization’ (in an earlier post about taxation levels as well as here) I want to end this post on a positive note. I strongly endorse Jeff’s view that individuals can benefit themselves and the societies in which they live by making efforts to become more mindful. We will do less harm and may do a lot of good if we become more moderate in our habits, achieve more balance in our lives, improve our knowledge, exercise more compassion, have more regard for the effects of our actions on the environment and future generations, consider how we can promote more constructive political deliberations and be more accepting of diversity as the path to peace.

Sunday, November 6, 2011

What motivated Roger Kerr?

Roger Kerr's Blog.jpgThere isn’t anyone I have known who could match the enthusiasm and energy that Roger Kerr brought to his work. I have had the privilege of working with quite a few highly principled individuals involved in public policy work - people who are clearly motivated to a large extent by the belief that they are contributing to the greater good of society. Roger stands out, however, as a person who always seemed to be enthusiastic and optimistic – he seemed to respond to setbacks by increasing his efforts to obtain better outcomes in future. It was obvious to everyone that he had a passion for presenting his views clearly, logically and forcefully, but it would not have been obvious to casual observers what was motivating him.

In his role as executive director of the New Zealand Business Roundtable (NZBR), for the last 25 years, Roger was perceived by some people as a free market ideologue. It is evident from various speeches he gave, however, that he was somewhat bemused (if not annoyed) by that description. In a speech he gave in 2005 he suggested that to characterize policy proposals as either ‘ideological’ or ‘pragmatic’ is at best a confusion and at worst a rhetorical trick that appeals to anti-intellectualism as a substitute for serious argument. He made the point that everyone involved in the debate about public policy argues on the basis of some set of principles or ideas, whether or not they are conscious of them or make them explicit. He also suggested that serious policy debate cannot proceed unless ideas are articulated and tested. His support for free markets was not unbounded. It was based ultimately on pragmatic grounds – evidence that free market outcomes are generally superior to the alternatives. I think Roger viewed himself as a principled empiricist.

In his eulogy to Roger, Bryce Wilkinson, who worked closely with him over many years, mentioned that Roger seldom spoke about his motivations and never wore his heart upon his sleeve. Bryce notes that at some point early in his career as a diplomat - when Britain entered the EEC - Roger decided that New Zealand's economic decline was in fact largely self-inflicted. That prompted him to transfer to the New Zealand Treasury in 1976 and to relaunch his career doing an economics degree part time. Roger’s interest in economic policy was prompted by a desire for New Zealanders to be able to enjoy more prosperous and satisfying lives. Bryce provides evidence that Roger cared particularly about the effects of bad policies on those who are most vulnerable.

Bryce argues that Roger's optimism was based on his belief that ideas actually matter in policy debates. In support, Bryce referred to an essay that Roger wrote on the subject of ideas, interests and policy advice on leaving the Treasury in 1986.

I have just re-read the version of this essay that was published in ‘World Economy’ in June 1987. In this article, Roger argued that economic policy advisors should be aware that they do not have a comparative advantage in making judgements about what courses of action might or might not be politically feasible.

Roger noted:
Perceived political constraints are not always immutable. They can be shifted by reasoned analysis and well-constructed strategies for policy change … . Second-guessing political reactions can lead to a narrowing of policy options and does less than justice, in recent New Zealand circumstances at least, to the intelligence of a number of politicians, on both sides of the political fence, who have been more aware of the gravity of New Zealand’s economic problems and prepared to tell the story like it is than many of their advising bureaucrats’ (pp144-5).

Roger also noted the importance of institutional structures in determining policy outcomes:
‘There is an important role for public information, open government, policy transparency and public inquiry processes in order to expose to critical scrutiny the claims of special interest groups and the performance of bureaucrats (including the propensity of some of the latter to act as taxpayer funded lobbyists for some of the former)’ (p 150).

Roger also made the claim ‘that the emergence of interest groups with broad representation, which are thus forced to take more of an economy-wide view, may be a source of influence which is more coincident with the interests of the community at large’ (p 150). That claim might seem excessively modest in the light of the subsequent performance of the NZBR – but Roger played an important role himself in ensuring that the NZBR maintained an economy-wide focus. A decade ago, New Zealand Institute of Economic Research chairman Michael Walls said of Roger:
‘No single individual has done more over the last 15 years to persuade important parts of the business sector to support economic policies which, though often contrary to the interests of individual firms, were in the interests of the country as a whole.’

Roger was motivated by a desire to play a part in promoting policy reforms – to avoid further economic decline and to enable New Zealanders to enjoy greater economic opportunities. He was enthusiastic because he knew he was fighting the good fight and he was optimistic because he knew that good policy evaluation and advice can make a difference. Above all, Roger was motivated by the impulse to ensure that his life was meaningful.

I urge readers to take a look at the many personal tributes to Roger that can be found on his blog.

Monday, October 31, 2011

Should we be more concerned about the policies being followed by the European Central Bank?

Jim was obviously agitated by my response to his question. He had just asked me whether I thought that the latest political deal in Europe would resolve the European financial crisis. Instead of saying I didn’t know I had tried to list some relevant factors, none of which I knew much about. I ended my list by mentioning that the policies being followed by the European Central Bank (ECB) were preventing the governments of southern Europe from following their pre-euro strategy of using high inflation to fund their profligacy.

‘I suppose that means you would be a strong supporter of the ECB’s anti-inflation policies’, Jim said. ‘You were an inflation hawk back in the 1980s. And I can remember a discussion in 2006 when you told me you were worried about expectations of higher inflation in America and the possibility of a re-run of the stagflation of the 1970s and 1980s. A year or so later inflation expectations started to fall. Then in 2008 we had the global financial crisis and it became obvious to everyone that there was actually more reason to be concerned about deflation than inflation’.

Jim was right about the 1980s, but I couldn’t recall our conversation in 2006. I pointed out that it wasn’t necessarily inconsistent to be concerned about rising inflation expectations in 2006 and to be concerned about the emergence of deflation a couple of years later. I suggested that central banks should be aiming to keep inflation expectations low and stable.

Jim said: ‘The fact that you keep talking about inflation expectations suggests you must have read some of the material on Scott Sumner’s ‘Money Illusion’ blog.  I started to try to explain that Scott actually recommends that central banks should target NGDP (nominal GDP i.e. aggregate demand) rather than inflation expectations, but Jim cut me off. He said: ‘I followed the link on your blog to Sumner’s blog to try to understand the European financial crisis. You obviously haven’t read whatSumner wrote a couple of weeks ago about the ECB’.

I had to admit that I haven’t been reading Scott’s blog regularly over the last couple of months. Jim said that in the post about the ECB Scott had a chart about inflation expectations in Europe that had been sent to him by Lars Christensen. At that point Jim got slightly distracted. He told me that I should read a post that Christensen had written recently on his blog, ‘The Market Monetarist’, about Calvinist economics and the gold standard mentality. ‘Christensen must have written that post with people like you in mind’, Jim said.

Jim eventually came back to the chart showing inflation expectations in Europe. He explained that the chart implies that the ECB has been driving inflation expectations sharply lower during August and September despite its mandate to produce stable inflation.

Jim ended by saying: ‘Look, why don’t you write something on your blog telling people to read Scott Sumner’s post about the ECB. And don’t forget to quote the passage where he points out how why it is so important for inflation expectations to be kept stable in Europe at present’.

I’m not sure which passage Jim wants me to quote, but this one seems to capture the main point:
‘I’m not saying a policy of steady eurozone inflation would solve the debt crisis, obviously it wouldn’t.  But the current policy is making it far worse than it needs to be.  The US made the same mistake in mid-2008.  Even at that time the subprime crisis was well understood, and estimated losses to the US banking system were quite high.  But when the Fed drove NGDP expectations much lower in late 2008 … the debt situation got far worse, and spread far outside the original subprime sector.  Now we are seeing the euro sovereign debt crisis spread to more and more countries.’

Perhaps we should be more concerned about the potential effects of the aggressive anti-inflation policies being followed by the ECB. 

Wednesday, October 26, 2011

Will Bhutan succeed?

Some readers will know exactly what I mean by this question. Others may be wondering: Where is Bhutan? What does he mean by success? And why should we care?

Bhutan is a small country which has not had much exposure to the modern world. The first roads were built in the 1960s and TV was only introduced in 1999. It is located at the eastern end of the Himalayas, sandwiched between India and China. It covers about the same area as Switzerland and has a population of about 700, 000 people. About 75% of the population are Buddhists and most of the remainder are Hindus of Nepali descent.

The 'Tiger's Nest' monastery, near Paro

What do I mean by success? About 40 years ago the former king of Bhutan famously declared that ‘gross national happiness is more important than gross national product’. This play on words led eventually to gross national happiness becoming a national objective of Bhutan. In terms of this objective, Bhutan will succeed if it can modernize so that the people can enjoy the benefits of the modern world, without major social problems, loss of culture or environmental damage.

Why should we care? Bhutan’s approach to pursuit of happiness is a social experiment that is attracting a lot of attention around the world. A few months ago the United Nations General Assembly accepted unanimously a resolution sponsored by Bhutan which recognizes the pursuit of happiness as a universal goal. In the years to come we can expect to hear a lot about the success or otherwise of Bhutan’s approach to pursuit of happiness.

So, will Bhutan succeed? If we look at the matter from a management perspective, some of the necessary conditions for successful pursuit of goals have been established: 
  • The government has a fairly clear view of what pursuit of gross national happiness means. It involves promoting socio-economic development and good government (including a vibrant democracy), while preserving cultural heritage and protecting the environment.
  • Surveys are being conducted to monitor progress. The surveys monitor the views of the people about the performance of government as well as resilience of cultural traditions, ecological knowledge, living standards and psychological well-being. 
  •  Survey results are used in de veloping policy e.g. a finding that meditation was not being practiced as often as expected led to meditation classes being offered in schools.


Archery: the national sport and an important cultural activity 

The chances of success might look good from a management perspective, but will the people of Bhutan actually be any more successful in coping with the modern world than the people in other countries have been?

The first point, which seems obvious to me from my short visit, is that most of the people of Bhutan, like most people elsewhere, want the amenities of modern life. The more they know about how people live in wealthy countries, the more they are likely to aspire to have the stuff that people in wealthy countries take for granted – the household items that take the drudgery out of life, the phones and internet access that enable us to stay in touch with each other, motor vehicles – all that and more. It will become obvious to an increasing proportion of Bhutanese that a lot of this stuff can be useful - even though they may be happy with what they have at the moment.

My second point is that Bhutan’s government is not likely to come under much, if any, pressure from the public to sacrifice environmental or cultural objectives to achieve a higher economic growth rate. There is considerable potential for economic development that does not involve major conflict with environmental or cultural objectives. For example, there is potential to sell more hydro power to India and to expand tourism based on cultural and environmental resources.

The big question, in my view, is the extent to which Bhutan will be able to obtain the benefits of modernity without ending up with the social problems of modern societies? How will they cope with the potential for weakening of traditional values and support systems as larger numbers migrate from rural areas in search of a better life in the cities? How can they ensure that young people continue to acquire social values and avoid the weakening of the social fabric (which seemed evident, for example, in the orgy of rioting and looting in London a couple of months ago)? How can they provide a social welfare safety net without ending up with large numbers dependent on welfare benefits? How can they avoid the excesses of a consumer society, with substantial numbers of people incurring excessive debts to live unaffordable lifestyles? How can they avoid having large numbers of people living unhealthy lifestyles, addicted to TV or the internet and vulnerable to inducements of advertisers?

I think there are grounds for hope that the government of Bhutan will learn from the mistakes of other countries and come up with sensible answers to such questions. It is obvious from the international conferences it has been holding that the government is actively seeking to learn from experiences of other countries. The way survey results are being used also provides grounds for hope that Bhutan will succeed. For example, the emphasis that the government is placing on providing opportunities for children to learn skills in mindfulness makes me hopeful that young people in Bhutan are more likely to learn as they grow up that it is their individual responsibility to make best use of the opportunities available to live a meaningful life. What that means at a practical level is learning to accept responsibility for the important choices in their lives, including choices about such mundane matters as what to eat and when to switch off the TV.

On balance, I think there is a better than even chance that Bhutan will succeed in modernization with fewer social problems than have been experienced elsewhere in the world.
Thimphu: the capital city of Bhutan

Friday, October 21, 2011

What is the price of civilization?

The Price of CivilizationAccording to Jeffrey Sachs, in his new book ‘The Price of Civilization’, the United States needs an increase in tax revenue equal to about 6 percent of GDP in order to balance the budget and ‘pay for civilization’. He arrives at this figure after making allowance for some cuts in government spending and increases in spending of about the same magnitude in areas such as education, training, childcare, infrastructure modernization and foreign aid.

Jeff Sachs asks himself a ‘crucial question’: ‘how do Canada, Denmark, Norway, Sweden, and other countries manage to educate their young, fight poverty, modernize their infrastructure, enjoy life expectancy well above America’s, and still maintain a budget that is more in balance than America’s?’ He concludes: ‘The answer, of course, is that the other countries tax their citizens more heavily in order to supply more public goods, including in the case of the Scandinavia, universal access to health care, higher education, and child care and support for families with young children’.

Jeff’s revenue-raising proposals would increase America’s tax revenue as a share of GDP to a magnitude similar to that of Canada, New Zealand and Britain. He points out that America’s tax revenue as a share of GDP is currently current second-lowest among the high-income jurisdictions considered, ‘just slightly larger than Australia’. (The comparison doesn’t include Singapore or Hong Kong.)

I was surprised to see that America now has a bigger government than Australia. This must have something to do with the relatively poor economic performance of the US over the last couple of years. It certainly can’t be attributed to any recent cuts in government spending in Australia.

But let us not get side-tracked by the trivia of short-term movements in GDP. There is a fairly clear implication in what Jeff has written that he thinks Australia must be uncivilized because tax revenues as a share of GDP are relatively low in this country.

Australians are so used to being told that they are uncivilized that they rarely take offence. But it is surprising to see this implied in the writings of an American. We tend to associate the view that Australians are uncivilized with chinless members of the English aristocracy, rather than people who espouse democratic principles.

Nevertheless, I think Jeff may have a point. I don’t want to undermine the efforts of Australia’s foreign minister to portray us as civilized people, but it is a difficult case to make. Australians generally make little effort to even appear to be civilized. Most of us require very little lubrication before singing our national song, which is a eulogy to a hobo who steals sheep. With very little more lubrication many of us can be encouraged to sing an advertising jingle we learnt as children, that identifies us ‘as happy little Vegemites, as bright as bright can be’. In this instance it may be equally true that ‘what we identify with establishes our identity’ and that ‘we are what we eat’!

More seriously, perhaps, it is difficult to argue that social outcomes in Australia are up to the standards that might be expected of a civilized country. Australia’s rating according the UN’s human development index (HDI) is only 0.937, just 6 percent higher than that for Sweden. When inequality is taken into account, our performance is even worse – a rating of 0.864, just 5 percent ahead of that for Sweden. Average life expectancy at birth in Australia is only 81.9 years, just a few months ahead of Sweden. Australians only spend about 12 years at school on average, again only a few months more than Swedes. In the few years Australians do spend at school, they don’t actually learn much. Not only are our PISA scores well below those in Shanghai and Korea, they are only slightly higher than those for Sweden.

I hope that anyone from Sweden reading this has a sense of humour. My real point is not that Sweden is uncivilized – just that it is not high levels of taxation that make Sweden a civilized country. Those who argue that Sweden is civilized because it has a big government should consider how they would respond to the view that Sweden is civilized country because it generally adopts market-friendly policies. According to the Heritage Foundation’s measures of economic freedom, Sweden’s policies are more market-friendly than those in the United States in relation to business, trade, investment, finance, monetary policy and corruption - just about all aspects of policy other than size of government and the labour market.

The general point I have been trying to make (in case anyone has missed it) is that it doesn’t make much sense to equate civilization with the size of government. Social outcomes in high-income countries with big governments tend to be fairly similar to those of high-income countries with smaller governments. It is possible to provide a decent social safety net, without huge levels of taxation if benefits are means tested. I have provided some references to research on this topic in a paper I wrote last year for New Zealand’s 2025 taskforce (‘How much does size of government matter for economic growth?’, 2010, p11).

I started off to review ‘The Price of Civilization’, but I haven’t progressed very far. The recommendation for higher taxes is probably the most important recommendation in the book – and it is the issue raised in the title – but that is only part of what the book is about. In particular, the book contains an interesting discussion about what is wrong with American politics, which I will consider in a later post.