Showing posts with label positional goods. Show all posts
Showing posts with label positional goods. Show all posts

Saturday, November 11, 2017

Where is the best place to live?

The pathway above Orion beach, Vincentia, NSW, Australia

Over the last few months I have had personal reasons to ponder this question. My wife and I decided that the time had come for us to move closer to family and downsize.

I can’t claim that I reviewed research relating to the question in a systematic way before we decided where we should live. However, I have been reading and writing about happiness research for over a decade, so that probably had some influence.
Since we made our decision I have read some of the more recent literature on the impact of happiness of location. Perhaps my recent reading could be explained in terms of seeking additional evidence to support the decision we have made, but I do find the topic intrinsically interesting.

My intention here is to discuss research findings on the impact of location on happiness rather than to attempt to justify our decision.  Relocation decisions made by different individuals and families obviously need to reflect their differing values and changing priorities at different stages of life.

If you do an internet search on “happiness best place to live” one of the first items to come up is likely to be an article telling you that according to a major Gallup poll, Hawaii is the U.S. state with the highest well-being ranking, with the top score in the physical, financial and community categories. If you search for the cities that are the best places to live, you are likely to find articles based on Gallup polls which suggest that the cities that score highest are near the ocean. When you read on you find that there is more involved than just beachside living. Research by Andrew Oswald has shown that average life satisfaction levels in different places closely correlate with objective measures of the quality of life – as measured sunshine hours, congestion, air quality etc.

Survey data on the happiness of people in different federal electorates in Australia suggests that many of the happiest electorates in Australia are not close to the coast (although the New South Wales south coast electorate of Gilmore, where we have lived for the last 12 years, is among the top five). Some of the unhappiest electorates in the country are in suburban Sydney. Some headlines claiming that major cities create unhappy Australians prompted me to write sceptically on this topic a couple of years ago. I suggested that current life satisfaction is not the only important consideration in making location decisions. Many families face trade-offs between current and future life satisfaction.

I recommend that people considering a move should also read an article by Brad Waters in Psychology Today which draws upon the insights of Daniel Kahneman to make the point that life satisfaction is influenced by many factors other than location. He suggests that people considering relocation should ask themselves: “Does a move satisfy those factors or does it temporarily distract us from satisfying them?”

There is evidence of substantial benefits from living in a location where it is possible to see family and friends frequently. For example, research by Nick Powdthavee, undertaken about a decade ago, suggested that the benefits of seeing relatives and friends “most days” rather than “less than once a month” was greater than the benefit of getting married and was sufficient to compensate for about two-thirds of the happiness loss from such events as unemployment or going through a separation.

A couple of years ago when I wrote about the link between happiness and nature connectedness I speculated that some part of the correlation between nature connectedness and happiness is associated with “feeling connected”. Feeling connected to nature might be similar in that respect to feeling connected with family, friends or community.

Evidence continues to accumulate that actual contact with the natural environment has positive benefits for health and happiness. For example, a study conducted by Simone Kuhn (and others) for the Max Planck Institute for Human Development (discussed in this Forbes article) found that city dwellers who live near forests were more likely to have healthy amygdalas and thus better able to manage stress, anxiety and depression. A study by Chris Neale (and others) using mobile EEG has found that when walking in urban green space old people had a higher level of engagement and lower levels of excitement than when walking in both busy urban commercial streets and quiet urban space. The authors concluded that the urban green space seemed to have a restorative effect on brain activity.

An article by Ming Kuo has identified 21 plausible pathways linking nature to human health and has postulated that one pathway, enhanced immune functioning, may be of central importance.

Thoughts along those line prompted me to begin reading The Secret Life of Your Microbiome, why nature and biodiversity are essential to health and happiness, by Susan Prescott and Alan Logan. Perhaps I will write more about that later.

Meanwhile, my bottom line is that, other things equal, it might be a good idea to find a place to live where you can spend a fair amount of time in the natural environment with family and friends. Unfortunately, many people in this world do not currently have the luxury of making that choice.

Monday, April 11, 2016

Is Australian housing more than 40% over-valued?

Source: Australian Bureau of Statistics

A recent article in The Economist suggests that “housing appears to be more than 40% overvalued in Australia, Britain and Canada” (“Hot in the city”, April 2, 2016 - possibly gated). This claim is based on the extent that the ratios of prices to disposable incomes and prices to rents are above their long term averages in those countries. By contrast, according to The Economist, housing prices in the United States are currently at “fair value” because those indicators are close to their long run average.

When they talk about “fair value” I guess what the authors of The Economist article have in mind is an equilibrium price that may differ from current market prices.  That raises some thorny conceptual issues, but I am prepared to accept that markets are sometimes affected by the irrational exuberance or pessimism of large numbers of investors.

The Economist has been using the same methodology for quite a few years now to suggest that housing prices are overvalued in countries in which they have risen strongly since the GFC.

When I wrote in 2011 about a previous article in The Economist using this methodology I pointed out that it was unrealistic to expect average rental yields (the inverse of the house price to rent ratio) in Australia to return to its long term average over the period since 1975 because over the first half of that period high nominal interest rates were suppressing demand for housing. 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. What we were seeing was a return to normality rather than the emergence of a house price bubble.

The Economist has published an infographic (ungated) which neatly illustrates how the ratios of prices to disposable incomes and prices to rents are currently above their long term averages in Australia, Britain and Canada. However, their infographic also illustrates the potential for large errors to be made by assuming that long term averages of house price to rent and house price to income ratios represent equilibrium prices. If you look at movements in the ratios of prices to disposable incomes and prices to rents over the whole period 1970 to 2016, you will notice that those ratios for Australia and Canada were well below the corresponding ratios for the US in the 1970s and ‘80’s. The same was true for Britain in the ‘90s. Even if actual price to income and price to rent ratios were currently the same in all four countries, the ratios for Australia, Canada and Britain could still be expected to be above their long run averages.

So, what does a comparison of actual ratios for Australia, Canada, Britain and the United States show? I haven’t attempted a complete assessment, but the latest data from Global Property Guide (GPG) on gross rental yields suggests yields of 4.4% for Australia (Sydney), 4.4% for Canada (Toronto), 3.2% for the UK (London) and 3.9% for the US (New York). The GPG data for the US relates to Manhattan which might be perceived by investors to offer better prospects for capital gains than most other localities in the US. The Economist’s data on price to rent ratio’s for the US implies a much higher gross rental yield for New York (about 7%) and even a somewhat higher yield for San Francisco (about 5%).

Given current and prospective interest rate levels, those comparisons do not seem to provide much evidence of irrationality in housing prices in any of those countries. It seems to me that there is no more reason to think housing investors in Australia, Canada and Britain have been irrationally exuberant in recent years than to think those in the United States have been irrationally pessimistic.  

Monday, October 1, 2012

Is it the duty of government to realize the good life for all citizens?

‘If the first goal of the individual is to realize the good life for himself, the first duty of the state is to realize, insofar as it lies within its power, the good life for all citizens’.

How Much is Enough?: Money and the Good Life By: Edward Skidelsky,Robert SkidelskyThe quoted passage is from ‘How Much is Enough?’(2012) by Robert Skidelsky - a biographer, economics professor and member of the British House of Lords - and his son. Edward, a philosopher.

Some readers might think that the quoted passage implies support for the view that it is the role of government to ensure that individuals have the freedom to realize the good life as they choose. That is far from what the authors have in mind, however.

Robert and Edward Skidelsky are unashamedly paternalistic in their views on the role of government. They recommend that governments should promote the good life by taxing the rich more heavily, imposing sumptuary taxes, regulating labour markets more extensively, disallowing tax deductions for advertising, and imposing more restrictions on international trade and capital flows. They see such interventions as necessary to ‘free up’ more time for leisure, reduce income inequality, improve the social bases of health, personality, respect and friendship, and help people to live in harmony with nature.

The authors describe their policy approach as ‘non-coercive paternalism’ because it involves incentives and disincentives rather than commands. Yet coercion must still be involved. The authors do not suggest that people who do not share the Skidelsky view of the good life would be exempt from compliance with their proposed taxes and regulations.

How do the authors make a case for paternalistic interventions to encourage people to live the good life? J M Keynes (later Lord Keynes), a famous economist, plays an important role in their story. In 1928, Keynes predicted that within 100 years humanity would be able to satisfy all its material needs by working at most three hours a day. For a time, it seemed as though this prediction might prove to be correct, because a substantial proportion of the benefits of rising productivity were being realized through greater leisure. The Skidelskys suggest that at the beginning of the 1970s it looked as though the rich part of the world was close to ‘the dawn of universal abundance’.

What went wrong? The explanation offered by the authors is that governments shifted to a market-based philosophy when Margaret Thatcher and Ronald Reagan came to power. They acknowledge that free marketeers made some telling points about the crisis of Keynesian economics (the combination of rising unemployment and rising inflation) resulting from attempts to pursue full employment through fiscal deficits. But they claim that the oil price hikes of 1973 and 1979 played a bigger role in exposing economic rigidities and paving the way for a move toward free market policies.

So, how could a move toward greater freedom discourage people from choosing ‘the good life’? The authors’ explanation seems to have two components.

First, they argue that a free market economy gives employers power to make employees work longer hours. That doesn’t make sense to me. If large numbers of workers wanted to work shorter hours, surely it would be in the interests of employers to find ways to accommodate their desires. Over the last 40 years, it seems to me that working hours have actually become more flexible, with a move toward casual employment and greater willingness of many employers to allow workers to take time off to meet family obligations.

Second, the authors claim that capitalism rests on an endless expansion of wants: ‘It has taken away the consciousness of having enough’. The authors see advertising as the major culprit:
‘Advertising may not create insatiability, but it exploits it without scruple, whispering in our ear that our lives are drab and second-rate unless we consume “more”.’

This seems to me to be another weak point in the story. Advertisers didn’t suddenly begin to whisper in our ears with the move toward freer markets in the 1980s. They were whispering in our ears during the 1950s and 60s, when working hours were declining. And it is possible for people to cope with the whispering and to decide for themselves how much is enough. A lot of people choose non-materialistic lifestyles. Many of those who choose to work long hours and/or multiple jobs do so in order to enjoy a more relaxed lifestyle at a later stage of their lives.

I disagree profoundly with the central argument of this book that governments should construct incentives and disincentives to guide people to adopt that particular perception of the good life. Nevertheless, I enjoyed reading ‘How Much is Enough?’ I agree with much of the discussion of the concept of happiness and strongly support the view presented there that a happy life is more than just a string of agreeable mental states. I admired the way the authors developed the idea that we should consider harmony with nature as part of the good life for humans.

In a personal sense, I find myself substantially in agreement with the authors’ vision of the good life. If they had confined themselves to sermonizing I would be cheering instead of jeering.

Thursday, February 9, 2012

How does income inequality affect happiness?

Early yesterday the thought occurred to me that it might be a good idea to write something about the effects of inequality on happiness levels. I have been thinking that the judgements people make about inequality are more like judgements about the characteristics of a good society than judgements about the effects of inequality on aggregate happiness (whatever that means). I thought I would spend an hour or so bringing myself up to date with the literature and then another hour or so writing something - and the rest of the day in the garden. However, the process has taken longer than I thought it would (and this post might also take longer to read than some people might think appropriate).

The issues involved are fairly complex. There are at least three different aspects of the relationship between income inequality and happiness that might be relevant – the effects of relative income levels on happiness, the more general effects of income inequality on happiness and the effects of income inequality on happiness inequality.

How do relative income levels affect life satisfaction? As discussed here some time ago, this is not always about envy and status-seeking. The findings of a study by Guy Mayraz et al, based on German panel data, are consistent with the more conventional view that income comparisons tend to have negative effects on life satisfaction of people with relatively low incomes. However, some of the authors’ findings shed further light on the issues:
  • ·         Life satisfaction of men is more affected by relative income than that of women.
  • ·          Comparisons with friends and neighbours are less important than broader comparisons with the whole population.
  • ·          Those who perceive income comparisons to be important tend to have lower life satisfaction.
  • ·         The negative effect of relative income comparisons for those with below average incomes is balanced (from a Benthamite perspective) by the positive effect for those with above average income.

Does inequality have an effect on life satisfaction over and above the relative income effect? Studies which have attempted to answer this question have often reached different conclusions. A recent study by Paolo Verme, which seems to be technically superior to previous studies, has found that income inequality tends to have a significantly negative effect on life satisfaction, after controlling for relative income effects etc. The results seem to apply in western countries as well as non-western countries and to rich people as well as to poor people.

This raises the question of why income inequality might have these effects. One possibility is that people feel more comfortable in societies where opportunities are relatively equal. Another possibility is that they are more concerned about equality of outcomes. If so, it seems reasonable to suppose that they are concerned about income inequality because they think it results in happiness inequality.

Is there strong correlation between income inequality and happiness inequality? In a post a couple of years ago I suggested that there was not much evidence of correlation between income inequality and happiness inequality - on the basis of a paper by Jan Ott and some research of my own. Since there were not many countries included in these studies, it seemed like a good idea to produce the scatter diagram below showing measures of income and happiness dispersion for a larger number of countries. (I used World Bank and CIA data on the income/consumption gini and data on standard deviation of life satisfaction from Veenhoven’s latest IAH paper. Both series are based on information for various years during the last decade.)

I can’t see any relationship between the variables in the chart, but statistical analysis suggests that a weak positive relationship might exist.  (The correlation between the variables is 0.13. The estimated coefficient relating inequality of happiness to inequality of income in a linear regression is positive, but the standard error is not much smaller than the estimate. The ‘t’ statistic is 1.38.)

The absence of a strong relationship between inequality of income and happiness at an international level is consistent with the observation of Betsey Stevenson and Justin Wolfers that there has not been a close link between trends in happiness inequality and income inequality in the United States. It is also consistent with the findings of a paper by Leonardo Becchetti et al, based on panel data, that the increase in income inequality has not been one of the drivers of the increase in happiness inequality in Germany.

So, how did this information enlighten me on the question of whether the judgements people make about inequality are more like judgements about the characteristics of a good society than judgements about the effects of inequality on aggregate happiness? The effects of relative income on life satisfaction do not seem relevant to this question. The relationship between income inequality and individual happiness does seem relevant, but I suspect it has more to do with empathy with compatriots and a desire to alleviate suffering of people near the bottom of the income scale rather than a more general concern about distributional equity.

Happiness inequality also seems relevant. When Ruut Veenhoven argues that the quality of a society should be judged by the disparity of happiness among its citizens as well by average happiness levels, he is clearly making a judgement about the characteristics of a good society. The weakness of the relationship between income inequality and happiness inequality certainly suggests that caution is required in basing judgements about the relative quality of different societies on income distribution data. The question I am left with, however, is to what extent disparities of happiness can be attributed to government policies and societal institutions (the rules of the game) rather than individual and group behaviour. It seems to me that to the extent that we introduce distributional considerations into our consideration of the quality of different societies, we are on safer ground in basing our judgements on the distribution of opportunities that are offered, rather than on the distribution of happiness outcomes.

Tuesday, January 31, 2012

Where is Ross Gittins coming from?

A few days ago, Evan, a person who comments on Jim Belshaw’s blog, wrote: ‘I think Ross Gittins is a good model for how to write on economics’. That was in response to a discussion Jim and I were having about Robert Frank’s ‘The Darwin Economy’ and the difficulty that we were experiencing in communicating on the issue of whether the ideology of the market is having too much influence in modern society. At least, that is my take on what the discussion was about. Jim and I agreed with Evan that Ross does write well.

It occurred to me soon afterwards that I have been ignoring Ross Gittins’ views on happiness for too long. Ross is the economics editor of the Sydney Morning Herald (SMH) and the leading economic journalist in Australia writing about happiness. When people have asked me what I think of Ross’s views on happiness I have refrained from saying much on the grounds that I rarely buy the SMH and haven’t read many of Ross’s columns in recent years.  I can’t use the excuse any longer, however, because I have discovered that Ross has a web site on which he posts his columns. (I have recenly included a link to the site on this blog to encourage myself to read his columns more regularly.)

When I looked at Ross’s site it was clear that, as well as the happiness theme, he is sometimes still playing an old tune that I like about the benefits of free trade. For example, one of the articles I read warns of the dangers to the rest of the economy from attempts to shield manufacturing industries from the consequences of the boom in the resources sector. This is consistent with the contribution Ross has made throughout his journalistic career in bringing good sense to public discussion of many economic issues.  I have a particularly high regard for the contribution that Ross made in earlier years in helping to improve public understanding of the costs of high trade barriers that were supporting inefficient resources use and unproductive work practices in this country. He deserves a medal!

But, what about Ross’s views on happiness? It wasn’t hard to find his review of ‘The Darwin Economy’. While well written and informative, the review is totally uncritical. In concluding his review, Ross gives the author, Robert Frank, the last word: ‘Frank concludes that the real reason we regulate markets is to protect ourselves from the consequences of excessive competition’. I was left with the impression that Ross concurs with that view.

How does Ross reconcile the view that regulation is desirable to protect against competition with his knowledge of how regulation has worked in the past in Australia to protect privileged interests at the expense of the rest of the community? How does Ross reconcile his opposition to economic growth, with his apparent ongoing support for productivity growth? I decided to buy Ross’s book, ‘The Happy Economist’ to see whether I could understand where he is coming from. (Since Ross is a strong supporter of international competition I’m sure he will not mind if I let readers of this blog know that I purchased the Kindle edition from Amazon for $9.99, rather than paying Allen and Unwin $26.99.)

I enjoyed reading Part I of the book, which is a discussion about such things as the nature of happiness, the evolutionary purpose of happiness, who is happy, whether wealth makes people happy, whether work makes them happy. This part of the book ends with a discussion of 10 hints about how to be happy. Perhaps it is strange for an economic journalist to be offering such advice, but from my (fairly extensive) reading in this field I get the impression that the advice Ross offers is based on the best research available.

Part II is comprised largely of an attack on mainstream economics and a sermon on ecological economics, mixed up with a strong dose of paternalism and proposals for increased government regulation. Despite all that, Ross manages somehow to convey the impression that he is more concerned about adulation of ‘the market’ than the actual existence of markets and competition.

Ross seems to be particularly concerned about the tendency of humans to over-indulge. He notes that many of us are tempted ‘to eat too much, get too little exercise, smoke, drink too much, shop too much, save too little, put too much on our credit cards, and work too much at the expense of our family and other relationships’.  He suggests that ‘individuals know they have trouble controlling themselves and would appreciate government taking temptation out of their way’.

This reminds me of a comment by the late Roger Kerr, executive director of the New Zealand Business Roundtable, in a speech aboutthe concept of progress that he made in 2009. Roger suggested that one consequence of the ‘fashionable academic preoccupation with happiness’ might be for more people to adopt the view: “I’m bald, fat and grumpy. What’s the government going to do about it?” I don’t think that is a necessary consequence of happiness research, but it seems to me that Ross is encouraging that kind of attitude in his paternalistic proposals. Among other things, Ross apparently wants governments to re-regulate shopping hours, limit advertising and take action to discourage spending on positional goods.

Ross’s presentation of his views on productivity, economic efficiency, market preferences and regulation involve as many twists and turns as the road from Thimphu to Punakha. At the risk of making this post excessively long, an appropriate place to begin might be with Ross’s claim that the regard mainstream economists have for ‘revealed preference’ – the idea that the choices people make reveals their preferences - has somehow led them to become ‘the great facilitators and advocators of economic growth – the high priests in the temple of Mammon’ (p 164). Economists who respect revealed preference actually have a long tradition of opposition to proposals by economic planners to lift savings and investment rates or give people incentives to work longer and harder in order to raise economic growth rates. My attitude has always been that if individuals prefer to spend rather than save or to enjoy leisure rather that to work long hours, their choices should be respected. A substantial component of my work involved providing advice about how governments could facilitate economic growth, but facilitating is about removing obstacles rather than pushing people around.

Ross makes it clear that he doesn’t see economic growth as being able to continue indefinitely – and in this regard he sees himself as one of history’s hastening agents (if I may borrow a phrase much used by a former work colleague). His discussion about ecological limits to growth and the desirability of the stationary state had me wondering how he was proposing to stop technological progress – a major source of economic growth. Ross eventually acknowledges that improvements in the efficiency with which resources are used are desirable. He suggests: ‘its growth in the throughput of natural resources we should forswear, not the rise in gross domestic product that comes from the continued pursuit of productivity improvement’ (p 221).

However, a few pages on Ross tried to convince me that I shouldn’t fear the end of economic growth. He states:
‘Many of the things that reduce our happiness stem from the search for greater efficiency so as to contribute to economic growth. Easing the efficiency imperative would be hugely liberating’ (p 229).
So, we will have productivity growth without the ‘efficiency imperative’ of market disciplines?

Ross agonizes further about efficiency a few pages later:
‘My fear is that, were the goal of increased efficiency to be abandoned, the motive of rolling back areas of privilege would be lost. It would then be a matter of first in, best dressed. Workers in unprotected industries would be obliged to continue propping up protected industries in perpetuity, with a great likelihood that, should further difficult times emerge, the privileged industries would be first in line for additional assistance in the name of preserving the status quo’ (p 233).

Well put! I am glad that Ross is troubled by that thought.

The closing sentence of Ross’s book reads: ‘In the end we are what we feel’. I think that might contain the key to the problem Ross has in reconciling his belief that because individual humans are inherently fallible they can’t be trusted to pursue happiness as they wish, with his admiration for the efficiency of markets and his understanding that governments are neither angelic nor infallible .

Our feelings are important. We obviously make ourselves unhappy when we make bad choices. But they are our choices. The nature of humans is such that we cannot flourish unless we have responsibility for our own lives.  

Wednesday, January 25, 2012

Should wasteful competition for positional goods be taken into account in tax policy?

In my last post I began my review of Robert Frank’s ‘The Darwin Economy’, by outlining how Adam Smith viewed the strivings of people to better their condition as being motivated to a large extent by concerns about their relative position in society. I suggested that if there are negative externalities associated with strivings to improve relative position, these should be balanced against the positive externalities relating to technological progress identified by Smith.

The negative externalities that Robert Frank is most concerned about arise when people forgo something that they value (e.g. leisure or workplace safety) in order to engage in competition for positional goods. The basic idea is that while this competition makes sense from the perspective of each individual, it is socially wasteful because individuals are forgoing something they value in order to compete for positional goods.

There is an important definitional issue, which I will come to later, about whether the supply of positional goods is fixed. Let us assume initially, however, that there is only one positional good which is fixed in supply – housing land with views – and that humans have such a strong urge to obtain a house with a good view that, once their subsistence needs have been satisfied, all their efforts go into obtaining better views. If we now make the additional assumption that the government has to raise a certain amount of revenue to fund provision of public goods (e.g. defence, law enforcement) I think it would probably be reasonable to suppose that a tax on income above a certain level, which causes people to substitute leisure for income, would be an efficient tax to use in such circumstances. (This runs counter to my prior view which would have been in favour of a tax, or combination of taxes, with a neutral impact on income-leisure choices.)

Now, let us add some complications relating to the real world. Account should be taken of the fact that different people have different preferences and tastes. Some people are particularly interested in houses with views, some like to live near water, some are interested in living near good educational facilities and some like to live near their work. Then, there are the people who prefer to spend additional income on goods other than housing.

House sites in good locations are not the only good for which there is a relatively high income elasticity of demand. In the case of most high income elasticity goods, however, an increase in demand tends to result in a supply response and a reduction in price. Moreover, many studies suggest that there is a relatively high income elasticity of demand for leisure. Such considerations suggest to me that potential economic losses associated with competition for positional goods are likely to be quite small.

At this point I should introduce the further complication relating to the definition of positional goods. Frank adopts Fred Hirsch’s definition of positional goods ‘as ones whose evaluations are particularly sensitive to context’. House sites with views would be considered to be strongly sensitive to context if people would generally prefer to live in a location where they have better views than their neighbours, than to live in a location where the views are generally much better, but their neighbours have better views than they have.

On the basis of thought experiments he has asked students to undertake, Frank suggests that size of house is strongly sensitive to context, whereas workplace safety and time spent on vacation are not strongly sensitive to context. Frank argues that positional concerns are stronger for luxury goods than for necessities. He suggests that since ‘luxury is an inherently context-dependent phenomenon, it’s uncontroversial to say that the last dollars spent by those who spend most are most likely to be spent on luxuries’. This reasoning leads him to argue in favour of a steeply progressive consumption tax to replace personal income tax.

In the end, it seems to me that the view Frank is presenting boils down to an assertion that those fortunate (or silly) enough to have high levels of consumption spending impose an externality on the rest of the community who feel that their relative standing is diminished unless they make the sacrifices required to emulate this behaviour. The main problem I have with this this line of reasoning is that people can choose not to get involved in such emulation games, and many people have made such choices.

Furthermore, I don’t think relative income or consumption levels are nearly as important to life satisfaction as people might suggest in their responses to thought experiments. A rough calculation I reported on this blog a few years ago suggests that the probability of a poor person in a rich country being satisfied with life is about 60 percent higher than for a rich person in a poor country.

International migration patterns are also inconsistent with the view that relative position is of huge importance. Many people seem to be willing to migrate from poor countries, where they are relatively wealthy, to wealthy countries, where they are relatively poor, in order to give better opportunities to their children.

My bottom line is that while I think there may be a grain of truth in the idea that competition for some positional goods (goods which are fixed in supply) is wasteful, Robert Frank has not succeeded in establishing a case on efficiency grounds for a steeply progressive consumption tax.

Tuesday, January 24, 2012

What did Adam Smith think of externalities associated with the efforts of individuals to improve their relative position?

bookjacketI have enjoyed reading Robert Frank’s new book, ‘The Darwin Economy: Liberty, Competition and the Common Good’, more than I thought I would. This may be because I felt that the book had been written for people like me - the author seems to want people who have a strong regard for individual liberty to give serious consideration to his views.

I had expected Frank to argue that competition for positional goods involves a negative externality because those who are most successful are envied by many of those who are less successful. However, the view he presents of the nature of externalities associated with competition for positional goods is more subtle and less easily dismissed.

The starting point of Frank’s analysis is the ‘invisible hand’ of the market, which Adam Smith had suggested in ‘Wealth of Nations’ leads self-interested individuals to promote the greater good of society, without intending to do so. Frank describes Smith’s invisible hand as ‘a genuinely groundbreaking insight’, even though, as Smith recognized, the invisible hand ‘breaks down’ to some extent in the presence of externalities, public goods, and so forth. The particular negative externality that Frank is most concerned about in this book is associated with circumstances where individual rewards depend on relative performance and result from the strivings of individuals to improve their relative position. He contrasts this striving to improve relative position (which he describes as Darwinian competition) with the benign competitive forces associated with Adam Smith’s invisible hand.

Frank’s discussion of the different views of competition that he attributes to Darwin and Smith reminded me that Adam Smith had actually written about the strivings of individuals to improve their relative positions in ‘The Theory of Moral Sentiments’ (TMS). Smith suggested in TMS that what people hope to achieve by bettering their condition is not ‘ease’ or ‘pleasure’ but ‘to be taken notice of with sympathy, complacency and approbation’ (p 50-51, Liberty Fund edition, 1982). Later in the book, Smith suggests, however, that ‘the poor man’s son, whom heaven in its anger has visited with ambition’ imagines that if he attained wealth and greatness ‘he would sit still contentedly, and be quiet, enjoying himself in the thought of the happiness and tranquillity of his situation’. According to the story, this ambitious man endures a great deal of misery striving to better his position. By the time he achieves his goal, however, he is near the end of his life ‘his body wasted with toil and diseases, his mind galled and ruffled by the memory of a thousand injuries and disappointments …’. At this point he begins to think that ‘wealth and greatness are mere trinkets of frivolous utility’ offering little ‘ease of body or tranquillity of mind’ (p 181).

In my view, Smith’s story understates the benefits that people obtain from wealth because it doesn’t take account of the greater autonomy wealth enables them to enjoy. (I have discussed the link between wealth and autonomy previously on this blog.)

Smith was suggesting that people tend to make cognitive errors of the kind discussed by Daniel Gilbert in his book, ‘Stumbling on Happiness’. This view of strivings to improve relative position differs from that of Robert Frank, who does not rely on departures from the individual rationality assumptions normally used in neo-classical economics.

The similarity between the views of Adam Smith and Robert Frank in relation to strivings to improve relative position lies in the fact that both seem to see this as more or less a zero sum game, with externalities involved. Adam Smith wrote as follows about the externalities associated with the strivings of individuals to better their condition:
‘The pleasures of wealth and greatness … strike the imagination as something grand and beautiful and noble, of which the attainment is well worth all the toil and anxiety which we are apt to bestow upon it.
And it is well that nature imposes upon us in this manner. It is this deception which arouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and the arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe, have turned the rude forests of nature into agreeable and fertile plains, and made the trackless and barren ocean a new fund of subsistence, and the great high road of communication to the different nations of the earth’ (p 183).

These days many people would be less inclined to count as a benefit some of the ways in which the face of the globe is being changed by the motion of industry. But Smith’s insight that strivings of individuals to improve relative position can encourage technological progress is still relevant. If such strivings also result in negative externalities, those need to be balanced against the positive externalities that Adam Smith identified.
I promise to write about Robert Frank’s views in my next post.