Is average over?

This question is prompted by the title of Tyler Cowen’s book, Average is Over. The book has been the subject of several excellent reviews since it was published in 2013, including one by Matt Yglesias and one by Rick Searle.

My aim here is to clarify what Tyler means when he says “average is over” and then attempt to consider the implications for high income countries.

As Tyler sees it, average is over in many aspects of life in America including occupations, earnings, education and where people live. The age of genius machines is arriving. People who have skills that complement those machines have brighter prospects that those who don’t. The people with higher earnings will increasingly have relevant post secondary education. Conscientiousness and self-motivation are likely to be rewarded more highly. People who lack the necessary skills and personal qualities are likely to see an erosion of their economic futures. The labour market problems of young people who lack the right training and attitudes are likely to intensify. People with skills that are becoming redundant or over-supplied are likely to experience falls in real income.

Tyler sees America becoming two nations: a fantastically successful nation working in the technologically dynamic sector, and everyone else. Highly educated people will increasingly gravitate to areas where a relatively high proportion of other individuals have post-secondary degrees e.g. San Francisco, Raleigh (North Carolina) and Stamford (Connecticut). Low-income retirees will face increased economic pressure to move to run-down areas where rents are lower and services are deteriorating and/or to shanty towns in the warmer states.

It is important to understand that Tyler is writing about what he thinks will happen rather than what he thinks ought to happen. The government policy responses that he has factored into his assessment are the responses that he considers to be most likely in the United States – largely a continuation of current policies.

Governments in other countries might respond differently. Nevertheless, it is clear that the underlying forces are common in many high-income countries. As Tyler puts it:

“These trends stem from some fairly basic and hard-to-reverse forces: the increasing productivity of intelligent machines, economic globalization, and the split of modern economies into both very stagnant sectors and some very dynamic sectors”.

After I finished reading the book I was left pondering how the mass of the population will benefit from having technologically dynamic growth sectors in the countries where they live. Tyler’s mention of the dreaded term ‘factor price equalization’ in the context of his discussion of the effects of international trade (outsourcing) and immigration implies that he expects real wages to fall substantially in non-dynamic sectors. Factor price equalization is, of course, a product of theoretical models which assume that all goods are internationally tradable, or that labour can and will flow between countries until wages are equalized. The market for unskilled labour is the last place where we should expect the law of one price to become a global reality.

Standard economic models lead us to expect international trade and immigration to provide net economic benefits to residents, even though they may leave a proportion of the population worse off. With that in mind, I think the emergence of technologically dynamic growth sectors based around development and use of intelligent machines should be viewed as just the latest step in a process of expansion in economic opportunities that has been occurring since the beginning of the industrial revolution. Growth sectors provide expanding opportunities for people in the regions/countries that have them, including unskilled people who benefit from the growth of demand for services and home owners who obtain capital gains. At a national level, citizens benefit from tax revenue generated, even if their careers are disrupted. For example, Tyler expects social security for the elderly in the U.S. to be maintained at around current levels - which are far higher than average earnings of unskilled workers in Mexico.

The best description I have seen of the job polarization occurring in the U.S. is provided by Figure 7 of David Autor’s paper ‘Polanyi’s paradox and the shape of employment growth’, published last year. I had thought of reproducing the graph here, but I want to encourage people to read the whole paper. The graph shows:

• the pace of employment gains in low wage, manual task-intensive jobs has been increasing since the 1980s;
• the occupations experiencing loss in employment are in the middle of the distribution, with the locus of displacement of middle-skill employment moving over time into higher skilled categories;
• the growth of high-skill, high wage occupations decelerated markedly in the 2000s, with only a modest recovery between 2007 and 2012. David Autor suggests that the deceleration of growth of high pay jobs was associated with macroeconomic events which led to a sharp deceleration in computer investment (the bursting of the dot-com bubble, followed by the collapse of the housing market and the ensuing financial crisis).

David Autor’s paper also contains some comparable data on job polarization in Europe. Some comparable data for Australia is shown in the chart below, which is based on data in the chapter on information technology and the Australian labour market by Jeff Borland and Michael Coelli in Australia’s Future Workforce recently published by CEDA (see Table 1, p136). CEDA’s report is worth considering at some length in a later post.

The picture of job polarization in Australia and Europe seems to differ substantially from that in America. It seems that there have been lower increases in employment in the lowest paid occupations in Australia and Europe than in the U.S. I can’t explain why. There are several possible explanations including differences in social security systems providing options other than low-paid employment in Europe and Australia, and differences in migration patterns.

The chart also suggests that in Australia, the rate of decline in the middle pay occupations and growth in the higher pay occupations have been higher during the 1970s and 80s than during the last couple of decades.

David Autor argues that employment polarization is unlikely to continue indefinitely because many middle skill jobs demand a mixture of skills that cannot readily be unbundled into routine tasks that intelligent machines can do and non-routine tasks that only humans can do, or because unbundling would involve a substantial drop in quality. Workers will maintain a comparative advantage in tasks involving interpersonal interaction, flexibility, adaptability and problem solving. Examples include medical support occupations, a wide range of skilled trade and repair occupations, e.g. plumbers and electricians, marketing, and clerical occupations that involve coordination and decision-making.

I conclude with another point emphasized by David Autor. In considering the future of the labour market it is worth remembering the long history - since the beginning of the industrial revolution - of leading thinkers overestimating the potential of new technologies to substitute for human labour and underestimating their potential to complement it.

Will paying for internet content raise productivity growth?

Productivity growth is important because the opportunities available to our children and grandchildren depend on it. As I write that I can almost hear some people saying: “Oh yeah, who needs more stuff?” It would be great if people who are satisfied with their current living standards didn’t have to worry about productivity growth. Unfortunately, even those people need productivity growth because their governments have already spent some of their future income on their behalf. Material living standards will depend on the income that remains after governments have taken away a slice (via reduced welfare payments and services or higher taxes) in order to service the public debts that continue to accumulate.

Some economists are worrying that the rate of productivity growth in high-income countries has declined since the turn of the century and is hampering recovery from the great recession in Europe and North America. In an article published by the Australian Treasury in 2013, Christine Carmody suggested that the substantial decline in productivity growth that has occurred in Australia might be related to a more general decline in productivity growth in other high-income countries. However, when I went looking for more recent OECD data on productivity to illustrate the slowdown I started to doubt whether it is a general phenomenon. The Figure below shows that in only about half of the countries covered by the OECD data was the rate of multifactor productivity (MFP) growth during the 2001 to 2007 lower than that in 1995 to 2001.

(Please click on graph for a better view.)

Multifactor productivity (MFP) measures the growth in value added output per unit of labour and capital input used. Labour productivity is sometimes still used in such comparisons but if we are interested in productive efficiency it makes sense to remove the impact of capital deepening (i.e. increasing capital per unit of labour).

After I saw the ambiguous OECD data I decided to take another look at Tyler Cowen’s book, The Great Stagnation, because that was where I had first come across the idea that all the low hanging fruit has been picked. As it happens Tyler’s book was about America and he did not rely on national productivity data to make his point. In fact he was highly critical of national productivity data. (Tyler relied heavily on data on median family incomes, which have growth slowly since the mid-1970s. Some analysis by Scott Winship suggests to me that there may also be problems in using that data to measure trends in productivity and earnings.)

Robert Gordon’s view that there has been a secular decline in productivity growth that is likely to continue is based on an examination of longer term trends in productivity growth in the United States. He notes that in the eight decades before 1972 labour productivity growth in the U.S grew 0.8 percent per year faster than in the four decades since then. He is sceptical of claims by techno-optimists such as Erik Brynjolfsson and Andrew McAfee that the global economy is on the cusp of a dramatic growth spurt driven by smart machines taking advantage of advances in computer processing, artificial intelligence, networked communication etc.

Tyler Cowen seems to be in broad agreement with what Bob Gordon writes about the past, but tends to agree with the techno-optimists about productivity growth in the future. There are other important contributors to this debate, including Joel Mokyr who makes the point that that the indirect effects of science on productivity through the tools it provides scientific research – such as searchable databanks, quantum chemistry simulation and highly complex statistical analysis - may, in the long run, dwarf the direct effects. The views of various contributors to the discussion have been summarised by Andrew Flowers in EconSouth.

In a recent article in the New York Times Paul Krugman made a useful contribution by suggesting that the productivity numbers are missing the benefits of new products and services. He wrote: “I get a lot of pleasure from technology that lets me watch streamed performances by my favourite musicians, but that doesn’t get counted in GDP”.

That point is, of course, not new. Australia’s Productivity Commission (with which I am still proud to claim past links) has recognized the problem of measuring the outputs of the information and communications technologies (ICT) industries - for example, see the staff paper on productivity concepts and measurement by Jenny Gordon, Shiji Zhao, Paul Gretton. The problems of measuring productivity of the internet were discussed at some length by Tyler Cowen in Chapter 3 of The Great Stagnation.

In order to answer the question I posed above I had hoped to point to some concrete evidence that content providers are finding effective ways to charge the users of their products. It seems all too obvious that it is happening with respect to a great deal of music, video and news, but I have not been able to find a summary of relevant information on the extent to which this is happening. Information such as that is usually easy to find on the Internet, but when I type in the words ‘revenue’, ‘internet’ and ‘content’ into search engines what comes up is a lot of information on models that firms can use to charge for content. Perhaps that is a sign of the times! The success of major sporting organisations in obtaining revenue from the entertainment they provide via all communications media seems to point toward a future in which consumers will pay for content directly and/or expose themselves to greater, and more personalised, advertising.

As people have to pay for more internet content it seems likely that will,of itself, make the productivity numbers for ICT industries look better, even though underlying productivity will not have improved and well-being of consumers may have declined. The potential upside of this return to old style capitalism is that as people pay for content there will be an increased incentive for firms to invest in providing content and to employ more people to produce content. 

Postscript 1:

Jim Belshaw has some related comments on his blog raising some questions about education, on-the-job learning and retention of corporate knowledge. My discussion with Jim in the comments section below has introduced me to the concept of productisation, which involves combining suitable elements to form something that is standardized, repeatable and comprehendible as product (a longer definition is provided in this abstract).  It has also prompted me to think more about the implications for productivity of ICT investment at the firm level.

The Productivity Commission’s research report "ICT Use and Productivity: A Synthesis from Studies of Australian Firms" published over a decade ago indicates that the rate of ICT uptake and effects on performance differ substantially across firms, even in similar circumstances. The differences were attributed to: differing technology and innovation strategies; availability of complementary skills; and differences in capacity to ‘learn-by-doing’. The Commission also suggests that differences between firms in their accumulation of organisational capital sets them apart from each other in their effective use of technology and in related innovation. 

A report by Ben Miller and Robert Atkinson entitled “Raising European Productivity Growth Through ICT” (prepared for the Information Technology and Innovation Foundation and published in June 2014) also draws heavily on firm-level productivity studies. The report cites many recent studies suggesting that investment in ICT has continued to have a strongly positive impact on productivity at firm level. The report argues that the regulatory environment in Europe has hindered the ICT investment needed to close Europe's increasing productivity gap with America.  

Postscript 2:
Noric Dilanchian has drawn my attention to a post by Timothy Taylor, the Conversable Economist, on a new OECD report entitled "The Future of Productivity". The OECD report seems to cover some similar ground to the report by Ben Miller and Robert Atkinson referred to above. I will read it properly and write more about it later. 

Will robots replace human labour and reduce real wage levels?

The potential impact of technological change on real wage levels in high-income countries seems to me to be more important than some other questions about the future that attract more public attention. In particular, the future of real wages must be much more important than income distribution, since there is not much evidence that income distribution has a significant impact on the well-being of the mass of the population. Real wage levels have traditionally determined how the mass of the population live their lives – how well they eat, the standard of housing they are able to afford, how much leisure they can afford, their ability to travel and so forth.

I made as similar point about the relative importance of real wages levels and income distribution last year in my review of Thomas Piketty’s book, Capital in the Twenty-First Century. I asked:

“What happens if technological progress makes capital a close substitute for labour? If a substantial component of the capital of the future can be thought of as a work-force of robots, the economic consequences might be a little bit like introducing slave labour to compete with the existing workforce. Real wages might fall under such a scenario, even though national income could be expected to continue to rise.”

I then went on to refer to an article on this blog a few years ago in which I asked: Will history judge Marx to have been right about the effects of technological progress on income distribution? Looking back now, I think the answer I gave was not too bad - but it was not particularly enlightening.

In trying to consider how to give a better answer I have been trying to come to terms with some maths in economic models relating to bias in technological change (including in a master’s thesis on technological change and capital labour substitution in Australian agriculture that I wrote over 40 years ago) and some relevant empirical research. I think some of this stuff is helping me to understand what might be going on, but in trying to explain it (even to myself) it is more useful to refer to some very simple economic models that can be described verbally.

The place I start is to consider what would happen if technological change consisted entirely of the introduction of robots that are very close substitutes for humans with respect to all attributes relevant to production processes. I then consider some implications of the deficiencies of that model.

As I wrote earlier, the consequences might be like introducing slave labour to compete with the existing workforce. Real wages might fall under such a scenario, but we should not be too hasty in reaching that conclusion.

It appears obvious that an increase in the supply of labour will cause the price to fall. People with rudimentary economics training might think of it in terms of the law of diminishing returns. As you add more labour, keeping other factors of production unchanged, the marginal productivity of labour tends to fall and this is accompanied by a fall in real wages. Of course, it is not even necessary to have a rudimentary knowledge of economics to grasp the idea that an influx of migrants which resulted in a substantial increase in supply of labour could reduce wage rates of workers.

The problem with that analysis is that it is unreasonable to expect other factors of production to remain unchanged in the face of an expansion in labour supply. An increase in quantity of labour will tend to raise the rate of return on capital (by raising the marginal productivity of capital) and thus provide an incentive for further investment. If the supply of capital is sufficiently elastic, real wages need not fall as a consequence of the increase in labour supply.

The potential for an expansion in labour supply to be consistent with higher living standards comes as no surprise to anyone familiar with empirical modelling of the economic effects of migration. For example, a recent study undertaken for Australia suggests that immigration has a strongly positive impact on labour participation, employment and wage levels.

So, in economic terms it seems that we would not have too much to worry about from an influx of robots who were just like humans.

However, the model of technological change I have presented above is deficient in several respects. One major deficiency is that technological progress consists of much more than introduction of machines that perform similar functions to humans. It also involves technical innovations that enable humans to do their jobs better and the introduction of superior consumer goods. If we take a broader view of technological change there is less room to fear that it might result in lower real wages.

Another major deficiency of the model is that it fails to recognize that the replacement of human labour by non-human labour is an ongoing process rather than a new phenomenon. Nick Rowe explained it this way a few years ago:

“Horses were once like robots. Horses could do a lot of the same work that humans could do. Humans and horses can pull things, if you feed them. But then mechanical horses, called tractors, were invented, that could pull heavier things with cheaper food. Tractors pushed horses' wages below subsistence, so the horse population declined.

The robot horse displaced horses, just as horses displaced humans from all the jobs where humans pulled things. But humans, unlike horses, can do lots of other jobs beside pulling things. Humans are very versatile. Horses can't really do anything except pull things. So humans switched to doing other jobs, while horses couldn't. And the marginal product of labour, and hence wages in those other jobs, increased. Horses and tractors were complementary factors to human labour in those other jobs.

But that won't happen if robots are invented that really are just like humans, and can do all the jobs that humans can do. Robots that are just like humans would be just like slaves, rather than like tractors and horses.”

What we are seeing now is robots that are displacing humans from a range of activities and freeing them to do things that robots can’t do - just as horses did. There are adjustment problems for people in the affected industries, but the impact on average real wages is likely to be positive. Over time, superior robots are likely to be invented that will replace the initial series of robots, just as tractors displaced horses. If robots can eventually reproduce like crazy, their capacity to live off “the smell of an oily rag” might mean that wages in many industries in which humans are currently employed will be driven below human subsistence levels.

 

However, it seems unlikely that robots will ever be viewed by humans as close substitutes for human labour with respect to all attributes relevant to all economic activities. My guess is that many humans will show a strong preference for some goods with a high human labour input e.g. home produced food, restaurant meals and beverages that are served by humans, live music by local musicians, handicrafts and works of art produced by humans, and some manufactured goods that individual humans have designed specifically for themselves or friends and relatives.

My bottom line is that over the next few decades the impact of robots in replacing human labour is likely to be a relatively small part of the total impact of technological change on the quality of life. Rather than worrying about robots replacing human labour perhaps we should be more concerned that the rate of technological progress may be slowing down. I will turn to that question in my next post.

Postscript:

I would like to draw attention to comments by Jim Belshaw (see below). Since the discussion may be of wider interest I will reproduce the main points here:

Jim:  Doesn't the evidence suggest that we have a higher proportion of the population employed in lower wage jobs and a higher proportion joining the ranks of the longer term unemployed? I accept that part of the impact is distributional and timing.

Winton: The evidence you refer to is one of the reasons I have been thinking about technological change and productivity growth. Some of the move to lower paid jobs and less job security could be associated with adjustment to technological change i.e. the timing problem you refer to. Some could also be associated with lower productivity growth and insufficient investment.
If tech change is a big factor I would expect it to be affecting older people, with young people finding it easy to pick up jobs created by new technologies. We do see older workers losing jobs, but we also see young people finding it more difficult to find employment.

Jim: We have seen lots of cases of older people losing jobs and dropping out of the work force. That was a particular feature of the early nineties adjustment. However, older workers are also more likely to be in "secure" jobs and to have been there for a time. There is a higher separation cost for the firm. This was a feature of Germany ten years back.
It is actually not clear to me how many jobs have been created by new technology compared to jobs lost. I am no Ned Ludd. I am well aware of previous cases (the industrial revolution is a huge example) where the application of new technology has produced long term gains. I would also agree and have been worried by what I perceive to be the slow-down in technological advance.
But we seem to be in a situation now where technological improvement is dominated by refinement, process improvement and cost reduction. I used to argue that we didn't need to worry about that because Government and community services broadly defined would redistribute benefits. Then and now there were just so many things that could be done to improve the quality of life.
I accept that was a naive view, partly because of globalisation, partly because of a cut-back in what Government might do. Realistically, the wealthier countries have to accept that they have reached a wealth peak, that competition will limit their gains while redistributing wealth to others.

Winton: I would have expected the cost reduction to have resulted in profitable investment opportunities and an accompanying expansion of employment opportunities. It doesn't seem to have happened and I don't really know why at this stage. I find it hard to perceive of cost reductions that do not increase profitability of investment. Perhaps we have reached the satiation point that Keynes wrote about, but I doubt it. 

Jim:  On Keynes, I doubt it too. I think one key issue with cost reductions lies in sustainability. There has been a problem with cost reductions designed to maximise immediate impact that have actually reduced value over the longer term.
There is also an issue that cost reductions increase the yield on what we do now but do not affect the yield on future investments. Increased profitability may increase the capacity to invest, but there is no necessary reason why additional investment should follow.
A recent RBA paper (referred to in a post on Jim’s blog) outlined the way in which investment decision processes (hurdle rates, pay back periods) might impede investment now. However, there is a timing issue here. If you accept that firm decision making processes have a degree of rationality, once firms are convinced that low inflation and lower interest rates will last for the immediate future, then the hurdle rate will come down.
The industrial revolution was based on the creation of mass markets. One of the difficulties in the thinning out of the middle class in many Western countries lies in the reduction of those markets. However, the mass market is growing elsewhere with economic development and globalisation. Investment rates in those countries are higher.

Winton: There are some interesting ideas there that are particularly relevant to Australia.
Another thought that has occurred to me is that a fair amount of the cost reduction is occurring in industries that are attempting to survive against competition from the free content available on the Internet. Think of the news media as an example. The internet is a major innovation providing substantial benefits, but causing a great disruption to the capitalist system as we once knew it. This is also part of the story about the apparent decline in the rate of productivity growth in the wealthy countries - the output of the Internet is not measured very well.

There has been a fair amount written around this topic but I have not yet come across anything that puts the pieces of the puzzle together in a coherent way.

Does nature show us the way to flourish?

There are good reasons to look to nature for an understanding of what it means for a human to flourish. By looking at nature we know that in many respects humans are similar to other animals. We consider some aspects of human flourishing in same way as we might consider whether animals in a zoo have adequate opportunities to flourish. For example, we consider whether humans have the food, shelter, companionship, and environmental interactions that are necessary for their physical and mental health.

However, when we look at human nature we also see potentialities that differ from those of other animals. We see greater cognitive capabilities, and greater potential for choice and self-direction. That suggests that human flourishing must involve development and exercise of cognitive abilities and skills in self-direction. When humans are flourishing they make fewer bad choices and are better at learning from their mistakes than when they are languishing.

The view just expressed is, of course, a Western libertarian view that owes much to Aristotle’s naturalistic perceptions of human flourishing. Contrary views are often heard, some of which also claim links to Aristotle. It is often argued that even adult humans are so prone to making bad choices – despite the help of family, friends and professional advisors - that they are unlikely to have happy lives unless they are subjected to a lot of paternalistic intervention by governments. Those who hold that view seem to think that governments are capable of designing and implementing regulatory systems that will enable people to have happier lives than under a spontaneous order relying on individual autonomy and mutually beneficial interactions with others. Such paternalists encourage people to become dependent on government like animals in a zoo become dependent on their keepers. 

 

The seemingly endless dispute over the relative merits of spontaneous orders and paternalistic governance has parallels in the disputes between Daoism and Confucianism in ancient China. That became evident to me while I was reading An Introduction to Daoist Philosophies by Steve Coutinho. The book also provides people in the West with a different way of considering what nature shows us about human flourishing.

I first encountered Daoist philosophy a few years ago when I stumbled across a quote from Laozi (also referred to as Lao-tzu or Lao-tze). I then read the Laozi (also referred to simply as the Tao Te Ching) and posted to my blog asking: Was Lao-Tzu a libertarian? When I wrote that post I had the impression Laozi was a person who lived in the 6^th century BCE, but there is actually no indisputable historical evidence of his existence. The Laozi may be a collection of the works of several authors.

In the early Daoist texts nature is perceived as the context in which humans finds their place, nurtured and sustained along with all other things. Nature is perceived as untamed, but it is not viewed through the frame of the predatory survivalism often seen in wildlife documentaries. Nor is nature viewed through the frame of Rousseau’s ideal of harmony and perfection. The Daoists saw nature as a source of inspiration about how we should live.

The Laozi does not view nature as some kind of entity which micromanages natural phenomena. It recognizes that the complex natural world could not exist if it had to be controlled or manipulated deliberately. The natural world allows living things to grow and flourish according to their natures.

The point of observing and understanding natural functioning is to provide a model of how we ourselves should behave. Steve Coutinho suggests that the inspiration that we can take from the Laozi is that we should refrain from imposing artificial structures in an attempt to control and manipulate things:

“We must first appreciate the natural tendencies of the circumstances, of our surroundings, of other people, and of ourselves. We should then explore the most efficient way of dealing with things, one that accords closely with their immediate tendencies. Rather than planning for all contingencies in advance, we should wait to observe how things develop, sense how they tend to move themselves, and then move with them, redirecting them with minimal effort”.

The somewhat anarchistic approach of Daoist philosophy stands in contrast to the Confucians, who sought to maintain social order through social hierarchies and ethical cultivation, and other branches of Chinese philosophy which advocated clear laws, regulations and standards, and emphasized language and linguistic distinctions.

Steve Coutinho’s book contains a chapter discussing the Daoist philosophy of skill, which is directly relevant to question of what nature tells us about how we can flourish. The chapter is based on the Zhuangzi and Liezi, which were written after the Laozi, but share some broad themes with it.

As Coutinho explains it, the path of cultivation of natural tendencies involves more than just going with the flow and following your desires - the interpretation of Daoist philosophy that is often implied by popularizations in the West.  Most of us no longer know instinctively how to live naturally because our thoughts and actions have become shaped by excessive artifice – unnatural complexity - which is a by-product of thousands of years of cultural development. The degree of artifice in our lives has divorced us from an intuitive understanding of the nature of things and of ourselves. The cultivation of natural tendencies and recovery of spontaneity require the undoing of some of this artifice.

What nature shows us is that natural creatures have a natural capacity to flourish without written instructions. Even when they know what they do, they do not necessarily know how or why they do what they do. It is the nature of humans to use their cognitive abilities to design and produce things and to enjoy cultural activities. What we can learn from nature is how to do these things in a simple way that is intuitive, natural, fluid and responsive to the natural tendencies of the phenomena one is engaged with.

An understanding of the Daoist message can be gained most readily by considering acquisition of physical skills. For example, in order to become skilled at archery a focus on scientific knowledge about how eyes and muscles work would be an unhelpful distraction. The skill can only be acquired through experiments in actual movement, which the teacher then attempts to correct and adjust. There are good reasons why this reminds me of the lessons I had in the Alexander Technique to help rectify stress-related back and neck problems.

The path to skill lies in nurturing the natural abilities we are born with. Many years of training are often required to develop increased sensitivity to the “innermost subtle tendencies” of the phenomena we are dealing with. Skilful performance requires awareness to be focused on the task so that potential distractions do not interfere.

The Daoist texts point toward the acquisition of the meta-level skill of being able to acquire new skills as well as the acquisition of specific skills. This “skill of skilfulness” can be applied more broadly to the art of living. As Steve Coutinho puts it:

“A flourishing life, a life lived well, for a Daoist, is one performed with consummate artistry”.

It seems to me that if more people in the West could think about that for a while it might help them to see the merits of spontaneous orders and to reject the artifices of paternalistic government. 

What is the appropriate discount rate to use in assessing climate change mitigation policies?

The correct answer, in my view, is that the appropriate discount rate depends on the kind of policy that is being considered. If that answer seems odd to you then there is a good chance you have not yet read Mark Harrison’s paper entitled ‘Addressing Wellbeing in the Longer-Term: a Review of Intergenerational Equity and Discount Rates in Climate Change Analysis’. The paper was published last year in Measuring and Promoting Wellbeing, a collection of essays in honour of Ian Castles (an Australian who deserved to be honoured highly for his work on measurement of wellbeing).

The kind of policy that was evaluated in the famous cost benefit study by Nicholas Stern (and the subsequent study by Ross Garnaut) involves imposing some kind of tax (perhaps via a cap and trade mechanism) on carbon emissions in order to improve the well-being of future generations. Stern and Garnaut assume that economic growth will continue even in the absence of policies to mitigate carbon emissions and global warming, resulting in much higher average income levels in future (3.6 times higher 100 years from now in Stern’s projection).

Photo by Robin Ellis. Some rights reserved.

The carbon tax that this kind of modelling exercise suggests to be appropriate is highly sensitive to the discount rate that is used to determine the present value of mitigation efforts. The use of a low discount rate suggests that strong immediate action is warranted to mitigate climate change, whereas a higher discount rate suggests that the most appropriate course of action is to begin with a very low carbon tax and raise it gradually. In an illustrative example Harrison shows that with a discount rate of 1.35%, as assumed by Stern, the optimal current carbon tax is $78.48 per tonne, whereas with a discount rate of 6% it is only $0.88.

The discount rates used by Stern and Garnaut are an application of the social welfare function approach. Social welfare functions necessarily embody ethical judgements, even though such judgements are hidden beneath empirical facts in some versions of the, so called, Ramsey formula used by climate change modellers. Opinions differ on what ethical judgements are appropriate and discount rates can vary widely depending on what assumptions are made. Harrison demonstrates that the Ramsey formula gives estimates of a risk free discount rate ranging from 0.24% to 11% under the range of parameter values used in a variety of studies over the past decade.

At this point some readers will probably be throwing up, while others will be wondering what discount rates would be consistent with ethical judgements that they would be prepared to endorse. One way to consider whether you would be prepared to pay a carbon tax costing you $x per month in order to make your great grandchildren better off is to ask yourself whether you would prefer to make a financial investment of the same amount each month into some kind of trust for their benefit. The answer you obtain by considering opportunity costs in this way is equivalent to discounting the real money value of the benefits of climate change mitigation by the rate of return that you could expect to obtain on the alternative investment – presumably higher than the average real long term bond rate over the past 20 years or so.

One possible objection to this approach is that the rate of return on alternative investments will incorporate an element of compensation for risk, which is not appropriate in considering public investments such as climate change mitigation. The response which Mark Harrison provides is to point out that investment in climate change mitigation are far from risk free. There is a great deal of uncertainty about future costs and benefits of such policies. Most obviously, if you decide to vote for the carbon tax option you have no guarantee that people in other countries will pull their weight by imposing similar taxes on their citizens.

Some of you will by now be thinking that the cost benefit framework outlined above must be a load of garbage because you remain concerned about climate change, even though you would prefer to invest money for the benefit of your great grandchildren rather than to pay a carbon tax. If you are concerned about climate change, you are unlikely to be concerned that your great grandchildren will suffer losses that you could compensate for by increasing your savings rate by a small amount. The chances are that you (like me) will be concerned about the remote possibility that your great grandchildren might suffer from having to live with potentially catastrophic climate change outcomes.

Mark Harrison points out that by explicitly accounting for risk, rather than assuming it away, we can distinguish between policies that reduce risk and those that don’t. Mitigation policies that are potentially effective in averting disasters should be subjected to a discount rate that is below the risk-free rate because they pay off at a time when returns on other assets are low or negative, and when willingness to pay is great.

So, my conclusion:

•  the most appropriate discount rate to use to evaluate policies such as carbon taxes is the long-term average of real market rates of return on capital; and  
• the most appropriate discount rate to use to evaluate policies directed more specifically toward averting disasters - such as public investment in research to develop low-cost ways to removing greenhouse gases from the atmosphere - should be lower than the long-term average of real government bond rates.

In the unlikely event that we are faced with something close to the worst case climate scenario, our current policies to encourage adoption of inefficient alternative energy options are unlikely to avert catastrophe.  If the objective is to reduce the risk of catastrophe we should be using an evaluation methodology that helps us to choose the lowest cost method of achieving that objective.

Postscript:

There seems to be increasing awareness that we should be asking how we can insure against the worst climate change outcomes at lowest cost. Martin Wolf has published a relevant article entitled ‘Climate actions hould be seen as insurance’, in which he discusses Climate Shock, a new book by Gernot Wagner of the Environmental Defense Fund and Martin Weitzman of Harvard University. There has been a fairly favourable review of Climate Shock by William Nordhaus in the New York Review of Books.

I get the impression that the authors of Climate Shock have come to the conclusion that the best form of insurance is to reduce CO2 emissions as rapidly as possible. They rule out engineering solutions directed toward managing solar radiation (probably for good reasons) but it is not clear whether they have considered the potential benefits of research into ways to take greenhouse gases out of the atmosphere.

It is also unclear whether urgent action is justified, given the fact that when global warming resumes it will probably have positive net economic benefits for a few more years. I expect the variance of potential outcomes is not as great over the next decade or so as it is when we look further into the future.

The review article by William Nordhaus offers a solution to the free rider problem in international negotiations in the form of a climate change club  imposing trade sanctions on countries that are perceived to be laggards. That kind of thinking makes me wonder whether the science of climate change might turn out to be less important for a country like Australia than foreign policy and trade considerations. The formation of a climate change club seems a more worrying prospect at the moment than the potential for an increased incidence of droughts and bushfires. 

How does nature connectedness affect happiness?

White sands walk: Jervis Bay, NSW, Australia

How important is a constant intercourse with nature and the contemplation of natural phenomena to the preservation of moral and intellectual health!   Henry David Thoreau, Journal, 6 May 1851.

Thoreau still speaks eloquently for everyone who feels a need to spend time in the natural environment in order to re-charge their emotional batteries. Recognition of the importance of the natural environment to human happiness now seems to be supported by the findings of social research which show that nature connectedness - identifying with and feeling connected to the natural world – is correlated with happiness. The strength of this relationship is similar to that between happiness and personal income, marital status, volunteering, and personality traits such as conscientiousness and agreeableness.

Formal evidence on links between nature connectedness and happiness has only emerged during the last few years. What I write below is based mainly on a meta-analysis by Colin Capaldi, Raelyne Dopko and John Zelenski published in September last year. In order to be included in the meta-analysis, studies had to include at least one explicit, self-report measure of nature connectedness and at least one measure of happiness and report on their relationship. The meta-analysis covered 30 samples, giving a total sample size of 8523. Most samples came from Canada, the U.S. and Europe.

The meta-analysis showed that the strength of the measured relationship between nature connectedness and happiness was influenced by the way these variables were defined and measured. A measure of inclusion of nature in self had a stronger relationship than other measures of connectedness. Vitality was the happiness concept with the strongest relationship to nature connectedness.

The authors note that correlation between nature connectedness and happiness does not necessarily indicate that nature connectedness causes people to be happier. It is possible that causation might run from happiness to nature connectedness or that some third variable might be responsible for the observed correlation.

However, there is fairly clear evidence from another meta-study (by  Diana Bowler et al) that exercise in natural environments promotes greater emotional health benefits – in terms of feelings of energy, and less anxiety, anger, fatigue and sadness - than exercise in an artificial environment. There is also evidence that nature connectedness is positively related with time spend outdoors in contact with nature.

It is possible 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 the community. The relationship between nature connectedness and happiness is still evident, however, when other connections (e.g. family and culture) are controlled for.

The authors note that the relationship between nature connectedness and some forms of happiness may be adversely affected, to some extent, by a tendency of people who feel connected to nature to be worried about the future of the environment. Such concerns are more likely to dampen positive emotions than eudaimonic measures of happiness because such people are likely to become engaged in pro-environmental behaviours that make their lives seem more meaningful.

There is evidence that feelings of nature connectedness are stronger in some cultures than others and are influenced by early childhood experiences. That suggests to me that causation runs from nature connectedness to happiness, rather than vice versa.

Is human flourishing inconsistent with living in harmony with nature?

A view of Sydney in 2014

I like many of the ideas in the Ecomodernist Manifesto, but I don’t like the idea of having to choose between making room for nature and living in harmony with nature. Before discussing this issue I will provide some background.

The Manifesto, published in April of this year, has 18 authors of whom the best known are probably Ted Nordhaus and Michael Shellenberger of the Breakthough Institute.

The Ecomodernists begin with the proposition that the earth has entered into a new geological epoch, the Anthropocene, or age of humans. That provides the backdrop for consideration of the interaction between human flourishing and the natural environment.

Many environmentalists assert that a good Anthropocene is not consistent with the ongoing expansion of opportunities for human flourishing which economic growth provides. By contrast, the authors of the Manifesto are optimistic that the Anthropocene can offer expanding opportunities for humans, as well as protecting the natural environment, if knowledge and technology are applied with wisdom.

I endorse this proposition:

“A good Anthropocene demands that humans use their growing social, economic, and technological powers to make life better for people, stabilize the climate, and protect the natural world.”

My problem is with what follows immediately after:

“In this we affirm one long-standing environmental ideal, that humanity must shrink its impacts on the environment to make more room for nature, while we reject another, that human societies must harmonize with nature to avoid economic and ecological collapse.

These two ideals can no longer be reconciled”.

I don’t see any necessary conflict between the two ideals. It seems to me that the ideal of harmonizing with nature means that we should seek to live in harmony with the natural laws of the world in which we live. That means accepting that humans are in many respects like other animals and have deep emotional connections to the natural environment and other living things. These emotional connections are explicitly recognized in Chapter 5 of the Manifesto.

That suggests to me that the problem is just definitional. Nevertheless, it is hard to understand why the authors of the Manifesto would risk losing support by asking people to make an unnecessary choice between ideals.

What is the real choice that the authors want us to make?  When they object to the ideal of human societies harmonizing with “nature”, it seems that what they are referring to are natural systems - the part of the natural environment that has not yet been significantly modified by human activity. 

The authors argue:

“Natural systems will not, as a general rule, be protected or enhanced by the expansion of humankind’s dependence upon them for sustenance and well-being.

Intensifying many human activities — particularly farming, energy extraction, forestry, and settlement — so that they use less land and interfere less with the natural world is the key to decoupling human development from environmental impacts. These socioeconomic and technological processes are central to economic modernization and environmental protection. Together they allow people to mitigate climate change, to spare nature, and to alleviate global poverty”.

The real choice the authors want us to make is between intensifying human activities in particular regions and allowing them to spread in ways that would be detrimental to the natural environment.

The idea of decoupling human development from environmental impacts seems to me to make a great deal of sense as a broad generalization. I expect that governments will encounter difficulties in implementing such a strategy sensibly, but outcomes are likely to be worse if they do not try. One of the difficulties that is likely to stand in the way of implementation in some areas is the need to recognize the rights of indigenous people to use the natural resources they own. Another difficulty is the tendency of over-zealous supporters of wilderness to oppose the eco-tourism which is likely to be necessary to maintain broad political support for protection of wilderness areas. In some areas the involvement of indigenous people in eco-tourism is helping to meet the twin objectives of improving their economic opportunities and enlisting their support for greater environmental protection.

It seems to me to be particularly important for human well-being that attempts to decouple human development from environmental impacts does not occur at the expense of the ideal of living in harmony with nature in areas of intense human activity. The emotional needs that humans have for connection with the natural environment and other living things are unlikely to be satisfied by observing nature on TV and a once-in-a-lifetime visit to a wilderness area. 

Postscript:
In my next post I discuss the link between happiness and feeling connected with nature. 

Is Bitcoin better than gold?

When suggestions have been made to me in the past that I should write about Bitcoin, I have expressed reluctance on the grounds that I don’t know much about it. Some would say, however, that is also true of some other things I write about on this blog.

Time seems to be running out for me to write about Bitcoin while the topic is still interesting. I keep reading news reports suggesting that Bitcoin is rapidly becoming respectable. Apparently New York State’s top financial regulator has just granted the first license to a Bitcoin exchange. A couple of weeks ago it was reported that Goldman Sachs is making a significant investment in a Bitcoin-focused company.

Anyone looking for a simple explanation of what Bitcoin is and how it works can find a fair amount of information online without much difficulty. The Economist attempted to provide an explanation a couple of years ago, but I found an explanation aimed at five year olds to be more helpful. A couple of months ago Nicolas Dorier referred me to the excellent explanation which Andreas Antonopoulos provided to a committee of the Canadian Senate in October 2014. Mr Antonopoulos also appeared before a committee of the Australian Senate and responded admirably to concerns about use of Bitcoin for nefarious purposes such as funding of drug trafficking and terrorism. He also argued strongly that incumbents in the finance industry should not be allowed to dictate government regulations applying to Bitcoin.

Should we view Bitcoin as money? In order to look at this question it is necessary to consider three functions of money: a unit of account; medium of exchange and store of value. Some economists, including Scott Sumner, argue that the unit of account function is the distinguishing characteristic of money from an economic perspective, and I am inclined to agree. Bitcoin is not widely accepted as a unit of account at the moment - it certainly does not seem likely to displace national currencies in that role in the near future.

However, Bitcoin seems to be proving itself to be very useful as a medium of exchange in international transactions. It is particularly pleasing to see reports of Bitcoin being used to enable guest workers from countries such as the Philippines to send remittances home to their families for a much lower price than is charged by firms such as Western Union. Further innovations are occurring in this area. For example, it has been recently reported that an Australian company, Digital CC, has set out to become the Uber of international transfers by developing a peer-to-peer transacting technology to allow remittance payments to be made via a mobile app.

There is no question that Bitcoin is much better than gold as a medium of exchange, because gold is expensive to store and transport.

It is when we consider the potential for Bitcoin as a store of value that the question of whether Bitcoin is superior to gold becomes harder to decide. A glance at the charts below might suggest that investors in Bitcoin are being optimistic if they think it will soon be accepted as a reliable store of value.

How much attention we should pay to past volatility in the price of Bitcoin in thinking about its potential as a store of value in the future?

The author of an article in Fortune, entitled ‘Gold vs. bitcoin: An apocalyptic showdown’, has suggested:

“Of course, as a new technology, bitcoin is subject to much more volatility than gold. But over the long run, given the fact that no new bitcoins will be mined after the 21-millionth, we can expect it to ultimately serve as a better store of value than gold”.

I feel inclined to agree. However, the more difficult question for me is whether to put my money where my mouth is. 

Postscript:
Nicolas Dorier has provided the following response:

"There is nothing to to fear about Bitcoin, but like owning gold, if your lose the map where you buried it, you lose everything. So one should be confident in his ability to protect the map. To learn how to do so, one should start training by protecting some pocket money first before burying his treasure.

First, start small, and consider it a learning experiment rather than an investment. Bitcoin is relatively new, and the tools and ecosystem are not as user friendly as they will become. The learning curve might be a little steep. Owning Bitcoin means being responsible for your money, and most people are not responsible of their own computer.

So be careful, you can always try to buy a few (for 10-50 dollars), and play with it by trying to buy stuff, transfer them between addresses, backup them on paper etc, restore them etc. This stuff was easy to learn for me as I am a developer. But it is not for most people. 

Second, never let your bitcoin on fiat/bitcoin exchanges once you bought. You don't own bitcoins if you don't own the private key. Any balance you see on exchanges are just IOU, not bitcoins.

By playing with it you will learn little by little all what you can do with it that you can't with traditional fiat currencies, and all the business opportunities that it opens. But don't rush it, start playing with it first.

Bitcoin is also an hedge against monetary mismanagement and financial oppression, a typical example right now is Argentina.

The value of Bitcoin increases when governments take measures to restrict the movement of other forms of money. As they do everything to restrict it, it forces people to use bitcoin. Not because they believe or use it as store of value, but because, it is easier to transact. (It is for this reason that Bitcoin came to be used first in black markets.)

As the failure of our central banks becomes more and more obvious, they will start to impose capital controls. (War on cash, that you start to see happening everywhere). This is mainly what will ultimately drive the value of Bitcoin."

Should self-funded retirees be concerned that interest rates on term deposits have declined?

Some readers will wonder why I am bothering to ask this question. It appears to be fairly obvious that people who are relying on interest on term deposits to fund their retirement must have greater difficult in surviving without drawing upon their capital when interest rates are as low as they are now.

However, it is by no means clear that the relevant interest rate is lower now than it has been over most of the last 15 years or so.

So, what is the relevant interest rate? First, nominal interest rates should be adjusted for taxation since the interest income that people are able to spend is the amount left after tax has been paid.

Second, it is also necessary to take inflation into account in the calculation. Inflation tends to deplete the purchasing power of the amount deposited, so some part of the after-tax interest has to be saved in order to prevent the real value of the nest egg from being depleted. Retirees who do not take inflation into account in their calculations are suffering from money illusion - an affliction that enables them to spend their children’s inheritances without feeling any guilt until they realize how much the real value of those sums have depleted.

So, if a retiree is intent on preserving the real value of her capital, the amount of interest income available to be spent is real after-tax interest. You might well ask why a retiree would want to preserve the real value of her capital. That is a very good question. If she has saved the funds to spend during retirement, it does not make any sense for her to be obsessed with the idea of living on interest and preserving capital. The important point is that awareness of the real after-tax interest rate might help her to avoid depleting the real value of her savings more rapidly than she intended.

The chart below shows trends in Australian interest rates on one year bank term deposits, after-tax interest rates on those deposits assuming a marginal tax rate of 30%, and real after-tax interest rates (deducting the CPI inflation rate for the previous 12 months). The data used in the chart is sourced from the Reserve Bank of Australia.

From the chart it looks to me as though it is about 15 years since retirees have been able to spend any of their interest income from term deposits without depleting the real value of their savings. 

It is easy enough to understand that some elderly people might suffer from money illusion and consider it to be sinful to deviate from time-honoured prudential rules about living off nominal interest. One would hope that professionals in the investment advice industry would encourage such people to modify their views somewhat to take account of tax and inflation.

However, some senior people in the investment advice industry have been encouraging the view that low interest rates have reduced the real spending power of retirees. For example, Jeremy Cooper, chairman of retirement income at Challenger Ltd, and the man who chaired the 2010 review of the superannuation system, has been reported in The Australian as saying:

 “Back when bank deposit rates were around 6 and 7 per cent there was no great problem with self-funded retirees relying on bank interest”.

In the same article, Jeff Rogers, chief investment officer of IPAC funds at AMP Capital, made a similar point. He is reported as saying bank deposit rates “will now adjust to just below 3 per cent, so with core inflation at around 2.4 per cent your real spending power is very small” in a self-funded retirement and warns that even if interest rates do start moving up again, “they won’t be going back up any time soon to the level that provided bank interest of 6 to 7 per cent’’. (Article by Andrew Main, ‘Risk rules for retirees reliant on bank interest’, May 6, 2015.)

It looks to me as though the after-tax real rate was close to zero when bank deposit rates were around 6 or 7 per cent, just as it is now.

Why are old Americans more satisfied with their lives than are old Europeans?

The latest WorldHappiness Report (2015) contains an interesting chapter examining how happiness varies around the world by gender and age. The chapter was written by Nicole Fortin, John Helliwell and Shun Wang.

What would you expect those comparisons to show? I guess many people would expect that, on average, women would be less happy than men because in most of the world the opportunities available to females are still less favourable than those available to males.

The data doesn’t actually show that. When people are asked to rate their lives relative to the best possible and worst possible life (i.e. using the so called Cantril ladder) the world averages show that until they are about 50, women tend to rate their lives more highly than men. Perhaps women are more inclined to look on the bright side of life.

In any event, differences between the happiness of women and men are much less marked than differences between young and old people. On average, happiness tends to decline to about age 40 - a few years later for men than women - and then to stay relatively flat.

That finding was a surprise to me. I was given the impression from research I had read about that happiness was U-shaped over the life cycle. When I looked for more recent literature, just now, I found an article by Paul Frijters and TonyBeatton, published in 2012, based on panel data for Germany, Britain and Australia, which suggests the dominant age-effect is a strong happiness increase around the age of 60, followed by a major decline after 75. So I should have had an open mind about what to expect.

The data in the World Happiness Report shows a great deal of variation in the relationship between age and happiness in different parts of the world. Happiness does not vary much with age in South-East Asia, South Asia and Sub-Saharan Africa. Happiness declines sharply with age in CEE&CIS region (former Soviet Union, Eastern Europe and Central Europe) and less sharply with age in Latin America, Middle East and North Africa and Western Europe. The only regions with the U-shape are East Asia and NA&ANZ (North America, Australia and New Zealand).

It does not surprise me that there is a different relationship between happiness and age in high and low income countries, but I did not expect to see the different patterns in Western Europe and NA&ANZ which are shown below (based on Figure 3.2 of the World Happiness Report 2015).The NA&ANZ data are dominated by America (regional averages are calculated using population weights) so I am seeking an explanation of why old Americans are relatively more satisfied with their lives than old Europeans.

The different pattern between America and Europe also showed up in survey respondents’ reports of some positive emotions experienced the preceding day: smiling and laughing a lot; enjoyment; and learning or doing something interesting. The survey data also shows that older women in Western Europe report experiencing greater sadness, physical pain and depression than do men of comparable age in that part of the world, or people of either gender in America.

A hint about the possible causes of the difference in patterns between America and Europe is given by looking at the determinants of life satisfaction, as indicated in the regression analyses undertaken for the report. Those determinants are income, health, generosity, corruption, freedom of choice and social report.

An inspection of the graphs showing how those variables differ according to the age of respondent suggests that the main area of difference is in respect of perceptions of social support. What this means is that, on average, older people in Western Europe perceive that they are less able to count on relatives and friends for support when they need it than are older people in North America.

It is interesting to speculate about the reasons why old people in Western Europe are less likely to feel that they can count on relatives and friends in times of need. The thought that passes my mind is that the reasons might have something to do with the nature of the welfare states of Western Europe, but that might just reflect my prejudices.