Sunday, January 17, 2010

Is the rule of law under challenge in Australia?

I expect that some readers will think that this is an absurd question. Australia has a well-deserved reputation for the quality of its legal institutions. Our ranking on the World Bank’s rule of law index is higher than that of the U.S. and U.K. So why ask the question?

First, I don’t think we can derive much comfort about rule of law from the World Bank’s rule of law index. It measures perceptions of the extent to which people have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police and the courts, as well as the likelihood of crime and violence. As I have noted in an earlier post it is a broad measure of the quality of legal institutions rather than a measure relating specifically to rule of law.

Second, there is evidence that Australia has problems with rule of law. An example has recently come to notice close to home. In order to avoid violence in public parks, as occurred in Huskisson on Australia day last year, the Shoalhaven council has introduced bans on alcohol in certain specified parks on certain specified public holidays. I don’t have a view on whether these bans are the best way to prevent anti-social behaviour. The problem regarding rule of law arises because the police have been reported as saying that people wanting to drink responsibly as part of family gatherings can ignore the bans without risk of prosecution. It is comforting to know that the police do not like interfering with family gatherings, but it is difficult to feel comfortable with a situation where laws are to be enforced selectively. What has happened to the idea that the law should be enforced without fear or favour?

Robin Speed has referred to the similar example of an agreement by two doctors who operated independent practices in a country town and who agreed that one would work on Saturday and the other on Sunday. A Senate committee recognised that this was caught by the definition of a criminal cartel, but swept aside that concern on the grounds that the ACCC and DPP would not be expected to prosecute in such a case. As Speed says, “that is the antithesis of the rule of law”.

In his article in “The Australian” yesterday, ‘The rise and rise of the regulators’, Robin Speed argues that there has been a fundamental shift in the relationship between the individual and the law: “Increasingly, the relationship is not of the individual knowing and complying with what the law states, but of knowing and complying with what the regulators state the law states, and then knowing the extent to which the regulators will apply the law as stated by them”.

Even when parliament passes laws with the intention of restraining regulators, this does not necessarily prevent them from seeking to avoid those laws. For example, I have been reliably informed that in the 1970s the government’s most senior legal advisor provided a legal opinion that legislation that had recently been passed with the support of both of the major parties in parliament did not restrain regulators in the way that those framing and supporting the legislation had intended. The circumstances of this example are quite distinct from those where a court finds that the wording of legislation does not have the meaning that parliament intended. In the circumstances to which I am referring the opinion of the government’s legal advisor had the effect of denying the intention of parliament to restrict the regulatory activities of a particular arm of government. It elevated the intentions of regulators above those of the parliament.

How can the regulators be constrained? The obvious answer is legislation that gives regulators less discretion. In my view one area of high priority should be reform of the tax system to introduce greater certainty and reduce role of the tax office in deciding what tax law means. It will be interesting to see whether the Henry tax review has anything useful to say on this question.

Greg Cutbush, a farmer near Yass, has told me that he thinks the rule of law problem Mr Speed identifies is very common. For example, he’s noticed the ACCC applies one rule to farm products and another to household appliances. Any farmer who is found to have conspired with his neighbours to insist that the local grain merchant pay them the same price for their canola will be prosecuted under the Trade Practices Act because collective bargaining is prohibited. And yet when his brother and three of his neighbours get together and all buy new lawnmowers from an agent they have bullied in Bathurst one Saturday morning, nobody gives a stuff. It seems like the ACCC’s watchdog role is all window-dressing.

Wednesday, January 13, 2010

How painful is economic reform?

In my last post I presented evidence that people in countries with relatively high growth rates tend to perceive that their lives are improving. This is one of the reasons why I reject the view that economic growth makes people unhappy and that so called ‘unhappy growth’ can explain the reluctance of some governments to undertake economic reforms.

This raises questions about the effects of economic reforms on perceived changes in the quality of life. Do people in countries undergoing economic reforms tend to perceive that their lives were better prior to the reforms? My initial thought was that this would depend on the success of the reforms in raising economic growth rates.

I have now attempted to test this view empirically. In the analysis the perceived improvement in quality of life over the last five years is calculated as the difference between the rating of life today and life 5 years ago using data from the Gallup World Poll. Regression analysis has been used to explain variation in perceived improvement in life for 104 countries in terms of economic growth rate over the five years to 2007, improvement in governance over the same period (the average change in the 6 World Bank governance indicators), change in regulatory quality (the World Bank governance indicator most closely related to reforms that increase economic freedom) and a variable reflecting the extent to which assessments that people in different countries make of their lives tend to differ from the ratings that would be expected on the basis of income levels.

The regression explains about 40 per cent of the variation in perceived improvement in life among the 104 countries. The results show:
• Economic growth has a positive effect on perceived change in quality of life.
• Improvements in governance have a positive effect
• Improvement in regulatory quality have a negative effect on perceived change in quality of life.
(These results pass the standard statistical test relating to standard errors of estimates. Anyone who wants to see the results is welcome to contact me by email.)

It is important for the negative impact of change in regulatory quality to be seen in context. Economic reforms are generally undertaken in the hope that they will result in improvements in quality of life through higher economic growth. The chart below shows that countries which undertook regulatory reforms generally had relatively high economic growth rates. There was only one country undertaking regulatory reforms which had a negative economic growth rate.

The green diamonds in the chart denote the 10 countries in which people had the greatest perceived improvement in their quality of life. The red diamonds denote the countries with the greatest perceived decline in quality of life. The green diamonds are generally associated with higher economic growth rates than the red diamonds.

The evidence seems to support my intuitions – which are probably similar to the intuitions of most other economists interested in public policy - about the painfulness of economic reforms. Reforms often involve removal of regulatory barriers that protect the incomes of some groups at the expense of the broader community. The people who experience these income losses tend to resist reforms and to perceive that their lives were better before they were undertaken. When reforms are successful in promoting economic growth, however, these perceived losses tend to be outweighed by the benefits to those who gain from the reforms. Ad hoc attempts to promote reform of particular regulations are likely to be less successful than reform programs that are sufficiently broad and persistent to enable a high proportion of the population to perceive that their lives have improved.

Thursday, January 7, 2010

Does 'unhappy growth' explain failure to adopt economic reforms?

Several researchers have noted that there is a tendency for average life satisfaction to be lower in the countries with high economic growth rates even though there is strong evidence that average life satisfaction is higher in countries with higher incomes. Carol Graham and Eduardo Lora have referred to this as the ‘paradox of unhappy growth’. In one recent paper Eduardo Lora (with Juan Camilo Chaparro) suggests that ‘unhappy growth’ may help to explain why some countries have been reluctant to adopt economic reforms that would lift economic growth rates (‘The conflictive relationship between satisfaction and income’, Nov. 2008).

This is an interesting view, but I doubt its validity. It seems to me that ‘unhappy growth’ could be a misnomer. Before explaining why I should try to summarise the authors’ explanations for ‘unhappy growth’. One explanation is in terms of an aspirational treadmill. Economic growth raises aspirations, so people experiencing high income growth may come to expect higher incomes and hence feel less satisfied with their current incomes than people experiencing low growth. The other explanation is that economic growth is often associated with structural changes that result in income losses to some groups as well as gains to others. As a result of loss aversion the average life satisfaction may decline while average income rises.

Both of these explanations seem plausible, but they leave us with a paradox. How can high incomes - which must have resulted from economic growth in the past - be associated with high average life satisfaction if economic growth reduces average life satisfaction?

There is a simple explanation that dissolves this paradox. The observation of lower average life satisfaction in the countries with higher growth rates might just reflect the shorter time that the people in the countries with higher growth have had to accumulate the capital necessary to enjoy the fruits of their current income levels. Consider two countries which currently have similar per capita incomes, one of which has experienced rapid growth over the last couple of decades and one which has experienced low growth. It would be reasonable to expect that per capita net wealth would be lower in the high-growth country than in the low-growth country because people in the former country have had less opportunity to accumulate wealth from their current incomes. People with lower per capita net wealth could be expected to have poorer standards of housing and to feel less financially secure, so it is only to be expected that they would feel less satisfied with their lives. (This is similar to the explanation offered by Angus Deaton, namely that life satisfaction responds to the long-term average income, as in a permanent income model of life satisfaction. See: ‘Income, health and well-being around the world’).

There is some evidence that average life satisfaction is strongly influenced by net wealth. A study by Bruce Headey and Mark Wooden has shown, using Australian data, that wealth is at least as important to subjective well-being as is income (IZA Discussion Paper 1032, Feb. 2004).

There is also some evidence of a similar phenomenon with respect to education levels. Regression analysis suggests that there is a tendency for average education levels to be lower in countries with high growth rates, after controlling for income levels. This can be explained in terms of the time taken for accumulation of human capital. It would make no sense to attempt to explain it in terms of economic growth resulting in less education.

Finally, there is evidence in the following chart that people tend to perceive that their quality of life has improved in countries that have experienced relatively high growth rates. The perceived improvement in quality of life over the last five years can be calculated as the difference between the rating of life today and life 5 years ago using data from the Gallup World Poll. The chart plots perceived improvement in quality of life against per capita GDP growth rate for the period 2002-07 (based on rgdpl data from Penn World Tables) for 103 countries. The pink dots in the chart lie on a line fitted by regression.

The evidence of perceived improvements in quality of life in countries experiencing high economic growth rates is not consistent with the idea that economic growth makes people unhappy. I don’t accept that the failure of governments to adopt economic reforms can be explained by ‘unhappy growth’.

Saturday, January 2, 2010

Can communitarians and libertarians agree about the good society?

Since Michael Walzer is often identified as a leading communitarian thinker I did not expect to agree with his views about the good society. I thought it might be interesting to read his short article, ‘What is “The Good Society”? (Dissent, Winter 2009) just to see how much his views differed from my own (See, for example, ‘Is the good society a useful concept?). I was surprised to find that there wasn’t much difference.

Walzer begins his article by asking how there could be one good society, given the immense variety of human cultures. He then proceeds to talk himself around to the position that the good society ‘is constituted by the peaceful co-existence of all the societies that aim at goodness’.

Walzer argues that this view of the good society involves focusing our hopes for goodness on ‘more local, more particularized “societies” rather that a single society in which all members share a single goal. What he has in mind is the possibility that a single individual could take part in many different good societies (movements, associations and communities uniting for a common purpose) organized at different levels of social life and over different geographic areas (p78).

This reminds me of similar views expressed by Friedrich Hayek: ‘It would be a sad misunderstanding of the basic principles of a free society if it were to be concluded that, because they must deprive the small group of all coercive powers, they do not attach great value to the voluntary action of small groups. ... The true liberal must on the contrary desire as many as possible of those “particular societies within the state” ... Liberalism is not individualistic in the “everybody for himself sense”. A few paragraphs further on he wrote: “It is the great merit of the spontaneous order concerned only with means that it makes possible the existence of a large number of distinct and voluntary value communities serving such values as science, the arts, sports and the like. And it is a highly desirable development that in the modern world these groups tend to extend beyond national boundaries ...’ (LLL, vII: 151).

The communitarian libertarianism that Michael Walzer is advocating in this article makes a refreshing change from the vision of the good society favoured by social democrats and paternalistic conservatives who view governments as having the central role of defining and achieving ‘societal objectives’. Our chances of continuing progress toward good or better societies in coming decades will be enhanced if there is more widespread recognition of the importance of the spontaneous activities of numerous small groups comprised of individuals who share common goals.