Thursday, May 13, 2010

Should we ever play the man rather than the ball?

I don’t think there is any situation on the sporting field where players are justified in playing the man rather than the ball. Immediately after writing that I have begun to think of exceptions. An exception should obviously be made for technical infringements of the rules that that have become an accepted part of the way some games are played. Should an exception also be made for giving a particularly dirty player in the other team an elbow in the ribs? It might be possible to convince an impartial observer that this could not have happened to a nicer person, but that doesn’t mean that the behaviour should be condoned. If we allow that violations of the code of behaviour can justify retaliation we are likely to end up with an all-in brawl rather than a ball game.

In case anyone is wondering why I am writing about sport, I am just using an analogy to introduce a discussion of the ethics of ‘playing the man’ in discussions of public policy. The post has been prompted by the comment of another blogger, Jim Belshaw, that I made a ‘cruel’ remark about Australia’s prime minister, Kevin Rudd, in a recent post on my blog. I implied that Mr Rudd's argument that the proposed resource rent tax will be paid mainly by foreign investors is similar to the nationalistic rhetoric that Hugo Chavez, president of Venezuela, has used to justify nationalization policies. To add insult to injury I suggested that Hugo, who is famed for long-winded speeches, was less verbose than Kevin.

I regret that comment because my intention on this blog is to raise the tone of policy discussion rather than to lower it. I don’t feel apologetic towards Mr Rudd, however, because I acted in retaliation for his past behaviour. I think Mr Rudd has done more than most other contemporary Australian politicians to lower the tone of public policy discussion in this country.

In trying to explain myself I have made an assertion that I now have to justify. The way politics is played in Australia it is fairly common for politicians to mis-represent the views of other politicians and to attempt to demonize them. But most politicians tend to treat academics with some respect unless they involve themselves directly in politics. Apart from Mr Rudd I don’t think many other politicians in this country who have sought to mis-represent the views of a Nobel-prize winning economist or to demonize him or her. I am referring in particular to Mr Rudd’s misrepresentation of the views of Friedrich Hayek, which I have discussed in an earlier post: Why does Rudd persist in misrepresenting Hayek? (On reflection, I also regret the sarcasm in the last sentence of that post.) In my view the real reason Rudd misrepresents Hayek is so that he can falsely claim that political opponents who respect Hayek’s views are adopting an extreme position.

As I noted in the introduction, I don’t think violations of codes of behaviour justify retaliation in kind. This applies just as much to policy discussions as to sport. The most appropriate response to bad behaviour by political leaders is to make other people aware of it.

Wednesday, May 12, 2010

Will history judge Marx to have been right about the effects of technological progress on income distribution?

‘The instrument of labour, when it takes the form of a machine, immediately becomes a competitor of the workman himself. ... That portion of the working-class, thus by machinery rendered superfluous, i.e., no longer immediately necessary for the self-expansion of capital, either goes to the wall in the unequal contest of the old handicrafts and manufactures with machinery, or else floods all the more easily accessible branches of industry, swamps the labour-market, and sinks the price of labour-power below its value’ Karl Marx, Capital, 1887 (first English edition).

Since Marx wrote that, real wages have increased by massive amounts in industrialized countries. Authors of some books I have read recently suggest, however, that Marx’s predictions could end up being right in the end. Gregg Easterbrook warns that we should not take too much comfort from the fact that Marx’s predictions of gloom have not yet come true (‘Sonic Boom’, p 153; discussed here) and Jacques Attali suggests that tomorrows West will resemble today’s Africa (‘A brief history of the future’, discussed here).

In attempting to think our way around this question an obvious place to start is with the effects of technological progress on the demand for labour. This approach makes sense if labour can be assumed to be more or less homogeneous, that aggregate capital stock can be measured appropriately, that most income from capital tends to accrue to people with high incomes and that technological change is the only factor influencing income distribution. I’m actually not sure that any of those assumptions stand up to scrutiny, but let us keep the discussion as simple as possible to begin with.

As Marx observed, new technology often involves capital-intensive processes displacing labour-intensive processes, e.g. the use of power looms to replace hand looms in the textile industry at the beginning of the industrial revolution and, more recently, increased use of robot technology in car manufacture replacing labour-intensive assembly lines. This kind of technological change tends to increase the ratio of capital to labour. However, introduction of new technology often occurs through the introduction of superior capital equipment that replaces existing capital (or more efficient sources of energy, financing innovations, business practices etc) without necessarily increasing the ratio of capital to labour. Most importantly, new technology makes possible an increase in national product, or real national income, and with increased demand for factors of production, including labour.

The net effect of those factors on future demand for labour will depend partly on whether, on balance, the new technology is a closer substitute for labour than for existing capital equipment (and other factors of production). Further development of electronics and robotics, in particular, can be expected to displace a lot more manual and mental labour, but my guess is that before too long new technology will largely involve superior robots replacing inferior robots, leaving demand for human labour relatively unaffected. There are some parts of the economy where new technology is unlikely to have much effect at all on the ratio of capital to labour, e.g. symphony orchestras. (William Baumol made the point in the 1960s that a symphony orchestra does not become more productive by playing faster.)

Another important influence on the future demand for labour will be whether average incomes are likely to result in a changing pattern of consumer spending toward more on labour-intensive or more capital-intensive goods and services. My guess is that ‘real’ experience (of foreign travel etc.) will trump ‘virtual’ experience and that people will prefer to interact with other humans rather than robots to obtain services such as restaurant meals.

So, I think there are limits to the extent that technological progress will result in substitution of capital for labour. When we take into account the fact that labour is not homogeneous, that investment in human capital and investment in physical capital can be substitutes or complements, and that people embody new technology in the skills they acquire it is not even obvious that it is particularly helpful to think in terms of aggregate categories such as labour and capital.

It is probably more meaningful to consider demand for particular categories of labour e.g. unskilled labour. Perhaps it is reasonable to predict that demand for unskilled labour will continue to shrink, but even that is problematic if we define ‘unskilled’ in terms of lack of formal qualifications and overlook the possibility that inter-personal skills - often acquired without formal training - will become increasingly important.

The idea that there is a class of people who obtain their income from selling their labour (workers) and another class of people who obtain their income from ownership of capital (the idle rich) seems likely to become increasingly irrelevant. As working people invest for their retirement they will be increasingly buying shares in the robots that will earn the income they previously earned for themselves.

Technological progress is not the only factor influencing income distribution. Factors affecting the supply of labour, e.g. immigration, could have effects on wage rates in some countries that are as important as the effect of technological progress. Then there are the effects of globalization both in providing international competition for labour-intensive industries and, increasingly, new sources of innovation and competition for technology-intensive sectors of industrialized countries.

Finally, the taxing and spending policies of governments modify the effects of technological progress on income redistribution. If Marx turns out to have been right about technological progress, it seems likely that governments in democratic countries will come under increasing pressure to intervene further in income distribution to ensure that all groups have an opportunity to benefit from the fruits of technological progress.

However, my personal view is that history will probably continue to judge Marx to have been largely wrong about the effects of technological progress on income distribution.
Winton Bates

Sunday, May 9, 2010

Does a resource rent tax solve the problem of sovereign risk?

I have been a supporter of resource rent taxes for as long as I can remember. More precisely, my view has been that taxes on rents are better than most other taxes because they extract funds with minimal distortion to production and investment decisions.

I think the best way to think your way around the question of resource rent taxes is to imagine initially that you are the sovereign of a territory in which there has been no previous mining or exploration. You want to obtain revenue from the minerals in your territory by the inducing mining firms to use their expertise to explore and to mine.

One way of obtaining revenue from minerals is to auction off mining rights and promise mining companies that there will be no further taxes on the minerals they find. A major problem with such a ‘finders keepers’ policy is that on the basis of past experience mining firms have good reason to be skeptical that sovereigns will keep their promises to let them keep what they find. When valuable resources are found sovereigns (and democratic governments) have a habit of changing their minds and wanting more revenue. As a consequence of this ‘sovereign risk’, mining companies are not likely to be willing to pay anything like what an exploration lease would be worth to them if they could believe the sovereign’s promise of finder’s keepers.

Another way that governments can obtain revenue from minerals is through a system of royalty payments based on the volume or value of minerals extracted. This is like imposing an additional cost on mining activities and can deter mining that would otherwise be commercially viable.

By contrast, under a well-designed resource rent tax the sovereign is, in effect, a silent partner in the venture. The sovereign shares in the rents and risks of the project without distorting investment and production decisions in the process.

So far so good, but Australia is not a country in which there has been no previous mining or exploration. There is currently a great deal of mining being undertaken in this country under long-established systems in which state governments obtain revenue from royalties. In that situation it becomes important to consider how to make the transition from royalty payments systems to a resource rent tax without disturbing the reasonable expectations of miners of rewards that they are entitled to receive for the risks that they have taken. If the transition to a new tax is used by the government to grab a larger slice of rents from successful mines, the miners are likely to perceive that they have under-estimated sovereign risk in this country. They will also perceive that there is a chance that the rate of resource rent tax could be increased in future, particularly if there are further increases in mineral prices. If they factor that into their calculations of expected returns they will reduce their investment in further exploration and new mines – even if the structure of the new tax minimizes disincentives to investment.

As is well known, the Australian Government has recently announced the introduction of a resource rent tax and its intention to grab a substantial additional slice of mining profits on top of revenue raised from existing mining royalties. The main source of this sovereign risk, Kevin Rudd, has defended the tax grab on the grounds that ‘what we are doing is to recover national sovereignty over our own resources’. Actually, I must confess that I don’t think Mr Rudd has used those precise words. Those words were used by Hugo Chavez, president of Venezuela. As far as I can see, however, the main difference is that Hugo is less verbose than Kevin.
Here is what Kevin Rudd has been saying:
‘Over the last decade the mining companies generated $80 billion in higher profits. At the same time governments, on behalf of the Australian people, received only an additional $9 billion over that period of time. What we're saying is that the mining companies deserve a fair return on their investment - that's important - but we also believe the Australian people deserve a fair return on the resources which they themselves own, and remember, these companies- you mention in your introduction BHP and Rio. BHP's 40 percent foreign owned. Rio Tinto's more than 70 percent foreign owned. That means these massively increased profits, the $80 billion that I referred to before, built on Australian resources, are mostly in fact going overseas’ (Interview on AM, ABC radio, 3 May, 2010).

Why is the percentage of foreign ownership of BHP and Rio relevant to the issue of resource rent taxation? The unmistakeable message is that Kevin Rudd views foreign investors as fair game. Tax reform has become a cover for expropriation of rents from assets owned by foreigners. All we can hope is that the more sensible members of the Australian government will encourage second thoughts about the rate of resource rent tax that should be imposed - and urge Kevin to restrain his rhetoric - before too much harm is done to Australia’s reputation as a safe location for investment.
Winton Bates

Postscript notes:
1. As I explained in a subsequent post I regret comparing Kevin Rudd to Hugo Chavez.
2. The additional $9 billion dollars that the prime minister refers to as the amount the Australian people have recieved from mining companies over the last decade does not include company tax.
3. Mining companies would be wise to factor into their considerations of new projects the possibility that the tax rules will be changed in future if substantial new investment projects are not profitable. Under the proposed tax mining companies are supposed to get a subsidy equal to 40% of losses. A government that is prepared to change the rules opportunistically to grab additional tax revenue could also be tempted to change the rules opportunistically to avoid substantial revenue losses at some time in the future.
4. In a subsequent post I have discussed the risk that state governments could still increase royalty rates.

Monday, May 3, 2010

Would an hedonimeter help us to choose between push-pin and poetry?

There seems to be enduring interest in the post, ‘Is push-pin as good as poetry’, that I wrote a few years ago. That post was about John Stuart Mill’s rejection of Jeremy Bentham’s assertion that if the game of push-pin gives more pleasure than poetry then it is more valuable than poetry. Mill argued that some pleasures are superior to others and that it is possible for people to become addicted to inferior pleasures. I followed up on the question of whether push-pin might be addictive in a subsequent post.

A logical place to begin this post would be to define an hedonimeter. Before I do that, however, I want to make the point that Mill’s thoughts about higher and lower pleasures seem to have been a side-track that did not lead anywhere in the subsequent development of economics. A few years after publication of Mill’s essay on utilitarianism, the famous economist, William Stanley Jevons, came down strongly in favour of Bentham’s view of utility. According to Jevons:

Whatever can produce pleasure or prevent pain may possess utility. ... The food which prevents the pangs of hunger, the clothes which fend off the cold of winter, possess incontestable utility; but we must beware of restricting the meaning of the word by any moral considerations. Anything which an individual is found to desire and to labour for must be assumed to possess for him utility. In the science of Economics we treat men not as they ought to be, but as they are’ (‘The Theory of Political Economy’, 1871, III.2).

Francis Edgeworth, who came with the idea of an hedonimeter, was a strong supporter of Jevons’ view that utility has two relevant dimensions: intensity and time. Edgeworth suggested that we:
‘...imagine an ideally perfect instrument, a psychophysical machine, continually registering the height of pleasure experienced by an individual ... From moment to moment the hedonimeter varies; the delicate index now flickering with the flutter of the passions, now steadied by intellectual activity, low sunk whole hours in the neighbourhood of zero, or momentarily springing up towards infinity’ (‘Mathematical Physics’, 1881).

I think that description tells us, in today’s language, that an hedonimeter might be a sexy idea. It will probably be a long time before you can buy an hedonimeter at your local supermarket but research indicates that levels of various chemicals (e.g. cortisol) in the body and activity in various parts of the brain are related to pleasant and unpleasant experiences. It seems likely that if we were able to conduct surveys using hedonimeters – perhaps one day it might be possible to carry one around like a pedometer – they would give similar results to those obtained by Daniel Kahneman and Alan Krueger using evaluated time use (ETU) techniques. In surveys using ETU techniques respondents are asked to account for time spent on various activities on the preceding day and to rate their feelings for each activity in terms of a range of affective categories e.g. happy, worried/ anxious or angry/hostile. The ETU data suggests that people tend to get most pleasure from sex and socializing and least pleasure from working and commuting.

If anyone was really interested in comparing the pleasures people obtain from push-pin and poetry it is possible to imagine conducting an experiment in which participants played push-pin and attended poetry readings and rated their experiences. If you were concerned that such information might not be relevant to you personally, you might be able to get someone to design an appropriate experiment to enable you to rate and record your emotions during the two experiences.

How would you feel about using the results of an ETU exercise (or an hedonimeter) to decide something that may actually be important to you – for example, whether to play sport A or B or have a holiday at location X or Y - on the basis of the balance of emotions that you have experienced in those activities in the past? I don’t know about you, but I would want to see whether the hedonimeter results are consistent with my memories of the different experiences before I decided whether to use them.

A recent presentation by Daniel Kahneman (on TED) suggests that what my reflective self might feel about my memories of the experiences that I want to choose between could differ substantially from the emotions that my experiencing self has actually felt (or what an accurate hedonimeter might record).

Would you ignore the evidence of an hedonimeter if it conflicted with your memories of the experience? Would you ignore suggestions from your spouse or a friend that your memories of a holiday might be biased by the way you felt about something that happened at the end? If you had a reliable hedonimeter to record your memory of past pleasures would you give less weight to consideration of what experiences it is good to have (or issues such as those raised by J S Mill about the superiority and inferiority of different pleasures) in making your choices? Why do humans have selective memories? Do our selective memories serve a useful function from an evolutionary perspective?
Winton Bates

Postscript 1:
In retrospect I would like to add some further questions: Do the reasons why human have selective memories make any difference to the way you and I should live our lives? If I am told that there are good evolutionary reasons why I should remember how an experience ended (e.g. because it was important to the survival of my ancestors to remember which of their hunting expeditions were successful and unsuccessful) is this relevant to the decisions I should make today?
I am beginning to think that while the evolutionary reasons for cognitive bias may be interesting they may not be particularly relevant to our current decision-making.

Postscript 2:
I obviously became sidetracked while attempting to answer this question. My answer is that whether the hedonimeter would help us to make the choice depends on the criterion we think is most appropriate. If the criterion is pleasure, the hedonimeter might help. If the criterion is what is good for us, then pleasure is only factor that we would take into account and an accurate measure of pleasure might not be particularly useful. We might consider that it is better for us to spend Thursday evenings reading poetry rather than playing pushpin even though we might get more pleasure from playing pushpin.