Chris Dillow's Blog, page 150

A case for inequality?

Here are two interesting new papers on inequality. First, LSE researchers say:

Household characteristics account for only part of the cross-country variation in household wealth and its distribution. The largest share of the differences remains unexplained pointing towards the importance of country specific effects.

If this seems unsurprising, it shouldn't be. It undermines the rightist idea that inequality is due merely to differences in individuals' skills or savings propensities. In this sense, it corroborates other evidence which shows that there is no correlation across countries or over time between inequality of income and inequality of human capital.

Instead, the causes of inequality lie in institutions and ideology. On the one hand, the US has institutions and ideologies which engender "winner take all" markets in which CEOs and "superstars" - of either an Adler (pdf) or Rosen (pdf) type - can get very rich. On the other hand, Scandinavians have strong welfare states which reduce income inequality but - by deterring saving amongst the middlingly poor - increase wealth inequality.

But could it be that the Americans have got it right? This is the possibility posed by our second paper. Che-Yuan Liang asks: how much inequality would agents choose behind a veil of ignorance? Rawls' answer - derived from the maximin principle - is: very little. But what if instead people in the original position used prospect (pdf) theory? Then, says Mr Liang, they'd have two reasons to favour inequality:

 - People overweight the small chance of a big gain. "Very low probabilities are generally overweighted" said Kahneman and Tversky. "People prefer what is in effect a lottery ticket over the expected value of that ticket."

- Big losses have diminishing marginal utility; this is why people who have made small losses often take bets that have poor expected value.

These two aspects of prospect theory could, says Mr Liang under some conditions (such as leaving aside loss aversion) lead people in the original position to choose a US-style economy in which many are relatively poor, but a few are extraordinarily rich.

But is this a rational preference? It's not, if the overweighting of the low probability is due to overconfidence or a misunderstanding of probabilities. But it could be rational if there are non-linearities in the marginal utility of income. For example, a £50,000pa salary gives you a life of dull drudgery in which you can't afford a house in London, whereas a £1m income gives you freedom, power and positional goods. You might, therefore prefer a 1% (or lower) chance of the £1m to a 20% chance of the £50,000.

If you want an argument for inequality, this might be a stronger one than claims that such inequalities are the "deserved" result of differences in people's abilities and aptitudes.

Parasitic social democracy

Larry Elliott points to a fact which Marxists and rightists agree upon - that social democracy is parasitic upon capitalism. Like all parasites, it needs a healthy host and if the host becomes unwell, so does it. Larry says:

The model of the past 70 years has relied on decent levels of growth providing the resources not just to raise personal consumption levels but also to allow the expansion of welfare provision...
Social democratic parties thrive in times of abundance and wither in times of dearth. A growing economy allows parties of the left to increase investment in public spending and to redistribute resources from rich to poor.

I'd add that there are three inter-related problematic mechanisms here:

1. Baumol's cost disease. Public services such as health and education tend to have low productivity growth, and so their relative price rises over time which requires rising taxes. This is not (just?) because of public sector inefficiency. As Ronnie O'Sullivan among many others will confirm, even private education is becomes more expensive over time.

2. Tax morale. At least two things suggest that tolerance of taxation will decline in recession. One is simply that the harder-up people feel, the less willing they'll be to hand money over to the state. Another is that sustained recession tends to undermine trust in governments, and this increases resistance to tax.

3. The moral consequences of slow growth. Ben Friedman has shown that slow growth makes people meaner and more intolerant. This might explain why - against all logic - there's more talk of "scroungers" now than there was before the recession. This reduces support for redistribution.

For these reasons, Larry's right to say that - if we are in a world of slow growth - then social democracy is in deep trouble. Which means that the Left cannot any longer take the health of capitalism for granted. This should reignite interest in something Keynes said:

It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment.

He thought that such socialisation would be compatible with private ownership, with "all manner of compromises and of devices by which public authority will co-operate with private initiative." But what if such crony capitalism is either undesireable or ineffectual? It's then that the case for supply-side socialism becomes more powerful. Yes, both the parasite that is social democracy and the host that is capitalism might die. But something better could take its place.

A caveat: Yes, I'm simplifying here. Social democrats have always had ideas for promoting growth, ranging from fiscal policy through soft planning to the "education, education, education" of New Labour. But it's always thought that such policies were compatible with and conducive to capitalism and private ownership. But what if hierarchical managerialist capitalism is no longer compatible with decent growth?

On endogenous preferences

The other day, I quoted Steven Lukes to the effect that one manifestation of capitalists' power is that voters do not challenge that power. This claim needs substantiating.

Let's start from the reasonable premise that voters do seem content with inequalities of power and income. Why might this be? One possibility is that it reflects a rational, autonomous preference. Maybe inequality is a price worth paying for economic freedom and prosperity, and that if we had a more socialist society people would rebel and choose managerialist capitalism. The other possibility is that contentment with inequality is endogenous - that capitalism generates preferences which help sustain inequality, against the interest of many people.

What's the evidence for this latter theory? A lot  is indirect and suggestive:

 - We know from the work (pdf) of people such as Christopher Hsee and (pdf) Dan Haybron that people's preferences don't necessarily promote their interests; this is the basis of "Nudge". But if our choices of consumer goods and savings can be irrational, isn't it more likely that our voting behaviour will be, given that inattention and ignorance towards politics can be rational?

 - Cognitive biases are ubiquitous, and many of these might bias people towards a greater acceptance of the existing order than is rational.

- We know that peer pressure can influence people's behaviour - even, for example, about which shares they buy. But if our preferences are malleable by our social networks, mightn't they be malleable by other social forces too?

- The function of social norms is to get us to behave in ways that are good for society, but not in our direct material interest. They explain why we don't steal even if we won't get caught, or why we tip in restaurants we'll not revisit. But if norms can restrain the pursuit of our interests in this way, mightn't other norms restrain hostility to capitalism and managerialism?

- We know that capitalism can generate irrationality in one respect; hunter-gatherers are less prone to the endowment effect than modern men. So, could it generate other types of irrationality, such as support for even damaging forms of inequality?

On top of this indirect evidence, we have some laboratory evidence. Jeffrey Butler got people to play an urn-guessing game, and found that people who were paid well for correct guesses thought they were better at guessing than people who were paid badly. This suggests that arbitrary inequality can boost the confidence of the well-off and depress that of the worst off, which in turn can entrench that inequality by giving the rich a sense of entitlement and the poor a sense that they shouldn't upset the apple-cart.

Another experiment was done at the University of Rennes. Researchers split subjects into two groups - advantaged and disadvantaged - and gave the disadvantaged group the chance to destroy some of the advantaged's wealth at a cost to themselves. They found that the subjects did so when inequality was modest, but not when inequality was greater. "The level of conflicts significantly declines with the extent of inequality", they concluded - probably because the disadvantaged become resigned to their fate.

All this is consistent with the Marxian hypothesis that capitalism generates an ideology which helps sustain inequality. And you don't need conspiracy theories or a belief in the power of mass media to believe this.

Granted, it's not proof. And there are other things that explain the weakness of leftist parties - not least of which is the stupidity of so many on the left. All I'm saying is that we should take seriously the possibility that preferences for the existing order are endogenous and not fully rational.

UKIP: the victory of the ruling class

In a protest against an out-of-touch political class, the British public have voted for a party led by someone whose class background is indistinguishable from Cameron's or Clegg's.

In this respect, UKIP's success demonstrates not the weakness of the ruling class, but the exact opposite - its complete victory.

I don't just mean this in the sense that political power is held in the hands of such a narrow group that the Dulwich-educated son of a stockbroker can present himself as an outsider.

What I mean is that, as Adam says, UKIP is not an anti-establishment party. For example:

- The demand for tougher border controls is a call for an increase in the power of the state.

- Whilst its possible that immigration control might be very slightly positive for low-wage workers, it would be bad for average wage-earners, and there are many better ways of improving the lot of unskilled workers.

- Hostility to gay marriage is fundamentally anti-liberty, as it asserts the power of the state to intervene in private relationships.

- The call for a flat rate 25% tax would be a big tax cut for the rich.

- Cutting employment regulations would worsen working conditions and job security for ordinary workers, without creating many jobs.

- The demand that welfare recipients do compulsory workfare and not buy cigarettes or alcohol would be a reduction in the welfare state safety net, to the detriment not just of actual recipients but also to those in insecure jobs who fear becoming jobless.

UKIP's policies, then, do not challenge either the power of capital over worker or (what is a similar but distinct thing) the power of managerialists.

This is why I say their support represents the victory of the ruling class, because it demonstrates their complete power. I'm thinking here of Steven Lukes' "third dimension" of power:

Is it not the supreme exercise of power to get another or others to have the desires you want them to have - that is, to secure their compliance by controlling their thoughts and desires?...Is it not the supreme and most insidious use of power to prevent people, to whatever degree, from having grievances by shaping their perceptions, cognitions and preferences in such a way that they accept their role in the existing order of things? (Power: a radical view, 2nd ed, p27, 28)

It's in this sense that the ruling class has triumphed. The discontent that people might reasonably feel against bankers, capitalists and managerialists has been diverted into a hostility towards immigrants and the three main parties, and to the benefit of yet another party with a managerialist and pro-capitalist ideology. In this way, even "protest" votes help sustain existing class and power structures.

News vs truth

In the Times, David Aaronovitch says the media's promotion of the MMR scare was "a crime worse than phone hacking." This poses a question: did this happen because of the nature of the media, or despite it?

What I mean is that there are two sorts of professional failings. Some are a shortcoming from recognised standards whilst others arise from the values of the profession itself - what the French call deformation professionelle.For example, if a policeman takes a bribe, he commits the former error, but if he is over-zealous in arresting a violent suspect he commits the latter. I suspect that phone-hacking was an example of the latter, as it was motivated by the professional urge to get stories. And I suspect reporting of the MMR-autism link was too. I mean this in three ways:

First, good journalism is not about reporting the "overwhelming scientific consensus", nor even about reporting dry statistics. It's about getting the human interest story. So "my son had the jab and now he's got autism" is a better story than "correlation between MMR jab and autism prevalence is approximately zero." 

Secondly, many journalists are employed by capitalists who are trying - with limited success - to make a profit. And there's a tension between what's true and what sells. There's a reason why OK! magazine sells almost five times as many copies as the New Scientist. People want gossip, sensationalism and human interest stories, not dry statistical analysis. And it's the job of employees in capitalist companies to give the customers what they want. (Yes, I know I sometimes try to provide statistics in my day job - but I'm an absolutely crap journalist with very few readers.)

Thirdly, David complains about BBC editors who "thought that you could balance a health spokesman with a campaigner, call it a 'controversy' and somehow do your job of informing the public." But this pursuit of "balance" is a longstanding aspect of a strand of "serious" journalism. It was satirized by Alexander Cockburn back in 1982 - "should cannibalism be regulated?" - and we hear it every day on Today and the PM programme. And it can be misleading. To take just two examples, the rough consensus amongst economists (there are exceptions, of course, and consensuses can be wrong) is that immigration controls and fiscal austerity are bad ideas. Not only do you not get this impression from the right-wing press - which is only to be expected - but you don't always get it from the BBC, because of its commitment to "balance" rather than truth.

A large part of the BBC's job is to try not to offend noisy or powerful interest groups. You can't achieve that without some jeopardy to the truth.

What I'm saying here is what I said the other day - that there is a distinction between the news and a good story on the one hand, and the truth on the other. Sometimes, the distinction is very sharp indeed.

Age, luck & unearned privilege

Everybody knows that politicians come from a privileged elite and govern in the interests of
that elite. What's not so well-known is that this privilege does not
consist merely in coming from a rich background. It also lies in the
fact of the time of year in which they were born.

A new paper by
Daniel Muller and Lionel Page shows that top US politicians are
disproprtionately likely to have been among the oldest in their school
year. This lucky accident of birth gave them advantages even many years
later, partly because being among the oldest in their year made them
likely to be bigger than their peers and so more likely to develop
leadership skills. They say, following Heckman and Cunha (pdf): "Skills
attained at one stage in life are self-productive in the sense that
they facilitate further accumulation of human capital. This phenomenon
may be especially pronounced for leadership skills."

This is consistent with research (pdf)
by Elizabeth Dhuey and Stephen Lipscomb, who have found that American
high school students who are old for their year are disproportionately
likely to have leadershiip positions, such as presidents of clubs or
sports team captains.

This is not an isolated finding. In Outliers Malcolm Gladwell describes (pdf) a strong relative age effect amongst sportsmen, so that those who are older than their peers are more likely to become top professionals; this benefits Americans (pdf) born early in the year and Englishmen (pdf) born in the autumn.

And researchers at the IFS have found (pdf)
that people born in August - and so are the youngest in their year - do
worse at school than those born in September who are the oldest in
their year.

So, do the birthdays of British politicians corroborate Muller and Page's finding? Sort of. Of the 32 current Cabinet ministers, only one (Gove) was born in August; a random sampling would give us 2.7 August-borns. If we add the shadow Cabinet,
we get four out of 63 August-borns; you'd expect 5.2.These numbers
aren't so dramatic as to establish anything in their own right. But they
are consistent with the notion that August is a disadvantageous time to be born.

This, I think, matters. It is more evidence of the importance that luck plays
in determining our outcomes in life; nobody, after all, can control the
timing of their birth. And so it further undermines the silly idea that
the successful somehow deserve their wealth and power

Biased news

In 2010, 140,000 children aged under five died in Bangladesh. If the country had the same mortality rate (pdf) as the UK, only around 15,000 would have done so. This implies that around 125,000 Bangladeshi children die each year from poverty.

This fact, however, does not feature prominently in nightly news bulletins, even though it is equivalent to two Rana Plaza collapses every week.

There is, of course a simple reason for this. The news reports abnormal events, not normal ones; "dog bites man" is not news. Collapsing buildings are abnormal and so newsworthy whilst acute poverty is normal and so isn't news.

This bias is inherent in the nature of news. And yet it can be misleading. You cannot understand why so many Bangladeshis tolerate working in sweatshops until you realize that doing so gives their children not just a better chance in life, but a better chance of life. Thanks in part to the economic development brough by those sweatshops, child mortality in Bangladesh has fallen.

However, news reports which draw attention to the evils of sweatshops but not to those of rural poverty understate the benefits which such sweatshops have brought. Yes, they're hellholes which perhaps could and should be improved upon - but they're better than the alternative.

In this sense, news generates a bias amongst its western consumers; it encourages a hostility to globalization and industrialization even though these are - albeit imperfect - routes out of poverty.

There's a parallel here with attitudes towards crime reporting. It's a commonplace that whilst crime has fallen in recent years, the fear of it hasn't. A big reason for this, I suspect, is that violent crime - being abnormal - gets reported whilst folks living safely, being normal, does not. Ordinary reporting thus warps our perspective.

You cannot reasonably judge a probability distribution merely by looking at the far tail of it. But this is what the news invites us to do. 

There's another relevant bias here. Whilst under-reporting deaths from rural poverty the news is full of the doings of the rich and powerful. This too can have pernicious unintended effects. Laboratory experiments (pdf) have found that the mere act of communicating with others can induce them to behave more altruistically towards us. This implies that we are likely to be better-disposed towards the rich and powerful than we otherwise would be, and less well-disposed to the silent poverty-stricken billions. This too generates a bias towards tolerating poverty.

I say all this as a caveat to a common complaint. Everyone complains - with justification  - about bad, right-wing, dumbed-down linkbait journalism. But even when journalists are doing their jobs well, they are contributing to some unpleasant biases, by the very nature of what constitutes news. You cannot, rationally, base your political opinions in what your see in the news.

Benefits: efficiency vs legitimacy

The suggestion that wealthy pensioners should hand back benefits such as the winter fuel payment poses another question: why do pensioners get hypothecated benefits such as free TV licences, free bus travel or fuel payments? Wouldn't it be simpler to just raise pensions generally? And if some pensioners are too rich, just tax 'em.

The issue here is not simply one of administrative efficiency, but of basic welfare economics.

To see the point, take free bus travel. For those who uses buses, this equivalent to a cash handout equal to the cost of their bus tickets. But for those pensioners who don't use buses much a cash payment would be better. Net, the cash payment is better than free bus tickets. And free bus travel incurs another cost, as it can encourage pensioners who wouldn't otherwise use buses to do so, thus adding to congestion and fuel costs.

Econ 101, then, tells us that cash transfers are better than benefits in kind. So, why are pensioners paid ear-marked benefits instead?

One possibility is paternalistic. Winter fuel payments and free bus travel nudges pensioners to keep warm or to visit their family in a way that higher pensions alone would not. 

But I want to suggest another possibility. It arises from a tension in the very concept of government.

On the one hand, the function of government is to be impersonal - to lay down general laws that apply to everyone; this was emphasised by Hayek and is captured by old saws such as "justice is blind" and "the law is no respecter of persons." But on the other hand, this isn't sufficient to generate popular support - as its very impersonality creates a distance between government and citizens. Politicians who want to "connect" with voters will thus want to appear human and caring. And they do so more by making hypothecated payments, such as winter fuel payments, than by raising pensions generally.

There's an analogy here with the economics of Christmas. Joel Waldfogel has shown that giving gifts is less efficient (pdf) than giving cash, for much the same reason that benefits in kind are inferior to cash payments; at best, the gift gives us what we would have bought anyway, and at worst, we'd spend the £10 on something we'd like better than socks.

So, why do we give gifts rather than cash? It's because doing so seems more human, more thoughtful, more caring. In like fashion, winter fuel payments seem more caring than raising the basic pension.

If I'm right, we have a conflict between legitimacy and efficiency. Efficiency requires simple cash benefits, but these are cold-hearted compared to benefits in kind. I suspect this trade-off occurs in other fields. One reason why governments make interventions which libertarians (often rightly) think are inefficient - such as minimum wage laws or drug prohibitions - is that a government which concerned itself only with freedom and efficiency would be too cold and distant from voters to command much support.

And this in turn implies that a government of Hayekian classical liberalism, whatever its other merits, is just infeasible.

A complication: Winter fuel payments and free TV licences are fungible, in the sense that their recipients can use the extra income to spend on other things. This is why I call them hypothecated benefits rather than benefits in kind. I don't think this much affects my argument. 

Quantifying the evil of unemployment

Imagine an industry had, through its own recklessness, caused over 10,000 deaths in the UK. Or imagine that a government minister had, by his own stupidity, caused hundreds of deaths. There would surely be demands for severe punishment.

But in a sense, this is just what has happened, with pitifully little outcry. This is because, in utilitarian terms, the misery caused by mass unemployment is equivalent to very many deaths.

Let's start from the ONS's survey on the question: "overall, how satisfied are you with your life nowadays?" On a 0-10 scale, the unemployed report an average of 6.47 whilst the employed report an average of 7.53, If we assume the causality runs from employment status to well-being (so that being grumpy doesn't cause folk to lose their jobs), this means that unemployment costs the individual 1.06 "utils." On the same scale, married people score 7.72 whilst the widowed score 7.26 - so the death of a spouse costs 0.46 "utils."

Now, this doesn't mean unemployment is worse than the death of a partner. A person's death represents a loss to his other family and friends. Let's assume (maybe generously) that 20 others feel as bad as the widow. This gives us a total bereavement loss from death of 21 x 0.46 = 9.66 points.

In utilitarian terms, then, the death of a loved one is 9.1 times as bad as unemployment. But this isn't the end of the story. Death is permanent but unemployment isn't. Let's therefore weight the two events by duration.

Latest labour market flows data (pdf) show that during Q4 2012, 595,000 of 2.48m people moved from unemployment to work, which implies an average unemployment duration of just over a year. For simplicity, let's call it a year. How much longer does bereavement last?

Not long! Andrew Clark and Yannis Georgellis have estimated that there is "complete habituation" over time to widowhood; it takes an average of one year for men and three for women to return to their pre-bereavement level of well-being. Let's split the difference and assume two years of breavement. Let's assume it takes as long for family and friends to adjust. This gives us a total bereavement cost of 21 x 2 x -0.46 = 19.3 "utils".

To this, we must add the fact that death represents a loss of well-being to the deceased. Let's call this a drop 7.72 utils, the average for a married person. And let's assume, arbitrarily, that had our subject not died when he did, he'd have enjoyed another 10 years of this utility. This gives us a total utility cost of death of 96.5 utils.

This gives us a utility cost of death of 91 times that of unemployment.With unemployment now 944,000 higher that at the end of 2007, this implies that the welfare cost of recession is equivalent to the deaths of over 10,000 people.And if you think Osborne's misjudged fiscal policies have added more than around 24,000 to unemployment - and I suspect his critics would put the number far higher - then he is, in utilitarian terms, worse than Britain's worst serial killer.

Now, this calculation isn't intended to be remotely precise; it's a Fermi estimate. How should we respond to it? There are, at least, three possibilities:

1. It shows that there's something fishy about happiness research.

2. It shows that utilitarianism is wrong. Causing someone's unemployment is qualitatively different from causing someone's death - especially if you intend one but not the other - and you just cannot compare them on the same scale.

3. It shows that unemployment is indeed a social evil of huge magnitude, a fact which we don't realise because the jobless are socially and politically marginalized.

Personally, I'm not sure how to respond.

On wage-led growth

Yesterday, I quoted Michal Kalecki pointing out that wage cuts cannot create full employment. The fact that GDP has flatlined recently as real wages has fallen is consistent with this.This raises the question: could it be that policies aimed at raising wages at the expense of profits would boost the economy? A nice non-technical paper (pdf) by Marc Lavoie and Engelbert Stockhammer discusses the issues.

The case for such wage-led growth is straightforward. If the marginal propensity to spend out of wages is higher than that out of profits, a transfer of incomes from profits to wages will boost aggregate demand. This could happen. Common sense tells us that the badly off tend to spend their incomes, whilst the fact that rising profits before the recession were not accompanied by strongly rising capital spending suggests that the propensity to spend out of profits has been low.

This casual empiricism is supported by a paper by Ozlem Onaran and Giorgios Galanis, who have estimated (pdf) that, in many developed countries, rises in the share of profits in GDP have been associated with lower aggregate demand.

Better still, say Lavoie and Stockhammer, wage-led growth might be self-sustaining, in one of two ways:

 - Verdoorn's law tells us that higher output growth is usually accompanied by better productivity growth. This means higher wages might partly pay for themselves, and that they might not be very inflationary.

 - Firms might respond to higher labour costs by investing more in labour-saving technology, which would also tend to hold down inflation. If policy-makers respond to this by loosening macroeconomic policy, we could get a virtuous circle of non-inflationary demand growth, investment and rising productivity. This happened in much of the 50s and 60s.

So, what could go wrong? For me, there are three issues here:

1. A rise in wages for worse-off workers (for example through a living wage) would lead to lower payments of tax credits. In this sense, transfering money from capitalists to workers would be partly a fiscal tightening. That would tend to depress aggregate demand.

2. Is the marginal propensity to consume out of low wages high? If households are over-geared, they could use the extra income to reduce debts instead.

3. The relationship between capital spending and profits is unstable, as it depends upon animal spirits. There are two especial difficulties here:

- Capitalists would be happy to invest with low profit margins, if they are accompanied by high expected demand and hence high output-capital ratios and a high profit rate. But confidence that this will be the case requires them to have confidence both that macroeconomic policy can maintain high demand and/or that overseas demand will be high. This isn't certain.

- For the last 30 years, capitalists have been accustomed to policy being made in their own direct, short-term interests. Any disturbance to this might weaken animal spirits by more than the prospect of high demand would improve them.

Such instability is no mere theory. In the 50s and 60s, wage-led growth was feasible because capitalists invested in the confidence that high aggregate demand would be sustained. But in the 70s, this changed as they fretted about the squeeze on profit margins.

These doubts hint at what Servaas Storm calls a "sobering asymmetry". He says:

Lowering real wages will be unambiguously counterproductive, but the opposite policy of raising real wages will not have much of an impact on the economic recovery.

Perhaps the ability of capitalism to provide full employment requires freakish historical circumstances of a sort we saw only in the 50s and 60s. And perhaps it is only wishful thinking by both rightists and social democrats that stops them seeing this.