Where Should the New Zealand Economy Be Going?

Third draft of Chapter 1 of Transforming New Zealand. Comments welcome. (Second Draft).

Keywords: Growth & Innovation;

In recent years the focus of economic policy has been on increasing GDP, which is a measure of the material production of the economy. The shrillest cries were that New Zealand should accelerate its GDP growth rate to rejoin the top half of the OECD on a per capita basis. As one business journalist, more noted for her rhetoric than her insight asked ‘what could be simpler than that?’ And she was absolutely right for the simple minded who had little conception of what constituted GDP or of how it might be accelerated.

Those with a more sophisticated turn of mind, might ask whether per capita GDP is the right indicator, and were it whether policies which accelerated it relative to other OECD countries were successful, why the others would not pursue the same policies and so neutralise the relative advantage. (They might notice too, that the proposed policies had little analytical or historical justification, but they certainly advantaged the advocates and their employers.) But the relevance of GDP is the first issue.

As every first year economics student knows GDP has numerous fundamental deficiencies as an indicator of national welfare. The public knows too because there are numerous books on the topic. The deficiencies are summarised in the appendix to this chapter. What must be reiterated is that GDP was devised for one purpose – the macroeconomic management of employment and inflation – where to this day it remains a powerful and useful measure. However the measured also became used – on far more tenuous grounds – as one of national welfare.

But is it? Nothing in the construction of the index is going to tell us how it relates to the lives of ordinary people. At issue is the empirical relationship between them. So what is the evidence?

GDP and Wellbeing

Nineteenth century economists tended to focus on material output, assessing how well off someone was by the amount they could consume. Given the much higher levels of hardship of their day, that notion was perhaps justifiable. But it still dominates today’s economics. Pushed, an economist might say it is better to have more material goods and services than less, and if all the other things which make up human happiness are assumed as given, higher material consumption is better.

Economists – or at least the good ones – have been aware of the importance of the assumption, but until recently they were not able to evaluate it in any scientific way. Now that we can, we find that ‘more means better’ proves to be only marginally correct, and that it is not nearly as important – directly anyway – as economic policy assumes.

A major source of evidence comes from an official US survey which each year asks whether each of the 1500 odd respondents were ‘happy’. (The question is motivated by the US Declaration of Independence that among ‘certain unalienable rights’ is ‘the pursuit of happiness’.) Since the questions have been asked over a number of years (together with a whole range of other personal variables), it is possible to study the trends and associates of happiness. Of course, happiness is not quite the same as personal wellbeing (consider a person on a psychedelic high). But the survey raises serious doubts about the importance of material consumption (and hence GDP) as a good indicator of wellbeing.

For instance, US citizens are no happier today than they were in 1972, when the survey began (or even back to 1946 according to older surveys), despite major increases in material consumption and GDP per capita over the period. There are differences between groups is even more puzzling. Men report themselves less happy than women, but over the period they have been getting slightly more happier and women slightly less happy (so the gender difference is converging). This is an astonishing finding, given the social changes over the last three decades are generally thought to favour women. No one is sure why. A cynical possibility is that ‘women’s liberation’ is making women as unhappy as men. Another non-obvious outcome is that happiness changes over a lifetime, initially decreasing as one gets older, hitting the bottom in the thirties, and rising thereafter.

But surely the most surprising finding – to those who think GDP is important – is that while real incomes have risen over the quarter of a century, average happiness has not. If we look at any point in time (‘cross-sectionally’, as the jargon says, rather than ‘longitudinally’, over time) we find that there is a very slight improvement in happiness for those with higher incomes in the community. The effect is small. By comparison consider the advantage of extra income to the advantage of being married, for respondents report being married is a much happier state than being widowed, separated, divorced or never married. (That is an average, of course. As Jane Austin reminds us, ‘happiness in marriage is entirely a matter of chance.’) Economists calculate being average married generates the same additional happiness as an additional income of $US100,000 a year. These figures apply for the US, but some less comprehensive European data generally supports the broad conclusions. (The annual sum capitalises to at least a $1,000,000. Look at the (average) spouse and think ‘you’re a million dollar baby.’)

Economic variables over which the government has some influence, and which give a much better increase of happiness than income, is the more years of education the happier. It is also happier to have a job (for the same income). This last result is intriguing, for it suggests that work is valuable in itself, and that job creation may generate greater happiness, even if that reduces average incomes. (However I would not jump to the conclusion that make-work schemes or low paid jobs are necessarily a good thing. Other studies suggest that work has to be seen as socially valuable. )

More recently the World Values Study asked people in many different countries ‘are you happy’ and ‘are you satisfied with life’. In 1998 (not a year of outstanding economic performance) 95 percent of New Zealanders said they were ‘happy’, which put them second equal in the world with Switzerland and Sweden, just behind Iceland. Some 84 percent said they were satisfied with their life. That is 14th in the world –– in the middle of the OECD. The divergence is intriguing suggesting that there are a lot of New Zealanders who are happy, but striving for better.

That New Zealand ranks higher on these measures than it does on per capita GDP is perhaps no surprise given the deficiencies of the measure. There is not a very good correlation among the rich OECD countries: The responses of New Zealand and the US are much the same even though US per capita GDP is about 40 percent higher than New Zealand’s.

Intriguingly there is a relationship between material production and happiness for those countries whose per capita GDP is less than 70 percent of New Zealand’s. It would appear that economic growth in poor countries increases happiness and life satisfaction. As a country gets richer, growth does not. This suggests that the nineteenth century equation of additional consumption being directly associated with a better quality of life may have been correct. But many economies have grown well pass that condition.

While there does not seem to be any connection among high income countries between wellbeing and measures of civil liberties and political rights (perhaps because the differences are too subtle to catch by statistical indicators), those in poorer countries with democratic institutions seem to be happier. Not surprisingly being in a Communist nation depressed the responses, although (sadly) happiness and satisfaction deteriorated when they threw off their Communist regimes. Regrettably the studies have not yet investigated the extent to which high employment and low unemployment affect happiness and life satisfaction. An eyeball over the data suggests there may be a statistically significant correlation, although the effect of superior labour market conditions may not be strong.

Would changing the material output measure from GDP to one of the host of proposed alternatives such as Net Economic Welfare (NEW) or the General Progress Indicator (GPI) change the conclusion? Probably not. Their focus remains on material consumption valued in a particular way. The indications are the richer nations have moved on past the simple utilitarian equation of more goods and services means more happiness. What is it to be replaced with?

An Alternative to Material Output: Functionings

The economist with the high standing who has written most about alternatives to material output is Amartya Sen who starts with the notion of ‘functionings’ which summarise the life a person might lead. Some functionings are elementary: being well nourished and disease free. Some are more complex: having self respect, preserving human dignity, taking part in the life of the community.

The list has echoes of Abraham Maslow’s hierarchy of needs:

High level needs
– need for cognitive understanding;
– need for self actualisation;
– esteem needs;
– needs for belongingness and love;
– safety needs;
– physiological needs.
Low level needs.

Observe that measures of material output such as GDP only directly address the lowest – and possibly the second to lowest – needs on the hierarchy, again warning us that we should not get obsessed with GDP.

Sen then introduces the key notion of ‘capability’ which refers to the alternative functionings (‘life choices’) a person might have. His notion of wellbeing is not what you consume (‘opulence’ as Sen calls it) but the choices (or ‘capabilities’) the individual has. These are:

(1) Political freedoms: ‘the opportunities that people have to determine who should govern, and on what principles, and also include the possibility to scrutinize and criticize authorities, to have freedom of political expression and an uncensored press, to enjoy the freedom to choose between different political parties, and so on.’

(2) Economic facilities: ‘the opportunities that individuals enjoy to utilize economic resources for the purpose of consumption or production or exchange.’

(3) Social opportunities: ‘the arrangements that society makes for education, health care and so on.’

(4) Transparency guarantees: ‘the need for openness that people can expect: the freedom to deal with one another under guarantees of disclosure and lucidity.’

(5) Protective security: ‘needed to provide a social safety net for preventing the population from being reduced to abject misery, and in some cases even starvation and death. Its domain includes fixed institutional arrangements such as unemployment benefits and statutory income supplements to the indigent as well as ad hoc arrangements such as famine relief or emergency public employment to generate income for destitute.’

So material consumption is only a part of the totality of capabilities.

Like the New Right, Sen talks of ‘freedom’ and ‘choice’. But unlike the New Right, Sen does not assume that if everybody has ‘freedom’ (in the New Right sense) in a ‘free’ market they will all be better off. Sen is an expert on inequality, and he knows ‘free market’ outcomes will have some people worse off (as happened in New Zealand in the 1980s and 1990s). But the capability approach also diverges markedly from the New Right when it concludes that government spending (on education, on health care, on other things such as the environment, culture and recreation facilities) can enable individuals to do and be so much more.

The logic of Sen’s approach led to the World Bank developing a Human Development Index’ (HDI), which is intended to replace GDP per capita as an indicator of the state of progress of a nation. It combines per capita material output with measures of educational and health achievement. Thus a rise in life expectation increases the HDI even if GDP per capita goes down (because the same output has to be shared among more). Literacy is there because the capability markedly affects our ability to flourish and enjoy life. The index has to be simple, because most countries do not have complicated statistical bases. Had it been practical, Sen would have wanted a measure of the differences between men and women, which can be grotesque.

Sen’s concerns are illustrated by Kerala, one of the poorest states of India, nonetheless has a life expectancy of over 73 years, not too different from the New Zealand’s 76.9 years. In contrast, US Afro-Americans, living in some of the richest cities in the world, have a shorter life expectancy than those in Kerala. Despite its material limitations, Kerala has organized itself – especially its education and health systems – to give its residents substantial freedoms.

New Zealand is 19th in the world on current HDI standings, three above its GDP per capita ranking. (The biggest divergence in the country rankings is for South Africa, whose HDI ranking is a whopping 44 places below its GDP per capita ranking, a terrible indictment on apartheid’s record on health and education, that will take generations to repair.)

However, the World Bank’s interests are poor countries, and the index is not be very good at discriminating between rich countries. How might we elaborate the HDI approach for rich countries?

At the very minimum we might want to add two further diversity for choice; and leisure to the World Bank’s three of material consumption, health, and education.

Choice is key to Sen’s account of human wellbeing. Health, education and leisure all enhance choice, but we need a measure which directly indicates the possibilities. There is no diversity component in the HDI, because it is difficult to measure even in rich countries. Relevant are such factors as ethnic and religious diversity. Opportunities for women and the disabled are good tests too. Richard Florida proposes a ‘bohemian’ index based on the ‘number of writers, designers, musicians, actors and directors, painters and sculptors, photographers and dancers’. Perhaps we should be less precious and extend his bohemian index by include sportsmen. Whatever, choice is hard to measure, although we would miss the point of human development were it left out.

American workers work 1867 hours a year, Dutch ones work 1347 hours, some 28 percent less. In fact hourly labour productivity in the Netherlands is higher than the United States (by almost 17 percent) even though GDP per capita is lower (by 23 percent). The Dutch have chosen to take out their higher productivity with more worker leisure, rather than more material consumption. It is a valid choice, and needs to be included in any index of human development. Ideally hours worked should include travelling time to and from work, and adjust for forced leisure from involuntary unemployment. (New Zealanders seem to work slightly longer than the OECD average, so unless involuntary unemployment is low – probably not – and travelling time to work is low – possibly – New Zealand’s leisure is not especially high.)

However, while such extensions may be useful we should not forget that Sen also assumed that some basic conditions – effective civil rights; personal security; national security; environmental sustainability – were also attained. In respect of some New Zealand must already be well above the OECD average.

Rawles’ Approach

The American philosopher, John Rawles, added the further requirement that we should judge society by how it treats its weakest. He argues that if we were choosing the best society from behind the veil of ignorance when we did not know whether we whether we would be rich or poor,, able-bodied or disabled, white or black, man or women …, we would choose the society which gave us the best deal if we ended up among the worse off, fearing that state more than the benefits from the being in other states much better off. (Many people find this exercise in empathy – Adam Smith’s term – difficult, as when an affluent able-bodied Pakeha male cannot comprehend the situation of a poor disabled Maori woman. It is worth asking oneself when you are being harangued, whether the sermoniser has any conception of life other than the one they have lived.)

Even so, practically applying the principle is problematic. Just who is worse off? An affluent elderly woman about to be robbed and terrorised may be worse off on that day than the poor young burglar.

The Rawlesian principle may seem to result in everybody have the same material standard of living. Leaving aside that it is difficult to compare the needs of different people, the principle also allows inequality – that is people on higher standards of living than the poorest – insofar as it is in the poorest’s interests. The reward of higher incomes is an incentive to work more, to invest more, and to innovate more. Thus from one’s veil of ignorance one may prefer a society in which the highest incomes are $1000 a week, or whatever, if that means that the lowest income is $200 a week, rather than the $100 a week if there are few incentives to produce more so the top income is $300 a week.

Insofar as the Rawlesian critique has force, any index or well being – even GDP per capita – should be adjusted to reflect the situation of the worse off. It would undoubtedly lead to a very different ranking among OECD countries.

The Alternative: The Vision Thing

But trying to construct an index which gives a unique non-controversial assessment of how well a country is doing may be, or how well it compares with other is the sort of impossible task the small minded take on, never realising its fundamental impossibility. For various reasons such indexes may be helpful, but they are not definitive.

An alternative approach is to settle on a non-quantitative vision, which describes the sort of society that is wanted. Of course it will be harder to assess whether it has been attained, but that is because it captures nuances which no index can. The current New Zealand government’s Vision for New Zealand was set down in the 2002 document Growing an Innovative New Zealand and repeated in the 2003 document New Zealand Sustainable Development Programme of Action.

The Vision for New Zealand

• A land where diversity is valued and reflected in our national identity.
• A great place to live, learn, work and do business.
• A birthplace of world-changing people and ideas.
• A place where people invest in the future.

We look forward to a future in which New Zealanders:

• celebrate those who succeed in all walks of life and encourage people to continue striving for success
• are full of optimism and confidence about ourselves, our country, our culture and our place in the world, and our ability to succeed
• are a nation that gains strength from its foundation in the Treaty of Waitangi and in which we work in harmony to achieve our separate and collective goals
• are excellent at responding to global opportunities and creating competitive advantage
• are rich in well-founded and well-run companies and enterprises characterised by a common sense of purpose and achievement, which are global in outlook, competitive and growing in value
• derive considerable value from our natural advantages in terms of resources, climate, human capital, infrastructure, and sense of community
• cherish our natural environment, are committed to protecting it for future generations and eager to share our achievements in that respect with others
• know our individual success contributes to stronger families and communities and that all of us have fair access to education, housing, health care, and fulfilling employment.

My only grumble about this vision is that it does not incorporate the vision the 1972 Royal Commission on Social Security who wanted a society in which ‘within limitations which may be imposed by physical or other disabilities, that everyone is able … to feel a sense of participation in and belonging to the community’. Their view is closely realted to the Rallesian view. I think it a pity it is not there, and in truth, I suspect also does the majority of the cabinet and the majority of New Zealanders.

Let me, however, not climb onto the pulpit and preach. Rather this technician proposes to accept the current vision, and write a book about how it might be implemented, albeit mainly from the perspective of economics policy. We shant ignore indicators such as GDP. But we will not build a policy focussed solely upon them.

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