This is the revised version of a paper given to the a public health group in Lower Hutt, and a Presbyterian Church group in Hamilton. It is a development of an earlier paper “What Are Our Economic Priorities?” (http://www.eastonbh.ac.nz/?p=1549) There is an accompanying PowerPoint presentation.
Keywords: History of Ideas, Methodology & Philosophy;
I want to talk about our public priorities. I’m going to differ from the conventional wisdom by arguing we should pay less attention to the growth of material output or (GDP) and more attention to employment, to social coherence and to the quality of life. While that may leave the conventional wisdom uneasy, I want to insist that my approach is within orthodox economic thinking, albeit a little ahead of much of the profession.
Before doing this I need to say a little about the economic context – about the past, the current, and the possible future state of the economy.
The New Zealand economy is in the fifth year of stagnation. There are always those who promise it will soon be over. I am reminded of the wife of an economist who sued for divorce on the basis of the non-consummation of the marriage. She explained that her economist-husband just stood at the end of the bed, beating his chest, and saying things were going to get better; ‘but they never did’.
In fact since 1862 New Zealand has already experienced five great stagnations, long periods – five and more years – when per capita real income did not rise. In all but the Rogernomics Recession of 1984 to 1993, the stagnation was caused by an unfavourable world economy. This is as true for this one, the sixth. I could go through the analysis of why the world economy is in a long stagnation and why it may take another five years before it returns to growth.
However my purpose in drawing attention to it is to ask what is to be done given the prospect of a long stagnation. I am not foolish enough to argue here for policies which will boost New Zealand’s economy – dragging the rest of the world out of recovery behind it. Rather I want to consider whether we should despair if we are in for a period of stagnation.
Note that the principal indicator which is used to assess economic stagnation is per capita GDP in constant prices over time. I am comfortable with its use for that purpose but there has been a tendency to assume that per capita GDP is some measure of well being. As its name ‘Gross National Product’ indicates, GDP is a measure of material production. It is also such an indicator of market incomes that I can use the terms GDP and income interchangeably.
That was not the purpose for which it was designed. Indeed when Simon Kuznets first conceptualised the measure nearly 80 years ago he wrote ‘[t]he welfare of a nation can scarcely be inferred from a measurement of national income’, and economists have held that position ever since. Kuznets was deriving a measure of total market activity, which was important at the time for tracking the Great Depression and employment and unemployment, and that and related purposes of observing the growth of market production of goods and services remain the main use of GDP by economists to this day.
Since there was no alternative measure GDP became equated with the welfare of the population, despite that not being its purpose and despite Kuznet’s warning that it was not. Economists suspected that there might be some sort of correlation and non-economists grabbed the measure because it was all that was available.
(Some think that broadening the definition of GDP may make a difference. Economists explored this about forty years ago with the notion of a Net Economic Welfare. More popular today is the General Progress Index proposed by some non-economists. Both are minor changes within the original GDP paradigm and dont really address the issues with which I am dealing today.)
Almost as an aside the Governor of the Reserve Bank has recently pointed out that the correlation is not a good one, especially in relationship to New Zealand. He drew attention to an OECD study which pooled together twelve measures of what one might judge as contributing to welfare and compared them with per capita GDP. The scatter diagram of it against their Better Life Index shows the 33 OECD economies cluster around a common line with the higher the per capita GDP the higher the index. There is one economy way out of line – New Zealand. Some have concluded that we may be underestimating our GDP by a third or more, but the modest scientific conclusion is that the relationship is not a very good one The OECD ranks New Zealand as fourth on its Better Life Index while it is below twentieth on GDP per capita.
We can get an understanding of why by looking at the components of the index. Here is New Zealand’s ranking out of 33. (I’ve put in Australia because that is such a natural comparison. It ranks second on the index, and fifth in terms of GDP per capita.)
New Zealand Australia
Environment 2 9
Housing 3 2
Community 3 6
Governance 4 1
Health 4 2
Jobs 5 6
Safety 7 4
Education 12 16
Life Satisfaction 12 6
OECD MIDPOINT 17
Income 25 14
Work-life balance 26 30
OVERALL 4 2
Before everyone gets chauvinistically excited about these results, I caution that there is a lot of judgement in the figures and that quite small differences – well within measurement error – can change rankings substantially. By adding other measures or changing the weightings one can alter where New Zealand is located.
Despite a host of limitations I have shown them to draw two conclusions.
First, where we do well is in areas which GDP does not measure very well at all, a sobering reminder of its limitations. If we take the measures – they are the best we have – we find that on many of them we are in the top half – or even quarter – of the OECD. Where we do really badly is income (which is a kind of direct measure of per capita GDP) and work-life balance which says that we seem to work longer hours than many other countries. (But that does not include time travelling to work whose inclusion might raise our ranking, a reminder of how sensitive the measures are to definitions.)
Second, one needs to be careful not to damage where we do well in order to pursue the increase of GDP. For instance we might well increase GDP per capita by cutting back on health care, but we would not necessarily be any better off. The obsession of a lot of politicians with the goal of increasing GDP may lead to our reducing national wellbeing.
It is an interesting feature of the table that New Zealand tends to do better where the government has more impact. We seem to have weaknesses in the market sector. That does not exempt the government, but it reminds us of the business sector tendency to divert attention from its failures by blaming the government for everything. The government may not be blameless but it is important we recognise its strengths and do not undermine them.
There is a particular danger that if we think per capita GDP is correlated with wellbeing (even though it is not) and if output remains much the same during a long stagnation, we may think there is no increase in wellbeing, or even that it is declining. Yet much of our political rhetoric is based upon the fallacy.
In particular in recent years economists have been evolving a more sophisticated account of what determines wellbeing. The OECD research I have just reported on is one attempt, but a very limited one.
This broadening of our understanding has been possible because of an increasing range of data bases which introduce various measures of how well off we are. In the past economists did not have them. We knew our understanding of the determinants of wellbeing was limited, but lacking the empirical evidence, we were unsure how to modify our theories. Recently accumulated data has enabled some progress.
One approach has been to ask individuals about their wellbeing, with questions like ‘how happy are you?’, or ‘how satisfied are you with your life?’ Individual responses are subjective, but there is evidence that the responses are consistent with the objective evidence. These surveys usually involve thousands of people and have been carried out in many different countries. The conclusions are pretty consistent across cultures; including New Zealand’s.
We can use the responses to identify regularities. For instance, women tend to say they are happier than men, although the difference has been converging over the years. The young are happier than the middle-aged, but after about the age of forty the decline reverses and the elderly are as happy as the young. Being married is, on average, associated with being happier than not being married.
All the results I reported here assume all other things are equal. If you dont do that, you can end up with weird results. A market research firm claimed that widows were happiest. There are not a lot of 40-year-old widows but a lot of elderly ones and the age effect outweighs the marriage effect; dont bump off your husband to make yourself happier, but you are welcome to outlive him.
Economists and government cannot do much about age, gender or marital status, but we claim to be able to influence incomes (and other economic variables). What is the evidence about the impact of incomes on happiness? There are three salient results which require a little care to reconcile.
The first result comes from looking at the data over time. More than 60 years of survey data from America shows no rise in average happiness, despite real incomes more than doubling. The implication is that raising national income does not increase happiness.
The second result comes from looking at the data between countries. It shows that happiness among rich countries does not seem to be much affected by relative income. For instance, New Zealanders are typically happier than Australians even though our income is lower.
However, those in poor countries are on average less happy than those in rich ones. It is not hard to see that an increase in income improves the lives of the desperately poor. But once the basics of food, clothing and shelter are met, it appears that rises in average income do not directly lift wellbeing. This level is well below New Zealand’s standard of living, so the phenomenon does not generally apply to us.
(I take a little comfort here about the sagacity of the founders of economics. Two hundred years ago almost everyone had a low income by today’s standards, so early economists were right to focus on raising incomes to raise wellbeing. Two hundred years later, the connection between material consumption and wellbeing is no longer true at current levels of affluence.)
The third result comes from looking within a country. It shows that those on higher incomes are happier than those on lower incomes. Above a threshold the effect is small; for instance, the married on about half the equivalent income are happier than those who are not married,. But the income effect is definitely there; the New Zealand research with which I have been involved with finds it too.
I suggest a way of thinking about these results is by using Maslow’s hierarchy of needs. You will recall it has five levels. Bottom to top they are:
1. Physiological needs: Breathing, Food, Water, Sex, Sleep, Homeostasis, Excretion
2. Safety and Security: Personal security, Financial security, Health and well-being, A safety net against accidents/illness and their adverse impacts
3. Love and belonging: Friendship, Intimacy, Family
4. Esteem: Self esteem, Confidence, Achievement, Respect of others, Respect by others
5. Self-actualization: Morality, Creativity, Spontaneity, Problem solving, Lack of prejudice, Acceptance of facts
(Some times a sixth level of self-transcendence is added.)
Now the economy really contributes only to the first two at the base of the pyramid, physiological and safety needs, although it can indirectly facilitate some which are a bit higher (as when communications make it easier to connect with the extended family).
That suggests that at a certain point the contribution of the economy to needs becomes less effective. That is perhaps what we see in the cross-sectional evidence of how after a certain point a rise in per capita GDP does not seem to increase wellbeing. That does not mean that everybody in countries above the threshold has all those needs met, but apparently the numbers are small enough not to affect the average. (Even so we should address their needs.)
What seems to be happening is that as average incomes rise the curve which relates people within the income distribution shifts. Why does this happen? Perhaps we should stop thinking of income as enabling you to buy things but think of it as indicating what you can buy relative to others – an indicator of your status in society.
In terms of the Maslow’s hierarchy of needs we can see that there could be a relativity effect at the esteem level. Perhaps one has more self-esteem and respect from others if one can purchase more. Perhaps high incomes treated as an indication of social achievement. That seems to be the way we think about these things.
Economists describe this phenomenon by a theory of positional goods, but it comes from an older tradition developed by an American economist and sociologist, Thorstein Veblen, of ‘conspicuous consumption’, where goods and services are acquired mainly for the purpose of displaying income, wealth and power.
You will be aware this is widespread in a modern affluent society. Particular products – homes, cars, clothes, extravagant parties – are used to display the holders’ wealth, and to upgrade their position in society. Underneath this is the notion that’s one social status is perceived largely – or importantly – by one’s income relative to others. It is not that additional income directly generates happiness, but that it contributes to self esteem and social status. Additional income raises ranking in society. But if everyone can buy more, the average ranking does not change, and people dont get collectively happier.
So what is the point of raising incomes since nobody, on average, is any better off? We have an economic system based on each of us seeking to raise our income. On the whole – periods of economic stagnation aside – it succeeds, and yet it does not make us individually happier. That leads to the deep philosophical question of the purpose of it all – I am not going to answer that tonight.
But to progress it, let’s think about the differences between me and my father, who was born about a quarter of a century before I was. It is a matter of record that, on the whole, my income has been higher than my Dad’s. It is a reasonable conjecture, on the basis of the research I have just reported, that I am no happier than Dad. So am I really better off than he was (except I have the better son)?
What strikes me is that despite all his achievements, Dad did not have the opportunity to go to university – he had the ability – and pursue the career for which he was naturally qualified – he would have been a superb general practitioner (as his final career as a psychopaedic nurse well attested).
That is the difference between Dad and me. I can regret that he missed his natural vocation; I doubt my son will think that I missed mine in the same way. Dad did not have the choices that I did. Economic and social development – and the support from Dad and Mum – meant I had opportunities that they could only dream of.
(Arguably my mother did worse than my father, because she was a woman. Later generations of women will not suffer as much as her generation did. That is true for other minorities. They may not yet have attained the same opportunities but the gap has narrowed. Many of the policies which reduced those gaps have little to do with economics.)
What I have been describing is a simplified account of objectives set out by the great Indian economist and philosopher, Amartya Sen, who emphasises the importance of life opportunities and choice: not the choice we have when we go into a supermarket and select between brands of baked beans, but the real choice of being able to select a life style consistent with one’s potential.
On the whole, the development of the economy improves those opportunities. From this perspective higher incomes are a collateral consequence of rising opportunities but they are not the social purpose of the economy, with the imperfect correlation between rising incomes and increased opportunity; sometimes the relationship may even be negative with higher incomes and lower opportunities. We should not focus on income as the sole policy target; at best it is an intermediate one which enables us to do other things. .
Consider the argument that higher taxation reduces the efficiency of the economy and lowers income. Suppose it were true (it probably isn’t). Having broken away from the fallacy that social purpose is about rising income, we can instead ask whether the additional income advances opportunity and achievement. It might not, if the consequence is a drop in the wrong public spending.
Some public spending – that which cannot be delivered effectively in any other way except through the public purse – contributes to the wellbeing of some individuals. This is a treacherous area because it involves supply-side and distributional issues, which I have not time to reflect upon here. So let me just list some salient examples of public spending which can increase wellbeing in non-economic ways: culture and heritage, the environment, recreation, safety and security. In each of these, the private sector has manifestly failed to supply sufficiently for our needs. If taxes are reduced the resulting cut back in the provision of public services ting them back may reduce wellbeing.
Education which creates fundamental opportunities and enlightenment is another area where it is difficult to envisage adequate private sector provision. That is why so much education is publicly funded. (But we should treat vocational training differently; that is about economic development.)
An even bigger public spending item is healthcare. While income may not really add to one’s happiness, effective healthcare may prolong the period when one is happy. It is not just a matter of living longer, but increasing the quality of life following sickness or disability. (This is a large topic in its own right. Much of the rhetoric on public policy on health remains in terms of extending mortality. However much of health care does not extend life – or only extend life. It increases the quality of life. I am not sure we have fully included this in our policy thinking.)
Now privately driven healthcare is ineffective and expensive – the American failure is a salient example – so it makes sense for the public sector to be involved. How to design that involvement is complicated – let’s leave that for another day too.
Observe then that my support for public spending is pragmatic rather than ideological. Its need arises when the private sector does not supply it well; taxation is a consequence. The economist’s task is primarily about evaluating the tradeoff between more public spending less private spending (although economists get sucked into managing the expenditures, if others do not try to use the resources efficiently).
However there are some aspects of the economy, other than the level of public spending, which directly impact on welfare and where economists have some expertise. One is the degree of inequality in a society.
Recently there has been a lot of excitement about the book The Spirit Level, published a couple of years ago, although there was a precursor The Impact of Inequality published four years earlier by the senior author, Richard Wilkinson. Another key player in this research has been Ichiro Kawachi, who did his doctorate in New Zealand. His and Wilkinson’s work goes back to the 1990s, so what I am to tell you is not as new to the profession as it is to the public.
What they show is that there is a correlation between the degree of inequality and various measures of poor social performance. The strongest and longest established correlation is that a larger gap between the rich and the poor is associated with poorer health status; poorer mental health, greater drug use, more suicide, poorer physical health, lower life expectancy, greater obesity and earlier pregnancy. More recently, violence and criminality have been shown to be associated with greater inequality. Inequality is also associated with unequal life opportunities, but that has been long known.
While there have been challenges to the conclusion that income inequality is associated with poor social performance, the empirical evidence is too strong to dismiss the relationship out of hand. More controversial is what the underlying causal processes are.
Social inequality is a complex phenomenon. Consider a society which pays insufficient attention to its elderly; contrast it with another that does not support its children and with yet another which has high unemployment which severely disadvantages its young adults. Each could generate exactly the same measure of income inequality, yet each is likely to malfunction differently. Ignoring the elderly is unlikely to increase criminality, disadvantaging adolescents may.
Wilkinson and his co-author Kate Pickett argue that neuro-endocrinological stress, provoked by a perception that others enjoy a higher status than oneself, undermines self-esteem and generates these malfunctions. Can a single channel explain so much, even if it seems consistent with my earlier discussion about the importance of social status in the economy? I think it better to treat their explanation as a hypothesis and look for further supporting evidence and alternative explanatory channels.
But whatever a research scientist may think, for practical policy purposes the material the authors bring together counsels that it is sensible to try to reduce income inequality and unwise to increase inequality except for a very good reason.
Increasing income inequality in order to accelerate economic growth is not a good reason. Some vigorously advocate cutting taxes on the rich to do so. The empirical evidence is that lower taxes would not have much effect on the growth rate; some contradict it suggesting lower taxes may even reduce GDP. If there is any effect, it is very, very small; so small that we cannot measure it with any certainty. In any case higher incomes do not in themselves promote greater wellbeing or happiness.
The rich are quite right when they say the tax cuts will benefit them. It increases their self-esteem. But Wilkinson and Pickett warn that not only may this be at the expense of those lower in the income distribution, but also at the expense of the nation in terms of poorer health, more criminality and loss of opportunity.
The second directly economic issue is the level of employment and unemployment. The survey evidence is that the unemployed are not as happy as the employed; that would be true even if they had the same income as they could earn, rather than the much leaner unemployment benefit. That is because work is a socially valuable experience. It does not just pay us, but it has some latent social functions:
– Employment imposes a time structure on the working day:
– It involves regularly shared experiences and contacts with people outside the nuclear family:
– It links an individual to goals and purposes which transcend her or his own:
– It enforces activity.
That is employment does not just contribute to the bottom of the Maslow pyramid by providing income, but makes some important contributions in the middle levels. A quick summary is that we because we are social animals we are happy to work, for it gives us more than just income.
(I am sure that Marie Jahoda who articulated the latent functions did not require the work to be paid, so her list certainly covers voluntary work. You will observe that housework is not quite as successful at covering the latent functions – as well as it is not paid – which may explain why it is unpopular.)
The implication of work having these values to a social being is that we can enhance wellbeing by keeping unemployment to a minimum. Now while it might seem to be easy to guarantee everyone a job, it is actually hard. Work and Income would love to get the unemployed off their books, they put a lot of effort into doing this, but they are not that successful. More subtly, we cannot guarantee everybody a job for life, other than by having a totally stagnant economy without any technological innovation. Such an economy would have reduce the opportunities which enhance wellbeing compared to a dynamic one. (And in truth I am not sure we can stop technological innovation, even it we wanted to.)
If people do not have a job for life, then sometimes they will be in transition between jobs: they will be unemployed. Some unemployment is not avoidable, but we can handle it poorly or badly. We sometimes talk about a pool of unemployment; a little limnology can be helpful. The pool may be stagnant with the water sitting there full of rotting detritus. Or the pool may consist of freshwater flowing in and flowing out quickly the other side. Far too much of our pool of unemployed is of the first sort; we need to extend the second, especially so a person who becomes unemployed has some confidence that the stay in the pool will be short and not too unpleasant. A first step would be to stop pouring the acid of contempt onto the unemployed. Their pool is an integral part of a dynamic economy.
Observe that I am sneaking in a case for economic progress. Its aim is not to lift incomes but to generate jobs and opportunities. Because of technological change, because of physical shocks like earthquakes, because of changing overseas conditions, the economy has to be dynamic and changing, even if aggregate real income is not increasing. We need to direct the dynamism so it contributes to wellbeing and not just higher output.
So I am not arguing we should try to catch up to Australian income levels at all costs. That is what some people want to do, although they are silent on just how the policies they advocate would do this. After all their policies got us well behind Australia when they were implemented a quarter of a century ago.
Moreover the policies will increase income inequality – did you know that we had the largest increase in inequality in the OECD between the mid 1980s and 2010? Didnt help us to catch up with Australia much. Our inequality is about seventh highest in the OECD. Is that really where we want to be? If Wilkinson and Pickett are right, we are heading for poorer health, more crime and less opportunity – and lower on the wellbeing list.
Did you know that our secondary schooling system is doing better than the OECD average and slightly better than Australia on the PISA scores? It is true that we have a brown tail of poor achievers where we need to do better. But will cutting back on educational spending and even privatisation – the inevitable consequence of tax cuts – mean we will do better? What evidence have we that charter schools are not driven merely by ideological hopes and will do something for those in the tail?
Forgive the tone of irritation in the last few paragraphs but it captures the central theme of this presentation. The empirical evidence cautions against the obsession of equating income with wellbeing or of pursuing income growth at all costs. There are other things which contribute as well, and some things – even economic things – may contribute much more: certain sorts of collective spending, better health and education, lower income inequality, less stressful unemployment. The economy can contribute to much of this, but we would be unwise to sacrifice them for the pursuit of income. It should be our servant, not our master; the same applies for economists.
That does not mean we should ignore economic issues. I support the government’s objective of reducing our borrowing by shifting from a budget deficit to a surplus. It is prudent to have reserves for the unexpected, like a need to borrow in the future if the world economy goes badly awry again. There remains a danger that when we need to borrow, lenders may say ‘no’ or charge extortionate terms – as they did just before the Second World War.
But if I support the government’s objective of reducing our dependency on lending, I do not think they are going about it in the right way. It seems to me a nonsense to fund the costs of the terrible Christchurch earthquake by squeezing other government expenditure. Later generations will puzzle over the absurdity of the decision, wondering why the government did not impose an earthquake levy on incomes which shared the costs across the entire community instead of requiring the weak and vulnerable to carry an unfair share, while cutting back on key elements of public spending which underpin the enhancement of wellbeing.
They may well snort at the claim that the government’s strategy of screwing the public sector will enhance economic growth – it hasnt and it wont – but they may also query whether it should have been focussing on material output to the extent that it did.
Instead, as Socrates advised us, we should be promoting the good life well lived. Which is what happened with my Mum and Dad. With Amartya Sen’s addition that we should also be enhancing people’s life opportunities. Beside that goal, income maximisation is trivial; in any case the economy is going to be stagnant for a while.