21st century economics is about thickening the doughnut, rather than expanding the pie

Kate Raworth's new book Doughnut Economics: 7 ways to think like a 21st century economist is out. The book calls for a radical re-think of basic economics 101 as it is presently taught.

A Penchant for Redistribution

I am taking the liberty of recycling the following article from my drafts bin from three years ago when the debate in America was raging over healthcare. This post could have been written yesterday given the way things have played out, which is why I am posting it here:

Many commentators have opined that America under Pres Obama is re-casting itself in the mould of European socialist regimes. As Alan Wolfe observes,

the covers of National Review ("OUR SOCIALIST FUTURE"), The Nation ("REINVENTING CAPITALISM, REIMAGINING SOCIALISM"), and Newsweek ("WE ARE ALL SOCIALISTS NOW") have--respectively--lamented, heralded, and observed the coming rise of socialism (Obama vs Marx, The New Republic, April 01, 2009).

From his statements, Richard W Stevenson surmises the intent of Obama to reshape capitalism by

diminishing the consumerism that has long been the main source of growth in the United States, and encouraging more savings and investment. He would redistribute wealth toward the middle class and make the rest of the world less dependent on the American market for its prosperity. And he would seek a consensus recognizing that an activist government is an acceptable and necessary partner for a stable, market-based economy (Redefining Capitalism After the Fall, New York Times, April 18, 2009).

A High Tolerance for Inequality

Politically the cover for undertaking redistributive policies in the US is being provided by the current crisis. According to Alberto Alesina and Paola Giuliano who have studied income and wealth inequality, Americans are less “inequality intolerant” by nature compared to the Europeans. This is due to the perception that prevails in the US that social mobility is possible (the World Values Survey found that 60%, compared to 40% in Europe, believed in the possibility of improving their standing income-wise).

Only during the “Great Compression” lasting from the mid-40s to the 70s has the US seen inequality decline continuously; that is apart from what seems now to be a blip that lasted from the mid-90s to the early 2000s. Franklin Foer and Noam Scheiber write in The New Republic that

(b)eginning in 2004, the data gradually began to undermine the Clintonites' central assumption: that the benefits of growth would accrue to the poor and middle class ... Workers' wages had once tracked productivity growth. Now workers were producing more, but only the wealthy were reaping the rewards; everyone else's income had basically flattened out.

Alesina and Giuliano tell us that by August 2008, inequality in the US had returned to its previous level in the 1920s. Following the crisis which is widely perceived to be the fault of financiers at the top of the income pyramid less tolerance for inequality will ensue as

voters (will) demand especially strong action to reduce inequality, even in a country like the US, where inequality is much more tolerated than in Europe.

While there is a greater appetite for social levelling, it is the extent of that levelling that will be determined soon. Alesina again:

(w)ill Americans turn into “inequality intolerant” Europeans? Probably not, but this crisis may imply a turning point towards more government intervention and towards redistribution.

"Poverty is a choice"

That seems to be the conclusion of Charles Murray, a scholar of the libertarian American Enterprise Institute and author of the controversial book, Coming Apart which looks at the growing divide among white Americans from 1960 to 1910.

After asserting in the Bell Curve a book he co-authored with Richard Hernstein that it was their inherent lack of intelligence or IQ more precisely that reduced African Americans to the bottom of the social and economic ladder, he now claims that poverty among white Americans is a result of the decline of civic culture, a result of changing preferences rather than structural policy imbalances.

Back in 1994, the unknown civil rights lawyer Barrack Obama, as a guest commentator at NPR spoke plainly regarding Murray's work then, that

He's interested in pushing a very particular policy agenda ... With one finger out to the political wind, Mr. Murray has apparently decided that white America is ready for a return to good old-fashioned racism so long as it's artfully packaged and can admit for exceptions like Colin Powell.

It doesn't seem as though there is a role for government either in closing the divide between upper middle class white Americans and their blue collar counterparts. According to Murray, the cure for this malady is for the wealthy "to drop their nonjudgmentalism and start preaching what they're practicing" (a case for cultural imperialism?). Perhaps, in Murray's policy brief, they deserve in exchange for exercising such noblesse oblige or civic duty tax cuts on top of the ones they already receive (?).

The person who could model this kind of behavior the best among the candidates is Mitt Romney. The introduction of the book comes at an opportune time as he recently stumbled over the issue of income inequality and as many independents within the party (blue collar teaparty Republicans) cast a suspicious eye at the 'Washington/Wall Street establishment' that he seems to represent. The 'non-Romney' candidates, Newt Gingrich, Rick Santorum and Ron Paul have all railed against these 'fat cats' and sought to capture the protest vote.

It turns out, these so-called elites share many of the religious and cultural preferences as the party base according to Murray (upper middle class whites more frequently go to church, marry and stay married for longer). Of course the recent research on happiness and income explains why that may be. In the end, Murray may have tried to establish a false causation here.

Given the stagnation of income and productivity in America, the 'choice' faced by ordinary Americans isn't the same as the one they faced in the 1950s when GDP and employment were rising. Consequently, people don't 'choose' to become poor because they have lost their work ethos; the lack of a work ethos comes as a result of people being poor or unemployed for an extended period of time.

Does anyone deserve to be poor?

The Nobel winning economist, Gary Becker, whose work on human capital I deeply admire writes a piece called Deserving and Undeserving Inequality in the blog which he shares with Richard Posner. In it he distinguishes between good inequality (deserved) and bad inequality (undeserved) saying

The great majority of people in different cultures do not object to someone who has made lots of money when they have superior abilities and talents, and they work hard at producing what are considered useful goods or services.

The meritocratic society with upward and downward social mobility would be in Becker’s view the most acceptable form. In this just society, the cream always rises to the top. He cites actors like Tom Hanks and Jennifer Anniston, entrepreneurs like Bill Gates and Steve Jobs, and skilled professionals like transplant surgeons who have grown rich by applying their exemplary talents and skills.

In contrast, Becker poses the problem society seems to have with hedge fund managers who make use of arbitrage (momentary bargains unnoticed by the market) to make huge sums of money. He lumps them together with speculators, Russian oligarchs and monopolists who enrich themselves through unfair, uncompetitive means (the latter two through government fiat).

Becker of course uses human capital theory as his framework for addressing this issue. Under its framework, individuals who acquire knowledge and skill through education and training (one cannot gain it any other way as it cannot be inherited or passed on) deservedly earn private returns in the form of higher incomes over the remainder of their working lives.

A meritocratic society should in Becker’s view reward the investments made by individuals in themselves and not rely on some other criteria. Elitism, the polar opposite of meritocracy rewards individuals for investing in other things (social standing or being raised on the right side of the tracks, marrying into the right family, etc).

It all sounds rational and justified, which is why Becker says “the great majority of people in different cultures” accept the legitimacy of a certain form of inequality. The wisdom of crowds is evident, until we start to consider the actual “merit” of the argument.

Economic, behavioral and neuro scientific research has demonstrated for instance that when it comes to employment, so many other factors aside from talent and intelligence determine the outcome of a hire/fire decision. Tall, handsome, Caucasian males for instance tend to earn more than their peers of equal and (as labor economist Daniel Hamermesh demonstrates) of even higher educational attainments.

If you are a plump woman working alongside office waifs, then you are more likely to be laid off during an economic downturn compared to your skinny female counterparts. In fact, studies in the US and replicated in other parts of the world show that job applicants could even be screened out simply because their names sound ethnically diverse (those with names such as ‘Tamika’ for instance got less callbacks from recruiters compared to those who had typically Anglo-Saxxon names like ‘Sally’).

The ‘good-bad’ dichotomy looks awefully strained at this point.

Reflecting on this a bit, I begin to wonder, how much of our lot in life really depends on our own actions, and how much of it depends on chance. In fact, beyond just the narrow hedonic enjoyment of earning more money, if the pursuit of happiness were to be the ultimate measure of success, then we could find an even bigger divide opening up.

About 50% of our ability to have a pleasant life depends on our genes, which is not very modifiable, according to psychologist Martin Seligman (other studies suggest this could be as much as 60%). This would not be good for those who weren’t born with the right disposition.  Of course, for those who are disadvantaged in this way, they can still influence their level of happiness by focusing on the residual aspects of life that can be modified to produce happiness, a mere 15-20%. That is if they can afford to pay for therapy which again disadvantages those who happen to be residing at the bottom of the economic ladder.

As James Kwak who recently re-read John Rawls’ A theory of Justice, has said

well-educated, hard-working people did not deserve to make more money than other people, at least not as a normative (as opposed to a utilitarian) matter.

Kwak quotes the passage from Rawls’ treatise to support his claim

[The liberal conception of the second principle of justice] still permits the distribution of wealth and income to be determined by the natural distribution of abilities and talents. Within the limits allowed by the background arrangements, distributive shares are decided by the outcome of the natural lottery; and this outcome is arbitrary from a moral perspective. There is no more reason to permit the distribution of income and wealth to be settled by the distribution of natural assets than by historical and social fortune. . . . Even the willingness to make an effort, to try, and so to be deserving in the ordinary sense is itself dependent upon happy family and social circumstances.

At work, I am currently involved in developing and implementing a pilot project that seeks to help socially disadvantaged groups improve their learning and employment outcomes through a range of interventions. Social disadvantage comes in many forms. The issues encountered by our case officers usually involve multiple and complex needs such as drug and alcohol abuse, inter-generational poverty, lack of economic opportunity where they live, sexual abuse, abandonment, domestic violence, discrimination, disability both physical and mental.

Unfortunately much of Australian mainstream society sees these individuals as “bludgers” or people who leech off the tax and welfare system. The mainstream of society cannot really see why they can’t just find work in a country where there are skills shortages in many industries. I must admit, I used to subscribe to this way of thinking too.

This is reflective of meritocratic aspirations Aussies share with their American and British counterparts. A study by Dan Ariely and featured recently by PBS finance correspondent Paul Solman demonstrates this. Respondents were given three pie charts resembling the spread of wealth in unnamed countries. The first showed an equal distribution of wealth. The second showed a slight advantage to the two top quintiles. The last showed a very disproportionate concentration of wealth to the top 40%.

They were asked to specify which country they thought the US represented. Most went for the pie chart that showed a slight skewing of wealth to the upper classes. They were unaware that it was actually the third chart which they thought represented a third world country which represented the US. And yet, as the piece by Solman suggests, there is a lack of appetite among voters for tax reforms that would correct such a lopsided distribution of income and wealth.

At least in affluent countries, there is a system for attending to marginal groups. In less developed countries, the problem of addressing poverty, inequality and social disadvantage is harder because of scarce resources. Even in countries like China and India which have lifted millions out of poverty, this mostly depends on where people live. Those who reside along coastal provinces in China tend to have higher incomes than those that live in the interior whose incomes are closer to some countries in Sub-Saharan Africa.

In a middle income country such as the Philippines that has experienced growth but not a lot of change in its distribution of wealth, the experience has been that such growth has not been inclusive. Not only is economic opportunity not evenly distributed in the population, but this distribution itself seems to be perpetuated by laws and policies of successive governments.

I say this because the sorts of reforms that have been proposed to address disadvantage, namely tax reform, land reform, and reproductive health have been held back or denied the kind of support, moral, political, and financial, required for them to be implemented correctly. There are two kinds of attitudes that might be responsible for this:

1. Self serving bias is the tendency to claim more responsibility for successes than failures. Thus, those who are well-off tend to think they deserve their successes.
2. Just world phenomonon is the tendency for people to believe that the world is just and therefore people "get what they deserve." So those who hold this belief look at poverty and social inequality and think that those who suffer from them deserve to be where they are.

These forms of ‘cognitive bias’ may lead us to misapprehend the problem of social disadvantage and inequality to the point that we may even claim self-righteously that certain outcomes are just when in fact they are not. I certainly have come to reconsider my views on this. What about you? 

London Burning

No matter how hard he tries, David Cameron's attempts to evade responsibility not just for the conditions that may have caused or contributed to the eruption of riots in London, but also the inadequacy of the response to it, it is becoming apparent that not only politicians, but the public at large are losing faith with his reforms and the Big Society it promises.

Cameron of course, beset by calls from the Labor Opposition to reconsider cuts to the police budget laid the blame on parents and the so-called broken society. The rioting was criminality run wild, not a form of political protest against an unjust social order. The police response was slow and tactically wrong, he intoned during parliamentary debates.

Unfortunately for him, the police did not take too kindly to this characterization of events, and the public appear to back them instead of the political leaders. The seeming disconnection of the politicians who were on holiday, the PM in Tuscany, his deputy in France and the London Lord Mayor Boris Johnson in the United States, when the burning of London raged surely did not help build credibility for them.

In this situation, the importance not only of empathy but also a desire to ease suffering on the part of ordinary citizens could have gone a long way.