Category Archives: Inequality

GDP not the indicator for wellbeing – Robert Kennedy was right 50 years ago

Traditional economic measures, such as gross domestic product (GDP), productivity and economic growth remain fundamentally important but they’re not the whole picture. We think economics is ultimately about improving people’s living standards but you can’t look at GDP as the indicator to focus on.

US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile.

The introduction of the living standards framework in New Zealand takes into account environmental resources, individual and community assets, ‘social capital’ – which includes cultural norms and how people interact – and human capital, such as people’s health, and their skills and qualifications.

By living standards, the NZ Treasury means more than income; it’s people having greater opportunities, capabilities and incentives to live a life that they value, and that they face fewer obstacles to achieving their goals.

Limitations of GDP as a measure of standard of living – see list below.

  1. Regional Variations in income and spending
  2. Inequalities of income and wealth
  3. Leisure and working hours
  4. The balance between consumption and investment
  5. The shadow economy and non-monetised sectors
  6. Changes in life expectancy
  7. Innovation and the development of new products
  8. Defensive expenditures

 

Does CEO pay equal their marginal revenue product?

One reason for the increasing inequality in society is the stagnant wages for the lower and middle income groups – in the USA the top 0.1% have as much wealth as the bottom 90%. Labour compensation at the very top has increased dramatically since the 1970’s.

1970’s – the top 0.1% took home less than 3% of all income
2010 – the top 0.1% took home more than 10% of all income

In the USA the top CEO’s average compensation has grown since the late 1970’s by over 900% to around $15 million a year. In contrast the lower income groups have gone up by only 10%. However when you look at hedge fund and private equity fund managers the salaries are astounding. In 2014 which was seen as not a great year for the industry 25 fund managers made at least $175 million each, and 3 made more than $1 billion.

Are CEO’s worth every cent?

In theory the demand for labour is determined by their marginal revenue product – that is the value of revenue generating by employing an additional worker. Labour markets are imperfect and a monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. The monopsonist will hire workers where:

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

So if Goldman Sach’s CEO, Lloyd Blankfein, made $24 million in 2014, that’s because he is worth $24 million to his company. In short, you make what you deserve based on your skills, effort, and productivity, in this fairest of all possible worlds.

However this theory has little to do with how the world actually works. The idea that good CEO’s are entitled to enormous rewards is based on the belief that success or failure of the company depends on one person. According to historian Nancy Koehn, business is a team sport: not only is it impossible to quantify a single leader’s marginal revenue product; it is hard even to describe it clearly. Ultimately a CEO can appoint friends and place them on the compensation committee which recommends the CEO salary. The committee invariably proposes to pay at least as much as the median comparable company, because no board wants to admit that its company has a below-average leader. CEO’s do have key performance indicators (KPI’s) but the CEO can encourage the committee to select metrics that will be easy to satisfy. John Kenneth Galbraith describes CEO pay very succinctly – “The salary of the chief executive of a large corporation is not a market reward for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.”

Luck plays an important role in CEO’s pay. Heads of oil companies were paid more when profits increased, even when the profits were not due to their decision making but simply by a rise in the price of oil. On the contrary it is argued that some boards actually do a good job in firing under-performing leaders and that in the end, high compensation is simply the result of the market for talent – supply and demand. The financial sector tend to use the marginal revenue product of labour theory in their awarding of compensation for CEO’s. Bonuses of traders and investment bankers’ are based on the profitability of their own deals but because bonuses can never be negative, individual employees can generate enormous payouts on bets that turn out well while sticking shareholders with the losses on bets that go bad. Furthermore even if bankers do make money by buying low and selling high in the securities markets there is no value generation as there is no tangible output that anyone can consume.

In aristocratic societies such as 18th century France or 19th century Russia, wealthy noblemen who owed their riches to the accident of birth had to worry about the prospect of violent rebellion by the have-nots. By contrast in the US today the wealthy are protected by the widespread belief that their extraordinary incomes – and the inequality that they generate – are simply the product of inescapable economic necessity.

Source: Economism by James Kwak

Holiday reading for the beach

That time of year when I take off to the beach out of internet range – here are some economics books that I recommend. I should be back on the blog on Monday 8th January – have a good Christmas and New Year. Reviews are from Amazon.

Economism: an ideology that distorts the valid principles and tools of introductory college economics, propagated by self-styled experts, zealous lobbyists, clueless politicians, and ignorant pundits.

In order to illuminate the fallacies of economism, James Kwak first offers a primer on supply and demand, market equilibrium, and social welfare: the underpinnings of most popular economic arguments. Then he provides a historical account of how economism became a prevalent mode of thought in the United States—focusing on the people who packaged Econ 101 into sound bites that were then repeated until they took on the aura of truth. He shows us how issues of moment in contemporary American society—labor markets, taxes, finance, health care, and international trade, among others—are shaped by economism, demonstrating in each case with clarity and élan how, because of its failure to reflect the complexities of our world, economism has had a deleterious influence on policies that affect hundreds of millions of Americans.
————————

The Great Leveler. Are mass violence and catastrophes the only forces that can seriously decrease economic inequality? To judge by thousands of years of history, the answer is yes. Tracing the global history of inequality from the Stone Age to today, Walter Scheidel shows that inequality never dies peacefully. Inequality declines when carnage and disaster strike and increases when peace and stability return. The Great Leveler is the first book to chart the crucial role of violent shocks in reducing inequality over the full sweep of human history around the world.

Ever since humans began to farm, herd livestock, and pass on their assets to future generations, economic inequality has been a defining feature of civilization. Over thousands of years, only violent events have significantly lessened inequality. The “Four Horsemen” of leveling―mass-mobilization warfare, transformative revolutions, state collapse, and catastrophic plagues―have repeatedly destroyed the fortunes of the rich. Scheidel identifies and examines these processes, from the crises of the earliest civilizations to the cataclysmic world wars and communist revolutions of the twentieth century. Today, the violence that reduced inequality in the past seems to have diminished, and that is a good thing. But it casts serious doubt on the prospects for a more equal future.
————————

Straight Talk On Trade. Not so long ago the nation-state seemed to be on its deathbed, condemned to irrelevance by the forces of globalization and technology. Now it is back with a vengeance, propelled by a groundswell of populists around the world. In Straight Talk on Trade, Dani Rodrik, an early and outspoken critic of economic globalization taken too far, goes beyond the populist backlash and offers a more reasoned explanation for why our elites and technocrats obsession with hyper-globalization made it more difficult for nations to achieve legitimate economic and social objectives at home: economic prosperity, financial stability, and equity.

Rodrik takes globalization’s cheerleaders to task, not for emphasizing economics over other values, but for practicing bad economics and ignoring the discipline’s own nuances that should have called for caution. He makes a case for a pluralist world economy where nation-states retain sufficient autonomy to fashion their own social contracts and develop economic strategies tailored to their needs. Rather than calling for closed borders or defending protectionists, Rodrik shows how we can restore a sensible balance between national and global governance. Ranging over the recent experiences of advanced countries, the eurozone, and developing nations, Rodrik charts a way forward with new ideas about how to reconcile today’s inequitable economic and technological trends with liberal democracy and social inclusion.

Scandinavia the place to go for social mobility

A HT to colleague David Parr for this article from the World Economic Forum site. Richard Wilkinson and Kate Pickett’s book ‘The Spirit Level’ (2009 – although a bit old it does make for interesting reading) goes about providing evidence that almost everything – from life expectancy, social mobility, violence – is affected not by how wealthy society is, but how equal it is.

Income Inequality and Social Mobility

Chapter 12 in the book addresses the link between high levels of income inequality and low levels of social mobility – see graph below. The graph below shows that countries with bigger income differences tend to have much lower social mobility. In the USA there is a lack of social mobility compared to other nations as well as there being high income inequality. The opposite applies to the Scandinavian countries where Norway, Sweden, Finland and especially Denmark have low income inequality but very high social mobility. The authors do alert the reader to be cautious as there is no data that allow to estimate social mobility for each state and test the relationship with inequality independently in the USA. But other variables such as public spending on education, changes in geographical segregation lend plausibility to the graph below.

Research from the The State of Working America 2006/7 report shows the power of the father’s income to determine the income of their sons. The lower percentage indicates that a fathers’ incomes are less predictive of sons’ incomes – therefore more mobility. A high percentage indicates that rich fathers are more likely to have rich sons and poor fathers to have poor sons – therefore less social mobility. The figures below show the declining social mobility.

1980 – 11% of sons’ income explained by fathers’ income.
2000 – 34% of son’s income explained by fathers’ income.

Social Mobility and Education

Education is generally seen as one of the vehicles for increasing social mobility. Wilkinson and Pickett found that public expenditure on school education is strongly linked to the degree of income equality.

Norway – 97.8% of money spent on school education is part of public expenditure
USA – 68.2% of money spent on school education is part of public expenditure

This is likely to have a substantial impact on social differences in access to higher education.

Some points from the World Economic Forum video:

  • America now has lower social mobility than Denmark, France and Germany.
  • In unequal societies, young people from poor families are more likely to drop out of school
  • More parents struggle with mental health problems, long working hours and debt
  • Income inequality in the USA is 0.39 (1 is complete inequality – 1 person owns all the income of the country) Denmark is 0.25

What does Denmark do?

  • University education is free and childcare is well funded
  • The biggest boost to social mobility is wealth distribution. The Personal Income Tax Rate in Denmark stands at 55.8%. It averaged 60.66 percent from 1995 until 2017.

Across the West rising inequality hampers innovation and entrepreneurship. A study of 21 countries showed that as inequality rose the number of patents fell. Reducing inequality is one of 17 of the United Nations Sustainable Development Goals. Below is an interesting TED Talk by Richard Wilkinson.

Recession Recovery or He-cession She-covery?

Radio NZLast Sunday there was a very good interview with Canadian economist Armine Yalnizyan on Radio New Zealand’s ‘Sunday’ Programme (with Wallace Chapman). She mentions that the neoliberal policies of the last 30 years have seen income inequality grow and the collapse of consumer spending (C) the main driver of any domestic economy. There has been an increase in the proportion of income accruing to assets which worsens inequality in many countries. China would be an economy that has relied a lot on its export sector (X) for growth but is now trying to drive domestic demand (C) to generate growth. Remember that Aggregate Demand = C+I+G+(X-M). She makes the point that corporates favour the return for shareholders rather than for example
the wages of employees.

“We have this very unusual situation here where corporations are gaining in strength for a host of reasons, similar to the type of corporate power 100 years ago, in key sectors of the economy with less ability to either tax a proportion of the profits they make or regulate their activities.”

Boosting the minimum wage is stimulatory

She also mentions an increase in the minimum wage being stimulatory with lower income groups spending a much higher proportion of their income and thereby increasing consumption. And the vast majority of this spending happens in the domestic economy – C↑. Some have talked of wage inflation by increasing the minimum wage but with the fall in trade union membership and bargaining power this has been significantly reduced. In fact we have seen wage compression.

He-cession and She-covery

However later on in the interview I was interested to her explanation of He-cession and She-covery during the interview.

Recession = “he-cession” – more men tend to become unemployed as areas that are initially impacted by the downturn are manufacturing, mining, construction etc which are likely to be male dominated.

Recovery = “she-covery”: men who lose $30 an hour jobs wince at accepting $15 an hour offers, but women grab them to make sure the bills get paid.

Veblen Goods and inconspicuous consumption?

Conspicuous consumption was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status.

Economists and sociologists often cite the 1980’s as a time of extreme conspicuous consumption. The yuppie materialised as the key agent of conspicuous consumption in the US. Yuppies didn’t need to purchase BMWs or Mercedes’ cars for example; they did so in order to show off their wealth. This period had its origins in the 1930’s with Austrian economists Ludwig von Mises and Fredrick von Hayek – the latter being the author of “The Road to Serfdom”, in which he said that social spending rather than private consumption would lead inevitably to tyranny. Margaret Thatcher (UK Prime Minister 1979-1990) and Ronald Reagan (US President 1981-1989) believed in this ideology and cut taxes and privatised the commanding heights in a move to a free market environment.

VeblenSo-called Veblen goods (also as know as snob value goods) reverse the normal logic of economics in that the higher the price the more demand for the product – see graph below

Over the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever-increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth.

However a recently published book The Sum of Small Things: A Theory of the Aspirational Class by Elizabeth Currid-Halkett looks at how the power of material goods as symbols of social position has diminished due to their accessibility. Although the lower income groups must dedicate a greater proportion of their income to basic necessities, they spend a higher share of their income to conspicuous consumption than the rich do. Between 1996 and 2014 the richest 1% fell further behind the national average in the percentage of their spending dedicated to bling. The middle income quintile went the other way: by 2014 they spent 35% more than the average as a percentage of their annual expenditure.

According to Elizabeth Currid-Halkett the higher income groups have moved away from buying stuff – materialism – to more subtle expenditures that reveal status and knowledge. The most common of them being education for their children.

Those in the top 10% of income earners now allocate four time as much of their spending to school and university compared to 1996, whereas for other income groups spending has remained fairly constant. However one could say that fees for both school and university have increased over that period of time. The upper class also invest heavily in domestic services such as housekeepers, freeing up time that the less fortunate must spend on chores.

Rather than frittering away that precious leisure time on frivolities, as Veblen’s leisure class did, they devote it to enriching experiences, like attending the opera, holidaying in far-off lands and working out at fancy gyms. Their children, by tagging along and thus absorbing this “cultural capital”, develop the sophistication needed to win admission to selective universities, vastly increasing the odds that they will form the next generation’s elite. The modern equivalent of Victorian worsted-stocking wearers are hipsters, who imitate the wealthy’s penchant for farmers’ markets and fair-trade lattes, even if they cannot afford a cruise to Antarctica.  Source: The Economist – August 5th 2017

 

 

DW Documentary – "The Money Deluge"

Below is a recent documentary from Deutsche Welle (DW – Germany’s international broadcaster) on the impact of exploding real estate prices, zero interest rate (see graph below) and a rising stock market. The higher income groups are benefiting greatly from these conditions but how does it effect middle income earners especially those in retirement. The DW documentary addresses these issues and explains how money deals have become detached from the real economy. Worth a look.

For years, the world’s central banks have been pursuing a policy of cheap money. The first and foremost is the ECB (European Central Bank), which buys bad stocks and bonds to save banks, tries to fuel economic growth and props up states that are in debt. But what relieves state budgets to the tune of hundreds of billions annoys savers: interest rates are close to zero.

The fiscal policies of the central banks are causing an uncontrolled global deluge of money. Experts are warning of new bubbles. In real estate, for example: it’s not just in German cities that prices are shooting up. In London, a one-bed apartment can easily cost more than a million Euro. More and more money is moving away from the real economy and into the speculative field. Highly complex financial bets are taking place in the global casino – gambling without checks and balances. The winners are set from the start: in Germany and around the world, the rich just get richer. Professor Max Otte says: “This flood of money has caused a dangerous redistribution.

ECB Rates.png

Those who have, get more.” But with low interest rates, any money in savings accounts just melts away. Those with debts can be happy. But big companies that want to swallow up others are also happy: they can borrow cheap money for their acquisitions. Coupled with the liberalization of the financial markets, money deals have become detached from the real economy. But it’s not just the banks that need a constant source of new, cheap money today. So do states. They need it to keep a grip on their mountains of debt. It’s a kind of snowball system. What happens to our money? Is a new crisis looming? The film ‘The Money Deluge’ casts a new and surprising light on our money in these times of zero interest rates.

The Elephant Curve – Inequality and Populism

I blogged on this topic late last year – Inequality and the Elephant Curve – but is it correct? – and see that Paul Solman of PBS news has done his own evaluation on the topic – see video and image below. The curve shows the % change in income on the vertical axis and on the horizontal axis is the entire world population, arranged by their incomes – poorest over to the left, the richest to the right. The time period is from 1988 to 2008.

We knew that people in China and large numbers of groups in Asia who were not rich, compared to Americans, have done very well. We knew that lower and middle class Americans and Japanese and Germans have not done well. And that’s exactly what the chart shows. And we also knew that the top 1 percent in the rich countries have done well.

elephant curve.jpeg

Everybody on that chart is above the point where we actually have zero growth. If you really were to be very cosmopolitan and look at the world as if it were one country, you would say, “Look, we have a situation that a large hunk of people — two and a half billion — have done extremely well. The level of global poverty has actually gone down. These people not only now have sewage and electricity, some have even become tourists. They have better jobs.” This is mainly resurgent Asia.

So then you say, “Well, what’s the big deal?”

The problem is that this is a very abstract view of the world, which doesn’t take any cognizance of the political reality. Because the political reality is there are all these people who have done poorly relative to the rest of the world. They feel poor people in Asia breathing down their necks because of outsourcing, because of imports and so on. And then they also see that the top 1 percent in their own countries have done very well.

They are feeling fear from both ends — from one end because the other people are catching up to them and from the other, as people from their own countries are moving further and further ahead.

Source: Branko Milanovic Author, “Global Inequality”:

 

 

Strong case for a Universal Basic Income in India but is it realistic?

UBI IndiaI have blogged about the UBI and read about how India would provide a strong case for its implementation. The rationale for this is the fact that India’s welfare programmes (950 that the central government run) are numerous, inefficiently run and encourage corruption. Add to those the programmes run by each state and you have a bureaucratic nightmare unfolding. However this has been part of Indian society and not so long ago it took businesses 6 months to acquire a permit to import computers. The UBI was raised as an alternative to the inefficiency of welfare handouts and this unconditional cash payment be disbursed not just to the poor but to everyone. In more advanced countries the case for UBI is based on technology making many jobs obsolete and no new jobs being created in their place. Although this is not the case in India and it warrants the UBI for other reasons:

1. UBI is easier to administer than India’s current antipoverty programmes which largely take the form of subsidies paid to sellers of grain, fuel, fertilizer and other essentials. Current programmes are plagued by waste, corruption and abuse. UBI would save 2.07% of GDP.

2. By making everyone eligible, a universal basic income removes the messy task of identifying who is and who isn’t in need of assistance.

3. By paying money directly into bank accounts, it would allow India to do away with the vast administrative machinery currently needed to supply the poor with cheap wheat, rice and other goods.

4. By one estimate, around one-third of the grain set aside for India’s food-welfare program never reached the intended beneficiaries in 2012, the most recent year for which comprehensive data are available. Payments under a giant rural-work program are regularly delayed, leaving families in the lurch.

5. paying a basic income directly into bank accounts would encourage more people to use formal financial services, which would then help banks invest in expanding access to banks and ATMs.

Concerns

1.  households—“especially male members”—may fritter away their basic income on liquor and tobacco

2. India’s underdeveloped financial infrastructure could make it hard for many people to access their entitlements. According to the World Bank, there are only around 20 ATMs for every 100,000 adults in India, compared with 70 in South Africa, 114 in Brazil and 132 in the U.K. Although the government says it has helped open 260 million bank accounts since 2014, one-third of Indian adults remain unbanked.

3. The government paper suggests that 25% of the population should be excluded in order to make it more affordable. However deciding who is poor and who isn’t an easy task especially when over 35% of the richest 1% of Indians benefit from subsidized food to which they are not entitled.

4. There is a risk that a UBI would just supplement the welfare programmes rather than replacing them.

Source: The Economist – Wall Street Journal

Global change in real income – 1988-2008

Below is graphic from ANZ Bank showing the change in real income between 1988 and 2008 at various percentiles of global income distribution (calculated in 2005 international dollars). Global inequality has improved except for the upper middle class.

income-inequality

Some comparisons of income distribution:

  • An American having the average income of the bottom U.S. decile is better-off than 2/3 of world population.
  • The richest 1% of people in the world receive as much as the bottom 57%, or in other words, less than 50 million richest people receive as much as 2.7 billion poor.
  • The three richest people possess more financial assets than the poorest 10% of the world’s population, combined.
  • In 2005, the three richest people in the world have total assets that exceed the annual combined GDP of the 47 countries with the least GDP.
  • In 2005, the 125 richest people in the world have assets that exceed the annual combined GDP of all the least developed countries.
  • In January this year Oxfam calculated that the eight richest men in the world own the same wealth as the 3.6 billion people who make up the poorest half of humanity.

The world’s 8 richest people are, in order of net worth:

1. Bill Gates: America founder of Microsoft (net worth $75 billion)
2. Amancio Ortega: Spanish founder of Inditex which owns the Zara fashion chain (net worth $67 billion)
3. Warren Buffett: American CEO and largest shareholder in Berkshire Hathaway (net worth $60.8 billion)
4. Carlos Slim Helu: Mexican owner of Grupo Carso (net worth: $50 billion)
5. Jeff Bezos: American founder, chairman and chief executive of Amazon (net worth: $45.2 billion)
6. Mark Zuckerberg: American chairman, chief executive officer, and co-founder of Facebook (net worth $44.6 billion)
7. Larry Ellison: American co-founder and CEO of Oracle  (net worth $43.6 billion)
8. Michael Bloomberg: American founder, owner and CEO of Bloomberg LP (net worth: $40 billion)

Sources: ANZ Bank, Wikipedia, Oxfam International