Category Archives: Inequality

The New Corporation – Documentary

Following on from the very successful documentary ‘The Corporation’ comes ‘The New Corporation’. The Corporation​ examined an institution within society. THE NEW CORPORATION reveals a society now fully remade in the corporation’s image, tracking devastating consequences and also inspiring movements for change. Click on the link below to view screening options – The New Corporation

Degrowth – is life better with less?

Most economics courses will include the topic of limitations of Gross Domestic Product as an indicator of standard of living. US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile. Increasing GDP has been the indicator of a healthy economy but is it time for degrowth? This CNBC video looks at whether degrowth is the way forward and should we priorities social and ecological well-being? Scotland, Iceland and New Zealand have focused on well-being rather than economic growth. New Zealand’s recent ‘well-being’ budget indicated this. Good video for the future direction of macro policies and where we are going as a society.

European Super League and so much for Joseph Schumpeter

Economist Joseph Schumpeter talked about creative destruction in that to survive capitalists continually seek more profits through the pursuit of new markets. With the presence of new markets this brings about more innovation removing the old businesses and opening opportunities for the new.

The free market, in which business is supposed to thrive, is based on weak barriers to entry, competition and less regulatory constraints. The extreme of this theory is perfect competition although in football we don’t have homogeneous products in that all teams are different. However the market does give teams the chance to gain promotion from lower divisions in English Football. Take for instance Leicester City winning the EPL and before them teams like Blackburn Rovers, Aston Villa, Nottingham Forest – the latter winning the league having just been promoted from the Second Division (in those days). These teams used innovation, coaching, strategically delving into the transfer market (not with the funds that some clubs have today) etc to form a successful team.

Nottingham Forest – Div 1 Champions 1977-78

The proposed ESL was all but free-market capitalism with an American style franchise system with 12 teams guaranteed a place in the competition – significant barriers to entry and not conducive to competition. So much for Joseph Schumpeter’s creative destruction with a group of elite clubs protecting their market and the owners being rentier capitalists. The ESL’s proposed move is similar to what has been happening in the market place – a structure of businesses taking huge debt and taking little interest in competition as long as they are making money. Manchester United, probably the most famous club in the world, got knocked out of the Champions League in the group stage but are still making a lot of money for the owners. It seems that the desire to win trophies has been superseded by profit – the proposed ESL avoids competition as member clubs are protected against the risk of failure. Not to say this is not already happening as the EPL and many other leagues in Europe are dominated by a small number of clubs which have significant funds available. This makes it near impossible for the other clubs to be competitive – remember Wimbledon winning the FA Cup in 1988 with the ‘crazy gang’. They had the worst stadium, poorly paid players and the lowest gates. It is hard to see supporters of less wealthy clubs being too enthusiastic about the excitement of victory.

The ESL has demonstrated that global capitalism operates on the basis of rigged markets not free markets, and those running the show are only interested in entrenching existing inequalities. It was a truly bad idea, but by providing a lesson in economics to millions of fans it may have performed a public service. Larry Elliott – The Guardian – 22-4-21

COVID-19 and a fairer economy

FT European Economics Commentary Martin Sandbu believes the COVID-19 pandemic is a once-in-a-lifetime chance to rebuild better economies that work for everyone. Sandbu author of ‘The Economics of Belonging’ – see previous post – talks here about the polarisation of rich societies since 1980. The main points of interest that he raises are below. Worth a look.

  • 1980 – large number of jobs available in factories start to disappear.
  • Globalisation – not the main cause of unemployment but technology has taken a lot of the manual and clerical jobs (structural unemployment) and retail has gone online.
  • Tax systems have not redistributed income – unions have been in decline.
  • Rural areas worst effected – good jobs more prevalent in cities so rural areas suffer.
  • Low paid service jobs have been impacted by COVID-19. Also as they involve contact with others there is more exposure to the disease.
  • Pandemic catalyst for change. History tells us – US Great Depression = New Deal, 2nd WW = postwar welfare state.
  • Technology change is with us so the need to find new ways of working. Do we have a Universal Basic Income (UBI)?
  • Lower burden of employing workers – less income tax, payroll tax and generally make it cheaper to hire people in to better jobs. Make up the shortfall in revenue elsewhere.
  • With the significant increase in inequality – introduction of a wealth tax. Also a tax on carbon emissions and redistribute to help the worse off.
  • Greater need to overcome regional inequality within countries
  • Need to the political will to make economies work better for everyone.

Minimal monetised societies and happiness

For less developed countries economic growth is often assumed to improve the happiness of the population although this relationship has come under a lot of scrutiny in recent times. A new study shows that people in societies where money plays a minimal role can have a level of happiness comparable to those living in Scandinavian countries which typically rate highest in the world. An interview with Eric Galbraith (McGill University, Canada) on Radio New Zealand’s ‘Sunday’ programme caught my attention in which he discusses the research undertaken in the Solomon Islands and Bangladesh. The paper is entitled:

Happy without money: Minimally monetized societies can exhibit high subjective well-being

Public policy that has focused on GDP growth fails to capture other aspects such as income inequality, the depletion of natural resources, environmental concerns etc. However subjective well-being (SWB) is an indicator that is more associated with the variables that matter to people. Galbraith et al question the role of money in determining SWB and reference the Easterlin Paradox (see below) which found that people don’t tend to get happier when their income goes up – see graph below.

What is the Easterlin Paradox?

Easterlin Paradox
  1. Within a society, rich people tend to be much happier than poor people.
  2. But, rich societies tend not to be happier than poor societies (or not by much).
  3. As countries get richer, they do not get happier. Easterlin argued that life satisfaction does rise with average incomes but only up to a point. One of Easterlin’s conclusions was that relative income can weigh heavily on people’s minds.

It is generally believed that people in less developed countries that have minimally-monetised economies have low that SWB. However the fact that happiness has a universal feeling suggest that income may be just a substitute for other sources of happiness, an assumption that is easier to notice in settings where money has little or no use. They used three independent measures to assess complementary but distinct psychological dimensions of SWB.

  1. Cognitive life evaluation – this asks about a person’s satisfaction with life and questions are phrased in a few different forms.
  2. Affect balance – asks what emotions they had experienced throughout the previous day, and calculated as the difference between positive and negative emotions.
  3. Momentary affect – data was obtained by querying subjects by telephone at random times about their emotional state.

Researchers selected four sites in two countries:

Solomon Islands – round 80% of the population live in rural subsistence communities and it has a Human Development Index (HDI) of 0.546 (rank 152 in the world). The sites were Roviana Lagoon (rural site) and Gizo (urban site)

Bangladesh – 35.9% of it being urban, and has an HDI of 0.608 (world rank 136). The sites were Nijhum Dwip (rural) and Chittagong (urban).

Results
The graph below shows that the 4 sites, although are minimally monetised societies,
do experience high levels of SWB which challenge the prevailing view that economic growth is a reliable pathway to increase subjective well-being. While the data presented here were collected only in two countries and four sites this is the first study to that systematically compares standardised SWB measures in minimally monetised, very low-income societies.

Those left behind and the attacks on US Congress

Been reading an excellent book by Martin Sandbu (FT) entitled ‘The Economics of Belonging’. In it he addresses the problem that when an economy moves to more efficient ways of production new methods are established and old ones decline. For some who have been part of the old methods of doing things, the economic system has passed them by. He explains four ways how this has happened.

The plight of the uneducated. Economic value is now derived from cognitive skills and knowledge. The competitive nature of the global economy demands increased productivity which has streamlined production using technology and is cognitively demanding for the labour force. This results in the diminishing use of blue collar (manual) workers which tend to use little knowledge or initiative. As a result manual labour is not demanded like before and if there is any demand the wage is does not equate to what they received 10-20 years ago. As Sandbu states: If the world today offers much less than it once did to routine workers with only basic schooling or training, it is because they are less useful to the modern economy.

The triumph of cities. In most western economies poorer areas grew faster than richer ones therefore they were catching-up with the big cities. However at the start of the Thatcher and Reagan era the richer urban areas have pulled away from their rural counterparts. Deindustrialisation, especially in the UK, with the move from manufacturing to the service sector favouring urban areas where there is a concentration of people today’s most valuable skills and talent. If urban and rural areas go about different economic direction for long enough, inequality will increase as well as cultural separation which is turn leads to political separation. Sandbu points out that the strongest support of antiestablishment movements is found in the regions that have lost out in the competition to attract capital and skill.

The cost of staying put. If you stay in an area that is ‘the wrong side of the train tracks’ moving away from home will increase your chances of success. In the last 40 years those that have moved have reaped the benefits of higher incomes. One thinks about the UK and the North South divide with the migration flows south in search of opportunity. Regional inequality favours those who actually move, but also those capable of moving. Mobility reflects risk taking and a tolerance for what is new, different and uncomfortable whilst staying put comes with greater economic disadvantage than it did 40 years ago. From the 2016 US election: White Americans who still lived in the community where they were raised supported Donald Trump by 57% against only 31% for Hillary Clinton. Even those who lived two hours’ drive away preferred Trump. Among those who had moved further away, however, more supported Clinton.

Feminism is good for your wallet. The old blue collar work whether it be on production lines, oil rigs, truck driving, farming etc. were traditionally done by men. There was a macho image portrayed in these jobs but the new jobs were focused on the skills that create value in the new service and knowledge economy. It is estimated in the US that one in four jobs in the next decade are expected come in health care, social assistance, and education which tend to come with low status and lower pay. This means that more men (particularly unskilled) must be prepared to work in the service sector in jobs that are traditionally done by women. Soft skills are now increasingly rewarded and traditional manual work (mainly done by men) no longer attract much pay in the job market. Job roles must adapt in parallel with changing cultural expectations of gender roles in the home. Trump’s make America great again was a call to bring back the blue collar jobs but this was never going to happen with globalisation.

Sandbu points out that the one group which has been particularly effected by these four changes is low-skilled white men in small rural communities and subscribe to traditional cultural attitudes. Often blamed on globalisation, these consequences are the result of how we now produce output which has been driven by labour saving technology. Sandbu states that:

But we should recognise that much else of value was lost with jobs, and the dissatisfaction from these structural changes goes far beyond the financial.

It is only to be expected that these groups have become more visible within the populist insurgency and fresh in our memory is the attack on the US Congress on 6th January.

Source: The Economics of Belonging – Martin Sandbu 2020

Auckland vs Canterbury and house affordability

Earlier this year the Demographia International Housing Affordability Survey was published covering 309 metropolitan housing markets in eight countries including New Zealand. The survey rates middle-income housing affordability using the “Median Multiple,” which is the median house price divided by the median household income. The Median Multiple is widely used for evaluating housing markets.

Source: ASB Bank

Although houses are more affordable in Canterbury than in Auckland they are still in the classification of severely unaffordable according to Demographia International Housing Affordability Survey. The 5.1 still compares favourably to the national average of 7.5 and Auckland’s 9.5. According to the ASB house price forecasts Auckland house prices exceed ten times median incomes (chart below).

Some other points to note internationally are that among all markets:

  • 54 are affordable (Median Multiple of 3.0 or less) they are in Australia (1), Canada (8), Ireland (1), and the United States (44).
  • No affordable markets in China (Hong Kong), New Zealand, Singapore or the United Kingdom.
Source: 16th Annual Demographia International Housing Affordability Survey: 2020 Rating Middle-Income Housing Affordability

Addressing savings glut needs more than monetary policy

Today central banks have a limited toolkit and the powers to deal with the savings glut (see image below), lack of investment, climate change and income inequality. There is a lot of money in the system but the velocity of circulation is slow – MV=PT – and this is one reason why we have little inflation.

Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

Add to this COVID-19 and the impact it has had on especially developing economies and we have economic stagnation.

Source: Bloomberg Economics

Some economists have suggested the need for more expansionary fiscal policy as well as structural reform to achieve economic growth. The latter being a long-term policy can take the form of price controls, management of public finances, financial sector reforms. labour market reforms etc. Although the US Federal Reserve is adopting a flexible average inflation target to avoid a disinflationary environment it will not be enough to deal with secular stagnation.

Secular stagnation
Since the GFC in 2008 it is evident that low interest rates are the new normal and according to Larry Summers (former Treasury Secretary) we are in an era of secular stagnation. This refers to the fact that on average the ‘natural interest rate’ – the rate consistent with full employment – is very low. There can be periods of full employment but even with 0% interest rates private demand is insufficient to eliminate the output gap. The US was in a liquidity trap for eight of the past 12 years; Europe and Japan are still there, and the market now appears to believe that something like this is another the new normal.

Paul Krugman suggests that there are real doubts about unconventional monetary policy and that the stimulus for an economy should take the form of permanent public investment spending on both physical and human capital – infrastructure and health of the population. This spending would take the form of deficit-financed public investment. There has been the suggestion that deficit-financed public investment might lead to ‘crowding out’ private investment and also how is the debt repaid? Krugman came up with three offsetting factors

  1. When the economy is in a liquidity trap, which now seems likely to be a large fraction of the time, the extra public investment will have a multiplier effect, raising GDP relative to what it would otherwise be. Based on the experience of the past decade, the multiplier would probably be around 1.5, meaning 3% higher GDP in bad times — and considerable additional revenue from that higher level of GDP. Permanent fiscal stimulus wouldn’t pay for itself, but it would pay for part of itself.
  2. If the investment is productive, it will expand the economy’s productive capacity in the long run.This is obviously true for physical infrastructure and R&D, but there is also strong evidence that safety-net programmes for children make them healthier, more productive adults, which also helps offset their direct fiscal cost (Hoynes and Whitmore Schanzenbach 2018).
  3. There’s fairly strong evidence of hysteresis — temporary downturns permanently or semi-permanently depress future output (Fatás and Summers 2015).

Source: “The Case for a permanent stimulus”. Paul Krugman cited in “Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes” Edited by Richard Baldwin and Beatrice Weder di Mauro

Bloomberg Economics – Yellen, Summers Say Central Banks No Match for Savings Glut

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

Veblen goods and how to own part of a Birkin Bag

Online trading site Rally Rd has introduced an opportunity to part own various luxury items. For instance you could become part owner of a $61,500 Birkin Bag or top of the range Lamgourghini car. Rally Rd acquire the most noteworthy items from collections and individuals all over the world and make them into “a company”. They then split it into equity shares and open an “Initial Offering” where investors can purchase shares & build a portfolio. After 90 days, investors have the chance to sell shares in-app or add to their position on periodic trading days (through registered broker dealers).

The market for investing in fractions of items otherwise seen as collectibles — and largely reserved for the wealthiest people — has seen an uptick in interest during the pandemic as people spend more time at home. Although there is a potential return on the investment you never get to see your Birkin Bag or Lambourghini. Shares are traded until the owner of the marketplace sells the asset.

Are Birkin Bags Veblen Goods?

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.

So-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.

The Economist 1843 bi-monthly magazine had a very good article on Hermès’s Birkin handbag (named after Jane Birkin, an Anglo-French actress who spilled the contents of a overfull straw bag in front of Jean-Louis Dumas, Hermès’s chief executive) and how it has become one of the world’s most expensive – prices start at $7,000; in June Christie’s Hong Kong sold a matte Himalayan crocodile-skin Birkin with a ten-carat diamond-studded white-gold clasp and lock for $300,168. The rationale for its expense is that it is hand crafted and can take up to 18 hours to complete although the production cost is estimated to be around $800.

One would think that this would be a Veblen Good – a good in which the higher the price the more demanded. However there are a couple of ways that the Birkin handbag is not.

1. The bag is not all that conspicuous as although most people can identify Gucci, Louis Vuitton or Chanel, a Birkin is not so easy to find. In fact it is an inconspicuous but expensive bag. This theory was explained in the article “Signalling status with luxury goods: the role of brand prominence” from the Journal of Marketing (2010). It divided the high income earners into two groups;

Parvenus – who want to associate themselves with other high income groups and distinguish themselves from those who do not have material wealth.

Patricians –  who want to signal to other people in their high income bracket and not to the masses. They are of the belief that more expensive luxury goods aimed at them will have less obvious branding than cheaper products made by the same company. This was achieved with smaller logos for more expensive items and larger ones for cheaper goods which are aimed at the masses. People who cannot afford the luxury items will buy the big logo items (louder products) and this is where the counterfeiters have a field day.

2. Normally producers of Veblen goods should raise the price till the point where the demand curve starts to follow it normal shape – downward sloping from left to right. However with Birkin they maintain its exclusivity not by raising the price but by limiting the supply. Unlike other Veblen goods you just can’t walk into a shop and buy a Birkin bag – you have to place an order and wait for it to arrive. But you would wonder why they don’t sell more and make more money? It is a supply constraint – limited availability of high-quality skins and craftspeople to make them – it takes two years training. Hermès suggests, Birkins are mined, not simply made.

Commercial Reasons to limit supply of Birkins

Rationing by supply rather than price does make good commercial sense for the following reasons:

1. It gives Hermès a buffer as if demand drops, sales will not.

2. It creates excess demand for the bags, which overflows into demand for other Hermès products – wallets, belts, beach towels etc.

3. Profitability in the short run would reduce its exclusiveness as the main buyers of the bags would eventually be those concerned with social climbing. Therefore the rich may lose interest in the bags and so will those that aspire to be like them.

However I not sure Hermès actually want you to buy their amazingly expensive bag.

Should we stop consumption?

Geoffrey Miller is his book – Spent: Sex, Evolution, and Consumer Behaviour – examines conspicuous consumption in order to rectify marketing’s poor understanding of human spending behaviour and consumerist culture. His thesis is that marketing influences people—particularly the young—that the most effectual means to show that status is through consumption choices, rather than conveying such traits as intelligence and personality through more natural means of communication, such as simple conversation. He argues that marketers still tend to use naive models of human nature that are uninformed by advances in evolutionary psychology and behavioural ecology. As a result, marketers “still believe that premium products are bought to display wealth, status, and taste, and they miss the deeper mental traits that people are actually wired to display—traits such as kindness, intelligence, and creativity.

The recent global downturn with Coivd-19 has sent out a few mixed messages. Firstly there has been the reduction in consumption as people’s credit lines have dried up but there are those that believe that you should spend more to maintain growth and employment in the economy. With household budgets being very tight smarter consumption rather than less consumption has been advocated by Geoffrey Miller. He refers to this as more ethical consumption where the production of produce does not involve the abuse of natural resources or the exploitation of people or animals.