Inequality and value judgements

I’m attending the annual conference of the New Zealand Association of Economists, and the first keynote was a terrific presentation by Professor John Creedy on inequality, or to be precise the history of economic thought on inequality and the light that sheds on the current resurgence of interest in distribution.

His starting point was the classic Tony Atkinson paper, On The Measurement of inequality. It was published in 1970, another time when inequality was a salient issue, and the talk moved onto Rawls and Sen as well. The theme was that any measure of inequality – income or wealth? Individuals or households? Gini coefficient or Atkinson’s own measure, or the simple 10/90 ratio? – incorporates some implicit value judgements. For example, do you care about individual well-being because of a principle of anonymity – who you are shouldnt matter to evaluating your distributional status? If so, then the Gini isn’t an appropriate measure because it depends on rankings of individuals relative to others. If you look at the 10/90 ratio, as Piketty does, you’re saying the middle four fifths of the distribution isn’t relevant.

Prof Creedy ended cited Lionel Robbins’ famous Essay on the Nature and Signifiance of Economic Science, to the effect that economics can’t avoid making value judgements but its contribution is to shed a clear light on what the judgements are. Or at least, ought to be, but too rarely is. The word of caution about understanding the value judgements embedded in specific measures of inequality is timely given the fact that everybody from New Zealand to New York is talking about it now.

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Economists and humanity

Peter Smith sent me his new book The Reform of Economics: How the complex systems approach is building a realistic and humane alternative to laissez-faire. In a letter accompanying it, he said he has two motivations. One is to get economics out of the trap of over-simplifying so that models can use linear algebra and thus be made ‘tractable’. This is one of the things that makes complexity economics and agent-based modelling appealing; virtual economies run on a computer do not need to be solved algebraically.

The other aim is to make economic methodology something more like normal scientific methodology. Economic method consists of choosing some basic postulates and making deductions from them. The deductions can then be tested against data. Normal science involves both induction and deduction. Careful empirical observation will shape theory.

The book dates the choice of the purely deductive path to Lionel Robbins and his 1935 essay The Nature and Significance of Economic Science. He defined economics as the science of constrained choice, which, “Not only excludes uncertainty, but it also excludes from the scope of economics both institutions and the medium-term evolution of economic systems.” This isolates economics from the institutional framework of the economy, and hence from what determines the availability of resources over time – it makes economics an inherently static subject.

Natural scientists do regard economics as bizarrely non-empirical – I’ve been in multi-disciplinary conferences about both macroeconomics and behavioural choice at which biologists exclaim about how rarely economists discuss data, for all that they might go away and test hypotheses. One of the joys of being on the Competition Commission for eight years was how profoundly evidence-based the process is, and hence a real insight for an economist used to generalising about how companies behave. There aren’t many business people who think about marginal cost curves and production functions.

The Reform of Economics is a game of two parts (not halves). It is mostly a critique of economic methodology but also has a useful introduction to agent based modelling. It ends on an upbeat note I very much like:

“Economics is becoming a much more interesting area in which to work and learn; and we have every hope that a more realistic and effective reformed science of economics will also be a more humane one. For, ultimately, economics is about the well-being of humanity.”

How free to choose is ‘homo economicus’?

Is economics the analysis of forms of rational conduct? Could you go further and define it – as Gary Becker’s work does – as the study of any conduct that responds systematically to modifications in any variables in the environment? Or is it something less expansive than that? This is the question with which Michel Foucault draws to a close his Essays on the Birth of Biopolitics.

Interestingly, he specifically points to behavioural economics – the incorporation in economics of “non-rational” choice from behavioural psychology – as a further extension of terrain. And there is a central paradox therefore in mainstream economics: is homo economicus a free agent the government should leave alone to engage in market activity, free to choose? Or instead is the agent responding to variables in not necessarily “rational” but systematic ways who can therefore be steered or manipulated by government action?

Somebody clever – I can’t remember who – recommended the book to me. I must admit that although there are some interesting points, I found it very heavy going. It’s because of the language of this style of philosophy, which seems very obscure to me. It reminded me of the story Bob Lucas once told, about discussing a problem in a particular model of the labour market with Ed Prescott. The next morning he found in his office a note from Prescott with an equation on it, solving the problem. Lucas said: “Many people would ask for words to explain what the equation means, but an economist will ask for an equation to explain what the words mean.”

The dog ate my homework

The new book by Richard Layard and co-author David Clark arrived in the post yesterday, Thrive: The Power of Evidence Based Psychological Therapies. It continues Professor Layard’s campaign for greater provision of mental health treatment – David Clark is a Professor of Psychology. The first half of the book covers the human and economic cost of mental illness, the second half is about which therapies are effective. I think I’m persuaded without reading it, but will do so to see whether it addresses the question of why governments so often treat mental health services as a low priority and what might change that.

A confession, though: the dog caught this one coming through the letter box and it has teeth marks right through it. I expect there was a lot of barking too – my apologies to the postman.

The dog ate my homework

Cautious giant leaps

The argument of Why Government Fails So Often and How It Can Do Better by Peter Schuck is set out wonderfully succinctly in the title, and the book does an excellent job of telling half of the story about the role of governments and markets in delivering economic outcomes.

The chapters cover a range of reasons for ‘government failure’. To list them, they are: incentives not aligned with the policy’s aims; non-rational choice; lack of information; lack of flexibility in delivering outcomes when circumstances change or things don’t work out; lack of government credibility so essential co-operation is not forthcoming; mismanagement including fraud and abuse. Schuck argues that these barriers to policy success have a “deep, structural, endemic nature.”

The book has many examples of policy failure – it’s an American and to be honest far less amusing version of The Blunders of Our Governments by Anthony King and Ivor Crewe. It’s hard to argue with the examples. This book cites also Clifford Winston’s Government Failure versus Market Failure, which has many more. indeed, there have been loads of policy failures, in all kinds of places and contexts.

An aspect of the argument here that I strongly agree with is the failure of policy analysts to build themselves into their ‘impact analysis’ or whatever framework they use for assessing the likely success of the initiative. In other words, the incentives the policy will create for the people affected to change their behaviour are hardly ever incorporated. Economists often think of themselves as being ‘outside’ the society, in a benign deus ex machina role.Yet all policies alter people’s behaviour and have many side-effects.

Schuck’s book does end with a chapter on policy successes – in fact it finds nine, including Airline Deregulation in 1978, the 1975 Earned Income Tax Credit, the food stamp program, the interstate highway system and the 1965 Voting Rights Act. However, it concludes: “It is hard to know for sure why these (and other) policies have succeeded when so many others have failed. Low costs, simple implementation, strong public good characteristics, and replacing far worse policies are all given as potential explanations. However, Schuck also concludes: “To succeed, the programs needed to engage the actors’ self-interest; they did not need to create new values or transform behaviors.” But he believes that the ‘low hanging fruit’ has gone.

Hence his main recommendation – be cautious. “Realistic meliorism” – make things a little bit better but keep your ambitions modest. The policy ‘doing better’ bit of the book’s title is doing far less.

I’m all for realism. There’s a missing half of the story here, though, which is how government actions unavoidably shape markets, so that to argue ‘don’t do much and just leave it to the market’ is in itself a policy. Collective choices are inevitable and government is how we make those choices. Why Government Fails So Often should be read alongside Colander and Kuper’s  recent book Complexity and the Art of Public Policy, which is about policy as determining the structure of a complex, and uncontrollable (in the old-fashioned policy sense) economy and society.

That approach is hard to get right too, but as it’s impossible not to have a structure within which markets operate, because here we are at a point in history where we have actually existing markets, it surely makes sense for governments to think about that structure. And while caution, in the face of the record of policies ranging from the inept to the horribly counter-productive, is surely sensible, thinking about structure does not automatically point to incrementalism.  Sometimes a cautious giant leap might be just the thing.