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Universal basic income: the dangerous idea of 2016

The Conversation

Gigi Foster, UNSW Australia

The resurrection of universal basic income (UBI) proposals in the developed world this year gained support from some prominent Australians. But while good in theory, it’s no panacea for the challenges of our modern economy.

UBI proposals centre on the idea that the government would pay a flat fee to every adult citizen, regardless of his or her engagement in skill-building activities or the paid labour market, as a partial or complete substitute for existing social security and welfare programs.

Of the schemes run in developing places like Kenya, Uganda, and India, some have been evaluated statistically, delivering some evidence of positive impacts on educational investments, entrepreneurship, and earnings.

In the developed world, Canada is trialling a UBI scheme. Finland also just rolled out a UBI trial, involving about 10,000 recipients for two years and costing about A$40 million. While Switzerland’s voters just rejected a UBI proposal via referendum, a similar proposal is presently looking like a goer for Utrecht in the Netherlands.

Here in Australia, it has been suggested the government might hand out somewhere between A$10,000 and A$25,000 a year to every man and woman.

Can we afford it?

There are two big questions to ask before taking a UBI proposal seriously, and the first is the most obvious one: where would the money come from to pay for it?

The present Australian welfare system (excluding the Medicare bill of A$25 billion) costs around A$170 billion per annum. Our GDP is around A$1.7 trillion per year, so this welfare bill is about 10% of annual GDP.

Giving A$20,000 to every Australian adult (19 million people) would cost approximately A$380 billion. That’s a little over twice the present total cost we pay for the above-mentioned programs.

Economics journalist Peter Martin has suggested that abolishing the tax-free threshold would pay for a UBI scheme. Working out whether the abolition of the tax-free threshold would fully fund a UBI is non-trivial, given the complexity of changing marginal tax rates as income rises and the need to estimate how many taxpayers fall into which tax brackets, but one thing is sure: the income tax bill of most if not all earners would have to rise in order to fund a UBI.

One scenario

Let’s look at what would happen to someone earning A$80,000 per year if we were to implement a UBI, abolish the tax-free threshold, and leave the marginal income tax rate kink points unchanged.

This person presently pays about A$18,000 in income tax – made up of a marginal tax rate of 19% on dollars from the tax-free threshold of A$18,200 to A$37,000, and a marginal tax rate of 33% on dollars from A$37,000 to A$80,000.

Under a UBI scheme involving the abolition of the tax-free threshold, that same individual would receive the UBI (say, $20,000) but would then face a 19% tax rate on ALL of the first A$37,000 of income, and then a marginal tax rate of 33% on dollars from A$37,000 to A$80,000, yielding a total tax bill of A$21,220.

This person would be better off under the UBI in terms of take-home pay: instead of A$62,000, he would get A$79,000 in his bank account. But is the additional revenue increment from abolishing the tax-free threshold enough to pay for the UBI, if we spread it across all earners? I’ve yet to see a hard-headed answer to this question.

We may need to increase taxes elsewhere to pay for a UBI – possibly corporate taxes, land taxes, etc. – and most of these other taxes disproportionately impact richer people. Would legislation to fund a UBI scheme via increasing taxes on the rich get passed?

Some might suggest taking the money we presently spend on social security and welfare payments and converting it to a UBI. This would be enough to fund payments of about A$10,000 to each adult. But it would be a reverse-Robin-Hood policy: instead of spreading a fixed sum across our neediest citizens, we’d be spreading that sum across everyone, making the neediest worse off in order to send cash to our more well-heeled citizens.

Question 2: What is the perceived “broken” part of our present welfare system, and would UBI fix it?

Any targeted (e.g. means-tested) social support payment must be clawed back as income and/or wealth rises. While arguably an efficient way to get money to where it’s most needed, means-tested social security payments inevitably depress the incentive to earn more, at least in the section of the earning distribution where social security payments are paid out. This is talked about a lot, but I haven’t seen a reliable cost estimate for Australia of the disincentivising effects of the claw-back of social security and welfare payments.

The administration costs of the present system of targeted payments, also an argument given for moving to a UBI, are estimated at about A$3-4 billion. Whether this includes all much-pilloried costs of “churn” is an open question. And a UBI scheme would also have administration costs, which have not yet been estimated.

Another frequent theme describes the modern economy as turbulent, with more part-time, casual roles and more employment uncertainty than in the past. The implication is that the way our present system compensates people in insecure work is inadequate. Yet a social support model like a UBI that makes it even easier for people to be precariously attached to the workplace carries the implication that the workplace is not good for them.

In fact, work is socially and psychologically supportive for many people. Studies have found negative psychological impacts from job loss and retirement that seem driven by the social aspects of working. Do we want to isolate our most vulnerable citizens even more?

Arguably the biggest problem in our current tax-and-transfer system is that the rich, and their organisations (like big companies), do not get taxed enough and/or benefit from special provisions (for example in regard to superannuation).

Instead of changing our present targeted welfare system into a diffuse scattergun money-for-all scheme, we could instead courageously tackle the worst part of the problem first.

What else is relevant?

Some worry that a UBI scheme would further depress the incentive to work. As I’ve stated elsewhere, I doubt that the drive to win in terms of labour market success is going to go away anytime soon.

Others have also found small impacts on work incentives from cash transfer programs, though this evidence is mainly drawn from developing countries.

In principle, two types of work incentives may be affected. People receiving unconditional handouts every year may feel less pressure to get and keep a job. Secondly, if the UBI were funded by the abolition of the tax-free threshold and/or increases to income tax rates, then people would be more strongly penalised for working additional hours and might hence work less.

Would people receiving unconditional handouts feel freer to explore their creative sides? To explore entrepreneurial ideas? To engage in more meaningful work than they presently do? These are all mentioned as possible benefits of a developed-country UBI, but we really don’t know whether they would materialise, nor do we really know how to measure them.

We do know that people adapt to new reference points (including income reference points), and there is good reason to expect that at least some of a long-term UBI would be soaked up in higher prices – particularly for goods that the poor buy most.

Watch and learn

A proposal to throw money at people, while wrapping that proposal in the flags of “equality” and “basic rights”, can be argued to be the lazy man’s face-saving response to the complex, entrenched problems of poverty. The poor arguably lack access and/or skills as much as or more than they lack money.

What’s more, the present Australian social security and welfare system can be viewed as a UBI scheme with exceptions for people who don’t need it. Some changes to the system that do not involve wholesale overhauls could address many of the problems discussed above.

My advice for Australia? Watch the policy experiments in Europe keenly. But don’t assume for one minute that universal basic income is a magic bullet. Compared to our current system, it is expensive, inefficient, and potentially regressive.

The ConversationGigi Foster, Associate Professor, School of Economics, UNSW Australia

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Explainer: what is contract theory and why it deserved a Nobel Prize

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Hongyi Li, UNSW Australia and Anton Kolotilin, UNSW Australia

The Nobel Memorial Prize in Economic Science has just been awarded to Oliver Hart and Bengt Holmström for building the foundations of contract theory.

Contract theory is not merely the study of legally binding contracts. Broadly defined, it studies the design of formal and informal agreements that motivate people with conflicting interests to take mutually beneficial actions. Contract theory guides us in structuring arrangements between employers and employees, shareholders and chief executives, and companies and their suppliers.

In essence, contract theory is about giving each party the right incentives or motivations to work effectively together.

Hart and Holmström have developed elegant and powerful methods that are taught to all students in economics. Their work forms the fundamental building blocks of many areas beyond economics, such as finance, law, public policy and management.

Previously, general equilibrium theory had already shown how efficient outcomes can be achieved under ideal circumstances, through detailed contractual agreements. In fact, research in this area has already led to a number of other economic science prizes (John Hicks and Kenneth Arrow, 1972; Gérard Debreu, 1983; Ronald Coase, 1991).

However, this research ignored two potential issues: informational problems and incomplete contracts. By studying these two issues, Hart and Holmström developed what has become modern contract theory. Here we examine a few of the papers that explore those problems and made substantial contributions to the field.

Holmström’s contributions

Holmström’s work focuses on informational problems in which some parties do not observe what others are doing.

Consider the problem of motivating an employee to work hard. If the employer can perfectly monitor the employee, then she can simply reward the employee if he works, and punish him if he shirks. However, such monitoring is often unrealistic. Often, employers can base employee rewards only on the outcome of the employee’s work.

Holmström’s 1979 paper, “Moral Hazard and Observability”, shows how employers should optimally link employee rewards to performance outcomes. One key insight is that a CEO’s pay should not depend only on his or her company’s share price. Such a scheme would unnecessarily penalize the CEO for factors beyond his or her control, such as commodity prices.

A better reward scheme would seek to eliminate such factors by, for example, linking the CEO’s pay to the company’s share price relative to competitors in the same industry.

Another paper, published in 1982 and titled “Moral Hazard in Teams”, extends his 1979 analysis to settings in which a team of employees contributes individual efforts towards a collective output, such as a team of inventors working together to develop a new product.

A partnership scheme that simply shares profits amongst team members creates a free-rider problem: Each team member is insufficiently motivated by his or her share of profits and thus exerts too little effort. Holmström shows that the free-rider problem can be resolved by introducing a “budget-breaker”, a third party such as a venture capitalist who assigns rewards and penalties to the team members and keeps what is left for herself.

Holmström’s 1991 paper with Paul Milgrom, “Multitask Principal Agent Analyses – Incentive Contracts, Asset Ownership and Job Design”, considers situations in which the employee allocates effort amongst multiple tasks. The employer only observes the outcome of some tasks. For example, a teacher may devote effort towards improving test scores or towards inculcating student creativity.

One insight is that the school should not make teacher pay too sensitive to observable outcomes. Rewarding teachers for high test scores may distort teacher effort away from hard-to-measure tasks such as developing student creativity.

Hart’s contributions

Hart, for his part, developed foundations for the theory of incomplete contracts.

The basic idea is that it is impossible to write a contract that anticipates every potentially relevant future contingency. Consequently, the allocation of control rights becomes a powerful tool for creating incentives. This perspective enables the analysis of fundamental questions such as whether companies should outsource or integrate production, which assets they should own and how they should choose between equity and debt financing.

Hart’s 1986 paper with Sanford Grossman, “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”, studies incomplete contracting in which various parties invest to increase the productivity of an asset. When unforeseen contingencies arise, the parties have to bargain over what to do.

Crucially, asset owners have stronger bargaining power, which motivates them to invest. Therefore, the asset should be owned by the party whose investment is most important.

A paper Hart published in 1990 with John Moore, “Property Rights and the Nature of the Firm”, extends his 1986 analysis to study optimal ownership of multiple assets. It shows that highly synergistic assets – whose values are enhanced when used together – should be owned by a single party, rather than separately by multiple parties.

Concentrating bargaining power in the hands of one party is more effective than diffusing bargaining power across multiple parties. This paper paints a compelling picture of large integrated firms where all physical and intellectual assets are owned by a single corporate entity.

From theory to real-world application

We have merely highlighted a few of Holmström’s and Hart’s fundamental contributions to contract theory.

These economists as well as others have applied this work to study key features of real-world contractual agreements: liquidity provision by governments and banks, long-term compensation and promotion schemes for senior managers and executives, and public versus private ownership of institutions such as prisons and utilities.

Contracts have governed the workings of the economy since ancient times. As technology improves and organizations become more complex, the theory and practice of contract design will only increase in importance.

As such, we owe a great debt to Holmström and Hart for giving us powerful tools to structure effective contracts.

The ConversationHongyi Li, Lecturer in Economics, UNSW Australia and Anton Kolotilin, Senior Lecturer, UNSW Australia

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A New Democratic Enlightenment?

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John Keane, University of Sydney

This is the slightly rewritten text of my address to the opening plenary session, ‘New Enlightenment Neue Aufklärung’, at the European Forum Alpbach, Alpbach, Austria, 28 August 2016.


European Forum Alpbach, Austria

Ladies and Gentlemen, Citizens and Citizenesses:

The disintegration of Europe that the world is witnessing, and in some quarters beginning to fear, no doubt has multiple causes and causers. One cause whose power to shape ultimate outcomes should not be underestimated is the felt decadence of democratic institutions. Many observers speak of a developing crisis of European democracy. While the headline phrase triggers my discomfort about unwarranted exaggeration, it plausibly captures a basic fact of contemporary European politics: the fact that the present-day paralysis of the spirit and institutions of democracy in the European region is bound up with the slow death of social democracy.

In the Austrian context, in the run-up to a bitterly contested presidential election, I’m aware that talk of the death of social democracy sounds straightforwardly a political statement. Understandably so, for once upon a time the Social Democratic Workers’ Party of Austria (SDAPÖ) was among the most powerful, dynamic and forward-thinking party machines of the modern world. In striking contrast, today’s Social Democratic Party of Austria (SPÖ) is a sickly pale shadow of its former robust self. The decline of social democracy in Austria is palpable. Yet what I have to offer to you this afternoon is an analysis that aims to be less local and more far-reaching, an audit of social democracy that is at the same time conceptual and historical and concerned with global trends, a probe that equally pays attention to language, through which (I remind you in the village of Erwin Schrödinger) people form pictures of ‘reality’ and move through their world.

Enlightenment

The theme of our European Forum Alpbach symposium on politics is the New Enlightenment (Neue Aufklärung) so here’s my opening conjecture: the language and ideal of social democracy has its roots in the 18th-century Enlightenment. Enlightenment: when people encounter the word, they think immediately of reason and rationality, a black swan moment when new mental energies flowed, when the early modern 18th-century world began to be turned upside down by fearless criticism of prejudice, pride and power.

The interpretation is unfortunately too simple. Truth is that the intellectual upheaval that came to be called the Enlightenment (the phrase was largely a 19th-century neologism, typically circulated by its enemies) was a much messier affair. Historians, philosophers and political thinkers have taught us to see this 18th-century upheaval in less Whiggish and sanguine ways. Most analysts of the so-called Enlightenment today prefer to view it as multiple enlightenments, as various intellectual and literary tendencies centred on many different themes, with positive and negative effects.

Consider, for example, how Theodor Adorno, Max Horkheimer and Michel Foucault long ago challenged us to see that the 18th-century fetish of ‘reason’, its will to know everything and to measure and master the world, fed the spirit of bureaucratic ‘unreason’, incarceration and totalitarian rule. Or think of Isaiah Berlin’s reminder that the opponents of Enlightenment, dubbed the ‘Counter-Enlightenment’, included thinkers, poets, painters and writers who plausibly championed pluralism and attacked the blind belief in scientific progress, in effect because they viewed the world as shaped not by the ‘laws of nature’, but by the contingencies of history.

My research on Thomas Paine and the eighteenth century (published as Tom Paine: A Political Life) tried to complicate matters by making the point that the Enlightenment also included champions of civil rights, social justice and democratic representation, rebels and radicals who were sharply aware of the miseries suffered by people ground down by modern institutions not of their own choosing. These dissenting rebels despised misery. Thanks to them, we could say, misery was given its proper name. Starvation and indignity, violence and powerlessness, were denounced as unnecessary blights on the face of the world. Misery was no longer regarded as God-given, or as part of the natural order of things (natura naturans). It was seen to be contingent, remediable, if necessary by means of revolutionary upheavals.

Social Democracy

Social democracy was the offspring of this bold way of imagining a world freed from misery. Its fortunes were tied to the rise and expansion of modern industrial capitalism. Coined during the 1840s, the neologism Sozialdemokratie first circulated among disaffected German-speaking skilled craftsmen, farm and factory workers, whose support for social democracy made possible the conversion of isolated pockets of social resistance into powerful mass movements protected by trade unions, political parties and governments committed to widening the franchise and building welfare state institutions.

Market inequalities fuelled resentments among the supporters of social democracy. Their powerful charge was that ‘free market’ competition produces chronic gaps between winners and losers and, eventually, a society defined by private splendour and public squalor. If Eduard Bernstein, Karl Renner, Rosa Luxemburg, Clement Attlee, Jawaharlal Nehru or Bruno Kreisky were suddenly to reappear in our midst, they would not be surprised by the way practically all market-driven democracies are today coming to resemble hour glass-shaped societies. In these societies, as Thomas Piketty and other political economists explain, the wealth of small numbers of extremely rich people has multiplied, the shrinking middle classes feel insecure and the ranks of the permanently poor and the precariat are swelling – as in the United States, the richest capitalist market economy on the face of the earth, where 1% of households now own 38% of the national wealth; or in Britain, where at the end of three decades of deregulated growth, 30 per cent of children live in poverty; or in Austria, where at least 20% of citizens are now suffering money and dignity problems.

Social democrats of the 19th- and early-20th centuries found obnoxious, and actively resisted, social inequality on this scale. They railed against the general dehumanising effects of treating people as commodities. Social democrats acknowledged the technical prowess, productivity and dynamism of markets. But they were sure that love and friendship, family life, public freedoms and the vote could not be bought with money, or somehow be manufactured by commodity production, exchange and consumption. That was the whole point of their radical demands for a living wage, the abolition of child labour and Eight Hours Work, Eight Hours Recreation and Eight Hours Rest. In the dark year of 1944, the Hungarian social democrat Karl Polanyi put the point in defiant words: ‘To allow the market mechanism to be the sole director of the fate of human beings and their natural environment’, he wrote, ‘would result in the demolition of society’. His reasoning, traceable to the 18th-century Enlightenment, was that human beings are ‘fictitious commodities’. His conclusion: dignity through democracy had to be fought for politically, which at a minimum meant the weakening of market forces and strengthening the hand of the commonweal against private profits, money and selfishness.

Market Failures

More than a few social democrats went further, by pointing out, in opposition to Jean-Baptiste Say, Friedrich von Hayek and other liberal political economists, the reasons why unregulated markets are prone to collapse. Economists of recent decades have regularly described these failures as ‘externalities’, but their jargon is misleading. Something more fundamental is at stake. Free markets periodically cripple themselves, sometimes to the point of total breakdown, for instance because (a) they whip up socially disruptive storms of technical innovation (Joseph Schumpeter’s point) or because (b) as we know from recent bitter experience, unregulated markets generate bubbles whose inevitable bursting bring whole economies to their knees.

The social democratic critique of free market capitalism proved compelling for millions of people. But what exactly did social democracy mean to its champions and sympathisers? Winning parliamentary elections and controlling the levers of state power, certainly. Yet there was always some muddle over the meaning of the ‘social’ in social democracy; and there were frequent brawls about whether and how the taming of markets, which many called ‘democracy’ and ‘socialism’, could be achieved.

There is no time for me to recall the great moments of high drama, conceptual strife and contradictions, dark sides and luscious ironies that form part of a recorded history that includes courageous struggles of the downtrodden to form co-operatives, friendly societies, free trade unions, and to spread literacy and win the struggle for the universal franchise through social democratic parties. There were fractious splits that gave birth to anarchism and Bolshevism; and outbursts of nationalism and xenophobia and (in Sweden) experiments with eugenics. The history also includes the re-launch of social democratic parties at the Frankfurt Declaration of the Socialist International (1951), as well as efforts to nationalise railways and heavy industry, to socialise the provision of health care and formal education for all citizens. And the history of social democracy also embraces big and bold thinking, romantic talk of the need to abolish alienation, respect for what Paul Lafargue called the right to be lazy (le droit à la paresse), even the vision of a future communist society projected by his father-in-law Karl Marx, a society in which women and men, freed from the shackles of the market, went hunting in the morning, fished in the afternoon and, after a good dinner, engaged others in frank political discussion.

A Slow Death

A strange but striking feature of the history of social democracy is just how distant and worn out this language now feels. The slow death of social democracy during the past several decades has the quality of an unfolding political tragedy; it certainly signals the decline and disappearance of the spirit and substance of the old Enlightenment. Yes, there is a Grosse Koalition in Germany, and a red-green government led by Stefan Löfven in Sweden. But almost everywhere social democratic political parties and organisations have run out of steam; their loss of organising energy and political imagination is palpable. Collaborators with financial capitalism (Jürgen Kocka) then double-speak apologists of austerity, their Third Way has turned out to be a dead end.

Gone are the flags, historic speeches and bouquets of red roses. Party leader intellectuals of the calibre of Eduard Bernstein (1850–1932), Rudolf Hilferding (1877-1941) and C.A.R. Crosland (1918-1977) are figures of a distant past. Today’s party leaders who still dare to call themselves social democrats are by comparison intellectual pygmies. Loud calls for greater equality, social justice and public service have faded, often into choking silence. Positive references to the Keynesian welfare state have disappeared. As if to prove that social democracy was just an intermezzo between capitalism and more capitalism, these leaders speak of budgetary restraint, triple ‘A’ ratings, ‘renewed growth’ and ‘competition’, public-private partnerships, ‘stakeholders’ and ‘business partners’.

Sometimes the duplicity induces pain. I once witnessed the fabulist Tony Blair reassure a gathering of trade unionists that he was against free market forces before moving on, two hours later, after a light lunch together, to tell a group of business executives exactly the opposite. The crisis of Atlantic-region capitalism since 2008 seems to have amplified the duplicity. Within the dwindling ranks of committed social democrats, few now call themselves socialists (Alexis Tsipras and Jeremy Corbyn are exceptions), or even social democrats. Most leaders are party faithful, machine men and women surrounded by media advisers, connoisseurs of governmental power geared to free markets. Few make noise about tax avoidance by big business and the rich, the decay of public services, the weakening of trade unions, or rising inequality. All of them, usually without knowing it, are blind apologists of the drift towards a new form of financial capitalism protected by what I have elsewhere called ‘banking states’ that have lost control over money supply, so that in most democratic countries over 95% of the ‘broad money’ supply is now in the hands of private banks and credit institutions.

Ladies and gentlemen: social democracy failed to understand, let alone regulate, this new historical type of capitalism, whose near-breakdown in 2007/2008 has damaged the lives of millions of people in Europe and elsewhere. But the disintegration of social democracy has been overdetermined by other, multiple forces. Among the most important are these entangled trends, here summarised in the briefest form:

● Membership of social democratic parties has dipped dramatically. Although accurate figures are hard to obtain – these parties are notoriously secretive about their active membership lists – we know that in 1950 the Norwegian Labour Party, one of the most successful in the world, had over 200,000 paid-up members; and that today its membership is barely one-quarter that figure. Much the same trend is evident within the British Labour Party, whose membership peaked in the early 1950s at over 1 million and is today less than half that figure. Helped by the recent £3 special offer registration, total membership of the Labour Party is now around 370,000 – less than the 400,000 figure recorded at the 1997 general election. During Blair’s years of leadership alone, membership declined steadily every year from 405,000 to 166,000. When it is considered that during the post-1945 period, the size of the electorate in most countries has been steadily increasing (by 20% between 1964 and 2005 in Britain alone) the proportion of people who are no longer members of social democratic parties is far more substantial than even the raw numbers suggest. The figures imply a profound waning of enthusiasm for social democracy in party form. Satirists might even say that its parties are waging a new political struggle: the struggle for self-effacement.

● Social democratic parties were among the slowest to react to the upheavals effected by the digital, globally networked communications revolution that began during the 1960s. The harnessing of big data through networked campaigning techniques by these parties has often been resisted, or ignored. Striking is the contrast with the powerful social democratic parties of the late 19th century. They stood for universal public literacy and published influential newspapers, books, pamphlets and best-selling utopian novels and literary fantasies such as Edward Bellamy’s Looking Backward, 2000–1887 (1888). Social democracy was once a powerful symbol of democratic openness and communicative empowerment. Today it symbolises sound bites and media grabs, the avoidance of bad news. The old class struggles have been replaced by phrase struggles;

● Social democratic parties have shown limited awareness of the emergence, since the 1940s, of monitory democracy. This is a new historical form of democracy in which free and fair elections and parliaments are of declining importance, certainly when compared with the rising importance of the public monitoring and restraint – humbling – of arbitrary power by means of a multitude of newly-invented watchdog institutions such as citizens’ assemblies, teach-ins, public forums, activist courts, environmental networks and WikiLeaks, to name just a few innovations;

● Gripped by a territorial state mentality and confined to nation state barracks, social democratic parties have underestimated the agenda-setting and blackmail and veto effects of cross-border chains of organised corporate and governmental power. Operating within the boundaries of territorial states, social democratic parties and governments have consequently been weakened and victimised by what Albert Einstein dubbed ‘spooky action at a distance’: cross-border butterfly effects, arbitrage pressures and quantum tunnels, all of which have greatly complicated the politics of wealth and income redistribution;

● The rise of the People’s Republic of China as an economic great power on the global power stage has had two ironic effects: it has weakened an important part of the social support base of social democracy (industrial manufacturing, trade unions, workers) and established a viable ‘socialist’ alternative to capitalism in social democratic form: one party state capitalism legitimated by locally-made forms of democratic rule; and

● The long-term silence of social democrats about environmental degradation has accelerated the death of social democracy. We have entered an age of gradually rising public awareness of the destructive effects of the modern human will to dominate our biosphere, of the bad habit of treating nature, just as Africans or indigenous peoples were once treated, as commodities, as objects of production, profit and other selfishly human ends.

This last-mentioned development needs some elaboration. For more than half a generation, beginning with works such as Rachel Carson’s _Silent Spring _(1962), green thinkers, scientists, journalists, politicians and social movement activists have been pointing out that the whole social democratic tradition is implicated deeply in the spoliation of our planet. They note that social democracy was the Janus face of free-market capitalism: both stood for the human domination of nature. Hence they call for a new politics with green qualities, a new democratic enlightenment that poses a fundamental challenge to both the style and substance of the old social democracy, or what remains of it.

The New Democratic Enlightenment

What is this new democratic enlightenment? It has multiple features, especially a strong sense of the complexity and indeterminacy of things and processes in our world. It displays resistance to wilful simplification, and opposition to all ideologies, including populism. There is preference for extra-parliamentary civic action and monitory democracy against the old model of electoral democracy in territorial state form. The Neue Aufklärung features sympathy for a rich repertoire of new political tactics practised in a variety of local and cross-border settings: citizen science networks, Barcelona-style municipalismo, bio-regional assemblies, green political parties (the first in the world was the United Tasmania Group), earth watch summits and the skilful staging of non-violent media events (Greenpeace originally called them ‘mind bombs’).

The new democratic enlightenment is marked by an earthy cosmopolitanism. It displays a deep sensitivity to the global interdependence of peoples and their ecosystems. There is support for new post-carbon energy regimes and opposition to fossil-fuelled growth and habitat destruction. There is also acute awareness of the opportunities and dangers posed by marketisation of the most intimate areas of everyday life, for instance fertility outsourcing, data harvesting, nanotechnologies, stem cell research and humanoid robots. The new enlightenment has a clear understanding of the golden rule that whoever has the gold rules. It displays strong awareness that market control of daily life, civil society and political institutions has negative social and political consequences, unless checked by open public debate, political resistance, public regulation and the positive redistribution of wealth, for instance through a basic citizens’ income. Especially striking is the new enlightenment’s call for the ‘de-commodification’ (Claus Offe) of the biosphere, in effect, the replacement of social democracy’s will to dominate nature and its innocent attachment to History with a more prudent sense of ‘deep time’ aware of the fragile complexity of the biosphere and its multiple rhythms.

The new democratic enlightenment is opposed to the old social democratic metaphysics of economic progress, and the machismo of its favoured imagery of warrior male bodies gathered at the gates of pits, docks and factories, singing hymns to industrial growth, under smoke-stained skies. The new enlightenment issues a warning: that unless we human beings change our ways with the world in which we dwell things may turn out badly – very badly indeed. Its overall attitude to the world is precautionary: whether we know it or not, it is said, we humans are now deciding which evolutionary pathway awaits us, including the possibility that we are trapped in an extinction event of our own making.

It is worth asking whether these themes of the new enlightenment are evidence of a black swan moment in global affairs? Are they proof that we are living through the beginning of a large phase transformation analogous to the last decades of the 18th century, when the rough-and-tumble resistance to the miseries produced by market-driven industrial capitalism slowly but surely morphed into a highly disciplined workers’ movement receptive to the siren calls of social democracy?

It is impossible to know with utter certainty whether these are the right questions, or whether our times are like that. Only the historians of the future will be able to tell us, yet it should be noted that many champions of the new enlightenment are now convinced that a tipping point has indeed been reached. Their sense of alternative possibilities (Robert Musil’s Möglichkeitsinne) is strong. In effect, the new enlightenment is an exercise in democracy ‘dreaming itself’. It demands that democracy be taken seriously and self-reflexively redefined as monitory democracy. It insists that the point is not only to change the world, but also to interpret it in new ways, through new languages, to grasp that so many things of our times are too strange to be thought, to see that although democracy is never fully realisable, that it is always the ‘democracy to come’ (Jacques Derrida), it is nevertheless still the most powerful earthly weapon available for humbling the powerful and taming their arrogant and foolish will to power.

But where does this new enlightenment leave social democracy? What is the relationship between the first and second enlightenments? Thinking social democrats will reply to such questions by emphasising the flexibility of their creed, the capacity of their originally 19th-century standpoint to adapt to 21st-century circumstances. I have friends and colleagues who are adamant that it’s much too early to bid farewell to social democracy. They reject the charge that it is a worn-out ideology whose moments of triumph belong to the past, or that it is a mournful lament for the achievements of bygone days (Tony Judt).

These social democrats admit that the goal of re-building social solidarity among citizens through civil society and government action has been damaged by market-produced inequality and fudged agendas designed to win votes from business, the rich and right-wing political competitors. These thinking social democrats know that the old slogans and sense of time of social democracy are exhausted. They admit to being impressed by the media-savvy initiatives and staged détournement of civic networks such as M-15, Amnesty International and the International Consortium of Investigative Journalists, whose actions aim to put a stop to the violence of states, armies and gangs, but also to corporate misconduct and market injustices and miseries in cross-border settings. These thinking social democrats then play the ace card in their pack: they reiterate the importance of ‘complex equality’ (Michael Walzer) as the core value of their creed. These social democrats aim to retrieve its most fruitful old ‘wish image’ (Wunschbild) to deal politically with the new problems of our time. They are sure that the old topic of misery, inequality, capitalism and democracy deserves to be revived. In a recent lecture in Firenze, along these lines, Jürgen Kocka, one of Germany’s most influential social democratic intellectuals, expressed this point well. The new ‘financialised’ capitalism, he noted, is ‘becoming more and more market radical, more mobile, unsteady and breathless’. His conclusion is defiant: ‘capitalism is not democratic and democracy not capitalistic’.

The Future?

Ladies and gentlemen: you will no doubt be asking after the chances of practical success of the new enlightenment, this new dreaming of democracy. In Europe and elsewhere, how viable is the hope that red and green can be mixed, you will ask? Can the result be more than bland shades of neutral brown? Might the old and new be combined into a powerful force for an enlightened politics of democratic equality against the power of money and markets and their ruination of our biosphere? Time will tell whether the proposed metamorphosis I’ve sketched can happen successfully. As things stand, only one thing can safely be said. If the new enlightenment happened then it would confirm an old political axiom famously outlined by the English designer, poet and socialist William Morris (1834 – 1896): when enlightened people fight for liberty, equality and democracy, he noted, the battles and wars they lose typically inspire others to carry on their fight. When they do that, in much-changed circumstances, he noted, they need to experiment with new languages, and use new and improved means, fuelled by new hopes and new sensibilities. Shouldn’t a new enlightenment, a second enlightenment that is less intellectually arrogant and more democratically powerful than its predecessor, heed this wise advice?

The ConversationJohn Keane, Professor of Politics, University of Sydney

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Flat-earth economists lead the hysteria over budget deficits

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Beth Webster, Swinburne University of Technology

Back in the good old days of the 19th century when market economies oscillated between boom and prolonged recession, economists believed that nations were like households. They had to balance their budgets. If they spent more in one year they would have to save more the next to pay off the debt. Sound advice for a household. But not so for an economy as a whole.

Welcome to the Keynesian revolution

Keynes proved this in 1936, and subsequently governments followed this theory to get their economies out of depression and onto the long economic boom that lasted until the mid-1970s.

What essentially did Keynes, and his doppelgänger Kalecki, argue? Let’s use a very simplified model to illustrate the point. Say there are two types of people who are active in the market economy: employees and investors. The investors own the assets of the business in which the employees work.

Altogether the businesses in a country produce $100 of goods and services in a year. If they could sell these goods and services, then say for illustrative reasons, that $70 would go to the employees as wages and salaries and $30 goes to the investors as a profit (return on their capital).

Now the businesses can only sell their goods and services if people with incomes (the same employees and investors) spend $100 buying these goods and services. No business keeps producing things that are not bought. The employees may be happy to spend their $70 on goods and services. But the investors will only spend their $30 if they can feel confident that they will get their $30 back plus a return for risk. This return may be 5% or more depending on the economic climate. Suppose the optimistic investors, in the first year, spend their $30 of dividends (or profits) on the goods and services. But at the end of the year, the business only makes $100 of sales and the investors only get back $30 (as $70 goes to employees). Not a good investment. Rate of return = zero.

So what do investors do? In the next year, they only spend $20 on investment goods and services. But then the combined purchasing power of employees and investors is $70+$20 = $90. The business cannot sell all their product ($100). With only $90 in income they pay wages of $70, leaving $20 for the return to investors, but in addition, they cut back on production and retrench staff in the following year. Investors also cut back on spending as they also got a rate of return below what they feel reasonable given the risk of investing. It is safer to leave the money as cash in the bank or under the bed. And so the economy enters a downward spiral. Investors cut back, businesses sack staff and unemployment rises.

Downward spiral

What stops this downward spiral? There needs to be an external injection of spending into the system. This is the essential Keynesian message. By external, we mean something that does not originate from employees (householders) or the investment community. It has to come from either the government in the form of
perpetual budget deficits or perpetual exports.

Clearly from the point of view of the world as a whole, exports cannot be the source. Some countries, for some of the time, can get income stimulus from exports (i.e. China for the last 30 years) but this is at the expense of other economies. At the end of the day, the stimulus to incomes has to come from governments who control the money supply and can thus spend without having to borrow. Essentially, they can monetise the debt. They do not have to pay this debt back – it is spending financed by central banks. The point is that if the government adds to spending (and production) without extracting an income for itself, it allows investors to realise the minimum rate of profit necessary for them to invest again.

This is what occurred for the 25 years following WWII. So what stopped it?

Inflation

Inflation. Inflation instigated by a series of oil price shocks but then prolonged by excessive government spending in the US to finance the Vietnam war. Governments in the late 1970s and 1980s reacted to inflation by drastically cutting spending. But the rate of inflation did not fall until the price of oil fell in the 1990s and China flooded the world with cheap manufactured goods. Certainly, if an expansion of the money supply is excessive we will get inflation. But taken to an extreme in the other direction, we get low growth and unemployment.

Where do you think we are in 2016? With 700,000 official unemployed, close to another 700,000 under-employed, and an inflation rate below 2%, I would say we are swung too far to the parsimonious side. It is all about balance. It should not be about blind and mechanical fear mongering about government budget deficits. The current political debate is on level with a Tony-Abbott-climate-change debate. Misguided, low brow and damaging to the well-being of many people.

Productivity growth

And incidentally, for those wondering, productivity growth will not break the deficient-demand impasse described above. Productivity growth would have to achieve a consistent rate of over 5% per annum to fill the void in spending. Given the historic rate has been about 1%, I would not count on it.

The ConversationBeth Webster, Director, Centre for Transformative Innovation, Swinburne University of Technology

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Apes make irrational economic decisions – that includes you

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Christopher Krupenye, Duke University

Just the other day I found myself in the waiting room of an automotive dealership. While my car was being serviced, I flipped through a product brochure. One ad for an oil change boasted that it would clean out at least 90% of used oil. Another for new brakes guaranteed maximum performance for twelve months. No one was advertising oil changes that leave behind 10% sludge, or brakes that begin to fail after only a year.

That’s because advertisers know that people are sensitive to how options are framed. We appraise goods more highly when their positive attributes are emphasized over their negative attributes, even if the details describe essentially the same situation (e.g., 90% clean versus 10% dirty).

This is called attribute framing, and it’s just one example of many irrational biases that humans exhibit when making economic decisions. Other examples include loss aversion (the preference for avoiding losses over acquiring gains), the endowment effect (people ascribe more value to something once they own it), and the reflection effect (people shift their risk preferences when dealing with gains versus losses).

These irrational biases are common, they’re really hard to overcome, and they have pervasive impacts on human market behavior. For example, people are more likely to spend a sum of money when it is framed as a bonus than when it is framed as compensation for a previous loss, like a rebate, which has implications for population trends in spending versus saving. Framing also influences people’s medical decisions, such as their tendency to undertake preventative measures in personal health care. And it’s often leveraged by marketing agencies to improve sales.

Decision-making research can help economic institutions – built on the erroneous assumption that people will behave rationally – to account for predictable irrationality. It can also help us to design choice environments that lead people to make decisions that are better for them. For these reasons, Daniel Kahneman was awarded the Nobel Prize in Economics in 2002, for his contributions (with the late Amos Tversky) to the understanding of irrational decision-making.

Most people have lots of experience in the marketplace, but our biases go much deeper than just what we’ve learned there.
Christopher Crouzet, CC BY-SA

Irrational… but why?

Recent research attempts to understand where these biases come from. In most societies, humans interact with monetary markets from a young age; it seems intuitive that such exposure would be the principle source of decision-making strategies and biases. Culture and socialization must be involved, right?

But while human culture and market experience may play a role, it now seems clear that choice biases are much more deeply rooted in our biology. Previous investigations had shown that some other species – including European starlings and capuchin monkeys – may also exhibit irrational biases such as framing effects. However, because these species are fairly distant relatives of humans, it is difficult to know if framing effects are shared as a result of common ancestry, or if they evolved independently in each species. To address this question, my colleagues, Alexandra Rosati and Brian Hare, and I investigated attribute framing in human beings’ closest living relatives, bonobos and chimpanzees.

We tested 23 chimpanzees at Tchimpounga Chimpanzee Sanctuary in the Republic of Congo and 17 bonobos at Lola ya Bonobo sanctuary in the Democratic Republic of Congo. In the study, we presented the apes with choices between several peanuts and some fruit. In the positive “gain” condition, we framed the fruit option positively. We initially presented it as a single piece of fruit, but, half the time that the apes chose it, we provided them with a second piece as well. The negative “loss” condition was identical, except that in this condition we framed the fruit option negatively. Here we presented the fruit option as two pieces of fruit, but, half the time the apes chose it, we took a piece back and only provided the ape with one.

Even though in both conditions apes who chose the fruit option received identical payoffs — a 50-50 chance of getting one or two pieces of fruit — they chose the fruit option significantly more when it was framed positively than when it was framed negatively: apes, too, make irrational economic decisions.

This chimp’s irrational biases are likely similar to yours.
Alexandra Rosati, CC BY-NC-ND

Irrational apes

Because bonobos, chimpanzees, and humans all exhibit framing effects, it is unlikely that this trait evolved independently in each lineage. Instead, it appears that choice biases are evolutionarily ancient. They were probably present in the last common ancestor of bonobos, chimpanzees, and humans, which lived about six million years ago, and may even be much older. That framing effects are shared with several non-human species also suggests that these biases are deeply rooted in our biology, and can arise in the absence of experience with uniquely human monetary markets. Choice biases may have evolved in response to certain challenges in foraging ecology, or they may represent a by-product for selection on other traits, such as emotions.

Interestingly, we found that male apes were much more susceptible to framing than female apes were. In humans, gender differences in decision-making may result from a number of different factors, including gender-specific socialization, motivational differences, or experience with markets. Our results underscore the importance of studying large populations of non-human animals: since animals lack many uniquely human characteristics such as gender norms, animal studies can address more basic hypotheses about the origins of individual differences in human decision-making.

Our findings contribute to a large body of research on human decision-making that tells a pretty consistent story: choice biases are deeply ingrained, and they’re often really hard to overcome. Even the well-informed psychologist may find him- or herself getting duped by marketing sway on a daily basis – at the mall, the grocery store, the local coffee shop. While decision research can facilitate more effective marketing strategies, it can also be used by health professionals, banks, architects, and urban planners to build better environments, environments that make people happier and help them to make better decisions.

The ConversationChristopher Krupenye, PhD candidate in Evolutionary Anthropology, Duke University

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What ‘fair’ superannuation would look like

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Rodney Maddock, Monash University

Australia is engaged in an ongoing debate about the fairness of the superannuation system. Those on the highest incomes are seen as extracting the greatest and an unfair advantage from tax benefits currently available. This problem of perception is inevitable in a system where contributions are made out of our pre-tax income.

To try to lessen the concern, the basic approach people have taken is to argue for restrictions on how much can be put into the system each year (on a pre-tax basis). There are also proponents of the view that there should be lifetime limits rather than annual limits. In a sense all these proposals are trying to make taxation of the savings system more progressive, basically driven by a desire for greater fairness. They all make the system more complicated.

Deloitte Access Economics is the most recent contributor. Its recommendation is a little different. It proposes we use the progressivity of the income tax system as our anchor point. This actually seems like a good starting point. The progressive income tax system is designed so that people with higher incomes make a greater contribution to funding society’s needs. It meets the basic requirement of being accepted as fair.

What is interesting with the Deloitte proposal however is that it suggests we all should have an equal discount off our marginal tax rates for our superannuation contributions.

While this too seems fair, it is not clear why we need to have any discount at all.

The common rationale is that we all need an incentive to compensate us because our savings are locked away for a long time. This is rather like a compensation for being compelled to do something. It is a bit odd though because the government compels us to do lots of things without any incentive payments. There is no incentive payment for driving on the left, or for paying one’s taxes. There is no obvious reason for the government to provide incentives for compulsory payments into superannuation. If you have compulsion you do not need incentives. It complicates the system unnecessarily.

A more subtle explanation for the incentive would be that savings should always be lightly taxed (as argued in the Henry review). This is to provide equity between savers and consumers – if I consume all my income today, but you save and then pay tax on your savings, you are paying higher taxes than I am. While this makes sense for voluntary savings, it is not relevant in the context of compulsory savings.

In a paper Stephen King and I wrote for CEDA we argued the sensible and fair approach is to require all payments to compulsory superannuation be made out of people’s after-tax income and there should be no discount at all. The progressive income tax system solves the fairness problem. Eliminating the incentives gets rid of an unnecessary complication and simplifies the system significantly.

The administrative savings would be substantial. Everybody simply pays x% of their after tax income into a compulsory superannuation fund. Get rid of all the limits and caps: get rid of the administrative complexity for once and for all. Compliance would be easy to monitor through the tax system.

People would probably save outside the compulsory system and these would be treated just as outside savings are now: no news rules would be required.

Once the savings are in the compulsory sector they would not need to be taxed further. Again this would simplify the system and reduce administrative complexity.

These changes would bring compulsory superannuation into a similar tax regime as people’s primary residence. In both cases assets are built up over one’s life, based on after-tax contributions, and not subsequently taxed. This might have other advantages of bringing the two systems into closer alignment since housing and superannuation are the two basic forms in which most Australian’s save.

Logic and fairness suggest superannuation and primary residences should both be included in assessing a retiree’s right to access government support in later life. This is an important issue but separate from the issue of providing fairness in the accumulation phase.

The ConversationRodney Maddock, Vice Chancellor’s Fellow at Victoria University and Adjunct Professor of Economics, Monash University

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A dissenting economist on GST: we should charge more on beer and smokes

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Harry Bloch, Curtin University

Recently, 49 prominent Australian economists were polled by the Economic Society of Australia on the issue of GST reform.

Each member of the panel was asked whether they agreed with the following statement:

Increasing government revenue collected through the Goods and Services Tax (GST) by removing exemptions (such as food, health and education) is better than achieving the same extra revenue by increasing the GST rate while retaining the existing exemptions.

Respondents were given five choices ranging from “strongly agree” to “strongly disagree”. The comments were highly varied, but a slight majority of respondents, 54%, chose “agree” or “strongly agree”.

I was among the 11% who chose to strongly disagree.

Among the respondents was Professor John Freebairn, an expert on tax policy. John focusses on the efficiency and equity aspects of the proposed removal of exemptions, arguing that “A broader base and lower rate reduces distortions to the mix of spending choices”.

Not surprisingly, he strongly agrees with the statement that exemptions should be removed, albeit subject to concerns about how the extra revenue is spent including possible compensation for low income groups on equity grounds.

My own comment in strongly disagreeing with the removal of current exemptions is that “it is appropriate for different categories of consumption to be discriminated for (food, health and education) or against (alcohol and tobacco) based on their considered contribution to social well being.”

The design of the GST, including the range of exemptions, was the outcome of a political compromise. In spite of the hyperbole that accompanied the political arguments of the time, the end result did arguably represent the will of the people.

Were people who favoured a GST with exemptions over a tax without exemptions poorly informed or misguided about the efficiency benefits of a broad-based tax over a discriminatory tax (in that it favoured some items of consumption over others)?

Many economists would answer yes to this question, but not me. Critical to my dissent is my view on the proper method for evaluating the benefits society derives from the goods and services consumed.

The standard method in economics for evaluating societal benefits from this consumption is to add up the benefits to each and every individual from their own consumption. Exceptions are allowed where a consumption activity has clear impact on others, such as smoking in an enclosed area. Otherwise, the method implies that government interventions that change the composition of what people consume are distorting in the sense of lowering overall benefits.

Sound good? Fortunately or unfortunately we live in a highly interdependent society. The consumption activities of each of us impact on our family, friends, neighbours and even the society at large. Although these impacts are usually very small, they do add up over large groups.

In this sense, there is a social impact of individual behaviour that often diverges from its private impact. Economists tend to downplay the difference between social impact and private impact, partly because we tend to be believers in individual liberty (“small l” liberals) and partly because economics lacks proper tools to deal with the difference.

So far I have dealt with general concepts; now let us turn to the specifics of the exemptions allowed under the current GST arrangements. Big exemptions, in terms of GST revenue foregone, are for health, education and most food consumed at home.

Using standard economic analysis of supply and demand, exempting these goods and services from GST means we have a healthier and better educated population that spends more time eating at home than would be the case with a uniform rate of GST. Is this good or bad for Australian society?

My fellow economists who agreed or strongly agreed with the statement posed by the ESA think the distortion of individual consumption choices through the GST is bad. Some explicitly mention the use of other methods to achieve socially desired results, but that involves reinterpreting the statement posed by the ESA. I evaluate the implied outcome of more education, more health care and more food at home directly on its merits and I think it is good for Australian society.

This is based partly on my own preferences about the type of society in which I live and partly on my understanding of how education, health and home life contribute to social cohesion. I’ll stop here, for the analysis of social cohesion would take me beyond the usual boundaries of economic analysis and the limits of my own expertise.

The ConversationHarry Bloch, John Curtin Distinguished Emeritus Professor, Curtin University

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Australia’s economy is slowing: what you need to know

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Richard Holden, UNSW Australia; Fabrizio Carmignani, Griffith University; Janine Dixon, Victoria University; Ross Guest, Griffith University, and Tony Makin, Griffith University

Australia’s economy grew by just 0.2% in the June quarter, below expectations of 0.4%, largely as a result of reduced mining and construction activity and a decline in exports of 3% during the quarter.

Nominal Gross Domestic Product grew by 1.8% during the year, which the Australian Bureau of Statistics said was “the weakest growth in nominal GDP since 1961-62”. Despite this, Australia has now recorded 24 straight years of growth.

The news has some analysts and economists spooked, and politicians blaming each other for the slowdown.

Treasurer Joe Hockey said:

At a time when other commodity based economies like Canada and Brazil are in recession, the Australian economy is continuing to grow at a rate that meets and sometimes beats our most recent budget forecasts.

He also said it was “factually wrong” to say it was the weakest growth since 1961.

The fact is that the economic growth we had in the last quarter was in line with expectations. Of course it bounces around from quarter to quarter, but it was in line with our overarching expectation to have two and a half per cent growth in the last financial year.

Shadow Treasurer Chris Bowen said:

Growth has flat-lined since the Abbott government’s first damaging budget last year and cost of living pressures are continuing to increase. This is the biggest quarterly decline in living standards since the global financial crisis.

This is a very weak set of figures and for the government to cast around for international comparisons to try and make it sound better is a pretty pathetic excuse.

//charts.datawrapper.de/VlSW8/index.html


The Treasurer says Australia is still doing better than Canada, Brazil, the US and New Zealand. How should people view these numbers in a global context? To what extent is the slowing rate of growth due to global economic headwinds, and to what extent is it due to domestic factors?

Griffith Business School Professor Fabrizio Carmignani answers:

In the past, the Australian economy has proved to be quite resilient to global economic shocks. Today we are facing what could be potentially a perfect storm.

For one thing, international commodities prices are very volatile and have resulted in a sharp contraction of Australian’s terms of trade. For another, China is going through a complicated economic phase and it is not, at this moment, the same solid anchor for the Australian economy as it might have been previously. So, it is not surprising to see that on a seasonally adjusted basis, quarterly growth in Australia has been oscillating between 0.2% and 0.3% for the last five quarters.

We owe it to some good old Keynesian stimulus on the demand side (read: government consumption and to a lesser extent public gross fixed capital formation) if we are not entering a technical recession.

The comparison with Canada, on surface, is favourable to Australia. Canada has officially entered a recession after recording two consecutive quarters of negative GDP growth in the first half of 2015. This is essentially due to low oil prices. However, according to media reports, Canada is still committed to achieving a target of annual growth of 2.5% this year, which is exactly what the Treasurer has stated for Australia. So, it seems to me that the difference between Australia and Canada here is thinner that what might appear at first sight. A fraction of a percentage point below or above the zero growth line is not really indicative of substantially different structural positions.

Both Australia and Canada are facing similar challenges in terms of diversification. The current “crisis” to me shows that these challenges are still far from being fully addressed in both countries.

Australia has had 24 years of consistent growth. How much of this can we attribute to the mining boom? And given the cyclical nature of the economy, can we expect a downturn?

Griffith University Professor Tony Makin answers:

Australia has performed relatively well compared to other OECD economies over recent decades, though did actually experience a recession during the GFC according to income and production measures of GDP.

Taking population growth into account, Australia’s economic performance since the global financial crisis has been worse than the raw GDP numbers show. On a per capita basis, national income has grown on average below one per cent per annum, less than half the almost two and a half per cent per head per annum average rate in the decade before the GFC.

The extraordinary boost to the terms of trade from the world commodity price hike, especially between 2005 and 2011, substantially raised Australia’s international purchasing power. However, GDP growth during the mining boom was actually less than during the economic reform era from the mid-1980s through to the end of the 1990s when commodity prices were fairly flat.

The main culprit for Australia’s sub-normal economic growth in recent years has not been falling commodity prices, which have undoubtedly played a role, but Australia’s underlying competitiveness problem, combined with a productivity slowdown that began from the turn of the century.

While the recent depreciation of the dollar will go some way to restoring Australia’s competitiveness and help stave off recession, genuine productivity-enhancing reform focusing on the economy’s supply side remains as important as ever for returning GDP and income per head growth to long-term average rates.

One journalist at Wednesday’s press conference said the new data showed “the weakest growth since 1961”, but the Treasurer said that was factually wrong. Who is right?

UNSW Australia Professor Richard Holden answers:

The statement that it is the slowest growth since 1961 seems, to me, to be false. We have had recessions in the 1990s and 1980s, which is two successive quarters of negative growth. And yesterday we had positive growth, so it was a slowdown but not the worst we have seen since 1961. I think the journalist’s statement doesn’t seem correct to me, on the face of it. I think the Treasurer is right.

It is possible the journalist was referring to the Australian Bureau of Statistics comment yesterday that:

GDP growth for 2014-15 was 2.4%. Nominal GDP growth was 1.8% for the 2014-15 financial year. This is the weakest growth in nominal GDP since 1961-62.

Nominal growth and growth are not quite the same thing. Nominal growth means GDP growth that is not adjusted for inflation.

But yes, yesterday’s numbers are still below projected growth. It is below market expectations. I think the Treasurer saying we have projected 2.5% annual growth this year and this is basically on target is a bit disingenuous. This is slow growth, it’s actually very troubling.

I understand the Treasurer can’t talk down the economy so his comments are understandable and he is in a difficult position. But the low rate of growth is genuine cause for concern.

I have written before about the concept of secular stagnation, which is the idea that growth of advanced economies looks like it has slowed down dramatically. The figures yesterday are further evidence of that theory.

Victoria University Senior Research Fellow Janine Dixon answers:

While it is factually correct that real GDP – the volume of production in the economy – has grown, the low growth in nominal GDP points to an underlying weakness in the economy. This is our exposure to the very large fall in commodity prices. When we translate real GDP into real income, we take into account that fact that the prices of the things we produce for export have fallen relative to the prices of the things we consume, some of which are imported. This has been a very important determinant of real incomes in the last few years.

Real net national disposable income is a better measure of our living standards than GDP. As well as adjusting for prices, we take into account the fact that some of the income generated domestically actually accrues to the rest of the world if the factors of production are foreign owned. We also deduct the value of capital that is “used up” or depreciated during the year.

Real net national disposable income per person has now failed to grow for 14 quarters in a row. This represents the most sustained fall in standards of living in the last 50 years.

What’s especially interesting about this period is that falling incomes have not been associated with falling output or particularly high unemployment. In the 1990-91 recession (the one we had to have) or the early 1980’s, incomes fell, but the solution to the problem was fairly clear. More than 10% of the workforce was unemployed. Fixing unemployment would boost production, incomes and living standards.

This time around, incomes are falling because commodity prices are falling. Commodity prices, set on world markets, are largely out of our hands. The labour market is much more flexible these days, and unemployment is 6%, not 10%. We are left with just one way to turn things around. In the words of Nobel laureate Paul Krugman, “Productivity isn’t everything, but in the long run it is almost everything”.

Is GDP really in line with expectations, both of the government and the market?

Griffith University Professor Ross Guest answers:

These GDP expectations are continuously being revised down as new information comes to hand.

The projected growth is lower than nearly everybody expected and everybody is having to revise downward their expectation.

What will the slowing annual growth mean for the federal budget, which had forecast growth for 2015-16 of 2.75%?

Ross Guest answers:

If growth were to remain at its current level of 2%, the budget deficit would be A$15 billion larger, in ball park terms, than the government projected. To put that in perspective, the total amount we spend on unemployment benefits is A$10 billion.

Australia living standards and the Australian government budget are being hit by a perfect storm of lower commodity prices and lower productivity growth.

Victoria University Senior Research Fellow Janine Dixon answers:

The GDP growth forecast for 2015-16 is fairly subdued at 2.75% and the budget not overly ambitious – a deficit of 2% of GDP. The trouble lies in 2016/17 and beyond, when annual GDP growth is forecast to be above 3%.

Over the next five years a couple of downside risks exist that will make it unlikely that GDP will grow this strongly, and consequently the budget’s return to surplus will be more difficult to achieve.

If the terms of trade fall further than allowed for in the budget forecasts, and if productivity growth remains weak, as it has been in recent years, real national income could be 3% lower than forecast by 2020. Roughly, this means the tax base for the government will be 3% smaller than expected. Rather than having a balanced budget by 2020, we would still be running a deficit, of around 0.75% of GDP or $12 billion in today’s terms.

The ConversationRichard Holden is Professor of Economics at UNSW Australia; Fabrizio Carmignani is Professor, Griffith Business School at Griffith University; Janine Dixon is Senior research fellow at Victoria University; Ross Guest is Professor of Economics and National Senior Teaching Fellow at Griffith University, and Tony Makin is Professor of Economics at Griffith University

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Economic theories that have changed us: game theory

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Partha Gangopadhyay, University of Western Sydney

Welcome to our series on economic theories that are changing the way we think. Today, Partha Gangopadhyay explains game theory.


Notwithstanding lingering discontent, faint murmurs and mild protests among economists, there is no denying the fact that game theory has assumed central importance in modern economics. In 1994 the first Nobel award to three game theorists – including mathematician John Nash – officially recognised the enviable role that game theory has played in advancing and propelling economic theory.

Game theory is concerned with decision-making in an interactive world such that the best decision of every decision-maker depends on what decisions others make. As a result, everyone in this interactive world, for advancing one’s self interests, will need to predict decisions of others.

Game theory officially entered the world in 1944 with the publication of the magnum opus in game theory, “Theory of Games and Economic Behavior”. This was a joint collaboration between an Austrian economist, Oskar Morgenstern, and John von Neumann – a universally acclaimed genius, polymath and polyglot from Hungary.

But for the purists the exact birth year of game theory is 1928 when von Neumann formally constructed the mini-max theorem in a paper entitled “Zur Theorie der Gesellshaftsspiele” published in a German mathematical journal known as the Mathematische Annalen.

Von Neumann was an undisputed genius, but he was a mediocre poker player and quickly realised that the probability theory cannot help one win poker games. His great appreciation for sketchy information, second-guessing and unpredictability of poker games laid the foundation of game theory: how poker players can hide information by strategically releasing information through their moves and prompting mistakes from rivals.

In other words, he formalised how poker players can “bluff” their rivals by playing a string of strategies that is supposed to deceive their rivals and hide information and finally win the game.

The theory has a fascinating interaction with George Orwell’s 1949 dystopian novel, 1984, set in a world mired in a world of perpetual war, intrigues, bluffs and public manipulation. So game theory is similarly rooted in this Orwellian world of deceit, information fudging and above all winning games and wars.

(Yet, modern game theory may have had another creator in the outstanding French mathematician, Emile Borel, who published at least two papers in 1921 in the context of poker games in French. Von Neumann did not acknowledge Borel in his 1928 publication and one will never know for sure whether von Neumann was blissfully ignorant, or just bluffing. In any case, Borel did not formally challenge this oversight.)

As game theory came of age, it was only a matter of time before it became a part and parcel of the perpetual war Orwell described. In 1948 von Neumann was hired as a consultant to the RAND Corporation – founded, funded and controlled by US defence contractors and the US Air Force – to “think about the unthinkable”.

The sole focus of RAND at that point in time was how to strategise to win future nuclear engagements if the USSR becomes a nuclear power. Von Neumann was to articulate a “preventive war” against the USSR.

Von Neumann urged the US to launch a nuclear strike at Moscow, destroying its enemy and becoming a dominant world power. Soon, von Neumann became a key member of the Manhattan Project. By 1953, as predicted by von Neumann, the Soviet Union amassed up to 400 warheads, ensuring what von Neumann later came to term ‘MAD’ – Mutually Assured Destruction.

By early 1950s von Neumann had become an intellectual luminary in the US. But his contribution was to be eclipsed in the public’s eyes by John Nash, who burst onto the scene with his 27-page PhD thesis in mathematics defining and proving the Nash equilibrium.

Nash, who died in May in a car accident aged 86, became the new hero in the mythological world of game theory when von Neumann died suddenly of pancreatic cancer in 1957. Yet he was considered a polarising figure by some game theorists. Nobel-laureate Eric Maskin, for instance argued that the concept of Nash equilibrium was “far and away Nash’s most
important legacy to economics and the other behavioural sciences” but had some important shortcomings.

Under the custodianship of Nash, it arguably became difficult, if not impossible, for mathematicians and economists to entertain and pursue research in multiple Nash equilibria, which calls for the selection of one equilibrium from many possible equilibrium outcomes.

The legacy of John Nash in game theory is a unique and attainable Nash equilibrium, and game theory thus became totally clinical and totally removed from the real world.

The only exceptions among accomplished economists today are two other Nobel-laureates Thomas C. Schelling and Roger Myerson.

A focal point (also called Schelling point) in game theory is an equilibrium outcome, out of many, that players come to share and choose, because it seems natural, special, or relevant to them. An equilibrium is thus rooted in social theory and social expectations. In his 1960 book “The Strategy of Conflict”, Schelling describes “focal point[s] for each person’s expectation of what the other expects him to expect to be expected to do”. Myerson, on the other hand, highlighted how agents come to share one equilibrium outcome as a focal point out of many.


Read more in the series here.

The ConversationPartha Gangopadhyay is Associate Professor of Economics at University of Western Sydney.

This article was originally published on The Conversation. (Reblogged by permission). Read the original article.


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Economic theories that have changed us: asymmetric information

The Conversation

Richard Holden, UNSW Australia Welcome to our series on economic theories that are changing the way we think. Today, Richard Holden explains how asymmetric information – when one party to a transaction knows more about the deal than the other – affects everything from car sales and IPOs, to credit costs and tattoos.


You may not consider yourself an economist but you almost certainly have first hand experience of an aspect of economic theory called asymmetric information.

In short, it’s when one party to a transaction knows more than the other about the deal underway. Suppose you are interested in buying a used car. You scour the classifieds and find just the car you want, and it’s right in your price range. You meet the seller, who seems nice, and you buy it. On the drive home it breaks down. You have no warranty, no recourse, and are pretty annoyed. What happened? Well, the seller, of course, knew a lot more about the car than you did. He knew whether the engine was regularly over-revved, regular maintenance had been performed, if it had been garaged.

Now, this is a sad story for our poor car buyer but from an economist’s perspective it could have been worse. After all, there was trade. An economist’s real nightmare is when markets break down altogether.

Goodies and baddies

In a famous paper in 1970 titled The Market for Lemons, the Nobel Prize-winning American economist George Akerlof pointed out how this kind of asymmetric information – where one party to a potential transaction is better informed than the other party – can lead markets to fall apart completely.

Here’s the logic. Suppose there are two types of sellers: good types and bad types. Good types have good quality cars, say, and bad types have bad ones. And suppose that there are equal numbers of good and bad types. If the car is a good type, buyers are willing to buy. If it is a bad type, they are not. What happens in this market?

To answer that question, we need to use to logic of equilibrium and think not only about buyers and sellers valuations, but about their beliefs. So, suppose that there is market in which both good and bad types sell their cars. What will buyers believe about the quality of the car they are getting? They will think that there is a 50% chance it is good quality and a 50% chance that it is bad quality. So they will value it halfway between how they value a high quality car and a low quality car. And that will be the market clearing price. Low quality sellers are happy with this – they are getting more than their dud car is worth. But high quality sellers are not happy – they are getting less than their car is worth to them. Why would you sell something for less than you value it at? You wouldn’t, so the high quality sellers don’t sell. They exit the market.

Our hypothetical market is now comprised solely of low quality sellers. This is the phenomenon known as “adverse selection”: the participants in the market are the bad types. Realising this, buyers are no longer willing to pay the intermediate price. That would be crazy. So we are left with a market of low quality potential sellers, and buyers unwilling to trade. The market has completely unravelled. The economist’s worst nightmare has occurred: there are gains from trade (buyers want to buy high quality cars) but they go unexploited because of asymmetric information. What to do? One thing that sellers could do is offer a warranty. That way, if the car turns out to be low quality, the buyer get her money back. No low quality seller would offer such a warranty, so the adverse selection phenomenon is reversed – only high quality cars are offered in the market. It’s hard for an individual to do that, but big car dealerships can credibly do so. And that’s exactly what we see in the world.

Asymmetric information in the real world

This idea explains a whole lot more than car dealerships, which are just a foil for the thought experiment. Why is credit so expensive, and often under-provided, in developing economies? Why do minorities often pay higher interest rates? In both cases, it is because they often know a lot more about their ability to repay than the lender does. Why is it hard for some companies to undertake Initial Public Offerings (IPOs)? It is because the existing owners or management know more about the prospects of the company than the public markets do. Of course, humans adapt.

Akerlof’s fellow Nobel Laureates, Americans Michael Spence and Joseph Stiglitz, asked how the informed and uninformed parties, respectively, might improve their outcome. Spence showed how an informed party can improve her outcome through costly “signaling” (telling or showing buyers that her product is good quality). Stiglitz and fellow American Michael Rothschild showed how the uninformed party can improve her outcome through “screening” (sifting through clues to determine quality). These even help us understand why people seek education, get tattoos, go to church and why firms pay dividends or insurance companies offer multiple levels of cover. They’re all forms of signalling that send messages about a person, firm or product at the heart of a transaction. They’re messages that others can “screen” to make decisions about transactions involving those people, firms or products.

In fact, once you start thinking about it, it’s hard to imagine any economic activity in which one party doesn’t know more than the other. And this usually has an impact on the nature of market activity, changing the way we interact with the world.

Richard Holden is Professor of Economics at UNSW Australia. This article was originally published on The Conversation. Read the original article.

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