Friday, June 15, 2018

Bob Allen's new "poverty machine" and its implications

Several days ago Bob Allen gave at the Center for Liberal and Democratic Studies in Belgrade an excellent lecture on the evolution of his own thinking about the basic needs poverty line (BNPL) and on how he moved from the subsistence and respectability baskets to the more ambitious baskets that reflect consumption patterns and relative prices across time and space (his beautifully titled "When necessity displaces desire" recent paper in the American Economic Review).

It was a riveting lecture perhaps mostly because of its autobiographic or chronological character: we could follow Bob’s own thinking as it evolved over the last two decades. The most recent (and yet unfinished) project is to calculate the minimum cost basket, under the constraints on calories, proteins, fat, for each country in the world (and potentially across time) and thus to produce the BNPLs  that are time and space specific—while at the same time being the same in terms of the “objective” needs they satisfy.

Allen is thus solving the perennial problem that consisted in the trade-off the researchers had to face between equivalency (sameness) of the baskets and their local representativeness, The more you insisted in that the baskets be the same the less were they representative for some areas of the world. For example, if you insist that every basket have rice because it is a staple in East Asia, the basket will be unrepresentative for, say Africa. Idem for wine etc.

But if the “background” sameness is accomplished through calorific/protein constraints and linear programming (cost minimization under the constraints) picks the cheapest combination, then you do not face the trade-off any more. (Note that the trade-off may thus be solved for subsistence needs because they can be defined using the calorific and other minimal requirements. The trade-off is still very much alive when it comes to PPPs because they deal with average consumption patterns which depend on tastes and preferences, and cannot be “codified” as the basic needs can.)

What Allen did was to create a unified approach for  solving the food component of the BNPL and partly the non-food. The food part is solved in the way I just described. The non-food component of housing and clothing is solved by using differences in climate: the needs are obviously greater in cold than in temperate or warm climates.

Now, note that none of these approaches was unknown. Allen mentions George Stigler’s 1945 paper as precursor. But the view that the needs in tropics and cold climates are different has (I would say) a millennial history probably going back to Herodotus. To go to the more recent times note that Colin Clark in his “Conditions of Economic Progress” argued that we should have two “international dollars”, one for the temperate areas and one (“oriental”) for warmer climates. Even the use of linear programming to solve for the minimum cost combination is not new. I remember seeing it used in the World Bank Poverty Assessments in the 1990s (in particular I remember a Poverty Assessment for Russia where it was used), and I doubt that the World Bank discovered it then. The idea was around for a while.

But Bob created a powerful “machine”, using these insights, a machine that, as I mentioned, delivers poverty lines “subscripted” for time and place. What did this “machine” produce?

First, it falsified the World Bank standard approach where $PPP 1.90 poverty line was supposed to really reflect the same consumption opportunities (bundles) across the world.  Mostly because of the differences in housing and clothing costs, but also in relative food prices, Allen shows that this line is broadly correct for African countries but that in Asia and in middle-income countries to achieve the same  level of calorific intake, clothing, shelter you need between $PPP 2.50 and $PPP 3.50, and that in rich countries, you need about $PPP 4.50. This means that the monetary amount of the global poverty line ought to vary between the countries.

Second, Allen’s results represent (in some ways) a revindication of the Pogge-Reddy critique of the World Bank approach. More than a decade ago, Thomas Pogge and SanjayReddy criticized the unique poverty line for the whole world by arguing that it underestimates the cost of food in poorer countries. Relative price of food in poor countries is higher than what is obtained from general PPPs. Although the Pogge-Reddy critique comes from a different direction, Allen’s results vindicate it in the sense that they show that a single global poverty line cannot do the job that the World Bank, since the first poverty report in 1990, claimed it could.

But, intriguingly, Allen’s work in this area has also implications for his work in another area: the origins of the Industrial Revolution. As is well-known, Bob is the originator of the hypothesis of High Wage Economy (HWE), an argument that the Industrial Revolution was driven by high cost of labor in England (and low cost of energy) which made the substitution of labor by capital profitable. This was most famously seen in the evolution of the welfare ratios (nominal wages divided by the cost of the subsistence basket) for North-West Europe vs. Italy vs. China/India. While all three welfare ratios were about equal in the 15th century, they diverged afterwards with North European being much higher and China/India’s welfare rations plummeting. Allen saw in that divergence the origin (and not the effect) of the Industrial Revolution.

Now, with the poverty lines that are subscripted for place and time,  what we see to be a welfare ratio from the worker’s perspective is no longer the same thing as the cost of that worker to a capitalist.  The new methodology introduces a wedge between what is the worker's welfare and what is the cost of labor for the capitalist. This is most obviously seen in Allen’s former and new results for Russia. With the same basket across all countries (the earlier approach) Russian welfare ratio during most of the 19th century was 2; with a climate/country specific baskets, the welfare ratio is around 1 (that is, is much lower because of high requirements imposed by a cold climate).

But note that the cost of that worker to a Russian capitalist is still twice as high as the cost of an equivalent worker (at the same subsistence) in India. When we now draw the welfare ratios using Allen’s new methodology, we have to explicitly state that they reflect welfare ratios from the worker’s perspective, not the cost of labor. The implication of this wedge is that, following Allen’s own HWE hypothesis, introduction of machines is --everything else being the same—more profitable in the North than in the South.

If that’s the case, then a geographically-determined explanation for the Industrial Revolution suddenly looks more plausible than before. So, I thought, perhaps one (unintended) effect of Bob’s new and much improved methodology is to help the geographical explanations for the rise of the West.  

Wednesday, June 6, 2018

Kate Raworth’s economics of miracles

My first Summer book  to read and review is Kate Raworth’s very successful “Doughnut economics: Seven ways to think like the 21st-century economist”. It is an ambitious book whose objective is to change the ways economists think and the economics is framed in order to respond to the “limits to growth”. It thus reconsiders the organization of the economy, from the financial sector, money creation, ownership structure of companies to the distribution of assets. It also wrestles with the “addiction” to economic growth, not only among the policy-makers but among most of the population (that understandably want more things) and it finally envisages a rich society with “zero growth”. The last term is avoided by Raworth by saying she is agnostic about growth and by presenting future growth as undulating around a stable level, with the economy at times going down and at times up “(“[we] embrace growth without exacting it”, p. 270).

The book is probably better than its competitors in the area. For example, Raworth’s discussion of inequality where she argues for the equalization of endowments rather than expansion of policies that  redistribute current income, makes lots of sense. Suggestions for the use of various incentives to make companies more environment-friendly are also plausible. Perhaps even the imaginative use of electronic currencies may help.   

Yet the book fails to convince for three reasons.

First, it never faces squarely (or even indirectly) the fact that if everybody in the world is to be “allowed” to have income level equal to the current median in the rich countries, world GDP would have to increase three times—not accounting for the rise in the world population. This is a fact for which Raworth has no answer and thus prefers not to mention it. (For obviously, if one is against trebling world GDP, one needs either to accept that half of the world population will continue living in poverty, or to produce some evidence that carbon intensity of production will suddenly plummet.)  

Second, numerous examples of companies and people who do innovative “green” things are listed (which is quite useful) but their importance is never assessed. The reader is right, I think, to feel that their importance is marginal and while progress is made, it is minimal compared to what needs to happen.

Third, the interpretation of the current phase of globalized capitalism is, in my opinion, wrong. Rather than seeing it, as Raworth does, as becoming more cooperative and “gentler”, it is more correct to see the inroads of commodification into our personal lives (which we not only willingly accept but promote) as moving us further toward a self-centered, money- and success-oriented society—that is, going exactly in the opposite direction from that which Raworth favors.  

I will illustrate this last point with Raworth’s discussion of intrinsic vs. extrinsic motivation. This last point (Chapter 3), where Raworth shows, based on empirical studies, that extrinsic (money-driven) motivations may at times produce worse outcomes than the use of non-cash motivation (emulation, social pressure etc.) is, in my opinion, the best part of the book—but it is also the one where I disagree, not with the arguments, but with Raworth’s interpretation of the current state of the world and tacit forecasts for the future.

Raworth very persuasively shows that working on intrinsic motivations may often be preferable (measured in terms of hard-nosed efficiency) than using cash grants. I agree with that (actually, I just follow the studies that show that) but I think that the contemporary hyper-commercialized capitalism leads us more and more to value only monetary incentives and to disregard others—even if the latter can produce better outcomes. But to do so they have to be grounded into traditional social norms, traditional hierarchy, social capital and the like, the very things which globalized capitalism erodes daily. Thus I conclude that non-cash incentives, despite their advantages in many situations, are doomed to extinction. Kate implicitly argues the opposite: if they are better they should be used more. But by whom? What are the social forces to promote them? Who has the incentive to do so? Is today’s societies’ ethos compatible with them?

And here appears the major weakness of the book. The world Kate has in mind is a world essentially devoid of major social contradictions. It often comes close to the world of Bastiat’s “universal harmonies”.  In many instances, Kate writes in the first-person plural, as if the entire world had the same “objective”: so “we” have to make sure the economy does not exceed the natural bounds of the Earth’s “carrying capacity”, “we” have to keep inequality within the acceptable limits, “we” have an interest in a stable climate, “we” need the commons sector. But in most of the real world economics and politics, there is no “we” that includes 7.3 billion people. Different class and national interests are fighting each other.

The same “we-ism” is apparent when Raworth calls for deemphasis (“agnosticism”) of economic growth. I have already mentioned that the world’s poor get a short shift, but the argument why growth in the rich countries should cease, and how to go about it, is also presented in a most confused fashion (and perhaps there is no way to present it better). Raworth acknowledges that economic growth is needed to soften distributional conflicts, to maintain democracy, as well as for people’s subjective happiness but she fails to provide any persuasive arguments  how a new “no-growth” regime will come about (who is going to vote for it?) nor how it would solve these real issues. “We” should somehow be magically transformed from acquisitive and money-grubbing beings, traits which the system itself encourages in us, to people, who under the same system, are rather indifferent to how well we do compared to others, and do not really care about wealth and income.      

Short of magic, this is not going to happen. It then becomes apparent  that Raworth’s book is a book of miracles, as well as why in such a world of miracles, the real “miracle” which is Chinese growth that has pulled out of abject poverty some 700 million people goes all but unmentioned. The reason is that poverty was eliminated by “dirty” growth that has polluted Chinese cities and the countryside, disrupted Arcadian idyll between man/woman and nature—and yet made the lives of millions incomparably better.

Raworth’s ideal world seems to be the one that we find in Giotto’s paintings of St Francis, but it is not the world we inhabit. In an attempt to convince us that “other worlds are possible” Raworth uses the example of an Indian tribe in northern Manitoba which a couple of centuries ago responded to an increase in price by providing fewer goods.   

Rather than proposing the economics for the 21st century, Raworth’s book brings us back to the imaginary world of the early Christendom. Perhaps that such imaginary people were then “thriving” (a term Raworth uses at least 50 times in the book), but the real world even in those times was different: it was the world of Augustus and Spartacus, burned temples and fortunes made through violence. Exactly like ours. Except that we are richer. Which is a good thing.

Thursday, May 31, 2018

Europe’s curse of wealth

I have already written  before (in a tweet) that no one who travels through Western Europe, especially in Summer, can fail to be impressed by the wealth and beauty of the continent as well as by its quality of life. The latter is less obvious in the United States (despite US higher per capita income) in part because of the greater size of the country and lower population density: US thus does not present to the traveler the spectacle of an impeccably maintained countryside dotted with numerous castles, museums, excellent restaurants and Wi-Fi, that one sees in France, Italy or Spain. I think that one can reasonably argue that no people in the history of the world have lived so well as the West Europeans today, and Italians In particular. Yet, as everybody knows, there is a deep malaise and dissatisfaction across the continent, not least in Italy: unhappiness with how European politics work, with immigration, with the prospects of the young generation, precariousness of jobs, inability to compete with a cheaper labor force from Asia or to catch up with American IT giants and American start-up culture. But I will not write about this today. Instead I would like to focus on two “curses of wealth” which paradoxically European prosperity bares

The first curse of wealth has to do with migration. The fact that the European Union is so prosperous and peaceful, compared both to its Eastern neighbors (Ukraine, Moldova, the Balkans, Turkey) and more importantly compared to the Middle East and Africa means that it is an excellent emigration destination. Not only is the income gap between the “core” Europe of the former EU15 and the Middle East and Africa huge,  it has grown.  Today, West European GDP per capita is just shy of $40,000 international dollars; sub-Saharan’s GDP per capita is $3,500 (the gap of about 11 to 1). In 1970, Western Europe’s GDP per capita was $18,000, sub-Saharan, $2,600 (the gap of 7 to 1). Since people in Africa can multiply their incomes by ten times by migrating to Europe, it is hardly surprising that, despite all the obstacles that Europe has recently began placing in the way of the migrants, they keep on coming. (Would, say, a Dutch citizen be indifferent between  making 50,000 euro annually in the Netherlands and half-a-million in New Zealand?)

Given the size of the income gap, migration pressure will continue unabated or greater for at least fifty or more years —even if Africa in this century begins to catch up with Europe (that is, to grow at rates higher than those of the European Union). Nor is that pressure, in terms of the number of people who are banging on Europe’s doors, static.  Since Africa is the continent with the highest expected population growth rates, the numbers of potential migrants will rise severalfold. While the population ratio between today’s sub-Saharan Africa and the EU is 1 billion vs. 500 million, in some thirty years, it will be 2.2 billion vs. 500 million.

But migration, as everybody knows, creates unsustainable political pressures on European countries. The entire political system is in a state of shock—as Italy’s cries of having been left alone by its European partners to deal with migration, or Austria’s and Hungary’s decisions to erect border walls, illustrate. There is hardly a country in Europe whose political system was not shaken by the question of migration: rightwing shifts in Sweden, the Netherlands, and Denmark; accession to parliament of  AFD in Germany, the renewed appeal of Golden Dawn in Greece.

Other than migration, the second issue fueling European political malaise is rising income and wealth inequality. European inequality is, in part, a “curse of wealth” too. The wealth of the countries whose annual income increases over several decades does not rise only in proportion to income but by more. This is simply due to savings and accumulation of wealth. Switzerland is not only richer than India in terms of annual production of goods and services (the ratio between the two countries’ GDPs per capita at market exchange rates is about 50 to 1), but Switzerland is even "more richer" in terms of wealth per adult (the ratio is almost 100 to 1).  
The implication  of the rising wealth/income ratio as countries grow more prosperous is that the amount of income from capital tends to increase faster than GDP. When wealth is heavily concentrated, as is the case in all rich countries, the rising capital share in total output almost automatically leads to an increase in inter-personal income inequality. To state it in simple terms, what is happening is that the income source that is very unequally distributed (profits, interest, dividends) is increasing faster than the source that is less unequally distributed (wages). Thus, if the very process of growth tends to produce higher inequality, it is clear that stronger measures to combat its rise are needed. But in Europe, like in the United States,  there is lack of political will (and perhaps it is difficult to summon it in the era of globalization when capital is fully mobile) to increase taxes on high earners, to reintroduce in many countries taxation of inheritance, or to enact policies in favor of small, rather than big, investors. There is thus a policy paralysis in the face of political upheaval.

When one puts these two longer-term trends together: continued migratory pressure and a quasi-automatically rising inequality, that is, the two problems that today poison European political atmosphere, and one contrasts this with the difficulty of moving decisively towards solving either of them, it is not surprising that one might expect political convulsions to continue. They will not be gone in a couple of years. Nor does it make sense to accuse “populists” of irresponsibility or to believe that people preferences have been distorted by “fake news”. The problems are real. They require real solutions.