THE FAIRNESS TEST

Just out from the Reform thinktank in the United Kingdom is a report The Fairness Test.  The author is Dr Patrick Nolan, formerly of the New Zealand Institute of Economic Research.

The current UK government has defined fairness as one of its three core values (together with freedom and responsibility).  The report argues that the current debate on fairness is flawed and in danger of leading policy astray:

• It is dominated by measures that emphasise existing spending through the tax and benefit system.
• It assumes that more government spending is synonymous with fairness.
• Many arguments around progressivity and inequality are based on little more than assertion.
• The role of economic growth in providing resources for redistribution is often ignored.
• The actual nature of tax avoidance and evasion (the tax gap) is poorly understood.

It concludes that:

To avoid these problems clearer thinking on fairness is needed. While there is no one single agreed view on fairness most people would accept that the extent to which government actions combat disadvantage should be central to any definition. This supports a focus on education and welfare reform. This does not support encouraging high-earners’ migration, maintaining the middle class money-go-round, increasing personal tax allowances or postponing difficult decisions.

Some specific points in the report resonate with debates on fairness and social policy in New Zealand.

On the book The Spirit Level, the report states:

There is no proven connection between the claims in The Spirit Level and the implied policy responses. The theory on equality could, for example, be used to justify a flat tax (which would equalise proportionate sacrifice).

It notes Okun’s “leaky bucket” trade-off:

Spending on welfare not only comes at a financial cost to the taxpayer but also creates other economic and social costs. This can be illustrated by the famous trade-off between equality and efficiency, which Arthur Okun described as the “leaky bucket.” Money transferred to the poor to alleviate poverty must be, as he wrote, “carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich.” The losses are due to administration costs and incentive effects. These incentive effects are due to people who are receiving welfare having less incentive to work as they are able to reach a desired standard of living with a lower level of work effort and they may face clawback of assistance as their incomes increase.

The report rightly stresses “the dynamics of income distribution (that people will move up and down in the income distribution over their lifetime” rather than static analysis, and the importance of facilitating social mobility, eg through education.

It criticises the use of personal tax allowances, noting that they benefit primarily higher income earners and damage work incentives because they require higher marginal tax rates to replace lost revenue.  A tax-free threshold, as proposed for New Zealand by the Labour Party, would have similar effects.

Interesting points are made about welfare reform in the United Kingdom, echoing material in the recent Welfare Working Group report in New Zealand:

• The flipside to having a welfare system which provides an important social safety net is that most people can reasonably be expected to take up work if it is available and adequate.
• The welfare system is too complex. The Department of Work and Pensions’ Decision Makers’ Guide is no less than 8,370 pages long.
• One of the first initiatives the Government announced was the Work Programme, which will outsource all welfare to work services. The new commissioning framework will give providers longer and larger contracts, greater freedom and will fund welfare to work services through the savings made in reductions in benefit expenditure. Following reforms begun under the previous Labour administration, a number of benefits for people out of work (such as the incapacity benefits) have been reformed to be more active. These are the right changes.

On education, the report endorses the moves by the UK government to adopt a Swedish-type education voucher programme, saying:

The greater use of choice and competition in the education system can support fairness. Competition is not a zero-sum game where the profits made by private sector companies deprive public services of funds. This zero-sum view ignores productivity. Profits (especially when they attract new entrants into markets) can encourage competition and drive up standards and productivity. These productivity improvements can mean, for example, that the supply of services can expand even when costs are falling. Indeed, as Tony Blair has argued:

“Choice mechanisms enhance equity by exerting pressure on low quality or incompetent providers. Competitive pressures and incentives drive up quality, efficiency and responsiveness in the public sector. Choice leads to higher standards. The over-riding principle is clear. We should give poorer patients or parents the same range of choices the rich have always enjoyed. In a heterogeneous society where there is enormous variation in needs and preferences, public services must be equipped to respond.”

The Business Roundtable has discussed issues of fairness in social policy in a number of reports.  They include the books Equity as a Social Goal by Cathy Buchanan and Peter Hartley, and Middle Class Welfare by James Cox.  Both are cited in the Reform report.

The Spirit Level 2

The Sunday-Star Times and journalist Anthony Hubbard in particular appear to have embarked on a crusade against inequality in New Zealand, motivated by the 2009 book The Spirit Level by British academics Richard Wilkinson and Kate Pickett (neither of whom are statisticians or economists).

To read the Sunday Star-Times you would never know that the book has been subject to devastating criticisms.

I had a lengthy blog on the book on 22 December, citing several references.

I also wrote this article which appeared in the Sunday Star-Times of 30 January.

For a biting short summary of some of the criticisms, see this article titled ‘If you want something trashy to read on the beach, I’ve got a recommendation’ by Toby Young in The Spectator of 14 August 2010.

Young refers to a paper by Peter Saunders published by the London think tank Policy Exchange which can be found here.

Saunders writes that the message of The Spirit Level, that redistribution is the cure of most social ills:

… has received an enthusiastic reception from politicians and pundits on the left who believe The Spirit Level offers a rational, evidence-based justification for the radical egalitarianism to which they have long been emotionally committed. However, careful evaluation and analysis shows that very little of Wilkinson and Pickett’s statistical evidence actually stands up, and their causal argument is full of holes.

He goes on to say:

In this report, Wilkinson and Pickett’s empirical claims are critically re-examined using (a) their own data on 23 countries, (b) more up-to-date statistics on a larger sample of 44 countries, and (c) data on the US states. Very few of their empirical claims survive intact.

And Saunders sums up:

This report shows that The Spirit Level has little claim to validity. Its evidence is weak, the analysis is superficial and the theory is unsupported. The book’s growing influence threatens to contaminate an important area of political debate with wonky statistics and spurious correlations. The case for radical income redistribution is no more compelling now than it was before this book was published.

According to a chart in the Sunday Star-Times, Australia comes just under New Zealand on the measure of inequality used.  There seems to be little political support in that country for the kind of redistributive measures advocated by Wilkinson and Pickett: the emphasis is, correctly in my view, on economic reform to lift all incomes.

I agree with Toby Young that the book “belongs in the trash pile”. Others are free to disagree, but if they do it is dishonest not to acknowledge the criticisms and engage with them.

The Spirit Level

For some time we’ve been hearing about The Spirit Level,[1] a book first published in 2009 advancing a case for equality of income. Many enthusiasts for the book have followed the authors in promoting it as an evidence-based, ‘scientific’ statement of the case for equality, as if no right-thinking person could disagree with it.  What’s going on?

The book differs from previous literature on equality in that it doesn’t argue principally that equality of income is the only just and fair distribution of income. The authors actually do believe this, but to get the necessary political consensus for equality they set out to prove that, as the book’s subtitle puts it, “equality is better for everyone”. They want to make the case for equality universally irresistible as well as irrefutable.

The authors, Richard Wilkinson and Kate Pickett, are epidemiologists at British universities, and when they say that equality is ‘better’ for everyone they mean that it promotes our physical, mental and social well-being.  They don’t mean that it promotes ‘welfare’ in the typical economist’s sense of maximising the consumption of goods that individuals define and choose for themselves.  They are quite clear that economic freedom must be curtailed if it prevents more well-being from being realised through the equalisation of incomes.  But they are confident that the promise of greater well-being will persuade us to prefer to equalise incomes rather than to increase them.

The authors set out by asserting what they take to be two established facts.  The first is that in developed countries economic growth no longer much increases individual economic welfare.  The ‘happiness curve’ that people in poor countries ride up as they become richer eventually flattens out, as it already has in the richest countries. The second established fact is that man-made global warming threatens a global environmental catastrophe, and so economic growth will have to be ended anyway in order to control carbon emissions.  But we can still improve our well-being by moving towards equality of incomes.  The core of The Spirit Level is its presentation of research results to back up this claim.

The authors argue that a range of pathologies are all several times worse in the most unequal developed countries than they are in the most equal ones. The same pattern is evident in US states: the most unequal states do much worse than the most equal ones.  Of the wide range of indicators used, the central ones are tenfold: level of trust; mental illness (including drug and alcohol addiction); obesity; children’s educational performance; teenage births; homicides; imprisonment rates; and social mobility (this last indicator is not available for US states). Using internationally recognised definitions and comparisons of these ten indicators, and drawing on data from 23 developed countries and the 50 US states, the authors show that the problems are worst in the most unequal countries, which include the United States, Portugal, the United Kingdom, New Zealand and Australia, and the most unequal US states, typically those of the South.  They are least bad in the most equal countries, which include Japan and the Scandinavian countries, and in the most equal US states, which are geographically dispersed and include Alaska, New Hampshire, Utah and Iowa.

The authors find only a weak relationship between the indicators and average incomes among rich countries (and the US states), which suggests that it’s the inequality of incomes that’s significant; and they believe that cultural explanations of the relationships don’t stand up to scrutiny. They conclude that inequality of incomes actually causes or exacerbates health and social problems. The more unequal a society is, the less people trust one another; those at the bottom of society are more likely to feel stressed and demoralised, to engage in self-destructive behaviour and to fall ill; and everyone is more likely to seek solace in wasteful and futile consumerism.  More equal societies, in contrast, are less atomised, more socially mobile, more socially relaxed and healthier.

In the final part of their book the authors canvass policies to lessen the extremes of income inequality in the most unequal societies.  They want to raise the lowest incomes with higher minimum wages, but they’re more concerned with dismantling concentrations of wealth by, for example, taxing the very rich heavily (they entertain a top income tax rate of 60 percent – see how serious they are about ending economic growth!) and by promoting alternatives to the standard corporate model with schemes like employee share-ownership and control of companies, and, in finance, by encouraging credit unions and mutual funds as alternatives to orthodox banking.   They have no doubt that the outcome of these changes would be a great advance in well-being. They have set up the Equality Trust (www.equalitytrust.org.uk) to help get a social movement for equality going.

But they haven’t had a completely clear run. Already at least two books have appeared challenging the central claims of The Spirit Level.[2]  Their authors argue that the analysis of social problems and income inequality suffers from many defects.  For example, there is the omission of countries like South Korea, Slovenia and the Czech Republic, which are relatively equal but don’t achieve high levels of well-being, and also Hong Kong, which is, conversely, highly unequal but scores highly on the well-being criteria. The authors of The Spirit Level are responding to criticisms on the Equality Trust website.  The debate will go on. It’s quite possible that the entire Spirit Level thesis will eventually disintegrate under the weight of such criticism, and be forgotten. It’s equally possible that some of the book’s claims will survive more or less intact.  But to my mind the central problem with the book is not its possibly defective analysis of the link between income inequality and health and social problems. It is its opening assertion that in the rich countries economic growth no longer promotes welfare.  (I cannot deal here with the second assertion, about climate change, but claims about the scientific irrefutability of the fact of man-made climate change have waned as legitimate doubts have emerged both about it and about the appropriate policy response to it.)

The claim that in the rich countries economic growth no longer promotes welfare indicates how irrelevant The Spirit Level is to the central political issue now confronting all developed countries, which is how to cope with the huge and growing demand for government spending brought about by demographic change. The global fiscal crisis is not just a short-term matter of closing structural budget deficits and stopping the rise of national debt; it is a long-term one of financing the pensions and health care of populations that are ageing as life expectancy rises, fertility rates are low, and the ratio of dependants to workers grows.  Economic growth is an indispensable part of the policy mix that governments are devising to meet the challenge. This has nothing to do with satisfying a taste for ‘consumerism’ or vainly pursuing more ‘happiness’; it’s about preserving existing standards of living and well-being which, without economic growth, would soon start to slip back, threatening vulnerable groups with poverty. This is well understood in Sweden, which the authors of The Spirit Level consistently find to be among the most equal and healthiest of countries. The election there on 19 September 2010 confirmed the conservative government in a second term of office after it implemented a programme of tax cuts, which beat the recession by reducing unemployment and creating about 100,000 jobs.[3]  Sweden’s economy is now growing at the impressive rate of about 4 percent a year.  The country may be somewhat less equal as a result of the tax cuts; but who apart from the authors of The Spirit Level would deny that the cuts were good policy?

Another relatively equal and healthy country is Japan. It faces perhaps the biggest demographic challenge of all the developed countries. Unlike Sweden, it allows in very few immigrants to boost the workforce.  A sizable immigration programme would doubtless increase inequality.  But if the Japanese nevertheless implemented one, how many observers would think they’d made a mistake?

By dismissing economic growth so brusquely from the outset, the authors of The Spirit Level exclude from their analysis any possible links between continuing economic growth and well-being even in relatively unequal developed countries. But such evidence exists. Writing recently in The Australian, Michael Stutchbury summarised the Australian Bureau of Statistics’ latest snapshot of Australia’s national progress during a ten-year period in which Australia’s per capita gross domestic product grew by 23 percent in real terms. He wrote,

A key indicator of health – life expectancy at birth – confirms Australians are living longer. In the decade to 2008, life expectancy for girls rose 2.2 years to 83.7 years and by 3.3 years to 79.2 years for boys. The suicide rate, which the ABS classifies as an indicator of social cohesion, has fallen even amid concerns about worsening mental health. The suicide rate for men aged 20 to 24 halved during the same period. And volunteering, seen as an indicator of social networks, has increased, up from 24 per cent in 1995 to 35 per cent in 2006.[4]

This last item in particular – the growth of volunteering – shows how utterly misguided the authors of The Spirit Level are to dismiss economic growth as the search exclusively for ever more material wealth.  On the contrary, economic growth makes it possible to pursue ever more non-material goods.  Higher productivity progressively reduces the time that has to be devoted to meeting material needs, so allowing more scope for other activities, including those of a social nature that the authors of The Spirit Level value.

I share much of the aspiration of The Spirit Level for more equality although I worry more about poverty and hardship and how to alleviate it.  A simple thought experiment shows that promoting income equality per se is not a sensible social goal.  Consider what would happen if Bill Gates and Steve Ballmer decided to move Microsoft’s Seattle headquarters, and all its US million dollar employees, to New Zealand.  Income inequality would ‘worsen’.  But how many New Zealanders would regard that as a bad thing?

Experience suggests that the compulsory imposition of economic  equality can eventually be self-defeating and impoverishing – which is why Sweden is rowing away from it.  Yet economic and social reform often promotes equality as an unintended but desirable side effect of promoting freedom and efficiency. Thus, educational reform to enhance national skills could improve the performance of the poorest social groups most, since they have the most to gain. Welfare reform would free the poor to take advantage of opportunities to rise up the income ladder and to escape the physical and mental health risks of dependency. At the other end of the scale, the global financial crisis has exposed the enormous incomes of some bankers as symptoms of barriers to entry into finance (allowing bankers to consume the implicit government subsidy arising from banks being ‘too big to fail’) and also of management domination of financial institutions.  Improvements to financial regulation, competition policy and corporate governance would help to spread the profits of finance more widely, crucially to shareholders, which include superannuation funds.  A shift away from the prevalence of bank credit towards other, possibly safer forms of finance might well see the growth and spread of mutual funds, credit unions and still other kinds of financial institution, like the internet bank Zopa.  And where economic freedom prevails, non-corporate forms of economic governance can be tried.

For a further international perspective on income inequality see this paper by Will Wilkinson of the Washington-based Cato Institute.  The summary reads as follows:

Recent discussions of economic inequality, marked by a lack of clarity and care, have confused the public about the meaning and moral significance of rising income inequality. Income statistics paint a misleading picture of real standards of living and real economic inequality. Several strands of evidence about real standards of living suggest a very different picture of the trends in economic inequality. In any case, the dispersion of incomes at any given time has, at best, a tenuous connection to human welfare or social justice. The pattern of incomes is affected by both morally desirable and undesirable mechanisms. When injustice or wrongdoing increases income inequality, the problem is the original malign cause, not the resulting inequality. Many thinkers mistake national populations for “society” and thereby obscure the real story about the effects of trade and immigration on welfare, equality, and justice. There is little evidence that high levels of income inequality lead down a slippery slope to the destruction of democracy and rule by the rich. The unequal political voice of the poor can be addressed only through policies that actually work to fight poverty and improve education. Income inequality is a dangerous distraction from the real problems: poverty, lack of economic opportunity, and systemic injustice.

My bottom line is that income equality may or may not promote well-being in the manner claimed in The Spirit Level.  Economic growth certainly does promote it. Attempts to promote well-being by engineering equality via the compulsory curtailment of economic growth and economic freedom can fail, by gradually undermining prosperity.  But the authors of The Spirit Level have more scope than they realise to promote their egalitarian ideals within the framework of economic freedom.

Some useful New Zealand data and perspectives on income inequality were contained in this recent presentation by Ben Gleisner of the Treasury.  His conclusions on trends are:

1.    Income inequality in New Zealand grew sharply between mid 80s and mid  90s, but stabilised recently

2.    Including government support, growth is less

3.    But still high inequality relative to other OECD countries

The first point is crucial.  The strongest driver of income inequality is usually unemployment.  This rose steeply in the 1980s with the refusal of the Labour government to free up the labour market.  It fell sharply from the early 1990s following labour market reforms.  There has to be a worry that the recent rise in unemployment, especially the loss of employment opportunities for many young people with the abolition of youth wage rates by the last Labour-led government, will see unemployment rise again.  The youth wage decision has been estimated by Eric Crampton of the University of Canterbury to have cost at least 9000 jobs.

Ben Gleisner also makes the point that educational outcomes and benefit dependency (as well as wealth inequality) matter for future equality.  An interesting slide shows that New Zealand scores the worst of all OECD countries for the variance in educational outcomes – the so-called ‘long tail’ of under-achievement.  Another slide highlights the problems of benefit dependency, with 25 percent of the Maori working age population on welfare benefits (2006 figures).  Typically people are better off – in income, health and other terms – by being in the workforce, even at low initial wages, rather than being on benefits.  This point is especially important from a long-term and intergenerational perspective.

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1. Richard Wilkinson and Kate Pickett, The Spirit Level: Why Equality is Better for Everyone. Allen Lane, 2009; Penguin Books, 2010.
2. Christopher John Snowdon, The Spirit Level Delusion: Fact-checking the Left’s New Theory of Everything, Democracy Institute/Little Dice, 2010; see also http://spiritleveldelusion.blogspot.com. Peter Saunders (ed. Natalie Evans), Beware False Prophets: Equality, the Good Society and The Spirit Level, Policy Exchange, 2010; see http://www.policyexchange.org.uk/images/publications/pdfs/Beware_False_Prophets_Jul_10.pdf
3. Fraser Nelson, ‘Swedish conservatives bucked the recession by lowering taxes – and won re-election’, The Spectator, 25 September 2010, p. 12.
4. Michael Stutchbury, ‘Plain old economic growth is good for society’, The Australian, 21 September 2010.