FRIDAY GRAPH: THE SPRAWLING BUREAUCRACY

A picture can tell as much as a thousand words. Here is a chart from a talk given by Andrew Kibblewhite, deputy chief executive of the Treasury, to the Institute of Policy Studies on 1 April this year.

 In Mr Kibblewhite’s words, “This chart underscores just how comprehensively our small country has divvied up our state sector into a clutter of agencies.”

The government has embarked on some restructuring and mergers, but in my experience the gains from such efforts over the years have not been great. An article in today’s Business Herald suggests we may be seeing the same thing this time round. It reads:

The merger of the Department of Internal Affairs, National Library and Archives New Zealand; the coming-together of the Ministry of Agriculture and Forestry and the Food Safety Authority; and the merger of the Ministry of Research, Science and Technology  and the Foundation for Research, Science and Technology have gone relatively smoothly. The $24 million in savings over four years was originally going to be offset by some $11 million in transition costs. Now, though, the agencies have had to find another $8 million in capital expenditure from within their balance sheets to “provide the necessary infrastructure and capability” – much of which can be translated as “none of our computer systems will work with each other”.

Two things in my view are much more important than rearranging the bureaucratic furniture.

The first question that should be asked is whether we need parts of the furniture at all.
On coming to office John Key as minister of tourism abolished the Ministry of Tourism.  Has anybody noticed or cared?

Second, instead of focusing on restructuring the bureaucracy (often by establishing advisory groups of bureaucrats), the government would do better to focus on leadership by top quality CEOs. Numerous appointments in recent years have been unimpressive, and there has been little sign of the State Services Commission moving poor performers on. The government would find that top CEOs would solve many of the problems of bureaucratic sprawl and inflated headcounts by themselves.

THE TREASURY’S LIVING STANDARDS DOCUMENT: NEW WINE OR OLD BOTTLES?

In May the Treasury published a paper Working Towards Higher Living Standards for New Zealanders.

It corresponds loosely with similar exercises by the OECD (on which I blogged recently) the IMF, the US Treasury and the Australian Treasury.

It’s not immediately obvious what’s new in the Treasury’s thinking.  The paper makes the conventional points that GDP as a measure of welfare has its limitations and that in framing policy, factors such as equity, environmental quality, the benefits of leisure and social cohesion need to be taken into account.  All these have been well-accepted principles of public policy in New Zealand for as long as I can remember.

Somewhat more prominence is given to individual rights and freedoms than in past Treasury writing.  However, the authors’ grasp of relevant concepts seems a little unsteady.  At one point the paper observes:

Some of the rights and freedoms that institutions should protect can be considered absolute and should not be traded off for another person’s wellbeing.  For example, the United Nation’s Universal Declaration of Human Rights (United Nations, 1948), to which New Zealand is a signatory, sets out rights that are intended to be alienable and indivisible.

But this is immediately followed by the claim that “the right to one’s property is not an absolute right.”  Presumably the authors have not stumbled on Article 17 of the declaration which reads:

(1) Everyone has the right to own property alone as well as in association with others.

(2) No one shall be arbitrarily deprived of his property.

Australian economist Winton Bates (who spent some time in the New Zealand Treasury) blogged on the paper here.  He makes a good point when he says:

… it would be hard to find a better indicator of relative living standards as perceived by New Zealanders and Australians than net emigration to Australia. Net emigration to Australia seems to me to be a highly reliable indicator because the preferences that people show about where they live must be heavily based on their assessments of living standards.

The relevance of this indicator was not considered in the paper.

At the launch Treasury was asked how its new framework differed from the OECD’s framework for its New Zealand reviews.  No differences were identified.  The operational significance of the new framework appeared to be a blank space.

Winton Bates observed that:

In launching the framework the Treasury Secretary, John Whitehead, certainly did not try to hide the fact that an important objective of the exercise, as he sees it, is to bring about a shift in the way NZ Treasury is perceived externally. He said:

“Misperceptions of the role Treasury has played since the 1980s have limited our ability to be persuasive when talking about what matters most for living standards.  Some have never got beyond believing that we are the root of all New Zealand’s economic evils.  Others see us as little more than the defenders of fiscal virtue …”

Winton commented:

I find that baffling. In the 1980s the NZ Treasury played an important role in saving that country from economic ruin. Why is that not more widely understood and appreciated in New Zealand?

I find that baffling too.  The Treasury seems to be at pains to tell the outside world that it is much nicer than people think.  As a demonstration of how nice it is, it will acknowledge that GDP is not a fully satisfactory welfare measure.  And because it is fundamentally nice it deserves a better hearing and more influence.

This seems a Quixotic hope.  If Treasury is doing its job properly it will not be loved – by interest groups seeking political favours, and by ministers and government departments whose spending plans are thwarted.  What the Treasury should aspire to is not love but respect – for the quality of its work on behalf of taxpayers, consumers and the community at large.  It has lost a good deal of respect on account of sub-standard work in recent years.  There is ground to be made up.

 

 

 

THE TRUTH ABOUT PRIVATISATION # 15: PROFITS GOING OFFSHORE

Last year the Treasury provided a report to its ministers headed Should we be concerned about profits going offshore?   It is a competent analysis and very relevant to the privatisation debate.

The report begins with some important factual observations which are not well understood.  One is that New Zealand’s current account deficit is dominated by investment income and transfers because goods and services have been largely in balance over the past decade.

Another is that:

The result of a long period of current account deficits is a very high net international investment position (NIIP), at about -90% of GDP. The overall position is predominantly made up of net debt rather than net equity. That is, New Zealand’s investment position with the rest of the world is better characterised as owing a lot rather than being owned.

The report then moves on to analytical issues.  It makes a point I have made repeatedly in this series:

There are two sides to the sale of an asset: a one-off payment to the seller and an expected stream of profits to the buyer. If the price is efficient, these two sides of the transaction should be equivalent: that is, the purchase price represents the net present value of the future stream of profits (i.e. the commercial value). In general, in respect of sales of government assets the value of the business to the purchaser should exceed the commercial value of the asset if retained in Crown ownership because of the greater efficiencies likely to be achieved in private ownership. A competitive sale process should ensure that the value of those expected efficiency gains are captured by the Crown in the sale price.

As regards the effect of ‘profits going offshore’ on the balance of payments, the report states:

The fundamental drivers of the current account deficit are national saving and domestic investment. Selling an asset to foreigners will only have a significant effect on the current account deficit if it affects these fundamental drivers.

A quibble here is that I would not I would not take an identity A ≡ B and C and argue that B and C are the drivers of A.  We could as easily write that B ≡ A-C and A and C are the drivers of B.  It follows that I (investment) and S (saving) are not the drivers of CAD (the current account deficit) just because CAD ≡ I – S. All three variables are endogenous outcomes, even in a model as simple as the closed economy IS/LM model.

The report then correctly points out that:

When an asset is sold to overseas investors, these overseas investors will be required to pay for their purchase of the New Zealand asset. The impact on the current account deficit will depend on how the seller of the asset uses these funds:

• If the funds are used to increase [consumption] spending, national saving would fall and the overall current account deficit would increase.
• If the funds are used to invest in overseas equity, there would be no change in national saving or domestic investment and therefore no effect on the current account deficit.
• If the funds are used to repay overseas debt, there will be a deleveraging of New Zealanders’ balance sheets. The composition of New Zealand’s NIIP would change by reducing debt owed to foreigners and increasing equity owned by foreigners. Overall this would be expected to reduce New Zealand’s vulnerability, because the vulnerabilities associated with a high NIIP are somewhat greater for debt than equity

It is also important to explain that it is not New Zealand that owes the NIIP to foreigners.   New Zealand is a place, not a person. The place owes nothing.  Foreign entities operating in New Zealand can and do borrow offshore.  So do entities operating in New Zealand that are owned by New Zealanders. New Zealanders are only liable for debts they have incurred.  They are not liable for debts foreign-owned entities have incurred.     If this is not explained, lay people (and even too many economists) are led to assume that the NIIP is a liability of New Zealanders. They then start thinking that New Zealanders are ‘not saving enough’ if national savings (which is only savings by New Zealanders) is not equal to the sum of capital formation in New Zealand by New Zealanders and by foreign-owned entities.  It is then an easy step for them to then start worrying that if gross fixed capital formation is greater than national savings then ‘we’ must be spending more than ‘we’ are producing.   This does not automatically follow.

The Treasury report concludes:

In sum, we think focussing on ‘profits going offshore’ has a weak economic basis because it focuses on only part of the picture. So we do not think it makes sense to be concerned about ‘profits going offshore’ per se. The more important places to focus from a macroeconomic perspective are the overall saving and investment balance and New Zealand’s overall external vulnerability. 

In the final analysis, a concern about ‘profits going offshore’ applies to all foreign direct investment.  Particularly in an era of globalisation it is hard to make a general argument that foreign investment is bad for New Zealand.

 

 

 

FRIDAY GRAPH: THE GREAT SPEND-UP

The following chart uses Treasury–Statistics New Zealand long-term time series to show that the increase in real tax revenues per capita during the Clark-Cullen period rivalled the increased taxation to fund World War II and the first Labour Government’s big spending programmes. Quite a remarkable ‘achievement’, in peacetime.  (The dollars are June quarter 2006 dollars).  A grand opportunity for tax cuts during a period of strong economic growth was sadly missed. 

THE TRUTH ABOUT PRIVATISATION: BLOG # 10

Recently the Treasury released a December 2010 paper Short History of Post-Privatisation in New Zealand, written by John Wilson, an experienced former Treasury official.

It records in a balanced and objective way the history of nine major privatisations by central and local governments.  The companies surveyed are Ports of Auckland, Bank of New Zealand, Air New Zealand, Auckland International Airport, Telecom, Tranz Rail, Trustpower, Contact Energy and the Forestry Corporation.

The paper notes that

The selection of companies was intended to illustrate the issues that have arisen from privatisation. The list of companies is not comprehensive, nor is it necessarily a sufficiently robustly drawn sample to draw strong aggregate conclusions about privatisation in New Zealand. The strongest general conclusions about the merits of private rather than government ownership can be drawn from global studies with much bigger samples.

Not covered are many of the other 20 plus privatisations that would generally be regarded as successful, such as NZ Steel, Petrocorp, Postbank, Rural Bank, State Insurance, Works Development Services and Capital Property Services.

The paper notes the range of objectives of privatisation of governments around the world:

• Putting businesses under the full pressures of private capital markets, and thus making them more efficient.
• Reducing the exposure of the government balance sheet to risky debt financed assets.
• Removing the capacity of the businesses to seek government aid in bad times, thus both promoting better business management (to avoid that risk) and reducing risks to government fiscal outcomes.
• Promoting the development of local capital markets, and/or encouraging a broad ownership of shares in the community.
• Using the sale proceeds for higher priorities, typically to reduce government debt.

All of these objectives have been relevant at different times in New Zealand.

On methods of privatisation, the paper comments:

Typically, in an asset sale, the best price is obtained by selling a controlling shareholding to a single entity that can control the destiny of the business (a trade sale). A float generally gets a lower price.

New Zealand governments mainly employed trade sales, with some floats or sell-downs.  Privatisation was not ‘done the wrong way’, as some critics allege.

The paper makes a key point on how to judge privatisation:

The outcomes for the individual companies dealt with here vary a great deal. Some have prospered and greatly rewarded their shareholders; others have gone into financial distress and some of those have required government finance again. It is probably unfair to see both of these ends of the spectrum as indicative of failed privatisation. In any group of companies over two decades, some will prosper and some will fail. That is in the nature of a competitive economy.

Interesting points made on the nine privatised companies are as follows:

Ports of Auckland

Partial privatisation achieved significant efficiency gains.  “For example between 1988 and 1993 staff numbers fell from 1393 to 504, and average turnaround times fell from 38.4 to 15.7 hours.”  The point is not made that after renationalisation the financial performance of POA fell away and the partially listed company Port of Tauranga has outstripped POA in terms of productivity gains.

Bank of New Zealand

The main takeaway here is a cautionary note about partial privatisation: “the period of mixed ownership of the BNZ was not a success.”

Air New Zealand

The paper records the lessons of Air New Zealand as follows:

It was private investors, rather than the government, who lost money as a result of Air NewZealand’s financial failure.

The Ansett purchase was a major strategic failure. It does not disprove the general principle that private ownership is more commercially adept than government ownership. But it reminds us it is a general principle rather than an iron law.

The paper is wrong to state that since (partial) renationalisation “the commercial performance of Air New Zealand has been good.”  As noted in an earlier blog (1 February 2011), Air New Zealand has not systematically met its cost of capital.

Auckland International Airport

There has been little controversy about this privatisation (other than the previous government’s misguided intervention in an overseas bid for a stake in the company).  As the paper notes, “AIA has become one of the major and respected companies on the NZX, and it retains a wide shareholding.”

Telecom

The paper states:

Telecom’s post-privatisation performance divides, on the face of it, into two periods. For the first five years or so the value of the company rose quickly, as reflected in its share price, and although that led to some critics arguing that it had been sold too cheaply, the public  also appreciated both Telecom’s improved service compared to the memory of the Post Office, and the new competition from Bell South and Clear.  Subsequently, as Telecom’s share price has fallen back to near the original float level, criticism of the original sale price has dissipated.

It does not go into the previous government’s politically motivated unbundling of Telecom, contrary to the advice of the Telecommunications Commissioner.  This was an unprincipled regulatory taking without compensation to Telecom shareholders which crippled the company and has led inexorably to further intervention, in particular taxpayer investment in broadband.

Tranz Rail

The key points here are that under private ownership cost reductions occurred and returns on capital improved, but the business was still not financially viable in the face of continuing declines in competing freight costs.  Rail is a very difficult business in New Zealand.  The paper notes:

Nonetheless, privatisation meant that for 10 years from 1993 to 2003 the Crown did not have to fund the rail freight system. That is quite likely the only such decade since rail came under central government control in the 19th century.

and:

As an integrated commercial asset rail is probably worthless now, though elements of it (for example the ferries; the West Coast coal route) would still have value in a break-up. The price paid by the government in 2008 reflected essentially a non-commercial transaction.

In other words, the Labour government paid an exorbitant price to buy back rail for political reasons, and taxpayers are now saddled with a business that loses “at least $100 million a year”.  Bill English has rightly described this as the price of nostalgia.

Trustpower and Contact Energy

Both have been success stories since partial and full privatisation respectively.

Forestry Corporation

The paper notes:

The FCNZ sale was a success, but not for reasons that were expected at the time. It shifted the write-down of forest assets as a result of the 1998 Asian crisis from the Crown to Fletcher Challenge and its consortium partners. Clearly in this case the price received for the asset was, with hindsight, excellent.

Contrary to claims that ‘family silver’ was sold too cheaply, Fletcher Challenge clearly paid too much for this business.

Conclusion

Three final points in the paper are worth noting:

• The privatised companies have followed very different paths, and the level of commercial success they have achieved has varied greatly. That should not surprise us. That is how an economy made up of competing private businesses functions.
• Five of the companies under discussion that remain listed on the NZX (Auckland Airport, Air New Zealand, Contact, Telecom, Trustpower) make up over a third of the market capitalisation of the NZX50.
• The privatisation programme of the 1980s and 1990s is one of the factors behind New Zealand entering the recent financial turmoil with a relatively modest level of government debt.

 

Government Size And Economic Growth

My reading of Treasury material in the last decade on whether high government spending harms economic growth is that size doesn’t matter in its view – the public sector can in principle spend taxpayers’ money as well as they can spend it themselves.

This view implicitly holds that the government is not constrained by problems of information and incentives.  Therefore if there is a problem it is only because not enough is being spent on ‘productive’ categories of spending and too much on ‘unproductive’ categories.  Treasury papers have also been at pains to make the trite observations that government spending can be too low as well as too high, and that the quality of spending matters, which of course it does.

Treasury has never engaged with a point the Business Roundtable has made countless times, namely that no OECD country with government spending over 40 percent of GDP has achieved sustained annual per capita GDP growth of 4 percent or more – the kind of growth rate necessary if New Zealand is to climb back to the top half of the OECD income range (the last Labour government’s goal) or to catch up to Australian income levels by 2025 (the current government’s goal).

This month the Treasury has released the paper Government and economic growth: Does size matter?  It is a slight advance on previous efforts.

In its two reports to date, the 2025 Taskforce has been in no doubt that the answer to this question is ‘yes’.  It said in its first report:

Our judgement, informed by a reading of the international historical experience, is that it would be almost impossible to achieve the sort of sustained transformation of our growth performance with the size of government at current levels (around 45 percent of GDP).

In its latest paper the Treasury still cannot bring itself to endorse this obvious conclusion.

The Treasury paper appears to be poorly researched.  For example, it does not cite a 2010 book by Andreas Bergh and Magnus Hendrekson on the very same topic, Government Size and Implications for Economic Growth.  The key conclusion of these authors is that in rich countries, a 10 percentage points increase in tax revenue as a share of GDP (say from 30 to 40 percent) leads to annual economic growth being between one half and one percentage point lower – a large reduction.

Even more curiously, the paper does not cite the study How Much Government: The Effects of High Government Spending on Economic Performance published by the Business Roundtable.  The author was Winton Bates, previously a senior official in the Australian Productivity Commission, a consultant at the New Zealand Treasury, and an adviser to the 2025 Taskforce.  Bates’ “conservative” estimate was that “a reduction in government spending from 40 to 30 percent of GDP could be expected to add about 0.5 percent to the rate of growth of GDP over about a decade.”

A subsequent Business Roundtable study by Bryce Wilkinson Restraining Leviathan, which had much to say on the subject, is also not cited.

Nor, when it comes to discussing public sector productivity, did the paper cite the Business Roundtable study overseen by former Treasury secretary Graham Scott, Productivity Performance of New Zealand Public Hospitals 1998/99 to 2005/06, authored by Mani Maniparathy.  It concluded, among other things, that overall productivity of personnel in public hospitals actually decreased by 8 percent in the five years to 2005/06.

The paper even fails to note research that the Treasury commissioned itself from Australian economist Ted Sieper which argued that the provision of public goods and a modest safety net  in New Zealand would require government spending of no more than 14-15 percent of GDP.

The following table from the 2025 Taskforce’s second report shows that this is not an unreasonable estimate.  Government spending today is as high as it is largely because of the level of government spending on ‘social assistance’.  Much of this spending presumes that governments can spend taxpayers’ money on health, education and welfare services better than individuals and households.   This presumption took over the Western world around the 1960s, as has been documented by Tanzi and Schuknecht. It is dubious to say the least.

Click to enlarge

Furthermore, the Treasury’s examination of the ways in which government spending may harm growth is much too narrow.  Winton Bates noted that “Big government adversely affects economic performance in many different ways”, and listed some as follows:

• When the range of services provided by the government extends into areas where it has no competitive advantage the cost of services tends to increase.
• High levels of government spending on goods and services (including public sector employment) often involve waste of resources.
• Excessive regulation imposes large compliance costs on businesses and individuals.
• Attempts to regulate the macro economy using counter-cyclical fiscal policies do not necessarily have intended effects and may lead to worse economic outcomes over the longer term.
• Redistribution of income has adverse effects on the incentives of the intended beneficiaries, including possible changes in norms of behaviour leading to greater welfare dependency.
• Increases in government spending tend to encourage wasteful lobbying activities by suggesting to interest groups that governments are likely to be responsive to their pressures.  As a result, much government spending – in areas such as health, education and retirement incomes – provides private goods for the benefit of middle-income families and is funded by the same people. Such government funding of private goods displaces more efficient private arrangements.
• The deadweight costs involved in raising additional revenue rise more than proportionately as the amount of revenue increases. When account is taken of deadweight costs associated with both taxation and delivery of benefits it is likely that these costs are equivalent to more than half of each additional dollar of government spending in New Zealand.

The Treasury’s focus is almost exclusively on deadweight costs and public sector productivity.  The omission of any material discussion of rent-seeking, and public choice issues in general, is extremely important.  The Treasury’s general framework presumes that governments spend money in order to overcome ‘market failures’ and fails to consider the more plausible proposition that they spend money in order to get re-elected or to favour their most important constituencies.  There is no assessment of the level of spending that could be justified on genuine public interest grounds.  Basically, incentives in the government sector are not a problem, so the paper implicitly assumes.

Another serious weakness of the paper is that its benchmarks are OECD countries in their modern, typically big-government, form.  Nowhere is there any recognition of the current reality that the majority of the Western welfare states are in deep economic trouble and the model may well prove to definitively broken.  The 2025 Taskforce in its first report pointed out that the average OECD country:

… isn’t the only model.  In several high-performing Asian economies (Singapore, Hong Kong and Taiwan), themselves with diverse political systems and spending imperatives, total government spending as a share of GDP has consistently been less than 20 percent.

These high-income countries, and other emerging economies, are more likely to offer lessons for New Zealand than the ‘old’ OECD.

Another frame of reference (missing in the paper) would be the performance of today’s OECD countries when the share of government in their economies was much smaller. In the 1950s and 1960s, for example, many of these countries had government spending ratios of around 25 percent. They also enjoyed much faster growth rates.

There are sundry other problems with the paper.  In discussing the Baumol hypothesis for creep in the size of government, it fails to consider why it did not apply in local government for at least a century.  It accepts ‘merit goods’ as a justification for government spending whereas many economists have jettisoned this idea.

Needless to say, there are useful observations in the paper.

It is dismissive of the Wilkinson and Pickett inequality argument and is supportive of privatisation.  It also mentions the bias toward big government of MMP:

The larger the number of parties forming the government and the higher the frequency of elections, the stronger this tendency. It also seems more prevalent in cases of proportional rather than majority-based election systems (for example, see Persson and Tabellini, 1999, 2002).

Overall, my judgment is that the paper is an advance on earlier Treasury work in the area.  But that is faint praise. Both theory and evidence indicate that government spending around New Zealand’s level is seriously detrimental to growth.  I hope some New Zealand academics join in with critiques.

FRIDAY GRAPH: THE DECLINE OF OUR TRADABLE SECTOR

Much has been made (and rightly so) of the decline in the output of our internationally competing industries (the so-called tradable sector) since around 2005, while non-tradables output grew strongly.

Obvious causes include the loss of international competitiveness associated with increasing regulatory burdens and the huge increase in public spending resulting from the policies of the last government.

This chart taken from a 2010 Treasury report to the minister of finance released under the Official Information Act tells the same story by looking at employment growth in the same period.

 

The chart shows that employment growth since 2004 has been concentrated in the non-tradable sector, including industries such as health care and social assistance (+26%), public administration and safety (+21%) and construction (+20%), while tradable sector employment (defined here as the primary and manufacturing sectors) has been weak (-8%).

This is not a picture of a healthy economy.  It highlights the economic imbalances the government talks about and underlines the need to shift resources, including labour, from the non-tradables sector (especially the public sector) into our internationally competing industries.

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.