Life, liberty and the pursuit of handkerchiefs

The latest end of Policy Magazine has an article discussing one of the latest crazes in economics happiness studies. The field usually involves working with data that has been generated by asking people how happy they are with their lives, their job, their personal circumstances, their friends and so on.

It’s an antidote to the lamentable drift away from commonsense which occurred in economics as part of the ‘neoclassical synthesis’ of the 1940s and 50s. The architects of the first wave of mathematisation in the late 19th century understood that the lines between the mathematics and real life could not be drawn ‘scientifically’ if by that word one means ‘indubitably’ or without the intervention of values.

Thus the connections between the maths and the economic phenomena they were intended to model were made commonsensically. Maths was used to provide a logical backbone to the science of choice constrained by resource availability. In consumer theory consumers were taken to be maximising ‘utility’ subject to a ‘law of diminishing returns’. The more one had of any one thing the less its incremental utility with each additional unit.

Thus, like others but not all of his contemporaries Marshall, the early synthesiser of this early period extended the law of diminishing marginal utility to income itself making the commonsensical claim that “the richer a man becomes, the less is the marginal utility of money to him”. Arnold Schwarzenegger said the same thing more colorfully. “I now have $50 million, but I was just as happy when I had $48 million”.

All this came unstuck as economists discovered surprise, surprise that one couldn’t prove this proposition. Utility couldn’t be directly observed. It was thus taken to be a metaphysical concept at a time of great suspicion of such things. And so this idea receded and gave way to Pareto’s proposal that welfare might be said to be improved when someone was made better off whilst no-one was made worse off. (This has some uses and some attractions in theory but pretty obviously it produces thin pickings in practice there are virtually no genuine Pareto improvements in the real world).

Under Marshall’s formulation, ceteris paribus, redistributing money from the rich to the poor increased total utility. Of course unpicking the ceteris paribus, clause makes it subject to all sorts of caveats. One can still argue that redistribution is unfair (that it unjustly confiscates property that is rightfully where it is), or that it will sap initiative, either fairly quickly or over time. The sensible upshot of taking all these ideas seriously would be some tradeoff or compromise between competing principles.

The use of the Pareto criterion as a criterion of welfare has seen the bifurcation of efficiency and equity in modern economics. Efficiency is hard science and equity is a matter of opinion. Under the older view up to some level, and starting from a sufficiently unequal distribution, and abstracting from individual cases over a large population, redistribution away from the wealthy improves both equality and efficiency because it allows a given economic product to generate more utility. In Marshall’s language, and using Schwarzenegger’s comment, Arnie’s last $2 million of income looks like a pretty inefficient use of $2 million to improve marginal utility.

Modern happiness studies has provided an (arguably) scientific way back to this position. But it occurs via a different route. One of the important and very strong findings of happiness studies is that people are very positional in their approach to life and to economics. Like my two kids, they care very much how they are treated relatively something that is deeply at odds with the way neoclassical economics was constructed.

This has provided a way for scholars like Layard for instance to argue for redistribution of income as happiness maximising. I think this is probably valid reasoning, but I’m much more comfortable with the older formulation. I think it is ethically superior because it does not buy into people’s invidious comparisons with others. For basing an argument for redistribution on the fact that the poor are envious of the rich seems much less ethically robust than basing it on some attempt to use resources to maximise utility which means addressing the strongest needs with greatest urgency.

In addition I think the older formulation offers a more robust foundation from which to guide practical policy. The evidence suggests that people care about their salary and their rank in hierarchies compared with their colleagues and progressive taxation leaves the basic pecking order of rank and income in tact. The older formulation is based on a more robust principle on which neoclassical itself relies in order to get anywhere the principle of diminishing returns in this case the diminishing marginal utility of money and the principle that economic resources are a means to an end, that end being redescribed with the metaphysical and only indirectly measurable concept ‘utility’ or if you like ‘happiness’.

Johan Norberg’s article in Policy is well worth reading. It punctures some of the assumptions that are too easily made by Layard and his followers. For their big claim is that beyond some point happiness doesn’t rise with income. Norberg points out that income has continued to rise with income, but at a greatly diminished rate. But then again as Norberg hints at maybe that’s just diminishing returns setting in. You can’t get more than 10 out of 10 and most people rate themselves pretty happy. Maybe it’s dead hard to raise happiness above a certain level, and Western societies have been raising it pretty successfully. We know of no happier time.

Norberg begins the article with a nice I presume somewhat flippant summary.

Happiness is electrical activity in the left front part of the brain, and it comes from getting married, getting friends, getting rich, and avoiding communism.

So go read the article as a good antidote to playing too fast and loose with the happiness data. Andrew Norton’s contributions to the blogosphere have been a good corrective to some of the more simplistic applications of it. Will Wilkinson also makes some telling (more philosophical) points. Even though I don’t agree with Wilkinson’s approach, he is still well worth reading on the subject and makes some telling points against Layard.

Norberg’s article is in the same vein. His stuff on the welfare state and happiness research was interesting. But the pity is that the article uses the happiness research to argue a particular ideological position. I guess there’s nothing so wrong with that, but it left me feeling let down. Norberg attacks the left of centre interpretations of the research at some of their weakest points which is a worthwhile exercise.

But their strongest point is not addressed. It is that people are hard wired to really care about their incomes compared with others. As I’ve suggested above, it’s not a straightforward logical leap from this to arguing that policies should impose greater equality. But the evidence is at least suggestive of such an argument. It mightn’t change their place in the pecking order in their jobs, but it’s likely to moderate the impersonal struggles for positional goods). Unfortunately the article is too busy arguing the well worn dichotomies between free choice and ‘government’ that there’s nary a word about this conundrum.

The left and right pass again, as ships, in the night.

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Cameron Riley
2022 years ago

In what way should policies influence? Up the base pay rate, and put a limit on salary pork at the higher levels?

This site;

http://bigpicture.typepad.com/comments/2005/09/recovery_bypass.html

is arguing that there are now four classes in the US; poor, middle-class, rich and ultra-wealthy. He sees the middle-class disappearing, and the ultra-wealthy increasing.

Australia has deflated salaries. Probably a reason why our diaspora is so quick to hop on a plane at the first oppurtunity. You could bump up the middle class salaries through government intervention, but who will pay for it.

I dont see this as feasible. I also think that “coveting” another’s salary is probably also a good driver for competition in the labor market, if not the wider economy. It has certainly led to western economies being consumer driven.

Helen
2022 years ago

Australia has deflated salaries. Probably a reason why our diaspora is so quick to hop on a plane at the first oppurtunity.

I think this is a theory much too often relayed as gospel. Young turks heading overseas might be inspired by another quite direct incentive – HECS fees to pay back if they stay. Another reason why user-pays education is shortsighted – it contributes to the brain drain.

Cameron Riley
2022 years ago

Helen, This is a survey of IT/Software salaries in the US;

http://www.sdmagazine.com/documents/s=9411/sdm0411a/sdm0411a.html

This was the closest, or most comparable Australian survey I could find;

http://www.hays.com.au/salary/pdfs04/InformationTechnology.pdf

With the US dollar dropping in value since 2001, the salaries have got closer, but the US dollar still has 20-25% greater purchasing power. Back when the Au dollar was 49c to the US dollar, it was a drastic difference.

Even with the exchange rate taken into account, there appears to be a difference of approximately $20,000 to $40,000 AUD between Australian and American salaries. If you are earning under 100,000 a year, that is a significant difference.

If Australia wants to stop the brain drain, then it is going to have increase salaries for professionals, and provide more oppurtunities.

I think the Imagining Australia folks talk about a government funded/backed R&D or VC bond. Even if some new form of VC stock/bond market was set up to fund startups that require less than $1 million in capital would be good. Either that or plough billions through the military in R&D funding.

Working in the US during the tech boom was exciting. Australia needs to somehow capture that excitement in it’s tech industries.