Ideology and economic policy – part 3 – Fred Argy

Parts 1 and 2 outlined six alternative ways of dealing with a socially disruptive economic reform. They all assumed that the postulated reform would proceed but dealt in different ways with the social consequences. In this final segment of the paper, I consider a seventh oft-overlooked approach i.e. substantially modifying the reform in a way which achieves the same economic benefits at less social cost. I also discuss the value judgments involved in choosing between the seven options and offer some advice to my fellow economists.

Option 6: Explore alternative reform paths

Many economists believe that options 1 to 4 (none of which involve actual redistribution) are questionable even on economic welfare criteria. Yet they are not attracted to the idea of compensating losers, even in the preferred form of active adjustment assistance, because of the complexities it causes and the scope for politicisation and arbitrariness. Instead they prefer to look for ways of appreciably modifying the reform package itself so as to achieve the desired economic goals with more “benign” distribution effects and lower adjustment costs.

Viable alternatives are not always available. But in employment policy, despite the many false prophets in our profession who go around asserting that ‘there is only one right way and no other way will do’, there are often good alternatives which can do the job just as well without the unwelcome social consequences.

At the start of 2006, there was bipartisan political agreement and widespread consensus in the economics profession that, after 15 years of strong and sustained economic growth, levels of joblessness in Australia were too high – around 10% if one if one included under-employment and discouraged workers (Argy 2005). The Howard Government decided to fix the problem through its Work Choice and welfare-to-work measures. The aim of these measures is to curb collective bargain and trade union entry rights, facilitate downward wage flexibility, diminish unfair dismissal protection, remove the ‘no disadvantage test’ and strengthen the welfare compliance penalties. The Howard reforms have few associated “carrots” – apart from a sprinkling of active labour market programs like training, counselling and relocation assistance and some increase in low pay tax offsets. Basically the reforms are an application of option 1 the “potential Pareto” approach favoured by neo-liberals.

Will this neo-liberal workplace-welfare strategy work in economic terms? While it will have little or no impact on productivity , it will almost certainly increase employment opportunities for low-skilled ‘marginal’ workers (who are hard to place in jobs). However, in my view, a different policy mix could achieve the same or better employment outcomes with a much smaller increase in wage and earnings inequality.

Hard neo-liberal economists are too inclined to blame joblessness on a lack of work ethic (a welfare culture) and wage rigidities. These are undoubtedly significant barriers to employment which can be reduced by welfare sanctions and wage flexibility (within the bounds allowed by community values). But there are three other causes of structural joblessness in Australia (a) a lack of sufficient financial incentive to work; this applies principally to the inactive jobless (those not subject to work or activity tests) such as many single parents and disability recipients, (b) a mismatch (occupational and spatial) between job vacancies and job seekers and (c) unfavourable personal characteristics, including physical and mental handicaps , which make some job-seekers unattractive to employers.

These last three barriers to employment are more important for the core jobless population than the other two; yet they do not always respond well to pure neo-liberal solutions. There are alternative policies which can achieve the same or even better employment results over time.

This alternative strategy needs to include some deregulation and welfare-to-work policies but less radical than the Howard reforms and liberally mixed with active government intervention. The intervention, some of it designed to impact well before the workplace starting gate, could take various forms:
“¢ measures to correct early childhood disadvantages (in cognitive skills and non-cognitive aptitudes like social skills and motivation) stemming from low parental income and education, poor parental attitudes, dysfunctional home environment, neighbourhood factors or exposure to poor role models;
“¢ remedial programs for older school children and youth (age 14-19) who are under-performing and at risk of dropping out early from high school;
“¢ improved access to key public services like health, education and public transport in low-income areas; and
“¢ active labour market programs; these could range from diligent, well-funded job search assistance and placement services and personal case management to earned income tax credits, wage subsidies, selective payroll tax concessions and targeted job-creation in the community and public sector.

If the experience of the Nordics and many smaller European countries is any guide, these policies can be as effective as neo-liberal policies in delivering good employment outcomes; and they have positive by-product economic effects which offset the negative effects of higher taxes.

So we have a stark choice. The Howard formula offers more income inequality and less equality of opportunity – but involves little or no cost to revenue. Under the Nordic formula, inequality is contained and low income people have a better chance to move up the income and occupational scale during their lifetime – but better-off taxpayers are asked to pay for these results.

Choosing between these two routes must depend on one’s values. The choice is more complex than just one between individual freedom and equality. True, lower taxation allows greater freedom of choice for taxpayers; it protects their right to do what they wish with their income gains (even though in the case of policy reform, the gains are in good part due to fortuitous policy decisions). But Nordic style policies widen the range of longer term employment opportunities and choices available to low-paid workers and jobless workers affected by structural change and make it easier for them to achieve their full potential. So one’s assessment must depend not only what weight one wants to give to freedom of choice relative to equality but also what weight to give to one kind of freedom relative to another kind of freedom!

So what role does the economist have to play in economic policy where trade-offs are involved?

The theme of this paper has been that economists will never be able to reach consensus on how best to deal with economic reforms which have socially disruptive effects. The reasons are obvious. They could never agree on appropriate ‘equity’ goals. They could never agree on what weight to give to equity relative to efficiency. And they could never even agree on the nature of the equity/efficiency trade-off (how much of one you have to give up to achieve the other) because of uncertainty about the relationship between scale of redistribution and economic performance (at least for developed countries with a broad commitment to market capitalism) and because the distribution effects of any reform are never easy to predict. In short, it’s all about values, stupid!

That said, economists can, purely as professionals, play a major role in helping governments to resolve efficiency-equity policy trade-offs. In particular, they can continue to refine their analysis on a number of key questions such as:
– the unresolved relationship between inequality and economic performance;
– the distributional effects of structural change;
– what “mainstream” Australians think about equality, freedom and indivdual responsibility (my own assessment of the evidence is that in essence, what they mean by “fair go” and “have a go” is that everyone should have an equal chance to succeed in life provided they do everything to help themselves);
– the “gaps” between community aspirations and reality (my research indicates that, as far as equality of opportunity is concerned, the gap is likely to grow in the future); and
– the social effectiveness and economic effects of alternative ways of closing this gap.
There will still be endless debate about these questions but it will be about professional analysis not value judgments.
Economists are of course as entitled as anyone else to make firm policy recommendations and in general it will be a more informed judgment. But economists who evaluate a policy reform by simply comparing two equilibrium points e.g. “GDP will be x% higher once the full effects of the reform have occurred” and pronounce it to be a good reform without taking account of how the benefits are distributed and the transitional adjustment costs are at best producing a very incomplete analysis and at worst are being dishonest and giving our profession a bad name. Fortunately, other economists see through them. As the famous British economist Joan Robinson said, ‘the purpose of studying economics is to learn how to avoid being deceived by other economists’.

===========
References

Argy, F (2005), An analysis of joblessness in Australia, Economic Papers, March

Argy, F (2006), Equality of opportunity in Australia myth and reality, Discussion Paper no. 85, The Australia Institute, April

Kahneman, D and Krueger, A. B (2006), Developments in the measurement of subjective well-being, Journal of Economic Perspectives 20(1) Winter

I am grateful to Nicholas Gruen for very helpful comments on an earlier draft

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Corin
15 years ago

Fred,

I should have waited a day to get to the “values” part.

What I would add (and is aluded to in your heading) that a values framework does not lend itself to an ideology.

Whilst Blair and Clinton are much maligned – for many reasons – the fact that neither have a central ideology reflects the fundamental transformation of the electorate(s) that want a different solution to each issue, with some core principles but not a rigid approach.

On your specific issue – IR indicates to me that Howard may have followed an approach that is too rigid to obtain widespread support. However he may have the personal gravitas in the electorate to pull it off. I also think the scare campaign on unemployment will be interesting. Without a good welfare to work policy – the ALP will be in trouble. I’d suggest they come up short on this.

Will Howard go for Tax Credits and confound your pessimism in his approach? He may do for votes – noting the Clintonian maxim of no ideology if you want keep your job.

Latham’s ‘interesting’ tax policy has some good points on welfare transition but not enough money in the pot to beat off the $600 scare campaign – the ALP will have a real balance on the family tax benefits/tax credits question.

Cheers,
Corin

taust
taust
15 years ago

Fred;
I much appreciate your three postings on Ideology and Economic Policy.

Don Arthur
Don Arthur
15 years ago

Fred – I was interested in your comment that:

Hard neo-liberal economists are too inclined to blame joblessness on a lack of work ethic (a welfare culture) and wage rigidities.

I can understand why an economist might suggest wage rigidities as a cause of joblessness but the work ethic argument seems a bit ad hoc. An economist who appeals to the idea of a ‘welfare culture’ is trying to explain the difference in employment between two populations by appealing to differences in their preferences. But since economics has no theory about preferences this doesn’t add much value to the debate.
Any economist who does this has effectively turned the debate over to the social sciences which do have something useful to say about culture and preferences — anthropology for example.
Which hard neo-liberal economists are you thinking of?

Fred Argy
Fred Argy
15 years ago

Don, there are two distinct types of “voluntary” joblessness. One is due to deliberate work-shirking (a preference for the lazy life) and the other is due to lack of financial incentive to work.

I have always acknowledged that the second type – which applies only to the “inactive” jobless such as single parents and disability pensioners who do not have to comply with the full official work tests – is signficant.

But I have argued that the first type (work-shirkers) is very rare given the tough work testing in Australia and the evidence that most people prefer to work and are very unhappy when they are idle. My understanding is that many right wing economists disagree with this latter assessment. You only need to read some of the CIS writers on the subject (notably Peter Saunders) and the views of participants on Catallaxy website forums to see that many of them gladly own up to it: they believe a high proportion of our residual unemployed are simply bludgers. And listening to what Howard Ministers have to say, there must be many government advisers with similar views to the CIS.

Don Arthur
Don Arthur
15 years ago

Fred – I think I understand your views on voluntary unemployment. But what I’m interested in are your views on economic explanation.

If an economist’s explanation appeals to changes in preferences over time or differences in preferences between populations, are they doing economics or are they just coming up with ad hoc explanations for something their models can’t account for?

For example, imagine we abolished all regulation of wages and employment conditions. Then we abolish income support, public housing, Medicare etc. But despite these reforms unemployment remains stubbornly high.

Then we go back to your hard neo-liberal economist and ask her why the reforms haven’t worked. She stares at her shoes for a minute and then say that the long term unemployed must be members of a sub-culture which “prefers near-destitution without work to relative abundance with it.”

It seems to me that this is a kind of shirking. What do economists know about sub-cultures and the formation of preferences? Since when was this part of their training? You might as well ask them to talk about values or social justice – another area where economists (as economists) have no expertise.

Sub-cultural explanations for joblessness usually appeal to differences in preferences between populations. As a sociologist ‘bad’ Peter Saunders is entitled to explore such explanations.

I’m curious about economists who offer these kinds of explanations becasue if they do, it seems to me they are speaking as lay people not as experts.

Nicholas Gruen
Admin
15 years ago

Nicely argued Don.

I agree with your argument, but, as you know, am quite sympathetic to the sociological instincts that drive the anxieties of the Peter Saunders of the world – even if I don’t necessarily support a lot of their proposals.

That sociology would hold that the cultural mores of those on or close to welfare has undergone a profound shift over the generations since welfare was introduced – it would be odd if a complete change in the economic base of these people had not brought this about over the generations.

I think it’s critical to engage with that fact, though you’re quite right that some economic training doesn’t give one any better credentials for talking about it than anyone else.

The economist might claim some credentials in the discussion in two ways. They might claim to have better knowledge of the economic costs of such developments and they might use techniques from the discipline (eg econometrics) to investigate and come to unusually informed views on the subject – as for instance Steve Levitt has to some (small) extent.

In fact I don’t see many economists bring these things to bear on their analysis. Their position is more informed by a kind of ‘barracking’ for the economy. This need not be a bad thing in the grand scheme of things – as one voice in a richer debate. But the assumptions that are being made are more often than not unacknowledged – very often by the economist/commentators themself. Accordingly their pronoucements serve as much to conceal issues as they do to elucidate them.

It’s ironic that so many of the practitioners of a discipline built on an obsessive fastidiousness in separating normative and positive analysis (‘is’ and ‘ought’ questions), are so slapdash in conflating normative and positive analysis in their public pronouncements.

Jason Soon
15 years ago

Guys
Who are these mythical economists you keep referring to? And who are these Catallaxy commenters? How many of those who made these comments are economists?

Name some names, guys, otherwise get off the soapbox, this is just a strawman attack and you’re fulminating to yourselves.

Peter Saunders is a sociologist.

My views on this have always been the same – the unemployed are priced out of work, and even when they are not they are simply rationally responding to price signals in the tax system because of high EMTRs. This is the same position that Milton Friedman has enunciated.

For the record – I have made the comment that the rich are probably statistically speaking more ambitious and hardworking but that has nothing to do with the ‘poverty because of unemployment’ debate – I was referring to Type A personalities.

Fred Argy
Fred Argy
15 years ago

Jason, if I read you correctly, you agree with me that if there is any “voluntary” unemployment it stems from inadequate financial incentives to work (high EMTR’s)- which can only reasonably be said of inactive workers.There is no real problem of “bludgers”.

Where you and I still disagree is on the importance of other causes of joblessness – i.e. other than wage rigidities and lack of work incentive.

Jason Soon
15 years ago

I’ve already clarified my position, Fred. What do you mean by lack of work incentives? If by that you mean the high EMTR then we already agree on that. What we disagree on may be the importance of wage rigidities. So what is this additional work incentives issue you identified?

What I am questioning is this:

You have alleged that:

You only need to read some of the CIS writers on the subject (notably Peter Saunders) and the views of participants on Catallaxy website forums to see that many of them gladly own up to it: they believe a high proportion of our residual unemployed are simply bludgers. And listening to what Howard Ministers have to say, there must be many government advisers with similar views to the CIS.

This then inspires Don and Nick to write a series of high-minded theses on how
‘neoliberal economists’ who still remain unnamed by either of them or by you are straying out of their field of competence by blaming unemployment on poor work ethic.

Now *rationally responding to the signals sent out by a high EMTR* is totally different from having a ‘poor work ethic’. I’ve only ever read ‘neoliberal economists’ lamenting wage rigidities and the perverse incentives sent out by high EMTRs. So I’m yet to see evidence for any of these neo-liberal economists the three of you are constantly demonising who believe in voluntary unemployment. The closest I can think of are perhaps the Real Business Cycle theorists (Thomas Sargent, et al) who don’t believe involuntary unemployment exists, period but they’re not exactly household names.

Jason Soon
15 years ago

BTW here is the hardest of hard-core Australian ‘neoliberal economists’ you can find – Gerard Jackson. And what does he say?

http://www.brookesnews.com/032506dolediary.html

The Government’s idea of a diary for the unemployed is stupid, costly and lacks compassion. It assumes, against overwhelming evidence, that there is a large body of dole recipients who are not really seeking work. Yet how can Howard, Costello and Vanstone, possibly suggest such a body of parasites exist when the ratio of unemployed greatly exceeds the number of vacancies?

The best that can be said for these ministers attitude is that it reveals a stunning ignorance of the cause of our widespread persistent unemployment.

Quite simply, the unemployed have been priced out of work. So long as markets are allowed to clear the present type of unemployment cannot persist. Instead of kicking the unemployed, Vanstone should start kicking union leaders and their mates in the arbitration commission who are responsible for the present level of unemployment.

It follows that if politicians and the electorate are going to support job-destroying policies then they have an obligation to compensate the victims of these policies. Bullying and slandering them is inexcusable and despicable. But not according to Amanda Vanstone, Minister for Family and Community Services, who said: “For the vast majority of people on welfare, the current mutual obligation requirements are appropriate.”

Really? Well I’ve got news for Vanstone: she and her political ilk have no moral right to implement fascist sounding policies like “mutual obligations” until they fully liberate the labor market. To attack the unemployed because unions and the arbitration commission have priced them out of work is cruel and cowardly.

Yobbo
Yobbo
15 years ago

Stop slapping them in the face with reality Jason. If the left can’t believe that the right are really monsters who want to see dole bludgers in slave-labour camps, then what can they believe?

Fred Argy
Fred Argy
15 years ago

Jason, sorry I thought Peter Saunders was also an economist. As for Catallaxy contributors, I am sure some participants professed a belief that the unemployed are bludgers (although obviously it wasn’t you I read). That said, I have no intention of doing a search around for it.

I am interested in the quote of Gerard Jackson. I love the bit about “bullyijng and slandering the unemployed” being “inexcusable and despicable”. It’s music to my ears. But this does not mean I accept for one moment Jackson’s notion of a “fully liberated labour market”, even if it were practicable, which it’s not. Even the USA does not have such a labour market!

Don Arthur
Don Arthur
15 years ago

Jason – I’m confused. You say:

This then inspires Don and Nick to write a series of high-minded theses on how ‘neoliberal economists’ who still remain unnamed by either of them or by you are straying out of their field of competence by blaming unemployment on poor work ethic.

The reason I haven’t named any ‘neoliberal economists’ who blame joblessness on poor work ethic is that I can’t think of any who do. That’s why I asked Fred which economists he was thinking about. When he suggested Peter Saunders I commented that "As a sociologist ‘bad’ Peter Saunders…" The economist in my second comment is a hypothetical one. That’s why I referred to her as "your
hard neo-liberal economist" in my reply to Fred.
 
I was thinking that you might have something interesting to say on the issue I was trying to discuss (an issue about economic explanation) because the inspiration for my comments is an argument by Gary Becker. Here’s the relevant passage from The Economic Approach to Human Behavior :

War is said to be caused by madmen, and political behavior, more generally, dominated by folly and ignorance. Recall Keynes’s remark about "madmen in authority, who hear voices in the air" (1962, p. 383), and although Adam Smith, the principal founder of the economic approach, interpreted some laws and legislation in the same way that he interpreted market behavior, even he, without much discussion, lamely dismissed others as a result of folly and ignorance.

Examples abound in the economic literature of changes in preferences conveniently introduced ad hoc to explain puzzling behavior. Education is said to change preferences – about different goods and services, political candidates, or family size – rather than real income or the relative cost of different choices. Businessmen talk about the social responsibilities of business because their attitudes are said to be influenced by public discussions of this question rather than because such talk is necessary to maximize their profits, given the climate of public intervention. Or advertisers are alleged to take advantage of the fragility of consumer preferences, with little explanation of why, for example, advertising is heavier in some industries than others, changes in importance in a given industry over time, and occurs in quite competitive industries as well as in monopolistic ones.

Naturally, what is tempting to economists nominally committed to the economic approach becomes irresistible to others without this commitment, and without a commitment to the scientific study of sociology, psychology, or anthropology. With an ingenuity worthy of admiration if put to better use, almost any conceivable behavior is alleged to be dominated by ignorance and irrationality, values and their frequent unexplained shifts, custom and tradition, the compliance somehow induced by social norms, or the ego and the id.

I do not mean to suggest that concepts like the ego and the id, or social norms, are without any scientific content. Only that they are tempting materials, as are concepts in the economic literature, for ad hoc and useless explanations of behavior. There is no apparent embarrassment in arguing, for example, both that the sharp rise in fertility during the late 1940s and early 1950s resulted from a renewed desire for large families, and that the prolonged decline starting just a few years later resulted from a reluctance to be tied down with many children. Or developing countries are supposed simply to copy the American’s "compulsiveness" about time, whereas the growing value of their own time is a more fruitful explanation of their increased effort to economize in their use of time (see chapter 5). More generally, custom and tradition are said to be abandoned in developing countries because their young people are seduced by Western ways; it is not recognized that while custom and tradition are quite useful in a relatively stationary environment, they are often a hindrance in a dynamic world, especially for young people (see Stigler and Becker 1974).

Chris Lloyd
Chris Lloyd
15 years ago

I disagree with the whole tone of both Fred and Jason. The latter says that those “rationally responding to the signals sent out by a high EMTR”