Attitudes to Economic Freedom – Libertarians, Economic Liberals And Social Liberals

Political thought can be classified in many different ways, having regard to ones attitudes to economic freedom, the environment, personal morality (abortion, gay rights etc), welfare, income inequality, inequality of opportunity, etc. Trying to build them all into a comprehensive categorisation of political thinkers in Australia is too complex for me. In this posting, I want to simply focus on attitudes to economic freedom and distinguish between the political stances of libertarians, economic liberals and social liberals.

In this piece, I am NOT trying to start a debate on the relative merits of the three schools of thought (although I have my views of course). I am only trying to define them. A fuller discussion of the concepts and how they apply to the vexed issue of labour market freedom can be found in the forthcoming (July/August) issue of Australian Quarterly and this piece draws heavily on it.

Meaning of economic freedom

Economic freedom is about the degree to which individuals are able to pursue their own socio-economic interests in the market place. The oft-used index of economic freedom is calculated by reference to the security of property rights; the openness of the economy to external trade; levels of business regulation (how easy it is for entrepreneurs to start a business); levels of regulation of investment and credit markets; the extent of regulation of labour markets (how much freedom managers have in setting pay structures and in hiring and firing); and the size of government (scale of government expenditure, progressiveness of taxes and extent of government ownership).

Views of libertarians

Libertarian thinkers believe that governments should seek to maximise a countrys economic freedom (in all its varied dimensions). They accept in principle that free markets do not work perfectly and can lead to excesses such as environmental pollution, economic instability and personal hardship which hurt third parties. But and this is crucial – they are deeply distrustful of the ability of governments to deliver remedies, stressing the pervasiveness and relative severity of government failure. They therefore start with a strong presumption against government intervention in markets and in favour of individual choice.

Libertarians justify their stance on two distinct grounds. One is that individual liberty is a paramount virtue in itself and should override other virtues such as equality or fairness. This value-based, philosophical case is often supported by an economic case that individual freedom produces optimal outcomes for output and employment. But the overriding concern of libertarians is individual liberty, so they are willing to support measures which enhance economic freedom even if these offer little or no economic gain or even involve an economic sacrifice. That is, they are driven much more by ideology (values) than economics.

Views of economic liberals

Economic liberals are a quite different kettle of fish. Their focus (at least when they are wearing their professional hats) is on efficiency and aggregate economic wellbeing. A reform is desirable if it expands national resources or helps get more out of existing resources.

In deciding whether a reform increases aggregate economic wellbeing, they assume (subject to the usual provisos about availability of information and third party effects) that individual consumers are the best judges of their interest, that they are able to successfully maximize their utility or preferences (rational man), that the extra utility from each extra dollar consumed is roughly the same irrespective of household income and that GDP is a good rough measure of the sum of individual utilities. These assumptions are of course over-simplifications but they are seen by economists as a sufficient approximation to reality that they do not fundamentally destroy the credibility of their overall analysis.

Given their approach to reform, economic liberals are like libertarians in two respects: they start with a presumption in favour of individual choice and they are not too fussed about the ultimate distribution effects of the reform, so long as it is potentially feasible for losers to be compensated by winners and still leave the winners better off, they are not concerned about actual distribution outcomes.

However economic liberals also differ from libertarians in two key respects:
they do not see an expansion of economic freedom as desirable per se: an expansion of freedom only wins their support if it meets the economic test i.e. if it is confidently expected to yield significant net economic benefits; and
they are much less cynical and distrustful of the ability of governments to correct market failure.

The disagreement between economic liberals and libertarians is greater for some kinds of economic freedom such as competition barriers and financial deregulation) but less so on small government low levels of government expenditure and taxes. The reason is simple: neither economic theory nor empirical evidence point firmly to any optimal size of government from an economic viewpoint: when examining proposals which seek to reduce the size of government, economic liberals look at each proposal on its merit to see if it meets their economic test.

Similarly, the gap between libertarians and economic liberals is most starkly evident with labour market freedom. Here too, as with small government, economics potentially clashes with ideology. Libertarians advocate labour market deregulation because it widens individual choice and this is seen as desirable for its own sake. On the other hand, economic liberals support deregulation of the labour market only where it is expected to produce economic benefits.

Views of social liberals

Social liberals, like economic liberals, seek to advance economic efficiency – but not exclusively. In assessing the merits of a proposed reform, they give equal weight to objectives such as its effects on income and wealth inequality, on the quality of the living and working environment and on intergenerational and intra-generational income and educational mobility. Like libertarians, they are ideologically driven – but with a very different set of values. [This does not mean that economic liberals are ideologically neutral: it is just that their values are more hidden.]

Take for example the distribution effects of a reform. Economic liberals abstract from these effects by focusing only on GDP outcomes (which are taken to approximate aggregate utility). If these effects are positive, it is assumed that winners will be potentially able to compensate losers and still remain themselves better off. With winners and losers presumed to have similar marginal utilities, there is no need for actual compensation. However social liberals start with the assumption that an extra dollar is worth more to a poor person than a rich person, so the distribution effects are important in their own right and need to be considered in the evaluation process even when there are aggregate benefits for GDP. They are therefore willing to sympathetically consider alternative policy packages which deliver a more neutral or progressive distribution outcome, even if the alternative packages are unable to achieve the same efficiency and employment gains as the freedom option. Such an approach is unacceptable to economic liberals as it may involve a sacrifice of economic efficiency. And as must of necessity involve higher taxation (at least for a period), it is anathema to most libertarians.

I view myself as a social liberal but this is not the place to discuss why.

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Fred Argy
Fred Argy
14 years ago

<p>Oops! Correction neded. In paragraph 5 of the section headed Views of Economic liberals, the sentence “the disagreement between economic liberals and libertarians is greater ….” should read “the agreement” not the “disagreement”.</p>

Jc
Jc
14 years ago

“They accept in principle that free markets do not work perfectly and can lead to excesses such as environmental pollution, economic instability and personal hardship which hurt third parties”

I’m not sure I agree with this, Fred. Markets are the best least perfect solution to any libertarian and issues such as pollution are a combination of badly structured property rights and self-serving interests implying market failure when no such thing exists.

“And as must of necessity involve higher taxation (at least for a period), it is anathema to most libertarians.”

Higher taxation is only considered evil because the outcomes in most cases are considered inferior. The large proportion of taxation these days goes to the middle class. The churn rate alone shows the outcome is mostly of inferior quality.

It could also be philosophically argued that taxation is really confiscation and theft in another name.

Yobbo
Yobbo
14 years ago

Your social liberals don’t sound very liberal. It’s just another name for “Socialists”.

A turd by any other name smells just as bad.

Yobbo
Yobbo
14 years ago

Donations AND Advertising now?

Elijah
Elijah
14 years ago

Bwhwhahah. Social liberals and socialism; same shit different smell.

Bingo Bango Boingo
Bingo Bango Boingo
14 years ago

Thanks for this piece, Fred.

You say that libertarians: ‘are willing to support measures which enhance economic freedom even if these offer little or no economic gain or even involve an economic sacrifice.’ I take it that ‘economic sacrifice’ means a reduction in output or some other measurable negative impact on wealth or economic growth. If so, can you provide an example of how enhancing economic freedom involves such a sacrifice? I’m just not sure what you had in mind.

Cheers
BBB

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Dave Bath
14 years ago

Bingo-Bango-Bingo:
The “economic sacrifice” I /think/ Fred mentions relates to the economic sacrifice of an individual person or company, at the expense of economic performance of the society.

Here’s an example that pops to mind:
1) Sarbanes-Oxley imposes costs on companies, and extreme economic libertarians rail against this. It imposes constraints on economic “freedoms” of individuals.

2) Sarbox improves governance and honest reporting that actually makes free markets operate better, because the decisions of the market are made using better information. This allows a wider range of investors to put money in companies that /actually/ produce more, rather than those who fudge the numbers to make themselves look good.

3) Empirically, the “Nordic Nannies” impose heavy compliance costs and economic constraints on activity, compared to the extreme economic libertarianism of the US, and the good current-account and trade-balance figures (together with good human development indices like health and education) support the Nordic policies.

Enemy Combatant
Enemy Combatant
14 years ago

Somehow, Australia’s Great Economic Freedoms had managed to elude Jacko. He was having a bad trot. He was broke, hungry and desperately pounding the pavement, seeking work. Jacko was too proud to go on the dole after hed been humiliated one too many times by CentreLink people shufflers. If politicians wern’t prepared to grovel and eat dirt, then neither would he.

Jacko noticed the footpath sandwich board. Pie & Chips $5. He clawed through his kick for loose change and cobbled together $3.75. Jacko cursed quietly and wished that he could reason like a libertarian, so that he might become detached from his own personal hardship.

Jacko knew that “Libertarians” believed that individual liberty produced optimal outcomes going forward. That individual liberty was, in essence, its own reward. And that the economic problems of people like himself could be solved in a trice. Dissolved in a trickle down. Any day now.

Jacko tightened his belt and soldiered on, silently.

harry clarke
14 years ago

I think economic liberalsc accept the value of markets but see market failures and income distribution problems as issues that can be addressed by improving the operation of markets, in some limited cases by regulating and by using the tax-transfer mechanism. I think their main idea is that markets are central but that occasionally they stuff up.

Economic liberals as you define them are using questionable – not always wrong – theory. They are assuming you need to interfere with markets to provide good distributional outcomes. For example to provide a bus service to service the poor. An economic liberal would split this up into a separate policy for making a market work efficiently and a tax/transfer.

I think of muyself as an inconsistent economic liberal. Sometimes I think governments should provide services not money (education for young kids) for example because of power issues in the household. I also think some weight should be placed on the feelings of a taxpayer to how transfers are spent. Thus I might be happy to transfer money to poor people to increase their education but not to buy beer. I think as the payee I have some rights to drive these choices.

I am also inconsistent in terms of preferring the ABC to commercial television and to liking things like public libraries and national parks. You can manufacture arguments for providing such things by markets but I am seldom convinced by these arguments. Hence I am genuinely inconsistent.

The libertarian and socialist positions seem to me uninteresting because they are obviously flawed. The most interesting issues are to me the areas within which you feel you want to be an inconsistent economic liberal.

Bingo Bango Boingo
Bingo Bango Boingo
14 years ago

Thanks Dave Bath.

Enemy Combatant: is yours a serious comment? Maybe it was subtle parody. If so, it wasn’t too bad at all. But for the sake of argument let’s assume not. Now overall, it’s unlikely that Jacko would be broke if he had a job. So did you ever stop to think that our Government, in league with the unions and other super-geniuses, had raised the wage level above its market-clearing rate, pricing Jacko out? No, thought not. For Teh Left, it is always someone else’s fault. Not enough jobs? Must be that pesky free market again. Oh wait, we don’t actually have a free labour market. Strange.

Let’s finish the story: “Still, as long as Jacko know, from the union and their politicians, that he was not being ‘exploited’, he felt nourishment, of a sort. If only those people at Centrelink (unbeknowst to him, an agency set up to solve problems that a different Government department had created) were nicer.”

Pathetic.

BBB

Bingo Bango Boingo
Bingo Bango Boingo
14 years ago

Er.. ‘As long as Jacko knew…’

BBB

paul frijters
paul frijters
14 years ago

Fred,

where does utilitarianism stand in your schema? As an example of that species I’m with you till the point
“Economic liberals are a quite different kettle of fish. Their focus (at least when they are wearing their professional hats) is on efficiency and aggregate economic wellbeing. A reform is desirable if it expands national resources or helps get more out of existing resources.

In deciding whether a reform increases aggregate economic wellbeing, they assume (subject to the usual provisos about availability of information and third party effects) that individual consumers are the best judges of their interest, that they are able to successfully maximize their utility or preferences (rational man)”

but I loose you when you say

” that the extra utility from each extra dollar consumed is roughly the same irrespective of household income”

which violates the dominant mainstream empirical findings and theoretical assumptions of economics. Indeed, you loose ALL social scientists who subscribe to diminishing marginal utility theory, which is a rather big group. I’m not sure any economist is left in your economic liberal group after this characterisation.

Brendan Halfweeg
Brendan Halfweeg
14 years ago

The idea that economic freedom can be separated from individual freedom is nonsense. Places like Hong Kong and Singapore are often said to have high levels of economic freedom and little individual freedom, it fails to show that with wealth, individual freedom can be purchased in these societies. Economics is merely about the efficient allocation of resources given the inherent constraint of scarcity and the artificial constraint of regulation, to acheive individual goals. In places like Hong Kong, excess resource is dedicated to money making enterprises in order to reach a status where a degree of personal freedom can be exercised. Economic freedom in these societies is merely individual freedom by other means.

Just as EC said above, individual freedom means little without economic means, economic freedom means little if it doesn’t buy you individual freedom. Wealth must buy status in authoritarian regimes, otherwise no one would pursue wealth. Few middle class, moderately wealthy Australians send their children to university in Singapore, but many Singaporeans send their children to Australia. Their wealth is buying individual freedom in education choice.

Irrelevent to your ideology, people have ways and means to undermine every restriction you place on their freedom. Socialist regimes face this where individuals hold back their best efforts to frustrate the economic planners. People will allocate their resources in response to artificial restrictions, which are often considered perverse according to the original intentions of the regulator.

Since wealth is not seen by libertarians as a universal goal for individuals in how they allocate their time and resources, it is merely one of the many types of things people may aspire to, any regulation that impinges on individual choice is negative, whether it has financial economic efficiencies or not. Freedom means being able to do what you want, it doesn’t have to be a positive on the national accounts to be good.

Jc
Jc
14 years ago

David Bath:

Heres an example that pops to mind:
1) Sarbanes-Oxley imposes costs on companies, and extreme economic libertarians rail against this. It imposes constraints on economic freedoms of individuals.
David, are you serious? Im not having a go at you but Sarbanes O is possibly the biggest regulatory disaster to hit the US. So much so that London has taken premier spot in IPOs as a result of this monstrosity of a regulatory environment. It is also a reason lots of US firms are trying to escape the shackles and go private or actually list elsewhere

———————–.
2) Sarbox improves governance and honest reporting that actually makes free markets operate better, because the decisions of the market are made using better information.
It does nothing to improve markets and transparency and has only added to costs burdening small companies with excessive an unnecessary expenses- up to $500,000 for small US firms: hence the migration to privatise or list in the UK.
http://www.translegal.com/digest/modules/smartnews/item.php?itemid=11

Its congressional overreach at its worst as well as a prime example of why government officials cant be trusted to produce a great outcome. It was a great example of cover my backside with any regulation after the Enron debacle.

—————————-

This allows a wider range of investors to put money in companies that /actually/ produce more, rather than those who fudge the numbers to make themselves look good.
Oh please. You cannot reduce risk to the nanny state status in everything we do. There are bad apples everywhere and it would be far more effective to go after them in a tough manner than to corset commerce with stupid rules and regulations that to nothing to prevent fraud but only add to costs.

——————————–

3) Empirically, the Nordic Nannies impose heavy compliance costs and economic constraints on activity, compared to the extreme economic libertarianism of the US, and the good current-account and trade-balance figures (together with good human development indices like health and education) support the Nordic policies.

There is nothing to suggest you cant have full employment in a very regulated economy such as the Nordics. However I wouldnt presume the great outcome you have spoken about if I were you. All you have to do is set the clearing rate for wages below the cost of regulations. However dont expect to be keeping the well paying jobs around. Sweden was 3rd in league tables on a per cap PPP basis in the early 70s. It is now 15th or so and its PPP wealth matches the poorer regions of the US. I also think you are stabbing in the dark to compare all of the US with say Sweden when the US is a very regionalized economy (like the EU). If youre going to compare accurately take the state of CT to put it beside Sweden. Sweden has a Per cap GDP of $29,000 to CTs $57,000 (PPP). Its really not that enticing. But thanks, Ill take the deregulated model anytime over Sweden..

Damien Eldridge
Damien Eldridge
14 years ago

Paul,

When we are talking about choice under certainty, it is standard practice to treat utility as ordinal. As such, inter-personal utility comparisons of the sort you are alluding to cannot be made. We typically talk about diminishing marginal rates of substitution rather than diminishing marginal utility. Given the problems with inter-personal utility comparisons, in applied work it is sometimes assumed that $1 is $1, regardless of who gets it. Any impact on the income distribution is then addressed separately. I suspect that this is what Fred was alluding to in his comment.

cs
cs
14 years ago

I tend to agree with Brendan, Fred,

I think your opening sentence could do with a little more work”

Economic freedom is about the degree to which individuals are able to pursue their own socio-economic interests in the market place.

Seems to me this forecloses much of the debate from the outset by assuming that an economy exists only in relation to the marketplace, and moreover that economic freedom is solely measured on an individual basis.

There are, surely, economic dimensions to everything people do, in a philosophical sense. Right now, for instance, my god given genes are depreciating, as I type.

There still are, to be a little less frivolous, some people who almost never go near a market-place (I think there is a “phobia” named after this), but it would be a leap to suggest that in the rest of their lives they contribute nothing to anyone or anything that does not enhance their own, anyone else’s or indeed the nation’s economic freedom.

Notionally, if not practically, perhaps economic freedom should be measured according to the degree that individuals are able to pursue their interests, period. More broadly, there are many economic activities that cannot be pursued on an individual basis, such as activities that require partnerships or larger collectives, to which everyone wqho is involved must agree or the individual is denied.

Jc
Jc
14 years ago

“Seems to me this forecloses much of the debate from the outset by assuming that an economy exists only in relation to the marketplace, and moreover that economic freedom is solely measured on an individual basis.”

I cannot see how you can approach this so inanimately to simply brush aside that “an economy” and the “marketplace” are actually people- individuals trading with one another.

If economic freedom werent measured on an individual basis I would behoove you to tell us exactly how you would measure it? Don’t leave us in suspense.

“More broadly, there are many economic activities that cannot be pursued on an individual basis, such as activities that require partnerships or larger collectives, to which everyone who is involved must agree or the individual is denied.”

Such as stock ownership in large corporations as well? A stockowner is behaving co-operatively by allowing the board to supervise the management of the firm on their behalf. Individuals are acting out of personal interest when they buy the stock because they feel the management will produce optimal outcome. People co-operating with one another doesn’t mean that individual interests aren’t being perused for a second. Their self interest relies upon it.

Co-operation happens in almost every aspect of modern life. Specialization of goods and service provision is a good example. The flourmill co-operates with the baker by making the flour and having it there on time. I think you’re confusing things a little here.

paul frijters
paul frijters
14 years ago

Damien,
I’m sorry but you’re wrong. Any macro- or micro-theorist who’s written down a convex utility of income function explicitly assumes cardinal interpersonal comparisons. In pracical economic decision making too, cardinal comparability is the norm, not the exception. Poverty alleviation is quite explicitly based on the idea that a dollar means more to a poor man than to a rich man. The ‘utility is only ordinal’ defense is a wafer-thin excuse that breaks down the very moment decisions have to be made (in which case ordinality becomes a fairly meaningless concept). I know non-practical economists often pretend utility is only ordinal but IMO that is only window dressing because ordinality places impossible demands on the information needed to justify actual decisions. In practise we make choices based on the rule of thumb that utility is subject to diminishing marginal gains.

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
14 years ago

I agree with Harry. “The libertarian and socialist positions seem to me uninteresting because they are obviously flawed. The most interesting issues are to me the areas within which you feel you want to be . . . inconsistent.”

My hunting ground is where the competing frameworks tug against each other. But I don’t really think of myself as being inconsistent. I would say that I agree with public funding of the ABC because the essential matter is the quality of the broadcast (not the last cent of productive efficiency) and I don’t know any other model that delivers it as well as public funding within the ABC style set of institutions – as imperfect as they are. (And I don’t have a problem with outsourcing ABC funded productions). So I’m going where the analysis leads me.

With making cars and many other things the market does a better job so I support it – and much of ideological/intellectual apparatus that goes along with it.

I accept that to some extent this is a quibble about how we use words.

Something like the labour market is hard because I think economic efficiency is important here and so is economic liberty (of both employer and employee for all sorts of reasons). And I expect labour market regulation is pretty costly and arbitrary in all sorts of ways, and not all that equitable. If I was confident that you got lots more equity without lots of arbitrariness but at a cost of some efficiency I’d feel quite comfortable with labour market regulation. But labour market regulation is often very arbitrary. It’s OK to pay someone 120% of the basic wage, unless you happened to be paying them 130% of the basic wage last week. That doesn’t strike me as very sensible or fair. It’s just sentimental.

Also I agree with Paul F on utility. Utility has been pretty much junked in terms of the justification of the structure of the discipline in favour of revealed preference though of course utility turns up all over the place both in models and in heuristic explanations. So the reason Marshall’s and Pigou’s argument that greater equality is ceteris paribus a more efficient way of converting inputs (money) into outputs (utility) fell out of favour was because ‘revealed preference’ offered a sneaky way of ignoring its power.

But if you think in terms of utility, and money’s power to purchase it, money ends up being the only thing that doesn’t obey the law of diminishing returns. Not very plausible methinks.

cs
cs
14 years ago

Dont leave us in suspense.

Why not?

cs
cs
14 years ago

But labour market regulation is often very arbitrary. Its OK to pay someone 120% of the basic wage, unless you happened to be paying them 130% of the basic wage last week. That doesnt strike me as very sensible or fair. Its just sentimental.

There are many curious statements on this thread, so I am not picking on Nicholas. But it seems to me that if you were paying someone 130% of the basic wage last week, you are likely not being fair if you only pay them 120% this week

Moreover, to change wage rates every week does not seem sensible at all, obviously making it difficult for workers to know what they are going to earn, which means they can’t commit, to their work, the employer or anything else.

I can’t see what sentiment has to do with paying consistent wages. On the contrary, if you were to rely on sentiment as a basis for how much you pay people, wages would be all over the place every week, like a John Howard trying to win an election.

Damien Eldridge
Damien Eldridge
14 years ago

Paul, you are wrong when you assert that I am wrong. Almost the only time economists write down utility functions over income alone is when they are considering choice under uncertainty. I explicitly said I was talking about choice under certainty. In situations involving choice under certainty, utility functions are in general ordinal and not cardinal. There are plenty of strictly convex preferences that are only unique up to a monotically increasing (rather than affine) transformation. The classic Cobb-Douglas preferences come to mind. Anyone who has passed intermediate microeconomics ought to be familiar with this result. Perhaps you were referring to indirect utility functions, but even then your claim is wrong. Perhaps you were talking about the marginal utility of income in these models? Even then your claim is wrong. The marginal utility of income will vary with the choice of utility function from the family of utility functions that represent a preference ordering. Once again, Cobb-Douglas preferences provide a good example of this.

If that is not good enough for you, let me know. I am happy to provide references to the page numbers of textbooks that emphasise that utility is an ordinal concept in choice under certainty. But you’ll have to wait until tomorrow, since my textbooks are in my office. If you want to look for yourself, I am fairly sure that this result will be mention in Mas-Colell, Whinston and Green (1995), which is currently the standard graduate level textbook on microeconomic theory.

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
14 years ago

I think we’re a long way from understanding each other on this one CS. You think what I’ve written is curious which is your prerogative. Me? Well I wasn’t thinking that regulating a basic wage but not regulating wages higher than that was a recipe for ‘wages being all over the place every week’. This isn’t what happens in existing labour markets where regulation doesn’t set the wage.

cs
cs
14 years ago

I think you are correct, Nicholas. I have no idea what you are talking about. I could probably work it out, eventually, maybe. Heck, there’s no time for a seminar. We’re probably both right. Happens.

paul frijters
paul frijters
14 years ago

Damien,

you’ve been conned by some of the micro-textbooks. Sure, the textbooks who start with preference mappings end up with utility as non-interpersonally comparable and ordinal. Indeed, they would even go so far as to refuse utility functions altogether because some preference cannot be expressed as functions at all (such as the infamous lexicographic preferences). You must make a distinction though between these esoterical descriptions of utility and economics-in-practise. In practise there is no known case of economists actually measuring all the preference mappings, which tells you that the preference defense of economics is in fact an excercise in religion, not science.
Similar things can be said for revealed preference: it is a highly restrictive concept since we only observe a few choices out of the many that could be taken and in daily practise its not clear which constraints and information the agent had at the time. Hence, when people operationalise revealed preference in practise, the econometrician usually assumes some cardinal inter-personally comparable utility function of which a restricted number of parameters are to be estimated.
Most important of all though, nearly all economic decision making I can think of has little to do with either preference maps or revealed preference. We do not base welfare payments, poverty alleviation, or industry regulation on revealed preference alone. For any practical decision there will be winners and losers and our decision implicitly reflects a cardinal interpersonally comparable utility function. My simple contention is that our policy choices as well as our modelling choices adhere to the notion that that utility is subject to diminishing margainl returns.

Being one of the idiots who writes textbooks on this stuff, I am more than happy to supply you with references. The basic point is simple though: there is a wide gulf between the current religious `underpinnings’ of economics (preference maps) and economic decision making and if you confuse the two, then you’ve been conned.

Damien Eldridge
Damien Eldridge
14 years ago

Paul,

When conducting applied work, there will typically be both winners and losers. As such, instead of using the Pareto criterion for economic efficiency, we typically use the Kaldor-Hicks (or potential Pareto improvement) criterion. This does not require cardinal utility, since we are only comparing each person with there benchmark position subject to some mythical transfer taking place. Furthermore, in this analysis, we typically ignore income distribution. The impact of the policy on income distribution is assessed separately.

There are plenty of times in applied work when we assume ordinal preferences rather than cardinal preferences. Consider the estimation of demand systems. These are often based on some explicit underlying preferences. In the early days, this was based on Cobb-Douglas preferences. Following this, CES preferences became popular because they nested a number of alternative preference orderings as special cases. More recently, there has been a tendency to use even more flexible functional forms that can be viewed as second-order approximations to arbitrary utility functions (or alternative representations of preferences such as expenditure functions). Obviously, a researchers choice of functional form will depend in large part on the sample size, since this will affect the number of parameters that can be independently estimated.

As for the differences between preference based approaches and revealed preference approaches, the main result is that if we are prepared to assume that peoples choices are sufficiently consistent, then it is perfectly alright for us to work with preference relations rather than explicit choices. Specifically, we need to assume that peoples choices obey Walras’ law for the individual (budget exhaustion), the weak axiom of revealed preference (allowing direct comparisons) and the strong axiom of revealed preference (allowing indirect comparisons). If these assumptions hold, then the two approaches yield equivalent results.

The fact that lexicographic preferences cannot be represented by a utility function is well known. However,for most empirical work, it seems reasonable to assume that preferences are continuous. This rules out lexicographic preferences.

Damien Eldridge
Damien Eldridge
14 years ago

Paul, I apologise for the intermediate micro comment in my second comment (number 23) on this thread. It was both rude and unwarranted.

Damien Eldridge
Damien Eldridge
14 years ago

Paul, a reference on the ordinality of preferences in the theory of choice under certainty is on page 9 of the following book:

Mas-Colell, A, MD Whinston and JR Green (1995), Microeconomic theory, Oxford University Press, USA.

Fred Argy
Fred Argy
14 years ago

I just want to pick up briefly on Harry Clarkes comment (and NGs response) and on the debate on utilitarianism between Paul frijter, Damien Eldridge and Nicholas Gruen.

Harry, you seem to imply that social liberalism is like socialism. That is not of course correct. On my definition, a social liberal is a pro-market economic liberal who is sensitive to distribution and quality of life issues. Socialism is anti-market and pro-public ownership and control of means of production. We should not muddy the two please.

Harry, you are not an inconsistent economic liberal if you prefer to spend money on education for young kids. Most economic liberals accept this proposition as meeting their economic test. Similarly they accept that some prudential regulation is necessary to ensure financial markets work efficiently.

It is on distribution issues that you might be an inconsistent economic liberal because (as I have defined it) economic liberalism is only interested in utility aggregates. If you want to give some weight to distribution, you are taking a small step towards social liberalism. As I have defined them, social liberals are economic liberals who want to promote efficiency but give considerable weight to distribution and quality of life issues. They are in your sense inconsistent economic liberals.

In practice, I suspect that I would give more weight to distribution and less to efficiency than you would. For example, I might be happier than you to see taxes increased to enable governments to level opportunities in education, health, housing and employment even if it meant a smaller GDP than otherwise. And I would be happier than you to explore Nordic methods of labour market intervention in lieu of labour market deregulation even if they produced a slightly inferior employment outcome (which incidentally they dont). So you probably fit better the description of an inconsistent economic liberal and I fit better the category of social liberal.

Regarding utilitarianism, I am on the side of Damien. Most economic liberals commenting on a prospective policy reform which is expected to have winners and losers (like labour market deregulation) tend to focus on aggregate utility, which they see as roughly measured by GDP (subject to usual qualifications). As Damien says, the implication is that they believe a dollar is a dollar no matter who gets it. The diminishing marginal utility theory is about an individuals sloping demand curve which is a different thing altogether from interpersonal comparisons of utility.

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
14 years ago

Fred, the idea of interpersonal comparisons and declining marginal utility are certainly different concepts. Very different concepts. But ‘a different thing altogether’? I disagree. This is not just quibbling. It’s important.

I would argue that, whilst one can’t be at all precise about it, a dollar to Arnold Schwarzenegger generates less utility than a dollar to most people. (I use him because he’s said that you could take a couple of million off him and it wouldn’t make any difference to his happiness). :)

I know that there are a thousand verbal objections. But we all know that it’s commonsense. This is precisely the way in which people like Pigou and Marshall meant to make interpersonal comparisons – not with any conceptual or formal precision (which would be silly) but in a commonsensical way – with all the usual caveats (on average, in most cases etc.)

This has more or less dropped out of economists’ commonsense and it’s a great pity. Economics has a precise core regarding some methodologies and that core has become more and more central to the discipline, and to economists’ conception of who they are, what they do and what they have to offer. Obviously that apparatus is a valuable thing but it tends to lead economists away from the issues to do with how it all gets applied to the real world. The way it applies to the world is by way of analogy. Economics in this sense is a loose, rough and ready science and that’s its strength – the way it gets to quite powerful and convincing conclusions with just a few stylised facts.

Within that context the idea that Arnold Schwarzenegger gets less utility from a dollar than you’re average Joe is an important piece of economic commonsense. We use ideas like this all the time to build a bridge between our formal analysis and the real world.

Fred Argy
Fred Argy
14 years ago

I agree with you Nicholas – it is good common sense to assume that Arnold gets less utility per arginal dollar. That’s precisely why I am a social liberal – not a pure or inconsistent economic liberal – which I have defined as someone who refuses to make interpersonal comparisons (looks only at aggregates).

Jc
Jc
14 years ago

Whether Arnold thinks a few million less doesn’t make him happier the point is that money belongs to him. It begs the question: who makes the decision th confiscate that money from Arnie and give it to someone else?

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
14 years ago

Yes that’s right JC. There are a million reasons why you don’t take the argument to its logical conclusion. It’s a consideration amongst many others.

Fred Argy
Fred Argy
14 years ago

JC, social liberals (as I define them) are not arguing for a redistribution of existing income and wealth as part of a utilitarian model. It is the INCREMENTAL distribution effects which concern them.

Thus, when a government is considering a policy reform (such as labour market deregulation) which is expected to improve efficiency and total utility (GDP) but produce a significant number of losers who are in the low-income category, an attempt should be made to either compensate the losers or to find an alternative reform path (like the Nordic model) which can achieve broadly similar efficiency gains without the regressive distribution effects. That’s what a social liberal would do because he or she builds distribution analysis into his evaluation. A pure economic liberal and a libertarian would simply ignore distribution effects.

As you can see, I am not a socialist revolutionary!

Christopher
Christopher
14 years ago

Aren’t Paul, Damien and Nicholas all correct, and all talking at cross-purposes?

Damien is correct in that the toolset we use means that to talk about diminishing marginal utility doesn’t take us very far because I can monotonically transform that to an increasing marginal utility function and derive exactly the same observable outcomes.

That is, the same demand functions fall out – which is what matters if we’re talking about empirically identifying policies with potential pareto improvements where the estimated benefits are greater than the costs. (Or more often, trying to kill off policy proposals with costs greater than benefits – but I digress)

However, although the toolset doesn’t admit the existence of diminishing marginal utility in income doesn’t mean economists don’t think that’s what the world looks like. As Paul says, we use it to justify a number of policies. We just don’t have a fully robust way of incorporating that view.

cheers,
Christopher

Brendan Halfweeg
Brendan Halfweeg
14 years ago

If income has a diminishing marginal utility, why do high income earners spend a disproportionate amount of money on tax minimisation? The percentage of a persons budget spent on tax management increases proportionately with income.

Part of the marginal utility of tax minimisation is the satisfaction in not feeding the ravenous beast, not seeing your hard earned pissed up against a wall by mindless bureaucrats. Kerry Packer used to piss money away in Vegas rather than hand it over to the ATO.

Jc
Jc
14 years ago

Fred:
Thus, when a government is considering a policy reform (such as labour market deregulation) which is expected to improve efficiency and total utility (GDP) but produce a significant number of losers who are in the low-income category, an attempt should be made to either compensate the losers or to find an alternative reform path (like the Nordic model) which can achieve broadly similar efficiency gains without the regressive distribution effects. Thats what a social liberal would do because he or she builds distribution analysis into his evaluation. A pure economic liberal and a libertarian would simply ignore distribution effects.

Fred several things.

1. Labor market reform does not add to productivity gains. It’s a loser from that score. Even the Treasury had to come out and correct the governments bad argument saying so in not so many words.

2. If total factor wages grow as a result of reform then, by definition it is a winner. There is no point arguing that Joe Blogs down the street lost a little of his union supported wages while 5 marginal workers find jobs that weren’t there before. This is a no brainer as far as I’m concerned, as you can’t fight the market if the market is telling you wages are too high through the price signal called unemployment. If wages grow in aggregate terms we are winners.

3. The real losers that deserve to be compensated are those who can’t find a job because labor market restrictions prevent them from doing so. These people ought to rightly be compensated by the government and those people belonging to unions which through restrictive practices managed to set wages for their members above the clearing rate resulting in unemployment. In fact if you like the idea of redistribution one ought to redistribute those ill gotten gains and given to the unemployed as direct transfer payment. Those not practicing this rort though should not be taxed.

4. The Nordic model doesn’t work Fred. You can of course set labor rates below the clearing rate as the some of the Nordics have done. But it hardly portends to high paying jobs. Sweden has been going on a one-way trajectory since it adopted more welfare polices in the early 70’s. At that time it’s GDP PPP was about the 3rd highest in the world. It is now about 15th. It now has a standard of living comparable to the poorest regions of the US. Comparing like with like- as I said earlier. Comparing say CT or MT to Sweden they enjoy a GDP PPP of around US$57,000 while Swedens is about $29,000.

So we can set a low wage structure but don’t bet on high paying jobs, which is what we want.

5 A pure economic liberal and a libertarian would simply ignore distribution effects.

Yes, but if all boats are rising why should we care. Why do I care how rich or poor I am to Bill Gates?

6. If there is economic growth: if our economy is growing it is an impossibility to keep wages lower than the clearing rate in a free labor market. It can’t happen and we have had 200 years of evidence and economic theory through the marginal productivity theory to say so.

cs
cs
14 years ago

Hi JC, let me take some idle time out on you.

If total factor wages grow as a result of reform then, by definition it is a winner.

The total factor wages, whatever that really means, can, by definition, like any total, grow; yet still leave most people worse off. By simple maths, we know a total can grow simply by benefiting one unit so much it overtakes every other unit’s loss.

The real losers that deserve to be compensated are those who cant find a job because labor market restrictions prevent them from doing so. These people ought to rightly be compensated by the government and those people belonging to unions which through restrictive practices managed to set wages for their members above the clearing rate resulting in unemployment. In fact if you like the idea of redistribution one ought to redistribute those ill gotten gains and given to the unemployed as direct transfer payment. Those not practicing this rort though should not be taxed.

Punish the collective, punish the collective often, and without mercy, wherever it appears. Do this always in the mythical name of someone who has no collective membership, for whom liberal hearts bleed dry more often than a Muslim says payers. There is no bleeding heart on earth that serves on behalf of a myth like that proferred by the liberal economist. An economist will justify a whole life of perdition in the name of the lost soul of liberal ideology, the individual, wandering the Hobbesian jungle, in whose name the world must be turned asunder, like it or not. Anyone who votes this way, by the way, should be relieved of tax.

If there is economic growth: if our economy is growing it is an impossibility to keep wages lower than the clearing rate in a free labor market. It cant happen and we have had 200 years of evidence and economic theory through the marginal productivity theory to say so.

Whatever. Real economic growth is difficult to measure, often partial and transitory. If our economy is growing overall, and this happens to be according to reputable measures, it remains that the the closer it gets to not growing. Some times you don’t need to listen to the weatherman to know that the whole job is to figure out which way the wind blows.

JC
JC
14 years ago

Hi JC, let me take some idle time out on you.
If total factor wages grow as a result of reform then, by definition it is a winner.
The total factor wages, whatever that really means, can, by definition, like any total, grow; yet still leave most people worse off. By simple maths, we know a total can grow simply by benefiting one unit so much it overtakes every other units loss.

CS, you cant have strong aggregate growth in wages and have most people worse off over a period of time. It really cant happen or if it can I would love to see the evidence. I would be careful using the US as an example though seeing the bottom 20 million workers have to grapple with wage slide from the 11 million illegals in the country. If youre looking for the reason why wage growth in the US in the unskilled sector has been slow look no further for an explanation.
——————————————–

Punish the collective, punish the collective often, and without mercy, wherever it appears. Do this always in the mythical name of someone who has no collective membership, for whom liberal hearts bleed dry more often than a Muslim says payers.

Funny. I like your sense of humor. I find it difficult to reconcile in my mind why those people employed in the free market and not using the union jackhammer should be mandated to pay welfare for those innocents unable to find a job because of union rorts or those protected by labor market regulations. You seem to, or at least allude to. Want to expand on this a little more rather than throwing that soft ball? Unions raise wages for their member, which as consequence at the expense of everyone else.. That practice ought to be taxed and the tax redistributed to the unemployed as compensation. Thats what I consider fairness.
Its pretty obvious to anyone with a reasonable understanding of labour economics that unions raise wages of their members at the expense of everybody else. Im not stating anything new here, CS.

————————
There is no bleeding heart on earth that serves on behalf of a myth like that proferred by the liberal economist. An economist will justify a whole life of perdition in the name of the lost soul of liberal ideology, the individual, wandering the Hobbesian jungle, in whose name the world must be turned asunder, like it or not. Anyone who votes this way, by the way, should be relieved of tax.

I really dont get what youre trying to say here Would you mind elaborating a little.
—————————-
Whatever. Real economic growth is difficult to measure, often partial and transitory. If our economy is growing overall, and this happens to be according to reputable measures, it remains that the the closer it gets to not growing. Some times you dont need to listen to the weatherman to know that the whole job is to figure out which way the wind blows.

Real economic is difficult to measure but the GDP aggregates are presently about the best thing we have going and until something else comes along we will continue to use GDP as a best guess of whats going on.. If its good enough for the RBA and Treasury its good enough for you and me.
If our economy is growing overall, and this happens to be according to reputable measures, it remains that the the closer it gets to not growing.

I dont quite get what youre trying to say here either. Are you telling me there are peaks and troughs? Sure there are, but I dont honestly see the relevance.

Some times you dont need to listen to the weatherman to know that the whole job is to figure out which way the wind blows.

You dont, true, but you also have less chance on a probability basis to tell us if it likely to rain tomorrow than the weather guy. Thats why we listen to the weather guys guesses, which are based on probability estimates and maps. But I guess you were using this to somehow criticise the last part of what I said. What I said still holds which is that it is impossible to experience economic growth in a free market and not see wage growth. Now Im serious, if you can falsify this, you are well on your way to a prize in economics. It is what the marginal productivity theory explains and at this stage it hasnt been disproved. There is evidence of this since the industrial revolution.

JC
JC
14 years ago

I actually think Gross Domestic Spending (or Revenue) is a better measure than GDP for gauge what’s actually going on within the innards of the economy. GDP is too consumer orientated and its a value added index of sorts.

GDR would show the economy is about 20 trillion dollars rather than $i trill and it would also be a better indicator of trends and sector activity. An even better one is to use the stock price of some firms that have very long lead times though you hav to be careful. I use Caterpiller in US the because of the long lead and lag times they have.

Bloomberg stock quote page:http://www.bloomberg.com/apps/cbuilder?ticker1=CAT:SW

And I use a couple of general long lead time engineering firms here. Miners are basically a China story.

cs
cs
14 years ago

CS, you cant have strong aggregate growth in wages and have most people worse off over a period of time. It really cant happen or if it can I would love to see the evidence.

Of course you can. You are trying to argue against mathematics in suggesting otherwise. All you need to have is a minority so well off they increase the aggregate by outweighing the losses of the majority. This is 101, JC.

Unions raise wages for their member, which as consequence at the expense of everyone else.. That practice ought to be taxed and the tax redistributed to the unemployed as compensation. Thats what I consider fairness.
Its pretty obvious to anyone with a reasonable understanding of labour economics that unions raise wages of their members at the expense of everybody else. Im not stating anything new here, CS.

This is a liberal economist’s daily prayer. Unions do lots of things. Sometimes they reduce the profit share, the incomes of a minority, for the benefit of the majority. But, as I say, unions do lots of things, and I would need a very big essay to give you a taste of the reality JC. But, when all is said and done, I don’t mind if the lost soul of liberal mythology doesn’t wish to join a union, so long as they make a donation equivalent the union dues to a charity or some good cause to prove they are not just lousy bludgers on their fellow man and society.

That’ll do for now. If I have any more idle time, you could get some more of it. You never know.

Christopher
Christopher
14 years ago

I actually think Gross Domestic Spending (or Revenue) is a better measure than GDP for gauge whats actually going on within the innards of the economy. GDP is too consumer orientated and its a value added index of sorts

GDP is producer surplus (economic profit) – and reflects value added because it’s the benefit that acrues to producers over and above the costs of doing whatever activity they do. Its got nothing to do with consumers (except that their the ones that enact the exchange at given prices).

Why would spending be a better measure for welfare/wellbeing? (despite all knowing that GDP has lots of problems).

Isn’t a measure that reflects how well we’re doing over and above the costs of our activities a more appropriate measure ?

cheers,
Christopher

Bingo Bango Boingo
Bingo Bango Boingo
14 years ago

“CS, you cant have strong aggregate growth in wages and have most people worse off over a period of time. It really cant happen or if it can I would love to see the evidence.

Of course you can. You are trying to argue against mathematics in suggesting otherwise. All you need to have is a minority so well off they increase the aggregate by outweighing the losses of the majority. This is 101, JC.”

CS, we are talking about the real world of the long-term labour market, not whether or not you can prove mathematically that wage growth for a subset of workers can offset wage decreases for another subset. As capital accumulates there will always be winners and losers. The simple truth is this: overall, labour tends to receive the value of its marginal product. Did you ever wonder why we don’t have 99% unemployment, or very few workers on the minimum wage, when we have ‘labour-saving’ machines all over the place?

You have provided a hypothetical scenario of large-scale losses which defies, as JC puts it, 200 years of economic history. The comment: “Sometimes they [the unions] reduce the profit share, the incomes of a minority, for the benefit of the majority.” shows just how tightly you cling to a moribund ideology that has failed some of the most vulnerable in our community: the low-skilled unemployed.

Cheers
BBB

JC
JC
14 years ago

“Sometimes they reduce the profit share, the incomes of a minority, for the benefit of the majority.”

Well, I would put it differently. Unions (when there laws favouring their behaviour) are really economic parasites living at the expense of others. I have no issue with people unionizing as the freedom of association is important. However I do have a problem when there are laws supporting Union activities. Unions do not and can never raise living standards for all of us. Only economic growth can do that , which to all intents and purposes iscapital accumulation.

Does capital accumulation raise all our living standards even for those who aren’t the direct beneficiaries? Sure it does.

Example
A barber’s productive improvement has been marginal over the past 100 years. Yet his wage has also improved along with the rest. It can only be because economic growth spreads the benefits.

——————–

But, as I say, unions do lots of things, and I would need a very big essay to give you a taste of the reality JC.

I’m sure they do lots of things, but they also exist at the expense of others when there are laws supporting their behaviour..

——————–

But, when all is said and done, I dont mind if the lost soul of liberal mythology doesnt wish to join a union, so long as they make a donation equivalent the union dues to a charity or some good cause to prove they are not just lousy bludgers on their fellow man and society.

Well I do. People are free to do what they like with their money. A donation in kind is a semi-obligation that no one ought feel.

—————————-

Thatll do for now. If I have any more idle time, you could get some more of it. You never know.

Fair enough.

cs
cs
14 years ago

Sure BBB. It is more than 350 years since Hobbes wrote that businessmen would suppress the theorems of geometry if it suited their interests. Good to see you keeping up the tradition. Next, explain why 2 and 2 doesn’t equal 4.

Well, I would put it differently. Unions (when there laws favouring their behaviour) are really economic parasites living at the expense of others. I have no issue with people unionizing as the freedom of association is important. However I do have a problem when there are laws supporting Union activities. Unions do not and can never raise living standards for all of us. Only economic growth can do that , which to all intents and purposes iscapital accumulation.

What a load of crap you type dear old JC, even going so far as to allow people to associate! Will the generosity of your great mind ever find a boundary? Lord be praised!

Leaving aside most of your foolhardy assumptions, economic growth is a mystery bag, as it happens. What counts, old bean, is productivity, and in this respect unions are the key, for their job is to ensure that the benefits of productivity growth are fairly distributed, which automatically also ensures the distribution of incentives to produce even more productivity growth, for the benefit of all. It is the non-unionised busines that does not share the proceeds of productivity growth with the producers who are the parasites, leaching ths system for themselves, grinding the place to a stop, bringing ruin to the populace.

Jc
Jc
14 years ago

Hahha CS. I read that last bit in Dickens somewhere didnt I? I never got to the part where he explained just why all those people migrated from the land to factory jobs. I guess it was the Lords who forced marched them to those horrid factory jobs for them to leave the beauty of working on a field from sun up to sunset.

Sure BBB. It is more than 350 years since Hobbes wrote that businessmen would suppress the theorems of geometry if it suited their interests. Good to see you keeping up the tradition. Next, explain why 2 and 2 doesnt equal 4.

He already did. In a relatively free society economic growth means higher living standards for all. Can you falsify this with economic evidence?
What a load of crap you type dear old JC, even going so far as to allow people to associate! Will the generosity of your great mind ever find a boundary? Lord be praised!
Resorting to ad homs when the going gets tough? It makes no difference because your argument is shallow and youre dishonestly presenting what I said.
Go back and read what I said. I wrote that I DONT have a problem with free association, but I do have a problem with laws stacked up in favour of unions who then use those powers for parasitical purposes- they raise their own living standards at the expense of others which in most cases means the least qualified and unskilled. In other words if unions wish to strike they should also fear the risk of lock out. If unions dont abide by an agreement one should have the right to sue them for loss of wealth.

Leaving aside most of your foolhardy assumptions, economic growth is a mystery bag, as it happens.

No it isnt- as best as we can make out. We know that rising living standards is congruous to capital accumulation. If it wasnt you and I would be still toiling away on the small plot instead of having all this free time and arguing over a screen. Its pretty clear that to all intents and purposes economic growth is not a mystery bag at all to those with any understand of economics.

——————————–
What counts, old bean, is productivity, and in this respect unions are the key, for their job is to ensure that the benefits of productivity growth are fairly distributed, which automatically also ensures the distribution of incentives to produce even more productivity growth, for the benefit of all

When Unions are armed with the law on their side they begin to treat available resources as captured capital. Motown USA is a perfect illustration of that. They will raise the wages of their members at the expense of everyone else.

The marginal productivity of an individuals labor input is what drives wages. Its simplistic in the extreme to even begin to believe that a strike for higher benefits will produce higher wages for all. In fact the opposite is true as it will produce misery for those out of work and unable to find jobs as a result. That is why I say legal sanction supporting unions causes parasitic behaviour.

It is the non-unionised busines that does not share the proceeds of productivity growth with the producers who are the parasites, leaching ths system for themselves, grinding the place to a stop, bringing ruin to the populace.

Oh. I never knew Microsoft employees were eating out of soup kitchens. So the 85% of the working population in OZ that doesnt belong to a union has the unions to thank for their rising living standards. Is that a pig I see flying outside the window?

BHP wage bill per person is about $75,000. lots of demand, lots of captial equipment leads to higher wages for workers. Unions have as much to do about that I do flying a plane when i’m a passenger.

What unions can do that is beneficial is to help explain why co-operation and non-antagonitic behaviour leads to higher pay- all things being equal.

cs
cs
14 years ago

Reads like a rant from a right-wing nutjob. No offence intended JC, of course. FWIW, I can only respond to comments that are able to be read in a flash, for I don’t have the time to clean up a dog’s breakfast

Jc
Jc
14 years ago

Cs, economics isn’t really your strongest point, is it? No offense intended either. You know how highly i think if you.

cs
cs
14 years ago

It might not be my strongest point, but I still beat you, pal. That’s what you get if you have many strong points, including a capacity for brevity.