What if Adam Smith was right about poverty?

Well-being isn’t just about our relationship with things, it’s also about our relationships with each other. Poverty hurts, not just because it can leave you feeling hungry, cold and sick, but because it can also leave you feeling ignored, excluded and ashamed. In The Theory of Moral Sentiments Adam Smith argued that all of us want others to pay attention to us and treat us with respect. And "it is chiefly from this regard to the sentiments of mankind, that we pursue riches and avoid poverty."

Recent research confirms Smith’s intuitions — social pain is every bit as aversive as physical pain. And Smith’s thoughts about the way people use material goods to achieve social goals are even more compelling in the light of Gary Becker’s theory of household production. Becker argues that all human beings have stable preferences that relate to fundamental aspects of life such as "health, prestige, sensual pleasure, benevolence, or envy" rather than to specific goods and services. If Becker is right, material goods are often only a means to social ends.

There is ample evidence that the trappings of wealth are effective as social tools. According to psychologist Helga Dittmar:

…wealthy people are seen as intelligent, responsible, hard-working, successful, skilful, physically attractive and resourceful. In contrast, poor people are viewed as lazy, unmotivated, lacking in abilities and skills, irresponsible, unattractive and lacking proper money management (p 162).

So if Smith is right then what should we do about involuntary poverty? Is it enough to provide state subsidised goods such as housing and healthcare and to dole out money for necessities?

Adam Smith — Poverty as social exclusion

According to Adam Smith, human beings are by nature social creatures. In The Theory of Moral Sentiments, he wrote:

Nature, when she formed man for society, endowed him with an original desire to please, and an original aversion to offend his brethren. She taught him to feel pleasure in their favourable, and pain in their unfavourable regard.

The reason poverty causes pain is not just because it can leave people feeling hungry, cold and sick, but because it is associated with unfavourable regard. As he explains:

The poor man … is ashamed of his poverty. He feels that it either places him out of the sight of mankind, or, that if they take any notice of him, they have, however, scarce any fellow–feeling with the misery and distress which he suffers. He is mortified upon both accounts; for though to be overlooked, and to be disapproved of, are things entirely different, yet as obscurity covers us from the daylight of honour and approbation, to feel that we are taken no notice of, necessarily damps the most agreeable hope, and disappoints the most ardent desire, of human nature. The poor man goes out and comes in unheeded, and when in the midst of a crowd is in the same obscurity as if shut up in his own hovel.

For Smith, a person’s possessions function as signals of underlying personal characteristics — characteristics that others regard either favourably or unfavourably. In the Wealth of Nations he wrote:

A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably, though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty, which, it is presumed, nobody can well fall into without extreme bad conduct.

As Mark Thoma notes, Adam Smith thought poverty was about much more than physical deprivation. The labourer’s linen shirt has value because it can be used to influence other people’s opinions. The labourer is using the shirt as a raw material in a production process — a process that affects other people’s mental states, changes their behaviour and, ultimately, improves the psychological well being of the wearer.

The ‘good’ that is being consumed here is not the shirt — it is the observer’s opinion. While it’s true that the observer’s opinion only affects the labourer’s well being via behavioural signaling, this is true of many consumer goods. For example, neuroimaging research suggests that wine really does taste better when it carries a high price tag (at least for some consumers). In both cases, the consumer cares about the quality of the good, even if they can’t directly observe it.

Social pain

Smith argued that human beings are hard-wired to care about each other’s opinions. As he put it, nature taught people to feel pleasure in the favourable regard of others, and pain in their unfavourable regard. And according to cognitive scientists, there is a good reason for this. According Naomi Eisenberger, "mammals require close contact with a caregiver in order to acquire the appropriate nourishment and protection to survive." As a result, it would have been highly adaptive for our ancestors to feel pain when their relationships with caregivers were threatened.

As Eisenberger notes, neuroscientist Jaak Panksepp "hypothesized that the social attachment system, the system that keeps us near close others, may have piggybacked onto the physical pain system to promote survival in mammalian species."

In a 2005 article ‘Why does social exclusion hurt?‘, Geoff MacDonald and Mark Leary write:

Most people have experiences in which socially mediated pain is so great that they are not only in agony but are overwhelmed or incapacitated. In this article, we argue that referring to these responses to social exclusion, rejection, or loss as pain is more than just a metaphor. Because inclusion in social groups has been a key to survival for social animals deep into the past, we propose that threats to one’s social connections are processed at a basic level as a severe threat to one’s safety. In fact, we argue that such threats are partly mediated by the same system that processes physical pain because the pain system was already in place when social animals evolved adaptations for responding to social exclusion.

The theory attracted media attention in 2003 when Eisenberger and her colleagues reported the results of a neuroimaging study. The researchers found that that feelings of social exclusion were associated with activity in a brain region which is also involved in pain processing.

According to researchers, our experience of pain has two separate components — pain sensation and pain affect. As MacDonald and Leary write, "Pain sensation provides information about ongoing tissue damage" while "Pain affect consists of the feelings of unpleasantness that are associated with pain sensation, as well as emotions associated with the future implications of those sensations". According to the social pain hypothesis, loss, rejection and social exclusion can trigger the same feelings of unpleasantness and emotional responses as physical pain.

Gary Becker and household production

Adam Smith’s labourer valued his linen shirt, not just because it protected him from the sun and wind, but because it protected him from the unfavourable judgments of those he depended on. Smith argued that all human beings want others to notice and approve of them. More recently, economist Gary Becker and Robert Michael suggested that all human beings might have the same basic preferences. It seems likely that some of these preferences relate to social approval:

In the standard theory [of choice] all consumers behave similarly in the sense that they all maximize the same thing — utility or satisfaction. It is only a further extension then to argue that they all derive that utility from the same "basic pleasures". From this point of view, the Latin expression de gustibus non est disputandum suggests not so much that it is impossible to resolve disputes arising from differences in tastes but rather than in fact no such disputes arise!

Extending Becker’s theory, cognitive sociologist Siegwart Lindenberg and his colleagues argue that "people produce their own well-being by trying to optimize achievement of universal goals, within the set of resources and constraints they face." In a 1999 paper the researchers argue that subjective well-being depends on the achievement of both physical and social goals. Social goals include status, approval and affection.

If this theory is right, then it makes sense to think that much of our material consumption serves social rather than physical ends. If it were possible to use material goods such as cars and clothes to influence other people’s opinions, then it would makes sense for people to do so.

The social utility of wealth

According to Smith, the rich get far more attention and respect than the poor — even when they’ve done nothing to merit it. "In equal degrees of merit", he wrote, "there is scarce any man who does not respect more the rich and the great, than the poor and the humble." Material consumption acts a signal of underlying characteristics — characteristics that are able to provoke deference, approval and affection.

In her book The social psychology of material possessions Helga Dittmar argues that observers use patterns of consumption rather than isolated items “to locate others in terms of class, status and social position, and that these categorical evaluations give rise to impressions of the owner’s personal qualities and attributes” (161). There is growing body of evidence for this claim.

For example, in a study of American adolescents Dianne Skafte found that subjects readily inferred character traits from information about wealth or poverty. She showed the young people a photograph of a person of around the same age as themselves and included a brief biographical sketch. The biographies were identical except that one group were told the person in the photograph was from a rich family while others were told that it was of someone who was from a poor or neutral family. Subjects were then asked to rate the person in the photograph on various traits.

Skafte’s subjects judged the people labeled as wealthy to be more intelligent, more likely to get good grades in school, more likely to succeed in the future, and to be healthier and happier than those labeled poor or neutral. While the poor people were judged to be harder working and more generous they were seen as lacking the talent and ability needed for success.

Dittmar performed a similar experiment with English school students aged 16 to 18 which she reported in her 1992 paper ‘Perceived material wealth and first impressions‘. Subjects were shown films of a man or women coming home from work, making a cup of tea, watching TV, listening to the stereo, and packing their sports equipment into their car. In one condition the person was shown in a well-off middle class context with props such as up-market appliances, a Ford Grenada car and a well decorated living room. In the other condition the person was shown using cheaper appliances, more basic furnishings and a VW. After viewing the film subjects were asked to rate how well various descriptions of personal qualities applied to the person they had seen.

Dittmar found that the wealthy person was seen as more intelligent, successful, educated, and in control of their life than the less well-off person. However the less well-off individual was seen as warmer, friendlier and more self-expressive. Another finding of Dittmar’s study was that these patterns of perception did not differ between students from a working class comprehensive school and those from prestigious public schools.

In a study of American undergraduates Cozzarelli, Wilkinson and Tagler asked subjects to rate how applicable various trait descriptions were to poor and middle class people. The poor were more likely than the middle class to be described as lazy, stupid, dirty, uneducated, unmotivated, criminal and less likely to be described as proud, intelligent, family oriented, responsible, and hardworking.

Signals of wealth have also been shown to have an effect on the perceiver’s behavior. For example, psychologists Anthony Doob and Alan Gross performed an experiment in the field where a car stopped at a traffic light failed to move through the intersection when the light turned green. Using two conditions, one with a cheap low status car and the other with a well cared for high status car the experimenters watched and waited to see how long it would take before the trapped drivers would honk their horns. On average, drivers stuck behind the low status car waited less time before honking and honked more often than those trapped behind the high status car (two subjects in the low status condition were excluded from the analysis because they drove their cars into the back of the bumper of the low status car instead of honking).

In a 1971 study of effect of status on honesty, psychologist Leonard Bickman had a confederate leave a dime in a prominent position in a public phone booth. Then, two minutes after a subject entered the phone booth the confederate tapped on the booth and told the subject that they may have left a dime in the phone booth asking if they had found it. In one condition the confederate was dressed in high status clothes while in another they were dressed in low status clothing. In the high status condition 77 per cent of the subjects returned the dime while in the low status condition only 38 per cent did.

In both these studies the experimenters went one step further. As well as running the experiment in the field they also asked another group of subjects using a questionnaire how they believed that they would respond to the situation. In both studies the answers to this question were different to the observed behaviour. Subjects told the experimenters that they would not treat people differently just because of the car they drove or the way they were dressed. It seems as if it difficult for most of us to admit that we rely so heavily on superficial features in making judgments and deciding how to act.

What if Adam Smith was right?

For Adam Smith poverty meant having visibly less than others. But it’s not obvious that Smith’s problem of poverty could be solved simply by handing out food, housing and health care to those at the bottom of the income distribution. Smith argued that people have social as well as physical needs. In our society, working-age adults meet many of these needs through paid employment. Work is not just a source of income, it can also be a source of status, belonging and approval from others.

This view of well-being helps explain why income redistribution on its own will never be enough to guarantee that the needs of the least advantaged are met. When income support payments are linked to tests of employability (as with disability payments) or job search effort (as with unemployment payments), eligibility for the payments is itself a signal (whether we like it or not).

If we’re committed to constantly improving well-being of the least advantaged, what policies should we support?

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67 Responses to What if Adam Smith was right about poverty?

  1. Ken Parish says:


    Subject to reading the concrete measures you eventually propose to improve the well-beng/dignity of the least advantaged, I suspect this post rests on the same logical fallacy that Sinclair Davidson identified in your previous equality post. That is, the fact that Hayek rightly conceded that there isn’t a tight correlation between merit and capitalist success/wealth does not deny that the correlation is significant, or that appropriate payoffs for merit (though imperfectly reflected by market incomes) both in material and status terms are important to the ongoing health of the system.

    Australians work on average around 42 hours per week, but I suggest there would hardly be a single highly paid corporate executive, doctor, lawyer or other professional who doesn’t work much longer hours than that under vastly greater pressure. Does the fact that a very few people fluke a big payoff without working hard mean that the hard workers should be levelled down in either income or status terms to equivalence with those who don’t work anywhere near as hard or under such pressure? What would happen if that occurred? Both the old communist system and traditional aboriginal kinship sharing systems give us some fairly strong clues IMO. In both systems most people didn’t/don’t bother to work hard because there’s little or no social or economic payoff for doing so.

    That isn’t to deny that there’s room in the Australian system for measures that increase the well-being of the poor and especially their children’s opportunities to maximise their skills, careers and so on. Hence I really can’t reach any clear view on what your point actually might be until you lay out concrete proposals as you foreshadow. However, despite Jason Soon’s recent suggestions, I don’t think I’d personally support decoupling unemployment benefits from job search or retraining efforts. Apart from anything else, Fred Argy’s case about the economic success of some of the Scandinavian countries relative to other parts of Europe appears to rest on the strong incentives provided by “mutual obligation” policies. No doubt that sends signals about social status/prestige, but the Scandinavian example seems to suggest that those signals serve a very real and important positive economic purpose. It may be that, in the absence of those signals, reduction of economic and social disparities would be at the cost of all of us ending up poorer.

  2. Don Arthur says:

    Ken – I think it’s a mistake to exaggerate the differences between my position and Sinclair‘s.

    And the point of this post really is to pose a question. I think it’s an interesting question.

  3. Ken Parish says:

    I don’t think I am exaggerating them, just restating them in stark terms and agreeing mostly with Sinclair on this occasion.

  4. Don – Though clothing is also used as a deliberate rejection of the majority culture to promote membership of a minority group. People prefer membership of a particular group – from punks to Muslim women – even if comes at some cost of ‘social exclusion’ from the majority group.

  5. NPOV says:

    “For Adam Smith poverty meant having visibly less than others”

    I certainly agree that “relative poverty” can’t be dismissed out of hand as a real issue. You can reasonably argue that relative to, Niger (about the poorest country in the world, with a per capita GDP of ~$300AU a year – 80c a day), that Australia has no “real” poverty. But it would be heartless to claim that Australia has no “poor”. Standards of poverty aren’t absolute. And I’m sure that in 50 years’ time when Australia’s poorest will probably be 3 times as well off as they are today, there will still be some people considered poor.
    Indeed, probably the only way you would ever be able to claim that a country had no “poor” at all is if income inequality was very low, but it still remained a rich country overall (relative to other nations).

  6. Don Arthur says:

    Though clothing is also used as a deliberate rejection of the majority culture to promote membership of a minority group.

    Andrew – I think that’s an interesting point.

    If Becker is right, then differences in individual behaviour arise largely from differences in resources and circumstances. His approach discourages explanations which appeal to deviant preferences.

    This approach to sub-culture seem similar to Robert Merton’s. In Merton’s 1938 paper ‘Social structure and anomie‘ he wrote:

    Our primary aim is to discover how some social structures exert a definite pressure upon certain persons in the society to engage in nonconformist rather than conformist conduct.

    For some reason taking an interest in Merton’s work has become a deviant behaviour in university sociology departments.

  7. Patrick says:

    This may be silly, but can’t you reconcile Merton’s question with your thesis by positing that people who realise that they have no immediate opportunity of being universally acclaimed choose to define the set of universal differently, ie in terms of a particular subgroup?

    Within the subgroup they can either:

    a) blame others/external factors for their lack of relative success;
    b) be ‘universally’ acclaimed by everyone who ‘matters’ (ie is within the new ‘universal’ set); or
    c) both.

    In response to Don’s question it seems to me that the only sensible kind of answer must be one which focuses on facilitating mobility.

    Perhaps, for those who are incapable of benefiting from any incentives/rewards/assistance for mobility, mobility could be sufficiently positive if it was intergenerational – ie if their kids could succeed.

    Maybe we are close enough to a new era in which hare-brained space exploration ventures can skim off the most desperately (and consciously) status-deprived and self-assessed undervalued in much the same way as the exploration of previous frontiers did?

  8. Caroline says:

    Poverty needs to be seen in relative terms both internationally (sobering) and nationally.

    I have little faith in government policy effectively being able to address general poverty without bringing the more well off down a notch or two. There is only so much money in the system. If you have more, logic would suggest that somebody else has less. The notoriously high pay packets and bonuses given to some CEO’s which are seen as disgusting even by the Peter Costello’s of the world, could be a place to start. Surely such people’s salaries, rob if not their own companies profit margins, then certainly the chance of people within that company ever being able to improve their circumstances.

    I think however that it would take a spiritually enlightened society, devoid of fear to ever make for a materially equitable society. And that’s never gonna happen. Especially when fear is ever-ratcheted up.

  9. Patrick says:

    There is only so much money in the system. If you have more, logic would suggest that somebody else has less.

    Ahh, logic. Where would we be without logic? Btw, what were the Romans doing with all this money hidden under the columns?

    And thats never gonna happen.

    If a spiritually enlightened society would be defined by the kind of logic on display in the previous quote, I think this is a good thing.

  10. NPOV says:

    Hmm…seems I was wrong…there really are people still believe that money/wealth is some fixed quantity…Caroline, have you really thought about how unlikely that notion is? How is it possible that the average material wealth of everyone today is orders of magnitude greater than that of those in past ages, if the total amount of money is some fixed quantity?

    Nor do I accept that it’s necessary to bring “the more well off down a notch or two”. I’m perfectly happy to see incomes at the top end of the scale increase – so long as they’re not increasing faster than those elsewhere, and that those increases are helping Australia become more prosperous as a whole, rather than primarily benefiting an increasingly small and rich elite, as has arguably been occuring in the U.S. (and certainly occurs in many corrupt 3rd world nations).

  11. Paul Frijters says:


    I saw ‘My Fair Lady’ yesterday with my kids, and came accross the following humurous conversation on the issue of poverty. I am sure my memory is not perfect, but this was the gist of it:

    Gov’nr, I am a member of the undeserving poor and I intend to keep on being undeserving. But does that mean my needs are less than those of the deserving poor? Nay I say. My needs are just as large, no, larger. I drink more and get more pleasure out of paid female company.

    I bring up this anecdote, because its renderer (Mr DooLittle) is, in a sense right: does it really matter if someone is ‘involuntary in poverty’ which you seem to find so important, or voluntarily so? On what basis should we assign sympathy to the poor, is it for their poverty (in which case it doesnt matter if its voluntary) or only if they somehow have done ‘what we want them to do’ but got unlucky? I dare say that nearly all the rhetoric of our society indicates the latter (including your blog and nearly all commentators on it), whereas our actual policy is more like the former. This means Don need not ask for policy advise: even trying to seriously cut off the voluntary poor from state support will give him plenty of reforms to implement for the rest of his lifetime.

    A propos the last remarks of NPOV: the widening gulf between the very rich and the others is not just a US phenomenon, its here too, and much of it is, according to Adrew Leigh, policy driven (see for instance http://ideas.repec.org/p/auu/dpaper/514.html).

  12. NPOV says:

    Yes, Paul, it is trend that worries me in Australia too, but at least Australia still “feels” like a generally prosperous country. On my last trip to the U.S. I simply didn’t get that impression – the condition of the roads, and houses, and other facilities etc. convey the impression of a country that isn’t doing well, despite the pockets of enormous wealth that exist. And I was in the some of the wealthiest parts of the country (CA and the Boston area).
    Yet it’s still consistently claimed to be “the richest country in the world”. I recently calculated (roughly) that its median income had now slipped just behind Australia’s, but even that must be hiding something deeper that raw figures don’t quite convey – i.e. the way that money is spent, rather than the amounts of it.

  13. Backroom Girl says:

    Caroline’s logic perhaps contains a clue as to why so many people are so bothered by CEO pay. If it really is a zero-sum game, then a CEO earning millions of dollars a year must be doing quite a few other people out of their fair share – stands to reason doesn’t it?

    For me, I can’t get all that excited about it. And I expect that most poor people don’t either. Well perhaps a few, some of whom probably fit Paul’s definition of ‘voluntary’ poor, who seem to have made a lifestyle out of militantly demanding their share of the pie.

    I am interested in Don’s ultimate question though – how would you actually go about improving the lot of the poor? How would you get to the stage that every poor person had the equivalent of Smith’s linen shirt?

    For starters, is there as much consensus these days as perhaps there was then on what non-poverty looks like? Even if there were, if you are going to measure failure by the fact that significant numbers of people don’t have good or service X, how would you actually go about improving that situation?

    People who focus on income inequality seem to imply that all that is or should be required is to reduce inequality (presumably by giving people on the bottom of the distribution more). But what if the people at the bottom don’t value the outward trappings of respectability sufficiently to actually prioritise those things in their spending decisions? What if their preferences, whether entirely voluntary or not, take them in other directions? To the extent that poor people still choose to spend the money they are given on something other than today’s linen shirt then such a policy solution will be less than effective.

    I think that maybe Don is onto something when he refers to the importance of paid work. But again, perhaps that is a norm that is breaking down. Certainly, the people who re-christen Welfare to Work as Welfare to Slavery, as I saw on another blog discussion the other day, don’t seem to think that paid work is necessary to social inclusion.

    I disagree with him however on the issue of whether income support eligibility linked either to an assessment of labour force capacity or meeting activity requirements is stigmatising in itself. My take on this is that for many people who receive those payments, the eligibility criteria offer a way of legitimising receipt. Even the people who think that Welfare to Work is akin to Welfare to Slavery in most cases justify their receipt of income support in terms of the valuable role that they play in society, whether by parenting their children or doing community work, or whatever.

    Notwithstanding the views of middle class people who like to dabble in policy formulation for the benefit of the poor (myself included), I suspect that many poor people would not feel less stigmatised if their income support came with no strings attached – because that would mean that other people couldn’t tell the difference between the deserving and the undeserving.

  14. NPOV says:

    Well if Caroline had phrased it as “CEOs earning millions of dollars a year must be doing quite a few other people out of their fair share” it might be at least partly defensible. It depends somewhat on whether you think most CEOs pay their workers “fairly”. I would tend to argue that if workers were paid fairly relative to CEOs then there’s be little support for a tax+transfer system at all, and a flat tax would be seen as the fairest system. But obviously it’s not just CEOs vs workers – I’ve only ever been an employee (usually salaried), and yet I don’t think it’s “fair” that I’m able to earn an income in the top 1-2% of personal incomes in Australia while plenty of others who surely contribute more towards society earn far less. On top of that, we have the security of knowing that should I lose my job or earning capacity, my wife also has the capacity of earning a very decent income, which she currently chooses not to exercise. Most families simply don’t have that choice.

  15. Backroom Girl says:

    I dont think its fair that Im able to earn an income in the top 1-2% of personal incomes in Australia while plenty of others who surely contribute more towards society earn far less

    I’ve seen you say this in a number of different forums a number of times now, NPOV. While I don’t doubt your sincerity, I am intrigued as to how you personally might choose to go about changing things. For example, you could voluntarily give away a fair bit of your income to people who you personally know are contributing more to society. Or, presuming you have transferable skills, you could go and work in a job where you yourself contribute more to society, whatever you mean by that. Or do you think it should all just be done by way of taxes and transfers? As a policy nerd, I always have trouble actually engisaging the mechanisms that society could use to ensure that all workers were appropriately rewarded according to their benefit to society.

    I’m probably in a similar situation to you (well, perhaps not in the top 1-2%, but certainly in the top 5%, as measured by the ABS). While I am grateful for the standard of living that my income provides me (interestingly, I don’t usually feel as if that is in the top 5%), I don’t spend too much time feeling guilty about it. If I did, I reckon I would go and work in the welfare sector, which might be more ‘worthy’ but not necessarily of greater value to society. I do try and hold my end up when it comes to consumption, though, to keep the service sector of the economy ticking along :-)

  16. Mark Hill says:

    Some people don’t want to be paid (financially) for their contributions NPOV. The job itself or how it changes other people’s lives is their reward.

    These people are more able to do their jobs when there is more philantrhopy. We will only have this when we make the tax system less progressive.

    If people didn’t find the longer they work, the longer they have to work to keep their earnings, they might find more time to donate blood for example.

  17. NPOV says:

    Backroom Girl, I don’t believe that governments can or should step in and try to make incomes “fair”, but as long as there are what I personally perceive to be significant amounts of unfairness in incomes distributions in our economy, then I’m happy to support a tax & transfer system that helps reduce the differences.
    As far as my own contribution to society goes – I write software that has a very small market, that happens to appeal to businesses and government departments with probably more dollars than sense. And I don’t even do it very productively (I’ve been far far more productive in previous jobs, that paid much less).

    Mark, show me one piece of evidence that, for instance, teachers or scientists or nurses do their jobs “better” in countries with more philanthropy?

  18. Mark Hill says:

    If you want more of those workers, end the brain drain and cut taxes, paticularly the higher rates.

  19. NPOV says:

    I don’t believe for a moment that will help. Sure, Australia has to keep its tax rates internationally competitive, but they already are.

    And how will having more of them help them get paid better?

  20. Mark Hill says:

    “As far as my own contribution to society goes – I write software that has a very small market, that happens to appeal to businesses and government departments with probably more dollars than sense. And I dont even do it very productively (Ive been far far more productive in previous jobs, that paid much less).”

    Don’t sell yourself short. You don’t know what productivity means.

    Working hard doesn’t mean you are productive. Being productive means producing something that is useful.

    Given the supply conditions you note, a formal model of productivity and labour supply explains your current favourable conditions.

  21. Backroom Girl says:

    Thanks for clarifying that, NPOV. You probably know that I, too, am broadly happy with the idea that the tax and transfer systems operate to reduce the extremes of income inequality. Moreover I think we do it pretty effectively (even efficiently) here in Australia. And I just don’t buy the level of income inequality that the ABS data apparently show we have. Your anecdote about Australia feeling like a much more prosperous (and by implication, equal) place than the US is telling – I think you should trust that impression.

    I suppose one point I was trying to make is that if you try to define poverty in non-income terms, for example by relative material deprivation or social exclusion (the concepts I think that Smith was getting at), its a pretty long bow to conclude that all of the people exhibiting those forms of poverty are that way simply because they don’t have enough income.

    I also think the Australian system goes about as far as it is really sensible to go in terms of income redistribution. While many people decry the level of tax/transfer churning we have, it is less here than in virtually any other country. And while our financial incentives for people to take low-paid jobs are not always great, by and large they are about as well as you can do in a fairly tightly income-tested system that nevertheless provides most people who are totally reliant on income support with enough to live on.

  22. Mark Hill says:

    When their real wages rise, more will stay or come back. You’re getting ahead of yourself and confusing cause with effect. They didn’t leave because there was too many of them in Australia. Look at class sizes for example.

  23. NPOV says:

    BG – the difference between the levels of equality in the U.S. vs Australia are actually pretty much reflected in the numbers though. It’s the lack of difference in median wage that surprised me.

    I’ve said in previous threads that I don’t believe Australia’s top marginal rate needs to be increased at this point. But the tax-free threshold surely needs raising, and the lower tax rates reduced, or better coordinated with transfers to avoid high EMTRs. I’m highly concerned that Rudd & Swann’s plan to reduce the progressivity of our tax structure by reduce the number of brackets is going to make Australia a better place (as I know, is Ross Gittins). Having many brackets doesn’t to me seem a bad thing per se, though perhaps using a more sophisticated formula that avoided the need for brackets at all, while still maintaining high progressivity, would be preferable.

  24. NPOV says:

    Mark, I know what productivity means in the context of software development. In my previous job, I wrote at least half of the code in a major application over a period of about 6 months that went on to generate several million in sales. In my current job, I’ve been tinkering away at an application as the sole developer over about 3 years, and I doubt it’s even hit the million dollar figure in sales yet.

  25. NPOV says:

    Or put another, the previous company I was at was making a good profit. The current one is still barely breaking even – but the board happens to believe they have a shot at convincing another major company to buy it out.

  26. Backroom Girl says:

    NPOV – I don’t have a particular view about the structure of income taxation, because my expertise lies more with income support. But the biggest contribution to high EMTRs for low-income earners is the rate at which benefits are withdrawn, not the marginal tax rate on income.

    While it would be entirely possible to withdraw Newstart Allowance at a lower rate than currently (first $31 a week free of withdrawal, followed by 50 cents for each dollar between $31 and $125 a week and 60 cents for each dollar above that), that would make most people’s entitlements cut out at an income above the full-time minimum wage. The lower you go with EMTRs, the more overlap you create with the full-time earnings distribution. (This is also the way you go if you lower the minimum wage in real terms.)

    I don’t really like the idea of lots of full-time earners drawing part-rate income support for themselves (as opposed to partners and kids attracting support), so personally I am happy to draw the line where it is now, even though as I said it means that work incentives are not as generous as some people might like.

    I do agree with you on the tax threshold, but I suspect that no government is going to go there in a hurry now that they have discovered that you can do it on the cheap through the Low Income Tax Offset (which is, by the way, on the way to making no tax payable until people earn over $16,000).

  27. Mark Hill says:

    “but the board happens to believe they have a shot at convincing another major company to buy it out.”

    This is just an example of a real option having value. Better management might make you more useful. Don’t beat yourself up about it.

    “Im highly concerned that Rudd & Swanns plan to reduce the progressivity of our tax structure by reduce the number of brackets is going to make Australia a better place (as I know, is Ross Gittins).”

    Trust me, this means you shouldn’t give a damn about it.

  28. Mark Hill says:


    Gittins is basically against workers you care about (nurses, teachers etc) getting a better real disposable income. Ignore him.

  29. NPOV says:

    And you say that based on…?

  30. Caroline says:

    In my previous job, I wrote at least half of the code in a major application over a period of about 6 months that went on to generate several million in sales.

    (I also have an enormous dick).

  31. NPOV says:

    Great…I have some posters accusing me of being envious, others accusing me of beating myself up, and now another accusing me of showing off.

    I think I’ll just shut up.

  32. Mike Pepperday says:

    Don Arthur

    Your post is interesting but biased.

    Jesus is one of the most admired persons ever. But not for his linen shirt. Buddha. St Francis. The Good Samaritan. Gandhi. All admired for their disregard for the linen shirt, no?

    A Smithian, individualist, economist’s dismal bias.

  33. Backroom Girl says:

    Don’t worry, NPOV, I’ve always always reckoned that if I’m getting criticism from both sides I’m probably at least half right :-)

  34. Patrick says:

    No, don’t, NPOV. Caroline is surely as much an idiot as her comments suggest she is! I for one appreciate your comments even if I don’t agree :)

    Mike, I don’t get it.

    Do you know anyone who goes beyond admiring and actually respects the teachings of these people? I do, but as I grew up I realised that they were an miniscule minority – more the exception that proves the rule than anything else. I think that this is a good example of when one should prefer revealed preferences over stated preferences.

  35. NPOV says:

    Jared Diamond makes a similar point in his Collapse book – that getting opposing criticism from both sides (environmentalists and industrialists) is usually a good sign that you’re probably pretty close to the mark!

  36. Mark Hill says:

    NPOV: Don’t shut up. Just ignore Gittens.

  37. Patrick says:

    Except he also got criticsm from most other people who had experience in the area he professed to cover, IIRC :)

    Moneyquote from the link:

    No one visits Stonehenge, she noted, and asks whatever happened to the English.

  38. NPOV says:

    He meant his general message of the need to better balance environmental constraints and industrialisation, not specific examples of evidence of collapse from the past, some of which do appear to be pretty weak. But thanks for the article, I’ll give it a read.

    And Mark, I’m just as inclined to ignore you as I am Gittens. Which isn’t all that much…

  39. Mike Pepperday says:

    Patrick, that you only know a few such admirers may be a function of who you know, not of the numbers. Or it may be a function of the Zeitgeist.

    Also, you are suggesting a small number does not matter. Crystal spheres explain the sun, moon, and thousands of stars so we should ignore the planets because they are few? Or should we ponder the exceptions to our (dismal) rule and see them as a test of our analysis?

    And realise the analysis is faulty.

    Certainly in the past there were many admirers of those people. Anchorites, to take an extreme example, have been admired in all cultures although they are usually very few indeed.

    And Smith conflates two distinct things when he says “there is scarce any man who does not respect more the rich and the great…” The great. Is Winston Churchill admired for his wealth? Do people admire Roger Federer for his clothes? Do you admire the Salvos? For their linen shirts?

    People can be admired, and be proud of themselves, for things other than their ability to display their wealth.

  40. NPOV says:

    Patrick, I will say, at the risk of going completely off-topic, regarding that money quote – it’s pretty silly. People very much *do* wonder what happened to the people that built Stonehenge. And there is a fascinating debate as to the degree to which the Celts and other early inhabitants of England were wiped out by or simply merged with the Saxons.

  41. Mark Hill says:

    That is kind of encouraging. I am happy for you to ignore me if you never read Ross Gittens again in your life.

  42. NPOV says:

    Mike, I think it’s fair to suggest that things were rather different in Smith’s day. It was a far less egalitarian society, and there really were very few opportunities for those without some wealth to make a name for themselves.
    On the topic of clothes, it’s also interesing that these days the immediately visible difference in quality between the clothes worn by the rich and those worn by the poor aren’t so great. You can buy a $500 suit that to most people doesn’t look all that different from a $5000 suit, or a $50 pair of jeans that are pretty much indistinguishable from a $500 pair (if anything, the $500 pair are more likely to be ripped, shredded, and patched up…go figure).

  43. Backroom Girl says:

    NPOV – I guess that was what I was getting at in part when I asked

    is there as much consensus these days as perhaps there was then on what non-poverty looks like?

    Is it enough for everyone to have a TV, or do we start to think that if most people have a plasma or LCD that the lack of that item is evidence of material devprivation. Similarly, do we have to give poor people enough money that their children can wear brand-name clothes, like the middle class kids? It looks like a very slippery slope to me, once you get into the area of defining deprivation by reference to quality/cost as well as the particular item in question.

  44. NPOV says:

    That’s a reasonable question, but as I see it, if it means anything to say that Australia is a rich, prosperous nation, then that implies that everybody in it can have a rich prosperous lifestyle. So not only should be there no (involuntary) poverty, but even the lowest-skilled workers should be able to enjoy a high standard of living. A high standard of living is at least partially psychological, and for instance, we’d would probably agree today that not being able to afford a TV at all would classify you as “poor” in Australia. In 20-30 years’ time, all TVs will probably be flat-screen LCD TVs (or better), so at that point, you’d probably agree that not being able to afford a flat-screen LCD TV would classify you as poor, absurd as the concept might seem today. But if you went back 60 or 70 years, and showed an average middle class family from that time the living standards of Australia’s poorest today, they’d probably laugh at the idea that anyone would consider them poor.

  45. Backroom Girl says:

    Ah, but the problem is how do you measure not being able to afford a TV? I’m certainly not arguing that we should classify poverty by reference to minimum living standards of the past, but the point is that most of these items that were once luxuries can now be had for a very small amount of money and probably for next to nothing if you are happy to get someone else’s cast-off. So is not having them really evidence that they can’t be afforded or is it evidence that, in the end, some people choose to spend their money, limited as it may be, on something else?

    And when you say that even the lowest-skilled should be able to enjoy a high standard living, what do you mean by that? Should the lowest-skilled employed (I assume you don’t mean unemployed?) have a standard of living equivalent to the median and, if so, where does that leave the people with average skills? If you want the lowest-skilled non-employed to also have a high standard of living, how do you manage to provide that while still keeping taxes relatively low and ensuring that there is sufficient financial incentive for people to work, acquire skills and, dare I say, provide for themselves?

  46. NPOV says:

    Well by “high standard of living” I obviously don’t mean relative to the mean in Australia…and I don’t even really mean relatively to the global mean, as ideally we should be hoping for a world where everybody enjoys a “high standard of living”. It will always be a moving target, and I’m not sure exactly how to pin it down. As it is, I think there’s only a fairly small percentage of people in Australia that don’t enjoy a “high standard of living” – maybe 7 or 8%. But I’d still like to see it much lower than that – ideally 0% of course (I include those that voluntarily choose to forgo material wealth as enjoying a high standard of living).
    I don’t know exactly how it can be done while keeping taxes “relatively low” – certainly looking at countries where the lowest-skilled workers (including the unemployed) seem to enjoy very decent standards of living (e.g. the Scandinavian nations), it’s easy to conclude that the only solution is higher taxation. However while Australia is currently enjoying its huge windfalls from the commodities boom, there really is little justification in increasing taxes here, so what I suppose a possibility might be some sort of “poverty alleviation fund” that will enable future governments to ensure that Australia’s poorest are still able to enjoy high standards of living. Certainly the amounts that the ALP currently plans to spend on poverty-alleviation programs are pretty pathetic, and don’t seem to be based around a truly long term program.

  47. Patrick says:

    Unfortunately, much, if not most, of one’s standard of living is subjective and only capable of being effected by personal choices, such as to eat better, etc. Those damn choices that tend to make us poor or not in the first place, actually.

    So I would be ver leery of being embarked on an absurdly expensive wild goose chase trying to spend other peoples’ way out of bad choices.

  48. backroom girl says:

    That’s my main problem with attempts to redefine poverty in terms of material deprivation, Patrick. Conceptually, the deprivation approach assumes that:
    1. there is a single basket of goods and services that everyone agrees is necessary for an adequate standard of living;
    2. because everyone agrees that such items are necessary, people will therefore purchase the essentials before non-essentials;
    3. following from 1. and 2., if someone doesn’t have an item in the essential basket, it is because they don’t have enough money; and
    4. giving them more money will improve their capacity to purchase all of the essential items and therefore reduce poverty.

    You can see that there are plenty of ways in which this chain of logic might come unstuck.

    The ironic thing is that defining poverty in terms of deprivation is supposed to get us away from an unhealthy pre-occupation with trying to define poverty in terms of income, but as far as I can work out you always come back to income in the end.

  49. NPOV says:

    Patrick, it’s only expensive if you seriously believe that the alternative (just sitting back and accepting that whatever levels of poverty we have are the inevitable resource of individual choices) costs very little.

  50. Patrick says:

    False, because where your reasoning is leading is that people should have what they want to have. Much more expensive than just accepting that there are people who make bad choices and trying to ensure that they don’t suffer greatly from that without trying to rescue them either.

    Even ignoring that, is it a wild goose chase for the reasons outlined by myself and BG?

  51. Ken Parish says:

    Just to insert some factual content into the discussion momentarily, it may be worth keeping in mind that Australia’s current minimum wage is very generous by international standards. It is around 58% of median weekly earnings, whereas the UK minimum wage is around 45% and US 35% (figures quoted from memory but they’re not too far from the truth).

    As for the comparative level of unemployment benefit/Newstart Allowance, this federal government research paper finds:

    Because of differences in the role of employer social security contributions, it has been argued that replacement rates-which compare benefit levels to wage rates-do not provide consistent measures of benefit generosity across countries (Whiteford 1995). The preferred methodology in this study therefore was based on comparisons using absolute benefit levels adjusted by purchasing power parities.41 When benefit levels were averaged over all the household types noted,42 Australian benefit levels were ranked eighth before housing costs and sixth after housing costs. Australian benefit levels were well above the OECD average, being 29 per cent higher than the mean before housing costs and 39 per cent above the mean after housing costs. Overall, Australian benefit levels were very similar to those in Sweden and the Netherlands, with most of the countries with higher benefit levels-Switzerland, Norway, Luxembourg and Canada-having substantially higher levels of national income.

    Just to pre-empt any nitpicking, in fact while Switzerland, Norway and Luxembourg certainly have higher national incomes per capita than Australia, Canada was only a shade higher on the most recent figures.

    Anyway, the point is that Australian levels of both inequality and poverty are very respectable by any global standard. Whether we could actually achieve greater equality (or greater “well-being” for the poor without reducing income inequality, which seems to be the possibility Don is foreshadowing however coyly) without simultaneously effectively reducing incentives to work hard, take risks, be innovative etc thereby making all of us poorer in the process is another question. Somehow I doubt it, but I’ll await Don’s next instalment with interest.

  52. backroom girl says:


    The FaCS research paper you quote was published in 2000 and must therefore have been relying on OECD cross-country analysis from the 1990s. Since then, the previous Government poured so much money into the social security system (particularly for families with children) that more recent comparisons show us doing even better relative to other countries.

    In particular, the Australian combination of high minimum wage, which you alluded to, generous family benefits and methods of topping up people in low-paid employment through means-tested benefits mean that on the OECD’s analysis we are second only to the UK in the level of income (relative to the median) that we provide to households with one earner on the minimum wage. With the exception of single people without children, our out-of-work benefits also compare very favourably relative to all other countries in the analysis, including Scandinavian countries.

  53. Don Arthur says:


    I wish I did have that next installment ready to go. It’d be great to have a post that lays out all the policies we need to implement to fix the problem.

    But if I had all the answers, I would have finished my PhD thesis years ago (that’s where most of this post comes from).

    I’ve got a major in psychology, honours in philosophy and some post-grad political science. What I don’t have is the economic expertise to model how changes to benefit rates, minimum wages etc would affect economic outcomes.

    If you’re waiting for me to write a policy manifesto you’ll be waiting a long time.

  54. NPOV says:

    Patrick, I’d phrase that more as “people should be able to have what they want to have, within reeason”. Australia has more than enough wealth available for even the least-skilled and, let’s face it, least-motivated individuals to enjoy a decent standard of living. By international standards, it’s certainly fair to surmise that this is already the case – but that doesn’t mean there isn’t room for improvement. Does this meaning having to rob more from the rich to give to the poor? On balance, no, I don’t think so – there are plenty of other ways governments and other bodies can work to ensure that the living standards at the bottom of the heap remain decent – decent not only by current international standards, but even relative to the standards of living that median wage earners in Australia enjoy. And I do think there is a big social, and potentially economic cost, to not continuing to strive for that objective.

  55. Backroom Girl says:

    But Don – aren’t you going to tell us what your answers to your questions are?

    NPOV – to be fair, I think you should tell us exactly what you think Australian governments should do in order to improve things. I have pointed out some of the reasons why I think it is difficult to achieve much more improvement through income transfers, but I’d be interested to know what kinds of policy solutions you would favour.

  56. Backroom Girl says:

    And, following up on your comment that

    people should be able to have what they want to have, within reason

    , surely this discussion is all about what you mean by ‘within reason’. It seems to me that reasonableness is a very subjective test. Should people who could work but don’t really feel like it be entitled to sufficient income to provide them with their own definition of an adequate standard of living, for example?

    Most of the countries that you appear to admire, like the Scandinavian countries, are much more rigorous than we are in making people seek work. In most, mothers are expected to return to work once their youngest child is a year old. I suspect that the main reason those countries have lower income inequality than we do is precisely this strong emphasis on labour force participation. I just don’t think you can allow people the degree of latitude in deciding their own level of labour force participation that our system does and expect to achieve levels of income inequality similar to those in countries where nearly everyone is expected to work to support themselves.

  57. Patrick says:

    NPOV, to summarise BG, people make choices, and what do you plan to do about it?

    I should note that I would support more investment in training – but I would not like to force people to do it nor to take up jobs. I would not like to compensate people for making the ‘wrong’ choice either, at least not any further than existing family benefits do.

  58. NPOV says:

    BG, I really don’t pretend to have the expertise to make judgements about what the best policy is to achieve what I see as admittedly vaguely worthwhile aims. I would be interested to know more about the system that Scandinavian countries use to encourage people to seek work – you say it’s more “rigorous”, but I’m not sure “rigour” is the problem here: from what I read, it seems to be a mixture of attitute, inflexibility and perhaps unrealistic expectations that lead to what seems to be often fairly miserable treatment of those who, for a whole variety of reasons, are not able to provide well for themselves and their families.

  59. NPOV says:

    Patrick, I would question just what percentage of Australia’s poorest were that way purely because of personal choices, but even then, there’s no reason it shouldn’t be straightforward to recover from having made poor choices initially.
    Further, I’ve made lots of pretty stupid financial choices in my life time, yet none of them have ever made life difficult. Whereas I’m willing to bet there are plenty of people out there that at each point have made pretty close to the best financial choices available to them, yet still struggle to make ends meet.
    Now, life is never going to be fair, and no government can abolish unfairness, but it can surely go some way to reducing the suffering caused by it.

  60. Backroom Girl says:

    I agree with you about training Patrick – I think anyone who wants to better their outcomes in life by putting the effort into getting new skills should be encouraged and assisted to do so. I am also more comfortable than you probably with placing fairly strong expectations on people to do what they can to be financially self-reliant. I would however give them more scope to work out what is right for them than is available under our current system, which tends to be pretty prescriptive and ‘one-size-fits-all’. But I think we would both agree that people should take more responsibility both for making their own decisions and for living with the consequences.

    NPOV – it really is pretty difficult to compare what we have with what is on offer in most Scandinavian countries, given that they decided long ago to go down a completely different track to the one Australia and New Zealand followed. However I think it is fair to say that, while the social insurance benefits offered by Scandinavian countries tend to look fairly generous compared with unemployment benefits here, life in their social assistance system (which is what you fall back into if you don’t qualify for social insurance) is probably considerably more ‘miserable’ than life on benefits here.

    Those benefits are much more tightly income-tested than ours (typically withdrawn ‘dollar for dollar’ for earnings), there is an asset test that eventually requires you to sell your car and even your house if you want to continue to receive assistance and the whole thing is managed by social workers.

    But the whole thing is underpinned by a much stronger social norms around labour force participation, particularly for mothers of young children, than we have in Australia.

  61. Backroom Girl says:

    NPOV – I’m sure no-one knows how many people are poor because of bad choices they have made, and how many due entirely to no fault of their own. I would suspect more in the former category than the latter (though presumably that would depend on your definition of poor). If you doubt the existence of completely voluntary welfare dependence, just have a listen next time the Government suggests that single parents (or any other group) should try to find a job to help support their children.

    While you say that you don’t have the expertise to know what should be done, the issues that Patrick, Ken and I raise are precisely those that need to be taken account of in the process of making policy decisions. If you just assume that most poor people are involuntarily in that situation and would be supporting themselves if only they could and go ahead and formulate your policy to make life easier for them, in no time at all you will find the welfare rolls populated with lots of people who are much less deserving of public sympathy and support. “No questions asked” welfare might well make life easier for the poor and downtrodden but it is also much easier to rip off than welfare that comes with strings attached and a certain degree of intrusion into personal lives.

  62. Patrick says:

    NPOV, you seem to be proceeding on blind faith.

    ‘unfairness’ is just so vague – what is fairness? Birth into a good family? Should we compensate people for being born to dysfunctional parents? In my experience that is probably the single biggest factor in how people turn out, so someone with ambitions as broad as yours must, it seems to me, tackle that issue head-on.

    I would imagine that if bad parents is unfair, and we continue to value equality, the ‘fairest’ outcome is found in Plato’s Republic!

    BG: yes, I think on the broad points we agree.

  63. NPOV says:

    Patrick, my only faith is in the possibility of making life better for those who currently have the least. Perhaps it’s blind, but I think it would be pretty fatalistic to assume there’s no effective solution.

    We already do indirectly compensate people for being born into dysfunctional parents (or for any reason that they might not be capable of fully supporting themselves). The question is whether we can afford to do it more generously or more effectively than we do now.

  64. Patrick says:

    Well, NPOV, what would not be fatalistic would be to identify if there was any area of Australia’s present policy that could be substantially improved.

    One is immigration broadly, a specific area of that is investment in education for immigrants, some improvements might be:
    – mandatory/freely available remedial english classes;
    – HECS-type loans for immigrants with no qualification period; or
    – forgiveness of those loans or part thereof for work in the above English classes.

    They are just top-of-my head examples and I am really not an expert there. But your vague and rather motherhoody statements look like leading where my previous comment suggested.

    For example, take your specific comment that

    We already do indirectly compensate people for being born into dysfunctional parents (or for any reason that they might not be capable of fully supporting themselves)

    Wel, yes, but only in a manner which is besides the point. Your point is that not everything is the result of choices. Mine was that probably the biggest non-choice influence (as well as arguably the biggest influence on choices) is parents. Plato knew this, and dealt with it explicitly.

    You seem reticent to come out and endorse either the idea that we should severly curtail or pre-empt the capacity of, essentially, poor people, to choose, or the idea that we should pay for the comfortable existence of people who choose to be indigent. Both are prett big ideas!

  65. NPOV says:

    Because I don’t endorse the idea that we should “severely curtail…the capacity of…poor people to choose”. Indeed we should support them in such a way that they ultimately have greater and more meaningful choices available to them.
    If this means taking certain other choices away from them (for instance, restrictions on how they can spend welfare payments), then so be it. Though the evidence on how effective this is seems to be mixed at best.

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