New Economist

Ten indicators for a happy society

Just about everyone seems to be writing about happiness these days - even investment bankers. Deutsche Bank economist Stefan Bergheim analyses 22 rich countries, and comes up with four varieties of capitalism: the happy variety, the less happy variety (Germany, Spain, France, Belgium and Austria), the unhappy variety (Portugal, Italy and Greece), and the Far Eastern variety (Japan and Korea). So which countries benefit from happy capitalism? it's the usual suspects - the Scandinavians and the Anglo-saxons:

The happy variety of capitalism: Australia, Switzerland, Canada, the UK, the US, Denmark, Sweden, Norway and the Netherlands as well as (to a lesser degree) Finland and New Zealand have organised society and institutions in such a way that they provide the conditions that are important for human happiness.

Lest American or British readers get too excited, Bergheim adds a coda:

Over the last ten years it is above all the Irish, the Spanish and the Scandinavians that have succeeded in implementing considerable happiness-enhancing changes.

Bergheim's paper, The happy variety of capitalism: Characterised by an array of commonalities (PDF), identifies ten commonalities or ''indicators for a happy society" from a cluster analysis of these countries:

1. High degree of trust in fellow citizens
2. Low amount of corruption
3. Low unemployment
4. High level of education
5. High income
6. High employment rate of older people
7. Small shadow economy
8. Extensive economic freedom
9. Low employment protection
10. High birth rate

One can quibble about one or two, but the list seems broadly right. However it is notable that Bergheim glosses over child poverty and inequality of income and wealth. These show greater divergence between the Anglo-saxon and Scandinavian countries than his analysis suggests. Likewise gender equality, or measures of 'active citizenship' and political engagament.

The key lesson of much recent cross-national happiness research, and the recent debates about social Europe, is that there is more than one path to economic prosperity and to high levels of subjective well-being. One is the Scandinavian/Nordic model of social democratic capitalism - more recenly dubbed 'flexicurity'. The other is the Anglo-saxon model of liberal capitalism - the so-called 'Anglosphere'. They each have their pros and cons, but both are associated with low unemployment, robust economic growth, and above-average levels of happiness and life satisfaction.

UPDATE: The Economist blog, Free Exchange, is more sceptical about the paper, particularly its policy conclusions: That's enough happynomics

There's nothing new in the data: happiness correlates positively with wealth, education and trust, negatively with corruption and unemployment. But the conclusion is a touch unusual, coming from an investment bank. For governments:

Happiness and life satisfaction should be explicit policy objectives

Eeek. To do Deutsche the courtesy of taking its paper seriously, has it given any thought to what would follow? Governments telling us how happy we are, civil servants walking around with absurd smiles on their faces, public festivities day in day out, holidays for every trade and age. A favourite slogan of Stalinism, in the depths of the terror, held that "life is better and merrier than ever before".

No! Enough social engineering, even in the name of happiness! let me be miserable in my own way, that's what would make me happy.   

 

The trouble with corporate America

Three recent books about corporate America are reviewed by James Lardner in the latest New York Review of Books. The piece, The specter haunting your office, covers:

The Disposable American: Layoffs and Their Consequences, by Louis Uchitelle (Vintage, 287 pp., $14.95)

The Great American Jobs Scam, by Greg LeRoy (Berrett-Koehler, 290 pp., $24.95)

The Battle for the Soul of Capitalism, by John C. Bogle (Yale University Press,260 pp., $16.00)

I won't pretend it's the most profound article you've ever read. But these are voices most economists seldom give heed to. Lardner concludes on a melancholy note:

Most Americans are troubled by the culture of dealmaking and financial engineering and insider self-enrichment that Bogle deplores; by the callous treatment of workers and work life that Uchitelle describes; by the erosion of communities and community institutions that LeRoy examines.

Not very far below the political surface, most of us feel some version of the same vexed ambivalence toward corporate America—dazzled by the conveniences and comforts it delivers, yet resentful of the tradeoffs that it continually demands; few Americans would be anything but grateful if our corporations and financial institutions could develop some respect for our non-material and non-individualistic selves. It is hard to imagine such a fundamental transformation of these giant institutions. It is even harder to imagine a better world in which they remain essentially what they are.

China's growth: headed for a car crash?

Later this week Wing Thye Woo from UC Davis and the Brookings Institution delivers a paper later this week at a Seoul conference on 'Assessing the Power of China: Political, Economic, and Social Dimensions'. His theme is the major risks or challenges to China's rapid pace of growth: What are the High-Probability Challenges to Continued High Growth in China? Here is a summary:

Analytically, if the Chinese economy is depicted as a speeding car, then are three classes of failures that could result in a car crash: (1) hardware failure, (2) software failure, and (3) power supply failure.

A hardware failure refers the breakdown of an economic mechanism, a development that is analogous to the collapse of the chassis of the car. Probable hardware failures are (1) a banking crisis that dislocates production economy-wide, and (2) a budget crisis that necessitates reductions in important infrastructure and social expenditure.

A software failure refers a flaw in governance that creates frequent widespread social disorders that disrupt production economy-wide and discourage private investment. This situation is similar to a car crash that resulted from a fight among the people inside the speeding car. Probable software failures could come from (1) the present high-growth strategy creating so much inequality, and corruption that severe social unrest results; and (2) the state not being able to meet the rising social expectations about governance issues.

A power supply failure refers to the economy being unable to move forward because it hits either a natural limit or an externally-imposed limit, a situation that is akin to the car running out of gas or having its engine switched off because an outsider reached in and pulled out the ignition key. Examples of power supply failures are (1) an environmental collapse; and (2) a collapse in China's exports because of a trade war.

My assessment is that the highest probability event in hardware failure is the weakening of China's fiscal position; the highest probability event in software failure is social disorder, and the highest probability event in power supply failure is water shortage. And my ranking of the probability of these three specific negative events in descending order is social disorder caused by outmoded governance, water shortage as a result of inept environmental management, and fiscal crisis generated by the repeated recapitalization of the state banks and the rapid aging of the population.

Woo is catiously optimistic - these hazards need not necessarily crash the economy.

Will China succeed in establishing a harmonious society and completing the overhaul of its economic system? My answer is a very cautious "yes". I am optimistic because both Chinese society and government want the economy to continue its convergence to a modern private market economy.

My considerable caution comes from (1) the new major reforms being technically difficult to implement (e.g. setting up social safety nets), and having few, if any, successful precedents in the world to draw upon (e.g. designing market-compatible environmental regulation); and (2) the possibility that the many potential losers from these major reforms could successfully organise to resist meaningful implementation of the reforms.

The silk pajamas

A moment of self-congratulation on winning the Third Annual Satin Pajama Awards for best economics weblog.... Just a moment, mind. Thanks to all those who voted for me. 

Identity and economics: what are we missing?

Is identity the missing motivation of economics? UC Berkeley's George Akerlof and University of Maryland's Rachel Kranton certainly think so. In a recent London lecture at the LSE, Akerlof explains how this interest arose:

In the spring of 1996 Rachel wrote me a letter which said that my previous paper, on Social Distance, in Econometrica, had missed the concept of identity. She also said that concerns regarding identity were a serious omission from economic theory.

Initially I was not pleased to receive this letter, which said that my previous paper was all wrong. I also thought that Rachel was in error. I thought that identity was just an aspect of people’s tastes. As a result, I also thought that standard utility theory already took full account of it. But after we talked it over for a great deal of time we discovered that identity really does have a meaning. We decided also that it is a major factor missing from current economics.

Rachel and I have now written four lengthy papers on this subject, and now we are trying to summarize it in a book. ...this lecture is a summary of where we have gotten to date on that book.

Of course, the fourth of these papers was Akerlof's January 2007 AEA Presidential Address, which has already attracted some econoblog commentary. But in his recent Stamp lecture Akerlof provides the wider argument, spanning all four papers. Both the Powerpoint (PDF) and transcript (PDF) from Akerlof's Stamp Lecture on 'Economics and Identity', delivered at the London School of Economics on April 25, are now available. This body of work is certainly starting to influence economic debates. Their first article, published in the QJE in 2000, has already been cited by over 100 economic papers.

Many of us would agree that the neoclassical model of human behaviour is incomplete. To what extent does the Akerlof-Kranton thesis help complete the picture? I'm not yet sure. But for those looking for a little economic theory to stimulate their neurons on a holiday Monday, reading the four papers below (which will form the basis of their forthcoming book) may be time well spent. I'm certainly taking them to read on my summer break.

Further reading:
* Economics and Identity (PDF), Quarterly Journal of Economics CXV(3), August 2000, pp. 715-733.
* Identity and Schooling: Some Lessons for the Economics of Education (PDF), Journal of Economic Literature, 40(4), December 2002, pp.1167-1201.
* Identity and the Economics of Organizations (PDF), Journal of Economic Perspectives, Fall/Winter 2004; a longer version with the modelling is available here (PDF).
* The Missing Motivation in Macroeconomics (PDF), AEA Presidential Address, January 2007

The joys of fiscal consolidation

'Fiscal consolidation'. Who but an economist could love such a clunky, unsexy phrase? But then, I am an economist; and so is the OECD. Their latest Economic Outlook includes a special chapter on: Fiscal consolidation: lessons from past experiences (PDF). The authors argue that alhough "fiscal consolidation is required in most OECD countries", it "remains a challenge' for many of them. Translation: they're spending too much and/or not taxing enough. The chapter looks for some lessons from on a dataset covering a large number of OECD fiscal consolidation episodes starting in the late 1970s. Here are their main findings, along with my own summary titles:

1. Facing a crisis helps

Consolidations were larger when the initial situation was difficult: Large initial deficits and high interest rates have been important in prompting fiscal adjustment and boosting the overall size of consolidation. These results may reflect that public awareness of fiscal problems and needs can help in overcoming resistance to consolidation, a hypothesis which is also supported by the observation that qualification for euro area membership significantly increased the probability of starting consolidation. The policy implication would be that consolidation may be helped by the provision of transparent information and analysis of the fiscal situation.

2. Spending cuts work better than tax hikes

Expenditure based consolidations tended to be larger and last longer: An emphasis on cutting current expenditures has been associated with overall larger consolidation and a large weight on social spending cuts increased the chances of stabilising the debt-to-GDP ratio. This could be because expenditure cuts, as opposed to revenue increases, are more likely to trigger lower interest rates and a sympathetic response of private saving, helping to bolster activity. But it could also reflect that governments more determined to consolidate are more willing to cut current expenditures, including social spending, possibly thereby also demonstrating a commitment that makes substantial consolidation more feasible.

3. Fiscal rules can help...

Countries with fiscal rules achieved better results: Fiscal rules with embedded expenditure targets tended to be associated with larger and longer adjustments, and higher success rates. This could in principle reflect that well designed fiscal rules are effective or, alternatively, that governments committed to prudent fiscal management are more likely to institute a rule.

4. ...but need careful design

Designing effective rules raises several issues: Fiscal rules need to be adapted to country specific institutions and political systems, but, based on experience across countries, certain common design features seem important for their effectiveness. These include the need to combine transparency with sufficient flexibility to face cyclical (and other) shocks, a wide coverage across various budget items and effective enforcement mechanisms.

The Economist also discusses this chapter, in its post Words of warning:

With a Kantian flourish, Jean-Philippe Cotis, the OECD's chief economist, argues that sticking to tight spending plans should be governments' “categorical imperative”. In fact, the organisation expects no further reduction in cyclically adjusted deficits in the next two years. It thinks America's will rise. And the historical record, presented in a special chapter of the Outlook, is not encouraging.

The chapter looks at 85 budget-tightening efforts undertaken since 1978 and tries to identify the conditions associated with success. Deficit cuts based on reduced spending have tended to be deeper and longer-lasting than those founded—as in the past couple of years—on increased revenues. That may be because lower spending leads to lower interest rates and hence stimulates economic activity. But it may be because it demonstrates a determination to limit the budget. When tax revenues go up, demands for new spending can be hard to resist—so that when revenues go down again, a new hole in the budget opens up.

Several countries have adopted rules designed to keep themselves on the fiscal straight and narrow. These usually place bounds on budget balances. However, the OECD finds they have more effect if combined with rules to limit expenditure—so that extra revenues are not automatically spent, as they might be if the fiscal balance were all that mattered. Balanced-budget rules not linked to expenditure limits, such as America's Gramm-Rudman-Hollings act of 1985 and the European Union's Stability and Growth Pact, have been less successful. Of course, it is hard to know whether fiscal rules stiffen finance ministers' spines or whether they are adopted by governments that already have the necessary political will.

Either way, the OECD's warning is a timely one. Though state counting-houses may be full now, it is not hard to imagine how they might be drained. The demands of an ageing population look staggering, unless today's systems are reformed. In Greece the combined toll of health care, long-term care and pensions is expected to amount to 7.5% of GDP by 2025 and 16.8% by 2050. In Portugal the expected burden is 6.1% by 2025, rising to 15.5% by 2050.

The Outlook has one more gloomy finding for budget hawks. Not surprisingly, governments are more likely to tighten their belts when budget deficits and interest rates are high—at times, in other words, precisely unlike these.

UK economy: robust growth, upside risks

Whoever replaces Gordon Brown as Chancellor next month will face a very favourable economic environment. According to the latest OECD Economic Outlook, published today, output is expanding "at a healthy pace":

The current expansion is well entrenched. Output grew by 2.8% in 2006. Business investment has been the main engine of growth in recent quarters, propelled by the highest profitability in 40 years and the buoyant outlook for activity.

...Overall, the outlook is for growth of 2½-2¾ per cent over the next two years, with little economic slack in the economy.

UK growth is projected by the OECD to run at 2.7% this year and at a still robust 2.5% in 2008, compared with last year's rate of 2.8%. The report elaborates:

With business and consumer confidence buoyant, and foreign demand growing rapidly, the outlook for the first half of 2007 looks bright. Investment spending should continue to provide the main stimulus in the short term. Household demand is projected to play a greater role, underpinned by higher disposable incomes and yet another recovery in house prices, which are currently rising at a pace of more than 10%. Nevertheless, this is much below the rate of increase at the 2002 peak in the house price boom, and price increases are now concentrated in the south of England and Northern Ireland rather than being widespread. Export demand should also stimulate activity, although this cannot be seen in the projections because of the clamp-down on VAT fraud.

What could spoil the party? The most likely candidate are the "upside risks to output and inflation'':

There is little economic slack in the economy and so far labour market bottlenecks have not materialised because of strong inward migration. But migration flows could diminish now that more EU countries have opened their borders. Although, real house prices are continuing to move up, the projection is based on the assumption that this will remain localised and eventually stabilise. This suggests a risk that more widespread and stronger house price inflation could fuel consumption. Finally, as already noted, the current wage round could be influenced by the recent spike in inflation, in which case additional interest rate hikes might be needed.

That could mean higher interest rates, which is hardly news. Last week saw the Bank of England raise official rates by another 25 basis points to 5.50%, with financial markets pricing in another rate hike to 5.75% with in the next three months. As the OECD notes, the Bank needs to be "vigilant":

The Bank of England has raised interest rates since mid-2006. While inflation should come down to the target, the Bank needs to remain vigilant as inflation expectations have risen, albeit by a lot less than actual inflation, and the current wage round may be affected by the recent spike in inflation.

The OECD notes that Britain's "fiscal stance continues to be mildly restrictive", and expects the budget deficit to fall to around 2½ per cent of GDP by 2008. but they would like to see greater fiscal restraint:

The March budget, which included both tax rate cuts and base broadening measures, had no significant impact on the fiscal stance, which is likely to damp demand somewhat. Going forward, greater spending restraint will be needed to achieve a more rapid reduction in the deficit. Improved work force skills and a better transport infrastructure are required to raise potential growth.

That is precisely what the forthcoming Comprehensive Spending Review is designed to do.

OECD: The song remains (much) the same

The OECD released its draft semi-annual Economic Outlook today. It contained few surprises, sticking to the view that "the US slowdown was not heralding a period of worldwide economic weakness" and expecting a 'smooth' rebalancing, "with Europe taking over the baton from the United States in driving OECD growth".

The "benign" central forecast is for OECD economic growth of around 2.7% this year (upwardly revised from last November's 2.5% estimate). This would be a notch below 2006's OECD growth of 3.0%, but impressive nonetheless.

US growth will slow from 3.1% last year to a downwardly revised 2.1% thus year. In his presentation and summary of the report, Chief Economist Jean-Philippe Cotis admitted there were downside risks from the "tricky" situation in the United States, where an over-extended housing market has slowed the economy. The slowdown "may be of a broader nature, and may involve a mild form of stagflation, with weaker trend productivity growth and output growth translating into more overheating".

But the central scenario is for continued robust growth, not for the US to slump and drag down other economies with it. The slowing US economy is expected to be more than offset by upwardly revised growth forecasts for Japan, the UK, Australia and the eurozone - particularly Germany and Italy.

What was new in this report was a heightened concern about inflation. As the Financial Times report by Scheherazade Daneshkhu, OECD warns on risk of higher inflation, says:

Jean-Philippe Cotis, chief economist, said inflation in the US had been “more persistent than expected” while in many other OECD countries, notably continantal Europe and the UK: “The amount of residual economic slack is also uncertain....This constitutes a challenge for central banks which, on both sides of the Atlantic, should probably err on the side of tightness.

...It identified “many signs of strong underlying global inflation pressures which could yet feed through into headline inflation”. These reflected increases in commodity prices and the fact that the inflation rate for intermediate industrial goods in most OECD countries had picked up, a surge in shipping costs over the past year and rises in the price of food relative to other consumer prices across most OECD countries.

The strong demand was also a reflection of robust economic expansion, which the OECD expected to continue. It forecast above-average economic growth this year and next in the OECD area due to upbeat business expectations, consumer confidence and “ongoing buoyancy in emerging market economies and favourable financial conditions.”

For those wanting to read the whole thing, a copy of the entire 253 page report can be found here (PDF).

Welcome George Borjas

As the blogosphere becomes more respectable (and/or influential), we are seeing a steady trickle of prominent economists join in. There was Greg Mankiw, then Dani Rodrik.

Now Harvard's Kennedy School of Government economist George Borjas has join the fray. The sub-heading on his blog is: "George Borjas's thoughts on immigration, labor markets, and random stuff". In his first post, Borjas explains his motivation:

I've been thinking about doing a blog for some time now. Some of my colleagues, particularly Dani Rodrik, have started one. If Dani, who has a brand new baby, can somehow manage to find the time to write some first-rate commentary on trade issues, I figure I can at least try to express some of my thoughts on matters that interest me. Plus--there's no time like now to comment on immigration issues.

Borjas he already has several provocative posts online, and he only started blogghing yesterday! Cant' say I've always agreed with his take on migration issues, but a welcome addition to the econosphere all the same.

Hat tip: Dani

Those missing migrants

I'm not the only one wondering what happened to the hoards of Bulgarians and Romanian migrants who were supposedly headed for British shores. Bulgarian journalist Nikolai Chavdarov also asks about the Missing migrants at the Guardian website:

Do you recall the live broadcasts from London airports on January 1? Reporters were desperately looking for hordes of Bulgarians and Romanians arriving in Britain as the tabloid press stirred up alarm about hundreds of hungry immigrants supposedly pouring from planes on the day the two countries joined the EU.

"How many more can Britain take?" asked Sir Andrew Green, chairman of Migration Watch UK, writing in the Daily Mail. "Are we about to see another wave of East European immigration? Will Bulgarian builders be hot on the heels of Polish plumbers?"

Two days later, the same paper reported fears that "a tidal wave of poorly skilled workers" from Bulgaria and Romania "could overwhelm Scotland's schools, NHS and council services".

Meanwhile, the Daily Star announced: "An army of 600,000 Romanian and Bulgarian immigrants will start entering Britain on Monday - and they won't even have to show a passport."

None of this actually happened. Officially, only 8,000 Romanian and Bulgarian migrants came to work in Britain in the first three months of this year and it is clear now that there will be no "tidal wave".

Why didn't they come? One reason is that at present Bulgaria and Romania are enjoying relative economic stability. The economic growth in both countries is still above the average compared to that of western European economies.

Also, the main wave of emigration from these countries had already occurred. In 18 years after the fall of the Berlin wall more 800,000 Bulgarians in their twenties, thirties and forties had gone. The shrinking population doesn't provide enough manpower to continue this trend now.

Besides all that, the UK is not the most preferred destination for Bulgarian workers with low qualifications - Greece, Spain and Italy are. The United States also provides opportunities for immigration. I remember a friend who told me that he would always prefer the United States. One of the main reasons was that when you say "I am from Bulgaria" in the United States, the next question usually is: "Where is that?" When you say "Europe", most Americans think "Ah, Europe - Paris", great. And no further questions asked.

...Bulgarian or Romanian beer is not going to be served in London pubs in the foreseeable future. Now is the time for the UK's home secretary to drop the restrictions on Romanian and Bulgarian migrants. This will send a clear message to rest of the EU member-states and make the labour market more flexible.

UPDATE: Even Madelaine Bunting has something sensible to say; see: The language of fear