Sunday, January 30, 2011

Why Inequality Matters

Adam Smith wrote in his 'Theory of Moral Sentiments' (1759): "This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition, though necessary both to establish and to maintain the distinction of ranks and the order of society, is, at the same time, the great and most universal cause of the corruption of our moral sentiments. That wealth and greatness are often regarded with the respect and admiration which are due only to wisdom and virtue; and that the contempt, of which vice and folly are the only proper objects, is often most unjustly bestowed upon poverty and weakness, has been the complaint of moralists in all ages."

One can argue that foolish admiration for wealth has always existed. We have an emblematic illustration in Italy's recent history. Conversely, people may regard this as unfair and will rebel against worship and power as shown by protests in Tunisia, Egypt and other Arab countries.

But the significance of this is more profound. Inequality is not a fatality; it is the product of savage capitalism. Many economists sympathise with the idea that governments should do something to reduce inequality, but this is often a wishful thinking or just a moral inclination. The fact is that inequality matters and governments should act to address this issue. This view is also shared today by many institutions which had always defended free market ideas.

In a 2009 report*, Angel Gurria, the OECD secretary-general warned of the dangers posed by inequality and the need for governments to tackle it: 'Growing inequality is divisive. It polarizes society, it divides regions within countries and it carves up the world between rich and poor. Greater income inequality stifles upward mobility between generations, making it harder for talented and hard-working people to get the rewards they deserve. Ignoring increasing inequality is not an option". 

More recently, D.Strauss Kahn, the IMF managing director and a former socialist finance minister, warned about "a large and growing chasm between rich and poor - especially within countries" and argued that " inequitable distribution of wealth could "wear down the social fabric". He then added: "More unequal countries have worse social indicators, a poorer human development record, and higher degrees of economic insecurity and anxiety". This marks a radical shift in the IMF discourse.

However, the Economist (January 22) asserts that inequality matters "most because of brands and status competition" and that "such concerns could seem peripheral compared with global woes such as poverty", In previous years it has asserted a similar critique focusing on the fact that income inequality is not reflected in consumption inequality. This is a fallacious argument as consumption does not increase dramatically in high income groups.

A reason for the revived interest for these issues is the rise of inequality as measured by the Gini coefficient which runs from 0 (everyone has the same income) to 1 (one person has all the income). Most countries range between 0,25 and 0,6. The Gini coefficient has been rising steadily since the 80s. Latin America has the world's worst income inequality, but it has fallen in Brazil more than five points since 2000 to 0,55. In the US, it rose from 0,34 in the mid-80s to almost 0,40 in the past decade. In China, it grew even more, from under 0,3 to over 0,4. Overall, higher growth in the so-called emerging countries does not necessarily lead to a reduction in income inequality.

Furthermore, there is no consensus on the causes of inequality. One simple explanation is that the wealthy are getting wealthier. Several studies examined the distribution of income in the US with rather converging results. A study from the Economic Policy Institute** in Washington found that the top 1% of the population earned ten times more than the rest at the end of the period and 20 times more at the end.

Some economists have argued that income inequality is not significant since it only means that the rich are gaining more income than the rest. But the picture is that the richest Americans are gaining so much of the  US total income that there is not enough left over for most families to see any possibility of increase of their real incomes. These patterns of extremely uneven income growth contrast to the period between 1947 and 1973 when income growth was distributed roughly equally across income classes, with the poorest 20% of families seeing income growth at least as fast as the richest 20%. 

The other argument put forward is that poverty matters rather than inequality. In other words, governments do not pay attention to the rich and even grant tax cuts for the richest as long they can devote (scarce) resources to reduce poverty. That view was shared by conservative governments as well as the new Labour in the UK. In fact,  poverty and income inequality are often interlinked. In the US, most poor people  have a car but they cannot afford medical care and even enough food or give to their children a decent education. The issue is not the disparity of status which matters, i.e.  how many 'positional goods' people can buy to increase their social status, but access to public goods such as healthcare or education.

Income inequality is the issue to focus on in today societies. The growing chasm between the rich and the poor has never been so big - those that continue buying diamonds and luxury cars and those (increasingly) who have barely enough to buy food. We would have to go back to the Great depression of the 30s to find similar income inequality. This is intolerable not only from a moral perspective, but from an economic one because the system will break down if demand continues its collapse. There are no simple remedial solutions, but there should be a political will to engage in building a fairer society. It will also be more efficient economically.

* OECD, Growing Unequal? Income Distribution and Poverty in OECD Countries, 2009

Sunday, January 23, 2011

The Barbarians

The Barbarians are at our gate and they are threatening our democracies.  They are not the uncivilized or uncultured people from ancient times which prevailed both in Western and Asian cultures. They do not necessarily use violence, but superficiality as their main strength. In doing so, they undermine the very foundations of our societies. Is it the end of  western civilization which invented art, music, literature and wonderful monuments?

The sack of Rome was perpetrated by the Barbarians. But this does not explain why the sophisticated society of ancient Rome, with its advanced technology and powerful armies fell to less developed people. Edward Gibbon's monumental work* argues that   the Roman Empire succumbed to barbarian invasions in large part due to the gradual loss of civic virtue among its citizens and the rise of Christianity. He wrote:  'the pure and genuine influence of Christianity may be traced in its beneficial, though imperfect, effects on the barbarian proselytes of the North. If the decline of the Roman empire was hastened by the conversion of Constantine, his victorious religion broke the violence of the fall, and mollified the ferocious temper of the conquerors." (chap. 39))'. 

We may disagree with this explanation but the fact is that there is no consensus among historians about the decline and fall of civilizations. Jared Diamond's book 'Collapse' attributes the decline of civilizations to external disasters . Another scholar, an American anthropologist, Joseph Taintner explained the collapse of complex societies to diminishing returns on investments in social complexity like education, energy or technological innovation.

This issue has also been discussed by prominent philosophers. F.Nietszche elaborated his doctrine on the overman  (├╝bermensch) as part of his critique of Christianity and modernity as an expression of decadence and nihilism. This vision opposed the idea of progress and equity and the advent of the new man was a liberation from the 'tyranny of Reason'. On the contrary, he saw his age as the final chapter in the levelling and mediocritization of men. He wrote : " The total degeneration of humanity down to what today’s socialist fools and nitwits see as their “man of the future” – as their ideal! – this degeneration and diminution of humanity into the perfect herd animal (or, as they say, into man in a “free society”), this brutalizing process of turning humanity into stunted little animals with equal rights and equal claims is no doubt possible! Anyone who has ever thought this possibility through to the end knows one more disgust than other men, – and perhaps a new task as well! **. 

Barbarians of today are, by no means, the higher men described by Nietszche. They do not see the complexity of societies. They use simplistic, superficial arguments to gain support from the population. Sometimes, they use (or even control) the media to manipulate public opinion and increase control over democratic institutions. They claim that their power stems from the people and that they have the legitimate right to change the rules of law to their advantage. They don't read books and newspapers and their only source of information is  commercial television with reality shows, soap operas and hardly any programme on classical music or fine arts. They mark the triumph of superficiality as opposed to deepness.

This is perhaps the most acute sign of this major transformation of our societies. But it is also the most dangerous one because it gives rise to forms of extremism and populism. Their strength is the use of simplistic and demagogic arguments such as the eviction of immigrants (especially muslims), the introduction of barriers to foreign goods and capital and exit from the euro area. Wise and clairvoyant politicians seem powerless and often fail to persuade their public opinions that these ideas are flawed.

But they must be fought on the terrain of ethics, not just because they are immoral. First, the return to the old currency would imply terrible consequences for businesses and citizens: more exports for few and failure of many living on imported products which become more expensive; incapacity to borrow on financial markets as debt will be reimbursed in euros with a depreciated currency; aggravated risks for the banking system which will transfer the increase of financing costs on businesses and citizens. Second, the return to protectionism in the form of giving preference to domestic products and protecting national firms does not make much sense. If  we rise tariffs against imported products, say from China or Japan, domestic exporting firms will be penalized in selling their products in those countries and the result would be a diminishing purchasing power for the more modest categories of the population. Third, the issue of immigration: in economic terms, the deportation of hundreds of thousands of immigrants would put in danger the survival of businesses which employ a large quantity of foreign workforce such as the construction sector, agriculture, hotels and restaurant; in human terms, we have a moral obligation to help them just as human beings regardless of their religion or color of the skin. .

In sum, they are no welfare gains from these measures but this needs to be explained in plain language to every citizen. Needless to say, education is the best argument against barbarians.

*  The History of the Decline and Fall of the Roman Empire (vol. I, 1776; vols. II, III, 1781; vols. IV, V,VI, 1788–1789). all London: Strahan & Cadell
**     Nietszche, F. Beyond Good and Evil- Prelude to a Philosophy of the Future.

The return of free market

It is odd to see that free market ideas are still prevailing despite the economic disaster that they caused just a few years ago.  When the financial crisis burst in 2007, we all (I mean, serious economists) thought that market fundamentalism was dead and that ideology would not come back. We were simply wrong.  

A year ago or so,  there was a general consensus about government regulation of financial markets in the G-20 in Pittsburgh. Now, many conservative leaders, such as the Republican Ron Paul reckon that there is no need for regulation.  The president of the World Bank, R. Zoelick (FT January 6) argues that free markets are more necessary than ever as if the Asian crisis never happened. 

Neoliberalism had its heyday  in the 90s roughly until the financial crisis of 1997.  As J. Stiglitz put it, the Asian crisis revealed one of the biggest failures of self regulating markets as the main cause of the crisis was precisely the  liberalization of  short term capital flows which turned into a monetary crisis and then destabilized entire economies and pushed millions of people into poverty.  

So, if free market ideas are so flawed, why are they still so powerful? We should go back to the fundamental work of  K.Polanyi*  who demonstrated how self regulating markets do not exist as market cannot be an end in itself, but just a means to an end and being part of  the broader society. But in a sense, free market is traditionally the ideology of  economic powers (just as free trade was imposed by the British Empire to the rest of the world in the 19s century).   

A British political philosopher (and former conservative close to Thatcher and the New Right) John Gray, in an original  book** , writes: 'the free market is not - as today's economic philosophy supposes- a natural state of affairs which comes about when political interference with market has been removed. In any long and broad historical perspective the free market is a rare, short lived aberration. regulated markets are the norm, arising spontaneously in the life of every society. The free market is a construction of state power (p211)'. 

But let's go back to the roots of economic liberalism. Adam Smith's fundamental argument was that individuals should be allowed to pursue their own private economic interests as much as possible and so long as they do not violate basic principles of justice. In this way, Smith thought, they would do much more to further the public good and public interests than if the same people were to try to help the public deliberately and intentionally. If this were true, there would be no ethics; the existence of the ethical problem arises from the fact that the 'normal' functioning of the economy leads to profound ruptures in the society in terms of social justice and equity.

The same ideology of 'laissez faire'  is tying up Europe and US with austerity policies. The problem is politics and political changes are needed to sustain growth and address global inequalities. The economy, by itself would not be able, to find the way to sustainable recovery in harmony with ethical aspirations. 

* K.Polanyi, The Great Transformation- The Political and Economic origins of Our Time - Foreword by J.Stiglitz, Press Beacon Books 2nd ed. 2001 
**  John Gray, False Dawn: The Delusions of Global CapitalismGranta Books (1998, 2nd ed. 2009)

Winds of change

Very few indeed predicted that the horrible self immolation of a desperate young man after police seized the fruits and vegetables he was trying to sell for his living would trigger a wave of protests that would finally bring down a dictatorial and corrupted regime in place for many decades.

But the power of people and the thirst for freedom and better quality of life have initiated a serious process of change. The key question is how these positive energies can be channelled into a peaceful transition to democracy. This would be a novelty in the Arab world. There are already signs of contagion and this  explains fears from long standing dictatorships in Libya, Egypt and other Arab countries after decades of oppression and humiliation for the masses.

Tunisia and its people have to set out a shared vision for the society they want to build. It will not be a 'chariaa' kind of regime but a true evolution towards a democratic country. The significance of this change in mindsets should not be underestimated: it means that there is not necessarily an Islamic alternative to the so-called Arab nationalist regimes which are increasingly contested by their people.

Europe, not France (the former colonial power) has an important role to play in this process in building a true partnership that would lead to political and economic reforms to ensure stability, peace and social justice. Tunisia needs certainly European support, but Europe also needs Tunisia to affirm its voice as a leading actor in promoting democratic rights in the entire Arab world. 

Sunday, January 16, 2011

Can Europe be saved?

P.Krugman has written a long paper  as editorialist on New York Times concerning the economic future of Europe, and in particular that of the euro. As many American economists, he expresses a skeptical view about the monetary union using the well known arguments developed by R.Mundell in his theory of optimal currency unions and the need for mobility of labour.

First, it has to be acknowledged that Europe is not a federation like the US; it is an original political project with supranational institutions. Economic power is shared with Member States, with a single currency issued by the European central bank whose aim is to guarantee its stability but fiscal powers of the EU are limited, with a budget of less than 1% of the GDP of the European Union and with no proper European tax.

Second, the debt crisis that affected Greece and Ireland is a different movie that the one we saw happen in Argentina in the 90s. Europe has responded to that crisis with the set up of a Fund to rescue those countries and to calm markets from further speculative attacks. It might not be sufficient but there was a coordinated response, whilst Argentina was left alone with its creditors and the intervention of the IMF which could dictate its conditions without any fierce resistance from national authorities.

Third, the way forward is not choosing between debt restructuring which would imply higher interests costs for borrowers and internal devaluation with wage cuts as in the Baltic States. P.Krugman is right though that the road to fiscal integration, which would indeed be a crucial step towards a stronger Union seems at the moment unrealistic, because of the obsession of German politicians about deficits. However, the cost of not doing it may result much higher if the debt crisis would cause higher interests and eventually higher sovereign debt levels, which would then be subject to new speculative attacks.

The euro project - which was essentially a political one, just after the disintegration of the Soviet block  in early 90s, cannot fail, as it would mean the failure of the entire European project. European leaders should show for once a vision for Europe instead of pursuing beggar my neighbour policies to seek benefits for them at the expense for the others, just like during the Great Depression of the 30s.

Saturday, January 1, 2011

Europe needs better schools

The eurozone debt crisis and its economic and social consequences should not distract the attention on real problems that Europe is facing in terms of competitiveness. As indicated in Europe's 2020 strategy, the long term future of its economy depends increasingly in its ability to innovate and the quality of its education systems, particularly secondary school education.

The Organisation for Economic Cooperation and Development (OECD) presented the results of its Program for International Student Association (PISA)'s recent testing on 28 million young people of 15 year old in 74 educational systems which account for 87% of the world economy*. These results are to be taken with great attention by all those who care about Europe's future.

There are important lessons that we can draw from them. First, the study shows that educational results can be significantly improved through government intervention. Poland is a clear example of how education reform has produced markedly better tests results. Germany - whose poor past performance was rated in PISA- show signs of improvement too as well as other countries such as Portugal and Hungary. Outside the EU, Chile shows improvements which can be attributed to government intervention.

The second lesson, which is double edged, is that relationship between public funds invested and results achieved is not straightforward. In general, the more is invested into education, the better for both individuals and schools; however, there are countries investing relatively less which perform better. Poorer countries cannot simply blame their below average results on their poverty. Nor can rich countries rely on their wealth to secure for their children their best possible education.

Finland spends a lot less on education than many European countries but has consistently ranked at he top in all PISA assessments over the past decade, and its performance has been notable for consistency across schools. Primary school teaching is, in fact, the most popular profession among Finnish young people and one of the most important lessons from PISA's evaluation is that raising the status of teaching has a powerful effect on results. After Finland, the Netherlands and Belgium are the most highest ranking EU countries for reading literacy, maths and science with Estonia and Poland above OECD average. Sweden, Germany, Ireland, France, Denmark, the UK, Hungary and Portugal are close to the OECD average. Bulgaria and just after Lithuania are the lowest ranking EU countries for reading. Greece is the second worst in maths and science.

Existing disparities in performance of education systems between Finland and other European countries cannot simply be dismissed. Political leaders should give due consideration to secondary school education as they have the power to affect the results and thereby change the daily lives of millions of young people and through them improve the growth potential of the European economy.

For Europe, education is a difficult issue because responsibility rests with national and regional governments. What is taught in schools and (how) is often politically and culturally sensitive. But the EU cannot ignore the issue , or just maintain the status quo. It has no choice, but persuade European nations to improve their educational performance for their economic survival.