The simplistic, aggregative economics of our intellectuals

A couple of months ago, I sat next to a leading economist, reputedly of the free-market variety (though our conversation led me to doubt it). I suggested to him that GDP was not a good indicator of the health of the economy. He said he thought it was, and (immediately betraying the weakness of his position) proferred the straw-man challenge that perhaps I preferred Gross Wellbeing.

Though the smarmy economist would not like to acknowledge it, it is possible to be critical of GDP without endorsing the hippy, Cameroony, pseudo-statistic of Gross Wellbeing. Here is one of many reasons why GDP hides a litany of economic and (particularly) political sins.

Consider two economies identical in every way - same size of population, same output of products, same prices - except for one feature. In one economy, the work is done by half the population available for work, working on average 70 hours per week whilst the other half of the working population do not work. In the other economy, the whole population available for work is in employment, working on average 35 hours a week. In aggregate, the same amount of money is paid in wages for the same amount of work to produce the same amount of goods, and the same amount of wages is spent on the same value (though probably not the same types) of goods. The GDP of the two economies would be identical. But are these economies equally healthy? To my mind, clearly not, and for fairly simple economic reasons.

Value is established at the margins. Our marginal valuation of any good will normally vary according to how much we have of that good. To take the Rothbard egg scale, two eggs is better than one egg, but not necessarily twice as good, and the value to us of an extra egg when we already have a dozen is probably less than when we have none (though not necessarily - this is always subjective and dependent on circumstances).

This logic applies as much to leisure and work as it does to any other good. For a given job paying a given wage (and ignoring counter-incentives erected by the state), the value to us of an hour's work is probably (though not necessarily) greater when we have no work than when we have already worked 69 hours that week. Conversely, the value of an hour's leisure time is greater if we have worked so many hours that we have little time for leisure, than if we have no work and every waking hour is leisure time.

In the first economy above, it does not seem enormously contentious to suggest that half the population available for work is getting less leisure than would be ideal, and the other half is getting less work than ideal.

It could be objected that the (labour) market reveals people's preference scales and valuations and is the only valid way to make interpersonal comparisons of these subjective quantities. If a person already working 69 hours is more suited or more willing to do an hour's work than an unemployed person, then in reality the subjective value of that hour's work to the former is higher than to the latter, regardless of what one might expect in the abstract, depersonalised, hypothetical scenario.

And it should be cautioned that, even if one accepts the premise that the first economy is suboptimal and inefficient, this does not justify (as it might seem to) government intervention to "spread the work". In the absence of artificial incentives that inhibit more even distribution of work, if the first economy's labour market chooses that distribution of work, that is the balance that most closely reflects the individual, subjective valuations of the population, and is therefore the optimal balance for that group of people, regardless of what we might think ought to be best for them.

I list the objection and the temptation to intervene in short succession because they, and the value of GDP as a measure of economic health, rely on an assumption of efficiency that is so far from the reality of our modern economies and state-created incentives that it is laughable to base any premise or action on that assumption. The efficiency that is assumed is that people in different circumstances face similar incentives and disincentives to work. In practice, our tax and benefits system has created different disincentives to work depending on one's existing state of employment. For those at the bottom end of the earnings scale, we reward leisure and penalize work (through the withdrawal of means-tested benefits combined with the basic rate of taxation above the personal allowance). For those in the middle of the earnings scale, we are particularly keen to encourage work (for that short gap between the level of earnings where one no longer receives means-tested benefits and the level of earnings where one starts to pay upper-rate tax). And for those at the upper end of the earnings scale, we are increasingly disincentivising work and rewarding leisure, though not (yet) as aggressively as we do to those at the bottom end of the scale. Ironically, it is precisely those egalitarian measures introduced by governments to try to redistribute income to reduce inequalities that are responsible for the disincentives that widen the earnings gap by encouraging those who are out of work not to work, those who are in work to work more, and those who are paid best (and most able to influence their levels of pay) to pay themselves more to compensate for the aggressive taxation. Yet people are surprised that inequality in the UK has widened under the Labour government! It is the direct effect of Brown's interventions, but politicians of all colours are too ignorant (and addicted to appearing to do good with other people's money) to notice.

It is not practical to try to design a different measure of the health of the economy that took this into account. Such a measure could reward economically-inefficient "make-work" schemes, and not adequately reflect the benefit of growth achieved through efficiencies that increased productivity without increasing employment. It could penalize changes in preferences and norms that might be socially-beneficial, such as increased stay-at-home parenting. But no one should be fooled by the difficulty of designing a superior measure of economic health into thinking that our preferred measures (whether GDP or GDP per capita) are adequate, nor that increasing GDP necessarily means a healthier economy. There is a tendency amongst politicians, their advisers (bureaucratic and academic) and the media to look for their keys not where they dropped them, but under the street-light where it is easier to search. We should not kid ourselves that GDP is the key measure of economic health simply because it is relatively easy to compile. Policy-making requires great judgment, awareness of many factors, and consideration of the interactions of the effects of all interventions. It cannot be reduced to maintenance of a stable upward trend in a few basic indices (such as GDP or inflation), as is implied by the decision (assumed by most commentators to be right) to hive-off to the Bank of England responsibility for maintaining a specified level of consumer-price-inflation, or the Government's boasting before the recent downturn about the number of quarters of continuous GDP growth that had been maintained. Most of the damage that resulted in the trouble we are now in was done in that time, partly through the fragmentation of responsibility and poor judgment of those who thought our economic health could be measured by such inadequate and misleading statistics.

Our intellectuals have it exactly back-to-front. They think our economy can be reduced to a few simplistic statistics, and yet immensely complicated measures are needed to "manage" it. In reality, the economy is immensely complicated, irreducable and unpredictable. It is futile and counter-productive to try to micro-manage it.

Those who saw Jim al-Khalili's excellent "The Secret Life of Chaos" on BBC4 last Sunday should have gained an insight into the relationship between chaos, complexity and simplicity (and those familiar with Hayek may have noticed strong similarities between his description of the self-organising nature of chaotic systems and Hayek's concept of spontaneous order). Our micro-managers fail to understand that the economy no more behaves Newtonian, mechanistic rules whose behaviour can be predicted by high-power computers and managed by the pulling of ever-more-intricate levers than does the climate or the universe.



Although I realise that the example you start with is meant to be an illustration rather than a proof of anything, it should be asked whether two such economies can actually exist simultaneously, or would the great difference in the distribution of labour make it impossible for total wages and productivity to be equal in the two cases?

It's just a thought experiment. I didn't particularly mean that they would exist simultaneously. Think of it as parallel universes, if you like. No connection, just a comparison of two hypotheticals.

In one sense, though, there is a countervailing effect to the one you describe. Not all people are equally able. The labour market tends to favour the more able, which is one of several reasons why productivity tends to decline as more marginal labour is brought into employment (which people always complain about as though this were a fault of the employers rather than an utterly predictable effect). I suppose it is hypothetically possible that the greater ability of the more able half of the population would balance the impact on their productivity of long hours, so that their net output was similar to the net output if the work were divided more evenly between the more able and the less able.

Or it might not. It's not important to the point. The point is that an economy with high GDP per capita might nevertheless be highly dysfunctional, if it incorporates mass unemployment and mass overstretch of another part of the population. In fact, from what I've seen, that's a pretty accurate description of the UK economy. Brown ought to be held more to account for creating this situation than he usually is by economists and politicians, who look only at the aggregate figures and not the imperfections that they hide.

I also ignored a lot of complexities (e.g. how money is redistributed from workers to non-workers in one of the models), but they would mostly exacerbate the comparison.

And there are many other reasons why GDP is a poor indicator. For instance, an increase in government spending funded by borrowing, or in personal spending funded by unsustainable credit, can also give the appearance of an economic improvement if measured by GDP, when the long-run impact is probably exactly the opposite (as we are finding).

GDP is a number that is better to have than not to have, but it is only one of many indicators that ought to be weighed when we are trying to judge the health of the economy, and can be highly misleading if considered out of context. There is a tendency amongst politicians and journalists to do exactly that.

It's a bit like all the crowing today about the decline in the unemployment numbers, when the number of people in work also declined by a similar amount. You didn't hear much about the latter statistic in the media, did you? All the reporting, and Government boasting, implied that the unemployment figure meant people were getting back into work, whereas what has actually happened (as is clear when one has the important context of the other figure) is that the number of economically-inactive people (i.e. not in work but not looking for work) has increased. That sounds rather less good for the economy, but no one mentioned that, because lots of people were frightened by the Crash, didn't understand its economic causes, think that it's just "animal spirits" losing confidence, and (following the psychological theory of the business cycle) are playing their part in trying to restore confidence by focusing only on the good news. In the short term, the delusions fostered by this and a flood of money into the financial sector have indeed reflated certain asset values (though not the economy). But they will get a nasty shock when they discover that the market crashed for good reasons and that prices before the Crash and now were totally unrealistic and can't be maintained by sticking our heads in the sand with regard to negative statistics and unresolved systemic imbalances.

So, any suggestions on how in a humane society (however that may be defined) we handle the problems of the less able and the increasing divergence between the halves and have-nots? It seems to be one of our great modern dilemmas that, while technology continually improves productivity, the blessings of that increase are not proportionally shared. It seems quite fitting that the very able should be highly rewarded, but is there, not merely a safety net, but a floor for those who, through not real fault of their own, are less able or less lucky? Is there a right to work? A right to a job?
Just asking, I don't pretend to have the right answers.

David, I'm a Basic Income man (try searching for the phrase in the search box in the left column for my earlier postings on the subject). Substitute it for all non-working and low-income benefits (including pensions), so the only other benefits you've got left are top-ups for special cases such as disability.

Do away with (a) the minimum wage (because it's up to you if you are willing to work for £1/hr so long as you can support a very basic standard of living without it on the Basic Income) and (b) all personal allowances on income tax (which should be merged with NI).

Set a flat income tax rate. Its nominal rate will have to be over 40% initially to give similar tax revenues to present, but should come down as cuts are made in public spending and more people gain employment through removal of the massive disincentives to work in the current system.

The combination of BI+FT gives you an infinitely progressive effective tax rate (from minus infinity for those out of work, through zero for those whose tax on their income is equal to the Basic Income) tending towards the nominal level of the flat tax for high earners.

The marginal effective tax rate (the most significant incentive to work) is flat - equal to the flat tax-rate - removing all poverty traps and minimising disincentives to work, whether it's a few hours a week or full-time (helping to get the vast numbers trapped on incapacity benefit and the like back into work).

It does away with any change in incentives at an arbitrary retirement age, so when you retire is up to you (your savings) and your employer.

And it does away with the need for any debate about married-couples tax allowance, because you are neither advantaged nor disadvantaged whether you live together or separately, wedded or unwedded. No one ever points out that the cause of this debate is the personal allowance, because all the politicians are wedded to the current tax and benefit system. If anything, they want to increase the personal allowance and therefore increase the problem of discouraging people from entering a traditional, nuclear-family arrangement with one wage-earner and one person staying at home to care for dependants (children and/or parents, in this world of increasing dependance in old-age and lack of funds for public provision of decent care).

Children should be entitled to BI (paid to parents/carers until thresholds are crossed). A proportion would support parents/carers in the cost of care (food/clothing/rent), as per Child Benefit. The remainder would be used for different purposes at different ages.

In the months after birth, it could be used by the parent/carer towards the cost of childcare (for instance if both parents return to work), or for supplementary income and support (for those who decide to quit work to bring up the child), or to pay employers to keep a job open (for those wanting temporary leave for the first few months). Rather than long maternity/paternity leave, the statutory leave period should be significantly reduced (to make people and particularly women of child-rearing age more employable by SMEs), but an obligation placed on all employers to keep the job open for upto a year, for a statutorily-defined cost per week, set at a level that can be covered by this part of the child's BI. The employer gets financial help for the temp cover that is required for as long as the job is being kept open. The new parents have an incentive to be realistic about whether they really intend to return to the job, and to let it go (so they can put the child's BI towards their costs of living) as soon as they decide that they may want to stay home to bring up the child for longer than a few months (or to change job). The employer would be freed to find a replacement sooner (reducing disruption and cost), and a new employee would be helped into a job rather than holding it open pointlessly for months.

After the first year, until the children go to school, this part of the child's BI is either a supplementary income for stay-at-home parents, or help with the costs of childcare for working parents.

Once the children are old enough to go to school, the child's BI goes towards schooling costs in a fully privatised education system. All schools are independent (no LEAs) and are guaranteed a top-up fee from central government for each place offered at a defined rate, equal to the value of this part of the child's BI. Schools are free to offer more expensive places, but for each more expensive place, they don't get the top-up. The leading public schools will thereby be encouraged to offer as many affordable places as possible (rather than a few wholly-funded scholars, their bursaries could support many more partially-funded scholars), and state schools will be freed from central control and will be able to develop and apply their own ethos and specialities on a more equal footing with public schools. Removing the chasm in freedom and incentives between, on the one hand, public schools and some privileged, independent, state schools, and on the other, the vast majority of centralised, homogenised, depersonalised state schools would be one of the most important elements in reducing the persistent divide in this country between the haves and have-nots. It would also make it very easy to setup new schools, perhaps progressing from home-schooling to cooperative home-schooling to the formal establishment of a school.

A small proportion of each parent's BI should also be earmarked as dedicated to the upkeep of each child. If a child is taken into care, or moved from the care of one parent to another, not only does the child's BI transfer to the carer, but that small proportion of the failing parent's BI does too. Single mothers are invited to declare the father of their child. The state will fund DNA tests for those fathers who contest the claim. But for those who refuse the test or who are proved to be the father by the test, a part of their BI transfers to the mother (or carer) as a contribution towards the care of the child. Even feckless fathers with no earnings would thereby have an incentive to try to avoid fathering children that they were not prepared to care for, and would be driven to try to earn more the more children they father. That would be a marked improvement on the current situation where potential claims on earned income and withdrawal of benefits provide a strong disincentive for feckless fathers to find employment or take responsibility for children, and create a vicious circle of deprivation where successive generations have become experts at exploiting the benefit system rather than learning useful skills for employment, and have strong incentives to avoid supportive family structures. This is additional to, not instead of, any decisions of courts on support from one partner to another amongst more affluent, separated parents.

Small amounts (like pocket-money) of a child's BI should transfer from the control of the carer to the control of the child as the child achieves certain landmark educational thresholds, to provide incentives to study. The child should be rewarded with full control of its BI when it achieves a satisfactory level (say equivalent to GCSE C grade) in key subjects like English, maths and science, or when it reaches the age of 18, whichever is the earlier. This marks the transition to adulthood, and again provides powerful incentives to study (and leverage for hard-up parents to control misbehaving children). If you are a smart kid bored by school (often the problem with troublemakers), it would make more sense to study and get the qualifications than to keep failing and have to stay in school for a couple of years longer than necessary. At the moment, the incentives are stacked in the opposite direction.

Young adults wishing to stay in education (academic or vocational) after they have achieved this level will have to use that part of their BI to contribute to the costs, just as their parents/carers had to previously. Parents/carers may also require a statutorily-defined contribution from the remainder of the young adult's BI for rent and board once the child has control of its BI. Reciprocally, they must continue to offer bed and board to the young adult if the young adult is willing to pay this amount, until they reach the age of 18. All children will therefore be able to stay in education until 18 if they wish to, whilst having considerably more freedom to choose not to if they are more interested in the real world than academia at that stage of their lives.

Higher-education funding should work along similar lines. All universities would be independent. The government would declare how many places in each subject it is willing to fund fully in the interests of the nation each year (e.g. with only slight exaggeration and tongue in cheek: tens of thousands of engineers, hundreds of historians, and no MBAs). The top students (on the basis of their A-level results, assuming that standards are restored and distinguishing between them becomes possible again) upto the declared number in each subject will receive a bursary from the government equal to the average cost of courses in their chosen subject, and can use this to pay the fees at whichever university they go to. If they choose a more expensive university, they can use some of their BI to top up the fees. Anyone below this standard may still go to university if they can get a place, and can use their BI to assist with costs, but they will have to fund the balance privately (loans, parents, scholarships, part-time work, spending some time in work before going to university, or however). In this way, the top students regardless of background and income will be encouraged and supported to go to university, but the total cost to the taxpayer for higher education will be substantially reduced. Taxi-drivers (and the like) will be paying for fewer middle-class children of ordinary academic ability to spend three years partying and drinking on the ostensible grounds of studying the history of art (or similar).

The BI should also include a component for housing. This would be a standardised amount across the country, regardless of different housing costs in different areas. Councils would be obliged to offer accommodation of a very basic standard (low enough that no one would choose to live in it if they could afford to move out but just sufficient to maintain dignity) at rents set relative to the value of this component of BI (and adjusted to take account of family sizes). It would be upto councils whether they did it through council housing or rented accommodation. If local accommodation is more expensive than average and the BI component is not sufficient to cover it, councils will have to cover the difference from their local tax revenue (business rates and other sources of income would have been repatriated, so councils would be in more direct control of their income). If property prices go up, the cost of providing this housing goes up, local taxes go up, the area becomes more expensive and less attractive to live in, and prices should come back down again. This should help to reduce the longstanding tendency to absurd property bubbles in the UK, eating up much too large a proportion of people's incomes to be sustainable or helpful to the economy (other than financial services). This would replacing Housing Benefit and similar schemes. It would remove the incentive to stay in social housing for fear of losing a valuable place that will be difficult to get back once you've lost it. If you can afford to move out, you move out and take all your BI housing money with you to put towards the cost of a nicer place. If you have to move back, you can move back. People can aspire and try to move up, without being overwhelmed by the risks of failure.

The usual argument against BI is that we couldn't afford it, but that is because people assume that the whole of a Basic Income would have to be paid to each person, and also because they assume it will continue to be partnered with a "progressive" taxation system roughly similar to what we have now. But if you do BI+FT together, do away with personal allowances, and administer it for everyone in work through the PAYE system by netting off the BI against the FT and allowing companies to aggregate for all employees and then claim or pay any difference outstanding as the net amount of income tax due, you will end up with costs that are not so dissimilar to present with vastly reduced bureaucracy and disincentives to work. Benefits offices will have to continue to deal with those without any work at all, but the vast majority will be dealt with through PAYE. It will be marginally more expensive for a given level of safety-net, because of the improvement in the marginal effective rate of tax on low-to-middle earners. I suggest we make up that difference through a combination of abolishing all VAT exemptions and special rates, an increase in the rate of VAT if necessary, and replacing the vast numbers of hugely-expensive and ineffective environmental and energy interventions with a fossil-fuel tax applied "upstream" at point of import or production (with compensatory measures to protect industry and the "fuel-poor").

The other main argument against BI is that it will increase the disincentive to work if people have a guaranteed income regardless of whether they are trying to find work or not. But this misunderstands the real impact of the tax and benefits system on incentives to work. It isn't the headline rate that counts, it's the effective rate (the combined effect of tax and benefits, including withdrawal of benefits). And it isn't the gross effective rate that is most important when people are deciding whether it's worth trying to earn an extra pound, but the marginal effective rate (how much of the extra pound they would keep after allowing for changes to tax and benefits payments). Most people aren't happy to live on an income that provides only for the most basic needs of life, if they can find work and it is worth doing. The real disincentives to work are such high rates of benefit-withdrawal (at the bottom end) and income-tax/NI and other deductions (at the top end) that you only keep a small proportion of any extra money you earn. BI+FT would dramatically increase incentives to work, not reduce them.

That's probably a slightly fuller answer than you anticipated, but as you can tell, the perversities of our current tax and benefits system and the advantages of a BI+FT alternative are passions of mine. I hope this shows that a free-market, classical-liberal outlook does not preclude concern for the wellbeing of the less fortunate. In fact, I believe the difference between socialists and classical-liberals is not whether they care, but whether they are interested in solutions that make them feel good about themselves, or solutions that work. My strongest driver in promoting the classical-liberal case is that socialism (which is what we have had for the last 13 years and for much of the twentieth century, regardless of what people might have been fooled into thinking) has been reducing our quality-of-life, destroying our economy, and trapping ever more people in poverty and unemployment. The very things that Labour introduced to try to reduce inequality and poverty are the things that exacerbate it. This reality is only now beginning to dawn on people, and even then, most of the solutions proposed (for example, by the other political parties) are variations on the same theme - Managerialism and Paternalism, Mark II.

There is a better way.