Saturday, May 19, 2012

No Jobs. No Hope. No Cash.

Executive Summary
As more people are pushed to the margins, society will increasingly be pressured to address inequality. But competition with emerging countries and the rapidly approaching limits of the environment will also force us to improve efficiency. In economics, equality and efficiency almost never go hand-in-hand. But in this case, our pursuit of efficiency will only be granted - and made more palatable - by the promise of greater equity. 
·         Income inequality has been driven by the automation of the production process and the outsourcing of jobs to emerging countries.
·         This trend will continue due to political and economic developments, which will lead to greater inequality in the future. 
·         Governments will have to respond to maintain social cohesion, alleviate burdens for low income individuals and to increase efficiency.
·         The progressivity of the tax system will need to be increase with greater burdens on the rich but this needs to be done in concert with other global economies.
·         The tax system must become more redistributive by transferring more income from the rich to the poor. 
o   A negative income tax system should be researched and, if beneficial, implemented.
·         Government must reduce its footprint except for services that exhibit clear market and individual failure, externalities and economies of scale. Privatized services would increase welfare for people, rich and poor, by allowing individual choice, competition and innovation (which would increase efficiency and effectiveness).
·         The strengthened tax system must take into account and address the effects on equity from the reduction of government services. 
·         Government will become an organization that facilitates fair and efficient delivery of services and satisfactory of basic needs rather than the primary delivery agent.
o   It can help do this by researching, pin-pointing and imposing taxes on products and services emitting externalities, which would help alleviate individual failures in decision making.
o   It must continually monitor the impacts on equity from new economic and social trends, and, if necessary, act to address them.
o   It must continue to deliver services that exhibit clear market failure such as roads, policing, defence and maintain a basic social safety net.
Note: This is an evolving draft paper, published just for preliminary comments on the thesis (which are all welcome).


It's hard being funny - even harder while surrounded by so much despair. But one could find humour not only in the crafty signs found at protests (and being funny, I guess is easy when one haven't much to do) but also in absurdities of the situation that brought protesters there. Many view that the gains in income inequalities since the near extinction of the aristocratic class is slowly being reversed. They are doing double takes at the political and economic forces that are unwinding the progress made in creating equal, fair and prosperous communities since the post-war period.

They have a point...

Figure 1: Income Inequality has Increased in Canada

Source: Statistics Canada.   Table   202-0705 -  Gini coefficients of market, total and after-tax income, by economic family type, annual (number),  CANSIM (database). 
Note: Figure represents the Gini coefficient for market income. After-tax income would reduce income inequality substantially because redistribution but was not used to demonstrate inequality before government intervention.
Income inequality has markedly increased since the 1970s, particularly in the era of austerity of the 1990s (Figure 1). Greater inequality has been blamed on a combination of:
·         Globalization which facilitated greater competition from emerging countries; and
·         Advances in technologies which, combined with the previous factor, increased automation in manufacturing and services industries.
In other words,  relatively well-paying jobs that required lower levels of skills have been outsourced to emerging countries where the same level of production could be sustained at lower costs. Companies have also discovered that routine jobs could be better handled by less demanding and error-prone machines. Generally, low-skilled labour is becoming obsolete. 
Seriously, this is what it used to take to make photocopies. 
New technologies help us produce more with less. Outsourcing helps lift other countries out of poverty. To most economists, these trends are not sources of problems but are rather solutions. But economists view and judge based on impacts on aggregates. In the real world, impacts on individuals matter. Economically, switching to more efficient methods and locations increases societal benefits. Personally, if you lose your job then to hell with society.

...Fairness matters...

Societies must be fair for individuals to participate in society. Those who choose not to work due to egregious inequities only exhibit a psychological trait common to us all. Experiments show that children who are untreated unfairly will hold back payouts for their partners even at a cost to themselves. It seems that the desire for fairness and the backlash when we are mistreated is primal in us all. So when irritated people ask why won't protesters just return to work. Well "Forbear to judge, for we are sinners all."
Even dogs understand fairness
Poverty breeds social ills. Extreme envy and dire need are hand-in-hand with criminality. Poverty is also an obstruction to education because low-income individuals have less opportunities to fulfill their potential. Greater education would not only reduce crime but also enhance health. Better nutrition, resulting from better education and more resources, could benefit the health of individuals over the course of their lifetime. Physical activity also increases along with income in addition to mental health. 

Figure 2: Low Income People Visit Doctors More Often

Source: Statistics Canada. Canadian Community Health Survey (2009-10) Public-Use Microfile

...But so does efficiency.

The evolution of industry is led by innovation that allows workers to produce more with less. In the modern era, this has meant assembly lines, circuit boards, robotics and now 3D printers. The automation of the production process leads to leaps in efficiency which will increasingly be important as our scarce resources become even scarcer. We face increasing constraints on how much we extract from the Earth; we have to ensure that we produce with as little waste as possible. The future is geared towards more automation.

Figure 3: The Manufacturing Sector in Canada is Increasingly Driven by Machinery

Source: Statistics Canada. Table 381-0013 - Inputs and outputs, by industry and commodity, S-level aggregation and North American Industry Classification System (NAICS), annual (dollars), CANSIM (database).
As more of the production process is captured by capital (machinery), labour is freed for more productive activities. Rather than participating in repetitive and routine processes, people could advance towards designing products and maintaining machinery. Theoretically, the higher that labour is elevated in the value-added process, the more income they receive.
Throwing a wrench in the works is the stubborn and persistent barriers to education to low-income families. The participation in postsecondary education is closely tied with parental income but not solely due to financial barriers. Rather, participation is mainly dictated by the culture at home and in the neighbourhood. Parents of low-income families place lower value on tertiary education and less pressure on their children. Kids from low-income neighbourhoods are exposed to friends that may tend to mock rather than embrace education. These cultural barriers are far tougher to break than financial barriers.
Since low-income families face barriers to education and are unable to compete for higher value-added jobs, labour shortages will become worse which propels the wages of skilled and high-income earners even further. Investors, a class of income earners who have savings (ie. not poor), will receive an increasingly greater share of the production process. Everybody else will fall behind. Income inequities will increase further.

The rich man's burden...

From the world's richest man to the poor men of the world, people have been pushing for more taxes on the rich by calling high-income earners to pay their "fair share". Warren Buffet famously said that his secretary pays more in taxes than him. People ask where is their bailout after the rescue of corporations. The 99 demands fairness from the 1. The principle behind this movement may be right despite some facts and arguments being so wrong.
Warren Buffet claims that he pays 17 per cent tax, half of his secretary. True but this disingenuously omit the 35 per cent implicit tax he pays on his corporate profits (he doesn't pay all of this because capital gains get taxed less than other income but I'm not looking this up). Corporations were rescued in 2008 and 2009, which in the end turned out to be loans because much was paid back. People neglect to consider billions in social assistance payments a year when they ask where are their bail outs. In fact, government is a large redistributive machine. The rich pays more into the system than they receive back in transfers and services. The poor pays less and get more. How about that for a bail out? How about that for fair share?

...Should become a bit heavier.

Money and value are not necessarily the same thing. Money is a human creation. We place a number on a piece of paper, and before that, a piece of metal, to guesstimate its value for an individual. Well, a penny a few decades ago could buy you a piece of candy. A penny today isn't even worth a penny (seriously, it takes 11 cents to print one which is why they're being phased out). More importantly, ten dollars for you isn't worth the same as ten dollars for a millionaire. Money, like everything else, exhibit diminishing marginal returns [More on this topic later]. The more you have, the less its valued. 
The lesson is that the rich have more and so for a given amount of money, it is valued less to them than to the poor. We know that the rich pays more into the system than the poor and I am of the view that they pay more than their fair share. I disingenuously measured it in cash terms but only because I don't know how to measure it in personal value. If a person makes over a million dollars and contributes at the highest tax brackets at 50 per cent, how much value does this person lose compared to a 30 per cent tax for a person making $70,000? I can't answer this but I assume less for the sake of the rest of the argument.
Diminishing returns also affect other things: food, medical services, education, etc. A rich person consuming copious amounts of resources not only gets less value for it than a poor person without those luxuries, but the rich will also incite envy which adversely affects them. For the altruistic motive of equalizing values across individuals and the selfish motive of survival, the rich has the responsibility, incentive and capacity to pay more.

Tax man by day? Robin Hood by night?

People hate taxes. In fact, the United States of America was founded on the refusal to pay taxes. Everybody hates them equally but the rich have more avenues to avoid them. In high demand in any country of the world are high income earners, rich in skills and assets. This means that increases in the progressivity of the tax system cannot happen in any lone country. It  must be done in concert with others but the public discourse has finally shifted which opens a window of opportunity (in now small part to those on the streets, voluntarily or otherwise).
Through the tax system lays the opportunity for redistribution but not only by bringing down the rich but also by pulling up the poor. The tax system already funnels money to low income individuals through an array tax credits such as the Universal Child Care Benefit and the HST/GST rebates.
But perhaps the greatest redistributive tool within the income tax system is the negative income tax which guarantees every citizen a minimum amount of cash. This designated income floor is clawed back as people earn more. Designed properly, the added benefits to society from lower hospitalization, crime and social cohesion more than makes up the loss to labour supply from free money.
So potent and efficient can the income tax system be at redistribution that it allows us to re-examine the delivery of public services without the anchor of equity considerations. In other words, because the tax system could be rejigged to counter any subsequent effects to equity, we can now have an adult and emotion-free conversation on the efficiency of public services - a conversation that is overdue and needs to happen.

Saving the Sinking Ship of State...

Government is inefficient at most things and ineffective at some and yet we demand that government step in at the sight of any problem. The inefficiency and ineffectiveness isn't solely because of incompetent public services and venal politicians. Rather, many of governments' problems are due to its leviathan size, and impossible and conflicting tasks. 
We expect government to solve most of our problems. But as organizations become larger, they become less effective. Specializations become generalization and the quality of each public service is slightly diluted. Accountability becomes more difficult because the organization becomes more complex. Responding to emerging trends becomes slower because there is more to consider and more conflicting issues to reconcile. This large and slow behemoth, disincentivized to compete with itself, becomes slower in adopting new technologies and ideas. The delivery of services become outdated and inefficient. The public dollar becomes ever increasingly wasted.
Furthermore, government is expected to serve everybody but is criticized when the service isn't catered to somebody. People are different - but centrally provided services are always pressured to be similar. Education is pressured to be uniform although people have different learning styles. Health care is pressured to be similar although people have different preferences on treatment. By not catering to individual preferences, a lot of potential satisfaction is uncaptured.

... By Dumping Excess Cargo, Plugging Leaks, Providing Life Rafts...

You can't please everybody - but you can come closer. The more choices people have, the better they are able to pick what suits them best. Benefits from individual choice could be huge but government face natural barriers to catering its services. The market, being made up of millions of small and nimble individual organizations that could quickly be bred and die, is more capable of catering to individual needs and responding to emerging trends. A business must to respond to demand from people else people will demand it elsewhere.
This competition for business not only benefits people by catering to their needs but by reducing unit costs. Competition generally breeds innovation which reduces waste and cost. The parts that make up government generally do not compete because they have monopolies over their responsibility and because they respond to a central hierarchy. Without competition, the processes in government are slow and wasteful.
On the other hand, competition also brings waste. The more products and more organizations that exists reduces savings from bulk purchases and mass production. These economies of scale have brought us cheap generic drugs, and quick cataract surgery and are best provided by government (the desire for scale is also a reason for the lack of responsiveness).
And the benefits from individual choice may be large for the individual but sometimes not for society. Given their own choice and the market price in each product, people would elect to under consume education, over indulge in tobacco and not produce infrastructure at all. That's because people would pay for education up to the point where they value the job they get from that higher education and not a dollar more for the benefits to society and democracy. People would decide to smoke for all the benefits that accrue to them now without any consideration for the cost to them in the future not to mention to those around them. Lastly, people, operating in committee, will never agree to appropriate and demolish a strip of residence to put a road through there so that the majority would benefit. Externalities exist and only government can effectively address them.

Figure 4: The Balance

So in the end, these opposing forces must be weighed against each other for individual government services (as well as those currently being provided by the market). When resources are becoming scarcer and the demand for goods, luxuries and necessities, are ever increasing, we have to find better ways of using the resources that we have.

... And steering in a new direction.

Who is we? Well, government of course and the people too. This dialogue over which services to be decentralized (or nationalized) should be held publicly but can only be done with the help of the bureaucracy. The public service is a giant information generating machine with legions of analysts, economist and talented decision makers. As government moves from an organization that directly provides public services to one that facilitates an environment where a fair and prosperous society can thrive, the government is required more than ever to become the final mediator, inspector, judge and aid-worker. 
As more services are transferred to the market, government must reinforce its role as a regulator to ensure that monopolies do not emerge to drive up costs, risks are not irrationally taken and public safety is not endangered. The government must be ready to take a stand in disputes that will emerge between competing organizations, and that rules are made clear and are obeyed.
Furthermore, government can continually observe, research and rectify flaws in individuals' decision making. Tobacco, alcohol, marijuana and carbon are taxed to reflect their true societal cost. Education, physical activities and culture subsidized to reflect their true societal benefits. In other words, government can use its powers to price-in externalities into individuals' decisions.
But, one of the most important roles of government should be jealously guarded and obediently performed. Government must continually observe changes in equity (both because of its decisions, and other societal, economic and political forces) and address it through its tax system. Now and in the future, equity will be increasingly challenged and government must be a central player in the defense of fairness. The tax system, through higher progressivity of income taxes and larger payments to low-income individuals, is a potent device to solve inequality.
This scale also likely tilts towards government for education. People having different learning styles and the sector could surely be improved from more innovation and competition but education is too key of a sector to decentralized. Education is a key indication of individuals' future success and driver of inter-generational mobility. One could argue that this very-public service should be subsidized (perhaps to even the fullest of extent) but only if it is mandatory for all.

Far too many are living in rags in our world of riches. 

As more people are pushed to the margins, society will increasingly be pressured to address inequality. But competition with emerging countries and the rapidly approaching limits of the environment will also force us to improve efficiency. In economics, equality and efficiency almost never go hand-in-hand. But in this case, our pursuit of efficiency will only be granted - and made more palatable - by the promise of greater equity. 


I've been some very bold assertions in this article and I hope to back them up soon with subsequent, separate and more detailed posts. 


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