Friday, November 16, 2018

How Adam Smith proposed to have his cake and eat it too

It is this deception which rouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe, have turned the rude forests of nature into agreeable and fertile plains, and made the trackless and barren ocean a new fund of subsistence, and the great high road of communication to the different nations of the earth… It is to no purpose, that the proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest that grows upon them. The homely and vulgar proverb, that the eye is larger than the belly, never was more fully verified than with regard to him. The capacity of his stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant. The rest he is obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets, which are employed in the oeconomy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity or his justice. The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining. The rich only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species. When Providence divided the earth among a few lordly masters, it neither forgot nor abandoned those who seemed to have been left out in the partition. These last too enjoy their share of all that it produces. In what constitutes the real happiness of human life, they are in no respect inferior to those who would seem so much above them. In ease of body and peace of mind, all the different ranks of life are nearly upon a level, and the beggar, who suns himself by the side of the highway, possesses that security which kings are fighting for. (emphasis mine)

Who has not read this long, and famous, paragraph in Smith’s “Theory of Moral Sentiments”, and been left absolutely speechless? Not only because it is the first (of only three) mentions of the invisible hand, but because after the most eloquent critique and even ridicule piled upon the rich landlords, it ends with a Panglossian conclusion that everything, in this world of inequity, is actually done in the best possible manner. Who, but the most stone-hearted writer, would seriously aspire to defend a distribution of whose injustice he is so aware and critical, and to do this by using the threadbare excuse that the rich really overestimate the worth of their wealth and comforts, and that the poor, “sun[ing]…by the side of the  highway” may be as happy as the rich? It seems so presumptuous a statement that our facilities of reacting to it appear, for a moment, to have been stunted.

David Wootton in a new book “Power, Pleasureand Profit: Insatiable Appetites from Machiavelli to Madison“ opens his chapter dedicated to Smith with this long quote. He relates it to the discussion (of which I wrote here) about the two Adam Smiths, the one of the TMS (a moralist) and another of the WoN (a realist). Wootton argues that Smith’s introduction of  self-delusion among the rich is crucial to downgrade the moral significance of acquisition of wealth. Smith needs people to believe that wealth will give them happiness so that they work hard, take risks, and invest, and thus make us all better off as the society gets wealthier. But he also needs self-delusion to make sure that there is equality in the space of happiness, in other words that the rich never attain the happiness after which they strive.  

The self-delusion is thus the key link that ensures that there is no trade-off between growth and equity. Self-delusion acts as a deflator of all actual wealth: yes, I have a big house, but if I use a delusion deflator of 100, the happiness that it gives me makes it feel like a hut. The social order  which produces such inequitable outcomes in the space of actual incomes and wealth, is not impugned: actually existing inequality is immaterial.

But did not Smith really delude himself about that delusion? Wootton writes: “Thus Smith failed to acknowledge the amorality of market forces…He failed to recognize that speculators and gamblers, thieves and fraudsters often flourished while people of industry, prudence, and circumspection were broken by forces outside their control” (p. 279).

Had Smith accepted that amoral and often immoral ways in which wealth is acquired (mentioned in innumerable examples in his two books) can lead to greater happiness of those who engage in such acts, he would have validated the rationality of such behavior.  A commercial society could be seen  not only as producing a visible hierarchy in which fraudsters are on the top but allowing them to live happier lives than the rest. How could then such a society be morally justified? Religion came with the answer that such riches are ephemeral: the real riches lie beyond. For Smith, the delusion does the job: it comes in to erase the importance of undeserved gains. Adam Smith can have his cake and eat it.

I do not think that anyone would have defended this point of view today because it relies on something that is manifestly false: the argument that higher income or wealth do not (at a given point in time and in a given society) lead to greater happiness. This opposite is true empirically (as the studies on happiness show), and it is revealed in our daily behavior through permanent striving for more. Thus the argument which denies the relevance of massive inequality in the distribution of “earthy” goods by minimizing their importance—or by claiming that in the end, we would all be dead—is indeed one of the most brazenly dishonest arguments. For if the authors of this kind of arguments seriously believed them, they should have nothing against the poor and the rich changing places. But they have seldom proposed to proceed to such a swap.

Monday, November 12, 2018

What is happening with global inequality?

With domestic inequalities and “populism” taking center stage, the changes in global income inequality have understandably moved out of the focus. My access to the data—many of them still best obtained from the World Bank especially for poorer countries not covered by LIS—has also diminished since I left the World Bank. But one can still put together a quick update (thanks also to the contribution by Christoph Lakner) that covers the period up to 2013. One small technical point is worth making at the outset. When one compares, as I will do here, 2013 results with the past, going back to 1988, one faces the following choice: either (1) to use the best 2000-2013 numbers which are all based on detailed micro data and 100 percentiles of the population from each country, plus better income data from India, or (2) to compress these numbers into country-deciles to make them more comparable with the 1988 data (when indeed we had much less detailed information with many fewer fractiles). I decided here to go with the solution No. 2—but if I were to compare a more recent period only (say, after 2000), I would have preferred to use No. 1.

Do household survey data track reasonably well what we know from National Accounts? The answer is yes. The Figure below shows the average annual  global growth rates of GDP per capita and mean income from household surveys over five-year periods, all expressed in 2011 international dollars. The two blue lines move together reaching both the peak growth of about 3% per capita per annum (pc; pa) in the period prior to the Global Financial Crisis before dropping to only 1% pc pa in the next five years.  


But the striking and important thing is what we cannot see from National Accounts but can see from household surveys: the dramatic increase in the global median income (income at the 50th global percentile). This positional income which reflects high growth rates of the relatively poor populations in Asia (China, India, Vietnam, Indonesia etc.) has throughout the past 25 years always increased faster than the global mean income, and in the most recent period (2008-13) the gap between the median and mean growth has soared: the median income went up by an average rate of 6% pc pa while the mean income grew by only 1%.

The shrinkage of the distance between the mean and the median is often taken as an indicator of reduced inequality (for asymmetric distributions). And this is indeed the case here. In 1988, the mean per capita income of the world was just over $PPP 4000 and the median just over $PPP 1000; a quarter-century later, these amounts were respectively $PPP 5500 and $PPP 2200. So the mean-to-median ratio has decreased from 4-1 to 2.5-1. The global Gini coefficient went down from 0.69 to 0.62; the global Theil index from 0.92 to 0.73. Most of the decline took place in the last five-year period. By 2008, the global Gini was 0.67, just slightly below its value at the time of the fall of the Berlin Wall. What happened after 2008 was the slowdown or negative growth of rich countries and continued fast growth of Asia, combined with the absence of further within-national increases in income inequality in big countries like China, Russia, UK and Brazil. Even in the United States, income inequality went down as the result of the shock to highest incomes during the crisis, before shooting back again after 2013 (the period not covered here though).

Does this mean that everything is fine? Not really. Measures of inequality such as the mean-to-median ratio or the top 1% share are fragmentary: they take into account only what is happening at two points of the distribution. Synthetic measures like the Gini are, in that sense, better (because they take into account the entire distribution) but they compress all that information into one number. To get a better sense of what is happening we want to look at various parts of the distribution and at various measures.

Let me give two examples. The growth of the median, which is, as we have just seen, a very good and encouraging development, has its other facet: it leaves behind those below the median whose incomes do not grow as fast as the median. If we take, for example, the income level equal to ½ of the median, which is often used as a measure of relative poverty or inequality, then we note that the number of people below that income level has increased by 300 million and the percentage of the global population falling short of ½ of the median has barely changed (see Figure below). It used to be 28% of the world population in 1998, it is 26% now.

The share of income received by the global 1% has also, despite the shrinkage of global inequality, remained unchanged. In 1988, its share was 11.3%; it then increased to around 13.5% in 2003 and 2008 before going back to 11% as the crisis struck the rich economies which “supply” most of the people in the global top 1%. Given that we are probably missing an increasing number of the super-rich or that they are hiding their assets more than in the past, it is very likely that the true share of the top 1% has even increased.

We thus have only apparently paradoxical developments over the past 25 years: on the one hand, strongly rising global median income and the shrinkage of global inequality when measured by the synthetic indicators like the Gini or Theil; but, on the other hand, the rising share of the global top 1% and increasing number of people in relative poverty (mostly in Africa).  The last point opens up again the vexed question of lack of convergence of Africa and its growing falling behind Asia (and of course the rest of the world).

So, is the world becoming better, as Bill Gates wants us to believe? Yes, in many ways, it is: the mean income in 2013 is almost 40% higher than in 1988, and global inequality is less. But is there a bad news too? Yes: the same share of the world population is being left behind and the top 1% are getting ever further away and richer than everybody else. So, we have, at the same time, the growth of the global “median” class and an increase in world-wide polarization.