Henry and Kant: outsourcing morality

Many might remember the way in which France qualified for the last World Cup. The equalizing goal  (which was enough for France to qualify) was scored because Thierry Henry, perhaps the most famous player on the French national team, kept by hand the ball from going off the pitch, brought it back and it was then easily tapped (by foot) it into the net. The reactions were fierce: from protests of the Irish players in the field, to the disagreements between the Irish and French politicians and requests for a replay. At the end, the Irish Football Association applied that, exceptionally, Ireland be included in the World Cup. Of course it all ended as such things usually end, the goal stood and Ireland stayed home.

But what I found interesting  in this story is not soccer but the role of morality and the institutions. The common defense of Henry’s act was as follows: sure, handball is a violation of soccer rules, but it is no different from a professional foul, or simulations to force a penalty kick. In every soccer game players try to use these tricks in order to win. To quote José Mourinho's famous words: to win is my job. So, the defense of Henry went on: it is the task of the referee, that is of institutions, to catch him, prevent them from breaking the rules and eventually to punish him. Hence Henry’s handball is not his problem (everybody would do the same), but the problem of inefficient institutions. Either the referees were not up to the task or soccer should improve its institutions, for example by the introducing more referees or by the use of video recordings.

Now I would like the reader to forget that we are talking about soccer. Consider it more generally.  Henry’s defense implies that  in life everything is allowed in order to achieve one’s objective,  and one should not feel at all bad or dishonest for doing it.  Institutions ought to prevent the achievement of such goals by illegal means. If I am a trader on Wall Street, my objective is to make money, by whatever means I can. It is the role of institutions to stop me. If they failed and the financial crisis happened, it is because they were badly designed. The entire moral order of society is outsourced, away from individuals and their internal controls to  institutions. We do not expect ourselves to be moral and behave fairly. It is not our duty: it is the duty of society to provide good institutions which would  punish those who steal and lie, and to create a good system of incentives which would reward those who contribute to society through their work, capital or inventiveness.

This position is close to the heart  of many economists. If the institutions and the system of incentives are well “calibrated", the society will move forward because misconduct will be  punished and good behavior rewarded. This will come about because each of us is a rational and profit-seeking individual and will follow own interests. The institutions will ideally “channel” our passions and interests so well that we shall, as “if led by an invisible hand”, be doing the things that are both in our own and social interest.

But is the improvement of institution, that is purely external control of human behavior with an implicit assumption that human nature obeys no rules unless it is punished, really enough to force people to behave morally? Returning to Henry’s handball, should our objective be only to improve the quality of refereeing or to introduce cameras, or should our objective be that the rules are  “internalized” so that people act in accordance with moral requirements regardless of whether they are expedient or not? Even if all other players are playing by hand and thus steal goals, we know that such behavior is immoral, and we shall not resort to it, regardless of  consequences.  But how can one convince people to apply internal breaks in a hyper-competitive capitalist society that rewards only success? Even when they start by behaving morally, would not the behavior of those who behave otherwise and who, behaving thus, become rich and successful, lead the first group also to lose their scruples?

It seems to me that with ever greater commercialization, globalization and the use of money as the sole criterion of success, we have gone further and further away from any attempt to impose internal control and have entirely outsourced it to institutions.  Perhaps it is inevitable because all previous attempts to do it internally, thorough religion or secular religion (like in socialism) have failed either because they led to endless wars (“my religion is better than yours”) or were incompatible with human nature (fall of socialism). So I have no answer to the “outsourcing” of morality. I see it as inevitable although I cannot say that I enjoy that prospect. Being an economist, I cannot even see exactly why I should not enjoy it, but I still do not.

After all, Thierry might have done the right thing. We shall get cameras and another handball will not happen. But something else will.

Was everybody under socialism a millionaire?

There was a couple of months ago a lively discussion on the measurement of wealth. It started with two results. First, Ed Wolff’s long-standing (but not widely publicized) results that the Gini for wealth inequality in the United States has reached an unprecedented high value of 87, and that some 30% of the population have zero net assets. Second, by a comparison made by Oxfam between the wealth of the top 1% vs. the wealth of the rest. Oxfam argued, using the Credit Suisse report on global wealth, that the top 1% in the world own almost one-half of global wealth. Some of those wealth-poor are people from rich countries who have no assets even if their income is obviously not zero, nor can they be considered globally or otherwise poor. Actually, many of them might lead relatively comfortable lives, even if they are running credit-card debts and living in homes that are almost 100% owned by the banks.

So, those who did not like either Ed Wolff’s results nor Oxfam’s comparisons went ballistic on what they termed “Oxfam misleading statistics”: “Look, these guys might have zero net assets, but they are not poor”, the critics argued. The argument was factually correct, but substantively wrong simply because there is a difference between income, consumption and wealth. You may be wealth-poor even if you live okay; these are two different things. I wrote about that on my blog.

But there was also another strand of attacks on these numbers that wanted to show them incomplete because the wealth definition used in standard wealth studies like the ones quoted here is the sum total of all marketable assets,  that is consumer durables, housing, shares, bonds, checking and savings deposits, patent right etc. that  you can sell right now. It does not include future, more or less secure claims on (say) Social security benefits, occupational pensions, medical help and the like. (Although Ed Wolff  does include the cash surrender value of pension plans.) Now, people who wanted these benefits to be added (in the amount of  their capitalized values) did so in order to argue that the top 1% are not as rich in relative terms as Oxfam and Credit Suisse claimed, and that it is not true that 30% of Americans have zero net assets. Indeed, if you include Medicaid, Social Security and welfare practically nobody in the US will come out as having zero net assets. It is also true that, if you do an international  comparison of the US with other wealthy countries, the inclusion of such future claims will make US wealth levels and distribution look even worse (because other rich countries generally have more developed social welfare systems), but those who argued for the change in the way wealth is defined, did not, at that point, think much about international comparisons.

However, you cannot do things in isolation, and ignore both the general rules about how private wealth is defined and how the definitions can be applied across various societies. Let me illustrate this. In a conversation over lunch, Ed Wolff and I concluded that private marketable wealth in Communist countries was, for most of the population, zero. How come? First, housing was mostly state- or enterprise-owned (in urban areas), and people who lived in these apartments paid low rent, but did not own them nor could they sell them. Second, there were no financial instruments of any kind: there was no stock market and no shares. There were, in some countries state bonds but they were less of an investment and rather a compulsory borrowing by the state. But the state bonds were minimal in any case. Third, the only asset that existed was savings in domestic or (even if it was illegal in many countries) foreign currencies. That was in reality the only financial asset. (And this is incidentally why people in the West did not sufficiently appreciate the pillage which the Yeltsin’s regime engaged in when it destroyed overnight the years of ruble savings by millions of households.)

Most of the private marketable wealth that existed was in the countryside. In countries like Poland and Yugoslavia, land was mostly private. In addition, urban residents owned their own weekend houses (the famous Russian dachas) and they were indeed privately-owned and marketable.  In addition there were owners of small-scale restaurants, bars, repair shops etc. Thus Ed Wolff and I agreed that if you applied the usual marketable wealth approach to Communist countries you would find that perhaps 80% of the population, or even 90% in the Soviet republics, had zero or wholly negligible net wealth, and 20% (or 10%) had some rather minimal wealth, and these 10-20% were not exactly the people you would associate with high incomes and certainly not with political power under socialism. Obviously, this did not mean that 80-90% of people lived on the edge of subsistence: actually most of them had “normal” middle-class urban lives. It is just that they had no private wealth.

But then I thought a bit more on this issue as I read the critics who wanted to include capitalized value of social security among private wealth. So, I said, let me see what their approach would give you for socialist countries. There first, you had guaranteed pensions for all. So, let’s capitalize that. Then, you had guaranteed jobs for almost all. Let’s capitalized that income too. You had guaranteed other social transfers like child benefits, invalidity pensions and of course free medical care. And although pensions and wages were small in dollar amounts, their capitalization produces a rather big total. Let me take the example of Yugoslavia that I know well. In the early 1980s, the average salary was about 250 dollars per month (post-tax). The average pension was about $200 per month (also post tax). That gives you about $3,000 annually for wages and $2,400 for pensions. In today’s dollars, it works out as $9,000 and $7,200 per year. Suppose then, very roughly, that wages are guaranteed for 30 years and pensions for 20 years. When you apply to the wages and pensions a low discount rate of say, 2% you get that total wealth of almost everybody was $300,000 dollars. Throw in additional medical costs that were also borne by the state and guaranteed to more or less all, and you may get to $400,000 or even to half-a-million US dollars.

So, would then those who argue that US wealth data should include capitalized value of not-marketable, but guaranteed, future incomes streams agree that everybody in socialism was a dollar (half-a-)millionaire and that perhaps two-thirds of the population in Yugoslavia, Hungary or Poland had greater private net assets than the corresponding people in the United States? Does this make sense? If it does not, then you are back to the “usual” calculations where only marketable wealth counts and where 30% of US population have zero wealth. So, you can choose:

1. Either everybody in socialism was a quasi-millionaire,  or
2. 30% of Americans have zero net wealth today.

Your call.

Bob Solow on rents and decoupling of productivity and wages

Atypical or difficult to explain movements in capital/labor ratio, productivity per worker and real wages have stimulated recent attempts to square the facts with neoclassical economics, make some adjustments in the neoclassical paradigm, or scrap it altogether.  I have already written here about Stiglitz’s recent focus on the difference between K (productive capital) and W (monetary wealth) as one way whereby increasing wealth/output ratios, emphasized by Piketty, can be made compatible with stagnant wages.

Bob Solow explored a couple of days ago another possibility. Going back to his own seminal work on the theory of growth, some 60 years ago, Solow asked the following question: why did we assume that there is perfect competition and that factors are paid their perfect competition marginal products? We knew, continued Solow, that there were monopolies; moreover, the theory of imperfect competition (Edward Chamberlin and Joan Robinson) existed since the 1930s. Solow said: “I could not find a good reason, but since theory and facts were broadly in accord, nobody bothered much with the assumptions”. That is, until recently. How can we explain, continued Solow, a sustained and significant divergence between non-farm sector productivity and real wage? Despite some quibbles about the measurement of the two, there is no doubt that  they have diverged. But that goes against everything we thought we knew! (I am paraphrasing Solow here.)

However, if you assume a model of imperfect competition, where in addition to labor and capital, there is also a rent (due to the fact that price is greater than the marginal revenue product), the issue becomes: how is that rent going to be distributed between labor and capital? And until the early 1980, due to trade union power (“The treaty of Detroit”), relative shortage of labor, trilateral (government-capital-labor) negotiations etc., the rent was divided in a way that favored labor. But with the decline of the unions, ideological assault on labor (the Reagan revolution) and a huge expansion of available wage-labor worldwide (as China and Eastern Europe rejoined the world economy),  the bargaining power of labor waned and that of capital increased. Consequently, the share of capital in national income increased, and productivity growth got decoupled from real wage growth.

This is my interpretation of Solow’s talk. There is  no paper yet, and, just to emphasize, I might have gotten something wrong. Or Solow might introduce some changes in his model. 

 What I find interesting here is a “marriage” between a standard neoclassical view of how income shares of capital and labor are determined (because even if they are determined in a kind of a monopolistic competition, this is still handled by the neoclassical production function), and the distribution of the rent that responds only in part to economic, and mostly to political factors. Readers will remember that the latter was an old idea, going back to neo-Ricardians who simply argued that the distribution between w and r can take place at any point along the w-r frontier: it is entirely politically determined. In Solow’s view, the determination of what share of the rent goes to labor and what to capital is not solely political. It depends also on their relative scarcities (or put it the other way, on "the reserve army of the unemployed"). But political factors do play a role too: power of trade unions, ideology, who controls the government, probably fear or not of a social revolution etc. So, as these  political factors have moved in a direction adverse for labor, the division of the pie has become more favorable to capital.

It is a nice story, and I like that it seems realistic in its combination of purely economic analysis with real-world politics. It needs to be obviously, fleshed out. Solow was surprised by lack of empirical knowledge among economists of the price mark-ups in different industries (mark-ups are an indication of the existence of rents). Apparently, it is not much studied empirically.  If, as Solow said, we come up with an estimate that (say) 20-30% of national income is rent, then surely political factors can explain why capital's share is up. If our estimate of rent is 2-3% of national income, then this is not a very promising story. So, it is back to the empirics!—a nice theory to test where many a young economist can hope to make a difference and become famous. Perhaps, who knows, as much as Solow has!