So far, I have been critical of the absence of foundations for the welfare statements to be found in modern economics. In the last part of the paper, I want to be constructive, suggesting how welfare economics can be positively helpful. I have for this purpose taken two issues very relevant to current policy. They are drawn from the EU Structural Indicators cited earlier, but they have wider resonance.
Employment as an objective
I start with the choice of employment as an objective of policy. Why exactly is raising employment, for the whole working age population, or for older workers, an objective of EU policy? It should be stressed that we are concerned here with increasing employment, not with reducing unemployment. The argument for reducing unemployment is much more immediately compelling. Of course, raising employment may well lead to lower unemployment, but it need not do so. The employment rate can be raised by inducing people to stay in the labour force, or to re-enter the labour force. This indeed has been much of the thrust of government policy. Governments in the UK have been trying to end early retirement and to encourage greater participation in the labour force by the disabled and by lone parents.
But there is a prior question that has been little asked. Why do we want to increase employment rates? Why should we want a larger labour force? Here we need to distinguish several different arguments. The first—often advanced in an EU context—is that Europe's labour markets are heavily distorted and discourage work. People's decisions are being tilted against work. They are influenced by taxes and transfers, rather than by the real costs and benefits of working. A classic case is where one member of a couple is receiving an income-tested benefit, so that the partner has little financial incentive to work, since each £1 earned will reduce the transfer received. In this case, the aim is to better align the incentives faced by individuals: to level the playing field. The end is welfare improvement, and increased employment is a byproduct.
However, this is only part of the story. Governments appear to be concerned with more than the distortion of decisions, as is evidenced by the fact that they seem more interested in the total elasticity of labour supply than in the compensated elasticity relevant to welfare measures. Policy is directed not just at the fact that people's choices are tilted but at the actual choices they make. This is particularly apparent when we look at the older end of the age spectrum. When studies of early retirement refer to ‘unused productive capacity’, they are attaching a positive value to work, quite independently of how it is viewed by the worker.
We have therefore to recognize that social decision criteria may be influenced by considerations other than individual welfare levels. Market employment may be an objective in its own right. One way of representing this is to say that employment is a ‘merit good’, like the more usual merits goods such as education or health care. It is of course important to note that it is market employment. If a person aged 63 gives up his or her job so as to look after the grandchildren, then this activity is not counted. Or, as is increasingly likely with four-generation families, the person aged 63 may be looking after their 90-year-old parent. Adoption of the employment rate target tilts the decision away from caring towards staying in the labour force, possibly of course as a paid carer for someone else's parent. But this raises the question as to why unpaid work should not be counted.
There are of course possible answers, but we need to set them out. One such answer may be developed in terms of social exclusion. Here we may see a parallel between the literature on welfare economics and that on the measurement of poverty. The measurement of poverty in the UK has evolved, under the influence of the research of Townsend (1979) and of developments in Sweden and France, from a primary focus on financial resources to a broader concern with the capacity of individuals to participate in society. And we can trace the EU concern with employment back to just such a concern: the 1994 EU White Paper on Growth, Competitiveness, Employment argued that the creation of jobs was necessary to ensure that our children
be able to find hope and motivation in the prospect of participating in economic and social activity. (European Commission, 1994)
As it was put by Burchardt et al., an individual is socially excluded if he or she does not participate in key activities in the society in which he or she lives (Burchardt et al. 2002, p. 30). Employment may quite reasonably be regarded as one of these ‘key activities’.
The employment target may therefore be rationalized in terms of social integration; moreover, we can see why it is market work that is being prioritized. Making explicit such a rationale in my view serves two functions. First, in a democratic society, governments have to persuade members of the society of the legitimacy of the objectives, and the argument has to be made and tested. Second, it allows us to refine the resulting policy conclusions. For example, the socially inclusive nature of employment was justified in terms of young people, and one can see immediately the relevance to the banlieux of Paris, but the application to those aged 55–64 is less immediately apparent. And for young people, we can see that the degree to which employment promotes social integration depends on the quality of the jobs and the extent to which they do indeed offer future prospects.
The move from financial poverty to a broader concept of social exclusion has involved a move from a single-valued indicator to a multidimensional approach, and this, I would argue, is a key feature of moving outside the standard utilitarian welfare economics. In moving from Bentham to Rawls or Sen, we are changing not just the maximand but also the dimensionality. Rawls had a list of primary goods. Capabilities have a number of different domains: Nussbaum (2000), for example, lists ten. Set out schematically, we have a (blank) matrix of people and domains—see Table 2. The standard welfare economic approach is to assume that the domains are reduced to a single number representing individual welfare or utility, and the aggregation issue involves combining these into a single overall level of social welfare, as with the Bergson–Samuelson social welfare function.
Table 2. DIFFERENT FORMS OF AGGREGATION
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|2|| || || |
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This process may be contrasted with that implicitly adopted when formulating the employment objective. Here what we are doing is to aggregate for one domain across individuals: i.e. aggregating first vertically. This, however, misses the correlation across domains. We may reject the utility route, but be concerned about multiple deprivations. We may worry whether it is the same people who lose their jobs at 55 and who have low education and low income. The same applies to my second example, to which I now turn.
Capability and the measurement of economic performance
My second example also relates to the EU Structural Indicators, but it is of wider relevance. Indeed, it may be illustrated by reference to Australia. The 2006 OECD Survey of the Australian Economy concluded that ‘living standards have steadily improved since the beginning of the 1990s' (OECD 2006, p. 3). The evidence cited, however, relates to the growth of national income. Growth in real gross domestic income had averaged over 4% in Australia. I am not questioning this figure, but what is debatable is the equation of the growth in national income (GDP for short) with improvement in living standards.
Here I am making not a purely semantic point, but rather one that goes to the heart of much economic debate. In a number of countries, there is increasing concern among economic policy-makers that we cannot take for granted that there is a direct connection between GDP and the living standards of households or individuals. Improvement in the macroeconomic numbers cannot be assumed to imply commensurate improvements in living standards across the population. As a result, politicians are rightly worried that success in securing economic growth, and raising the employment rate, has not been recognized by the population as a whole (or more crucially by the electorate as a whole). There is a sense among the citizens that their living standards have not risen. This is most obvious in the USA, where has been much questioning as to where the fruits of growth have gone, as ordinary people seem to be no better off than 10 or 20 years ago. In France, there is much concern about ‘le pouvoir d'achat’. Yet in France GDP per capita has been rising: according to the IMF figures, real GDP per head at national prices in 2006 was nearly a fifth higher than in 1996. Even if the growth rate is less than in the past, and less than in the USA, it is still definitely positive, but this macroeconomic performance has not fed through into a sense of improved living standards.
This is causing a reconsideration of the basis for our economic assessment in terms of national accounts. National accounting is, I believe, one of the great social science success stories. The introduction of a systematic framework, broadly comparable across time and across countries, has transformed macroeconomic policy-making. At the same time, the foundations are rooted in a number of compromises. In fact, if one goes back to the origins of modern national accounting in the 1930s and 1940s, then one can see it as emanating from two different streams of economic thought. The first, and the most urgent in policy terms at the time, was the development of macroeconomic management. It was no accident that Keynes was a strong advocate. For this purpose, what was needed were consistent national aggregates—it was very much accounting. The second stream is the expression of the level of national welfare, stemming from the earlier welfare economic tradition developed by Pigou. The title of one of the articles cited earlier by Samuelson was the ‘Evaluation of real national income’, and this article was essentially concerned to provide a welfare economic underpinning to the numbers appearing in the national accounts.
At the time, it was clear that the marriage of these two sets of concerns was to some degree a marriage of convenience. The time has perhaps come for divorce. A number of people have come to the view that we need to construct new indicators of economic and social performance. And new indicators have already been constructed, of which I cite just one—the Human Development Index—chosen because it has been very much influenced by the capability approach. The HDI was introduced in 1990 under the aegis of Amartya Sen and Mahbub ul Haq of Pakistan, and continues in a more refined form to be published by the UN Development Programme in its annual Human Development Report. The HDI is a very reduced form of the capability approach; indeed, Sen has described it as a ‘vulgar’ measure. At the same time, he has noted that it is of the ‘same level of crudeness as GNP’ (Sen 1999, p. 318, n. 41). Moreover, it is a concrete implementation of an alternative approach to the underlying concept of wellbeing.
The HDI has three main domains, slightly different from those used before. Countries are ranked on each of these three domains. The UK ranks 18th equal on life expectancy, 16th on education and 10th on GDP per capita. And then the domains are aggregated into the HDI. The UK is 16th overall, between Austria and Belgium. We are above Germany and below France. But what I am interested in is the procedure. What do capabilities bring to the party? Obviously they extend the dimensionality. This is perhaps the most important part, but the HDI also changes the way in which income is introduced. The index is based not on GDP per capita but on its logarithm. Why is this? According to the UNDP website, ‘the HDI uses the logarithm of income, to reflect the diminishing importance of income with increasing GDP’ (UNDP website, 2008). Or, as put when the index was first published, there are ‘diminishing returns to transforming income into human capabilities’ (UNDP 1990, p. 12).
But if there are diminishing returns, this applies at the individual level, not to the aggregate national income. This means that the appropriate procedure is not that used in the HDI but to take the logarithm of income at the individual level and then aggregate. In other words, we want to take not the logarithm of mean national income but the logarithm of the geometric mean. Unless all incomes are equal, the geometric mean is less than the arithmetic mean, reflecting the reduced rate at which income is transformed into capabilities as income rises. Taking the alternative approach seriously suggests, then, that we should assess economic performance by the geometric mean of incomes,6 not by the arithmetic mean as in the national accounts. This seems a very modest change, but it leads us to take a rather different view of recent growth performance, as is illustrated in Figure 2 for the case of the USA. As we know, overall household income has grown in the USA, particularly since 1990: from 1990 to 2006, the mean household income grew by a fifth. The geometric mean, on the other hand, grew more slowly. Over the period as a whole, it grew around 0.5% per annum more slowly than arithmetic mean income. This is a large amount: about equal to the difference in growth rate between the USA and the UK in the past decade. And in the most recent period, the geometric mean rose in the Clinton years and fell in the Bush years, leaving the 2006 figure scarcely higher than in 1990.
Figure 2. Two different perspectives of the growth of the US economy. Source: US Census Bureau: Income, poverty, and health insurance coverage in the United States: 2006, Table A-3.
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