Outline of Topics A Troubled Marriage: Microeconomics & Macroeconomics Gross National Product GNP and Total Welfare Defensive Expenditures and Natural Capital Depletion Sustainable Income Alternative Measures of Welfare: MEW and ISEW Beyond Consumption-Based Indicators of Welfare Relative Wealth and Well-Being Human Needs and Welfare Max-Neef’s Matrix of Human Needs Joseph Stiglitz (Nobel Prize Econ btw) : Adam Smith’s “Invisible Hand” is a Myth I love the Yogi Berra quotes: We may be lost but we’re making great time?
Summarizing Ideas Microeconomics focuses on Markets and avoids policy prescriptions. The Microeconomic prescription is usually – laissez faire or ‘let the magic of the marketplace do its thing’. Macroeconomics looks at the economy as a whole. Fiscal Policy (Government Spending & Taxation) Monetary Policy (money supply & interest rates) Policy intervention implies one or more goals NCE goals: Unlimited Economic Growth & Full employment Ecological Economic goals: Optimal Scale and Fair Distribution The ‘Real’ (GNP) and the ‘Imaginary’ (Monetary policy)
A Troubled Marriage: Micro and Macro If Adam Smith’s “Invisible Hand” really worked then economic theory would stop with microeconomics. There would be no need for things like: The Coast Guard, Minimum Wage Laws, Government Regulation of Utilities, and a million other things. Monopoly was the first recognized ‘Market Failure’ that justified some government intervention. It was believed that the Laws of Supply and Demand would fix problems like unemployment. Confidence with that idea pretty much died with the ‘Great Depression’. Unfortunately, it seems many people today still cling to these old ideas. Economists like John Maynard Keynes began to think that unemployment – though theoretically impossible – was sufficiently real to warrant rethinking of microeconomic theory. “Laisez-Faire” (“let do” in French) was a dominant government doctrine until the Great Depression. It was essentially the microeconomic idea that ‘Markets are magical’. This magical thinking (while still present today) lost many adherents during the Great Depression – which many would say gave birth to Macroeconomic Theory.
The Fallacy of Composition - Examples A tiger eats more food than a human being. Therefore, tigers, as a group, eat more food than do all the humans on the earth. Atoms are colorless. Cats are made of atoms, so cats are colorless. "Every player on the team is a superstar and a great player, so the team is a great team." This is fallacious since the superstars might not be able to play together very well and hence they could be a lousy team. "Come on, you like beef, potatoes, and green beans, so you will like this beef, potato, and green been casserole." This is fallacious for the same reason that the following is fallacious: "You like eggs, ice cream, pizza, cake, fish, jell-o, chicken, taco sauce, soda, oranges, milk, egg rolls, and yogurt so you must like this yummy dish made out of all of them." Sodium and Chloride are both dangerous to humans. Therefore any combination of sodium and chloride will be dangerous to humans. One worker may gain employment by being willing to work for a lower wage, but all workers probably could not, because lower wages means less spending on goods and services, and less demand for labor even at the lower wage. Question: How does this last one tie into Boeing, The state of Washington, The state of South Carolina, and collective bargaining?
Macroeconomics for ‘Aggregate Phenomena’ The idea that ‘The whole is greater than the sum of its parts’ captures many problems of ‘ aggregation ’. Other names for these these kinds of problems are: ‘The Fallacy of composition’, ‘The Ecological Fallacy’, and ‘The Modifiable Areal Unit Problem’. Aggregate Phenomena like Unemployment and Inflation became legitimate concerns that required Macroeconomic policy But….. Macroeconomics is not just Microeconomics simply aggregated. That would be more ‘invisible hand’ magical thinking. Gerrymandering – an Aggregation effect. Case ‘A’ four 8-8 districts. Case ‘B’ three 10-6 and One 14-2 district.
The General Equilibrium Model & Policy While the general equilibrium model is enlightening and conceptually satisfying, it is not very helpful from a policy perspective simply to know that “everything depends on everything else”. Policy needs a few leverage points at which to influence gross behavior of the big system in its most important aspects. Key leverage points and indicators that have been identified by macroeconomics are: Money Supply Aggregate Price level Interest Rate Aggregate Consumption & Investment Exports & Imports Growth of GNP (big one)
Is Economic Growth the Answer? For most of modern history the answer has been “yes”. Ecological Economics questions this seriously. Problems that Economic Growth was supposed to solve: Population Growth Inequitable distribution of wealth Involuntary unemployment Did “Rising Tides Lift all Boats”? Microeconomics is “Price Theory” Macroeconomics is “Income Theory”
Laziness as cause of Unemployment? (don’t get me started – I graduated in 1983) The view shared by most of my undergraduate students is that unemployment is caused by laziness or lack of training. The argument they often use is that “I can get a job, therefore all the unemployed could get jobs if only they tried harder, or got better education and training”. The way I go about demonstrating that fallacy is a dogs and bones example. Say we have 10 dogs and we bury 9 bones in the backyard. We send the dogs out to find bones. At least one dog will come back without a bone. We decide that the problem is lack of training. We put that dog through rigorous training in the latest bone finding techniques. We bury 9 bones and send the 10 dogs out again. The trained dog ends up with a bone, but some other dog comes back without a bone (empty-mouthed, so to speak). The problem, of course, is that there are not enough bones and jobs to go around. It is certainly true that a well-trained and highly motivated jobseeker can usually find a job. But that is no evidence that aggregate unemployment is caused by laziness or lack of training.
It’s not just economists who want to ‘stay the course’ ……..
Gross National Product (aka GNP) Economic growth is the paramount goal of nations. How is that measured? Typically – Growth in GNP. Top Flow (Factors) = Bottom Flow (Goods & Services) National Product at Consumer Prices = National Product at Factor Prices Gross National Product (GNP) is the market value of all goods and services purchased by households, by government, and by foreigners, (net of what we purchase from them), in the current year. Note: GDP vs. GNP – GDP counts only That done within U.S. borders. GNP Counts only that done by U.S. citizens
What does NOT get counted in GNP? Household Production does not count – How can you double the GDP? Get moms to pay each other for child care Cooking, Cleaning, Child Care Does Not Count (unless paid for) Intermediate Transactions among firms are not counted – The wheat sold by farmer to Miller – not counted The Four sold by Miller to Backer – not counted The Bread sold by baker to Safeway – not counted Only the bread sold to the consumer counts Proceeds of the sale of a used car do not count Basic Natural Resources are regarded as Free – The price of coal is the cost of labor and capital used to extract it. Only the Transforming Services of Labor and Capital Count Remember the Cobb-Douglas Production Function on the left (K & L only)
GDP per capita: An overused measure of welfare? Beyond GDP: GDP divided by population is stated as GDP per capita World Map, World Map, on the wall – Who’s the Happiest Nation of All?
Measuring GNP Good Video: GNP is measured in “Dollars Worth” Dollars worth of “What”? The quantity of Goods and Services traded in the current year times their price. The Consumer Price Index (CPI) is used to correct for price changes do to inflation and/or deflation. GNP figures are converted to constant PPP dollars with CPI Changes in REAL GNP need to be due to changes in quantities, not price levels. GNP cannot be correlated directly with change in physical magnitude or material/energy throughput of the economy.(it’s not totally unrelated though) Predicted changes in National GNP
GNP and Total Welfare GNP is a measure of Economic Activity GNP is NOT a measure of welfare or human well being Total Welfare = Economic Welfare + Noneconomic Welfare It is a “Faith Based” Assumption that Economic Welfare and total welfare move in the same direction. Tradeoffs – As labor becomes more mobile GNP goes up. However, there is a loss in noneconomic welfare from being separated from family & friends. Getting married has similar tradeoffs. We often overemphasize the importance Of what we measure (economic welfare) and underemphasize that which we don’t measure (noneconomic welfare)
Defensive Expenditures and the Depletion of Natural Capital Defensive expenditures are those expenditures that we have to make to protect ourselves from the unwanted consequences of the production and consumption of other goods by other people. Examples: Soundproofing homes near airports. Medical expenses for environmental pollution Freely chosen expenditures that are “anti-bads” Involuntary intermediate costs of production that should not count as welfare or final consumption. Can be broadly or narrowly defined. Other examples given broader interpretation: All costs associated with global warming Cost of institutions such as SEC, Coast Guard, Police, TSA GNP is GROSS National Product NNP (Net National Product) = GNP – Depreciation of Manmade Capital GSP (Gross Sustainable Product) = NNP – Natural Capital Depletion
Sustainable Income The whole idea of income accounting is the prudent concern to avoid inadvertent impoverishment by consuming capital. The true definition of income is the “maximum that a community can consume in a given time period without causing itself to have to consume less in future time periods.” Individuals may consume retirement ‘nest eggs’ of capital because they rationally perceive their own death. Nations, on the other hand, exist indefinitely into the future and should not consume capital as if they were a business in liquidation. GNP counts natural capital consumption (overexploited fisheries, forests, crops; depleted mines, wells, and aquifers) as income. This is entirely incorrect. Some NCEs are recognizing that nature’s services are a huge essential infrastructure for the economy that is depreciating and degrading rapidly. Liquidation (for nonrenewables) vs. Depreciation (for renewables) WHY? NATURE IS NOT PERCIEVED AS A SCARCE RESOURCE.
Alternative Measures of Welfare: MEW and ISEW MEW (Measured Economic Welfare – William Nordhaus & James Tobin) Correlated with GNP, 2/3 size of GNP adjusts GDP by adding leisure, unpaid housework and the value of services given by consumer durables over the year. Deductions are made for 'regrattables' such as expenditure on commuting to work, defence,the police, negative externalities including pollution, and expenditure on consumer durables. Approach seeks to cover more of the aspects which affect economic welfare although it has its own share of problems of having to attach a monetary value to non-marketed products o ISEW (Index of Sustainable Economic Welfare – Daly and Cobb) ISEW = personal consumption + public non-defensive expenditures - private defensive expenditures + capital formation + services from domestic labour - costs of environmental degradation - depreciation of natural capital Both ISEW and MEW correlate with GNP till about 1980 then they stray.
Continued use of GNP as a proxy for welfare and Yogi Berra: “We may be lost, but we’re making good time.” The objective, accurate scientific measurement of national costs and national benefits is not a realistic goal. Both costs and benefits of economic growth are spread out over time, and how we treat costs and benefits that affect future generations is an ethical issue, not a scientific one. The use of a particular discount rate to address intertemporal distribution is, for example, clearly a value-laden decision. Ecosystem change and evolution are not predictable, and how we treat the resulting uncertainty is also an ethical issue. Even using monetary measures of market goods is not objective; markets will yield different monetary values depending on the initial distribution of the wealth, and what comprises a desirable initial distribution is an ethical judgment. My Father’s Bridge Partner and “Initial Distribution of Wealth”
Flaws with GNP Costs or Benefits? Get it Right Looking Forward – Stock market Or Looking Backward – GNP Impact on GNP? (see below) War? Natural Disasters? Disease? Divorce? Mining? Clear Cutting?
Beyond Consumption-Based Indicators of Welfare Relative Wealth and Well-Being ‘Keeping up with (or staying ahead of) The Jones’ is real. Doubling GNP with no change in distribution might have no real impact on welfare. (blind pursuit of ‘positional wealth and consumption’) Could have hugely negative effect if raising GNP diminishes ecosystem services Human Needs and Welfare 1.2 Billion people live in extreme poverty. For these people an increase in consumption would undoubtedly increase their welfare. For the other 80% of us our welfare is more determined by meeting a whole suite of primary needs. Max-Neef’s Matrix of Human Needs Subsistence, Protection, Affection, Understanding, Participation, Idleness, Creation, Identity, Freedom. (see next slide) The Happy Planet Index
Max-Neef’s Matrix of Human Needs
What’s wrong with Maslow’s Triangle? Even the 1.2 Billion living in absolute poverty seek to fulfill needs other than subsistence. Max-Neef summarized & organized human needs into nonhierarchical axiological and existential categories. Needs are inter-related, inter-active, and often complementary. Also, more than one can be pursued at once. The Max-Neef matrix of needs are few and finite; in STARK contrast to the infinite wants or nonsatiety axiom of Neoclassical Economic Theory. “The most important fact to understand about QOL indicators is that all measures of Quality are proxies – indirect measures of the true we are seeking to judge. If quality Could be quantified, it would cease to be quality. Instead, it would be quantity. Quantitative measures should not be judged as true or false, but only in terms of their Adequacy in bringing us closer to an unattainable goal. They can never directly Ascertain quality.” Clifford Cobb
Objective Measures Studies still find only WEAK correlations between people’s self report of welfare (“How happy are you?” surveys) and other measures like MEW, ISEW, Max-NEEF indices, etc. Perhaps “Welfare” is too rich a Gumbo for us to recapture its flavor with so few ingredients (particularly when so many ‘ingredients’ are measures of consumption. ‘Satisficing’ levels of need confused issue. If you have enough ‘love’ in your life, more ‘love’ does not mean you are happier. Measurement of some things should ‘max out’ and perhaps go down with increases. For example, the right amount of ‘free time’ is a great thing, too much can look like ‘unemployment’ or ‘boredom’. NCE and GNP are strictly utilitarian perspectives and measures. This ‘Human Development’ approach to welfare values human actions independently of their outcomes. Amartya Sen, Martha Nussbaum, and Max-Neef argue that ‘capabilities’ and ‘functionings’ are critical to welfare. ‘Human Development’ approach opts for maximizing choices. Warning: Barry Schwarz & his ‘Paradox of Choice’ book tells us that too much choice can be paralyzing and utility degrading.
Human Needs Assessment as a measure of Welfare Measuring the extent to which human needs are satisfied is a big task. Measuring ‘capabilities’ (access to satisfiers) may be easier. Specific ‘capabilities’ (states of being and opportunities for doing) and ‘functionings’ (human needs) vary by culture. These differences may be the very things that define culture. Consequently, Objective “Welfare Accounts” may be very culture specific. Human Needs Assessment (HNA) – A task for the coming generations. “Empirical tests, as well as efforts to operationalize HNA accounts, must involve people in dialogues to confirm or refute the validity of the needs Max-Neef specifies, as well as the validity of the satisfiers we use to assess the degree to which needs are met. Such dialogues will almost certainly elicit additions and alternatives to the generic satisfiers Max-Neef needs.” “ Perhaps it is better to be vaguely right than precisely wrong ” Amartya Sen on measuring human welfare
Some Notes on ‘Measurement Problems’ Measuring ‘Dollar Value’ of non-economic welfare The concept of leisure is an important part of welfare, but the problems of valuing leisure are difficult. Is the leisure chosen or unchosen? Should sleep time count as leisure? Is commuting time leisure or “time cost of working”? Should we use the wage rate? The minimum wage? Should the ‘leisure’ of a mom taking care of children be valued at her opportunity cost if she’s a doctor, or at the cost of avoided day care? Such difficult choices have a huge impact on indices like the MEW and the ISEW. Measuring the ‘satisfaction’ of human needs across cultures Food and shelter are specific dimensions of ‘having’ that are satisfiers of the need for ‘subsistence’. How we actually meet out needs for food and shelter are culture-specific. A traditional Innuit might be satisfied with walrus blubber and an igloo, while a New Yorker would require hamburgers and a high-rise apartment. Distribution of Wealth effects on prices There are people in the world today that will pay $100,000 for a ferrari or lamborghini. Redistribute the world’s wealth evenly across the population and there would be no market for cars like that at all. Prices are profoundly driven by the existing distribution of wealth. (My father’s bridge conversation)