Ovid (publius_ovidius) wrote,

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Equality, Efficiency and Externalities

This is yet another train wreck of thought that I've been on. It tends to ramble, but it's just a way for me to work out some of the thoughts that go through my head at times.

Today I'm thinking about things people are ignorant of. I don't mean "ignorant" in a pejorative sense. I am ignorant of the central tenets of Hinduism, but I don't have a need to know about this and I certainly don't make decision based upon it. If, however, I were a chemist and I didn't know what happens when pure sodium is dropped in water, than my ignorance would be a Bad Thing.

In other words, if something is likely to have an impact on you and the decisions that you make, ignorance of that thing is bad. Today, I'm going to write a bit about economics and if your eyes glaze over and you choose to move on to someone else's journal entry, I won't be offended, but please don't vote (that's a joke).

In the early eighties, Ronald Reagan rambled relentlessly about the top marginal tax rates and how they were hurting our economy and whether or not that was really the cause of our economic problems, the fact remains that between 1980 and 1984, tax rates fell by around 23 percent and the economy surged forward. Unfortunately, we were also saddled with a huge debt due to the tax cuts, the recession of the early eighties and a huge surge in military spending1

For those who despise Reagan's economic policies, you're probably also unhappy with either Bush Senior or Bush Junior. However, Clinton had basically the same economic policy. The major difference was his desire to improve the quality of the workforce via training. Clinton supported tax incentives to corporations, lowering the capital gains tax, easing regulations against many companies and was instrumental in gutting much of the Kyoto Protocol in order to protect US business interests. He also oversaw the removal of millions of people from our welfare rolls (most were kicked off -- they didn't work their way out of poverty) and managed to balance the budget at the same time. I'm still hard-pressed to explain why Republicans hated the man so much.

But what does all of this mean? Since the late seventies, the US has led a world-wide trend to improve productivity by making industry more efficient via lower taxes, deregulation, privatization (mostly outside of the US) and a reduction in social benefits on the theory that starving people will work for food. And the truth is, they will. Despite a few bumps in the road, the US economy has appeared to be very healthy for the last twenty years.

But what price do we pay for this prosperity? Some will simply point to the poverty rate and state that since poverty rate has declined slightly in the past 20 years (and the number in poverty is roughly the same now as it was 20 years ago), that we are definitely better off. Unfortunately, as economics professor Don Matthews explains, poverty rate statistics are a sham. From his explanation:

How are the income thresholds determined? They are based on 1955 U.S. Department of Agriculture data on food budgets designed for families under economic stress. The thresholds were first computed in 1963?64 and have been updated for inflation (using the standard Consumer Price Index, CPI-U) each year since.

Thus, the official U.S. poverty rate, this statistic that receives so much attention from government policy makers, social scientists and the media, is based not on an assessment of living conditions but on 48 year-old USDA food budget data.

The article is worth further reading, but an executive summary might be that the poverty rate, like the unemployment rate, is a number that is constantly manipulated for political purposes and has little to do with the real world.

So if poverty can't be measured well, what can be measured?2 Despite having no definitive correlation with reduced crime rates, our prison population has skyrocketed since 1980. The US has more people in prison per capita than any other nation in the world. Additionally, amongst major industrialized nations the US:

Needless to say, this isn't what Fox News is telling us. We're seeing the poverty gap widen, our babies and their mothers are dying, we're tossing people into prison left and right and functional illiteracy is rampant. Much of this we don't notice because we don't see other countries, but the question must be asked, why is the wealthiest and most powerful nation on the plant suffering these ills?

Because we chose to.

You see, one things our politicians aren't telling us is that there is a trade-off between efficiency and equality. The more efficient we become, the less fair we are and vice versa.

A perfect example is Aid to Families with Dependant Children (AFDC). Prior to 1967, every dollar a person earned over the minimum need assessed by local welfare officials was subtracted from the person's (90% women) benefit amount. This was a simple and efficient method of calculating aid. However, any time spent earning money was more time and money that the women needed for for child care, transportation, and work-related clothing. In short, women had every reason to not work and in fact, this is exactly what was happened. The AFDC was altered by Congress to allow for this problem. Of course, this meant more paperwork and oversight, but it also meant that this loss of efficiency made the system more fair. The Republicans (note that I said "Republicans", not "conservatives") complain constantly about increasing the size of government, but there are some issues that practically mandate increased government intervention.

If I purchase something from a business, I receive a good that I desire and they receive money (or services) that they desire. If the business and I are the only two entities affected, this is fine. However, what if people external to this transaction are affected? This often happens and it's referred to as an "externality". For example, if a business dumps hot water into a stream and kills fish, fisherman might suffer. However, if the business doesn't have to bear the cost of the damage they cost, then I can purchase a good from them at a cost lower than the actual cost to society. If the business is forced to internalize the cost of the damages they cause (by compensating the farmers or being forced to cool the water before it's dumped in the stream), then the business will have to pass the cost on to me and I will be paying the true price of the good. This would be less efficient, but more fair. Of course, business seldom will voluntarily increase there costs, so this is why the government needs to step in from time to time and correct situations that the market cannot correct.

The preceding example is what is known as a negative externality. Because businesses do not internalize the full costs of their operation, products whose manufacture results in negative externalities tend to be overproduced (because their street price is cheaper and there is a higher demand). On the other extreme are positive externalities. For example, if 19 kids gets vaccinated, the 20th kid's parents might think "I don't need to pay for vaccination because no one else will get sick and pass on the illness to my child". Social services also have this problem. Even if you cheat on your taxes, police and fire fighters will still reduce crime and fires -- to your benefit, even though you didn't pay. As a result, because people can benefit from positive externalities whether they pay for them or not, goods and services that generate positive externalities tend to be underfunded. Think "teacher's salaries". Again, we have an example of a market problem that the government could correct but the market cannot.

It really doesn't matter whether you shoot for efficiency or equality. Either extreme tends to break down. The US is suffering from very high levels of heart disease and cancer, which some think is not very fair, but we err on the side of efficiency and don't generally don't force fast-food companies or polluters to foot the bill (the tobacco lawsuit was unusual, but it was still a farce). As a result, the US strives for more efficiency and we voluntarily accept that more people will die as a result. Do you doubt this? You realize that if we eliminated cars, we would eliminate automobile fatalities, but we're willing to accept that some people are going to die to fuel (pun intended) our need for transportation.

So what's to be done? If we voluntarily choose quantity of life over quality of life, so be it. However, it doesn't have to be that way. While there is no moral obligation that can force a rich person to give away his money to poor people, neither is there a moral obligation that we allow him to become rich without considering the harm that he does to others. This is a choice, not a mandate from God. Personally, I choose fairness over efficiency. I have a good income and live fairly well, but I would happily work towards a system where greed at the expense of others is not the ideal.

1. Actually, surplus Social Security funds are borrowed to artificially reduce the apparent size of the deficit -- a practice that began with the Reagan Administration. For most of the history of Social Security, incoming contributions were paid out to those receiving the benefit. As the ratio of elderly to working increased dramatically, the system broke down and Alan Greenspan headed a commission to save Social Security. Benefits were reduced, withholdings were increased and the plan was to be converted to a trust fund. Unfortunately, surplus money was once again available and the Reagan administration decided that we would spend that money to reduce the apparent size of the deficit and the money was replaced with Treasury Notes. You and I would refer to these as "IOU"s. These IOUs will have to be paid, but there is no money for them. This practice is referred to as creating an unfunded liability. If your company were to borrow your surplus retirement funds the way the government does, the officers of the company would quickly discover that this is a felony offense.

2. Unless otherwise noted, these statistics are culled from the United Nations' Human Development Reports for the USA for 2003 and all statistics about the US are in relation to the major industrialized nations in the world, which I have limited to the top 25 nations in Human Development Indicators.

3. In other words, if you have money, you can get access to adequate medical treatment. If you don't have money, you can't. This is the reason for our high infant mortality rate, the high rate of our mothers dying in childbirth and possibly has a bearing on our lower life expectancy.

Tags: economics, politics
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