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 Inequality: lost in the long grass?

Opinions of the York Professor who foresaw the crisis

Global warming: how to take it on, by an economist!INSI

DE:

Challenges for the new economy

2 Spring 2013

Contents Economics Society

But, Justice - So What? // 23

Global round-up // 4

Economic means of preventing global warming // 6

Unemployment in Recession // 8

What’s a Summer Internship with the University like? // 10

Macroeconomic Policy and the Credit Crisis // 11

Feedback: how to turn it to your advantage // 13

Challenges for the new economy: scaling the fiscal cliff // 15

The Unsung Heroes and Heroines – The Entrepreneurs // 19

Inequality - So What? //21

Article references available at www.yorkeconomicssociety.co.uk

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Contents Economics SocietyThe University of York

A Brief Message from the President and Vice-President of the University of York Economics Society

In an ever-globalizing world, there has never been a better time to be interested in economics. Laying the foundations of trade, development, environment and culture, the study of economics seamlessly under-pins the choices we make and the consequences we endure.

EconSoc was founded on the principal of support-ing students, and it is with a focus on employability, advice and networking that the Economics Society continues to thrive, with over 1000 members con-tributing to a society run by students, for students. In November last year, a new committee was elected which kick-started our first social: The Clash of the Titans. With an impressive turnout of over 200 students, the committee members were delighted to see so many students representing the society in a frenetic night with two other well-known societies.

Following on with events such as a careers seminar for first-years, a commercial awareness talk and joint coverage of the 2012 US elections, the society was once again pleased to see rows of economists take time out to attend our ‘Money Never Sleeps’ film

night. Over 150 members of the society were greeted with popcorn, pizza and beverages, and we are especially thankful to the joint efforts of both social secretaries for their vast contributions to its success.

It is the dedication of our members that continue to make EconSoc a success, but we don’t intend to stop there. The committee has many more events for you to look forward to, including a module choices talk, a charity social, more skills talks by employers and a Women’s social towards the end of this term.

We hope you enjoy the cumulative efforts of editors, writers and academics in our latest issue of Equilib-rium, and that you will join us in the future for more outstanding events.

Until next time,

The EconSoc Committee

President: James DaveneyVice-President: Josh Carson

Printing:

James Daveney, Dominic Falcão and James Lomas

Graphic design:

Editors:

Copy- editor:

Daniel Howdon

Jessica Ochalek

Want to write for EQ? Article submissions are

more than welcome, please send to econsoc.

editors@live.com

4 Spring 2013

Worldwide Economic UpdateBy Usama Polani, 1st Year Economics

Abenomics: a solution to Japan’s economic woes?

The newly appointed Japanese Prime Minister, Shinzo Abe, is hoping that his brand of economic thinking – reflating the economy via monetary, fiscal and structural remedies – is the solution to Ja-pan’s ongoing economic problems of entrenched deflation, accom-panied by low GDP growth and interest rates close to their zero nominal bound. His philosophy is that expansionary monetary policy cannot work when demand for borrowing is low in the pri-vate sector and that, to tackle this problem, demand must be pro-vided by the government in the form of a fiscal stimulus. His plan is to guarantee this using the asset purchases scheme, operated by the Bank of Japan (BoJ). His belief in structural reforms (including en-tering into trade agreements such as the Trans-Pacific Partnership) is highlighted by their integration within a government document, to be regularly reviewed by him and the BoJ governor. His plans are helped by the early retirement of the current governor, Masaaki Shirakawa, who has been reluc-tant to agree to a more aggressive monetary stance. This has allowed Mr Abe to appoint a new gover-nor, Haruhiko Kuroda, who more

closely shares his belief in bold monetary easing. His deputy-elect, Kikuo Iwata, even supports more extreme measures, such as the large-scale purchases of foreign bonds to cheapen the yen (which many see as overvalued) to bolster the economy. This aggres-sive stance on monetary policy has led to some countries fearing the effect of a devalued yen on their exports. Whether Mr Abe will meet his self-assigned 2% infla-tion target and also rescue Japan’s economy is yet to be seen but, even if successful, at what cost to others might this come?

The end of the Millennium Devel-opment Goals, and what comes next…

As the 2015 deadline for the fulfil-ment of Millennium Development Goals (MDGs) approaches, it provides an apposite moment to reflect on the worldwide success of thwe goals, as well as to consider what should come next. While three of the eight goals have been achieved, progress has been un-even both across and within coun-tries: while countries such as Bra-zil have already achieved many of the goals, Benin is expected not to reach any. Furthermore, the halv-ing of the number of people living

in absolute poverty, the World Bank suggests, was mostly thanks to progress in countries such as China and India, while countries in Sub-Saharan Africa have only reduced poverty by 1%. Although aid from developed countries to-wards the completion of the goals has been rising consistently, it has been shown that more than half goes to debt relief, while much of the remainder goes to disaster relief and military aid, leading many to question their effect on assisting development. There has also been criticism that the MDGs fail to take into account the need for sustainable development. In July 2012 the Secretary-General launched his High-level Panel of Eminent Persons to provide guid-ance and recommendations on the post-2015 development agenda. They are expected to release a re-port in May, which will provide an indication of the new post-2015 goals, and of whether the les-sons from the implementation of MDGs have been taken on board.

Argentina vs the IMF on inflation

Since the Argentine government took control of the country’s national statistics office in 2007, discrepancies between the offi-cial inflation numbers and those

5

reported by independent econo-mists have ranged up to 15 per-centage points. Having censured the country for such inaccuracies, the IMF has given the government until September 29 to address these problems, stating that, if it fails to do so, it could face punish-ments ranging from suspension of voting rights to possible expulsion from the IMF. With labour unions protesting the disparity between wage increases and true inflation, the government has announced that it has ordered supermarkets to enact a price freeze for two months. The government has re-alised that this could escalate into social unrest and, with an election imminent, has announced that a new price index will be introduced in the final quarter of 2013. It is unclear whether such a move will meet the IMF’s demands, with the relationship between the Fund and the Argentine government already fraught following President Cris-tina Kirchner’s public condemna-tion of the Fund in the aftermath of the country’s economic melt-down in 2001. The potential for economic and social instability after the imposition of this new price index remains clear, with any new estimates likely to be treated with suspicion.

Obama and income inequality

Barack Obama‘s attempts to re-duce income inequality have con-tinued, with a proposal to raise the federal minimum wage by 24% to

a nominal $9 an hour by 2015, and to index this figure to inflation thereafter. The US’s federal mini-mum wage is, at present, one of the lowest in the OECD, was last increased by Congress in 2009, and has historically been allowed to be eroded in real terms by infla-tion. The move by Obama has sparked a flurry of debate: while mainstream economic theory sug-gests that such a move could lead to unemployment, much empiri-cal analysis has thrown this into doubt. Although this debate will continue to rage on in academic circles, whether the proposed increase takes place is ultimately dependent on the support of the Republicans, in a highly-charged political climate which is apt to suffer gridlock.

Moody’s being moody

The UK has lost its coveted AAA credit rating from one agency, and has been downgraded to AA1. Moody’s cited the reason for the downgrade as expected sluggish growth, due to weak global activ-ity and the drag from the domestic “deleveraging process”. Although the change will not significantly increase Britain’s ability to borrow, it raises the question of whether the coalition’s path of severe aus-terity is working. George Osborne remains adamant that this move further motivates him to continue his fiscal consolidation, noting that deficit reduction policies are cited by Moody’s as part of the reason why the UK’s credit wor-

thiness is still “extremely high”. Others are less confident of the strategy, citing growing research from bodies such as the IMF that aggressive austerity may not work, and recent figures showing that the economy contracted by 0.3% at the end of 2012.

Haggling over the EU budget and missing the real problems

EU leaders have, after seemingly endless talks, finalised a new EU budget. While it only constitutes 2% of EU spending, the process is lengthened by both resistance from already indebted countries, as well as anger from others at a perception that the EU is trying to exempt itself from the austerity it has imposed on others. An axis led by Angela Merkel and David Cameron has already succeeded in trimming the 2014-2020 budgets by 3%. Although the European Parliament has already rejected the proposed budget, amidst possible suggestions of a possi-ble review of the issue in two or three years, they continue to miss the real problems of the budget. The Common Agricultural Policy still makes up 40% of the budget, while agriculture only contributes less than 2% of GDP. Slashing these expenditures would free up resources for thriving industries while, at the same time, allow overall spending to be reduced.

6 Spring 2013

The disappointing series of failures to reach agreement

among the 194 members of the United Nations Framework Convention on Climate Change in Copenhagen (2009), Cancún (2010), Durban (2011), and Doha (2012) highlights the international impasse in preventing further global warming. Yet immediate action seems to be called for; re-cent research reports rapid reduc-tions in ice mass balance from both Greenland and Antarctica with a projected sea-level rise of one to two metres by 2100. Since an estimated 160 million people live currently in locations less than one metre above sea level, the im-pact of such change on the world economy would be substantial. In new research, Beatrice Roussillon and I study and attempt to answer two questions arising in this con-text: i) How can incentives be pro-vided to reduce harmful emissions to their socially efficient levels while not infracting upon produc-tive efficiency? ii) What would this efficiency cost in percentage of our model-GDP? The present article outlines our answers to both.In our model environment, there are two ways to reduce emissions: by producing less or abating more. Our mechanism plays on these two aspects in order to achieve efficiency in both. Our an-swers to the above two questions in-volve a stylised contest among nations, rewarding the countries with the highest abatement ef-forts with some share of global output. In a nutshell, marginal pro-duction is ‘taxed’ to fund a prize pool, and marginal abate-

ment increases the probability of winning a share of this pool. By designing the contest parameters correctly, both equilibrium incen-tives can be set efficiently at the margin. This contest is based on a relative ranking of all nations’ abatement efforts. The precision with which this ranking is cor-rect, i.e., the precision of mutual abatement monitoring, is one of the design parameters of our proposed mecha-nism. Since imperfect monitor-ing leaves an element of luck to winning, there is a lottery flavour to this competition.The main type of emis-sions we have in mind is greenhouse gases. These are widely seen as the main contributing factor to global warming. Emitted by one country as inher-ent part of the produc-tive process, they are distributed around the globe regardless of where they were produced and, as such, present an externality. A reduction of emissions benefits all countries but the costs of such re-ductions are carried individually. This generates a classic free-rider problem in which each coun-try would like the threat of global warming removed but none is ready to pay the cost.

The environmental literature employs three main approaches to overcome the inefficient emissions abatement problem: command-and-control regulation, quantity-oriented market approaches,

and tax-or-pricing regimes. The approach adopted by the 187 signatories of the Kyoto protocol is the quantity-oriented market approach targeting a reduction based on developed countries’ emissions in 1990. The treaty, however, failed to obtain ratifica-tion by major players including, most promi-nently, the United States. Moreover, the concern was

expressed that developing coun-tries might have ratified the treaty without the intention of keeping emissions in check. This mars the current emissions reduction reality with the dual frustrations of insufficient participation and diluted objectives.

Economic means of preventing global warmingBy Paul Schweinzer, Lecturer, Department of Economics

7

Yale economist William Nordhaus is among the most prominent advocates of the implementation of market-based instruments and, more specifically, a world-har-monised tax on each ton of CO2 emissions. This proposal presents many advantages: it can achieve efficiency at the world level, it is simple to implement, and it is a well-known instrument. With a harmonised tax, however, each country pays the same price/tax for a ton of CO2 emissions regard-less of its revenue and responsi-bility for climate change. This could be particularly hard on poor countries and reduce their incen-tives to join any international agreement. Moreover, there is no guarantee that the solution will be cost effective. Our mechanism of-fers the ability to provide individ-ualised incentives to each country to abate efficiently. A harmonised tax is based on the ‘polluter pays’ principle whereas our mecha-nism is driven by a ‘cleaner wins’ princi-ple which we believe could im-prove participation by devel-oping countries. The reason is that there are many ‘low hanging fruits’ in developing countries rep-resent-ing easy abatement possibilities and thus high chances to win the competition we suggest.

Estimating the cost of reaching the efficient outcome in a real-istic model is conceptually and com-putationally difficult, even if a meaningful agreement on the model parameters could be

achieved. To get a feeling for the magnitudes implied by our pro-posed mechanism we build a small Mickey-Mouse example of the world economy just consisting of two independent nations (blocks), each producing half the world GDP (of $61tr in 2008). In this simple example, our mechanism reaches efficiency—at various specific and agreed upon monitor-ing levels—at a minimal transfer level of at 1.1-2.7% of individual GDP. Although these still imply enormous two-player payments of $0.4-0.8tr, these transfers do not seem to be outside of the politi-cally feasible range.

The prevention of free-riding on the agreement, i.e., not join-ing the agreement but benefiting from the cleaner environment the agreement brings about without contributing, is crucial for any inter-national environmental agreement. The mechanism we propose can theoretically ensure universal participation through an insurance property of the redistributive contest mechanism. Specifically, we show that for sufficiently income-shock-averse players, the risk-pooling through redistribution implied by the proposed mechanism can assure participation without the need

for punishment strategies such as exclusive trade agreements or en-vironmental standards excluding agreement de-serters from trade within the agreement. In reality, of course, reaching agreement on and commit-ting to the efficient mechanism’s parameters, the necessary transfers and the exact specification of the contest still present a formidable political task.

To a large extent, however, we feel that any mechanism attempting to solve the emissions problem will have to face a variant of these problems. We attempt to name and discuss these challenges—and provide first results showing that

a mechanism along the lines we indicate can in theory correct na-tions’ combined incentives to emit too much while abating too little.

In a nutshell, marginal production is ‘taxed’ to fund a prize pool, and

marginal abatement in-creases the probability of winning a share of this

pool.

A harmonised tax is based on the ‘polluter pays’ prin-ciple whereas our mecha-nism is driven by a ‘clean-er wins’ principle which

we believe could improve participation by develop-

ing countries.

8 Spring 2013

Unemployment in RecessionBy Neil Dodd, 3rd Year Economics

The University of York hosted this year’s Royal Economic

Society annual public lecture. The topic of discussion was ‘Un-employment in Recession’, with a particular focus on young people. 2010 Nobel prize-winning econo-mist Professor Christopher Pis-sarides of the London School of Economics delivered an interest-ing and good-humoured talk. A lecture delivered by such a re-spected economist on a currently relevant issue attracted an eager and varied audience.

The following questions were some of those addressed during the lecture:

‘Why are nearly half of young peo-ple in Spain out of work? ’

‘Why is youth unemployment so much lower in Germany than in Britain and Southern Europe? ’

‘Which policies are most effective in combating unemployment in recessions? ’

The Nobel laureate also outlined key elements of an active labour market policy for young people. This, he suggested, could include extending education places: through universities and colleges offering more applied and shorter courses; providing specially designed training; subsidising self-employment or recruitment of unemployed youths by companies; and teaching young people how to look for and learn about jobs.

Professor Pissarides started by discussing the vast differences in the unemployment levels of OECD countries, five years prior to the recession. Before the reces-sion, Britain had unemployment relatively under control. Only 5% of the whole workforce and 14% of young people were unemployed. Even in normal economic times, youth unemployment is higher than adult unemployment, but in a recession the gap widens and young people stay out of work for too long. In 2008 we were hit by the worst recession since the 1930s, although unemployment levels didn’t reach that of the 1980s recession. Spain has been hit hardest in terms of unemploy-ment and has suffered detrimental effects: unemployment has risen by nearly 10% and three times as many young people, compared to adults, are now out of work. The recession, however, barely affected Germany, and youth unemploy-

ment levels have actually fallen since 2008. How can it be that certain countries are barely affect-ed, and others virtually ruined? In times like these, urgent policy ac-tion is needed to avoid long-term unemployment, which destroys talent and creates social problems.

Supply and demand analysis is the conventional method used to explain the differences between the changes in countries’ unem-ployment levels caused by the recession. Although the frame-work is sufficient when studying technology or tax, the model fails on several counts when look-ing at unemployment. First, the framework is inadequate at pre-dicting the impact of a recession. The model demonstrates that a recession will cause hours of work (employment) to fall slightly, and the real wage rate to fall drasti-cally. However, economic data and intuition implies that the exact opposite occurs: employment falls significantly and wages hardly fall. Second, supply and demand analysis does not take into account many features of the modern labour market. Much emphasis has recently been placed on the institutional structure of coun-tries with particular reference to trade unions, the structure of the benefits system and employment legislation.

Professor Pissarides is a Cypriot economist. He is currently a School Professor of Economics at the London School of Economics. His research interests focus on several topics of macroeco-nomics, notably labour, economic growth, and economic policy. In 2010, he was awarded the Nobel Prize in economics, jointly with Peter A Diamond and Dale Mortensen, for his con-tributions to the theory of search frictions and macroeconomics.

‘Unemployment in Recession’ by Chris Pis-sarides, the 2012 Royal Economic Society (RES) Public Lecture, was delivered at the Royal Institution, London at 5pm on Thursday 22 November and at the University of York at 5pm on Wednesday 5 December

Photo: Telegraph, July 30th 2012

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As a result of this, Professor Pis-sarides has spent much of his academic life developing ‘search and matching’ theory. He ex-plained how this framework deals with some of the many issues that conventional supply and demand analysis cannot. Traditionally, economists assume full informa-tion: this is wherein Professor Pis-sarides believes the problem lies. The key difference with ‘search and matching’ theory is the reali-sation that there is a vast amount of information that needs to be digested in labour markets, and that in reality we can never reach the market-clearing equilibrium in the absence of perfect informa-

tion. Workers in the labour mar-ket, in conventional theory, are uniform products: in reality this isn’t true. Workers are heterogene-ous and one worker’s labour may differ from another’s. There are also many other costs involved when entering employment, and changing jobs can often involve mobility costs (such as moving an entire family). People also have varied preferences: different jobs

are preferred by different people. Professor Pissarides refers to the factors that slow down the adjust-ment from one equilibrium to another as ‘frictions’.

The term ‘search’ refers to the process by which firms and work-ers learn about each other and get together for productive employ-ment. A ‘match’ is a job between a worker and a firm. Professor Pissarides explained that youth unemployment is almost always higher than adult unemploy-ment because young workers start unemployed. They have relatively little idea about their talents and need the chance to experiment and learn. A young person may also not want to take the first job that comes along. Professor Pissar-ides believes the way in which we should tackle this problem is by allowing young workers to go ‘job shopping’.

An ideal labour market is one where young people are given the opportunity to ‘job shop’ until they discover what they are good at. Professor Pissarides joked: ‘Just as they are not expected to marry their first boyfriend or girlfriend, they should not be expected to take their first job and stick with it forever’. The concept of ‘job shop-ping, he claimed,’ explains why youth unemployment is greater than adult unemployment in normal times. A desirable market

is one that provides this experience, and is flexible by having a high degree of job turnover. This market allows em-ployers to take advan-tage of new job oppor-tunities and create many jobs for young people to try out.

A natural outcome of this process is unemployment: it is normal to become unemployed for brief pe-riods during this shopping period. Germany is the most successful of the major countries in its ratio of youth to adult unemployment. They have developed a very elabo-rate subsidised apprentice system for young people. However, Italy and Greece are the least successful: both countries have rigid labour markets with a lot of job protec-tion for adults and low levels of job turnover. Therefore, employers aren’t willing to hire people and, as a result, young people struggle to gain experience of work.

Fundamentally, in rigid labour markets or in recessions, young workers stay unemployed for too long. But, Professor Pissar-ides claims, this is when we need labour markets to be the most flexible, and we need active labour market policies.

The talk was rounded off by a warm drinks reception, allowing A-level students the opportu-nity to ask any questions about economics at York. There were a whole host of people from the department present, including undergraduates, PhD students and lecturers. Everyone also had the opportunity to question Professor Pissarides, and in some cases even got the odd photograph.

Just as they are not ex-pected to marry their first

boyfriend or girlfriend, they should not be expect-

ed to take their first job and stick with it forever.

Photo: “The Young and the Unemployed” by “Odins-Girl”

10 Spring 2013

What’s a Summer Internship with the University like?By James Daveney, 2nd Year Economics

Throughout most of my Sum-mer I had an internship in the

Ron Cooke Hub on Heslington East (you know, the ‘other’ cam-pus?) My time there was spent with only a handful of people in a very small office in a flagship building less than two years old. There are many stakeholders in the Ron Cooke Hub, from start-up companies and academic depart-ments to Science Park offices and the White Rose Enterprise Group. Truly an inspirational place to be.

And it challenges you. Over the course of my internship, I helped organise a community fete in and around the Hub, which was attended by over 600 people. I learned about marketing, product

development, the internal politics of running the Hub and complet-ed tasks outside my comfort zone. This might all sound to you like a work-intensive internship, one where you are taught how to do something and expected to do just that for the next eight or twelve weeks.

I was not taught the basics, I had to work them out for myself, and had to find the style of work that best suited me. This was, how-

ever, one of the great things about working in the Hub. Would I work an extra few hours to make a programme of events for the people attending the community fete? Would I go home and leave people to run around the Hub like mad chickens the next day? Luckily, I did the former. I am not saying everyone has to put in extra time during internships: my point is that working in the Hub made me want to put in more effort, as I could see the great things that people were doing around me and I wanted to match that.

It might sound like I am trying to sell the Ron Cooke Hub to you and – at least partly – I am. I am also trying to sell internships with the University. I think they are extremely valuable to everyone involved: just look at the people who benefited from there being an internship at the Hub this Sum-mer:

First, the person doing the Intern-ship. In this case that was me, but it could be anyone in the future as there will be new opportunities every year. I learned more about the importance of networking, making deadlines and how the University works – which was not very well at times.

Second, the Hub. The office in which I was working now had the staff to assist in events, to make events of their own and to help with the day-to-day running of the Hub. The other stakeholders in the Hub like business staff, academics

and the local community gained from this too.

Third, the Careers Service. They can use the internships this sum-mer to advertise what they have done to help students become more employable. The Service can then use them to help promote other opportunities they offer.

Want to know how I got the in-ternship in the first place? Head to York’s Interactive Careers Service website and sign up to get emails about everything they have to of-fer. The Service is in charge of the Student Internship Bureau, who, as the name suggests, organise all on- and off-campus internships. These are throughout the year, not only in the summer, and are highly flexible in terms of hours you can work, skills you can gain and work you will be enjoying.

I learned about marketing, product development, the

internal politics of running the Hub and completed

tasks outside my comfort zone.

11

The Careers Service website initially had about fifteen intern-ships on offer: I applied to two, using a very simple application form, submitting my CV which was to be passed to a potential manager. I did not hear back from the other application, but it did not matter as I had an inter-view scheduled at the Hub. The interview itself was the most use-ful one I have ever had. This was chiefly because, for the first time, the interviewer – my soon to be manager – delved into the jobs and work experience I had listed on my CV. That is something that no other person had done before. I also gained a lot from a chat about the Hub after he had finished with his questions.

So, in essence, I hope I have persuaded you of the value of internships during your Univer-sity life. Yeah, sure, I could have spent my Summer back home raiding my Mum’s fridge every half an hour looking for food, whilst having barely anything else to do. But what would I have gained from that? Also, did I mention the pay? (This and the occasional free sandwiches were a factor in me applying for one in the first place.) It is a standard £230 a week, not bad at all for a student. Furthermore, I hope I have shown that, even though the work might be challenging at times, it is definitely worth the effort.

I was not taught the ba-sics, I had to work them

out for myself, and had to find the style of work that

best suited me.

Macroeconomic Policy and the Credit Crisis

Michael Wickens is a Professor of Econom-ics at the University of York. He was formerly Managing Editor of The Economic Journal. He now serves as Specialist Advisor to the House of Lords Economic Affairs Committee. He is a Fel-low of the Centre for Economic Policy Research, Fellow of the CESifo Group and is a consultant to the International Monetary Fund and the UN Food and Argiculture Organisation. Mi-chael’s is the author ofMacroeconomic Theory: A Dynamic General Equilibrium Approach, (Princeton University Press).

A central concern of macroeco-nomics is how best to con-

duct monetary and fiscal policy. Despite lengthy and authoritative expositions in macro textbooks, there is still no consensus on the answer. The current crisis in the eurozone, the UK government’s emphasis on bringing down its deficit and debt despite a double dip recession, and the switch of the Bank of England to uncon-ventional monetary policies show how deep and unresolved the problem is. For several years, my research at York has focused on these issues.

Before the eurozone crisis, I identified the problem that would come to engulf the eurozone. My diagnosis was that although the ECB had been successful in achieving its target for average inflation in the eurozone, its mon-etary policy was inappropriate for most eurozone countries. Until the euro crisis it was difficult to persuade the ECB that there was a problem with a single currency. Initially, joining the euro seemed

extremely beneficial to the weaker economies: Ireland grew by more than 40%, Spain and Portugal grew similarly, while Germany grew by only 10%. However, the price level in Ireland also rose by 40% and the price levels in Spain and Portugal grew by around 35%, while Germany’s rose only 5%. The problem was that – for coun-tries with higher inflation than average – monetary policy was too loose and resulted in cheap credit, while – for countries with lower than average inflation – credit was much more expensive. As a result, countries like Greece, Ireland, Portugal and Spain borrowed far too much – much of it on residen-tial construction – and are now paying the penalty. In short, the single currency has played a major part in causing the debt crisis.

The solution that I recommended was that, having given up their monetary independence and still having an inappropriate monetary policy, they had to use tighter fis-cal policy to compensate. In fact, because borrowing was cheap,

12 Spring 2013

their governments spent freely and debt-financed this. Even now the Commission is trying to im-pose a uniform fiscal policy on EU countries when what is required is a policy tailored to each country’s situation.

A closely related issue is whether or not a government’s fiscal stance is sustainable. If not, it must change. In other research I pro-posed a way of determining this.

Based on the government budget constraint, the aim is to assess whether future expected budget surpluses are likely to be suffi-cient to pay off current govern-ment debt. I found that many EU countries have for many years had unsustainable fiscal stances, in-cluding countries, such as France, commonly thought to be in a healthy fiscal state.

The UK government has been heavily criticised for seeming to be more concerned with reducing its deficit and debt than in borrowing more in order to deficit-finance a stimulus to the economy, the text-book recommendation in reces-

sion. The basis of the government’s policy is the large structural deficit inherited from the previous gov-ernment – due to a huge expan-sion of welfare benefits and spend-ing on health that was financed by borrowing when it should have used taxes – and the concern that higher government borrowing would become increasingly ex-pensive as the credit rating agen-cies would then downgrade their rating for the UK. Recent state-ments by the credit rating agencies have made this even more likely. This has raised the influence of the credit rating agencies on fiscal policy.

How the credit rating agencies reach their judgements is a puz-zle. At the same time, the fact that they gave a triple-A rating to both the UK and the US throughout

the financial crisis has tended to undermine the agencies’ credibil-ity. My current research proposes a new way for a government and the financial markets to assess the credit rating of government debt. This is based on forecasting the future debt-GDP ratio and evaluating the probability that this exceeds the upper limit on sus-

tainable debt. It appears, accord-ing to this research, that both the UK and the US should have had a credit downgrade from 2007, contrary to what the credit rating agencies have said.

I hope that you will agree that all of this shows that macroeconom-ics is dealing with important and interesting issues that are worthy of your study. There are many other similar issues for you to research on in your PhD!

Michael Wickens

Professor of Economics

University of York

Because borrowing was cheap, governments spent freely and debt-financed

this.

How the credit rating agencies reach their judge-

ments is a puzzle.

13

how to turn it to your advantageBy Jacco Thijssen, Chair Departmental Teaching Committee and Feedback Coordinator

We’ve all been there. You get a disappointing mark for

an assignment and you feel frus-trated. It is worth, however, taking a couple of minutes to examine how you react, as time and again we find that what distinguishes outstanding students is not their early marks, but their attitude to feedback. In fact, being able to use feedback in a constructive way is one of the most important trans-ferable skills you can take with you when you leave York, and it is one that we take very seriously in the Department.

We know from the NSS that feedback is high on your list of priorities, and it’s an area in which we’ve worked hard this year. In addition to helping you improve your grades (something we’re both interested in!), we also hope to better prepare you for your profes-sional career, where independent learning and being able to spot for yourself when you’re not on the right track really comes into play.

When I speak of feedback here, I mean feedback on work that you are asked to engage with during term time. Our policy is clear on this – you will receive at least one piece of feedback per term per module. This can take various forms, such as comments on writ-ten work, or model solutions to problem sheets.

The deal we strike

Feedback truly is a two-way process. The deal between us is clear. You put a lot into your as-signments, and we put a lot into designing feedback that helps you to (i) engage with learning, (ii) improve your understanding of the material, and (iii) allow you to develop a critical attitude to your own work. That seems fairly sim-ple, but often the process breaks down, causing frustration for both parties.

How to get the most out of feedback

1. Make sure the objectives of the task are clear to you.

Remember that old piece of exam advice: ‘answer the question’? It’s well-acknowledged that students often put many hours of unpro-ductive work into their studies (see, for example, Kember et al., 1996). It’s really important that, before you begin, you’re absolutely clear about what you’re being asked to do. Giving unambiguous

instructions is something we work hard on in the Department, but it is difficult sometimes to place our-selves in the student’s shoes and imagine what it was like before we knew what we know. Therefore, if the goal of an essay/problem sheet is not clear, ask.

2. After finishing the task, but before handing it in, try to mark your own work.

How good are you at critically as-sessing your own performance? It can be interesting to put this to the test. Before you hand in your next assignment, try to give yourself a mark for the work that you are going to submit and then compare with the actual result.

This is an important skill, because in your professional career you

In fact, being able to use feedback in a constructive way is one of the most im-portant transferable skills

you can take with you when you leave York, and it is one that we take very seriously in the Depart-

ment.

14 Spring 2013

will have to be able to judge the quality of your own work before you send it to your manager/team/client, etc. This is also where model solutions come in. These only make sense if you use them to compare to your own solutions. If your own assessment of your work is very different from that of the academic who has marked it or provided the model solutions, make sure you use our office hours to find out why.

3. Upon the work being returned, try to square your own judgement with that of the academic using the comments provided.

When you get feedback, good or bad, make sure you spend suf-

ficient time digesting it. If you’ve put considerable time into your assignment, don’t rush engaging with the feedback.

Numerous studies show that often feedback is either not read at all (Hounsell, 1987) or not understood (Lea and Street, 1998). A quick example from my own experience might illustrate. In the first year module “Intro-duction to Statistical Theory”, each student hands in two prob-lem sheets. I noticed during the spring term last year that the same group of students, on the whole, made the same mistakes in

both problem sheets. That indi-cates that somewhere between my writing comments on student work and your receiving those and acting upon them, something does not always work. If parts of feed-back that you receive aren’t clear, ask.

4. Use the feedback on your work to improve performance in your next piece of work.

In my experience, becoming better at something you once found dif-ficult is even more satisfying than doing something with ease from the outset. It means you’ve got some return on your investment. If you’ve had poor feedback, use it well, and turn it to your advan-tage.

If in doubt, ask

There’s a common thread run-ning through this article, and it’s this: if in doubt, ask. Ask your-self if you’re clear what you’re being asked to do. Ask yourself what mark you’d give yourself. Ask yourself or your tutor how the mark was arrived at. Finally, when you get that feedback, ask yourself how you’re going to deal with it. And make sure you turn it to your advantage.

References available online.

When you get feedback, good or bad, make sure

you spend sufficient time digesting it. If you’ve put considerable time into your assignment, don’t rush engaging with the

feedback.

There’s a common thread running through this ar-

ticle, and it’s this: if in doubt, ask.

15

As the White House and Congress play politics on the

brink of a fiscal cliff, doubts have inevitably emerged about the ro-bustness of the US recovery. Will the uncertain outlook for US fiscal policy hold back business invest-ment and consumer confidence? Will America follow Europe into recession as fiscal policy tightens? And how will all of this impact the UK?

The US economy was allowed to recover…

The experience of the Eurozone is not particularly illuminating

since unlike the US, its imbalances are internal rather than external. The UK offers a more interesting counterfactual since like the US it was unbalanced by a bubble in credit and asset prices and needs to make similar price and bal-ance sheet adjustments. It offers an interesting comparison since it embarked on a programme of fiscal adjustment at an early stage of its recovery. Arguably, the UK did not have the luxury that the US did of waiting for the economy to recover fully before retrenching. Even so, this comparison reveals a lot about our own economy and where we are going wrong.

…before being knocked back by fiscal retrenchment

Many commentators have sug-gested that the disappointing nature of the UK recovery and retrenchment largely reflects the decision to attempt the fiscal ad-justment before the private sector had time to recover. In contrast, the US allowed the household

sector to deleverage without the added pressure of the austerity programme, which has made this adjustment so much harder for UK households. Furthermore, the US allowed foreclosures and sales of newly built houses to push prices back into equilibrium, while in the UK these adjustments were eased by policy measures and forbearance on the part of lend-ers. During 2009 and 2010 over four million families lost their homes in the US, compared with 86 thousand in the UK. Follow-ing this brutal adjustment, the US housing market has bottomed and is now bouncing back strongly. The result, as the first two charts show, is that the US has been able to reduce its deficit in a similar way to the UK, but using market adjustments and growth-friendly policies rather than austerity.

Similar contrasts are seen in the labour market. In the UK, employ-ers and employees agreed short time working and other schemes to keep staff on as output fell,

Challenges for the new econ-omy: scaling the fiscal cliffBy Peter Spencer, Professor of Economics and Finance, Department of Economics

The charts in this article show developments over the last decade and are extrapolated using the ITEM Club Winter Economic Forecast, published on 21 January.

16 Spring 2013

while in the US employers took a sharp knife to payroll. Conse-quently unemployment rose much more rapidly in the US, approach-ing 10% of the labour force. The UK paid a price in terms of labour productivity, which fell sharply in the recession and has been very weak during the recovery phase. Although the recent growth in

UK full time employment has been impressive, it is unlikely that this growth will be maintained if the economy remains in the doldrums. The worry is that firms that have held on to staff in the hope of an upturn will be disap-pointed and start to shed staff.

Remarkably, US productivity and profitability hardly fell at all dur-ing the recession and have been very strong during the recovery phase, putting US producers in a very competitive position in-ternationally. Labour cost infla-tion normally increases during a recession due to the cyclical fall in productivity, but the first of the charts shown below reveals that it actually fell in the US during the recession, in contrast to the experience of UK and other coun-tries. The chart on the right of the next pair shows the level of each country’s labour costs measured in dollars, compared with those

of its competitors. The effect of sterling’s 2008/09 devaluation in bringing down our relative costs is very clear. Although the dollar has depreciated against the Euro and other countries, the downtrend in the costs of US firms is largely due to their high rate of productivity. They are winning back market share at home and abroad and

many are moving production back home from overseas. I think that the US should be able to keep the spectre of recession at bay despite the effect of the dysfunctional political system on consumer and corporate confidence.

The Fed led the way to recovery with innovative financial policies…

Another contrast is evident in the sphere of monetary policy. The Fed has been much more innova-tive than the Bank of England in dealing with the financial crisis and supporting economic activ-ity. It was quick off the mark when the money markets froze in August 2007, immediately recog-nising the threat to the banking system and the wider economy and flooding the money mar-kets with liquidity. Instead, the Bank of England was transfixed by the bogey of moral hazard and did not accept that the game

had changed until the Northern Rock collapsed six weeks later. Its programme of Quantitative Easing has focussed narrowly upon the gilt market, avoiding the purchases of residential mortgages and other securities that the Fed has made. The Funding for Lend-ing Scheme is certainly an innova-tion for the Bank, but it leaves the

banks with the credit risk while providing cheap funding.

…putting the US economy in a good position to withstand a fiscal contraction

Part of the problem admittedly lies in the very specific inflation remit set for the MPC by the HMTreas-ury. In contrast, the Fed has a dual mandate, involving both inflation and unemployment. This gives it a great deal of flexibility,

17

which it has used to the full. Last September the Fed’s rate-setting panel, the Federal Open Market Committee (FOMC) announced that it would make unlimited purchases of residential mortgages to stimulate household spend-ing and the housing market until there was a significant improve-ment in the labour market. Then at its December 12th meeting the FOMC announced that it would keep interest rates close to zero until unemployment had fallen below 6.5% or until inflation was forecast to exceed 2.5%. The Fed’s switch to a pro-growth policy stance should have the effect of making the private sector more confident about future economic activity in the face of fiscal and other shocks, in the same way that its former anti-inflationary stance bolstered confidence in low and stable inflation.

The UK Treasury and MPC…

Now, with a new Governor desig-nate, the Bank and the Treasury are in a position to reassess the remit. It is clear that although in-flation targets initially worked well in stabilising price expectations, they passed their sell-by date around the turn of the millenni-um. With the benefit of hindsight it is now clear that a favourable supply-side shock taking the form of a fall in world consumer goods price inflation initially kept inter-est rates artificially low and helped stimulate a credit-fed bubble in as-set prices. Then in the second half of the decade the shock turned negative as oil, food and other commodity prices pushed up to record highs, putting upward pres-sure on inflation and interest rates and crushing consumer spend-ing power. With the economy in recession, the MPC faced an

invidious choice: between fur-ther depressing the economy and risking its reputation by allowing inflation to consistently overshoot the target. … should now adopt a more sensi-ble target…

Money GDP (MGDP) growth targets have emerged as the front runner in the debate about a new remit. The growth in MGDP is not difficult to understand: it is sim-ply the sum of real GDP growth and inflation and thus gives equal weight to both. This is appropri-ate when inflationary expectations are well-anchored and the cen-tral bank can afford to give some weight to what is happening in the real economy.

The main argument for a MGDP target is that it handles the effect of external supply side shocks very neatly. The basic idea as we know from macro lectures is that the central bank can control the money value of output but not the way that this is split between real

output and prices. This split is de-termined by the private sector. The central bank can however steer the inflation trend indirectly by setting the growth in the money value of output in line with the trend in real productive poten-tial and a medium term inflation target. If an adverse supply side shock (like a rise in world com-modity prices) occurs, then output falls below trend and inflation moves above trend for a while, with the opposite happening for a favourable shock. Either way, inflation departs temporarily from trend without seriously disrupting the real economy or damaging the central bank’s reputation.

…to accommodate supply-side shocks…

This is the textbook argument for the superiority of MGDP over inflation targets and seems com-pelling in current circumstances. Moreover, the money value of output is not just easier for the MPC to control, it is also much easier for the Office for National

The Bank of England on Threadneedle Street, London, England

18 Spring 2013

Statistics (ONS) to measure than inflation. We naturally look at our income and expenditure in pounds and pence. Companies do the same for their management, as well as the taxman and sharehold-ers. Splitting these values into real and price components is relatively straightforward for a manufactur-ing firm producing standardised that can be measured as physical quantities. However this is notori-ously for service sector firms that have sales invoices and perhaps figures for payroll and hours worked but few tangibles to go on. Digital products, which have zero marginal cost, also present formi-dable measurement problems.

…and handle measurement prob-lems…

The problems of measuring infla-tion in the consumer sector have been highlighted by the ONS pro-posals to change the methodology used to construct the RPI. Techni-cally, it is very difficult to devise indices that do not suffer from an in-build upward bias. The RPI is particularly prone to this problem and has the awkward property

that it shows an increase in prices if they fluctuate during a period even if they return to where they were at the beginning! Indeed the advent of the new CPIH and the new RPI measures proposed by the ONS in their attempt to duck the issue of index bias has left us with nine official inflation meas-ures. Take your pick!

…without risking credibility

As ever, there are one or two caveats. The textbook explana-tion of MGDP targets assumes that in order to steer the medium term inflation trend the authori-ties can assess the output gap and the trend in productive potential. However these are particularly difficult to gauge at the mo-ment. The adoption of a target for MGDP growth would mean that this uncertainty was mirrored in the inflation trend – a disappoint-ing economic growth trend would mean that inflation was consist-ently higher than expected for example. Also, to get MGDP we subtract the value of imports from the value of total expenditure. This leads to all sorts of statistical

quirks and would make MGDP give a misleadingly good signal if a spending boom was met from imports. It would make much more sense to target the growth in the money value of Total Final Expenditure.

The standard argument for an inflation target is that inflation figures are understood by the general public and are available on a timely basis and never revised, unlike GDP figures. However, an intelligent lay person would surely understand why it was important to put economic growth on a par with inflation in present circum-stances. Moreover, recent infla-tion target overshoots and debates about the way that inflation is measured have undermined the credibility of the inflation target. Ultimately, with employers now firmly in the driving seat when it comes to negotiating wages, it is not clear that public perceptions of inflation count for very much anyway these days. Perceptions are crucially important in bond and foreign exchange markets but these are surely sophisticated enough to accept the arguments for a change in the remit. In my view, apart from these minor caveats there would seem to be little reason to continue to target an indicator that is very hard to measure, let alone control.

19

By James Paton, 3rd Year Philosophy, Politics and Economics

The Unsung Heroes and Heroines – The Entrepreneurs

The public always looks to-wards politicians and bu-

reaucrats for the solutions to all economic problems – especially in times as grave as the present. However, the people we should be looking towards are not politi-cians. I argue that the capitalist or, a name with less negative con-notations, the entrepreneur, is by far the most important person in society. These individuals are driv-ers of change, sources of growth and employment, and ultimately form the engine of wealth crea-tion. This is not an exclusive group of people, but can be anyone will-ing to have a shot at running their own business – no matter how big or small.

Prices transmit dispersed knowl-edge throughout the economy and, through this mechanism, profit can be calculated. Chas-ing profit is the end of the entre-preneur and this is fundamental to the process of discovery and creative destruction that generates material wealth. Entrepreneurs are really the unsung heroes and heroines of society, and the public should admire, praise and look to them for inspiration. They will not help us out of the current mess unless we truly set them free from the burdens of government regula-tion and taxation.

Entrepreneurs use prices, as knowledge is distributed across

the economy (See Hayek, 1945). Prices aggregate individuals’ pref-erences in particular markets, and changes in preferences lead to the fluctuation of the prices for goods and services. This is not to say that markets are ‘perfect’ and ‘purely’ efficient, as the imperfection of human action and markets is what makes markets work (Butler, 2010: pp. 48-49). Mistakes happen, which makes markets fallible, but prices guide the flow of resources to the production of that which consumers most want.

With prices set by the market for inputs and outputs, entrepreneurs calculate expected profit from their investment. The individual who organizes the means of pro-duction wants to make money, and therefore seeks to maximise profit. He must make use of the very limited resources that he has, and use them to the best of his knowledge. There are two schools of thought on entrepreneurialism that can enlighten us on this issue.

Kirzner saw entrepreneurship as a discovery process (Sobel, 2008): as individual firms are guided by profit, they try to shape individual preferences with new and innova-tive products that no one would ever have seen before. By calculat-ing costs, potential revenues, and therefore expected profits by using market prices, they decide to sup-ply the market with new services

or products. Through this pro-cess, many products have become crucial to our lives (such as mobile phones), but others fail. Entrepre-neurs will adjust their behaviour in the light of their mistakes, communicated through the price and profit and loss mechanism, by quickly changing course .

On the other hand, Schumpeter argued that entrepreneurship was creatively destructive (Schumpet-er, 1961). In a competitive market environment, firms are always seeking profit: to do this they must be constantly innovating, making

better quality products or services for their consumers and always trying to achieve these goals at the lowest cost and price. Through new methods and the creation of new, better quality products at lower prices, entrepreneurs move on from old methods and products, to achieve their end of greater profit.

In most cases, entrepreneurship

If we want to set entre-preneurs free, and spur a new generation of ambi-tious individuals to build a wealthier, more innova-tive and dynamic society, we need to call on govern-

ment to do less.

20 Spring 2013

seems to me to be more like a dis-covery process. A small restaurant owner seeks to change the taste and test the preferences of the lo-cal community’s palate for exam-ple. However, there seems to be a bridge between the two theories – especially in consumable goods, where innovators are driving creative destruction. It seems that markets have a tangible discovery process. Take, for example, video cassettes: the destruction of videos through their replacement by DVDs, and then by digital files. It seems by simple analogy that we need discovery before destruction, but both are vitally important in the process of wealth creation.

The importance of a free market and unfettered price mechanism is therefore founded upon the distri-bution of knowledge throughout society. When governments inter-vene in the market through spend-ing and taxation, this distorts the mechanism that brings together fragmented knowledge.

First, a government central plan-ner cannot know where to put resources because market knowl-edge is dispersed, not centralised. There is no market and no rational pricing mechanism when gov-ernment tries to provide a ser-vice through a central body (the socialist calculation problem –see von Mises, 1920), and it hence does not know where to allocate resources.

Second, intervention distorts the price mechanism because it cre-ates false demand for goods and services. As prices rise because of government spending, this distorts the mechanism and pushes the real reflections of market prefer-ences to what they are. Resources therefore tend to be misallocated by government to what the market really demands.

Third, where government does not compete, and does not have an in-centive to use resources efficiently (as it has the power of taxation to raise more funds), and is not motivated by profit, where does innovation come from?

If we want to set entrepreneurs free, and spur a new generation of ambitious individuals to build a wealthier, more innovative and dy-namic society, we need to call on government to do less. As I have

argued, resources are best left with the people who are trying to make a profit, as they wish to make our lives better on the condition that they serve us with better products, services and at the lowest cost and prices. This is why first we need to cut taxes so entrepreneurs can keep what they earn in order to spur them on to become even more entrepreneurial. Second, the state needs to cut spending so firms can allocate resources to what the market demands, by letting the price mechanism work with less interference. And finally, we need to bring down the wall of bureaucracy that scares potential entrepreneurs away from starting their own business. It raises costs, so profits are eaten away, deter-ring entry into the market and the expansion that is required for greater national growth, output and employment.

References available online.

21

Inequality - So What?By Dominic Falcão, 3rd Year Philosophy, Politics and Economics

Typically, politicians stay away from the idea of really tack-

ling inequality of outcome. And it is quite clear that this is because the first obstacle is persuading anyone that it is a problem. Peo-ple are different, their activity in the world will bring them differ-ent fortunes. Our lives are not trains that can be regulated and made to advance at a steady, even pace (and even trains are seem-ingly troublesome to maintain in check). And even if they could be, the argument goes, our incomes would only stay even because no-one would earn anything at all - there would be no incentives, no differentiation between people. And there must be something true in these kinds of arguments: some people are more hard-working, do make bigger sacrifices to advance themselves and so the economy, their talents rarer, their productiv-ity higher and so on. Moreover, a perfectly efficient market is comfortably the most effective way of converting these inequali-ties in talents into incentives, and

it is one that necessarily leads to inequality of outcome. What’s the problem?

In considering why the market can appear both disgusting and perfectly suited to its task, it is important to note that the quotes from Sen and Gauthier above are founded on different premises. Their arguments do not overlap at the most important point: the fundamental goal of whatever

framework governs society. For Sen, if a society fails to ensure that people have the basic tools to lead a good life, there is something urgently wrong. For Gauthier, even if society seems “unfair”, interference for “moral” reasons needs explanation beyond moral intuitions: a society which acts in ways that cannot really be justified in terms of the self-interest of each individual (to put it crudely) acts in ways that are not justifiable at

At present, across OECD countries, the average income of the richest 10% of the population is about nine times that of the poorest 10%. While this ratio is much lower in the Nordic countries and in many conti-nental European countries, it rises to around 14 to 1 in Israel, Turkey and the United States, to a high of 27 to 1 in Chile and Mexico.

Growing Income Inequality in OECD Countries: What Drives it and How Can Policy Tackle it ? Forum, Paris, 2 May 2011

“[Efficiency can exist] even when some people are rolling in luxury and others are near starvation, as long as the starvers cannot be made better off without cutting into the pleasures of the rich. In short, a society can be Pareto optimal and still be perfectly disgusting”

Amartya Sen, 1970, Collective Choice and Social Welfare

What is central to a view of justice grounded in rational choice—that it does transmit natural inequalities into outcomes ... social institutions that failed to do this would not be rationally acceptable in failing to recognize the separateness of persons.’

Gauthier (1993b). ‘Uniting Separate Persons’, in Gauthier and Sugden (1993: 176–921).

“So long as the gap is smaller, they’d rather have the poor poorer”Margaret Thatcher, Prime MInister’s Questions, November 22, 1990.

22 Spring 2013

all. If the purpose of a cooperative enterprise like “society” is mutual advantage, this must be the final judge. In between these two posi-tions is the key gulf: the fact that there are some basic tools to lead a good life that it is not in everyone’s interests to provide. It is perhaps this conflict which makes equality such a vexed issue for politicians. If people need things, they need to justify any deprivation that fulfill-ing that need entails (how do we justify tax to those taxed if they don’t gain from it?).

But there is not only a conflict at this lower end, there is a gap at the higher end of the scale too. Gauth-ier notes in Morals by Agreement that if an individual’s rare talents allow her to extract economic rent (income above the marginal pro-duce that he contributes to socie-ty), the market is failing to allocate efficiently and the positions of some can thus be improved with-out making any worse off. Never-theless, it is just too quick to take advantage of this shortfall and say: tax the money and give it to those who will not survive without it, or whose lives will be significantly improved by it. For instance, their lives may well significantly improve if they pull their socks up and work conscientiously. In which case, welfare actually makes everyone worse off: the rich are taxed and poor disincentivised from contributing to the economy. Righting inequality thus runs into underdetermination of outcomes and the problem of personal re-sponsibility; the state doing things for people who would otherwise do things for themselves. Even where the market is inefficient, there is not a clear justification for interference.

Despite this complexity, justifica-tions for reducing inequality are

very wide-ranging and persua-sive. I will not attempt to deal with all of them here, but will merely attempt to (very briefly) survey some of them. One set of arguments focus on the relation between stability and inequality, as third year students of Applied Economics will be aware. An ama-teur historian might be tempted to offer this as a reason for the rise of welfarism post-WW2. Con-temporarily for instance, at the time of the London riots, many cited inequality, resentment and “class” tension as causal reasons for that unrest. If it is the case that inequality causes instability, it is surely in everyone’s interests to take appropriate measures to alter this? And indeed, there is a significant body of literature gesticulating quite roughly in this direction (with all of the attendant difficulties that such gesticulation inevitably entails):

“A large group of impover-ished citizens, facing a small and very rich group of well-off individuals is likely to become dissatisfied with the existing socio-economic status quo and demand radical changes, so that mass violence and illegal seizure of power are more likely than when income distribution is more equitable.” 2

And it is just this sentiment that the Economist quotes Dominique Strauss-Kahn as expressing:

“More unequal countries have worse social indicators, a poorer human-development record, and higher degrees of economic insecurity and anxi-ety.” 3

Alesina and Perotti, from whose work that quotation above is lifted, do not stop at the relation between inequality and instability, but try to show a connection between

23

inequality and growth by showing that instability threatens investment by reducing certainty about the future of the economy. Less growth, less mutual advantage: might this satisfy a Gauth-ierian proponent of firm inequality?

The Spirit Level by two University of York lecturers provides a gamut of arguments:

Inequality causes shorter, un-healthier and unhappier lives; it increases the rate of teenage preg-nancy, violence, obesity, imprison-ment and addiction; it destroys relationships between Inequality Inequality causes shorter, un-healthier and unhappier lives; it increases the rate of teenage preg-nancy, violence, obesity, imprison-ment and addiction; it destroys relationships between individuals born in the samesociety but into different classes; and its function as a driver of consumption de-pletes the planet’s resources.4

My personal feeling is that the best way of construing tax in terms of the self-interest of the taxed (if we must face Gauthier on his own premises) is to refer to Sen’s idea of a “perfectly disgusting” society: if my greater wealth comes at the cost of convert-ing my society into something that is “perfectly disgusting” this is a non-monetary incentive to accept tax of almost universal appeal. This is not revolutionary, it does not rest on ques-tionable metaphysics; it simply gets at a good reason for acquiescing to some taxation and not fleeing to the Isle of Man. It is this idea which motivates unrest too: a highly unequal socio-economic order which neglects the vulnerable is in a clear way repugnant, and being part of a repugnant society is something we ought to resist, with force if necessary.

References available online.

But, Justice - So What?By Dan Howdon, 3rd Year PhD Economics

Dominic’s article correctly, I think, identifies one

unhelpful diversion in seeking to achieve greater equality of opportunity. I too think that there’s little to be gained in engaging with abstract theoreti-cal discussion about what a ‘fair’ society constitutes, and what the pursuant implications for inequality are. I don’t, however, think the answer is to seek to justify greater equality of out-come to every member of our present society in terms of their

own self-interest. If our aim is to equalise outcomes, it does not seem to me that this is best achieved by giving a veto, on movements from an initial dis-tribution, to those who benefit most from this current distri-bution, and to encourage them to use this veto where their self-interest is harmed. There is one big, unasked, question that pervades all of these issues.

What do we talk about when we talk about inequality?

From the weighty file of Bad Arguments in Favour of Good Ideas, Alesina and Perotti are quoted as stating that (I para-phrase only slightly) a substan-tial change in the social order would leave Phillip Green six feet under, whereas his Top Shop cleaners would live a rela-tively unchanged life. I’m not sure about the merits of this as an argument for greater equality

of outcome, except as the meek-est justification for any taxation of the rich at all. If we adopt this position, we’re accepting an implicit objective of seeking to minimise the extent to which we reduce unequal outcomes within society, handed down by the ineffable logic of our exist-ing economic relations, subject to the constraint of not provok-ing a full-blown revolution. In

Photo: ktprior (http://www.flickr.com/photos/23743449@N00/480539103/sizes/l/in/photo-stream/)

24 Spring 2013

short, we accept the power rela-tions within society as given, and we see if it’s possible to tinker at the edges – but only insofar as, in doing so, we further protect the essential character of these power relations themselves. This may be fine depending on your objectives, but seems to betray something of a paucity of ambition on the part of those apparently in favour of equality of outcome.The fundamental reason for which politicians do not tackle inequal-ity of outcome is that they do not wish to do so. Not only is the virtue of meritocracy (a term born from a satirical warning about the idea itself), and its corresponding unequal rewards, an ‘unknown known’ within society1, but the benefits of inequality are, tautolog-ically, unequally shared. That ine-quality of outcome is a problem to those at the bottom is obvious to those at the bottom: it simply isn’t experienced as a problem to those at the top. It is unlikely that any theory of fairness, no matter how

elegant, or any attempt to con-vince the rich of the self-interest of the forfeiting of their advantage, will affect this. As Aesop – ac-cording to some fiction, relevantly, an ex-slave – wrote: ‘When the hares addressed a public meeting and claimed that all should have

fair shares, the lions answered: “A good speech, Hairy-Feet, but it lacks claws and teeth such as we have”.’ Those who wish to push for equality of outcome should seek to increase the power of the weakest in society, rather than seeking to

‘justify tax to those taxed if they don’t gain from it’, or ‘appeal to everyone’s interest’.

I think this is in part why I in-creasingly become ill-tempered with appeals to ‘fairness’ or ‘jus-tice’ as a political slogan, or a domain of enquiry in general. Nobody ever points out that, let alone questions whether, say, the victims of a murder are the victims of an injustice. Not only would this appear as hideously insensitive, but also as a category error, akin to questioning whether the colour pink can swim across the Atlantic Ocean. The best you’ll popularly get, when our own systems bring about deaths that could be delayed2, is a dis-cussion of whether this is is ‘fair’. More important than the political sensitivity of what defines ‘fair-ness’, the determining of what falls under the umbrella of what may be discussed in terms of ‘fairness’ is itself a political act.

In short, we accept the power relations within so-ciety as given, and we see if it’s possible to tinker at the edges – but only inso-far as, in doing so, we fur-ther protect the essential character of these power

relations themselves.

25

To kick essential political questions of who gets what into the long grass grow-ing resplendently in the

abstract realm of fairness is, given the existing mas-sively unequal power in

society, to avoid answering these questions at all.

RD Laing, writing in 1967, noted that it was popularly taught that questions in this sphere of value judgement were considered to be ‘unanswerable, or untestable, or unverifiable, or not really ques-tions at all’ and that ‘[m]eanwhile, Vietnam goes on’3. While Viet-nam may have ended, it would be hard to dispute this today. So much writing about, and study of, fairness seems to be the only competitor to mainstream eco-nomics in the studious avoidance of the issue of power, and the re-sults of it. As a working example, I’ve personally heard one of the many worthy people referenced in Dominic’s article publicly whinge, without providing any context or suggestion of understanding of

why this is the case, about how rude and incompetent call-centre workers are. Thanks for your beautiful discussion of inequality of outcome: I too enjoy my com-fortable academic position. To kick essential political questions of who gets what into the long grass growing resplendently in the abstract realm of fairness is, given the existing massively unequal power in society, to avoid answer-ing these questions at all.

Dominic ends his article by sug-gesting that ‘being part of a re-pugnant society is something we ought to resist, with force if neces-sary’. It’s hard to disagree. But what form would this force take? Is this something to take serious-

ly? Are we all off to Blue Moon Trading on Goodramgate tomor-row morning? If not, where are the claws and teeth of those push-ing for greater equality? Where is the destruction in The Spirit Level? Comment is Free hand-wringing about fairness? In any economics you’ve ever read? I don’t know the answers to these questions, but it’s just as well that, before we react with horror to Dominic’s clear, explicit and unmistakable call for social revolution, we recognise

that it’s only a latent, fully cocked, force within society that maintains the existing social order. As Doug Henwood, author of a superb ac-count of financial markets, re-

marks of his time as a secretary in a brokerage firm:

‘One morning, riding the elevator up to work, I noticed a cop standing next to me, a gun on his hip. I realized in an instant that all the sophisticat-ed machinations that went on upstairs and around the whole Wall Street neighborhood rested ultimately on force.’4

As any honest economist would surely agree, and as the Athenians attest, without mystification, in the Melian Dialogue: ‘Right, as the world goes, is only in ques-tion between equals in power, while the strong do what they can and the weak suffer what they must’5. Those genuinely in favour of equalising outcomes can have endless discussions as to how best to justify theoretically, or in terms of everyone’s own rational self-in-terest, what they deem to be a de-cent or just society, but they would do well to take heed of this: God knows, their opponents have...

References available online.

I don’t, however, think the answer is to seek to

justify greater equality of outcome to every member of our present society in terms of their own self-

interest.

26 Spring 2013© Ernst & Young 2011. Ernst & Young is an equal opportunities employer and welcomes applications from all sections of the community. The UK firm Ernst & Young LLP is a limited liability partnership and a member firm of Ernst & Young Global Limited.

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