An Illustration of Wealth Inequality in America

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Powerful data visualisation illustrating the point below. While the principle of inequality is not problematic in itself, the actual position today is toxic – and not just in America

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Inequality, Happiness and how Economics got us lost

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It’s increasingly obvious that one of the issues that emerges from our current social set up is growing inequality. No longer the domain of marginal voices on the far left, talk of a crisis in capitalism and inequality that is economically inefficient is now firmly mainstream. This post will look at why equality is a worthy goal to pursue in its own right.

Economics’ focus

Orthodox economics tends to focus on growth (and to a lesser extent, employment) as the primary goals of economic policy. This wasn’t always the way however.

Jeremey Bentham, a pioneer of the discipline in the Eighteenth century argued the goal of economic policy should be to bring about the greatest happiness of the greatest number of people. What happened next is crucial. Typifying the best and the worst of economic thinking, there was a move to produce a simpler, intellectually more elegant model. Rather than attempting to measure all the intangible inputs to societal happiness, it was assumed that people would spend their money in a way that maximised their personal happiness. Following this logic, giving people more money to spend increases the amount of happiness each individual can buy, and thus the most efficient way in increase total societal happiness is to increase total societal income.

As with any classical reductionist model, it is contingent on a number of assumptions. The passage of time has made these assumptions less and less tenable.

1. Increasing income will increase happiness

This was difficult to measure initially, but advances in neuroscience and survey methods have given us reliable measures of happiness. While increasing income leads to increasing happiness initially, beyond a certain point the relationship breaks down – as argued by Richard Layard – and demonstrated in the graph from the World Values Survey below.

Graph of income against happiness from the World Values Survey

The upshot of this is that increasing the wealth of the wealthiest has minimal impact on their own happiness.

2. If a country maximises income, wealth will trickle down and questions of distribution will take care of themselves

This assumption has its basis in the work of Simon Kuzntes. Kuznets completed a study showing an inverted u-shaped relationship between GDP and equality. As countries grow, they become less equal initially. Kuznets suggested that a tipping point is reached however, and wealth is redistributed. Kuznets completed his study at a time when data was not available for any country over time. Instead, Kuznets used a cross-section of countries at one point. Despite being well received, the theory has failed to predict what would actually happen.

More importantly as time series data has become available,for individual countries the “Kuznets curve” has failed to manifest itself.

While Kuznets’ hypothesis is now widely discredited, the orthodoxy of focusing on growth and ignoring equality remains.

3. Happiness comes from growth in absolute income – not growth in our own income relative to peers

While this initially seems logical, there is a range of research showing the rivalrous nature of income – again excellently outlined in Richard Layard’s book, “Happiness“. Habituation and social comparison mean that beyond a basic level, absolute income is less important than income relative to peers.

4. The market will lead to a fair distribution of resources

Fairness matters to people’s happiness; and acting in a fair and cooperative way has been shown to activate neurotransmitters in the brain associated with happiness. For reasons discussed in the next post, inequality is growing, and increasingly there is a sense that the way the market distributes income is not fair. The last two points taken together mean that current policies that increase the wealth of the wealthiest can actually have a detrimental effect on societal happiness.

Taken together, we are pursuing happiness by maximising GDP, allowing the market to determine a relatively fair initial outcome and trusting the Kuznets curve to correct this initial distribution as necessary.

But maximising GDP is increasing the wealth of the wealthiest – whose happiness is largely unaffected by this increase; the initial market outcome is no longer perceived to be fair, decreasing everyone else’s sense of happiness; and the mechanism by which we thought society would correct this distribution turns out not to exist. These are clear signs of a failing and a need to intervene to ensure a more equitable outcome.

While classic economic theory might have produced seemingly fair outcomes up until now, that is less and less the case. The reality is the middle is being squeezed, the rich are becoming ostentatiously wealthy and the poor are being left behind and isolated as never before. Whether that is down to social dynamics, crony politics or something entirely random, its not good for us as a society. We have to recognise that a laissez-faire approach is no longer producing a fair, equitable or happy result.

Competing with Competition and the Wisdom of Starlings

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Photograph from Flickr. See the incredible original gallery here

Once upon a time, in a land not-so-far-away, a gaggle of economists thought very hard about the best way to bring the greatest happiness to the greatest number of people. They came up with some pretty smart answers: Among other things, in an attempt to increase the level of innovation, they identified competition as a useful spur and set up a system that legally protected competition, and rewarded those that won.

Except – as with all economic models – the idea is based on an approximation of reality. And while that approximation might be quite close at one point in time, the longer the model stands, the further from reality the model is likely to go. And more than that, the longer a model stands, the more likely people are to treat means as ends in themselves. In this case, competition was identified as a way of bringing about the greatest happiness for the greatest number, not as a goal to be pursued for its own sake. This is exactly what Christopher Meyer and Julia Kirby argued earlier this year in the Harvard Business Review.

With all the focus on competition, policy makers and organisations have forgotten, or overlooked the value of collaboration. In his excellent TED talk, Don Tapscott outlines his vision for an open society, based on collaboration, sharing, transparency and empowerment.

While the potential benefits for business are massive (as Tapscott’s Gold Corp example demonstrates), there is a lot of work for businesses to do to get to a place where they can make a difference. Rick Lash has argued that businesses produce the behaviours they reward; and at the moment, they reward employees who work in silos and will turn the world upside down to achieve the objective they have been set. Lash argues that a totally different competence is needed to build a collaborative organisation – one that rewards teams forsaking their own objectives for the sake of the broader organisation. He offers the example of how Apple were able to develop the i pod far more quickly than Sony developed their MP3 Walkman, because they recognised the potential of the product for the company as a whole far outweighed the projects they were working on in individual functions. Beyond that, a collaborative organisation might genuinely commit time to crowd-sourcing and incentivise employees for proactively look to connect disparate strengths in the organisation. Most importantly, organisations would put their best ideas and their biggest problems in the public domain, acting as a focal point and moderator, rather than a secretive, cannibalising black box.

The shift in mindset is massive, the legal infrastructure for it to work is nearly non-existant; but it looks to be the right model – the means to our ends for our time. And it’s on its way (see the UK government’s brave decision to make all scientific papers free to view)! If we can build half the enthusiasm for collaboration that we have had for competition over the last century, the possibilities are massive.