Will the elderly poor fare better under pensions means tests?

I ended my last post suggesting that it is absurd to provide pensions that are not subject to means tests because this involves taxing people of working age more heavily in order to add unnecessarily to the incomes of wealthy retirees. This raised the question of whether the elderly poor are likely to fare better in the context of the looming pensions crisis in OECD countries under means tested pensions or universal benefits.

This question is most relevant in countries that have not already adopted some form of pay-as-you-go universal aged pensions. Path dependency is involved. Once a country goes down the universal pensions path there are substantial political difficulties in back-tracking because this system encourages each generation of retirees to expect rewards for the taxes they have paid to support the preceding generations of retirees.

I expect that the political economy of how the elderly poor are likely to fare under alternative systems has been researched previously, but I haven’t yet found any papers that are directly relevant. So I will attempt to sketch out some preliminary ideas, based heavily on Australian experience.

One factor that will influence how the elderly poor fare under alternative pension arrangements will be their own political power as a group. This seems to vary greatly between countries depending on such factors as their use of voting rights. The presence or absence of means-testing could make an additional difference to the political power of this group since it identifies pensioners as a particular group of elderly people who have a common interest in lobbying for higher pensions. In that respect, means testing causes the interests of the elderly poor to differ from those of other elderly people.

Pension levels of the elderly poor are also likely to be influenced by the way the political objectives of other elderly people (and of middle-aged people who are planning for retirement) evolve under different systems. Peter Lindert’s analysis of the political economy of the public pension crisis seems to provide a good starting point to consider this. He summarises as follows:

‘At first, up to the 1980s, the rise of the elderly population gave the elderly more political clout in the industrialized OECD countries. The rise in their political strength was one reason why the relative generosity of pensions rose and budgets switched from fully funded pension systems to pay-as-you-go systems, giving one lucky generation higher pensions paid for in part by the younger generation. By the 1980s, the pressure on government budgets had become acute.

From that point on, the further rise in the elderly share of population began to undermine their political strength. True, pension budgets are not declining and are projected to rise a bit more as a share of GDP. Yet, the level of pension support per elderly person is destined to go on dropping as a percentage of the average income of the whole population’ (‘Growing Public’, Vol. 1: 208).

As the number of retirees rises relative to numbers of people in the workforce, their interests are increasingly aligned with those of the community at large in maintaining incentives for the goose to continue laying golden eggs. If excessive demands by retirees result in higher tax rates the adverse consequences for economic growth will be reflected back in their future pension levels.

The demographic transition stemming from lower birth rates and increased longevity is far more advanced in some countries (e.g. Sweden) than in others (e.g. Australia). Signs that the increase in the elderly share of the population may be beginning to undermine their political strength are only now beginning to appear in Australia, with a foreshadowed increase in the age of eligibility for pensions.

Australian experience suggests that when the aging middle classes have political clout they can exercise it to look after their own interests despite means tests for aged pensions. The relaxation of means tests, combined with tax concessions to encourage investment in private superannuation, has resulted in total government support for retirees being remarkably similar across a wide range of income levels (shown here). This suggests that total government support for retirees would be much the same under a flat rate universal system without incentives for private superannuation. Complicating matters further, however, the government has allowed people to access tax-privileged superannuation funds in lump sums prior to pension age. This has provided an added incentive for people to retire early, splurging lump sums and living off accumulated wealth until they become eligible for the aged pension.

As the increase in proportion of elderly people in the population in Australia reduces the per voter political power of this group, I would expect the per voter political power of the elderly poor to diminish to a smaller extent than that of the much larger group who hope to benefit from the private superannuation tax and pension means test rorts. I expect incentives for early retirement implicit in the superannuation arrangements will be an early casualty as attempts are made to contain government spending on retirees. If a choice has to be made at some time in the future between, say, maintaining the current level of the aged pension in real terms and maintaining superannuation tax concessions, I expect that maintaining the aged pension levels would be likely to win the political debate. Similarly, given a decline in grey power on a per voter basis I doubt whether superannuation tax concession would win the political debate if a choice has to be made at some time in the future between maintaining these tax concessions and an overall lowering in income tax rates to promote economic growth.

I suspect that the elderly poor would be less able to protect their interests under a universal pension because the support arrangements would not enable them to distinguish themselves as a group whose economic interests differ from those of other elderly people.

Does Wagner's law make sense?

Wagner’s law refers to the proposition of Adolph Wagner (1893) that there is a positive relationship between the level of economic development and the size of government. The underlying idea seems to have been that the demand for services provided by government tends to rise strongly as average incomes rise.

I think Wagner’s law still has a huge influence on the thinking of many economists. This influence is evident in the tendency of many economists to view big government as the norm for high-income countries. For example, it explains why economists pose questions like: Why doesn’t the US have a European-style welfare system? This is an odd question because there is considerable variation in the size of welfare states even within Europe and Swedish-style welfare systems are certainly not common among high-income countries outside of Europe.

The influence of Wagner’s law on the modern thinking of economists seems to rest on it being an empirical regularity or stylized fact. If you overlook the wide variation in size of government in high income countries, Wagner’s law does appear to fit some of the facts. Looking back at the recent history of individual OECD countries, most of them clearly had smaller governments 50 years ago when their average incomes were much lower. Yet, a recent study for the UK and Sweden from the beginning of industrialization until the present (a period of 177 years for the UK) found that Wagner’s law does not hold in the long run. The data are inconsistent with Wagner’s law in the initial industrialization phase (prior to 1860) and since the 1970s (Dick Durevall and Magnus Henrekson, ‘The futile quest for a grand explanation of long-run government expenditure’, INF Working Paper 818, 2010).

The Durevall and Henrekson paper also rejects a rival theory – the ratchet theory – that government spending ratchets up in times of crisis (wars, social upheavals, recessions) and then tends to remain at the new higher level. The expansion of government spending in the 25-35 years following WW2 cannot be explained in terms of a ratchet effect.

Some people might try to rescue Wagner’s law by arguing that it always applies at some stage during the process of industrialization. Thus it might be argued, for example, that Wagner’s law will result eventually in the development of big governments in jurisdictions such as Hong Kong and Singapore that have been able to restrain growth in government, even though they now have relatively high average incomes. However, there do not seem to be any reasons why governments of high income countries would necessarily find it harder than governments of medium to low income countries to resist political pressures to become more heavily involved in activities such as funding of retirement incomes and provision of education and health services. Nor would they necessarily find it harder to resist arguments for the social welfare safety net funded by taxpayers to rise more than proportionately as incomes rise.

If we were desperate to rescue Wagner’s law perhaps we could argue that bigger government is an inevitable response to political pressures associated with the demographic transition - declining birth rates and aging population age structures – associated with economic growth. On this basis Peter Lindert argues that we should expect an expansion of the welfare states in East-Asian countries ‘as they age and prosper’. In OECD countries, including Japan, political systems responded to an increase in the proportion of old people in the populations by providing pensions for aged persons. The further aging of populations has led to increased government spending on pensions - a major factor associated with the growth of government spending in high income countries. Lindert asks: ‘Do we really know that China, Singapore and other East Asians will be more resistant to rising transfer budgets than Japan has been, when they approach Japan’s income level and age structure?’ (‘Growing Public’, Vol 1: 221).

My answer to Peter Lindert’s question is that I don’t know how East Asian governments will respond to an increase in grey power. Perhaps they will see what lessons they can learn from the experience of the big government welfare states of Europe and decide that there is a better way to fund retirement incomes. They might even decide that the compulsory savings approach that has applied in Singapore since 1955 is preferable to the absurdity of providing pensions that are not subject to means tests. Why should people of working age be taxed more heavily in order to add unnecessarily to the incomes of wealthy retirees?

Are some questions too difficult? Part II: How can we understand teenage drug use?

This post continues my discussion with Ruth about teenage drug use. In the last post Ruth, a nurse who has worked in psych wards and prisons, illustrated the nature of the problem by telling the sad story of a man who has been suffering from drug induced psychosis (DIP) over a long period following an incident just before his 18th birthday.
Ruth continued:

It is well established that the human brain does not finish physiological development until well into the 20's, and that smoking one cone (none before and none after) alters brain wave functioning for up to 7 years. Together, these 2 facts paint a dire outlook for teens taking drugs of any sort.

Just as an aside, much of the cannabis available on the streets these days is lined with heroine as a 'good business measure' on the dealers part. No wonder most big time suppliers don't take drugs of any sort. For them, the cost is too great as they see first hand the longer-term effects of their drugs on their clients. Maybe that is a clue for helping - that the dealers are some of the few non-health workers who see these same people year after year. Most of us loose touch with people around us after just a couple of years, which is not long enough to see the long term effects of drug taking. These 'big guys' of the drug world understand the cost of drug taking, especially the cannabis suppliers. They have said to me as their intake nurse in the prison system over and over "I'm smart miss; I sell it, I don't smoke it".

On another note, the use of cocaine in the legal and corporate worlds is astounding - a colleague of mine who works as a consultant in this industry and who has a counselling background estimates that nearly 1/3 of these professionals are taking cocaine just to get their work done in the time allocated. These people do not tend to end up in mental health wards though, but those who take a lot of cannabis do. As a result, we are dealing with the impact of cannabis much more commonly than with cocaine for example. Which leads to the next question, What affect will the lifestyle and workstyle we currently assume to be acceptable have on our society and on our youth? And are we prepared to address it?

In our initial discussion Ruth and I agreed that the problem cannot be solved by just warning young people about the consequences of drug use. Young people are warned already about the mental health risks associated with drug use. Yet a lot of them don’t heed the warnings.

Ruth’s asked: ‘What is all that about?’ I said that I thought that was the right question. We shouldn’t just jump to the conclusion that this is a law and order problem. It might be possible to reduce levels of cannabis use among young people by putting more of them in jail, but that would hardly enhance their lives.

Ruth responded:

Nice point! In fact, there are those who prefer to live in a prison than on the streets, but the real issue is getting more of those people into care when they need it and into mainstream society when they don't. And that's the real issue we face in the western world - there is simply not enough resources to address the overwhelming problem of acute mental health issues in our youth. Not enough money, not enough staff, not enough vision. Especially not enough vision. The solution has to come from the opposite side of the spectrum - enticing people to want to hold onto their reality instead of giving their reality to their dealer, or their doctor. Which is definitely not a law and order problem.

My starting point in thinking about why some young people might use cannabis despite mental health warnings was Gary Becker’s rational addiction model. We are talking about DIP, schizophrenia and depression rather than addiction, but the principles are the same. The point is that the behaviour may be consistent with maximizing the discounted value of future happiness as perceived by the individuals concerned. In observing their behaviour we might observe that their discount rates are high and their assessments of the probability of being affected by mental illness are low. Well, economists say that kind of thing. Other people would be more likely to say that they are being short-sighted and excessively optimistic in their assessments of the risks involved. Nevertheless, it is possible that those assessments are quite rational.

When I put this to Ruth she replied:

Despite addictions and hallucinations and even delusions, those with mental illness retain the ability to make rational decisions about their own welfare in light of resources available to them and their experience of reality. Young people in particular take drugs in order to escape their reality. Those without a functional psychosis - read schizophrenia and 'traditional' type mental illnesses - who experience acute addictive / psychotic phenomena induced by drug taking spend a good deal of their lives straight, going about their work, their relationships in the usual manner. These are often people who own their own business, hold well paid responsible jobs and otherwise live perfectly acceptable and rewarding lives. And yet they have a real need to escape the reality of their lives - the cost of living within normal reality seems to outweigh the risk of loosing their cognitive autonomy. And this is what concerns me most of all.

Have we not created a world our youth want to live in? Rational theory must tell us that we have to act, that the cost of not acting far outweighs the cost of thinking, of postulating, of delaying what one day must be done. If our youth want to find another reality then surely we are charged with the responsibility of providing a liveable reality for them and for us. And for their children.

My feeling is that Ruth and I are both putting the problem back into the too hard basket. Rational addiction theory tends to put the onus on young people to make good choices even though adults must share responsibility with school age children for the choices they make. Yet, if we see the problem in terms of creating a world that our youth would not want to escape from, we may put real world solutions beyond reach. Perhaps it is a normal part of human nature to seek temporary escape from the reality of our own lives, no matter how good that reality might be. There is no problem in seeking temporary escape by reading novels or going to the movies. The problem is that some people seek forms of escape that may ruin their lives or the lives of others.

The discussion is continued here.

Are some questions just too difficult? Part I: Should I blog about DIP?

The other day I was talking to Ruth about this blog. Ruth is a nurse who has worked in psych wards and prisons. So she has an interesting range of experiences to talk about and she's interested in economics.


I mentioned that there were some issues that I steered clear of in my blog because they were just too difficult. Ruth objected strongly to this approach on the grounds that ‘someone should be writing about the difficult issues’. I’m not sure why that someone should be me, but I can see the point she was making.

The first example that Ruth gave of what she was talking about was the high incidence of mental illness among young people that has been linked to drug use. She said that this had increased to a huge extent, since the 1990's. We talked around the problem for a while and later exchanged emails about it. The story that Ruth tells below is one of the saddest stories I have ever read.

Ruth says that the most prevalent mental health diagnosis in acute mental heath facilities these days is a relatively new one - Drug Induced Psychosis (DIP). People are only admitted to acute mental health facilities if they are in danger to themselves or someone else (not simply suffering extreme effects of illness as was the case prior to the onset of the drug problem). DIP is now recognized in the DSM4 manual - the diagnosis tool used by all western mental health medics. A major difference between DIP and schizophrenia is the level of associated violence and treatability. Schizophrenia is treated reasonably well with psychotropic medications as the primary treatment regime whereas DIP is treated mostly through drying out and containment (of extreme violence) with medications used as secondary measures.

Ruth tells me that she has chosen not to study a great deal of the theory about the relationship between drug use and mental illness because she wants to stay in touch with the reality on the wards. She writes:

Can I tell a story? It's the story of a young man, well, a boy about to be a man. He was out with his friends celebrating early, his 18th birthday which was to fall during the next week. So this weekend he and his friends went partying to celebrate. During the night one of his friends slipped him a tablet - slyly into his drink. The young man woke the next day still tripping. He was happy as can be, but by the Tuesday, his parents were very worried and took him to the doctor; he was still tripping - having a laugh. He celebrated his 18th birthday in an acute mental health ward, thinking he was still tripping, but was now fed up with being unable to tie his shoe laces, unable to get the fork into his mouth and having to eat with his hands. He was now hating this experience and getting angry with himself for not 'straightening out'. He began to cry in desperation. He cried over and over again, day in day out, while the medics tried in vain to help. After a couple of weeks, his parents wanted to take him home - they wanted to get him out of hospital thinking that maybe it was the hospital causing their son's problem. They took him home and he stopped crying. He still could not tie his shoe laces, or dress himself if there were buttons to be managed. But his parents were happy he'd stopped crying. After all, this fine young man was looking down the barrel of a great career as expected dux of his school, and a fine life. They were devastated at this turn of events. After a few days they brought him back to the hospital. They had not helped him and were even more devastated than they were before. This young man spent nearly a year in hospital, unable to 'get off his trip' as he so beautifully put it.

I was one of his nurses at the time. I was 22 years old, just 4 years his senior. Eventually both he and I left that hospital. But our paths met again in another hospital, another city even, about 6 years later. He told me he had never had a job for more than a few days, he still couldn't do up his buttons - he didn't wear buttoned garments - and that he was still having his 18th birthday trip. He still wanted to study economics (ironically enough) at university. He could still quote and discuss GDP / inflation / employment figures, monetary and fiscal policies, but old figures, those he'd learned for the HSC he still wanted to sit. And yet that young man has no mental health issues in his family, had all the academic potential in the world and a caring, present family. His parents had never divorced, his siblings all got along ok, his relationship with his girlfriend was going well. And there were no identifiable early warning signs of a mental illness about to strike. This man has DIP. He has never been diagnosed with schizophrenia, or any other mental illness.

Ruth concluded:

I wish I was telling the story of just one man, but I'm not. I've seen this same story and similar others so many times. Are some questions too difficult? Yes Winton, absolutely some questions are too difficult and too costly to avoid asking AND finding answers for.

The discussion continues in the next post.

Do global problems require domestic solutions?

‘Overall the best governments seek to extend the freedom of their citizens; we should not want them to wither away but to maximize individual choice while standing guard over a sturdy infrastructure of institutions and services. What they do within their (permeable) borders is reflected in what they should seek to do outside, increasing the range of free choices that people can make. Far from there being a clear choice between domestic and foreign policy, they are now frequently one and the same’ (Chris Patten, ‘What Next?’, Penguin 2009: 443).

It might seem to be a challenge for me to agree with the sentiments in that quote so soon after writing about the desirability of community self-regulation - governance without government. Those who want more self regulation must want government to ‘wither away’ to some extent to make room for this to happen. Yet I doubt whether it would be possible for people to prosper for long in a self regulating community without some kind of government to organize defence against external predators. I think Chris Pattern is right that we need governments to stand guard. I also think that if we had a government that was seeking to extend the freedom of its citizens, as Patten suggests, it would promote more community self regulation as a substitute for government regulation.

I’m not sure whether or not Patten would agree with me on that last point. Perhaps he would. He was not noted as a fan of statism when he was the last governor of Hong Kong and this book shows that he has retained many views favourable to individual freedom and free markets, despite having served as a European Commissioner.

One of the points that Patten makes in this book is that, despite globalization, nation states remain ‘the principal arbiters of politics’ (p.7). However, he questions how much states can do or achieve on their own:

‘Can they secure the welfare and safety of their citizens, policing borders, regulating economic activity, preventing financial ruin, protecting public health, avoiding environmental catastrophe? As the vocabulary of state aspirations becomes more ambitious, with political leaders promising almost every sort of fulfilled happiness, the capacity of states to deliver on these promises appears to become ever more suspect. A peaceful life, let alone a happy one, often seems more problematic than rhetoric suggests should be the case’ (p.9).

At the end of the book Patten tells us that his intention when he started to write it was ‘to demonstrate that nation states had to work together to cope effectively with the problems that crowd in on us all’. The point he ends up making is that ‘more effective domestic policies and better government at home are often needed to deal with global problems’ (p. 443). Three examples he gives are drugs (domestic policies in rich countries keep warlords in business in Afghanistan), epidemic diseases (breeding grounds in poor countries are sustained by inadequate public health facilities) and global financial crises (bad policies in individual nation states have effects that spread to other countries like an epidemic).

In my view there is another important example that Patten could have given of how domestic and foreign policy are frequently one and the same. This is particularly evident in international trade negotiations in which governments come together to talk about reducing trade barriers without any chance of achieving worthwhile outcomes because they are acting as the agents of the domestic interests which benefit from trade barriers. It is not possible for any government to take a sensible negotiating strategy to international negotiations unless it is supported by public understanding of the damage that its own trade barriers impose on its domestic economy.

However, I must be becoming a grumpy old man to complain that this book should have discussed any issue more thoroughly. This is one of the most perceptive books about global problems that I have ever read. The book shows that it is possible for a politician to acquire wisdom even though the incentives faced by people who choose that profession tend to work in the opposite direction.

Is reasonable regulation compatible with democracy?

Peter Boettke recently wrote a paper entitled: ‘Is the only form of “reasonable regulation” self regulation?’ (GMU Economics Paper 10-05).

This paper draws attention to the potential for self-regulating communities (governance without government) to achieve benefits of social cooperation even in unpromising situations. The subtitle describes the contents of the paper: ‘Lessons from Lin Ostrom on regulating the commons and cultivating citizens’.

Boettke attributes the concept of reasonable regulation to Anne Krueger. He tells us that Krueger got him thinking about the concept when she said at some conference that rather than central planning or unfettered markets we need reasonable regulation – regulation that is not capturable by special interests. Having read some of what Krueger has written about rent-seeking societies I imagine she put forward the concept of reasonable regulation as an ideal worth striving for rather than as something that could easily be achieved.

Boettke argues that self-regulation systems apply reasonable regulation. He suggests that since self-regulating systems are operating outside the formal realm of politics they do not face the problem of protecting against the unwarranted influence of politically empowered special interest groups.

I think that is a good point, but it may be over-stated a little. Community organizations do have to cope with the problem of protecting against the unwarranted influence of special interest groups among their members. They also have to deal with free-rider problems. The main difference is that when decisions are made within such organizations opportunistic behaviour is more easily seen to be opportunistic. It is more difficult for any individual or group to argue for unwarranted preferential treatment when the people who have to pay for this are members of the same community. It is also easier for the opportunistic tendencies of individual members to be restrained by subtle (or not so subtle) threats of retaliation by other members. It would be more defensible to argue that self-regulating systems are able to deal more effectively with the unwarranted influence of special interest groups.

Self-regulation systems seem to have some attractions for everyone opposed to statism, including self-styled commie libertarians and anarcho-capitalists (as well as sensible people like myself :-) . Such systems would presumably also be attractive to Burkean conservatives who emphasize the importance of the ‘little platoons’ i.e. the spontaneous social groups that arise in society.

Yet self-regulation may appear to be too utopian to play a major role in modern democracies. Everyone can understand that tribal groups were able to self-regulate to ensure that forests and fisheries were sustainable. They can understand that their ancestors were able to run schools and hospitals through local community organisations without help from governments. But I expect that many people would feel that there are powerful reasons why self regulation of many areas of life has been displaced by the regulatory apparatus of the democratic state. Is there something about democracy that leads inevitably to taking decisions out of the hands of local communities and placing them into the hands of governments, and then centralizing those decisions at the highest level of government?

This is a big question that I don’t think I can answer adequately at the moment. But I will make a few relevant points.

First, I think it is inevitable that a lot of people will look to politicians to offer solutions to local problems and that politicians will offer such solutions. Politicians do not win many votes by telling voters that they aren’t interested in local problems.

Second, I think that most people are aware that when a politician offers to solve problems by displacing self regulation, then someone has to pay for the costs involved. When people weigh up the benefits of regulation that will take the trouble out of things (to borrow a phrase from Charles Murray) against the additional taxes involved, there doesn’t seem to be any a priori reason why they should choose regulation. Perhaps the problem is that they think other people will pay – which could stem from confusion over tax incidence.

Third, to borrow another thought from Charles Murray (which he may have borrowed from Friedrich Hayek) I think the tendency for government regulation to displace self regulation is related to a tendency for people to see problems from an engineering perspective rather than a healing perspective. There is a tendency to try to solve problems by designing new systems to replace self regulating systems, rather than to think in terms of solutions that will enable self regulating systems to work better. I don’t think there is any fundamental reason why politicians should see themselves as engineers rather than healers.

These considerations provide grounds for optimism that reasonable regulation might be sustainable in a democracy.

Postscript:

The references to Charles Murray are from his book, ‘In Pursuit of Happiness and Good Government’, which I wrote about here and here.