Why should Australians be concerned about the deficit and debt projections in the latest Intergenerational Report?

Before publishing the latest intergenerational report, Joe Hockey, the Australian Treasurer, said that people are “going to fall off their chairs” when they see some of the graphs in it.

I didn’t fall off my chair. The picture of government debt levels painted by the report is not as bad as I was expecting. The report suggests that under current legislation – the budget measures that have obtained Senate approval – net debt would increase to around 50% of GDP by 2055, slightly higher than the current level in Germany and substantially below the current level in the United States and United Kingdom.

The reason why net debt is not projected to deteriorate as rapidly as I had anticipated is bracket creep – the movement of individuals into higher income tax brackets as a result of inflation.  Bracket creep is projected to result in a substantial increase in the ratio of tax revenue to GDP over the next five years.

Bracket creep is a sneaky way to raise additional revenue. In the past, governments have adjusted tax rates downwards from time to time to compensate for bracket creep, but there is no provision for that to occur automatically under current legislation.

Consideration of bracket creep helps to focus attention on the main problem with government deficits and growing debt levels – namely, the need for debts to be serviced and repaid from government revenue of one kind or another. Some readers might like to remind me at this stage that future Australian governments could follow the example of the Greeks, among others, and neglect to service debts. The downside of that strategy is that if you ever want to borrow again the cost of funds is likely to be much higher, to reflect the risk of default.

The intergenerational report notes that bracket creep can reduce incentives to work, particularly by people on low incomes. This implies that the marginal excess burden (MEB) associated with bracket creep might be fairly high.

So, what is MEB? In broad terms, taxes impose an excess burden or deadweight cost to the extent that aggregate income is reduced by imposing the tax, for example as a result of reduced incentives to work or invest.  (That definition of excess burden is not perfect but it has the virtue of being reasonably easy to understand.) The MEB is the excess burden associated with a small tax increase as a percentage of the additional revenue collected. Thus, for example, a 40 percent excess burden means that for each $1.00 of additional revenue raised, there is an associated deadweight cost of 40 cents. With an MEB of that magnitude, each additional dollar of revenue raised - for infrastructure spending for example - would need to yield a return (discounted to present value terms) of at least $1.40 in order to be worthwhile.

A few years ago the Henry Tax Review commissioned a major study by KPMG (Econtech) of the marginal excess burden (MEB) associated with different forms of taxation in Australia. While the estimates of MEB ranged up to 90 percent, more typical estimates were 40% for taxes on capital income, 24% for labour income, 8% for GST and 2% for municipal rates.

Tax revenue from bracket creep could be expected to involve an MEB somewhat higher than the MEB on labour income. On that basis, the projected increase in tax revenue from bracket creep, equal to about 2% of GDP, could be expected to involve an excess burden of around 0.5% to 0.8% of GDP. That is quite a lot of wealth to be throwing away on top of the deadweight cost of about 6.5% of GDP associated with current levels of taxation.

The obvious way to reduce excess burden is to substitute taxes with relatively low MEBs, such as GST, for income taxes. That would raise concerns that lower income earners might be worse off, but I doubt whether those concerns would be justified if an increase in GST was used to compensate for bracket creep.

The fundamental problem that cannot be overcome by replacing one tax by another to fund high levels of government spending is that MEBs rise exponentially as the tax rate rises. Thus, as shown in the Figure below, if relevant elasticities result in a moderate MEB of 10 percent with a tax rate of 10 percent, the MEB rises to 37.5 percent with a tax rate of 30 percent and to 83.3 percent when the tax rate is 50 percent. I constructed the graph for a report entitled “How Much Government?”, prepared for the New Zealand Roundtable in 2001. The reasoning behind the graph is an application of the standard tools of economic analysis and is spelled out in the report (page 53).

So, what are the implications for excess burden of taxation of the net debt projections in the intergenerational report? The report estimates that the projected net debt of around 50 percent in 2055 under current legislation would involve an increase in net interest payments from 0.7% of GDP to 3.5% of GDP. Under current legislation, assuming an MEB of 40%, there will be an additional deadweight cost of around 1.2% of GDP just to pay interest on government debt. If the government raises taxes sufficiently at that point to eliminate the 6% deficit (underlying cash balance) that would double the additional deadweight cost estimate. Adding on the deadweight cost of bracket creep, gives a total additional deadweight cost of increased taxation equal to about 3% of GDP.

Another way to look at the issues involved is to consider the excess burden of taxation required to pay for the projected increase of government spending equal to 6.5% of GDP - which is the difference between the projected average ratio under the current legislation (31.2%) and the average ratio for the 40 year period 1974-75 to 2013-14 (24.7%). That is the perspective adopted by Henry Ergas in The Australian, March 9, 2015 (article behind paywall). His conclusion is that the required tax increase would cause “a permanent loss of nearly 3 percent of GDP”.

The main reason why the deficit and debt projections should of concern to Australians is that they imply that our grandchildren will have to pay a high cost for government spending that is primarily for the benefit of the current generation. I doubt whether many people would be keen to have the government spend so much money on them if they were aware that for every $1.00 of benefit they receive, their grandchildren would be likely to have to pay about $1.40 plus interest.

  

When you buy coffee and chocolate do you want to know the story about the people who produced the beans?

I bought my first batch of Arabicas Blue Mountain Gold coffee online from Papua New Guinea last year, after sampling the product when I was working in Port Moresby. I was impressed by the flavour, but was also attracted by the story of how this fine variety of coffee - first planted in PNG in the 1930's from seeds imported from Jamaica - is grown mainly by farmers with small plots of coffee trees, using traditional farming methods.

It is not clear to what extent the farmers actually benefit at present from marketing telling that story, but there must be potential for them to obtain greater rewards in future if the combination of a good story and a product of consistently high quality leads to growth of demand for their output.

Before spending a couple of weeks in PNG recently I told people who asked why I was planning to have a holiday in such a dangerous place (please see my last post for an attempt to put those risks in perspective) that one of my reasons for visiting was to see where my coffee came from. As things happened, I didn’t actually get to see where my coffee came from, but I did see a coffee plantation near Goroka. The fruit shown in the photo will turn red over the next few weeks before being ready for harvest.

I also had the opportunity to visit a processing facility in Goroka and to learn a little about the industry from the manager of the firm. He has asked me not to give him any publicity because his firm does not sell directly to the public and gains no benefit from any time he spends showing tourists around. I was fortunate to arrive on his doorstep just as he was about to show his operation to a group of bank officials and to be allowed to tag along.

 It was interesting to see the effort required for quality control, particularly in order to give purchasers of organic coffee (usually grown on small holdings) a high quality product. For example, quality is better when care is taken to only pick ripe fruit and to ensure that beans are properly dried in the sun. If the beans are not dry when they come to the mill they have to be dried using equipment such as that shown below.

The factory tour ended with a coffee tasting which demonstrated large differences between various grades and blends of coffee.

 During my PNG holiday I also visited Madang and had the opportunity to see cocoa being grown. The Madang Resort hotel organised for me a trip to Hobe, a small village not far from Madang. I spent an hour or so with Joel Lalek on his cocoa farm. 

Joel described himself as a subsistence farmer, but his cocoa activity looked fairly commercial to me. His crop is fermented and dried by his brother using the equipment shown below.

Joel buys seedlings from the Cocoa Coconut Research Institute (CCRI).  The photo below shows seedlings at the Stewart Research Station, CCRI.

The research manager of the Stewart Research Station explained to me the origins of PNG cocoa and the aims of the current breeding program. PNG cocoa is based on the Trinitario variety, often used in high-quality dark chocolate. Unfortunately, the variety is susceptible to cocoa pod borer, which has devastated harvests in PNG during the last decade. One of the aims of the breeding program is to provide greater resistance to this pest. Meanwhile, farmers in some areas have had considerable success in controlling pest outbreaks through pruning and sanitation practices e.g. burying diseased pods. 

A question I was turning over in my mind during my PNG visit is why I haven’t found the same opportunities to obtain single source chocolate based on PNG cocoa as I have to purchase PNG coffee. It would be good to be able to find a regular supplier of high quality dark chocolate with a PNG village story attached to it.

It seems likely that better opportunities to buy single source PNG chocolate might arise in future. People who live in the US can already buy chocolate made from PNG beans from Tejas Chocolate. Perhaps the partnership between Cadbury Australia and Monpi Cocoa Exports will eventually provide similar opportunities to Australians.

It would be nice to be able to end this article with some optimistic observations about the opportunities for better returns for coffee and cocoa farmers in PNG arising from the increasing demand of consumers in high income countries to be told the story behind the food and beverages they buy. I have not found any research which would provide a solid basis for such optimism, but I have not spent much time searching the relevant literature. All I can offer at this stage is a glimmer of hope.

It is indisputable that many consumers like to know the story behind some of the products they buy. Wine comes to mind as a prime example. Yet, in recent years we have seen a trend toward commodification of wine sales in supermarkets, with the use of hidden labels and own-brands. That trend is presumably meeting a demand for a product of reasonable quality at a relatively low price. The trend toward commodification may continue for some time, but when people are buying high quality wine they will still look for a label which tells the story of when, where and how it was produced. I guess the pattern of demand is fairly similar for coffee and chocolate.

The characteristics of farming in PNG typically meet a range of the interests and concerns that people are likely to have when they want to know the story behind the products they buy. The fact that the varieties of coffee and chocolate grown in PNG are at the high quality end of the market certainly provides a basis for positive stories. The fact that chemicals are rarely used by village farmers helps to meet some consumer concerns about health and environmental impacts. Telling a story about village farming can also be consistent with marketing arrangements which help meet the concerns that many consumers have about remuneration for farmers.

Most importantly, the stories that PNG farmers can tell are intrinsically interesting because their lives are so different from those lived by most people in high-income countries.

So, dear reader, when you buy coffee and chocolate do you want to know the story about the people who produced the beans?

Is Papua New Guinea a safe place for tourists to visit?

My short answer – based on my recent two weeks holiday – is that it is safe for tourists to visit PNG, provided they take sensible precautions.

As I wrote that sentence I was sitting in the terminal at Nadzab airport, fully aware that it had been the scene of a holdup by a group of 30 armed men a couple of months ago. I am not a particularly intrepid traveller, but I felt safe, given the number of people in the terminal – about 100 in the Airlines PNG area where I was sitting - with quite a few security guards not far away.

 

At the time of the hold-up, government officials claimed that Nadzab airport, which serves Lae - the second largest city in PNG - is not much used by foreign tourists. That claim is probably true. During the five hours I spent in the terminal I did not see many people who looked like foreign tourists.

However, it seems odd to me that there are not greater numbers of foreign tourists passing through Nadzab airport. Lae seems to be well located to be a natural hub for air travel, as well as for land and sea transport. Perhaps the accidents of history which made Port Moresby the administrative centre of the country have impeded the development of Lae as a hub for air travel.

My sojourn in the terminal at Nadzab airport occurred in the latter part of my visit to PNG. I spent a more enjoyable day looking around Lae earlier in my visit. Of the places I visited in PNG, Lae is probably the least safe, but the security available there seemed more than adequate. The streets of Lae appeared to be quite peaceful through the grill on the windows of the Guard Dog Security vehicle that took me to and from the airport and around Lae.

I had not expected any problems in finding a tourist operator to take me to places of interest to me in Lae. However, the operator I was referred to told me that city tours had been discontinued because tourists had become an endangered species. Reception staff at the Melanesian hotel arranged for Guard Dog Security to take me to the places of interest to me - the Lae War Cemetery and Rainforest Habitat - for a reasonable fee.

The war cemetery is well worth visiting, particularly for those, like myself, who have relatives who fought on the Kokoda track. The cemetery is well-maintained by the Australian government. At the time of my visit, there were no other visitors present. I was given a great deal of help to find the names of my relatives, but the lack of other visitors is a sad commentary on the state of foreign tourism in Lae.

The Rainforest Habitat was worth visiting to see some of the local birdlife, even though I didn’t get to see a bird of paradise. The security man who accompanied me said that there had been more to see at the facility a few years ago. Apparently too few people are visiting to generate the revenue required for the facility to be properly maintained. While I was at this tourist attraction I think there was only one other visitor there.

The other places I visited were Port Moresby, the capital, Goroka, in the Eastern Highlands, and Madang, on the north coast. Port Moresby is less safe than the other two towns.

It is unsafe for tourists to walk around most parts of Port Moresby alone except within the boundaries of major hotels, modern shopping malls and other locations where security is provided. The same applies to local residents. Tourists are more fortunate than most of the locals because they can afford to be transported safely from one secure area to another.

I had no hesitation in relying on taxis for travel in Port Moresby during my current visit. As a foreigner I had expected to be charged more than locals, but that didn’t happen when staff at Holiday Inn negotiated with the taxi drivers on my behalf. Disputes were avoided by negotiating the fare prior to travel and ensuring that the driver had change available for large notes when that was required.

Tourist guides suggest that some taxi firms in Port Moresby are more reliable than others but, as far as I am aware, there is no taxi firm that is sufficiently safe to be recommended for women to use to travel alone at night.

Port Moresby has tourist attractions that are well worth visiting during daylight hours, including the National Museum and Parliament Haus (see below).  It is possible for tourists to visit these places without much risk to personal safety.

When I arrived in Goroka, the bus from the Bird of Paradise Hotel was not there to meet me. Perhaps the plane arrived early. In any case, Peter Samuel, a young man whom I had just met on the plane, offered to walk with me to the hotel which would have been no more than a couple of hundred metres from the airport terminal. Peter saw me safely to the hotel, but as I was walking with him along the street shown below, the thought occurred to me that if I was advising another traveller in that situation, I would have suggested that they should ring the hotel and wait to be picked up.

Peter Samuel and I exchanged phone numbers and he later sent me this message:

“Please, when you are in Australia remember me and give my phone number to one of the Australian Girl to get Courtship with me”.

I don’t normally do this kind of thing, but if any young women reading this would like to get in touch with a young man from the Eastern Highlands of PNG, who has shown kindness to at least one stranger, I am willing to pass their phone numbers to Peter.

I felt safe walking around Goroka by myself, but obtained the services of a guide to visit a coffee plantation (which I will write about in a subsequent post) and to visit the Saturday market which is a short walk away from the town centre. I was impressed by the fresh vegetables on sale at the market.

In Madang I stayed at the Madang Resort, a magnificent hotel, at the gateway to the harbour and close to the town. The hotel arranged a trip to a local village for me to see a cocoa being grown. I will write more about that subsequently.)

As in Goroka, I felt safe walking around Madang during daylight hours. I felt particularly safe walking around on my second day because a cruise ship, Pacific Dawn, was docked in the harbour for the day.

It was particularly interesting for me to compare my experience wandering around by myself with the experience of a couple I met from the cruise ship. The photo shows Tania and Peter with a couple of ladies from the Country Women’s Association (CWA), who had just sold them some new hats.

Cruise ships seem to be an ideal way for people to see coastal towns in safety and to experience organised sight-seeing and cultural experiences. The downside for people on the cruise ships is that they don’t get to see the highlands and don’t have as much interaction with local people. The photo shows the Pacific Dawn leaving Madang harbour.

In my view the risks in organising my own itinerary to travel around PNG were minimal because I was able to stay in good hotels and to pay people to accompany me when necessary. Despite PNG’s reputation as a dangerous place to visit, many of the people I met went out of their way to protect my safety, as well as to make me feel welcome.  

Is there reliable evidence that people can learn to be happier?

There is plenty of evidence that people who use cognitive reappraisal strategies -  for example, changing the way they think about situations in order to reduce negative emotion – tend to have higher life satisfaction than those who try to suppress negative emotion. There is also a growing body of research findings that such skills can be learned and that some reappraisal strategies are more effective than others.

A recent study by Bryan Denny and Kevin Ochsner compared the effects of training using two common variants of reappraisal: distancing and reinterpretation. Distancing involves reappraisal of an emotional event by viewing it from the perspective of a third person observer or an objective, impartial observer. Reinterpretation involves reappraisal by changing the meaning of actions, context or outcomes e.g. by inventing a more positive story to interpret the event.

The 103 participants in the study were divided into three groups: on receiving training only in distancing; one receiving training only in reinterpretation and a third group that was asked to respond naturally to stimuli, but not trained in any form of reappraisal. The training was provided in four sessions separated by 2-5 days. Participants were presented with images and asked to let themselves respond naturally. Those who had been given reappraisal training were also asked to reappraise images.

Both distancing and reinterpretation led to drops in self-reported negative emotional responses over the four sessions. Participants in the distancing group also experienced drops in negative emotional response when they were asked to respond naturally. The results suggest that people can learn to make distancing a habitual response to emotional stimuli during a relatively short training course.

In another recent study Rachel Ranney, Emma Bruehlman-Senecal and Ozlem Ayduk compared the impact of three brief online cognitive reappraisal interventions: self-distancing (watching a personal negative experience as a fly on the wall); temporal distancing (considering the event from the perspective of their future selves); and positive reframing (identifying positive aspects of the experience). The results showed training in temporal distancing to be effective in raising well-being and positive reframing to be effective in reducing ill-being.

I went looking for evidence that people can learn to be happier to follow-up my preceding post about regret. I concluded that post by resisting the temptation to suggest that people who suffer from regrets that do not serve a useful purpose should learn cognitive retraining. At that stage I was not able to cite reliable evidence that such training was effective. Having found some evidence, however, I am not still not sure how effective it would be in dealing with regrets.

If someone regrets a bad choice made a long time ago, temporal distancing is unlikely to work. Viewing the choice as an impartial observer might not help either if it was a really bad choice. Positive reframing could help the person concerned to see something positive in the experience – for example, it could be seen as a learning experience, inducing positive changes in personality. Such reframing is likely to be difficult, however, if the person concerned believes that personality is fixed for life.

There is evidence that the implicit theories that people have about the extent to which attributes such as personality can change has important implications for their mental health. A recent study by Hans Schroder, Sindes Dawood, Matthew Yalch, Brent Donnellan and Jason Moser has shown that people who believe that their attributes can change report greater use of cognitive reappraisal and fewer mental health symptoms. This raises the question of whether people who currently believe that their attributes are set in stone are capable of learning to adopt a mind-set more conducive to improvement.

If your satisfaction with life is adversely affected by regret, what should you do about it?

The purpose of feelings of regret is presumably to help us to make better choices. That suggests that the best way to deal with regret is to make sure we make better choices in future. But regret can also put people into a frame of mind where they make poor choices and find it difficult to enjoy of life.

Regret does not feature prominently in conventional economic theory, even though everyone knows that sensible people take into account the potential for regret when they make decisions.  I suppose that is because Max U, the rational economic man of economic theory, does not let potential for regret prevent him from seeking to maximize utility. Even when economists allow for the possibility that Max might feel losses from the status quo to a greater extent than gains (as in prospect theory), the potential for disappointment and regret still does not come into consideration in the choices he makes.

It is normal for humans to feel disappointment when outcomes are worse than expected – for example when an investment fails even though we have good reasons to expect it to succeed. We feel regret about the opportunities we have foregone in making such investments. Regret is likely to be particularly intense if you mortgage your home to fund an unsuccessful investment.

It usually makes sense for people to take account of the potential for regret in making choices. It is also possible, however, for regret to lead people to make poor choices – choices they later regret. For example, when share prices slump, people who are unduly influenced by regret about the losses they have experienced may decide precipitously to reallocate funds to less risky investments, and later regret that they have sold at the bottom of the market. Alternatively, they may gamble to recover past losses (for example, by buying more shares) and come to regret that choice if the market falls even further. Some economic studies, for example theoretical and experimental work by Philip Strack and Paul Viefers, illustrates the potential for regret to influence decisions in this way.

There is some evidence that regret can have a large impact on life satisfaction. The results of a recent study by Olivia Pethel and Yiewei Chen seem particularly interesting, since these authors use a measure of the intensity of regret, in addition to indicators of negative decision outcomes and the tendency of people to feel regret. The study focuses on mature adults, people over age 35, who are old enough to have had opportunities to make decisions which they might regret. The findings of the study should probably be viewed with caution because of the small size of the sample (119 adults) sex composition (71% female) and the potential for bias in the informal sample selection process that was used.

The regret intensity variable used in the study was constructed by asking people how much they regretted having made wrong choices in various aspects of their life on a 5 point scale (1 = no regret; 5 = very strongly regret) and averaging across the scores. The results of the regression analysis suggest that “very strongly regretting” a wide range of choices in life would be likely to have a large impact on life satisfaction – reducing it by about 1.6 points on the 7 point scale used in the study.

The authors suggest that people who have lower levels of regret intensity may have developed effective emotional regulation strategies in dealing with life regrets. Unfortunately the study does not directly test the use of regulation strategies.  However, the regression results support previous findings that cognitive reappraisal - use of emotion regulation strategies that change the way situations that elicit negative emotions are viewed - has a positive impact on life satisfaction.

I will resist the temptation to conclude that everyone should be taught the bygones principle - much loved by economists - that decisions should focus only on future costs and benefits, leaving aside regrets about the past. In my experience, the bygones principle is much easier to apply to public policy than to one's private life. 

I will also resist the temptation to conclude that people who are allowing regrets to interfere with their enjoyment of life should learn cognitive reappraisal skills. It would be easy to draw upon my own personal experience to suggest ways people might be able to acquire such skills, but at this stage I can't cite reliable studies testing what works and what doesn't work.

Does it make sense to think of trade-offs between life satisfaction and wealth?

Before you answer the question, I would like you to conduct a couple of thought experiments.

The first step is to answer the following question:

All things considered, how satisfied are you with your life these days? Please give your answer as a number between 1 and 10, with a rating of 1 is you are dissatisfied and 10 if you are satisfied.

That is a standard question that has been asked by happiness researchers. Now we come to the thought experiments.

Thought experiment 1:

Imagine that your circumstances suddenly change so that it becomes possible for you to increase your peronal life satisfaction rating by 25% if you are prepared to sacrifice some wealth. What is the maximum amount of wealth that you would be prepared to sacrifice in order to achieve an improvement of 25% in your life satisfaction rating?

Don’t worry if the 25% improvement would take you beyond the top of the rating scale. For the purpose of this exercise it is deemed to be possible to increase your life satisfaction beyond the end of the scale e.g. from 10 to 12.5. That makes sense because people who are completely satisfied with their lives sometimes find that their lives get even better.

Thought experiment 2:

Now imagine a different scenario. Your circumstances change so that it becomes possible for you to increase you wealth by 25% if you are prepared to sacrifice some personal life satisfaction. How much life satisfaction would you be prepared to sacrifice in order to achieve a 25% increase in wealth?

My guess is that in answering the first question there are not many people who would be prepared to sacrifice all their wealth to obtain a 25% increase in life satisfaction. In relation to the second question I don’t think there would be many people who would be unwilling to sacrifice any life satisfaction (if only for a limited period) in order to obtain a 25% increase in wealth. Those are just my guesses. If large numbers of people tell me that I am wrong, I will have to admit that I have made a mistake.

What is the point of this exercise?  Some economists have been prepared to assume that the sole aim of individuals is to maximize life satisfaction as measured in social surveys. That might seem to be a reasonable assumption until you think of the implications. If your sole aim is to maximize personal life satisfaction it would be irrational not to sacrifice all your wealth in order to obtain greater life satisfaction, if that possibility became available. Similarly, it would be irrational to sacrifice any life satisfaction under any circumstances to obtain greater wealth.

If the choices that people make imply that they do not aim to maximize life satisfaction, that doesn’t mean that they are irrational. It just means that there are some things more important to them than life satisfaction, including some things that money can buy.

What could be more important to people than life satisfaction? Some clues are offered by research, discussed here a couple ofmonths ago, which asks people to choose between hypothetical situations with different ratings of life satisfaction and other well-being indicators. 

The people surveyed indicated a stronger preference for options offering high overall well-being to you and your family than for life satisfaction. Other well-being indicators ranked above life satisfaction included personal health, being a good, moral person and living according to personal values, the quality of family relationships, financial security, your mental health and emotional stability, a sense of security about life and the future, having many options and possibilities in life and freedom to choose among them and a sense that your life is meaningful and has value.

How does economic freedom promote tolerance?

The headline of Tyler Cowen’s recent article in the NYT is: “Economic Freedom Does Not Necessarily Lead to Greater Tolerance”. Tyler has acknowledged on his blog that the headline “doesn’t exactly capture” the message his article that economic freedom does tend to lead to greater tolerance. The headline seems to me to be almost as bizarre as suggesting that sunshine doesn’t necessarily cause plants to grow.

Tyler Cowen’s article provides a good summary of research findings by Niclas Berggren and Therese Nilsson, particularly their paper “Does Economic Freedom Foster Tolerance?” I urge people to read Tyler’s article, so I will just provide the briefest possible summary of his summary.

The main points are:

• Societies characterized by economic freedom tend to exhibit greater tolerance toward gay people. There is a similar but weaker relationship between economic freedom and racial tolerance.
• This greater tolerance is strongly associated with certain features of economic freedom i.e. secure property rights and low inflation.
• Economic freedom has a closer association with tolerance in societies which exhibit high levels of social trust.

Niclas Berggren and Therese Nilsson suggest that economic freedom promotes tolerance through two main mechanisms: market institutions protecting private property offer a framework in which it becomes less risky to engage in transactions with unknown members of other groups; and market processes involving interaction between members of different groups lead to greater understanding and recognition that intolerance comes at a cost (e.g. loss of profit from failure to employ the best person for the job).

The authors suggest that these positive impacts are reinforced by social trust. Social trust can be expected to have a direct positive impact on tolerance – if you trust people you don’t know, you are more likely to be open and generous in your attitudes to people who are different. Social trust can also be expected to enhance the impact of economic freedom on tolerance – for example, because trust reinforces the expectation that the legal system will treat people equally and in accordance with the rule of law.

So, what do the authors say about the influence of economic development on tolerance? Per capita GDP is included as a control variable in their regression analysis, but the results seem to imply that economic development has no impact on tolerance.

At first sight those findings appear to conflict with other empirical analyses, which I have supported, which suggest that the widespread economic opportunity that tends to accompany economic growth also tends to foster emancipative values, including greater tolerance.

I think economic freedom shows up as being more important than per capita income levels because tolerance is more likely to be sustained if economic opportunities are growing - and because economic freedom fosters economic growth. It is reasonable to expect tolerance levels to be lower in high income countries where economic opportunities are contracting (e.g. where there is high unemployment) than in high income countries where economic opportunities are expanding. That was one of the points that Benjamin Friedman made in his book, The Moral Consequences of Economic Growth, which I discussed on this blog a few years ago.

The point I am coming to is that it still seems reasonable to expect that one of the mechanisms by which economic freedom promotes tolerance is by promoting widespread economic opportunities. When opportunities are expanding, people are more likely to perceive the potential for mutually beneficial economic interactions with others and are more likely to be open and generous in their attitudes toward people who are different. 

Are Fijians really happier about their lives than Australians?

This might be an appropriate question to consider on Australia Day.

My attention was aroused when I saw the headline “Global happiness survey shows Fijians are the world’s most content”, because I hadn’t previously seen any happiness data for Fiji. The headline refers to a survey of 65 countries recently conducted by WIN/Gallup. (The Gallup organisation involved is not the one that conducts the Gallup World Poll.)

When I looked further I found that the survey also has happiness data for Papua New Guinea, which shows that people in that country also tend to be relatively happy. By contrast, Australians appear to be relatively unhappy.

The question asked in the survey was: “In general, do you personally feel very happy, happy, neither happy nor unhappy, unhappy or very unhappy about your life?” I have constructed the average happiness ratings in the accompanying Figure by assigning a score of 5 to “very happy”, 4 to “happy”, 3 to “neither happy of unhappy”, 2 to “unhappy” and 1 to “very unhappy”.

I am not sure what to make of the rankings shown in the Figure because they seem to be difficult to square with the findings of other happiness surveys. This may be because the survey question is interpreted differently in different parts of the world.

A central issue, it seems to me, is whether the question is more likely to evoke emotional responses or responses that involve some cognitive input. John Hall and John Helliwell, who have expertise in happiness research, leave no doubt that they believe survey participants respond differently when asked how happy they are than when asked how happy they are with their lives:

“As has been shown in the first and second World Happiness Reports, respondents to surveys recognize the difference between happiness as an emotion and happiness as a judgment about the quality of life as a whole. The responses of individuals to these different questions are highly distinct. A very poor person might report himself to be happy emotionally at a specific time, while also reporting a much lower sense of happiness with life as a whole; and indeed, as we show later, people living in extreme poverty, whether in terms of income or social support, do report low levels of happiness with life as a whole”.

The WIN/Gallup survey appears to be asking people how happy they are with their lives, but it doesn’t seem to be interpreted that way. I used regression analysis in an attempt to explain the findings in terms of Gallup World Poll data on “life evaluation” (relative to the best and worst possible life) and “happiness yesterday”. The analysis was conducted for 60 countries for which some matching data was available. The analysis was not very successful in explaining the WIN/Gallup data: it suggested a positive relationship with the happiness variable and no relationship with the life evaluation variable.

Further analysis suggests that the WIN/Gallup question elicits a particularly positive response in African, South Asian, CIS and Latin American countries.

On Australia Day it might be worth thinking for a moment about the kind of response you are likely to get from an Australian if you ask: “In general, do you personally feel very happy, happy, neither happy nor unhappy, unhappy or very unhappy about your life?”. I expect it would be common to get a response something like: “I’m happy enough about my life, I suppose”. The surveyor interprets that to mean that the respondent is “happy”, whereas the respondent might actually feel very happy about his or her life, but reluctant to appear exuberant unless intoxicated.

How long will the "Clash of Civilizations" last?

My main reason for re-visiting Samuel Huntington’s article, “The Clash of Civilizations?” published in 1993, was to see how Huntington’s thesis is faring these days, in the light of the increasing threat of Islamic terrorism and the rise of Islamic state.

Is such violence attributable to an ongoing clash of values that will always make followers of Islam hostile to Western culture, or is a temporary phenomenon that is likely to gradually diminish as economic opportunities expand in Islamic countries?

In his Foreign Affairs, Huntington “set forth the hypotheses that”:

• “differences  between civilizations are real and important”;
• “civilization-consciousness is increasing”;
• “conflict between civilizations will supplant ideological and other forms of conflict as the dominant global form of conflict”;
• “international relations … will increasingly … become a game in which non-Western civilizations are actors and not simply objects”;
• “successful political, security and economic international institutions are more likely to develop within civilizations than across civilizations”;
• “conflicts between groups in different civilizations will become more frequent, more sustained, and more violent than conflicts between groups in the same civilization”;
• “violent conflicts between groups in different civilizations are the most likely and most dangerous source of escalation that could lead to global wars;
• “the paramount axis of world politics will be the relations between ‘the West and the Rest’;
• “the elites in some torn non-Western countries will try to make their countries part of the West, but in most cases face major obstacles to accomplishing this; and
• “a central focus of conflict for the immediate future will be between the West and several Islamic-Confucian states”.

As far as I can remember I was not particularly impressed by Huntington’s thesis at the time it was published. I am still not over-impressed. His labelling of cultures as “civilizations” seems to exaggerate the differences between cultures. I disagree with his view that the “notion that there could be a ‘universal civilization’ is a Western idea, directly at odds with the particularism of most Asian societies”. As I have explained on this blog, it seems to me that there would be widespread agreement among people from different cultural backgrounds about the characteristics of a good society.

However, I have to admit that many of Huntington’s hypotheses look as though they are standing up fairly well in terms of the experience of the last couple of decades. He was spot-on target in pointing out that Western intervention in particular Islamic countries, such as Iraq, would unite other Islamic countries in opposition to the West, even though he did under-estimate the importance of conflict between nations/groups within broad cultural groupings. It is now obvious that he was correct in claiming: “The Velvet Curtain of culture has replaced the Iron Curtain of ideology as the most significant dividing line in Europe”.

Huntington’s also made some accurate predictions about developments in Russia. His prediction that conditions did not exist for Russia to join the West was accurate. The people in Russia were divided on the issue and the West was wary of embracing Russia. Similarly, he was correct in predicting that relations between Russia and the West “could again become distant and conflictual”, if Russians rejected liberal democracy and began behaving like authoritarian traditionalists.

Huntington was wrong in his prediction that the cultural similarities between Russia and Ukraine would enable those countries to avoid violent conflict over territory, but that error could be attributed to a faulty application of his theory.  His discussion of how Russia was torn between the West and traditional Russian cultural influences can also be applied to Ukraine. The difference is that favourable conditions exist for Ukraine to join the West, even though it is being badly torn in the process.

The main problem I have with Huntington’s thesis is that it pays too little attention to the processes of social change. It seems to imply that countries like Turkey will always be torn between Western influences and traditional cultural influences. It largely overlooks the cultural changes (discussed here) that have occurred in the West, and increasingly in other parts of the world, as economic development has led to the growth of emancipative values such as those supporting freedom of speech.

Most people in the West seem to be able to manage to support emancipative values these days, despite the fact that only a few generations ago many of their religious leaders were violently opposed to such values. It seems reasonable to expect that a similar transition toward adoption of emancipative values will occur in Islamic countries during this century. It is difficult to predict exactly how this might happen, except that it is unlikely to be assisted by Western intervention. 

What is missing from "Mind,Society and Behavior"?

There is no prize for any reader who suggests that there is a “u” missing from “behavior”.

Mind, Society and Behavior is the title of World Development Report 2015, recently published by the World Bank. The title of the report is intended to capture

“the idea that paying attention to how humans think (the processes of mind) and how history and context shape thinking (the influence of society) can improve the design and implementation of development policies and interventions that target human choice and action (behaviour)".

The main point that the report seems to be making is that policy outcomes depend on psychological and social influences as well as economic incentives.

The report argues that it is important to take account of three different kinds of thinking:

• Automatic thinking causes us to simplify problems and base decisions on associations that automatically come to mind. This means that policy outcomes can depend heavily on the framing of choices (the way information is provided) and default options.
• Social thinking causes behaviour to be influenced by social preferences, networks, identities and norms. These influences can lead societies into self-reinforcing patterns of behaviour, which may be highly desirable (e.g. norms of loan repayment) or undesirable (e.g. a culture of corruption).
• Thinking with mental models involves concepts, stories and views of how the world works which influence our understanding of what is possible, what is right and what governments should do. An example cited in the report is that people from disadvantaged groups can have mental models that cause them to under-estimate their own abilities.

The report draws upon a substantial amount of research which establishes the relevance of these different types of thinking to policy issues. I am probably more familiar than most readers would be with the underlying research in psychology, behavioural economic and institutional economics that is referred to in this report. However, it was interesting to see how the authors were able to draw on an impressive array of relevant research related to poverty, child development, household finance, productivity, health and climate change.

Anyone with an interest in economic development is likely to find the overview of the report interesting and easy to read. I read the whole report, but it took a long time because I kept finding more interesting things to do. The report seems to have been prepared by bureaucrats to be read by bureaucrats. As I was reading, I could not help thinking that while psychology and sociology do influence behaviour, we should not overlook the importance of pecuniary incentives. I find this kind of report easier to read when I am being paid.

I found the tone of the report to be slightly irritating, but I suppose it is difficult not to appear to have superior wisdom when discussing biases in decision-making of ordinary people. The tone in the rest of the report is balanced somewhat by a chapter which discusses the biases of development professionals in the World Bank. The chapter notes, among other things, that predictions by development professionals grossly understated the extent to which poor people in selected developing countries perceive themselves to be in control of their own lives and grossly overstated the extent to which these people perceive themselves to be helpless in dealing with life’s problems.

There is a major omission in this report, in my view. Any discussion of the influence of cognitive bias in decision-making on economic development should take into account the influence of bias in the mental models on economic development policies. There is no discussion of the deficiencies mental models that led to trade protectionism, widespread public ownership of business enterprises in many countries or the over-emphasis on the role of savings and capital investment in economic development. And there is no discussion of institutional arrangements for policy development that might help prevent biased views of how the economic growth process works from continuing to have a huge adverse impact on government policies in many parts of the world.

This report makes a useful contribution, but it could have been a lot better.

Does education make people happier?

There is conflicting evidence on the impact of education on happiness. Some studies show that higher educational qualifications have a positive impact on life satisfaction, while others show a negative impact.

One reason for the conflicting findings is the indirect nature of some of the positive contributions that education makes to life satisfaction. For example, education may contribute to life satisfaction by enabling people to earn higher incomes. Such indirect contributions are disregarded when researchers attempt to estimate the impact of education on life satisfaction by using single equation regression analysis to disentangle the impact of education from other factors such as income.

Some recent research by Nattavudh Powdthavee, Warn Lekfuangfu and Mark Wooden has applied a structural equation model to Australian data to estimate both the direct and indirect effects of education. The authors found that the positive indirect impacts of education on life satisfaction outweigh its negative direct impact (i.e. holding other things equal). The strongest positive indirect effect is via income, followed by long-term health.

These findings may provide some comfort to the providers of educational services. They can claim that education tends to enable people to have happier lives because it makes them to become wealthier and remain healthier.

However, the findings also suggest that young people seeking life satisfaction might achieve that goal to a greater extent if they can remain healthy and find a path to wealth that  does not involve a great deal of education.

Providers of education services might do better to argue that it is better to have a meaningful life rather than to have high levels of emotional well-being. Roy Baumeister has reported some research findings which suggest that although there is fairly high correlation between being happy and feeling that your life is meaningful, there are some important differences. For example, happiness is about the here and now, whereas meaningfulness seems to be more about assembling past, present and future into some kind of coherent story. It would be nice to think that education would help people to do that, but I have not seen that proposition tested against evidence.

Cartoon by Nicholson, originally published in "The Australian".

Providers of educational services may also be able to argue that the education experience itself is not the cause of unhappiness of educated people. A study by Michael Dockery, previously discussed on this blog, indicates that young people in Australia who experience higher education switch from having relatively high to relatively low levels of happiness (compared to others of the same age) at about the time they complete their degrees. There are several possible explanations for this, but the one I now favour is that young people compare themselves to a different reference group when they make the transition from higher education to work. When at university they are likely to compare their lifestyles to those of other members the undergraduate community, but after they gain employment they are more likely to compare their lifestyles with those of successful workmates.

If higher education tends to encourage people to compare their own achievements in life with those of other educated people, who tend to be high achievers, is that a bad thing? I don’t think so.  

Do people value the happiness of their families above their own personal happiness?

One way to answer this kind of question is to ask people to choose between hypothetical situations with different ratings of family well-being and variables such as life satisfaction, ratings of life relative to best and worst possible, appreciation of life and absence of negative emotion. That is the approach taken in an exploratory study by Daniel Benjamin, Ori Heffetz, Miles Kimball and Nichole Szembrot entitled, “Beyond Happiness and Satisfaction: Toward well-being indices based on stated preferences.

The people surveyed tended to indicate a stronger preference for options offering high “overall well-being to you and your family” than for any options regarding the 135 other aspects of well-being covered in the survey. The findings were based on an internet survey of 4,600 Americans.

The results help to explain why previous studies have shown that many people are prepared to sacrifice life satisfaction in order to obtain higher incomes.

Some of the other findings of the study are interesting:

• Life satisfaction is ranked more highly than positive emotion (e.g. “how happy you feel”).
• The absence of negative emotion, such as anger, stress, pain and worry tends to rank around the middle of aspects of well-being covered.
• Eudaimonic dimensions of well-being, such as being a moral person and living according to personal values tend to rank highly.
• Other aspects of personal well-being to be given a high ranking include health, the quality of family relationships, mental health and emotional stability, financial security and “having many options and possibilities in your life and the freedom to choose among them”.
• Men tended to give higher ranking to “your sense that your life is meaningful and has value”, whereas women tend to rank more highly “your mental health and emotional stability”.
• As regards policy options, greatest importance was attached to “freedom from corruption, injustice and abuse of power in your nation”, “the morality, ethics and goodness of other people in your nation” and “freedom of speech and people’s ability to take part in the political process and community life”.

The authors are at pains to point out the exploratory nature of their study and the many problems yet to be resolved in developing well-being indexes based on stated preferences. That might explain why some results that seem anomalous. For example, it is difficult to understand why “your rating on a ladder where the lowest rung is ‘worst possible life for you’ and the highest rung is ‘best possible life for you” is ranked far below “how satisfied you are with your life”( 103 versus 13). Previous research suggests that survey respondents view high ratings on those well-being indicators as close substitutes. Again, the ranking of “your material standard of living” (98) is much lower than the ranking of “your financial security” (6) and “your feeling that you have enough time and money for the things that are most important to you” (12).

My final comment on the study is that I was left wondering whether it might be possible to use a simpler approach to obtain useful indicators of well-being based on stated preferences. What I have in mind is to use each respondent’s current income and ratings of various other aspects of well-being as the initial basis for comparison and then asking them to choose between options involving various combinations of changes in income and other aspects of well-being. That might enable researchers to compare the marginal utility of different aspects of well-being in dollar terms and to map how preferences for different aspects of well-being tend to differ for people at different income levels.

Why are the French so unhappy?

It is well known that people in France tend to rate their happiness and life satisfaction lower than other people with comparable living standards. Until recently I thought that might just reflect a tendency to get pleasure out of pretending to be grumpy. After all, the French know all about joie de vivre, don’t they?

However, after reading an article on the topic by Claudia Senik I think there might be some deeper cultural factors at work.

The tendency for the French to be unhappy is not just superficial. It is associated with relatively high scores in negative dimensions of mental health and exceptionally high consumption of psychotropic drugs. And it has been observed at least since the early 1970s. 

The author attempted to disentangle the influence of circumstances (such as institutions, regulations and general living conditions) and the influence of mentality (attitudes, beliefs, ideals and ways of apprehending reality that individuals acquire during infancy and schooling). She did this by using survey data to examine differences between the happiness of different categories of migrants. Her main finding was that immigrants of the first generation who had attended school in France before the age of 10 were less happy, other things equal, than those who had not.

The results of the study seem to suggest that there is something associated with attending school in France that tends to make people less happy than they would otherwise be. The author has speculated that one factor that might be involved is the competitive nature of the education system in France.

I thought it might be interesting to take a look at World Values Survey data on desired child qualities on the grounds that the values inculcated via education systems might reflect the values of the broader population. The latest data available for France is from the 2005-09 round of surveys. The specific question is:

“Here is a list of qualities that children can be encouraged to learn at home. Which, if any, do you consider to be especially important? Please choose up to five”. Unfortunately, none of the qualities listed relate specifically to ambition or scholastic attainment.

Some of the qualities for which responses of French people seem differ substantially from those of people in other countries are shown in the following Figures.

The Figures do not shed a great deal of light on the issue. It is interesting, nevertheless, that the French tend to attach great importance to children learning the virtue of hard work and tend to give relatively low priority to independence and imagination. Perhaps there is something wrong with my perception that life in France is characterized by enjoyment of leisure, and free expression of individuality and creativity.

What makes people grumpy about life in Australia?

Most people who live in Australia seem to be highly satisfied with life in this country. Data from the 2013 AQOL Australian Unity wellbeing survey suggests that 75 percent of people give life in Australia a grade of 8/10 or above. Less than 4 percent of people give life in Australia a grade of less than 5/10.

Most of the people who give Australia a rating of less than 8/10 are not particularly grumpy, but there are some questions worth trying to answer about what makes them less satisfied than the rest. Are they particularly grumpy about some aspects of life in Australia, or are they less than satisfied with several different aspects? Are they grumpy because they enjoy grumping, or are they unhappy people? If they are unhappy, is this related to their personal circumstances?

In this post I use the survey data to compare the characteristics of the lower quartile – the 25 percent who gave life in Australia a grade of 7/10 or less - with the remaining 75 percent of the population.

I was pleased to discover that the lower quartile is not comprised disproportionately of grumpy old men. On average, the  age and sex of those who gave a relatively low rating to life in Australia was much the same as for the remainder of the population.

 Figure 1 suggests that those who are grumpy with life in Australia are somewhat more inclined to give any aspect of life in this country a failing grade (less than 5/10) than are the remainder of the population. They were most grumpy about government, but they shared that attitude with many people who were satisfied with life in Australia. (The survey was conducted in August 2013, not long before a Federal election which resulted in a change of government.) In proportionate terms, people in the bottom quartile were most grumpy about social conditions, the economy and national security.

As might be expected, Figure 2 suggests those in the lower quartile are more likely than the remainder to be grumpy with more than one aspect of life in Australia. Nevertheless, multiple grumpiness is not particularly common, even among people in the lower quartile. Only a tiny percentage of the population are grumpy about all aspects of life in this country.

Figure 3 suggests that people who are relatively dissatisfied with life in Australia tend to have lower satisfaction with their own lives. There do not seem to be many people who get a lot of personal satisfaction from being grumpy about life in Australia.

The people who are relatively dissatisfied with life in Australia cannot generally be characterized as being grumpy because they are particularly dissatisfied with personal relationships or health. Figure 4 suggests that they are more likely to be particularly dissatisfied with their future security and standard of living. They are also more likely to feel unsatisfied with the community in which they live. (The relevant question is: “How satisfied are you with feeling part of your community?”)

The general picture that emerges is that the people who are less satisfied with life in Australia tend to be particularly grumpy about the way social and economic conditions are impacting on their personal lives. Perhaps many of them are disappointed because their expectations of economic security and community support are not being met.