How good is life satisfaction as a measure of psychological flourishing?

In recent years psychologists have adopted a number of somewhat different approaches to measuring psychological flourishing. This is not an area in which I can claim much expertise, but that will not stop me from writing about it. The question of what it means for a human to flourish is one that everyone should be encouraged to consider for themselves.

The definition of flourishing adopted by Felicia Huppert and Timothy So in their article ‘Flourishing Across Europe’ (published in Soc.Indic.Res. in 2013) viewed it as lying at the opposite end of a spectrum to depression and anxiety. The authors identified 10 features of positive well-being by examining internationally agreed criteria for depression and anxiety (DSM and ICD) and defining the opposite of each symptom. The 10 symptoms of flourishing identified were: competence, emotional stability, engagement, meaning, optimism, positive emotion, positive relationships, resilience, self-esteem, and vitality.

A measure of flourishing was developed from responses to questions included in the European Social Survey. Indicators used were as follows:

• Competence: Most days I feel a sense of accomplishment from what I do;
• Emotional stability: (In the past week) I felt calm and peaceful;
• Engagement: I love learning new things;
• Meaning: I generally feel that what I do in my life is valuable and worthwhile;
• Optimism: I am always optimistic about my future;
• Positive emotion: Taking all things together, how happy would you say you are?
• Positive relationships: There are people in my life who really care about me;
• Resilience: When things go wrong in my life it generally takes me a long time to get back to normal (reverse score);
• Self-esteem: In general, I feel very positive about myself;
• Vitality: (In the past week) I had a lot of energy.

I would have liked to see autonomy included in this list. Adult humans can hardly be said to be flourishing if they do not exercise their potential to organize their own lives. The authors argue against including autonomy on the grounds that its opposite is not specified in the DSM and ICD. It is difficult to accept that mental health professionals do not view failure to become or remain an autonomous individual as a mental disorder. Various problems in self-direction seem to be recognized as associated with personality disorders in DSM-5.

Leaving as aside my views about their failure to incorporate autonomy in their measure of flourishing, one of the attractive features of the approach adopted by Huppert and So is that it does not pretend to provide a comprehensive measure of human flourishing. It relates specifically to the psychological aspects of individual human flourishing and doesn’t pretend to encompass physical health, wealth, practical wisdom etc.

One interesting feature of the results of the study using data from a sample of 43,000 Europeans was that the individuals identified as flourishing did not correspond very closely to those identified as having high life satisfaction. For Europe as a whole, the percentage who were both flourishing and had high life satisfaction was 7.3%. Among people who met the criterion for flourishing, 46.0% had high life satisfaction, and among people who had high life satisfaction, 38.7% were flourishing. (The correlation between life satisfaction and flourishing was only 0.34.) The authors conclude:

“Clearly, flourishing and life satisfaction are overlapping but distinct concepts, and a great deal would be lost by measuring life satisfaction alone, although there is frequently pressure in large scale surveys to do so.”

However, the ranking of European countries according to the estimated percentage of the population who are flourishing seems fairly consistent with the rankings obtained using life satisfaction. In in order to compare the ratings with a similar measure based on life satisfaction, I have used the Gallup organisation's data on “thriving” covering a similar time period. Gallup uses the Cantril Self-Anchoring Striving Scale to measure life satisfaction by asking respondents to place the status of their lives on a "ladder" scale with steps numbered from 0 to 10, where 0 indicates the worst possible life and 10 the best possible life. Individuals are classified as thriving if they rate their current lives a "7" or higher and their future lives at "8" or higher. The relationship between the estimated percentages “flourishing” and “thriving” is shown in the graph below.

It seems clear from the graph that it doesn’t matter a great deal whether you use indicators of psychological health or life satisfaction to compare the psychological well-being of people in different countries. (At a national level the correlation between flourishing and thriving is 0.87.) The errors in using life satisfaction as an indicator of flourishing that are evident at an individual level tend to cancel out in aggregating to a national level.

What this means, I think, is that if you want to know about an individual’s psychological well-being, measures of life satisfaction are a poor indicator. However, if you are looking for a summary indicator of psychological well-being at a national or regional level, life satisfaction might be good enough.

Do major cities create unhappy Australians?

Sydney's eastern suburbs

“Major cities create unhappy Australians”. That headline jumped out at me when I was doing an internet search recently. The source was The Melbourne Newsroom – a media unit at the University of Melbourne. The news release tells us that Australians who live in rural locations or towns of less than 1,000 residents “have significantly higher life satisfaction than those living in major cities”. (Major cities have more than 100,000 residents.)

The news release is linked to a recent publication based on the highly regarded HILDA survey undertaken by Melbourne University. The survey results suggest a boost to average life satisfaction (on the 11 point scale from 0 to 10) of 0.127 points for females and 0.108 points for males from living in a rural location or town rather than a major city. That might seem small, but it appears to imply that living in a major city has an adverse impact on life satisfaction of similar magnitude to being unemployed or divorced.

The authors of the HILDA publication conclude:

“other things being equal, the major cities are the least desirable places to live”.

The qualification in that statement is important. The authors go on to point out that the undesirability of living in cities is somewhat counteracted by the fact that the major cities contain areas of greatest socio-economic advantage.  Life satisfaction is influenced by the effects of the relative socio-economic advantage or disadvantage of the area in which an individual lives.

The main reason I was sceptical when I read the headline “Major cities create unhappy Australians” was because earlier in the day I had read a paper by Arthur Grimes and Marc Reinhardt which found that the differences between life satisfaction in rural and urban areas in other high-income OECD countries disappeared in a model controlling for other variables. The other variables controlled for were own income and reference income (mean income within a country of individuals of the same gender, age and employment status).

A study examining differences between life satisfaction of rural and urban residents of Victoria, undertaken a decade ago by Dianne Vella-Brodrick et al, also found that the significance of rurality disappeared when other variables were controlled for. The other variables in the model included satisfaction with community and perceived level of satisfaction with distance from services.

In a post I wrote on this blog a few years ago I considered the differences at a regional level between the stories told by a range of wellbeing indicators in Victoria. The (rural) local government areas (LGAs) with higher average subjective well-being (SWB) also tended to have higher ratings in terms of satisfaction with being part of the community, social support (ability to get help from friends), citizen engagement (e.g. attending town meetings, writing to politicians), safety (e.g. feeling safe walking in the local area at night) and volunteering. However, those LGAs tended to have lower household income, lower satisfaction with work-life balance and less acceptance of diverse cultures. The latter variables tended to have higher values in Melbourne and in LGAs close to Melbourne.

Do those results suggest major cities create unhappy Australians? I don’t think so. As discussed in a more recent post, major cities in Australia are ranked among the most liveable in the world. People who choose to live in major cities may well do so for good reasons, in full knowledge that they are making choices that are likely to reduce their life satisfaction. Life satisfaction is important, but it is not the only argument in individuals’ utility functions. For example, it can be rational for people to sacrifice some life satisfaction now to obtain more life satisfaction later (e.g. by accumulating wealth to fund their retirement in a more pleasant location). There is also some evidence that many people are prepared to sacrifice their own happiness in making location choices in order to provide better opportunities for their children.

How close is the relationship between freedom and life satisfaction?

I would be happy to declare myself a fan of the OECD’s Better Life index if it included an appropriate indicator of freedom. Perhaps the authors might argue that freedom is adequately covered by “civic engagement”. However, that seems like arguing that it is not possible for people to suffer persecution from government when they have the right to vote. I don’t think J S Mill would have been impressed:

“The limitation … of the power of government over individuals, loses none of its importance when the holders of power are regularly accountable to the community, that is, to the strongest party therein” (On Liberty, Chapter I).

Perhaps the authors of the index see freedom as a characteristic of the social environment that people desire because it enables them to have greater life satisfaction, rather than as one that contributes directly to the quality of life. I don’t buy that argument. Humans have a passion to control their own lives (even though many have no qualms in voting to have governments restrict the freedom of others). I predict that many users of the Better Life index would give a higher weight to individual freedom than to many of the other items included in the index, if they were given the opportunity to do so. (One of the features of the Better Life index is the ability of users to assign whatever weights they choose to the variables that are included in the index.)

It is possible, however, that freedom makes little difference to country rankings. That might happen if freedom indexes are highly correlated with life satisfaction. I am focusing attention here on the relationship between freedom and life satisfaction because most of the 11 components of the OECD’s Better Life Index are correlated with life satisfaction. Civic engagement is one of the exceptions. The others are education, safety and work-life balance.

The freedom indexes I have chosen to consider are the Fraser Institute’s economic freedom and personal freedom indexes. Both of those indexes are highly correlated with life satisfaction (r = 0.73 for personal freedom and r = 0.61) in OECD countries. A regression analysis shows both variables to have a positive (significantly greater than zero) influence on life satisfaction, together explaining 68% of the variation in life satisfaction among OECD countries. (The data and results are available from the author.)

The relationships between life satisfaction and the two freedom indexes are shown in the charts below.

There seems to have been a fairly strong tendency for people who argue that government policies should be directed toward raising average life satisfaction to advocate policies involving restrictions on freedom. Such people have been barking up the wrong tree. The countries with highest average life satisfaction are those with the least restrictions on economic and personal freedom.

Postscript: 
 I neglected to refer to a recent article by Boris Nikolaev entitled "Economic Freedom and the Quality of Life". This article provides a fairly extensive discussion of the relationship between economic freedom and the quality of life at a national level. 

  

Which countries have the greatest personal and economic freedom these days?

The results of the latest Human Freedom Index by Ian Vásquez and Tanja Porčnik (published by the Fraser Institute and several other policy think tanks) have surprised some people.

Among the social media comments was one from a person who had lived in several different parts of the world who was surprised that Scandinavian countries ranked so highly in terms of personal freedom. (Sorry, I can’t find the link.) I wasn’t surprised to see Hong Kong in first place in the overall freedom ranking, since the methodology gives equal weight to economic freedom and personal freedom and does not include voting rights as a component of personal freedom. It was a surprise, however, to see the United States ranked so lowly, in 20^th place overall and in 31st place in terms of personal freedom.

In order to better comprehend the rankings of particular countries I have used conditional formatting  to prepare the table below showing the components of personal freedom and economic freedom ratings for the 50 countries assessed to have the highest overall freedom ratings. For each component index green denotes a relatively high rating, yellow a moderate rating and red a relatively low rating.

It seems that the US has a relatively low rating on rule of law and freedom of movement.  The US ratings on the three components of the rule of law index - procedural justice, civil justice and criminal justice – are all rated as more than 20% below the world’s best practice. (Data are from the World Justice Project, an independent non-profit organization, originally founded in 2006 as a presidential initiative of the American Bar Association.) The US’s low rating on freedom of movement is attributable to restrictions on foreign movement i.e. freedom of citizens to leave and return to their country. (Data are from the CIRI Human Rights Data Project.)

Another surprising item highlighted in the table is the relatively low rating of New Zealand on freedom of religion. This low rating apparently reflects some kind of restriction on freedom to establish religious organisations.

The relationship between economic freedom and personal freedom is interesting. The chart shown below suggests a fairly strong correlation, but there are some interesting outliers.  

It seems to me that economic freedom and personal freedom are so strongly linked that it is inherently difficult to maintain high economic freedom without high personal freedom and vice versa. It is reasonable to predict that Singapore’s high level of economic freedom will continue to support relatively high economic growth, which in turn will support the development of emancipative values and greater personal freedom in the decades ahead. In the case of Slovenia and Italy I am not sure whether we are more likely to see a rise in economic freedom or a decline in personal freedom.  

Will future technological advances provide widespread opportunities for human flourishing?

A range of issues related to this question have been discussed in a recent series of posts on this blog. My conclusions are summarised below.

Recent trends in productivity growth do not provide persuasive evidence that the rate of technological advancement is slowing.

On the one hand, we have techno-pessimists such as Robert Gordon who argues that technological progress is slowing down.  On the other hand, we have techno-optimists such as Erik Brynjolfsson and Andrew McAfee who argue that the global economy is on the cusp of a dramatic growth spurt driven by smart machines taking advantage of advances in computer processing, artificial intelligence, networked communication etc.

My post discussing these issues notes that the evidence does not support the view that there was a general slow-down in productivity growth in high-income countries prior to the global financial crisis and great recession. In only about half of the countries covered by the OECD data was the rate of multifactor productivity (MFP) growth during the 2001 to 2007 lower than that in 1995 to 2001.

It seems likely that the slow-down in measured productivity growth in the US and some other countries may be attributable, in part, to difficulty in measuring the outputs of the information and communications technologies (ICT) industries - particularly free content provided on the internet.  As means are found to require users to pay for more internet content it seems likely that will, of itself, make the productivity numbers for ICT industries look better even though underlying productivity will not have improved.

A post discussing recent OECD research on technological diffusion gaps at firm level suggests that there is a technological diffusion problem rather than a slow-down in technological advances. Productivity growth of global frontier firms has remained relatively robust, despite the slowdown in productivity growth in many OECD countries during the 2000s. A widening technological diffusion gap is particularly evident for service sector firms.

Technological innovation is likely to destroy a substantial proportion of current jobs, but it will not necessarily be more disruptive than it has been in the past.

As discussed in my post ‘Is average over?’ there is strong evidence of job polarization in the US. Research by David Autor shows that the occupations experiencing loss in employment are in the middle of the distribution, with the locus of displacement of middle-skill employment moving over time into higher skilled categories.  The pace of employment gains in low wage, manual task-intensive jobs has been increasing since the 1980s. The growth of high-skill, high wage occupations decelerated markedly in the 2000s, with only a modest recovery between 2007 and 2012. Autor suggests that the deceleration of growth of high pay jobs was associated with macroeconomic events which led to a sharp deceleration in computer investment (the bursting of the dot-com bubble, followed by the collapse of the housing market and the ensuing financial crisis).

Australian research, published in a recent report by CEDA (discussed here) shows a similar pattern of job displacement. The jobs that are disappearing involve routine tasks, not just low-skilled tasks. Researchers estimate that over the next 10 to 15 years about 40% of jobs have a high probability of being susceptible to technological change in Australia.

Growth in labour demand will occur in occupations that tend to involve perception and manipulation, creative intelligence and/or social intelligence. Many jobs will be concerned with the creative application of technology to solving problems.

In recent years enough new jobs have been created in Australia at a rate sufficient to replace those that have disappeared.

Some authors have suggested that the world faces a period of extraordinary economic disruption over the next few decades. My reflection on economic events over the last 40 years (in this post) suggest to me that perceptions of extraordinary disruption are a product of the economic stagnation in many high-income countries during the last decade.

During the 1970s I was under the impression that the pace of change was quickening, but that was an illusion. The economic disruption occurring in the wake of the first oil price shock and the emergence of stagflation certainly involved a quickening in the rate of change relative to the abnormal stability of the 1950s and 60s. Looking back now, however, economic change over the last 40 years seems to have been less about quickening than about fits and starts.

I suspect that when people look back in 40 years’ time they are they are not likely to perceive that the first half of the 21^st century was extraordinarily disruptive. They are more likely to perceive this to have been a period of fairly normal disruption, with the pace of change being similar to that occurring on average since the beginning of the industrial revolution.

There is potential for future technological advances to lift average real wage levels in high-income countries.

At an aggregate level, innovations that raise labour productivity tend to increase the demand for labour because they make labour more productive. International comparisons show that real wage levels are more or less proportional to average productivity levels.

Real wage growth has not been quite proportional to labour productivity growth in high-income countries where labour’s share of national income has fallen over recent decades. As discussed in this post, average real wages in high-income countries have typically been growing at a rate around 0.35% per annum less than the median labour productivity growth of 1.64% per annum.

In most countries the most plausible reason for the failure of real wages to keep pace with the growth of labour productivity is that capital deepening (the growth of capital per unit of labour) has not been sufficient to offset the labour augmenting (or labour saving) bias of technological progress. (See my post discussing the elasticity of substitution between capital and labour.) In other words, investment levels have been too low.

A slowdown in the contribution of investment to GDP growth was evident the United States, Europe and Japan in the period 2000-07 and was accentuated after the global financial crisis.  Investment levels in Australia remained strong until recently, mainly reflecting investment in mining to supply inputs to the construction boom in China.

Investment in natural resource development has had a modest direct impact on demand for labour in Australia, but the impetus it has provided to overall economic growth in Australia had a more profound indirect impact. The impacts on labour demand of the growth of urban centres as hubs of highly innovative activity are similar in some respects.  As discussed in my post on the competitiveness of cities, when cities become attractive places for location of technology-intensive activities that tends to increase demand for many categories of labour including teachers, nurses and building workers.

Technological advances offer the potential for ongoing improvements in the quality of life.

It is sometimes suggested that because most people in high income countries are already highly satisfied with their lives, the additional opportunities provided by technological advances are not worth having. However, the benchmarks that people use when asked to evaluate the quality of their lives tend to change with changes in their perceptions of what might be possible. As noted in an earlier post, survey data indicates that a substantial proportion of people who claim to be completely satisfied with their lives (above 40% in some countries) are in complete agreement with the proposition that “because of science and technology there will be more opportunities for the next generation”.

In my last post I considered whether the disruptions associated with technological innovations cause a great deal of anxiety and unhappiness. There is a great deal of evidence many people who lose their jobs or feel that their jobs are threatened do suffer anxiety and unhappiness. However, these feelings are strongly associated with the state of the economy and the prospects of obtaining alternative employment.

Discussions of technological unemployment tend to focus unduly on potential job losses and to overlook the impact of new technology on economic growth and the associated expansion of employment opportunities. Many people will lose jobs as a result of technological change at some point in their lives. Most will readily find alternative employment, but some people are likely to have their lives severely disrupted by the high levels of unemployment that may persist in some regions where declining industries have been major employers.

If governments want to ensure that technological advances provide widespread opportunities they should stop protecting narrow interests.

Recent OECD research on technology diffusion gaps (discussed here) suggests that the ability of firms to learn from the global frontier is stronger in economies where there is less protection of domestic interests through international trade barriers, product market regulation, employment regulation and bankruptcy laws that that leave people with valuable skills employed in zombie firms. The research also suggests that skill mismatches can be exacerbated by high transactions costs in housing markets (e.g. stamp duties on transfers).

The competitiveness of cities as locations for technology-intensive activities is likely to be adversely affected by powerful interest groups opposed to increases in population density and innovations that have potential to reduce the cost of transport, including congestion costs. (See post on competitiveness of cities.)

There is increasing recognition that excessive regulation to protect intellectual property rights is discouraging the diffusion of new technology and limiting the opportunities created by technological progress. As discussed in a post on this topic, the economic benefits of copyright and patent laws derive from the incentive they provide to authors and inventors to engage in creative activity. If granted appropriately such monopoly rights could therefore be expected to result in more technological progress and higher productivity growth than would otherwise occur. However, in recent decades these regulations have been used to provide monopoly rents to holders of rights far beyond those required to provide incentives for creative activity.

* * *

My general conclusion is that if governments were to do no harm we could be much more confident that future technological advances would provide widespread opportunities. That is probably too much to ask, but it might be reasonable to expect governments to do less harm than at present. For example, if governments want to help unemployed people who live in regions of persistently high unemployment, they should consider welfare measures designed specifically to assist those most affected (including relocation and early retirement). This is likely to be a less costly approach than the alternatives of supporting uncompetitive firms and industries through subsidies, tariffs, anti-dumping measures, government procurement policies etc. or funding uneconomic infrastructure projects. 

This series of posts has focused on likely trends over the next few decades and has not addressed longer term issues that may emerge as robots come to play more important roles in our lives. I might have something to say about those issues after reading and thinking more. One day I might even feel able to write sensibly about the implications of the 'singularity' for individual human flourishing.


Postscript:
I think William Nordhaus may be writing sensibly about the timing of the 'singularity' and its implications for real wages in his paper: "Are We Approaching an Economic Singularity?" 

How will future technological advances impact on the quality of life of people in high-income countries?

As discussed in earlier posts, I am fairly optimistic about the potential for technological progress to continue to provide widespread economic opportunities for people in high-income countries. In this post I want to consider two arguments advanced by people who are pessimistic about the potential for technological advances to continue to improve the quality of lives of people in high income countries. 

The first argument of the pessimists is that because most people in high income countries are already highly satisfied with their lives, the additional opportunities provided by technological advances are not worth having. As I see it, this fails to recognize that the benchmarks that people use when asked to evaluate the quality of their lives tend to change with changes in their perceptions of what might be possible. It would be unreasonable to expect that peoples’ perceptions of what it means to be living the best possible life will remain unchanged over the next 50 years.

Introspection is probably sufficient to persuade most readers that it is possible to be highly satisfied with life and nevertheless perceive that there is potential for the lives of future generations to become even better in some respects. Some formal evidence that this happens was provided in an article on this blog last year. Using World Values Survey data for a range of high-income countries the article demonstrates that a substantial proportion of those people who claim to be completely satisfied with their lives (above 40% in some countries) are in complete agreement with the proposition that “because of science and technology there will be more opportunities for the next generation”. The corresponding percentages who completely disagree with that proposition are tiny.

The second argument of the pessimists is that the disruptions associated with technological innovations cause a great deal of anxiety and unhappiness. 

It is obvious that many people who lose their jobs or feel that their jobs are threatened do suffer anxiety and unhappiness. As previously discussed here, rising unemployment has been associated with declines in life satisfaction in countries of southern Europe following the global financial crisis.

A recent article by Rainer Winkelmann has drawn several important conclusions about the relationship between unemployment and life satisfaction from German panel data:

• Over the last three decades, average life satisfaction of unemployed people – around 5.5 to 6.0 on a ten point scale - has always been at least one point below that of employed people.
• Life satisfaction tends to decline prior to unemployment and does not fully rebound to pre-unemployment levels four years after an episode of unemployment.
• About half the people who became unemployed experienced no reduction in life satisfaction. Unemployed people experience a substantial reduction in life satisfaction (and find a job more quickly) when they have a strong work ethic.
• Duration of unemployment seems to have no impact on the life satisfaction of people who are unemployed.
• There is a strong association between the aggregate unemployment rate and average life satisfaction levels even for employed workers, reflecting the negative impact of perceived job insecurity.

 Australian data also suggests that the level of job insecurity is strongly related to the state of the economy. The Household Financial Comfort Survey (conducted by Me Bank) shows marked fluctuations from quarter to quarter in perceptions of how easy it would be for workers to obtain another job if they become unemployed. In June 2015, casual workers were most pessimistic about finding another job (85% said it would be difficult), followed by self-employed workers (63%) part-time workers (63%) and full-time workers (51%). However, NAB’s Quarterly Australian Consumer Anxiety Index suggests that job security is a much less important source of anxiety for Australians than government policy, cost of living, ability to fund retirement, and health.

Discussions of technological unemployment tend to focus unduly on potential job losses and to overlook the impact of new technology on economic growth. It is far from obvious that technological innovation reduces employment opportunities at an economy-wide level. The chart below shows the annual rates of growth in employment and multi-factor productivity (probably the best measure available of technological innovation) for the period 1995 to 2013 for those high-income countries for which comparable OECD data is available.

 The chart certainly does not show a general pattern of low employment growth in countries with relatively high levels of technological innovation. If anything, it suggests the opposite. The modest growth in employment in Korea may reflect limits on growth in available labour since the unemployment rate in that country has been relatively low (less than 4% of the civilian labour force in each year of the last decade) and a rising percentage of the age 15 to 64 population is in employment.

High rates of growth in employment at a national level will not necessarily prevent the emergence of persistently high levels of unemployment in regions where declining industries have been major employers. This poses a policy problem in helping older workers to cope with the changes in their circumstances. The current policy framework in Australia seems to provide incentives for many such people to migrate from long term unemployment to disability pensions. The problem is likely to be exacerbated by increases in the age at which people become entitled to aged pensions. Past experience suggests that regional development policies do not provide a panacea for regions that have little to offer investors other than an aging unskilled workforce. It is difficult to see the problems being resolved by adopting an NZ style investment approach to removing people from unemployment benefits as proposed in the McClure report (discussed here) but, hopefully, I am wrong about that.

In a chapter in the CEDA report Australia’s Future Workforce? Andrew Scott suggests that one of the lessons learned from the decline of employment in manufacturing locations since the 1970s “is that you cannot just take middle-aged workers out of factory environments, put them into classrooms and then expect them to immediately learn new skills for new jobs in that unfamiliar setting”. He suggests that the approach to active labour market policies adopted in Denmark has much to commend it. I will remain unpersuaded until I see a good cost benefit study of the policies adopted in Denmark, comparing the approach adopted there to a range of alternatives including offering early access to aged pensions (at say, age 60) at a lower than normal rate of benefit, to unemployed people in regions of high unemployment.

To sum up, I don’t think there are strong grounds for pessimism about the ability of technological progress to provide widespread opportunities for people in high-income countries to improve the quality of their lives. It is important to recognize, however, that many people will lose jobs as a result of this process at some point in their lives. Most will readily find alternative employment, but in regions that are adversely affected by technological unemployment some people are likely to have their lives severely disrupted.

Should regulation be allowed to limit the enjoyment of opportunities created by technological progress?

Two conflicting stories are being told about technological progress: the first has it creating widespread opportunities, while the second has it reducing real wages and creating misery for large numbers of people. The first story is a much more credible. That means, among other things, that governments should stop protecting vested interests that are trying to prevent technological innovations.

Machines are certainly replacing labour. As discussed in a recent post on this blog, new technologies are displacing routine jobs, including many jobs requiring technical and professional skills. This technological change is often described as labour-saving, for obvious reasons, but like many other economists I prefer to call it labour-augmenting, because its impact is like that of an increase in labour supply. (Think of robots.) Technological change also creates new jobs - often involving creative application of technology to solving problems – but the overall impact is less labour being required per unit of output. In other words, the story is about rising average labour productivity.

At an aggregate level, innovations that raise labour productivity tend to increase the demand for labour because they make labour more productive. High labour productivity is associated with high real wages rather than with low real wages: international comparisons show that real wage levels are more or less proportional to average productivity levels. It is almost axiomatic that countries with high average productivity (national output or national income per unit of labour, Y/L) will have high real wages (S_L*Y/L where S_L is labour’s share of national income).

Actually, real wage growth has not been quite proportional to labour productivity growth in those countries where labour’s share of national income has fallen over recent decades. The median labour’s share of income for OECD countries has fallen from 66.1% in the early 1990s to 61.7% in the late 2000s. That implies (on my calculation) that real wages have typically been growing at a rate around 0.35% per annum less than the median labour productivity growth of 1.64% per annum in high-income countries.

As discussed in an earlier post, the most plausible reason for the failure of real wages to keep pace with the growth of labour productivity is that capital deepening (the growth of capital per unit of labour) has not been sufficient to offset the labour augmenting (or labour saving) bias of technological progress. In other words, investment levels have been too low.

This is consistent with the OECD’s recent analysis in The Future of Productivity which indicates that while the slowdown in the contribution of investment to GDP growth in the United States, Europe and Japan was accentuated after the GFC it was evident in the period 2000-07 (Figure 5, p 20). Investment in information and communication technology – a major source of labour augmenting technological change – remained relatively strong despite the overall weakness of investment.

Investment levels in Australia and Canada have remained strong until recently, mainly reflecting investment in mining to service a construction boom in China.  Looking to the future, however, Australia is unlikely to be immune from the malaise affecting the US, Europe and Japan, unless it follows superior economic policies.

The weakness of investment does not mean that governments should be scrambling to put in place an array of new investment incentives, but it does mean that they should be seriously considering removal of regulatory and tax impediments to innovation. The OECD’s recently updated Policy Framework for Investment provides a checklist of questions that are just as relevant to stagnating high-income countries as to the developing countries they were originally designed to assist.

There is a discussion of some aspects of government failure in high-income countries in my recent post on the policy implications of widening diffusion gaps. Last week’s post relating to the competitiveness of cities raised the relevant question of whether powerful interest groups that stand to lose will have the political clout to slow down innovations that have potential to reduce transport costs e.g. Uber. The issue I want to raise now is whether excessive regulation to protect intellectual property rights is likely to limit the opportunities created by technological progress.

The idea that protection of intellectual property rights could ever be excessive may seem to be morally suspect to some authors and inventors. Questioning whether people have an unlimited natural right to ownership of their intellectual creations might seem akin to questioning whether people have a natural right to the fruit that grows on their trees. Even so, individual claims to ownership of land and fruit trees are viewed as unethical in some traditional societies.

Arguably, laws regarding property rights have tended to evolve in market economies over many centuries in ways that now serve the individual interests of the vast majority of citizens in living peacefully and enjoying economic opportunities.

Viewed in that context it makes sense for claims to property ownership to be assessed in terms of what it is reasonable for people to expect. For example, it seems to me that it would be unreasonable for property owners to view passers-by who pick fruit from branches overhanging the boundary of their property as having breached a claim to ownership that is worthy of being enforced. It is possible that view might reflect my ignorance of reasons why such picking of fruit might be viewed as a crime in some jurisdictions. My point is merely that the property owner’s claims need to be balanced against the reasonable expectations of other citizens.

The economic benefits of copyright and patent laws derive from the incentive they provide to authors and inventors to engage in creative activity. The granting of such monopoly rights could therefore be expected to result in more technological progress and higher productivity growth than would otherwise occur. However, the exercise of such monopoly rights imposes a cost on users and can restrict adoption of new technology. In this context it seem reasonable to expect that the aim of government involvement in enforcing intellectual property claims would be to achieve an appropriate balance between providing incentives for creative activity and diffusion of technology.

A recent issue of The Economist (August 8, 2015) notes that a high proportion of patents (40-90%) are never exploited or licensed out by their owners. The authors suggest that “the system has created a parasitic ecology of trolls and defensive patent-holders, who aim to block innovation, or at least to stand in its way unless they can grab a share of the spoils”. The authors suggest that patents should come with a blunt “use it or lose it” rule, so that they expire if the invention is not brought to market.

A recent article by Brink Lindsey also argues that current laws regarding copyright and patents in the US are retarding growth of productivity by raising the price of copyrighted and patented products excessively and inflating the costs of innovation. He suggests some modest reforms to rein in the vast expansion in reach of copyright and patent law during recent decades:  removal of criminal liability for copyright infringement; removal of liability for non-commercial copying; reducing copyright terms from life plus 70 years to 14 years; and ending patent protections for software and business methods.

It seems paradoxical that while there is recognition in some quarters in the US that current intellectual property (IP) laws have over-reached, the US government is actively engaged in trade negotiations to impose dubious intellectual property regulations on international trading partners. Australia’s Productivity Commission noted in Trade and Assistance Review 2013-14 that under the Australia-United States Agreement (AUSFTA) copyright protection was extended to the life of the author plus 70 years, compared with life plus 50 years under the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).

 

The Commission added:

“The relevance of trade related IP issues for Australia has gained even greater prominence because of the potential reach of the proposed TPP in this area. Potentially, the IP chapter in the TPP could be extensive and go beyond the provisions contained in the TRIPS Agreement and AUSFTA. For example, based on US media access to the current draft text, it appears likely that the TPP will include obligations on pharmaceutical price determination arrangements in Australia and other TPP members, of an uncertain character and intent. The history of IP arrangements being addressed in preferential trade deals is not good. Indeed, to the extent that the return to IP holders awarded by more stringent IP laws outweighed the benefits to the broader economy, the provision would also impose a net cost on both partners, lowering trading and growth potential across the bloc.”

Let us hope Australia’s trade negotiators do not end up paying too high a price for the sweet deal they are still seeking on sugar exports to the US market.

Postscript:
The Australian Government has now asked the Productivity Commission to undertake a public inquiry on intellectual property. Further information is here.

Will Sydney become internationally competitive?

International competitiveness is a useful concept to apply to cities that are competing globally. Major cities are in competition to attract people with scarce skills and entrepreneurial ability, and to maintain reputations as attractive places for people to do business, invest, innovate and develop skills.

Liveability is important, but it does not encompass everything that is important. International competitiveness also involves natural advantages - including location, human resources and business culture - the regulatory environment and the efficiency of organisations providing infrastructure and other services.

Unfortunately, there is probably as much room for confusion in writing about the international competitiveness of cities as there is in writing about the international competitiveness of industries. Advocates of various industry interest groups in Australia have sometimes argued that they need tariff protection, import quotas, subsidies and tax concessions in order to become internationally competitive. I have the impression that such advocacy has diminished in recent years, but that might be because it is now a long time since I was paid to listen to it. The important point is, of course, that internationally competitive industries should be able to thrive without government assistance.

Similarly, the representatives of particular cities sometimes argue that they need central government assistance to fund infrastructure that will help make them internationally competitive. The merits of such claims are particularly difficult to assess in Australia, given overlapping responsibilities for funding of federal, state and local government activities. Nevertheless, the point stands that within a sensible funding framework, internationally competitive cities should be able to thrive without central government subsidies to fund infrastructure.

Another potential problem in talking about the international competitiveness of cities is that some people will assume that if a city is lacking in some aspect of competitiveness this can be remedied by more intensive planning and regulation by an ‘entrepreneurial state’. We don’t hear the term ‘Australia Inc.’ so often these days, but it is not difficult to find academic commentators who have faith in the ability of governments to perform entrepreneurial miracles. The recent contribution of Roy Green, Ian Marsh and Christos Pitelis to the CEDA publication ‘Australia’s Future Workforce?’ comes to mind in this context.

My interest in the international competitiveness of Australian cities was aroused by a couple of other contributions to the CEDA publication (which I have previously written about here).  Steven Callander makes the point that Australia needs liveable cities in order to be good at innovation: 
“Turning a city into a great place to live is often taken as an end in itself, and in many respects it can and should be. Yet it is also a starting point for innovation. … Moreover, the benefits are widespread: When a city becomes a ‘brain hub’, jobs for plumbers, teachers, nurses and other local services are created at a rate of five to one over other cities, raising salaries and standards of living for all. A more liveable city attracts knowledge workers who affect change that makes the city ever more liveable”.

Fiona McKenzie makes the point that growing population is likely to add to costs of urban congestion with increasing city density placing more pressure on infrastructure, the environment and the social fabric of cities.

Sydney is generally ranked fairly highly as a global city. With regard to liveability, The Economist ranks Sydney in 7^th place, behind such cities as Melbourne and Toronto; Hong Kong is 31^st, Singapore and San Francisco are 52^nd, London is 55^th and New York is 56^th. Sydney is ranked 10^th in Mercer’s quality of living index, behind Vienna, Zurich, Auckland, Munich, Vancouver, Dusseldorf, Frankfurt, Geneva and Copenhagen. Singapore is in 26^th place in this index.

Sydney also ranks fairly highly in indexes that cover a wider range of aspects relating to competitiveness. A T Kearney’s Global Cities Index ranks Sydney as currently in 15^th place, with prospects of rising to 11^th place. These indexes are intended to measure global engagement and cover business activity, human capital, information exchange, cultural experience and political engagement. The current world leaders are New York, London, Paris and Tokyo, but those cities are expected to be overtaken by San Francisco and joined by Boston in the years ahead. A T Kearney’s current rankings put Sydney behind Singapore and their prospective rankings put Sydney ahead of Singapore.

Sydney ranks in 11^th place in the Global Urban Sustainable Competitiveness Index (GUSC) which covers economic dynamism, social cohesion, environmental quality, cultural diversity, technological innovation, global connections and government management. The world leaders according to this index are London, New York, San Jose, Paris, Hong Kong, Seoul and Tokyo. Singapore is in 12^th place. It is worth noting that the rating given to Sydney by the GUSC is 0.698, far below London’s rating of 1.000.

The other index I have looked at is PWC’s cities of opportunity index, which ranks Sydney in 9^th place behind London, New York, Singapore, Toronto, San Francisco, Paris, Stockholm and Hong Kong. Sydney’s overall rating is equal to 89.4% of the highest overall rating (London’s). The graph below suggests that Sydney’s competitiveness in relation to the PWC’s indicators varies from world best to being a long way from world best. (The best performing cities in the world are shown in brackets).

In some instances where Sydney’s performance is relatively poor, this is attributable to natural disadvantages. But poor policy performance has contributed to Sydney’s relatively low rating on some indicators, including transport and infrastructure. For example, Sydney’s performance in terms of numbers of licensed taxis relatively to total population is abysmal. Perhaps Uber might make it easier for people to get around in Sydney in future, provided it is not excessively taxed and regulated to protect the incumbents.

Unfortunately the competitiveness indexes I have looked at do not provide a very clear picture of how Sydney stands relative to cities in other parts of the world in terms of restrictions on economic freedom associated with regulation of incumbent service providers and artificial scarcity created by land-use regulation. A recent article by Brink Lindsey suggests that such regulation constitutes ‘low- hanging fruit’ that could readily be picked in the United States if politicians become interested in lifting economic growth.

The general impression these indexes give me is in that Sydney is in some respects already an internationally competitive city. Sydney may not have what it takes to become a major centre for software development, like San Francisco or Boston, but it has good prospects of becoming a major centre for highly innovative service sector activities in the Asia-Pacific region. The main downside risk, in my view, comes from powerful interest groups opposed to increases in population density and innovations that have potential to reduce the cost of transport, including congestion costs.

What are the policy implications of widening productivity diffusion gaps?

When I read the suggestion in the foreword of the OECD’s recent publication The Future of Productivity that governments should be “reviving the diffusion machine” to “promote inclusive growth” my initial reaction was that the OECD would have a difficult task persuading me that markets could not deal with diffusion of new technology without government help. However, it turned out that I had grasped the wrong end of the stick. The OECD researchers have been investigating whether diffusion gaps might be linked to government policy failures. Reviving the diffusion machine involves, among other things, reducing government regulation that prevent markets from functioning efficiently.

The growing diffusion gap in OECD countries is shown in the graphs below. The graphs have been reproduced elsewhere, including by Timothy Taylor, the conversable economist, but they deserve to be widely published.

 The frontier firms are the top 100 firms in terms of productivity levels in each year. These firms are from a range of different countries and many are very much global firms. The data for non-frontier firms is the average of all other firms. Charts for multi-factor productivity show a similar pattern. See the supporting paper by Dan Andrews, Chiara Criscuolo and Peter Gall, Figure A2.

The graphs suggest that productivity growth at the global frontier has remained relatively robust, despite the slowdown in productivity growth in many OECD countries during the 2000s (as previously discussed on this blog). It is interesting that the productivity divergence between top performers and the rest began to widen prior to the financial crisis. That is particularly evident in the case of service sector firms.

The authors acknowledge that the productivity gap is consistent with winner-take-all dynamics or “superstar effects” as well as slower diffusion of new technologies. However, the former explanation is discounted because the divergence is not confined to the ICT sector where winner-take-all dynamics might be expected to be most important. For a discussion of this point by Dan Andrews see the video of the launch of The Future of Productivity at the Petersen Institute (Dan’s response to the relevant question is near the end of the session).

Regression analysis suggests that the ability to learn from the global frontier is stronger in economies that are more open to international trade and more integrated in global value chains (GVCs). The productivity of national frontier firms is negatively influenced by cumbersome product market regulation, and positively influenced by quality of education systems, R&D subsidies, closer R&D collaboration between business and universities, and stronger patent protection. In some economies where national firms have productivity that is close to the global frontier, the impact of those firms on national productivity is muted because they are undersized. The difference between the size of national frontier firms and global frontier firms tends to be smaller in industries with higher job layoff rates, less stringent employment regulation and bankruptcy laws that do not overly penalize failure.

The growth of innovative firms is restricted by high rates of skill mismatch in many countries.  The authors suggest that skill mismatches can be exacerbated by high transactions costs in housing markets (e.g. stamp duties) and bankruptcy legislation that leaves people with valuable skills employed in zombie firms.

The report suggests:

“It is important that young firms either grow rapidly or exit but no longer linger and become small-old firms”.

That set off alarm bells in my mind. What the authors meant to say, presumably, is that governments should reform regulation that assists low-productivity firms to hold resources that could be used more efficiently elsewhere. The idea that young firms should grow rapidly or exit brought to mind memories of the phrase “get big or get out”, coined by an Australian agricultural economist in the early 1970s, and used by industrious bureaucrats and politicians to justify questionable interventions in the normal functioning of credit markets.

A question some of my readers might be asking themselves at the moment is how well Australia scores in relation to the policy variables noted above. The question is not easy to answer because Australian data is not included in some parts of the analysis.

• Australia’s participation in GVCs is relatively low for a small economy. (GVC participation is measured in terms of imported inputs used in exports and exports used as inputs in other countries’ exports.) This reflects Australia’s remoteness, but it may nevertheless make it more difficult for Australian firms to maintain close linkages with the global frontier.
• Some OECD data on product market regulation (Koske, I et al,2015, The 2013 update of the OECD’s data base on product market regulation …) suggests that Australia is among the best for OECD countries. Our regulation is apparently more restrictive than that for the Netherlands, UK and Estonia, but less restrictive than for Greece.
• In 2013 Australia’s score on the OECD’s data base on restrictiveness of labour market regulation – covering ease of dismissal etc. - was 1.94 out of a possible score of 6 (higher scores indicate more restrictions). Australia’s score implies somewhat less restrictions than the OECD average (2.21) and Greece (2.41), but more restrictions than New Zealand (1.01) and the US (1.17).
• The World Bank’s Doing Business ratings suggest that Australia’s performance in resolving insolvency (rating of 81.6%) is somewhat better than the OECD average (76.9%) although not as good as the US (90.1%) or Canada (89.2%). The average time required to resolve recover debt in Australia is 1 year, considerably lower than for the OECD average (1.7 years) the US (1.5 years) but higher than for Canada (0.8 years).

The fact that some of Australia’s policies look relatively good by comparison with OECD averages is hardly grounds for complacency.  OECD averages are heavily influenced by some of the most sclerotic economies in the world which have had woeful productivity performance over several decades.  

Does capital deepening reduce labour's share of national income?

The share of wages and other labour remuneration in national income has been declining in most high income countries over the last few decades. I have previously argued that if we are concerned with the well-being of the poor, we should be more concerned about trends in real wages than about trends in the distribution of income between labour and capital. That is still my view, but it hasn’t stopped me trying to understand the reasons why labour’s share has been declining.

My interest has been aroused, in particular, by the claims of some researchers that capital deepening (increases in capital per unit of labour) have contributed to the decline in labour’s share of national income. For example, the OECD’s Employment Outlook 2012 provides the following answer to the question: What explains the decline in labour’s share?

“Total factor productivity (TFP) growth and capital deepening – the key drivers of economic growth – are estimated to jointly account for as much as 80% of the average within-industry decline of the labour share in OECD countries between 1990 and 2007”.

The message that seems to be giving is that if a country or a region has the institutions, people and natural advantages needed to attract substantial additional investment, don’t expect the associated capital deepening (increase in capital to labour ratio) to have a strong positive impact on demand for labour. 

There are some circumstances where that might be a reasonable proposition. For example, as Dean Parham has shown in work for the Productivity Commission, the growth of the capital-intensive mining sector in Australia during the 2000s was strongly associated with the decline in labour’s share of national income over the same period.

However, the circumstances of Australia’s mining boom are somewhat peculiar. If it is generally true that capital deepening doesn’t have a strong positive impact on demand for labour I might need to make some fundamental revisions to my views about how economic systems work.

Dear reader, the next few paragraphs are somewhat abstruse, but please bear with me because I need your practical wisdom about production technology and the elasticity of substitution between capital and labour.

The elasticity of substitution between capital and labour is the critical factor determining the impact of capital deepening on demand for labour. It can be defined as the percentage change in capital deepening for a 1% change in the ratio of the wage rate to the rental price of capital (making the standard assumption that factors are paid the value of their marginal products). The sensitivity of the impact of 1% capital deepening (a 1% change in the capital to labour ratio) on labour’s share of output and real wages is shown below (assuming labour’s share of national income is 62%, the median for OECD countries).

The graph is drawn under the assumption of zero technological change. The underlying equation for percentage change in labour’s share is Equation 3 of Robert Lawrence’s recent working paper for the Peterson Institute on the decline in labour’s share in the US. The equation for the change in real wage is as derived in the end note below.

The OECD’s assertions about capital deepening reducing labour’s share were backed up by what appears to have been a fairly sophisticated econometric study by Samuel Bentolila and Gilles Saint-Paul (published in 2003) subsequently updated by OECD staff. These analyses suggest that capital and labour are gross substitutes (i.e. the elasticity of substitution between them is greater than 1) and attribute the decline in labour’s share to both capital deepening and capital augmenting technological change (i.e. technological change that has an impact similar to adding more capital).  

However, other econometric studies suggest that the elasticity of substitution between capital and labour is less than 1. For example, Robert Lawrence’s recent analysis of the decline in labour’s share of US income provides econometric evidence that it is attributable to technological change being so strongly labour augmenting (labour saving) that it has more than offset the positive impact of capital deepening. His results suggest that as a result of technological change “effective capital-labour ratios have actually fallen in the sectors and industries that account for the largest portion of the decline in labor share in income since 1980”.

I will leave it to others to attempt to unravel the mysteries of these conflicting econometric findings. It probably makes more sense for me to focus here on considering which set of results seems more plausible in terms of what you and I know (or think we know) about production functions at the level of the individual firm.

Think of any firm in any industry. In order to keep the analysis simple, assume that the firm leases the capital equipment that it uses and that the firm is small enough not to have any impact on either the rental price of capital or the prevailing wage rate. In the hypothetical situation I want you to consider there is no potential to change technology, only the potential to vary the amount of equipment or labour that is hired (and to vary other inputs in proportion to output). Now, consider to what extent the ratio of capital to labour is likely to change if the rental price of capital equipment declines by 10%, thus causing an increase in the ratio of the wage rate to the rental price of capital.

The answer that some readers may come up with is that the ratio of capital equipment to labour is fixed by existing technology, so that it will not change even if output changes in response to the lower input costs. For example, there is not much point in having more taxis than drivers or more desk-top computers than staff to use them. That corresponds to Wassily Wassilyevich Leontief’s assumption that the elasticity of substitution between capital and labour is zero.

The assumption of zero substitution possibilities is too extreme in my view, but I can’t think of an industry where it would be reasonable to expect a change in the wage rate to rental price of capital ratio to result in a more than proportionate change in capital deepening. Perhaps the time is approaching when firms will be employing both driverless vehicles and human-driven vehicles, so a decline in rental price of driverless vehicles could easily displace humans. But I don’t think that time has yet arrived. (Of course capital equipment can often be substituted for labour by introducing new technology, but the elasticity of substitution relates to unchanged technology.) Perhaps these comments just reflect the limits of my experience. Please enlighten me if that is so.

My bottom line is that unless I am persuaded otherwise I will cling steadfastly to the belief that capital deepening normally tends to raise real wages and labour’s share of national income, and that the decline in labour’s share of national income in high-income countries is attributable to labour augmenting technological change.

Endnote: some of the math behind the graph

Assume CES technology and that labour and capital are paid their marginal products. The rate of growth in the real wage is given by:

(1)     d log W = [(Ϭ – 1)/Ϭ]g + [1/Ϭ][d log (Y/L)]      

where W is the real wage rate, Ϭ is the elasticity of substitution between capital and labour, g is the rate of labour augmenting technological change, Y is output and L is labour input, so Y/L is average labour productivity.

We also know that the rate of growth of output is given by:

(2)    d log Y = S_L(d log L + g) + (1-S_L)(d log K + h)

where S_L is labour’s share of output, K is capital services, h is capital augmenting technological change, if we assume constant returns to scale and Euler’s theorem.

Substituting (2) into (1) and rearranging terms I obtained:

(3)    d log W = g + (1/Ϭ)(1 – S_L)[d log (K/N) – (g – h)]      (Both times I tried!)

The graph is drawn assuming no technological change i.e. that g and h are both zero. However, it is apparent from (3) that technological change tends to have a positive impact on real wages (assuming g>0). This impact is diminished when technological change has a labour-augmenting bias (g>h) and amplified when it has a capital-augmenting bias (g