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Opinions of Friday, 24 June 2005

Columnist: Amegashie, J. Atsu

Thoughts on social organizations

Consider a communal system based on sharing. Suppose that Ama produces 200 bags of corn and Kofi produces 50 bags. Under an egalitarian allocation, we would give each of them 125 bags. We would take 75 bags from Ama and give them to Kofi. Such a system is sustainable, so long as Ama has been socialized to believe that this is a fair allocation. Otherwise, she would demand a higher share on grounds of being the more productive of the two or reduce or hide her output in protest of this egalitarian system. The reduction of output is the disincentive effect of egalitarianism or any sharing very close to it.

Ama may not reduce her output if she cares about the social sanctions of her behavior; for example, people in the community may shun her. In a small community, it is easy to detect and punish such "deviant" behavior. But as the community gets bigger with population growth, the probability of detecting Ama's behavior becomes very small. Also, detecting her behavior will require time and effort to monitor her. This is another cost to the community since the time and effort of the people monitoring her could have been used for other productive activities. This cost of monitoring would be very huge in a centrally-planned system like the former Soviet Union which was run on the principle of ?from each according to his ability and to each according to his need?. Any system which does not allow people to retain a sufficient proportion of the fruits of their own labor/ability needs to spend huge resources in monitoring people or to socialize them to accept it as a fair system. This is what makes such systems very difficult to sustain.

There is yet another cost to society of a system which does not sufficiently reward high-ability people. If we give Kofi too much of what he did not work for, he may choose to work less. Kofi is less talented than Ama. What we want to do is to help the less talented but hardworking Kofis not the less talented and lazy Kofis. We have to carefully choose the magnitude of the transfers to Kofi such that we maintain his incentive to work while we also minimize any disincentive effects on Ama. The disincentive effect of excessive transfers is captured in the Samaritan?s dilemma or in the Akan saying ?wofa woho, nti menye djuma?, which literally means that ?I won?t work because I can depend on the charity of my uncle?. This behavior is NOT unique to Akans or Africans. I only mention it for the sake of emphasis.

What I have done is present simple story of a community in which the distribution of output which does not reward individual effort can lead to negative effects and indeed reduce aggregate output. The sharing rule must then strike a balance between incentives and the distribution of output. For example, Ama could be given 75% of her output. The remainder of her output (25%) will be a tax imposed by the government intended to transfer her output to Kofi. The free market is a social organization with an incentive mechanism to reward individual ability and effort. But the market can lead to extreme inequalities in the distribution of income. Countries which design their tax/transfer policies carefully can redistribute income to the poor or less able without having significant adverse effects on market performance.

Why should we take part of Ama's output and give to Kofi? So far, I have given the impression that redistribution will, at best, leave aggregate output unchanged, and will, at worst, reduce aggregate output (e.g., Ama reduces her output). But there are situations where transferring output from Ama to Kofi can actually increase aggregate output. Suppose there is no redistribution, so that Ama has 200 bags of corn and Kofi has 50, where aggregate output is 250 bags. Suppose Kofi believes that the current distribution of income (output) is unfair or that it is worthwhile to steal part of Ama's output rather spend his time trying to produce corn. Then he might spend his time and resources to steal Ama's output. On the other hand, Ama will spend time and resources to protect or defend his output. The net effect is that both Kofi and Ama spend time and resources to steal and defend the output of the economy, when these resources could have used in productive activities. Aggregate output will fall below 250 bags of corn. However, if Ama voluntarily transfers part of her output to Kofi, he may no longer find the need to steal. Aggregate output may be higher in this case. Hence redistribution can enhance efficiency or increase aggregate output. In this example, redistribution is a ?bribe? from the rich (i.e., Ama) to the poor (i.e., Kofi) which allows the rich to sleep peacefully without worrying too much about the security of their property.

Here is another example of how redistribution or less inequality can enhance efficiency. Consider a winner-take-all society where being first comes with everything and being second, third, etc comes with nothing. As an example, consider three athletes competing in a 100-meter race. Call them Kofi, Musa, and Edem. Let there be a prize worth $1 million. Suppose Kofi is an outstanding sprinter relative to Musa and Edem. Musa and Edem are equally matched. If the winner gets $1 million and the losers get nothing, then Musa and Edem will exert very little effort because they know that they can't really compete with Kofi and the runner-up does not receive a prize. But if Edem and Musa exert very little effort, then Kofi does not have the incentive to exert a high effort either. Aggregate effort will therefore be low and income inequality will be high since one person will be a million dollars richer than the others. Suppose that the race is no longer a winner-take-all race but instead $700,000 goes to the winner and $300,000 goes to the runner up. In this case, Edem and Musa will exert a higher effort because being second comes with a prize. The higher effort of Edem and Musa will also induce Kofi to increase his effort. Aggregate effort will be higher and the distribution of income will be less skewed. Hence, less inequality in the distribution of the million dollars led to an increase in aggregate effort. This argument makes sense if the distribution of abilities is very unequal (i.e., Kofi is an outstanding athlete relative to Edem and Musa). If the abilities of Musa and Edem were comparable to Kofi's, a winner-take-all prize structure would have resulted in a higher aggregate effort. However, the basic point is that the distribution of income or resources can enhance performance or increase aggregate output. But we have to redistribute taking cognizance of the fact that it could have adverse effects on output.

Harvard philosopher, the late Robert Nozick argued in his classic book ?Anarchy, State and Utopia? that a distribution of income or resources is just so long as the distribution was brought about by free exchanges by consenting adults, even if large inequalities emerge from the process.

According to Nozick there are three sets of rules of justice, defining:

1. how things not previously possessed by anyone may be acquired;

2. how possession may be transferred from one person to another; and

3. what must be done to rectify injustices arising from violations of (1) and (2).

A distribution is just if it has arisen in accordance with these three sets of rules.

There is a wide literature on Nozick's libertarian view of the world. To elaborate on Nozick?s argument, consider a society with 1001 people each with $2. Suppose Michael Jackson is a member of this society. If each member of this society voluntarily pays $1 to see MJ perform, the distribution of income will be such that MJ now has $1002 and everyone else has $1. According to Nozick this extremely unequal distribution of income is just and fair since no one was forced to pay $1 to see MJ's performance. This distribution of income arose through voluntary exchange. In Nozick's view, one cannot argue that a given distribution of income is unfair without taking into account how that distribution of income emerged. But there is something missing in Nozick's argument. For example, who determined that each person should pay $1 for MJ's show. Couldn't they have paid 5 cents to watch him, giving MJ a total income of only $52? In a free market, the $1 will be determined by the forces of demand and supply. Essentially, the patrons of MJ are given a take-it-or-leave-it offer of $1 to watch MJ. They have zero bargaining power. If the 1000 members of this society could join forces with each other, they could bargain collectively with MJ to watch the show for a total fee of $50. It is greed, impatience, etc which prevents them from doing so. Alternatively, the government, much akin to a union, of this society could bargain with MJ on behalf of the other members of the society. Or the government could allow MJ to charge a price of $1 per person but then require him to pay a tax of $950 leaving him with $52. The $950 is then redistributed to the other members of the society. The point is that Nozick cannot use apparent voluntary exchange to determine that a process was truly voluntary without taking into account the structure of power. In their disparate and unorganized form, the other 1000 members of this society had very little power to negotiate with Michael Jackson. In this example, a benevolent government may then be seen as a social arrangement which mobilizes and empowers the other 1000 members of this society. Indeed, each patron may, ex ante, see her payment of $1 as individually fair. But, ex post, she may see it as collectively unfair.

Nozick argues for a minimal state that protects people against force, fraud, theft, and enforces contracts. The state violates peoples? rights if it transfers income from one person to another. But one could argue that the state, in the example above, bargains with MJ over the price of his show before he acquires his income. When libertarians like Nozick argue against government redistribution, they ought to recognize that they are not necessarily doing so based on any compelling logic but by appealing to the sense of fair-play and justice of other members of society: it is immoral to take someone?s property without their consent. But in the same vein, advocates of redistribution also use a similar but reverse moral argument: it is morally right to help the poor, even if the rich have to be coerced to do so. To some extent, the argument on both sides is purely a matter of opinion.

I have implicitly assumed the existence of government. Why do we need government? I do not plan to address this question. However, given that we have a system of government, can competition among political parties through the electoral process ensure the good performance of governments? That is, can democracy ensure good social and economic performance by politicians? It depends on what one means by good performance. Consider a country with two political parties X and Y. Suppose party Y is in power after X had previously been in power? How should voters decide whether or not they want to keep Y in power or whether they prefer Y to X? One criterion is to compare X?s past performance to Y?s performance and vote for the party with the better performance. But suppose X was a very corrupt and bad government. Then this voting rule will re-elect Y, so long as Y is a little bit better than X. If this continues, the improvement in the performance of government will be very minimal because the voters? benchmark performance is too low (i.e., the very low performance of party X) and the parties just do enough to stay in power. The parties X and Y will take the voters for a ride. Now suppose the voters used a much higher but achievable absolute benchmark instead of a relative benchmark and chose to vote for the party in opposition if and only if the incumbent party performed below this absolute benchmark. Note that this voting rule applies to both parties. Then one can easily demonstrate that if politicians care sufficiently about their future welfare or are not myopic, each party will strive to meet the higher absolute standard. This is a better outcome than using the low performance of each party as the benchmark. Of course, the implicit assumptions here are that the incumbent party (whether X or Y) is committed to free and fair elections and the higher absolute standard is achievable. In reality, some circumstances outside the control of the incumbent party might make the attainment of the absolute standard impossible. If so, the voters should take this into account. Otherwise, they should following this voting rule. The real world is, however, a bit more complicated since voters have pecuniary and non-pecuniary motivations. A political party which can deliver a better economic performance may not be elected if it is, for example, pro-gay marriage and/or pro-abortion and/or pro-legalization of marijuana.

The power to tax and redistribute income is in the hands of governments. Take affirmative action, a policy described by some as reverse discrimination. Is it really reverse discrimination? The answer is ?it depends?. Suppose we agree that there is discrimination against group W in favor of group M in the job market. Assume that, in the absence of discrimination, each member of either group has a 50-50 chance of getting a job. Now suppose that discrimination indeed exists such that a member of group W has a 30% chance of getting a job and affirmative action is put in place to rectify this problem. Then affirmative action is reverse discrimination if a member of group W has more than a 50% chance of getting a job and member of group M has less than a 50% chance. Otherwise, affirmative action is not reverse discrimination. The above argument hinges on the assumption that discrimination currently exists. There are others who argue that even if discrimination no longer exists, affirmative action is required to correct any past injustices in the sense of Nozick?s third rule of justice above. Like most government policies, affirmative action distributes resources from one group to another.

In February 2005, Dr. Lawrence Summers, president of Harvard University, came under intense fire for suggesting that innate differences between men and women might be one of the reasons fewer women succeed in the higher reaches of science and math. He also urged scientists to look into the possibility that genes might explain this difference. His defenders saw the attack on him as an attack on academic freedom and the search for knowledge and truth. But why should Summer?s statement invoke such anger and mixed reaction? Here is one reason. For the sake of argument, suppose it were genetically proven that women had less IQ or innate ability than men in the sciences. There would be two possible public policy outcomes: (1) women will be given extra help in math and science and will not be considered as an inferior species, or (2) women will be considered as inferior and be oppressed by men. Don't dismiss this. Imagine that over a very long period, it becomes generally accepted that women have low IQ than men in the sciences and this is even taught in schools as part of the common social wisdom.

Now if you fear that (2) is more likely than (1), you can see why a reasonable person will temper her/his quest for truth, research etc. Which outcome you think is more likely will shape your views. It is a difference in beliefs about social justice and redistribution that will cause reasonable minds to differ. The groups against this kind of research and those for it may both be right. It all depends on their subjective probabilities that (1) or (2) will occur. Or may be, some folks don't even care if (2) occurs, so long as they don't bear the brunt of the oppression. The outcome of this research could redistribute resources from women to men or from men to women.

In most societies the median of the income distribution is lower than the mean (average). This is a fancy way of saying that a majority of the population earns less than the average income or more than 50% of the population earns less than 50% of total income. So what prevents the poor from voting for massive redistribution in a democracy? There are several reasons. The perception of social justice and fairness is one of them. In the introduction of their 2005 paper ?Fairness and redistribution?, Harvard economist Alberto Alesina and MIT economist George-Marios Angeletos, observe that ?[p]re-tax inequality is higher in the United States than in continental Western European countries (?Europe? in short). ? Nevertheless, redistributive policies are more extensive in Europe. The income tax structure is more progressive in Europe, and the overall size of government is about 50 per cent larger in Europe than in the United States (that is, about 30 versus about 45 per cent of GDP). The largest difference is indeed in transfers and other social benefits, where Europeans spend about twice as much as Americans. Moreover, the public budget is only one of the means to support the poor; an important dimension of redistribution is legislation, and in particular the regulation of labor and product markets, which are much more intrusive in Europe than in the United States. The coexistence of high pre-tax inequality and low redistribution is prima facie inconsistent with either the Meltzer-Richard paradigm of redistribution, or the Mirrlees paradigm of social insurance. Instead, the difference in the political support for redistribution appears to reflect; etc, at least in part, a difference in social perceptions regarding the fairness of market outcomes and the underlying sources of income inequality. More Americans than Europeans believe that poverty is due to bad choices or lack of effort rather than bad luck or social injustice; Europeans view poverty as a trap from which it is hard to escape. Americans perceive wealth and success as the outcome of individual talent, effort, and entrepreneurship; Europeans attribute a larger role to luck and connections. According to the World Values Survey, 71 per cent of Americans versus 40 per cent of Europeans believe that the poor could become rich if they just tried hard enough; and a larger proportion of Europeans than Americans believe that luck and connections, rather than hard work, determine economic success.?

Redistribution is a pervasive aspect of our lives. It appears in subtle and overt forms. It is partly a reflection of greed, our sense of social justice, and the quest for power. Wars, empire building, slavery, tribalism, racism, colonialism, pay-as-you-go social security, universal health care, affirmative action, trade liberalization, public schools, subsidies, unemployment insurance, tariffs, scientific inquiry, out-sourcing, immigration policies, etc. are all forms of deliberate or unintended redistribution with varying social costs and benefits. We spend an inordinate amount of time fighting over how to distribute national/global resources or output when we should be spending our time on how to increase output. However, the time spent on trying to redistribute output is not wasted because, as argued above, the distribution of resources and income could enhance output. But we shouldn?t carry redistribution too far. We need to find a balance.

Given that human beings have some greed in them, the market is the most pragmatic form of economic organization. We should not abandon it. We should maintain what it does well and fix its inefficiencies and shortcomings. Moderation is the cure of world.

J. Atsu Amegashie is an economics professor at the University of Guelph, Canada

Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage.