I’m responding (as usual with a long delay) to a post by Chrish Bertram over at Crooked Timber on the Baumol effect and also to discussions more recently on this blog about public spending on health and education. The reference is to a paper from the 1960s: Baumol, W. (1967), ‘Macroeconomics of unbalanced growth: the anatomy of the urban crisis’, American Economic Review 57(3), 415–26.

To simplify drastically, the Baumol effect arises when productivity growth is more rapid in the goods-producing sector than in the service sector, and particularly in the provision of ‘human services’, including health, education, culture and recreational services (including the subject of Chris’ post, restauarants). Since labour and capital are mobile between sectors in the long run, wages grow at much the same rate in both sectors, so the price of services has to rise relative to the price of goods.

In addition, we need to assume that, for broadly defined categories of goods or services, demand is inelastic. That means that, when the price goes up, we consume less, but not so much less that our total expenditure falls. (This won’t be true in cases where goods with declining prices, such as vacuum-packed cassoulets in Chris’ example, are close substitutes for services with rising prices).

Given all this, we can expect to see an increasing share of income being spent on services like health and education, even though the real supply of these services is increasing only modestly (in the extreme case of zero productivity growth in services, supply will actually decline). Conversely, we will consume substantially increased quantities of manufactures even as employment in the manufacturing sector declines.

Since productivity is rising in at least part of the economy, we expect incomes to rise as well. But it’s useful to observe that the relative price effects would arise even if there were no income growth at all.

Once we understand the role of relative prices, it’s easy to understand things that puzzle a lot of quite smart people. For example, in the last few years we’ve seen a book called Myths of Rich and Poor by Cox and Alm asserting that even the poor are much better off than they used to be, and another called The Two-Income Trap , by Warren and Tyagi asserting that even the middle classes are finding it hard to pay for the bare necessities. These books are reminiscent of the story of three visually challenged persons examining an elephant.

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Peter Saunders has challenged me to provide a more detailed response to his paper ‘Do we still need the welfare state?’ The full paper is here (PDF). The core of the argument is summarised reasonably well by this para from his comment.

My argument is essentially about ‘churning’ (i.e. the fact that most of us pay in taxes for most of what we get back in welfare payments and services), not poverty. I explicitly recognise that some provision still needs to be made for those who cannot look after themselves (I estimate this at no more than 5% of the working-age population – back in the sixties it was only 3% and we are a lot wealthier now than we were then, so it really shouldn’t be much more than 5%). In my AIFS paper in February this year, for example, I note: “There will always be some people who for one reason or another are incapable of supporting themselves on a long-term basis. But their numbers are not so large as to require a welfare system on anything like the current scale to support them.”
My key point is that, unlike 100 years ago when the *mass* of the population could not earn enough to provide its own basic necessities (which is why a *mass* welfare system evolved to fill the gap), today this is patently no longer the case. …The image that most of us have of the welfare state is of a system that takes from those who can afford to pay and reallocates to those who are poor. The reality, however, is that as welfare spending has grown, so it has had to be funded increasingly by taking money from all sections of society, not just the wealthy or high income earners. This means many people now pay with one hand and receive the money back with the other, and that most beneficiaries end up paying for most or all of what they receive. Indeed, the main reason many welfare recipients appear to need government assistance is that the government has taken so much of their income away in taxation, thereby pushing them into dependency.

The central problem with this argument is that Saunders confuses arguments about transfer payments with arguments about publicly provided services, lumping both together under the term ‘welfare’ and assuming that the purpose of these payments is to alleviate poverty.

As far as transfer payments (age and other pensions) are concerned, I agree with Saunders’ basic point that we should not tax ourselves heavily to fund universal benefits, effectively taking money out of one pocket and putting it back into the other. But of course, we don’t. As far as I’m aware, there are no cash welfare payments in Australia that are not subject to means tests, usually tight ones. Saunders may perhaps favour even tighter means tests, but this gets us straight into a huge and messy debate about effective marginal tax rates.

So even though the majority of Saunders’ discussion is about poverty-alleviation and cash transfers, the real issue, as far as Australia is concerned, is whether governments should reduce spending on services like health and education. There are strong arguments for public funding of these services which have little to do with income redistribution. Saunders concedes the crucial point early on his paper. While he’s opposed to governments actually providing health and education (a ‘socialised’ mode of consumption) and welcomes shifts towards funding of private schools and hospitals ‘a privatised mode of consumption’, he concedes that this does not imply big reductions in spending:

The overall level of government social expenditure might not fall much as a result of this transition, but what does change very visibly is the form in which services are produced and consumed. (emphasis in original)

If, with Saunders, we rule out substantial cuts in expenditure on health and education and we are already imposing tight means tests on cash payments, the only options remaining are to reduce the value of pensions and benefits and to tighten eligibility. These have been the approaches adopted in the US, and they have contributed to the outcomes noted in the previous post.

A number of readers have asked about Peter Saunders (the CIS one) and his claim that, with rising incomes, we no longer need the welfare state.* Although his argument raises a number of issues, the easiest response is to look at Saunders’ preferred model, the United States, and see what rising incomes have done to reduce poverty in the last 30 years or so. Here’s the data from te US Census Bureau
The measure used is an absolute one, calculated to equal a poverty-line budget in the 1960s. Price changes since then have had mixed effects, but the increased relative price of health and housing means that, overall, the standard of living associated with the poverty line income has probably gone down, not up.
You can read the whole Census Bureau report on poverty here (PDF file)

* In the comments thread, Peter Saunders takes exception to this characterization of his views and says his objection is to the *mass* welfare state. I don’t think this distinction is relevant to the point made in the post above. However, it is one of the more general issues, I mention, and hope to tackle later. Peter’s papers are available from the CIS website.

As expected, the World Trade Organisation has ruled that Bush’s tariffs on imported steel violate the WTO rules, and that countries affected can impose retaliatory tariffs.

It’s possible that the Administration will back down, though I can’t see an easy way to do so and save face. And it seems unlikely that the EU, which has already had lots of fun publicising the items on its list, targeted at swing states for 2004 (Harley-Davidsons, Florida orange juice) will refrain from exercising its legal rights. Once that happens, the possibility of a face-saving climbdown will be gone for good, and most of the Republican base will be pushing for another round of (illegal in WTO terms) retaliation. This would undermine the WTO, perhaps fatally.

As I’ve previously mentioned, the WTO made lots of enemies by overreaching itself in the 1990s, on the assumption that big-country governments would always back it up in the end. The wisdom of that assumption is now being tested.

Christopher Hitchens has a piece in Slate, deriding accounts of a last-minute peace offer from the Iraqis. I don’t think there’s much to the story, but I was struck by this paragraph, which gives an indication of the kind of parallel universe still inhabited by many hawks.

The Iraqi side openly conceded that U.N. inspections as then being conducted were a farce and a sham. Hassan al-Obeidi, chief of foreign operations of the Iraqi intelligence service, is at one point reported to have offered to allow “2,000 FBI agents” to enter Iraq and look at anything they wanted. He had clearly got bored with the easy and transparent routine of thwarting Hans Blix.

Given that there were no weapons, stopping Blix from finding any was indeed easy and transparent’.

Read as a whole, the piece seems to show Hitchens morphing from his original position (war for human rights) to one of generic hawkishness.

Every Monday, I invite readers to comment on any topic that takes their fancy, requesting only that discussion is kept civilised and that no coarse language should be used. As I mentioned a couple of days ago, I really value comments.

I would like, once again, to invite anyone who’s been reading the blog for a while and found it to provoke some thought to post a comment and tell the rest of us what you’ve been thinking.

The Salinity Crisis by Quentin Beresford and others. This is about dryland salinity which (oversimplifying drastically) occurs when trees are cleared and saline water tables rise to the surface. It’s less well known than the salinity problems that arise in irrigation systems like the Murray-Darling, but equally significant and apparently more intractable. The only clear solution is to replant trees, but the area that has to be planted is so great and the time to fix the problem so long that, in a lot of cases, it appears not be economically feasible.

One topic mentioned in passing, and in which I’m interested is that of amateur vs expert science. In the dryland salinity context, the amateur/community science viewpoint is that of Harry Whittington and his Whittington Interceptor Banks. Whittington, a farmer, proposed a kind of drainage that was rejected as unsound by the hydrologists who had studied the problem, giving rise to a debate that went on for decades. Although debate still continues, belief in Whittington’s approach seems to have dwindled.

I’m of the view that the experts are usually right in this kind of dispute, but their are undoubtedly cases where a particular viewpoint or group interest dominates the expert view to the exclusion of all others.

In a recent post, I criticised British sociologist Alan Buckingham who gave a number of presentations for the CIS criticising speeding laws and their enforcement. I made the point that Buckingham was not presenting research-based arguments but a series of sloppy and misleading arguments(while I usually disagree with assumptions that guide CIS research, and the results that flow from those assumptions, the quality is generally pretty good, unlike some other rightwing thinktanks) . It emerged in the ensuing discussion that Buckingham wasn’t even presenting original arguments of his own but was restating and endorsing those of a British lobby group, Safespeed, of which he’s a member. In a statement on its website , Safespeed said

Dr Buckingham is a Safe Speed member and frequent visitor. It is obvious that his article draws heavily on our material, but unfortunately the print version of the article appeared without giving Safe Speed the required credit. We’re happy to accept that this was an oversight and not a deliberate attempt to infringe our copyright. The PDF version of the article has been officially amended to include the necessary acknowledgement. (Thanks to Don Arthur for this link. On checking, the statement is not there any more. It has apparently been withdrawn while a new one is being drafted. If anyone has a cached version, I’d appreciate it).

Having criticised Buckingham for not doing, or using, the right kind of research, I should say something about what kind of research is appropriate. Although I’ve done research on the economic aspects of road crashes and law enforcement, I’m not an expert on the effectiveness of particular road safety measures. However, reader Mark Leggett has kindly supplied me with this study by Newstead, Cameron and LeggettFor those who don’t want to read the whole thing, here’s the abstract

Random Road Watch (RRW) is a traffic policing program in operation in Queensland, Australia. It differs from conventional traffic policing in that an explicit resource management technique is used which randomly schedules low levels of police enforcement in a manner intended to provide long-term, widespread coverage of a road network and hence maximise road safety benefits. Implementation of the program studied in Queensland covered 55% of total crashes within the state. This study aimed to measure the crash effects of the RRW program in Queensland. A quasi-experimental study design was used for the evaluation incorporating Poisson regression statistical analysis techniques. Analysis of the effects of the Queensland RRW program on crash frequency has shown the program to be effective overall. Estimated program effects were largest on fatal crashes, with an estimated reduction of 31%. Estimated aggregate program crash effects reduced with crash severity and increased with time after program introduction. Crash reductions in the third year after program introduction translated into savings, at state level, of some
12% of the state’s crashes of all severities and some 15% of the state’s fatal road crashes. Overall, the program produced a significant 11% reduction in total crashes in areas outside of metropolitan Brisbane. The opportunity-cost benefit:cost ratio for the program was estimated to be 55:1.

I should say that I don’t claim that this study is conclusive or that its results are necessarily applicable to other road safety initiatives. In addition, I would have preferred a broader benefit:cost analysis, though from the data here it’s clear that the result would have been the same. But this is the kind of research that’s needed if you want to make claims about the effectiveness of specific road safety measures, such as speed cameras.

The time series evidence of dramatically declining death rates, and the comparison with rising death rates in the US, provides pretty conclusive evidence of the effectiveness of road safety measures in general. But to look at individual measures you need detailed research of the kind undertaken by Newstead et al. To try, as Buckingham does, to link second-derivatives of the death rate (a slowdown in the rate of decline) to specific initiatives such as speed cameras, is silly, and would not stand up to the kind of statistical scrutiny that is required in serious academic work.

I haven’t mentioned it for a while, but I really appreciate the contribution made to this blog by the many readers who contribute comments. I get lots of useful information, occasional correction and plenty of points on which to sharpen up my arguments. You get the chance to have your say without the hassle of running a blog. So if you’ve been too shy to comment, now’s the time to have a go. Remember you don’t have to use your real name or anything that would identify you.

The Economist magazine has been an enthusiastic backer of the Castles critique (now joint with David Henderson) of the economic projections used by the IPCC in modelling the impact of Kyoto. It’s also been an enthusiastic backer of the use of purchasing power parity measures, notably through its Big Mac index.

Its surprising then that they endorse an argument by Castles which gets the crucial issues precisely backwards. The crucial para

The IPCC’s procedure relied, first, on measuring gaps between incomes in poor countries and incomes in rich countries, and, second, on supposing that those gaps would be substantially narrowed, or entirely closed, by the end of this century. Contrary to standard practice, the IPCC measured the initial gaps using market-based exchange rates rather than rates adjusted for differences in purchasing power. This error makes the initial income gaps seem far larger than they really are, so the subsequent catching-up is correspondingly faster. The developing-country growth rates yielded by this method are historically implausible, to put it mildly. The emissions forecasts based on those implausibly high growth rates are accordingly unsound.

To see what’s wrong here, suppose you use the PPP-adjusted estimates of income in poor countries. Then the growth required for convergence is lower, and the estimates become more plausible not less.

What is the impact on projections of energy consumption. None whatsoever, as far as I can see. The projections assume that energy use in the poor countries will converge to that in the rich countries as income converges.

The only potentially valid criticism Castles has is that the assumption of convergence is overoptimistic. I don’t think there’s a lot of weight in this, as I argue here/