Talk to The New Institute, Merewether – October 12, 2010

Ross Gittins, Economics Editor, The Sydney Morning Herald

I’m sure you know that economics is divided into two parts: micro-economics and macro-economics. According to Yoram Bauman, who bills himself as the World’s First and Only Stand-Up Economist, micro-economists are wrong about specific things, and macro-economists are wrong about things in general. Well, anyway, my new book, The Happy Economist, is divided in to the same two parts: micro-happiness and macro-happiness. Micro-happiness deals with the happiness of the individual, while macro-happiness deals with the happiness of the nation. In my talk to the Albion lunch tomorrow I’m going to deal with the happiness of individuals, but tonight I’ll talk about happiness at the national level.

Should governments get involved in their citizens’ pursuit of happiness? And even if they should, is there anything useful governments can do to increase national happiness? I answer yes to both questions. If it’s OK for governments to seek to maximise gross national product, why would it be wrong for them to pursue gross national happiness? Actually, I think they are seeking to increase aggregate happiness, and always have been. They’ve just been going about it the wrong way.

Although you could be forgiven for not knowing it, economics is supposed to be about maximising happiness, or ‘utility’ as economists call. Trouble is, a long time ago economists took the logical shortcut of assuming that increased consumption was the same thing as increased happiness. So I devote part of the book to offering a critique of conventional economics.

Conventional economics is dedicated to the pursuit of higher material living standards by means of increased efficiency in the allocation of resources. What the economic rationalist episode in Australia demonstrates is that if governments take economists’ advice, it works. The country’s affluence – as measured by gross domestic product – increases significantly, although this says nothing about how the increased income is distributed between rich, middle and poor. In principle, the greater affluence would make it easier to afford to redistribute more income from the top to the bottom. In practice, economic rationalists often object to such measures, arguing that they would dampen the incentive to strive for greater affluence.

In the early years of my career as an economic journalist I was a great advocate of economic rationalism and its ‘micro-economic reform’. In more recent years I’ve gained a greater understanding of the weaknesses of conventional economics and a greater appreciation of the real but intangible and often unmeasurable price we’ve paid for greater efficiency. The standard theory has failed to incorporate and adapt to advances in psychology, evolutionary biology, neuroscience and ecology. It’s unscientific assumption that humans are ‘rational’ – carefully calculating and self-interested – does much to explain its bad record in predicting human behaviour and the unintended consequences that arise from implementing its recommendations. That unsupportable assumption also casts doubt on the economists’ confident assertion that no government could know what’s in my best interests better than I do. Real-life humans have a great problem with self-control – making yourself do what you know you should – and they’re often grateful to have governments take the struggle out of their hands.

We aren’t the rugged individualists economists assume us to be, but highly social animals, at once anxious to fit in with our group and jealous of our status within the group. The more economists assume otherwise, the more they misunderstand our deeper desires and urge on us solutions that won’t genuinely increase our happiness.

Economists are too narrow and too missionary. They focus on the material aspect of our lives, ignoring all the other dimensions, but then they urge us to advance our material prosperity at the expense of the dimensions they ignore. They’re like the French teacher who piles the homework on to her year 12 students, believing she’s helping them but, in truth, tempting them to neglect their other subjects. Rather than maximising the material we should be optimising all the various aspects of our lives, including the social and the spiritual.

Economists often present efficiency and economic growth as the universal cure to all problems. The richer you are the more easily you can afford to buy solutions to your problems, including those you created for yourself in your pursuit of wealth. Neglect your kids so you can afford to send them to expensive schools? Wreck the environment so you can afford to clean it up? I don’t think so. Governments should be seeking a wider range of advice.

The chemist, the engineer and the economist.

In our governments’ almost single-minded pursuit of economic growth they tend to underrate and encroach upon leisure, family life and ‘social capital’—the social connections, trust and norms of reciprocity and acceptable behaviour—that hold the community together and give life much of its meaning. Social capital also does much to support the smooth functioning of the economy. But such intangibles are beyond the ken of most economists. They see the material benefits of greater efficiency but don’t see its non-material costs. None of this says we should abandon the goal of efficiency. After all, inefficiency has nothing to recommend it. Rather, it says efficiency shouldn’t be our only goal and we should seek a better trade-off between efficiency and our other, non-material goals.

So great is the conventional economists’ commitment to greater affluence through growth in the annual production of goods and services that they long ago rejected the notion that there could be physical or environmental ‘limits to growth’. Yet this is exactly the contention of the ecologists. They remind us that the global economy exists within the global ecosystem. The ecosystem supplies the economy with ecosystem services such as photosynthesis. The economy extracts renewable and non-renewable natural resources from the ecosystem and returns them as all manner of wastes, including greenhouse gases.

But whereas the ecosystem is of fixed size, the global economy has grown hugely over the past 200 years, thanks to multiplying population and rising material living standards. The scientists’ advice that the build-up of greenhouse gases in the atmosphere has reached the point where it’s causing the globe to warm, changing weather patterns and raising sea levels is just the most pressing respect in which humans have reached the limits to growth. Other limits are approaching, such as the rundown of fish stocks, the worsening problems with water and land use, and the destruction of species.

The response of a new and radical school of economic thought, the ecological economists, led by Herman Daly of the University of Maryland, is that we need to change the goal of economics from ‘growth’ to ‘development’. Growth, as measured by increasing GDP, includes increased throughput of natural resources plus increased productivity in the use of all resources. Development, as defined by the ecological economists, aims for no increase in the throughput of natural resources but still permits increased productivity.

(Economists define increased productivity as achieving more output of goods and services from the same quantity of inputs of economic resources—land, labour, capital and raw materials. This amazing achievement, which market economies perform year after year and which is the primary source of 200 years of rising real incomes per person, occurs mainly because of advances in technology, including improvements in know-how as well as in machines.)

Thus some increase in GDP would still occur in the ecological economists’ better world, but none that increased the burden of the economy on the ecosystem. The managers of the economy would still pursue greater efficiency in the allocation of resources, the source of rising productivity. With the right constraints, greater productivity in the use of natural resources—that is, everything except human labour and man-made capital equipment and structures—could be used to reduce our throughput of natural resources, not just hold it steady, without this reducing our living standards.

The many conventional economists who accept the scientists’ advice that the globe’s greenhouse gas emissions need to be greatly reduced if we are to limit the extent of global warming advocate the use of ‘economic instruments’ such as a carbon tax or an emissions trading scheme as the least inefficient way to achieve the necessary reduction in emissions. Herman Daly and his ecological economists would make extensive use of ‘cap-and-trade’ arrangements to limit the quantity of natural resources being used.

This would force up the prices of natural resources—and the cost of goods and services whose production relied on those resources—relative to the prices of everything else, a design feature that reflected our changed definition of the ‘problem of scarcity’. As with carbon emissions, raising the relative prices of natural resources encourages consumers and businesses to economise in their use, recycle them and look for substitutes, as well as creating a monetary incentive for searching out technological solutions. These price increases would disadvantage low income-earners but, because cap-and-trade systems are a form of taxation provided governments sell rather than give away the permits to use natural resources, the additional government revenue can be used to compensate the disadvantaged.

As I mentioned earlier, I believe governments can, should and do seek to increase national happiness, or ‘aggregate happiness’ as a macro-economist might put it. All governments would say their goal is to increase the wellbeing of the community and under this heading almost all of them are committed to the pursuit of economic growth. Why? Because they believe a higher material standard of living will make their people happier. So the problem is really their unduly narrow definition of ‘wellbeing’. It puts too much emphasis on material wellbeing, with other aspects of objectively measurable wellbeing (including such things as health, education and the natural environment) usually not receiving sufficient attention, and subjective wellbeing coming a distant last.

So how could governments make a better fist of increasing aggregate happiness? For a start, by adopting a more enlightened attitude towards economic growth and efficiency. I cast doubt on the obsession with economic growth on two grounds. First, the psychologists tell us that, particularly in the rich countries, raising the general level of incomes does nothing to make people happier, though raising some people’s income relative to the income of others does make the winners happier at the expense of the happiness whose relative income declines. The trouble with this is that whereas governments can by the pursuit of economic growth raise incomes generally, they obviously can’t raise everyone’s relative income.

Second, the ecologists tell us that ever-growing global economic activity is fast approaching the limits to growth imposed by the fixed ecosystem. We’re on a path that’s environmentally unsustainable and unless we want to impose devastation on humankind we need to switch to a path that’s sustainable, while still allowing progress in making the world a better—and happier—place.

Herman Daly and the ecological economists have outlined the means by which we—and the rest of the planet—could move to economic and ecological sustainability. For reasons of both morality and acceptability to the poor countries, it has to involve a differential approach between those countries that are already rich and the poor countries still aspiring to reach our living standards. The two variables are population growth and growth in income per person. While all countries should be aiming to at least stabilise their populations, this has largely been achieved in the rich countries (ignoring immigration), whereas it requires a lot more effort in most poor countries, China excepted.

With growth in income per person, it’s the other way round: the rich countries’ material living standards need to stabilise and maybe fall somewhat so as to make room for the poor countries’ material aspirations, which the happiness research suggests will lead them to greater happiness. The more that living standards can be stabilised in the rich countries and increased in the poor countries while using technological advance and other efficiencies to reduce the natural-resource intensity of each dollar of GDP, the better for our goal of avoiding further ecological destruction.

Turning to other, less apocalyptic ways for governments to raise aggregate happiness, a less manic commitment to growth and efficiency could permit more attention to be paid to the effects of economic activity and government policy on social capital, leisure, the distribution of income between rich and poor, and relationships.

And in a less growth-obsessed world, employers and governments could put a new emphasis on what I call ‘job enhancement’—making jobs more satisfying by redesigning them to provide workers with more of the three factors known by psychologists to contribute to happiness at work: the ability of workers to have some control over their environment and see themselves as effective; the ability of workers to feel they belong and are connected to others; and the freedom of workers to make their own decisions and see themselves making a difference. Job enhancement is an end in itself, needing no further justification. But I don’t doubt that, sensibly done, it would raise workers’ productivity.

To summarise the ‘macro’ part of the book let me quote the British epidemiologist Richard Wilkinson: ‘We’ve got to realise that how we improve the quality of life in our societies now is not by material improvements so much as improvements in the quality of social relations.’

Ross Gittins, Economics Editor, The Sydney Morning Herald

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