Earlier this year, a couple of high-level staff at the IMF’s research department and a colleague at the IBRD published a paper on the determinants of long-term growth – that is, of growth spells that continue over time rather than sinking countries into depression and stagnation. Among the determinants they found were: “the degree of equality of the income distribution; democratic institutions; export orientation…; and macroeconomic stability.”
That is, the more equal the income structure of the country, the longer the country would be able to sustain growth. The fact that the IMF is now publishing research making this link clear may be surprising, but the result itself is not. After all, Nancy Birdsall has done work for years showing the link between income equality and economic development – she’s even developed a course on the subject! She’s hardly alone. A group of Action Canada fellows (which included Sauvé Scholar alum Sadia Rafiquddin) wrote a well-received report last year pulling much of the literature together, and trying to explore the implications of these insights for Canada. There are lots of good reasons why this might be the case. Even The Economist is getting in on the game!
On the other hand, there is a problem with this entire kind of analysis. Sure, there is the usual normative broadside of “why do we care about growth!?” but I also have a methodological concern I’ve alluded to elsewhere. As two of the authors, Berg and Ostry, make clear in a summary of the equality dimensions of this research, “[t]he immediate role for policy, however, is less clear. More inequality may shorten the duration of growth, but poorly designed efforts to reduce inequality could be counterproductive.”
Such ambiguity fits perfectly with their actual data (so often a repository of key information missed by linear regression): high-inequality countries may not be able to sustain growth, but having relatively low inequality only makes sustained growth possible, not assured.
What should be obvious is that the ability of more or less income equality to translate into growth has to do not only with national trade law, or the frequency of elections, or the independence of the central bank. It also has to do with institutions. Strictly speaking, Berg and Ostry’s study, like much of the related literature from recent years, do not ignore institutions, or not exactly.
Somewhere in the background, Berg and Ostry know that institutional structures are at play. Their discussion of “distorted incentives” in Chinese farming policy makes this clear. they totally ignore the qualitative structure of institutions. But by referencing the “quality of economic and political institutions” , they seem to suggest that the role of institutions can be reduced to a single, numerical dimension. Good institutions give people incentives to work (or to save, or to “create jobs”, or to invest in human capital, or in new technology); bad incentives keep people lazy and greedy. Anyone who has had to wrestle with actual on-the-ground policy-making, though, knows that those incentives don’t always line up, and understanding institutions is at the very least about trying to see how people’s incentives coordinate in economic activities, not only whether individuals are inspired to serve the ends of growth.
First, Helen Dewitt (in a Berlin fashion week spread!) on how things used to work in Britain:
I started thinking about it when Britain introduced the National Lottery. Before the Lottery there was an investment scheme called Premium Bonds which gave participants the chance to win a million pounds: you had to buy a minimum of 100 Premium Bonds for Ł1 apiece, you were assigned 100 numbers, and your numbers went into the draw every week. You could get your Ł100 back at any time. You could leave them going into the draw for years. You could buy up to Ł20,000. In other words, you were gambling the interest you could otherwise have earned if you had left that Ł100 in a bank. When they brought in the Lottery, they reduced the frequency of draws in Premium Bonds to once a month. They also promoted the Lottery very heavily – it was widely advertised, tickets could be bought over the counter in newsagents, people could pick their own numbers. So it was much more entertaining, but you were almost certain, not just not to win, but to lose the money you put in. That was interesting in itself, and also seemed to be connected to other things that were going on in Britain at the time.
Given what we know about incentives, beliefs, identities, risks and rationality in modern society, it is hard to argue that the lotteries are anything other than a tax on the poor. God knows the 1% aren’t buying tickets. Of course, it doesn’t feel like a tax to the participants, but rather feels like gambling. But marginal expected loss (the proportion of every dollar paid that the government keeps, averaged out over all participants, including the winners) of the lottery is so high that calling it gambling pushes against the fair definitions of the word. Your chances are better betting on black at Vegas.
It’s interesting to wonder how people characterized their purchase of Premium Bonds under the old system. There is a good argument that people felt at least in part that they were investing in the country, and in the good of society. It’s that, along with the clearly much lower withholding rate of the bond, which make the scheme seem less egregious in light of marginal tax rates on the rich.
But these ruminations lead to a thought, not about how to tax the poor less, but how to tax the rich more. The last thirty years of relative political influence of the world’s well-to-do indicate that, in aggregate, they are not particularly prepared to pay higher taxes, even when it is clearly intended for the overall benefit of the population. So the question is, is there some way that paying taxes to the government can be made to feel like gambling, or like investing on their own account, for society’s wealthiest members? The rise of social impact bonds seems to suggest one possible avenue of pursuing such “behavioural” policy-making. The only problem with these schemes, as with a large portion of private-public partnerships, is that the private party often seems to be the one leaving the table with all the chips.
One of my favourite things about my neighbourhood is my local grocery store, the Supermarché P.A. It’s a half block away, which means that my partner or I shop there almost every day for dinner makings. It’s tiny, maybe twice the size of my apartment; yet it almost always has the produce I am looking for and has a wider variety of prepared food than the big chain store I was in most recently – plus the prices are better. The staff are friendly (and bilingual!), the owner greets us when we come in the door, it’s a huge provider of jobs in the neighbourhood and I often run into friends when shopping for dinner. So.
Hurst and Pugsley, two University of Chicago economists, have written a paper to confront the recent (and not-so-recent) enthusiasm for small businesses, asking What Do Small Business Do? [pdf] Small businesses are often cast as being the haven of “entrepreneurs,” manna from heaven for productive innovation, jobs creation and economic growth. So they surveyed people starting new businesses. What’s their conclusion?
…few small businesses intend to bring a new idea to market. Instead, most intend to provide an existing service to an existing customer base. Further, using the same data, we find that most small businesses have little desire to grow big or to innovate in any observable way. We show that such behavior is consistent with the industry characteristics of the majority of small businesses, which are concentrated among skilled craftsmen, lawyers, real estate agents, doctors, small shopkeepers, and restaurateurs. Lastly, we show non pecuniary benefits (being one’s own boss, having flexibility of hours, etc.) play a first-order role in the business formation decision.
In other words, most small businesses are just that – small businesses. Essential to the economy, but not engines of growth. Small business owners don’t generally have some better way of doing some old thing, they don’t usually plan to grow, and they aren’t motivated for the most part by a desire to work harder and reap more of the reward, but simply by the desire to work at their own pace.
The undercurrent here (these are University of Chicago economists after all) is that there is no market failure which small business subsidies actually address. Their point is that small businesses are a terrible proxy for innovative firms, labour-intensive production and services, and growth industries. Thus, small business benefits are market distorting, not market correcting.
The first problem with the conclusion is one of research design: they don’t have a negative case. They are studying the intentions and outcomes in a US small business sector which already benefits from a network of subsidies and tax benefits. The relevant question isn’t: given existing subsidies, what portion of the small business sector is innovative? It’s: without these subsidies, would the economy as a whole see lower employment growth, and less innovation? I don’t think they’ve provided relevant data to answer that question.
The other problem I have with their conclusions turns on their narrow definition of market failure. Now, for the most part they are responding to a certain set of arguments, so this isn’t a failing of the paper so much as of the entire discussion. Because the discussion seems to discount the overall social benefit of a rich ecology of small businesses. One of the market failures which small business subsidies can provide is that the market doesn’t necessarily make a city liveable, because there are obvious collective action problems in getting citizens to pay for ‘liveability.’
Now, does the P.A. benefit from small business subsidies? Maybe not – it does have another branch in another part of town. But there is no doubt that without these subsidies, my neighbourhood Starbucks may have priced out some of the local cafés, and the McDonald’s two blocks away would have found it easier to compete with local restaurants, rather than shutting down for lack of profitability three years ago. Now I don’t know about you, but that’s market distortion I can live with.
[h/t David Lizoain]