The End of the Road: A Reflection on Value

There was a song I have heard a long-long time ago which had started or ended, I am not quite sure with the following words: “the king of the road”. Sitting on my desk pondering whether or not I should begin work on my next book, about the state of the Federal Budget and the unsustainable levels of debts in the US and most EU member countries, I found myself recalling this particular tune. The mind works in mysterious ways, as so many believe.

Why this tune, and at this point in time. I am sure psychologists can answer this question. For me, a trigger prompted me to recall it. I have just published a paper on the “Rate of Return to Aging: A capital Stock Approach” (International Advances in Economic Research, November 2013, vol.19, pp.355-366), where I came up with the finding that the rate of return to aging if not negative is close to zero. Another and perhaps a more subtle reminder about the implications of aging is the relationship between old age and work, especially the value of work. On reflection I knew why I associated the song with age.

I am fond of watching a program on PBS called “Window to the Wild”. There the host of the program, perhaps in his 60’s or early 70’s takes his viewers into the “wild”. A day or two ago, I saw an episode where the host of the program took his viewers into a place in Massachusetts quite deserted called “Dog Town”. What prompted me to think, I believe about the song and the title of this blog is a most interesting statement carved on one of the town boulders that stated: “When Work Stops Value Diminishes”. Whoever thought of it did well to carve it in stone.

Not every one, I am sure will realize or envisage how this small, yet a most powerful sentence pricks the mind. For an economist, value is a very important concept in the economist’s repertoire. Value has two characteristics: Value in “use”, and value in “exchange”. An inquiry into the history of economic thought leads you to the question of what determines value.

Value defines a good or service. A good such as bread or water have a value to the user but may not have a value in exchange. For example, water in a river can be obtained free of charge, and if the water is available to all, it will have no exchange value. On the other hand, if water is not available to all, and it is useful to users, then it will have a value in exchange. Whoever possesses the water can exchange it for other commodities or for money.

Determining a good's value in exchange has been at the foundation of economics from Adam Smith’s the Wealth of Nations (1776) to Leon Walras Elements of Pure Economics (1873) and Alfred Marshall (1890) to name a few. Through the history of economic thought one of the issues that have occupied the classical and neo- classical economists has been the determination of value in exchange. Although the analysis differed, one thing they have settled on was that “LABOR” determines the value in exchange (For a review of the history of economic thought on this issue see Attiat F. Ott with Sheila Vegarie: What Economists Do: A Journey Through the History of Economic Thought i Universe LLC, 2013, ch.4).
If “Labor” as our forefathers put it is the source of value in exchange, then the statement carved in stone in the Dog Town is quite remarkable.

As a professor of Economics who spent all my academic life teaching and writing about economic issues and principles, my value to my profession was determined by my labor. When dispensing labor services stops—comes to an end with retirement, value unquestionably diminishes. A person who has retired from the work force, his/her labor clearly has value in use but little in exchange in a monetary economy.

Everyone knows that, if a good has an exchange value, and if such a good has a limited life span, (an exhaustible resource) from instantaneous to a relatively longer duration, at some point in time it will cease to command a value in exchange. Labor is such a good, its services fall under the label of exhaustible resource. By labor, it is meant not only physical existence, but also the embodiment of said labor in value in exchange. When labor diminishes, or erodes through the passage of time, so does its value.

The law of Economics, since Adam Smith still holds. Labor is the source of value in exchange, and when work stops, as it happens sooner or later, “VALUE DIMINISHES” and that is the end of the road.

Shutting down the Federal Government: It is Time for a Nationwide Recall of Our Representatives in Congress

“Here we go again”. These four words were uttered by former president Ronald Reagan during a televised debate in New Hampshire back in the late 1970’s during the primary. Frustrated over a repetitive question raised by his fellow contestants for the White House, Reagan admonished his fellow contenders for such behavior so that they move on to address issues of national priorities. The admonishment seems to have worked—they moved on and Reagan won the presidency in 1980.

President Obama should do no less. He should remind the Republicans of the futility of hanging on the one issue that is holding the government and the people hostage to “ideology. President Obama articulated such behavior best in stating (October 1) that “”holding the function of government hostage to ideology is “‘unseemly”.

The American public should be indignant about the shutdown of the Federal government. True, the Republican minority that are holding the functioning of the Federal government over the Affordable Care Act—Known best as the Obama’s care plan are acting on behalf of their constituents who share their ideology. This is how democracy functions. They were sent there to represent their constituents, their votes offered or withheld should reflect those of their constituents. But in this instance, they are not acting the way they should in a representative democracy where a vote up or down is governed by a simple majority. The issue on which government shutdown rests is irrelevant. The Affordable Care Act or the so called Obama’s care plan is the law of the land. It has been challenged, and the challenge was defeated as the US Supreme Court affirmed its legality. The ideology was put to test and in the case of the Obama’s care plan was defeated. In a representative democracy, this how a democracy functions. Our representatives have to either accept the outcome of a single majority vote, or insist in cases that divide their constituents according to ideology, that the issue should be determined by a 2/3 majority.

The American public should not let the government shut down go by the wayside. Our representatives are sent to Washington (their accountants only know how much they spend to get there) to serve the public and not the private interest. That may be an old fashion concept but that what democratic institutions are about. The segment of the Republican Party in the House of Representative that are holding the government functioning hostage to their unsuccessful effort to defeat the Obama care law, when they had the opportunity to do so, should reserve their fight for another day. Win or lose they must honor a system that allowed them to be there. A democratic system of government built on simple majority rule. Failure to achieve simple majority on any issue should be hammered out to insure the survival of democracy. The blame game should be beneath men and women in both houses of Congress. It is unworthy of representatives who pride themselves in living and serving in a democracy.

This is not the time or place to argue for against the Obama care law. Those who failed to stop it from becoming the law of the land, if they adamantly believe it to be injurious to their constituents should, in a democracy, garner the support of a majority to repeal it. That is how a democracy survives and avoids the pitfalls of autocracy.

The current ideological battle is not one that it ought to be fought by shutting down the government. Just look at what the battle is about: not to repeal the law, that battle was fought and lost, but to delay the funding for one year. You should ask: then what? Will the government be threatened with a shutdown next year, or the year that follows? Will the delay impede the implementation of the law? Just listen to what president Obama said in his televised speech: “The government is shutdown but the health care act is alive and well--the uninsured are ready to get insurance; to bail themselves out of a burden for long has been on their shoulders”.

Yesterday an American citizen reacting to the President speech put it to the Network carrying the speech: “do you know a country in either the Eastern or the Western Hemisphere where they shutdown the government because of differences in ideology?” The question was left hanging there.

The last shut down of the Federal government that took place 17 years ago lasted 21 days. How many days will it last this time around? Placing the responsibility of the shutdown on the shoulders’ of either Senator Reid or Representative Boehner does not help matters much. The American people should hold members of Congress; Democrats and Republicans hostage for their votes.
It is time for a “Nationwide recall of our representatives in Congress”. If they cannot discharge their obligations to govern, they should be sent home. The country will not be worse off than it is today.

A Time to Remember: a Memorial to a Nobel Laureate, James M. Buchanan (1919-2013)

Nobel laureate James M. Buchanan passed away January 2013. His death, to his family, colleagues, friends and students, was heart retching. For me, personally, it was devastating as I was looking forwards to see professor Buchanan at least one more time at the Public Choice Society meeting in March celebrating the 50th anniversary of the publication of his seminal work (with Gordon Tullock): “The Calculus of Consent”. One knows that death is always waiting at the doorstep, but never realizes it until it comes.

Today, I find myself in remembrance of Jim Buchanan looking back at the history of public Economics. In remembrance one accepts death as a continuation of life. Today, like so many others of Jim’s colleagues and friends, I face his passing through remembrance of what his life’s accomplishments have meant to us, colleges, friends, students, but most of all to our discipline—the discipline of public economics.

Professor James Buchanan together with professor Gordon Tullock have revolutionized our thinking about the role of the individual in a free society, and how he/she interacts (or should) interact with the sovereign. Their Philosophy embodied in the Calculus of Consent will forever light our way as we seek to forge a relation tempered with good will with the representatives of the public sector—the sovereign.

The Calculus of Consent: Logical Foundations of Constitutional Democracy (1962) was published by the University of Michigan Press. At the time of publication I was a PhD student in Economics at the University of Michigan. One of my fields of specialization was Public Economics, known then as Public Finance. I studied with Professor Richard Musgrave, known then as well as today as the father of public economics. I felt so fortunate to be one of his students and since my graduation; I have remained faithful to the discipline of public Economics.

As a student of Richard Musgrave, I have espoused a positive role for the public sector. The individual, to be sure had a role to play in setting budget allocation and distribution, but the framework of analyses left no room to think about an alternative arrangement—arrangement where the individual in a democratic setting sets the rules by which the “sovereign” is to interact with the individual in a “public choice” setting.

Not until I met Professors James Buchanan and Gordon Tullock at VPI in 1975 at the campus of the University (where I was invited to join the Public Choice group housed in the so called “white House” of the university) that I have realized that an alternative view of the public economy should complement the traditional study of the public economy. Although at that time I could not accept the invitation to join, it has given me an entrée to the field of public choice. Listening to Professors Buchanan and Tullock discussing the shortcomings of our knowledge about the role of the individual in the sphere of public economics I appreciated the force of the arguments presented in the Calculus of Consent. Reading it over and again I realized the enormous task and the burden the Calculus of Consent has placed on students of public economics. It was a path breaking for all of us students of public economics to understand what public choice is about and how individuals’ choice has to be effected in a democratic setting. The rest is history.

The Nobel Prize Committee in awarding the Nobel Prize to James Buchanan in 1986 has cited his contribution for: “the Development of the Contractual and Constitutional Bases for the Theory of Economic and Political Decision Making”. Not quite adequate a description of the colossal impacts of the contribution of Buchanan to the study of the public economy. Students of the public Economy have found in the Calculus of Consent a blue print, a guide to the complex and intricate relationship that has existed and remain so between the rights and aspirations of the individual in a democratic setting against the power of a sovereign motivated by self interest or the so-called the public interest.

For those of us whose task was, perhaps still is, the search for those institutions that would meet the Buchanan ideal of the Contractual and Constitutional bases for a theory of the public economy, need look no further than a second reading of the Calculus of Consent.

The public choice school, the brainchild of Buchanan and Tullock enriched the economist’s knowledge of the process of decision making when the collectivity replaces the individual as the decision maker. The contribution of the public choice school, when put in the frame of reference of our forefathers; the political economists dating back to the 17th century, clearly changed the landscape for the study of the public economy.

But, there is a softer side to Professor Buchanan. When I first met the great Economist, Professor Buchanan, I did not think that I could talk with him about other life undertakings. I found out how easy and wonderful it was to listen to Jim talking about his home in Blacksburg, Virginia, the pecan trees he had where he spent a relaxing time shelling those pecans, and to my delight found out that we shared the love of one author; Nevil Shute. One particular novel we both felt it to be a great novel was: “In The Wet”. I told Jim that I have gone to Torquay, England to see the place where Nevil Shute wrote his novels. At that time I was given the task to put together a conference sponsored by the Liberty Fund, and we thought perhaps it would be nice to have the conference there. Unfortunately, that was not done; I guess the expenses would have exceeded the grant.

Many of Jim colleagues, students and friends, I am sure, would have a great deal of soft memories of the Jim Buchanan, the great economist and the wonderful thoughtful human being. In his presence, you felt his greatness flow over and engulf you with warmth and appreciation of being there. Those of us who knew him, personally or through his writings, will always carry with us the soft glow imparted on us in knowing him and been rewarded with a glimpse of his inner thought. The economic profession has lost one of its pillars, but he lives on through his contributions to the economics discipline and the many students who followed in his footsteps.

Professor Buchanan: We shall miss you, but your thoughts will forever live on.

Falling off the Fiscal Cliff

Everyone is talking about the fiscal cliff, maybe not exactly everyone. Those who are talking about the fiscal cliff are “naturally” our policy makers and the media guru. One expects our policy makers to make “hay” about the so called cliff, but the pundits in Washington and just about anywhere they can hook up a so called commentator to the phone or to a TV camera the news makers are having a field day about the so called fiscal cliff.

Before getting into the nitty-gritty of what the fiscal cliff is all about and where the country is heading, off or on the cliff, let me backtrack a little and talk about the ingenuity of the label—the FISCAL CLIFF. It sounds ominous, or does it? The first time I heard of the term--the Fiscal Cliff, I had this image of those superb divers in Acapulco Mexico diving from extreme heights off a cliff. None, at least to this viewer have suffered ill consequences of a dive, but it obviously takes skill, stamina and fortitude for a diver to achieve such an exhilarating and superb dive. So what will it be like to fall off the Fiscal Cliff: will the economy survive the fall? What is at stake?

To put the issue in some order let us begin with the label. Obviously there is no such thing as a fiscal cliff; it is a metaphor, which is ascribed to one of our illustrious policy makers. When I heard the term, I presumed that someone either in the popular media, or a talk show host coined the phrase. A bit of poking however, identified the source. According to Wikipedia, the term “Fiscal Cliff, if not invented by our illustrious Chairman of the Federal Reserve, it was popularized by him. Stan Collender in a blog posted 12/07/2012 identified the source. He attributes the phrase to Ben Bernanke the chairman of the Fed. He goes even further to note that Alan Greenspan, the former chairman of the Fed “would have been proud of the Ben Bernanke-coined fiscal cliff”; he goes further to postulate that Greenspan himself would have used the phrase. But would he?

I raise the question as a graduate teacher of macroeconomics and public economics for more than a quarter of a century. Our books and articles are rich in models, theoretical and empirical about the macro economy, the public sector, its budget posture, the budget deficit, the aggregate as well as the structural and cycle adjusted deficits, the “equilibrium” level of debt to GDP and so many other thesis about the debt/GDP ratio and the implications of this ratio for the stability of the economy. Nowhere in our arsenal do we label a parameter value indicative of either the Deficit/GDP ratio and or the Debt/GDP ratio as something akin to a fiscal cliff. But then “Who” would have listened if economists would explain the equilibrium value of these ratios and the dire consequences if these ratios exceeded their equilibrium values. The term fiscal cliff whether coined by the Chairman of the Fed or popularized by him, caught the imagination of both the policy makers and the news establishment—it is more ominous to fall off a cliff than to fall of an equilibrium formula developed by economists.

Now that you know, that you are not likely to find the term “Fiscal Cliff” at least in macroeconomics, and public economics books and articles vintage 2011 and earlier, let us make some economic sense of what the “cliff” is made off, who is ready to jump, the players who would like to push the other team off the cliff and whether it really matters in the “longer-run” whether the jumper survives the jump or simply hang in there waiting for the next jump.

For a start, there is indeed a critical value for the federal debt to the gross domestic product (GDP), beyond which the national economy suffers adverse economic consequences, put in current terminology: “falls off the cliff”. What is this critical value, and why is it said that the economy falls off the cliff. To make sense of this claim, key economic principles are in order.

The national economy consists of three major components: Consumption, investments and government. These three have activities we refer to as consumption, investment and government spending. Consumers and investors generate activities and products hence income that enable them to consume, save, produce and invest. Unlike consumers and investors, government has no income of its own (of course there are some assets, but these assets are not sufficient to fund its activities), thus the government has to acquire the resources (income) from someone—consumers and investors. Taxation is the method all governments use to transfer income to themselves. The transfer is done through taxation whether a direct tax such as the income tax or an indirect taxation such as excise tax, or sales tax. If the taxes imposed are sufficient to cover government expenditures there will be no need for further transfer from the private economy to the public economy, in other words there will be no public debt.

But then few of us are debt free, so why should the government be? Households borrow to finance the purchase of assets, such as homes, their children education and the like. Borrowing is made possible because the lender evaluates the future capability of the borrower and if sound they lend, if not they do not. Most borrowers are careful not to exceed some critical value: the ratio of debt to personal income (debt/income), for if this ratio is exceeded, not only their credits will be cut off but they may slide off their own cliff.

The same scenario applies to the federal government—its take falls short of its spending. True the government has a better access to funds, its credit rating, until 2011 was superior to most of us borrowers and the universal faith in its ability to pay its debt was unshaken. But then came the summer of 2011 when the battle of the debt ceiling was waged and almost lost. The fiscal cliff is linked to this battle.
Let me backtrack a bit and talk about where we got here from there. As I mentioned earlier there is a critical value of the debt to GDP ratio. A great deal of economic modeling has come up with a value of this ratio: The ratio (debt/GDP) cannot exceed 60%. This is the ratio adopted by the European Union (one of the Maastricht criteria for membership). When and how far the US has departed from this ratio will be taken up below.

Taking a look at the recent history of the federal budget one cannot help but wonder at the way the budget posture slid out of control over a relatively short span of time. If economists’ debt to GDP ratio was a marker to be taken seriously, it is quite apparent from the progression of this ratio that the day of reckoning is not too far away. Going back to 1980 the ratio of federal debt in the hand of the public to GDP was 42.3%, the ratio began creeping upward a bit slowly over the 1980’s and the 1990’s decades reaching 50% in the year 2000. The explosion of the federal debt took place in the following 10 years. The first danger signal appeared in the year 2008 when the ratio reached 70%, at present (2012) the ratio is 102%.

One reason that the danger was ignored is the status of the economy. By now everyone knows how difficult the year 2008 was; the economy was in a “recession”, the financial system was in disarray, and a responsible public sector could not remain on the sideline. Economic advisors had to invoke the Keynesian remedy of pumping money to stimulate aggregate demand, hence the stimulus packages. The cost of course is a rise in the federal debt—no advisor at that time would have argued for tax increases to fund the stimulus packages, although some advisors, outside the policy clique argued for restraint. Given a persistent high rate of unemployment, the “prevailing wisdom” was to throw good money after good money—more stimulus and more debt. Economists of the Keynesian tradition would argue that the stimulus cost is a price worth paying, for without the stimulus the recession would worsen and the recovery date would be further away. The optimistic view, not necessarily the consensus was that once the economy began to recover, economic activities will pick up, taxes rise and support payments such as unemployment compensation would fall. Under this scenario, the debt/GDP ratio would begin a downward slide toward its “efficient” value.

Well this did not happen. In 2012 and the coming year of 2013 a reality show is in the offing. A few numbers at this point are in order.

To understand what is at stake one needs to be appraised of the imbalance in the federal budget. Looking at the ratio of federal debt in the hand of the public to GDP in 2011, and the ratio of federal taxes to GDP in 2011, it is not surprising that the economy is poised to jump over a cliff, fiscal or otherwise--the deficit/GDP (8.5%) is almost as much as the federal tax revenues/GDP (8.5%), can anyone of us be able to sustain this kind of behavior? Well so far the Federal Government, with the acquiescence of Congress was able to do just that. Now we face, I believe more than the proverbial CLIFF.

Remember that when either a household or government borrows to finance “current” expenditure, the debt incurs interest charges. These charges have to be paid from current income, and if current income is not sufficient to cover the spending plus the interest on the debt, further borrowing takes place and the debt incurs additional interest and the debt accumulates as well as the interest charges. In the case of the individual the lender may extend the repayment date, increase the interest charge and or downgrade the borrower “credit score” foreclosing on whatever asset the borrower has and/or driving the borrower to bankruptcy. The situation is similar for the government except that the government has no asset to be ceased, and most importantly the economy cannot function with a bankrupt public economy. One thing that differed in this scenario with respect to the borrowing of the government versus the borrowing of the household is that the rules are different; the government cannot increase the size of its debt unilaterally—there is a debt ceiling imposed on the federal government borrowing that cannot be exceeded without congressional approval. This is the battle that was fought in the summer of 2011 giving rise to the “Mandatory” tax increases and spending cuts in the Simpson-Bowles blue print of fiscal reform.

The battle over raising the debt ceiling in 2011, gave impetus to the creation of the National Commission on Fiscal Responsibility and Reform. The underlying reason behind the creation of this Commission is to draw a line in the sand: if neither the President nor Congress has the will or the ability to fix the Debt problem then they faces a legal biding resolution which takes off their hands the discretion over tax increases and spending cuts. The path for spending cuts and tax changes embodied in the Commission recommendations would take effect as of January 1, 2013. Facing the prospects of a deadlock on raising the debt ceiling, both the President and Congress had a temporary respite from the fight over the debt ceiling, in the expectation that once the presidential election is over, a new leaf is turned—the winner can bargain more forcefully about which expenditure cut should be legislated and which tax increase or reduction should be the order of the day. The expectation (at least in my view) was that, the Commission’s recommendation will serve only as a guide to policy making in the 2013 and beyond, that the new president and Congress will iron out their differences and come up with a “rescue” plan that takes down the path of the debt to GDP from its current unsustainable level to something closer to its “”efficient value”. The club that the commission held over the executive and the legislative branches of government is a powerful one. No matter what the election results turned out to be, a compromise has to be worked out between the two branches of government to put the debt/GDP on a downward path toward a sustainable ratio. Failure to do so, it is said that the COUNTRY WILL GO OFF THE CLIFF”. In terms of economics, the expiring Bush tax cuts and new tax increases along with spending cuts (sequester) in entitlement programs as well as defense amounting to some $600 billion will take effect as of January 2013. Falling off the cliff then means that a fall in aggregate demand due to the fall in private spending (consumption and investment) and government spending on defense and nondefense will be a drag on the economy which (under all reasonable forecasts) will cause a rise in unemployment and a decline of GDP growth, even a recession.
With the current experience with unemployment, the fall in income and the rising disparities in the distribution of income, the consensus is that no one wants to see a return to a 9 or 10 per cent rates of unemployment, a collapse in the housing market and a reduction in the safety net.

If all agree that falling off the “cliff is the worst policy outcome” why the deadlock over budget and debt policy.

The president will not submit his budget until February 2013, or thereabout, after the inauguration of his second term. The Simpson-Bowles Commission recommendations take effect January 1, 2013. Congress is supposed to adjourn December 14 (although the likelihood is that they will not do so in the expectation that a compromise will be worked out before the beginning of the year).

Given these constraints you would have thought that both the legislative and the executive branches of government would NOT HAVE SIGNED ONTO THE WORST POSSIBLE OUTCOME (The Simpson- Bowles).

By now, most individuals are apprized of the contents of Simpson- Bowles’ Commission ‘s legislation, although some may be more aware than others of how the implementation of their provisions would affect their personal finances. Two things that stick out in the mind of most people are that: their taxes will rise and those who are beneficiaries of Medicare will see their benefits eroded. What is clouding the debate over the so-called fiscal cliff is the tax issue. During the months and months of campaigning for the Presidential election, one group of population was bid against another—the 2% versus the so-called 47%. The president insisted that no deal with the Republican in Congress will be made unless the taxes of the 2% high-income group are raised. The Republicans, whose party believes that higher taxes adversely affect investment, are against taxes on those most likely to invest—the top 2%. Since neither the President nor the speaker of the House of Representatives are willing to let this issue remain dormant until next budget season, or find a middle way, the Simpson- Bowles option may not be a bad deal for either.

Let us pose a minute to think about the Simpson- Bowles plan:
First, the President wants to remove the Bush tax cut from the top 2%. The plan does away with the Bush tax cut for all including the top 2%. Without doing anything the president would fulfill his campaign promise. What about the Republicans in Congress? Everyone knows especially their constituents that “Republicans” oppose tax increases. So, lacking a compromise where the Speaker has to bow to the President demand and accept tax increases on the top 2%, he is in a better position with his party—the president forced the issue, refusing to compromise, and the tax increase on the top 2% is not of his making.

Second, take the recommendation that entitlements have to be cut and reformed. The President finds a way out of facing constituents who have overwhelmingly supported him during the Presidential election. The President can blame the Republicans in Congress for failure to negotiate, and avoid making the tough choice of enumerating the cuts to the entitlements program.
What about the Republicans in Congress? They too will get what they vowed to do: cut and/or reform the entitlement program. The Simpson- Bowles recommendations accomplish the objectives without the Republicans in Congress appearing to be anti- the old folks.
What of the Fiscal Cliff?

If you think about it, no matter what plan is put in effect, the economy will “stagger” through the next few years, with a modest if not small growth until the budget posture improves and the debt/GDP ratio retreats to its “efficient” level.
The Fed Chairman in his news conference yesterday (12/12/2012), although stating that the Fed does not have in its “arsenal” tools to offset the expected adverse effects if we go over the “fiscal cliff”, he nonetheless outlined Fed policy that would certainly ameliorate the predicted adverse outcome. One tool in the Fed arsenal is liquidity. He stated that the “federal fund rate” will remain near the ZERO level until the unemployment rate reaches 6.5% or lower. This is a novel principle as the Fed has not in the past targeted the unemployment rate. Moreover, the Fed announced that they will increase their holding of assets effectively increasing the quantity of money. Economists may debate the potency of fiscal versus monetary policy, but the fact the Fed acted indicates that the Fed will not remain passive if the economy were to go over the so called Fiscal Cliff. Of course time will tell if we were to fall off the Cliff or go around it.

Attiat Ott, Ph.D.
Research Professor, Clark University, Worcester, MA
President, Institute for Economic Policy Studies, Worcester, MA

Worcester Going the Timbuktu Way (Round Two)

Someone once said you can’t fight City Hall! To whoever said that I take off my hat (I do indeed wear a hat). Now that the City of Worcester Public Work Department won the day, Their Salisbury- Forest Streets expansion plan was put in place. Some of the residents’ objections were swept away like dust, and we ended up with a vision of the historic district that suited the Commissioner of Public work plans. I will not dwell on the matter, as the saying goes “why throw away good money after bad”. What I would like to address are a few learned on hand experiences in dealing with the public sector. As a Public Economics professor, I have taught, did research about the economic of the public sector. Our accumulated knowledge has given us a view of the activities of the public sector, mostly in the aggregate and not on individual basis. We build models about the role, activities and behavior of government, Federal, State and local; we test our models by injecting appropriate date, draw conclusions and offer advice as to the efficiency or lack of public sector provisions, the allocation of tax shares, and the role of the individual as a consumer and tax payers in the public economy. True we point out the various inefficiencies associated with public sector provisions, the sometimes unjust distribution of the tax burden, the perils of a growing public debt and the role of the individual, in a democratic society viz a viz his government. In the sphere of local government we have offered and tested the “Tibout model” or what has been referred to as “voting with one’s feet”—if you do not like the provision and tax allocation of your local government, you have recourse—pick up and leave. That may be easier said than done. Given the so many constraints that face the individual, and the relatively small weight of public sector involvement in the life and burse of the individual, picking up and leaving can only be accomplished in the relatively longer run. Of course they may be so strong that the cost of voting with one’s feet become the preferred option. As this blog is not intended as a thesis on the economics of the public sector, but rather use what we have learned and teach about the public economy to identify gaps in our presumed relation of “the individual” viz a viz his government learned by this Public Economics professor in one instant of interaction with representatives of the public sector. The case used is The City of Worcester Plan for the Salisbury- Forest Streets. In the previous blog, round one, I pointed out the implications of the choice of the form of local government for the citizens. The City of Worcester like few others has opted for the Council-Manager form of local government. Under this system the council members are elected by the voters’ citizens and their tenure is subject to voters’ approval. A Councilman can represent a district, or be elected at large. The Mayor is the Councilman elected at large who garners the highest number of votes. The Council appoints the Manager, and he reports to the Council. The Council has the legislative power whereas the Manager performs the day-to-day activities of running the City. Another form of local government is the Mayor-Council. In the other form of local government, the Mayor –Council, the Councilman, whether represents a specific district or elected at large is in tone with his constituents’ needs. This form of local government is perhaps the most responsive to voters as a councilor’s tenure depends on the voters’ approval. The City of Worcester form of government has undergone a few changes since its formation back in 1848 where its first Charter went into effect. The Charter established a Mayor Bicameral form of government. In 1947, the City approved a change whereby the form of government was replaced by the Council- Manager form. This was the structure from 1949 until the mid-1980’s when the Citizens of Worcester, seemingly unhappy with such representation sought to change it to a “more” representative form— the Mayer- Council form of government. Sadly, that did not pan out. Every community seems to sprout “cliques” of powerful men and women who have interest in shaping the affairs of their City. Worcester is no exception. Tired of the Council- Manager form of their local government, the citizens of Worcester mounted a campaign to replace it with the Mayer-Council form. In 1983 the City voters decided to change the City Charter. A Charter Commission was formed (guess what) chaired by Mr. Morgan, one of those powerful Worcester residents. As Chairman of the newly formed Charter Commission, he was instrumental in deflecting all efforts directed by some Charter Commission members to change the form of government to the Mayer- Council form in response of the citizens’ wishes. Powerful men and women seem to dominate the scene. Whether through the use of tacit or open persuasion, they rule the day. The Charter Commission under the stewardship of Mr. Morgan, and while fully aware of citizens dissatisfaction of the Council- Manager form pushed through his agenda and succeeded in overruling all objections to his favorite form of government—the Council- Manager form, thus succeeding in silencing dissent. A quarter of a century later we the citizens of Worcester (at least this Economist) are reflecting about what happened back in the 1980. Given our latest experience with the Salisbury- Forest Streets expansion plan, perhaps the time is ripe to effect a change in the form of local government for the City of Worcester. One May not succeed in fighting City Hall, but surely we the Citizens can Change it. Over the past few weeks, the news about the Civil War in Mali, the West African nation has reached our shores. As my first blog used Timbuktu, the great City of Mali as an example of a revival of a magnificent city and the efforts of its citizen to return their city to its earlier glory, I am saddened by these developments. The Civil war that is tearing up the fabric of a great city and inflicting death and destruction on a nation that faced a great deal of turmoil to secure a better living for its citizen and in promoting democracy and liberty. Being apprized with what the Citizens of Mali are facing, I am more than ever convinced that individual rights, just causes must be won, they cannot be left in the dust. Civil wars are quite prevalent in Sub-Saharan Africa. Their causes are varied, and the outcome is never certain. The Civil war in Mali has many roots and grievances abound. What role outside forces play and how far civil liberty will be ignored will be the subject of my next blog. One thing I need to say in closing: There should not be a price put on liberty. Complacency breads tyranny and tyranny is the death of liberty.

Worcester Going the Timbuktu (Tombuctou) Way

Few residents of Worcester or the State of Massachusetts for that matter know about the history of Timbuktu, a historical city in Mali, a West African country. The history of Timbuktu came to mind few days ago (October 2nd), as I was attending a special meeting organized by the Worcester City Council in response to an outrage voiced by some residents of a historical district in the city of Worcester; Specifically residents whose properties are located at a corner bounded by Salisbury and Forest streets. The outrage was prompted by a decision taken by the City Manager who gave the green light to the Commissioner of Public Works to devise a road plan, that in their views would ease the traffic congestion during the rush hours—morning and early afternoon in the said corner It is heartening that the city “officialdoms” finally saw fit to include in their plans resurfacing of Salisbury Street and re-paving the sidewalks. As a resident of Salisbury Street for over 30 years I did not have the good fortune to witness the Department of Public Works in action in my street or Forest Street. Salisbury Street was never resurfaced, the sidewalks crumbled especially in front of my residence but the City was oblivious to the residents needs, even though the neighborhood is perhaps the highest taxed residential area under the City property tax. Opposition to the plan, it seemed incensed some of the Council members and some individuals appearing on the “Council’s corner”. As taxpayers, the residents not only are entitled to voice their concerns for their own neighborhood , but have the “right” under the Manger- Council municipal government to air their concerns before the City Council, after all the Manager is appointed by them and he and his budget must be approved by them. This is what a Manger-Council form of municipal government is about. Perhaps at this stage, I need to enlighten you about the choice of the title of this Blog, and why I felt the need to put down on paper not only my own concerns about the proposed plan, but most importantly the flagrant comments we have received for voicing our opposition to the plan—a right guaranteed to us by the Constitution. In a subsequent Blog I shall address the forms of municipal government: the Mayer- Council form versus the Manger- Council format. For a start, let me convey to you very briefly my own outrage about the decision taken by the City Manager to “mess” around with our neighborhood. Aside from the fact that the plan would reduce if not destroy the quality of life for the residents at the corner of Salisbury and Forest and increase rather than decrease the traffic safety (more on that later), my own concerns have to do with the way the decision in our type of municipal of government—Manger-Council—was carried out. Residents of that corner woke up one morning to find “Orange Markers” placed on their properties, without a word from either the City of Worcester’s department of public works or from their representatives at the City Council as to the reason for this invasion of their property rights. The most obvious action for us was to contact a representative from the public works department to find out. This was done by my neighbor. No satisfactory answer was given. All told was that major expansion affecting the corner is scheduled to take place in a few days. The next course of action was to find out on whose “authority”, and “why” the residents were not contacted about whatever the Manger’s public works department had in mind. We did just that in contacting our Councilman, the one who represents our district. If you believe in a democratic – representative form of government you would be as concerned and incensed as I was. Not only, “we”, the property owners were not consulted before those “orange markers” were placed on our properties, but even worse, that our own Representatives on the Worcester City Council knew nothing about it! To placate few of us, letters appeared the following two days, some neither dated others not signed to inform us of the plan (with incomprehensible maps), explaining the plan and a hurried up meeting was arranged by our district Councilman so that we may hear about the details of the plan, and to allow some of us to voice our reservations about it. To add insult to injury some Councilmen and those on the Manager-council corner not only showed total lack of concerns for the rights of the residents in the affected corner but also sought to educate us about the “role” of government. As an economist of repute with a specialization in the economics of the PUBLC SECTOR, I cannot let some of the contents of said lecture go unchallenged. It is unfortunate for the Councilman who thought to educate us that he made his comments before an economist. To show off his knowledge of the role of the public sector he chose to use John Stuart Mill’s social philosophy to tell us that social rights supersede individual rights. Unfortunately, the speaker invoked an argument by Mill who was concerned with the status of the “LABOURER CLASS” in EIGHTEEN-CENTURY ENGLAND. Had he read the 900 or so pages of Mill’s Principles of Economics he would realized the context in which Mill have formulated his social philosophy. Moreover, if he was aware of the judgments of Nobel Laureates in Economics about Mill, he may have been reluctant to invoke Mill Philosophy. Paul Samuelson, a Nobel Laureate in Economics describes Mill’s presence in the economic sphere as a “transitional figure”, another Nobel laureate in Economics, George Stigler, points out that Mill’s contribution to economic thought was so “minimal” that he had to relinquish the field as an academic to work as a journalist to support his family. Even the father of Socialist thoughts, Karl Marx, had few unkind words about Mill’s brand of socialism. I do not mean by this critique to belittle Mill’s contributions to the principles of economics. Within his 900 pages of his Principles, he pioneered the analysis of tax burden and tax incidence as well as the returns to the factors of production—the heart of the economics of the private economy. It is to be emphasized that the context in which Mill’s socialist philosophy was put before us was not appropriate to the issue being discussed. Expanding the road to help commuters (mostly out of the City of Worcester) avoid traffic delays while causing injury (material in the form of a reduction of the value of property in the affected area, as well as other non pecuniary factors such as the quality of life) to affected property owners do not involve a redistribution to a “labourer class”. In effect residents in the affected area, a highly taxed area under the City of Worcester property tax do pay taxes to support social programs to benefit the resident of the city of Worcester, especially the support of public schools. Spill over of their tax dollars go to support residents of the surrounding Towns especially Holden, a wealthy community whose residents use the Salisbury- Forest Streets for own convenience rather than the use of accessible roads such as Route 190 or Indian lake route. In the public sector economics we call that the “spill over” effect and policy makers in the City of Worcester should be concerned of this effect not only on the residents of the city of Worcester but also on the City budget allocation. Another comment made by an individual in the Manager-Council’s corner was that those of us, who came before the Council to air our concerns, came there in his own words “to hear ourselves talk”. “Pardonez Moi”. I am not privileged to know what kind of education said individual had or from where, but I am more than confident to state, that the average level of education of those of us attending the meeting exceeded the Master degree or MBA and few of us have a PhD degree. I do not believe that any of us needed to speak at the meeting so that we can “hear ourselves talk.” That brings me to the title of this Blog: why the reference to “Timbuktu”? I grew up in Cairo Egypt. One of the hallmarks of education in a country like Egypt at that time was to instill into the children few values, foremost among them is the value of education and good dietary habits. In addition, every child was made aware of the Egyptian history and heritage, after all the Pharaohs dynasty is something all Egyptian have to behold and never forget. No Child in Egypt was not made aware of his/her Egyptian heritage, indeed there was no need to tell about it: everywhere one looked, there before him stood the glorious past made immortal by the accomplishments of the pharaohs, from the Gaza pyramids to the Luxor temples. In short, history resides in every Egyptian’s blood. Where does Timbuktu come in? Mothers all over the world teach their children by examples often invoking history and historical fables. My mother strived to influence our behavior in the formative age with interesting historical foibles. As I was growing up, around the age of 8 years or so, my mother had two things that she insisted on: to be at the top of my class, and to drink a glass of milk daily. The first was not a challenge, throughout my life I have accomplished that; the second was not easy to comply with. No matter how I thought of ways to get away with non compliance, she found out and I had to drink it under her supervision. When I was caught disposing of the milk in lieu of drinking it, I was threatened with the following: “If you do not drink your milk or if you falter in your study you will be shipped to Timbuktu”. At the time it sounded too ominous a threat. I had no idea where Timbuktu was, how I was going to be shipped there, or what to do when I got there. An 8 year-old has not got that far in the history study to have the answers, But as most children know “curiosity” is at the heart of knowledge (WGBH in Boston have been teaching this with their Curious George Fables). Of course I drank the milk and outperformed all my classmates, but I could never get Timbuktu out of my thoughts. Two questions had to be addressed: Where? And why? Studying history gave me the first answer. I find out where Timbuktu was: the second involved not only knowing the location but the political development that shaped the fortunes not only of Timbuktu but also Mali the West African Nation. History unlocks all mystery. History apprises you with the historical development that shaped the fortunes of the city of Timbuktu and its residents as well as the historical and economic development of the West African State of Mali—there I found out the answer to my mother reference to the city of Timbuktu. Going back through history (for a quick historical over view, see The Rough guide to West Africa, edited by Jim Hudgens and Richard Trillo., www. Roughguide.com), I uncovered the glorious past of Timbuktu, the trials and the tribulations that followed, the rise and fall of the city of Timbuktu, fortunes made and lost, and above all liberty lost and won by the citizen of Timbuktu. What was intriguing to me is to find out the reference by my mother to Timbuktu. As the history unfolds, I found out that Timbuktu, The “Forbidden City” as it has been named from the time of the crusaders, has always fascinated outsiders. The folklore developed in Egypt about Timbuktu goes back to the fourteenth century during the visit to Cairo by Mansa Mousa, the Emperor of Mali. The Emperor stunned the city residents as well as their King with the fabulous entourage, especially with all the gold he carried. The Wealth and opulence of Timbuktu’s royal court was described and marveled at by visitors as late as the sixteenth century, when the fortunes of Timbuktu plummeted. The opulence was replaced with a new legendary reputation: going to Timbuktu became synonymous with “going to the end of the earth – or to hell”. In between these two epics lies the threat. Timbuktu lost its glory, its citizens lost more than wealth—they lost their liberty as one ruler foreign or home grown, one after the other stifled dissent, plundered the city’s resources, imposed heavy and arbitrary taxes on wealthy traders. It took many rulers and few centuries for the citizen of Timbuktu to extract themselves from the tyranny of its rulers, foreign and home grown. Seven centuries later, Timbuktu is regaining some of its glorious past. In 1988, it was formally declared “UNESCO World National Heritage”. The lesson my mother instilled on me in using the example of Timbuktu is that one must be vigilant, if one is to gain a place in the sun, or in Timbuktu’s case in UNESCO World National Heritage. The residents of Worcester, specifically those of us residing in Worcester Historical District, face the threat of the loss of liberty, put differently we face taxation without representation—pay the tax but have no voice. One should always remember that complacency is not compatible with liberty. Here I would like to remember a lesson given by Dr. Herbert Stein, former Chairman of the President’s Council of Economic Advisers. When asked: “what taxes are for?” His answer: “Taxes are the price of civilization”. We the residents of the Historical District pay our taxes and as taxpayers we have exercised our rights in protesting the expansion plan imposed on us by a manger- council form of municipal government. Our representatives ought to remember that voters can exercise their rights by choosing a form of government that is responsive to those they represent. History had always championed liberty. My next Blog will address this issue as well as the history of the governing structure for the city of Worcester.

Saying Goodbye to a Friend

One hardly ever gives a thought to commonly used phrases, salutations and the like. We say good morning when we meet friends in the morning, good night in the evening, goodbye when friends part. I said all of those greetings or whatever one calls them, yet I have never once stopped and thought about what these words conveyed, not to the listener, to the one who uttered them, that is, not until today. Today, I felt the need to say goodbye. I need to tell goodbye to a friend, a friend whom I have lost, but I could not say it, and even if I could, what such a word would convey. On an early morning, I found a message on my cell phone informing me that Dr. William Blake had passed away, not that day, or the day before, but several days ago. I had made a call to Dr. Blake only a few days before asking about his health and set up a time for a visit. You see, I had plans to visit him on the first week of July. When I called and received his voice on the answering machine I thought it was strange, and when I did not receive a return call I thought that something was amiss. I knew Dr. Blake was quite ill, but I had never thought that he would not be there; that he would not defy fate. When I saw him last, few weeks earlier, I had “jokingly” told him: “Dr. Blake, you cannot go before I do”. The echo of that message rings in my heart. It said, “Dr. Blake passed away on May 30th; you know he was quite ill”. Yes, I did know. Dr. Blake, to all of those thousands of patients who have known him, not only was he a great physician and a caring person: for me he was also a great scholar. Dr. Blake was my Physician for over 30 years. I owe him not only my gratitude for his care, but also for the quality of life he has imparted on me. Thirty years ago, he taught me how to listen, a task that is difficult for someone like me—a graduate school professor whose students hang on every word I say. Graduate students, as great as they are, look up to the teacher for enlightenment, and guidance, the teacher is like a preacher, the word the teacher utters is the gospel of the discipline. To them I was the preacher. I talked economics with Dr. Blake. Over 30 years, he not only attended to my medical care needs, but also enlightened me about the way people perceive economists and about what we the economists, had to say. More than thirty years ago, as a professor of economics at Clark University and Director of the Institute for Economics Studies, I had put in place a program called “Conversation With”, where speakers from academia, businesses and governments, especially those in public policy were invited to engage in a dialogue with members of the community. Issues ranging from health care to tax reform and the debt ceiling were aired out; dialogues across the various constituents took place. For ten years the program was in full swing, meeting once a month. Dr. Blake attended almost all such meetings, he has shown acumen in his grasp of economic jargons, and theories, offered us a point of view that needed to be heard and for me personally an appreciation of what others, the non-professional economists have to say. Two years ago, Dr. Blake retired from his practice of medicine due to illness, but thankfully knowing my peculiar reactions to certain foods and medicine, he kindly kept me under his radar screen, offering guidance and suggestions about what course of treatment I should pursue. During these two years I talked with Dr. Blake not only about medical issues but most importantly about economic ones: we talked about the 2008 financial crises, the health care bill: the so called Obama Care, the Euro zone crises, the downgrading of government bonds, the fiasco over the debt ceiling as well as other issues. Indeed, I did post some economic blogs inspired by our conversations. Talking with Dr. Blake made me feel at home, for I too have retired from my professorial duties at Clark University. But a teacher and an author have home only in his work. I began to work on a volume tracing “our discipline’s roots”; a volume showcasing the principles of economics put forth by our forefathers. During one of my visits, Dr. Blake asked me about what my latest venture: “a book about principles of economics”, I said. He asked: “What do you call the book?”, and I put before him the title and what I hoped to accomplish: “What Economists Do: A Journey through History of Economic Thought: from the Wealth of Nations to the Calculus of Consent”. “Well”, he said, “it is time someone put in ink what you fellow actually do”. He was kind enough to offer to read the chapters as I wrote them, offered his editorial talent as well as provide comments on what I had put down. Dr. Blake read, edited and took issue with my presentation especially the use of economic jargon and kept me going in earnest to finish the volume. Even when I felt ill, I had to pull myself up for he was there waiting for my next installment, encouraging me to get to the last chapter—chapter 7—where I put down my thoughts as to what economists do. I was distracted from completing this chapter, as I had a more urgent task to attend to, so instead of finishing the writing of chapter 7 by mid-May, I put it off until the end of June. I mentioned to Dr. Blake that he shall have it the first week of July, and I did. I mailed the chapter, but then I had no response. I have taught Economics for some forty years, written several books and articles, but this volume had a special meaning for me. Talking about the foundations of my discipline with Dr. Blake made me aware of a human side to economics I have seldom seen. My highest reward was in seeing Dr. Blake shake his head in recognition of my efforts in spreading the gospel of my chosen métier. My one regret is that Dr. Blake was not there to read what I have put down as to “What Economists Do”. Nonetheless, I know in my heart that he would have liked what I had to say. Dr. Blake, you shall be missed: that I can say, as I know what is to be missed. But to say “good bye”! Merriam Webster Dictionary (p. 527) defines the term goodbye as: “God be with you “, a concluding remark or gesture at parting. So I will say: Goodbye My Friend. Maybe someday, I shall know. Attiat F. Ott Emeritus professor: Clark University, Worcester Massachusetts. President: The Institute for Economic policy Studies, Worcester, Massachusetts.

Globalization of the Old and the Very Old

A recent article by Ted C. Fishman titled “The Old World” (the New York Times Magazine, October 17, 2010, pp.50-53), paints a very disturbing picture for the developing economies. Mind you that the current picture is as bad as “probably” can get, nonetheless the author gives the impression that it is going to be even worse. The author puts the following thesis: “The world is currently divided between those under 28 and those over 28”.Twenty eight seems to be the magic number. If you are one of those, I say REJOICE, if not read on. But, before getting into the nitty-gritty of the old age globalization thesis, let me begin by defining the globalization term. This may turn out to be as useful to understanding the current economic problems as it is for understanding the problems of an aging world population. So what globalization means and how did the term came about?
Robert Cox (1994) defines the global economy as a “system generated by globalizing production and global finance”. Thus, the definition conveys two things: First that the global economy is not a universe without borders. Rather, it is a socio-cultural, economic structure brought about by some event or events. Secondly, globalization is a process encompassing modes of production, trade and finance. Reinicke (1998), advanced the notion that globalization is a process brought about through transborder by firms undertaken to organize their development, production, sourcing and financing activities. The globalization process thus described links globalization of the world economy to the organizational structure of the firm. In short, it is an economic phenomenon undertaken to enhance competition in the belief that the market ideology and discipline enhance “world” welfare.
Having defined the concept as it has originated why the term did become imbedded in our lingo and when it is talked about it seems to conjure all sorts of influences most of them are not salutary. Two issues are commonly talked about. The first is outsourcing – exporting jobs and the resulting dislocation of workers giving rise to unemployment, wage differentials and hence income redistribution. These effects are magnified in stagnant economies and during severe and prolonged recessions. The second is the technical revolution and the rapid transmission of technology. A technology that makes low skills redundant have not only far reaching impact on low skills workers in both advanced and developing economies but also the changes the dynamics of production (where firms would locate) with far reaching implications for the world wage structures and balance of payments.
The US and many of its partners in the developed world is the engine that spurts technical advance and innovation. Put to practice, these advances are labor saving technology replacing workers by “workerless” production techniques and thus making labor redundant. Reallocation of labor across industries or occupations is not easy or rapid. When labor services become redundant, it has a devastating effect on workers, not only on those who lost their jobs but also on those in occupations or industries close to the ones that have experienced updated and/or new technical advances.
It is worth emphasizing that the middle age group—those between the ages of 28 (the magic number) and 40 will likely bear the brunt of redundancy and reallocation. The reason is that skills are acquired well before the age of 28. Augmenting skills to meet advances in technology is needed if the economy were to accommodate displaced workers. This task may be accomplished during periods of economic growth but may not be feasible when the local or the global economy is in recession. In short displaced workers with low skills have a long “row to hoe”.
How about the old-- those over the age of 40? This group traditionally has had the lowest unemployment rate. However, with outsourcing and a “executive watch over the bottom line”, their employment picture is far from clear. This group clearly have a mix of skills acquired by “being on the job” as well as through formal education. Hence, this group will experience job security as well as redundancy.
Let me now turn to the old and very old.
It need not be emphasized that “we, the people,” have brought the “aged-nonaged” problem on ourselves. How many articles and speeches were given about the need to restrict the size of the family to insure a better standard of living? The development of birth controls and their widespread use in the developed world was the medical response to the “Malthusian” prediction that population growth if left unchecked spell hunger, wars and disease. In his First Essay on Population (1979) reprinted 1926, Malthus wrote: “The power of population is indefinitely greater that the power in the earth to produce subsistence for man”. Another factor which took a life of its own is advances in medical technology that eliminated many of the ills that made life if not unbearable as one ages but also inspired the old to seek forcefully these cures to insure longer and healthy life. Initially, the benefit by far exceeded the cost. Children and their parents in the developed world enjoyed higher standard of living, higher educational attainment and better health. Unfortunately, the dynamics of these events meant that a smaller population has down side effects: a shrinking pool of the young and an expanding pool of the old. It does not take a “mathematician” to figure out the odds against the young. They have to bear the cost of “raising” their parents as their parents once did. That is o.k. The problem is that the scale has become unbalanced, not enough young to return the favor bestowed on them by their elders.
The cost of living longer is unattainable in a stationary population especially in periods of unemployment and stagnant economy. Short of undertaken “measures” at either end of the age structure, societies need to think of ways to address intergenerational transfers. It is worthwhile to remember that today’s old were yesterday’s young. They raised today’s young and educated them, they funded the public sector budgets, they made advances in health technology as well as other technical innovation possible, and they went to war giving up their life to secure the life and liberty of today’s young. Every generation bears the cost for the succeeding generation and under a social contract it follows that the younger generations transfers some of its wealth to the older generations. The problem is, when resources are diminished the social contract looses its imperative. Intergenerational transfers are reexamined.
Guess who will make such reexamination? With few exceptions they are likely to be made by the “younger generations”. They will have to legislate higher taxes, cut spending or both. The inescapable fact is that they have to face the question of intergenerational transfers.
Let me now return to the globalization of the old and the very old which is the title of this blog. A look at the population data is quite useful (Table 1).
A few examples suffice. Three types of data are shown: The age distribution of the population; the birth rate and the US unemployment rates by age group. The dat given covers 10 year periods. The story that emerges is what Fishman’s article sought to convey. The age structure of population in the developed world makes it clear that a shrinking pool of the young faces a growing pool of the old and the very old. Birth rate data show one of the fundamental reasons why the young pool has been shrinking over time. Without changes at either end of the age spectrum (not likely in the short run), the young need to garner higher intergenerational transfers. Short of




that, the very old will see the social contract crumbles and they have to find ways to cope with the loss of support.
A look at the US unemployment rate by age groups, population in the two age brackets (34-44 and 45-54) have typically enjoyed the lowest rates of unemployment. If this scenario were to change a further stress on society resources will be manifested. That is not only transfers of resources will have to take place from the young to the old but also from the working population to the unemployed population.
Putting the unemployment issue aside (for another blog), the question that was raised in the Fishman’s article is how to deal with the old and especially the very old. One solution which has been practiced not only in the US but elsewhere is to alter the social contract—raising the retirement age, taxing pension benefits and health benefits and so on. The problem is these remedies are ad hoc solutions that are not likely to “remove” the problem of aging from the social agenda.
Good minds and not such good minds have advocated many solutions ranging from “privatizing” the social insurance system including pension and medical care to keeping the old and the very old in the work force. But as Fishman puts it “one conundrum for aging societies is how to keep older people employed”. Obviously, if that was possible, then tax revenues rise, benefit payments fall or pushed further into the future. This scenario has been achieved to some extent in the US but the problem of an aging population did not go away. As outlined above, the problem gets exacerbated when economic conditions worsen and when technical advances favor the very young. Mr. Fishman is very pessimistic about the future outlook of aging societies. According to Fishman “…as the world gets older, we need to anticipate how this extraordinary change might undermine our commitments, weaken nations and push able people to the side…it now looks as if global power rests on how willing a country is to neglect its older citizens”.
Well… I wonder how old is Mr. Fishman? Would he retain this thought when he gets to join the “army of the old and the very old”?
What kind of solutions are likely to emerge if the age structure continue as it has been in the past? If the future is a repetition of the past, societies will have to revisit those solutions advocated by many. Mind you, these solutions are not new—they are worn out so to speak, but there they are:
• Negate or abolish the “implicit” social contract—you pay, do not pass go and do not collect your “owed” pension.
• Curtail the delivery of medical care through rationing—if you are over 50 you are on your own—sink or swim (The British National Health Service ration medical care to the old).
My prescription is:
• “Do not send the young to do the business of the old. If the over 40 politicians need to change the world through war-like engagement, they should send the age group over 40, over 50 and over 60’s (that should end war quickly).
• Lend credence to the world globalization by allowing free movement of people. Migration is one way to populate a country by the “young”. Of course that means not only migrants have to be young but also possess needed skills. This option not only will chip away at the “outsourcing” problem but also will neutralize the effects of aging throughout the global economy.
Alas, these solutions, at least for the moment, are far fetched solutions. Nonetheless, they should give us all a pose, perhaps food for thought.

Is it Irrational Behavior or Risk Aversion? (Round Two)

On July 15, 2010, I posted a blog with the same title except that it was round one. Today, I write a follow up hence the label round two. Why the designation? In the first round, I have contrasted the outcome of choice involving two medical options (pp.2, 3). The options involve a risky choice. One of the options had a certain outcome—the individual knows with certainty the outcome of the choice whereas the other was labeled “risky” choice as it involves uncertainty. I discussed how the individual calculates the outcomes of the two options by assigning what economists call utiles, a scale of measurement for the utility of the choice. My example was intended to show that the risk averter is likely to choose the certain outcome over the risky choice. I have also shown, that to make the uncertain option equally valued would require (given my numerical assignment) a reduction of the risk valuation ascribed to the risky option. In this round I would like to put forth another scenario. I would like to suggest another way of making option Y the winning option. For this to take place option X is rendered an “uncertain” option. Given that my examples are medical intervention options, the agent who can alter this and hence the choice is the “physician”.
Now assume that the physician who monitors the patient were to inform the patient that the certainty attached to the outcome of option X is no longer valid. That is, the probability of success now is equals to zero. Moreover, assume that the physician were to point out that there exists the probability that a side effect that did not exist earlier will materialize if option X is chosen. This means that not only the intervention with 100 percent probability has become ineffective, but also it carries with it a “negative” outcome. The comparison between the two options will hinge on the value a risk averter will assign to this negative effect. Note that in comparison to option Y there is no benefit attached to continuing the treatment. This scenario then pushes the individual to choose option Y without a change in its probabilities or the negative valuation attached to the side effect, a component of the option.
In short, the purpose of the exercise was to show how difficult it is for the individual to exercise choice when faced with uncertainty, not only because information may be incomplete but also because of his/her dependence on the market (third party) to evaluate the risky options. When an option is chosen in situations involving risk or uncertainty it is not an easy task to label the choice as rational or irrational. The saving grace is that in some situations a choice can be amended, in others the loss arising from the “wrong” choice cannot be recouped. That brings me to the literature that brought the risky choice models to the theory of consumer choice.
I have mentioned in the previous blog the seminal article by Milton Friedman and L.J. Savage (1948). A year earlier a most influential contribution by Von Neumann, J and O. Morgenstern’s Theory of Games and Economic Behavior (1947) offered utility functions that permit the complete ranking of options in situations involving uncertainty; the comparison of utility differences and the calculation of expected utilities thus making it possible to analyze choice in situation involving uncertainty (see chapter 1 of their book). Since then we have gained insight into this issue through contributions by several economists about consumer choice in situations characterized by risk and uncertainty. It is worth noting that risk has an objective probability while uncertainty involves assigning “subjective” probability. Hence the importance of ascertaining the individual type: whether he/ she is a risk averter, a risk neutral or a risk lover as this is critical to understanding choice. It is of note that an individual may be a risk averter in one situation and a risk lover in another. Now, I turn to the contribution of Behavioral Economists to the study of consumer choice.

Behavioral economists reject the economist models’ assumptions of rationality and maximization of utility. Rationality is defined as the “cognitive abilities” for solving economic problems .Behavioral economists dispute full rationality on the basis of research findings by psychologists and some economists “people exhibit preference reversals; have problems with self control and make different choices depending on how the issue is framed.” For a number of reasons, people make errors and behave in a manner contrary to their self interest. Given this premise, placing constraints on the exercise of free choice may be called for. That is, “paternalistic” intervention by the state or the community may be called for.
There are many variants of state paternalism: Paternalism (Mead, editor 1997), Patronizing Paternalism (Burrows, 1993), Libertarian Paternalism (Sustains and Thaler 2003), Permissible Paternalism (Goodin 1991), Benign Paternalism (Choi et al.2003), and Asymmetric Paternalism (Cramer et al. 2003). The different labels notwithstanding, the underlying premise of paternalism is simple: intervention by the state or the community will generate significant welfare gains. Sources that give rise to “bad” individual choice are: bounded rationality, slow learning, framing and lack of self control.

A question that needs to be posed: when people choices are ‘bad’, should the state and /or the community (a) Override their choices? (b) Steer them towards ‘welfare’ improving choices? (c) Encourage “good” choices without being coercive? or (d) Do nothing?
I have explored this issue in a conference presentation: “State Paternalism and the Rules of Reason” at the International Atlantic Economic Society meeting, which took place in Savanna, GA, on October 2007. In the paper presented, I have summarized the arguments put forth in a number of papers pointing out differences in the policies advocated to deal with “irrational” behavior. In a nut shell, paternalistic policies are advocated to help those individuals whose rationality is bounded (i.e. less than perfect) from costly errors. In the medical intervention example, if the individual was to reject option Y then he/she will bear a costly outcome.
It needs to be emphasized that not all policies advocated by behavioral economists call for coercion. Libertarian paternalism for example allows for differences between individuals and ‘covert’ coercions are not contemplated. At this juncture, it is befitting to call upon one of the architect of liberalism in economic thinking, John Stuart Mill. In his essay on liberty (1859), Mill wrote: “the only purpose, for which power can rightfully be exercised over any member of a civilized community against his will, is to prevent harm to others” (1984 edition, p.92). Following the writing of Nobel Laureate James Buchanan in his Logic of Limits (Buchanan and Musgrave 2000, p.111), one may ask: Why should constraints be placed on the individual when his actions do not infringe on others?
An understanding of the logic of limits may be gained by examining individuals choice in situations where they voluntarily impose restrictions on own actions. Behavioral economists advocating paternalistic intervention do so because they doubt the validity of the logic of limit concept altogether or at least as it applies to those individuals exhibiting bounded rationality. Buchanan’s observation that persons do adopt rules that they intend to abide by is valid for many but not for all. Not all smokers purchase stops smoking aid; alcoholics join Alcoholics Anonymous (the examples given by Buchanan, p.112).
Ruling out the logic of limits as it applies in the example of medical intervention given above in favor of paternalistic intervention; it is imperative to recall that “state or community” intervention most often entails coercion for they command the tools to implement said intervention (power to tax, impose fines, outlaws certain actions and so forth). Paternalism exercised by a parent and/ or a care giver does not command the same coercive power. In the medical intervention example cited above, the physician may attempt to move the patient towards his preferred option but he cannot coerce the patient to do so. Unlike the state, or the community, his power over the individual is not absolute; the patient can opt out of his care.
To conclude:
Behavioral economists have made a significant contribution towards our understanding of human behavior. It is undoubtedly true that some “bad choices” at least from the point of view of society are likely to be made, others are not .But placing constraints on free or voluntary choice of the individual should not be taken up lightly. To err on one side or the other demand more empirical proof that we currently do not have.
Each and every one of us can relate to situations where choices made were far from utility maximizing and/ or ‘fully’ rational. Most of us believe that the choices we voluntarily make are optimal in the sense that their expected costs are below those associated with alternative-dictated choices.

Is it Rational Behavior or is it Risk Aversion?

As I was struggling with a “medical” decision as to whether to continue a “mode” of treatment that has run its course and is no longer viable or alternatively embark on a new treatment with a new technology, I read a most interesting and to the point write up in THE WEEK. It goes without saying that the “old” is familiar; the new is approached with apprehension if not suspicious. Hence, anything that makes the “new” a bit “old” helps. In the June 18th issue of THE WEEK, under the heading of “Author of the Week” , a story unfolds about a medical choice made quite a few years back by Dan Ariely who has written a couple of books using this choice to facilitate the understanding of a relatively new theory of economics.
Dan Ariely is a fellow economist, a “behavioral economist”, who according to THE WEEK has written a 2008 bestselling book: “The Upside of Irrationality”. Behavioral economists are a new breed of economists who are challenging the standard “textbook” notion of human “rationality”, a notion so fundamental to main stream economics. Rationality is a basic assumption economists use to analyze the individual decision, whether the choice is that of a consumption basket, a choice of occupation, and work versus leisure and so on. It is assumed that the individual knows the alternatives and chooses the one that “maximizes” his or her utility. This assumption is essential to our understanding of choice exercised in the market place in a setting which does not involve risk or uncertainty. When the individual is confronted with a choice that involves “RISK”, the choice is not as simple. In this situation we need to sort out individuals in terms of their “sensitivity” to risk taking.
Economists analyze three categories of risk taking exhibited by the individual: Risk averter, Risk lover and Risk neutral. The individual is said to be “risk averse” when he/she places a much higher weight to a choice that “minimizes” taking of risk; a risk lover goes for a risky choice while a risk neutral gives equal weight to risky and non-risky options.
That was more or less all we needed to know to decipher choices of the individual. But then, a group of economists mainly from the “Chicago School” revived a critique levied against the assumption of rationality and self control (See for example Schelling, T., (1978) Economics or the Art of Self Management, Am. Eco. Rev. pp. 290-94). The new group including Sunstein, Thaler, Laibson, O’Donoghue and Rabin to name but a few, earned the label: Behavioral economists for their contributions to the understanding of human decisions. In a nut shell, behavioral economists challenged the notion of rationality and maximization of utility. In effect, they argue that observed behavior is more likely to exhibit “irrational” rather than a rational decision making process. An example that is often cited has to do with the consumption of “sin” goods—cigarettes, alcohol, drugs and the like. Lack of self control is essential to the analysis, as well as the dimension of choice.
Back to the choice made by Dan Ariely, which THE WEEK Magazine uses in alluding to his book on the thesis of behavioral economics. As the magazine tells it (I have yet to read the book), Dan uses his own choice to explain one of the tenants of the behavioral economists’ theory—that people are less than perfectly rational in their choices. The author uses his own choice which he has made several years back to make the point. The choice involved two types of “medical intervention”. According to the write up, at the age of 18, the author suffered burns on 70% of his body. Two medical options were put before him: Amputate his right arm and replace it with a “hook”, or retain the arm after an excruciating surgery and endure severe pain and partial use of the arm for the rest of his life. At the time, at the age of 18, the choice he made was to retain the arm. Was this a rational or irrational decision?
At the time the decision was made, the author, in my view, exhibited what traditional economists label as “risk aversion”. As he put it: I was “incredibly attached to my hand—in multiple ways”. On backward reflection on such decision, Dan Ariely posits that the decision made at the time was “irrational”. When revisiting the decision about his own arm, as it is retold by THE WEEK, he admits that IRRATIONALITY may have led him astray. On revisiting the decision, at least for the book’s benefit Dan Ariely speculated about whether “prosthesis might have been more functional—that keeping my arm was, in a cost-benefit sense, a mistake”.
This reflection on a past decision causes me to revisit in this blog the assumption of rational choice not in terms of one period horizon but intertemporally. In simple terms, a choice with consequences lasting more than one period, for example, a choice involving one period can be depicted by the consumption of an ice cream cone, a cup of tea or a glass of mineral water. An intertemporal choice is a choice with consequences beyond the period when the item is consumed. As an example, cigarette smoking in one period gives satisfaction in that period but carries with it undesirable consequences in subsequent periods.
A great deal has been written about this type of choice. Traditional economists have advanced theories explaining intertemporal choice. The add-on by behavioral economists is that the individual may exhibit what is called “bounded rationality”—that the individual lacks self control when it comes to consumption of sin goods. Accepting this proposition has led some behavioral economists to advocate “paternalism”. Government or some higher authority would override individuals’ preferences for society’s preferences (the ban on smoking in public places, restaurants and bars is an example). For more on this point and references see Bae and Ott “The Public Economics of Self Control”, Journal of Economics and Finance (October 2008. Pp. 356-367).
Let us contemplate a decision at time t, involving two courses of action: An action A and action B. If one knows with “certainty” the outcomes of both, then the standard economist model applies. That is if a choice of A gives pleasure or satisfaction equal to X utiles, and B gives satisfaction equal to Y utiles (discounted if it were to materialize in a future period), then if A is chosen rather than B, then X utiles are greater than Y’s and vice versa. The individual choice maximizes his/her utility. Two problems arise in this scenario: first, a choice with outcome extending beyond the one period (future period(s)), involves uncertainty or unmeasured risk. Secondly, what discount rate to apply to future outcomes?
Back in the late 1940’s, Milton Friedman and T. J. Savage put this issue before us in their seminal article “The Utility Analysis of Choice Involving Risk” in the Journal of Political Economy (August 1948, pp. 279-304). In order to get as close as possible to explaining the individual temporal choice—a choice involving one period when faced with risky choice, they use the categorization of individuals as risk averter, risk lover and risk neutral. In their example the choice involved two options: a “certain sum of money”, and a chance (game) with two outcomes: losing with a high probability a small sum of money and winning with a very small probability a very large sum of money. Depending on the threshold of risk a choice is made among the two options. If the individual is risk averse he is likely to choose the “certain outcome”, if risk lover he will choose the “bet”. Nothing in the second choice is said to exhibit irrational behavior even if the individual were to bet the house and looses it.
Fundamental to the analysis of choice involving risk, is not only the computation of the expected value of the bet so that it can be compared with the “certain” option, but also the expected utility of the uncertain outcome. The expected utility depends on the shape of the utility function of the individual exercising the choice. Such utility is a function of the individual tolerance of risk. Unfortunately, this is a subjective value that can only be assigned by the individual. Which brings me back to Dan Ariety’s choice, and to a choice I am contemplating.
To illustrate:
Using the example of medical intervention, let option X be current treatment mode which has lost most of its effectiveness in the face of the disease progression. Staying with option X is given a probability Pr. =0.2 that it will have some effect. Let individual A be designated as “risk averter”. He/she assigns a utility value to this option as equal to 100 utiles (some scale of value). Hence:
Pr* Ux= 0.2(100) +0.8(0) =20 is the expected utility.
Option Y has the probability of success of 0.7 that it will be effective, (1-0.7) it will not be. If effective, the utility is 1,000. Accordingly:
Pr*Uy=0.7(1,000) + (1-0.7) (0) =700.
Comparing the expected utility of the two options clearly indicates that option Y will be chosen.
This however is not the complete story. If the new technology carries with it, in addition to the failure probability, a probability of adverse side effects then such probability has to be incorporated to arrive at the expected utility of this option. This complicates the analysis as one needs to know, in addition, something about the risk tolerance of the individual.
Let the side effects (usually ascertained from clinical trials) to have a low probability equals (0.007) such that if it materialized will have severe consequences, even death. To calculate the expected utility of option Y one needs to account for this second component.
But there the problem with the optimal choices lies: one needs to know the risk profile of the individual.
As I have mentioned earlier, the individual can be a risk averter, risk lover or risk neutral (this last category is not likely to be prevalent in the population). Hence, I focus on the risk averter.
Suppose that the risk of side effect was evaluated as equal to -100,000 utiles and a probability of occurrence equals to 0.007. The calculation of the expected utility of option Y is: 0.7(1,000) + (1-0.7) (0) +0.007(-100,000) =0. Option Y will be rejected. For it to win over option X the evaluation of the risk has to be lowered. The equivalent value of the option Y to X requires a risk evaluation equals -97,142 utiles. With this value the individual would be indifferent between the two options. For Y to be chosen over X the risk tolerance has to be reduced so that the expected value of the loss is below the threshold of -97,142 utiles.
This is a problem a concerned physician is likely to face: First, he/she has to ascertain the risk tolerance of the patient (that can be done with a full review of the patient medical history a time consuming process to be sure), and secondly, how to induce the patient to lower the evaluation of risk as the probability of occurrence of the side effects is not subject to change without new information. The solution of this problem is not easy, not for the physician or for the patient.
It needs to be emphasized that at the time one is contemplating a choice involving risk, risk assessment has to be made so that the appropriate discount rate can be applied (the discount rate is used to convert future values to the present. This is ignored in this presentation). The choice Dan Ariely faced was a choice involving risk. His first option, keeping the arm may be viewed as the “sure bet” or the “certain” option. The second option is the uncertain option or the risky choice. The uncertainty about the outcome of the second option with all its ramifications would suggest that at the time the decision was made a very high discount rate was applied to the utility derived from choosing the second option to tip the scale in favor of the first option. In my view, that decision has nothing to do with being “IRRATIONAL”.
In a dynamic world, the discount rate does not remain constant. The discount rate that one would use at the age of 20, 30 versus 50, 60 or 70 is not likely to be the same. Accordingly, many years after the fact the author may have denigrated the discount rate he has used when he was at the age of 18. The traditional theory still holds in that intertemporal choices are made at the beginning of the period. However, nothing is irrational about revising the choice in subsequent periods when more information becomes available.
Having cleared up in my own mind as to how my own choice of the two medical options is likely to come down to, I maintain that “given the information at hand whatever option I choose”, my choice will be a “RATIONAL” choice. A fundamental lesson I have learned during my studies, teaching and research is the value of information and the quality of said information. Without good information the discount rate will be faulty and the choice “suboptimal” although “not irrational.”
A final note to reflect upon:
In a decision involving medical intervention, with an option that has an uncertain outcome, a physician uses his/her expertise to calculate the probability of a successful outcome of the option so that it can be compared with the status quo or some other less uncertain options. This probability when communicated to the patient would help the patient to calculate the discount rate that must be applied to obtain the expected value (and utility) of the uncertain mode of intervention, which can then be compared with the outcome of other options including the status quo. It is worth emphasizing at this juncture that the discount rate computed by the patient reflects his/her type, whether, he/she is risk averter, risk lover or risk neutral. As only the individual can put himself/herself in one of these three categories, a choice that may appear “irrational” is in effect completely “rational.”
In my next blog I shall review some of the literature on risky choice and some of the contributions of the behavioral economics especially as some aspects of the theory pits individual choice against societal choice.