Thursday, September 15, 2011

Private vs. Public Transfers, Social Security, and the Market

I've been reading Public Spending and the Poor and came across a particularly interesting section which reminded me of the Social Security debate.  Chapter 12, "Private Transfers and the Effectiveness of Public Income Redistribution in the Philippines" by Donald Cox and Emmanuel Jimenez looks at the income of public anti-poverty spending and the impact this has on private transfers.  It provides a nice review of the subject and some good data and models from the Philippines, including transfers linked to age, retirement spending, transfers to families from workers abroad, etc.

The article finds that there is a significant crowding out effect of public spending on private transfers.  While the poor are still much better off after the public transfers the reduction in private transfers means this is not as large as it would otherwise be.

What I want to focus on though, is to think about the effect this has on wealthier households.  Specifically, I want to think about how private spending to boost the consumption of someone else may be rather inefficient.

To explain, think about two different people that decide to start their own business.  This isn't a new factory but rather something modest that a moderate income person is more likely to do, a restaurant or small retail shop.  They're both from poor backgrounds, say their parents were poor immigrants who worked on the farm to provide their kids with enough to get through school, neither set of parents has any assets.  Shortly after starting the business, the father of one of our burgeoning businessmen is injured and can no longer work.  We're in a world without Social Security, so the businessman feels obligated to chip in to keep his parents out of abject poverty since his mother only has part time work cleaning rooms at a local hotel and at her age is unlikely to be able to work extra hours, especially since she has to spend more time at home caring for her husband.

Our other businessman's parents died in a car accident 5 years ago and doesn't have these concerns.

So how are our two businessmen going to compare over time in this world?  The first businessman is likely to always be at a competitive disadvantage in this kind of moderately profitable business, he's not managing a large factory or other sort of firm where $10,000 or so a year to his parents is negligible.  Undoubtedly much of this will come out of his own consumption but relative to the other guy it is quite likely that he will also be plowing less of his profits back into the business every year.  While it's fairly certain he won't let this shut him down, it's not unlikely that over 15-20 years there will be substantial growth and linked employment that is foregone for society as a whole, in addition to his personal welfare loss.

There are two points I want to make from this example.  The first is moral.  I assumed an altruistic businessman, while he undoubtedly gets personal fulfillment from helping his parents he is financially worse off than if he were a complete asshole and did nothing for his parents.  Morally, I just don't like this world.

The second point is that this impacts economic efficiency.  The point of competition and the market is that we can optimize the production of needed goods and services and allocate scarce resources efficiently.  In this case, even if businessman #2 is the worse businessman, he is probably doing better than his competitor simply through having more capital to invest because of his personal circumstances.  These circumstances don't matter at all to society, we're worse off that businessman #1 lacks capital because he has to support the consumption of additional people.

This is one of the things I mean by marketization, the more individuals can focus on market incentives rather than cultural and normative distributional concerns the more efficient an economy is likely to be.  I draw this viewpoint from three sources.  First of all, historically, before the state began to step in there were quite well developed mutual aid networks in both urban and rural areas, such as peasant communes, guilds, and mutual protection societies.  Growth rates were quite low.  As markets expanded, state institutions, starting in the Dutch Republic and England, grew and displaced these networks.  Second, comparatively, poor countries tend to have these networks and they quite frequently blend into clientelism and work for below market wages to pay off these debts.  Third, anecdotes regarding the poor often describe large self-help networks where someone that does fairly well ends up supporting siblings and sometimes even friends to some degree.  Also, this tends to promote dependency far more than faceless bureaucrats do.  We can quite accurately describe institutions such as client networks as a form of dependency, often the person at the center of the network wants to promote these for their own prestige and other benefits.  It's hard to see government as having the same role, look at how eager governments officials are to reduce welfare roles, for instance.  There's little evidence these programs are vote winners, it's usually the opposite.

There are several problems with this form of anti-poverty provision from the viewpoint of the giver.  First, it tends to impose quite high effective marginal tax rates on better off individuals.  If you feel expected or obligated to give and this drains a great deal of your income, this is just as likely to provide work disincentives as if the government were taxing you.  After all, you aren't getting any better off.  Second, it is even less likely to provide work incentives to the poor.  While individuals will know their friends and relatives much better than government officials and know if they are slackers or not, many people will find it far more difficult to impose penalties beyond haranguing than government officials will.  That there are individual exceptions doesn't make this much less of a problem in aggregate.  Third, it makes too much of success due to luck, rather than skill.  Someone without these ties ends up with too many advantages unrelated to their ability to do anything productive.  Skills and ability should matter, whether or not your parents are poor or your brother is a loser shouldn't.

While society can't, and shouldn't, do anything about every characteristic that meets these criteria, it will be more efficient to do what it can to alleviate the income effect of these problems in predictable circumstances, such as old age.  Questions regarding issues like children are more difficult.  While, in economic terms, they will be similar in costs to needing to take care of the elderly, individual choice is at work here.  We can decide if we will have children, we can't choose our parents.  On the other hand, society benefits from more children.

On the whole, however, most of us bear some statistical risk of falling into a situation where much of our time, energy, and money might become tied up in caring for someone else, whether the result of old age, a child with a severe disability, or our spouse suffering an accident.  With enough wealth accumulation we may be able to self-insure, but even here, having reached this stage doesn't mean that we were not once at a vulnerable point where if luck had gone differently this wealth never would have been accumulated.  Unless we're assholes and would simply ignore the circumstances of others, which is not a characteristic I believe we should select for but that the market will unaided.

It is simply not efficient for this entire risk to fall on the individual who happens to end up in this bad circumstance, the circumstance has nothing to do with their ability to contribute to resource production or how efficiently they can use resources.  It's irrelevant to the market, but not to other considerations.  This is why public transfer programs are so important, it lets us spread at least the financial component of socially destructive circumstances across the broadest possible pool.  It allows the women whose child has a severe disability to complete medical school rather than having to get a direct care job at minimum wage to support the needs of her infant, it allows Social Security to pick up the tab for supporting aging parents rather than needing to live nearby to give in kind support (though of course, many individuals will voluntarily do this anyway but lack of income shouldn't come into this consideration), and it means a poor person trying to do better doesn't find his wages being drained away trying to keep the kids of his/her irresponsible brother/sister decently fed and clothed.  It's more efficient for society to share these burdens broadly through taxes rather than have luck play such a strong determining role in whether or not we can save and invest or if our social obligations drain away our resources, as they do in so many other countries and as they did so much in the past.  The costs to the better off, as well as the circumstances of the poor, are essential to figuring out the true benefits of a social transfer scheme.  A few percent in taxes to everyone creates a much more even playing field than people having no burdens at all, other than capital investments like helping their kids with college, competing with people who have social burdens linked to family and neighborhood ties.  Private networks can do a good job easing poverty but they are terrible at creating incentives for economic growth.

In particular, absent assistance, these problems are likely to have a particularly strong impact on income mobility.  Since entrepreneurship is so closely tied to the ability to move up the income scale and with assets it is particularly problematic if those just above the bottom of the scale have their income being drained off to support relations even worse off than they are.  I wouldn't be surprised, though I have no data, if this is a big part of the reason why income mobility among the poor is low compared to other countries with better social safety nets.  Absent public provision, the best endowed among the poor find too much of their earnings going towards others consumption rather than building their own assets.  Given that these networks are a constant of human society unless the state intervenes it seems like these effects are likely to make the existing income distribution far more permanent.  Those with wealth can survive life's downs at little cost to themselves, while those without much current wealth can find even excellent plans destroyed by the misfortunes of themselves or people they are close to.  There's nothing efficient about this.

[How did I end up rambling on so long, wow]

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