Why do the poor remain with us?

Norman Geras raises a point that recurs in his commentary in his excellent blog:

but what a mark against the world's wealthiest countries that there remains in them such a category of people - the poor - who can be spoken about in this way. These are societies fat, bulging, overflowing, with stuff; oozing personal wealth, economic crisis notwithstanding; and they are yet to provide all their citizens with a standard of material well-being such that no one would any longer need to be referred to as the poor but might enjoy, even as unequals, the advantage both of a more comfortable state and a more dignified style of description.

An obvious response is that, by the standards of history and of much of the globe, the people referred to as ‘the poor’ in developed democracies are not poor. [This point is made very powerfully via a graph here.] They have life expectancies, security of food and shelter and rates of possession of consumer durables that mark them out as among the blessed of history. Indeed, as Michael Cox and Richard Alm point out in their Myths Of Rich And Poor: Why We're Better Off Than We Think, poor people in the US in the mid-90s had an average level of possession of consumer durables that would have marked them off as middle class in the early 1970s. [This point is expressed graphically here.]

But, by the standards of their own societies, they are poor, even if poor means “middle class two or so decades ago”. So, why do we have a persistent category of people who lag behind the general prosperity?

Well, for no single reason. As Norman Geras intimates, it is not a matter of how productive the society is, as used to be the case when poverty was the general human condition. There have been sharp drops in the general level of poverty in Western societies over time. Which is another way of saying that developed societies have been great engines of mass prosperity: that is what makes them “developed societies”. But these drops in poverty rates slowed and then stopped: for example, the proportion of people in poverty in the US dropped steadily, even dramatically, during the postwar boom until the mid 1960s and has been stubbornly persistent ever since. Rather discouragingly, the apparent ending of mass exit from poverty coincided with increased government effort against war on poverty: the US “war on poverty” has been about as successful as the “war on drugs”. But similar patterns can be discerned in other developed societies.

Indeed, one way to put the question is “why has poverty persisted despite massive expansions in the welfare state?” The question is not often put like this, but it is a very reasonable question to ask, on the evidence. After all, the welfare state is a century or more old: the failure of eliminate poverty is a reasonable criteria to evaluate it by, particularly given its massive expansion from the 1960s onwards. (It can hardly be the fault of “capitalism”, as its success in generating unprecedented and steadily increasing mass prosperity is what has made the elimination of poverty a remotely plausible goal in the first place. Indeed, the first post-classical public welfare measures – Venetian public health measures, English poor law provisions – grew up in the most commercial societies in part precisely because they were the richest societies.)

One answer to the persistence of poverty might be: because of the expansion of the welfare state. After all, the great mass exits from poverty clearly were not products of the welfare state: they were the result of massive expansion in productive capacities. The welfare state needs clients: if there are no poor people, then there are no poor people to be clients. Milton Friedman pointed out that, if one took the entire expenditure on anti-poverty programs and divided it by the number of poor Americans, there would be no poor Americans. Clearly, employing people in secure jobs with good pensions in welfare bureaucracies, and the transferring of funds to people who are not poor, take up a considerable amount of welfare resources and generate a considerable number of beneficiaries: beneficiaries who might be of some risk of losing said benefits if poverty was abolished.

So, waste and failure in welfare might be one reason for the persistence of poverty. Particularly if such retards economic growth – given why the mass exits from poverty have occurred – by, for example, reducing the level of productive investment.

Or it might be due to welfare subsidising unfortunate patterns of behaviour. The richer the society, the less absolute the penalties for destructive behaviour patterns tend to be, but they still exist. One of the effects of welfare can be to soften the effects of folly (or, to be less blunt, lessen the penalty for patterns of behaviour not conducive to increased income). People can get away more with clinging to leisure preferences, instant gratification preferences or familiar attitudes and patterns of behaviour which are not conducive to good incomes. (And the behaviour of parents may well have effects on the prospects of their children.) If there is a bell-curve of income-producing behaviour, then there will always be a tail end. The richer the society, the better off the tail-end will tend to be. But they will still be the tail-end.

In the US, if one completes high school, get and stays married, get and stays employed (even starting at a minimum wage job) and avoids becoming involved in crime, one’s chances of staying poor are small.

We also get into some stubborn persistences here. Consider that, in the US, students of Asian ethnic backgrounds do far more homework, on average, than do black students. If lifetime income prospects are connected to educational achievement (as they are) and educational achievement is connected to student effort (as it is) then we can reasonably predict that poverty will be more common among black Americans than Asian-Americans on that one indicator alone (as it is).
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So, what can we do about this? If doing less homework leads to higher rates of poverty, does poverty lead to doing less homework? No, but the patterns of behaviour and outlooks which lead to poverty (for example, by discouraging scholastic effort) may do so. A society where human capital is important, and increasingly important, has limited ability to get specific groups to value the acquisition of human capital. But, if they fail to do so, they will have higher rates of poverty. So poverty will persist due to a failure to take advantages of the opportunities available (with some depressive effect on the general productivity of the society, since the level of human capital will be lower than it otherwise would be).

Moreover, how good is the welfare system likely to be at putting itself out of business by encouraging patterns of behaviour that lead to exiting from poverty? Noting that, to the extent that a social system can be said to have “an interest”, poverty is not in the interest of “capitalism” – there is far more profit to be made from selling to rich consumers than poor ones. More precisely, the logic of capitalism has clearly been to generate mass prosperity, since capitalism is the best system ever developed for creating and using capital (the produced means of production) and the more capital, the more production, the more prosperity, the less poverty.

The welfare system can also create barriers to exit from it. Public housing can “trap” people in high unemployment areas, as to move is to lose one’s eligibility. The very high effective marginal tax rates that beneficiaries face (from their benefits reducing, and taxes increasing, as they earn more money) also constitute a barrier to exiting from poverty. But such are expensive to fix and tend to keep the level of clients for the welfare system higher, so there is little incentive from within the system to push for reform.

There are also some forms of poverty that simply are not much of a concern. That university students have low incomes in their 20s is not a concern if they end up being high-earning professionals in their 40s. Indeed, as Cox and Alm point out, the increased participation in higher education is a major reason for increased income inequality – we can tell this, because the slope of “life cycle” income changes (i.e. average income by age group) has become much steeper than it used to be.

So, given the increased participation in higher education, something that also took off in the 1960s, some of the persistence in poverty is a life-cycle effect.

Some of the persistence of poverty is a “recent entry” effect. New migrants, lacking skills and entre into various networks, will tend to start off with low incomes. Increased low-skill migration will also tend to lead to persistence in poverty rates, particularly if there is an increase in the importance of human capital in an economy. It is likely that the children and grandchildren of new migrants will not live in poverty, but if the flow-in is constantly replenished, then the poor are being replenished.

And, of course, if migration to a developed democracy becomes a guarantee that one will not be poor, the incentive to migrate will be greatly increased. Milton Friedman famously argued that the welfare state was incompatible with open borders: certainly the welfare state is likely to increase the resentment of migrants if people believe they are paying for people whose arrival they had no say in.

The low-skill migrant point interconnects with the educational point. It is clear that the Anglosphere is better at attracting productive migrants than much of Europe (and, apparently, my own country of Australia is the very best at cherry-picking its migrants).

But that second-generation male Muslim migrants in Europe are “going backwards” in their economic participation points to another difficulty – barriers to economic participation. Some of these can arise from the behaviour of those with lower levels of economic participation (e.g. the lower levels of homework among black American students). Others can flow from regulation or other institutional factors.

Regulation has a persistent tendency to protect the interest of incumbents: this is particularly true in land use regulation and labour regulation: unfair dismissal laws, for example, protect incumbents against new entrants to labour markets (since they raise the risk of employing new people, particularly for small businesses). Faced with increased risks in employing new staff created by such regulations which is not compensated for by increased productivity, businesses respond by cutting back on hiring, relying more on certification and on “vouching for” networks, became more reluctant to deal with differences that might get in the way of communication (i.e. the transaction costs of cultural differences) and so on. If migrant Muslim males put less effort into school and so are less certificated, are more likely to “have attitude” (or are believed to be so), are less plugged into networks, have less skills then they will be disproportionately excluded by such regulation. Though young people generally suffer from such “protect incumbent” laws.

The problem of persistence of attitudes not conducive to exit from poverty are not only a matter for the poor, they can be attitudes among the better connected as well. Labour market regulation penalising the more marginal in the labour market, land use regulation driving up rents and housing prices by restricting the supply of land for housing are not created or justified by the poor, and certainly do not benefit them, but do disproportionately penalise them.

The capacity for “progressives” (or, as former Labor Senator John Black puts it [pdf] the inner city rich, the code word for which is apparently, ‘progressive’) to romanticise green fields (which are every bit as much human creations as any suburb, and may well have less biodiversity), thereby driving up the value of their inner city properties by restricting the supply of land able to be used for housing, and to frame labour market regulation as “protecting workers” (as, indeed it does: it protects incumbent workers against competition from marginal workers) does its bit to increase barriers to economic participation and so to the persistence of poverty.

Add all these factors together and the elimination of poverty – that is, of a category of “middle class minus two or so decades” – becomes difficult, to say the least.

So, is it a “mark against the world’s wealthiest countries”? Well yes, though not as much as it may seem at first blush and those who are most likely to hold it so are often very much part of the problem.

Or, to put it another way, the sort of mushy, self-satisfied reasoning that Norman Geras likes to berate Guardianistas for in international affairs has its domestic equivalents. There is even some suggestive social science research (pdf) that implies that conservatives signal competence while progressives signal trust: hence the importance to the latter of policy positions which allow one to signal one’s good intentions (and conservative contempt for any disastrous consequences, which the liberals deride as being unfeeling or otherwise lacking in virtue).

Indeed, we observe people who not that many years ago would have been nodding along to descriptions of science as a “patriarchal Western discourse”, not worthy of any privileging, now holding the results of climate science as absolutely authoritative: attitudes to science clearly being subordinated to the commitment to signalling virtuous intentions. But embracing of such serial, or even concurrent, contradiction actually improves the capacity to signal that one’s priority is membership of the club of the ostentatiously virtuous.

If we allow actions to have income consequences (since that promotes productive behaviour) but not negative ones (since that can lead to poverty), stop low-skill migration, ensure that the welfare system promotes independence and not dependence (even at the risk of losing its client base) but otherwise pays those who cannot be independent enough not to be poor, only permit students in higher education who won’t be on low incomes while they are studying and eliminate regulations and other institutional factors that are barriers to economic participation (which will require neutering the “progressive” intelligentsia having any effective capacity to frame public debate so as to block such changes), we in developed countries can have “tail ends” which are not poor by the standards of our societies.

Good luck with that.

Still, the good news is that we could do better: the bad news is that we probably won’t (beyond general increases in productivity).

Applying Barzel: cognition, belief, unions, class

It is a sign of how penetrating book of analysis is that it expands your understanding of matters beyond what the author consider directly in their book. I found that very much to be the case in Prof. Yoram Barzel’s Economic Analysis of Property Rights, which I reviewed in my previous post. So I consider below some applications of his analysis that occurred to me but did not figure in his book.

Consider Barzel’s notion that humans-as-maximisers is perfectly reasonable provided one takes in all applying constraints. Simple concepts of humans-as-maximisers analyse behaviour as if every decision will be fully considered on every occasion—that is, cognition and information are costless. But they are not. Thinking takes time and effort, as does gathering information. So, given such constraints, genuine maximisers will use habits and routines, saving on time and effort.

Moreover, the benefits of cognition depend on one’s capacity to do so. So, the less able one is at thinking, the more one will tend to rely on habits and routines and, in particular, the more one will tend to rely on “piggy-backing” on other folk’s decisions. (Hence John Stuart Mill’s observation that stupid people tend to be conservative: Walter Bagehot famously characterised British politics as the battle between the stupid party and the silly party.) There are all sorts of complexities here, however. Those less able at cognition are still going to tend to be much better informed about their own situation than someone else is. As the saying goes, a stupid man can put on his own trousers better than a wise man can do it for him.
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The nature of the matter being considered is also important. Thus, the effects of of a belief for the believer will generally be much more subject to feedback to the believer than will the effects of implementing said belief on others. So beliefs that operate as status-markers will have much stronger feedback in terms of their status effect than in terms of their implications for other folk. Hence, dramatically increasing the number of folk who traffic in ideas (e.g. expanding higher education) but who are insulated from the consequences of their ideas for others (e.g. by having tenure, by working in tax-paid institutions) will tend to lower the quality of the ideas being trafficked in (in terms of wider social consequences) but, via feedback effects, increase their role as status-markers.

Transaction costs

Expressing a belief is a form of transaction. Barzel makes much of the characteristics of the transaction as being crucial to understanding how folk will behave. So, for example, as wages rise, workers will tend to move towards self-employment since they will be more able to cope with income variability (p.151).

Consider union officials (not an example Barzel uses). Union officials act as negotiation and risk management agents for workers. Union officials will prefer labour remuneration to be centralised (i.e. channelled through mechanisms they deal with) and complex (divided up into lots of allowances, benefits, etc, particularly deferred and contingent benefits). Complexity increases the union officials' importance to workers as managers of complexity and provide specific measures of their performance (in terms of identified allowances gained) while contingency (e.g. sick leave) and deferral (e.g. firm-specific superannuation) encourage workers to stay "in place".

Workers, however, will generally tend to prefer remuneration to be direct (less time-constraining), simple (easy for them to understand and manage directly) and flexible (so they can shift along various margins, such as hours of work, as convenient for them). So, the larger the aggregation of workers in similar situations (e.g. in manufacturing, construction, public service, etc), thereby having fewer coordination problems, the more unionised they are likely to be.

Thus—unless there are countervailing pressures—as the possibilities of employment diversity increase (particularly true for service industries) and wages (or, at least, household incomes) increase generally, workers will have less tolerance for the gap between their interests and those of union officials, whose utility as negotiation and risk management agents will decline. So unionisation will tend to decline (i.e. fewer workers with transact with union officials as their agents) and will do so more in the private sector than in the public sector.

Indeed, to the extent that union officials impede the application of capital to labour, unions will actually tend to reduce overall living standards and wages. Also, unions are, as coercive bodies, effectively substitutes for state action in the provision of various public goods to workers. The more “hostile” or “indifferent” the state, the more utility there is in union action for workers. The more services the state provides which are genuinely useful for workers—and not connected to union membership—and the more competition from other agents for such (e.g. lawyers), the less benefit unions can provide and the less workers will transact with union officials for services.

In Australia, Bill Kelty’s union amalgamations and centralisations aggravated the process, by increasing the distance between officials and members without any significant economies of scale gains—not a single union official position was abolished as a result of the amalgamations. Thus unionisation declined faster in the outlying States, with greater distance and difference between members and the Sydney or Melbourne headquarters.

Such declines in unionisation are not signs that workers are becoming more stupid, or some are more stupid than others, or that they are increasingly deluded. It is a rational response to shifting circumstances.

As Barzel demonstrates with a wide range of examples, transaction cost analysis has the capacity to greatly improve understanding. Classical Marxism missed the implications of marginal analysis, being stuck on the (false) labour theory of value, so all profit is exploitation, loss and risk of loss are, at best, minor issues, etc. Yet avoidance of loss and risk management are crucial to understanding economic behaviour, particularly commercial behaviour.

Marxism (and its Post-Marxism derivatives) also misses the implications of transaction cost analysis. Assuming, for example, that there are no coordination problems for classes so they can be analysed as coherent historical agents. So all capitalists act together, all landlords act together and so on, as coordination is costless—there are no search costs, no information costs, no monitoring costs, no divergent interests. Scarcity (e.g. of capital) can be unproblematically analysed as monopoly.

Which is nonsense, of course. A firm owner has rather more severe conflicts of interest with his or her competitors than with his or her workers (otherwise firms couldn’t exist). Conversely, the power of unions rests on excluding competing workers (known as “scabs”).

But, by assuming that all capital is held by capitalists and that capitalists have no coordination problems, it follows in Marxian economic logic that, since capitalism is very good at generating capital, the power of capitalists will increase against workers who will become poorer and poorer (either relatively or absolutely)—the immiseration thesis. Which is completely false. Capitalism does generate more and more capital, but that capital is held more and more widely. (So capitalists are, if anything, less and less able to coordinate as a group.) Labour becomes more and more scarce vis-a-vis capital. So the value of labour goes up and up via bidding processes as capitalists bid for increasingly scarce labour. So workers become wealthier and wealthier with higher and higher incomes. (Though, clearly, if women enter the workforce in significant numbers and there is large-scale migration, the scarcity effect for labour from growth in capital will be reduced, particularly for lower skilled workers.)

Note that there is nothing here that bars regularities in behaviour based on class. People in similar situations will tend to act in similar ways. Without such regularities in behaviour, society and social analysis would be equally impossible. But class is hardly the only socially significant line of commonality/difference

Of course, since coordination is a public good, the one body able to relatively easily provide that public good is the state. Hence the necessity of state action (or some other coercive body: organised crime is a coercive rival to state action) to produce genuine, systematic exploitation—and the state with the most overweening power (Stalin’s Soviet Union) was the most effectively exploitative, though North Korea is also extremely exploitative. (In developed societies, unions typically come second in power to enforce coordination, hence their utility for enforcing cartels, such as the Australian waterfront.)

These are just some of the ways Yoram Barzel’s transaction cost and property rights analysis can make the social world around us clearer.