The Second Groove

The reasons behind the gender pay gap

2011-06-24T20:34:00.000-07:00

A slightly modified of this article appeared in the New Zealand Herald on Saturday June 25, 2011.

Women should get paid the same as men for doing the same job. This should not be a matter of debate, particularly in the country that was first in giving women the right to vote way back in 1893.

The existence of a gender wage gap in the work-place is well documented. Women earn less than men in similar jobs even after controlling for other factors such as education and experience. In the United States annual earnings data released by the Census Bureau in September 2010 shows that women working full time make, on average, only 77 cents for every dollar earned by men.

The UK Office of National Statistics reported in April 2010 that hourly wage rates for men working full time was £13.01 while for full time working women the rate was £11.68. This difference amounts to women earning about £10.60 less per 8-hour working day and about £425.60 less per 40 hour work week. Assuming a 48 week year, in 2010 women working full time in the UK earned £20,428 less than men working full time.

What explains this lower earning for women? A number of people put forward arguments similar to those expressed by the Employer and Manufacturers Association chief Alasdair Thomson, albeit with finesse; that women often take time off from work to start a family or take care of children and other arguments along those lines.

The question has been the subject of much research. If we do observe differences in the relative pay of men and women, this can be due to two separate sources; either differences in observable characteristics such as education, hours worked, work experience, and choice of occupation, or due to unobserved factors like discrimination against women in the work place such as lower wage for the same work.

Two leading labour economists from Cornell University Francine Blau and Lawrence Kahn carried out a comprehensive study that takes into account a large number of variables such as education, labor market experience, race, choice of occupation and report that while the gender wage gap does diminish when all these factors are taken into account nevertheless a substantial part of the gender wage gap – about 12% - remains unexplained.

Robert Wood, Mary Corcoran and Paul Courant look at graduates of the University of Michigan Law School. They match the men and women in their sample for many of the possible explanatory factors, such as occupation, age, experience, education, and time in the workforce, time spent in childcare, average hours worked, grades while in college, etc. Even after accounting for all that the authors find that one-quarter to one-third of the gender wage gap remains unexplained.

Recent research throws up another reason why women may earn less than men: women simply do not ask for more. In the 2003 book Women Don’t Ask Linda Babcock and Sara Laschever point out that among MBAs from Carnegie Mellon University starting salaries for men were almost $4000 higher than that for women; to a large extent because while only 7% of the women negotiated their starting salary, 57% of the men did so. While $4000 at the beginning of one’s career may not be a large difference, given that salary increments are typically a percentage of base salary – and other things like bonuses also depend on current salary - a small difference early on translates into large differences later in life.

In research carried out by me and others, we document a similar reluctance on the part of women to compete. Given the essentially competitive nature of the work-place this usually does not bode well for their future success. To a large extent this aversion to competing is a function of women’s socialization and nurture.

In the late 1990s Lilly Ledbetter’s lawsuit against the Goodyear Tire and Rubber Company in the US became an important milestone in the fight for gender pay equity. When she retired after 20 years of service she found that her monthly salary was lower than the salary of the lowest paid male workers. Why didn’t she ask for more? Ledbetter said that this was because she simply had no idea that she was getting paid so much less than the men for doing the same work!

The US Supreme Court decided against Ledbetter by a 5-4 margin arguing that the statute of limitations had passed since she did not file suit within 180 days of the first act of discrimination as was required by law. In January 2009 one of the first bills that President Barack Obama signed into law is the Lilly Ledbetter Fair Pay Act which got rid of this 180 day filing requirement.

Women, here and elsewhere, are not asking for a hand-out. They are asking to be paid the same wage as men for the same work, an idea that is fundamental to democratic ideals of equity and justice. Catherine Delahunty’s bill which proposes to amend the Equal Pay Act by allowing for gender pay comparisons in the work place will help reduce the disparity in pay between men and women. It will prevent others from suffering the same fate as Lilly Ledbetter. It is an important step forward for achieving the goal of gender pay equity.

I wrote this article as a response to comments made by Alasdair Thomson, the Chief Executive of Employers and Manufacturers Association. Related articles on the topic in the New Zealand Herald:

Call for employers' chief to resign after 'insult to women

Alasdair Thompson walks off interview over 'sexist' claims

Murray Deaker's comments

2011-06-06T22:40:00.000-07:00

I do not really expect much in the way of scholarship, thoughtfuness or intellectual depth from radio and television commentators in New Zealand. It is a small country and obviously draws from a very shallow talent pool. But is it too much to expect that they will stay away giving vent to their latent racism while on air? In recent years we had Paul Holmes calling the UN Secretary General a "cheeky darky". Then came the asinine jokes from the crude Paul Henry. Now we have Murray Deaker with his euphemism for blacks.

The strange thing is that in each of these cases the employers of these commentators, rather than expressing their dismay and condemning the comments, jumped up to defend these people and suggested that it was not a big deal.

It is a very big deal. Of course, I have no delusions that these people will turn into enlightened souls any time soon. But could we at least expect their employers to set slightly higher standards and ask their commentators to keep a check on the racist remarks during a broadcast? And how about the Broadcasting Standards Authority? Does it have any teeth at all?

We should not make our bill payments records public

2011-06-01T20:41:00.000-07:00

(A version of this blog appeared as a perspectives article in the New Zealand Herald on June 1, 2011 under the title "Banks put vulnerable at risk from predatory lending")

We should not make our bill payments records available to lenders. Doing so has the potential of exposing consumers to predatory lending practices which ultimately will not serve our best interests. I will come back to this shortly.

According to the banking industry this is all about being a responsible consumer. The idea is that paying your bills on time will help you get a better credit rating and better access to loans. Those who are struggling with their bills will not be given any more credit to prevent them from piling up debt.

If you buy that argument, then you should also buy the argument that with all those sub-prime loans that the banks handed out, they just made honest mistakes. They did not realize that they were making loans to people who would not be able to repay. If only they had access to the debtors’ bill payments history they never would have advanced those loans!

Suppose for the moment that banks are really concerned with credit-worthiness and want to figure out who would be diligent about repaying the loans and who not.

They have adequate means at their disposal right now. They can ask you whether you have a steady income or not and how much money you make. They can ask you for your payslips and for your bank statements. And you know what - if they really wanted - they can ask you about your payment history as well!

For most of the transactions we engage in such as telephone and utilities payments our past bills and payment records (usually up to a year’s worth) are available on-line. All you have to do is to log in to your account and print them out. Getting an online account is free and so is printing out the past bills. If you want you are at liberty to provide this information to your bank.

There is absolutely no reason why all of us should be subjected to this massive intrusion on our privacy just to help banks figure out who is credit-worthy and who is not.

So what is it about then? This is, I believe, to a large extent about credit card debt.

A lot of our household debt is carried on credit cards. According to the Reserve Bank, at present the total amount of outstanding credit debt in New Zealand is approximately $5.4 billion and the average interest rate on these is 18.8%. Our banks are raking in a little over $1 billion in interest payments on credit card debt.

According to Dan Ariely, a professor at Duke University and author of the book “Predictably Irrational” “the average American family has six credit cards (in 2005 alone, Americans received 6 billion direct-mail solicitations for credit cards). ...the average debt on these cards is US $9,000; and seven in ten households borrow on credit cards to cover such basic living expenses as food, utilities and clothing.”

And when it comes to credit cards, banks are actually looking for people who are having difficulties paying of their bills; people who will run up debts, carry the balance and keep making the exorbitant interest payments.

But how do you find the consumer that will keep on making the interest payments rather than paying off their balance? This is a little trickier. The bank cannot really say to you: so I hope you are not the type that likes to pay off your card balance at the end of every month; because what we are really looking for are people who will only pay the interest.

But if they can look at your bill payments history and see that you have had some trouble in that area, then they know who is a good mark and who is not. Then they know whose mailbox to stuff (or whose phone to call during dinner-time) with the announcement of an exciting new card offer of a low teaser interest of 5.99% for the first 6 months but then going up to 25.99% after that.

With the bill payment history available, finding desirable targets becomes easier. The lender can even tailor his appeal more specifically. Having trouble with the heat bill? What do you know, we have a credit card with a very low introductory rate that will also give you gift vouchers that you can use to pay for your heat!

Providing detailed records will place the more vulnerable consumers at much greater risk of being subjected to predatory lending practices.

Will our banks do this? Banks in other countries have certainly engaged in such practices. But, at the very least, making our records available makes it possible to exploit such information to the detriment of consumer interest. The downside to making such records public should be obvious.
What is the upside?

Why would the banks wish to promote consumer responsibility, when their profits depend crucially on consumers behaving irresponsibly?

Should we pay more to our school teachers?

2010-09-21T16:53:00.000-07:00

A version of this blog appeared as a perspectives article in the New Zealand Herald on Tuesday, September 21, 2010.

Should our school teachers be paid more? I think so. Because at current salaries we will have a very hard time attracting high quality individuals to that profession. Only those motivated by a desire to serve society at some level might step forth but possibly not too many of them.

At the University of Auckland, I teach a course called “Understanding the Global Economy” which is designed for students who are studying disciplines other than business and economics. The course usually has upwards of 500 students in the class and attracts students from all over the university. These are the best and brightest students in our community. Every year I ask them what they are planning to do after they graduate. Doctors? A multitude of hands. Engineers? Another array of hands. School teachers? And a strange hush falls over the lecture theatre.

Why? The answer is simple. The salaries are abysmal.

But how can we afford to pay them more, critics ask? The right question to ask, I think, is how can we not? Teaching students at our schools is fundamental to our long-term well-being. This is where our children are spending their formative years and it is imperative that they be taught by people who are enthusiastic, inspiring and visionary. Do we get them currently? I doubt very many.

The answer is easy to understand. Consider two job candidates. I will call them Harry and Sally. Sally is a dynamite young person; full of ideas and getting ready to change the world. Harry is a bit of a plodder with limited ambitions. Sally has decided that after she graduates she will only accept jobs that pay her $50,000 or more while Harry is content with $30,000.

Along comes a multinational company which offers $55,000 and a primary school offering $35,000. Which job do you think Sally will take? Maybe Sally is an altruist and does take the job in the primary school. But then one day Sally will meet Harry, fall in love and start a family. She will realize that if she is to give her children the best opportunities in life then she cannot afford to be a school teacher anymore. Sally will start looking for another job that pays more.

Now think of this from the employer’ perspective. Will paying more attract better qualified applicants? This is not guaranteed but certainly improves the odds. Why? Suppose you are recruiting for the primary school. Harry and Sally both look like impressive young people; clean-cut, well-dressed, well- spoken. But you know that there is one-half chance that one of them is more qualified than the other. What you do not know is whether it is Harry or Sally who is the better candidate.

The problem is that you cannot quite make out from the interview which of the two is more dynamic. What salary do you offer them? If you offer anything less than $50,000 then it is guaranteed that Sally will not accept the job and only Harry will. This in turn implies that offering less than the minimum Sally – the more dynamic candidate – is willing to accept is a certain recipe for ending up with the less qualified candidate. But what if you offered $50,000? Will that guarantee you get Sally. No. But it certainly improves your chances of recruiting Sally. Offering the higher salary radically improves your chances of hiring the better candidate because you will now be attracting a better pool of candidates – Sally and many others like her.

Can we afford to pay our teachers more? I do not know. But what I do know for sure is that if we keep paying these low salaries then our children will not be taught by inspiring and visionary teachers. Are will really willing to take that gamble with our children and the future of our nation?

Is New Zealand a rip-off?

2010-08-10T18:40:00.000-07:00

(This blog is co-authored with my colleague Dr Debashis Bandyopadhyay. A version of this blog appeared as a perspectives article in the New Zealand Herald, Page A13, August 11, 2010)

In recent days there has been a lot of discussion about whether New Zealand is a “rip-off” following comments – no doubt well-meaning ones - made by a British columnist, later supported among others by our very own Justin Marshall. However, it is important to understand that there are actually two separate questions implicit in this one simple phrase.

First, is New Zealand a rip-off in the sense that our prices for day-to-day goods are higher than other countries even after you make the necessary corrections for differences in exchange rates? Second, and probably more importantly in the current context, are those prices high because of deliberate over-charging by producers? I would submit that the answer to the first question is most likely yes and the answer to the second is most likely no.

Let us start with the second question first. It is important to remember that the extent to which a producer has power over the price he charges depends on how competitive the market is. A producer can only charge high prices if there are no competitors available to undercut his price and lure customers away from him or if he can somehow or the other collude with his competitors in over-charging his customers. Because if a particular producer is making large profits, then it is most likely that another producer can come into the market, undercut his prices and still make enough profit to make such price cutting worthwhile.

This implies that in markets with vigorous competition and many small firms, it would be difficult to keep over-charging customers because there are enough other producers around who can and will undercut prices if it makes money to do so. And if there are a whole lot of competitors, colluding with all of them is a difficult proposition. This in turn most likely implies that – given the profusion of cafes around the city – we are most likely not paying too much for our daily dose of flat-white and those prices truly reflect the underlying costs with not much of a margin. A similar argument is probably applicable to hotel prices in popular tourist resorts.

How about fine dining? These markets are certainly not competitive and the issues here are somewhat different. Is $28 for an entrée in a restaurant in the Viaduct Harbour too much? There is no clear answer to this question. For those who are going there and enjoying the food along with the ambience and the view of the water, it most likely is not. Someone who is not willing to pay that price is surely not going to eat there. What the restaurant is clearly exploiting is their monopoly power arising out of their prime location. But the point here is that the restaurant is not primarily interested in the price it charges but rather in the profit it makes. It is most likely that the restaurant calculates that they can get away with charging $28 for an entrée and still enough people will line up to make it worth their while. Because if their profits would go up by charging lower prices they would surely do so!

Given that restaurants in the Viaduct Harbour or on top of the Skytower clearly enjoy the advantages of being in a premier location they are charging the prices that maximize their profit and it is difficult to see how one can increase competition in this regard in an attempt to lower those prices. So if the view and the setting are not worth that much to you then you should probably not patronize these establishments. It is also probably worthwhile to remember that these people also pay a premium on the rent for these locations.

Okay, so are there any situations where producers are deliberately over-charging? Yes, it is most likely that we are paying too much for our meat and produce at the local supermarket. It is one thing if we have to pay through the nose for exotic foreign goods that are shipped from a long distance away. But that does not explain why we pay top prices for locally grown meat, fruits and vegetables.

In the absence of hard data, one can make conjectures as to why this might be the case. In Auckland, the supermarkets are owned by one of two companies Woolworths and Foodstuffs. The extreme lack of competition in this market pretty much guarantees that the supermarkets can get away by charging high prices. It is also not unlikely that there is some amount of implicit collusion among these two companies.

However, before we condemn the supermarkets, there is one other issue that needs to be remembered. It is possible that our supermarkets also experience higher costs than would be true of supermarkets in other countries. We all know the price a producer charges is related to the underlying costs. For large supermarkets there are large fixed or set-up costs. It costs money to build and operate one of these stores. This cost is fixed in the sense that if you decide to build a large supermarket then you have to incur some of these costs in terms of building costs, the cost of air-conditioning etc. which is independent of the amount of goods that you sell.

Now the more you sell the less your costs become on average because this large fixed cost gets distributed over a larger volume of goods making each item less expensive to produce and sell on average. But the extent to which these average costs decrease depends on the volume of your sales. Here is the problem. Auckland – and New Zealand - is a very small market. And therefore it is possible that the sales volumes are just not large enough to give the producers adequate cost savings. So which view is correct? Are costs too high? Or are they deliberately over-charging given the lack of competition? Probably a bit of both. This is an open research question.

So, what is the average consumer to do? Well, it depends. How important to you is the convenience of buying everything under the same roof in air-conditioned comfort? How pressed are you for time? If you can spare the time, then drive to the nearest Chinese supermarket or farmers’ market. But this might mean having to make multiple stops for all the things you need during the week.

And how about romantic dinners? Summer is just around the corner. Pack a chilly-bin, grab a beach-mat, get in the car and drive to a scenic spot. We are lucky to live in a country where there are plenty of these in close proximity and they are all free!

An Economics Nobel Prize for Elinor Ostrom

2009-10-27T17:20:00.000-07:00

This year the Nobel Prize in Economics went to Elinor Ostrom of Indiana University and Oliver Williamson of the University of California, Berkeley.

Williamson is a senior and respected economist whose work on transaction costs is certainly worthy of recognition. But the big news, really, is Ostrom’s award. Not only is she the first woman laureate – out of 64 Economics Nobel Prizes handed out since the award was first instituted in 1969 – but she isn’t even an economist, strictly speaking, but rather a political scientist and does not work at one of the glamorous “top ten” universities which tend to dominate the Nobel and other prizes.

This is a great choice by the Nobel Committee, very much in keeping with Alfred Nobel’s original vision for the prize. She may not be a technical mainstream economist but she is a superb social scientist and her findings are of interest and relevance for economics and other disciplines and more generally, for social policy.

What is Ostrom’s contribution? She has focussed on the fundamental problem of governing the use of shared resources such as the environment or common grazing land – a problem often referred to as the “tragedy of the commons”.

This is because these problems pose a social dilemma. Collectively we are all better off if we cooperate – do not over-graze public lands, do not over-fish in shared waters, do not pollute the atmosphere, do not throw rubbish on the streets – but the problem is that if everyone abides by these rules, then an individual who flouts the rules is better off at the expense of everyone else. And if everyone reasons along similar lines then everyone behaves in a self-interested manner resulting in a bad outcome for all concerned. These social dilemmas pose a tension between cooperation and self-interest, between maximizing the public good and acting in a self-interested manner thereby benefiting the individual at the expense of society.

The insight was summed up brilliantly by Joseph Heller in Catch 22, in the following exchange between Yossarian and Major Major Major Major.

“Suppose we let you pick your missions and fly milk runs,” Major Major said. “That way you can fly the four missions and not run any risks.”
“I don’t want to fly milk runs. I don’t want to be in the war any more.”
“Would you like to see our country lose?” Major Major asked.
“We won’t lose. We’ve got more men, more money and more material. There are ten million people in uniform who can replace me. Some people are getting killed and a lot more are making money and having fun. Let somebody else get killed.”
“But suppose everybody on our side felt that way.”
“Then I’d certainly be a damned fool to feel any other way. Wouldn’t I?”

In economics, a maintained assumption is the idea of rational self-interest; that individuals will usually act in their own self-interest as expressed in the above quote from Catch 22. Given this assumption of self-interest, economists believe that individual humans will have an exceedingly hard time in addressing social dilemmas and that successful resolution of such problems will require government intervention; ie., one needs a Hobbesian leviathan to address such dilemmas.

But Ostrom’s work- based on hundreds of case studies and numerous detailed controlled experiments - shows that the self-interest based prediction is almost always incorrect and that humans, left to themselves, are much better at tackling such problems than traditional economic theory suggests.

To take one instance, Ostrom and her colleagues at the “Workshop in Political Theory and Policy Analysis” at Indiana University have been collecting thousands of written cases about resources managed by local users of fisheries, irrigation systems and grazing lands. In Nepal, they have collected data about the rules and general management strategies used to manage over 200 irrigation systems. Some of these are managed by government agencies (agency managed irrigation systems or AMIS) while some are managed by the farmers (farmer managed irrigation systems or FMIS). They find that compared to AMIS, FMIS are able to achieve a higher agricultural yield, a more equitable distribution of water and better maintenance of the irrigation systems. There are striking differences in the way the two systems are managed. Under AMIS, infractions are recorded by government officials while under FMIS they are recorded by the farmer-monitors. Furthermore, the AMIS tend to rely more on fines for infractions than FMIS. Rules and quotas are followed 65% of the time in FMIS compared to only 35% of the time in AMIS. Thus rules and sanctions designed by the farmers themselves tend to be more effective than those imposed by government officials.

Why is this work important? Because it gives us practical answers to how we can go about addressing such problems at the local level, using decentralized mechanisms, a very similar idea to Muhammad Yunus’s approach to micro-finance using the Grameen Bank. What Ostrom provides are directions about how to address real-life problems using simple policies yielding effective results. That is surely deserving of the Nobel Prize!

Thoughts on the 2009 budget

2009-06-02T15:58:00.000-07:00

(This is a guest-blog by Dr. Stephen Poletti. Dr. Poletti is a lecturer in the Department of Economics at the University of Auckland and an executive member of the Child Poverty Action Group (CPAG). This blog is an edited version of comments made by Dr. Poletti at the Ninth Annual Budget Breakfast organized by the CPAG on May 29, 2009. The views expressed are those of Dr. Poletti and not mine; though, for the most part, I agree with the sentiments expressed in this blog.)

The background to the budget is the world financial crisis which has developed over the last year. Despite the rally in world equity markets since mid march the outlook for the next year is grim. The IMF recently downgraded their January prediction for world growth this year from plus 0.5 per-cent to minus 1.3 per cent - the worst slowdown since the great depression. They dryly note that “Recovery will take longer than normal because the slump was precipitated by a world wide financial crisis.”

The numbers are unnerving. Just to take a few recent announcements. In the last six months Japan’s GDP has fallen 8%, Singapore registered a 10% drop in GDP over the last year and German GDP fell 4% in the first three months of 2009. A recent article by respected economists Barry Eichengreen and Kevin O’Rourke looked at the trends for a number of key variables over recent months compared to the great depression. They conclude that the initial stages of the world financial crisis are at least as bad as the early days of the depression. However they go on to analyse the fiscal and monetary response of governments globally which are much more stimulatory than during the depression and conclude that “the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.”

Underlying the financial crisis has been the huge increase in income inequality in the countries at the heart of the world financial markets. Financial markets have come to dominate the real economy. Global financial assets have increased from 100% of world GDP in 1980 to 360% of world GDP in 2007. 40% of US corporate profits were from the finance sector, up from 20% to 30% in the 1990s. Coupled with this has been a dramatic rise in inequality as the top few per cent skimmed off most of the extra income generated as the economy grows. From 1993 to 2006 the top 1% in the USA captured 52% of the growth in income of the country. Between 2002 and 2006 they managed to grab a staggering 72% of the growth in GDP. The top 10% of income earners in the US now get 50% of national income up from 35% in 1982. The last time things were this extreme was just before the great depression. On the other hand the real income of the bottom 90% of society in the US actually fell between 1973 and 2006.

How could such a state of affairs persist in a democracy? Part of the answer is that those at the bottom managed to borrow to supplement their income ensuring that consumption kept growing. Much of the funds for this were imported from Asia (particularly China) which ran up big surpluses. At the peak, America absorbed about 70 per cent of the rest of the world’s surplus savings. House prices went up and up creating “ the biggest asset bubble in human history”. Household debt in the English speaking countries went up dramatically after 1980 more than doubling in many countries which fuelled the growth of the financial sector.

Finally as we know the whole pyramid scheme unravelled as people with “sub-prime” mortgages in the US started to default on their loan payments and it slowly dawned on people that house prices weren’t going to keep going up forever. As the crisis intensified bank lending almost dried up completely.

Here is a quote from the economics editor of the Financial Times in England. “The proposition that sophisticated modern finance was able to transfer risk to those best able to manage it has failed. The paradigm is, instead, that risk has been transferred to those least able to understand it.”

In summary, the present global economic crisis is likely to persist for a lengthy period of time. It is unlikely to be as severe as the great depression because governments are stimulating demand much more. At the heart of the meltdown is the fact that the financial sector started to dominate the real economy. This in turn was associated with a dramatic rise in inequality, the impact of which was ameliorated by households funding increased consumption by borrowing and a resulting housing asset bubble.

Turning now to New Zealand we see a similar story. Household debt sits at 160% of GDP (compared to 170% in the UK and 130% in the US). Real house prices have increased by a similar amount to that experienced by the US and UK. To finance this we have borrowed from the rest of the world – a sort of pyramid scheme where we borrow to service our debt payments. On a per capita basis we are one of the most indebted countries in the world. The tragedy is that the vast bulk of this debt has not been used to make the country more productive and the economy stronger and more able to service the overseas debt. Instead much of it has fuelled a housing asset bubble in the first instance which then flows on to increased consumption as housing equity is drawn down.

Inequality in New Zealand has also increased dramatically in recent years where in terms of the Gini index (a measure of inequality) our degree of inequality is on a par with the UK and only slightly better than the US. New Zealand’s degree of inequality is the 23rd worst out of the 30 OECD countries.

Over the last couple of decades we have taken advantage of the worldwide expansion of the financial sector to borrow well beyond our means year in and year out to fund consumption a circumstance that cannot continue. We have also seen dramatic increases in inequality and child poverty.

Over the last year GDP in NZ fell 1.8% and the first quarter figures are certain to be bad. In Budget 2009 Bill English does acknowledge the severity of the world economic outlook and our reliance on overseas debt to fund consumption. Having acknowledged these concerns he then does almost nothing to address them.

As expected he made no mention of inequality in this budget. No mention of child poverty. And he has no conception that the events of the last year must fundamentally change the way we manage capitalism. To quote from Martin Wolfe “Another ideological god has failed. The assumptions that ruled policy and politics over three decades suddenly look as outdated as revolutionary socialism.”

A lot of weight was put on the fact that Standard and Poor might downgrade the New Zealand government credit rating. If one was cynical one could argue that this was no accident and the government was quite happy to use this as an excuse to bear down on social spending. Already we have seen 1400 jobs lost in the public sector. It should be noted that Standard and Poor gave Enron an AAA rating weeks before it went down.

Spending on health and education continue to increase at a similar rate to that seen under Labour. It is also encouraging to see extra money ($323m over four years) to help insulate houses making them warmer and healthier. We welcome the cancellation of the tax cuts but point out that this now broken election promise was never plausible.

Overall however this is a bland budget that offers no vision and no coherent response to the economic crisis that is buffeting New Zealand. There is almost no fiscal stimulus to speak of. Instead the economy will just drift along with a bit of spending bought forward here and there balanced by cuts to government spending elsewhere.

Bill English has the approach of a shop keeper when facing hard times – trim costs and hunker down. This is exactly the response which turned the financial shock experienced in 1929 into the great depression. I would have liked to see a billion dollars invested in public transport and an electric rail system in Auckland, and also several billion dollars put into building decent state houses. We know that decent housing would make a huge difference to the health and well being of many of the poorest and most vulnerable in our society. It also makes good economic sense. It is an effective way of stimulating demand.

The government could have announced that taxes would be raised when the recovery is well underway to finance this in the longer term. It could also have followed the British and US government’s initiatives to increase the top tax rates and start to reduce the vast inequalities in our society.

The elephant in the room is housing investment. This budget does nothing to change the incentives around housing investment which has seen Kiwis borrow from overseas to fund the housing asset bubble as discussed earlier.

Unemployment is expected to rise to 7.5% next year and could go as high as 9%. That means that up to 200,000 people will be forced to rely on inadequate benefits. Many families will suffer extreme financial stress. Their children will suffer. Where in this budget is a reversal of the 1991 benefit cuts or an announcement that the in work payment would be extended to cover all children. I remind you that the Child Poverty Action Group (CPAG) estimates that over 150,000 children in New Zealand live in severe or significant hardship.

Already we are seeing extra stress in communities. Budget service managers are describing 40 to 400% increase in demand for services; Food bank demand has increased 50-60%. Family counselling demand is up 30%. And this is before the expected dramatic increase in unemployment.

We are supposed to be pleased that they have not cut WFF- but all the problems of poor children who miss out because they are not working enough or on a benefit remain. CPAG have calculated that it would take $450m to pay the IWTC part of the WFF to all those families that miss out at the bottom. This is worth $60+ per family. The Restart package acknowledges that families who lose their jobs need this payment, but the restart package is woeful—only a handful of families around 700 have qualified and they can receive the payment for only 16 weeks. CPAG estimates the government is spending 0.5% of what it should be spending.

Instead of initiatives to lift children out of poverty there was a lot of talk about building new prisons. Instead of investment in innovation and programs to increase the skills and productivity and pay of workers the main contribution the government has determined it can make to growth is to cut red tape for business. One wonders do they really believe that this is a serious response to the worst crisis we have seen since the great depression?

Price gouging by electricity companies: may be legal, but is it fair?

2009-06-02T15:37:00.000-07:00

(Posted by Ananish Chaudhuri)

(A version of this blog appeared as an op-ed article in the New Zealand Herald on June 2, 2009.)

I am somewhat bemused by the recent hue and cry about price gouging by our electricity companies. After all, the companies have done exactly what we teach students in our economics principles courses; charge high prices when demand is high, a policy commensurate with profit maximizing, which is at the core of market based economies. After all, no one is accusing these firms of doing anything illegal. In cases like this there is always the possibility of implicit collusion among the companies involved, but at this point there seems to be no evidence to support this conjecture. (The National government’s outrage in the matter appears rather disingenuous, given their decision to fire Paula Rebstock, who, by all accounts, was doing an excellent job of combating such practices during her tenure at the Commerce Commission.)

Furthermore, on the face of it, what the electricity companies were doing is no different from the pricing practices of others. Try buying tickets on Air New Zealand during the school holidays or check out the fare differences in flights at peak and off-peak times and you will know what I am talking about. No one, as far as I can make out is making similar accusations against Air New Zealand. One could argue that price gouging in electricity markets is of greater concern given that heat and electricity are necessities in life. Airline travel is more of a luxury. (Though if you live on one of two tiny islands in the middle of the South Pacific, then your transport choices are often rather limited.)

But what the outrage over electricity prices shows is that beyond profit maximization and market economics, people care deeply about fundamental fairness and companies that contravene those fairness norms do so at their own peril.

Firms that have some degree of monopoly power often exploit that power to increase profits by charging different customers different prices depending on their willingness to pay a higher price. What the seller is trying to achieve in such cases is to get from each customer the most that the latter is willing to pay for the good.

A group of American researchers including the 2002 Economics Nobel laureate Daniel Kahnemann have used extensive questionnaires to understand people’s predispositions towards a multitude of pricing strategies adopted by businesses. Here is an example that is particularly relevant in the current context: “A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.” Respondents were asked to rate this move as (1) completely fair; (2) acceptable; (3) unfair and (4) very unfair. Out of 107 respondents, 82% considered this unfair or very unfair.

Many forms of price discrimination were considered outrageous by the survey respondents. Consider the following question: “A landlord rents out a small house. When the lease is due for renewal, the landlord learns that the tenant has taken a job very close to the house and is therefore unlikely to move. The landlord raises the rent $40 per month more than he was planning to do”. Out of 157 respondents only 9% thought this was acceptable while a whopping 91% considered this unfair. On a different question, a majority of respondents thought it unfair for a popular restaurant to impose a $5 surcharge for Saturday night reservations.

The near unanimity of these responses suggests that pricing strategies that deliberately exploit the vulnerability of a particular individual is considered offensive by most. These findings illustrate the role that norms of fairness play in day to day pricing decisions and how these norms can and do serve as a constraint on unfettered profit-making.

The survey responses suggest that many actions that are both profitable in the short run and not obviously dishonest are likely to be perceived as unfair exploitations of market power. Now one might be tempted to discount some of these conclusions by arguing that these are, after all, responses to hypothetical questions. A particular respondent might say that he will not patronise a firm that is engaging in price-gouging by jacking up the price of an essential commodity in an emergency but when push comes to shove the buyer might easily give in. The problem here is that it is very hard to show that people are not buying something in protest since it is impossible to prove a negative.

But recently economists have used economic decision making experiments with relatively large amounts of money at stake, to show that indeed “demand withholding” by buyers - where the buyers essentially refuse to buy at prices considered unfair and discriminatory - can be a significant factor in market interactions. Such demand withholding is especially pronounced when the sellers are significantly better off at the expense of the buyers and especially when the buyers are made aware of this inequitable distribution of the benefits by providing them with information about the profits accruing to each party.

In the backdrop of the current recession, where households are really feeling the pinch, what the electricity companies have done may not be illegal, but by exploiting consumer vulnerability, they have contravened fundamental notions of fairness that many of us hold dear. And for that, I expect, they will pay a price. We will have to wait and see what that price is.

Fighting the recession: cutting wages or laying off workers?

2009-05-20T18:56:00.000-07:00

Posted by: Ananish Chaudhuri

(A version of this blog appeared in Section C2 of the Dominion Post on Thursday, May 21, 2009.)

Recently, the Chief Executive of Air New Zealand announced a freeze on wage increases and said his goal was "to do everything I can to minimise the risk of job losses…". Freezing wages is a way of containing costs. The implication here is that if costs keep rising and freezing wages don’t do the trick then the next – inevitable- step is to lay off workers.

A pertinent question to ask in this context is this: why not cut wages across the board rather than lay off some people? In January of this year Radio New Zealand reported that some business leaders including the Chief Executive of Business New Zealand were calling for a freeze in the minimum wage. In February, Business New Zealand, in its recommendations to the jobs summit, suggested that cutting the hourly wage rate should be considered as one of the options for preventing job losses. Even if the wage is only frozen rather than cut, as long as increases in the minimum wage do not keep pace with rising prices, then the net effect is to reduce the “real” wages of workers because with rising prices their wages are worth less than before. In fact, during recessions one often hears calls for cuts in the minimum wage, or even doing away with it completely. The argument is that the presence of the minimum wage prevents employers, faced with falling revenues, from lowering wages to get the cost-savings they need to justify maintaining their workforces. Under this view, unemployment must increase because the minimum wage blocks the needed adjustments in costs.

However the fact remains that all over the world employers tend to show a strong preference for laying off workers rather than cutting wages. So why is this? If the primary aim is to save on costs, then pay-cuts across the board for all workers might actually save more money than laying off an unfortunate few, especially given that laid off workers often get severance pay.

Based on hundreds of interviews with managers at a variety of firms in the north-eastern United States, Truman Bewley of Yale University found that the managers of most enterprises were reluctant to enact a reduction in wages even though, given the extensive unemployment, they could then pick up new workers willing to work for less. But in fact top management is extremely reluctant to enact wages cuts and the main reason they gave for this is that such cuts hurt morale and therefore reduce workers’ productivity.

OK, wage cuts hurt in the wallet, but what is the link with morale more generally? Morale has a number of different components including identifying with the firm and its objectives as well as a mood that is conducive to good work. Psychologists say that most of us engage in what is called “anchoring”, whereby our current wages become a reference point for us to measure future developments against. Furthermore, most of us are “loss averse” in that a $10 loss makes us more than twice as unhappy as a $10 gain makes us happy. Therefore, pay-cuts are psychologically painful. Workers are used to receiving regular pay increases as a reward for good work and loyalty and so interpret a pay cut as an affront and a breach of implicit reciprocity. The morale of existing employees is hurt by pay cuts because of an insult effect. This explains how a general cut in pay can indeed lead to serious losses in productivity via its detrimental effect on worker morale.

There are two other factors at work here as well. First, pay-cuts can often lead to a problem of “adverse selection” whereby a general cut in pay may lead to the most productive members of the firm leaving, resulting in a much greater than proportional fall in productivity. In this case the savings from lower wages are outweighed by the resulting loss in productivity. The second factor has to do with the concept of “efficiency wages”. In a variety of jobs monitoring workers is difficult and the cost to the firm from workers shirking is high. In such cases, firms routinely pay workers more than the minimum amount that they have to pay. This higher pay is certainly desirable but workers also understand that being fired from the job now comes with the potentially high penalty of having to settle for an alternative that pays much less. Efficiency wages have the effect of fostering loyalty on the part of the employee and therefore reducing the possibility of workers shirking or even leaving. Firms paying efficiency wages are always reluctant to cut wages even in the face of pervasive unemployment, because of its detrimental effect on worker loyalty and productivity.

General pay cuts hurt everybody and can cause lasting resentment and loss of morale. Layoffs affect morale as well but that effect seems relatively short-lived since the laid-off workers are no longer around. This implies that with jobs where workers are hard to monitor including jobs in customer service or information systems or jobs that require close cooperation among groups of workers, we would not expect to see any pronounced cuts in wages. To the extent workers use the minimum wage as an anchor, cuts in this wage may have a tremendously detrimental effect on morale and may not have any impact on job losses in any case.

Creating Optimistic Beliefs Key to Tackling Global Recession

2009-05-19T18:21:00.000-07:00

Posted by: Ananish Chaudhuri

(A version of this blog appeared as a "Viewpoint" article in the University of Auckland News on Friday, May 15, 2009.)

During this on-going economic crisis, a number of commentators have urged consumers to keep spending. Except, it’s not that simple. An individual consumer increasing spending makes no difference to the recession. What is required is for all consumers to increase consumption simultaneously. As a consumer, I might clearly understand that we can make a difference if we increase consumption, but how do I know if others will actually increase their consumption if I do so?

A wide variety of economic situations require coordinated action on the part of individuals or groups in order to achieve a successful outcome. Economists refer to these as ‘co-ordination problems’ and they arise, for instance, in any industry engaged in team production along an assembly line such as in steel mills and automobile factories.

Even if everyone works at speed, just one individual or group lagging behind is needed to slow down production significantly to the detriment of everyone else. This may not seem like a large problem, but in reality getting a large group of individuals to successfully coordinate their actions often poses a difficult challenge for many organisations.

While coordination failures at individual organisations may only be of passing interest, when they apply to the economy as a whole, all of us are affected. Economic recessions are to a large extent an outcome of wide-spread pessimism among businesses and individuals, rather than the result of inherent systemic problems. Creating appropriately optimistic beliefs is a key to addressing such crises.

One fundamental problem in deep recessions is that the economy gets caught in an under-employment trap...a situation where no firm wishes to expand production unless it can be assured that others will do the same - yet not doing so leads to an outcome that is worse for everyone concerned. The crux of the issue here is that taking a risky action makes sense if - and only if - everyone matches that action. If they don’t, then the individual or firm taking that risk is worse off and makes no difference.

Such a lack of coordination can also lead to a run on banks if depositors lose faith and rush to withdraw their money, even though everyone is better off if they keep their money where it is. Such loss of faith, which often tends to be self-fulfilling, can have devastating financial consequences.

Along with Andrew Schotter of New York University and Barry Sopher of Rutgers University, I recently used economic decision-making experiments to understand whether it was possible for groups to “talk” themselves out of such an under-employment trap. To do so we developed an innovative ‘inter-generational’ paradigm in which one group of players - after playing the game - could leave advice for their successors. This continued for a number of generations.

We found that allowing one group to pass advice to the next could indeed create the optimistic beliefs that led to coordination on the risky action, but with a twist. When the advice was private and given from one participant to his immediate successor, this advice tended to be pessimistic, suggesting following the least risky course of action.

In order for the advice to make a difference it needed to be public and common knowledge, in the sense that everyone in the group must get the same advice and must also know that everyone else has got the same advice. So if a political leader makes a public announcement heard by everyone, and everyone knows that everyone else has heard it, then a necessary condition has been met for successful coordination.

We conclude that getting a message to coordinate was not enough; each person must be convinced that others have received the same message and interpreted it in similar ways. A shared comprehension of the message is absolutely crucial to solving such coordination problems. Thus, in combating our financial crises, we really need to think of innovative actions or social processes that generate optimistic beliefs. This, in turn, suggests that economic stimuli packages might need to be accompanied by exhortative messages that clearly highlight the aims of these packages and are designed to reduce consumer pessimism.

These results appear in the January 2009 issue of the Economic Journal, which is published by the Royal Economic Society and is a leading international scholarly journal in economics.

In the context of the current crisis, an example of such a commonly perceived public announcement might be the one made by the British government early on of a plan for major equity injections into British banks, backed up by guarantees on bank debt that should get lending among banks going again. This may have gone a long way towards calming jittery financial markets.

The recent “jaw-boning” by Alan Bollard about banks passing on rate cuts to consumers and companies keeping prices down should also help. Another example of this is the recent announcement by the US Federal Reserve that not only was it cutting interest rates, but aiming to keep it at that level for the foreseeable future. In this regard, New Zealand may be well situated, given the population’s generally high trust in the government and other social institutions which makes public pronouncements more credible.

Do Three Strikes Laws deter Violent Crime?

2009-05-19T18:20:00.000-07:00

Posted by: Ananish Chaudhuri

It is not clear that National’s support for enhanced punishment of repeat offenders under a ‘three strikes and you’re out’ legislation is based on a careful sifting of the available evidence and deliberation. If the aim is to reduce violent crime, then such mandatory sentencing may not be an effective way of achieving that.

In the United States - where Washington and Wisconsin were the first states to adopt a ‘three strikes’ law in 1993 - the State that has systematically and strictly enforced the ‘three strikes’ statute is California. California has used the law broadly to cover pretty much all felonies.

California has also allowed limited judicial discretion preventing judges from circumventing the law in those cases where its application seemed uncalled for, such as for non-violent felonies. As of 2000, more than 40,000 offenders have been sentenced under the ‘three strikes’ legislation in California. No other State has even reached 1000.

Armed with those statistics, you have to ask...does the law work in preventing violent felonies? Surprisingly, there is very little evidence to answer this in the affirmative. A 1994 study commissioned by the Rand Corporation found huge costs and limited deterence from this law change requiring mandatory sentencing for a third offence.

In an article published in the Stanford Law and Policy Review in 1999, Mike Males and Dan Macallair compared California counties with ‘strict’ versus ‘lax’ enforcement of the law, and concluded that counties that strictly enforced the enhanced sentencing guidelines saw negligible effects on crime rates.

Thomas Marvell and Carlisle Moody’s 2000 article, published in the Journal of Legal Studies - a leading scholarly journal - undertook a cross-state analysis and found that ‘three strikes’ laws have little effect on overall crime rates. Moreover, a recent study by Radha Iyenger of Harvard University suggested that ‘three strikes’ laws may have a wholly unintended consequence of increasing the incidence of violent crime.

Using data from California, Iyenger reported both good and bad news. She found that ‘three strikes’ legislation reduced participation in criminal activity by 20 percent for second-strike eligible offenders and by almost a third for third-strike eligible offenders. But, because the California law is non-discriminatory in that a wide variety of felonies will attract the ‘three strikes’ penalty, Iyenger found that criminals were much more prone to committing more violent crimes as their third-strike offence.

The rationale is not difficult to understand. If you do participate in a third-strike eligible criminal act, then it no longer matters much whether you commit a violent felony or a non-violent felony, because in either case you would be looking at a mandatory 25 years-to-life sentence. There is no strong incentive to avoid violence in the course of committing a third offense.

California’s Proposition 184, which brought the ‘three strikes’ law into existence, was approved by more than 70% of the State’s voters. Yet, in 2004, opponents of the law put a measure on the ballot – Proposition 66 – that would have required the triggering third offense to be a serious or violent crime. This proposition was defeated narrowly by a 53% to 47% margin, demonstrating widespread dissatisfaction with the way the law is applied.

Following the defeat of Proposition 66, the District Attorney of Los Angeles County has now taken up a drive to soften the law, an effort that is supported by the Sheriff of Los Angeles County and the police chief of Los Angeles.

Under the proposed revision, a criminal would typically be subject to the mandatory ‘three strikes’ law only if the third strike is for violent or serious felony, although in some cases the mandatory sentence may apply for a minor felony such as drug possession or petty theft only if that particular criminal has already been convicted of a serious felony in the past.

But in many cases, where the third offense is a relatively minor felony, this will not attract the mandatory sentence under the ‘three strikes’ law. This revision then will also reinstate a measure of judicial discretion that was missing from Proposition 184.

It is obvious that California, the one State that has applied the ‘three strikes’ law most systematically, is now questioning its effectiveness. Under the circumstances, one would hope that the National Party would engage in much greater consultation before implementing such a drastic change in current sentencing guidelines, especially in light of the fact that New Zealand already has relatively high rates of incarceration per capita.

There must be other more innovative ways of dealing with recidivist offenders than borrowing a policy from the United States which does not seem to have worked in the first place. Is there any particular reason to believe that it will work any better here in New Zealand?