Month: September 2022

Trickledown economics is back with a vengeance this week, as Kwasi Kwarteng, the new Etonian and Harvard educated Chancellor, announced his so called “mini” budget today. The labor front-bench derided his bonfire of tax cuts as a return to trickledown, quoting President Biden, who tweeted earlier this week:

Kwarteng’s response in the commons: “For too long in this country, we have indulged in a fight over redistribution. Now, we need to focus on growth”. Nobody in economic policy is against growth. However, achieving growth by cutting the top rate of income tax and scrapping the cap on bankers bonuses – now that is a lot more contentious. 

Trickledown, at its core, is entirely based on the idea of incentives. In the new governments view, taxes reduce incentives for wealth creation because they reduce the amount of money available in the pockets of people who are the most innovative, hard working, and industrious. By lowering the burden of tax on these people, the hope is that they will spur new spending, investment, and generally start working harder and better. As a consequence, the riding tide will lift all boats and we will all be better off through more and better paid jobs.  In fact, Truss and her allies will hope that the tide will rise so much that these tax cuts will pay for themselves through growth.  

In theory, it’s not entirely implausible that by removing burdensome taxes the economy can be kickstarted. However, trickledown isn’t really about tax reform, or reducing taxes where they are most harmful to growth. It’s a pure and simple handout to the already extremely wealthy and rich members of societies with the blind hope it will somehow benefit the rest. Kwasi may loath policy makers focus on redistribution, but he’s certainly not afraid to redistribute to the very top of society. 

Trickledown is not a new idea, but fortunately that means it’s been tried before, and people have analysed whether it works. So what does the evidence say? An IMF paper published in 2015 found that increasing the top 20%’s share of income was actually bad for growth in the medium term. This is driven by the fact that, among other things, a widening gap between the rich and poor creates political instability, lowers investment in education, and increases the probability of financial crisis. 

In another paper, published by the LSE International Inequalities Institute in December 2020, researchers find that tax cuts on the rich have no effect on economic growth.  Their main finding is that, overall cutting taxes on the rich has no effect on growth and only leads to more inequality.

Overall, our analysis finds strong evidence that cutting taxes on the rich increases income inequality but has no effect on growth or unemployment. 

The Economic Consequences of Major Tax Cuts for the Rich, LSE 2020

In another paper, Picketty and co authors run a series of models and also find no connection between the rate of tax on top earners and the growth of GDP. A really revealing graph from that paper is shown below. This is for the United States but the story is very similar for the UK.

It shows you how from 1950 to around 1970 the real incomes of the worst off in society grew exponentially quickly. This is the what economic historians call the “golden age of growth”. By many accounts, this was the largest sustained increase in living standard in history. What is telling is the red-line. During this period of miraculous growth the top marginal tax rate (i.e the tax rate paid on an additional dollar earned by the highest incomes) never fell below roughly 70%. Today it was announced that the 45% rate on earnings over £150,000 will be scrapped and the highest rate will be now 40% for incomes over £50,000.  It appears the he chancellor, who by the way hold a PhD in Economic History from Cambridge, will do well to actually study the history of growth. During the time where the economy grew the fastest the top rate of tax was way above what it is today. 

The government is taking a huge gamble on a policy that is proven to not work. The only affect this will have is to drive up inequality and increase division in an already divided society. The fate of the UK economy appears to be on a knife edge, or as Kwarteng call it today, a “new era”. But nothing  has changed, the Conservatives have slipped their mask and revealed their fundamental support for the wealthy and privileged few. All of this under the pretence of an intellectually flawed and empirically unsupported fantasy. The next few months will be interesting. 

 

 

I’ve recently been interested in the role of culture in the process of economic development. Within the growth literature this is a topic which finds less support than other more conventional explanations for the global differences in development, such as geography or institutions. In part, this is due to the difficulty in defining culture – let alone attempting to measure it statistically. However, recent research points to culture being an important factor in long-run and current income disparities, both between and within nations.

What exactly is culture? Huntington (2000) describes it as follows:

Clearly, the values and beliefs of a society are likely to shape its political and economic intuitions, as well as affect the incentives and behaviours of workers and businesses. Hence, culture has been claimed to be an important, if not major factor in explaining differences in income across countries. For instance, take Italy, and the widely known Putnam theory. Italy is a relatively small, homogeneously populated, and well connected country which has been politically unified since 1861. However, any visitor to Italy will notice significant differences in the level prosperity between the North and the South of the country. Why is there such a difference? Putnam argues this about culture – or more technically what he terms “social capital”. Broadly, this captures the degree of trust between citizens. Societies with high social capital cooperate better, are honest and value norms of reciprocity and fairness more. In contrast, low social capital societies work together less, distrust others outside their close connections, and tend to display less self-agency over their lives.  This can manifest itself in rent-seeking, corruption, and low investment – all of which can blight development. 

But where does social capital come from? Moreover, if trust, openness, and self-agency are growth enhancing norms – how do they manifest? And can, or should, public policy play a role in influencing them? Recent research has attempted to answer some of these questions. 

A key piece of research in this area is a paper by Tabellini (2010). In this paper Tabellini argues that historical institutions influence contemporary culture, which then affects economic development. Survey data allows Tabellini to codify cultural straights identified as being supportive to growth; trust, respect, and control. These capture an individuals perception of how much they can trust others, how important teaching respect for others is when raising children, and also to what degree they feel like they have control and influence over their own lives. 

Tabellini finds that each of these variables are highly correlated with historical political institutions and literacy rates. For example, people living in a region of Europe, which in 1800 was highly literate and governed by strong political institutions (meaning the ruler was constrained by checks and balances on his or her power), are likely to have higher trust in others today. Higher social capital is then found to lead to higher output per capita, independent of the historical institutions and literacy rates, and after controlling for all other variables likely to influence output today. Thus, it appears culture does matter for development. 

But, how are these “good” norms and beliefs formed? And how are they passed down? In a paper published last month, the role of kinship institutions is argued as being key to understanding this process. The core idea of the paper is summarised in the figure below. It shows a clear negative relationship between the prevalence of marriage between 2nd cousins (or closer) and the level of GDP per capita. The negative slope appears to show that countries with tight kinship cultures tend to be poorer. 

In the detail of the paper, the authors construct an indicator of kinship intensity (KII) for each region, which measures the prevalence of norms related to cousin marriage, polygamy, co-residence of extended families, lineage organisation, and community organisation. They find a higher KII to be associated with a lower level of economic development. One of the channels they explore is how the KII impacts trust. They find that tight kins display much lower trust to outside members compared to inside members. 

Thus, a story is beginning to emerge: deep-rooted kinship institutions passed down through the generations shape the beliefs, attitudes, and underlying assumptions of the population, which in turn either leads to a positive build up of social capital and sustained economic growth, or incubates norms and ideas that inhibit growth. This is only one story; there are infinitely many more. 

However, how does policy fit into this? Is it ethical to even discuss attempting to dismantle certain cultural practises, let only implement policies to do so? 

Firstly, it remains an open question as to whether culture, in the sense we have been discussing here, can be influenced by policy. However, a recent paper by Natalia Bou studies the cultural practises of matrilocality and patrilocality (whether male or female children live with the parents are marriage). Bou focuses on specific policy changes in Indonesia and Ghana, which introduced pension systems in 1977 and 1922, respectively. In theory, the practise of having a child live with the parent after marriage is a form pension security for the parents, since live-in children will be expected to provide support and care for the parents. However, the introduction of a pension system has the possibility of weakening the need for this informal system, therefore the policy has the potential to change cultural norms. Bou finds this is indeed the case: males from traditionally patrilocal ethnic groups exposed to the pension policy are less likely to practise patrilocality in the future. Thus, there appears to be some evidence of policy being able to influence cultural norms, but is this an over-reach by policy makers? 

The very idea of a discussion around culture may offend some. The notion of comparing one culture to another, and therefore inevitably drawing a distinction between a “better” or “worse” culture, is not one I wish to do. Nor is the idea of a world dominated by a single culture (whether it be predisposed to generate wealth or not) a welcome thought. The beauty of the world is largely derived from its diversity and uniqueness. However, on the basis of growing evidence, cultural norms and beliefs do tend to matter for prosperity. Therefore, by caring about the prosperity and opportunities of others, we must also try to understand what factors hold them back – even when that requires examining culture. 

Life is better than death. Health is better than sickness. Liberty is better than slavery. Prosperity is better than poverty. Education is better than ignorance. Justice is better than injustice.

Executive Board of the American Anthropological Associations, 1947

Hence, I argue that the American Anthropological Associations alternative assertion to the U.N. Declaration of Human Rights, which they refused to endorse on the grounds of being an ethnocentric document, is a great benchmark to start an examination.  Almost all would agree that any aspiring culture would not resist change and progress along those lines. Accordingly, it’s important for economists, anthropologists, and policy makers to continue studying the role of culture in economic development.