Nova workboard

a blog from young economists at Nova SBE


HOW TO VALUE LIFE ?

Reading the posts on the topic “How to value life”, a topic that I find particularly challenging, I find several confused and confusing economic reasoning and statements on the subject.  The main areas of confused arguments are related, firstly, to the concept of economic valuation, and secondly, to the meaning of the value of a statistical life (VSL).

Contrary to what is said or implicit in most blog posts neither human actions nor economic value theory contradict the fact that” life is priceless”.

Life/death human choice decisions are neither common nor usual economic decision. Fortunately, suicide (even in the form of euthanasia) and kidnaping are rare phenomenon and, apart from abortion laws, protection of life crimes is enforced by law in most modern states.

Anyway, using economic theory to value life in monetary terms is a possible (although awkward) exercise. The correct concept to measure the opportunity cost of life is our “WTA being killed” (i.e. the compensation variation, because “alive” is the status quo). If this value was to be estimated on average for a particular population it will most probably be a very high value, probably ∞, “priceless”, due to the fact that it is not income restricted.

More common human choices are those related with living in a higher or lower life risk environment. Here, in fact, human (in some cases economic) choices reveal positive WTP (WTA) to decrease (increase) life risk environment and those revealed values can be used to evaluate public policies. The Value of a Statistical Life is based on these revealed choices but we need to correctly understand the limits of this useful tool.

First, what VSL is not! It is not the economic value of a particular life. It is not even the economic value of a statistical life.

So, what is VSL?

It is a convention that provides a low cost although highly imperfect proxi to the monetary  value of a statistical life. It can be used to value the impact of public spending on life risk changes.

The math formula is: VSL= MWTP or MWTA (estimated for a particular revealed or stated change in risk ) divided by that particular risk change.

Therefore, VSL is what a large number of similar people would together pay to eliminate the risk that is expected to kill one of them randomly in a given period (Stavins, 2005).

Note that there is no need to use VSL to evaluate public policies. Instead,  we could estimate the marginal valuations of  risk reduction for each particular project, and use directly those estimated values. However, this is an expensive solution that in most studies would not be justifiable.

Note also that, VSL is not even in technical terms the economic value of a statistical life, because MWTP or MWTA ( the numerator) are not constant :

a) over different risk base lines (ex: 1/500,000 or 1/ 2,000,000)

b) nor over different incremental risk changes 1/500,000 or 3/500,000

c) nor equal between an increase or a decrease in life risk. Life risk changes are likely to have very different WTP and WTA ( Haneman (1991)).

In this case, as in all economic valuation, individual WTP (WTA) depends on the particular marginal choice under analysis, information of present and future consequences, preferences, status quo income distribution and risk environment…. Consequently, as humans live in different economic conditions, cultures and environments their average WTP (WTA) will be different, implying different VSL.  In this context, economic theory is a very usefull tool to rationalize public spending choices but nothing else, because even if correctly understood and applied many ethical problems persist and society has to deal with them. 

Clara Costa Duarte

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Will granny understand you?

One of the benefits of an academic education is the common language that is developed. A common language eases the exchange of ideas and decreases the information losses across different people. There are clear benefits in having a similar conceptual framework. Each time someone says “opportunity cost” or “decreasing marginal returns” everyone that has studied economics understands roughly the same thing. Having everyone standing on a similar ground allows a more seamless thesis/anti-thesis interplay. But, as every economist would say, there is no such thing as free lunch, i.e., there is always a cost associated with a benefit. One of the costs of having a common language is excluding those who do not share it. In general, we forget how to communicate with non-economists.
Our working relations are not restricted to other economists. Many times we have to cooperate with people with different backgrounds. It is very likely that we meet people that have never heard of models and don’t know what elasticity means. It is also possible, although hopefully less likely, that even a figure in percentage terms is not well understood. The people we communicate with may have an idea of what we are talking about, but they will certainly interpret what we say differently from what we mean.
What should we do to increase the effectiveness of our communication?
Firstly, avoid all economics jargon. If the public will, in all likelihood, not understand the concept of “marginal cost”, then it is best not to use it at all. We should try not to lose the audience in the easy things. How about using “the cost of producing the next unit”?
Secondly, remember that there is an optimal point of conciseness that depends on the public. Unlike academia, most concepts are not ex-ante defined. Therefore it is good to give the public time to get used to them. In academia, the more information you can fit into a paragraph, the better. For other types of public, explaining the same concept more than once may be a good idea. We can use 3 different and complementary explanations to help the public reach the central point. When we mean “marginal cost” we could use “the cost of producing the next unit”, and we could complement it with “the additional effort the producer will have to exert” or even “what the producer will have to forego in order to have a slight increase in output”.
Thirdly, use what you are trained for: examples. Our academic training is based in models which, in the end of the day, are stylized examples of reality. If we are at ease with examples, we should use them. The best is to use daily life examples. Try to use easy numbers and real life currencies. Make the public comfortable. Don’t say “the marginal cost is increasing” try “when you are producing 50 chairs producing one more costs you €5, whereas when you are producing 100 chairs producing one more costs you €10” instead. In this line, we can also use diagrams to illustrate our points. Just be aware that most people understand a bar diagram or a pie chart if they have clear legends, but no one will understand functions, even if they seem straightforward. The following figure could illustrate an increasing marginal cost.
Grafico
Finally, note that many times we use economic jargon defensively. When we are not at ease with a certain point we start using difficult words so that the audience thinks we are really smart. Avoid this at all cost. How? There is a unique solution for all of us: know better and study harder. A good benchmark we should always keep in mind: would my granny understand this explanation?

Nuno Alvim, RBB economics
(Nova SBE Alumnus)


Trends in income inequality over the last decades

In this blog I would like to explain the trends in income inequality over the last decades. Before we start analyzing what happened in the last decade we need to understand how to measure or which coefficient describes income inequality. There are many different methods to measure, but I am going to use the most common Gini coefficient. The well known coefficient, named after and developed by Italian statistician and sociologist Corrado Gini, deserves at least a short definition to make it clear to all of readers of this blog. The coefficient measures the distribution of income and shows us the inequality of disposal incomes. The coefficient ranges from 0 to 1. The value 0 refers to a perfect equality, what means that everybody gets the same share of income and 1 refers to an opposite, when all income goes to the population or person with the highest income.

Gini coefficient of income inequality, mid 1980s and late 2000s

The graph reflects the ongoing increase of income inequality in most of the countries till the beginning of financial crisis. Why did that happen? To be accurate, the real disposal incomes increased by 1,7 % a year in average, but the increase was higher in the richer population than the poorer, so the inequality is higher. There are different factors that influence income inequality such as economic development, demographic (e.g. aging), political, cultural and environmental, then macroeconomic factors. As from public economic point of view I will go further and look at why income taxes and benefit systems become less effective in redistribution of income. The less effectiveness is clearly visible in the growth of Gini coefficient in the Nordic countries where the redistribution of income is really high. Now, let us go through three instruments which are crucial for cash redistribution. The redistributions were led mainly by benefits which over time lost their progressivity. The increased benefits, which started to support more out-of-work population caused that more unemployed people chose to use the benefits instead of working which rose the gap between the richest and the poorest population and increased income inequality.  The next instrument is social contribution which has minor effect on income inequality. The last instrument is the income tax. Its redistribution was cancelled by using two opposite effects, lower income taxes and more progressive taxation. To sum up, the income inequality will probably increase more as the redistribution instruments are less effective and it is expected that the income of richer people will rise faster than the poorer ones.

Tomas Csorgo

Bibliography

Kaasa, A. (n.d.). Factors of inequality and their influence mechanisms:a theoretical overview. Retrieved from http://www.mtk.ut.ee/orb…/febawb40.pdf

OECD. (n.d.). An overview of growing income inequalities in OECD countries: Main findings. Retrieved from http://www.oecd.org/els/soc/49499779.pdf

 

 

 


How the right policies can turn into Government failures

In Public Economics literature the Government is said to intervene to ensure that markets exist and function properly. It defines property rights and regulates trade, by having the monopoly of legal enforcement, and it remedies market failures such as externalities, imperfect competition and the inability for markets to provide public goods. In addition, not only is the Government concerned with market efficiency, meaning the best allocation possible to scarce resources, but also with the distribution of the economy’s aggregate output among the various economic agents. Therefore, it acts as a redistributive agent to guarantee what it believes to be a fair distribution of benefits in order to enhance social welfare.

Its main sources of spending rely on health, education and social protection. Regarding the last topic, most of the Portuguese welfare programs suffered several reforms for the past years, and are currently under close supervision of the Troika given their importance for the necessary budget consolidation and the impact over macroeconomic variables, namely through labour market decisions.

Given its wide sphere of action, it is relevant to ask how the State has been performing in tackling the issues of its concern and achieving its multiple goals. At this point evaluation of public policies is necessary and desirable. However, this may reveal to be a difficult task since in complex and dynamic open economies as ours, a lot of variables act to influence others and policy effects may get blurred. Actually, even the “right” policies can have unexpected, counterintuitive or “wrong” consequences due to the complexity of the economic system.

One can identify a set of aspects able to influence policy effectiveness, namely: economic cycles, political cycles (actually the political partisan theory is a possible explanation for cyclical fluctuations of the economy), time-inconsistency and goal-inconsistency of different policies, and the quality of institutions.

The first relates to the importance of the timing of applying expansionary or contractionary measures, while the second to the alternation of parties in power. The latter makes long-term structural policies difficult to implement since each party has different perspectives for what the future should look like and alter the working framework as soon as they are elected. This can raise the issue of time-inconsistent policies as the preferences of decision-makers are likely to change over time (for instance each time we change Government) and get misaligned, thus skewing a certain policy results. Additionally, several policies aimed at addressing different issues (say different sides of a trade-off) can be condemned to fail if they cancel the effects of one another – the goal-inconsistency problem.

The last referred aspect is the quality of public and political institutions. It has been subject of research as an explanatory variable for entrepreneurship and economic growth, and, more recently, for public policy effectiveness. Rothstein and Teorell define the quality of a Government as “the impartiality of institutions that exercise government authority”. According to their view a Government is impartial and has good institutions if it serves all equally, free of personal considerations or certain groups’ pressure.

Scartascini, Stein, and Tommasi, come to add that Government capabilities also affect the effectiveness of public spending. The authors confirm that institutional environment matters and policies will be effective if there is a credible commitment to them, to sustain them and to adapt them over time. The Government must be indeed capable of “setting and maintaining priorities, targeting resources, innovating when old policies have failed, coordinating conflicting objectives, ensuring effective implementation, and ensuring policy stability so that policies have time to work”.

Following was said so far, the possibility for Governments to fail in correcting market failures and increasing welfare, can resume to: limited information, limited control over agents’ responses, limited control over bureaucracy and limitations imposed by political processes (Stiglitz 2000).

To conclude, and concerning the first and second points focused by Stiglitz, I would like to highlight the uncertainty regarding economic agents’ perceptions and the difficulty in predicting dynamic effects. The most partial equilibrium models used in policy analysis can detect problems and help design the solution, but they may not be enough to determine the true impact of a policy. As Hayek perpetuated, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

 

Sofia Oliveira

 

References:

  • Rothstein, B. and Teorell, J., (2008) What Is Quality of Government? A Theory of Impartial Government Institutions. Governance: An International Journal of Policy, Administration, and Institutions, Vol. 21, No. 2, pp. 165–190.
  • Scartascini, C.,Stein, E., and Tommasi, M,.(2008) Political Institutions, State Capabilities and Public Policy: International Evidence. Inter-American Development Bank, Working Paper #661
  • Stiglitz, J., (2000) Economics of the Public Sector. 3rd Edition, W.W. Norton & Company, Inc.


Somalia is a condition, not a country, or?

For the past four years, 15 states took turns to hold the top spots on the index of the world’s most failed states. Somalia has topped the index all four years.

 

Somalia, with its lawlessness, internal refugee flows, Islamist militias and pirates, tops enough once the index with 114.9 of 120 possible points.

 

Violence and lawlessness has characterized Somalia since President Siad Barre was overthrown in 1991. The country is currently without a functioning government, police force or a national judiciary. Population is dependent on clan systems, and more or less official Islamic legal systems for protection. All transitional government formed since 2000 has been weak and have only controlled a small part of the country. Puntland region in recent years has had major challenges related to piracy and Somali pirates have become a major threat to international shipping in the area. Most of southern and central Somalia is controlled by Islamist groups and is characterized by conflicts. In 2010, as much as one of six Somalis is one the run. The drought that hit Somalia in 2010 – 2011, in combination with conflicts led to starvation in many parts of the country.

 

Somalia’s economy is largely influenced by the political situation in the country and to the lack of a functioning infrastructure. Agriculture in the form of livestock provides employment for the majority of the population. Export earnings also comes primarily from livestock production. Lately has the revenues from livestock production declined because many Gulf states have banned imports of Somali livestock. The reason is that they fear that the livestock are infected with Rift Valley fever, which can be transmitted from animals to humans. The Somali economy is highly dependent on transfers from Somalis living abroad. Annual transfers Somalis emigrated circa $ 12 billion to relatives in their home country. Despite the lack of a central authority, the service sector has grown, and there are private initiatives in communications and infrastructure. Nevertheless, a substantial improvement of the economic situation and access to development assistance currently difficult because of the internal conflict in the country.

 

Somalia has taken an important step toward political stability and peace in the election of Sheikh Hassan Mohamud to the country’s new president. For the first time in over two decades, a Somali presidential election took place inside Somalia. The Somali leaders have now completed the difficult transition period, the country has been through in a way that demands respect. I hope this means the beginning of a new era for Somalia, and appeals to all parties in Somalia to cooperate across former divides.

 

Already in January 2013 did President Mohamud discussed bilateral cooperation with Hillary Clinton. With the new constitution and the new parliament is established institutions that can provide the basis for creating a society with more democracy, freedom and justice.

Ole Andreas Lågøen #1236

Sources:

http://www.foreignpolicy.com/failed_states_index_2012_interactive


Size and possibilities of the Public sector.

By Ulf Bjerre 21009

The size of the public sector varies greatly around the world, and so do the responsibilities of it.

What in some countries are considered a necessity of supply of public goods may in other countries be considered as an act of interference of the private sphere. In many western countries the size of the public sector is a political decision. 

But the size of the public sector is not only determined by mere politics, there are also constraints on the possibilities of public intervention between countries.

 

Measuring the size of the public sector can be done in several ways, but one way to look at it is in terms of total tax revenues as percentage of GDP. With this measurement unit one finds that Denmark was the highest ranked country in the world in 2010[1], closely followed by the other Scandinavian countries.

 

Coming from a small Scandinavian country as Denmark one is used to a big and very paternalistic public sector. Even though the last years of economic crisis have put its pressure on the size of the public sector, and that most politicians now talk of zero-growth in the public sector, the size and responsibilities are still some of the highest in the world. With one of the highest tax pressures in the list of public supplied goods in Denmark is long and this had led to the term “The universal welfare model”, which is very typical for the Scandinavian countries. The Scandinavian welfare model is based on the idea of community, shared responsibility and equal rights to health, education and culture[2].

Even though most people would probably agree on these relations, the means of achieving them vary a lot from country to country. 

One thing however, that is common for all countries independent of political conviction is the thought that a public sector is necessary. The public sets conditions for the market, such as property rights, and remedies market failures such as externalities.

 

Besides having some of the world’s biggest public sectors, the Scandinavian countries are also among the wealthiest. Not that there necessarily has to be a correlation between the two, but many aspects of controlling the public sector becomes easier.

 

One example of a country placed in the other end of the lists, both concerning public sector size and wealth is the West African country Burkina Faso. My personal impression is that there is a desire for a bigger public sector amongst the population, but paying taxes and thereby contributing to the public sector is often close to impossible. In Burkina Faso the personal income tax rate varies from 2%-30%, and the top corporate tax rate is 30 %. Other taxes include a value-added tax (VAT) and a tax on insurance contracts. In the most recent year, overall tax revenue, as a percentage of GDP was 11.5 %.

 

There is per say, nothing extraordinary to these numbers, but in a country where up to 85%[3] of the employed are working in the informal sector, collecting income taxes is not just a problem, it is impossible. Furthermore paying taxes for some families is not an option, as the income is not sufficient to feed the households. When income taxes are not a realistic and sufficient opportunity for collecting taxes to run the public sector, VAT taxes is an obvious opportunity. However Burkina Faso has temporarily suspended the VAT on foodstuffs, but there are consumption taxes on specified items, such as petroleum products and tobacco and local taxes on motor vehicles.

 

In countries such as Burkina Faso public sector of the size and range like the Scandinavians is not a possibility, no matter the political desires.

 

The growth of the public sector in the western countries happened at the same time as the period of high economic growth in the period after the Second World War. Therefor it is obvious to believe that a development of the public sector is closely related to the development of the respective country.