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Wednesday, 2 December 2009

Inequality is bad news for everyone

S'pore could be a test bed to temper rat-race impulse to keep up with others
By Tan Hui Yee, Correspondent

WE MIGHT know it as the rat race; academia call it the 'expenditure cascade', but it amounts to the same treadmill.

In short: When the rich get richer, but the poor stay poor, life becomes tougher for everyone else.

Not that the rich intend that outcome but the bigger homes, flashier cars and nicer clothes they buy make everyone else raise his expectations. Soon, the less well off spend more too, but it's a struggle to keep up because their income hasn't grown as much.

Professor Robert Frank applied the term expenditure cascade to this unfortunate product of rising inequality, a phenomenon that could just as well apply here as it does in his native United States.

And while public policies to temper expenditure cascade seem a political impossibility in the US, Prof Frank believes Singapore could make an ideal test bed.

The Cornell University economist, who was in town two weeks ago to lecture at the Civil Service College, told The Straits Times: 'Even if envy and jealousy were non-existent, there would still be perceptions of quality that depend on context. And so everybody would have a tendency to spend more when others spend more.

'When everybody spends more on high quality things, the things that used to seem high quality don't seem so any more.'

The award-winning 64-year-old academic says the effects of the expenditure cascade wouldn't be that bad if it merely centred on items that were not crucial to survival.

'The main problem is if you don't match the spending of others like you, then sometimes that makes you less able to achieve basic goals.'

Take the case of the suit you wear to a job interview. If everyone spends more money on a suit to make a good impression, bucking the trend could mean losing your stab at the job, he says.

Or a home near a good school. Since the number of homes near popular schools is generally limited, parents bid up the prices of such homes to give their kids the head start in life.

'If you don't spend as much as people like you on housing, then your kids will go to below-average schools,' says Prof Frank.

'Most parents spend more even though they don't have more, which means they would have to borrow more, save less and work harder.'

When everybody spends more, they all pay a higher price only to end up in the same positions in the social hierarchy as they were before. End result: Society 'wastes' a lot of money.

After all, some things in life are what economists call 'positional goods' - their value lies more in how they are ranked in relation to their peers.

Military hardware is one example - a country's security is not guaranteed by the number of bombs it has, but by having a greater number of bombs than its neighbours.

Ironically, the educator also thinks that education itself can be a positional good.

'A good education just means a better education than what others have,' says Prof Frank.

The question, he says, is whether the skills learnt are essential to one's job.

'If the answer is yes, then the money is not wasted. But if the best jobs go to the people with the most education, but the education isn't necessary to do the job, when you double the amount of money spent on education, the same jobs will go to the same people at the same salaries.'

Since it is human nature to want to get ahead, Prof Frank is under no illusion about curbing that instinct. Rather, he advocates a progressive consumption tax to reduce wasteful spending.

Instead of taxing people's incomes, governments should tax incomes left over after subtracting savings. Since the biggest spenders are taxed more, the rich have the greatest incentive to cut expenditure, which in turn reduces pressure on those less well off.

The resulting tax extracted could then be put to more productive uses - 'hiring teachers, or doctors, or fix the roads or build a new subway line' - all items that increase the welfare of all citizens.

He thinks the idea has dim prospects in his home country, given how it is 'politically paralysed' by Republicans blocking attempts at social reform.

Singapore is a different story.

'Singapore has been a leader in innovative policy change. It was among the first place to tax congestion... if there is any new idea with merit, it would have a better chance to be implemented here than anywhere else.'

He feels rising inequality should be a concern not just because of the spending pressure it puts on us all, but because of the way it affects our sense of well being.

Officials here are quick to point out that absolute incomes have risen for the majority over the years even though the incomes of top-tier earners are pulling away from the rest of the population.

Prof Frank sees absolute and relative incomes as being relevant in this area: 'Both frames of reference are important. When people ask 'how am I doing?', they have two frames of reference - 'how am I doing compared with before', and 'how am I doing compared to other people like me.''

Whether one's progress in one area can be used to justify a deficiency in the other depends on the extent of either.

Studies elsewhere have drawn the link between people's relative income levels and levels of happiness. Generally, richer people are happier than poor ones. Yet, when everybody's incomes rise at the same rate, average levels of happiness stay fairly constant.

It does suggest that average levels of happiness can never be raised.

'I think it's possible,' he says without hesitation. 'Making the income distribution a little tighter takes some of the net pain out of inequality. You can't change the fact that half of the population is in the bottom half, but the pain they suffer can be lessened if they are below average by a smaller amount.'

In other words, people will generally be happier if the disparity between the rich and poor was not so glaring. What about the argument that a more equal society would reduce the motivation for people to work hard?

'There doesn't have to be great inequality for people to want to work hard... In countries that have low inequality, gross domestic product (GDP) grows faster on the average,' he says.

'In the United States, GDP grew faster in the three decades after World War II than in the three decades that followed those, even though inequality was lower in the first three decades.'

In any case, free markets don't always give the best results.

Before 1991, elite American universities agreed among themselves not to compete for the best students through merit-based scholarships in order to channel their money to truly needy students. But the US Justice Department charged them with violating anti-trust legislation, prompting them to end such cooperation.

What ensued was a free for all as universities tried to match each other's scholarship offers to attract the highest-scoring students, which drained funds available for financial aid.

Prof Frank himself has seen this competition first hand. One of his four sons, Chris, was offered a generous scholarship of more than US$50,000 a year to study at New York University in 2005.

Chris, knowing his father's position on this issue, didn't know what to do. He asked his father for advice.

'He's a very good student. And I could afford to pay for his college. He was going to get to go whether he got a scholarship or not,' says Prof Frank.

'I said, 'What do you think is going to happen if you tell them you don't want the scholarship?'

'He paused and said, 'Well, they're just going to give it to the next kid on the list.'

'I said, 'Yeah, that's about right. So what should you do?'

'He said, 'I should accept the scholarship, and then if I am successful, I should make a big donation to NYU someday.''

There's a tinge of pride in his voice as Prof Frank relates how his son struggled with the unfairness of the whole situation but just as quickly, he adds: 'But it's still a problem... It's grossly unfair that some poor family wouldn't get that.'

The moral of the story, he says, 'is more competition isn't always better'.

It's like being spectators in a ball game. 'If everybody stands to see better, then nobody sees better than if they were to remain seated.'

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