Social attitudes and re-distributive policies

The Journal of Socio-Economics 37 (2008) 1597–1623

Social attitudes and re-distributive policies Amos Witztum ∗ Department of Economics, London Metropolitan University, 84 Moorgate, London EC2M 6SQ, UK Received 4 July 2006; received in revised form 22 May 2007; accepted 19 June 2007

Abstract The aim of this paper is to examine how the presence of social attitudes (our views of the others as a collective) may influence the effectiveness of re-distributive policies. The analysis will be focused on individuals’ attitudes towards income which is directly connected to their own effort, and income which is derived from other people’s effort. It will be shown that traditional views about the inefficiencies of some forms of taxation and welfare provisions are not universally true, and that the distribution of social attitudes plays an important role in determining the efficiency of public policy. © 2007 Elsevier Inc. All rights reserved. JEL classification: A12; A13; D10; D11; D60; H20; H21 Keywords: Social attitudes; Re-distributive policies; Efficiency; Rationality

1. Introduction The purpose of this paper is to inquire further into the reasons why the effectiveness of redistributive policies seems to depend so much on the means by which they are administered. The difference in the response of agents to changes in what is perceived to be their ‘earned’ and ’unearned’ income is the foundation of the traditional view according to which there are disincentives at both ends of the re-distribution cycle. On the one hand we have disincentives specifically created by effort related taxes (non-lump-sum taxes). On the other hand, recipients of welfare payments would lack the incentives to improve their position because of the lump-sum nature of the transfer.1 ∗

Tel.: +44 20 7320 1593. E-mail address: [email protected]. 1 Snower (1997) and Phelps (1997), for instance, make the point that it is better to substitute welfare entitlement with subsidy for work in order to reduce the disincentive effects of welfare payments. While Nickell and Bell (1997) suggest a subsidy for unskilled workers in order to induce demand, they too concede that such a policy may end-up costly if we bear in mind the inefficiency of raising taxes. 1053-5357/$ – see front matter © 2007 Elsevier Inc. All rights reserved. doi:10.1016/j.socec.2007.06.005

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These conventions have serious policy implications. With a growing concern regarding the expected increase in the share of ’social cost’ (i.e. transfer payment) and its proposed adverse effect on competitiveness (see, for instance, Alesina and Perrotti, 1995) some governments have tried to move towards more incentive-based welfare payments. By so doing, it is hoped, the inefficiency created by the welfare system may be offset by efficiency gains through an improved incentive scheme.2 In more general terms, it is these views of the difference in agents’ response to changes in their income according to its origin that is at the heart of the drive to associate greater parts of public policy with market operations. But there is a certain anomaly in all this. If the policy is aimed at achieving that which society deems equitable (or desirable), why would such a policy have an adverse effect on the behaviour of individuals just because of the means by which it is being administered?3 And if so, is it reasonable to expect all agents, recipients and donors alike, to be guided by the same principle in their response to public policy? To make sense of why individuals may respond differently to changes in their income according to its origin, it would be useful to try to establish in what way these origins differ from one another. The simplest distinction between them would be that from the individual’s point of view, the level of one source of income is directly connected to one’s own actions (on labour, or effort), while that of the other, depends on other people’s actions (on labour, or effort). The way we view the others, therefore, could be detrimental to our response to changes in income, which are due to their effort. Some may claim that the ‘others’ are too remote and numerous to be of any significance. This may be so, but on many occasions, our ability to access the fruits of other people’s labour depends on the form of our association with them. We have to be members of society to be eligible for social benefits or belong to a corporation to receive part of our remuneration in share options.4 In such cases, our response to changes in income derived from our association could reflect our attitudes towards the association as a whole rather than our feelings towards, sometimes, the anonymous other. Traditional conceptions of rationality suggest that when income depends on our own actions, tension may arise between the disutility of effort (or labour) and the utility derived from additional income. When income is a result of other people’s effort, we simply withdraw effort due to its

2 In a series of papers, an effort had been made to examine the effects of such policies on the supply of labour (see, for instance, Blundell et al., 1998; Eissa and Liebman, 1996; Bingley and Walker, 1997; Gregg et al., 1999). There are ambiguities in the results although there seems to be a trend which suggests that such policies may be effective among some sections of the population, in reducing unemployment but whether or not this actually means an increase in the overall supply of labour or greater productivity is a more complex question. Recently, Blundell et al. (2003) report in details on the consequences of the New Deal in Britain which epitmoises the notion of welfare to work. According to Labour Force Survey data it transpires that while there was a fall in unemployment between 1997 (the starting year) and 2001 for both age groups of 18–24 and 25–30 (by 2 and 0.9%, respectively), employment rose by only 0.2% for the former group and actually fell by 1.2% for the latter. Moreover, there was also an increase in economic inactivity among these age groups. It rose by 2.2% for the 18–24 and by 3.8% for the 25–30. While causality is a complex issue, it is equally clear that there are no obvious signs of the success of the welfare to work policy in terms of actual employment or productivity. 3 Notice that this cannot be explained by the distribution of income being a public good. Even if redistribution is a public good, our wish to free-ride should not be so obviously affected by the methods by which we contribute or receive benefits. 4 Evidently, everybody can buy shares in a company but I draw a distinction between those who receive part of their remuneration in such a way and those for whom buying shares is a form of savings. The difference is that for those to whom shares produce returns on savings, the decision to save (and the expected returns) are part of an inter-temporal decision making which includes the decision on how much effort to exert in the working years. It is not much different, then, from income, which is directly dependent on one’s on effort.

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universal disutility and our improved ability to expand our effort-free existence.5 By implications, it is thus suggested that within the standard theory, the disutility experienced by others is of no concern to us whatsoever. Nor do we allow the contribution of effort to be associated with a direct increase in our well-being which may be the result of our wish to contribute to the other. But when the others do not matter at all, it is difficult to see in what sense our rational utility maximiser can remain a social being. However, there is mounting evidence that the other, either directly or indirectly, does matter and that the attitudes towards the other are not uniform. Consequently, the predictions of the standard model of the rational utility maximiser no longer hold universally. For instance, Algan and Cahuc (2006) examine the ability of the Danish model which combines high unemployment benefits with low job-security to generate such high participation rates. According to standard theory, the combination of low job-security and high unemployment benefits should drive people into the arms of the state. So clearly, the standard model is missing something about what motivates people. Algan and Cahuc find that the explanation is embedded in civic attitudes. Namely, the reason why people would not just opt to claim the high unemployment benefits instead of engaging in the precarious world of work is embedded in the public perception that it is immoral to claim something which has not been earned. I discuss further evidence which suggests that the other matters in the consideration of the individual and that this may lead to different outcomes from those predicted by the sociallyneutral-rational-utility maximiser in Section 2 below. However, to capture agents’ attitudes towards the other and how it may influence their motivation is not a simple task. There are, of course, a host of means by which individuals can express their sense of cohesion with, or alienation from, society. But from an economic point of view, our main concern is how such attitudes translate into individuals’ choice of actions. This is particularly relevant in the case of the poor who are dependent on other people’s effort and society’s consent to provide them with a share of the product of these efforts. It is also relevant to the more wealthy people who depend on some form of social consent to derive a share of the overall surplus created by the collective activity of all members of society, which may not be construed, in the eyes of the public, as being a due reward to effort. The effects of allowing access to the product of other people’s effort will inevitably depend on social attitudes. The poor may wonder if what they receive from society is theirs by right as market forces deprived them of their real share in the cake. Alternatively, they may blame themselves for their predicament and be both pleased and grateful because the government is doing so much to help them. An individual who is at one with the competitive system implicitly believes that society will be better off if everyone cared for himself. Such a person, whom we shall call ‘self-reliant’ or, simply ‘self-interested’ (SI), is more likely to respond positively (i.e. increase his, or her effort) when their effort related income is well compensated relative to other sources of it. An individual, who feels that the organisation of social institutions along the lines of market systems is ethically repugnant, probably believes that what is socially desirable, cannot be obtained by everyone pursuing their own affairs. We shall call such an individual ‘socially reliant’ or, ‘socially minded’ (SM). This, of course, does not necessarily mean that such an individual prefers central planning and/or believes in metaphysical notions of society. In an individualistic framework one can easily imagine an individual who lives in an elaborate welfare state where society provides

5 The normal-good nature of effort-free existence (or leisure) implicitly suggests that duties, commitment and the sense of belonging are entirely functional for the rational utility maximiser.

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all individuals with, say, a universal basic income.6 This income may be designed to guarantee a reasonable standard of living. In such a case, even when effort related remuneration is only a small element in one’s total income, socially minded individuals may wish to reciprocate and provide this benevolent society with a considerable amount of their own effort. Conversely, when there is no guaranteed basic income, with such high expectations from society, individuals may be frustrated by having to rely totally on their own effort to achieve what they feel should have been provided by society. As they do not believe the system to properly compensate effort in the first place, they will feel their efforts are all in vain and that society has failed them. In their exasperation, they will then reduce their effort contribution the greater is the relative share of own-effort related income. Social attitudes, therefore, towards social organisation (the system of market economy in this case) can be either of ‘self-interested’ (SI) nature or of the ‘social-reliance’ (SM) type. The former suggests a positive correlation between the element of own-effort-related income and effort supply while the latter suggests an inverse relationship.7 The aim of this paper, therefore, is to examine how the presence of social attitudes (our views of the others as a collective) may influence the effectiveness of social policies. The analysis will be focused on how social attitudes could influence the relationship between our effort contributions and income, which is directly derived from our own effort (‘earned’) as opposed to income which is derived from other people’s effort (‘unearned’). We will construct a measure of social synergy which indicates the degree to which one is dependent on other people’s effort and we will argue that it is upon this measure that individuals make their decision about effort contribution.8 As was suggested above, we will characterise the difference in social attitudes by the difference in individuals’ response to changes in this measure. Our confidence in the generality of our formulation will be strengthened by the fact that our model will yield results which are consistent with traditional theory when all agents are equally self-interested. However, we will also show that under different distributions of social attitudes these conclusions are no longer true. We shall also look at some evidence concerning welfare to work programmes to uphold our conclusion 2. Some evidence on the relevance of the social dimension There is a great deal of evidence to suggest that the other, either directly or indirectly, does matter. Fehr and Schmidt (1999), for instance, observe that the results of a number of experimental games do not seem to be consistent with our traditional views of the self-interested rational utility

6

See van Parijs (1995). Camere et al. (1997) and Chou (2002) find a negative wage elasticity for the number of hours worked by taxi drivers in New York and Singapore, respectively. Fehr and Goette (2002) find a similar result in their experiment with bicycle messengers in Zurich. Fehr and Goette (2004), see in this support for Kahnemann and Tversky (1979) who argued for Reference Dependent Preferences (RDP). According to this theory, people’s preferences must be viewed in relation to some sort of reference point. The problem with the RDP theory is that it does not explain the origin of the reference point. In their original paper, Kahnemann and Tversky suggest that the reference point is some sort of a status-quo. Namely, we measure everything in terms of whether it is a loss or a gain relative to an initial position. But whether a move away from an initial position is a gain or a loss depends on how one perceives the status-quo. If one’s income is a combination of a result of one’s direct effort and of one’s association, the status-quo can be defined either in terms of the overall level of income, or in terms of its composition. If we assume it to be defined in terms of income levels alone, then an increase in wages should induce greater effort. But if it is income’s composition that matters, the outcome may be different. 8 It is possible to show that such a principle of behaviour is consistent with some formulations of the modern concept of rational utility maximisation. Due to space limitation, I shall not pursue this point here. 7

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maximiser. Instead, they found that by allowing a certain distribution of ‘other-regarding’ characteristics (notably, ‘selfishness’ and ‘fair-mindedness’) they could better explain these results. Similarly, Clark and Oswald (1996) report on the finding that job satisfaction depends on a notion of relative income. This means that one’s position relative to others with similar characteristics seems to have a considerable influence on a certain element of one’s sense of well being. Put differently, if job satisfaction is indeed a proxy for utility9 then this means that how we view others (which could be the subject of social constructs) matters to how we view our more intimate decision making domain (like work). Duncan (1975), Easterlin (1973, 1975, 1995, 2001) and Scitovsky (1992) provide evidence that the level of one’s own income has not influenced even a more general sense of well being (‘happiness’). It has, instead, been seriously affected by one’s relative position in the distribution of income. Some work has already been done towards extending the dimensions of individuals’ consideration to include other members of society or notions of equity with regard to their relative position in it.10 But while these suggest that individuals are more conscious of the others as individuals, society as an institution – the association – plays no role. What I mean by ‘society as an institution’ is the expectations which people may have of society which are distinct from the expectations they may have with regard to other specific individuals.11 Such expectations would normally be informed by culture, history and ideology and may have little to do with specific individuals in society at any given point in time or, for that matter, with their relative position in it. For instance, an agent may feel that society has a certain responsibility towards him without considering whether or not other people are better or worse off than himself.12 Consequently, his response to public policy is unlikely to be influenced merely by the way in which it affects his relative position in society but rather by whether the policy reflects a commitment by society to fulfil its perceived role. Piketty (1995), for instance, argues that voting behaviour of individuals reflect their beliefs about their ability to use effort to improve their position. If they feel that effort can be effective in achieving a crossing of classes, people will not vote for redistribution. Such a belief – informed by experience – is an example 9 which is indeed a complex issue (see, for instance, Levy-Garboua and Montmarquette, 2004; and Frey and Stutzer, 2003). From our point of view what really matters is not whether or not reported satisfaction is a measure of utility. Rather, it is the fact that issues pertaining to social organisation may influence one’s view of things (like jobs) which in themselves, may not have an obvious social dimension. 10 One line of research has been focused on how the actions of the others may influence the behaviour of a traditionally self-interested individual (see, for instance, Conslik, 1980; Banerjee, 1992; Bagwell and Bernheim, 1996; Bernheim, 1994). Another, focused on how other social constructs, like custom, equity values, stigma and status may influence the behaviour of the same self-interested individual (see, for instance, Akerlof, 1980; Akerlof and Yellen, 1990; Agell and Lundborg, 1995; Bingley and Walker, 1997; Lindbeck et al., 1999). 11 Frey and Stutzer (2000) show that self-reported well being is influenced by institutional arrangements like degree of democracy and autonomy. In part, this is due to the fact that they are more likely to get the policies they want the more direct and the less intrusive the political system is. However, it may equally reflect their approval of political systems which are consistent with their social expectations. 12 Within the job satisfaction literature a great deal of emphasis has been put on relative income as the means of explaining the U-shape (over income) reports on job satisfaction (see, for instance, Clark and Oswald, 1996). There is, however, an element in these finding which raises some doubt about such an explanation: the fall in job satisfaction with education. The most obvious explanation could be that the more educated are less likely to have found what they wanted. Namely, their expectations from life in society generated greater disappointed than those with lesser expectations. In an interesting study by Levy-Garboua and Montmarquette (2004) they offer an alternative explanation to the one of relative income. According to their finding, it is possible to explain job satisfaction as representing one’s experience against one’s expectations. These, in my view, represent what I consider one’s intimate relationship with society. It has nothing to do with what others have achieved (in a direct manner) and everything to do with what one learns and expects from society regarding his own personal happiness.

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of expectations, which are almost entirely directed towards society as an institution rather than towards specific individuals. This, of course, is not to say that the attitudes towards society and the attitude towards the others are not related. In an experiment on the problem of free riding, Burlando and Hey (1997) found that in similar circumstances the response of UK participants was very different from that of the Italian participants. The former tend to free-ride more than the latter. Moreover, they found that there was a much greater dispersion of free-riding behaviour among Italians than there was among UK participants. To some extent, the difference in the overall levels of free riding between the two groups is a reflection of the cultural differences in the perception of society as an institution. It is likely that an individual who feels alienated or unrelated to society would be less inhibited to free ride than an individual who feels at one with society and its objectives. The degree of uniformity, on the other hand, could be thought of as a reflection of the attitude towards the others. Intuitively, one would suspect that the more uniform behaviour would be more typical of cultures where others are less significant. Namely, it does not matter with whom one pairs, one would always free ride in the same manner.13 What is obviously missing from current analysis of how people respond to changes in exogenous variables is an explicit reference to diverse internal motivations. Some research in social psychology suggests that motivation could be affected by one’s self-attribution. Bem (1967, 1972) has argued that the way in which we judge others through their actions could also be applied to our self-assessment.14 That is to say, if, for instance, we do not shoulder the burden with others, we may view ourselves as exploiters of others. Consequently, even in the absence of external causes (i.e. the others themselves), we may choose not to shirk. Deci and Ryan (1985) provide evidence that external motivation (i.e. incentives) may be less effective than internal one. Offering a large bonus for a job to be finished on time may not result in the employee being more motivated had he simply liked his job.15 Condry (1977) and Frey and Goette (1999) found that even a simple change from internal to external motivation might have performance implications. Offering a reward for something, which until now has not been rewarded, may lead to a decline in performance.16 3. Social disposition and the supply of effort Traditionally, effort and labour supply were used interchangeably. Later on, with the development of the principal agent problem and contract theory, effort was taken as a choice variable in 13 While the expectation is that rational agents should free-ride more in repeated public-good experiments either because it takes time for agents to learn the Nash equilibrium optimising strategy or because they free-ride less at the beginning for strategic reasons, there seems to be a difference in the response of the agents when the same people took part in all rounds (‘partners’) and when each round had been inhabited by different participants (‘strangers’). According to these experiments’ results as well as those of Weimann (1994) (with Germans) and Andreoni (1988) (with Americans) AngloSaxons participants tend to free-ride more in repeated partners’ sessions than in repeated strangers’ sessions. Europeans (more specifically, Italians and Germans), on the other hand, tend to free-ride more in repeated strangers’ session than in repeated partners’ sessions. A possible interpretation of this could be that once the other becomes familiar, she become one with society, free riding diminishes in those culture where society matter enough to generate lower levels of free riding. In the individualistic Anglo-Saxon cultures, the familiarity with the other only opens the opportunity to free ride more. Society, one may say, remains a distance and irrelevant object. 14 This is very much the same as the process of socialisation in Adam Smith’s Theory of Moral Sentiments (1756). 15 Gamel et al. (2006) who show that well over 50% of people at the margin of the labour force would not change their behaviour had their income been guaranteed to them rather than depended on their work. This demonstrates the possible presence of other forms of motivation than external ones. 16 Frey and Jegen (2001) provide a survey of empirical evidence which supports this ‘Motivation Crowding Theory’.

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maximising one’s expected income given the pre-supposed disutility of effort, the probability of shirking detection and the outside option.17 This means that we have really moved into a two-stage maximisation problem. The individual first chooses his labour and consumption bundle and upon it, given an un-identified object called the ‘disutility of effort’, chooses the level of effort against the background of a policing policy of his work place. Effort, therefore, is not rewarded as such but there is a penalty for its withdrawal. In other words, the general assumption is that, like labour, people will always wish to withdraw their effort (and thus increase their utility). The objective then is to find an incentive scheme that will prevent them from doing so. Shirking will thus be reduced (effort increased) the more there is to lose: i.e. the higher are the wages and the lower is the unearned income (which is the outside option). Efficiency wage theory, making use of this extension, derives from the second stage of the optimisation an effort function, which is increasing in wages. More recently, a more positive approach has been used among the new institutional economists in their attempt to find the distribution of property rights that will enhance effort contribution. However, in these attempts too, the universal principle of the disutility of effort is upheld. But this kind of interpretation of both labour and effort is somewhat limited. It does not allow ‘excitement’ or ‘enthusiasm’ to be part of the rational utility maximiser’s life. Moreover, in spite of repeated claims about the neutrality of the rational utility maximiser with regard to motivation, he, or she, are never allowed to have diverse responses to similar changes in incentives. This, in turn, implies that there cannot be substantial differences in their motivation. Akerlof and Yellen (1990) use an aggregate effort supply – not derived from anyone’s utility maximisation problem – to allow other considerations to influence the choice of effort and thus, productivity. In their case, it was the question of equity among different types of workers. They have shown that through effort supply, individuals’ ethical sense may have considerable implications for the functioning of markets. A similar idea is then used to show how different opinions about equity may disadvantage an economy (from a productivity perspective) in the business of trade (Agell and Lundborg, 1995). Witztum (1994) shows how a mismatch between the introduction of a new economic system and conception of social justice may influence the outcome of privatisation in the process of transition. In all these cases the predominant departure from standard theory is in the way people response to effort remuneration. Altogether, effort is broadly seen as an important means through which individuals can express their social disposition in a manner which is economically meaningful. While there is plenty of evidence that social disposition matters, not much has been said about whether or not such an extension of individuals’ considerations is consistent with traditional notions of rationality. In principle, economists tend to claim that the rational utility maximiser says nothing about that which motivates individuals. Accordingly, the traditional depiction of rationality only suggests that rational agents will seek the best means to an end when they choose how to act. If this is indeed the case, there should be no problem to accommodate both types of social attitudes in the model of the rational utility maximiser. It is, perhaps, interesting to note that Weber (1922) distinguishes between two types of rational actions. One which is equivalent to the one we use in economics (which he calls Zweckratonalitat or, instrumental rationality). The other, however, is more socially conscious and implies that people may sometime act out of a commitment to an idea with a much reduced concern to the optimality of their choice of action (which he calls Wertrationalitat or, value rationality). We may or may not wish to follow Weber

17

See, for instance, a summary in Polachek and Siebert (1993).

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and consider such actions as rational but we have to admit that there is a considerable amount of evidence to suggest that many people do act like this.18 Whether or not diverse social attitudes require a departure from the standard rational utility maximisation is an important question with which I shall not deal here. Instead, I choose to focus on a general effort function, which will allow diverse opinion to emerge, but which is nevertheless consistent with at least some general forms of preference representations that are commonly used. To capture individuals’ social disposition, the effort function must be based on some measure of self-reliance or, dependence on others. Perhaps the most intuitive measure would be the ratio between income derived directly from other people’s effort (denoted by A and which I shall label as ‘unearned’) and income derived from one’s own effort (say, ω(ε)). To make it a bit more poignant we may wish to think of one’s economic relationship with society as represented by a form of a synergy measure that may reflect individuals’ dependence on the others. Such a measure could be the amount of money derived from collective efforts, per pound paid for a unit of one’s own effort (A/ω ). If for every pound one gets for a unit of one’s own effort, one gets something from the ‘collective’ purse, one can explicitly measure his, or her, dependence on the others. We may call such a measure ‘reliance measure (R)’. If for every pound one gets per unit of his own effort, he gets nothing from other people’s effort, (R = 0) we may say that the agent is socially independent of the others. An increase in the value of R suggests that there is an increase in the money derived from other people’s effort per pound paid to a unit of one’s own effort. This suggests greater social synergy, or greater relative dependence on other people (or society). Naturally, the ‘self-reliant’ individual will increase his, or her, effort contribution the less dependent he, or she, is on other people’s effort. Conversely will be the case for the socially minded. Thus, individuals’ supply of effort is a function of the degree of their relative dependence:   A s ε = ε = ε(R) ω Clearly, for the agent, ω is given. Apart from the intuitive reason why individuals may choose their effort contribution according to their degree of social synergy, this measure is also consistent with a large family of preferences as represented by the traditional notion of the rational utility maximiser (see Appendices A and B). For a ‘self-reliant’ (SI) individual, ε < 0 which means that the greater is the income he, or she, derive from other people’s effort, per pound paid to their unit of effort, the less desirable it will be, in his eyes, to invest effort. For the ‘socially minded’ (SM) individual, the greater will be this ratio, the more will society appear to him, or her, as fulfilling its duties. This, in turn, will merit rewarding society by putting more effort into it (ε > 0). 4. Equilibrium levels of effort supplies Consider an economy which is producing a single good Y. Suppose that there are only two means of production: labour (L) and management (or entrepreneurial activities) (M). The amount of labour hours is fixed (at L), but what determines their productivity is the effort (ε) which is embedded in these hours. The size of management (which is fixed too) is in itself a source

18

See, for instance, Hollis (1987) and Frank (1988).

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of productivity both through its effects on the productivity of labour as well as through direct contributions to output.19 The accumulated labour-effort (ε), as well as that of management, should normally depend on the mean and variance of the distribution of those efforts. For simplicity sake, however, I take the representative agent approach. Hence, Y = F (L(ε), M(εM )) = Fˆ (ε, εM )

(4.1)

where F1 > 0, F2 > 0 and F11 < 0, F22 < 0. Without loss of generality we shall assume F to be homogenous of degree 1 in L and M. Markets are competitive and there are, therefore, no rents in the system. Nevertheless, I shall introduce a distinction between that part of the marginal product which can be directly attributed to one’s effort contribution, and the part which is independent of one’s own action. As L and M are fixed, the marginal product when effort is set at zero is explained by the number of workers and managers rather than by their choice of action (effort). We shall denote this part as W and WM for workers and managers respectively. The other part of the marginal product is due to effort and we denote it by ω(ε) and ωM (εM ) for workers and managers respectively. Without any re-distribution policy, the workers’ equilibrium income comprised of an action dependent element and a choice independent (‘unearned’) variable as follows: W = FL (L(0), M(εM )) ω(ε) = FL (L(ε), M(εM )) − W

(4.2)

Equally, the marginal product of management (M) captures the competitive return for ‘earned’ and ‘unearned’ income according to: W M = FM (L(ε), M(0))ωM (εM ) = FL (L(ε), M(εM )) − W M

(4.3)

To introduce a clear institutional divide we shall assume that only managers pay taxes and that there is a single rate of tax on the two components of their income. Only workers are the recipients of that part of the tax revenue that is re-distributed. Part of the transfer is independent of the workers choice of effort and the other is not. The total amount of tax that is raised by the government will be: T = t(ωM + W M )M

(4.4)

4.1. The equilibrium supplies of effort: workers The actual ratio between ‘unearned’ income and the marginal reward to effort – upon which the workers’ decision with regard to effort supply will be made – is as follows:   T W + (1 − ψ)μ L A W R = = ≡ ρW (ε, ψ, μ, εM , t, W) (4.5) 1 ω ω + ψμ ∂T ∂ε L 19 I shall assume a fixed size of management and will therefore ignore the change in transaction costs as the economy moves from one level of output to another. In other words, I will assume that the optimal management size is not necessarily related to the size of output as it might be to the number of firms which, without loss of generality, I will assume as unchanged.

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Fig. 1. Partial Equilibrium determination of workers’ effort. (a) Workers are ‘self-interested’; (b) Workers are ‘socially minded’.

where ψ is the proportion of the benefits which are directed through effort related activity (welfare to work programmes) and μ is the proportion of taxes dedicated for re-distribution purposes. We can now establish the relationship between equilibrium values of RW , and levels of workers’ effort for any given level of managers’ effort. Proposition 1. When the marginal return on workers’ effort is non-negative and non-increasing in ε, and the marginal returns on managers’ efforts with respect to workers’ effort is positive and non-increasing in ε, (namely, ω > 0, ω ≤ 0, ∂ωM /∂ε ≥ 0 and ∂2 ωM /∂ε2 ≤ 0), the equilibrium measure of workers’ dependence (RW , or ρ) is increasing in ε. Proof. Proof is straightforward and can be found in Appendix B.



The meaning of this is that the technological relationship between workers and managers is that of complementarities but this, of course, does not mean that so must be their social relationship. Fig. 1, above, depicts the determination of (partial) equilibrium supplies of workers’ effort when workers are either self-reliant (SI) or socially minded (SM). The curve ρW (Eq. (4.5)) represents the correspondence between different levels of workers’ effort and actual values of RW for a given level of managers’ effort and distribution parameters. The upward sloping εSM in the right-hand diagram represents the optimal choices of effort supply per levels of R for a ‘socially minded’ individual (SM). In the left-hand diagram, (εSI ) depicts the optimal response of the ‘self-interested’, or self-reliant, individuals to actual levels of R. Point A in both diagrams depicts the equilibrium supply of workers’ effort and its corresponding level of workers’ social dependence (R). It is clear from the diagram that whichever way managers’ effort influences the measure of workers’ dependence (ρW ), the effect on workers’ supply of effort will be very different if workers were socially minded or self-reliant. Let us examine now the indirect influence, which the managers may have on the actual levels of RW (and subsequently, the equilibrium level of effort). Proposition 2. When the marginal return to effort is non-increasing with respect to the other groups’ effort contribution (i.e. second-order cross derivatives of each group’s returns to effort is non-positive) management’s effort contribution will increase the actual level of workers dependence measure (RW ) for any given level of workers’ effort.

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Proof. Straightforward in Appendix B.  Hence, whatever excites the managers or entrepreneurs will have an adverse effect on the supply of effort by workers if most of the latter group is comprised of self-interested individuals (a shift to the right of ρW in Fig. 1(a)). This is so in spite of the fact that increases in managerial efforts will have a positive effect on the productivity of workers’ effort. The opposite would be true if most of the workers were socially minded. The meaning of this is that for technological relationships to become a reality there must be some correspondence between them and the social attitudes of the participants. In spite of the fact that managers’ effort will contribute positively to workers’ return to effort, the latter will respond by withdrawing their efforts if they are self-interested. 4.2. The equilibrium supplies of effort: managers As the Managers only pay taxes – and there is a single rate applied to their entire income – but receive no direct benefits, the actual measure of their social synergy becomes:   W M (1 − t) A WM M R = = ≡ ρM (ε, εM , W M ) (4.6) =   (ωM ) ωM ωM (1 − t) where t is the rate of tax. Proposition 3. As long as (ωM ) ≤ 0, managers’ measure of dependence (RM ) will rise with the increase in managers’ effort contribution. Proof. Straightforward, see Appendix B.



Fig. 2, below, depicts the equilibrium determination of managers’ effort for any given level of workers’ effort. As before, the left-hand diagram depicts that case where managers are selfreliant (self-interested) while the right-hand diagram depicts the case where managers are socially minded. In terms of the relationship between workers’ effort and the equilibrium level of managers’ effort we have a similar story to the one we had earlier.

Fig. 2. Partial Equilibrium determination of managers’ effort: (a) managers are ‘self-interested’; (b) managers are ‘socially minded’.

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Proposition 4. When the marginal returns to effort is non-increasing with respect to the other groups’ effort contribution (i.e. second-order cross derivatives of each group’s returns to effort is non-positive), workers’ effort contribution will increase the actual level of managers’ dependence measure (RM ), for any given level of managers’ effort. Proof. Straightforward in Appendix B.  This means that an increase in workers’ effort will reduce the equilibrium level of managers’ effort if the latter are of the self-reliant type. If, however, managers are socially minded, the increase in workers’ effort will yield an increase in managers’ effort. 4.3. General equilibrium The equilibrium levels of effort supply is at points like A (in the above diagrams), where the actual levels of effort correspond to their optimal levels. Agents observe the level of R and adjust their effort supply to that which is optimal according to whether they are self-reliant or socially minded individuals. The two endogenous variables, which concern us, are the supply of effort by workers and managers. Equilibrium, therefore, is a pair of effort supplies, which each group of agents will not wish to alter. For any given level of the actual measure of their dependence (RI ), agents will adjust their effort contribution to the one consistent with their optimal choice if it differs from the actual level of effort supply. The following equations capture this dynamics of workers’ response: −1

ε˙ = Ω[εSI (RW ) − (ρW )

(RW , ψ, μ, t)]

(4.7)

where Ω is monotonically decreasing in RW and Ω(0) = 0. Equally, the same mechanism of adjustment exists for the managers: −1

M M ε˙ M = ΩM [εSI M (R ) − (ρ )

(RM )]

(4.8)

where ΩM is monotonically decreasing in RM and ΩM (0) = 0. We can now draw the equilibrium conditions in the (ε,εM ) plane where there are four possible social situation. Fig. 3(a) depicts the cases where workers and managers are self-interested. It is easy to see from Eqs. (4.7) and (4.8) (as well as from Figs. 1 and 2) that the loci of all ε,εM which satisfy Ω(ε,εM ) = 0 and ΩM (ε,εM ) = 0 will be downward sloping. Together with the appropriate stability conditions20 we get that Ω(0) = 0 should be steeper than ΩM (0) = 0. The second situation is when managers are pre-dominantly self-interested (or self-reliant) while workers are pre-dominantly socially minded. In such a case (Fig. 3(b) below) the main difference is that the loci of all ε, εM satisfying Ω(0) = 0 is upward sloping. The third case is when both managers and workers are socially minded. Here (Fig. 4(a) below) the loci of equilibrium lines are upward sloping. Here too, the appropriate stability conditions dictate that Ω(·) = 0 should be steeper than ΩM (·) = 0. The last case is where workers are self-interested and managers are socially minded. This case is depicted by Fig. 4(b). In each case there exists a pair of effort contributions which constitute the productive efficiency of the general equilibrium system for a given set of distributional parameters.

20

Which are straightforward.

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Fig. 3. General equilibrium: (a) when both workers and managers are ‘self-interested’; (b) when managers are ‘selfinterested’ but workers are ‘socially minded’.

Fig. 4. General equilibrium: (a) when both workers and managers are ‘socially minded’; (b) when managers are ‘socially minded’ but workers are ‘self interested’.

5. Policy and attitudes: some comparative static It is not difficult to imagine from what has been said so far that the consequences to productive efficiency of a change in any of the parameters will be significantly different in each set up of public attitudes towards society and its functions. Nevertheless, it is important to notice that all these scenarios are consistent with the notion of rational utility maximisers and they are, in fact, finite. This means that what we are trying to do here is not merely to offer a more ‘realistic’ foundation to economic inquiries but to highlight a specific characteristic of human behaviour which has so far been ignored but which, as will soon be demonstrated, has considerable implications for social policy. In turn, this should better inform our views about the consequences of social policy as well as direct public bodies to research into the question of social attitudes as part of the process through which social policy is being devised. Therefore, although we could offer here a complete analysis of the effects of a change in each of the model’s parameters, we chose to concentrate on a few examples which will demonstrate the

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Fig. 5. Comparative statics when both agents are of the ‘self-interested’ type (a); when managers are SI while workers are SM (b); when all agents are of the SM type (c) and when managers are SM while workers are SI (d).

sensitivity of social policy to social attitudes. We shall also like to demonstrate how institutions matter even though we are dealing here with a model of competitive general equilibrium without any problems of information or externalities. 5.1. Institutional dimension I To begin with, consider the most basic question of the existence of earnings, which are not directly effort related. In the absence of any ‘unearned’ income in the economy, the supply of effort will be at points U in the above diagrams.21 Surprisingly enough, in the case where all agents are selfinterested (or traditionally rational), the economy will be much more efficient without any form of ‘unearned’ income (point U in Fig. 5(a)).22 U, in this case, clearly represents social arrangements that are superior from both productive and allocative efficiency points of view. In terms 21 I assume that effort is bounded from above and below. Without loss of generality I assumed the lower boundary to be other than zero. 22 Recall that output Y is a function of ε and ε and that there are typical iso-quants in the plane of (ε, ε ). Point U is M M on a much higher iso-quant.

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of our specific set up, this could have been obtained by setting ψ = 1 (no transfers which are not effort related) and by breaking away from market arrangements which will allow individuals to earn income whether or not they put effort into their work. Paying someone their marginal product-determined by factors other than his, or her, choices – may be neither efficient nor ethically justifiable as the returns cannot be attributed to the agent’s own activity. Notice however, that in this case it is insufficient to prevent one class of agents from accessing ‘unearned’ income. Adjustment in the earnings arrangement of the other group will be equally important. In the case where all agents are socially minded (Fig. 5(c)) the position of point U suggest that an economy without ‘unearned’ income is in an inferior position (efficiency wise) to a situation where ‘unearned’ incomes are present. The cases of mixed attitude too suggest (in a slightly less clear-cut manner) that having ‘unearned’ income in the economy would be desirable. 5.2. Institutional dimension II: economic freedom and social attitudes We saw in the above section that in the absence of any form of ‘unearned’ income, the only behavioural environment within which the economy would clearly benefit is that where all agents behave like the traditional rational utility maximiser. This, of course, is consistent with the general drive-based on neoclassical economics-to ensure that as many economic interactions as possible are market driven and that the state, with all its non-market mechanisms should be kept at minimum. In such a world, it is argued, people can act as they choose and will be rewarded according to their actions. Subsequently, there would be a clear incentive for agents to exert themselves as their efforts would be rewarded. Notwithstanding the theoretical question whether markets do or do not reward effort,23 the evidence about the effects of market dominated economy on effort does not seem to support this view. Some of the most obvious competing institutional arrangements are those distinguishing the Anglo-Saxon economies from the European Continental ones. Whereas the former seems much more committed to the idea of the market, the latter tends to emphasise the social dimension of economic organisation and subsequently, prefer greater intervention and restrictions on markets. This is particularly true of the labour market where the Continental economies tend to provide a mixture of greater support for people at work (in terms of tenure) as well as support for those out of work. According to standard theory, based on the traditional rational utility maximiser, this should lead to stagnation and low productivity. In the eyes of some, the idea of a market driven non-interventionist economy are closely associated with what they would call ‘economic freedom’. Evidently, this is an enormously laden and contestable term. Notwithstanding the philosophical debate surrounding this question, the term is clearly defined and has a simple and clear interpretation. The measure of ‘economic freedom’ created by the Wall Street Journal and the Heritage Association simply measures the regulations and non-market activities which affect economic interactions. Thus, in spite of its heavy connotations, ‘economic freedom’ is a measure of how near is an economy to the recommendations of the neo-classical paradigm, i.e. to the market dominated economy.

23

See a discussion in Witztum (2006).

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Not surprising, all the Anglo-Saxon economies are at the top of the list and constitute the category of ‘free’.24 Most Continental economies are in the lower category of ‘mostly free’. Thus, the distinction I draw between these two blocks in terms of their commitment to the market is consistent with other measures distinguishing institutional structures. According to the prediction of the competitive paradigm, the ‘free’-market dominatedeconomies should provide the greatest incentive for people to exert effort. Hence, one would expect to find high levels of productivity in these economies. These levels should be considerably higher than those of the less ‘free’ economies where intervention in the markets (and in particular the labour markets) breaks the traditionally perceived connection between market reward and effort. Recent evidence, summarised in the table below, may suggest otherwise:25 GDP per hour worked, USD (a)

Measure of Economic Freedom (b)

Annual average hours worked (c)

Hours worked per head (d)

Continental Austria Belgium France Germany Italy Netherlands Denmark Finland Norway Sweden

39.20423 51.59137 46.96888 42.47704 35.93899 46.89183 41.0346 38.26896 59.71369 40.98656

25 17 45 19 60 14 13 16 30 21

1636.108 1522 1543.056 1439.796 1803.37 1403.845 1540.029 1718.559 1358.509 1583.766

830 608 617 678 760 704 783 778 679 760

Averages

44.30761

26

1554.904

37.18633 35.77047 27.16161 38.86828

3 10 5 6

46.27978 37.05329

Anglo-Saxon Australia Canada New Zealand United Kingdom United States Averages

Average annual social spending (% of GDP) 1991–2001 (e)

Average annual real GDP growth 1971–2004 (f)

GDP per capita 2004 (g)

25.69379 28.60939 26.69644 23.94207 25.20449 30.70858 28.99932 25.31245 32.40265

2.7 2.4 2.5 2.2 2.3 2.5 1.9 2.8 3.4 2.1

32520 31390 28992 28813 27312 32992 32141 29782 40568 31139

719.7

27.50769

2.48

31564.9

1815.53 1751.169 1826.2 1918.043

871.5297 889.774 905.9676 793.2552

16.9926 19.27885 20.08367 22.05915

3.2 3.2 2.4 2.4

32408.99 31827.63 24607.54 30832.47

4

1667.613

858.513

14.71765

3.2

39731.79

5.6

1795.711

863.8079

18.62638

2.88

31881.68

Sources: (a), (c),(d) OECD Productivity Database, January 2006, (b) 2007 Index of Economic Freedom, The Heritage Foundation and the Wall Street Journal. (e–g) OECD Factbook, 2006: Economic, Environmental and Social Statistics – OECD, 2006.

What we see from this sample is that while both groups have a more or less the same level of economic development (column (g) suggests that the average GDP per capita in each of the groups in 2004 was more or less the same)) and more or less than same average rate of growth in the last 30 years (column (f)) – which means that we are looking at economies which have been, for the last thirty years, more or less at a similar stage in their development-productivity per hour worked is considerable larger in the European block than it is in the Anglo-Saxon block (column (a)). Moreover, the hours worked per head (column (d)) and the average annual hours worked (column 24 It also includes Singapore and Hong Kong but given the past of these two territories, it is difficult to ascertain whether they constitute a departure from the Anglo-Saxon world. 25 In my sample I did not include all economies. Among the Anglo-Saxon I removed Ireland as it was an outlier. In Europe, I focused on those economies that had similar experience (in the last 40 years) to the Anglo-Saxon economies in terms of political stability and economic development. I also excluded Luxemburg which was an outlier. Neither exclusions would have affected the conclusions I will draw.

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(c)) are much lower in the European block than in the Anglo-Saxon one. In simple term this means that the European achieve the same level of economic development by being more productive and working less. In fact according to the 2004 issue of the OECD Employment Outlook (Chart 1.3) there are two opposite trends in the number of hours worked per capita. Between 1970 and 2002 the US experienced an almost 20% increase in the number of hours worked per capita while at the same time, France experienced over 20% decline in the number of hours worked per capita.26 In terms of our blocks, the average change in hours worked per capita in the Anglo-Saxon block was positive while in the European block, it was distinctly negative. The meaning of this is that in contrast with the predictions of the neo-classical paradigm, the less economically ‘free’ (column (b)) and more interventionist (column (e)) do better in terms of effort exertion than the more market dominated economies. There is, of course, the traditional explanation where greater utilization of the labour market, for a given level of capital, will inevitably bring down the marginal and average productivity of labour (assuming more or less similar technologies). Porter and Ketels (2003), for instance, argue that both the level of utilisation of the labour market in the UK and the low capital per hour may explain the low productivity of the UK relative to other European economies. However, there are other reasons to suspect that this may not be the right explanation. If we look at the development of the compensation per employee on the one hand, and the unit cost of labour to business on the other, we will find that in the UK, between 1991–2001, the average percentage annual increase in compensation was 4.5% and that unit labour cost was 2.5%.27 Both numbers are outliers relative to all the other economies in our sample. This does not sit comfortably with the idea that wider participation means lower wages (and productivity) as capital remains low. If we look at the two sets of economies we would find that on the average, the annual growth of employee compensation in the Anglo Saxon block was 3.28% while in the Continental block 3.35%. On the other hand, the average annual growth of unit labour costs was 1.46% in the former and 1.26% in the latter. This seems to suggest that while labour compensation grew faster in the continental block, it had a smaller impact on the cost of labour. Given the interventionist nature of these economies, the most plausible explanation is that the productivity of labour grew faster in the Continental block than it did in the Anglo-Saxon one. Altogether, we find ourselves with the following story. The first thing we noticed is that over the last three decades, the Anglo-Saxon group of economies increased, on average, the number of hours worked per capita while the Continental block reduced them. Even Blanchard (2004) finally admits that there may be a different story to tell other than the traditional claims of the inefficiencies of an overly regulated labour market. He concedes that it is possible that Europe, in general, preferred to invest its productivity growth in increasing leisure while the US in increasing

26 From the point of view of our own model of human behaviour it seems to be clear that there are diverse social attitudes. Evidently real wages have gone up over the last 30 years across the OECD countries. The fact that some respond by increasing their working hours, is consistent with the traditional rational utility maximiser and with our notion of the ‘self-reliant’ individual. The fact that some reduce their supply of labour is consistent with our notion of the ‘socially minded’. The fact that most of those countries where working hours per person increased are Anglo-Saxon seems to be consistent with the conclusions we drew from the experiments in Public goods about which I reported in Section 2 above. Naturally, changes over 30 years are more difficult to attribute merely to social disposition but in principle, these development are more in line with our perception of diverse social attitudes than with the traditional view of the rational utility maximiser. 27 OECD Employment Outlook 2004 (p. 23).

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material wealth (growth) but the differences in average growth rate may not be sufficient to justify this kind of conclusion. In other words, there may be indeed a different story to be told. According to our model this would mean that the social attitudes of the European are sufficiently different from those of the Anglo-Saxon to have an impact on the economy. Namely, the AngloSaxon increase their effort when wages are rising because they are ‘self-reliant’ or ‘self-interested’ type of individuals. The Europeans, on the other hand, behave like our ‘socially minded’ individual. All of this sits well with our previous discussion in Section 2 above about the experimental results of the free-riding games. However, there seems to be a certain anomaly here which needs further clarification. Had the Anglo-Saxon been ‘self-reliant’ this would have meant that their effort too should increase as the low level of social spending would suggest that the composition of their income is dominated by effort-related pay. In other words, as both Anglo-Saxon and Continental Europeans have the kind of regime they want, why do the European increase their productivity by more than the Anglo-Saxon? One possible answer could be the differences in labour market and the share of part-time workers. However, our own story offers a further insight. The European economies are far more engaged in re-distribution than the Anglo-Saxon economies. If we examine Fig. 5 above, you will find that the effect of greater re-distribution activity is captured by the move from points A to C (this will be discussed in details in Section 5.4 below). In an economy where all agents are ‘socially minded’ (case c), the move from A to C means a clear increase in overall productivity (effort contributions). At the same time, throughout this period, the Anglo-Saxon economies were engaged in welfare to work policies (which will be discussed in Section 5.3 below) which means a move from A to B (in case a). According to our story, such a policy will produced and ambiguous result as the effort of one group would increase but that of the other would decrease. Hence, the increase in effort generated by the institutional arrangement was dampened in the Anglo-Saxon system by the drive for more welfare to work policies. There is, of course, the other possibility that social attitudes in both groups are diverse and in some of the discussion about the effects of welfare to work in the US, we will detect the possibility of such diversity. In such a case, to draw empirical conclusions we would need to conduct a full and separate examination. 5.3. Welfare to work Perhaps the most significant development in recent years in the provision of re-distributive policies has been the rise of the idea that the tax benefits must be closely linked to work (effort) so as to reduce the inefficiency of tax. The idea behind this, of course, is that the traditional utility maximiser would respond to an increase in unearned income by withdrawing his or her efforts. However, the evidence does not seem to support these expectations. Even the more narrow presumption according to which the introduction of welfare-to-work will encourage people to work has not been clearly supported by the evidence. For instance, between 1997 – when welfare to work programmes have been introduced in the UK – and 2000, while there was a marked decline in unemployment there has also been a sharp increase in economic inactivity, in particular among the male population of working age. According to the Labour Force Survey (LFS) in the UK inactivity rates among men aged 25–64 rose from around 11% for the years 87–96 (prior to the introduction of welfare-to-work new deal) to 12.8% in 97–99 and 13.3% in 2002.28 28 See Faggio and Nickell (2003, p. 42). While there was a sharp increase in inactivity between the 1970s and the 1980s, the rate was more or less constant (around the 11%) for the years 87–96.

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In particular, this is true of the age and social group which was the main target of the ‘new deal’. If we look at the 18–24 age group with low school leaving grades we shall find that inactivity before welfare to work was around the 12%, in 1999 this number rose to 13.4% and reached 14.6% in 2001.29 For the 25–30 age group with low qualifications, the picture is very similar, from an average of 11% inactivity before 97, to the rate of 15.2% in 2001.30 In general, according to the LFS, there was a rise in inactivity of young male (25–54) and a decline in older men’s inactivity. Altogether, taking the labour market liberalisation (from 1979 under the Conservatives) and the welfare to work programme (under Labour) in one, inactivity among the working age population (16–64) almost doubled: from 8.6% in 1977 to 15.5% in 2000.31 Obviously, these trends may reflect much deeper and more fundamental problems associated with technological development and the ability of the labour force to adjust. But at the same time one cannot preclude the influence which both liberalisation and welfare-to-work programmes have had on the rate of growth of inactivity. The absence of protection and the insistence on deriving income from direct effort contributions may have generated an effort response function which is more consistent with our perception of the socially minded individual than with the traditional self-reliant rational utility maximiser. Bell and Orr (1994) study the effects of welfare-to-work programmes in seven US states. In spite of the apparent universal acceptance of the ideas embedded in the American dream which suggest a self-reliant population, the results were mixed. The programme was introduced for AFDC (Aid for Families with Dependent Children) recipients in order to encourage less dependency on the state. The experiment was conducted by creating a control group of non participating recipients of state benefits. The results in terms of hours worked (per month) were far from uniform. Only in one state (Texas) had the increase in hours worked, per month, by people who participated in the programme (two years after its termination) been greater than the increase in such hours by the control group comprising of people who were Aid recipient but who did not participate in the welfare-to-work programme. Of the results of the study which were significant I have ranked the states in terms of the success of the programme in increasing the labour contribution of participants (relative to non participants) after two years. The ranking is as follows (in brackets, the percentage of mean hours worked by participating recipient as a percentage of hours worked by the control group): Texas (105%), Arkansas (46%) Ohio (41%) New Jersey (37%) and NY (−15%, for the first year). Apart from the obvious sense of failure in the sense that other than Texas, nowhere did the attempt to link people’s benefit to work resulted in that group working more, there is a clear difference between the level of success. What may explain these differences is the type of social attitude which is prevailing in these communities.32 The fact that local governments are voted in on issues such as welfare, I imagine that the welfare policy will reflect the overall attitude of the public. Indeed, if we rank these states by the amount of welfare spent per person around the year of the experiment (1994) we will find great diversity. More importantly, we will get the exact

29

These numbers do not include those in full time education. See a study by Blundell et al. (2003, p. 29). 31 See a more detailed discussion of this problem in Faggio and Nickell (2003) and Beatty and Fothergill (2003). 32 The possibility of diverse social attitudes is, of course, important. This may not contradict the presumption of our previous discussion that the Anglo-Saxons tend to be more of the ‘self-reliant’ type, as most of these economies experienced either the impact of large immigration or the encounter with local cultures. The question one will need to resolve is whether the dominant culture is Anglo-Saxon or not. 30

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inverse ranking; namely, the states which spent more in welfare per person of its population were less successful in the programme. The total welfare spending per person of population (from the bottom to the top) in Texas was about $564 in 1994, it was $620 in Arkansas, $728 in Ohio, $892 in New Jersey and $1395 in NY.33 This means that there is complete correspondence in our small sample between the order of success and the order of welfare spending per person. In many respected, NY with its colossal failure, and Texas with its success, represent the two extremes of social attitudes. NY is a clear welfare state with more than double the welfare spending per person in Texas. Texas is clearly the lowest such spender out of the five states. Assuming that the governments of these states reflect, to some extent, the values of their inhabitant, it is reasonable to expect that socially minded individuals would support a relatively high welfare activity while self-reliant people would wish to keep welfare to minimum. So is it possible that the programme in NY failed because the public (the recipient) was predominantly socially minded while in Texas it succeeded because the public was predominantly self-reliant? Traditional perception of the rational utility maximiser cannot resolve this paradox but I shall now show that this can be accommodate by the framework which we have set-up here. Suppose now that we start at point A, where there are ‘unearned’ incomes in the economy. What will be the implication of a drive to relate greater parts of individuals’ welfare payment to effort? In terms of our model this is simply a question of raising ψ. It is easy to see that as ψ increases, the equilibrium values of RW fall (less dependence or synergy) for any given level of workers’ and managers effort. The ρW curve in Fig. 1 will shift to the left. In terms of equilibrium conditions, this will mean a shift to the right of Ω(·) = 0 when workers are self-interested and a shift to the left of Ω(·) = 0 when they are socially minded. There will be no change in ΩM (·) = 0 whether managers are self-interested or socially minded. These changes are captured in Fig. 5 where general equilibrium will shift from points A to points B. When all agents are SI (Fig. 5(a)), there will be an increase in workers’ effort (which is consistent with the objectives of the programme) but at the expense of managers’ effort. It is thus unclear whether or not overall productivity will increase. However, if all agents were SM (Fig. 5(c)) then the result of such welfare to work programme will mean a fall in the efforts of both workers and managers. In this case, B clearly represents an overall collapse in productivity and output. It is worth noting that the SM type of behaviour does not necessarily mean that all agents have the same sense of association. It is possible to conceive a situation where workers’ ‘unearned’ income comes solely from the state, while managers’ ‘unearned’ income may come from ownership. Therefore, it is possible to have a society comprised of similar type of individuals but with very different trigger for their sense of association. In the case where workers are SM while managers are SI (Fig. 5(b)) there is again an ambiguity. Here, however, things are less favourable than they were in the first case. Instead of enticing workers to increase their efforts, the consequence of channelling greater part of welfare support through effort related activities would cause workers’ effort to drop. While there is some compensation in productivity from the increase in managers’ efforts, there is no particular reason to believe that it will be sufficient to offset the adverse effects of the policy on workers. When, however, workers are SI while managers are SM (Fig. 5(d)), we end up at point B where there is a clear improvement in productivity.

33

The data was taken from the US Census Bureau (www.census.gov); my own calculations.

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5.4. Tax policy and the pursuit of re-distribution A general increase in transfer payments is captured in our model by an increase in ␮. Had this been the only change, the results will be orthogonal to those when a greater amount of an existing fund was re-directed through effort related means. In Fig. 5, the effects of an increase in ␮ are depicted by the moves from A to C. We can see either a clear improvement in overall productivity in the case where both groups are socially minded (Fig. 5(c)) or a possible improvement when managers are socially minded while workers are self-reliant (Fig. 5(b)). The corresponding opposite will be true in the case where managers are socially minded while workers are self-reliant (5(d)) and when both groups are self-interested (5(a)). What all this means is that regardless of the composition of social attitudes, an increase in transfer payments (from an existing fund) together with re-direction of more of these funds into effort related activities will neutralise each other. If, however, we wish to consider the influence of an increased tax liabilities, the analysis becomes slightly more complicated. As there is a single tax rate and it is levied on all sorts of managers’ income, changes in the tax burden will have no effect on the equilibrium values of the managers’ measure of dependence (RM ) (see Eq. (4.6)). The effect that an increase in the tax burden will have on workers is, of course, dependent on how the tax is being distributed. Proposition 5. Changes in workers’ measure of social dependence (or synergy) (RW ) will be directly related with changes in the tax burden levied on managers as long as 1 − ψ/ψ > (ηωM ε /ηωε )(W W /ω) and inversely related otherwise. Proof. See Appendix B.



It is clear from this that as ψ approaches 1 (i.e. all re-distribution is channelled through effort related pay), (1−ψ/ψ) → 0. As the effects of an increase in workers’ effort on their own productivity and that of the managers is positive (captured by the respective elasticities), the condition in Proposition 5 is reversed. This means that an increase in the tax burden will have an adverse effect on the workers measure of synergy. The general equilibrium consequences are similar to the move from A to B in Fig. 5. When, however ψ approaches 0 (i.e. all re-distribution is channelled through non-effort related pay), (1−ψ/ψ) → ∞ and the condition stipulated in Proposition 5 will definitely hold. In such a case, an increase in the tax burden will have an effect, which is similar to the shift from A to C in the above diagrams. Let ψ* be the rate of work related transfers for which 1 − ψ ∗ /ψ∗ = (ηωM ε /ηωε )(W W /ω). Thus, whether or not there is much scope of productivity improvements when the government wishes to enhance welfare-through-work policies, depends on workers’ effort elasticity of managers’ returns to effort, workers’ effort elasticity of workers’ returns to effort (ηωM ε /ηωε ) and the ratio of W/ω which reflects the composition of workers’ earnings. When effort remuneration is sufficiently small, an increase in taxes will always shift the economy from A to B. When both types of agents are of ‘self-interested’ (case 5(a)) or, when managers are SI while workers are SM (case 5(b)), the outcome will be ambiguous. However, when all agents are of the SM type (case 5(c)) and when managers are SM while workers are SI (5(d)), the effects will be damaging in the first case and positive in the other. To offset the decline in productivity, the government may wish to increase the share of tax revenues devoted to re-distribution (␮). Doing the same when effort contributions have increased (5d) will offset the benefits.

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6. Conclusion We set out to show that social attitudes may have a greater influence on public policy than is normally assumed. Traditional theories attribute to agents a pattern of behaviour according to which there will be a unique form of response to public policy based on a single form of motivation and a single type of implied social attitude according to which individuals have no real sense of association. It is upon such perception of human behaviour that the inefficiency of re-distributive policy has been based. We argued against this tradition by claiming that evidence suggests that there could be other forms of social attitudes (which we believe are consistent with the idea of a rational utility maximiser) which may generate a different type of response to public policy than the one suggested by traditional theory. Moreover, we argued that it is quite possible that societies are comprised of individuals with diverse social attitudes. Inevitably, the inefficiency of re-distributive policy cannot be taken for granted. As the main source of concern with regard to the inefficiency of public policy is the disincentives that it generates, we too chose to concentrate on the effects of the policy on overall productivity (and subsequently, competitiveness). We set up a framework of a general equilibrium model with complete markets where the distribution of social attitudes became crucial to the success of public policy. In other words, what has been shown in this paper is: (a) that incentives cannot be viewed outside the context of motivations; and (b) that what may appear as a disincentive to one group in society may be a strong enough motivation for another. In practice, this means that government should concentrate on devising means for monitoring social dispositions and choose policies in accordance with these findings. We also saw, briefly, that the efficiency of some institutional elements in the organisation of society may be susceptible to the distribution of social attitudes. In particular, we noticed that the distribution of property rights, which governs the flows of unearned income, could be a general cause of inefficiency. Together with other market considerations (like, for instance, efficiency wages) a given distribution of property rights may also influence the effectiveness of an incentive-based welfare programme. In general terms, we have found that even without any form of incompleteness, social institutions do matter in the debate about the efficiency of the competitive paradigm. Appendix A In this appendix, I would like to give an example of how the effort function used in the model can be derived from rational utility maximization. In order to get diverse social attitudes we must assume that contributing something, even implicitly, to society, is perceived differently by the agents. An individual consumes a composite good y and exerts effort (ε) to generate earnings. His income is comprised of an ‘unearned’ element A, which is independent of his effort contributions, and an earned element, which is dependent on his effort contribution ω(ε). The choice variables for the individual are therefore ε and y, and the constraint the individual confronts is: A + ω(ε). Compatible with price-taking behaviour, we assume the effort reward function to be linear. The difference in social attitudes of the agents presents itself through the way in which they perceive their effort contribution (which will also affect others).34 The simplest approach would

34 This is consistent with the meta-economics literature developing from neuroscience which demonstrates that social pain is captured by the same part of the brain as individual pain. See, for instance, Lynne (2006).

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have been to assume that some enjoy their effort contribution while the other dislikes it. However, this would create analytical problems which lie at the heart of the universal assumption in economics that agents’ decision about work is merely a residual of their decision about leisure. So the only way to distinguish between the two types of agents would be through their marginal disutility from effort. For one, we shall assume that every extra unit of effort is equally painful. For the other agent, the more involved he gets, the less painful he considers an extra unit of labour. This, I believe, is as near as we can get-within the framework of the rational utility maximiser-to distinguish different attitudes to work. Assume that effort inputs are limited by, say, E. When an agent chooses his, or her, level of effort (ε), it leaves some effort for other (leisurely) pursuits. The way they perceive this could either be linear (E − ε) representing the constant marginal disutility of effort or (E/ε) which represent the case of growing enthusiasm. This means that in the linear case every extra unit of effort would have the same impact on the rest of one’s effort (i.e. ∂2 (E − ε)/∂ε2 = 0) while for the other person, every extra unit of effort would diminish the decline in the remaining effort (i.e.∂2 (E − ε)/∂ε2 > 0). The former is the self-interested or self-reliant agent who treats effort as a means to an end while the latter is the case of the socially minded individual where being involved at work does not diminish his enthusiasm. The Self-interested problem: max

y, εU(y, ε) = α ln y + γ ln(E − ε)

s.t y = A + ω(ε) = A + bε

The first order conditions are: α −λ=0 y

−

γ + λb = 0 E−ε

A + bε − y = 0

where λ is the Lagrange multiplier and which lead to: λ=

α γ α A α = and ε∗ = E− y b(E − ε) α+γ α+γ b

Clearly, effort would fall with an increase in the synergy measure (A/b). This is consistent with standard theory. The socially-minded problem:   E max y, εU(y, ε) = α ln y + γ ln s.t y = A + ω(ε) = A + bε ε Again, the first order conditions would be: α −λ=0 y

−

γ + λb = 0 ε

A + bε − y = 0

Which would lead to: λ=

α γ γ A = and ε∗ = y bε α−γ b

Here, effort is proportional to the level of synergy.

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Appendix B Proof of Proposition 1.     1  + ψμ ∂T 1 − ω + ψμ ∂2 T 1 (W + (1 − ψ)μT ) ] ω [(1 − ψ)μ ∂T ∂ε L ∂ε L ∂ε2 L =  2 ∂ε 1 ω + ψμ ∂T ∂ε L

∂RW

(B.1.1) where ∂T ∂ωM = t M ∂ε ∂ε

(B.1.2)

∂2 T ∂2 ωM = t M ∂ε2 ∂ε2

(B.1.3)

As by definition, ψ ≤ 1, the sign of B.1.1 depends on the numerator. If ω > 0, ω ≤ 0, ∂ωM /∂ε ≥ 0 and ∂2 ωM /∂ε2 ≤ 0 which are all standard assumptions, the sign of B.1.2 will be positive, that of B.1.3 negative and thus the sign of B.1.1 will be positive.  Proof of Proposition 2. The effects of managerial effort contribution on workers’ synergy measure is:    2  ∂T 1 ∂ ω ∂2 T 1 T  + ψμ ∂T 1 − W ω W + (1 − ψ)μ L + ψμ (1 − ψ)μ ∂R ∂εM L ∂ε L ∂ε∂εM ∂ε∂εM L =  2 ∂εM 1 ω + ψμ ∂T ∂ε L (B.2.1) as (∂2 T/∂ε∂εM )=t(∂2 ωM /∂ε∂εM ) and according to the assumption (∂2 ω/∂ε∂εM ) ≤ 0; (∂2 ωM /∂ε∂εM ) ≤ 0. As (∂T/∂ε)=t(∂ωM /∂ε)M and (∂T/∂εM )=t(∂ωM /∂εM )M while ω > 0, (ωM ) > 0 and ∂ωM /∂ε ≥ 0 B.2.1 will always be ≥ 0.  Proof of Proposition 3. Differentiating 3.6 w.r.t. managers’ effort: ∂RM (ωM ) W M = − ∂εM [(ωM ) ]2

(B.3.1)

Clearly, the sign of B.3.1 will be –sign [(ωM ) ]. With a standard assumption of diminishing returns, B.3.1 will always be positive.  Proof of Proposition 4 (:). Differentiating 3.6 w.r.t. workers’ effort: ∂RM (∂2 ωM /∂εM ∂ε)W M = − ∂ε [(ωM ) ]2 as ∂2 ωM /∂ε∂εM ≤ 0, B.4.1 will always be positive.

(B.4.1) 

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Proof of Proposition 5. Differentiating 3.5 w.r.t. t will yield:  

 M M ω + ψμt ∂ωM M − ψμ ∂ωM M W + (1 − ψ)μtωM M W (1 − ψ)μω ∂R L ∂ε L ∂ε L L =  2 M ∂t ω + ψμt ∂ω∂ε M L (B.5.1) which can easily be reduced to:   M M ω − ψ ∂ωM W W W (1 − ψ)ω μ ∂R L ∂ε   = ∂ωM M ∂t  ω + ψμt

(B.5.2)

∂ε L

Thus, sign(∂RW /∂t) = sign[(1 − ψ)ωM ω − ψ(∂ωM /∂ε)WW ]. The expression in the brackets will be positive as long as: 1−ψ ∂ωM 1 W ≥ ψ ∂ε ωM ω multiplying and dividing the right hand side by ε and ω and we get the following condition: η M W 1−ψ ∂ωM ε W ∂ε ω ≥ = ω ,ε ψ ∂ε ωM ω ∂ω ε ηω,ε ω



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