A Common Trap in Growth-Disparity Argument

Fumio OTAKE (Professor, Osaka University)

Recently there has been argument between those who emphasize the importance of economic growth and those who insist on reduction in economic disparities in Japan. From an economist's viewpoint, it is interesting to point out that neither side is talking about the absolute level of economic affluence.

Just to look for economic well-being, the policy objective could be to maintain the current level of affluence or to raise the standard of living for the poorest people. In reality, that is not the case, but the point of policy argument is the rate of economic growth, which is relative changes in income compared to the past level, and also the degree of disparity, which concerns one's relative well-being compared to others.

In traditional economics, people are supposed to obtain satisfaction out of the amount of goods and services that they consume themselves. It seems, however, that many people tend to be more sensitive to changes or relative positions in income or consumption than their absolute levels in many instances. For example, people could be happier with a low, but growing income level than a high, but stagnant income level. The worst thing for the consumer might be ever decreasing income levels.

People could possibly be happier with an increasing annual income from $35,000 to $45,000 than with a decreasing income from $60,000 to $50,000. One might well feel unhappy with the annual income of $35,000, when the society's average annual income is $60,000, compared to the situation where one's income is only $30,000, but the society's average is also $30,000.

The feeling of happiness is somewhat like the feeling of altitude, as people cannot easily answer how high they are above the sea level, unless they have an altimeter, but it is much easier to tell whether they are going up or down.

For policy purposes, however, the criterion for affluence should be the absolute level of income or consumption. This is because unreasonable policies might result unless the absolute level of income is taken into consideration.

It would be unreasonable, for example, if those who feel unhappy with an income of $50,000, down from $60,000 in the previous year, are subsidized, whereas those who are happier with an income of $45,000, up from $35,000 in the previous year, are taxed to finance the subsidy. By the same token, it would be unacceptable if an income transfer is to take place from those with an annual income of $30,000, living in the area of the average annual income of $30,000 to those who feel unhappy about their income of $35,000, living in the area of the average income of $60,000.

The reader might think the above examples are too obvious to mention. In reality, however, it has often been the case that those with an annual income of $100,000 are protected from job cuts, because it is assumed that they would become very unhappy if they were fired and had to take up a job with a lower income of $30,000, although there are many workers with that low level of income all along.

This could happen, since those who feel very unhappy tend to resort to strong political power. Such human peculiarity might well explain unreasonable redistribution or regulation policies to transfer income from the poor to the rich in absolute terms. It may be for the same reason that the "ice age" for new recruitment occurred, while regular workers were protected, and also that reform of the social pension system has been resisted in Japan.

In order to avoid such unreasonable redistribution, it is necessary to think of the present and the future in terms of absolute levels, instead of comparing to the past or others, as in the growth or disparity approach.

(The original Japanese article appeared in the March 10, 2007 issue of Weekly Toyo Keizai)