Considering the World’s Welfare

Considering the World’s Welfare

It’s not uncommon for me to start one of my articles with a statement which superficially suggests the topic of the blog. Of course, soon after in a declaration of my omnipotence, I’ll announce to the reader that what they had anticipated was in fact wrong.

Now, you’d probably think from that last paragraph I’m not going to do the same thing this time. But you’re wrong, I am.

But logical inconsistencies aside, I’m going to start today’s blog by telling you the point of today’s blog post: the cost of a world social security system.

The Thought Lab

One of the things you might not know about me, is that I love ideas. So much so, that one day I’d like to start a blog entirely devoted to them.

Of course whether I ever manage to achieve this is yet to be seen. But until that day I’ll be sure to keep up my habit of learning, writing and thinking about random stuff.

Bruce Willis or the Beach

Now, I may have mentioned earlier the idea of an ‘opportunity cost’.

Imagine you’re making a choice between going to a movie or going to the beach.

You figure that Die Hard IV is probably going to be reasonably similar to the last three and, being hungry, consider that scavenging food by sidling up to random picnics is easier to do near the sea (seagulls are great cover).

So you choose the beach, but in making this choice you’ve had to sacrifice quality time with Bruce Willis. Essentially this sacrifice is what we call the opportunity cost as it’s the forgone opportunity (seeing Die Hard IV) of doing that other thing (going to the beach).

Back to the World of Economics

So, the reason I was thinking about this is that I started to consider how we should go about making choices in the world of aid. For instance, when we are deciding to build a bridge in a remote community how do we know this is the best, or even a worthwhile choice? What do we compare it against? What’s the opportunity cost of an aid project?

Well, one of the ways we do answer this question is by conducting a ‘benefit cost’ analysis of a project. Again, for those of you who aren’t too sure what this means, essentially it’s just where economists attempt to see whether there are more potential benefits to a decision than costs. Crucially, this also goes beyond financial costs and should include all benefits and costs. Pain, happiness and the number of pigeons displaced.

However, a project needs to be more than socially profitable. A project also has to be better than the best known alternative. For instance, maybe getting Bruce Willis to the community to tackle poverty head-on is better than building a bridge to connect two community markets.

        

Talk Nerdy to Me

So we need to compare against a choice against the alternatives to confirm that it’s a good idea.

For example if the choice is between building a bridge, or giving money to directly to the community then the ‘social profit’ is the difference in net benefits achieved between the two alternatives.

Differently put, if the beneficiaries would benefit more by being given the money than having a bridge built over their house, then that’s probably a better choice.

In fact, this is the essential idea behind the ‘discount rate’ which is used as a benchmark for a reasonable level of social profit (or a rate of return) from a project. That is, it asks the question ‘how much would society (or a target community) benefit if it were given the money now’?

A Thought Experiment

So the thought experiment I would suggest we are undertaking (or at least should be undertaking) when doing development is, given that people tend to be pretty good judges of what they need or want:

Are the participants better off under the project than they would have been if I had just given them the money”.

Again, this is very similar to the question we currently ask, except we don’t tend to explicitly phrase it this way. But the point is if I can’t answer “yes” to this question, maybe I’m wasting my time having a bridge built.

Not convinced? Check out this:

This is essentially the level of economic growth which has accompanied aid expenditure.

The key idea I would like my good-looking readership to get out of this, is that the connection between aid and economic growth is far from settled. Even in a Keynesian sense.

Now, I’m not going to try and cover off everything around this idea, the gist is that there is a real possibility in some scenarios that we would be better off to simply hand people cash as opposed to engaging in more direct forms of devastation through development.

So this leads me to a different question, how much would moving to a global system of cash payments cost?

Coming Up With the Moolah

Assuming that our overall goal is to provide a minimum level of assistance to the world’s poorest. Let’s start small and take the UN’s word for it that there are about 2.8 billion people in the world living in poverty.

Again, I’m not going to argue about the appropriateness of this metric, this is just a thought experiment committed to paper.

Now assuming that this, reasonably arbitrary, $2 a day measure is a good benchmark or proxy for extreme poverty and that all people in this category are living on nothing, suggests that we would need around 4.1 trillion (365 x $2 x 2.8 billion) dollars in cash transfers to alleviate extreme poverty.

But Wait There’s More!

But, of course this assumes the poor have an income equivalent to $0, which is not true. So what we need to know is both how many poor there are and how far away they are from achieving our world safety net. Luckily, something called the ‘poverty gap’ provides us with this information.

Essentially, the poverty gap is the average level of income needed for a person to have them reach the $2 a day. A poverty gap of 17.8 per cent for the $2 a day benchmark suggests that on average those people who are below $2 a day need 17.8 per cent, or 36 cents, more income to reach the $2 level.

So based on this we might expect to foot a bill of $131 per year for each of those 2.8 billion people living in extreme poverty which amounts to a cost of $367 billion per annum.

Putting it in Perspective

So here’s the thing, $367 billion is already more than the world is giving in international aid, but it’s not very much when we consider that:

It also doesn’t seem like an unreasonable level of outlay given that it would provide for more than a third of the world’s population and is equivalent to less than one per cent of global GDP.

And Then I Sez to Murtle

Now of course I am completely aware these calculations are simplistic. For one, this idea is similar to Sach’s ‘Big Push’ (ie ramping up aid as per the ‘End of Poverty’). The calculations also ignore the delivery costs and the ‘C’ word….

Corruption.

It also ignores the administrative costs of setting up the system and population growth. But even if we doubled the annual cost in recognition of this, it is still less than one per cent of gross world product.

Furthermore, given that the distribution networks for money naturally follow the profit motive (which is hell-bent on efficiency) it seems plausible that direct transfers are likely to be less costly when compared with food drops and hiring armies of consultants. That is, moving physical quantities of stuff around is likely to be harder than their disembodied equivalent (cash).

There are also great examples of ideas, such as mobile money and bio-metric welfare distribution systems that allow money to be securely and efficiently transferred. So it seems unlikely delivery and administration costs would be prohibitive after systems were set up.

The ‘C’ Word

Also, although corruption is an issue, it seems plausible that a wider distribution network would be less able to be exploited as resources are more widely spread.

For instance, imagine two scenarios. One where there is a pot of gold at the end of the rainbow, and the other where the leprechaun, being drunk, has spread coins everywhere.

If we had to choose between the two scenarios we’d probably prefer the one without the clumsy leprechaun, as getting the same amount of gold coins is easier if it’s neatly in a bucket. Similarly, a key concept surrounding the ease of corruption occurring is how valuable and ‘capturable’ a resource is.

A welfare system, I would argue, is much further from the obnoxious drunk leprechaun as the distribution of money is more diffuse and therefore harder to capture. Consequently, provided the distribution networks could be secured (which I consider plausible) corruption would likely be less under a global social welfare system.

Bottom Line

Now assuming you’re not brandishing a confederate flag and are still not convinced, how about this. A world social security system could be good for business.

And here’s how.

Firstly, economists talk a lot about this idea of the consumer sentiment, stimulus packages and consumption. Now this last one doesn’t necessarily mean over-consumption, it just means that people who earn an income will either spend it or put in in the bank. If you spend it, it goes into creating demand (and more employment) if you save it, the bank will lend it out to somebody else who needs money for longer term investment.

So if we take $367 billion from where it is needed less and move it to the hands of those who are poor, the total amount which is likely to be spent is likely to be higher. Not only that, but as a consequence of diminishing returns we might also expect that such redistribution would result in higher level of welfare (or happiness) for the world overall, as money is likely to be valued more highly by the poor (because they have less).

In addition, because consumption has gone up (as a consequence of proportionally less of it being saved) there is likely to be an increase in global employment. Now, although this would be partially offset by diminishing employment in those industries that produce goods that rich people buy (as the rich would spend less on sharks and lasers), this is still likely to increase global employment overall, or at least redistribute it to more valuable industries.

Social security can also help encourage people to take risks and make longer term investments like getting an education or starting a business. Would you try to learn the trapeze without a safety net?

Welfare systems are the safety nets of life. If you don’t have them people are likely to be more reluctant to engage in risky ventures. Particularly as we tend to overestimate the  downside risks, so if there is nothing to catch us when we fall we might not innovate. So a world safety net might actually drive greater innovation and increase a person’s willingness to invest in themselves (through education).

Social security systems are also like economic suspension systems. What I mean by this is that because having a social security system guarantees a certain level of income for the poorest; when times are tough  and there are greater numbers of the poor there is also more support provided, boosting employment and taking the edge off a global downturn.

Leaving the Lab

Now I’d be opening myself up to ridicule if I suggested this was a holistic assessment of what is a very complicated idea.

But what I would like to suggest is that we don’t have to consider aid to be a form of charity distributed by armies of development experts. On the contrary, it can be a practical application of what we would expect in our own country.

It is also born from the realization that there are some fundamental standards that we expect to be fulfilled for ourselves regardless of where we are born. But I’ll let Rawls take it from here.

If you’re interested in reading more about this idea, from somebody who doesn’t use leprechauns for examples check out this.

Giles

I'm an economist, data geek and public speaker.

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