(This essay was published in South China Morning Post on 23 July 2014)
Tackling poverty is a very difficult problem. First there is the issue of the causes of low income, which boils down to one thing – low productivity. This requires solutions that open up economic opportunities and enhance the capacity of the poor to become productive.
Second is how to tackle the direct consequences of poverty. A poor person can only afford a low level of consumption. Giving him an allowance alleviates its direct effect. This can be accomplished most efficiently through a cash-based income redistribution policy rather than cumbersome subsidies-in-kind.
The government’s proposed “Low-income Working Family Allowance” aims to provide such an income supplement for low-income working families below (or nearly below) the newly-defined poverty line. This proposal is quite similar to the earned income tax credit scheme in the U.S., which is a refinement of Professor Milton Friedman’s negative income tax proposal.
Friedman argued that income redistribution by government was justified because relying solely on voluntary private charity would lead to a free rider problem – if someone else gives charity to help the poor, I would be able to benefit from the charity of others. This leads to too little charity.
Friedman also argued for moderation in income redistribution so that it was targeted at those who could not help themselves through no fault of their own.
Two considerations are relevant here. First, negative work incentive effects cannot be avoided. A person receiving the cash subsidy also has a reduced incentive to work because he is now paid to enjoy leisure and consumption – this is the famous income effect. The work disincentive problem is particularly acute in rich societies because labor force participation declines as leisure is increasingly valued.
Second, in an ageing population the effects of reduced total hours worked and labor supply cannot be ignored. Both factors are rising in Hong Kong.
That people respond to incentives is clearly revealed in the data.In the past two decades, the percentage of Hong Kong people not working “for no compelling reason” increased dramatically from around 0.5-1.5% in 1986-1996 to 2.0-4.5% in 2001-2011. This occurred among both men and women, from 20 to 59 years of age.
“For no compelling reason” means they are not looking for a job, not at school, not sick, not in prison, and not homemakers. They have just decided not to work.
Why has there been such a big leap in these individuals? An obvious answer is the big increase in social welfare transfer spending, which more than doubled from 6.0% of government spending in 1993-94 to 13.8% by 2007-08.
The growth of government expenditure on subsidies and transfers is not confined to Hong Kong. There has been phenomenal growth across Western economies, too, rising from an average 1.1% of GDP around 1870 to 23.2% in 1995.
When over one-fourth of GDP is redistributed to help the underprivileged, one would expect poverty to have been considerably alleviated in these societies. But this has not happened. Poverty in the West has not improved by much over time. Helping the poor is a laudable goal, but let us not go overboard – we need both warm hearts and cool heads.
It is important that the “Low-income Working Family Allowance” avoid providing an overly generous program. The government’s proposal aims to mitigate the work disincentive effects by making the amount of subsidy contingent upon hours worked. Whether it will succeed depends on the details, which has yet to be debated in Legco.
Most likely, income redistribution has its limits in alleviating poverty; and like everything else is subject to diminishing returns. Poverty alleviation has to be tackled through another front – economic growth.