(This essay was published in South China Morning Post on 21 October 2015.)
Professor Angus Deaton won the Nobel Prize in Economics this year for his work on consumption, poverty and welfare. I have always greatly admired his work and I use his book, The Great Escape, in my freshman common core course on “Poverty and Growth in the World”.
Deaton’s work has three critical elements for understanding poverty and welfare in both developing and developed countries.
First is that income is not the only thing that matters in determining the well-being of individuals and households. By implication, the obsession in both rich and poor societies with using income to measure welfare is incomplete and could be misleading for our understanding and policy design to tackle poverty or inequality.
Time free from work is a non-income measure of well-being. Increases in productivity lead to higher incomes but also reduce the amount of time a person spends at work. Time not spent in work is not idle or wasted. It is often spent investing in human capital (including studying, training, exercising and sleeping) and in play.
Increases in life expectancy due to better health have also greatly increased well-being. A better measure of well-being therefore must also include the additional time available to an individual when productivity, health and income increase.
To appreciate the significance of this, consider the consequences of recognizing health as an element of well-being. A general empirical observation is that the rich have better health than the poor, and people in developed nations on average have better health than those in developing countries, as reflected in longer lives, fewer sick days, taller body heights, and other measures of health robustness.
These indicators are strongly correlated with income across individuals, across countries, and over time. But the correlation is not perfect. It cannot be reduced only to income effects.
In fact, the health gap between rich and poor individuals, and between rich and poor nations, has both narrowed and widened depending on which age groups are affected by advances in medical treatments.
Empirical economic work by Gary Becker (also a Nobel economist) and others have found medical and scientific breakthroughs that reduce mortality among people younger than 50 from infectious, respiratory, digestive, congenital, perinatal, and “ill-defined” conditions are responsible for most of the increase in life expectancy of all individuals. This not only increases welfare for all – it reduces relative inequality both within and across countries, and contributes to a more equal distribution of well-being.
However, recent medical breakthroughs that reduce mortality after age 50 from such things as AIDS and conditions affecting the nervous system, senses organs, and heart and circulatory system, have contributed to increased health inequality across countries and also within rich nations.
The second critical element of Deaton’s work is his deep understanding of individual consumption choices. He focused on the lifetime outcomes of well-being and income and not just at a particular moment in time, which the popular Gini-coefficient of household income dispersion measures.
Milton Friedman was the first to emphasize that individual and household incomes vary considerably from year to year, and Deaton developed that idea further. Evidence came in a study by sociologists Mark Rank, Thomas Hirschl, and Kirk Foster that looked at 44 years of longitudinal data for individuals in the US aged 25 to 60 and found 12% of the population spent at least one year in the top 1% of the income distribution over their working lifetimes and a whopping 73% spent a year in the top 20%.
A big part of short-term mobility in income is simply transitory ups and downs. A relevant consideration of well-being is therefore total outcomes over an entire lifetime. One might more usefully ask whether income redistribution policies that raise the incomes of the measured poor can reduce lifetime and cross-generational income differences between rich and poor.
The third critical element of Deaton’s work is that it reminds us how economic theory can guide policy design to alleviate poverty and inequality. Deaton has taught us that health is as important as income in human well-being, and that lifetime outcomes are more relevant than snapshots of a moment in time. His work on the economic theory of consumption guides us to focus on the importance of education, health care, and early childhood intervention policies that help young children in poor families, as a critical focus of any policy to alleviate poverty and inequality.
Income redistribution policies that are aimed to support the consumption of the poor will be successful in reducing poverty measures based on Gini-coefficients, but Deaton has taught us that the alleviation of poverty is not about fixing measures. He also recognizes the inequalities that reward effort, risk taking, and luck are necessary even as society escapes from poverty.
