Increasing welfare and reducing poverty

Rafael Pampillón y Cristina Mª de Haro. Professors. IE Business School

29 October 2015

The latest winner of the Nobel Prize for Economics, Angus Deaton, is optimistic about the future evolution of world welfare, because, even though there is still a great deal left to do, the economic situation is heading in the right direction

This year the Nobel Prize for Economics went to Angus Deaton for his work on poverty, wellbeing and consumption. The UK-born economist has effectively enabled a better understanding of the demands of economic agents and how they behave to secure the best possible results for themselves. He wrote an article on the subject in 1980 headed “An almost ideal demand system” together with John Muellbauer, a revolutionary piece of work considered to be among the twenty best articles published by the American Economic Review in the last hundred years. Hence it comes as no surprise that the demand system he suggested has served as a base for more recent analysis of the effects of economic policies on the welfare of consumers.  

Deaton linked his study of Microeconomy with that of Macroeconomy. A difficult balance to attain but essential for making decisions related to economic policy. Specifically, his work is centered on how tax reforms affect the allocation of consumers’ resources, or how economic agents distribute their income between savings and spending, which is basically the same thing. If we are capable of understanding and forecasting this behavior, we will also know how tax decisions affect the economic cycle. This is something that many a politician and many a government must surely learn to do. Unfortunately, many politicians still do not realize that tax policies should be anticyclical. 

What is more, Deaton has also contributed to changing the model used to research economic development. While traditionally research has been based on aggregate consumer data, the Princeton professor proposed a study of the consumption of individual families as an indicator of the level of economic development in a country. Hence, Deaton has often commented on the effects of key fiscal measures taken during the economic crisis on the welfare of different social groups.  

The problem arises when too much debt is run up during the expansive phase of an economic cycle, or, when governments have not been capable of implementing remedies before an impending crisis, which amounts to the same thing. The result is that the government then has to administer medicine during a recessive phase, which is often a far more painful process given that it reduces citizens’ level of welfare. All because it did not apply preventative measures. 

As Deaton demonstrates, as in many other fields in economics there are a series of false premises that are widely accepted among demagogues which collapses the moment they are subject to rigorous analysis. 

Austerity medicine 

One example of this is the well worn argument that the origin of the problems plaguing citizens in Spain and in many other countries lies with austerity policies. Austerity is not the root of the problem. Austerity is the medicine that has to be taken in order to restore the balance every economy needs.  

Fortunately, austerity programs have permitted the Spanish economy to return, little by little, to normality, bringing a higher standard of living than that experienced during the crisis, and a lower level of unemployment. An improvement, which, to use one of Deaton’s expressions, will eventually give citizens more hope and happiness. 

It is a hard path to tread, but if we stick to the route it will end well. The Spanish economy has been on the path it needs to follow to exit the crisis for a while now. As a result of austerity and improvements in productivity and competitiveness, Spain has seen a rise in export levels for both goods and services, and a fast rise at that. Investment levels are also recovering, driving up levels of employment (850,000 more workers in the last two years) which in turn has reactivated consumption. 

The latest recipient of the Nobel Prize for Economics seems optimistic about the evolution of welfare in the world over the next few years, and considers that the economic situation is improving, although there is still a long way to go. Many countries have to do a great many more things to reduce social inequality, and wealth is still concentrated in the hands of a very small percentage of the world’s population. It is also necessary to tackle other social needs, such as improving healthcare. Precisely in his latest work (The Great Escape: Health, Wealth, and the Origins of Inequality, 2013) Deaton examines the major positive effects of innovations in the field of healthcare have had on economic development and the reduction of poverty over the last 250 years. 

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