Monday, March 31, 2008

Conspicuous Consumption

The last Mint Saturday Supplement (Lounge: 29/March) was devoted to the topic of luxury. That is one area where we can expect to see a lot more discussion in the coming years.
A strict economic definition of a luxury good is one that has a high income elasticity of demand, i.e. demand increases faster than the growth in income. And as we are in the middle of an unprecedented salary boom (at least for the readers of Mint), it would seem logical that luxury is dragged out of the closet and lists of the latest objects of desire or envy (depending on where you are on the elasticity curve) are drawn up.
In India, we tend to be a little apologetic about wealth - call it a hangover from Nehruvian socialism and/or Gandhi's 'pastoralism'; or more realistically, the fact there was too little of it going around for the last 50 years or so. And so the tendency has always been to look down upon it (nothing riles the intellectual snobs more than the naked display of wealth) and for the ones who did have it, the best thing to do was to stuff it in a pillow or at least, not admit to having too much of it. None of the chest-thumping variety of consumption (have it, flaunt it) that is common in the US. I would like to imagine that some of it was also the effect of religion as well - but the fact has been that has been more preaching than practice.

The story, however, is changing - in the last few years, people are increasingly not averse to spending more on discretionary items - including luxury goods. An interesting sub-category of luxury goods is what are called 'Veblen goods' (after the rabble-rousing Thorstein Veblen of the 'Theory of Leisure Class' fame). These are goods where demand actually tends to increase with the price. Apparently, this is because of the envy factor - if you believe that your social standing will go up in proportion with the price-tag, you would be willing to put down that premium. In effect you are buying social prestige - how very noveau riche, some would say.

It would all be very nice, if luxury consumption was just an economic oddity. However, social scientists have been pointing out for sometime that envy as a benign force with salutory effects may work in developed economies but in case of developing economies, where income (and wealth) disparities tend be very large, this could have social implications. Much has been written about this - what remains to be seen is how as societies, we cope up with these kind of trends. This will probably be capitalism's greatest test - can it ensure that economic growth is rapid and inclusive enough to offset the potential for social unrest and such pangs that growth brings along with it?

Friday, March 28, 2008

The economics of happiness

Bhutan recently held general elections (in a planned transition from an autocracy to democracy - quite an interesting process in itself, but that does not concern us). The Royalist Party that won the elections pledged to continue the king's focus on Gross National Happiness (See article).
Needless to say, this is an interesting concept - especially where the mainstream economic and policy thinking revolves around the measurement of material well-being and growth (measured in monetary terms). See the article for how the Bhutanese interpret this concept. While it does sound like an attractive proposition, there are two obvious challenges:
1. How do we measure GNH? Happiness is a devilishly elusive concept - one man's happiness may be the next one's gripe. T
2. The bigger challenge is how do we compare GNH across countries or within a country across states?
3. Third and most importantly, happiness is largely an individual goal - as the hedonist would say, to each his own. In fact, the religions (at least the major non-Semitic ones - Hinduism and Buddhism) have squarely put the responsibility of the definition and subsequently, the pursuit of happiness on the individual. Given that, would it be possible to arrive at a common definition of happiness?
Bhutan, which is largely dominated by a single ethnicity and more importantly, a single religion, may attempt a GNH, but try that in the bewildering diversity (economic, social and religious) that is India. Cannot imagine the argumentative indians agreeing on a common definition.

One of the biggest advantages of the traditional measures of GDP/GNP has been the ability to compare differential growth rates and/or prosperity levels. That serves as an important tool in making policy decisions, especially allocation of resources. Unfortunately, the human race (with its economists, philosophers, godmen et al) has yet to come up with a standard that can improve upon the existing standard measure - money. Since the birth of money, we have come to accept that as a common standard that can be used to assign a value to any TRADEABLE good/service. The assumption here being that anything that is tradeable can be exchanged between two or more individuals and if that be so, it needs to be assigned a value that all the parties could agree upon (that at least is the primary assumption of economics). Conversely, we have also seemed to accept that whatever is not tradeable is not worth measuring in terms of money - which brings us back to the original question - what is the price of happiness, which is clearly not a tradeable commodity?

That said, there is certain merit in taking a more holistic approach to development - something that goes beyond the singular focus on material growth. Such examples abound - selling more cars is good for the economy but that leads to pollution, traffic jams etc which have a definite cost attached to them. So what is the net cost/benefit of putting an additional car on the road?

But then, as the economist would say, it is futile to try and devise a GNH - a worthier goal may be to eliminate all the externalities (positive and negative) so that the 'true' cost can be arrived at, and let the market make the decisions. That of course, is based on the rational choice theory - which, some say, credits the homo economicus with too much intelligence!

Wednesday, March 26, 2008

Global Warming

Yesterday's papers carried a small news item on the melting of the Wilkins glacier in Antartica (NY Times Article). I am sure most people chose to gloss over it - for a few, there may have been a slight pang of guilt (myself included) but for most, it would amount to some remote news item of little immediate interest. In almost all cases, readers would find it impossible to accept any responsibility for this, just as most people fail to accept any personal responsibility to problems arising out of collective failure like global warming, traffic jams et al. This has often been characterized as the prisoner's dilemma, where participants often maximize their own payoffs, at the cost of the 'collective payoff' (creating a pareto-suboptimal solution).

Here in lies a paradox that has continued to flummox economists for several years now (at least the proponents of behavioural economics) - the fact that we humans consistently end up failing to factor the long-term consequences of our immediate actions. One possible reason could be that we are hard-wired for such behaviour. In the hunter-gatherer mode with the constant threat of predators, natural forces etc, it is hard for the brain to look beyond the next few meals. Even so, it is extremely difficult to quantify the complete set of externalities (negative and positive) in many cases - most notably in the case of environment. What is the incremental impact of switching on the air conditioning in your car? Can the environmental cost of that be built in to the cost of petrol? Assuming yes, who is the beneficiary of that cost? Does it go to some environment fund? The implementation challenges are obvious.

Which then begs the question - is there any point in even trying to influence/change this behaviour? This obviously has profound policy implications - the most obvious (and pressing) issue at hand being global warming and the policy choices to keep the human race from destroying the planet, or at least postponing the inevitable.

The good news is that the academics are beginning to sit up and take notice - hopefully, there will be some solution frameworks soon and then the challenge will be to get the governments to adopt them. One such solution that is being tried out is the idea of carbon credits , which could work at the industrial level - it is possible (and is already happening) to impose carbon charges on polluting industries and also award carbon credits for non-polluting ones and then monetize this by creating a trading market for these credits. The real challenge is to move this to the individual level - i.e. impose/award carbon charges/credits for individual decisions. Measurement (how to measure, how to charge) and agency (who charges and who gets to keep the charges etc) issues need to be overcome.