August 22, 2010
The Decline in American Optimism
The Decline in American Optimism—Posner
I don't put much weight on public opinion polls that show a drop in Americans' optimism about the economic future of the country. Optimism and pessimism are personality traits that condition people's reaction to uncertainty, but they are also influenced by uncertainty. This was one of Keynes's insights. When a sharp economic downturn creates the kind of uncertainty about economic prospects that we're now observing, people's "animal spirits" (his term for optimism) droop; hoarding increases and entrepreneurship flags. These are rational responses to uncertainty, but they do not predict a nation's future economic performance.
There are, however, objective reasons to worry that the nation's economic growth may be stunted for years to come. One reason is the high level of international political instability threatening to U.S. interests (think of Pakistan, Iran, Afghanistan, Iraq, Lebanon, Yemen, and North Korea, and of potentially tense relations between the United States on the one hand and Russian and especially China, on the other hand), which will require the United States to continue to spend disproportionately on national security. A second reason for concern is looming fiscal crisis in the United States, as a result of a diminished tax receipts, huge and growing federal public debt, uncontrolled entitlement spending, and deterioration in state and local government finances. And third is our government's inability to address in a serious fashion, let alone solve, a host of serious structural problems. We badly need tax reform, education reform, health reform, immigration reform, environmental reform (with emphasis on climate control and preserving biodiversity), repeal of the drug laws, a reduction in economic inequality (with particular emphasis on improving the lot of the black underclass), a better transportation network, and a slimmed-down public sector. Our political system seems incapable of achieving improvements in any of these areas. So we need reform of the political system, but that is blocked by a combination of incumbent self-interest and a constitutional structure optimized for eighteenth-century conditions.
In assessing the likely impact of these factors on our economic future, we need to distinguish between per capita income and a more inclusive measure of social welfare—call it happiness or utility (though, depending on how "happiness" is defined, it might better be regarded as a component of utility; see Becker's comment on a well-known paper by Stevenson and Wolfers, which together with the paper can be found at http://bpp.wharton.upenn.edu/jwolfers/Papers/EasterlinParadox.pdf, analyzing the correlation across countries of happiness with income). Per capita income is a proxy for and input into happiness, but it is not a synonym for it. If there is diminishing marginal utility from increased income, then an increase in income inequality, which we have been experiencing of late and which may continue, may offset the effect of an increase in average income on utility. So also an increase in the average age of retirement as a result of increasing the age of eligibility for full social security benefits (one reform that is at least conceivable), or other increase in hours worked, are offsets to increased per capita income. But against this is the seemingly continuous increase in the quality and variety of most products and services. (Not all: airline service has deteriorated markedly since the 1990s and traffic congestion has increased.) Increased longevity, and the greater youthfulness of most middle-aged and elderly people, are only the most dramatic signs of impovements in welfare that are related to but not adequately proxied by increases in average personal income.
Innovation is costly, so if the rate at which per capita income rises declines, the rate of improvement in the quality and variety of goods and services will slow. Nevertheless that improvement will continue even if per capital incomes stagnate.
While, as Becker points out, per capita income has been growing in the United States for a long time at an average annual rate of about 2 percent, happiness has been growing at a much lower rate, if at all. People in 1810 were not sad at the thought of how much better people would be living in 2010; and people in 2010 take for granted improvements in product quality before they were born. One has to be a certain age to appreciate these improvements; the first car I drove was a 1953 Pontiac.
The issue of increased per capita income over time is often discussed in terms of parental preferences: parents want their children to be better off than they. Here I think the distinction between income and welfare is critical. I believe that most parents want their children to be happy, though some want them to be successful even at some (modest) cost in happiness, rather than to be financially better off than they (than the parents). The farther down one goes in the income distribution, however, the closer the correlation between income and happiness; this is an implication of diminishing marginal utility of income. So poor people, or people who are not poor but are beset by anxieties, do want their children to be better off financially than themselves; but I do not think people who are well off do, or at least should, want their children to have higher incomes than they. Parental altruism implies concern for children's welfare, rather than for children's incomes per se; and the higher a family's standard of living, the less likely an increase in that standard in the next generation is to increase happiness.
Will the Next Generation be Better off Than Their Parents' Generation? Becker
The great majority of parents would like to see their children become better off economically than they are, and that hope would be even more common among the children. Yet, polls for a while have suggested that neither the majority of children nor parents in the United States are confident that this progress will happen. Despite frequent recent commentary on these polls, little systematic analysis has been presented of what determines whether the average child will be better off than the average parent, and why pessimism about such progress has apparently grown in the US.
The relation in particular families between say the earnings of adult children and those of their parents at comparable ages depends on many factors unique to any family. The abilities and health of the children relative to that of their parents, the luck of both children and parents in occupational and other choices, how concerned are the parents about ensuring that their children will become better off than they are, and many other considerations special to that family. I will not deal with individual family idiosyncratic factors, and instead focus my analysis on how well average persons in one generation fare compared to average persons in their parents' generation.
The rate of growth in per capita income is by far the most important single variable in determining whether children will be better off than their parents. If per capita income is stagnating over time-the lot of the world throughout the vast majority of history- the average person in one generation will tend to be about as well off as the average person in his parent's generation. Expectation during this long history of time that children will be better off then their parents would have been atypical.
During the past couple of centuries, much of the world has experienced systematic growth in per capita incomes that has radically changed such expectations. For example, if income per capita were growing only at 1 percent per year, the average individual in the next generation would have about a 30% higher income than the average individual in the present generation- I assume that generations differ by about 25 years. From about the middle of the 19th century to the beginning of the 21st century, per capita incomes in the US grew on average close to 2% per year. This implies that over this period of more than 150 years, or about 6 generations, the average income in one generation would have been about 60% higher than the average income in the prior generation.
Add to this that health improved rapidly during the 20th century as mortality of mothers during childbirth and that of children during their first 3 years were virtually eliminated, and that the huge number of immigrants to America did vastly better than their parents did in their home countries. No wonder that optimism abounded in the United States about how children would fare compared to that of their parents. The decline in this optimism is mainly related to declines in expectations about whether the US will continue to grow at similar rates as in the past.
The difference between generations is even more dramatic in rapidly developing nations. Consider, for example, China with a per capita income that has been growing at around 8% per year since about 1980. In such a growth environment, the average income in the next generation would be more than six times larger than that in the present generation. No wonder most Chinese families are happy with what is happening in their country and with their government's policies, despite various restrictions on freedom of speech and writing.
Comparisons among the income and health of the average person in different generations are not the only determinant of wellbeing and optimism about the future. Changes over generations in the degree of economic inequality also have important effects. Inequality has increased considerably since 1980 in the United States, and many other countries, developing as well as developed. When inequality is growing between generations, even if per capita income were stagnant, families at the higher end of the income distribution in their generation would be optimistic about their children's prospects relative to their own, as long as they expect their children to also be at the higher end of the income distribution in the children's generation. Conversely, under the same conditions, parents at the lower end of the income distribution would be pessimistic about their children's opportunities if they expect their children also to be at the lower end of their generation's income distribution.
A third factor determining the relation between childrens' and parents' economic position is called the degree of intergenerational income mobility. That is, the degree to which richer parents are likely to have richer children relative to the income of the children's generation, and the degree to which poorer parents are likely to have poorer children relative to the children's generation. When the degree of intergenerational mobility is lower, rich parents will tend to be more optimistic about their children's prospects, and poorer parents will tend to be more pessimistic. Some evidence suggests that intergenerational mobility in the US has fallen some over time, which would lead to greater pessimism among poorer families about their children's prospects.
Despite the inequality that has grown by a lot since 1980, and intergenerational mobility that has apparently fallen, I believe that fears about economic growth are the main reason for the growing pessimism in the US about the long-term economic future. As I have argued on many occasions in posts on this blog, faster economic growth by the US can compensate for growing government debt, growing inequality, and other factors that create pessimism about the economic future.
I will not repeat much of what I have said previously on improving long-term economic growth in the United States and other rich countries (for example, see my most recent post on August 15th for some discussion of how to improve growth). I summarize these discussions by stressing three factors. Of greatest importance are improvements in the American K-12 school system available to students from poorer families, so that many more of these students graduate high school, and those who graduate are better prepared for college-the recent report on the results of scores on the ACT test is depressing reading since it shows that far more than half of all students taking the test are unprepared for college courses.
Second, it is important to have low marginal tax rates on personal and corporate incomes, and on capital gains, in order to stimulate greater investments and innovations. Finally, entitlement need to be brought under greater control by shifting much more of medical costs to patients through greater out of pocket payments, and by converting public and other pension systems to defined contribution systems rather than defined benefit systems.
America has always been optimistic about its future. The decline in such optimism during the past couple of decades is understandable, but highly regrettable. The best way to restore this optimism is to promote faster economic growth. That is feasible with the right policies, but will not happen automatically. Even America has no destiny to be optimistic about the future without important redirection of various public priorities.