STIGLITZ2003rev
Global Public Economics
A B Atkinson, Nuffield College, OXFORD
1 Global Public Economics
My title combines the research interests of Joe Stiglitz circa 1970 with those
of Joe Stiglitz today.
In the late 1960s/early 1970s, there was a flowering of the field of “public
economics”. This brought together the theorems of general equilibrium and the tools
of dynamic optimisation with the traditional concerns of public finance and welfare
economics. Consideration of equity and efficiency drew on the latest developments in
moral philosophy. It was a heady cocktail. Arrow-Debreu and Ramsey-Samuelson
and Bentham-Rawls all mixed into Richard Musgrave’s Theory of Public Finance
(1959). It was a cocktail that brought not just refreshment but also considerable
insight into the analysis of policy. There were advances in understanding both
positive and normative issues.
The lessons of public economics have wider application than to public finance
issues, but these lessons have diffused slowly. Robert Lucas once remarked that, as a
macro-economist, he had “greatly enjoyed [his] excursion into public finance ... How
refreshing it is to spend some time in the company of a group of applied economists
who simply take for granted the desirability of using (and extending) the powerful
methods of dynamic general equilibrium theory to gain a deeper understanding of
policy issues” (1990, page 314). This remark is generous but reveals the extent to
which public economics has not been assimilated into the mainstream of economics.
Its main lessons have not been fully disseminated in the profession. Nowhere is this
failure of communication greater than discussions about globalisation. Many of the
global issues being currently discussed are concerned with public policy: tax
competition, survival of welfare states, global public goods, trade policy, role of
multinational corporations, worldwide inequality, and the financing of the Millennium
Development Goals.
In order to create a global public economics, at least three elements are
required. The first, on which considerable progress has already been made, is the
analysis of national policy in a global context. Models of tax competition, for
example, have been extensively investigated. Here I concentrate on two further
elements: the need for developing models appropriate for the analysis of policy
incidence in an interdependent world, and the application of principles of
cosmopolitan justice to the normative issues of global policy making. There are of
course many other promising avenues, but space does not allow me to explore them
here.
2 Modelling Policy in an Interdependent World
One important ingredient in making progress in economic analysis has been
the development of new models. A classic example is the introduction into public
finance by Arnold Harberger (1962) of the two-sector general equilibrium model
widely used in international trade theory. The model allowed the formalisation of
existing insights into tax incidence and the derivation of new results. The trade model
provides the example that I take here. The standard Heckscher-Ohlin model of 2
countries, each with 2 sectors, using 2 factors (“the 2 x 2 x 2 model”) has been used to
examine the implications of different redistributive policies in a model of increasing
global trade. Contrasts have been drawn between a country with clearing competitive
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labour markets (the “US”) and a country with a wage floor governed by minimum
wage legislation or unemployment benefit (“Continental Europe”). Opening up of
trade with newly industrialising countries (NICs) shifts demand away from products
that use unskilled labour intensively. In the “US” case, the relative wage of unskilled
workers falls, causing increased wage dispersion. In the “European” case, relative
wages are fixed, and the result is unemployment for unskilled workers. In this way, we
have a unified explanation as to how a single cause – increased trade with NICs - has a
differential impact on the US and on Continental Europe.
However, as Donald Davis (1998) has pointed out, we cannot look at two
parallel universes with 2 trading regions (in one case US and NIC, and in the other
Europe and NIC). We need a minimum of 3 trading regions (US, NIC and Europe). If
in a unified analysis the US and Europe both produce the good that faces NIC
competition, then the wage floor in Europe determines the relative goods prices (in a
standard two good two-factor Heckscher-Ohlin model, where it is assumed that one
good uses unskilled labour relatively intensively). If the minimum wage is unchanged,
this prevents the relative price from falling. The US is therefore unaffected by
increased trade. Europe bears the brunt in terms of unemployment. On this basis, the
outcry about globalisation should be in Europe not in the US. On the other hand,
Europe may be protected to a degree because it has already become specialised in
goods that use skilled labour intensively. If, in the standard trade theory model, we
allow the EU to have become specialised, then the consequences of opening trade are
different. Suppose that the NICs are specialised in the good that uses unskilled labour
intensively. Their entry into world trade drives down the price of this good, and
hence causes the relative wage of unskilled workers to fall in the US, which produces
both goods. We then have the US side of the textbook conclusion, but not the
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European side, since the demand for the good using skilled labour intensively is
higher, causing a fall in unemployment. Either way, one or other part of the
explanation cannot apply. It is not therefore a simple application of standard theory of
the Heckscher-Ohlin variety. The model has to be expanded.
We have to move to a 3 x 2 x 2 model. In many cases, moving from 2 to 3 in
economics adds nothing but complexity. But here the third dimension is crucial.
Indeed, I believe that we need 3 factors and 3 goods as well as 3 countries: a 3 x 3 x 3
model. The 2 factors identified above were skilled and unskilled labour. This serves
to highlight one aspect of income distribution: the dispersion of wages. It does not
however illuminate the role of capital income. Changes in the real rate of return can
have powerful distributional consequences, particularly at the very top of the
distribution. We need therefore to incorporate capital as a third factor. This allows us
to address the classic, but now neglected, question of the distribution of national
income between capital and labour. The behaviour of factor shares must be part of the
story. Factor shares in turn have to be linked to the distribution of income among
persons. Here, the model of Stiglitz (1969), drawing on the work of James Meade
(1964), remains the key theoretical reference, even if it needs to be supplemented by
introducing intermediaries such as pension funds.
Much of the structural change in modern industrialised economies concerns,
not agriculture and manufacturing, but manufacturing and services. The growth of
service employment is a major element. We need therefore a three good model.
Services may in the past have been treated as a non-traded good, but this may be
changing as a result of new technology. Indeed, one way of representing the impact of
increased globalisation would be to open to international trade the third service sector
in a 3 x 3 x 3 model.
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The model has moreover to be made dynamic. Factor supplies are evolving
over time. Skill is a matter for investment as well as endowment, and the incentive to
invest depends on the rate of return. Rising dispersion may in part be a reflection of a
rising real rate of return on capital. Here too is work for the research agenda. The
model of structural change advanced by Simon Kuznets (1955) has been used to
throw light on the evolution of the distribution of income by Sudhir Anand and Ravi
Kanbur (1993), among others, but the standard Kuznets model lacks both of the
ingredients in which we are interested. The economy is assumed closed to foreign
trade, so that globalisation has no direct role. There is no redistributive state. Nor is
the accumulation of capital usually treated explicitly. The model has to be enriched to
provide a basis for the analysis of public policy in a global context.
I introduced the example by reference to the role of economic models, but the
policy relevance is clear. The role of the welfare state in a globalising world is one of
the central policy issues facing Europe, and the implications of European decisions
will be felt in the US and in the developing world. The US policymakers calling for
greater labour market flexibility in Europe may be aware that this can raise the rate of
return to capital in the US. This possibility is not however widely recognised in the
public debate. Nor is the impact on the US labour market. A weakening of the
position of the less skilled in Europe will spill over to the US. Moreover, if the
relative wage of the unskilled falls in Europe, this will reduce the relative price of the
good using unskilled labour intensively, and this will turn the terms of trade against
the newly industrialising countries. World output may rise, but some of the gains to
European economic performance may be achieved at the expense of poorer countries.
If welfare states in Europe become more ‘competitive’, then this can reduce the
opportunities for the rest of the world.
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3 Cosmopolitan Justice and Global Redistribution
The evaluation of policy has been a key part of public economics. Its role has
perhaps been misunderstood. A false dichotomy has been created between public
choice theory and welfare economics. The purpose of the literature on optimum
taxation, for example, is to illuminate the structure of arguments that take place within
a political context. It seeks to test these arguments and see whether the policies
proposed in the political debate follow from the professed objectives of the
protagonists.
In a national context, welfare economic arguments have often been founded,
explicitly or implicitly, on a moral calculus. The whole Pigouvian tradition of public
finance was deeply influenced by Benthamite utilitarianism. As it was put by Paul
Samuelson, “to a man like Edgeworth ... individual utility – nay social utility – was as
real as his morning jam” (1947, page 206). More recently, it has been recognised that
individual welfares can be aggregated in different ways, ranging from distributional
indifference through to Rawlsian concern with the least advantaged. And a variety of
non-welfarist objectives have been taken into account, including explicit treatment of
horizontal equity. As shown by Stiglitz (1982), horizontal equity may be a biding
constraint on policymakers, since the pursuit of social welfare maximisation, or even
Pareto efficiency, may be aided by random taxation.
In a global context, however, we cannot appeal to such ready-made principles,
and the calculus is more complex. The issue has been well stated by Amartya Sen
(1999). He distinguishes two positions and argues that neither is satisfactory. The first
is “national particularism”, where welfare judgments are made for each nation treated
separately, and then the relations between nations governed by an over-arching
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judgment involving international equity. Whereas one can understand some of the
principles that may apply to the over-arching judgment, this form of “two stage”
evaluation does not allow, as Sen notes, for direct relations across national
boundaries. Direct consideration of the position of individuals may call into question
policy changes positively evaluated by this procedure but which involve transfers
from poor people in richer countries to richer people in poor countries. The second
position responds to such concerns by supposing what Sen calls a “grand
universalism”, where we have a global social welfare function in which everyone
enters symmetrically and where nationality has no role. On this view, the country in
which one lives has no intrinsic claim on our attention. Such a position is, in my view,
less easily dismissed. A global social welfare function is a valid point of reference.
However, it would not be sensible to construct a normative theory of global public
finance solely on this basis, totally ignoring nationality. National governments, by
revealed preference, appear to give greater weight to their citizens, and it would be
natural to consider the implications of national social welfare functions where citizens
received a greater weight than non-citizens.
Some people may suppose that these matters are largely abstract. In fact they are
highly relevant to the issues of public policy with which Joe Stiglitz has been involved in
recent years. The World Bank regularly publishes estimates of the number of people in
developing countries whose income is less than $1 a day, and halving the proportion
poor is one of the Millennium Development Goals (MDGs). To achieve the full set of
MDGs is going to require a substantial increase in the flow of resources for
development. In considering how this flow is to be ensured, one has to consider the
impact on people in the transferring counties. Are higher taxes in donor countries
going to be borne in part by lower income groups, aggravating poverty in those
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countries? If so, then how can these be balanced? We then have to confront the tension
between `absolute' definitions of poverty, such as the $1 a day standard, and the
thoroughgoing relativity adopted in many OECD countries when measuring poverty,
where the poverty line is set as a percentage of median income. On the first basis, there
is little or no poverty in donor countries, but on the second basis risk of poverty remains
a serious concern, as witnessed by the European Union programme for social inclusion.
How can these be reconciled? One line of reasoning is to postulate a hierarchy or lexicographic order - in the field of poverty. Poverty is first defined on an absolute
basis as referring to people whose income is insufficient to cover physical basic needs.
When this is achieved, poverty is then defined on a relative basis as referring to people
whose income does not allow them to function properly in their social environment. In
this case, meeting the MDGs would have priority. A second line of reasoning consists of
making relative and absolute poverty two dimensions to be evaluated jointly through
some aggregate index. Such a view leads to defining poverty uniformly in all countries
as some combination of the absolute and relative poverty concepts. As is developed in
Atkinson and Bourguignon (2000), overall poverty is a weighted combination of
poverty in developing and developed countries. Such a measure may become
increasingly appropriate as an increasing number of countries acquire middle-income
status.
The welfare economic basis for global public economics is an important area
for future research. In grappling with these questions, economics can fruitfully cooperate with other disciplines. In particular, the flowering of literature on
cosmopolitan justice in the fields of political theory and philosophy may well
influence global public economics in the same way that John Rawls and Robert
Nozick influenced national public economics 30 years ago.
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References
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Atkinson, A B and Bourguignon, F, 2000, “Poverty and Inclusion from a World
Perspective” in H de la Largentaye, P-A Muet, J-F Rischard and J E Stiglitz, editors,
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Davis, D R, 1998, ‘Does European unemployment prop up American wages? National
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Harberger, A C, 1962, “The incidence of the corporation income tax”, Journal of
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Kuznets, S, 1955, "Economic Growth and Income Inequality". American Economic
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