BOOK EXTRACT: Wellbeing Economics – Capital and the value of work

© Paul Dalziel and Caroline Saunders. Wellbeing Economics: New Directions for New Zealand is published by BWB Texts (Bridget Williams Books, Wellington). Reprinted by permission.

Two Lincoln University academics developed the concept of wellbeing economics after more than a decade of joint research projects.  This extract examines the contribution of physical capital and the value of work, including the difference between minimum wage rates and a living wage

Physical capital and wellbeing
Adam Smith observed that the ability of specialisation to increase the productivity of human work is due to three factors:

“... first, to the increase of dexterity in every particular workman; secondly, to the saving of the time that is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many.”

The third of these – the invention of ‘a great number of machines’ – is an example of investment in ‘physical capital,’ which covers human-made assets used in ongoing production. The amount of investment in new physical capital every year is substantial. Statistics New Zealand estimates that in 2012/13 New Zealand’s ‘gross fixed capital formation’ (that is, its total expenditure on business investment and new residential buildings) was $35.3 billion, or 22.7% of the country’s total expenditure that financial year.

Investment expenditure on such a scale is essential not only to increase worker productivity and raise living standards, but also to maintain full employment. This latter insight was explained by John Maynard Keynes in The General Theory of Employment, Interest and Money, published in 1936.

More than 75 years later, his language may appear arcane, but the analysis remains as important as ever:

“Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less than is required to induce them to offer the given amount of employment.”

Keynes’ theory rests on the idea that at least some people do not spend all their earned income; some is set aside as savings. Only the amount spent on consumption becomes new income for other people, who in turn decide how much of their new income to save and how much to spend.

This income-spending-income cycle continues until it eventually peters out. Keynes was the first to recognise that this process determines the aggregate level of spending in the economy each year.

Keynes then asked two questions. First, if the economy is at full employment, how much income is produced? Second, given the propensity to save of the country’s citizens, what is the total level of savings set aside at that full employment level of income? Since savings by definition must equal investment expenditure, the answer to this second question determines the level of investment needed to maintain full employment.

This key insight can be illustrated with reference to New Zealand’s experience after the global financial crisis in 2008. Gross fixed capital formation in New Zealand fell by 7.8% in 2008/09 and by a further 9.6% in 2009/10. As predicted by Keynes’ theory, these large falls in investment spending were accompanied by a sharp rise in unemployment, from 3.5% of the labour force at the end of 2007 to 6.9% by the middle of 2010.

Keynes called this phenomenon ‘involuntary unemployment’ since his analysis demonstrated that full employment cannot be restored by wage cuts when the lack of jobs is caused by insufficient investment. Individuals are powerless when the whole market system is affected by such a sharp shock. This can be disastrous for citizens because of the strong connections that exist between market employment and wellbeing.

Market employment and wellbeing
A recent article in New Zealand Economic Papers by Denise Brown, Julie Woolf and Conal Smith noted that a negative relationship between unemployment and life satisfaction is one of the strongest findings in the international literature on wellbeing economics.

This will not surprise many readers and indeed their article confirmed the negative relationship using New Zealand data: unemployment was one of four factors with a strong impact on a citizen’s life satisfaction reported in the New Zealand General Social Survey 2008. The three other factors (all positively related to life satisfaction) were health status, income and social relationships.

Competitive markets were described earlier in this chapter as the heart and lungs of national systems for supporting personal and communal efforts to develop wellbeing. Continuing that analogy, the experience of involuntary unemployment for any sustained period is like struggling continuously for breath. It is not simply that market goods and services are out of reach; it is also hard to participate in any value-added activities (including creating a normal family life or engaging in outdoor recreation) without the ability to make relevant market purchases.

The capability to find employment is therefore critical for wellbeing. Further, wellbeing requires decent work. This was emphasised in a recent United Kingdom study headed by Michael Marmot, Professor of Epidemiology and Public Health at University College London. Published in 2010, the Marmot report emphasised the risks to wellbeing of low-paid, insecure and heath-damaging work:

“Insecure and poor quality employment is also associated with increased risks of poor physical and mental health ... Work is good – and unemployment bad – for physical and mental health, but the quality of work matters. Getting people off benefits and into low-paid, insecure and health-damaging work is not a desirable option.”

Wellbeing is related to the capabilities of people to lead the kinds of lives they have reason to value. This sets a standard for defining decent work; it must provide sufficient income for workers and their families to live with dignity and participate as active citizens in society, including the ability to arrange healthy housing. The social standard for this income level is called the country’s ‘living wage’.

The living wage is higher than a country’s statutory minimum wage because of different social norms reflected in each concept. The minimum wage sets a floor for the socially acceptable amount earned by any worker (for example, a school-leaver in a first job). Because employers cannot pay a lower rate, it also sets a floor for the value produced per hour of work in any job.

This is an important benchmark in the national economy, but is clearly not designed to support a socially acceptable family life. This requires a higher wage, the living wage.

The Family Centre Social Policy Research Unit has estimated a living wage for New Zealand based on 2012 prices. The study by Peter King and Charles Waldegrave measured the minimum income needed for a socially dignified life in a household of two adults (one working full-time and one working part-time) and two school children (one aged under ten and the other a teenager). Their calculations produced an hourly rate of $18.40, nearly $5 higher than the 2012 statutory minimum wage of $13.50.

Although the minimum wage may provide adequate income for a school-leaver with no dependants, wellbeing problems arise when parents are in jobs paying less than the living wage. By its definition, an inability of parents to earn the living wage gives rise to child poverty and causes other damage to the quality of families’ lives.

It is therefore distressing to note the situation of adults aged 35-39 in the 2006 Census. Members of this age group had more than two decades of life experience since turning 15, during which time they should have developed valuable labour market skills.

Nevertheless, 40% reported total personal income below the annual value of working at the minimum wage for 40 hours a week (about $20,000). This suggests that large numbers of people in this age group, most of whom are parents, are not able to earn a living wage. This in turn indicates problems in New Zealand’s systems for developing and rewarding labour market skills.

© Paul Dalziel and Caroline Saunders. Wellbeing Economics: New Directions for New Zealand is published by BWB Texts (Bridget Williams Books, Wellington). Reprinted by permission.