The Economics of Welfare

Pigou, Arthur C.
(1877-1959)
CEE
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First Pub. Date
1920
Publisher/Edition
London: Macmillan and Co.
Pub. Date
1932
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4th edition.
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Part I, Chapter VIII
ECONOMIC WELFARE AND CHANGES IN THE DISTRIBUTION OF THE NATIONAL DIVIDEND

I.VIII.1

§ 1. IF income is transferred from rich persons to poor persons the proportion in which different sorts of goods and services are provided will be changed. Expensive luxuries will give place to more necessary articles, rare wines to meat and bread, new machines and factories to clothes and improved small dwellings; and there will be other changes of a like sort.*87 In view of this fact, it is inexact to speak of a change in the distribution of the dividend in favour of, or adverse to, the poor. There is not a single definitely constituted heap of things coming into being each year and distributed now in one way, now in another. In fact, there is no such thing as the dividend from the point of view of both of two years, and, therefore, there can be no such thing as a change in its distribution.

I.VIII.2

§ 2. This, however, is a point of words rather than of substance. What I mean when I say that the distribution of the dividend has changed in favour of the poor is that, the general productive power of the community being given, poor people are getting more of the things they want at the expense of rich people getting less of the things they want. It might be thought at first sight that the only way in which this could happen would be through a transference of purchasing power from the rich to the poor. That, however, is not so. It is possible for the poor to be advantaged and the rich damaged, even though the quantity of purchasing power, i.e. of command over productive resources, held by both groups remains unaltered. This might happen if the technical methods of producing something predominatingly consumed by the poor were improved and at the same time those of producing something predominatingly consumed by the rich were worsened, and if the net result was to leave the size of the national dividend as defined in Chapter V. unchanged. It might also happen if, by a system of rationing or some other device, the rich were forced to transfer their demand away from things which are important to the poor and which are produced under such conditions that diminished demand leads to lowered prices. Per contra—and this point will be seen in Part IV. to be very important practically—the share, both proportionate and absolute of command over the country's productive resources held by the poor may be increased, and yet, if the process by which they acquire this greater share involves an increase in the cost of things that play a large part in their own consumption, they may not really gain. Thus a change in distribution favourable to the poor may be brought about otherwise than by a transference of purchasing power, or command over productive resources, to them, and it does not mean a transference of these things to them. None the less, this sort of transference is the most important, and may be regarded as the typical, means by which changes in distribution favourable to the poor come about.

I.VIII.3

§ 3. On this basis it is desired, if possible, to establish some connection between changes in the distribution of the national dividend and changes in economic welfare, corresponding to the connection established in the preceding chapter between changes in the size of the national dividend and changes in economic welfare. In considering this matter we must not forget that the economic welfare enjoyed by anybody in any period depends on the income that he consumes rather than on the income that he receives; and that, the richer a man is, the smaller proportion of his total income he is likely to consume, so that, if his total income is, say, twenty times as large as that of a poorer man, his consumed income may be only, say, five times as large. Nevertheless, it is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old "law of diminishing utility" thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare.*88 This conclusion is further fortified by another consideration. Mill wrote: "Men do not desire to be rich, but to be richer than other men. The avaricious or covetous man would find little or no satisfaction in the possesion of any amount of wealth, if he were the poorest amongst all his neighbours or fellow-countrymen."*89 More elaborately, Signor Rignano writes: "As for the needs which vanity creates, they can be satisfied equally well by a small as by a large expenditure of energy. It is only the existence of great riches which makes necessary for such satisfaction a very large, instead of a very small, expenditure. In reality a man's desire to appear 'worth' double what another man is worth, that is to say, to possess goods (jewels, clothes, horses, parks, luxuries, houses, etc.) twice as valuable as those possessed by another man, is satisfied just as fully, if the first has ten things and the second five, as it would be if the first had a hundred and the second fifty."*90 Now the part played by comparative, as distinguished from absolute, income is likely to be small for incomes that only suffice to provide the necesaries and primary comforts of life, but to be large with large incomes. In other words, a larger proportion of the satisfaction yielded by the incomes of rich people comes from their relative, rather than from their absolute, amount. This part of it will not be destroyed if the incomes of all rich people are diminished together. The loss of economic welfare suffered by the rich when command over resources is transferred from them to the poor will, therefore, be substantially smaller relatively to the gain of economic welfare to the poor than a consideration of the law of diminishing utility taken by itself suggests.

I.VIII.4

§ 4. It must be conceded, of course, that, if the rich and the poor were two races with different mental constitutions, such that the rich were inherently capable of securing a greater amount of economic satisfaction from any given income than the poor, the possibility of increasing welfare by this type of change would be seriously doubtful. Further-more, even without any assumption about inherent racial difference, it may be maintained that a rich man, from the nature of his upbringing and training, is capable of obtaining considerably more satisfaction from a given income—say a thousand pounds—than a poor man would be. For,if anybody accustomed to a given standard of living suddenly finds his income enlarged, he is apt to dissipate the extra income in forms of exciting pleasure, which, when their indirect, as well as their direct, effects are taken into account, may even lead to a positive loss of satisfaction. To this argument, however, there is a sufficient answer. It is true that at any given moment the tastes and temperament of persons who have long been poor are more or less adjusted to their environment, and that a sudden and sharp rise of income is likely to be followed by a good deal of foolish expenditure which involves little or no addition to economic welfare. If, however, the higher income is maintained for any length of time, this phase will pass; whereas, if the increase is gradual or, still better, if it comes about in such a way as not to be directly perceived&madash;through a fall in prices, for example—the period of foolishness need not occur at all. In any case, to contend that the folly of poor persons is so great that a rise of income among them will not promote economic welfare in any degree is to press paradox beyond the point up to which discussion can reasonably be called upon to follow. The true view, as I conceive it, is admirably stated by Messrs. Pringle and Jackson in their special report to the Poor Law Commissioners: "It is in the unskilled and least educated part of the population that drink continues to hold its ground; as greater regularity of employment and higher wages are achieved by sections of the working-classes, the men rise in respectability and character. That the drink bill is diminishing, while wages are rising throughout the country, is one of the most hopeful indications of progres we possess."*91 The root of the matter is that, even when, under existing conditions, the mental constitution of poor persons is such that an enlarged income will at the moment yield them little benefit, yet, after a time—more especially if the time is long enough to allow a new generation to grow up—the possession of such an incomoe will make possible the development in them, through education and otherwise, of capacities and facilities adapted for the enjoyment of the enlarged income. Thus in the long run differences of temperament and taste between rich and poor are overcome by the very fact of a shifting of income between them. Plainly, therefore, they cannot be used as an argument to disprove the benefits of a transference.*92

I.VIII.5

§5. After all, however, general reasoning of the above type, though perhaps necessary to provide formal justification for our thesis, is not necessary to convince us practically that it is valid. For that purpose it is sufficient to reflect on the way in which, in this country, income has in fact been distributed in recent times. There are not sufficient data to enable this to be calculated with any degree of accuracy. On the basis, however, of work done by Dr. Bowley,*93 we may hazard the following rough estimate for the period immediately prior to the war. The 12,000 richest families in the country received about one-fifteenth of the total national income; the richest fiftieth of the population received about one-quarter, and the richest ninth of the population received nearly one-half of that total income. The remainder of it, a little more than a half, was left to be shared among small independent workers and salary-receivers earning less than £160 a year and practically the whole body of wage-earners. The table below, giving Dr. Bowley's estimate of distribution among a portion of this last group in 1911, carries the matter a little farther.

WEEKLY MONEY WAGES OF ADULT WORKMEN IN ORDINARY FULL WORK
(INCLUDING VALUATION FOR PAYMENT IN KIND)*94
Wage.Number of Men.Per cent of whole.
Under 15/- 320,000 (mainly agriculture) 4
15/- to 20/- 640,000 8
20/- to 25/- 1,600,000 20
25/- to 30/- 1,680,000 21
30/- to 35/- 1,680,000 21
35/- to 40/- 1,040,000 13
40/- to 45/- 560,000 7
45/- and over 480,000 6

In studying these figures we must, indeed, remember that in families where the man has a small income the wife and children are more likely to be earning wages than they are in families headed by richer men; so that distribution among families was probably more satisfactory than distribution among individuals. This, however, is comparatively a small matter. What the figures cited meant in the concrete is brought out very clearly in the same author's pre-war study of the conditions of life in four industrial towns. Together these towns embrace "about 2150 working - class households and 9720 persons. Of these households 293 or 13½ per cent, of these persons 1567 or 16 per cent, are living in a condition of primary poverty," i.e. with incomes so low that, even if expended with perfect wisdom, they could not have provided an adequate subsistence. "Out of 3287 children who appear in our tables, 897, or 27 per cent, are living in families which fail to reach the low standard taken as necessary for healthy existence."*95 The excess incomes of the richer classes did not, of course, represent corresponding excess consumption. The dominant part of the annual new investments of the country—before the war perhaps 350 millions—and a large part of the expenses of central and local government—over 200 millions—had to be provided out of them; so that not more than 300 millions annually can have been spent by the rich and moderately well-off on any form of luxury. Moreover, estimates of money income tend to exaggerate the relative real income of wealthy persons, because these persons are often charged higher prices than poor persons pay for the same services. A number of London shops, for example, discriminate against "good addresses," and hotel charges are also of ten discriminatory. It has even been suggested that as much as 25 per cent of the money income of the rich, as spent by them, represents no equivalent in real income.*96 In like manner, estimates of money income sometimes make it appear that the real incomes of poor persons are less than they really are, by ignoring discriminations in their favour. Thus Dr. Bowley points out: "A butcher can perhaps raise his prices to his day customers without much affecting the sale, but not to those in the evening. In this case the working class would suffer a smaller rise than the richer class. This consideration applies especially to the very large volume of purchases made late on Saturday night." But, when all qualifications have been made, the figures cited above leave no room for doubt that there was before the war, and is still, a substantial excess income in the hands of the richer classes available, in Dr. Bowley's phrase, "for attack" by way of transference.

I.VIII.6

§6. Some study of the post-war distribution of income in Great Britian and Northern Ireland has been made by Dr. Bowley and Sir Josiah Stamp with special reference to the year 1924. From this it appears that the proportion of the total accruing, pre-tax, to the richest classes, i.e. those with incomes in excess of £9400, which roughly corresponds to £s;5000 at the pre-war price-level, has somewhat diminished.*97 In general these writers conclude as follows. The distribution of income between wage-earners, other earners and unearned incomes was changed slightly in favour of the earning classes. Manual workers on the average make slightly increased real earnings, and there have also been transfers for their benefit in insurance schemes and other public expenditure. In addition they have the advantage of a reduction of about one-tenth of the working week. This change can be connected with the reduction in the real income derived from house property and investments bearing fixed rates of interest. The indications are that profits as a whole, reckoned before tax is paid, form nearly the same proportion of total income at the two dates (i.e. 1911 and 1924). Within the wage-earning classes women and unskilled workers have received a substantial real advance in wages; the great majority of skilled workers made at least as much (after allowing for the rise of prices) in 1924 as in 1911.*98That these changes have meant a great deal to the lives of the very poor is well brought out by Dr. Bowley's second investigation, made after the war, into the conditions of the four towns referred to in the preceding section. "Even," he writes, "on the assumption that all the families suffering from unemployment in a particular week had no adequate resources, and that their unemployment was chronic, the proportion in poverty in 1924 was little more than half that in 1913. If there had been no unemployment the proportion of families in poverty in the towns taken together would have fallen to one-third (3·6 per cent as against 11 per cent), and of persons to little over a quarter(3·5 per cent against 12·6 per cent) of the proportion in 1913."*99Again: "The proportion of families, in which a man is normally earning, found to be in poverty, was in 1924 only one-fifth of the proportion in 1913, if full employment is asumed; while, if the maximum effect of unemployment is reckoned, it is little over one-half."*100 This large improvement is partly due (to the extent of about one-third of the whole) to a decrease in the average number of children per family; but chiefly (to the extent of the remaining two-thirds) to a rise in the rate of real wages of unskilled labourers. In spite of this improvement, however, and in spite of the fact that, "when the full effects of taxation are taken into account, the real income available for saving or expenditure in the hands of the rich is definitely less than before the war,"*101 the distribution, not merely of incomes prior to taxation, but of what is left over after taxes have been taken away, is still very uneven. It was still true, for example, in 1924, that something like 100 millions a year net, i.e. about 2½ per cent of the total income of the country, was enjoyed by 3000 families. We must not hesitate, therefore, to conclude that, so long as the dividend as a whole is not diminished, any increase, within wide limits, in the real income enjoyed by the poorer classes, at the expense of an equal decrease in that enjoyed by the richer classes, is practically certain to involve an addition to economic welfare.

I.VIII.7

§ 7. It should be noticed that the conclusion set out above is not exactly equivalent to the proposition that economic welfare will be increased by anything that, ceteris paribus, renders the distribution of the national dividend less unequal. If the community consisted of two members only, it would, indeed, coincide with this. But, in a community consisting of more than two members, the meaning of "rendering the distribution of the dividend less unequal" is ambiguous. Pareto measures inequality of distribution by dividing the logarithm of the number of incomes in excess of any amount x into the logarithm of x. This measure is very difficult to apply unless we accept Pareto's view that, in any given income distribution, the ratio between his two logarithms is approximately the same for all values of x; and, even so, it is a matter of dispute whether the reciprocal of his measure,—which, of course, would indicate less equality when the measure itself indicates greater equality,—is not to be preferred to that measure.*102 Among other measures of inequality the most familiar is the mean square deviation from the mean. With that criterion it can be proved that, assuming similarity of temperament among the members of the community, a diminution in the inequality of distribution probably, though not necessarily, increases the aggregate sum of satisfaction.*103


Notes for this chapter


87.
It should be noticed that one of the things to which people will divert consumption, if distribution is altered in favour of the poor, is the quasi-commodity, leisure. It is well established that the high-wage countries and industries are generally also both the short-hour countries and industries and the countries and industries in which the wage-earning work required from women and children in supplement of the family budget is the smallest. The former point is illustrated by some statistics of the wage rate and hours of labour of carpenters in the United States, Great Britain, France, Germany, and Belgium, published in No. 54 of the Bulletin of the U.S. Bureau of Labour (p. 1125). In illustration of the latter point, Sir Sydney Chapman notes the assertion that, whereas the German collier finds only 65·8 per cent of his family's earnings, the wealthier American collier finds 77·5 per cent (Work and Wages, i. p. 17). Mr. Rowntree's interesting table for York points, when properly analysed, in the same direction (Poverty, p. 171); and Miss Vessellitsky shows that low-paid home-work among women is found principally in those districts, e.g. East Anglia, "Where the bad conditions of male labour make it almost indispensable for the wife to supplement the husband's earnings," whereas, in districts where men's wages are good, women only work at industry if they themselves can obtain well-paid jobs (The Home-worker, p. 4). Again, reference may be made to the familiar correlation found in recent English history between rising wages and falling hours. Yet again, a study of the rates of wages and hours of labour in different districts in England would, I suspect, reveal a correlation of the same type. It does so for the wages and hours statistics of bricklayers as given in the Abstract of Labour Statistics for 1908 (pp. 42, etc.). These facts are somewhat awkward to fit in to the method of exposition followed in this book, because leisure is not included as a commodity in my definition of the national dividend: and in so far, therefore, as improved distribution causes leisure to be substituted for things, it must involve a decrease in the national dividend. Plainly, however, this sort of decrease should be ignored when we are considering the effect of changes of distribution on economic welfare; for the loss of welfare associated with the constriction of production to which they lead is necessarily less than the gain of welfare due to the leisure itself.
88.
The difficult case in which a transference leads to a contraction in the size of the dividend from the point of view of either the pre-change or the post-change period, and not from that of the other, will not be considered here. Henceforward it will be assumed that we have to do with changes in the dividend that are either positive or negative from both the relevant points of view, and, therefore, except for special reasons, we shall speak simply of increases and decreases in the dividend.
89.
Posthumous Essay on Social Freedom, Oxford and Cambridge Review, Jan. 1907.
90.
Di un Socialismo in accordo colla dottrina economica liberale, p. 285
91.
[Cd. 4795], p. 46.
92.
Similarly, of course, when we are taking a long view, the argument that a reduction in the real income of the rich inflicts a special injury, because it forces them to abandon habits to which they have grown accustomed, loses most of its force.
93.
Quarterly Journal of Economics, Feb. 1914, p. 261; and The Division of the Product of Industry before the War, 1918, pp. 11 and 14.
94.
From the Contemporary Review, Oct. 1911, p. 1.
95.
Livelihood and poverty, pp. 46-7. The reason for the excess in the proportion of children in poverty is the twofold one, that poor families are apt to be larger than others, and that a large family is itself a cause of life in poverty. Cf. Bowley, The Measurement of Social Phenomena, p. 187.
96.
Urwick, Luxury and the Waste of Life, pp. 87 and 90.
97.
The National Income, 1924, p. 58.
98.
The National Income, 1924, pp. 58-9.
99.
Has Poverty Diminished, p.16. The discrepancies between the percentages given in this passage for 1913 and that given in Livelihood and Poverty is apparently due to the fact that in the latter work 480 houses inhabited by the middle and upper classes were excluded from the calculation (Cf. Livelihood and Poverty, p. 46, footnote).
Has Poverty Diminished, p.21.
The National Income, 1924, p. 59. It must, of course, be held in mind that a large part of the heavy taxation of rich persons goes to pay interest on war loan held by rich persons.
Cf. Gini, Variabilità e mutabilitd, p. 72.
If A be the mean income, n the number of incomes, and a1, a2...deviations from the mean, aggregate satisfaction, on our assumption,

But we know that {a1 + a2+...}=0. We know nothing to sugest whether the sum of the terms beyond the third is positive or negative. But it is certain that 1/2 {a12+22+ &hellip}f'' is negative. If, therefore, the fourth and following terms are small relatively to the third term, it is certain, and in general it is probable, that aggregate satisfaction is larger, the smaller is (a12+a22+...). This latter sum, of course, varies in the same sense as the mean square deviation or standard deviation Dr. Dalton, in the course of an interesting article on "The Measurement of the Inequality of Incomes," has shown that, in a community where many incomes diverge widely from the average, the probability which the above argument establishes is only of a low order (Economic Journal, Sept. 1920, p. 355)

Part I, Chapter IX

End of Notes


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