Three Points Down and Three Points Up

There is a well known problem in economics - the problem of time inconsistency. We all know that the policy maker always has the incentive to deviate from the announced policy (ex-post cheating) if he could get away with it. And because we citizens understand this incentive to cheat, we never believe what the policy maker says. We build in the expectation (ex-ante) that cheating will occur. In the end, every one is worse off for it because we cannot credibly commit to a stable policy that will benefit us in the long term.

The classic example is inflation expectations, something we already learnt from economics textbook. But there is an equally compelling local illustration to the problem of time inconsistency - employers' CPF contribution rate.

How often have we told ourselves that the CPF contribution rate is a blunt instrument? How many times have we convinced ourselves that CPF rate should be geared only towards meeting the (long term) retirement needs? How many times have we said that it should not be used for short term economic management?

Yet, how many times have we cheated? I used 'we' because we the citizens often abet the process. When the economy was down and potential CPF cut loomed, we often gave reason so and so (like those mentioned above) why CPF policy should not be adjusted so indiscriminately. But when the economy went up, we could not help but demand an increase in the contribution rate, an extra bite at the cherry. However much we professed it was not good policy to use CPF rate this way, it always ended being a cyclical policy tool.

The temptation to cheat is so palpable - it is like giving a child sitting an exam the model answers and then asking him not to use it, fat chance. So here we go again. The talk is that CPF is to be restored to 16 per cent.

Pinch me, I am making so much money!

For a newspaper often derided for being not much more than an official mouthpiece of the government, one would imagine Straitstimes to be a little more sensitive about reporting. Or perhaps it was because the newspaper had been mouthcuffed so much that there was really nothing much else to report. Or perhaps there just weren't many newsworthy events during the weekend.

Having just arrived home on Saturday, and having suffered a night of fitful sleep due to the jetlag, I was looking forward to Sunday Times to catch some local news. My fresh newspaper arrived at the doorstep and I eagerly read it over breakfast. What made 'news'? Young Super Earners. It first featured an investment banker Mr Yeo Soen Ming from London Business School who was reported to have made more than US$500,000 in the past year. Turn over the page, there were another three young high earners - Janice, Joao and Chris.

Bravo to them.

But it certainly was not 'news' material in my opinion. Even if it was somehow in the interest of the public to know about these high earners, it was still a terrible piece of reporting.

To the informed reader, this piece of reporting was superficial and condescending. The central message was not how each career choice could be satisfying in its own way. It was about money, money, money. For good measure, there was even a box item on page 3 - "How to Land a Job in Investment Banking". It was as if the reporter felt others could actually benefit from the five short lines of advice - which, by the way, could have applied to any other jobs!

To the lay person, this was nothing but more evidence of the great income divide - young brash professionals at around age 30 making more in a year than what others would in a lifetime. And it would obviously grate many to hear how these high earners were so full of themselves. Yeo Soen Ming, 34, said "If you are at this level and don't make around US$500,000 this year, it would be quite sad."

If you have followed my previous posts, you will know I am not against high income earners. I can accept that market outcomes are unequal. My wife is doing her MBA, also at the London Business School incidentally, for the same reason of wanting a give a further boost to her career. It is not ignoble to aim for higher pay. Perhaps the reporter made more of what these high earners actually said (you know, reporters are often guilty of this). But it bordered on bad taste to go on national newspaper to announce to the world how much money you make.

In the same weekend, it was revealed that the CEO of Morgan Stanley received US$40 million. I searched the internet for 20 minutes and could not find a single comment from him on his pay. When you have truly arrived, there would be no need to announce it.

The Perception and Reality of Income Gap - Take a Long Term View

Discussing income inequality is often emotional. Whether one thinks income inequality by itself is a problem or not often depends on convictions, it is sometimes akin to discussing religion. Reasonable people sometimes become unreasonable - rhetoric and political positioning become more important than facts and good policies.

The Economist not too long ago had this rather interesting article "Snakes and Ladders" (27 May 2006).

[Start of excerpt] Europeans deplore the idea that people may remain mired in poverty, and they have large welfare programmes . . resent the sight of rich families staying at the top for generations . . impose high taxes to redistribute wealth and income . . [Research] confirms that if one compares the incomes of children with those of their parents . . . Nordic countries emerge as far more mobile than America . . Around three-quarters of sons born into the poorest fifth of the population in Nordic countries in the late 1950s had moved out of that category . . In contrast, only just over half of American men born at the bottom later moved up. . In other words, Nordic countries have almost completely snapped the link between the earnings of parents and children at and near the bottom. Britain is more like the Nordics than like America: some 70% of its poorest sons escaped from poverty within a generation. That is not at all true of America. Redistributive fiscal policies cannot be all there is to it. The other part of the explanation seems to be their superior education systems. Education has long been recognised as the most important single trigger of social mobility and all four Nordic countries do unusually well in the school-appraisal system developed by the OECD. That in turn may explain why the bigger continental European countries, notably France, Germany, Italy, are not as mobile as Nordic ones. [End of excerpt].

The interesting point is that US is perceived to be a highly mobile society, when it is actually not. Furthermore, a 2006 Pew Research Centre study polled that 84% of Americans were either "very happy" (34%) or "pretty happy" (50%). Clearly, there is no right or wrong when it comes to discussing whether income gap is by itself a problem. It is only one attribute out of many that affects happiness and welfare of citizens.

Moreover, how significant it is as a factor depends on how obsessed one is with it - is the glass half full of half empty? A remarkable 84% of Americans are pretty happy with life, what income divide? Perception alters reality. The same study concluded that Britain actually did better than the US in terms providing social mobility but obsession with class was still very much a British trait. Continental Europe, despite its generous welfare, is not quite as socially mobile. Without good education system, welfare traps people into social stratas.

Let me finish this blog by recalling a conversation with a British friend. When he visited me a couple of years ago, he was affronted by the sight of domestic maids doing menial work for Singaporeans. I had to explain to him that even though the maids earned lowly wages compared to Singaporeans, it meant a lot to them back home and could actually provide their families a decent way out of poverty. Social justice needs a time dimension. Focusing on the present income gap ignores the time dimension to social justice. So what if the Gini coefficient looks bad? It says nothing about how socially mobile a family is over a period of time. It can take more than a decade before the effects of policies (like education) can be felt. To answer any question about social mobility, one needs good longtitudinal data, not cross sectional income differences.

Income gap is not itself a problem, but the lack of social mobility or social stratification is. Good people become trapped by the circumstances of their parents. This is the real market failure. Moreover, creating the perception of social mobility is equally important. Therefore, providing good education opportunities - particularly for children of the poorest quintile - is key to fostering real and perceived social mobility in Singapore.

Take a long term view when it comes to social justice. Worry less about the income gap, but build a consensus on how to make Singapore society more socially mobile. Let's make sure the cream can rise to the top.