Seguridad Social

Social security reform in transition economies: Lessons from Kazakhstan. 

Becker, Charles M. et al.
Nueva York, Palgrave y Macmillan, 2009. 296 págs. (Economics & finance).
ISBN 978-0-230-60736-1.

Charles Becker y sus colaboradores proporcionan la explicación más detallada hasta la fecha sobre la radical privatización de las pensiones llevada a cabo por el Gobierno de Kazajstán en 1997, incluidos los cambios que condujeron a la adopción de la ley y un decenio de experiencia en materia de ejecución. La información detallada que se proporciona en esta publicación es abundante en comparación con la mayoría de los análisis de las pensiones. Los cinco autores de esta obra son: un alto funcionario del Banco Nacional de Kazajstán y cuatro empleados de una empresa de consultoría en materia de pensiones patrocinada por la Agencia de los Estados Unidos para el Desarrollo Internacional (USAID, por sus siglas en inglés) que prestó apoyo al Gobierno a lo largo del proceso de privatización. Si bien la reforma de Kazajstán no es un tema nuevo en la literatura internacional sobre las pensiones, una gran parte del análisis previo fue realizado o patrocinado por las instituciones financieras internacionales (IFI) y expresa su perspectiva. En esta publicación se añade otra opinión importante, la de los ciudadanos kazakos que estuvieron presentes, elaborando y apoyando la política de pensiones, y que ahora relatan lo sucedido en sus propios términos.

Si bien el hecho de que existan múltiples autores enriquece este relato, también puede

explicar las incoherencias existentes, tanto en los hechos como en las perspectivas. Inicialmente, se indica a los lectores que el régimen privado de pensiones cubre en la actualidad al «90 por ciento de la población activa», pero un centenar de páginas más adelante se señala que sólo el 37 por ciento de las personas económicamente activas cotizan habitualmente a las cuentas de ahorro individuales privadas. Del mismo modo, en las primeras páginas se señala que la ley de 1997 que se elaboró de manera apresurada se ha mejorado de manera constante en los años siguientes. Se afirma que en casi todos los años desde 1997 se habían introducido diversos cambios y que se habían retirado algunas disposiciones problemáticas. Sin embargo, en un capítulo posterior los autores se lamentan de lo contrario, a saber, de que una vez superado el período de la crisis, no hay ningún esfuerzo sistemático para revisar la legislación promulgada. A su vez, al tiempo que elogian a los autores de la privatización por su visión coherente y unificada, su hábil ejecución, y su notable coherencia, templanza y serenidad ante la presión, los autores señalan que su voluntad de poner freno a los ingresos potenciales para los pobres y el sector dependiente de la población fue también un factor importante.

En esta publicación se aportan nuevas respuestas a viejas inquietudes sobre la interacción entre los responsables de la formulación de la política nacional de pensiones y las organizaciones internacionales de ayuda de Desarrollo, BAsD, el Fondo Monetario Internacional, FMI, y la USAID). Si bien algunos observadores de las organizaciones afirman que utilizan su apalancamiento financiero para establecer la política nacional de pensiones, en este informe se muestra que el Gobierno de Kazajstán estaba más que dispuesto a aceptar la ideología de la privatización y utilizarla para sus propios fines. El grupo de trabajo se movió más rápido y adoptó una privatización más radical que la recomendada por las organizaciones de ayuda. Los autores explican que se trataba de una iniciativa obligatoria y descendente, cuyo objetivo principal era reducir la responsabilidad pública con respecto a las pensiones y poner en marcha a todo el sector financiero.

Estas motivaciones son más excepcionales que las expresadas por los defensores de la privatización en otros países que siguieron esta trayectoria política. En otros lugares, los defensores normalmente describieron la privatización como un esfuerzo para ayudar a los trabajadores y empleadores, por ejemplo, brindándoles la oportunidad de elegir un proveedor de pensiones, una administración más eficiente y receptiva, y unas cuantías de las pensiones más elevadas. Si bien no todos estos resultados se lograron en otros lugares, ni siquiera tienen lugar en esta explicación sobre la motivación que existía en Kazajstán para proceder a la privatización.

Los autores también subrayan la determinación del grupo de trabajo para actuar con celeridad. Con objeto de alcanzar sus objetivos, el grupo de trabajo hizo llegar al Parlamento una reforma casi universalmente impopular, y ocultó información para evitar que la oposición se consolidara, incluso la del Ministerio de Finanzas. Como reflejo del compromiso visceral del grupo de trabajo con la privatización, la mayoría de las decisiones

primordiales se tomaron sobre la base de una información mínima, y su compromiso se contrajo antes de realizarse un análisis actuarial.

Aun así, los autores atribuyen a las organizaciones de ayuda un papel importante. Consideran que la evaluación actuarial inicial de los efectos de la privatización patrocinada por la USAID es tan optimista que pone a prueba su credibilidad, y sostienen que en dicha evaluación se ignoraron importantes previsiones de costos a favor del pensamiento del modelo basado en tres pilares del Banco Mundial. Señalan que el Banco Mundial, el BAsD y la USAID no se pronunciaron en público con respecto a lo que los autores denominan graves fallos en la legislación. Al ofrecer al Gobierno un préstamo por valor de 300 millones de dólares estadounidenses para cubrir los costos iniciales de transición de sustituir el régimen público de pensiones de reparto que se aprovechaba de las pensiones privadas, el Banco Mundial inclinó la balanza del apoyo al grupo de trabajo. «El Gobierno de Kazajstán pretendía reducir los compromisos del gasto y restablecer el orden financiero. En principio, podría haber logrado este objetivo dentro de la estructura (de pensiones) de Solidaridad; sin los préstamos internacionales recibidos para financiar los costos de transición, Kazajstán tal vez nunca habría emprendido la Reforma de Acumulación.»

En esta publicación no se proporcionan aquellas cifras que suelen servir de puntos de referencia para evaluar las pensiones privadas. No se indica, por ejemplo, toda la magnitud de los costos de financiación de transición, ni su duración prevista. Tampoco se indica la parte del ahorro de los trabajadores retenida como gastos administrativos privados. Sin embargo, los autores describen claramente los graves efectos de la privatización, a saber: a) la baja tasa de cumplimiento del requisito de la cotización, hasta el punto de que tal vez entre el 60 y el 70 por ciento de la población acabará teniendo unas cuentas de acumulación individuales inadecuadas si persisten las tendencias establecidas; b) los rendimientos negativos sobre la inversión, debidos en parte a unos mercados financieros superficiales y poco desarrollados, a la escasez de reguladores con experiencia, a una gobernanza empresarial que dista mucho de ser ideal, a unos bajos niveles de comunicación de resultados, y a la ausencia del activismo de los accionistas centrado en los derechos de inversión, y c) una enorme disparidad de género en el régimen de pensiones que, a menos que se aborde, dará lugar a que la pensionista mujer promedio en 2050 reciba tan sólo el 8,3 por ciento del salario promedio de las mujeres en comparación con una tasa

de sustitución promedio del 18 por ciento de los salarios promedios recibidos por los pensionistas hombres.

Como conclusión, Becker y sus colaboradores formulan observaciones que pueden ser tomadas muy en serio por los reformadores de pensiones de todas las tendencias. Reconocen

que el éxito de todos los regímenes de pensiones, ya sean públicos o privados, depende del rendimiento económico del país, y no viceversa. Citando a Brown, señalan que en un régimen cerrado los recursos disponibles para su consumo por los pensionistas son iguales al superávit producido por la población activa, y que esto no se ve afectado por el régimen de pensiones que se elija. También reconocen que la desigualdad generada por el sistema de acumulación es considerable, lo que genera grandes diferencias en las tasas de rendimiento sobre la inversión, dependiendo del salario del trabajador y de su nivel de cotización. A fin de evitar un gran problema social que afecte a un vasto número de mujeres de edad pobres, los autores hacen un llamamiento para que se establezca una

pensi ó n m í nima p ú blica m á s adecuada y para que se aumenten las pensiones privadas de las mujeres mediante la igualación de la edad de jubilación reglamentaria de hombres y mujeres.

Para los lectores que están interesados en la economía política de la privatización de las pensiones, Becker y sus colegas proporcionan abundante información y dan a conocer una apasionante historia.

Desarrollo humano en el contexto de la globalización

 Desarrollo humano en el contexto de la globalización, en Economía, Gestión y Desarrollo 

Cali. Pontificia Universidad Javeriana. 
Diciembre de 2007.

“El desarrollo humano debe ser la pro- moción de la riqueza de la vida humana entera, antes de la economía que es sólo una parte de aquélla”, dice Alberto Romero al estudiar el proceso de globa- lización y su relación con la evolución del desarrollo humano. Su objetivo es ver cómo se puede reorientar el actual proceso de globalización para favorecer al desarrollo mundial y local. Esta propuesta se divide en dos secciones; se analiza el fenómeno de la globalización y sus antecedentes, donde se destaca que éste no es un proceso nuevo en la historia de la economía. Menciona que su so- porte ideológico es la corriente neolibe- ral que absolutiza el papel del mercado, la libre competencia y el sector privado, y desestima la intervención del Estado en el desarrollo económico. La segunda parte hace referencia al desarrollo humano, donde define conceptos y la situación actual, así como el análisis de las desigualdades en el mundo. Existe una estrecha relación entre los factores de la globalización y el desarrollo hu- mano, donde la primera actúa en contra de los intereses del segundo, con lo que se abre el debate de nuevas formas o estructuras que impulsen el desarrollo humano mucho más álla de la voluntad política de algunos gobernantes.

Norma Samaniego, “El crecimiento explosivo de la economía informal”, en Economía unam, número 13, enero-abril de 2008.

El sector informal se define como el re- sultado de la presión que ejerce el exce- dente de la mano de obra sobre el empleo, ante una insuficiencia de puestos de traba- jo en el sector moderno (Tokman, 2001). “La informalidad, lejos de ser vista con pasividad, al considerarla como una vál- vula de escape ante los desequilibrios del mercado de trabajo, representa un proble- ma sustantivo que requiere de atención urgente de la política económica y social”, afirma Norma Samaniego en este trabajo que estudia el crecimiento desbordante que ha adquirido este sector de la econo- mía en las últimas décadas. En este artícu- lo se analiza el origen y la evolución del concepto, los distintos enfoques sobre sus causas y su crecimiento explosivo, arrojan- do conclusiones acerca de la reformulación de nuevas políticas que den lugar central al empleo dentro de la estrategia de desarro- llo, ya que la informalidad no es un fenó- meno marginal, se trata de una situación complicada, que tiene factores de autorre- fuerzo, y que hoy en día debe ser una de las principales fuentes de ocupación dentro del mercado laboral de país.

SOCIAL PROTECTION AND SOCIAL INCLUSION IN THE EUROPEAN UNION IN THE CONTEXT OF THE ECONOMIC CRISIS

SOCIAL PROTECTION AND SOCIAL INCLUSION IN THE EUROPEAN UNION IN THE CONTEXT OF THE ECONOMIC CRISIS

Alina HAGIU1

ABSTRACT

Firm policy intervention and the automatic stabilizers embedded in European welfare systems have limited the economic and social impact of the worst recession in decades. However, the human cost of the crisis is difficult to evaluate fully as yet. The impact on labour markets and on the population, notably the most vulnerable, is still unfolding. Investing in regular monitoring of social trends and enhancing social statistics is crucial for designing early and effective policy responses and assessing their impact.

The crisis has highlighted great diversity within the EU. Its scope, magnitude and effects vary as does the capacity of national welfare systems to provide adequate protection. Not all Member States have the financial means to meet rising demand and some have large gaps in their safety nets. Narrowing these gaps is now a priority.

At the same time, the need to contain the rise in public spending calls for enhancing the quality of intervention, and in some cases setting clear priorities. This means more effective and efficient social inclusion and social protection, in line with the principles of access for all, adequacy and sustainability.

KEY WORDS: social protection, social inclusion, health, pensions, economic crisis JEL: E24, H31, I38

1. INTRODUCTION

Strong policy intervention and automatic stabilisers played a major role in mitigating the social consequences of the crisis. However, the full impact of the crisis on people is yet to be faced. The Commission forecasts that unemployment could exceed 10% in 2010, with social expenditure rising from 27.5% to 30.8% of GDP between 2007 and 2010.

With 5 million more unemployed than at the outset of the crisis, income has dropped for many households, exposing them to poverty and over indebtedness, and some have lost their homes. Migrants, younger and older workers, and those on temporary contracts, especially women, were affected early on, but unemployment is touching other categories, hitherto fairly safe. Unemployment rates may stay high for some time, with the attendant risks of long-term unemployment and exclusion.

The nature, size and effects of the crisis differ within EU. Unemployment rose from 2.7% to 3.9% in one country and from 6.0% to 20.9% in another. Also, Member States started with different social situations. In 2008, at-risk-of poverty rates ranged from 9% to 26%. The coverage and level of support provided by social protection also varied across countries and social groups. Public perceptions echo these disparities: in

1

Sciences, Romania, alinahagiu.upit@yahoo.com

University Assistant Ph.D. Candidate, University of Pitesti, Faculty of Economic

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June 09 while the majority felt the crisis had increased poverty, those who sensed a profound impact ranged from 10% to 69%.

Policy responses also vary in scale and emphasis. The Commission estimates that spending on discretionary measures varies from less than 1% of GDP in some countries to more than 3.5% in others. The Commission forecasts that between 2007 and 2010 social spending will rise, by less than 1 pp in three countries and up to 6 pp or more in another four.

Member States used the European Social Funds to enhance support to the unemployed, to keep workers in employment and to help the most vulnerable facing structural barriers to labour market integration. They used flexibility in the ESF adjusting operational programmes, modifying them where necessary, and used the simplifications proposed by the Commission to improve the effectiveness of the fund. ESF programmes also provide financial support for long-term EU social inclusion objectives, underpinning the recovery and social cohesion.

The crisis emphasises the need to support citizens at a time of major budget constraint. This highlights the EU agenda for more effective and efficient social inclusion and social protection, pursuing access for all, adequacy and sustainability; which is a long term concern of the Social OMC. Short-term responses should be consistent with structural reforms needed to modernise social policy, prevent lasting damage to the economy and society and prepare for long-term challenges, such as ageing.

2. SOCIAL PROTECTION AND SOCIAL INCLUSION

The social climate survey also yields interesting results about how people see some key social policy issues. With a satisfaction score of 1.3, health care provision is regarded as satisfactory by a majority of Europeans. Most satisfied are respondents in Belgium (5.5), followed by those in the Netherlands, Luxembourg, Austria and the United Kingdom, all scoring above 4. The lowest levels of satisfaction are in Bulgaria, Greece and Romania where scores are all below -3. In most countries, more people tend to see past and likely future changes as being for the worse rather than the better, but there are some exceptions — notably Cyprus, Spain, Malta and Belgium.

The people least satisfied are those who report health care needs that are not being met.

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Figure 1 - Health care provision

Source: Special Eurobarometer no 315

Figure 2 - Satisfaction with health care provision (QA 2.3) and unmet need for care (in 3rd income quintile)

Sources: Special Eurobarometer no 315 and EU-SILC 2006. Total self-reported unmet need for medical care for the following three reasons: financial barriers + waiting times + too far to travel.

Pension provision is perceived much more negatively with an EU-wide satisfaction score of - 1.0. The countries with the highest levels of satisfaction are Luxembourg, the Netherlands, Denmark and Austria with scores ranging from 4.6 to 2.9. The least satisfied are the Greeks, Bulgarians and Portuguese, all with scores below

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-4. In almost all countries, a negative view of past and future changes prevails, with two notable exceptions: Cypriots tend to see an improvement over the past five years, and a larger proportion of them expect further improvements; Estonians also acknowledge progress over the past five years, but they are pessimistic about the coming twelve months. People's current satisfaction with pension provision seems to be poorly correlated to the relative income of pensioners.

Figure 3 - Provision of pensions

Source: Special Eurobarometer no 315

Figure 4 - Satisfaction with the provision of pensions (QA2.3) and Relative median income ratio (65+/0-64)

Sources: Special Eurobarometer no 315 (index for current situation - see methodology in the introduction of this section) and EU-SILC 2006

With a score of -1.2, the level of dissatisfaction with unemployment benefits is similar to that for pensions. The countries with the lowest scores are Greece, Bulgaria,

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Romania and Hungary, all scoring below -4. The highest score is in the Netherlands at 3.5, followed by Austria, Luxembourg, Denmark and Belgium (1.9). In all Member States, a majority of respondents expect the situation to worsen or stay the same over the next twelve months, and there is only one country, Cyprus, where a larger proportion perceive an improvement rather than a deterioration over the past five years.

Figure 5 - Unemployment benefits

Source: Special Eurobarometer no 315

There is strong feeling of dissatisfaction with the way inequalities and poverty are addressed. The score for the EU as a whole is -2, and there are only four countries scoring 0 or above. Luxembourg comes top (0.9), followed by the Netherlands, Sweden and Finland. Dissatisfaction is greatest in Latvia, Hungary, Greece, Bulgaria and Lithuania, all scoring -4 or below. France, at -3.8, also displays a strong feeling of discontent in this regard. With the exception of Malta, the prevailing sentiment is that the situation has not improved but rather deteriorated over the past five years and will continue to do in the near future. There is a correlation between a country's income inequality and the way that country addresses inequality and poverty.

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Figure 6 - The way inequality is addressed

Source: Special Eurobarometer no 315

Figure 7 - Current satisfaction with the way inequalities and poverty are addressed in the country (June 2009) and income inequality S80/S20 (2007)

Sources: Special Eurobarometer no 315 (index for current situation - see methodology in the introduction of this section) and Eurostat – EU-SILC 2006 for the S80/S20

Relations between people from different cultural backgrounds or of different nationalities are seen in a much more positive light than inequalities and poverty. The satisfaction score for the EU as a whole is positive, although only 0.3. It is highest by far in Luxembourg (2.5), followed by Finland, the United Kingdom, Lithuania, Estonia, Romania and Latvia, all between 1.3 and 1.5. The countries with the lowest scores are Greece, the Czech Republic, Italy, Denmark, Hungary and France, scoring between -1.7 and -0.6. People in the countries with low scores also perceive a deterioration, both in the past and near future, but strong pessimism about the quality of community relations is also evident in the Netherlands, Austria and Slovenia.

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Figure 8 - Relation between groups

Source: Special Eurobarometer no 315

The overall picture that emerges from this first European social climate survey is a contrast between relatively high levels of satisfaction and confidence regarding people’s personal situation and a very negative perception of the general economic situation and living conditions and of key social policy issues. While apprehension about the general economic situation and living conditions is perfectly understandable under current circumstances, policymakers should be concerned about people’s dissatisfaction with key social policy issues and their strongly negative view of the way things are going in these areas. Indeed, these views seem to be deep-seated and might call for a review of policies to ensure that they are better designed and better explained.

Another important observation is that, in general, it is in some of the most prosperous Member States that people have the highest levels of satisfaction and are most likely to perceive a positive trend. This may be because the recession hits some of the poorer Member States harder. However, over the long run, it would be reasonable to expect that the poorer Member States would display a positive trend given that they are in the process of catching up with the richer countries, raising hopes for better social conditions and policies. However, this is clearly not the current perception in most of the poorer countries. Many of them are at the bottom of the satisfaction ranking and at the same time among the least optimistic about the changes that have occurred or will occur across the wide range of areas covered by the survey. If these perceptions are not just the reflection of a temporary mood caused by the recession, they could point to an increasing and worrying divergence: countries with good social conditions making further progress and countries with the poorest social conditions falling even further behind.

3. EFFECTIVE AND EFFICIENT SOCIAL INCLUSION POLICIES IN AND AFTER THE CRISIS

Unemployment in the EU is now at 9.1%, and could reach 10.3% in 2010. The rate is more than double for young workers (20.7%) and migrants (19.1%). The loss of

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earnings affects all family members, and especially children and other dependants. Young people are also affected by the lack of job opportunities. The maturing of pensions systems has helped reduce poverty risks for the elderly in many countries. However, the crisis threatens the development of adequate pensions where elderly poverty remains very high.

The crisis is also likely to affect those furthest from the labour market, either inactive or long-term unemployed. Even beforehand, the low skilled, people with disabilities or mental health problems, migrant - particularly women - had limited access to training and other enabling services. Recent efforts to boost employability for all may be undermined by lack of jobs and increased pressure on training and employment services.

Maintaining decent living standards for all is both crucial to ensure that people live in dignity, and to sustain their employability and learning capacity. Overall, most Europeans can rely on some of the most effective safety nets in the world. However, there are gaps.

The effectiveness of unemployment benefits vary greatly depending on the coverage, duration, conditionality and replacement rate of the benefits. Young workers with short contributory records and some of the self-employed may not be entitled to unemployment benefits, while workers on part-time or temporary contracts often receive lower benefits than other workers.

Reforms to strengthen work incentives have tightened eligibility criteria, or reduced the level or duration of entitlements. Together with a greater emphasis on activation measures, these reforms contributed to a reduction in long-term unemployment. However, they have not always reduced long-term welfare dependency. In addition, even though several Member States prolonged benefit duration and relaxed eligibility rules in response to the crisis, the pressure on last-resort schemes has started to increase, as unemployment benefits run out for more and more people. This underlines the need to prepare comprehensive exit strategies based on active inclusion principles.

The coverage and adequacy of minimum income provisions vary greatly across EU. In most countries, social assistance alone is not sufficient to lift people out of poverty, but in general it reduces its intensity. Recent efforts to modernise social assistance have focused on financial incentives to work; but, the lack of clear mechanisms to up-rate minimum incomes has in some instances led to deterioration in benefit adequacy over time. In all countries, non-take-up significantly affects the effectiveness of the schemes, though to various degrees. Complex rules, lack of information, discretionary assessment, administrative errors and fear of stigma are some of the multiple reasons that explain non-take up. There is therefore room for increasing the effectiveness and efficiency of minimum income schemes.

Adequate income support is crucial for people in time of need, but policies must also help them to participate in the labour market. Both spending and participation in active labour market measures, including life long learning, have improved overall in recent years. However, more needs to be done to ensure that all are reached, including the low skilled, the young and the elderly, lone parents and those returning from caring breaks, migrants and ethnic minorities, and people with disabilities. Experience shows that long-term unemployment and inactivity tend to persist long after recovery. Modern social security policies are an important tool to prevent people moving on to long-term sickness and disability benefits, or early retirement schemes.

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Adequate and individualised social and employment services are also essential to overcome structural barriers to participation in the labour market and in society. The personal, family and social hurdles people face need to be addressed by quality social and health services. It is of particular importance to improve the reconciliation of work and family-life. Supporting children and families is investing in a sustainable future for Europe.

4. CONCLUSIONS

While there are signs that the recession is bottoming out, its full social consequences have yet to materialise across the EU. Unemployment is likely to rise further. Previous recessions have shown that the people hardest hit by unemployment are men working in the construction and manufacturing sectors and young people arriving on the labour market. In several Member States there appear to be gaps in benefit systems, with the result that many unemployed people do not receive any form of social benefit. Over the longer term, the social consequences of the recession will depend partly on the speed of the recovery. Slow growth might result from weak consumer demand due – for instance – to employment insecurity and inadequate social protection or to reduced housing wealth and access to credit. A long period of slow economic growth would imply a prolonged lack of job opportunities and a risk that many people – in particular young people entering the labour market – will suffer long spells of unemployment. To prevent these people from being permanently excluded from the labour market and thus falling into the poverty trap, governments must ensure adequate provision of unemployment benefits and must actively support employment. There will also be a need to closely monitor the social consequences of budget consolidations.

Public spending cuts may also affect the welfare of households in the longer run, for instance, if social benefits and public services (education, child care, health and long-term care) are reduced. Moreover, the financial situation of households could be affected by various policy measures. The Social Protection Committee is constantly monitoring all these social impacts of the economic crisis and the policy responses in the Member States.

REFERENCES
Buzducea, D., (2005), „ Aspecte contemporane în asistenţa socială”, Iaşi, Editura Polirom; Cace, C., (2004), „Sistemul de asigurări sociale în România: posibilităţi şi direcţii
De dezvoltare şi perfecţionare”, Bucureşti, Editura ASE;
Council of the European Union, (2010), „Report on Social Protection and Social Inclusion
2010“;
Council of the European Union,(2010), „Report on Pensions“, Brussels;
European Comission, (2009), „Social Situation in the European Union”;
Ferrera, M., (2005), „The boundaries of welfare: European integration and the new spatial
politics of social protection”, Oxford: Oxford University Press;
Preda, C. M., „Alinierea şi coordonarea sistemelor de securitate socială în Uniunea
Europeană”, Bucureşti, Editura ASE.
*** Special Eurobarometer 315, “Social Climate”. Available at
ec.europa.eu/public_opinion/archives/ebs/ebs_315_en.pdf *** www.insse.ro

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MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES OF ECONOMIC GROWTH AND DEVELOPMENT

STEFAN D . JOSTEN*
Federal University Munich, Germany

This paper analyzes a heterogeneous-agents endogenous-growth model incorporating both transaction costs and social capital. An individual can either become an active part of the society's middle-class networks of trust and mutual co-operation, thus making a positive contribution to overall social capital. Alternatively, the individual can stay socially disintegrated and free-ride on the community's social capital. Due to the existence of asymmetric information, agents face a moral-hazard problem on the credit market which gives rise to transaction costs and can be alleviated by private, governmental or social governance structures. An increase in inequality and shrinking of the middle class depresses the community's social capital, which, in turn, weakens the informal social governance system and increases economy-wide transaction costs. As a r^esult a more unequal distribution lowers the economy's growth rate.

Keywords: Social Capital, Inequality, Middle Class, Economic Growth, Distribution JEL classification: D3, 041, Z13

1. INTRODUCTION

One of the most important issues in economics is the problem of economic growth and development. What sustains economic growth over long periods of time? Why do some countries grow rapidly while other countries stagnate? And where do the huge differences in income per capita and worker productivity which can be observed across countries in the world come from?' The latter question is particularly puzzling, since neoclassical growth theory tells us that economies around the world should actually

' The author is thankful to the anonymous referee for useful comments and suggestions on the earlier draft of the paper. He is, however, solely responsible for any remaining errors.

' Existing differences in income per capita and worker productivity across countries are described e.g., by Acemoglu (2009), pp. 8-15.

STEFAN D.JOSTEN

converge - either (if all economies were intrinsically the same) in an absolute sense or (if economies differ in various respects), at least, in a conditional sense, i.e., in relation to their respective long-run equilibria. All of the three questions above can be answered at two distinct levels: with respect to the mechanics, i.e., proximate causes, or with respect to the fundamental causes of economic growth, respectively.^ According to the "mechanics" of economic growth, persistent cross-country differences in income per capita or economic growth rates are explained by countries' different propensities to save, incentives to work, access to technology, or different government policies. Such conventional textbook explanations remain unsatisfactory, however, in at least two respects: First, instead of solving it, they merely move the "mystery of economic growth" (Helpman, 2004) to another, more fundamental level. If, e.g., differences in savings rates across countries determine cross-country income or growth-rate differences, then why do some societies save more than others? A more satisfactory answer will have to look at more fundamental social structures that determine development outcomes (see e.g.. Park, 2008).

Secondly, even after we account for the accumulation of physical and human capital, large differences in income per capita remain across countries. Investment in research and development explains a certain part of this cross-country variation, particularly in industrial economies. But still substantial variation in growth remains after accounting for both accumulation and R&D investment.^ The question is: Why? Again, to answer this question, we are lead to look more closely at fundamental characteristics of societies.

In this vein, the present paper puts forward two interacting elements of the social stnicture as fundamental causes of economic growth and development: the existence of a broad middle class the members of which share with each other a fairly homogenous set of social orientations ("middle-class consensus"), and the social capital built by social interactions and informal relationships within this middle class.

Accordingly, this paper is related to two recent strands of literature: First, there is the literature on the economics of social capital which will be dealt with in some detail in section 2 below; secondly, there is the literature on the role of the middle class -or, more generally, of distribution- for economic development. Economic historians have long been emphasizing the importance of a large middle class for economic development. In a perspective dating back to German sociologist Max Weber (2003 [1905]), the middle class is a source of social norms and values that emphasize foregoing present consumption to save and invest, thus promoting capital accumulation and economic growth. More recently, Landes (1998) reflecting on England's leading role in the process of industrialization points out that the "ideal growth and development society"

^ See Acemoglu (2009), p. 22f.

^ For a comprehensive overview of respective empirical results from growth accounting see Caselli (2005).

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES 3

would be characterized, among other things, by "a relatively large middle class" (p. 217f.). The role of different behavior of classes for economic growth was also analysed by J.M. Keynes and modem (Post-) Keynesian economists. Following the classical tradition, classes in Keynesian thinking are defined in accordance with their respective ownership of production factors: capitalists own capital goods used in production, rentiers own land and workers perform wage labor. J.M. Keynes noted the class structure of saving by advancing the view that household saving and consumption is determined by the interaction of disposable income and class-dependent propensities to consume among rentiers, capitalists and workers. In the present paper, individuals do not differ in their absolute ownership of factors; in particular, all private agents are assumed to be endowed with the same amount of physical capital. They only differ in their respective ownership shares in the economy's aggregate stock of capital and labor. Accordingly, the middle class is conceived in this paper not as a given entity with specific habits and economic interests, but is -instead- derived endogenously as those income groups who share with each other a set of social orientations that is homogenous enough to form the economy's social capital. Implicit in this conception is the idea that the middle class holds a particular set of values and orientations that distinguish it from both its poorer and wealthier counterparts.

In contrast to the approaches mentioned above, mainstream (neoclassical) economics has been virtually silent on the middle class for a long time. Only recently Easterly (2001) puts forward the existence of a middle-class consensus as a critical determinant of international development differences. Defining a "middle-class consensus" as a situation of relative equality and ethnic homogeneity, he goes on to show empirically that such a middle-class consensus facilitates higher levels of income and growth, as well as higher levels of public goods. Banerjee and Duflo (2008) provide the most recent attempt at finding defming characteristics of the middle class and discuss its economic role in today's developing countries.

Since "middle class" is -among other things- a distributive category, the present paper is also linked to the large literature on inequality and growth. A number of empirical cross-country studies find high inequality - measured in several studies by the income share of the middle class (quintiles 3 and 4) - linked to poor growth performances.^ SincetheemergenceofDeininger'sandSquire's(1996)newdataseton income inequality the overall empirical evaluation of the effects of inequality on growth has become quite blurred, however.* Most of the theoretical literature so far has been

" In the same vein, Adehnan and Morris (1967, p.3O) nofe that "in the economic development of Western Europe, the middle class were a driving force" and, accordingly, "the growth of a robust middle class remains of crucial importance in contemporary low-income nations".

A survey and overall assessment of early studies can be found in Bénabou (1996).

' In particular, Forbes (2000) and Barro (2000) fundamentally challenge previous findings of a negative inequality-growth relationship. Note, however, that both Forbes (2000) and Barro (2000) use panel data and

focused on two sets of transmission channels between distribution and economic growth: First, there are economic channels, notably capital market imperfections (see e.g., Aghion and Bolton, 1997),' as well as inequality's effect on an economy's demand structure, innovation incentives (see Zweimüller, 2000; or Chatteijee and Raychaudhud, 2004) and economic development (see Murphy et al.^ 1989). In addition, there are politico-economic channels emphasizing how income inequality influences the balance of power in the political system in such a way as to generate pressure to the government to increase income redistribution that, in turn, reduces incentives and, thereby, slows down economic growth.^ The present paper points to a third set of channels linking distribution and growth that has received much less attention in the literature: socio-economic transmission mechanisms.

The present paper adds to the existing literature in three significant ways. First, it modifies the model set-up of Zak and Knack (2001) in which heterogeneous agents transact under asymmetric information, which gives rise to a moral hazard problem and economy-wide transaction costs, to allow for endogenous growth. Secondly, the present paper features an endogenous determination and identification of the middle class which can be distinguished both economically and culturally from the lower class (the "poor") and the upper class (the "rich"), respectively. Thirdly, it supplements the model's economic sector by an endogenous, rational-choice derivation of social integration and social capital building: An individual can choose to become an integral part of the society's networks of trust and mutual co-operation, thus making a positive contribution

estimation methods, thus removing county-specific effects and focusing on short-tenn intertemporal variations, while most of the previous empirical studies on inequality and growth focus on long-nm growth effects of inequality. Furthermore, Deinlnger and Olinto (2000) find that even in Foibes' (2000) and Barro's (2000) econometric methodology wealth inequality, as measured by the distribution of land, still has a causal negative effect on growth. One possible way to reconcile the conflicting results is to argue that the impact of inequality on economic growth depends on the development stage (see Galor and Moav, 2004). Recent estimation results by Khalifa and El Hag (2010), for instance, suggest that there is, indeed, a statistically significant threshold income per capita, helow which the relationship between inequality and growth is significantly negative and above which it is positive (but not statistically significant).

' Further seminal papers within this subset of theory include Galor and Zeira (1993); Baneijee and Nevmian (1993); and Bénabou (1996).

^ Important contributions to this field of study include Bertola (1993); Alesina and Rodrik (1994) as well as Persson and Tabellini (1994). Perotti (1993), as well as Saint-Paul and Verdier (1993), combine asset market incompleteness with the politics of redistribution.

' Notable contributions to this field of study include Alesina and Perotti (1996), Benhabib and Rustichini (1996), as well as Knell (1999). According to the former two, inequality may lead to socio-political instability and may thus have a detrimental effect on economic growth. Knell (1999) considers the growth effects of inequality and status-seeking in a social comparison model with different degrees of status preferences for young and old individuals. The basic result is that the negative impact of inequality on growth is aggravated if individuals are more status-oriented.

STEFAN D. JOSTEN

MIDDLE-CLASS CONSENSUS, SOCLSLL CAPITAL AND THE FUNDAMENTAL CAUSES 5

to overall social capital. Altematively, the individual can stay socially disintegrated, participate in the society's economic transactions but not contribute to the community's social capital, thus fi-ee-riding on others' investments in socio-structural resources. Within this formal framework, the present paper shows that, when the gap between the rich and the poor widens in a society, the size of the middle class whose members make positive contributions to the value of resources embedded in the society's informal relationships shrinks, while the share of social drop-outs in the population increases. The economy's social capital will be depressed which, in turn, increases economy-wide transaction costs and, thereby, slows down capital accumulation. As a result, inequality and economic growth are inversely related.

The rest of the paper proceeds as follows. Section 2 provides a definition of social capital and characterizes the concept by three particular features which are especially relevant for the current analysis. Sections 3 and 4 develop the formal fi-amework of analysis, starting with decentral optimizing decisions of individual agents and then moving to aggregate variables describing macroeconomic behaviour and the economy's equilibrium growth path. Section 5 explores the effects of increased inequality on the economy's growth rate and section 6 concludes by providing a summary of results.

2. ON THE ECONOIVIICS OF SOCIAL CAPITAL: A DEFINITION AND THREE CHARACTERISTICS

The fundamental cause of economic growth and development proposed in the present paper are resources embedded in social networks of mutual tmst and co-operation that -among other things- provide an informal govemance structure against opportunistic behavior and, thus, help to reduce transaction costs. The notion of social capital provides a useful umbrella term for these resources.'" While the ideas associated with social capital have been fi-equently linked to growth and economic development, there has, so far, been relatively little formal modelling of this intertemporal connection." Gradstein and Justman (2000) present a political economy framework in which public schooling contributes to economic growth not only by building human capital but also by instilling common norms that increase social cohesion (see also Gradstein and Justman, 2002). Chou (2006) proposes three models of social capital and growth in which social capital assists in the accumulation of human capital, affects financial development or facilitates innovation-related networking between firms. Dinda

'" The growing awareness among some (though not all) economists that 'society matters' is documented, for instance, by Durlauf (2002a) and the symposium he introduces. Temple and Johnson (1998) emphasize that society matters for growth for reasons other than trust or social capital; however, they also show that one of their indexes of "social capability" may be a useful proxy for social capital in developing countries.

" For a general survey of social capital from a growth perspective, see Durlauf and Fafchamps (2005).

6 STEFAN D. JOSTEN

(2008) studies the development of social capital through human capital formation that is created from productive consumption in an endogenous-growth framework; the hypothesis that social capital has significant impact on the income level and economic growth rate is also supported by his empirical frndings.

How can social capital be defined more exactly, and what are its characteristics? There is no single universally accepted definition of social capital, but rather various approaches to the concept exist. For the purpose of this paper, I utilize a definition which is closely related to Coleman's (1988, 1990) original concept and define social capital as the set of socio-structural (symbolic) resources - like values, norms, roles and moral obligations ~ that inhere in systems of social relations and that facilitate co-operative behaviour within or between these social aggregates. This definition implies several characteristics of social capital, three of which are of particular relevance for the issues discussed in the present paper and will, therefore, be outlined more closely in the following:

(i) Social capital exhibits public-good characteristics. Coleman (1988, 1990), among others, emphasizes the public-good characteristics of socio-relational features that are useful to individuals for specific actions. As an attribute of the social structure in which a person is embedded, social capital is not the private property of any of the persons who benefit from it. Once provided, these collective assets and features can be utilized in a nonrival manner and are available to all members of the community, regardless of which members actually promote, sustain, or contribute to such resources (non- excludabihty).'^ Accordingly, many of the benefits of actions that bring social capital into being are experienced by persons other than the person so acting, i.e., there are positive externalities, and, thus, individual incentives to invest in social capital are systematically depressed.'^

(ii) Social capital is built as a by-product of various social activities typically sustained by individual investment of time and effort. Even though social capital exhibits public good characteristics, many forms of social interactions and networks also either have intrinsic value or are inextricably intertwined with private, instrumental benefits for single agents.'** As a result, most forms of social capital are built as a by-product of

'^ An important example is honesty. If each community member is honest in commercial transacdons, all of society benefits due to the reduction of the costs of doing business. Such cost reductions are characterized both by non-excludability and non-rivalness.

'^ Chou (2006) demonstrates analytically that the public-good aspects of social capital may lead to an underinvest-ment into the building of social capital and shows how a public-policy scheme may correct this resource under-allocation. For a systematic study on factors influencing individual social capital investment behavior, see also Shideler and Kraybill (2009).

'^ E.g., according to Burt (1992) benefits flowing from social networks may be identified not only in the form of social solidarity involving co-operation, a sense of social duty and indirect reciprocity, but also include two types ofprivate benefits: information and influence (over one's own actions or that of others).

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES ^

various social activities not necessarily undertaken with a view to strengthen social capital. Putnam (1993) gives the example that "members of Florentine choral societies participate because they like to sing, not because their participation strengthens the Tuscan social fabric".

(Hi) An essential part of the instrumental value of social capital lies in thefact that it reduces transaction costs by providing an informal governance structure against opportunistic behavior. In a world of bounded rationality, positive transaction costs and imperfect foresight, contracts are necessarily incomplete, incompletely self-enforcing and incapable of dealing with all relevant aspects of human action and contingencies. Furthermore, there exist systematic incentives for opportunistic behavior both before (ex ante) and after (ex post) a transaction takes place. In such a setting, social capital can work to reduce transaction costs by embedding single economic transactions in a system of social relations, thus acting as an informal governance structure against opportunistic behavior. Among other things, socio-structural resources that inhere in systems of social relations generate expectations, informal rules of thumb and common understandings that allow agents to conduct their personal interactions und business dealings efficiently. Well-developed networks are also likely to reduce transaction costs both by reducing search costs and by reinforcing compliance with group norms. Finally, the high levels of trust associated with social capital are critical for many transactions that take place "in the context of an individual forming expectations about actions of others that have a bearing on this individual's choice of action, when that action must be chosen before he or she can observe the actions of others" (Dasgupta, 2000, p. 330). A typical example of such a context is given by credit markets: Financial contracts represent an exchange of financial resources today for a promise to return more financial resources in the future. The nature of these activities implies risk-taking by market participants which is fiirther aggravated by endemic informational asymmetries. As has been stressed by Ferrary (2003), agents in credit markets, therefore, not only rely on instrumental risk-evaluation methods, but also integrate social networks to accumulate social capital.'*

See also Bowles and Gintis (2002) who argue that community governance can provide less costly solutions to various principal-agent and collective-goods problems than can markets or government interventions.

'* By using regional data from Italy, Andriani (2010) confirms empirically that social capital is positively related to better credit-market performance.

3. SOCIAL CAPITAL, TRANSACTION COSTS, AND ECONOMIC GROWTH: A SIMPLE MODEL

To illustrate the basic interactions between social capital, transaction costs and economic growth, the present paper utilizes the basic model set-up of Zak and Knack (2001).*^ Let us consider an economy with a continuum of infinitely-lived consumers who differ only in their respective ownership shares in the economy's aggregate stocks of capital and labor. Each consumer seeks to smooth his consumption over time by saving. However, to access the capital market consumers have to utilize investment brokers. Only the brokers can observe the actual return earned on an investment free of costs, which gives rise to a moral-hazard problem. The brokers' opportunity to cheat their clients is counteracted by three potential governance mechanisms: private (time and resources spent monitoring), governmental (formal institutions) and social ones (informal institutions).

The closed economy modelled below consists of four sectors of economic agents: a sector of firms producing the economy's single good; an (implicit) government sector providing a governmental governance structure which is financed via lump-sum taxes paid by private households; a sector of heterogeneous infinitely-lived private consumers; and finally a sector of investment brokers who are distinct from consumers and identical to each other in all relevant respects. Economic agents interact on a goods market, a labor market and a capital market.

3.1. Firms and Factor Payments

The key to endogenous growth of the modelled economy is the interaction of leaming-by-doing and knowledge spillovers. According to Arrow (1962), the creation and adoption of knowledge is most closely related to experience. In particular, he considers a firm's investment a good measure for this firm's increase in experience and knowledge, since "each new machine produced and put into use is capable of changing the environment in which production takes place, so that learning takes place with continuous new stimuli" (Arrow, 1962, p. 157). Romer (1986) uses Arrow's set-up and combines it with the second key assumption that each firm's knowledge is a public good that any other firm can access at zero costs. In other words, once discovered; a piece of knowledge spills over instantly across the whole economy.

More formally, consider a neoclassical production function with labor-augmenting technology for firm/,

" Zak and Knack (2001) do not, however, make use of an endogenous growth model, but employ a neoclassical production function.

'^ For an open-economy set-up which studies how growth is affected when credit relations suffer from the danger of moral hazard, see Broer (2007).

STEFAN D. JOSTEN

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES ^

Yj=FiKj,WjLj), (1)

whereYjdenotesthefirm'soutputwhichisafunctionofthefirm'sstockofphysical capital,Kj,thefirm'slaborinput,Lj,andtheindexofknowledgeavailabletothe firm. Function F ( ) satisfies the usual neoclassical properties and physical capital depreciates at rate ô which is identical for all firms. Combining the assiunptions of leaming-by-doingandknowledgespilloversoutlinedaboveAjcanbereplacedby

economy-wide capital K in Equation (1). Assuming, furthermore, that the production function takes the Cobb-Douglas form, the production fiinction for firmy can be written as

Yj=Ay{KjnKLjy-'', 0<a<l. ( 2 )

Let us assume that each firm is small enough to neglect its own contribution to the aggregate capital stock and therefore treats K a s given. Denote b y yj:=Yj/Lj,

kj:=KjlLj, y:=YIL and k:=KlL the usual intensive variables, where L gives aggregatelaborinput.Inequilibrium,allfirmsmakethesamechoices,sothatyj=y and kj =k . Economy-wide production in intensive form is thus given by

y = Ayk''K'-\ (3) and the average product of capital amounts to

^ =AY&''. (4) k

According to (4), the average product of capital is increasing in the size of the aggregate labor input. On the other hand, this average input is invariant with respect to the capital stock k because the leaming-by-doing and spillover effects eliminate at the social level the diminishing returns to physical capital which each single firm faces.

Assuming, as usual, that each competitive firm takes factor prices as given, profit maximization and the zero-profit condition imply productive factor inputs to be paid their respective private marginal product:

(5a)

10 STEFAN D. JOSTEN

(5b)

where r denotes the net interest rate (rental price of capital) and w is the wage rate per labor unit. The private marginal product of capital is invariant with respect to the capital stock, is less than the average product and is increasing in L.

3.2. Households and Factor Accumulation

The economy's household sector consists of a continuum of heterogeneous infinitely-lived consumers, indexed by / G [0,1], who differ only in their respective

relative endowment with production factors labor, h', and capital, k'. For analytical tractability, let us assume that all consumers are endowed with the same amount of physical capital, i.e., V/;A¿ ^k^}^ Thus at time t they differ only in their individual endowments with the non-accumulated factor labor. The aggregate labor endowment of the economy is normalized to unity:

V/;

Each individual can earn incomefi-omboth capital and labor. However, to access the capital market consumers have to utilize investment brokers. Only the brokers are able to observe the actual retum r, eamed on an investment free of costs and, due to this

informational asymmetry, they are able to appropriate a certain fraction of that retum on investments. Consumers have access to an investment investigation technology:

with,

drj/de' >0, dti/dp>Q and dr¡ldS>Q. (6)

Technology (6) permits agents to determine the fealty of brokers in reporting investment income; it gives the fraction of the actual retum to an investment that the consumer receives from his broker.

'^ Since capital is an accumulated factor, individual capital stocks may, in principle, diverge over time; however, it will tum out that this is not the case in the present model.

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES 1 >

That fi'action is determined by three alternative governance structures against the broker's opportunism. First of all, a consumer can spend time and resources investigating her broker in order to reduce the broker's ability to cheat. This private governance structure can be thought of as either time or earned income spent gathering information to judge the comparative worthiness of investments, making contributions to private credit market organisations (such as credit bureaus or bond ratings services), writing detailed contingent contracts, enforcing incomplete contracts, etc. Given the current model's level of abstraction, both time and material resources spent can be represented by the fi'action e' <h' of her individual labor endowment that a private household i devotes to investigate the actual return on her investments.^" Secondly, formal institutions, provided by the government and fiinded by a lump-sum tax T paid by consumers, seek to detect and punish cheating brokers; such formal institutions include: financial regulations (such as financial and non-financial disclosure requirements as well as anti-market abuse rules), investigative agencies that oversee brokers, and the judicial system that enforces contracts and prosecutes cheaters.^' Let the effectiveness of such formal institutions be denoted by p. Finally, a broker's opportunism can be sanctioned by informal institutions. Sanctions due to informal

institutions that constrain opportunism by agents include among other things: feelings of shame and guilt when violating social norms, anticipation of "afterlife sanctions" associated with religious beliefs, loss of reputation, as well as social exclusion. Such informal sanctions depend on, or are facilitated by, a system of social relations in which single economic transactions are embedded and that determines the rewards for co-operation or penalties for deviation. Accordingly, informal sanctions will be the more effective, the higher an economy's social capital S.

All three governance structures act to constrain the brokers' opporttinism, thus partial derivatives in (6) are positive. Since, furthermore, the governance structures are alternatives to each other, let us assume that second-order cross partial derivatives are negative.^^

An agent allocates her labor endowment either to investigating her broker or working in goods production. Accordingly, at any point in time t, labor supply of

^'' In terms of lost consumption opportunities -and, thus, welfare- there is no real difference between income lost due to time spent investigating instead of working (opportunity costs), on the one hand, and earned income spent on material resources to investigate one's broker on the other hand.

^' For more detailed studies on the key role played by the quality of institutions in explaining long-run economic performance and development see, among others, Tebaldi and Ehnslie (2008) as well as Lobsiger and Zahner (2012).

^^ The analysis by Bartolini and Bonatti (2008) is, in a similar way, based on the fact that alternative governance mechanisms can be substituted for one another - albeit with strikingly different results: In their model, when society reacts to a decline in social capital by spending more to protect property and enforce contracts, this substitution may actually result in a higher GDP level.

12

STEFAN D. JOSTEN

consumer /, / ' , is restricted b y

ei+i;<h;.

After-tax income of consumer i is thus given by

,p,,S,]ki - r,.

(7)

(8)

Let us assume that all individuals have the same CIES utility ftinction. Allocative decisions of the ith individual are determined by solving the following problem:

i-e

o

s.t.: ki:=^ = w{h;-e',) + r,;[e;,p„S,]r,k;-c;-T„ (PI) at

where Ö > 0 , so that the elasticity of marginal utility with respect to consumption equals the constant -6, and /? > 0 is the subjective discount rate (or rate of time preference). The necessary and sufficient conditions for a consumer optimum are

' de\''

Equation (9) is a standard Ramsey rule of optimal savings with the expected net yield on savings being rjir,. According to (10), the utility-maximizing allocation of individual labor input balances the marginal income earned by working with the extra income one can generate by investigating one's broker.

Since individual endowment with physical capital is the same for all consumers, Equation (10) implies that in /=0 all consumers make identical choices of

"investigative labor", e¿'. Taken (6) into account, it then follows from (9) that individual growth rates of consumption at time 0 are also the same for all consumers. Furthermore, using the households flow budget constraint in (PI) along with the

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES ' 3

transversality condition of (PI), one can show that all individuals in í = 0 accumulate capital at that very same rate.^^ Thus, interindividual identity of capital endowments is preserved over time and we have for any later point in time:

V/; k',=k,,e''=e,,ri',=ri,. 3.3. Investment Brokers

As mentioned above, to access credit markets consumers must utilize investment brokers who are distributed over the same interval but are distinct from consumers. Brokers take a portion of the investment principle and interest as their wage w ' . For simplicity, brokers are assumed to be risk neutral and do not save. Consumption of a representative investment broker in t is, thus, given by

c;=wl={l-ri,[e,,p,,S,]}r,k,. (11) 3.4. Equilibrium Growth Path

For the labor market to clear in any given period, overall labor input into goods production must equal the sum of individual labor supplies:

111

L, = \i;di = J(A; -e^)di = H,-¡e':di = l-e,. (12) 000

Equilibrium in the capital market requires:

di= k,=k,(l-e,). (13)

With population normalized to unity, economy-wide and individual capital stocks coincide, i.e., k, =K,. Utilizing this normalization, as well as factor payment rules (5), (10) can be written as

(14)

^' See Barro and Sala-i-Martin (1995, p. 142f, 149) for a formal derivation of this result in a leaming-by-doing model with knowledge spillovers and homogenous consumers.

14 STEFAN D. JOSTEN

For any constant values of p, and 5, , labor spent by each consumer on

investigating her broker is also invariant over time. Let us assume from now on that both the effectiveness of pubhc governance structures p and the economy's social capital S are indeed constant over time. Accordingly, the economy's growth rate is given by:

Proposition 1. Long-Term Growth

For a given level of social capital, economy-wide output, physical capital stock and consumption all grow at the common and time-invariant rate of

Proof.

Acording to (9), dynamic evolution of consumption and physical capital stock of any individual consumer is characterized by the following growth rate

¿' ¿' 1

V/; —^=-T-=—(r.n, - p).

Ic' c' 0

As this growth rate is the same for all consumers, economy-wide consumption and physical capital stock, as well as aggregate goods production, also grow at this rate. Taking into account (5a) and the time-invariance derived above, one finally ends up with (15). Q.E.D.

According to (15), the economic growth rate is the higher, the higher is the fraction ri of the actual return to an investment that the consumer receives from his broker and

the less labor e consumers have to spend on investigating their brokers.

3.5. Transaction Costs

The model economy presented so far implies a simple measure of the economy's overall transaction costs caused by asymmetric information and opportunistic behavior in the capital market. Economy-wide transaction costs can be expressed as the aggregate amount of labor that agents spend on verifying their brokers' actions. That is, aggregate transaction costs are given by

TC =\-L, = {e^di = e . (16) 0

MIDDLE-CLASS CONSENSUS, SOCL^L CAPITAL AND THE FUNDAMENTAL CAUSES 15

4. SOCIAL CAPITAL, INEQUALITY AND MIDDLE-CLASS CONSENSUS

4.1. Social Capital

In order to formalize the intuitive ideas presented in section 2, let us assume that at time / an economy's social capital, 5,, simply consists of the sum of symbolic resources, s,, that each of its individual members is willing to contribute to the social structure:

sidi. (17)

Due to the public-good characteristics of social capital, no individual has an incentive to directly invest time and/or effort in its accumulation. However, every individual rationally decides whether she wants to become an integral part of the social community sharing a general social orientation (norms, values, language, culture, etc.) or not. If an individual opts for social disintegration she does not actively promote or sustain social interactions and networks and, thus, does not contribute to the economy's social capital. If, instead, an individual chooses to become an active part of the society's networks of trust and co-operation, she makes a positive contribution to the value of resources embedded in these social aggregates.^'' Accordingly, social capital produced by any consumer / is given by

,• [= 0, if i is socially disintegrated, > 0, // /' is socially integrated.

^'* Clearly, this set-up is one of the more unrealistic assumptions about social behavior employed in the present paper. Generally speaking, social disintegration can also be either a two-sided process or enforced in an authority relation upon the weaker party (e.g., an ethnic minority) by the stronger party (ethnic majority). The individual investment approach taken in this paper is primarily motivated by the wish to keep the model both within the rational-choice paradigm eind, more importantly, analytically solvable. The essential result of the approach taken, namely that social integration depends on a certain degree of homogeneity in community members and social orientations, possesses, however, a much more general validity: Empirically it is well established that both the relative similarity of group members and similarity in attitudes are positively associated with increased social integration and promote group cohesion significantly; some support for the association between social integration and similarity in demographic attributes such as race, age, and education is also available (see O'Reilly, Caldwell and Bamett (1989) and the literature cited therein).

16 STEFAN D. JOSTEN

4.2. Individual Integration Decision

Every consumer bases her rational-choice decision on whether to socially integrate or dissociate herself on a comparison of her own advantages and disadvantages. On the one hand, being part of a community with shared norms, values, language, etc. will improve one's own happiness and well-being.^^ To keep the exposition tractable, let us simply assume that social integration gives any individual member of society a "warm-glow" utility denoted by the strictly positive constant wj > 0. On the other hand,

however, social integration does not come without costs. For one to become an integral part of the community, one has to adapt oneself to the group's common attitudes and social orientation which, probably, will deviate from one's own. In terms of Coleman (1990)'s rational-choice sociology, by joining a social community an individual gives up the rights to control certain of her own actions and transfers these rights to the collectivity. This transfer of rights imposes costs on the individual which are indicated by the difference between the utility level actually secured and the level which would have been secured under full maintenance of individual rights to control one's own actions. As outlined in Coleman (1990, p. 234f.), these costs will be all the higher, the less the individual's preferred behavior is congruent with the community's prevalent norms or expectations. Since, in the model above, individuals differ only with respect to their labor endowments, it is natural to assume that individual social orientation is (perfectly) correlated with this individual labor endowment. Accordingly, the cultural distance between consumer / and the community's social orientation is measured by

h-h' ,where

denotes the community members' average labor endowment. Furthermore, Coleman (1990)'s reasoning implies that the larger this distance, the higher is individual /'s disutility from social integration, as indicated by the following disutility function:

d's=ds{h,h'), (18)

^^ With reference to empirical studies on the association between supportive relationships and self-reported happiness and well-being, Putnam (2000, p. 332) sums up that "in study after study, people themselves report that good relationships with family members, friends, or romantic partners - far more than money or fame - are prerequisites for their happiness".

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES

where ds(h,h) = O, f •^ . > 0 , limd's(h,h') = oo, lim SI !/ AI''->0 ft I'

dh-h'

According to (18), anyone with labor endowment equal to average will be able to comply to the social reference norm without any loss of individual well-being. On the other hand, any individual with h' ^h will still be allowed to join the community, but will suffer from her non-compliance with the social norms. Therefore, her adherence to the community's social orientation comes at a loss of individual well-being. While still enjoying the warm-glow effect of being a part of a community, non-average individuals, thus, have to weigh MJ against the disutility d'^ caused by their social integration. For any individual /, overall net utility from social integration will be given by

and agent / chooses social integration as long as her net utility is positive.

Given the assumptions made about (18), there exist exactly two critical values,

denoted by h- <h and h' >h , respectively, for which the respective consumer will be just indifferent between social integration and social disintegration, for which in other words

u's=ds{hM) = ds(h,h^). (19)

All individuals with labor endowment between h- and h^ constitute the society's middle class: They share a common set of relatively homogenous social orientations ("middle class consensus") and actively engage in social interactions and networking, thus making a positive contribution to the economy's social capital. On the other hand,

individuals with labor endowment below h- ("lower class") or above h^ ("upper class") opt for social dissociation. They participate in the society's economic transactions, but they do not contribute to the community's social capital. Due to the public-goods aspects of social capital, they are, nevertheless, able to capture the instrumental benefits of economy-wide social capital, thus free-riding on others' investments in socio-stmctural resources.

4.3. Inequality and Social Capital

The continuum of individuals is defined over the intervall [0,1]. Therefore, the

^' A similar disutility function can be found in Gradstein and Justman (2000) refering to the cultural distance between parents and child in an ethnically divided society with public schooling.

18 STEFAN D. JOSTEN

fraction/ of consumers who are socially disintegrated can be expressed in terms of the value of the cumulative distribution function of the variable h', denoted by Ff, (•), as

J= jy{^-]) =F,{h'-)+{l-F,(h'^)). (20)

Due to this simple relationship, the effects of an increase in income inequality on an economy's social capital can be derived as:

Lemma 1.

A more unequal distribution, in the sense of a simple mean-preserving spread in h', is associated with a shrinking middle class, while the share of the population that does not contribute to the economy's socio-structural resources increases. Accordingly, a more unequal distribution lowers economy-wide social capital.

Proof. See appendix. Q.E.D,

The proposition that growing inequality of income and wealth leads to a decline in social capital finds some support in the empirical literature: Knack and Keefer (1997), Knack (1999) and Zak and Knack (2001) all find trust and income equality to be positively correlated at the cross-country level. Using US state-level data, Kawachi et al. (1997) also argue that income inequality lowers social capital. Based on a broad survey of relevant empirical studies, Putnam (2000, p. 359) concludes that "both across space and across time, equality and fraternity are strongly positively correlated"; he goes on to claim that the recent decline in social capital in the US is linked to growing inequality of income and wealth.^'

5. INEQUALITY AND INTERTEMPORAL ALLOCATION

As shown by Lemma 1, the share of socially disintegrated consumers and, thus, the size of the middle class depend on the extent of inequality prevalent in an economy. Therefore, a simple mean-preserving spread in the distribution of labor endowments infiuences the economy's growth rate by its adverse effect on social capital:

Proposition 2. Growth Effects ofInequality

^' See, however, Durlauf (2002b) for a general warning that much of the statistical evidence produced in empirical studies on social capital is somewhat problematic and that there are limits to what can be learned about social capital from conventional data sources.

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES ^9

An increase in inequality reduces social capital, increases economy-wide transaction costs and, thus, lowers an economy's growth rate.

Proof

According to (15), an economy's growth rate is given by

where, according to (16), e depicts aggregate transaction costs. None of the determinants of the economic growth rate depends on the economy's distribution in a direct manner. However, both variable e and the value of function r][e,p,S'\ are dependent on social

capital, the value of which, in turn, depends on the inequality in the distribution of labor endowments. Thus, we have

According to Lemma 1, dSldal1< 0 . Furthermore, it has been assumed above that dTjldS>0. Implicitly differentiating optimality condition (10), the effect of social

capital on the optimal individual amount of labor allocated to investigation follows as

dedS ^ p dS d^t/j/

/de'

Therefore, it follows that del dal > 0 . dri/dal<0, and, finally, dyldal < 0. Q.E.D.

The economy's growth rate is reduced by higher inequality due to the following socio-economic mechanism: A mean-preserving spread in the distribution of individual labor endowments widens the cultural gap between the rich and the poor in a society. Accordingly, for a higher fraction of individuals the costs of conçliance with the community's norms outweighs the advantages of social integration. Therefore, the size of the middle class whose members make positive contributions to the value of resources embedded in the society's networks shrinks, while the share of social drop-outs in the population increases. As a result, the economy's overall social capital is depressed. The

20 STEFAN D. JOSTEN

reduced level of social capital, in tum, reduces the effectiveness of informal govemance structures against opportunistic behavior and, thus, lowers the economy's growth rate via two channels: First, economy-wide transaction costs rise because individual consumers try to compensate the lowered effectiveness of social govemance stmctures by increasing the amount of labor they allocate to their ovm investigations. This reallocation of labor induces a fall in the marginal productivity of physical capital and, thus, the economy's growth rate. Since, furthermore, the increase in private investigation against opportunistic behavior is only an imperfect substitute for the role of social capital as an informal govemance structure, the effective yield on savings that the consumers receive is lowered. Households' savings and the rate of private capital accumulation are, therefore, reduced, which is also detrimental to economic growth.

6. CONCLUSION

This paper has analyzed a neoclassical endogenous-growth model which conceives of household consumption and saving as resulting from the rational choices of heterogeneous agents facing a moral-hazard problem on the credit market. In the model's set-up, only financial intermediaries (investment brokers) are able to observe the actual retum eamed on a household's investment free of costs. The resulting brokers' opportunity to cheat their clients is counteracted by three potential govemance mechanisms: private, governmental (formal institutions) and social ones (informal institutions). Private households are assumed to differ in their respective ownership shares in the economy's aggregate stock of capital and labor. The economy's middle class is conceived as consisting of those individuals who share with each other a sufficiently homogenous set of social orientations (though not necessarily economic interests); the size of this middle class is derived endogenously. Social capital amounts to the sum of symbolic resources each individual member of society voluntarily contributes to the overall social structure. It is assumed that each individual rationally chooses whether she wants to become an active part of the society's middle-class networks of trust and mutual co-operation, thus making a positive contribution to overall social capital. Altematively, the individual can socially dissociate herself, participate in the society's economic transactions, but not contribute to the community's social capital. In this set-up, an increase in inequality, as measured by a simple mean-preserving spread in individual labor endowments, is associated with a shrinking middle class and has been shown to depress the community's social capital. These developments, in tum, weaken the informal social govemance system and increase economy-wide transaction costs. As a result, a more unequal distribution lowers the economy's rate of capital accumulation and growth.

The results obtained rely -without doubt- on some assumptions that drastically abstract from reality. Two qualifications of above conclusions seem particularly relevant and point to possible future research: First of all, the paper addresses both income

MIDDLE-CLASS CONSENSUS, SOCIAL CAPITAL AND THE FUNDAMENTAL CAUSES 21

inequality and credit-market imperfections but provides no analysis of the potentially resulting instability of modem financial systems. As has been emphasized by modem Keynesian economist, in particular Hyman P. Minsky (1982), the interaction between corporate debt and/or rising household indebtedness, on one side, and investment spending (capital accumulation) as well as the dynamics of different classes' income shares, on the other side, establishes a fundamental link between inequality of incomes and financial instability.^^ Therefore, one of the most promising avenues for further research is to expand the current model formally and take into account such mechanisms that link income inequality to the financial fragility of contemporary economies. Secondly, as mentioned above, to represent social disintegration as an individual rational-choice act is one of the more unrealistic assumptions about social behavior employed in the present paper. Thus, in future research some feedback effect from aggregate social capital to individual behavior should be taken into account. Such an addition would render the current model analytically intractable, but it may well serve, in a different context, to generate interesting growth dynamics.

All in all, the above analysis -while itself fairly restrictive- serves to illustrate two points of more general validity. First, the existence of a broad middle class the members of which share with each other a fairly homogenous set of social orientations ("middle-class consensus") and the social capital built by social interactions and informal relationships within this middle class are important determinants of economic growth and development. Secondly, in addition to economic and politico-economic transmission channels mediating the relationship between distribution and growth, there also exist socio-economic ones. As mentioned before, the specific transmission mechanism demonstrated in the present paper should be seen as merely one of several channels through which social structures fundamentally determine economic growth and development - charmels remaining to be fiorther elaborated on in future research.

APPENDIX
Proof of Lemma L
^'Jarsulic (1988) develops a Keynes-Kalecki model of accumulation and growth with debt in which income distribution plays a crucial role with respect to financial instability. See also Delli Gatti and Gallegati (1990) as well as Palley (1996). Furthermore, Shahbaz and Islam (2011) examine the relationship between financial development and income inequality and find, among other things, that while fmancial development reduces income inequality, fmancial instability aggravates it.

22 STEFAN D.JOSTEN

Let F!, and F^ be two distribution functions of the random variable h' . Furthermore, let F^ differ from FJ, by a simple mean-preserving spread (as deflned in Rothschild and Stiglitz, 1970). This is equivalent to saying that both distributions have the same mean and in addition 3h' such that \/h' <h', Fl{h')<F^{h'), and
V/i' > h ' , Fl{h')>F^(h') (single crossing property). For analytical simplicity, let us assume that the single crossing occurs somewhere in the open interval |i-,/i-'[. Then,

the single crossing property of a simple mean-preserving spread implies that
while T:=F^{hJ)>f:=F,\hJ).
According to (17), economy-wide social capital is given by:
Therefore, for any simple mean-preserving spread, we have
di.
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26 STEFAN D. JOSTEN

Mailing Address: Stefan D. Josten, Professur fur Finanzwissenschafl und Soziale Sicherungs-systeme, Fakultät fur WOW, Universität der Bundeswehr München,
Wemer-Heisenberg-Weg 39, D-85577Neubiberg. Germany. Tel: 49 89 6004 2334.Fax: 49 89 6004 4228. E-mail: stefan.josten@unibw.de.