Herman Daly Festschrift- Hicksian Income, Welfare, and the Steady State

Herman Daly Festschrift- Hicksian income, welfare, and the steady state

• 1 Foreword
• 2 What Is Income?
• 3 Adjusting the Conventional Estimates
• 4 Hicks’s Income
• 5 Income in Value and Capital
• 6 Income from Wasting Assets
• 7 Later Hicksian Thoughts on Income
• 8 Steady and Stationary State Economics
• 9 A Digression on Valuation by Cost or by ‘Utility’?
• 10 More on Welfare
• 11 A Kind of Summing Up
• 12 References
• 13 End Notes

Lead Author:Salah El Serafy(other articles)

Article Topic:Ecological economics

This article has been reviewed and approved by the following Topic Editor:Joshua Farley(other articles)

Last Updated: September 2, 2009

The range of Herman Daly’s contributions to environmental economics has been extensive. I select here one topic upon which he pondered and successfully propagated among environmental economists. This is ‘Hicksian Income’. The estimation of national (or social) income, particularly the portion of it that derives from the exploitation of natural resources, is a subject that has occupied my thinking for some considerable time. This chapter discusses Herman’s ‘Hicksian income’, and additionally touches on the related topic of ‘steady state economics’ which I take to be Daly’s most enduring interest. Another aspect of the same topic also reviewed is Daly’s clear preference for viewing income estimates, not just as gauges of output, but as indicators of welfare. In this he has obviously been following Pigou but, surprisingly, as I hope to show below, Hicks also.

Foreword

Herman Daly popularized what he called ‘Hicksian income’ among environmentalists as well as others. Generally speaking ‘Hicksian income’ is the standard concept of income as traditionally used by accountants and also by the more thoughtful economists. Income, thus defined, must not contain any element of capital. To estimate income correctly, capital must remain intact. Here, keeping capital intact is a theoretical device for the estimation of income and does not entail a normative advocacy. Quite appropriately, Herman argued for extending the category of capital that must be kept intact to natural resources since they are obviously part of society’s assets. In practice, the estimators of national income make no allowance for natural capital erosion, regularly inflating income estimates by including in them the proceeds of natural asset sales such as forest products, fish or mineral deposits, while turning a blind eye to their deteriorating stocks. This ‘standard’ practice is obviously a major estimation error of which most users of the national accounts seem to be unaware. But Daly has had a wider interest going beyond the descriptive ex post estimation of income—a description that conflates income with ‘output’. Such a conflation, in fact, is the general view held by national income statisticians who would deny vehemently that they are in the business of estimating ‘welfare’. For instance, what the domestic product measures, they would claim, is simply the domestic ‘output’ as it is transacted in the marketplace. Put simply, without knowing the size of population or how individual incomes are distributed, a rise of GDP cannot be read as a rise of welfare. However, following essentially Pigou, and also Hicks (albeit occasionally in the case of Hicks), Herman, with suitable qualifications, set out to interpret national income estimates as signifying the ‘welfare’ which the product sheds on the income recipients. Interpreting output as synonymous with welfare, however, is a complex matter and an attempt is being made here to disentangle this complexity.

The present chapter will begin with Hicks’s income as elaborated in his magnum opus, Value and Capital, (first edition 1939, second edition 1946) together with the variations or ‘approximations’ Hicks discussed around his central meaning of income.

This chapter strays out of the concept and measurement of income to dwell briefly on the not unrelated topic of ‘steady state economics’ which is one of Daly’s enduring interests. It will be shown that as there is a ‘Hicksian income’ there is also a Hicksian ’steady state’, and a Hicksian ‘stationary state’--both of them having deep roots in classical economic thought. While obviously looking upon national income as a metric of output, Hicks entertained on occasion the view that it could also indicate welfare.

What Is Income?

Income is a quantity received by an individual, a group or a nation that is usually recurrent. It ordinarily derives from wages, property rent, earned interest, or profits. It is a flow that accrues per unit of time, and it is decidedly not a stock existing at a point of time. In The Wealth of Nations, Adam Smith used ‘wealth’ synonymously with an income flow -- a usage that has misled some economists into thinking that Smith’s wealth was other than the ‘national income’ of nations. Historically, the accountants confronted the estimation of income before the economists, who came to the field much later though with a great deal of analysis that manifested a somewhat different perspective. The accountants, to their credit, had initiated the notion of ‘keeping capital intact’, not as a normative imperative, though this may not be discounted, but as a tool for a rough and ready estimation of the illusive quantity called income. In the late Middle Ages the sea-faring merchants of the Mediterranean ports (both north and south) had asked their accountants to estimate how much of their revenues could be allocated to family consumption. The accountants’ response was that enough from the receipts should be put aside for ‘maintaining capital’ before regarding any remainder as income. Needless to say the merchants could, if they wished, save part of their income, adding it to capital for expanding the business. But the accountants, qua accountants, had no say on this ‘managerial’ matter; they were simply estimating income during a period that had become past.

Adam Smith recognized that wealth could not increase without additions to capital, such additions, he held, came only from thrift. This view dominated the thinking of the classical economists down to J.S. Mill, but when the turn of neoclassical economists came, and the variety of capital categories multiplied, defining the capital that must be kept intact in practice became almost impossible. By the time of Marshall we find several capital categories: auxiliary and instrumental capital; free and floating capital; social capital, circulating capital, fixed and overhead capital--among others. The problem of obsolescence added to the problem as machinery that had not physically depreciated became outmoded (Hicks, 1942). Economists including Pigou, Hayek and Hicks battled over the concept of ‘keeping capital intact’ in the 1930s, to conclude in effect that an objective notion of the intactness of capital, let alone its empirical calibration, was not possible. This is before natural resources in their almost infinite diversity were proposed as unquestionably part of society’s capital (see below).

The correspondence between income and capital is obvious. Alfred Marshall, often recognized as the father of ‘neoclassical economics’, reminded us that Adam Smith had said that ‘a person’s capital is that part of his stock from which he expects to derive income’, adding that ‘almost every use of the term capital which is known to history has corresponded more or less closely to a parallel use of the term Income’. On the same page of his Principles of Economics Marshall wrote: ‘When capital ceases to increase, income likewise will stop growing.’ (Principles, 8th Edition, 1920, p. 78.) Hence seeking to keep capital intact should be seen as fundamental to income generation.

Relevant to both income, and the intactness of capital, is the proper valuation of end-period stocks which will be bequeathed to the next account period. For this purpose the accountants had devised a precautionary valuation rule with which the economists have not always been happy. This may be paraphrased: ‘When in doubt opt for undervaluing rather than overvaluing this stock’. In other words income should rather be underestimated than overestimated. In this respect the accountant functions as a guardian of ‘sustainability’, but it is a shorter period sustainability, namely from one accounting period to the next. If this rule were to be observed year after year, the short term survivability of the enterprise (or the nation) could be made to extend over longer periods. Economists, however, have favored a different view – a view that has seeped into national accounting--placing a greater store on valuing stocks at current prices, and this in practice has frequently undermined the accountant’s concept of sustainability .

Most commonly, overestimated income must have included elements of capital—elements that should not be there in the first place. The expression ‘sustainable income’ is usually a misnomer because the adjective ‘sustainable’ becomes redundant if income is properly estimated. Herman’s invocation of the name of Hicks in this regard was indeed proper, and probably motivated by his intention to convince doubting economists of the solid economic foundations upon which the estimation of income should rest. Economists, whether they needed convincing or not, are the principal users of the macroeconomic magnitudes produced by national accounting. And it is remarkable that, with few exceptions, they take these magnitudes at their face value, proceeding to analyze them sometimes with ostensible sophistication. Economists would arrive at dubious interpretations of economic performance, often leading them to questionable policy recommendations.

For many countries, the conventionally compiled national accounts would need correction, but such a need is acutest where serious deterioration in natural resources is taking place and not captured in the accounts. The fact that the richer countries at present tend to derive most of their national income from manufactures and increasingly from services reduces for them the importance and urgency of reforming national accounting practices in the direction of ‘Hicksian income’. Their national accounts are good enough for meeting their macroeconomic needs, both for indicating past performance and providing guidance for future policy. Having in most cases depleted the bulk of their natural capital in the process of industrialization they, with some exceptions, tend to underestimate the value of what has come to be known as ’green accounting’, and appear even to oppose it. The poorer countries, on the other hand, whose economies depend on primary activities to a much greater extent, and whose conventional accounts often cry out for drastic adjustment, understandably carry little influence in the international fora that devise national accounting procedures. Even when certain developing countries have well-founded doubts about their own national estimates that are faithfully tailored on internationally-devised standards, suspecting that the accounts falsify their performance and show them to be more prosperous than they actually are, they put up with the judgment of the national accounting ‘experts’ who, regrettably, include those employed by the United Nations. To this day, even the revenue obtained from the commercial extraction of natural resources (fish, timber, minerals inter alia) still appears in the standard accounts as ‘income’ with no allowance made in the flow accounts for the disinvestment associated with the observed decline in resource stocks. (See Commission of the European Communities et.al., System of National Accounts 1993.)

Adjusting the Conventional Estimates

Herman participated during the 1980s in the series of international workshops organized by the United Nations Environment Programme (UNEP) jointly with the World Bank. Initially, the workshop participants were searching for a periodically reckoned ‘number’, or index, capable of expressing environmental and natural resource deterioration. This, they thought, would impress citizens and politicians alike about the worsening state of the environment and thus spur remedial actions. After some hesitation the workshops settled down to considering the set of national income and product accounts as an excellent medium for meeting their purpose. The fact that income estimation depends on the principle of ‘keeping capital intact’ provided a major theme that gathered momentum during these discussions, with natural resources having to be recognized as part of society’s capital. The work accomplished at the workshops contributed in no small way to the 1993 revision of the United Nations System of National Accounts (SNA) which had remained virtually unchanged for a quarter century . Subsequently a number of meetings were held before the issuance of the new SNA, one of which was the important conference organized by the International Association of Research in Income and Wealth in Austria in 1991. It should be stressed that the process of amending the accounts was viewed from the outset as slow and gradual, and would hopefully move in time, with further research and ingenuity, from being partial and tentative in the direction of comprehensiveness and robustness.

A selection of the contributions made during the UNEP-World Bank Workshops was subsequently published, containing Herman’s paper ‘Toward a Measure of Sustainable Social Net National Product’ (Chapter 2, pp.8-9 in Ahmad et al., eds., 1989.) Herman’s piece began with Hicks’s basic concept of income (Value and Capital, Oxford, 1939; second ed., 1946) which defined ‘sustainable’ income. The rock base on which Daly’s income rested was netting out from the estimated gross product an allowance for the deterioration of natural resources—resources, here to be taken in their wider sense as ‘sink’ as well as ‘source’. How much should be netted out, however, was not easy to determine and has remained a bone of contention. The adjustment proposed by Daly included also the deduction from the conventional estimates of any ‘defensive expenditure’ undertaken to correct harmful side-effects of production and consumption. Interestingly, in that short piece Herman was looking at the national or domestic product (alias income) as output without any connotation of welfare. However, almost simultaneously in his joint book with Cobb (Daly and Cobb, For the Common Good, 1989) he was emphasizing national income as an indicator of welfare: a rise in estimated income suggested a rise of welfare and a drop suggested a decline. In that work Herman and Cobb proceeded further to adjust the official national income estimates for the United States employing a number of deductions varying from losses of source resources to deterioration of amenities. This endeavor set in motion and reinforced already begun efforts that viewed natural resource deterioration as welfare losses, with the result that both the adjusted income level and, quite often (but by no means always), its presumed growth, had to be scaled down.

In later publications, especially in tandem with his advocacy of ‘stationary state economics’ Daly convincingly explained that the pursuit of unending growth, which most economists strongly favor, was untenable since the economy is a subset of a finite biosphere that is not expanding. Daly persisted in stressing the argument that the apparent benefits of economic expansion must be balanced against its costs in a truly Pigouvian manner that centered on welfare. For Pigou had said in the 4th edition of his Economics of Welfare (1932) that ‘economic welfare….consists in the balance of satisfactions from the use of the national dividend….over the dissatisfactions involved in the making of it.’

Hicks’s Income

Hicks had given a lot of thought to the concept and estimation of income and written about it in several of his publications, but his chapter on ‘Income’ in Value and Capital (second edition 1946 which is used here) contains his most detailed thoughts on the subject. He would come back to the subject intermittently, finding something fresh to add in scattered obiter dicta, but most significantly in his seminal paper, ‘The Scope and Status of Welfare Economics’, (Oxford Economic Papers, 1975). However, it would be remiss to overlook his earlier book The Social Framework, an Introduction to Economics (first published in 1942) which was totally devoted to national income in theory and practice. In the Social Framework, he systematically elaborated the relevant macroeconomic concepts and examined their interconnections, including consumption, investment, factors of production, population, capital, the social product and foreign payments. He also faced up to the formidable task of sorting out a tabulation of the social accounts of the United Kingdom for 1938 and 1949 (the latter year appearing in the 1952 Second Edition) while explaining related quantities and definitions. In the process he went back and forth in time to offer comparisons, pointing out practical estimation difficulties and how he dealt with them. This was a brave exercise that revealed to the uninitiated how difficult it was (and still is) to come up with objective estimates, with a warning to users ignorant of the practical obstacles that have to be faced by national income statisticians. It will be seen below that Hicks’s views on income, while safely anchored in Value and Capital, were to receive in 1957 an intriguing interpretation by none other than himself--an interpretation of relevance to Herman’s income work.