The Economics Analysis of Wellbeing in New Zealand

I read about “wellbeing” in 2014 when the Chief Economist of the Treasury sent me his paper on this issue for comments. He had a economic model, which included a variables called social cohesion and environmental indicator, as I recall. Wellbeing is something, probably, about higher employment rate, decent wages, better education and health care, cleaner environment, and gender and race equality…etc. Essentially, his key objective was to maximize GDP growth.

The Treasury still adopts the same wellbeing program, but this time without a macroeconomic model, analysis, or anything formal. It is unclear how the Treasury advises the government about this issue. I learned that the Treasury uses the large micro data (100 variables), which are produced by Stat NZ to shed light on these issues.

It is unclear how the Treasury advises the government using these data!

Undoubtedly, formal macro analysis is required for the Treasury’s work to be credible.

There is something about utility maximization, perhaps. To begin with, it is very difficult to design a social welfare function although some economists are still trying.

You can imagine that many economists have been trying to understand how this works! I think that it is still incomplete.

A simple approach most economists know well is to begin with a small general equilibrium model, whereby the average household maximizes an expected utility function, which is a function of a consumption bundle (all goods and services), and leisure subject to a budget constraint. The budget constraint is where after-tax income from work and other assets is equal to expenditures on consumption and investment. The government budget constraint remains unchanged. Later, one could vary the analysis with sex, age groups, race, etc., or find a way to deal with heterogeneity.

For completeness, there must be also a production function of the goods and services. Optimal growth is a key. Output is produced by choosing (and substituting) inputs such as physical capital, labor and maybe human capital and other inputs… This process is also subject to a resource and other constraints, and needs optimization.

Combining these consumer / producer optimal solutions yield a consistent optimal outcome, say for example, the consumption to output ratio. The ratio combines optimal consumption and output, which may convey useful information about the wellbeing of the average household.

What could affect the optimal the consumption – output ratio?

Actual hours – worked is a key variable – the supply of labor. The share of capital (or labor) in the production of output matters too. Many policies affect these decisions. A tax on capital and labor might reduce these shares because they affect the prices of capital and labor, which induce substitutions. Savings matter too because savings are capital, eventually investments, which determine the output of goods and services, and eventually the consumption-output ratio. Finally, within this simple structure, the relative value of leisure matters a great deal for the optimal consumption – output ratio. Would this model explain the actual consumption-output ratio?

This simple model can generate dynamic stochastic projections for the future of optimal consumption and output. Such a humble beginning would lend some credibility to this program.