Economic Equality And Efficiency: False Choices
Andrew Berg et al. sum up a study from late last year, in which it was found that efforts to reduce economic inequality through redistributive policies is not, as economists previously believed, detrimental to economic growth:
IN his influential 1975 book Equality and Efficiency: The Big Tradeoff, Arthur Okun argued that pursuing equality can reduce efficiency (the total output produced with given resources). The late Yale University and Brookings Institution economist said that not only can more equal distribution of incomes reduce incentives to work and invest, but the efforts to redistribute—through such mechanisms as the tax code and minimum wages—can themselves be costly.
And yet, as Galileo might say, “it moves:”
In recent work (Berg, Ostry, and Zettelmeyer, 2011; and Berg and Ostry, 2011), we discovered that when growth is looked at over the long term, the trade-off between efficiency and equality may not exist. In fact equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years or even decades and the many others that see growth spurts fade quickly may be the level of inequality. Countries may find that improving equality may also improve efficiency, understood as more sustainable long-run growth.
There’s something important that needs to be acknowledged, however. Returning to Arthur Okun:
Okun likened these mechanisms to a “leaky bucket.” Some of the resources transferred from rich to poor “will simply disappear in transit, so the poor will not receive all the money that is taken from the rich”—the result of administrative costs and disincentives to work for both those who pay taxes and those who receive transfers.
That’s absolutely true. Redistribution is inherently inefficient. But the question is whether the inefficiency of redistribution is nonetheless outweighed by the inefficiency of structural economic inequality. Value loss occurs in voluntary transactions as well as public transactions. Impoverished persons have economic needs that they can’t meet due to a lack of liquid assets. They may also be unemployed and without the means to acquire new skills that would allow them to fulfill a more pressing economic need without some sort of extrinsic intervention on their behalf. And the marginal propensity to consume by an impoverished individual is larger, up to a certain income threshold (relative to constant price levels), than the transfer-loss created by redistribution. Obviously it’s not always that simple, but comparative data sets often confirm the theory.
Another thing that’s important to keep in mind is that we do have a choice in what the distribution of wealth looks like. It is, all other things being equal, a policy decision, and not the result of inevitable primordial economic forces. Take it away, John Stuart Mill:
We cannot alter the ultimate properties either of matter or mind, but can only employ those properties more or less successfully, to bring about the events in which we are interested.
It is not so with the Distribution of wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. They can place them at the disposal of whomsoever they please, and on whatever terms. Further, in the social state, in every state except total solitude, any disposal whatever of them can only take place by the consent of society, or rather of those who dispose of its active force. Even what a person has produced by his individual toil, unaided by any one, he cannot keep, unless by the permission of society. Not only can society take it from him, but individuals could and would take it from him, if society only remained passive; if it did not either interfere en masse, or employ and pay people for the purpose of preventing him from being disturbed in the possession. The distribution of wealth, therefore, depends on the laws and customs of society. The rules by which it is determined, are what the opinions and feelings of the ruling portion of the community make them, and are very different in different ages and countries; and might be still more different, if mankind so chose.
And mankind can so choose. If he wills it.
Update: The NYT posted an article yesterday about the rising education gap between the rich and poor. As the economy becomes more complex and technologically advanced, education is required to fill the job roles that the economy demands. That means that unskilled laborers are less likely, as a class of individuals, to be able to find gainful employment as the skills needed to participate in the labor market become more complex. Without the resources to acquire the education necessary to get these skills, a larger and larger portion of the class remains unproductive. This is precisely the kind of inefficiency that redistribution (e.g. publicly-funded education) is meant to alleviate.