Thursday, June 16, 2011

The Efficiency/Equity Non-Tradeoff

-- Posted by Neil H. Buchanan

"Remapping Debate" is a new online journal dedicated to the idea that good journalism involves more than merely reprinting the press releases from official Republican and Democratic sources on an issue. Their shocking claim is that journalists must actually gather and -- gasp! -- intelligently assess the facts and arguments relevant to a story. Investigative journalists should, under this model, challenge conventional wisdom and explore all of the evidence with a skeptical mind. This is a definition of journalism that has all but disappeared, replaced by the idea that journalists are somehow biased if they challenge the conventional wisdom and dare to question baseless assertions by the spokespeople of the powerful interests in the world.

Earlier this week, one of Remapping Debate's reporters interviewed me about a piece that he was writing about the connection between economic growth and living standards. A recent article in The New York Times had repeated the claim that growth inevitably, at least over the long haul, raises living standards. Is that true? If it was once true, is it possible that it is no longer true? My recent posts on Dorf on Law expressing skepticism about the benefits of technological change (here, here, and here) apparently made me a worthy interviewee. The article was published yesterday.

During the interview, one of the topics that I discussed was the hoary notion of the "efficiency/equity tradeoff," an idea taught in nearly every Intro Econ class that suggests that a society can have relatively equal distributions of income only if it is willing to reduce the overall size of the economic pie. Back in the 1960's, for example, the Brookings economist Arthur Okun famously described the "Leaky Bucket" problem as one in which the mechanisms necessary to move income from one group to another would inevitably result in losses from, among other things, administrative costs of government transfer programs. In addition, the taxes and transfers necessary to enact such redistribution would "distort" incentives such that people would not work as hard as they otherwise would have.

Part of the problem with the Leaky Bucket analogy is its imprecise use of the term "efficiency," which I discussed in my post last Friday. The Leaky Bucket mixes together various notions of efficiency, from duplicativeness to reduced output, in a way that may or may not map onto any particular notion of "economic efficiency" (i.e., Pareto-efficiency). Still, the intuitive picture of a leaking bucket captured the idea that underlies the bipartisan neo-liberal agenda: government policy and "the market" are opposing forces, with the market poised to do its work if only the government would get out of the way.

Near the end of the article in Remapping Debate, therefore, I am quoted as saying that "the efficient modern economy that is so focused on growth is not giving us the results we need." What is missing from that quotation is my deliberate irony in using the word "efficient," as I was mocking the very notion that an "unfettered" economy was even a meaningful concept. (To be clear, I am not saying that I was misquoted or even quoted out of context. The journalist accurately described my argument, but without being able to capture in print my scorn at the broad misuse of the concept of efficiency.)

The efficiency/equity tradeoff is thus based on the idea that an economy can be more productive (of things measured in GDP) if the government leaves it alone. If we accept this non-Pareto definition of efficiency as the relevant measure of efficiency -- and why shouldn't we, given that Pareto-efficiency is an empty concept? -- we are left with the idea that we can choose between an economy that grows a little or a lot, depending upon how much fairness the government "artificially" imposes on the economy. (Sorry for all the scare quotes, but the terminology of orthodox economics is so embedded in the language, in such misleading ways, that it is necessary to highlight when words are being used in ways that are freighted with assumptions and special meanings.)

As a numerical example, we could supposedly step back and allow the magic of the market to create annual growth of 3% per year, or we could impose ("inefficient") redistributive policies that reduce growth to 2% per year. After a few decades, the less equal economy has more than doubled in size, while the more equal economy falls behind. (In 24 years, 3% growth doubles the size of the economy, while 2% growth leads to an economy that is only 60% larger.) With the larger economy, everyone can have more -- and even if wealthy people capture an outsized share of the higher GDP, at least everyone else can be better off than they would be in the more egalitarian society.

There are, of course, a lot of assumptions buried in that analysis, not least of which is the belief that the distribution of income has no effects on political decisions. (For a contrary view, see my recent review of The Trouble With Billionaires.) But what is most important, perhaps, about the efficiency/equity tradeoff is the standard assumption (at least among American economists and policymakers) that higher rates of growth really will improve everyone's living standards, albeit by unequal amounts. In other words, the assumption that "a rising tide lifts all boats" is very much at the core of the argument for choosing efficiency over equity.

The article in Remapping Debate, therefore, is absolutely on target in asking whether we can really be sure that economic growth (eventually) leads to higher living standards for everyone. As I point out in the article, it is tautologically true that higher growth means that there is more "stuff" being produced. What is not tautologically true -- or, it turns out, necessarily true at all -- is the belief that the resulting GDP-stuff will be shared in ways that make everyone truly better off than they would have been in a more egalitarian society. "There's more stuff for everyone" need not mean that everyone gets more stuff, only that they could have received higher living standards, if only the economy had been more egalitarian. Nice paradox.

In the context of the 1960's and 1970's, it made intuitive sense that "more stuff" would be shared by everyone, as average wages rose pretty much in tandem with GDP. Since about 1980, however -- not a coincidental date, I would emphasize -- GDP has continued to grow, but wages have not. We used to face a difficult empirical question: If we eliminate equitable policy A, will that lead to economic growth sufficient to leave the people who would have benefited from the equitable policy absolutely better off, even if they fall relatively further behind the rest of society? (There were also questions about leaving some people worse off in the name of helping larger numbers of people, but we can set those more brutal calculations aside.)

We now have proceeded through more than three decades during which we have dismantled or severely weakened a broad range of policies that were intended to produce more equitable income and wealth distributions, during which time all but the very highest incomes have remained essentially unchanged. (Any increases in incomes among the non-wealthy have been purchased by increased workloads, which raises other questions about how to measure living standards.) One supposes that it could have been worse. Still, what we have seen is that higher GDP has not led to higher incomes across the board.

We definitely have experienced the increases in inequality that are the inexorable result of choosing efficiency over equity. What we have not experienced are the higher living standards for all that are supposed to be our payment for making that choice. Why do we continue to believe that growth must ultimately be good for everyone?


tjchiang said...

I don't think that the usual argument is that increasing efficiency will lead to higher living standards for everyone. It is that overall living standards will increase. And if you accept that living standards=GDP (as you say a contestable assumption, but it seems to be the assumption of your post), then we have seen an increase in GDP along with inequality.

When you say that the argument is that higher inequality was supposed to lead to higher living standards for everyone, even if it benefits some (i.e. the rich) more than others (the poor), in the sense that the poor are still supposed to be better off than they would be under a more egalitarian government, you are adopting a Pareto definition that you earlier disclaimed. I am sure that the argument for greater inequality does sometimes make the argument in this type of Pareto efficiency language (everyone is better off), but I don't think that is the norm; and more importantly you were expressly not operating on a Pareto criterion.

Neil H. Buchanan said...

I reject Pareto efficiency because it is ultimately meaningless. That does not mean that others have not used win-win arguments to sell their policy agendas. Those who pushed liberals to accept efficiency over equity did so quite explicitly.

No one ever said, "Average living standards will increase, but the vast majority of people will see none of the increased income that raises the average." The argument was always that accepting a more unequal distribution of income and wealth would create so much more stuff that even the people at the bottom would be -- would be, not could be -- better off.

In the political vernacular, the idea was that people should get over "the politics of envy" and just be happy that their incomes are up. If poorer people's incomes go up by 50%, the argument goes, why should they care if richer people's incomes go up by 75%?

Whatever force that argument might have had before now, it is undercut by current reality. The term "overall living standards" is just another term for averages, and everyone has now experienced a generation of rising averages while the vast majority run to stand still.

tjchiang said...

Overstating the win-win argument goes for both sides. That is par the course for political rhetoric. But you cannot explicitly accept a definition of efficiency that says "an economy can be more productive (of things measured in GDP)" and then say that this is untrue because not every last person is made better off and some conservative politicians sometimes phrase the argument in terms of making every last person (and not just GDP) better off. Like I said, I am sure that sometimes the argument is phrased in those Pareto-efficiency terms, and your refutation would be perfectly fine for that. But that is not the definition you accepted.

tjchiang said...

And lest I come across as nitpicking on one quote, the point is that if we accept that there is a trade-off between GDP and inequality (at least within limits, obviously at extreme levels of inequality GDP will go down), then the efficiency/equity tradeoff is not as illusory as you make it seem.

Neil H. Buchanan said...

"But you cannot explicitly accept a definition of efficiency that says 'an economy can be more productive (of things measured in GDP)' and then say that this is untrue because not every last person is made better off and some conservative politicians sometimes phrase the argument in terms of making every last person (and not just GDP) better off."

That's simply not what I said. I said that the prospect held out by those (conservative and liberal) arguing for efficiency over equity was that even the people on the wrong side of equity would share in the gains. They have not, by a long shot. Even if one views it as trickle-down economics, the idea was supposed to be that something trickles down.

And we're not talking about "every last person." If I were arguing that we were promised 100% and we only got 99.6%, then that would be one thing. We're talking about the vast majority of the country.

It is not that some conservative politians sometimes phrased the argument in terms of people and not GDP. No one ever said, "If we choose efficiency, GDP will go up, but there's no guarantee that the vast majority of people will receive any of those gains." And they didn't say so for good reason. The efficiency/equity tradeoff was supposed to be appealing because it promised more for everyone. We can't pretend ex post that people were foolish because they didn't understand that efficiency merely means higher GDP.

In other words, it is not that I "accepted" a definition of efficiency and then failed to live with it. I described a complete argument, which says that we can choose "efficiency" -- in which we abandon equity-enhancing policies in the hope that those policies will make everyone better off -- rather than "equity" -- which is supposedly bad because it results in leveling down. Saying, "But GDP went up, so you got what efficiency promised," simply misses what the efficiency/equity tradeoff debate was about.

tjchiang said...

If your point is only that the majority of voters, or, lets take a more precise definition, the median voter, would be better off under a more redistributive policy, I have no disagreement. But that is a political point, not an economic one. It does not deny that there is a tradeoff between GDP and equality. You may think that society should clearly favor more equality, and you may think that the median voter should so clearly agree with you that the only reason that current policy is otherwise is that they have been bamboozeled or betrayed by corrupt politicians. But again those are not economic points.

Economically, the reason I jumped straight from your argument about majority to "every last one" is that economics does not distinguish between benefits to majorities and minorities. You may think that government policy should. But neither you nor I are politicians, and I have no expertise on what the median voter should do.

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In the language of politics was the idea that people should get more politics of envy and just be happy that their income is rising. If the income of the poor increased by 50%, the argument, why should they care if the income of the rich increased by 75%?
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