Sunday, December 8, 2013

What equality-efficiency trade-off?

As my online debates with ‘well trained’ economists continue with full force I will again use this blog as an outlet to expand on arguments that can’t be made in 140 characters or less, or those that simply attract religiously-held views via comment pages.

On Facebook an otherwise innocuous comment, that it is “undeniable there is an equity-efficiency tradeoff,” really leapt off the screen at me. Why would a sophisticated economist make such a strong statement that has little to no empirical support. Could it be that this little book has had such an enduring impact on the discipline?

What is rarely taught, in the haste for economics departments across the Anglosphere to pump out energetic graduates, are the numerous built-in assumptions of the core models that lead to this apparent trade-off. Nor are alternative models presented that parcel together different, often more realistic, assumptions, and which arrive at far different conclusions.

To be more concrete, if there really is an equality-efficiency trade-off at a broad level, then there should be no single regulatory change that can increase both equality and efficiency, since if there exists such a reform, or set of reforms, it negates the entire aggregation to a macro level trade-off. Nor should you be able to simultaneous decrease efficiency and equality, as this leaves the door open for reversals of such policies.

My preferred alternative way to approach such problems is to consider the set of institutions that led to the current level of equality as a whole. Then evaluate the costs of these institutions against alternative institutions that result in more, or less, equality.

One might interject at this point to say that the shifting nature of equality is a product of technology change, education, or some other such thing. I’ll leave it to Matt Bruenig to address this point
When we talk about how economic changes, technological swings, and even education will affect the distribution of income in society, we always sort of assume away our government’s distributive policy as if it will or must remain static. But that’s not true at all. At any time we can change the huge set of policies that direct the distribution of income in society to something else. 
The last few decades of median income stagnation didn’t have to happen. Even if you say it was caused by international competition or technological change or whatever else, the point is that if we had put a different set of distributive institutions into place, we could have avoided the maldistribution of income that we have seen. It is not like the median incomes stagnated because the economy as a whole stagnated. Quite the contrary: the economy is much larger on a per capita basis now than it used to be. If we had wanted to make sure median incomes continued to rise, we could have done that. We would have just needed different distribution policy.
Let us now consider a couple of important cases in the set of reforms that, by most estimates, would increase both equality and efficiency.

First is shifting the tax base to land (and other resource monopolies). This is probably the simplest to  administer, and the one reform that would have the greatest efficiency boost and equality gains. Unfortunately it is also the one reform that, by virtue of its distributional impact, is the least palatable to the wealthy and therefore the least palatable politically.

The reason for the win-win nature of land taxes is that deadweight losses from taxation are reduced, increasing efficiency, while at the same time the tax will fall on those entities with the largest ownership claims to the natural wealth of a country, increasing economic quality.

The second case comprises any investment in public goods by government that would disproportionately benefit the poor due to their characteristics. I’m thinking here of, say investment in a fibre optic communications network to all homes, or investments in parks and community services in poorer neighbourhoods, or any number of things. These investments would then be provided free of charge or at token prices.

The policy space is vast, and economic thinking often limits it. Consider the case of gifts of land and accessible government-backed construction finance to households on low incomes. Such a scheme would provide the poorest in society an asset they can use to support themselves - to borrow against, to invest in, and use as a cushion in times of financial distress. We did it once before with the soldier resettlement programs, but for slightly different reasons.

In the case of Australia I might even suggest intervening in currency markets to keep the AUD low and foster local investment.

That’s a nice handful of policy ideas that appear to negate the apparent ubiquitous equality-efficiency trade-off. 

Why do these ideas still hold so much sway? Why do we teach that the usual case is for a trade-off, when it is equally valid to teach that the usual case that there is no trade-off? Why constrain the thinking of graduates in this way?

I can't provide a complete answer to these questions now. I can only do my part to expand the thinking of receptive readers of this blog. 

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  1. I'm starting to struggle to understand your posts. Perhaps you're pitching to a more savvy audience, or just to economics people. Probably a hard communications road to tread. Anyway when you say:

    "while at the same time the tax will fall on those entities with the largest ownership claims to the natural wealth of a country."

    I wonder about this, for what about people who own land which is not "wealthy" but important for non-productive (in economic human valued terms). Perhaps that land is only significant because it forms the home to a biodiversity group that is valued but can't afford to pay?

    Or would this land be exempt from such taxes?

    1. It is important not confuse the size of land and its value. The type of conservation land you refer to would be valued very low, since it is unable to produce income. In fact, if such land had protection from future development via zoning regulations or some such thing, and there is no way to make a significant income from the land, its value will be very low, and the tax will be some small proportion of that low value.

      There is also wide scope for exemptions for land used for community purposes. An example of a current exemption is of residential land up to a certain value (in QLD).

      Other cases, such as agricultural land, would need some further consideration due to the variability of income from the seasonal and extreme weather dependent nature of the business. Such things as reduced rate of tax and carry-over provisions for payment of taxes etc.

      Most of the land value in the country is residential. Have a look at the breakdowns in this report

  2. Greetings ~ a brief thought:

    Any model or discussion (article, blog post) about economic policy is bound to over-simplify and generalise enough that its conclusions are false if taken literally to apply to all (note paradox of this statement). Another truism is that every economic model must be considered ceteris paribus, for any validity--empirical or theoretical--to be discerned or accepted. Yet, you seem to consider the "equity-efficiency tradeoff" both as a binary that must be uniformly-true or not at all AND you fail to account for conditions affecting ceteris paribus, based at least on my reading of this paragraph (my ** added for emphasis):

    "To be more concrete, if there really is an equality-efficiency trade-off at a broad level, then there should be *no single regulatory change* that can increase both equality and efficiency, since if there exists such a reform, or set of reforms, it *negates the entire aggregation* to a macro level trade-off. Nor should you be able to simultaneous decrease efficiency and equality, as this leaves the door open for reversals of such policies."

    (of course, equity and efficiency must be defined and the policy universe in question identified, before the query can even be undertaken...)

    But: Really? The equity-efficiency tradeoff cannot (1) be a tendency rather than an absolute (see complex systems models, models of various heterodox schools, etc which allow for such things), nor (2) be affected by other factors, such that a regulatory change produces this effect (simultaneous increase or decrease) for reasons other than the truth or falsity of the equity-efficiency tradeoff....?

    Now, I agree that the equity-efficiency tradeoff should not be taught as if it were valid in any and all cases -- that is the point I make above, nothing should -- but this does not mean that it has no validity in any of the forms in which it has been defended. Many scholars have found such a tradeoff under certain conditions, within certain bounds, keeping certain things constant, and though I agree that it is far from universal it should not be dismissed outright so simply as you do.

    Note that I say all this despite agreeing with your policy prescriptions.

  3. Cameron,
    I'm a bit surprised that you didn't tackle the biggest obvious fallacy here in "the efficiency/equity trade-off" meme - efficiency AT what. "Economic efficiency" is a tautology with "free markets", but bears little relation to any meaningful "efficiency". It is clear that at any point of time you could increase social welfare by redistributing consumption from the rich (who get low marginal utility from each additional dollar to poor who get high marginal utility from each dollar). The cost will be in terms of incentives to work and incentives to invest in the future. I sort of hate the word "efficiency".