Economic Equality vs Efficiency

99cents

“Equality vs efficiency” is a classic debates in economics. Moralizing liberals pout about the poor, while those cold conservatives wave around their economics textbooks. Both sides are usually talking about completely different issues and they always talk past each other. It doesn’t get much more left vs right than this.

Take Bernie Sanders’ statement about economic growth:

If 99 percent of all the new income goes to the top 1 percent, you could triple it, it wouldn’t matter much to the average middle class person. The whole size of the economy and the GDP doesn’t matter if people continue to work longer hours for low wages and you have 45 million people living in poverty. You can’t just continue growth for the sake of growth in a world in which we are struggling with climate change and all kinds of environmental problems. All right? You don’t necessarily need a choice of 23 underarm spray deodorants or of 18 different pairs of sneakers when children are hungry in this country. I don’t think the media appreciates the kind of stress that ordinary Americans are working on.

This is probably the clearest expression of the typical liberal position on inequality I’ve ever seen. If you actually sit down to consider it, and not scoff at the fact that Sanders is a socialist, I think it’s a pretty reasonable position. Yet the media still managed to botch it. They thought he was literally talking about how 23 choices of deodorant causes poverty. Or they thought he was advocating central planning Soviet style. Or they thought he hated economic growth or something. This is all completely wrong.

I’ll illustrate my point with numbers, because I find that numbers make everything much clearer. Let’s consider two cases.

  • In case 1, we have a simple economy made up of units of “economic benefits”. These benefits are things like wealth, innovation, and whatever else you would consider good for the economy. Let’s assume that this economy has legal structure A. After a year of economic activity, there are 100 more “economic benefits”. This legal structure causes pre-tax distribution to go disportionately, say 80%, to the top 20%. It might look something like this:
Top 1% 50
19% 30
50% 12
20% 7
Bottom 10% 1
Total Benefits 100
  • In case 2, we have the same simple economy, but with legal structure B. This results in more equitable distribution, but we only get 90 units of “economic benefits”. It might look something like this:
Top 1% 30
19% 20
50% 18
20% 13
Bottom 10% 9
Total Benefits 90

It’s obvious from Sanders’ statement that he would prefer case 2 to case 1. That’s what he means when he says “you can’t just continue growth for the sake of growth“. He’s not “opposed to growth”, he’s just thinking about the “trade-off” between growth and equality. It’s a moral issue that he thinks is important. If the economy is growing but the poor are only getting 1%, that doesn’t really help them much. It’s a simple, but reasonable argument and none, literally none, of the pieces I’ve read addressed it.

Of course his point is nothing new and it’s heavily disputed. Perhaps economic growth will falter because of the distortions caused by redistribution, which would hurt the poor even more. Dismantling the welfare state could result in economic gains beyond our wildest dreams. You might even dispute the ethics. These are all possibilities, but extraordinary claims require extraordinary evidence. Unfortunately, most of the debate on inequality is rhetoric, and not the good kind (1).

Personally, I think the whole “equality vs growth” dichotomy is utter nonsense, a mischievous framing device. Just off the top of my head, I can think of several things that cause inequality and hurt economic growth:

  • Occupational licensing artificially restricts the supply of labor and raises the wages of that profession. This is form of economic rent. While necessary on some level, there are major costs when the practice is taken too far (2). And lo and behold, the percentage of US workforce that is licensed has increased dramatically since the 1960s:

licensing2

  • Bad incentive schemes used in the finance sector not only inflate the incomes of CEOs, but also provide horrible incentives. When compensation increases with stock prices, CEOs and management will want to increase the value of those stocks. Unfortunately, there’s a lot of dishonest ways to do this, e.g. excessive risk taking, deceptive accounting, etc. (3). Given these incentives, it’s no wonder that these schemes played a role in the recent financial crisis.
  • Subsidies that have long outlived their usefulness also contribute to inequality. Farm subsidies , stadium subsidies, and many others are a pernicious form of rent-seeking.

This is just a small list. Some of these things are caused by the government, some by the market and getting rid of all of them would improve economic growth. They also have one thing in common, i.e. a contempt for the rule of law. Major legislative efforts to reduce inequality won’t mean a damn thing if we continue to see pervasive levels of rent-seeking in our economy. Our problem of inequality won’t be solved until we are serious about the rule of law. Unfortunately, I don’t think any of these presidential candidates care about that, except, ironically enough, Bernie Sanders.


Footnotes:

1. There’s also a problem of bad data. That will probably change in the near future and maybe we can get some more definitive answers. But that doesn’t mean they’re aren’t some great debates going on. There’s stuff in the dark corners of the econ-blogosphere. You’ll have to do some digging, but it’s definitely there.

2.

The most obvious social cost is that any one of these measures, whether it be registration, certification, or licensure, almost inevitably becomes a tool in the hands of a special producer group to obtain a monopoly position at the expense of the rest of the public. There is no way to avoid this result. One can devise one or another set of procedural controls designed to avert this outcome, but none is likely to overcome the problem that arises out of the greater concentration of producer than of consumer interest. The people who are most concerned with any such arrangement, who will press most for its enforcement and be most concerned with its administration, will be the people in the particular occupation or trade involved. They will inevitably press for the extension of registration to certification and of certification to licensure. Once licensure is attained, the people who might develop an interest in undermining the regulations are kept from exerting their influence. They don’t get a license, must therefore go into other occupations, and will lose interest. The result is invariably control over entry by members of the occupation itself and hence the establishment of a monopoly position. (Friedman 1962: 148)

3. Joseph Stiglitz has written at length about the problem of poorly constructed incentive pay schemes. See his book, The Price of Inequality, pages 108-114 and his congressional testimony on January 22, 2010 for the clearest expression of this position.

Links:

Bernie Sanders’ ‘deodorant’ comment ignores realities of economic growth by Jeff Jacoby

Sorry, Bernie Sanders. Deodorant isn’t starving America’s children by Jim Tankersley

Bernie Sanders’s Dark Age Economics by Kevin D. Williamson

Bernie Sanders’ Fossil Socialism by Matthew Continetti

Economists and Rhetoric: Defending McCloskey by Alex Lenchner

Why Conservatives Should Care About Occupational Licensing by Adam Ozimek

Incentives and the Performance of America’s Financial Sector by Joseph Stligliz

References:

1. Baker, Dean. The End of Loser Liberalism: Making Markets Progressive. Washington, D.C.: Center for Economic and Policy Research, 2011. Print.

2. Friedman, Milton. Capitalism and Freedom. Chicago: U of Chicago, 1962. Print.

2. Stiglitz, Joseph E. The Price of Inequality:. New York: W.W. Norton, 2012. Print.

4. Weeden, K. A., and D. B. Grusky. “Inequality and Market Failure.” American Behavioral Scientist. 58.3 (2013): 473-91.

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