Good and Bad Inequality

Economics is a science that can claim to have uncovered few, if any, universal truths. Like almost everything else in social life, the relationship between equality and economic performance is likely to be contingent rather than fixed, depending on the deeper causes of inequality and many mediating factors.

PRINCETON – In the pantheon of economic theories, the tradeoff between equality and efficiency used to occupy an exalted position. The American economist Arthur Okun, whose classic work on the topic is called Equality and Efficiency: The Big Tradeoff, believed that public policies revolved around managing the tension between those two values. As recently as 2007, when New York University economist Thomas Sargent, addressing the graduating class at the University of California, Berkeley, summarized the wisdom of economics in 12 short principles, the tradeoff was among them.

The belief that boosting equality requires sacrificing economic efficiency is grounded in one of the most cherished ideas in economics: incentives. Firms and individuals need the prospect of higher incomes to save, invest, work hard, and innovate. If taxation of profitable firms and rich households blunts those prospects, the result is reduced effort and lower economic growth. Communist countries, where egalitarian experiments led to economic disaster, long served as “Exhibit A” in the case against redistributive policies.

In recent years, however, neither economic theory nor empirical evidence has been kind to the presumed tradeoff. Economists have produced new arguments showing why good economic performance is not only compatible with distributive fairness, but may even demand it.

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