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No, there is no trade-off between equality and efficiency

Matt Yglesias has a good post up knocking down Tom Sargent’s claim (now circulating the econo-blogosphere, although the speech was in 2007) that “There are trade-offs between equality and efficiency“.

The thing of it is that not only is Sargent wrong here–although the sentiment is common among professional economists–but more importantly is that there really isn’t any reason to believe that this is right… just some vague sense that proper incentives require paying the most skilled among us more.  So basically, Yglesias is letting Sargent off much too easy.

To show why, I’ll go through all the interpretations of Sargent’s claim one-by-one and explain why each is wrong.    I could do much more than this: one of my thesis projects is directly relevant here, although that work’s not really ready for daylight.

  1. Efficiency requires a particular distribution.   Nope.    In standard theory, the set of Pareto efficient allocations turns out to contain any distribution of wealth/utility between the agents.  One person has 100% of the wealth?   There’s an efficient allocation like that.   A different person has 100% of the wealth?  Also one like that.   Complete equality?   Yep, there’s one like that, too.  This is always true in any trading situation.   The only thing that causes Pareto inefficiency are market distortions.
  2. Efforts to correct for the distribution result in inefficient allocations.  Nope.  The proof for the Second Welfare Theorem in fact requires redistributing wealth before trading.  Then, after this redistribution is completed, it is shown that any efficient allocation can be attained.   You like perfectly equal, efficient outcomes?   The Second Welfare Theorem says that there is a redistribution which will provide that efficient outcome.  The statement precisely is that the efficient market will produce the efficient outcome as a “price quasi-equilibrium with transfers” (from Mas-Colell if you’re curious).
  3. Dynamic Inefficiencies from redistribution?   This is the point that Yglesias is in effect debunking.  So, I’ll leave that to him and send you back to that post.   I will add to his argument only that wealth is itself a market distortion.  How can I say that?   Well, I’d say go look at my thesis, but that’s out (for now)… so instead just think about it in terms of Piketty’s point: if the rate of capital accumulation, r, is greater than the economy’s growth rate, g, then it must be the case that wealth (i.e. claims to ownership) explodes in the limit.  That is, one  person eventually owns everything.
  4. Countries with unequal wealth grow faster, and do so for a longer time?   No, on both counts.   Don’t ask me, though, just ask the IMF.  Oh snap.   The sign seems to go in the opposite direction.  Ouch.   In fairness, Sargent didn’t know about this line of research which hadn’t been published yet.   But then, maybe that’s why he shouldn’t make strong claims to impressionable college students who go home with the wrong lesson which they then hold tight to for the rest of their lives.
  5. Wealth rewards the exceptional for being awesome.   Heh.  No.   And anyway, economics isn’t a morality play and outcomes aren’t rewards for anything.  If I were Joe Stiglitz I might even argue that the current economy is one in which fortunes are amassed mostly through rent-seeking, anyway.

So, yeah, there’s no support in economic theory for Sargent’s claim.   He’s just saying something that he believes without any theoretical or empirical support.

Now it IS generally true that most taxes will have a dead-weight loss… that people will react to the tax in a way that results in less economic activity.   A tax can distort the market.  Interestingly, though, there are taxes which in theory mimic an efficient “lump sum” tax.   I’m thinking an idealized consumption tax in particular.

I would also emphasize that the Second Welfare Theorem’s redistribution has a flavor of “wealth” redistribution, not income redistribution.   That’s important.   That’s all the caveats that occur to me at the moment.

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  1. May 4, 2014 at 3:06 pm

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