The New Economics of Having It All
The Brookings Institution has just republished a classic study on economic policy -- Arthur Okun's "Equality and Efficiency: The Big Tradeoff," which first came out in 1975. It's a favorite book that really shaped my thinking. Re-reading the new edition I thought it had lost none of its force. If anything, I think it's gained some.
A lot about the economy has changed since 1975. Okun died in 1980 (he was only 51), and we can't know how his ideas would have evolved. To my mind, though, his main idea remains fundamental:
Throughout this essay, I have sounded a recurrent two-part theme: the market needs a place, and the market needs to be kept in its place…
A democratic capitalist society will keep searching for better ways of drawing the boundary lines between the domain of rights and the domain of dollars. And it can make progress. To be sure, it will never solve the problem, for the conflict between equality and economic efficiency is inescapable. In that sense, capitalism and democracy are really a most improbable mixture. Maybe that is why they need each other -- to put some rationality into equality and some humanity into efficiency.
Brookings organized a panel discussion to mark the occasion and I was interested to see that my reverence for the book was not universally shared. (The video is well worth watching.) Brookings' Melissa Kearney spoke eloquently on behalf of all admirers, saying what I would have wanted to say about the enduring centrality of the Okun's trade-off. Harvard's Greg Mankiw in the main agreed. But Brookings' Justin Wolfers and Heather Boushey of the Washington Center for Equitable Growth seem to see Okun's book as not much more than a historical curiosity. Trade-offs, they think, are so 20th century.
More to my surprise, in a mostly admiring foreword for the new edition, and in remarks prepared for the event, Larry Summers echoed the Okun-is-over sentiment -- as Boushey correctly pointed out in her comments. (Summers couldn't attend in person: Ted Gayer read his comments, which you can also read here.)
What's changed over the course of recent decades, of course, is the surge in U.S. income inequality. Note that this surge didn't happen alongside a big improvement in average living standards -- as Okun's trade-off might have led you to expect. It isn't as though greater inequality has been the price the country paid for growth. Maybe greater inequality helps to explain why ordinary Americans aren't getting ahead.
I think Okun would have taken some versions of that notion seriously -- but this doesn't mean his framework is wrong.
In Okun's world, the country makes policy choices that affect both total output and the distribution of incomes. Imagine a frontier of well-designed choices, such that it's no longer possible to improve both at once. Moving from policy A to policy B along this frontier might raise output or it might increase equality -- but it can't do both. That's the trade-off.
Okun's critics say this is wrong. There's no such dilemma. Today, more equality would give us more output as well. The economy has moved so far inside the frontier that the trade-off doesn't apply.
Is this right? It's true that the economy is deep inside the frontier of well-designed policies. It always has been and always will be. This unavoidable fact of life doesn't make the trade-off between equity and efficiency irrelevant.
Certainly, opportunities abound to make society both fairer and more prosperous. The idea that the U.S. system of taxes and transfers is (or ever was) anywhere near the good-policy frontier is laughable, so win-win options should be possible to find. Bloomberg View's editors, in their series on the middle-class squeeze, recently made some specific suggestions of this kind. Simplify the tax system by cutting so-called tax expenditures and use some of the proceeds to cut tax rates, especially for workers on low incomes.
Yet you can't help but notice how hard it is to get intelligent tax reform passed. The same goes for other good ideas, such as promoting foreign trade while offering better support for adversely affected workers -- something else, by the way, that Bloomberg View's editors recommend.
In both these cases, a combination of policies is needed to move the economy toward the frontier. One part of the bundle makes growth the priority, the other addresses fairness. That's an acknowledgment that the trade-off matters. True, you can also imagine one-dimensional policies that, other things equal, promote growth and fairness at once -- taxing pollution or monopoly rents, for instance -- though these opportunities aren't always as simple as they look.
Still, let's agree that in the real world of stupid policy, changes that would improve equality and efficiency at the same time are available. That's what being inside the frontier means. Yet people are far from indifferent toward those supposed win-win alternatives. Disagreement doesn't stop because you're inside the frontier.
Why not? What are those disagreements really about? No doubt, pure differences in values -- about what matters more -- are the root. Pure selfishness (the reluctance to surrender the carried-interest income-tax privilege, say, or the wage premium accruing to workers in a protected industry) also makes it hard to agree. Economics can't help with those things. But part of the problem is disagreement over facts. And the facts arousing most disagreement are about -- you guessed -- the effects of policy on efficiency, on one hand, and fairness and equality, on the other.
It was ever thus. A lot has changed, but Okun's great trade-off will never go away. Even in the 21st century, the most useful thing economists can do is take it seriously and clarify the terms of possible choices. That's exactly what Okun urged them to do. He was right then and he’s right now.
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