One way to think of the left-right economic policy debate is between fans of two different economic outcome criteria: equity and efficiency. For the right, the goals are to increase total surplus through trade, market liberalisation, better productivity and low taxes. They focus on efficiency, innovation and growth. By contrast, the left are more interested in equity, fairness and the distribution of value.
Well call me greedy, but I want both.
My working life mostly involves thinking about how to promote of efficiency, competition, innovation and economic growth. But conditioning through work is not the only reason economists are mainly in the efficiency camp. Equity issues also much more difficult to analyse. And there is a constant fear that incentives for efficiency will be undermined.
So I often squirm when I hear people trying to justify policies on the grounds that they are “fair” without appreciating that their concept of fairness is entirely subjective.
To put it bluntly, there is a yawning chasm of difficulty/applicability between the fine but complex work of co-operative game theorists and the simple rules advocated by efficiency-oriented economists. Its no wonder that efficiency tends to win the intellectual battle within the economics profession.
2009 could be a watershed year for equity economics though, if we define that term loosely enough. There are three pointers, the first of which is the spectacular and very public own-goal recently scored by the efficiency criterion in the form of the GFC. When students asked for examples of perfect competition I used to point to the financial markets as getting close. Now the efficient market hypothesis looks like its gone a couple of rounds with David Tua.
Second we have the work of Williamson and Ostrom taking out the Nobel Prize for economics (and BTW Ostrom is an economist). The defining characteristic of their work has been a willingness to tackle the messy detail of how economic activity is organised, which institutions perform well in specific circumstances and why. I doubt either of this year’s winners would hold themselves out as promoters of equity over efficiency, so this could be stretching the metaphor a tad. But in the case of NZ’s agricultural co-operatives (which have strong equity rationales) Williamson and Ostrom would probably focus on how and why they arose, rather than how they could be demutualised.
The third pointer is a book published earlier in the year called The Spirit Level. It was written by non-economists, so let me rephrase its argument. Suppose the goal of public policy is to increase the quantity and quality of the lives of people. We have reasonably good quantity measures in the form of life expectancy data, so lets use that as the indicator. What about quality? Well, we could use self-reported happiness surveys, but the authors instead use indicators of social problems: crime levels, suicide rates, child abuse, obesity, mental illness etc. They argue that we would all generally prefer fewer to live in a country that has fewer of these social problems.
To examine what affects the quantity and quality of life, they look at cross-country data on life expectancy and social problems. They correlate these with income data, and show two things.
First, the relationship between life expectancy and average income has very strong diminishing marginal returns. For poor countries, small rises in average income are associated with big leaps in life expectancy, but once income gets up to the levels achieved in Costa Rica, Uruguay and Mexico, doubling, trebling or quadrupling income has only a modest impact on life expectancy. The implication is that diseases of poverty can be eliminated relatively cheaply.
Then they examine social problems on a subset of 23 rich countries, and separately on the states of the USA. They show that income inequality has a very strong relationship with social problems in both of these samples, but that average income levels have no significant correlation.
Conclusion: more equal societies almost always do better. The policy prescription is to work on getting the income distribution more equal. Its a simple rule. The authors have a few ideas about how that might be done, but they don’t claim to have done justice to that aspect.
This is where economists should get involved I think. The answer is certainly not to nationalise everything; incentives to innovate are still required. But maybe we could be a bit more innovative ourselves in the way we think about policy.
Interesting ideas, although I think the definition of ‘social problems’ is difficult. For example I would not say that japan has low social problems.