Equity vs. growth
Does it have to be either or?
A good post reinforces your priors, and offers clever punchlines for next time you get into an argument. Yeah. Nah. In my experience, good posts, indeed the best ones, are those that both inform and challenge me. And leave me thinking about the world a little differently.
Bryan Caplan’s July substack post The Distributive Distraction certainly challenged my priors. I’m still thinking about it. I thought I’d share where I’ve got to.
offers a simple, but “painfully realistic” thought experiment:
imagine that a society faces a menu of possible reforms. The menu features fifty ways to increase equity, and fifty ways to increase growth. Each of these reforms will definitely work if tried, and none of the equity reforms impede growth in the slightest.1
The catch: To actually adopt a reform requires a massive public debate, followed by a prolonged fight in the legislature. As a result, the society is only capable of implementing one reform per year.
Caplan writes that equity reforms are “vastly more thrilling to discuss” and thus out-compete and crowd-out growth reforms. He quotes Nobel laureate Robert Lucas as to why he thinks this undesirable:
of the vast increase in the well-being of hundreds of millions of people that has occurred in the 200-year course of the industrial revolution to date, virtually none of it can be attributed to the direct redistribution of resources from rich to poor. The potential for improving the lives of poor people by finding different ways of distributing current production is nothing compared to the apparently limitless potential of increasing production.
Caplan and Lucas correctly identify a significant problem with pursuing equity reforms alone. No amount of within-country redistribution in a country like say Chad could make its citizens anything as like as rich as the poorest deciles in most OECD countries.2 The citizens of Chad presumably compare their situation with those in other countries as well as those in their own. And they cannot achieve equity with other world citizens without growth reforms.
Caplan’s post ends with a plea:
A society can’t think about everything. A society can’t talk about everything. When our society thinks and talks about distribution, we are, by default, failing to think and talk about growth. If if we don’t think and talk about growth, we can’t implement policy reforms to promote it.
One post to irk them all
Caplan’s thought experiment would no doubt have irked those with strong preferences towards equity reforms. And likely those with strong preferences towards growth reforms would be irked as well — even though Caplan sides with them, he says they are losing out. But the existence of divergent groups with strong opinions just reflects one of his main observations — there is intense competition (in the political sphere) between people with strongly held but conflicting social preferences over policy reform.
I think the post got under my skin for a different reason. I’m a fan of both growth and equity reforms3, and disliked being constrained to a hard choice between them. That got me thinking about the dynamics of pursuing one over the other, and under what circumstances it might be possible to pursue them both.
Limits to equity reforms
In a zero- or very-low-growth economy, the set of resources is fixed.4 This will likely lead to more intense fights between citizens and groups over the allocation of those resources. If gain can only be achieved at someone else’s loss, then every redistributive reform will be very hard fought indeed.
Seen this way, the (sole) pursuit of equity reforms in a democracy is likely self-limiting, as the populace gets increasingly grumpy. Growth might smooth these hard tradeoffs, creating room to right wrongs without creating further ones.
And limits to growth reforms
Similar limits apply to the pursuit of growth reforms alone. Growth reforms require change, and not everyone benefits from change. Inevitably, some will lose out. Make enough reforms, and everyone will have experienced at least one reform in which they lost out or didn’t benefit.
Even if equity does not decline on the standard metrics (e.g. Gini coefficients of income inequality), prospect theory5 tells us that people weight losses more heavily than gains.
So, the (sole) pursuit of growth reforms in a democracy may also be self-limiting — just a different route to a grumpy populace. Equity reforms, especially targeting those who feel left behind, might just be the sauce that makes growth reforms more palatable.
What can a country do?
If the one-eyed pursuit of either equity or growth reforms is ultimately self-limiting, then what are the alternatives? Here are some thoughts.
Pursue reforms that achieve both growth and equity
These problems would presumably not arise if society only pursued reforms that achieved both growth and a more equitable allocation of resources. Are there such reforms? Yes — one good example is the expansion of paid work opportunities for women over the past half century. The reforms that progressively expanded the previously limited set of women’s occupations both increased women’s incomes — reducing income inequality — and, through better matching of skills and capabilities to jobs, grew the economy.
I suspect that such examples are rarer than we might like them to be. But, where they can be found, they should be pursued with vigour.
Similarly, it is important to avoid reforms that achieve neither. One example was the $785m Auckland Harbour cycle bridge project. Servicing the richer northern shore suburbs, it was hardly likely to increase equity. And, with a projected benefit—cost ratio of just 0.6, it would have shrunk rather than grown the economy. I can’t imagine any economists lost sleep when the Government (sensibly to my mind) canned the project in 2021.
Finding win-win and avoiding lose-lose reforms is a great step. But going no further would rule out a lot, perhaps most, worthwhile reforms.
Relax the one reform per year criterion
Caplan’s thought experiment has a hard constraint: the society is only capable of implementing one reform per year. Could this be relaxed? Well yes, but that comes with its own costs and risks.
Too many reforms overloads the public sector, media and public. Overloading lowers the quantity and quality of ex ante policy design and analysis, and the ex post learning from previous reforms. It increases the interactions between reforms, making analysis and execution more complex and less reliable. It puts at risk the delivery of the most effective reforms. The old adage applies: better to do a few things well, than a great deal badly.6
Pursue a mix of growth and equity reforms
A government could, at least in theory, alternate between equity and growth reforms. This might well be the optimum strategy, within the constraints of this thought experiment.
Flip-flop between growth-reforming and equity-reforming governments
Another possibility is for a country to alternate between between growth-reforming and equity-reforming governments, flipping when the population gets sufficiently grumpy with the incumbents. A less than optimum outcome perhaps, but realistic nonetheless.
Not the final word
Simple models make for great thought experiments. The model in this post assumes away a lot of things that go on in the real world, including the information issues that you might expect Asymmetric Information to be all over — incomplete information, strategic misrepresentation, reputations, credible commitments, political economy, etc. Where would adding in such factors take the discussion? Over to you…
If I’d been writing Caplan’s thought experiment, I would have added a symmetric condition: none of the growth reforms leads to a reduction in equity. I don’t think this condition would have changed Caplan’s conclusions. I have written this post assuming this symmetry.
I’m using “rich” and “poor” to refer to the material standard of living and/or the range of life choices available to citizens. I believe the arguments hold whether this is measured in terms of GDP per capita, subjective wellbeing, life expectancy or other life-quality proxies. While the most commonly discussed equity reforms are those affecting income, equity goals are also applicable to subjective wellbeing, etc.
Proper analysis, good execution, comprehensive monitoring, cost-effectiveness, and all the other standard policy-wonk caveats apply.
Similarly, I’m using “growth” fairly loosely here to mean an improvement in the material standard of living and/or the range of life choices available to the citizens of a country. While there is a lot worth saying about different metrics for for those things, I’m not going expand on them in this post.
Kahneman, D., & Tversky, A. (1979). Prospect theory: an analysis of decision under risk. Econometrica 47(2), 263-292.
Attributed to Socrates.