Tuesday, May 5, 2015

Why the Equity Versus Efficiency Focus Should Shift in Economics

Larry Summers gave a speech at Brookings in honor of the 40th anniversary of a book by Arthur Okun on the tradeoffs between efficiency and equity.  In that period it was assumed that the distribution of income was relatively constant.  Therefore, the profession focused primarily on increasing efficiency because everyone would benefit from productivity growth.  The benefits from productivity are not being shared today so our focus should be on a more equitable distribution of income.

Summers points to a signal statistic which shows how things have changes since 1979.  If the distribution of income today were the same as it was in 1979, the bottom 80% of the income distribution would have 25% more income than it has today.  The top 1% would have half as much of total income than it has today.  The gains from efficiency and productivity have not been equally shared.  Summers then shifts his attention to policy issues which are tilted in the direction of greater equity versus efficiency.

 Tax policy over the last 40 years has been directed towards an increase in efficiency.  Summers argues that it ought to be directed towards redistribution.  We should also be less concerned with reducing to cost of capital and more concerned about increasing taxes on capital.

The financial sector, and the corporate system to which it is connected, has also increased it share of income substantially.  The financial system has also been a source of economic instability.  We need more regulation, which may decrease efficiency, in pursuit of equity and greater stability.

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