Efficiency vs. equity

Where would you strike the balance?

“Had I been present at the creation, I would have given some useful hints for the better ordering of the universe.” Alfonso X—“the Wise”—of Castile

People who lived in pre-agricultural times didn't require much in the way of economic theory. Living at the margin of subsistence, they devoted all their energy to getting by, and left the theorizing to later generations.

With agriculture came the opportunity for surpluses, which allowed some members of populations not to work. At this point societies had to devise rules for determining who worked and who didn't, and how much each received. These are questions societies have dealt with ever since. 

Two principles are involved. The first is efficiency. How shall we arrange our economy to produce the greatest amount—to bake the biggest pie? 

The second principle is equity. How shall we distribute production in order to maximize fairness or some other social value? How shall we divide up the pie? 

To maximize efficiency, we should strive to ensure that individual talents are optimally employed. Some people are really good at being bricklayers; we should make sure they lay bricks. Some people are good at brain surgery; they should become brain surgeons. And so on.

Two questions arise here. First, how do we identify talent? Second, how do we channel talent in the appropriate direction?

Conceivably a centralized authority could engage in screening procedures to identify talents. Alternatively, we could allow individuals to self-identify. We could let people try their hand at any activity, and see who turns out to be best. Individuals who don't make the cut at any one activity could then try other activities until they find something they’re good at.

How can we insure that people wind up in the activity they are best at, and not simply an activity they like? One way is to reward them. Money is the most straightforward means. Offer the highest remuneration for the services most in demand. Presumably lots of people will want those big bucks, but only the most talented in the given activity will be chosen to receive them. 

How to determine what pay will be associated with what activities? Again, let individuals decide. If lots of people want something, they will bid up the price for it. That in turn will attract people to provide the good or service in demand.

What all this describes, of course, is a market economy. Give people the freedom to do what they want and buy what they want, and let others respond to these market signals. It's not perfect; some things get oversupplied and others undersupplied. But of the methods that have been tested historically, it's the one with the best track record. That is, it's the one that provides the greatest efficiency.

But not the greatest equity, as that quality is generally understood. Capitalism, to use the common term for a market-based economic system, generously rewards people with rare and valued talents. Professional athletes, film actors, and leaders of large corporations receive incomes of tens of millions of dollars per year. People without such talents have incomes far lower. People unable to find jobs might have no income at all.

Moreover, the highly rewarded activities are sometimes not activities that serve the general welfare. Finance mavens who devise risky schemes for repackaging loans might receive enormous windfalls, while school teachers make do with incomes a thousand times less. Many people think the teachers contribute more to social betterment than the Wall Streeters and that their compensation should reflect their contribution; capitalism disagrees.

So: If you had the chance to be present at the creation of a new system, how would you balance efficiency against equity? What useful hints would you give for the better ordering of the universe of political economy? 

Historically, two approaches have been taken. The American approach, based on capitalism, prioritizes efficiency. When the inequities capitalism invariably produces became politically intolerable, as during the Progressive era of the early 1900s, the New Deal of the 1930s, and the Great Society of the 1960s, capitalism has been retrofitted with redistributive schemes. These include income taxes designed to take more from the wealthy than from the poorer, and programs that provide various benefits to those who unable to afford them on their own. 

The retrofits have touched capitalism itself only indirectly. Higher tax rates on the wealthy have diminished to some degree the effectiveness of the signals the economy sends regarding which talents should be recruited to which activities. But never has the American government or a substantial portion of the American electorate seriously questioned the capitalist premises of the American economy.

The second historical approach prioritizes equity. Embraced to one degree or another in countries ranging from Russia in the 1910s to Britain in the 1930s and China in the 1950s, this approach takes socialism rather than capitalism as its economic model. Government plays a large role in determining who does what and at what prices. These countries have generally succeeded in avoiding inequalities on the scale found in America.

But the avoidance has come at a cost to efficiency, not to mention individual autonomy. The socialist economies of Russia, Britain and China lagged in performance behind the capitalist economy of the United States. Eventually Britain in the 1970s and 1980s, China in the 1970s and 1980s, and Russia in the 1990s abandoned socialism in favor of a more capitalist model.

China's case is particularly instructive. Without surrendering socialism in its rhetoric, the Chinese government after the death of Mao Zedong allowed reforms that made the Chinese economy increasingly capitalistic. In the process, the performance of the Chinese economy improved dramatically, while inequality among Chinese increased sharply. Individual freedom increased for a time, within limits, then decreased under the current Chinese president, Xi Jinping.

In the system you devise, would you take something from the American model and something from the British model? Even after its pro-capitalist reforms, Britain retains its National Health Service, guaranteeing medical care to everyone. It has a very loyal following in Britain. The political economies of most countries, including the United States, have taken a mix-and-match approach.

Or perhaps you’d go all in for efficiency. You might reason that equity is a red herring; better that everyone get richer, even if some get richer than others.

Or maybe you’d do the opposite, and give full priority to equity. Many people think capitalism’s headlong rush for more of everything beguiles us with stuff we don’t need and is ruining the planet besides.

For the purposes of this exercise, assume the slate is blank. You don’t have to overcome attachment to existing institutions. You’re living Alfonso’s dream; you really are present at the creation.

What do you choose?