Dani Rodrik — Good and Bad Inequality

In the pantheon of economic theories, the tradeoff between equality and efficiency used to occupy an exalted position. The American economist Arthur Okun, whose classic work on the topic is called Equality and Efficiency: The Big Tradeoff, believed that public policies revolved around managing the tension between those two values.… 

The belief that boosting equality requires sacrificing economic efficiency is grounded in one of the most cherished ideas in economics: incentives. Firms and individuals need the prospect of higher incomes to save, invest, work hard, and innovate. If taxation of profitable firms and rich households blunts those prospects, the result is reduced effort and lower economic growth.… 

In recent years, however, neither economic theory nor empirical evidence has been kind to the presumed tradeoff. Economists have produced new arguments showing why good economic performance is not only compatible with distributive fairness, but may even demand it.… 

Economics is a science that can claim to have uncovered few, if any, universal truths. Like almost everything else in social life, the relationship between equality and economic performance is likely to be contingent rather than fixed, depending on the deeper causes of inequality and many mediating factors. So the emerging new consensus on the harmful effects of inequality is as likely to mislead as the old one was.… 

It is good that economists no longer regard the equality-efficiency tradeoff as an iron law. We should not invert the error and conclude that greater equality and better economic performance always go together. After all, there really is only one universal truth in economics: It depends.

Economists like to compare a limited number of variables in order to discover patterns in an otherwise jumbled and confusing context of events. Economists especially like identifying patterns that can be expressed in terms of an independent variable and dependent variable. By assigning different quantitative values to the independent variable, the effect on the dependent variable can be expressed neatly as the result of a mathematical function.

This method requires a imposing level of abstraction using qualifying assumptions such as cet. par. This approach is the basis of the claim that economic behavior can be viewed in terms of "tradeoffs" that reveal the degree to which one thing must be sacrificed in order to gain the advantage of another that stand in inverse relationship. Opportunity cost is key to the economic notion of rationality based on utility maximization that underlies conventional economic, for example. Other tradeoffs operate similarly.

The "it depends" relates to the actual context that is independent of the stylization for modeling convenience and remains operative. This stylization assumes a homogenous background, which is a huge simplification in an economy embedded in a society as a complex system under uncertainty functioning as a network with a web of feedback loops.

The question is whether any can "iron laws" emerge from such a procedure?

Project Syndicate
Good and Bad Inequality
Dani Rodrik | Professor of Social Science at the Institute for Advanced Study, Princeton, New Jersey