The Trade-Off Between Equality and Efficiency

Reference: Chapter - 17 Economics by Nordhaus and Samuelson

 The debate between equality and efficiency is not new and no economy in this world is immune to this trade-off. Let us examine the main propositions in this debate:

Proposition 1: The Theme of Welfare Economics is Universally Accepted

In an ideal scenario, markets should be able to balance between equality and efficiency and governments do not have to interfere with market mechanisms but in reality, capitalist economies are like jungles, only those who are fit enough can survive. So it is widely accepted that the responsibility of the welfare of the poor and ill-equipped falls on the governments of the day. Governments across the world undertake several welfare schemes including social security, health care, pensions for the elderly and unemployed, insurance, women and child welfare, cash transfers, income - support etc.

Proposition 2: The Bucket is Leaky


Consider the figure above in which real incomes of the upper half are shown on the x-axis and the real incomes of the lower half are shown on the y-axis. At point A, a large proportion of the incomes are going to the upper half and a very small portion of the incomes are going to the lower half. In an ideal situation, redistribution through taxation on the rich should lead us to point E. (the line segment AE has a 45 degree slope) But the reality is far from this slope - the transmission through redistribution taxes is not 1-to-1, in other words the bucket is leaky. The economy may end up at point B on its way to Point Z both of which are far below the point of efficiency at E. The re-distribution is not leak proof due to inherent defects such as administrative costs, corruption and inefficiencies.

Proposition 3: Welfare Schemes create a Permanent Class of Dependents:

As stated above, egalitarian societies around the world have undertaken measures to promote equality in opportunity and well-being. The flip side of welfare schemes is that they promote a perpetual dependence on government. The long term solution is to aim at improving income-levels and discouraging dependence on welfare schemes as far as possible. What citizens sacrifice in the form of welfare subsidies comes back to them in the form of better infrastructure, investment and job opportunities.

Proposition 4: Balancing between Growth and Redistribution:

If taxes are too high then there is a danger of the rich moving their investments elsewhere, so the key lies in balancing growth and redistribution. In emerging markets where the scope for redistribution taxes is limited, every penny is invaluable and leakages cannot be tolerated.

The trade-off between equality and efficiency is at the center of policy making and administration in every society.

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