Wednesday, January 7, 2009

New paper! In Search of the Elusive Equality/Efficiency Trade-Off

Yes, I've written a paper. To call it new is a bit cheeky, since I first presented this work at the 2004 APSA conference (people have started and finished PhDs in the meantime). The paper is co-authored with Mark Blyth, the man who taught me, amongst other things, that The Matrix is political science.
Anyway, here's an abbreviated intro, and if you fancy reading the rest a link is provided. Comments very welcome, of course (especially critical ones).

Policymakers, political pundits, and even political economists, are much enamored by the notion of ‘trade-offs.’ That is, while we may seek more of good ‘X’ to satisfy our desires, doing so necessarily implies a diminution in our consumption (or production) of good ‘Y’. For example, one of the most famous trade-offs of the post war era was the Philips curve, which purported to show an inverse relationship between the rate of change in money wages and prices (more prosaically, unemployment versus inflation) (Philips 1958). Lower unemployment necessarily implied a trade-off in terms of higher prices. It should give us pause then that as soon as the Philips curve was declared an immutable fact of life, the curve, and the trade-off it implied, collapsed (Friedman 1975/1991).

The validity of theorized trade-offs may matter less than the conviction with which such beliefs are held by policy makers. Once such ideas become the ‘conventional judgment’ regarding economic affairs, to use Keynes’ term, they tend to become self-reinforcing. In this regard, one particular trade-off seems particularly hard to shake-off. A little over thirty years ago, Arthur Okun’s well known book Equality and Efficiency: The Big Tradeoff argued that “efficiency is bought at the cost of inequalities in income and wealth.” (Okun 1975: 51). In Okun’s view, societies simply had to choose between an efficient economy and an egalitarian society. If equality undermines incentives or if pro-equality policies distort market allocation, economic performance can only be improved at the expense of a less equitable distribution of income. This dilemma has informed much of the debate around the relative economic performances of the United States and other Anglo countries on the one hand, and continental Western Europe on the other.

However, the equality/efficiency trade-off is far from universally accepted. The unpalatable implications of Okun’s argument have encouraged politicians and scholars to find ways around the stark choice between Anglo-Saxon inequality and the economic underperformance of the largest continental European economies. In this paper we provide further evidence to challenge the existence of a trade-off between economic performance and social justice.

Our paper addresses the problem from an unexplored angle, by examining the ways in which the institutions of welfare capitalism regulate markets. Liberalization – the freeing of markets from the burden of heavy market distorting regulation and legalistic restrictions – has been an influential policy prescription for enhancing economic efficiency and growth. The theory underpinning this prescription is that ‘free’ markets are more efficient than more ‘regulated’ markets, provided that functional legal and property rights arrangements are in place; in the absence of distortions caused by government interventions, the free operation of the price mechanism will allocate resources efficiently.

This article uses data from a variety of sources to assess how this ‘institutional’ dimension of efficiency relates to levels of inequality in Western European countries. Although it is well documented that high spending welfare states in Western Europe tend to have low levels of inequality and poverty, we find that the same high spending and egalitarian welfare states also tend to have efficiently regulated markets. In contrast, less regulatory efficiency is generally associated with higher levels of inequality. This analysis therefore provides novel support for the view that there is no simple trade-off between efficiency and equality, by showing that efficient market regulation can be - and usually is - combined with egalitarian policies and institutions, and that inefficiencies tend to have inegalitarian effects.