Was There Ever Really a Big Tradeoff Between Equality And Efficiency?

Probably not.

In the last couple of days there was a big meeting at the Brookings Institution to celebrate the 40th anniversary of the publication of Arthur Okun's influential 1975 book, Equality and Efficiency: The Big Tradeoff, an idea that went into the textbooks and became a VSP de rigueur truism for quite some time.  The conference was asking its relevance today, which it looks like some questioned.  Many big cheeses were participating, representing a range of views from Mankiw on the right to Heather Boushey on the left, with Larry Summers making the introductory speech, and Janet Yellen in the audience.  But the real  question is: Was it ever at all true to begin with?

Mark Thoma provides some quotations from Summers's opening address.  He clearly seems to think that the relationship has gone off the rails.  The quoted material talks a lot about rising inequality and increasing problems in the financial sector, with the undertow of slower growth and his bugaboo of secular stagnation.  Nothing I saw there looked unreasonable.  But, again, I am wondering if anybody asked the deeper question in a location where the late Okun was long highly revered, and I think still  is.  I never met the man, but plenty there think he was just wonderful, and maybe he was.  But I think he was never right about this Big Tradeoff, or not very right.

OK, so back in the day we had the Big Poster Boy of communist states with lots of equality, think Maoist China, but not a lot of either growth or high income.  Yes, there was certainly an argument there: a society with essentially no incentives to make capital investments or technological innovations, with those incentives maybe leading to greater inequality (and indeed the fall  of communism did lead to higher inequality, with China in particular growing rapidly since, an outlier to support Okun's argument, even as many other former socialist states did  not do all that well).   So, he had some things going for him.  But all along there was this problem of Latin America and parts of Africa, with the highest levels of  inequality in the world and pretty pathetic growth and income records.  This led to an eventual  modification of the truism, usually voiced as indeed going against this deep truth, the idea that the relationship between at least per capita income and inequality being an inverted U-shape.  It also increasingly was noted that the source of inequality was important, with it coming from being "earned" rather than inherited or through corruption making a big difference.

That the relationship was not  all that it was cracked up to be dates back at least to the turn of the century, even among those who ideologically might be inclined to support it.  Thus, in 2000 Robert Barro published a paper in the Journal  of Economic Growth, Inequality in a panel of countries.  He summarized that there is "little overall relation between income inequality and rates of growth and investment."  Barro also noted the likely inverted U-shape  relationship between per capita income and inequality.

In the previous year, a long paper by Aghion et al in the JEL argued that it looked increasingly like if anything the relationship might be the other way around, with more equal  naitons growing more  rapidly and programs to increase equality being associated with accelerated growth.  They posed the Philippines and South Korea, equal in per capita  income in 1960, but with the Philippines having twice the quartile income ratio of South Korea.  We know what their subsequent growth records have been.

I would push this forward to note the experience of Latin America, one of the poster boys for high inequality and poor growth performance.  During the Great Recession this was arguably the best performing region in the world in terms of growth compared to its several decades past.  Curiously, it was the only major region of  the world where incomes were becoming more equal, if still more equal than in the rest  of the world.  This does not prove anything, but then that China fits Okun's story does not prove it, and that nation increasingly looks like a big outlier, quite aside from its decelerating growth rate.

Update: I read the speech by Larry Summerslarrysummers.com/2015/05/04/okuns-equality-and-efficiency at the event. He praise Okun as brilliant, of whom Paul Samuelson basically said that he never said anything incorrect, someone not only insightful in economic policy, but also of philosophical depth.  His only comment on how things were back then was that the income distribution did not change.  He did not directly comment on the basic issue of whether or  not there really was an equality/inefficiency big tradeoff then.  He does now think that rising inequality has been linked to slowing growth. 

Second Update:  Mark Thoma links for 5/6/15 to Heather Boushey's talk at the Brookings conference, and after long discussing how inequality has soared since Okun's day, she finally comes to the same conclusion I do, that Okun was basically wrong and that his legacy is part of our problem today.  There  never was a Big Tradeoff, just a Big Myth about there being one (latter is my terminology).

Barkley Rosser