The Equity/Efficiency Trade-off in Retrospect

Writing in 1975, Arthur Okun is generally credited with popularizing the idea of a “great tradeoff" between equity and efficiency. Indeed, a generation of economists has been brought up thinking that in the allocation of scarce resources to competing ends, the tradeoff between “equity” and “efficiency” is just another one of the many tough choices that economically rational individuals have to make. Although “equity” and “efficiency” are rarely defined precisely and the mechanisms which link them are often only vaguely specified, the idea of a tradeoff is still a prominent feature of introductory economics texts (e.g. McConnell et al., 1993). However, a major theme of the recent literature on endogenous growth is that this tradeoff does not exist. Many articles, both theoretical and empirical, lead to the conclusion that countries characterized by greater equality grow faster, other things equal. The general presumption of recent growth literature is a positive association between equality and growth. Clearly the contrast between the 1990s analysis of growth and equality and the 1970s rhetoric on “tradeoffs” deserves some examination. Section one of this article surveys a sampling from the recent endogenous growth literature. Its objective is to demonstrate that a positive correlation between equality and growth is the new orthodoxy of this literature and to illustrate the diversity of empirical evidence and theoretical mechanisms which test and explain the positive relationship between equality and growth. Section two considers why the “trade-off” arguments of the 1970s are no longer convincing. Three key points are made about how economic thinking had evolved by the 1990s: (1) the importance of the intergenerational transmission of human capital had been recognized; (2) econometric research had concluded that the wage elasticity of labour supply (and hence the deadweight loss of income taxation) is rather small; and (3) the discussions of efficiency had shifted from static allocative efficiency to dynamic efficiency in the growth of output over time. The concluding section briefly considers the implications of this changing perspective on efficiency and equity for economic and social policy in Canada.