A Parable About Efficiency and Equality

A commentator recently asked how efficiency and equity could both increase at the same time.  I have outlined the idea in previous posts, but I also think a parable is a good way to illustrate the general principle.  Suppose you created policies that created extreme equality for everyone in society.  Then everyone would get exactly the same amount of economic wealth and income.  Everyone knows that wouldn’t work and so nobody has ever proposed to create such a society on Earth.  Not even Jesus.  That is probably because it isn’t really fair for some people to do risky, unpleasant, or difficult work when other people still get the same monetary compensation regardless of the real sacrifices that anyone makes.  Also, there would be zero selfish motivation to be productive because you would get the same income regardless of what you do.  People would only work for altruistic reasons.  That is a significant motivator, but that motivation is also present in fairer societies where people are more fairly compensated for their effort and sacrifice, so less monetary equality will produce more goods (efficiency) than a perfectly equal society.

That is the common textbook parable about the dangers of absolute egalitarianism, but the textbooks neglect to tell the parallel parable about the dangers of excessive inequality.  Absolute inequality would also be an absurd situation that nobody proposes for any society on Earth.  It would be an even worse hell than absolute equality.  The greatest inequality would be a slave society where one person owns everything on earth.  This would be an extremely inefficient system because one guy would not really need billions of slaves and they would be a headache to manage, so he would probably let most of the population of the world starve to death.  Too many people would just get in the way of his adventures.  Like with perfect equality, there is no incentive for people to work because they don’t own anything and won’t be able to keep anything because anything that they try to work with is already owned.  The only way to create incentives to work is for the slaveholder to increase equality.  If the slaveholder doesn’t share some of his food, everyone else will die.  Furthermore, giving food in exchange for work would raise production by motivating people to do more work.  That will increase equality because the slaves will gain some de-facto property rights to the food, and more equality will increase production (efficiency) because slaves will produce more.

For any kind of property rights, you can draw a curve where efficiency is enhanced by greater equality up to a point, but at some point there can be too much equality as drawn on this simple diagram:

2.3 inequality and human capital

For this diagram representing the overall income distribution, I drew the point that maximizes MELI to the right of the efficiency maximizing point because it would be worthwhile to sacrifice some production to be able to increase prosperity for the majority of people.  Nobody knows exactly what the shape of the efficiency-equality curve is, and the curve will be different for different kinds of policies, but it is a general law of economics that both excessive equality and excessive inequality are worse than a golden median.  For example, the curve for different levels of education will maximize efficiency at different levels of inequality.  Pretty much everyone in society should get a primary education, but it would be a waste of resources (and it would make a lot of people miserable) to try to get everyone to earn a PhD.

2.3 inequality and human capital3If you want other examples of how different kinds of property follow this rule, feel free to leave an example in the comments.

 

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Posted in Inequality, Medianism

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