Some thoughts on equity and efficiency

I was recently looking back on some notes I wrote a while back on the difference between efficiency and equity. These notes came about for two reasons: 1) I’ve had fits and starts over the years of writing a Principles-level economics book from an environmental/sustainability perspective, and in thinking about this, 2) I’ve realized that by presenting markets as ‘efficient’ in the standard Principles-level treatment, we may be missing the mark.

In deciding how best to allocate our scarce resources, there is thought to be a trade-off between equity and efficiency.  As Greg Mankiw puts it in his Principles of Microeconomics textbook:

Another trade-off society faces is between efficiency and equality.  Efficiency means that society is getting the maximum benefits from its scarce resources.  Equality means that those benefits are distributed uniformly among society’s members…When government policies are designed, these two goals often conflict…In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.

I agree with Mankiw, to an extent; given the social goal of maximizing the size of the economic pie, a policy that aims at equity creates incentives inconsistent with the goal.  But what is missing from this discussion and what is implicit in Mankiw’s definition of efficiency is that everyone is OK with the goal of maximizing the size of the economic pie.  Efficiency does not imply the goal of maximizing total economic productivity; to the contrary, maximizing total economic productivity is the subjective goal to which the objective definition of efficiency is being applied. 

This distinction is important because it is often assumed that there is a one-to-one correspondence between total economic productivity and total societal well-being or happiness.  Therefore to improve societal well-being, concerns of equity must be thrown away since total economic productivity can only be maximized through efficiency.  Hence the trade-off.  But what if there is not a one-to-one correspondence between happiness and total economic productivity?  Does that render the concept of efficiency–and consequently economics–useless?  

Quite the contrary and this is where some of the critics of economics overreact when they see Mankiw-like definitions of efficiency.  Efficiency is usually defined with the underlying social goal of maximizing total productivity.  But what if society values equality?  That is, what if total productivity is only part of what determines well-being and people actually care about the distribution of resources–at least minimally. 

The trade-off that is typically discussed between equity and efficiency is really a trade-off between equity and total economic productivity.  The logical problem comes in assuming that total economic productivity and total well-being are the same.  But what if part of our societal goal is some concept of equity?  Can we still achieve it efficiently?  According to our definition of efficiency– achieving a defined social goal using the least amount of society’s resources as possible—yes, we can still achieve any societal goal efficiently if we allocate resources to align with the stated goal.  Efficiency doesn’t have to be predicated on the particular goal of maximizing total economic productivity.  The social goal may be total economic productivity, or it may be any one of a million other distributions of social well-being.  No matter the goal, economics provides a valuable set of tools for understanding how to achieve those goals using the least amount of society’s resources–and thereby freeing those resources for other uses (or nonuses).