The Inequality Divide
Greg Mankiw has two quotes that highlights the differences on inquality between the “Right” and the “Left”,
[T]he challenge for policy is not to eliminate inequality per se but rather to spread economic opportunity as widely as possible.–Ben Bernanke
An unequal society cannot help but be an unjust society.–Brad DeLong
Mankiw then goes on to ask,
The key question: To what extent is inequality of outcomes a source for concern in and of itself? People will always differ in productivity. Should policymakers act to offset these innate differerences, or should their goal be to give everyone the same shot and not be surprised or concerned when outcomes differ wildly?
Well part of the issue is that there is an incentive problem here. Eliminating all inequality is not a desirable outcome because we live in a world of imperfect and asymmetrical information. As I have argued in the past, from an incentive stand point some level of income inequality is necessary.
The problem can be cast as an incentive problem which is precisely how Jean-Jaques Laffont and David Marimort cast it in their new book The Theory of Incentives: The Principal Agent Model. Moral hazard, or hidden action, problems are quite common. How does a supervisor get a worker to put forth his best effort? How does an insurance company induce drivers to drive safely? How does the government achieve income equality without diminishing work effort? This latter one is the problem with income redistribution schemes. The naive approach of say giving each person a fixed dollar amount results in some people providing no work effort and a drop in output. Thus, if one is going to favor income redistribution, then it seems to me it is incumbent on that person to at least spend some time looking at the issue from an incentives stand point.
When work effort is unobservable, then you have a problem of moral hazard–i.e, hidden action, that requires an additional constraint: the incentive compatibility constraint. Basically, if you want to ensure that there is no work effort at all you solve for the first best solution in which case no work effort is expended. The second best solution incorporates the incentive compatibility constraint which is to ensure that people at least put forward some work effort. Even in this case, insurance in not complete, i.e. you still have income inequality, and you also get less work effort than in the first best situation. In other words, just as with insurance markets that have deductibles to help seperate high risk from low risk customers, you have transfers/taxes that do not eliminate inequality. The inequality provides and incentive to expend work effort.
Now the question becomes one of how much inequality is necessary? Theoretically it depends on the parameters of the model. Looking at different countries wont necessarily be of any help here since individuals in different countries will probably have different utility functions (i.e., preferences). So just because country X has inequality at one level does not necessarily mean that is the level of inequality country Y should strive for.
[...]Another problem comes from political pandering. While it is all nice and neat to talk about the theory of how to achieve income redistribution while being aware of the incentive problem, there is also the potential pitfall of politicians using income redistribution for political gain (i.e., retaining an elected office). This itself can be viewed as an incentive problem as well. How do the voters ensure that their elected official votes for the best feasible outcome? Further, when we look at government today do we see results that are the second best results? While the second best results are sub-optimal they are the best feasible results. Is this what we are observing with government today? Was the energy bill a second best outcome? Was the Prescription Drug Bill for Seniors a second best outcome? So while, we can theoretically outline how these things should be done, it is far from clear that our current government is structured in a way that can achieve them.
For Brad DeLong he will just have to accept the fact that he is going to have to live in a fundamentally unjust country, if not the entire world.
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