Originally published in 1975, Equality and Efficiency: The Big Tradeoff is a very personal work from one of the most important macroeconomists of the last equality and efficiency hundred years. In classrooms Arthur M. Okun may be best remembered for Okun’s Law, but equality his lasting legacy is the respect and admiration he earned from economists, practitioners, and policymakers. Equality and Efficiency is the perfect embodiment of that legacy, valued both by professional economists and readers with a keen interest in social policy. Okun presents an engaging dual theme: the market needs efficiency a place, and the market needs to be kept in its place. As he puts it, institutions in a capitalist democracy prod us to get ahead of our neighbors economically after telling us to stay in line socially. This double standard professes and pursues an egalitarian political and social system while simultaneously generating gaping The Big Tradeoff disparities in economic well-being. Today, Okun’s dual theme seems prescient as we grapple with the hot-button topic of income inequality. As Lawrence H. Summers writes: On what one might think of as questions of “economic philosophy,” I doubt that Okun has been improved on in the subsequent interval. His discussion of how societies rely on rights as well as markets should be required reading for all young economists who are enamored with market solutions to all problems. with a new foreword by lawrence h. summers This new edition includes “Further Thoughts on Equality and Efficiency,” a paper published by the author two years after the book’s publication. foreword by lawrence h. summers brooKinGs institution Press Washington, D.C. www.brookings.edu/press Series cover design by Beth Schlenoff Final_Okun.indd 1 3/30/15 1:04 PM EQUALITY and EFFICIENCY THE BROOKINGS CLASSICS Thoughtful, relevant, and timely books have been the hallmark of the Brookings Institution Press since its founding, and the press has been fortunate to count among its authors some of the most important thinkers of the twentieth century. With The Brookings Classics the press draws on its vast library of original work to reintroduce some of its most influential books to new audiences. Each book in the series has made important contributions to policy debates and scholarly discourse and has stood the test of time to remain relevant in today’s world. Each Classic also includes a foreword written by an influential thinker in his or her field, explaining the book’s significance while grounding the work in a contemporary context. Check out the Brookings website to learn more about the individual titles in the series: www.brookings/edu/classics. The Irony of Vietnam: The System Worked Leslie Gelb with Richard K. Betts Development Projects Observed Albert O. Hirschman Red Tape: Its Origins, Uses, and Abuses Herbert Kaufman Equality and Efficiency: The Big Tradeoff Arthur M. Okun Camp David: Peacemaking and Politics William B. Quandt Systematic Thinking for Social Action Alice M. Rivlin ARTHUR M. OKUN EQUALITY and EFFICIENCY The Big Tradeoff FOREWORD BY LAWRENCE SUMMERS brookings institution press Washington, D.C. Copyright © 2015 THE BROOKINGS INSTITUTION 1775 Massachusetts Avenue, N.W., Washington, D.C. 20036 www.brookings.edu All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from the Brookings Institution Press. This book is a revised and expanded version of material originally delivered in April 1974 as a Godkin Lecture at the John F. Kennedy School of Government, Harvard University. The Godkin Lectures on the Essentials of Free Government and the Duties of the Citizen were established at Harvard University in 1903 in memory of Edwin Lawrence Godkin (1831–1902). The final chapter, “Further Thoughts on Equality and Efficiency,” is reprinted from Colin D. Campbell, ed., Income Redistribution (American Enterprise Institute for Public Policy Research, 1977), and used with permission. The first Brookings edition of Equality and Efficiency was published in 1975. The Brookings Institution is a private nonprofit organization devoted to research, education, and publication on important issues of domestic and foreign policy. Its principal purpose is to bring the highest-quality independent research and analysis to bear on current and emerging policy problems. Interpretations or conclusions in Brookings publications should be understood to be solely those of the authors. Library of Congress Cataloging-in-Publication data Okun, Arthur M. Equality and efficiency : the big tradeoff / Arthur M. Okun ; foreword by Lawrence Summers. pages cm — (The Brookings Classics) “This book is a revised and expanded version of material originally delivered in April 1974 as a Godkin Lecture at the John F. Kennedy School of Government, Harvard University.” Includes bibliographical references and index. ISBN 978-0-8157-2653-1 (pbk. : alk. paper) — ISBN 978-0-8157-2654-8 (e-book) 1. Comparative economics. 2. Equality. I. Title. HB90.O38 2015 330—dc23 2015006126 Printed on acid-free paper Typeset in Sabon Composition by Cynthia Stock Silver Spring, Maryland CONTENTS Foreword vii Lawrence H. Summers ONE Rights and Dollars 1 TWO The Case for the Market 31 THREE Equality of Income and Opportunity 63 FOUR Increasing Equality in an Efficient Economy 86 Further Thoughts on Equality and Efficiency 117 Index 149 v FOREWORD still remember the excitement with which I first read Arthur I Okun’s Equality and Efficiency: The Big Tradeoff as a first-year graduate student. It was the antithesis of the first-year economic theory sequence in which I was mired: a thoughtful, engaging, rig- orously logical analysis of real issues that were crucial to the well- being of the American people. His text helped me realize that I had become an economist because I, like Okun, wanted to devote my career to thinking about—and on occasion to helping to act on—major public policy issues. I was impressed and influenced especially by two aspects of Okun’s analysis. First, he emphasized the good reasons why many things, even in capitalist economies, are not for sale—a very useful antidote to my youthful infatuation with the notion that mutual voluntary exchange was presumptively beneficial. Second, Okun’s leaky bucket experiment provided a compelling way to think about the tradeoffs involved in using taxes and transfers to redistribute income. I remember burdening my friends for weeks with questions about whether it would be good to take $100 from someone with an income of $200,000 and give $50 to someone with an income of $50,000. Rereading Equality and Efficiency: The Big Tradeoff after forty years, I am struck at one level by how well it reads and at another by how much the world has changed. On what one might think vii viii | FOREWORD of as questions of “economic philosophy,” I doubt that Okun has been improved on in the subsequent interval. His discussion of how societies rely on rights as well as markets should be required reading for all young economists who are enamored with mar- ket solutions to all problems. He is careful and rigorous in draw- ing out Polanyi’s insights regarding the broader social systems in which markets must reside.1 Indeed, Okun largely anticipates the main tenets of Michael Sandel’s recent critique of markets when he discusses what would be wrong with permitting individuals to pay a fee to hire a substitute for jury duty or authorizing those conscripted to buy their way out of military service or allowing people to sell themselves into some form of bondage.2 Okun’s development of the theme that “the market has its place, but must be kept in its place” was prescient with respect to the governing philosophy adopted by the Clinton administration in the United States during the 1990s and by “New Labor” in the United Kingdom around that same period. Okun rightly emphasizes the dangers of excessive interference with markets while simultane- ously stressing that markets without public action are unlikely to produce distributional outcomes that are sustainable in a democ- racy. His emphasis on access to education on an equal basis for all and on the need for taxes and transfers in many ways anticipated the Clinton administration’s focus on “Putting People First.”3 However, much has happened in the last four decades that Okun did not and probably could not have anticipated. — Okun wrote that productivity growth had supported steady increases in median family incomes and reductions in poverty for more than a generation. Yet, since the mid-1970s, productivity 1. Karl Polanyi, “Our Obsolete Market Mentality,” in George Dalton, ed., Primi- tive, Archaic, and Modern Economies (Beacon, 1971), pp. 59–77. 2. Michael J. Sandel, “What Money Can’t Buy: The Moral Limits of Markets” (Macmillan, 2012). 3. This was a Clinton campaign slogan as well as a policy memorandum released during the campaign. Governor Bill Clinton and Senator Al Gore, “Putting People First: How We All Change America” (Times Books, September 1992). FOREWORD | ix growth has slowed and growth in median family income has been minimal. —Okun noted that the U.S. income distribution had been rela- tively stable over the post–World War II period. But, a few years following Equality and Efficiency’s publication, the distribution of income started to become steadily more unequal, with the share of income going to the top 1 percent rising from about 8 percent at the end of the 1970s to about 20 percent today.4 —Okun took essentially no account of the openness of the U.S. economy in discussing efficiency and equity. Today, concerns that global economic integration is hurting workers—especially the unskilled—frames debates about trade policy and much else.