Friday, September 30, 2005
Compromising on efficiency can hurt growth
Professor, Institute of Economic Growth
It is seemingly legitimate and logical to say, as does the World Development Report 2006: Equity and Development (World Bank), that greater equity can reduce poverty, enhance economic growth and advance development. But the trade-offs between equity and efficiency can sometimes be high. Also, compromising on efficiency can hurt growth not just in the short run, but over the long run too. So the central contention that neither growth nor equity is attainable without efficiency, holds despite WDR 2006’s contention that the inequality of opportunities underutilises human potential, leads to extreme deprivation and weakens growth prospects. The divergence of growth rates seem to have started in the ’90s, leading rich states to grow faster than relatively poorer ones. They grow faster as they have better infrastructure and meet other prerequisites; they can thus also attract FDI, gain from economic reforms and energise overall growth. But growth would be immediately dampened if equity got precedence and distorted natural market responses. The losses arising from that would not be compensated even over the long term by a more equitable distribution of resources. The principle of ‘agglomeration economies’ also suggests that firms in large cities are more efficient than their small town counterparts. Hence it may be counterproductive to push policies that curb locational concentration in favour of a spatially ‘equitable’ industrial spread. Firms, instead, would gain by reaping the advantages of agglomeration in an increasingly more competitive world. Concentration will hike efficiency and competitiveness — as scale economies slash costs, motivate price cuts and competitive trading. Finally, equity-targeted outgoes on health, education or poverty reduction can be sustained only after growth attains high levels. Forcing through efficiency losses before that can leave the economy in a stagflationary state, and militate against poverty removal. That is because deficit financed transfers will nullify the potential of development programmes aiming at equity. In short, efficiency must get priority even if it initially exacerbates inequality. Markets fail the efficiency test in real life
Professor CESP, JNU
It is often argued in economic theory that it is impossible to simultaneously achieve efficiency and equity in the development process. But, looking closer at the World Development Report 2006: Equity and Development, equity can mean different things to different people. Economists now define equity as ‘non-envy’ — or, an allocation under which no individual envies another. Economic theory also shows there is no way of achieving an equitable and desirable (or Pareto-efficient) allocation in an economy wherein some are more productive than others. (A resource allocation is said to be Pareto-efficient if it meets given constraints and also if no one can be made better off by altering the state of affairs while satisfying the same constraints.) Economic theory also shows that none of the equilibria that exist need be Pareto-efficient if the economic environment is characterised by increasing returns to scale, externalities in production and consumption, non-convexities in consumption, and indivisibilities. The efficiency of the economic system is, thus, not guaranteed in any realistic situation — except in an idealised market-driven model of a competitive economy. Hence, no theory can support the overlooking of equity on efficiency grounds. It is, moreover, thus because markets, in real life, fail to achieve efficiency while governments do not pursue equity. Yet, equity is even more relevant today than ever before. The pursuit of market-led, ‘efficient’, growth over the past two centuries has so degraded the environment that it threatens the very existence of life on earth. Ever-increasing inequalities have led to greater social discontent and hiked the incidence of crime. So the case for equity is based on common sense: a society that prioritises poverty eradication and employment creation, targets health, promotes literacy and allocates resources for the provision of food, clothing, shelter, health and education for all will achieve a higher level of happiness and harmony than another which attaches priority to the production of luxuries and newer methods of mass destruction.