Common sense didn’t survive reality

WASHINGTON — In 1975, the Brookings Institution — perhaps Washington’s best known think tank — published an elegant essay by Arthur Okun, who had been one of the leading economists of the Johnson administration. The essay was called “Equality and Efficiency: The Big Tradeoff.” Its premise, as the title suggests, was that government faced a choice in fashioning its economic and social policies. A bias toward more equality might weaken economic growth by dulling the incentives to work, save and invest; on the other hand, leaving matters to the market could worsen inequality by widening income and wealth gaps. We could balance equality and efficiency. Once stated, the logic seems impeccable.

Only it isn’t.

Four decades later (Brookings is marking the anniversary by reissuing the book), the big tradeoff has proved unworkable. The facts on the ground have made a mockery of the seemingly rational and controllable choices implied by Okun’s framework. As a society, we wanted more of both growth and equality. Okun anticipated this; the outcome, he said, would be compromise. What he didn’t anticipate — what hardly anyone anticipated — is that we would get less of both: less growth and less equality.

The tradeoff vaporized. Poof!

Look at the numbers. On either measure, our performance is disheartening.

Start with economic growth. From 1950 to 1973, the U.S. economy expanded at an average annual rate of 4 percent. This would have been Okun’s reference point. For the coming decade (2015-2025), the Congressional Budget Office projects growth at only 2.1 percent annually. About half the decline reflects slower labor force growth. We can’t do much about this. Baby boomers are retiring; the influx of new workers only slightly exceeds this large workforce exodus. But the other cause of slower economic growth is lower productivity gains that come from new technologies, better business practices and more skilled workers.

These are the qualities that Okun labeled “efficiency.” Americans like to think that we excel at nurturing and exploiting these qualities. But the numbers say otherwise. During the 1950-73 period, labor productivity grew an average of 2.4 percent annually; the CBO’s projection for the next decade is 1.6 percent annually — and even this exceeds recent experience, which is less than 1 percent a year. These numbers describe an economy that, despite highly visible digital advances, strains to innovate and to raise living standards.

Next, equality. Okun found the income distribution of the early ’70s to be “terrible.” He was appalled that the richest 1 percent of Americans had “as much after-tax income as nearly all the families in the bottom 20 percent.” And it was “disturbing that the top fifth of families have about as much after-tax income as the bottom three-fifths.” Well, if he was disturbed then, he’d be livid now. In 2011, the after-tax income of the richest 1 percent was twice the income of the poorest fifth of Americans, estimates the CBO. As for the richest 20 percent of Americans (including the top 1 percent), they commanded nearly half the after-tax income; that was just shy of the incomes of the bottom 80 percent.

It’s not true that incomes stagnated for everyone but the upper middle class and the rich. From 1979 to 2011, calculates the CBO, the after-tax incomes of the poorest fifth rose nearly 50 percent. But it is true that the gaps have widened dramatically. Over the same period, the after-tax incomes of the top 1 percent jumped 200 percent. (All figures are adjusted for inflation.)

How did this happen? How did we end up with degraded efficiency and equality? Why did Okun’s sensible-sounding scheme not survive contact with the real world?

The big tradeoff presumed the politicians, policymakers and the public could consciously pick among a variety of choices. Our economic understanding was sufficient to shape the future according to our tastes. This turned out to be a mirage. We do not know enough to manipulate economic growth, productivity and income distribution. Much of what we experience today may be the unintended result of past events and developments, not deliberate policies. The fabulous economic growth of the 1950s and ’60s may have reflected technologies created in the 1930s and ’40s (synthetic fibers, television, antibiotics), plus the advantage that the economies of our main global competitors had been nearly destroyed. History matters, but Okun’s essay lacks this or any other history.

Okun’s book is emblematic of an era of overconfident economics. The underlying questions remain. Is the convergence of rising inequality and falling economic growth simply a coincidence? Or is more inequality a cause of weaker growth, a consequence of it — perhaps both? We lack definitive answers. Government must routinely act without full knowledge. That’s the point: In the real world, we often don’t know the true tradeoffs.