A sideways look at economics

As a boy I remember arguing with my sister about how to divide up cakes, pies and similar comestibles. The fairest approach we came up with was: “You cut, I choose”. But that approach is problematic because no cut is perfect. One slice of the pie is always fractionally larger. I preferred, and often insisted on, being the chooser rather than the cutter. My reasoning was: if anyone is going to get more than their fair share, it’s me. I completely accepted that we should put in place protocols that are as fair as possible. But I wanted any residual unfairness to benefit me.

Of course, there was always the option of a second cut, to redistribute the residual unfairness. If one slice of the pie were larger than the other, then you could trim the large slice and redistribute the trimmings to the smaller slice. However, I generally resisted this kind of redistribution, on grounds that I was later to learn were tantamount to saying it would be Pareto sub-optimal. At the time, the way I put it was: you cut and I chose and now that’s just how it is. Pareto’s suggestion was that a policy intervention could be justified only if it satisfied his definition of optimality: that at least someone should be made better off, while no one was made worse off. You could not redistribute the trimmings without making me worse off, so no such redistribution could be justified.

I knew that this was sophistry really, a position I argued rather than felt to be fair. But I argued it nonetheless. My sister, being more sensible than me, would tend to overlook small differences in our shares and focus on the large slice of pie in front of her, thinking, perhaps, that there will always be another pie.

A slice of the economic pie

I came into the discipline of economics thinking that it was all about Pigou — reshaping the existing economy wholesale by redistributing the share of pie through taxation and subsidy to minimise negative and maximise positive externalities arising from economic activity. But I discovered that it was actually all about Pareto, at that time anyway. Economists, I learnt, should focus on Pareto improvements — modest ways of finetuning the economy so that in future at least some people would be better off without disadvantaging anyone. The best way to do this was to find ways of increasing the size or number of pies. Suppose, for example, the time I spent as a boy fretting about marginal differences in the size of pie slices had been spent instead in preparing another pie: that would have been a Pareto improvement arising from higher productivity on my part (although my lamentable cooking skills meant you would have had to be totally indifferent to the taste and texture of the finished article).

At the macro level, if you can shift resources, including people, from fundamentally unproductive, redistributive activities (such as the bulk of the legal profession and, if you’re in the mood for being cruel, a lot of the consultancy industry too) and into activities that make the pie bigger (such as education and medicine) that would be Pareto improving. And if you can find ways in which all economic activity can be done more efficiently (eg., through innovation or deregulation) then that tends to be Pareto improving too.

That was the guiding spirit of economic analysis through most of my career to date. Focus on things that improve economic efficiency and have the potential to make at least some people better off, without making anyone worse off. Focus on Pareto.

The clincher, for people who wanted to reduce economic inequality (including myself), was that Pareto improvements can actually be redistributive too, shifting the share of income from the relatively rich to the relatively poor, as long as that is achieved in the context of economic growth — increasing the amount of pie in the round. A bigger pie means you can nibble away at inequality without making anyone worse off in an absolute sense. And that makes redistribution politically achievable.

The difference between centre-left and centre-right in economic policy was largely about how much redistribution should take place from the fruits of economic growth: Pareto-efficient redistribution. Some on the right argued that too much redistribution undermined the incentives to grow the pie. Some on the left argued that too much inequality resulted in wasted resources that would otherwise grow the pie. We flipped and flopped between administrations that took one side or the other, but usually within the same overarching assumption that we will seek growth and redistribute primarily out of the fruits of that growth.

What if we’ve had enough of growth, though? Some would argue that position out of concerns about the impact continuous growth has on the climate: these are interesting arguments but I’m not going to address them here. Others, such as my mum, for example, would argue that once you’ve reached a decent average standard of living there’s no need for further growth. We should be happy simply to be the richest generation of humans in the history of our species, and stop worrying about becoming even richer.

Whether intentionally or not, my mum’s vision of arrested growth seems to have been taking hold in advanced economies over the last couple of decades. First Japan, after the bursting of its bubble economy, and subsequently the rest of the developed world after the Great Financial Crisis, have seen economic growth slow sharply and stay lower. Fathom has long argued that policies that would be more disruptive in the short term could have created stronger growth down the line. But policy makers, and the people that elect them, seem to feel that ‘the nets’ are not worth it, so far.

There are many problems that flow from that choice, but the biggest one is redistribution. If the pie is fixed in size, then you can’t do redistribution in a Pareto-efficient way. Someone has to be made worse off in an absolute sense. And it turns out — guess what! Most people on the receiving end are highly resistant to policies that make them worse off. Moreover, since the people resisting such policies are the richest (those who would stand to lose the most), they tend also to have the loudest voices, the best lawyers, the closest links (financial and personal) with politicians: they tend to be very good at protecting what they have.

If the pie is fixed, you can’t really do progressive redistribution at all. In fact, if anything, the redistribution goes the other way: it’s regressive, from poor to rich. Rich parents tend to want their kids to be better off than they are, and to see their own income and wealth increase. The only way that can happen, with a fixed pie, is by making the poor worse off.

The pie is growing fast right now, but growth is likely to slow and even stall in a few years, unless we are prepared to make radical, disruptive policy choices now. We have accepted too meekly the idea that the pie is fixed in size, without apparently even realising that’s what we’ve done. It’ll work out alright for the rich, as things usually do: but don’t be poor in that world, is my advice.

PS I find that the supreme importance of having the largest slice of pie when I was a kid has vanished completely. I genuinely don’t care at all. I would rather cut than choose nowadays, and will do that very approximately. I suppose this has to do with sibling rivalries and so on: anyway, I just don’t feel that way any more.

PPS If you were wondering who ate all the (literal) pies, well — that would be me.