Efficiency vs equality (part II)

In the previous post, I discussed “efficiency” without defining it. Economists have a very strict definition of this important term: if a state of the world can make some better off, without hurting anyone, that state of the world is more “efficient.” On the other hand, a new state of the world, that increases the overall size of the pie but makes some better off and others worse off is not “efficient” by this definition. One reason why economists use the stricter definition of efficiency is that under diminishing marginal utility, overall social welfare may not necessarily increase in the second case. However, in the first case, social welfare is always higher.

Economists have spent considerable time arguing that international trade is efficient. (As a caveat, Stiglitz and others have demonstrated instances where international trade can be inefficient but that is a discussion for another day). So in theory that means international trade makes some people better off and no one worse off. But at the same time, economists acknowledge that international trade leads to “winners” and “losers.” But there are no “losers” in a more efficient state of the world. How to square this circle? Economists argue that there can be a transfer of monies from the “winners” to the “losers” such that the “winners” are still better off and the “losers” are no worse off than before. Hence, as the example of international trade shows, efficiency and redistribution are not mutually exclusive. In fact, redistribution is absolutely necessary for international trade to be efficient!

Economists who believe in the efficiency of international trade (including myself) should also believe in increasing re-distribution from the “winners” to the “losers”. However, the tax code in the US has become increasingly regressive at the same time that globalization has increased dramatically. This is not efficient by economists own definition of efficiency. (Side note: are there situations under the theory of second best where increasingly regressive taxes contemporaneous with international trade can be efficient?).

In order to make international trade efficient, we need to better understand the “winners” and “losers.” The recent trade literature has luckily ignored Lucas’s advice and spent considerable effort trying to understand who is hurt from international trade. Hopefully this research will move us towards making international trade more efficient, but in the meantime, I am curious why economists have been silent as the US tax code has become more regressive over the years while loudly touting more free trade.