Dialing in Economic Policy: Growth and Equality

Imagine we had two dials to control the economy: one would increase the size of the pie (economic growth), and the other would make the slices more equal (wealth distribution). In this simplified scenario, the optimal strategy would be straightforward — we would simply turn both dials to their maximum settings. This would create a wealthy, egalitarian society where prosperity is both maximized and shared equitably.

However, real economic policies rarely offer such clean, independent controls. Our policy choices typically involve more complex trade-offs.

A More Complex Set of Dials

In practice, imagine we have these four dials instead:

1. A dial that makes slices more equal without changing pie size
2. A dial that increases equality while also growing the pie
3. A dial that increases equality but shrinks the pie
4. A dial that decreases equality while also shrinking the pie

How should we set these dials? Let’s analyze each one carefully:

• Dial #4 should obviously never be turned up since it worsens both metrics we care about — it makes society both poorer and more unequal.
• Dial #3 is the critical case that requires careful consideration. Even though this dial improves equality, we should avoid turning it up entirely. Why? Because of a fundamental asymmetry in our options:
  - We already have two excellent ways to address inequality through dials #1 and #2.
  - If we need more equality, we can simply turn up dial #1 (which makes society more equal without economic cost) or dial #2 (which makes society more equal while growing the economy).
  - But once we shrink the pie with dial #3, that economic output is permanently lost — there is no dial that can specifically undo pie shrinkage without other effects.
• Dial #2 should be maximized since it improves both metrics simultaneously — it grows the economy while making it more equal.
• Dial #1 should be used freely to achieve whatever level of equality we desire after maximizing dial #2. It improves equality without any negative impact on economic growth.

The Critical Asymmetry

This creates a profound insight: we should never accept pie shrinkage to achieve equality because we have better tools at our disposal. If a policy grows the pie but makes it more unequal, that’s fine — we can use dials #1 and #2 to correct the inequality without sacrificing growth.

However, if we shrink the pie to achieve more equality using dial #3, we permanently lose economic output that cannot be recovered. There is no “pure growth” dial that can undo the damage of pie shrinkage without affecting other variables. We’ve already maximized the growth-promoting policies (dial #2), so any pie shrinkage represents a permanent, irreversible loss.

Real-World Economic Tools

These abstract dials correspond to actual economic policies:

Dial #1 (Equality Without Affecting Economy Size)

• Land Value Taxes: Tax only the unimproved value of land, which doesn’t discourage productive activity
• Universal Basic Income: Provides direct transfers without distorting work incentives

Dial #2 (Equality While Growing the Economy)

• Pigovian Taxes: Taxes on activities with negative externalities (like pollution), which can actually improve economic efficiency

Dial #3 (Equality at the Cost of a Smaller Economy)

• Income and Sales Taxes: Create “deadweight loss” by discouraging economic activity
• Subsidies for Specific Industries: Distort markets and create inefficiencies

Dial #4 (Less Equality and a Smaller Economy)

• Price Controls: Function as implicit taxes and subsidies, creating market distortions

The Optimal Policy Approach

Now we can see why economists often advocate for a specific policy mix:

1. Use Pigovian taxes (dial #2) to correct market failures and grow the economy
2. Implement Land Value Taxes (dial #1) to raise revenue without economic distortion
3. Fund a Universal Basic Income (dial #1) with this revenue to achieve desired equality
4. Minimize or eliminate policies that shrink the economic pie (dials #3 and #4)

If someone suggests exempting poor people from paying Pigovian taxes or Land Value Taxes, this is equivalent to turning dial #3 — attempting to increase equality but at the cost of economic efficiency. Instead, we can achieve the same equality goal more efficiently by keeping the broad-based taxes and adjusting the UBI amount.

This framework reveals a profound insight: the apparent trade-off between equality and growth often disappears when we choose the right policy tools. We can create both a larger economic pie and ensure everyone gets a fair slice. But we must remember that economic shrinkage cannot be undone, while inequality can always be addressed through efficient redistribution mechanisms.

Beyond Left and Right: A Third Way

This dial framework helps us see why both traditional economic left and right perspectives contain fundamental flaws.

Where Both Sides Fall Short

The economic left often makes the fallacy of assuming that addressing inequality requires shrinking the pie. They propose policies like strict employment protections, price controls, and mandatory worker ownership that create deadweight loss. For instance, laws making it difficult to fire employees in countries like Spain might seem compassionate, but they ultimately shrink the economic pie. Companies that can’t adjust their workforce during downturns might go out of business entirely, causing even more unemployment in the long run.

Meanwhile, the economic right correctly values market efficiency but often rejects redistribution entirely. They recognize that many left-wing policies create market distortions but offer no alternative solution to inequality. This leads them to be characterized as callous or uncaring, further polarizing the debate.

A Better Synthesis: The Nordic-Style Approach

What we need is a third way that combines the best insights from both perspectives:

1. Free and efficient markets that maximize productivity and growth
2. Robust, non-distortionary redistribution through universal programs

This closely resembles the Nordic model — countries with relatively free markets (including flexible labor markets where companies can hire and fire easily) combined with strong social safety nets funded through broad-based, efficient taxation.

Reframing the Debate

We need to teach the right that it’s possible to provide a comprehensive social safety net without damaging the productive output of the economy. And we need to teach the left that many socialist policies are deeply flawed because they attempt to address inequality through means that distort the economy and crush productivity.

For example, forcing employees to own the “means of production” effectively tells workers they can only be paid in a specific form that may have substantial deadweight loss. A worker might receive a benefit they value at $20,000 that costs their employer $30,000. Most would prefer the cash so they could decide for themselves how to spend it.

This “gift card fallacy” lies at the heart of many inefficient policies. Why restrict people’s choices when you could give them resources directly and let them decide what they need?

By understanding the dial framework, we can break free from the false dichotomy between unfettered capitalism and inefficient socialism. We can carefully tune our economic policies to get the best of both worlds: a thriving, innovative economy where prosperity is broadly shared.