How Does the Distributional Role of the State Conflict with the Objective of Economic Efficiency - Coursework Example

How does the "distributional" role of the (in income redistribution and the alleviation of poverty) conflict with the objective of economic efficiency?                Introduction: The market economy provides opportunities for individuals to earn an income and also acquire wealth. But the opportunities of earning and income are not equally distributed. Individuals are not provided with equal opportunities in education. Some are also limited in their capacity to learn or they may have acquired a skill only to find that the skill is declining. Discrimination is what distorts earnings and thus can result in women; people from ethnic minorities and the disabled earning less from the same work as able bodied, white male employee’s .In addition, individuals are subject to illness and incapacity. The market system does not guarantee that everyone will have the same opportunity to accumulate wealth and once an inequality in the distribution of wealth arises it tends to be self perpetuating because wealth can be inherited. (SJ Grant 2000). It is a general characteristic of developing countries that income is unevenly distributed. Partly, because the income generating assets especially land are owned by the few. As a result we can see great extremes of both the rich and the poor. In 1998 for example the World Bank figures show that in Peru the poorest 20% of the population had only 4.4percent of total household income, while the richest 20% had 51.3% of total household income. These great extremes of the rich and the poor mean that in developing countries deprivation is very common. Distribution of Income: The distribution of income can be examined in two main ways .One is by examining the distribution of income between the factors of production. In this case the wages account for the largest percentage but the share of income has fallen over the years. Another way of examining the distribution of income is to examine how disposable income is distributed. Disposable income mainly consists of incomes that are derived from factor services together with various forms of cash benefits, i.e. social security payments etc . Minus direct taxes i.e. income taxes and national insurance contributions. Two very vital elements in the income of households of distribution are the investment income and the income derived from self employment. The unequal distribution of wealth is a major cause of the inequality in the distribution of income. How much Inequality? ‘Gross Inequalities in the distributions of income and wealth lead to feelings of ‘unfairness’ because , quite apart from creating inequalities in living standards , they lead to inequalities of opportunities in living standards ,they lead to inequalities of opportunity. The wealthy can buy superior education and training for their children and there is no doubt that the possession of wealth confers certain social advantages .Inherited wealth provides the recipient with an income regardless of his /her abilities, aptitudes or efforts. In deciding what an equitable distribution of income is, the economist can offer no conclusive answers because it is a matter of personal judgment (i.e. a value judgment) On the assumption that the purpose of the economic activity is to maximize the satisfaction of wants, it might be argued that an equal distribution of income would be the ideal. This conclusion is based on the notion that the law of diminishing marginal utility applies to income and that everyone derives the same utility from a given amount of income. But incomes are also incentives to production .In order to get people to work harder, accept greater responsibility, develop new ideas, undertake long and difficult training or to carry out unpleasant tasks, it is claimed that it is necessary to offer higher rewards .Some economists argue that if these incentives are not forthcoming, the amount of real income available for distribution will probably be reduced. The problem is to weigh these considerations against each other .equal distribution may give the highest level of satisfaction from any given income, but probably would cause total income to be less than it would be under an incentive system. Purely economic arguments about the desirability of different patterns of income distribution may be inconclusive. In any case, the criterion of desirability (i.e. Satisfaction of wants) is only one of several possible ways of judging what is best. There are people who think that rewards should be strictly related to effort or risk or responsibility. Others believe that peoples needs (e.g. family responsibilities) should be the deciding factor. However, there is fairly a general agreement that the distribution of income and wealth brought about by market forces is inequitable and most governments have policies fro reducing these inequalities. the main instruments for doing this are a system of direct taxation which is progressive , and a distribution of cash benefits in kind to raise the incomes of those most in need . (Garry 2000) Poverty: In regards to poverty it is also noticeable that Absolute poverty occurs when individuals are unable to purchase any basic necessities of life, whereas relative poverty occurs when people are poor as compared to other individuals of society in which they live .it is possible for individuals to be able to afford more goods and services but to be relatively poor if the incomes of others. Economic Efficiency: Economic efficiency is defined as the ‘allocation of resources to their highest valued use and the production and distribution of goods and services at the lowest possible cost. In such a situation, societys resources are allocated so that no change in the allocation can further improve anyones well-being without making someone else worse off. The unfettered pursuit of self-interest in a perfectly competitive economy leads to economic efficiency’ .Economically, the ratio by value of input to output. The higher the ratio, the greater the efficiency. Main Argument: How does the "distributional" role of the state (in income redistribution and the alleviation of poverty) conflict with the objective of economic efficiency? ‘Several features distinguish the state from the private sector. It is essential to understand the strengths and weaknesses of the state in order to decide what functions it should perform. On the positive side, first, in democratic countries the individuals who are running public institutions are elected or appointed by somebody elected. This makes them legitimate vis-à-vis the population. Second, the state is endowed with certain rights that private institutions do not have: imposing taxes on citizens, seizing private properties for public use, prohibiting, punishing and requiring participation. These capacities can be exercised because state institutions have two unique features: cohesion and universality’. (J. Stiglitz, 1995 ) ‘On the negative side, the state also faces limitations which are different from the private sector. First, the political process itself imposes restrictions, since the mandate of the state is often vague and subject to political pressure from interest groups’ (. Public choice theorists study how to prevent the government from expanding as a result of rent seeking interest groups). ‘If we consider observing the functions of a state as a contributor, there exists widespread Acceptance of the fact that possession of regular production processes are not reasonable functions for the government. The private sector obtains better results even in areas that were previously considered monopolies (energy telecommunications), essentially as a result of technological changes. The state is better placed to provide public goods, provide protection from poverty, protecting individual’s rights and social constancy. ‘In principle, the goals of the state should be established in such a way that they are consistent with its ability to operate efficiently, while promoting an improved role of markets. However, the great needs for state intervention remaining in developing countries, to reduce market imperfections and inequalities, call essentially for reducing government and institutional failures, and improving government performance, so that the main functions of the state can be ensured. It is also essential that the choice of policy instruments used by the state contribute to improving, and not worsening, income distribution, as well as eliminating, and not creating, market distortions’. ( B. Moreno-Dodson and J.M. González-Páramo, Consequences of Alternative Forms of Public Expenditure Financing) ‘The poverty line, in effect, splits the working class and tends to generate coalitions between the better-off workers and the middle class against the lower sections of the working class, something which can result in tax revolts and welfare-state backlash. In an institutional model of social policy, however, most households will directly benefit in one way or another. Therefore this model “tends to encourage coalition formation between the working class and the middle class in support for continued welfare state policies. The poor need not stand alone" (Korpi 1980a:305). The hypothesis here is thus that the size of the budget available for redistribution is not fixed and that the Institutional structures of welfare states are likely to affect the definitions of identity and Interest among citizens so that in the end an institutional welfare state model based on a universalistic strategy intended to maintain normal or accustomed standards of living is Likely to result in greater redistribution than a marginal one based on targeting ( also Rosenberry 1982).’( Walter Korpi and Joakim Palme) ‘The analysis of income distribution and economic progress (or growth) in the past was largely dominated by the conventional approaches such as neo-classical and neo-Keynesian schools. However, institutionalism offers an alternative explanation, particularly on the relationship between income distribution and economic growth. The institutionalist approach to income distribution is different in several respects from the conventional approaches. First, the conventional theories are theories of the functional distribution of income which focus on how total income is distributed among factors of production. The institutionalist approach, however, is more concerned with the size (or personal) distribution of income, i.e., the distribution of income among family units or households in a nation. According to neo-classical economists, each factor of production tends to receive income according to its marginal contribution to the production of output. Neo-Keynesian theories centre around the distribution of total output between labor and capital. Institutionalists claim that the current size distribution of income has been largely determined by discretionary institutional arrangements which include power relationships in the society’. (Jan, 1996  by Kang H. Park) The real connection between income distribution and economic progress (or growth) is imaginary, or loose at best, in the conventional approaches. According to these approaches, economic growth is majorly dependant on the level of investments and the rate of technical progress. The levels of investment also play a vital role in the distribution of total income between wages and profits. If there does exist any correlation between these two variables, it can be deemed the substitution relationship according to the conventional views. The institutionalist approach is observed to be distinctive from the conventional views in its emphasis upon the association and relationship between that of the income distribution and economic progress. The state of income distribution may be promoting or stalling economic progress. Institutionalists generally agree with the notion that inequality of income, especially extreme inequality, is detrimental to economic progress. Institutionalists consider equity and growths to be complements and not substitutes. Researches have proven to a large extent that along with focusing on economic efficiency also combines the policy of income re distribution. A Trade off can be considered. If the reduction in poverty is achieved rapidly by reducing inequalities the distributional policy can be deemed as higher priority. On the other hand if, we observe higher levels of inequality appearing in order to secure the rapid growth which ultimately will lead to faster poverty reduction. The association between inequality and growth are vital to be observed from a policy perspective. Simon Kuznets in his article published in 1995, had investigated the relationship between per capita incomes and inequality in a cross-section of countries. His findings included what he deduced as a U Pattern which specified: and initial increasing trend in Inequality, then decreasing as the per capita income increased. He assumed the driving force was a structural change in a dual Economy setting. In this the labour shifted from a traditional undifferentiated sector to a more productive and modern one. Kuznets inverted U has been in the past times exposed to a large number of tests over the years. Conclusion: The role of state in the redistribution of income is in various forms of measure in the policy of the payment of cash benefits since these go largely to people who are not earning .Direct taxes further increase the share of income going to the lower income groups but the net effect on distribution is much less than that a rising from cash benefits. The effects of indirect taxation are less clear. The taxes take a higher percentage of the disposable income of the middle income households spend a large proportion of their income on food and rent.While High income households tend to allocate more of their income to savings mortgage interest and insurance premiums which eventually attract little tax.   Bibliography  1. J. Stiglitz, 1995 The stat’s essential properties of universal membership and the associated powers of compulsion and proscription”, “Role of the State in a Contemporary World”. 2. SJ Grant 2000 Stan lakes Introductory Economics. 3. J. Stiglitz, 1995 “Role of the State in a Contemporary World” 4. J.M. and Páramo, Consequences of Alternative Forms of Public Expenditure Financing) 5. Korpi and Palme The Paradox of Redistribution and Strategies of Equality 6. H. Park 1996 , Income inequality and economic progress: an empirical test of the institutionalist approach American Journal of Economics and Sociology Read More