How Efficiency/equity Tradeoffs Resolve through Horizon Effects

By Jennings, Frederic B., Jr. | Journal of Economic Issues, June 2005 | Go to article overview

How Efficiency/equity Tradeoffs Resolve through Horizon Effects


Jennings, Frederic B., Jr., Journal of Economic Issues


The so-called efficiency/equity tradeoff emerges from the notion that competition is efficient and that the financial incentives spurring output do not consist with equity in the outcomes so achieved. Distributional equity is seen to conflict with the allocative efficiency of individuals seeking gain within a competitive frame. But is competition truly efficient? The claim is seldom probed, despite its sundry flaws. Special exceptions to market "perfection" may be general laws. The underlying conditions of the case for competition need more attention than they get. The interdependence of social relations should be our first concern.

Human associations in a myopic competitive world are rivalrous: substitution and tradeoffs serve as economic descriptions thereof. Economists' substitution assumptions show competition to be efficient: the opposition of wants is better resolved through bidding than force. Substitution depends substantially on diminishing returns, which only apply to short-term models with some input taken as fixed. But long-term production technology yields to increasing returns in cost.

How do increasing returns affect the efficiency/equity tradeoff? First, as Nicholas Kaldor explained, increasing returns make complementarity more important than substitution in our economic relations (1972, 1975). But complementarity--as a concert of interest--demands a different form of social organization from substitution and conflict of interest. Competition in the presence of complementarity fails, just like collusion with substitution. The route to economic efficiency in the presence of complementarity is not competition but cooperation, to reach an optimal outcome. Where gains are common, we ought to collude.

The key economic question turns on the nature of interdependence. Does substitution prevail? If so, our mainstream models suffice. But where increasing returns are the rule--and therewith complementarity--competition is inefficient. In these situations, cooperation resolves the efficiency/equity tradeoff. Cooperation calls for inclusion, not exclusion through competition: its magic comes from a synergy of all and not the lone effort of one. (1) So which is more important: substitution or complementarity?

An introduction of planning horizons here reverses the usual answer in favor of substitution. Not only does social extension of planning horizons shift our relations away from substitution to complementarity but most direct interaction of planning horizons is complementary also. If you, in my decision environment, become more reliable through better foresight, I can plan better too. You and I are related thus: shorter horizons for you will likely shrink mine as well. We all create disturbances in each other's endeavors. Stability and instability yield a spreading contagion.

So planning horizons and changes thereof--which we should call horizon effects--suggest that complementarity is more general than we think. Both increasing returns and horizon effects shed new insight on our relations of interdependence, beyond just substitution assumptions: they offer resolutions for many economic conundra, including efficiency/equity tradeoffs. So how do horizons relate to price? That is the place to start.

Planning Horizons, Horizon Effects, Pricing, and Interdependence

Planning horizons emerge from the nature of choice in an interdependent domain. The essence of both ecology and institutional economics is a recognition of interdependence throughout all living systems. As Gunnar Myrdal (1978, 772-74) put it: "There is no one basic factor; everything causes everything else. This implies interdependence within the whole social process." If every act ripples outward forever on everyone else in its spreading effects, so is our rational anticipation thereof forcibly bound (Simon 1982-97). The fog around our radiant impact is also related to others' stability: all our planning horizons--in their range of imagined projection--are linked. …

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