Monday, October 22, 2012

"Inefficient" Redistribution, or "Efficient" Insurance?

This crossed my mind this morning. I'm wary of lowering downside risk without some mitigation of the rewards, i.e. a mean preserving spread. But the new institutional economics has a lot to say about this. For example, one seeming paradox is that democracy complements markets, yet is more prone to social redistribution. North and his various coauthors have argued in several places that, for one thing, this cannot be explained by simple neoclassical theories, and two, that it may not be such a paradox.
Oddly, the argument made by Jon Stewart (and which they guy with the funny name was hesitant to endorse) is close to what the institutional school has argues for some time.
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The main roles of the state in promoting social welfare (that is, the overall well being of society) are (1) protecting private property rights (from both internal and external bandits); (2) lowering transactions costs; and (3) mitigating the risks associated with market participation. For example, a feudal system may not have promoted much "efficiency", but it did provide a framework for protecting both elites and non-elites from violence.
Fast forward a bit. Why is it today that the most market-oriented economies are also both democratic and the most prone to "inefficient" redistribution? Is it mere rent-seeking by special interests? Hardly, although this may be partly the case. In fact, it seems that the most well-organized interests influencing the government would be opposed to redistribution in the form of social security, medicare, health care, welfare, etc. The argument that North and others make (and one that liberal politicians should be making more) is that reducing risk is important to a well-functioning market economy because it makes it easier for citizens to participate in the market.
Two things I disagree with from the video: (1) it's not just about lowering risk - for justify this in the context of market mechanisms, there has to be a premium that individuals pay when they realize the "high returns" outcome, i.e. higher average tax rates for the rich and wealthy; (2) it's not about "entrepreneurship", it's about market participation in general.

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