Equity Versus Efficiency: The Elusive Trade-Off

Author(s): Julian Le Grand

Source: Ethics, Vol. 100, No. 3 (Apr., 1990), pp. 554-568
Published by: The University of Chicago Press
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Equity versus Efficiency: The Elusive

Trade-off
Julian Le Grand*
The objectives of equity and efficiency appear high on most lists of the

aims of welfare policy. That a welfare program should be assessed at

least in part by its ability to promote equity, fairness, or justice seems

almost axiomatic.' That a program should not at the same time create
inefficiency or, indeed, that it should actually reduce it, is also a widely

accepted criterion for assessment. There will, of course, be other criteria

for evaluation-the impact of the program on individual liberties, for
example-but none perhaps with the salience of these two.2
It is also commonly asserted that there is, or that in most situations

there is likely to be, a trade-off between these objectives. That is, the
implementation of a program designed to "increase" one may result in

a "decrease" in the other. For example, a social security system that

reduced poverty, thus promoting greater equity under most interpretations

of that term, may also reduce individuals' incentives to work or to save,

thus creating inefficiency-at least under some interpretations of that

term. Another example concerns comprehensive education, widely thought

to improve equality of educational opportunity and thus equity, but
accused by some of simultaneously damaging educational "excellence,"
thus damaging efficiency. Yet another case might be a health-care program
on the dangers of smoking that increased the average life expectancy of

all groups in the population, thus promoting efficiency, but produced a

greater increase in life expectancy for the better off (who, for various

* This article forms part of the Objectives of Welfare project of the Welfare State
Programme at the Suntory Toyota International Centre for Economics and Related Disciplines

(ST/ICERD), London School of Economics, whose support is gratefully acknowledged. I

am also grateful for comments from A. B. Atkinson, Brian Barry, Robert Goodin, David
Miller, and other participants at the ST/ICERD Tenth Anniversary Conference on Political
Philosophy and the Welfare State, June 1988.

1. I shall use the terms equity,fairness, and justice synonymously throughout this article.
2. On the aims of welfare policy, see J. Le Grand and R. Robinson, The Economics of

Social Problems (London: Macmillan, 1984); and N. Barr, The Economics of the Welfare State
(London: Weidenfeld & Nicolson, 1987), chaps. 3, 4.
Ethics 100 (April 1990): 554-568

C 1990 by The University of Chicago. All rights reserved. 0014-1704/90/0003-0003$01.00

554

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Le Grand Equity versus Efficiency 555

reasons, were more responsive to the message) than for the poor, thus

increasing the gap between them and arguably increasing inequity.3

Now, there are a number of questions that can be asked about this

trade-off. Some of them are empirical: Does the social security system
really discourage people from working? Does comprehensive education
actually produce worse exam results on average than selective systems?
Do antismoking campaigns have a greater impact on the better off than

the poor? and so on. These are important and controversial questions,
but they are not my concern here. Rather, I want to concentrate on the

more philosophical issues concerning the intrinsic nature of the equity-

efficiency trade-off. In particular, I want to examine the question whether

the general notion of a trade-off between the two actually makes sense.
A necessary condition for it to do so is that efficiency is a social and

economic objective in the same sense that equity is an objective. But does
efficiency have the same status as equity or, indeed, as other possible
objectives of economic and social organization, such as liberty? If it does
not, and it will be one of my contentions that at least in one important

sense it does not, then what do people mean when they talk of the equityefficiency trade-off? It is to these questions that this article is addressed.
The article begins with a distinction between two kinds of trade-off,

either of which could form the basis for the equity-efficiency trade-off.
It then discusses various possible interpretations of the term efficiency,

and their implications for the existence or otherwise of the trade-off.

There is a brief concluding section. Some of the arguments are a little

technical; where possible these have been relegated to an Appendix.

TYPES OF TRADE-OFF

The first point to be made is that there are two different kinds of phe-

nomenon to which the phrase "equity-efficiency trade-off" could refer.

The first concerns values; the second, what might be termed production.
The ideas underlying the value trade-off were, I believe, first laid

out systematically by Brian Barry. He argued that when evaluating social

outcomes, it was not necessary for rationality in that evaluation to assume
that attaining one objective should always dominate attaining another.
Rather, the "extent" to which one objective was attained could be traded
off, or substituted for, the extent to which another was attained. In the

equity-efficiency context (the example actually discussed by Barry) it

would be perfectly consistent with most notions of rationality for someone

to consider an allocation of resources that was highly efficient but grossly

inequitable as equally good (or equally bad) as one which was extremely

equitable but highly inefficient. "The fundamental idea ... is that although

3. The equity status of inequalities in life expectancy is discussed in J. Le Grand,

"Three Essays on Equity," Discussion Paper WSP/23 (ST/ICERD Welfare State Programme,
London School of Economics, 1987).

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556 Ethics April 1990

two principles need not be reducible to a single one, they may normally
be expected to be to some extent substitutable for one another. The
problem of someone making an evaluation can thus be regarded as the

problem of deciding what mixture of principles more or less implemented

out of all the mixtures which are available would be, in his own opinion,

best."S'
The idea that in making social evaluations people might be indifferent

between various combinations of objectives or principles, just as in making

their consumption decisions they might be indifferent between various

combinations of goods, seems eminently sensible. Moreover, it is a way

of resolving dilemmas concerning apparent inconsistencies in people's

moral decisions that have puzzled some thinkers.5 However, I do not

think that, when people refer to the equity-efficiency trade-off, it is genera

value-substitutability that they have in mind. It is more likely that they
are concerned with what might be termed "production-substitutability";
that is, with the ability of a welfare program or of other aspects of the
economic and social system to deliver different combinations of objectives.
The sort of questions involved here are not value ones but are more

empirical in nature; they concern the possibility or feasibility of alternatives.

Is it possible or feasible to allocate resources within the economy in a

way that is both "fully" equitable and "fully" efficient? If not, then what
are the various combinations of degrees of equity and efficiency that are
feasible? How much equity has to be sacrificed to obtain a given level of
efficiency or vice versa? These kinds of questions relate to the productive
capacities of different kinds of social and economic organization rather
than to the values of the person making an assessment of them.

4. B. Barry, Political Argument (London: Routledge & Kegan Paul, 1965), p. 6. As

Barry notes, any reference to the extent to which an objective can be attained clearly
contains within it the assumption that movement toward the objective can be measured

or quantified in some way. In making this assumption it is not intended necessarily to imply
that meaningful numbers can be constructed that represent, e.g., the level of efficiency or
equity that characterizes an economy (although even that is not as hopeless a task as it
might seem; indicators of both have been constructed). All that is necessary for this discussion
is that it is meaningful to say that one outcome is more equitable or more efficient than
another, a not unreasonable requirement.
5. Milton Friedman, e.g., gives two examples of the trade-off between equity and

liberty that he thinks provokes inconsistent reactions (Capitalism and Freedom [Chicago:

University of Chicago Press, 1962], p. 165). One is where three individuals are starving
and a fourth has food but refuses to give it to them; the other is where four people are
walking down the street and one finds a ten-dollar bill in the gutter and refuses to share
it with the others. Friedman thinks that a common judgment would be that the three

poorer individuals in the first case would be justified in overriding the liberty of the fourth
and forcing a more equitable distribution, but that they would not be justified in doing so
in the second case, a reaction that he would consider inconsistent. But all the examples

show is that people are prepared to trade off more liberty to promote equity if the initial
situation is already grossly unfair than if it is already broadly equitable, an outcome that
seems to be perfectly reasonable.

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Le Grand Equity versus Efficiency 557

The productive capacity of a society in terms of its abilit

a given set of objectives is perhaps a slightly novel idea and
some amplification. First, it should not be confused with a more conventional interpretation of the capacity of an economy in terms of the
physical resources available to produce material commodities: to produce
goods and services. Although undoubtedly constraints on physical resources
will affect a society's ability to achieve its objectives, they will not be the
only determinants of that ability. Other important determining factors
are likely to include the society's economic system-whether it is predominantly capitalist, collectivist, mixed, or whatever-and the psychological makeup of its inhabitants-whether they are individualistic or
cooperative, materialist or ascetic, and so on. For instance, the combinations

of equity and, say, economic growth attainable in a competitive market

economy full of individualistic materialists might be rather different from

those attainable in a cooperative economy run by and for ascetic altruists,

even if both had the same initial resources.
The distinction between the value and the production trade-off can

be illustrated in a simple diagram such as that in figure 1 below. Suppos

there are two objectives, I and II, movement toward each of which can

be measured by an index, XI and XI,. In figure 1, XI is measured alon

the vertical axis and XI, along the horizontal axis. The convex lines, w

XI

W3

w2
Wi

XII
FIG. 1

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558 Ethics April 1990

w2, and W3, are the indifference or welfare contours for the policymaker(s)

or whoever is making the evaluation. Each contour connects points corresponding to all the combinations of I and II (equity and liberty) between

which the policymakers are indifferent or, in other words, all the combinations that, in the relevant individuals' perception, yield the same
level of social welfare. Each contour thus corresponds to a particular
level of social welfare, the level increasing with movement outward from

the origin. The slope of each contour represents the trade-off in terms

of values between the two objectives, that is, how far society could move

away from one objective in order to obtain a given movement in the

direction of the other without causing a fall in social welfare. The convexity
of this slope represents the not unreasonable assumption that the closer
society is to the attainment of one objective, the more it will be prepared
to sacrifice in order to obtain a given movement in the direction of the
other.

The concave line in the diagram refers to the society's productive

capacity in terms of its objectives. It represents what might be termed

the "objective possibility frontier."6 All points on or within the frontier

are feasible, that is, they represent combinations of values of the two
indices that in principle could be attained by the society,,given its constraints.

Each point on the frontier shows for a given value of one index the
maximum value of the other that the society can "produce," given its
resources, economic system, individuals' psychologies, etc. The slope of

this line therefore represents the production trade-off: the amount of

one index that would have to be sacrificed in order to obtain a given
amount of the other. It is concave because it incorporates the assumption
that this amount will decrease, the higher the value of the index to be

sacrificed, a reasonable assumption in most cases but one that will not
necessarily be true in all circumstances.
Point B-at which the objective possibility frontier is tangent to the

welfare contour w2-represents the "best" combination of the two objectives

for the society concerned. For among all feasible combinations this is the
one that yields the highest possible level of welfare. At B the slope of
the objective possibility frontier is equal to the slope of the relevant
welfare contour (w2), so at this point (but at this point only) the tradeoffs are numerically equal.
It should be noted that this formulation is sufficiently general so as

to be able to capture not only conceptualizations in terms of broad objectives

such as equity or liberty but also the individualistic forms commonly
found in the welfare economics literature. Suppose the objectives of

society include the raising of each individual's utility. In that case the
relationship between values and social welfare can be expressed in the

6. In passing it might be noted that this terminology is doubly appropriate in that

the frontier is objective both in the sense that it is concerned with society's objectives but
also in the sense that it is not based on subjective assessments of value.

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Le Grand Equity versus Efficiency 559

standard Bergson-Samuelson formulation of a social welfare function

postulating social welfare as a general function of individual utilities. In

terms of figure 1, Xj (j = I, II) represents the jth individual's utili

contours are standard Bergson-Samuelson welfare contours, and the
objective possibility frontier is the utility possibility frontier. A utilitarian
social welfare function can, of course, be represented as a special case
of a Bergson-Samuelson function with straight, negatively sloped welfare
contours. Rawls's maximin or difference principle can also be represented
in a similar fashion, with each individual's utilities (or, more strictly, each
individual's amount of primary goods) as the Xs and with right-angled
welfare contours.

So there are two forms of trade-off that have to be distinguished:

the value trade-off and the production trade-off. They are distinct not
only conceptually but also in methods of establishing their existence and

magnitude. The magnitude of the value trade-off can only be established

by reference to personal or social values, that of the production tradeoff, in principle at least, by reference to empirical observation. At point
B the two will be equal, but equality does not imply identity.
EFFICIENCY: AN INTERPRETATION

The reader will have noted that, in my exposition of the diagram in

figure 1, I did not refer to efficiency as an example of the objectives

concerned. This was not because of a formalistic desire to remain within
the abstract confines of algebraic notation. Rather, it was because the

diagram suggests a definition of efficiency that seems a sensible interpretation of the meaning of the term but one that would not be compatible
with its being measured on the horizontal or vertical axes-or, more

generally, with its being an objective that can be traded off against another,
such as equity.

The definition is this: An allocation of resources is efficient if it is imposs

to move toward the attainment of one social objective without moving away

the attainment of another objective. In terms of the diagram this implies th

all points on the objective possibility frontier are efficient, whereas all
points inside the frontier are inefficient.7
The better to understand the definition, consider a point such as R

on figure 2. This represents a combination of the indices that is inside

the frontier; it is an inefficient combination because it is possible to
increase the value of one index without reducing the value of the other.

Thus it is possible to reallocate resources so as to move society to point

S, for example, increasing the value of XI while keeping XI, consta

to move to point T, increasing the value of XI, while keeping XI con
7. This definition presumes that there is more than one social objective to be considered.
If there is only one (as is arguable in the case, e.g., of utilitarianism) then the definition

of an efficient allocation of resources becomes simply that which moves as close as possible
to the attainment of the objective.

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560 Ethics April 1990

XI

XI I
FIG. 2

A movement to points on the frontier between S and T would increase

both XI and XI,. Points S and T and the points between them, o
other hand, represent efficient combinations of the two indices, for it is
impossible to move from any of those points to any other feasible combination without reducing the value of at least one of the indices.
If this interpretation of efficiency is indeed a plausible one, what is

the implication for the equity-efficiency trade-off? Simply that the notion

of a trade-off is meaningless. For acceptance of this interpretation implies

that efficiency can be defined only in relation to the ability of forms of
social and economic organization to attain their primary objectives and

that therefore efficiency cannot itself be one of those primary objectives.

In this sense, if equity is one of the objectives it is meaningless to talk
of a trade-off (either in value or production) between equity and efficiency.
Efficiency is not an objective in the sense that equity is an objective;
rather, it is a secondary objective that only acquires meaning with reference

to primary objectives such as equity.8

8. The argument that efficiency can only be defined in terms of wider objectives has
an apparent similarity to that made in R. Goodin and P. Wilenski, "Beyond Efficiency: The
Logical Underpinnings of Administrative Principles," Public Administration Review, November/

December (1984). However, their point is rather different. They argue that efficiency as
narrowly conceived by administrators (presumably, something like least resource cost)
cannot be justified except by reference to what they term a metaprinciple, such as want

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Le Grand Equity versus Efficiency 561

OTHER INTERPRETATIONS OF EFFICIENCY

What, then, do people generally mean when they are talking about the
trade-off between equity and efficiency? For the reasons explained, they

cannot be referring to a trade-off between equity and efficiency in the

sense of the latter outlined above, yet they clearly have some phenomenon
in mind. The explanation has to be that they are using the term efficiency

in some different way. One common interpretation is to identify efficiency

with growth in aggregate economic production; another is to identify it

with Pareto-optimality. Both create problems for the notion of the equityefficiency trade-off, as I now hope to show.
Efficiency as Economic Growth
The identification of efficiency with economic growth is widespread in

both popular and academic discourse on the economy. It is also often

asserted that the attainment of efficiency in the sense of economic growth
is incompatible with the attainment of equity and, hence, there is a trade-

off between the two. Examples of this abound; an influential one is

Arthur Okun's famous volume Equality and Efficiency: The Big

A similar interpretation underlies many of the debates concerning

the trade-off between efficiency and equity in the' context of social security.
A system of unemployment benefits that provides the unemployed with

a basic income and/or that imposes high marginal tax rates on earned
income may discourage people from seeking employment and, hence,
from increasing their work effort; and if hours of work are reduced, so

will be economic growth. A system of state pensions may reduce the

incentive of individuals to save to provide for their old age; unless this
is offset by an increased propensity of the state to save, then this will

result in smaller aggregate savings, smaller investment, and, hence, a

lower rate of economic growth.
This identification of efficiency with economic growth has an obvious

appeal; and undoubtedly any production trade-off between equity and

economic growth that may exist would have serious policy implications.
However, a single-minded concentration on growth does have its curious

aspects. Increasing economic production does not seem a sensible objective

on its own. Presumably, the only point of doing so is if the increase can
be put to use in some way, that is, if it can provide want satisfaction-

generate utility-for one or more individuals. The relevant objective then

satisfaction or respecting persons, and that at times pursuit of the metaprinciple may
require overriding the administrator's narrow conception of efficiency. For the latter is

simply one among many ways of satisfying the metaprinciple; others include equity, democracy, due process, etc. But this is saying that equity and (one particular interpretation

of) efficiency are objectives of similar status, which may have to be traded off against one
another; this is quite different from the argument here, which provides an interpretation

of efficiency in terms of the ability to attain any objective or set of objectives.

9. A. Okun, Equality and Efficiency: The Big Trade-off (Washington, D.C.: Brookings
Institution, 1975).

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562 Ethics April 1990

becomes one of increasing individuals' utilities, presumably aggregated

in some way.

Again, it is of obvious importance to establish, so far as possible, the

existence of any trade-off between equity and aggregate want satisfaction.

But there are complications. The exact method of aggregation has to be

established. Is it to be a form of utilitarianism, with individual utilities

being simply added together, or are they to be weighted in some way?
Can utilities be "added" in any reasonable fashion? These are standard
problems, but their very familiarity does not mean they can be ignored.
Moreover, there are other, less well-known, difficulties. For example,

if the reason for identifying efficiency with economic production and

thereby elevating it to the status of a primary objective is because increases
in production lead to increases in individuals' utilities, then the utility

costs of increased production should also be taken into account. Yet these
are frequently neglected. The argument concerning the impact of social
security on work effort, for example, often seems to ignore the possibility
that work itself can have costs-that it may create disutility. This may
have perverse consequences. In the Appendix an example is given of

the impact on an individual of a change in social security that reduces

benefits to the unemployed but also lowers marginal tax rates on earned
income. The result is an increase in the individual's work effort, an

increase in his or her money income, but a reduction in his or her

In short, the identification of efficiency with economic growth and,

hence, its elevation to the status of a primary objective, will indeed raise
important issues concerning possible trade-offs with equity. But economic
growth itself is far from unproblematic as an objective. Moreover, its

identification with efficiency robs the latter of the more general interpretation discussed in the previous section, an interpretation that concerns

the ability of society to achieve any or all of its objectives. In many ways,
it would seem preferable to divorce the idea of efficiency from that of

economic growth and to discuss the issue of any trade-offs between growth

and equity explicitly rather than obscuring the issue by reference to

efficiency.

Efficiency as Pareto-Optimality
Another common interpretation of efficiency, at least among economists,
is that of Pareto. Under this definition an allocation of resources is efficient
10. In fact, one suspects that much of the expressed concern over work incentives
stems not so much from worries over aggregate production but from a perception by

politicians and other policymakers of a general reluctance among taxpayers to subsidize

laziness-to give money apparently for nothing. In other words, a social security system
that appparently encourages people not to work is thought to reduce the utility of those

paying for it by more than if the payments did not apparently discourage work effort. In
that case the supposed trade-off between equity and efficiency becomes a trade-off between

increasing the utility of recipients and not reducing the utilities of taxpayers, a trade-off
that has meaning, indeed, but one that seems a little way from the rather grander notions
of equity versus efficiency.

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Le Grand Equity versus Efficiency 563

if it is impossible to make one individual better off without making a

worse off. An allocation of resources with this property is described as
Pareto-optimal or as Pareto-efficient. On this interpretation, an equityefficiency trade-off will exist if there is no feasible allocation that is simultaneously equitable (according to a chosen definition of equity) and
Pareto-optimal.

To establish the existence or otherwise of such allocations has been

a preoccupation of many economists. As an illustration of the at times
rather bizarre directions which this activity can take, it is worth digressing
briefly to consider the literature concerning the relationship between
Pareto-optimality and one particular definition of equity that has recently

attracted attention. This relates the existence of equity or inequity to th

existence or otherwise of envy. More precisely, it defines an allocation

of resources as equitable if no individual envies any other's position.

This conception of equity was first put forward explicitly by D. Foley,
although its origins lie in the much older conception of the "I cut; you
choose" method of equitably dividing a cake. It was developed by S. C.
Kolm and by H. Varian in the mid-1970s. Since then the literature has
expanded enormously, culminating in a book by William Baumol which
also provides a brief history of the development of the idea."
It might be thought that in promoting a new idea of equity the first
concern would be to establish its acceptability by, for instance, direct
reference to intuition or by using impartiality mechanisms such as a
Rawlsian social contract or the "undistorted rational discourse" of Haberm
or Ackerman.'2 But no. Varian, perhaps the most influential of the
writers concerned, provides little by way of moral arguments in support
of the conception; in the recent book by Baumol, the most sustained
treatment of the concept, less than two pages (out of 266) is given to a
discussion of the idea's philosophical underpinnings. Instead, the principa
concern of most of these writers is with the equity-efficiency trade-of
or, more precisely, with the trade-off between this conception of equi
and efficiency defined as Pareto-optimality. Batteries of intellectual artiller
are deployed to establish the conditions under which allocations exist
that are simultaneously equitable (under this definition) and Paretooptimal-allocations that, it should be noted, are termed by Varian "f
thus confusing fairness with Pareto-optimality and displaying a disr
for the English language that may be symptomatic of a lack of a ph
sophical base for the ideas.

1 1. D. Foley, "Resource Allocation and the Public Sector," Yale Economic Essays 7 (

45-98; S.-C. Kolm, Justice et Equitg (Paris: Editions du Centre National de la Reche
Scientifique, 1972); H. Varian, "Equity, Envy and Efficiency,"Journal of Economic The
(1974): 63-91; W. Baumol, Superfairness: Applications and Theory (Cambridge, Mass.:
Press, 1986).

12. J. Rawls, A Theory ofJustice (Cambridge, Mass.: Harvard University

J. Habermas, Legitimation Crisis (London: Heinemann, 1976); B. Ackerman,
in the Liberal State (New Haven, Conn.: Yale University Press, 1980).

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564 Ethics April 1990

A related feature of this literature is that if no "fair" allocations are

found to exist under certain realistic conditions, then the definition of
envy-freeness-indeed, of envy itself-is altered so as to ensure that
some do exist. For example, one of the early results established in the
literature was that in economies with production it may be impossible to
find allocations that were simultaneously envy-free and Pareto-optimal.
Accordingly, Varian proposed an alternative definition of envy, for which
such allocations do exist, namely, that envy does not exist (and, hence,
an allocation is equitable) if an individual, i, prefers his or her own
consumption and work effort to the consumption of any other individual,
j, and the work effort that i would have to make in order to produce as
much asj. In effect, this is saying that no one envies another's superior

abilities, a statement that seems factually incorrect as well as having little

apparent connection with intuitive or other interpretations of equity. In
fact, no moral argument is put forward to support it; the only justification
presented is that defining both envy and equity in these ways means that

"fair" (according to Varian's definition of the term) allocations exist.13

Nor is Varian alone in devising interesting but apparently ad hoc
notions of equity that will permit the existence of allocations that are
equitable and Pareto-optimal. Another example is the suggestion that
an allocation be defined as equitable if its distribution of utilities could

have been achieved by an equal division of any set of commodities. 1

Again the principal argument put forward to justify this definition is
that it permits "fair" (equitable and Pareto-optimal) allocations to exist.
Again, no moral justification is offered; indeed, it is hard to see what it
would have been.

The rationale for this emphasis on the importance of finding a

definition of equity such that feasible allocations exist which are simultaneously equitable and efficient is not immediately apparent. In a pluralistic
world, it seems quite plausible to suppose that there may be objectives
whose simultaneous achievement is impossible. Economists, in particular,
should be sympathetic to the possibility of trade-offs between objectives-in other contexts, after all, the trade-off is the hallmark of the
profession. There seems to be nothing intrinsic in the concept of equity
(or, indeed, of any other moral value) which requires that, for a particular
conception to be acceptable, feasible allocations must exist that are simultaneously equitable and Pareto-optimal; discovery of concepts with
this property, although doubtless a worthy endeavor in some respects,
does seem an essentially secondary task.

13. To be fair (in a more usual interpretation of the term), some other contributors
to the literature have expressed moral reservations about this conception of equity: e.g.,
E. Pazner, "Pitfalls in the Theory of Fairness,"Jowrnal of Economic Theory 14 (1977): 45866.

14. E. Pazner and D. Schmeidler, "Egalitarian-Equivalent Allocations: A New Concept

of Economic Equity," Quarterly Journal of Econtomics 92 (1978): 1-45.

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Le Grand Equity versus Efficiency 565

Moreover, there is another problem with this trade-off. This concerns

the nature of Pareto-optimality. Frequently offered as a definition of

efficiency, it is more correctly interpreted as a form of value or social

welfare function, one that, in certain forms, actually incorporates a notion

of equity-rather a curious one, as we shall see. This perhaps can be

best illustrated by reference to the literature concerning potential Pareto-

optimality or the Hicks-Kaldor compensation principle. There it is asserted

that there is an increase in welfare from a particular economic change
if the gainers from the change can compensate the losers and still remain
gainers. In the words of Sir John Hicks himself: "If A is made so much
better off by the change that he could compensate B for his loss, and

still have something left over, then the reorganisation is an unequivocal

improvement," a test that he goes on to describe as "perfectly objective

What this implies is that a potential Pareto-improvement always
constitutes an increase in welfare. One of the assumptions underlying
this is a welfarist one: that social welfare depends only on individuals'

utilities. In terms of figures 1 and 2, this implies that XI and X

to two individuals' utilities and that, therefore, the objective possibility
frontier is a utility possibility frontier. Yet, more seriously, it also implies

that all points along the utility possibility frontier are equally good in

terms of welfare. But this can only be true if the welfare contours have
the same shape as the utility possibility frontier-more specifically, if
one of the welfare contours incorporating the values implicit in the social
welfare function lies along the utility possibility frontier. In that case the

slope of the welfare contour must at all points be the same as the slope
of the utility possibility frontier. And that implies a particular, and to
many a rather unattractive, concept of equity, one in which a greater

value is placed on increases in the utility of the better off than on similar
increases for the worse off.
The formal proof of this last point is rather technical, and I have

relegated it to the Appendix. But an intuitive understanding may be

gleaned from the following example. Suppose there is a change of some
kind that benefits a rich person by an amount estimated as ten dollars

but also imposes a cost on a poor person of nine dollars. Clearly, the
rich person could fully compensate the poor person and remain a gainer.
So, according to the compensation principle, whether or not the compensation actually takes place there has been an increase in social welfare.
But now consider the utility changes involved. On the not unreasonable

assumption of diminishing marginal utility of income, if there is no

compensation it is likely that the reduction in utility for the poor person
due to the change is greater than the increase in utility for the rich
person. Therefore, the only way that there could be a net increase in

15. J. R. Hicks, "The Rehabilitation of Consumer Surplus," Review of Econom

8 (1940-41): 108- 16.

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566 Ethics April 1990

social welfare (in the absence of any actual compensation) is if the (smaller)
change in utility for the rich person is weighted in such a way that it
increases welfare more than the (larger) utility change for the poor person
reduces welfare. And this could only occur if the social welfare function

weights rich people more (values them more) than poor people.
All this is an illustration of the general point that Pareto-optimality
is perhaps better viewed as a specialized form of social welfare or value

function rather than as an objective or universal definition of efficiency.

In that case, investigations of the trade-offs between various interpretations
of equity and Pareto-optimality are not really concerned with the trade-

off between equity and efficiency at all. Instead they are investigating
what is, at least in part, actually a trade-off between two different kinds

of equity: that whose properties are being explored and that embodied
in the Pareto social welfare function.

CONCLUDING COMMENTS
This article has argued that the idea of an equity-efficiency trade-off is

an elusive one. There are three main points. First, there are two types
of trade-off to which the concept could refer: a value and a production
trade-off. In practice it is usually the latter that is of concern, but the
two must be kept distinct.
Second, at least according to one general definition of efficiency-

one that refers to society's ability to attain its primary objectives-the

notion of a trade-off between equity and efficiency literally does not make

sense, for trade-offs can only occur between these primary objectives, of
which efficiency is not one. Third, even if efficiency is interpreted in
such a way as to make it a primary objective, in terms of economic growth

or of Pareto-optimality, for instance, there are serious problems in teasing

out precisely what is being traded off against what (in either value or
production terms). Moreover, although establishing the existence or oth-

erwise of trade-offs between equity and these objectives is undoubtedly

important, the relevant discussions are often confused by their identification
with the broader notion of efficiency.
A final point. It is conventional in economics to treat efficiency, in

contrast to equity, as a concept that is relatively unproblematic. If I have

done nothing else in this article, I hope I have demonstrated that this
relative complacency is misplaced. The interpretation of efficiency is as
much a complex and value-laden business as the interpretation of equity,

a fact that complicates even more the interpretation of the trade-off

between them.
APPENDIX
1. The Impact of Changes in Social Security: An Example

In figure Al, an individual's money income, y, is plotted along the vertical axis

and his or her leisure, (, measured in hours, along the horizontal axis. It is
assumed the individual can freely divide his or her hours between leisure and

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Le Grand Equity versus Efficiency 567

Y

By~~~~~~~~~

I~~~

--

FIG. Al

work. A social security system of the social dividend/negative income tax type is
in operation, giving each individual a basic income whether or not he or she is

working, and taxing all earned income. The individual's only sources of income
are earnings and social security.
Initially, the individual's after-tax-and-transfer budget constraint is given by

ABC, where BC is the amount of the basic income. The individual is in equilibrium
at point E 1 on indifference curve u 1. A change in the system is then introduced
that reduces the basic income to DC and reduces the marginal tax rate, thus

swiveling up the angled section of the budget line. The new budget line is now

FDC; the new equilibrium E2 on indifference curve u2, with higher money income,
less leisure (hence, more work), and lower utility.

2. The Social Welfare Function Implicit in the Compensation Principle

Suppose there are two individuals with utility functions uI and u2 defined o
money incomes y 1 and Y2 Suppose there is only a fixed amount of total inc
Y = Y + Y2; then the utility possibility frontier is:

y = f(U1, U2).
Differentiating this totally gives:

dy = aflau1 du1 + af/au2 * du2.

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568 Ethics April 1990

Along the frontier, dy = 0. Therefore, the slope of the frontier (-du 1/du2) is
af/8u2
8f/8U1-

From the inverse function rule:

al/87 ly and u2/8y = fl

af/au ~ af/aU 2

Therefore,
du1 _ au/lay

du2 a u2/aY

Thus, the slope of the utility possibility frontier (-du2/du I) equals the ratio o
the marginal utilities of income for the two individuals.
The Paretian social welfare function is a form of the general Bergson-Sam-

uelson function, W = W(uI, u2). Differentiating this totally gives:

dW = MWu1 du, + 3W/au2 dU2.

Along each welfare contour, d W = 0. Therefore, the slope of the contour (-du 1/

du2) is given by aW/U If the utility possibility frontier lies along a welfare
contour, as is required if all potential Pareto improvements are to constitute
improvements in welfare, as in turn is required by the compensation principle,
the slopes must be the same. Hence,

aW/du2 du l/dy

aWIu1 au2laY
Thus, the welfare weight attached in the social welfare function to a change in

a given individual's utility varies inversely with that individual's marginal utility
of income. If there is diminishing marginal utility of income, then this implies
that the higher an individual's income, the higher the welfare weight. In other
words, the social welfare function implicit in the compensation principle favors
the better off."6

16. This argument is developed in more detail (with a more general proof) in J. Le

Grand, "Optimal Taxation, the Compensation Principle and the Measurement of Changes

in Economic Welfare," Journal of Public Economics 24 (1984): 241-47. See also H. Varian,
Microeconomic Analysis, 2d ed. (New York: Norton, 1984), p. 208.

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