Positive Limitations on the Scope of Redistribution in Market-Oriented Economies

Abstract

This paper aims to study the following positive question: If some of the central features of a market-oriented economy are explicitly taken into account, then what is the extent to which government policy can or can not reduce economic inequalities in such an economy?

It is shown that several qualitative observations about the scope of redistribution can be made based almost entirely on the government budget constraint. We examine the role of bureaucratic and administrative costs in inhibiting redistribution: bureaucratic inefficiencies not only reduce the scope of redistribution but, because of these costs, no redistribution is possible under a range on policies. Also, the presence of alternative transactions (that is, semi-legal or illegal transactions induced by government policies) is likely to reduce the scope of the redistribution. These and other similar observations apply to a wide range of policies (they do not depend, for instance, on the shape of various tax or subsidy schedules).

For restricted policy environments (where, because of bureaucratic and informational costs, only limited types of instruments are feasible), the paper illustrates how explicit assessment of the scope of redistribution can be made. Under plausible assumptions, it turns out that the scope of redistribution is quite limited in such environments.

The economic issues which our analysis raises have potential implications for several important controversies (including the debate on the virtues of market versus socialist economies). Some of these implications are discussed in the paper.