Does Redistribution Increase Output? The Centrality of Labor Supply

By Karthik Athreya, Andrew Owens and Felipe Schwartzman

http://d.repec.org/n?u=RePEc:fip:fedrwp:14-04&r=dge

The aftermath of the recent recession has seen numerous calls to use transfers to poorer households as a means to enhance aggregate activity. We show that the key to understanding the direction and size of such interventions lies in labor supply decisions. We study the aggregate impact of short-term redistributive economic policy in a standard incomplete-markets model. We characterize analytically conditions under which redistribution leads to an increase or decrease in effective hours worked, and hence, output. We then show that under the parameterization that matches the wealth distribution in the U.S. economy (Castaneda et al., 2003), wealth redistribution leads to a boom in consumption, but not in output.

While all the discussion about Thomas Piketty’s new book about redistribution of wealth focuses on the long term, this one is about redistribution of wealth in the short term. The result that one can increase consumption while output decreases is interesting. It highlights that the obsession about GDP is misplaced. But to some extend so is the focus on consumption. What really matters is how this redistribution improves (or not) well-being, a measure the model used in this paper can and should provide for each quintile. The paper shows what proportion of households is better off, yet something like consumption equivalence would be more convincing.