An Economic Theory of Differential Treatment

Abstract: When are differential treatment policies—such as preferential treatment in school choice, affirmative action in university admissions, and gender equity policies in labor markets and in promotions within organizations—justified by efficiency concerns? This paper proposes an assignment model of differential treatment, where a policymaker assigns agents to different treatments or positions in order to maximize total surplus, based on the agents’ characteristics and on noisy information about their types (i.e. abilities or productivities). I provide necessary and sufficient conditions on the agents’ signaling structures which characterize whether surplus maximization requires differential treatment or not, in a general non-parametric information framework. I show that under reasonable conditions the optimal assignment policy is characterized by an index which measures the agents’ expected marginal benefits from different treatments, and also examine further conditions on the bias and informativeness of signaling structures that determine the efficiency implications of differential treatment. I examine applications of this model to inequality, decentralization, and organizational design. The model also provides novel questions and predictions for empirical research on the economics of discrimination.