Cutting the pie fairly makes it bigger

The size of the pie is independent of how you cut it up. This is a central claim in economic theory: markets allocate resources efficiently, no matter how wealth is distributed. Of course you need some assumptions to obtain the market efficiency result (perfect competition, no externalities, etc.) These deviations from the ideal, or market failure, for a long time lay in the dark underbelly of economics.

Equity however is a widely accepted dimension of development. Many underdeveloped countries are characterized by gross inequities, which goads the state to undertake redistribution. The old conventional wisdom saw a trade-off between enforcing equity and achieving efficiency. After all, markets are efficient (regardless of wealth distribution), while redistributive measures would create distortions. For example, income taxes to finance income transfers to the poor would be a disincentive to supply labor. Subsidies on goods patronized by the poor would either weigh the economy down with onerous taxes, or else penalize investment through government borrowings. Another source of investment disincentive would be expropriation of the assets of the rich in favor of the poor.

Now the conventional wisdom appears to be moving the other way: inequality is thought to be associated with various inefficiencies. The latest World Development Report ("Equity and Development") provides plenty of evidence for this emerging view (hat tip: Pablo Halkyard of PSDBlog.) See especially chapters 5 and 6. Hence, equity is not just a dimension of development in its own right; correcting it would improve the allocation of resources. Cutting up the pie fairly makes it bigger.

After decades of research, complementaries between equity and efficiency are now front and center of development economics. For example, it's widely held that capital markets are afflicted with "asymmetric information", i.e. the creditor doesn't have the same information about investment risk that a borrower has. So they typically require collateral; this obviously works against the poor, who need the loans to undertake productive investments in themselves (e.g. education) or their enterprises.

This doesn't mean markets should be dispensed with, or that any redistributive measure will do. The equity-efficiency trade-off still holds if the wrong redistribution policies are implemented. Crafting the right set of policies and institutions to simultaneously improve equity and efficiency is the big challenge of economic development.