1.2 Efficiency and Social Justice

Transcription

1 1.2 Efficiency and Social Justice Pareto Efficiency and Compensation As a measure of efficiency, we used net social benefit W = B C As an alternative, we could have used the notion of a Pareto efficient outcome, after Vilfredo Pareto ( ) Pareto efficiency in production occurs when a given quantity Q is provided using the least resources Pareto efficiency in consumption is achieved when an allocation of goods or income across people cannot be changed to make someone better off without making someone else worse off Pareto efficiency in the market occurs when an efficiently produced quantity Q is also the quantity demanded by consumers Pareto efficiency thus means the absence of waste Apart from the exceptions mentioned, decisions to buy and sell in competitive markets are generally Pareto efficient We saw earlier that, if we redistributed outputs across producers (relative to the competitive outcome), we would be raising total cost This means that the vector of quantities q s arising from the free choice of producers manages to provide Q at the least possible cost It is thus a Pareto efficient outcome On the consumption side, consumers cannot be worse off from a voluntary decision to purchase goods They are necessarily doing the best for themselves and cannot be hurt by the free choice to participate in the market Redistribution of wealth (and thus of the consumption bundle) would hurt those who give income and benefit those who receive Again, the market outcome of free consumer choices is Pareto efficient

2 Efficiency can also be defined in terms of change: Change is Pareto efficient if someone gains and no one loses Using the concept of change, we can also redefine the concept of Paretoefficient outcomes: An outcome is Pareto efficient when Pareto improving changes cannot take place That is, it is not possible to make someone better off without making someoneelseworseoff Cost-Benefit Analysis Decisions by the government require investigation to determine whether or not its consequences are Pareto improving No one person may be willing to build a free access road Beneficiaries of the road can ask the government to levy taxes and build it However, with efficiency as a social objective, it must be determined whether any given policy is justified as efficient public spending In the case of the new road, for example, the decision of whether or not to build it is made by applying cost-benefit analysis The cost-benefit criterion is that change is justified as efficient if W = B C >0

3 The cost-benefit criterion does not necessarily seek maximal efficiency by finding the precise public spending that maximizes W = B C To decide on whether a proposal is justified, B and C are computed to determine whether W >0 In evaluating W, the government requires information In the case of the road, benefits include the reduction in travel time and knowledge of the value of time of the different users of the road Another potential gain from the road is that of having fewer injuries taking place due to the reduction in accidents The road also brings environmental costs in terms of a reduction of biodiversity, which also need to be computed The road is also a public good because of simultaneous use by many Markets do not exist to reveal these benefits and costs (they are externalities associated with the proposed road) Cost-benefit analysis is the procedure whereby governments indirectly seek to compute costs and benefits that are not revealed in markets where markets do not exist because of externalities and public goods

4 Compensation and Pareto Improvement While generally the decisions of private individuals to participate in the market are Pareto efficient, the same need not be true of public decisions It could be that a given public decision still raises net social benefit, W = B C >0, but does not benefit everybody For example, a road that benefits many people might go through someone s house This measure building the road will not be Pareto efficient change if the owners of the house are worse off overall (they might benefit from the road as well but not by enough to compensate for the loss of the house) If total benefit from building the road exceeds total cost ( W >0), those who gain from the policy gain more than the losers lose The gainers from the policy could compensate the losers and everyone wouldbebetteroff The policy would then be a Pareto improving change Compensation and Social Justice > 0) therefore allows in principle for Pareto- Efficient policies ( W improving change The possibility of compensation follows from the definition of efficiency: If a new policy (with associated W = B C) isefficient W >0 gainers can compensate losers and still win Though efficient change allows, in principle, for Pareto-improving change as well by compensation to the losers a different question concerns social justice: Does social justice require that actual compensation take place?

5 Actual compensation might only be possible in principle and not in practice In the case of the road construction, it might be easy to identify those who lose their homes But in many other cases, the identification of the losers and of the loss to compensate for is very difficult or impossible For example, the introduction of new technologies e.g. personal computer replacing typists would have made it very difficult to identify gainers and losers Additionally, it would have been needed to identify how much each gainer gained and how much each loser lost It would have been necessary to create an administrative office to administer the compensation... This example shows that the administrative and information costs of making compensation payments might be too high to make compensation feasible Somewhere down the list of losers, society might decide to draw a line and stop compensation payments This might occur at the very beginning of the list, with no compensation given at all

6 Note that compensation is not designed to ensure efficiency If the policy satisfies W >0, it will be efficient: The gains will outweigh the costs Compensation might be required in the cases that some people are net losers from the policy while others are net gainers In such as case, compensation is motivated by the desire of social justice If it is not possible to compensate the losers (it could be too costly), society faces a trade-off between efficiency and social justice Compensation of the losers is socially just But too costly on efficiency grounds However, there is a cost in requiring that only Pareto efficient change be implemented Efficiency is blocked when compensation is not feasible and this results in the policy not being undertaken We have a dilemma between efficiency and social justice A society that emphasizes efficiency might choose to adopt the general rule that public policies are justified whenever W >0 Such a society does not investigate how benefits B and costs are distributed among the population The principle might be that, over time, all will come to benefit evenif some initially lose

7 1.2.1 Are Competitive Markets Socially Just? We have seen that competitive and free markets deliver efficient outcomes Are these outcomes socially just? Socialjusticeismoredifficult to define than efficiency We will next consider several sides of social justice and examine whether theoutcomesoffreeandcompetitivemarketsaresociallyjustineach case Social Justice as the Natural Right of Possession One definition of social justice says that an outcome is socially just if the natural right of possession is honored According to English political economist John Stuart Mill ( ), The institution of property [...] consists in the recognition, in each person, of a right to the exclusive disposal of what he or she have produced by their own exertions, or received either by gift or by fair agreement, without force or fraud, from those who produced it. Based on the natural right of possession, it is socially just that individuals be rewarded according to the value of their personal productive contributions This is what competitive markets do

8 Competitive markets provide income to individuals in accordance with their contribution to production To see this, consider the problem of a firm hiring labor L The firm chooses L in order to maximize profits π: π = PQ(L) wl, where P is output price, w the wage rate, L the labor input and Q (L) the firm s output, which depends positively on L Optimal choice of labor satisfies: PQ 0 (L) =w or the equality between the value of labor s marginal product (or contribution to production) and the wage rate Thus, individual workers will receive as wage the value of their contribution to production Personal incomes earned in competitive markets are consistent with social justice if we make the judgement that people should be rewarded according to the value of their personal contributions to output If we make this judgement, then a competitive market is both efficient and socially just Personal reward according to one s contributions to production leaves incapacitated people with no income, however... Moreover, people may object to this reward criterion since innate ability is random and a factor of luck at birth Further, luck also determines whether or not individuals received a lot of support and encouragement to study from their families (and raise their human capital) Some people may consequently regard the inequality arising from a competitive market as unjust and view social justice as requiring equality

9 1.2.2 Social Justice as Equality Equality can be of two types: 1. Ex-ante equality requires equal opportunities for everyone expressed as equal chances for improvement later in life 2. Ex-post equality requires that everyone end up equally Ex-ante equality requires that there be no privileged beginnings in life But how could that be? If privileges include having high intelligence, patience to study, motivation, help from loving parents... Governments may seek to provide ex-ante equality through equal access to education and health But children and their motivation to pursue education are already very different at early ages (before kindergarten) The objective of sharing to attain ex-post equality appears very deeply rooted in humans People shared food in early hunter-gatherer groups for failing to share resulted in starvation and even death In general, ex-post equality is inconsistent with Pareto improvement, as in the following example Three people each have incomes CHF 1000 After the government spends CHF 600 on education with a tax of CHF 200 paid by each person, the incomes increase but unequally The new incomes are CHF 1400, 1600 and 2000, respectively

10 In this example, B = CHF 2000, C = CHF 600, B C = CHF 1400 > 0 The policy is efficient and even Pareto-improving change: all are better off, nooneworseoff Yet, the policy would have meant departing from the initial conditions of ex-post equality In general, insisting on ex-post equality prevents Pareto-improving change The Choice Between Efficiency and Equality ThechoicebetweenParetoefficiency and equality is illustrated by the story of two travellers in the desert who have water enough for only one of them to survive Sharing the water in any way results in an equal outcome which is also the death of both travellers... If the person in charge of the water keeps it all, the outcome is a Pareto improvement compared to any form of sharing: one person alive is better than none

11 This question is discussed in the Talmud, a central text of mainstream Judaism, where two opinions are given A commentator named Ben-Petura proposed that the water be shared because it is better that both should drink and die than that one should witness the death of his fellow This is the notion of ex-post equality through sharing Another, R. Akiva, proposed that your life takes precedent over your fellow s life, and so, if the water can save only one, you are obliged to save yourself This suggestion reflects Pareto efficiency Efficiency and Ex-ante Equality A lottery could assign ownership of the water with equal probability to both travellers and provide social justice in the form of ex-ante equality After the lottery s draw, one person owns all the water and the outcome is Pareto efficient The lottery presupposes that neither person owns the water If someone owned the water, the lottery would contradict the natural right of possession A lottery is thus a socially just way of providing ex-ante equality only if there is no pre-identified owner of the water

12 The Popular Bias Against Efficiency Judgements about whether an outcome is socially just require a definition of social justice The choice of ex-post equality requires in turn the acceptance of the efficiency losses that equality generally entails When confronted with the need to choose between the alternatives of efficiency and ex-post equality, people often reject allocation through markets Forexample,afterasnowstorm,peoplewereaskedwhetherornotthe market price of snow shovels should rise to equate demand with the limited supply Most people viewed the market allocation as unjust Evidence from experiments shows that economists tend to favor the market and efficiency more than the public The public tends to favor fair allocations in the sense of ex-post equality Economists seem to believe that people who work hard to achieve personal advancement should benefit from their efforts And, likewise, that if someone values something more than others, s/he should be allowed to pay more and obtain what they value At any rate, ex-post equality was a decisive survival practice in human evolution and this might explain why notions of social justice are centered on it

13 Efficiency, Equality and Social Justice As a summary of our conclusions regarding efficiency, equality and social justice, we have that: When social justice is defined as ex-post equality, Pareto efficiency is generally inconsistent with social justice However, efficiency and social justice are consistent objectives when social justice is defined as ex-ante equality or as the natural right of possession